Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended February 28, 2007
o | 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 000-20562
COREL CORPORATION
(Exact name of registrant as specified in its charter)
Canada (State or other jurisdiction of incorporation or organization) | 98-0407194 (I.R.S. Employer Identification No.) |
1600 Carling Avenue, Ottawa, Ontario (Address of principal executive office) | K1Z 8R7 (Zip Code) |
Registrant’s telephone number, including area code:
(613) 728-0826
(613) 728-0826
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero Accelerated filero Non-accelerated filerþ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
The number of shares outstanding of the registrant’s common stock as of March 31, 2007 was 24,851,193.
TABLE OF CONTENTS
Table of Contents
COREL CORPORATION
Form 10-Q
For the Quarter Ended February 28, 2007
INDEX
Page | ||||
PART I FINANCIAL INFORMATION | ||||
Item 1. | Unaudited Consolidated Financial Statements | |||
a) Balance Sheets as of February 28, 2007 and November 30, 2006 | ||||
b) Statements of Operations for the Three Months Ended February 28, 2007 and 2006 | ||||
c) Statements of Cash Flows for the Three Months Ended February 28, 2007 and 2006 | ||||
d) Notes to Financial Statements | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | |||
Item 4. | Controls and Procedures | |||
PART II OTHER INFORMATION | ||||
Item 1. | Legal Proceedings | |||
Item 1A. | Risk Factors | |||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | |||
Item 6. | Exhibits | |||
Signature |
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1.Unaudited Consolidated Financial Statements
Corel Corporation
Consolidated Balance Sheets
(In thousands of U.S. dollars or shares)
(Unaudited)
Consolidated Balance Sheets
(In thousands of U.S. dollars or shares)
(Unaudited)
February 28 | November 30 | |||||||||||
Note | 2007 | 2006 | ||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 40,906 | $ | 51,030 | ||||||||
Restricted cash | 717 | 717 | ||||||||||
Accounts receivable | ||||||||||||
Trade, net | 15,650 | 18,150 | ||||||||||
Other | 1,233 | 808 | ||||||||||
Inventory | 3 | 1,893 | 914 | |||||||||
Prepaids and other current assets | 4,975 | 2,300 | ||||||||||
Total current assets | 65,374 | 73,919 | ||||||||||
Investments | 203 | 203 | ||||||||||
Capital assets | 6,145 | 3,651 | ||||||||||
Intangible assets | 4 | 110,666 | 37,831 | |||||||||
Goodwill | 4 | 82,488 | 9,850 | |||||||||
Deferred financing and other long-term assets | 6 | 5,938 | 5,232 | |||||||||
Total assets | $ | 270,814 | $ | 130,686 | ||||||||
Liabilities and shareholders’ deficit | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable and accrued liabilities | $ | 62,858 | $ | 28,220 | ||||||||
Due to related parties | — | 167 | ||||||||||
Operating line of credit | 6 | 23,000 | — | |||||||||
Income taxes payable | 5 | 2,411 | 235 | |||||||||
Deferred revenue | 11,806 | 12,719 | ||||||||||
Current portion of long term debt | 6 | 2,637 | 1,426 | |||||||||
Deferred income tax liability | 4,972 | — | ||||||||||
Total current liabilities | 107,684 | 42,767 | ||||||||||
Deferred revenue | 1,748 | 2,015 | ||||||||||
Deferred income tax liability | 4,5 | 14,830 | — | |||||||||
Income taxes payable | 9,875 | 8,488 | ||||||||||
Long term debt | 6 | 157,331 | 89,223 | |||||||||
Total liabilities | 291,468 | 142,493 | ||||||||||
Commitments and contingencies | 7 | |||||||||||
Shareholders’ deficit | ||||||||||||
Share capital: | ||||||||||||
Common Shares (par value: none; authorized: unlimited; issued and outstanding: 24,714 and 24,535 shares, respectively) | 32,828 | 30,722 | ||||||||||
Additional paid-in capital | 4 | 5,535 | 4,612 | |||||||||
Accumulated other comprehensive loss | (46 | ) | (46 | ) | ||||||||
Deficit | (58,971 | ) | (47,095 | ) | ||||||||
Total shareholders’ deficit | (20,654 | ) | (11,807 | ) | ||||||||
Total liabilities and shareholders’ deficit | $ | 270,814 | $ | 130,686 | ||||||||
See Accompanying Notes to the Consolidated Financial Statements
Table of Contents
Consolidated Statements of Operations
(In thousands of U.S. dollars or shares, except per share data)
(Unaudited)
(In thousands of U.S. dollars or shares, except per share data)
(Unaudited)
Three months ended February 28 | ||||||||||||||||
Note | 2007 | 2006 | ||||||||||||||
Revenues | ||||||||||||||||
Product | $ | 47,304 | $ | 39,498 | ||||||||||||
Maintenance and services | 5,330 | 4,789 | ||||||||||||||
Total revenues | 52,634 | 44,287 | ||||||||||||||
Cost of revenues | ||||||||||||||||
Cost of product | 8,487 | 5,005 | ||||||||||||||
Cost of maintenance and services | 198 | 314 | ||||||||||||||
Amortization of intangible assets | 5,757 | 6,627 | ||||||||||||||
Total cost of revenues | 14,442 | 11,946 | ||||||||||||||
Gross margin | 38,192 | 32,341 | ||||||||||||||
Operating expenses | ||||||||||||||||
Sales and marketing | 17,104 | 14,504 | ||||||||||||||
Research and development | 11,344 | 6,181 | ||||||||||||||
General and administration | 9,095 | 5,395 | ||||||||||||||
Acquired in-process research and development | 7,831 | — | ||||||||||||||
InterVideo integration expense | 4 | 785 | — | |||||||||||||
Restructuring | 9 | — | 560 | |||||||||||||
Total operating expenses | 46,159 | 26,640 | ||||||||||||||
Income (loss) from operations | (7,967 | ) | 5,701 | |||||||||||||
Other expenses (income) | ||||||||||||||||
Interest expense, net | 3,921 | 3,863 | ||||||||||||||
Amortization of deferred financing fees | 265 | 444 | ||||||||||||||
Other non-operating income | (632 | ) | (120 | ) | ||||||||||||
Income (loss) before income taxes | (11,521 | ) | 1,514 | |||||||||||||
Income tax provision | 5 | 355 | 3,152 | |||||||||||||
Net loss | $ | (11,876 | ) | $ | (1,638 | ) | ||||||||||
Other comprehensive loss | ||||||||||||||||
Unrealized losses on securities, net of taxes | — | (48 | ) | |||||||||||||
Other comprehensive loss, net of taxes | — | (48 | ) | |||||||||||||
Comprehensive loss | $ | (11,876 | ) | $ | (1,686 | ) | ||||||||||
Net loss per share: | ||||||||||||||||
Basic | $ | (0.48 | ) | $ | (0.08 | ) | ||||||||||
Fully diluted | $ | (0.48 | ) | $ | (0.08 | ) | ||||||||||
Weighted average number of shares: | ||||||||||||||||
Basic | 24,627 | 19,490 | ||||||||||||||
Fully diluted | 10 | 24,627 | 19,490 |
See Accompanying Notes to the Consolidated Financial Statements
Table of Contents
COREL CORPORATION
Consolidated Statement of Cash Flows
(in thousands of U.S. dollars)
(Unaudited)
(in thousands of U.S. dollars)
(Unaudited)
Three Months Ended February 28, | ||||||||||||
Note | 2007 | 2006 | ||||||||||
Cash flow from operating activities | ||||||||||||
Net loss | $ | (11,876 | ) | $ | (1,638 | ) | ||||||
Depreciation and amortization | 702 | 399 | ||||||||||
Amortization of deferred financing fees | 265 | 444 | ||||||||||
Amortization of intangible assets | 5,757 | 6,627 | ||||||||||
Stock-based compensation | 1,008 | 852 | ||||||||||
Provision for bad debts | 16 | 122 | ||||||||||
Deferred income taxes | (1,035 | ) | 435 | |||||||||
Acquired in-process research and development | 7,831 | — | ||||||||||
Unrealized loss on forward exchange contracts | 35 | 28 | ||||||||||
Gain on interest rate swap recorded at fair value | (191 | ) | — | |||||||||
Change in operating assets and liabilities | 11 | 15,928 | (1,343 | ) | ||||||||
Cash flow provided by operating activities | 18,440 | 5,926 | ||||||||||
Cash flow from financing activities | ||||||||||||
Proceeds from operating line of credit | 6 | 23,000 | — | |||||||||
Proceeds from long term debt | 6 | 70,000 | — | |||||||||
Repayments of long term debt | 6 | (681 | ) | (9,294 | ) | |||||||
Proceeds from exercise of stock options | 1,302 | — | ||||||||||
Financing fees incurred | 6 | (1,672 | ) | (1,763 | ) | |||||||
Other financing activities | — | 50 | ||||||||||
Cash flow provided by (used in) financing activities | 91,949 | (11,007 | ) | |||||||||
Cash flow from investing activities | ||||||||||||
Purchase of InterVideo Inc, net of cash acquired | 4 | (120,368 | ) | — | ||||||||
Purchase of long lived assets | (110 | ) | (430 | ) | ||||||||
Cash flow used in investing activities | (120,478 | ) | (430 | ) | ||||||||
Effect of exchange rate changes on cash and cash equivalents | (35 | ) | (37 | ) | ||||||||
Decrease in cash and cash equivalents | (10,124 | ) | (5,548 | ) | ||||||||
Cash and cash equivalents, beginning of period | 51,030 | 20,746 | ||||||||||
Cash and cash equivalents, end of period | $ | 40,906 | $ | 15,198 | ||||||||
See Accompanying Notes to the Consolidated Financial Statements
Table of Contents
Corel Corporation
Notes to the Consolidated Financial Statements
(All amounts in thousands of U.S. dollars, unless otherwise stated)
(Unaudited)
(All amounts in thousands of U.S. dollars, unless otherwise stated)
(Unaudited)
1. Unaudited Interim Financial Information
The interim financial information is unaudited and includes all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of our financial position at such dates and our results of operations and cash flows for the periods then ended in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated balance sheet as of November 30, 2006 was derived from the audited consolidated financial statements at that date, but, in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”), does not include all of the information and notes required by U.S. GAAP for complete financial statements. Operating results for the three months ended February 28, 2007 are not necessarily indicative of results that may be expected for the entire fiscal year. The financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-Q, and in conjunction with Management’s Discussion and Analysis and the financial statements and notes thereto included in the Company’s Form 10-K for the period ending November 30, 2006 (File No. 000-20562).
2. Summary of Significant Accounting Policies
Basis of presentation
The consolidated financial statements have been presented in United States (US) dollars.
On December 12, 2006, Corel completed the acquisition of InterVideo, Inc, which had a majority interest in Ulead Inc. (“InterVideo”). Since December 12, 2006 the results of InterVideo have been included in our results of operations. See Note 4 for details of the acquisition and pro forma results of operations of Corel and InterVideo for the three months ended February 28, 2006.
The purchase price allocation associated with this acquisition is still preliminary as some amounts are dependent upon future actions. These include restructuring costs have been estimated and approved but have not yet been completed. There are contingencies related to certain legal proceedings that InterVideo was involved with in the normal course of business that have not yet been settled. The valuation of identified definite lived intangible assets has not yet been finalized. Finally, estimates have been made for certain provisions related to working capital for which final amounts are dependant upon actual actions taken by the Company’s business partners which that could impact the value of certain acquired assets and liabilities assumed. Any difference in the final amounts related to the above estimates could result in a change in the final purchase price allocation.
Defined employee benefit plans
The Company maintains a defined benefit pension plan in certain jurisdictions for which current service costs are charged to operations as they accrue based on services rendered by employees during the year. Pension benefit obligations are determined by independent actuaries using management’s best estimate assumptions, with accrued benefits prorated on service.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board released FIN 48,Accounting for Uncertainty in Income Taxes — An Interpretation ofFASB Statement 109 (“FIN 48”) and is effective for annual periods beginning on or after December 15, 2006, which is the year ending November 30, 2008 for the Company. FIN 48 provides a comprehensive accounting model and prescriptive disclosure requirements related to income tax uncertainties. The Company is currently assessing the impact the adoption of this pronouncement will have on the financial statements.
In September 2006, the Financial Accounting Standards Board released FASB 157,“Fair Value Measurements”and is effective for fiscal years beginning after November 15, 2007, which is the year ending November 30, 2008 for the Company. FASB 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The Company is currently assessing the impact the adoption of this pronouncement will have on the financial statements.
In February 2007, the Financial Accounting Standards Board released FASB 159,“The Fair Value Option for Financial Assets and Financial Liabilities”and is effective for fiscal years beginning
Table of Contents
after November 15, 2007, which is the year ending November 30, 2008 for the Company. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company is currently assessing the impact the adoption of this pronouncement will have on the financial statements.
3. Inventory
The components of inventory are as follows:
February | November | |||||||
28, 2007 | 30, 2006 | |||||||
Product components | $ | 463 | $ | 444 | ||||
Finished goods | 1,430 | 470 | ||||||
Inventory | $ | 1,893 | $ | 914 | ||||
4. Acquisition of InterVideo
On December 12, 2006, Corel completed the acquisition of 100% of the voting equity interest of InterVideo, a provider of digital media authoring and video playback software with a focus on high-definition and DVD technologies, in an all cash transaction of approximately $198.6 million. In 2005, InterVideo acquired a majority interest in Ulead, a leading developer of video imaging and DVD authoring software for desktop, server, mobile and Internet platforms. As part of the Company’s acquisition of InterVideo, the remaining voting equity interest in Ulead was acquired by the Company on December 28, 2006 in an all cash transaction of approximately $21.7 million.
The acquisition expanded the Company’s presence in the digital media software market by increasing its portfolio of digital media and DVD video products. With the addition of InterVideo, Corel will extend its presence in Asian markets, such as China, Taiwan and Japan.
The acquisition of InterVideo was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards No. 141 (“SFAS 141”) “Business Combinations”. Assets acquired and liabilities assumed were recorded at their estimated fair values as of December 12, 2006, and the results of InterVideo have been included in the Company’s consolidated operations from that date.
Purchase Price
The preliminary total purchase price of the acquisition is as follows:
Cash consideration – InterVideo acquisition | $ | 198,624 | ||
Cash consideration – acquisition of remaining interest in Ulead | 21,731 | |||
Fair value of stock options assumed | 3,503 | |||
Deferred stock-based compensation | (2,784 | ) | ||
Estimated direct transaction costs | 2,837 | |||
Estimated restructuring costs | 3,869 | |||
Total preliminary purchase price | $ | 227,780 | ||
Fair value of stock options assumed
Under the terms of the acquisition agreement, each InterVideo stock option that was outstanding and unexercised at the date of acquisition are, once vested, exercisable for Corel Common Shares at a ratio of 1 to 0.918 which was determined by the relative market value of Corel and InterVideo common shares at the date of closing.
Table of Contents
These options have a per share exercise price equal to the original exercise price of InterVideo options divided by the Option Exchange Ratio. There were InterVideo stock options outstanding at December 12, 2006 which, if exercised, would yield 1,700,717 Corel common shares. The estimated fair value of these outstanding options was $3.5 million as determined using the Black Scholes option pricing model (“Black Scholes model”) with the following assumptions:
Expected option life (years) | 3 to 7 | |
Volatility | 16.1% to 36.1% | |
Risk free interest rate | 4.77% to 4.80% | |
Forfeiture rate | 36.79% to 45.11% | |
Dividend yield | Nil |
The stock price used in the valuation was $10.60, which was the average of closing prices for Corel common shares for a range of trading days (August 23, 2006 through August 31, 2006) around the announcement date (August 28, 2006) of the proposed transaction. The risk-free interest rate used in the valuation was the zero-coupon yield implied from U.S. Treasury securities with equivalent remaining terms. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore an expected dividend yield of zero was used in the valuation. Corel estimated the expected term of unvested options by taking the average of the vesting term remaining and the contractual term of the option. The volatility used in the model was based on the blended rate of the Company’s own stock price and the US Dow Jones Software and Computer Services Index. The fair value of stock options assumed has been included in additional paid-in capital.
Deferred stock-based compensation
Deferred stock-based compensation represents the portion of the estimated fair value, measured as of December 12, 2006, of unvested Corel options issued in exchange for the InterVideo stock options. The fair value of unvested options exchanged was estimated at $2.8 million using the Black Scholes model. The stock price used in the valuation is $14.16, which was the closing price of Corel shares on December 11, 2006, the last trading day before the close of the acquisition. The risk-free interest rate used in the valuation was the zero-coupon yield on December 12, 2006 implied from U.S. Treasury securities with equivalent remaining terms. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore an expected dividend yield of zero was used in the valuation. Corel estimated the expected term of unvested options by taking the average of the vesting term remaining and the contractual term of the option. The volatility used in the model was based on the blended rate of the Company’s own stock price and the US Dow Jones Software and Computer Services Index. The fair value of stock options assumed has been included in additional paid-in capital.
The assumptions used to value deferred stock-based compensation are as follows:
Expected term (in years) | 4 to 7 | |||
Volatility | 19.7 to 34.2 | % | ||
Risk free interest rate | 4.45 to 4.49 | % | ||
Forfeiture rate | 36.79% to 45.11 | % | ||
Dividend yield | Nil |
The deferred stock-based compensation is being amortized to expenses over the remaining vesting periods of the underlying options.
Table of Contents
Estimated direct transaction costs
Direct transaction costs of $2.8 million include investment banking, legal and accounting fees, and other external costs directly related to the acquisition.
Estimated restructuring costs
Restructuring costs of $3.9 million relate to InterVideo operations, and are primarily for costs for severance and excess facilities. See Note 9 for further details of the amounts accrued and payments made during the first quarter of fiscal 2007.
Purchase Price Allocation
Under the purchase method of accounting, the total purchase price is allocated to InterVideo’s net tangible and intangible assets based on their estimated fair values as at December 12, 2006. The excess of the purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on estimates and assumptions of management. The allocation of the preliminary purchase price is as follows:
Amount | ||||
Cash, cash equivalents, and short-term investments | $ | 106,691 | ||
Working capital | (21,129 | ) | ||
Capital and other long term assets | 3,839 | |||
Identifiable definite lived intangible assets | 86,577 | |||
Deferred tax liability | (20,836 | ) | ||
Net assets acquired | 155,142 | |||
Total preliminary purchase price | 227,780 | |||
Goodwill from InterVideo acquisition | 72,638 | |||
Goodwill at November 30, 2006 | 9,850 | |||
Goodwill at February 28, 2007 | $ | 82,488 | ||
The purchase price allocation is still preliminary as some amounts are dependent upon future actions. These include restructuring amounts that have been estimated and approved but for which payments have not been made. There are contingencies related to certain legal proceedings, that InterVideo was involved with in the normal course of business, that have not yet been settled. The valuation of identified definite lived intangible assets has not yet been finalized. Finally, estimates have been made for certain revenue provisions for which final amounts are dependant upon actions taken by the Company’s business partners which could impact the value of certain acquired assets and liabilities assumed. Any difference in the final amounts related to the above estimates could result in a change in the final purchase price allocation.
Identifiable definite lived intangible assets:
Approximately $86.6 million has been allocated to definite lived intangible assets acquired, including $7.8 million related to in-process research and development (“IPR&D”). IPR&D represents new projects that, on the date of acquisition, the related technology had not reached technological feasibility and did not have an alternate future use. All IPR&D has been expensed at the date of acquisition. The capitalized identifiable definite lived intangible assets are as follows:
First Year | Estimated Weighted Average | |||||||||||
Assigned Value | Amortization | Life (in years) | ||||||||||
Acquired technologies | $ | 57,520 | $ | 10,874 | 4.8 | |||||||
In-process research and development | 7,831 | — | — | |||||||||
Customer relationships | 10,651 | 2,140 | 5.4 | |||||||||
Trade names | 10,575 | 2,115 | 5.0 | |||||||||
Total | $ | 86,577 | $ | 15,129 | ||||||||
Intangible assets at February 28, 2007 was comprised of the following:
Cost of intangible assets at November 30, 2006 | $ | 99,802 | ||
Cost of intangible assets acquired with InterVideo | 86,577 | |||
Total cost of intangible assets | 186,379 | |||
Less: | ||||
Accumulated amortization | 67,882 | |||
In-process research and development acquired with InterVideo | 7,831 | |||
Net book value of intangible assets at February 28, 2007 | $ | 110,666 | ||
Table of Contents
To determine the fair value of intangible assets, Corel engaged an independent valuation firm who used the income approach, specifically the present value of the operating cash flows generated, to determine the fair value of existing technologies, customer relationships, and the trade name.
Existing technology relates to InterVideo products across all of its product lines that have reached technological feasibility. Corel will amortize the fair value of the acquired existing technology on a straight line basis over 2 to 7 years which best reflects the period over which the economic benefits of the intangible asset will be realized.
Customer relationships represent existing contracts that relate primarily to underlying customer relationships. Corel will amortize the fair value of these assets on a basis which best reflects the period over which the economic benefits of the customer relationship will be realized which is expected to be 4 to 6 years.
The InterVideo trade name and other product names will be amortized on a straight line basis over 5 years which best reflects the period in which the economic benefits of the intangible asset will be realized.
Deferred Tax Liability
Approximately $25.8 million was estimated as the deferred tax liability arising from the difference between the value assigned to acquired technologies, customer relationships and trade names and their related tax value. As of the date of acquisition, the fair value of the InterVideo deferred tax assets was approximately $5.0 million.
Goodwill
Approximately $72.6 million has been allocated to goodwill arising from the acquisition representing the excess of the purchase price over the fair value of the underlying net tangible and intangible assets. In accordance with SFAS No. 142,Goodwill and Other Intangible Assets, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of goodwill has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.
Pro Forma Results
The unaudited financial information in the table below summarizes the combined results of operations of Corel and InterVideo, on a pro forma basis, as though the companies had been combined December 1, 2005. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the period or of results that may occur in the future. The pro forma financial information includes the following adjustments:
• | additional amortization of intangible assets related to the acquisition of $3.5 million | |
• | deferred tax recovery of $1.3 million related to the amortization of acquired intangible assets | |
• | additional interest expense of $2.3 million on additional debt financing for the acquisition | |
• | reduced stock compensation expense of $0.8 million | |
• | removal of minority interest income of $0.4 million | |
• | additional deferred financing fees of $0.1 million related to acquisition financing |
The unaudited pro forma financial information for the three months ended February 28, 2006 combines the historical results for Corel for the three months ended February 28, 2006 and the historical results for InterVideo for the three months ended March 31, 2006.
Three Months | ||||
Ended | ||||
February 28, | ||||
2006 | ||||
Net revenues | $ | 75,609 | ||
Net loss | $ | (4,748 | ) | |
Basic net loss per share | $ | (0.24 | ) | |
Diluted net loss per share | $ | (0.24 | ) |
Table of Contents
5. Income Taxes
For the three months ended February 28, 2007, the Company recorded a tax provision of $355 on a loss before income taxes of $11.5 million. The current tax provision is $1.4 million and the deferred tax recovery is $1.0 million. The deferred tax recovery is related to the amortization of the intellectual property acquired with InterVideo which has a tax basis of $nil. Current taxes consist of foreign withholding taxes plus taxes incurred by Corel’s foreign subsidiaries.
For the three months ended February 28, 2006, the Company recorded a tax provision of $3.2 million on income before income tax expense of $1.5 million. Current taxes, consisting of foreign withholding taxes plus taxes incurred by Corel’s foreign subsidiaries, were $2.3 million.
6. Long-term Debt
The Components of long term debt for the periods presented are as follows:
February 28, 2007 | November 30, 2006 | |||||||||||||||||||||||
Current | Long Term | Total | Current | Long Term | Total | |||||||||||||||||||
Term loan | $ | 2,111 | $ | 157,042 | $ | 159,153 | $ | 900 | $ | 88,650 | $ | 89,550 | ||||||||||||
Promissory note | 526 | 289 | 815 | 526 | 573 | 1,099 | ||||||||||||||||||
Total | $ | 2,637 | $ | 157,331 | $ | 159,968 | $ | 1,426 | $ | 89,223 | $ | 90,649 | ||||||||||||
Line of credit | $ | 75,000 | $ | 75,000 | ||||||||||||||||||||
Outstanding balance | 23,000 | $ | — | |||||||||||||||||||||
Available line of credit | $ | 52,000 | $ | 75,000 | ||||||||||||||||||||
Term Loan
On May 2, 2006, the Company entered into a $165.0 million senior credit facility consisting of a $90.0 million term loan with a six-year maturity and a $75.0 million revolving line of credit with a five-year term as part of its debt restructuring. Proceeds from this refinancing were used to repay Corel’s debt at that time. As a result, the Company incurred a loss on debt retirement of $8.3 million. On December 12, 2006, this facility was amended as the Company completed its acquisition of InterVideo an Ulead. The acquisitions were funded through an additional $70.0 million term borrowing, $43.0 million draw on our revolving line of credit and the remaining in cash of the combined Company. During the quarter, the Company repaid $20.0 million of the revolving line of credit. The balance outstanding on the line of credit at February 28, 2007 was $23.0 million.
The credit facility agreement requires the Company to make fixed quarterly principal repayments of 0.25% of the original principal amount on the term loan, or $225 from June 2006 to December 2006 and $400 from January 2007 through to December 2011, with the balance of the loan due in April 2012. The term loan and revolving line of credit bear interest at floating rates tied to either the Alternate Base Rate (“ABR”, which equal the higher of (i) the federal funds rate plus 50 basis points, and (ii) the prime rate) plus 2.25% until December 2006 and ABR plus 3.00% thereafter or the Adjusted LIBOR plus 3.25% until December 2006 and Adjusted LIBOR plus 4.00% thereafter. On an annual basis, beginning the first quarter of fiscal 2008, the Company is required to make a cash sweep payment to fund its principal balance, based excess cash flow as defined in the agreement.
In addition to the above loans, the facility also provides the Company with a $25,000 letter of credit and a $5,000 Swingline commitment. The applicable interest rate on any borrowings is based on a leverage ratio pricing grid. As at February 28, 2007, no balance was outstanding on either the letter of credit or the Swingline commitment.
In connection with the senior credit facility, the Company obtained interest rate protection by entering into interest rate swaps totaling $59.5 million. The variable rate of interest is based on three-month LIBOR plus 4.00%. The fixed rates range from 9.40% to 9.49%.
Table of Contents
The borrowings under the senior credit facility are collateralized by a pledge of all the Company’s assets, including subsidiary stock. Under the terms of the credit agreement the Company is subject to restrictive covenants. The agreement contains restrictions, such as restrictions on additional borrowing, distributions and business acquisitions/divestitures. It also includes the following financial covenants:
• | a maximum total leverage ratio, which is defined as the ratio of total debt to trailing four quarter consolidated Adjusted EBITDA, as defined in the credit agreement, to be less than specified amounts over the term of the facility, of 3.50:1.00 reducing over the term of the facility to 2.25:1.00 at maturity; | ||
• | a minimum fixed charge coverage ratio, which is defined as the ratio of trailing four quarter consolidated Adjusted EBITDA to fixed charges, 2.00 to 1.00 from January 2006 until November 2010 and 2.25 to 1.00 from December 2010 to November 2011. |
As of February 28, 2007, Corel was in compliance with all debt covenants.
The future debt payments on long-term debt as of February 28, 2007, are as follows:
Term Loan | ||||||||||||
Principal | Interest | Total | ||||||||||
2007, remainder of | $ | 1,453 | $ | 11,213 | $ | 12,666 | ||||||
2008 | 2,108 | 14,819 | 16,927 | |||||||||
2009 | 1,641 | 14,668 | 16,309 | |||||||||
2010 | 1,596 | 14,517 | 16,113 | |||||||||
2011 | 1,596 | 14,367 | 15,963 | |||||||||
2012 | 151,574 | 4,783 | 156,357 | |||||||||
Total | $ | 159,968 | $ | 74,367 | $ | 234,335 | ||||||
Deferred Financing Charges
In relation to the amendment of the Company’s term loan on December 12, 2006, the Company incurred financing charges in the amount of $1,672. These charges have been deferred and are amortized over the term of the associated debt using the effective interest rate method. During the first quarter, amortization of deferred financing charges was $265.
7. Commitments and Contingencies
Commitments
The Company rents office space in Canada, the United States, Europe, Asia and other international locations under various operating leases, which contain different renewal options. The leases begin to expire in 2007. In connection with the acquisition of InterVideo, we assumed all the obligations of their existing 19 locations.
The Company recorded lease expenses of $1,682 for the first quarter of fiscal 2007 and $1,152 for the first quarter of fiscal 2006.
Legal Proceedings
The Company is currently, and from time to time, involved in certain legal proceedings, as well as demands, claims and threatened litigation that arise in the normal course of its business, including assertions from third parties that it may be infringing patents or other intellectual property rights of others and from certain of our customers that they are entitled to indemnification from us in respect of claims that they are infringing such third party rights through the use or distribution of our products. If challenged, management believes that, if necessary, they would be able to obtain any required licenses
Table of Contents
or other rights to disputed intellectual property rights on commercially reasonable terms. However, the ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation can have an adverse impact on the business because of defense costs, negative publicity, diversion of management resources and other factors. Failure to obtain any necessary license or other rights on commercially reasonable terms, or otherwise, or litigation arising out of intellectual property claims could materially adversely affect the business
In addition, some of our agreements with customers and distributors, including OEMs and online services companies, require us to indemnify these parties for third-party intellectual property infringement claims, and many of these indemnification obligations are not subject to monetary limits. The existence of these indemnification provisions could increase our cost of litigation and could significantly increase our exposure to losses from an adverse ruling
At the time of the acquisition of InterVideo, InterVideo was involved in certain legal proceedings and was the subject of demands, claims and threatened litigation that arose in the normal course of its business, including assertions that it may be infringing patents or other intellectual property rights of others. An estimate to settle these claims has been included in the preliminary purchase price of InterVideo, however, it is possible that such estimates may be significantly different from the settlement amounts. This difference may be reflected in the final purchase price allocation if resolved during the allocation period.
At February 28, 2007, we were a defendant in an ongoing patent infringement proceeding described below:
Electronics For Imaging, Inc., Massachusetts Institute of Technology v. Corel Corporation et al.Plaintiffs filed this patent infringement action on December 28, 2001 against the Company and 213 other defendants in the U.S. District Court for the Eastern District of Texas, alleging infringement of U.S. patent 4,500,919. The patent expired on May 6, 2002. Plaintiffs allege that the defendants infringed the patent through the use of various color management and correction systems in their products. Plaintiffs seek unspecified damages and attorneys fees. Following the Markman hearing and the trial court’s rulings on various summary judgment motions the plaintiffs dismissed all claims against every remaining defendant except the Company, Microsoft, Roxio, Abacus and MGI Software. The plaintiffs then stipulated to non-infringement in respect of these remaining defendants including the Company, and the action was dismissed in November 2004. In December 2004, the plaintiffs filed an appeal of various interlocutory rulings by the trial court including the trial court’s ruling on the Markman hearing and certain of the summary judgment decisions. On September 13, 2006 the US Court of Appeals for the Federal Circuit issued a decision on the appeal vacating, in part, the trial court’s dismissal and remanding the matter back to the trial court for further proceedings consistent with the Court of Appeals’ ruling. The Company believes it has meritorious defenses to the plaintiffs’ claims and intends to defend the litigation vigorously. However, the ultimate outcome of the litigation is uncertain.
8. Shareholders’ Equity
Stock option plans
The following table shows total stock-based compensation expense included in the consolidated statement of operations:
Three Months | ||||||||
Ended February 28, | ||||||||
2007 | 2006 | |||||||
Cost of products | $ | 9 | $ | 8 | ||||
Cost of maintenance and services | 2 | 2 | ||||||
Sales and marketing | 270 | 191 | ||||||
Research and development | 195 | 63 | ||||||
General and administration | 532 | 588 | ||||||
Total stock-based compensation expense | $ | 1,008 | $ | 852 | ||||
Table of Contents
There have been no capitalized stock-based compensation costs. The Company has recognized cumulative expenses of $1,340 for performance-based awards, including $13 and $294 for the three months ended February 28, 2007 and February 28, 2006, respectively.
Corel estimates the fair value of its options for financial accounting purposes using the Black-Scholes model, which requires the input of subjective assumptions including the expected life of the option, risk-free interest rate, dividend rate, future volatility of the price of the Company’s common shares, forfeiture rate and vesting period. Changes in subjective input assumptions can materially affect the fair value estimate. Prior to the Company’s public offering in April 2006 there was no active market for the Company’s common shares. Since the Company has been public for less than the vesting period of its options, the Company does not consider the volatility of the Company’s share price to be representative of the estimated future volatility when computing the fair value of options granted. Accordingly, until such time that a representative volatility can be determined based on the Company’s share price, the Company will use a blended rate of its own share price volatility and the US Dow Jones Software and Computer Services Index.
The fair value, estimated using the Black-Scholes model, of all options granted during the quarter ended February 28, 2007 and February 28, 2006, was estimated as of the date of grant using the following weighted average assumptions:
Three Months Ended | ||||||||
February 28, | ||||||||
2007 | 2006 | |||||||
Expected option life (years) | 7 | 7 | ||||||
Volatility | 34.20 | % | 36.59 | % | ||||
Risk free interest rate | 4.03 | % | 4.11 | % | ||||
Forfeiture Rate | 16.82 | % | Nil | |||||
Dividend yield | Nil | Nil |
As of February 28, 2007, there was $8,049 of unrecognized compensation cost related to equity incentive plans, adjusted for estimated forfeitures, related to non-vested stock-based payments granted to Corel employees. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. Additionally, as of February 28, 2007, there was $2,550 of unamortized deferred compensation, related to the acquisition of InterVideo, which will be recognized over a period of 3.78 years.
2006 Equity Incentive Plan
The 2006 Equity Incentive Plan was adopted by the Board of Directors in February 2006. This plan provides for the grant of options to employees and employees of the Company’s subsidiaries, and restricted shares, share appreciation rights, restricted share units, performance share units, deferred share units, phantom shares and other share-based awards (“options”) to the Company’s employees, consultants and directors, and employees, consultants and directors of the Company’s subsidiaries and affiliates. Corel has 2,704,399 common shares authorized for issuance under the 2006 Equity Incentive Plan.
As part of the InterVideo acquisition, each InterVideo stock option that was outstanding and unexercised shall, once vested, be exercisable for Corel Common Shares at the Option Exchange Ratio at a per share exercise price equal to the original exercise price of the InterVideo options divided by the Option Exchange Ratio. The Company assumed these stock options in accordance with the terms of the applicable InterVideo stock option plan. There were InterVideo stock options outstanding at December 12, 2006 which, if exercised, would yield 1,700,717 Corel common shares.
Option activity under the 2006 Equity Incentive Plan for the three month period ended February 28, 2007 is presented below:
Table of Contents
2006 Equity Incentive Plan | ||||||||||||
Weighted Average | ||||||||||||
Weighted Average | Grant Date Fair | |||||||||||
Options | Exercise Price | Value | ||||||||||
Balance at November 30, 2006 | 513,333 | $ | 9.56 | $ | 6.26 | |||||||
Granted | 90,260 | 13.68 | 4.97 | |||||||||
Assumed in exchange for InterVideo stock options | 1,700,717 | 12.95 | 2.06 | |||||||||
Exercised | (143,970 | ) | 8.65 | 4.75 | ||||||||
Forfeited | (117,313 | ) | 13.09 | 3.58 | ||||||||
Outstanding at February 28, 2007 | 2,043,027 | $ | 12.47 | $ | 3.13 | |||||||
Exercisable at February 28, 2007 | 844,110 | |||||||||||
Weighted average fair value of outstanding options | $ | 3.13 | ||||||||||
Weighted average remaining life of the outstanding options | 8.16 | Years |
In January 2007 the Company issued 30,000 units of restricted stock to a senior officer of the Company under the 2006 Equity Incentive Plan. These units will vest fully if the officer remains with the Company until June 1, 2008. Furthermore, if certain performance conditions are met, these restricted stock units may vest earlier. These units will begin to vest on September 1, 2007 and will vest fully by June 1, 2008. These units were classified as equity awards and accordingly were valued at the market price of our shares on the date the Board authorized their issuance.
2003 Share Option and Phantom Share Unit Plan
In the three months ended February 28, 2007, no options were granted as this plan is no longer eligible for grant distribution. Unit activity for the three month period ended February 28, 2007 is presented below:
The 2003 Plan | ||||||||||||
Weighted | ||||||||||||
Average | ||||||||||||
Weighted | Grant Date | |||||||||||
Average | Fair | |||||||||||
Options | Exercise Price | Value | ||||||||||
Balance, November 30, 2006 | 1,320,714 | $ | 1.98 | $ | 7.24 | |||||||
Exercised | (35,043 | ) | 1.17 | 3.42 | ||||||||
Forfeited | (4,031 | ) | 4.46 | 5.17 | ||||||||
Balance, February 28, 2007 | 1,281,640 | $ | 1.98 | $ | 7.22 | |||||||
Exercisable at February 28, 2007 | 673,201 | |||||||||||
Weighted average fair value of outstanding options | $ | 7.22 | ||||||||||
Weighted average remaining life of the outstanding options | 7.92 | Years |
9. Restructuring Charges
InterVideo Acquisition Related Restructuring Charges
In conjunction with the acquisition of InterVideo, management has implemented a restructuring plan (“InterVideo plan”) and expects to incur restructuring charges in fiscal 2007 related to this plan. The InterVideo plan includes the reduction of headcount across all functions, the closure of certain facilities and the termination of certain redundant operational contracts.
As of February 28,2007, the majority of the headcount reductions had been identified and the majority of the terminations will be complete by May 31, 2007. Facilites that will be closed have been
Table of Contents
identified and notices of termination are in process. Operational contracts are under review and the Company is currently negotiating with some partners to terminate redundant operational contracts.
A summary of restructuring activities related to the acquisition of InterVideo that have been included as part of the purchase price allocation follows:
Balance at | Cash | Balance at | ||||||||||
December 12, 2006 | Payments | February 28, 2007 | ||||||||||
Termination benefits | $ | 2,969 | $ | 687 | $ | 2,282 | ||||||
Cost of closing redundant facilities | 900 | — | 900 | |||||||||
Total | $ | 3,869 | $ | 687 | $ | 3,182 | ||||||
Pursuant to Emerging Issues Task Force Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination”, all restructuring charges related to the InterVideo acquisition are recognized as a part of the purchase price allocation and have been accrued for as of February 28, 2007. Any changes in estimates related to the InterVideo plan would result in an offsetting change to Goodwill.
Fiscal 2006 Restructuring
In the first quarter of 2006, the Company initiated a realignment of its sales and marketing team after completing an internal review of its overall future requirements. The only costs associated with this realignment are one-time termination benefits relating to various sales and marketing employees. All of these costs were included in the statement of operations during the period.
10. Loss Per Share
The impact of the exercise of Corel options is not anti-dilutive in the periods presented. Potentially dilutive instruments for the three months ended February 28, 2007 represent the impact of the weighted average number of common shares subject to options outstanding of 3,354,667 and 1,483,771 for the three months ended February 28, 2007 and February 28, 2006, respectively.
11. Change in Operating Assets and Liabilities
Three months ended February 28 | ||||||||
2007 | 2006 | |||||||
Accounts receivable | $ | 15,658 | $ | 3,295 | ||||
Inventory | 740 | (124 | ) | |||||
Prepaids and other current assets | 290 | 67 | ||||||
Accounts payable and accrued liabilities | (872 | ) | (5,036 | ) | ||||
Due to related parties | (167 | ) | — | |||||
Accrued interest | 22 | (613 | ) | |||||
Taxes payable | 1,601 | 2,272 | ||||||
Deferred revenue | (1,344 | ) | (1,204 | ) | ||||
Total change in operating assets and liabilities | $ | 15,928 | $ | (1,343 | ) | |||
12. Segment Reporting
The Company has determined that it operates in one business operating and reportable segment, the packaged software segment.
As a result of the acquisition of InterVideo, the Company changed the definition of its product lines reporting to be better aligned with how it manages the combined businesses. For comparability, the prior fiscal period’s results have been reclassified to reflect the realignment of the new product line
Table of Contents
categories Graphics and Productivity, and Digital Media. There was no impact on net income as a result of this reclassification.
Prior period amounts have been reclassified to conform to the presentation used for the year ended November 30, 2006 for revenue in the Americas, Europe, Middle East, Africa (EMEA), and Asia-Pacific. There was no impact on net income as a result of this reclassification.
Revenues by product and region are disclosed in the following table:
Three Months Ended | ||||||||
February 28, | ||||||||
2007 | 2006 | |||||||
By product category: | ||||||||
Graphics and Productivity | $ | 34,064 | $ | 36,637 | ||||
Digital Media | 18,570 | 7,650 | ||||||
$ | 52,634 | $ | 44,287 | |||||
By geographic region: | ||||||||
Americas | ||||||||
Canada | $ | 570 | $ | 1,386 | ||||
United States | 25,435 | 23,506 | ||||||
Other | 1,188 | 760 | ||||||
Europe, Middle East, Africa (EMEA) | 17,658 | 15,784 | ||||||
Asia-Pacific | 7,783 | 2,851 | ||||||
$ | 52,634 | $ | 44,287 | |||||
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
Certain statements made in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this filing (including in the section entitled “Risk Factors” constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws. Forward-looking statements are based on estimates and assumptions made by Corel in light of its experience of historical trends, current conditions and expected future developments, as well as other factors that we believe are appropriate in the circumstances. However, many factors could cause our actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements, including, without limitation, the following factors:
• | we face competition from companies with significant competitive advantages, such as significantly greater market share and resources; | |
• | as an increasing number of companies with advertising or subscriber-fee business models seek to offer competitive software products over the Internet at little or no cost to consumers, it may become more challenging for us to maintain our historical pricing policies and operating margins; | |
• | the proliferation of open source software and open standards may make us more vulnerable to competition because new market entrants and existing competitors could introduce similar products quickly and cheaply; | |
• | we rely on relationships with a small number of strategic partners and these relationships can be modified or effectively terminated at any time without our approval; | |
• | the manner in which packaged software is distributed is changing rapidly, which presents |
Table of Contents
challenges to established software companies such as us and presents opportunities for potential competitors; | ||
• | our “Alta” strategy may fail to achieve market acceptance with consumers and our strategic partners; | |
• | many of our core products have been marketed for many years and the packaged software market in North America and Europe is relatively mature and characterized by modest growth, accordingly, we must develop new products, successfully complete acquisitions, penetrate new markets or increase penetration of our installed base to achieve revenue growth; | |
• | we have significantly higher levels of indebtedness following the InterVideo acquisition, including an additional $70.0 million of term loan debt and an additional $23.0 million under our operating line of credit, which could have important consequences for our business such as limiting our ability to make further significant acquisitions; | |
• | our acquisition strategy may fail for various reasons, including our inability to find suitable acquisition candidates, complete acquisitions on acceptable terms or effectively integrate acquired businesses; and | |
• | we face potential claims from third parties who may hold patent and other intellectual property rights which purport to cover various aspects of our products and from certain of our customers who may be entitled to indemnification from us in respect of potential claims they may receive from third parties related to their use or distribution of our products. |
These and other important factors are described in greater detail in the section entitled “Risk Factors” in our annual report on Form 10-K dated February 23, 2007 filed with the Securities and Exchange Commission and with Canadian securities regulators. A copy of the 10-K can be obtained on our website (http://www.corel.com), or atwww.sec.gov
The words “expect”, “estimate”, “project”, “intend”, “believe”, “plan” and similar expressions are intended to identify forward-looking statements. Forward-looking statements speak only as of the date of the document in which they are made. We disclaim any obligation or undertaking to provide any updates or revisions to any forward-looking statement to reflect any change in our expectations or any change in events, conditions or circumstances on which the forward-looking statement is based.
The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes for the three month period ended February 28, 2007. All amounts are in United States dollars, except as otherwise noted.
BACKGROUND
Corel is a leading global packaged software company with an estimated installed base of over 100 million current users in over 75 countries. We provide high quality, affordable and easy-to-use productivity and graphics, and digital media software. Our products enjoy a favorable market position among value-conscious consumers and small businesses. Our products are sold through a scalable distribution platform comprised of OEMs, our e-Store, and our global network of resellers and retailers. Our product portfolio includes well-established, globally recognized brands, such asCorelDRAW,Paintshop Pro,WordPerfect, WinZip,andWinDVD.
Table of Contents
OVERVIEW OF THE QUARTER
Operating Performance
Results for the first quarter of 2007 include the results from our acquisition of InterVideo as of December 12, 2006.
Revenue was $52.6 million, up 19% year over year. Excluding InterVideo revenue of $9.7 million in the first quarter, revenue from the Corel business was $42.9 million, a decline of 3% year over year, primarily driven by a decrease in revenue for ourWordPerfectbusiness. More specifically, theWordPerfectbusiness declined by $3.3 million in the first quarter, and the rest of the Corel portfolio, before the impact of the acquisition of Intervideo, grew by $1.9 million or by 5% year over year. This was primarily driven by growth ofWinZip, iGrafx and Paintshop Pro.
Our net loss for the first quarter 2007 was $11.9 million, or $0.48 per share, compared to a net loss of $1.6 million, or $0.08 per share in the first quarter of 2006. Non-GAAP Adjusted EBITDA was $8.7 million and cash flow from operations was $18.4 million in the quarter. The first quarter results were impacted by a number of acquisition related impacts, primarily related to the recognition of certain revenues and one-time acquisition accounting charges.
Acquisition of InterVideo
On December 12, 2006, we acquired InterVideo, a provider of digital media authoring and video playback software with a focus on high-definition and DVD technologies, in an all cash transaction of approximately $198.6 million. As part of the acquisition of InterVideo the remaining voting equity interest in Ulead was completed by the Company on December 28, 2006, in an all cash transaction of approximately $21.7 million. The acquisitions were funded through an additional $70.0 million term borrowing, $43.0 million draw on our revolving line of credit and the remaining in cash of the combined Company. During the quarter, we repaid $20.0 million of the revolving line of credit and ended the quarter with cash and cash equivalents of $40.9 million.
The acquisition expanded our presence in the digital media software market by increasing our portfolio of digital media and DVD video products. With the addition of InterVideo, we have extended our presence in Asian markets, such as China, Taiwan and Japan.
InterVideo has historically derived a substantial portion of its revenue from sales of its flagship product,WinDVD, a DVD player software, to PC Original Equipment Manufacturers (“OEMs”). In the future, we expect to derive an increasing percentage of our revenue from sales of products other thanWinDVD, including:
• | DVDMovie Factory, a consumer DVD authoring software | |
• | VideoStudio, a video editing software; and | |
• | PhotoImpactandPhotoExpress, image editing software | |
• | DVD Copy |
As a result of the acquisition, for this period and future periods, we will report on Corel’s two product categories: Digital Media and Graphics and Productivity. Our primary Digital Media products include the InterVideo products listed above and also ourPaint ShopandSnapfire products. Our primary Graphics and Productivity products include,CorelDRAW Graphics Suite,WinZip, WordPerfect Office SuiteandiGrafx.
Table of Contents
RESULTS OF OPERATIONS
Three Months ended February 28, 2007 and February 28, 2006
On December 12, 2006, we acquired all of the outstanding shares of InterVideo. Accordingly, because the financial information for the first three months of fiscal 2006 does not include InterVideo operations, it is not directly comparable to the consolidated financial information presented for the first three months of fiscal 2007. In the analysis, “Corel products” refers to the revenues and expenses related to the products which were owned by Corel prior to the acquisition of InterVideo on December 12, 2006.
Revenues
Three Months Ended | ||||||||||||
February 28, | ||||||||||||
Percentage | ||||||||||||
2007 | 2006 | Change | ||||||||||
Product | $ | 47,304 | $ | 39,498 | 19.8 | % | ||||||
As a percent of revenue | 89.9 | % | 89.2 | % | ||||||||
Maintenance and services | 5,330 | 4,789 | 11.3 | % | ||||||||
As a percent of revenue | 10.1 | % | 10.8 | % | ||||||||
Total | $ | 52,634 | $ | 44,287 | 18.8 | % | ||||||
Total revenues for the three month period ended February 28, 2007 increased by 18.8% to $52.6 million from $44.3 million for the three months ended February 28, 2006. Of this increase, $9.7 million is attributable to additional revenues generated from InterVideo products. There was a revenue decline in Corel products of $1.4 million from the same quarter last year. The decline was due to a decrease inWordPerfectrevenues of $3.3 million from the same quarter last year, offset by an increase of $1.9 million from the rest of our product portfolio, including growth inWinZip, Paint Shop ProandiGrafx.
Product revenues for the three months ended February 28, 2007 increased by 19.8% to $47.3 million from $39.5 million for the three months ended February 28, 2006. Product revenues for the Corel products prior to the acquisition of InterVideo decreased by $1.9 million or 4.8% to $37.6 million for the three month period ended February 28, 2007. This decline was primarily the result of a $3.3 million decline in sales ofWordPerfect.This was partially offset by a $1.4 million increase in the sales of the rest of the portfolio of products, including growth inWinZip, iGrafx and Paint Shop Prorevenues. The decline in WordPerfect revenues is due primarily to the decrease in point of sale royalties from Dell, the decrease in enterprise license revenue, which we believe was primarily driven by distractions associated with the VISTA launch, and the launch ofWordPerfect Office X3 in the first quarter of the prior year. We are also seeing the effect of the product life cycle, with WordPerfect Office Suite X3 having been launched in the first quarter of 2006. Revenues from ourWinZipproducts have increased due to new license sales and upgrades resulting from increased conversion of trial customers to license users through more aggressive in-product messaging. The increase iniGrafxrevenues is attributable to additional marketing and promotional initiatives undertaken in the current quarter.
Maintenance and services revenues increased by 11.3% to $5.3 million for the three month period ended February 28, 2007. This increase is largely attributable to increased sales of WinZip’s maintenance program.
Table of Contents
Total Revenues by Product Group
Three Months Ended | ||||||||||||
February 28, | ||||||||||||
Percentage | ||||||||||||
2007 | 2006 | Change | ||||||||||
Graphics and Productivity | $ | 34,064 | $ | 36,637 | (7.0 | %) | ||||||
As a percent of revenue | 64.7 | % | 82.7 | % | ||||||||
Digital Media | 18,570 | 7,650 | 142.7 | % | ||||||||
As a percent of revenue | 35.3 | % | 17.3 | % | ||||||||
Total | $ | 52,634 | $ | 44,287 | 18.8 | % | ||||||
As a result of our acquisition of InterVideo, we changed our revenue by product group classification so that it was aligned with how we now manage our product groups. Revenues by product for the three month period ended February 28, 2006 were reclassified to conform to the current period.
Our products generally have release cycles between 12 and 24 months and we typically earn the largest portion of revenues for a particular product during the first half of its release cycle. In the past we have experienced declines in product revenues during the second half of product release cycles, with the sharpest declines occurring toward the end of the release cycle. The fiscal quarter of the most recent and prior release of each of our major products is set forth below:
Version | Quarter of | Quarter of | ||||||||||
Product | Current | Current Release | Prior Release | |||||||||
Graphics and Productivity: | ||||||||||||
CorelDRAW Graphics Suite | 13 | Q1 2006 | Q1 2004 | |||||||||
WinZip | 11 | Q4 2006 | Q4 2005 | |||||||||
WordPerfect Office Suite | 13 | Q1 2006 | Q2 2004 | |||||||||
iGrafx FlowCharter | 11 | Q1 2006 | Q4 2004 | |||||||||
Corel Designer Technical Suite | 12 | Q2 2005 | Q3 2003 | |||||||||
Corel Painter | 10 | Q1 2007 | Q4 2004 | |||||||||
Digital Media | ||||||||||||
Corel Paint Shop Pro | 11 | Q4 2006 | Q4 2005 | |||||||||
Snapfire | 1.0 | Q4 2006 | N/A | |||||||||
WinDVD | 8 | Q4 2006 | Q2 2005 | |||||||||
VideoStudio | 10 | Q2 2006 | Q2 2005 | |||||||||
DVD Movie Factory | 6 | Q1 2007 | Q1 2006 | |||||||||
DVD Copy | 5 | Q3 2006 | Q1 2006 | |||||||||
PhotoImpact | 12 | Q3 2006 | Q4 2005 |
Graphics and Productivity revenues decreased by $2.6 million or 7.0% to $34.1 million in the first quarter of fiscal 2007 from $36.6 million in the first quarter of fiscal 2006. Of this decline, $3.3 million is the result of lower sales ofWordPerfect Office. The rest of the Graphics and Productivity portfolio of products increased by $0.7 million or 2.5% year over year, primarily driven by growth inWinZipandiGrafxrevenues. Revenues from ourWinZipproducts have grown significantly due to increased new license sales and upgrades resulting from increased conversion of trial customers to license users through more aggressive in-product messaging. The increase iniGrafxrevenues is attributable to additional marketing and promotional initiatives undertaken in the current quarter. The decline inWordPerfect revenues is due primarily to the decrease in point of sale royalties from Dell, the decrease in enterprise license revenue, which we believe was primarily driven by distractions associated with the VISTA launch, and the launch ofWordPerfect Office X3 in the first quarter of the prior year.
Digital Media revenues increased by 142.7% to $18.6 million in the first quarter of fiscal 2007 from $7.7 million in the first quarter of fiscal 2006. The significant increase is due to the inclusion of
Table of Contents
$9.7 million of revenue in the first quarter of fiscal 2007 that resulted from products acquired with our acquisition of InterVideo on December 12, 2006. Revenue from Corel products increased by 15.8%, due to revenue growth inPaintShopPro.
Total Revenues by Region
Three Months Ended | ||||||||||||
February 28, | Percentage | |||||||||||
2007 | 2006 | Change | ||||||||||
Americas | $ | 27,193 | $ | 25,652 | 6.0 | % | ||||||
As a percent of revenue | 51.7 | % | 57.9 | % | ||||||||
Europe, Middle East, Africa (“EMEA”) | 17,658 | 15,784 | 11.9 | % | ||||||||
As a percent of revenue | 33.5 | % | 35.6 | % | ||||||||
Asia-Pacific | 7,783 | 2,851 | 173.0 | % | ||||||||
As a percent of revenue | 14.8 | % | 6.4 | % | ||||||||
Total | $ | 52,634 | $ | 44,287 | 18.8 | % | ||||||
Revenues by region for our three month period ended February 28, 2006 were reclassified to conform to the current period presentation of revenues in the Americas, Europe, Middle East, Africa (EMEA), and Asia Pacific. As a result there was a reclassification of reported revenue in the aggregate amount of $1.2 million from the Americas to EMEA and Asia Pacific in the amount of $872,000 and $294,000, respectively.
Revenues in the Americas increased by 6.0% in the first quarter of fiscal 2007 to $27.2 million compared to $25.7 million in the first quarter of fiscal 2006. The increase was principally driven by the revenues associated with our newInterVideoproducts, which generated sales of $3.0 million. Revenues for existing Corel products prior to the acquisition declined by 5.6% due to lowerWordPerfectrevenues related to PC shipments by our key OEM partners, and in particular Dell, and a decrease in enterprise license revenue.
Revenues in EMEA increased by 11.9% to $17.7 million in the first quarter of fiscal 2007 from $15.8 million in the first quarter of fiscal 2006. The main reason for the increase was the revenues generated by ourInterVideoproducts which totaled $2.2 million. Revenues from Corel products decreased by 1.8% primarily due toCorel Drawproduct sales, which decreased due to the product’s life cycle stage.
Asia Pacific revenues increased by 173.0% to $7.8 million in the first quarter of fiscal 2007. The increase is due to sales from InterVideo products of $4.6 million in the three month period ended February 28, 2007 and revenue growth in Corel products of 12.3%. The increase in products is due to the increase in revenues from Corel Draw in the emerging markets of China and India.
Table of Contents
Cost of Revenues
Three Months Ended | ||||||||||||
February 28, | ||||||||||||
Percentage | ||||||||||||
2007 | 2006 | Change | ||||||||||
Cost of product | $ | 8,487 | $ | 5,005 | 69.6 | % | ||||||
As a percent of product revenue | 17.9 | % | 12.7 | % | ||||||||
Cost of maintenance and services | 198 | 314 | (36.9 | %) | ||||||||
As a percent of maintenance and service revenue | 3.7 | % | 6.6 | % | ||||||||
Amortization of intangible assets | 5,757 | 6,627 | (13.1 | %) | ||||||||
As a percent of revenue | 10.9 | % | 15.6 | % | ||||||||
Total | $ | 14,442 | $ | 11,946 | 20.7 | % | ||||||
Cost of Product Revenues.Cost of product revenues increased by 69.2% to $8.5 million in the first quarter of fiscal 2007 from $5.0 million in the first quarter of fiscal 2006. As a percentage of product revenues, cost of product revenues increased to 17.9% for the three months ended February 28, 2007 from 12.7% in the three month period ended February 28, 2006. The increase in the period is largely attributable to the change in our product mix caused by the acquisition of InterVideo and introduction of InterVideo product. Historically, and in this quarter, there is a lower gross margin on InterVideo products compared to Corel products. As a percentage of product revenue, the cost of product revenues for Corel products was 12.0% in the current period, which is consistent with the period ended February 28, 2006.
Cost of Maintenance and Services Revenues.Cost of maintenance and services revenues decreased to 3.7% of related revenues in the first three months of fiscal 2007 from 6.6% in the first three months of fiscal 2006, and is primarily attributable toWinZip’shigher maintenance revenues and the limited incremental costs to provide such revenue.
Amortization of Intangible Assets.Amortization of intangible assets decreased by $0.9 million in the three months ended February 28, 2007, from $6.6 million in the three months ended February 28, 2007. The decrease is due to the fact that the intangible assets which were revalued and pushed down to our accounts in connection with our acquisition by Vector Capital are now fully amortized, as compared to the three months ended February 28, 2006 when there was still some amortization recorded related to the re-valuation. This decrease is offset by $3.2 million of amortization incurred on the intangible assets of $86.6 million acquired with InterVideo.
Operating Expenses
Three Months Ended | ||||||||||||
February 28, | ||||||||||||
Percentage | ||||||||||||
2007 | 2006 | Change | ||||||||||
Sales and marketing | $ | 17,104 | $ | 14,504 | 17.9 | % | ||||||
As a percent of revenue | 32.5 | % | 32.8 | % | ||||||||
Research and development | 11,344 | 6,181 | 83.5 | % | ||||||||
As a percent of revenue | 21.6 | % | 14.0 | % | ||||||||
General and administration | 9,095 | 5,395 | 68.6 | % | ||||||||
As a percent of revenue | 17.3 | % | 12.2 | % | ||||||||
Acquired in-process research and development | 7,831 | — | n/a | |||||||||
As a percent of revenue | 14.9 | % | 0.0 | % | ||||||||
Restructuring | — | 560 | n/a | |||||||||
As a percent of revenue | 0.0 | % | 1.3 | % | ||||||||
InterVideo integration expense | 785 | — | n/a | |||||||||
As a percent of revenue | 1.5 | % | 0.0 | % | ||||||||
Total | $ | 46,159 | $ | 26,640 | 73.3 | % | ||||||
Table of Contents
Sales and Marketing.Sales and marketing expenses increased by 17.9% to $17.1 million in the first quarter of fiscal 2007. For the first three months of fiscal 2007, sales and marketing expenses remained fairly consistent as a percentage of revenue at 32.5%, as compared to 32.8% for the prior period. The increase in sales and marketing expenses is as a result of $2.7 million of costs associated with InterVideo operations. The sales and marketing expenses associated with existing Corel operations and products decreased by 1.0% to $14.4 million for the three months ended February 28, 2007. The decrease in the first quarter is attributable to a reduced spending related to our OEM relationships.
Research and Development.Research and development expenses increased by 83.5% to $11.3 million in the three months ended February 28, 2007. This is due to the inclusion of $4.9 million of research and development costs related to InterVideo activities. As a percentage of total revenues, research and development expenses increased significantly to 21.6% from 14.0%. This is due to the mix of InterVideo products which are research intensive relative to Corel products. The research and development costs relating to existing Corel activities increased by 4.9% to $6.5 million for the three months ending February 28, 2007 as compared to February 28, 2006. The increase in expenses is a direct result of higher salaries and benefits and localization costs related to our products targeted for emerging markets.
General and Administration.General and administration expenses increased to $9.1 million in the first quarter of fiscal 2007 from $5.4 million in the first quarter of fiscal 2006, due primarily to the inclusion of InterVideo operating costs of $2.3 million, which have not been impacted by expected acquisition synergies. As a percentage of total revenues, general and administration expenses increased to 17.3% in the quarter ended February 28, 2007 due to the nature of InterVideo operations which have historically had a greater amount of general and administration costs as a percentage of revenues as compared to Corel. Also, the general and administration costs related to existing Corel activities and operations increased by 26.5% to $6.8 million for the quarter ended February 28, 2007, due to additional public company costs such as director and officer insurance.
Acquired in-process Research and Development.Intangible assets acquired with InterVideo included $7.8 million of in-process research and development projects that, on the date of the acquisition, the related technology had not reached technological feasibility and did not have an alternate future use. As required by purchase accounting, this in-process research and development was expensed upon acquisition.
InterVideo Integration Expense:Integration costs relating to the acquisition of InterVideo totaling $785,000 have been recorded for the three month period ending February 28, 2007. These costs relate to the integration of the InterVideo business into our existing operations, including travel costs, retention bonuses and other incremental costs for Corel employees who worked on the integration planning process.
Non-Operating (Income) Expense
Three Months Ended | ||||||||
February 28, | ||||||||
2007 | 2006 | |||||||
Interest expense, net | 3,921 | 3,863 | ||||||
Amortization of deferred financing fees | 265 | 444 | ||||||
Other non-operating income | (632 | ) | (120 | ) | ||||
Total non-operating expenses | $ | 3,554 | $ | 4,187 | ||||
Interest Expense, Net.Net interest expense increased by $58,000 in the first quarter of fiscal 2007 from $3.9 million in the first quarter of fiscal 2006. The increase is due to the additional long-term debt carried in this period, which is offset partially by the lower interest rates on the existing term loan facility as compared to the facilities that existed during the first quarter of fiscal 2006.
Table of Contents
Amortization of Deferred Financing Fees.Amortization of deferred financing fees decreased to $265,000 in the first quarter of fiscal 2007 from $444,000 in the first quarter of fiscal 2007 as a direct result of the lower financing fees incurred under the senior credit facility.
Income Tax Expense (Recovery)
For the three months ended February 28, 2007, we recorded a tax provision of $355,000 on a loss before income taxes of $11.5 million. The current tax provision is $1.4 million and the deferred tax recoverable is $1.0 million. The deferred tax recovery is related to the reversal of the deferred tax liability of $25.8 million in respect of the intellectual property acquired as part of the InterVideo acquisition. Current taxes consist of foreign withholding taxes plus taxes incurred by Corel’s foreign subsidiaries.
For the three months ended February 28, 2006, we recorded a tax provision of $3.2 million on income before income tax expense of $1.5 million. Current taxes, consisting of foreign withholding taxes plus taxes incurred by Corel’s foreign subsidiaries.
FINANCIAL CONDITION
Working Capital
Our working capital deficiency at February 28, 2007 was $42.3 million, a decrease of $73.5 million from the November 30, 2006 working capital balance of $31.2 million. The decrease is primarily attributable to the non-recurring impact associated with the acquisition of Inter-Video. The acquisition of InterVideo used approximately $48.8 million of net working capital during the quarter, consisting of $19.1 million of cash, $23.0 million operating line of credit and $6.7 million of direct transaction and restructuring costs. The Company has and expects to continue generating positive cash flows from operations which we expect will significantly reduce the working capital deficiency over the next 12 months.
Liquidity and Capital Resources
As of February 28, 2007, our principal sources of liquidity are cash and cash equivalents of $40.9 million and trade accounts receivable of $15.7 million. As a part of our senior credit facility, we also entered into a five-year $75.0 million revolving line of credit facility, of which $52.0 million is unused as at February 28, 2007. In addition, we expect to generate cash from operations for the remainder of the fiscal year which will allow us to address our current working capital deficiency.
Cash provided by operations increased by $12.5 million to $18.4 million for the three months ended February 28, 2007 compared to $5.9 million for the three months ended February 28, 2006. The increase is due to the receipt of cash for royalty revenues in advance of our related obligation.
Table of Contents
Cash provided by financing activities was $91.9 million for the three months ended February 28, 2007 compared to the use of cash in financing activities of $11.0 million for the three month period ended February 28, 2006. The increase in financing activities relates to the $70.0 million term loan and the use of $23.0 million of our operating line of credit obtained to finance our acquisition of InterVideo. We also incurred $1.7 million of financing fees to obtain these financing arrangements, and received $1.3 million through the exercise of stock options. We made an $9.3 million repayment on our long-term debt in the three month period ended February 28, 2006.
Cash used in investing activities was $120.5 million in the three months ended February 28, 2007, a significant increase over the cash used of $430,000 in the three months ended February 28, 2006. This cash outlay reflects the purchase of InterVideo on December 12, 2006, and the remaining interest in Ulead on December 28, 2006 for $120.4 million.
Adjusted EBITDA
Adjusted EBITDA was $8.7 million in the first quarter of fiscal 2007 compared to $14.4 million in the first quarter of fiscal 2006.
Adjusted EBITDA is a non-GAAP measure that we use to assist in evaluation of our liquidity and is used by our bank lenders to calculate compliance with certain financial covenants. This measure does not have any standardized meaning prescribed by GAAP and therefore is unlikely to be comparable to the calculation of similar measures used by other companies, and should not be viewed as alternatives to measures of financial performance or changes in cash flows calculated in accordance with GAAP. We consider cash flow from operations to be the closest GAAP measure to Adjusted EBITDA. For the three months ended February 28, 2007 and 2006, we had cash flow from operations of $18.4 million and $5.9 million, respectively. The table below reconciles Adjusted EBITDA to cash flow from operations:
Three Months Ended | ||||||||
February 28, | ||||||||
2007 | 2006 | |||||||
Cash flow provided by operations | $ | 18,440 | $ | 5,926 | ||||
Change in operating assets and liabilities | (15,928 | ) | 1,343 | |||||
Interest expenses, net | 3,921 | 3,863 | ||||||
Income tax provision | 355 | 3,152 | ||||||
Deferred income taxes | 1,035 | (435 | ) | |||||
Provision for bad debts | (16 | ) | (122 | ) | ||||
Unrealized foreign exchange losses on forward contracts | (35 | ) | (28 | ) | ||||
Gain on Interest Rate Swap | 191 | — | ||||||
InterVideo integration costs | 785 | — | ||||||
Restructuring costs | — | 560 | ||||||
Reorganization costs | — | 117 | ||||||
Adjusted EBITDA | $ | 8,748 | $ | 14,376 | ||||
Item 3.Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of a loss that could affect our financial position resulting from adverse changes in the financial markets. Our primary risks relate to increases in interest rates and fluctuations in foreign currency exchange rates. Our market risk sensitive instruments were all entered into for non-trading purposes.
Table of Contents
Interest Rate Risk
Our exposure to interest rate risk relates primarily to our long-term debt. We have significantly larger amounts of interest bearing debt as compared to interest bearing assets. The risk is associated with increases in the prime lending rate, as a significant portion of the debt has a floating rate of interest based on the prime lending rate.
Given the amount of debt that we have, if lending rates were to rise significantly, the resulting interest cost could materially affect the business. Our annual interest expense would change by $498,000 for each 0.5% change in interest rates, based on debt outstanding as of February 28, 2007. In connection with the current debt facility, we use interest rate swaps to limit our exposure to changing interest rates and related future cash outflows. Interest rate swaps provide for us to pay an amount equal to a specified fixed rate of interest times a notional principal amount and to receive in return an amount equal to a variable rate of interest times the same notional amount.
As of February 28, 2007, our interest rate swaps convert an aggregate notional principal amount of $59.5 million (or approximately 37% of our interest-bearing debt) from floating rate interest payments under our term loan facility to fixed interest rate obligations. The variable rate of interest is based on three-month LIBOR plus 4.00%. The fixed rates range from 9.40% to 9.49%. During the first quarter of fiscal 2007, we have recorded a gain of $191,000 as a result of recording this interest rate swap at fair value.
Foreign Currency Risk
We earn most of our revenues in U.S dollars and the majority of our operating activities are located in Canada. Therefore, we incur a disproportionate percentage of costs in Canadian dollars as compared to Canadian dollar denominated revenues. We are therefore exposed to loss if the Canadian dollar appreciates against the U.S. dollar.
We manage our financial exposure to certain foreign exchange fluctuations with the objective of minimizing the impact of foreign currency exchange movements on our operations. We try to minimize the effect of changes in U.S. and Canadian dollar exchange rates on our business through the purchase of forward exchange contracts. As of February 28, 2007 we had three U.S. dollar foreign exchange contracts totaling $6,000,000, which will be settled between March 15, 2007 and May 15, 2007.
As of February 28, 2006 we did not have any U.S. dollar foreign exchange contacts.
As we also operate internationally, a portion of our business outside North America is conducted in currencies other than the U.S. dollar. Accordingly, the results of our business may also be affected by fluctuations in the U.S. dollar against certain European and Asian currencies, in particular the Pound Sterling, the Yen and Euro. Our exposure to these and other currencies is minimized due to certain hedges naturally occurring in our business as we have decentralized sales, marketing and support operations in which most costs are local currency based.
Item 4.Controls and Procedures
Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no changes in our internal control over financial reporting during the quarter ended February 28, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We acquired InterVideo on December 12, 2006 and contemporaneously with the closing of the acquisition commenced the process of conducting an ongoing review of the internal control over financial reporting of InterVideo. During the course of this evaluation, we made certain preliminary observations in respect of potential material weaknesses related to the financial reporting of InterVideo. More specifically the potential weakness related to the consolidation of InterVideo financial results. We have advised Corel’s Audit Committee and its Auditors of these preliminary observations. A material weakness is a control deficiency, or a combination of control deficiencies, that result(s) in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by employees in the normal cause of their work.
During the first quarter of 2007 the Company has taken the following actions to remediate the potential material weakness described above:
• | Hired and is in the process of hiring additional staff to review the consolidation reports and process |
• | Hired consultants to assist with the migration of InterVideo to Corel’s current financial reporting software expected to be finalized early in the third quarter of 2007 |
• | Arranged for temporary relocation of certain Corel senior management to InterVideo’s operations both in Fremont and Taiwan |
We identified an internal control weakness related to the preparation of our tax provisions. This weakness existed due to insufficient staff levels within our tax department and we believe it did not result in any material issues. We advised our Audit Committee and our Auditors. We have addressed this issue by increasing our staff levels in our tax department.
Table of Contents
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent or detect all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Corel have been detected.
PART II. OTHER INFORMATION
Item 1.Legal Proceedings
The Company is currently, and from time to time, involved in certain legal proceedings, as well as demands, claims and threatened litigation that arise in the normal course of its business, including assertions from third parties that it may be infringing patents or other intellectual property rights of others and from certain of our customers that they are entitled to indemnification from us in respect of claims that they are infringing such third party rights through the use or distribution of our products. If challenged, management believes that, if necessary, they would be able to obtain any required licenses or other rights to disputed intellectual property rights on commercially reasonable terms. However, the ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation can have an adverse impact on the business because of defense costs, negative publicity, diversion of management resources and other factors. Failure to obtain any necessary license or other rights on commercially reasonable terms, or otherwise, or litigation arising out of intellectual property claims could materially adversely affect the business.
In addition, some of our agreements with customers and distributors, including OEMs and online services companies, require us to indemnify these parties for third-party intellectual property infringement claims, and many of these indemnification obligations are not subject to monetary limits. The existence of these indemnification provisions could increase our cost of litigation and could significantly increase our exposure to losses from an adverse ruling
At the time of the acquisition of InterVideo, InterVideo was involved in certain legal proceedings and was the subject of demands, claims and threatened litigation that arose in the normal course of its business, including assertions that it may be infringing patents or other intellectual property rights of others. An estimate to settle these claims has been included in the preliminary purchase price of InterVideo, however, it is possible that such estimates may be significantly different from the settlement amounts. This difference may be reflected in the final purchase price allocation if resolved during the allocation period.
At February 28, 2007, we were a defendant in an ongoing patent infringement proceeding described below:
Electronics For Imaging, Inc., Massachusetts Institute of Technology v. Corel Corporation et al.Plaintiffs filed this patent infringement action on December 28, 2001 against the Company and 213 other defendants in the U.S. District Court for the Eastern District of Texas, alleging infringement of U.S. patent 4,500,919. The patent expired on May 6, 2002. Plaintiffs allege that the defendants infringed the patent through the use of various color management and correction systems in their products. Plaintiffs seek unspecified damages and attorneys fees. Following the Markman hearing and the trial court’s rulings on various summary judgment motions the plaintiffs dismissed all claims against every remaining defendant except the Company, Microsoft, Roxio, Abacus and MGI Software. The plaintiffs then stipulated to non-infringement in respect of these remaining defendants including the Company, and the action was dismissed in November 2004. In December 2004, the plaintiffs filed an appeal of various interlocutory rulings by the trial court including the trial court’s ruling on the Markman hearing and certain of the summary judgment decisions. On September 13, 2006 the US Court of Appeals for the Federal Circuit issued a decision on the appeal vacating, in part, the trial court’s dismissal and remanding the matter back to the trial court for further proceedings consistent with the Court of Appeals’ ruling. The Company believes it has meritorious defenses to the plaintiffs’ claims and intends to defend the litigation vigorously. However, the ultimate outcome of the litigation is uncertain.
Item 1A.Risk Factors
The risk factors set forth in the section entitled “Risk Factors” in our Form 10-K for the period ending November 30, 2006 (File No. 000-20562), which is incorporated by reference into this quarterly report.
Our success depends on our ability to adequately prevent piracy of the proprietary content owned by others which is accessed by customers through the use of our products
Our products allow our customers to use or display proprietary content owned by third parties, such as our customers’ use of our WinDVD product to play movies owned by various movie studios and production companies. Individuals who are sophisticated in the field of DVD technology and encryption have made use of our products to bypass security measures implemented by movie studios, hardware and software manufacturers (the “AACS Security Protocol”) and pirate the proprietary content thereby making it available to others who can then view the content without paying the required fees to the content owners or their agents. While we continuously update the security of our products to prevent such occurrences we can provide no assurances that such breaches will not occur in the future. The use of our products to improperly access proprietary third party content, and our requirement to update our software to correct any deficiencies, could harm our reputation with third party content providers and our customers. In some circumstances, it could also expose us to litigation and/or the requirement to compensate the owners of the proprietary content which is pirated. Further, repeated deficiencies in our products of this type could cause the AACS licensing authority to terminate our AACS license which allows us to participate in the AACS Security Protocol, a prerequisite for our products to be able to play high definition DVD content distributed by some movie studios and production companies. The loss of our AACS license would make our WinDVD product less attractive to some of our important OEM customers, who we rely upon for a significant amount of our revenue. Accordingly, our failure to adequately protect proprietary third party content could cause us to lose customers and potentially expose us to having to pay compensation to content owners, either of which would harm our business.
Our products allow our customers to use or display proprietary content owned by third parties, such as our customers’ use of our WinDVD product to play movies owned by various movie studios and production companies. Individuals who are sophisticated in the field of DVD technology and encryption have made use of our products to bypass security measures implemented by movie studios, hardware and software manufacturers (the “AACS Security Protocol”) and pirate the proprietary content thereby making it available to others who can then view the content without paying the required fees to the content owners or their agents. While we continuously update the security of our products to prevent such occurrences we can provide no assurances that such breaches will not occur in the future. The use of our products to improperly access proprietary third party content, and our requirement to update our software to correct any deficiencies, could harm our reputation with third party content providers and our customers. In some circumstances, it could also expose us to litigation and/or the requirement to compensate the owners of the proprietary content which is pirated. Further, repeated deficiencies in our products of this type could cause the AACS licensing authority to terminate our AACS license which allows us to participate in the AACS Security Protocol, a prerequisite for our products to be able to play high definition DVD content distributed by some movie studios and production companies. The loss of our AACS license would make our WinDVD product less attractive to some of our important OEM customers, who we rely upon for a significant amount of our revenue. Accordingly, our failure to adequately protect proprietary third party content could cause us to lose customers and potentially expose us to having to pay compensation to content owners, either of which would harm our business.
Table of Contents
Item 2.Use of Proceeds
Not applicable
Item 6. Exhibits
Exhibit | ||
Number | Exhibit | |
3.1* | Certificate and Articles of Continuance | |
3.2* | Articles of Amendment | |
3.3* | By-laws | |
10.1** | Form of Voting Agreement | |
31.1 | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Incorporated by reference to the exhibit of the same number in the Company’s Registration Statement on Form F-1, as amended (File No. 333-132970) | |
** | Incorporated by reference as an exhibit to the Company’s Current Report on Form 8-K filed August 31, 2006. |
Items 3, 4 and 5 are not applicable to us and have been omitted.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Corel Corporation | ||||
By: | /s/ Douglas McCollam | |||
Douglas McCollam | ||||
Chief Financial Officer, Director (Principal Financial Officer and Chief Accounting Officer) | ||||
Date: April 20, 2007