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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 August 31, 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 | 98-0407194 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
1600 Carling Avenue, Ottawa, Ontario | K1Z 8R7 | |
(Address of principal executive office) | (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. Yes þ No o
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 filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares outstanding of the registrant’s common stock as of September 28, 2007 was 25,269,269
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EX-32.2: CERTIFICATIONS |
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COREL CORPORATION
Form 10-Q
For the Quarter Ended August 31, 2007
INDEX
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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)
August 31, | November 30, | |||||||||||
Note | 2007 | 2006 | ||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 21,257 | $ | 51,030 | ||||||||
Restricted cash | 217 | 717 | ||||||||||
Accounts receivable | ||||||||||||
Trade, net of allowances for doubtful accounts of $1,183 and $1,003, respectively | 24,309 | 18,150 | ||||||||||
Other | 1,431 | 808 | ||||||||||
Inventory | 3 | 856 | 914 | |||||||||
Income taxes recoverable | 6 | 1,024 | — | |||||||||
Prepaids and other current assets | 4,419 | 2,300 | ||||||||||
Total current assets | 53,513 | 73,919 | ||||||||||
Investments | 218 | 203 | ||||||||||
Capital assets | 9,156 | 3,651 | ||||||||||
Intangible assets | 4,5 | 98,041 | 37,831 | |||||||||
Goodwill | 4 | 83,419 | 9,850 | |||||||||
Deferred financing and other long-term assets | 7 | 4,852 | 5,232 | |||||||||
Total assets | $ | 249,199 | $ | 130,686 | ||||||||
Liabilities and shareholders’ deficit | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable and accrued liabilities | 10 | $ | 49,699 | $ | 28,220 | |||||||
Due to related parties | — | 167 | ||||||||||
Operating line of credit | 7 | 7,000 | — | |||||||||
Income taxes payable | — | 235 | ||||||||||
Deferred revenue | 13,333 | 12,719 | ||||||||||
Current portion of long-term debt | 7 | 2,164 | 1,426 | |||||||||
Current portion of obligation under capital leases | 8 | 655 | — | |||||||||
Total current liabilities | 72,851 | 42,767 | ||||||||||
Deferred revenue | 2,285 | 2,015 | ||||||||||
Deferred income tax liability | 4,6 | 22,189 | — | |||||||||
Obligation under capital leases | 8 | 2,209 | — | |||||||||
Income taxes payable | 12,528 | 8,488 | ||||||||||
Long-term debt | 7 | 156,808 | 89,223 | |||||||||
Total liabilities | 268,870 | 142,493 | ||||||||||
Commitments and contingencies | 8 | |||||||||||
Shareholders’ deficit | ||||||||||||
Share capital: | ||||||||||||
Common Shares (par value: none; authorized: unlimited; issued and outstanding: 25,166 and 24,535 shares, respectively) | 37,526 | 30,722 | ||||||||||
Additional paid-in capital | 4 | 6,211 | 4,612 | |||||||||
Accumulated other comprehensive income (loss) | 10 | (46 | ) | |||||||||
Deficit | (63,418 | ) | (47,095 | ) | ||||||||
Total shareholders’ deficit | (19,671 | ) | (11,807 | ) | ||||||||
Total liabilities and shareholders’ deficit | $ | 249,199 | $ | 130,686 | ||||||||
See Accompanying Notes to the Consolidated Financial Statements
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Corel Corporation
Consolidated Statements of Operations
(In thousands of U.S. dollars or shares, except per share data)
(Unaudited)
Consolidated Statements of Operations
(In thousands of U.S. dollars or shares, except per share data)
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||||||
August 31, | August 31, | |||||||||||||||||||
Note | 2007 | 2006 | 2007 | 2006 | ||||||||||||||||
Revenues | ||||||||||||||||||||
Product | $ | 55,018 | $ | 36,362 | $ | 161,875 | $ | 115,011 | ||||||||||||
Maintenance and services | 5,352 | 4,892 | 16,161 | 14,740 | ||||||||||||||||
Total revenues | 13 | 60,370 | 41,254 | 178,036 | 129,751 | |||||||||||||||
Cost of revenues | ||||||||||||||||||||
Cost of products | 12,143 | 5,338 | 34,640 | 15,392 | ||||||||||||||||
Cost of maintenance and services | 244 | 287 | 663 | 877 | ||||||||||||||||
Amortization of intangible assets | 6,925 | 2,712 | 19,055 | 11,987 | ||||||||||||||||
Total cost of revenues | 19,312 | 8,337 | 54,358 | 28,256 | ||||||||||||||||
Gross margin | 41,058 | 32,917 | 123,678 | 101,495 | ||||||||||||||||
Operating expenses | ||||||||||||||||||||
Sales and marketing | 17,231 | 11,810 | 51,827 | 40,337 | ||||||||||||||||
Research and development | 11,282 | 6,379 | 33,323 | 19,200 | ||||||||||||||||
General and administration | 8,803 | 5,833 | 27,085 | 17,421 | ||||||||||||||||
Acquired in-process research and development | — | — | 7,831 | — | ||||||||||||||||
InterVideo integration expense | 4 | 2,220 | — | 3,865 | — | |||||||||||||||
Restructuring | 10 | — | — | — | 811 | |||||||||||||||
Total operating expenses | 39,536 | 24,022 | 123,931 | 77,769 | ||||||||||||||||
Income from operations | 1,522 | 8,895 | (253 | ) | 23,726 | |||||||||||||||
Other expenses (income) | ||||||||||||||||||||
Loss on debt retirement | — | 17 | — | 8,292 | ||||||||||||||||
Interest expense, net | 4,195 | 2,334 | 11,834 | 9,404 | ||||||||||||||||
Amortization of deferred financing fees | 270 | 188 | 804 | 989 | ||||||||||||||||
Other non-operating (income) expense | (497 | ) | 377 | (650 | ) | (271 | ) | |||||||||||||
Income (loss) before taxes | (2,446 | ) | 5,979 | (12,241 | ) | 5,312 | ||||||||||||||
Income tax recovery (provision) | 6 | (4,314 | ) | (485 | ) | (4,082 | ) | (5,427 | ) | |||||||||||
Net income (loss) | $ | (6,760 | ) | $ | 5,494 | $ | (16,323 | ) | $ | (115 | ) | |||||||||
Other comprehensive income (loss) | ||||||||||||||||||||
Unrealized (loss) gain on securities, net of taxes | 56 | (36 | ) | 56 | (107 | ) | ||||||||||||||
Other comprehensive income (loss) income, net of taxes | 56 | (36 | ) | 56 | (107 | ) | ||||||||||||||
Comprehensive income (loss) | $ | (6,704 | ) | $ | 5,458 | $ | (16,267 | ) | $ | (222 | ) | |||||||||
Net income (loss) per share: | ||||||||||||||||||||
Basic | $ | (0.27 | ) | $ | 0.22 | $ | (0.66 | ) | $ | (0.01 | ) | |||||||||
Fully Diluted | $ | (0.27 | ) | $ | 0.22 | $ | (0.66 | ) | $ | (0.01 | ) | |||||||||
Weighted average number of shares: | ||||||||||||||||||||
Basic | 25,041 | 24,494 | 24,828 | 21,708 | ||||||||||||||||
Fully diluted | 11 | 25,041 | 25,348 | 24,828 | 21,708 |
See Accompanying Notes to the Consolidated Financial Statements
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Corel Corporation
Consolidated Statement of Cash Flows
(in thousands of U.S. dollars)
(Unaudited)
Consolidated Statement of Cash Flows
(in thousands of U.S. dollars)
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||||||
August 31, | August 31, | |||||||||||||||||||
Note | 2007 | 2006 | 2007 | 2006 | ||||||||||||||||
Cash flows from operating activities | ||||||||||||||||||||
Net income (loss) | $ | (6,760 | ) | $ | 5,494 | $ | (16,323 | ) | $ | (115 | ) | |||||||||
Depreciation and amortization | 544 | 336 | 2,215 | 1,112 | ||||||||||||||||
Amortization of deferred financing fees | 270 | 188 | 804 | 989 | ||||||||||||||||
Amortization of intangible assets | 6,925 | 2,712 | 19,055 | 11,987 | ||||||||||||||||
Stock-based compensation | 9 | 1,770 | 805 | 4,068 | 2,451 | |||||||||||||||
Provision for bad debts | 115 | (24 | ) | 180 | 150 | |||||||||||||||
Deferred income taxes | 3,667 | — | 1,352 | 636 | ||||||||||||||||
Acquired in-process research and development | 4 | — | — | 7,831 | — | |||||||||||||||
Unrealized (gain) loss on forward exchange contracts | (26 | ) | (43 | ) | 9 | 178 | ||||||||||||||
Loss on early retirement of debt | — | 17 | — | 8,292 | ||||||||||||||||
Loss on disposal of fixed assets | 48 | — | 102 | — | ||||||||||||||||
(Gain) loss on interest rate swap recorded at fair value | 337 | — | (245 | ) | — | |||||||||||||||
Change in operating assets and liabilities | 12 | (6,387 | ) | (3,453 | ) | (3,321 | ) | (3,981 | ) | |||||||||||
Cash flows provided by operating activities | 503 | 6,032 | 15,727 | 21,699 | ||||||||||||||||
Cash flows from financing activities | ||||||||||||||||||||
Reduction (increase) in restricted cash | 500 | (1 | ) | 500 | (1 | ) | ||||||||||||||
Proceeds from operating line of credit | 7 | — | — | 48,000 | — | |||||||||||||||
Repayments of operating line of credit | 7 | (6,000 | ) | — | (41,000 | ) | — | |||||||||||||
Proceeds from long-term debt | — | — | 70,000 | 90,000 | ||||||||||||||||
Repayments of long-term debt | (399 | ) | (225 | ) | (1,479 | ) | (148,954 | ) | ||||||||||||
Repayments of capital lease obligations | (128 | ) | — | (128 | ) | — | ||||||||||||||
Financing fees incurred | (4 | ) | (70 | ) | (1,681 | ) | (7,708 | ) | ||||||||||||
Net proceeds from public offering | — | (3,221 | ) | — | 69,317 | |||||||||||||||
Proceeds from exercise of stock options | 1,298 | 3 | 3,987 | 4 | ||||||||||||||||
Dividends paid | — | — | — | (7,500 | ) | |||||||||||||||
Other financing activities | (272 | ) | (340 | ) | (221 | ) | (1,438 | ) | ||||||||||||
Cash flows provided by (used in) financing activities | (5,005 | ) | (3,854 | ) | 77,978 | (6,280 | ) | |||||||||||||
Cash flows from investing activities | ||||||||||||||||||||
Purchase of InterVideo Inc., net of cash acquired | 4 | (203 | ) | — | (121,357 | ) | — | |||||||||||||
Purchase of capital assets | (1,441 | ) | (616 | ) | (2,159 | ) | (1,471 | ) | ||||||||||||
Cash flows used in investing activities | (1,644 | ) | (616 | ) | (123,516 | ) | (1,471 | ) | ||||||||||||
Effect of exchange rate changes on cash and cash equivalents | (7 | ) | (29 | ) | 38 | (140 | ) | |||||||||||||
Increase (decrease) in cash and cash equivalents | (6,153 | ) | 1,533 | (29,773 | ) | 13,808 | ||||||||||||||
Cash and cash equivalents, beginning of period | 27,410 | 33,021 | 51,030 | 20,746 | ||||||||||||||||
Cash and cash equivalents, end of period | $ | 21,257 | $ | 34,554 | $ | 21,257 | $ | 34,554 | ||||||||||||
Supplementary Disclosure | ||||||||||||||||||||
Cash paid for income taxes | $ | 842 | 4,110 | $ | 1,758 | 5,506 | ||||||||||||||
Cash paid for interest | $ | 4,499 | �� | 1,698 | $ | 12,617 | 8,012 | |||||||||||||
Purchases of capital assets under capital lease | 8 | $ | 494 | — | $ | 2,991 | — |
See Accompanying Notes to the Consolidated Financial Statements
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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 and nine months ended August 31, 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 and nine months ended August 31, 2007.
The purchase price allocation associated with this acquisition is still preliminary as some amounts are dependent upon the expected receipt of finalized information. These include restructuring costs that have been estimated and approved but for which the restructuring is not yet 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, and estimates made for certain revenue provisions for which final amounts are dependant upon actual 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.
Recently adopted accounting policies
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.
Leases
Leases are classified as capital or operating depending on the terms and conditions of the contracts. The costs of assets acquired under capital leases are amortized on a straight-line basis over their estimated useful lives. Obligations recorded under capital leases are reduced by lease payments net of imputed interest.
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Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board released FIN 48,Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement 109and 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 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:
August | November | |||||||
31, 2007 | 30, 2006 | |||||||
Product components | $ | 338 | $ | 444 | ||||
Finished goods | 518 | 470 | ||||||
$ | 856 | $ | 914 | |||||
4. Acquisition of InterVideo
On December 12, 2006, Corel completed the acquisition of 100% of the voting equity 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 has extended 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.
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Purchase Price
The total preliminary 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 (note 9) | (2,784 | ) | ||
Direct transaction costs | 3,552 | |||
Estimated restructuring costs (note 10) | 4,142 | |||
Total purchase price | $ | 228,768 | ||
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.
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, once vested, are exercisable into 1,700,717 Corel 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 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 |
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The deferred stock-based compensation is being amortized to expenses over the remaining vesting periods of the underlying options.
Direct transaction costs
Direct transaction costs of $3.6 million include investment banking, legal and accounting fees, and other external costs directly related to the acquisition.
Restructuring costs
Estimated restructuring costs of $4.1 million relate to InterVideo operations, and are primarily for costs for severance and excess facilities. See Note 10 for further details of the amounts accrued and payments made during 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 made by management. The allocation of the preliminary purchase price is as follows:
Amount | ||||
Cash, cash equivalents, and short-term investments | $ | 106,691 | ||
Working capital | (21,072 | ) | ||
Capital and other long-term assets | 3,839 | |||
Identifiable definite lived intangible assets | 86,577 | |||
Deferred tax liability | (20.836 | ) | ||
Net assets acquired | 155,199 | |||
Total preliminary purchase price | 228,768 | |||
Goodwill from InterVideo acquisition | 73,569 | |||
Goodwill at November 30, 2006 | 9,850 | |||
Goodwill at August 31, 2007 | $ | 83,419 | ||
The purchase price allocation associated with this acquisition is still preliminary as some amounts are dependent upon the expected receipt of finalized information. These include restructuring costs that have been estimated and approved but for which the restructuring is not yet 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, and estimates made for certain revenue provisions for which final amounts are dependant upon actual 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.
During the third quarter of fiscal 2007 changes were made to our initial purchase price allocation. Working capital in the allocation increased by $1,045 due to changes in contingencies, revenue provisions, and other assets and liabilities. The preliminary purchase price increased by $203 due to a $14 increase in restructuring costs (refer to note 10) and $189 of direct transaction costs related to professional fees.
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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 value assigned to identifiable definite lived intangible assets are as follows:
First Year | Estimated Weighted Average | |||||||||||
Assigned Value | Amortization | Life (in years) | ||||||||||
Acquired existing technologies | $ | 57,520 | $ | 10,874 | 4.8 | |||||||
In-process research and development | 7,831 | — | — | |||||||||
Customer relationships | 10,651 | 3,045 | 5.4 | |||||||||
Trade names | 10,575 | 2,115 | 5.0 | |||||||||
Total | $ | 86,577 | $ | 16,034 | ||||||||
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.
Acquired existing technology relates to InterVideo products across all of its product lines that have reached technological feasibility. Corel amortizes 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 are expected to be realized.
Customer relationships represent existing contracts that relate primarily to underlying customer relationships. Corel amortizes the fair value of these assets over 7 years, based on the pattern in which the economic benefits of the customer relationship are expected to be realized.
The InterVideo trade name and other product names are being amortized on a straight line basis over 5 years which best reflects the period in which the economic benefits of the intangible asset are expected to 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, for which a full valuation allowance was applied in the quarter ending August 31, 2007 (refer to note 6).
Goodwill
Approximately $73.6 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.
InterVideo Integration Expense
Integration costs relating to the acquisition of InterVideo totaling $2.2 million and $3.9 million have been recorded for the three and nine month periods ending August 31, 2007. These costs relate to the integration of the InterVideo business into our existing operations, including travel costs, retention bonuses, incremental employees engaged solely for integration activities, other incremental costs for Corel employees who worked on the integration planning process, consultants for integrating systems, and other one time charges for integrating systems
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
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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 $3.4 million and $10.2 million, for the three months and nine months ended, respectively | |
• | deferred tax recovery of $1.2 million and $3.6 million, for the three months and nine months ended, respectively, related to the amortization of acquired intangible assets | |
• | additional interest expense of $2.3 million and $7.0 million, for the three months and nine months ended, respectively, on additional debt financing for the acquisition | |
• | reduced stock based compensation expense of $0.6 million and $2.0 million, for the three months and nine months ended, respectively | |
• | elimination of minority interest loss of $0.2 million and 0.8 million for the three months and nine months ended, respectively | |
• | amortization of deferred financing fees of $0.1 million and $0.2 million, for the three months and nine months ended, respectively, related to acquisition financing |
The unaudited pro forma financial information for the three and nine months ended August 31, 2007 combines the historical results for Corel for the three and nine months ended August 31, 2006 and the historical results for InterVideo for the three and nine months ended September 30, 2006.
Three Months | Nine Months | |||||||
Ended | Ended | |||||||
August 31, | August 31, | |||||||
2006 | 2006 | |||||||
Net revenues | $ | 66,182 | $ | 215,722 | ||||
Net loss | $ | (142 | ) | $ | (11,077 | ) | ||
Basic net loss per share | $ | (0.01 | ) | $ | (0.51 | ) | ||
Diluted net loss per share | $ | (0.01 | ) | $ | (0.51 | ) |
5. Intangible Assets
Intangible assets are comprised of the following as at August 31, 2007:
Cost of intangible assets at November 30, 2006 | $ | 99,802 | ||
Cost of intangible assets acquired with InterVideo | 86,577 | |||
Other intangibles acquired since November 30, 2006 | 542 | |||
Total cost of intangible assets | 186,921 | |||
Less: | ||||
Accumulated amortization | 81,049 | |||
In-process research and development acquired with InterVideo | 7,831 | |||
Net book value of intangible assets at August 31, 2007 | $ | 98,041 | ||
6. Income Taxes
For the three and nine months ended August 31, 2007, the Company recorded a tax provision of $4.3 million and $4.1 million on a loss before income taxes of $2.4 million and $12.2 million, respectively. The majority of the tax provision relates to an additional $5.0 million valuation allowance against all deferred tax assets assumed in the InterVideo acquisition (refer to note 4). In the current quarter, Corel determined that it was no longer more likely than not that the deferred tax assets would be realized, and accordingly a valuation allowance was recorded. The remaining balance reflects foreign withholding taxes plus provisions for income taxes for subsidiaries that have taxable income in the period, offset by a reduction in our deferred income tax liability related to the amortization of intangible assets recorded on the acquisition of InterVideo. The Company has increased the valuation allowance to fully provide for tax losses realized by other subsidiaries in the quarter.
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The income tax recoverable balance of $1.0 million reflects installments made in excess of estimated tax expense for the upcoming year for various tax entities. The deferred income tax liability of $22.2 million arises from the acquisition of InterVideo. A balance of $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. Of this balance of $25.8 million, $3.6 million has been amortized in the nine months ending August 31, 2007.
During the three and nine months ended August 31, 2006, the Company recorded a tax provision of $485 and $5.4 million on income before income taxes of $6.0 million and $5.3 million, respectively. The entire provision is for current taxes. Current taxes consist of foreign withholding taxes plus taxes incurred by Corel’s foreign subsidiaries.
7. Long-term Debt
The components of long term debt are as follows:
August 31, 2007 | November 30, 2006 | |||||||||||||||||||||||
Current | Long Term | Total | Current | Long Term | Total | |||||||||||||||||||
Term loan | $ | 1,596 | $ | 156,757 | $ | 158,353 | $ | 900 | $ | 88,650 | $ | 89,550 | ||||||||||||
Promissory note | 568 | 51 | 619 | 526 | 573 | 1,099 | ||||||||||||||||||
Total | $ | 2,164 | $ | 156,808 | $ | 158,972 | $ | 1,426 | $ | 89,223 | $ | 90,649 | ||||||||||||
Line of credit | $ | 75,000 | $ | 75,000 | ||||||||||||||||||||
Outstanding balance | 7,000 | $ | — | |||||||||||||||||||||
Available line of credit | $ | 68,000 | $ | 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 term to 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 and 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 remainder from cash of the combined Company. During the nine months ended August 31, 2007 the Company has repaid $36.0 million of the revolving line of credit. The balance outstanding on the line of credit at August 31, 2007 was $7.0 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 May 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 on excess cash flow as defined in the agreement. The Company currently estimates that no payment will be required for the fiscal 2007 cash sweep and that no payments will be required through August 31, 2008.
In addition to the above loans, the facility also provides the Company with a $25.0 million letter of credit and a $5.0 million Swingline commitment. The applicable interest rate on any borrowings is based on a leverage ratio pricing grid. As at August 31, 2007, a balance of $2.2 million was outstanding on the letter of credit, and no balance was outstanding on the Swingline commitment. The letter of credit is used as a bond for a litigation ruling that is in the process of being appealed.
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%.
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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, 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 August 31, 2007, Corel was in compliance with all debt covenants.
The future debt payments on long-term debt as of August 31, 2007, excluding the annual cash sweep as discussed above, are as follows:
Term Loan | ||||||||||||
Principal | Interest | Total | ||||||||||
2007, remainder of | $ | 399 | $ | 3,792 | $ | 4,191 | ||||||
2008 | 2,164 | 15,073 | 17,237 | |||||||||
2009 | 1,646 | 14,919 | 16,565 | |||||||||
2010 | 1,596 | 14,766 | 16,362 | |||||||||
2011 | 1,596 | 14,613 | 16,209 | |||||||||
2012 | 151,571 | 4,866 | 156,437 | |||||||||
Total | $ | 158,972 | $ | 68,029 | $ | 227,001 | ||||||
Deferred Financing Charges
The deferred financing charges of $4.7 million reflect the unamortized portion of financing charges incurred on our senior credit facility agreement reached on May 2, 2006 and the amendment of this facility on December 12, 2006. In relation to the amendment of the Company’s term loan on December 12, 2006, the Company incurred financing charges in the amount of $1,681. These charges have been deferred and are being amortized over the term of the associated debt using the effective interest rate method. Amortization of deferred financing charges was $270 and $804 respectively, for the three and nine month periods ended August 31, 2007.
8. 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. As part of our integration activities some of these locations have now been closed or merged with existing Corel offices.
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. 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
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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 allocation 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.
During the period ending August 31, 2007, we resolved an ongoing patent infringement proceeding as 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. In August 2007, a settlement was reached with the Plaintiff, and in September 2007 the District Court dismissed the action. The impact of the settlement was immaterial to the results from operations.
At August 31, 2007, we were a defendant in an ongoing patent infringement proceeding described below
Disc Link Corporation v. H&R Block Digital Tax Solutions, Corel Corporation, Corel Inc., et al.Plaintiff filed this patent infringement action on April 10, 2007, against Corel Corporation and Corel Inc. (collectively “Company”) and 26 other defendants in the U.S District Court for the Eastern District of Texas, alleging infringement of U.S. Patent 6,314,574. The patent issued November 6, 2001. Plaintiff alleges that the defendants infringed the patent through the use of hyperlinks in software in software applications sold on discs, in particular hyperlinks which allegedly facilitate the provision of certain types of technical support. Company filed its answer and counterclaims to Plaintiff’s complaint on July 13, 2007. On August 1, 2007, twenty-one defendants including Company filed a motion to transfer this case to another court. A decision on the motion to transfer has not been issued by the court. As of the end of August 2007, several defendants have entered into license agreements with Plaintiff and settled their disputes with respect to this lawsuit. Company believes it has meritorious defenses to the Plaintiff’s claims and intends to defend the litigation vigorously. The ultimate outcome of the litigation, however, is uncertain.
At the beginning of the third quarter of fiscal 2007, Corel received a notice of reassessment from the Ministry of Revenue of Ontario (the “Ministry”) for CDN$13.4 million. The Ministry’s reassessment disallows various deductions claimed on our tax returns for the 2000, 2001 and 2002 taxation years resulting in a potential disallowance of loss carryforwards and liabilities for tax and interest. Subsequent to August 31, 2007, Corel received further notice that the Ministry had applied tax losses and other attributes which reduced the assessment from CDN$13.4 million to CDN$5.8 million. The Company intends to vigorously defend against the reassessment. While the Company believes that they have adequately provided for potential assessments, it is possible that an adverse outcome may lead to a deficiency in its recorded income tax expense and may adversely affect its liquidity. However, the Company believes that the positions taken in its tax returns are correct and estimates the potential loss from the re-reassessment will not have a material impact on our financial condition or results of operations.
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Obligations under Capital Leases
In 2007, Corel entered into various capital leases totaling $2,991. The leases expire on various dates, at which time the Company has the right, but not the obligation, to purchase the equipment. Minimum lease payments for capital leases in aggregate and for the next five years are as follows:
Obligations under Capital Leases | ||||
2007 (remainder of) | $ | 167 | ||
2008 | 904 | |||
2009 | 904 | |||
2010 | 825 | |||
2011 | 320 | |||
Thereafter | 191 | |||
Total minimum lease payments | $ | 3,311 | ||
Interest included in minimum payments at rates varying between 6.94% to 7.89% | 447 | |||
Present value of minimum lease payments | 2,864 | |||
Less current portion | 655 | |||
$ | 2,209 | |||
Operating Lease Commitments
On August 9, 2007 management entered into a new lease agreement for the rental of office space at our corporate head office in Ottawa. The agreement extends over the period of January 1, 2008 through December 31, 2017. The committed amount for basic rent over this period is $12,401.
Letter of Credit
As at August 31, 2007, a balance of $2.2 million was outstanding on the letter of credit balance available to us under our credit facility agreement. The letter of credit is used as a bond for a litigation ruling that is in the process of being appealed.
9. Shareholders’ Equity
Stock option plans
The following table shows total stock-based compensation expense included in the consolidated statement of operations:
Three Months | Nine Months | |||||||||||||||
Ended August 31, | Ended August 31, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Cost of products | $ | 15 | $ | 4 | $ | 33 | $ | 19 | ||||||||
Cost of maintenance and services | 3 | 2 | 7 | 6 | ||||||||||||
Sales and marketing | 468 | 231 | 1,049 | 543 | ||||||||||||
Research and development | 369 | 101 | 857 | 217 | ||||||||||||
General and administration | 915 | 467 | 2,122 | 1,666 | ||||||||||||
Total stock-based compensation expense | $ | 1,770 | $ | 805 | $ | 4,068 | $ | 2,451 | ||||||||
There have been no capitalized stock-based compensation costs.
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.
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The fair value, estimated using the Black-Scholes model, of all options granted during the quarter ended August 31, 2007 and August 31, 2006, was estimated as of the date of grant using the following weighted average assumptions:
Three Months Ended | ||||||||
August 31, | ||||||||
2007 | 2006 | |||||||
Expected option life (years) | 7 | 7 | ||||||
Volatility | 30.64 | % | 36.11 | % | ||||
Risk free interest rate | 4.92 | % | 4.46 | % | ||||
Forfeiture Rate | 16.58 | % | 16.82 | % | ||||
Dividend yield | Nil | Nil |
As of August 31, 2007, there was $13,856 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 August 31, 2007, there was $1,942 of unamortized deferred compensation, related to the acquisition of InterVideo, which will be recognized over a period of 3.28 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. In May 2007, the board of directors authorized that an additional 2,000,000 common shares were available for issuance. Corel has 4,459,025 remaining common shares authorized for issuance under the 2006 Equity Incentive Plan.
Option activity under the 2006 Equity Incentive Plan for the three and nine month periods ended August 31, 2007 are presented below:
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, (note 4) | 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 | |||||||||||
Granted | 1,295,283 | 12.83 | 4.93 | |||||||||||||
Exercised | (115,356 | ) | 10.78 | 4.55 | ||||||||||||
Forfeited | (276,532 | ) | 14.48 | 2.06 | ||||||||||||
Outstanding at May 31, 2007 | 2,946,422 | $ | 12.51 | $ | 3.97 | |||||||||||
Granted | 424,372 | 13.40 | 5.33 | |||||||||||||
Exercised | (130,018 | ) | 11.04 | 6.13 | ||||||||||||
Forfeited | (357,847 | ) | 13.56 | 3.45 | ||||||||||||
Outstanding at August 31, 2007 | 2,882,928 | $ | 12.61 | $ | 4.51 | |||||||||||
Exercisable at August 31, 2007 | 750,150 | $ | 12.63 | $ | 3.25 | |||||||||||
Weighted average remaining life of the outstanding options | 8.79 | Years | ||||||||||||||
Total intrinsic value of exercisable options | $ | 110 | ||||||||||||||
Weighted average remaining life of the exercisable options | 7.01 | Years |
During fiscal 2007 the Company has issued 50,000 units of restricted stock to senior officers of the Company under the 2006 Equity Incentive Plan. There are 30,000 and 20,000 units which will vest fully if the officers remain with the Company until June 1, 2008 and April 24, 2011, respectively. Furthermore, if certain performance conditions are met, 20,000 of these restricted stock units may vest earlier. These units will begin to vest on September 1, 2007 and will vest fully by April 24, 2011.
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.
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2003 Share Option and Phantom Share Unit Plan
As options are no longer offered for distribution under this plan, in the three months ended May 31, 2007 no options were granted. Unit activity for the three and nine month periods ended August 31, 2007 is presented below: Corel has 1,233,523 remaining common shares authorized for issuance under the 2003 Equity Incentive 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 | |||||||||||
Exercised | (123,103 | ) | 1.17 | 6.52 | ||||||||||||
Forfeited | (6,485 | ) | 1.79 | 5.65 | ||||||||||||
Balance, May 31, 2007 | 1,152,052 | $ | 2.07 | $ | 7.30 | |||||||||||
Exercised | (83,055 | ) | 1.17 | 6.47 | ||||||||||||
Forfeited | (30,345 | ) | 1.81 | 5.60 | ||||||||||||
Balance, August 31, 2007 | 1,038,652 | $ | 2.15 | $ | 6.25 | |||||||||||
Exercisable at August 31, 2007 | 703,185 | $ | 1.71 | $ | 5.73 | |||||||||||
Weighted average remaining life of the outstanding options | 7.41 | Years | ||||||||||||||
Total intrinsic value of exercisable options | $ | 7,781 | ||||||||||||||
Weighted average remaining life of the exercisable options | 7.25 | Years |
10. Restructuring Charges
InterVideo Acquisition Related Restructuring Charges
In conjunction with the acquisition of InterVideo, management has implemented a restructuring plan (“InterVideo plan”) and has incurred 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. These charges have been included in the purchase price of InterVideo (refer to note 4).
As of August 31, 2007, the majority of the headcount reductions have been identified and completed. Facilities that will be closed have been identified and notices of termination are in process. Restructuring activities are expected to be completed by the end of fiscal 2007.
A summary of restructuring activities related to the acquisition of InterVideo that have been included as part of the purchase price allocation follows:
Balance as at | ||||||||||||||||
Initial Estimate | Changes in Estimate | Cash Payments | August 31, 2007 | |||||||||||||
Termination benefits | $ | 2,969 | (208 | ) | $ | 2,047 | $ | 714 | ||||||||
Cost of closing redundant facilities | 900 | 481 | 638 | 743 | ||||||||||||
Total | $ | 3,869 | 273 | $ | 2,685 | $ | 1,457 | |||||||||
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 August 31, 2007. Any changes in estimates related to the InterVideo plan would result in an offsetting change to Goodwill.
Restructuring costs of $811 incurred in the nine months ending August 31 2006 represent severance costs related to the realignment of our sales and marketing force in the Americas and our research and development team.
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11. Net Income (Loss) Per Share
With the exception of the three month period ending August 31, 2006, the impact of the potential exercise of Corel options is anti-dilutive in the periods presented. Potentially dilutive instruments relating to the weighted average number of common shares subject to options outstanding for the nine month period ended August 31, 2006 and the three and nine month periods ended August 31, 2007, were 1,512,000 options, 4,003,000 options, and 3,394,000 options, respectively. For the three months ending August 31, 2006, the dilutive impact of the outstanding options on common shares was 854,000.
12. Change in Operating Assets and Liabilities
Three months ended | Nine months ended | |||||||||||||||
August 31 | August 31 | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Accounts receivable | $ | (4,695 | ) | $ | 1,653 | $ | 6,184 | $ | 4,173 | |||||||
Inventory | 185 | 360 | 1,407 | (279 | ) | |||||||||||
Prepaids and other current assets | (73 | ) | (70 | ) | (38 | ) | (189 | ) | ||||||||
Accounts payable and accrued liabilities | (4,108 | ) | (1,794 | ) | (12,221 | ) | (5,330 | ) | ||||||||
Due to related parties | — | — | (167 | ) | — | |||||||||||
Accrued interest | (504 | ) | 161 | (418 | ) | (100 | ) | |||||||||
Taxes payable | (37 | ) | (3,658 | ) | 1,212 | (577 | ) | |||||||||
Deferred revenue | 2,845 | (105 | ) | 720 | (1,679 | ) | ||||||||||
Total change in operating assets and liabilities | $ | (6,387 | ) | $ | ($3,453 | ) | $ | (3,321 | ) | $ | (3,981 | ) | ||||
13. 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 categories Graphics and Productivity, and Digital Media. 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 | Nine Months Ended | |||||||||||||||
August 31, | August 31, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
By product category: | ||||||||||||||||
Graphics and Productivity | $ | 33,683 | $ | 32,619 | $ | 102,264 | $ | 103,330 | ||||||||
Digital Media | 26,687 | 8,635 | 75,772 | 26,421 | ||||||||||||
$ | 60,370 | $ | 41,254 | $ | 178,036 | $ | 129,751 | |||||||||
By geographic region: | ||||||||||||||||
Americas Canada | $ | 1,159 | $ | 3,694 | $ | 6,106 | $ | 7,354 | ||||||||
United States | 29,147 | 21,778 | 82,057 | 68,684 | ||||||||||||
Other | 1,120 | 1,087 | 3,471 | 3,103 | ||||||||||||
Europe, Middle East, Africa (EMEA) | 14,566 | 10,887 | 49,332 | 40,336 | ||||||||||||
Asia Pacific (APAC) | 14,378 | 3,808 | 37,070 | 10,274 | ||||||||||||
$ | 60,370 | $ | 41,254 | $ | 178,036 | $ | 129,751 | |||||||||
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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 challenges to established software companies such as us and presents opportunities for potential competitors; | |
• | our “Alta” strategy, as described in our 10-K filing for the period ended November 30, 2006, 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 $69.5 million of term loan debt and an additional $7.0 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 at www.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.
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The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes for the three month and nine month periods ended August 31, 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 Graphics Suite,Paint Shop Pro,WordPerfect, WinZip,andWinDVD.
OVERVIEW OF THE QUARTER
Operating Performance
Results for the three and nine months ended August 31, 2007 include the results from our acquisition of InterVideo as of December 12, 2006.
Revenue for the third quarter was $60.4 million, up 46.3% from the three month period ending August 31, 2006. Excluding InterVideo revenue of $19.7 million in the third quarter, revenue from the Corel business was $40.6 million, a decline of 1.5% year over year, primarily driven by a decrease in revenue from ourWordPerfectandDigital Imaging (Paint Shop Pro, Snapfire and Photo Album)products.WordPerfectand theDigital Imaging productsdeclined by $4.0 and $1.7 million, respectively in the third quarter, and the rest of the Corel portfolio, excluding InterVideo products, grew by $5.0 million or by 21.8% year over year. This was primarily driven by growth ofWinZip, CorelDRAW, Painter and iGrafxproducts.
Our net loss for the third quarter of 2007 was $6.8 million, or a loss of $0.27 per share, compared to a net income of $5.5 million, or $0.22 per share in the third quarter of 2006. Cash provided by operations was $503,000 in the quarter. The year-to-date results were impacted by a number of items resulting from the acquisition of InterVideo, primarily related to the inability to recognize certain revenues and acquisition charges, including the write-off of acquired in-process research and development.
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, we completed the acquisition of the remaining voting equity interest in Ulead, a subsidiary of InterVideo, on December 28, 2006, in an all cash transaction of approximately $21.7 million. The acquisition was 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. Since the acquisition we have repaid $36.0 million on the revolving line of credit.
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:
• | DVD Movie Factory, a consumer DVD authoring software | |
• | VideoStudio, a video editing software; and | |
• | PhotoImpact, image editing software | |
• | DVD Copy |
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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 Shop Pro, Snapfire, Photo Album,andMediaOneproducts. Our primary Graphics and Productivity products include,CorelDRAW Graphics Suite,WinZip, WordPerfect Office SuiteandiGrafx.
RESULTS OF OPERATIONS
Three and Nine Months ended August 31, 2007 and August 31, 2006
On December 12, 2006, we acquired all of the outstanding shares of InterVideo. Accordingly, because the financial information for the three and nine months ended August 31, 2006 does not include InterVideo operations, they are not directly comparable to the consolidated financial information presented for the three and nine months ended August 31, 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.
Revenues
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
August 31, | Percentage | August 31, | Percentage | |||||||||||||||||||||
2007 | 2006 | Change | 2007 | 2006 | Change | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Product | $ | 55,018 | $ | 36,362 | 51.3 | % | $ | 161,875 | $ | 115,011 | 40.7 | % | ||||||||||||
As a percent of revenue | 91.1 | % | 88.1 | % | 90.9 | % | 88.6 | % | ||||||||||||||||
Maintenance and services | 5,352 | 4,892 | 9.4 | % | 16,161 | 14,740 | 9.6 | % | ||||||||||||||||
As a percent of revenue | 8.9 | % | 11.9 | % | 9.1 | % | 11.4 | % | ||||||||||||||||
Total | 60,370 | 41,254 | 46.3 | % | 178,036 | 129,751 | 37.2 | % |
Total revenues for the three month period ended August 31, 2007 increased by 46.3% to $60.4 million from $41.3 million for the three months ended August 31, 2006. Of this increase, $19.7 million is attributable to additional revenues generated from InterVideo products. There was a revenue decline in Corel products of $605,000 from the same quarter last year. The decline was due to a decrease inWordPerfectrevenues of $4.0 million andDigital Imagingrevenues of $1.7 million from the same quarter last year, offset by an increase of $5.0 million from the rest of our product portfolio, including growth inWinZip, CorelDRAW, iGrafx, PainterandDesigner.Total revenues for the nine month period ended August 31, 2007 increased by 37.2% to $178.0 million from $129.8 million for the nine months ended August 31, 2006. Of this increase, $52.0 million is attributable to additional revenues generated from InterVideo products. There was a revenue decline in Corel products of $3.7 million from the same nine month period last year. The decline was due to a decrease inWordPerfectrevenues of $10.9 million and a decrease in the combinedDigital Imaging revenues of $2.6 million from the same nine month period last year, offset by an increase of $9.9 million from the rest of our product portfolio, including growth inWinZip, CoreDRAWandiGrafx.
Product revenues for the three months ended August 31, 2007 increased by 51.3% to $55.0 million from $36.4 million for the three months ended August 31, 2006, and product revenues for the nine months ended August 31, 2007 increased by 40.7% to $161.9 million from $115.0 million over the nine month period ending August 31, 2006. Product revenues for Corel products decreased by $1.1 million or 2.9% to $35.3 million for the three month period ended August 31, 2007. This decline primarily reflects the decline in sales ofWordPerfectand the decrease in sales ofDigital Imaging products,which was partially offset by an increase in the sales of the rest of the portfolio of products, led by growth inWinZip, CorelDRAWandiGrafx revenues. The decline inWordPerfect revenues for the three and nine month periods ended August 31, 2007 is due primarily to a decrease in point of sale royalties from one of our largest OEM customers, the decrease in enterprise license revenue and the latter part of the product lifecycle given the launch ofWordPerfect Office X3in the first quarter of the prior year. The decline inDigital Imaging revenuesfor the three and nine months ended August 31, 2007 is primarily attributable to lower POS and APOS (after Point of Sale) revenue for Snapfire at one of our largest OEM customers, a decrease in the level of upgrades from earlier versions of Paint Shop Pro to Paint Shop Pro X1 and the repositioning of this brand as our higher end product relative to our acquiredPhoto ImpactandPhoto Expressbrands. A new version ofPaint Shop Prowill be released in the fourth quarter of fiscal 2007. Also, we expect improved performance from the recently announced MediaOne product, which is the follow-on product to Snapfire. 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 significant new customer wins in the Japanese market, the overall competitiveness of our product portfolio and additional marketing and promotional initiatives undertaken in the current year.
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The increase inCorelDRAWrevenues during the three months ended August 31, 2007 is attributable to growth in the European market due to significant enterprise license agreements and additional promotion and marketing activity.
Maintenance and services revenues increased by 9.4% to $5.4 million for the three month period ended August 31, 2007 and by 9.6% to $16.2 million for the nine months ended August 31, 2007. This increase is largely attributable to increased sales of WinZip’s maintenance program.
Total Revenues by Product Group
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 and nine month periods ended August 31, 2006 were reclassified to conform to the current period.
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
August 31, | Percentage | August 31, | Percentage | |||||||||||||||||||||
2007 | 2006 | Change | 2007 | 2006 | Change | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Graphics and Productivity | $ | 33,683 | $ | 32,619 | 3.3 | % | $ | 102,264 | $ | 103,330 | (1.0 | %) | ||||||||||||
As a percent of revenue | 55.8 | % | 79.1 | % | 57.4 | % | 79.6 | % | ||||||||||||||||
Digital imaging | 26,687 | 8,635 | 209.0 | % | 75,772 | 26,421 | 186.8 | % | ||||||||||||||||
As a percent of revenue | 44.2 | % | 20.9 | % | 42.6 | % | 20.4 | % |
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 | 12 | Q2 2007 | Q1 2006 | |||||
Corel Designer Technical Suite | 12 | Q2 2005 | Q3 2003 | |||||
Corel Painter | 10 | Q1 2007 | Q4 2004 | |||||
Digital Media | ||||||||
Paint Shop Pro | 12 | Q4 2007 | Q4 2006 | |||||
MediaOne | 2 | Q4 2007 | Q4 2006 | |||||
WinDVD | 8 | Q4 2006 | Q2 2005 | |||||
VideoStudio | 11 | Q2 2007 | Q2 2006 | |||||
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 increased by $1.1 million or 3.3% to $33.7 million in the third quarter of fiscal 2007 from $32.6 million in the third quarter of fiscal 2006, and declined by $1.1 million or 1.0% to $102.3 million for the nine month period ending August 31, 2007 as compared to the nine month period ending August 31, 2006. Of this decline, $10.9 million is the result of lower sales ofWordPerfect Office. The rest of the Graphics and Productivity portfolio of products increased by $5.0 million or 21.8% as compared to the quarter ending August 31, 2006, and $9.9 million or 13.0% for the nine months ending August 31, 2007. This was primarily driven by growth inWinZip, CorelDRAWandiGrafxrevenues. 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, and new licensing deals in Japan. The increase inCoreDRAWis due to new licensing deals reached in EMEA. The decline inWordPerfectrevenues is due primarily to the decrease in point of sale royalties from one of our largest OEM customers, the decrease in enterprise license revenue, and the launch ofWordPerfect Office X3in the first quarter of the prior year.
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Digital Media revenues increased by 209.0% to $26.7 million in the third quarter of fiscal 2007 from $8.6 million in the third quarter of fiscal 2006, and increased by 186.8% to $75.8 million for the nine months ending August 31, 2007. The significant increase is due to the inclusion of $19.7 million and $52.0 million of revenue in the third quarter of fiscal 2007 and the nine months ended August 31, 2007, respectively, that resulted from products acquired with our acquisition of InterVideo on December 12, 2006. Revenue from Corel products decreased by 19.3% to $7.0 million in the third quarter of fiscal 2007, as compared to $8.6 million in the third quarter of fiscal 2006. Revenues from Corel products for the nine month period ending August 31, 2007, have decreased from $26.4 million to $23.8 million year over year. The decrease in revenues was driven by the performance of the Digital Imaging product line which was primarily the result of lower conversion rates and lower point of sales and after point of sales (APOS) revenue at our largest OEM customer. Some of this decline was offset by the growth ofMediaOne,which was not sold in the first nine months of the prior year, as we continued to acquire new OEM partners and started to realize the benefit of APOS revenue. Also, during the quarter, we continued to repositionPaint Shop Proas the high end, high value product in a portfolio of digital imaging products, which now also includesPhoto ImpactandMediaOne.
Total Revenues by Region
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
August 31, | Percentage | August 31, | Percentage | |||||||||||||||||||||
2007 | 2006 | Change | 2007 | 2006 | Change | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Americas | $ | 31,426 | $ | 26,559 | 18.3 | % | $ | 91,634 | $ | 79,141 | 15.8 | % | ||||||||||||
As a percent of revenue | 52.1 | % | 64.4 | % | 51.5 | % | 61.0 | % | ||||||||||||||||
EMEA | 14,566 | 10,887 | 33.8 | % | 49,332 | 40,336 | 22.3 | % | ||||||||||||||||
As a percent of revenue | 24.1 | % | 26.4 | % | 27.7 | % | 31.1 | % | ||||||||||||||||
APAC | 14,378 | 3,808 | 277.6 | % | 37,070 | 10,274 | 260.8 | % | ||||||||||||||||
As a percent of revenue | 23.8 | % | 9.2 | % | 20.8 | % | 7.9 | % |
Revenues in the Americas increased by 18.3% to $31.4 million in the third quarter of fiscal 2007 compared to $26.6 million in the third quarter of fiscal 2006. For the nine months ended August 31, 2007 revenues increased by 15.8% to $91.6 million as compared to revenues for the period ending August 31, 2006. The increase was principally driven by the revenues associated with our newInterVideoproducts, which generated sales of $8.0 million and $20.1 million, for the three and nine month periods ending August 31, 2007, respectively. Revenues for Corel products declined by 12.0% in the third quarter of fiscal 2007, due to lowerWordPerfectandDigital Imagingrevenues.WordPerfectdecreased due to the decrease in point of sale royalties from one of our largest OEM customers, the decrease in enterprise license revenue, and the launch ofWordPerfect Office X3in the first quarter of the prior year. The decline inDigital Imagingrevenues for the three and nine months ending August 31, 2007 is primarily attributable to lower POS revenue at one of our largest OEM customers and the repositioning of this brand as our higher end product relative to our acquiredPhoto ImpactandMediaOnebrands. A new version of the product will be released in the fourth quarter of fiscal 2007.
Revenues in EMEA increased by 33.8% to $14.6 million in the third quarter of fiscal 2007 from $10.9 million in the third quarter of fiscal 2006, and increased by 22.3% to $49.3 million in the first nine months of fiscal 2007 from $40.3 million in the first nine months of fiscal 2006. The main reason for the increase was the revenues generated by our InterVideo products which totaled $2.0 million in the third quarter of fiscal 2007 and $7.3 million for the nine months ending August 31, 2007. Revenues from Corel products increased by 15.8% primarily due to increases inCorelDRAW Graphics SuiteandWinZipproduct sales, which offset decreases in sales inWordPerfectandDigital Imagingproduct. CorelDRAW Graphics Suiterevenues increased in the third quarter in EMEA due to continued advances made in the retail and enterprise market.
APAC revenues increased by 277.6% to $14.4 million in the third quarter of fiscal 2007 and by 260.8% to $37.1 in the first nine months of fiscal 2007. The increase is due to sales from InterVideo products of $9.7 million and $24.5 million for the three and nine month periods ended August 31, 2007. Revenue growth in Corel products was 22.4% for both the three and nine month periods ended August 31, 2007, due to revenue growth inWinZipandiGrafx.iGrafxgrowth was larger in this region due to licensing deals reached with one of our distribution partners initiated in the second quarter of fiscal 2007. 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.
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Cost of Revenues
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
August 31, | Percentage | August 31, | Percentage | |||||||||||||||||||||
2007 | 2006 | Change | 2007 | 2006 | Change | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Cost of product | $ | 12,143 | $ | 5,338 | 127.5 | % | $ | 34,640 | $ | 15,392 | 125.1 | % | ||||||||||||
As a percent of product revenue | 22.1 | % | 14.7 | % | 21.4 | % | 13.4 | % | ||||||||||||||||
Cost of maintenance and services | 244 | 287 | (15.0 | )% | 663 | 877 | (24.4 | )% | ||||||||||||||||
As a percent of maintenance and service revenue | 4.6 | % | 5.9 | % | 4.1 | % | 5.9 | % | ||||||||||||||||
Amortization of intangible assets | 6,925 | 2,712 | 155.3 | % | 19,055 | 11,987 | 59.0 | % | ||||||||||||||||
As a percent of revenue | 11.5 | % | 6.6 | % | 10.7 | % | 9.2 | % |
Cost of Product Revenues.Cost of product revenues increased by 127.5% to $12.1 million in the third quarter of fiscal 2007 from $5.3 million in the third quarter of fiscal 2006, and increased by 125.1% to $34.6 million for the nine months ending August 31, 2007. As a percentage of product revenues, cost of product revenues increased to 22.1% and 21.4% from 14.7% and 13.4% for the three and nine months ended August 31, 2007, respectively. 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. InterVideo products have higher royalty content then Corel products.
Cost of Maintenance and Services Revenues.Cost of maintenance and services revenues decreased to 4.6% of related revenues in the third quarter of fiscal 2007 compared to 5.9% in the third quarter of fiscal 2006. For the nine months ended August 31, 2007, costs as a portion of related revenues decreased to 4.1% from 5.9% in the prior period. These increases are primarily attributable toWinZip’shigher maintenance revenues and the limited incremental costs to provide such revenue.
Amortization of Intangible Assets.Amortization of intangible assets increased by $4.2 million in the three months ended August 31, 2007, from $2.7 million in the three months ended August 31, 2006. This increase is due to the $4.2 million of amortization related to the intangible assets of $86.6 million acquired with InterVideo.
Operating Expenses
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
August 31, | Percentage | August 31, | Percentage | |||||||||||||||||||||
2007 | 2006 | Change | 2007 | 2006 | Change | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Sales and marketing | $ | 17,231 | $ | 11,810 | 45.9 | % | $ | 51,827 | $ | 40,337 | 28.5 | % | ||||||||||||
As a percent of revenue | 28.5 | % | 28.6 | % | 29.1 | % | 31.1 | % | ||||||||||||||||
Research and development | 11,282 | 6,379 | 76.9 | % | 33,323 | 19,200 | 73.6 | % | ||||||||||||||||
As a percent of revenue | 18.7 | % | 15.5 | % | 18.7 | % | 14.8 | % | ||||||||||||||||
General and administrative | 8,803 | 5,833 | 50.9 | % | 27,085 | 17,421 | 55.5 | % | ||||||||||||||||
As a percent of revenue | 14.6 | % | 14.1 | % | 15.2 | % | 13.4 | % | ||||||||||||||||
Restructuring | — | — | n/a | — | 811 | (100.0 | %) | |||||||||||||||||
As a percent of revenue | 0.0 | % | 0.0 | % | 0.0 | % | 0.6 | % | ||||||||||||||||
Acquired in-process research and development | — | — | n/a | 7,831 | — | n/a | ||||||||||||||||||
As a percent of revenue | 0.0 | % | 0.0 | % | 4.4 | % | 0.0 | % | ||||||||||||||||
InterVideo integration expenses | 2,220 | — | n/a | 3,865 | — | n/a | ||||||||||||||||||
As a percent of revenue | 3.7 | % | 0.0 | % | 2.2 | % | 0.0 | % |
Sales and Marketing.Sales and marketing expenses increased by 45.9% to $17.2 million in the third quarter of fiscal 2007 as compared to $11.8 million in the third quarter of fiscal 2006. For this quarter, sales and marketing expenses as a percentage of revenue decreased to 28.5%, as compared to 28.6% for the prior period. Sales and marketing expenses increased by 28.5% to $51.8 million for the nine months ended August 31, 2007, as compared to $40.3 million for the nine months ended August 31, 2006 and declined as a percentage of revenue from 31.1% to 29.1%. The increase in sales and marketing expenses is as a result of additional costs associated with assuming InterVideo operations. The decline in expenses as a percentage of revenue from the prior year is due to our integration activities which have created cost synergies in the current period.
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Research and Development.Research and development expenses increased by 76.9% and 73.6% to $11.3 million and $33.3 million in the three and nine months ended August 31, 2007, respectively, as compared to $6.4 million and $19.2 million in three and nine months ended August 31, 2006, respectively. The increase in research and development expenses is as a result of additional costs associated with assuming InterVideo operations. As a percentage of total revenues, research and development expenses increased to 18.7% from 15.5% in the third quarter of fiscal 2007 as compared to the third quarter of fiscal 2006. The costs as a percentage of revenue have increased due to the mix of InterVideo products which traditionally are more research intensive relative to Corel products.
General and Administration.General and administration expenses increased to $8.8 and $27.1 million in the three and nine months ended August 31, 2007, respectively, from $5.8 million and $17.4 million for the three and nine months ended August 31, 2006. The increase in general and administration costs is due largely to the assumption of InterVideo operations and resources as well as additional charges incurred to be compliant with Sarbanes Oxley. As a percentage of total revenues, general and administration expenses remained consistent at 14.6% in the third quarter of fiscal 2007, as compared to the third quarter of fiscal 2006.
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 in the first quarter of fiscal 2007.
InterVideo Integration Expense:Integration costs relating to the acquisition of InterVideo totaling $2.2 million and $3.9 million have been recorded for the three and nine month periods ending August 31, 2007. These costs relate to the integration of the InterVideo business into our existing operations, including travel costs, retention bonuses, incremental employees engaged solely for integration activities, other incremental costs for Corel employees who worked on the integration planning process, consultants for integrating systems, and other one time charges for integrating systems.
Non-Operating (Income) Expense
Three Months Ended | Nine Months Ended | |||||||||||||||
August 31, | August 31, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(dollars in thousands) | ||||||||||||||||
(unaudited) | ||||||||||||||||
Loss on debt retirement | — | $ | 17 | $ | — | $ | 8,292 | |||||||||
Interest expense, net | 4,195 | 2,334 | 11,834 | 9,404 | ||||||||||||
Amortization of deferred financing fees | 270 | 188 | 804 | 989 | ||||||||||||
Other non-operating (income) expenses | (497 | ) | 377 | (650 | ) | (271 | ) | |||||||||
Total non-operating expenses | 3,968 | $ | 2,916 | $ | 11,988 | $ | 18,414 | |||||||||
Interest Expense, Net.Net interest expense increased by $1.9 million in the third quarter of fiscal 2007 from $2.3 million in the third quarter of fiscal 2006, and increased by $2.4 million for the nine months ending August 31, 2007, as compared to the prior year. The increase is due to the additional long-term debt as a result of our acquisitions as well as a loss of $337,000 resulting from the decline in the fair value of our interest rate swaps in the period
Amortization of Deferred Financing Fees.Amortization of deferred financing fees increased to $270,000 in the third quarter of fiscal 2007 from $188,000 in the third quarter of fiscal 2006, as a result of the additional debt we assumed on the acquisition of InterVideo. However, the amortization of deferred financing fees decreased to $804,000 from $989,000 for the current nine month period ending August 31, 2007 compared to nine months ended August 31, 2006 decreased due to the write-off of financing fees relating to debt retired in April 2006.
Income Tax Expense (Recovery)
For the three and nine months ended August 31, 2007, the Company recorded a tax provision of $4.3 million and $4.1 million on a loss before income taxes of $2.4 million and $12.2 million, respectively. The majority of the tax provision relates to an additional $5.0 million valuation allowance against all deferred tax assets assumed in the InterVideo acquisition. In the current quarter, we determined that it no longer more likely than not that the deferred tax assets would be realized, and accordingly a valuation allowance was recorded. The remaining balance reflects foreign withholding taxes plus provisions for income taxes for subsidiaries that have taxable income in the period, offset by a reduction in our deferred income tax liability related to the amortization of intangible assets
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recorded on the acquisition of InterVideo. We have increased the valuation allowance to fully provide for tax losses realized by other subsidiaries in the quarter.
For the three months ended August 31, 2006, we recorded a tax provision of $485,000 on income before income taxes of $6.0 million. The entire provision is for current taxes. Current taxes consist of foreign withholding taxes plus taxes incurred by our foreign subsidiaries, including $251,000 relating to WinZip operations
At the beginning of the third quarter of fiscal 2007, Corel received a notice of reassessment from the Ministry of Revenue of Ontario ( the “Ministry”) for CDN$13.4 million. The Ministry’s reassessment disallows various deductions claimed on our tax returns for the 2000, 2001 and 2002 taxation years resulting in a potential disallowance of loss carryforwards and liabilities for tax and interest. Subsequent to August 31, 2007, Corel received further notice that the Ministry had applied tax losses and other attributes which reduced the assessment from CDN$13.4 million to CDN$5.8 million. The Company intends to vigorously defend against the reassessment. While the Company believes that they have adequately provided for potential assessments, it is possible that an adverse outcome may lead to a deficiency in its recorded income tax expense and may adversely affect its liquidity. However, the Company believes that the positions taken in its tax returns are correct and estimates the potential loss from the re-reassessment will not have a material impact on our financial condition or results of operations.
FINANCIAL CONDITION
Working Capital
Our working capital deficiency at August 31, 2007 was $19.3 million, a decrease of $50.5 million from the November 30, 2006 working capital surplus of $31.2 million. The decrease is primarily attributable to the financing of the acquisition of InterVideo and the working capital deficiency of $21.1 million which existed in InterVideo when we completed the purchase on December 12, 2006. The acquisition of InterVideo used approximately $69.6 million of working capital, consisting of $19.1 million of cash, $43.0 million operating line of credit and $7.7 million of direct transaction and restructuring costs. We have since repaid $36.0 million of the operating line of credit over the nine month period ending August 31, 2007. Our working capital deficiency has improved by $11.2 million from its position at May 31, 2007. In addition, the Company has and expects to continue generating cash which we expect will reduce the working capital deficiency over the next 12 months.
Liquidity and Capital Resources
As of August 31, 2007, our principal sources of liquidity are cash and cash equivalents of $21.2 million and trade accounts receivable of $24.3 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 $68.0 million is unused as at August 31, 2007. In addition, we expect to generate cash during the remainder of the fiscal year which will allow us to reduce our current working capital deficiency.
Cash provided by operations decreased by $5.5 million to $503,000 for the three months ended August 31, 2007 compared to $6.0 million for the three months ended August 31, 2006. The decrease to our change in net operating assets in this quarter is largely due to the timing of certain cash receipts from significant OEM’s and a reduction of our accounts payable. Cash provided by operations for the nine months ended August 31, 2007 of $15.7 million has decreased by $6.0 million from $21.7 million for the nine months ended August 31, 2006. The decrease is consistent with the decrease in cash provided by operations in the third quarter.
Cash used by financing activities was $5.0 million for the three months ended August 31, 2007 compared to $3.9 million for the three month period ended August 31, 2006. The increase in cash used by financing relates to the net repayment of $6.0 million on our operating line of credit during the period offset by the $1.3 million of cash provided from the exercise of stock options, as compared to the public offering costs of $3.2 million in the third quarter of fiscal 2006. Cash provided by financing activities increased by $84.3 million to $78.0 million for the nine month period ending August 31, 2007 as compared to the usage of cash of $6.3 million for the similar period in the prior fiscal year. This increase is largely due to an additional term loan of $70.0 million to execute the acquisition of InterVideo, net draws from our operating line of credit of $7.0 million, and additional cash generated by the exercise of stock options of $4.0 million.
Cash used in investing activities was $123.5 million in the nine months ended August 31, 2007, a significant increase over the cash used of $1.5 million in the nine months ended August 31, 2006. This cash outlay reflects the purchase of InterVideo on December 12, 2006 and the remaining interest in Ulead on December 28, 2006 for $121.4 million. Cash used in investing activities increased by $1.0 million to $1.6 million for the three months ending August 31, 2007, as compared to the cash used of $616,000 in the similar period ending August 31, 2006, resulting from additional restructuring and direct transaction costs related to the InterVideo acquisition of
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$203,000 and additional purchase of property, plant, and equipment of $825,000. During the third quarter, we entered into capital leases for capital assets with a value of $0.5 million. For the nine months ending August 31, 2007 we have entered into capital leases with a value of $3.0 million for assets. Payments on these leases will be made until fiscal 2013.
At the beginning of the third quarter of fiscal 2007, Corel received a notice of reassessment from the Ministry of Revenue of Ontario ( the “Ministry”) for CDN$13.4 million. The Ministry’s reassessment disallows various deductions claimed on our tax returns for the 2000, 2001 and 2002 taxation years resulting in a potential disallowance of loss carryforwards and liabilities for tax and interest. Subsequent to August 31, 2007, Corel received further notice that the Ministry had applied tax losses and other attributes which reduced the assessment from CDN$13.4 million to CDN$5.8 million. The Company intends to vigorously defend against the reassessment. While the Company believes that they have adequately provided for potential assessments, it is possible that an adverse outcome may lead to a deficiency in its recorded income tax expense and may adversely affect its liquidity. However, the Company believes that the positions taken in its tax returns are correct and estimates the potential loss from the re-reassessment will not have a material impact on our financial condition or results of operations.
Adjusted EBITDA
As of August 31, 2007 we were in compliance with all debt covenants. We have included the following reconciliation from the cash flow provided by operations to the Adjusted EBITDA used in the covenant calculations. 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. Adjusted EBITDA was $13.5 million in the third quarter of fiscal 2007 compared to $12.4 million in the third quarter of fiscal 2006. For the nine months ending August 31, 2007, adjusted EBITDA was $37.4 compared to $40.5 for the nine months ending August 31, 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 August 31, 2007 and 2006, we had cash flows provided by operations of $503,000 and $6.0 million, respectively. For nine six months ended August 31, 2007 and 2006, we had cash flow from operations of $15.7 million and $21.7 million, respectively The table below reconciles Adjusted EBITDA to cash flow from operations:
Three Months Ended | Nine Months Ended | |||||||||||||||
August 31, | August 31, | |||||||||||||||
(dollars in thousands) | 2007 | 2006 | 2007 | 2006 | ||||||||||||
Cash flow provided by / (used in) operations | $ | 503 | $ | 6,032 | $ | 15,727 | $ | 21,699 | ||||||||
Change in operating assets and liabilities | 6,387 | 3,453 | 3,321 | 3,981 | ||||||||||||
Interest expenses, net | 4,195 | 2,334 | 11,834 | 9,404 | ||||||||||||
Income tax provision | 4,314 | 485 | 4,082 | 5,427 | ||||||||||||
Deferred income taxes | (3,667 | ) | — | (1,352 | ) | (636 | ) | |||||||||
Provision for bad debts | (115 | ) | 24 | (180 | ) | (150 | ) | |||||||||
Unrealized foreign exchange losses on forward contracts | 26 | 43 | (9 | ) | (178 | ) | ||||||||||
Gain / (Loss) on Interest Rate Swap | (337 | ) | — | 245 | — | |||||||||||
Loss on disposal of fixed assets | (48 | ) | — | (102 | ) | — | ||||||||||
InterVideo integration costs | 2,220 | — | 3,865 | — | ||||||||||||
Restructuring costs | — | — | — | 811 | ||||||||||||
Reorganization costs | — | — | — | 117 | ||||||||||||
Adjusted EBITDA | $ | 13,478 | $ | 12,371 | $ | 37,431 | $ | 40,475 | ||||||||
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.
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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 $497,000 for each 0.5% change in interest rates, based on debt outstanding as of August 31, 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 August 31, 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%. We have recorded a loss of $337,000 and a gain of $245,000 as a result of recording this interest rate swap at fair value for the three and nine month periods ended August 31, 2007, respectively.
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 as 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 August 31, 2007 we had one foreign exchange contract for $1.0 million against the Canadian Dollar that was settled on September 17, 2007.
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, the new Taiwan dollar 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 August 31, 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; specifically the potential weakness related to accounting for the acquisition of InterVideo and the related consolidation of their 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 course of their work.
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To address this potential issue 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, which was finalized in the third quarter of 2007. | ||
• | Temporarily relocated certain Corel senior management to InterVideo’s operating sites in Fremont and Taiwan. |
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.
During the period ending August 31, 2007, we resolved an ongoing patent infringement proceeding as 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. In August 2007, a settlement was reached with the Plaintiff, and in September 2007 the District Court dismissed the action.
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At August 31, 2007, we were a defendant in an ongoing patent infringement proceeding described below
Disc Link Corporation v. H&R Block Digital Tax Solutions, Corel Corporation, Corel Inc., et al.Plaintiff filed this patent infringement action on April 10, 2007, against Corel Corporation and Corel Inc. (collectively “Company”) and 26 other defendants in the U.S District Court for the Eastern District of Texas, alleging infringement of U.S. Patent 6,314,574. The patent issued November 6, 2001. Plaintiff alleges that the defendants infringed the patent through the use of hyperlinks in software in software applications sold on discs, in particular hyperlinks which allegedly facilitate the provision of certain types of technical support. Company filed its answer and counterclaims to Plaintiff’s complaint on July 13, 2007. On August 1, 2007, twenty-one defendants including Company filed a motion to transfer this case to another court. A decision on the motion to transfer has not been issued by the court. As of the end of August 2007, several defendants have entered into license agreements with Plaintiff and settled their disputes with respect to this lawsuit. Company believes it has meritorious defenses to the Plaintiff’s claims and intends to defend the litigation vigorously. The ultimate outcome of the litigation, however, 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.
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.
Item 2.Use of Proceeds
Not applicable
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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: October 11, 2007
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