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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the period ended August 31, 1999
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or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from __________________________ to ___________________
Commission File Number 0-20562
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COREL CORPORATION
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(Exact name of Registrant as specified in its Charter)
Canada Not Applicable
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1600 Carling Avenue, Ottawa, Ontario, Canada K1Z 8R7
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(Address of principal executive offices) (Zip Code)
(613) 728-8200
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(Registrant's telephone number, including area code)
Indicate by check mark whether registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO_____
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As of October 13 , 1999, the registrant had 64,130,787 Common Shares
outstanding.
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COREL CORPORATION
TABLE OF CONTENTS
Page No.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as at August 31, 1999
and November 30, 1998...................................................... 3
Consolidated Statements of Operations and Deficit
for the three months and for the nine months ended August 31, 1999
and August 31, 1998........................................................ 4
Consolidated Statements of Changes in Financial Position
for the nine months ended August 31, 1999 and August 31, 1998.............. 5
Notes to Consolidated Financial Statements.................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................... 22
Item 6. Exhibits and Reports on Form 8-K................................................ 24
SIGNATURES................................................................................... 25
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
COREL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of U.S.$)
August 31, November 30,
1999 1998
-------------- -------------
ASSETS (unaudited) (audited)
Current assets:
Cash and short-term investments......................... $ 23,792 $ 24,506
Accounts receivable (note 2)
Trade............................................... 47,359 45,789
Other............................................... 2,494 877
Inventory (note 3)...................................... 14,549 17,098
Deferred income taxes................................... 1,642 2,495
Prepaid expenses........................................ 2,213 4,618
----------- -----------
Total current assets......................................... 92,049 95,383
Investments.................................................. 3,180 -
Capital assets............................................... 48,245 44,776
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Total assets................................................ $ 143,474 $ 140,159
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities................ $ 47,488 $ 58,209
Current portion of Novell obligations................... 11,800 11,800
Income taxes payable.................................... 3,743 7,549
Deferred revenue........................................ 17,629 17,933
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Total current liabilities.................................... 80,660 95,491
Novell obligations........................................... 9,085 16,085
Shareholders' equity
Share capital........................................... 216,100 203,088
Contributed surplus..................................... 1,099 1,099
Deficit................................................. (163,470) (175,604)
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Total shareholders' equity................................... 53,729 28,583
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Total liability and shareholders' equity..................... $ 143,474 $ 140,159
=========== ===========
(See accompanying Notes to Consolidated Financial Statements)
COREL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND DEFICIT
(in thousands of U.S.$, except per share data)
(unaudited)
Three months ended Nine months ended
August 31 August 31
------------------------- --------------------------
1999 1998 1999 1998
--------- --------- ---------- -----------
Sales............................................ $ 71,312 $ 71,083 $ 182,119 $ 179,585
Cost of sales.................................... 15,466 14,932 41,118 36,682
--------- --------- ---------- -----------
Gross profit.................................. 55,846 56,151 141,001 142,903
--------- --------- ---------- -----------
Expenses
Advertising................................... 11,641 7,403 32,358 30,372
Selling, general and administrative........... 19,377 19,717 59,934 57,232
Research and development...................... 10,671 16,981 36,526 59,911
Depreciation and amortization................. 1,895 2,465 4,568 10,445
Restructuring charges......................... - 15,880 - 15,880
Settlement proceeds........................... (6,342) - (6,342) -
Loss (gain) on foreign exchange............... 319 (78) 265 675
--------- --------- ---------- -----------
37,561 62,368 127,309 174,515
--------- --------- ---------- -----------
Income (loss) from operations.................... 18,285 (6,217) 13,692 (31,612)
Interest expense (income)........................ (46) 154 283 994
--------- --------- ---------- -----------
Income (loss) before income taxes................ 18,331 (6,371) 13,409 (32,606)
Income taxes
Current...................................... 693 494 422 4,068
Deferred..................................... 44 969 853 556
--------- --------- ---------- -----------
737 1,463 1,275 4,624
Net income (loss)................................ 17,594 (7,834) 12,134 (37,230)
Deficit beginning of period...................... (181,064) (174,552) (175,604) (145,156)
--------- --------- ---------- -----------
Deficit end of period............................ $(163,470) $(182,386) $ (163,470) $ (182,386)
========= ========= ========== ===========
Earnings (loss) per share:
Net earnings (loss)
Basic....................................... $ 0.28 $ (0.13) $ 0.20 $ (0.63)
Fully diluted............................... $ 0.26 $ (0.13) $ 0.18 $ (0.63)
Weighted average number of Common Shares
outstanding (000s)
Basic....................................... 62,793 59,346 61,519 59,505
Fully diluted............................... 69,062 59,346 68,720 59,505
(See accompanying Notes to Consolidated Financial Statements)
COREL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN FINANCIAL POSITION
(in thousands of U.S.$)
(unaudited)
Nine months ended
----------------------------------
August 31, August 31,
1999 1998
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Cash provided by (used for):
Operations:
Net Income (loss).................................................... $ 12,134 $ (37,230)
Items which do not involve cash:
Depreciation and amortization................................... 14,436 19,877
Gain on disposal of assets...................................... (80) (79)
Restructuring charges........................................... - 3,086
Deferred income taxes........................................... 853 556
Decrease (Increase) in accounts receivable........................... (3,187) 3,865
Decrease (Increase) in inventory..................................... 2,549 (5,230)
Decrease in prepaid expenses......................................... 2,405 40
Increase (decrease) in accounts payable and accrued
liabilities......................................................... (10,721) 14,289
Increase (decrease) in deferred revenue.............................. (304) 2,343
Increase (decrease) in income taxes payable/recoverable.............. (3,806) 1,898
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Cash provided by (used for) operations............................... 14,279 3,415
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Financing:
Issue of share capital............................................... 13,012 -
Shares repurchased for cancellation.................................. - (987)
Repayment of Novell obligations...................................... (7,000) (7,125)
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6,012 (8,112)
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Investments:
Purchase of investment............................................... (3,351) -
Purchase of capital assets........................................... (17,750) (6,159)
Proceeds on disposal of assets....................................... 96 79
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(21,005) (6,080)
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Net decrease in cash.................................................... (714) (10,777)
Cash at beginning of period............................................. 24,506 30,629
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Cash at end of period................................................... $ 23,792 $ 19,852
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Cash is defined as cash and short-term investments
(See accompanying Notes to Consolidated Financial Statements)
COREL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars, tabular amounts in thousands except per share data)
(unaudited)
1. Basis of Presentation
The accompanying unaudited interim consolidated financial statements of Corel
Corporation (the "Company") have been prepared by the Company in accordance with
accounting principles generally accepted in Canada. These principles are also
generally accepted in the United States except as disclosed in Note 6. The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries, Corel Corporation Limited, Corel International
Corporation, Corel, Inc. and its wholly-owned subsidiary, Corel Corporation
(U.S.A.). Corel Computer was amalgamated with Corel Corporation on December 1,
1998 and is no longer a subsidiary of the parent company.
In the opinion of Management, these unaudited interim consolidated financial
statements reflect all adjustments, which are of a normal and recurring nature,
necessary to state fairly the results for the periods presented.
These financial statements should be read in conjunction with the Company's
audited financial statements as of November 30, 1997 and 1998 and for each of
the three quarters in the period ended November 30, 1999 including notes
thereto, included in the Company's Annual Report on Form 10-K for the year ended
November 30, 1998. The consolidated results of operations for the first three
fiscal quarters are not necessarily indicative of the results to be expected for
any future period.
2. Accounts Receivable
Included in trade accounts receivable are the following reserves:
August 31, November 30,
1999 1998
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Promotional rebates........................... $ 3,876 $ 6,197
Sales reserve................................. 31,318 21,882
Allowance for doubtful accounts............... 7,014 6,804
3. Inventories
August 31, November 30,
1999 1998
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Product components............................ $ 10,419 $ 12,799
Finished goods................................ 4,130 4,299
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$ 14,549 $ 17,098
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4. Capital Assets
The Company revised the estimated useful life of all computer equipment and
research and development equipment in the second quarter of 1999. All of the
equipment from these classes have a useful life of 3 years. The previous
estimated useful life for computer equipment was 2 years. The previous method
to depreciate research and development equipment was 20% on a declining basis,
this change in estimate was accounted for on a prospective basis.
5. Restructuring Charge
The Company proceeded with the implementation of a consolidation plan in the
third fiscal quarter of 1998. As at August 31, 1999, the restructuring accrual
included in accounts payable and accrued liabilities is comprised of the
following amounts:
- ---------------------------------------------------------------------------------------------------------
Asset write - Severance Facilities Total
downs cost closure costs
- ---------------------------------------------------------------------------------------------------------
Restructuring charge.................... $ 3,086 $10,104 $ 2,690 $ 15,880
Payments................................ - (8,495) (2,633) (11,128)
Reallocation............................ - (1,609) 1,609 -
Non-cash asset write downs.............. (3,086) - - (3,086)
- ---------------------------------------------------------------------------------------------------------
Restructuring accrual - - $ 1,666 $ 1,666
=========================================================================================================
6. Significant Differences Between Canadian and United States GAAP
The Company's financial statements are prepared on the basis of Canadian GAAP,
which is different in some respects from US GAAP. Significant differences
between Canadian GAAP and US GAAP are set forth below:
(a) Calculation of earnings per share
The Company adopted Statement of Financial Accounting Standards (SFAS), No. 128,
"earnings per share" during the year ended November 30, 1998 and restated
earnings per share for all prior periods presented is required by such
statement.
The dilutive effect of the weighted average share calculation results from
employee stock options.
Fiscal Quarter Nine Months ended
Ended August 31
August 31
--------------------------------------------------
1999 1998 1999 1998
---------------------------------------------------
US GAAP - basic and diluted
Net income (loss) per share -Basic $ 0.28 ($0.13) $ 0.20 ($0.63)
-Diluted $ 0.27 ($0.13) $ 0.20 ($0.63)
Weighted average number of common shares
Basic 62,793 59,346 61,519 59,505
Dilutive effect of employee stock
options 1,393 -- 465 --
-------------------------------------------------
Diluted 64,186 59,346 61,984 59,505
=================================================
Options to purchase 2,324,054 shares for the third quarter and first nine months
of 1999 were outstanding but were excluded from the computation of diluted
shares outstanding because the price of the options was greater than the average
market price of the common stock for the period covered.
(b) Deferred income taxes:
The Company follows the deferral method of accounting for income taxes. Under US
GAAP the asset and liability method is used. In the case of the Company, the
application of the asset and liability method does not result in a significant
difference in the amount of the deferred tax asset. US GAAP also requires the
disclosure of the tax effect of temporary differences that give rise to deferred
tax assets and liabilities. This information is provided in the following:
August 31, November 30,
1999 1998
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Operation loss carryforward................................ $ 9,098 $ 15,437
Depreciation............................................... 6,209 10,246
Reserves................................................... 5,393 5,473
Royalties not yet deducted for tax purposes................ 1,416 1,556
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22,116 32,712
Valuation allowance........................................ (20,473) (30,217)
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Net deferred tax assets.................................... $ 1,642 $ 2,495
=========== =============
The net current deferred tax assets relate to the operations in the United
States of America. These assets are temporary differences which the company
believes will reverse in the near future.
(c) Consolidated statements of changes in financial position
The Company defines cash for purposes of the consolidated statements of changes
in financial position as cash and short-term investments. As at August 31, 1999,
the Company had no
short-term investments. All short-term investments held at November 30, 1998
($2,100,000), were sold or redeemed during the first fiscal quarter of 1999. The
short-term investments as at November 30, 1998 would not qualify as cash
equivalents under US GAAP, consequently cash flows from operating activities
under US GAAP would decrease by $800,000, and cash from investing activities
under US GAAP would increase by $2,900,000 in the first fiscal quarter of 1999.
(d) Recent accounting pronouncements
The Company has adopted the Financial Accounting Standards Board Issued
Statement (SFAS) No. 130, "Reporting Comprehensive Income". The adoption of SFAS
130 did not have an impact on the Company's financial disclosures for the three
months ended August 31, 1999.
The Company will adopt SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information" for its fiscal year ending November 30, 1999.
6. Contingencies
On May 25, 1998, Revenue Canada advised the Company of proposed income tax
adjustments for fiscal years ended November 30, 1992 to 1995. The Company filed
a Response to Revenue Canada's Proposal on October 23, 1998 and had subsequently
continued to dialogue and exchange of correspondence in respect of a number of
particular issues in question. The company has recorded a provision of
$2,468,000, inclusive of interest and penalties, for certain adjustments.
However, it is not possible to accurately estimate the amount, if any, of
additional income taxes that may result from the remaining adjustments
identified and therefore, no further provision has been made.
The Company is a party to a number of additional claims arising in the ordinary
course of business relating to intellectual property and other matters. The
Company believes that the ultimate resolution of these claims will not have a
material adverse effect on its business, financial position or results of
operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
The following information must be read in conjunction with the unaudited
Consolidated Financial Statements and Notes thereto included in Item 1 of this
Quarterly Report and the audited Consolidated Financial Statements and Notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-K for
the year ended November 30, 1998 (the "1998 Form 10-K"). This Form 10-Q contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements involve
uncertainty and risk, and all assumptions, anticipations, and expectations
stated herein are forward-looking statements. The actual results that the
Company achieves may differ materially from any forward-looking statements made
herein due to such risks and uncertainties. The Company has identified by
italics various sentences within this Form 10-Q which contain such forward-
looking statements, and words such as "believes", "anticipates", "expects",
"intends" and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such statements. In
addition, the section labeled "Factors That May Affect Future Operating
Results", which is not italicized for improved readability, consists primarily
of forward-looking statements. The Company undertakes no obligation to revise
any forward-looking statements in order to reflect events or circumstances that
may arise after the date of this report. Readers are urged to carefully review
and consider the various disclosures made by the Company in this report and in
the Company's other reports filed with the Securities and Exchange Commission
that attempt to advise interested parties of the risks and factors that may
affect the Company's business. Therefore, historical results and percentage
relationships will not necessarily be indicative of the operating results of any
future period. All amounts in this report are in US dollars unless otherwise
indicated.
Overview
For the purposes of this discussion, unless the context otherwise requires
"Corel" refers to the consolidated operations of Corel Corporation and its
wholly owned subsidiaries, Corel Corporation Limited, Corel International
Corporation, Corel Inc. and Corel Corporation (U.S.A.), while the Company refers
to the parent, Corel Corporation. Corel Computer was amalgamated with Corel
Corporation on December 1, 1998, and is no longer a subsidiary of the parent
company.
Corel develops manufactures, licenses, sells and supports a wide range of
software products, including graphics, business productivity and consumer
product applications and video communications products.
On December 31, 1998, the Company transferred its Java-based jBridge solution in
exchange for a 25% equity stake in GraphOn Corporation.
On February 17, 1999, the Company transferred all of the assets of Corel
Computer supporting the Netwinder family of Linux-based thin client/thin server
computers and $1.3 million cash in exchange for a 25% equity stake in Hardware
Computing Canada.
On April 17, 1999 Corel acquired certain assets of GraphicCorp, a leading
supplier of clipart images, photographs and web images.
Sales
Sales increased 0.3% to $71.3 million in the third quarter of fiscal 1999 from
$71.1 million in the third quarter of fiscal 1998 primarily due to the launch of
Corel's recent flagship products, Corel WordPerfect Office 2000(R) and CorelDRAW
9(R) in the second quarter of 1999.
Product groups. The table below shows sales for the third fiscal quarter and the
nine months ended August 31, 1999 and 1998, consisting of graphics software new
licenses (full kits and competitive upgrades) and existing user upgrades,
productivity software new licenses (full kits and competitive upgrades) and
existing user upgrades, consumer products software and video communications:
Three Months Ended Nine Months Ended
August 31 August 31
--------------------- --------------------
1999 1998 1999 1998
--------------------- --------------------
Graphics software - new licenses.......... $14,833 $19,206 $ 36,421 $ 43,493
Graphics software - existing user......... 10,572 9,541 26,157 33,330
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Total graphics software.............. 25,405 28,747 62,578 76,823
--------------------------------------------
Productivity software - new licenses...... 21,790 21,055 56,614 60,854
Productivity software - existing user..... 17,080 11,617 50,879 23,595
--------------------------------------------
Total productivity software.......... 38,870 32,672 107,493 84,449
--------------------------------------------
Consumer products......................... 7,043 9,432 11,743 17,765
Video Communications...................... (6) 232 305 548
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Total sales............................... $71,312 $71,083 $182,119 $179,585
============================================
Graphics software revenues decreased in the third quarter of fiscal 1999, as
compared to the third quarter of fiscal 1998, primarily due to a reduction in
price of Draw 9 upgrade compared to Draw 8 pricing in the previous year as well
as the launch of Draw 8 for MacIntosh during the third quarter of 1998.
Productivity software revenues increased in the third quarter of fiscal 1999, as
compared to the third quarter of fiscal 1998, primarily due to the launch of
WordPerfect Office 2000 during the second quarter of 1999.
Consumer products software revenues decreased in the third quarter of fiscal
1999 as compared to the third quarter of fiscal 1998, primarily due to the
product launch for the Gallery products being in an earlier phase of the product
life cycle.
Sales channels. Corel distributes its products primarily through distributors
(as retail packaged products), OEM licenses and corporate licenses. The table
below shows sales through these channels for the third fiscal quarter and the
nine months ended August 31, 1999 and 1998:
Three Months Ended Nine Months Ended
August 31 August 31
----------------------------- ---------------------------
1999 1998 1999 1998
----------------------------- ---------------------------
Retail packaged products............... $42,471 $47,168 $103,560 $108,328
OEM licenses........................... 8,464 7,510 21,835 18,234
Corporate licenses..................... 20,377 16,405 56,724 53,023
----------------------------- ---------------------------
Total sales $71,312 $71,083 $182,119 $179,585
============================= ===========================
Retail packaged products and corporate licences are sold primarily through
distributors. The three largest distributors accounted for $21.4(30%) million
and $27.2(38%) million of Corel's sales in the third quarter of fiscal 1999 and
1998, respectively. Packaged product volume decreased in the third quarter of
fiscal 1999 primarily due to decreased sales of Graphics and Consumer products
software which are predominately sold in the retail packaged products channel.
OEM licenses increased in the third quarter of fiscal 1999 as compared to the
third quarter of fiscal 1998, due primarily to increased contracts to bundle
WordPerfect Suite 8.
Corporate licenses, including maintenance revenues, increased in the third
quarter of fiscal 1999, as compared to the third quarter of fiscal 1998, due to
expanded marketing efforts in this area.
Sales By Region. The table below shows Corel's sales geographically for the
third fiscal quarter and the nine months ended August 31, 1999 and 1998:
Three Months Ended Nine Months Ended
August 31 August 31
------------------------ ------------------------
1999 1998 1999 1998
------------------------ ------------------------
North America............ $48,191 $44,534 $120,266 $108,006
Europe................... 14,690 15,894 45,937 49,863
Other international...... 8,431 10,655 15,916 21,716
------------------------ ------------------------
Total sales.............. $71,312 $71,083 $182,119 $179,585
======================== ========================
Sales outside North America, principally in Europe, were 32% and 38% of Corel's
sales for the third quarter of fiscal 1999 and 1998, respectively.
Corel's products are sold primarily in US dollars in all countries other than
Canada and in US dollars to Canadian distributors. Sales in US dollars as a
percentage of total sales were in excess of 90% in the third quarter of both
fiscal 1999 and fiscal 1998.
Gross Profit
Corel includes in cost of sales all costs associated with the acquisition of
components, the assembly of finished products, product royalties, the
amortization of software acquisition costs and shipping. Costs associated with
warehousing are included in selling, general and administrative expenses.
Acquired software has been capitalized and is currently being amortized over a
36-month period commencing with the month of first shipment of the product
incorporating such acquired software, except for the cost of the WordPerfect
family of software programs and related technology, which is currently being
amortized over a five year period.
Gross profit as a percentage of sales decreased in the third quarter of fiscal
1999 compared to the third quarter of fiscal 1998 and is primarily attributable
to a larger number of licenses being amortized.
Advertising Expense
Advertising expenses include all marketing, advertising and trade show expenses.
Advertising expenses increased in the third quarter of fiscal 1999 compared to
the third quarter of fiscal 1998. The increase in advertising expenses was due
primarily to the Company supporting the launch of its two new products,
WordPerfect Suite 2000 and CorelDRAW 9.
Selling, General and Administrative Expense
Selling, general and administrative expenses include all general administrative
expenses as well as expenses associated with warehousing. Selling, general and
administrative expenses decreased in the third quarter of fiscal 1999 compared
to the third quarter of fiscal 1998.
Research and Development Expense
The Company has expensed all of its internal software development costs as
incurred, in accordance with Canadian GAAP. Research and development expenses
are reported net of Canadian investment tax credits.
Net research and development expenses decreased in the third quarter of fiscal
1999 compared to the third quarter of fiscal 1998. The decrease in net research
and development expenses was primarily attributable to the consolidation plan
initiated by the Company in the third fiscal quarter of 1998. The Company
transferred the research and development activity in the Orem, Utah engineering
center to the engineering facilities in Ottawa, Ontario. As a result of this
transfer, approximately 550 employees were terminated in the Orem, Utah location
which significantly reduced research and development expenses.
Depreciation and Amortization Expense
Depreciation and amortization expenses, which do not include the amortization of
purchased software, decreased in the third quarter of fiscal 1999 compared to
the third quarter of fiscal 1998. This decrease is primarily due to the decrease
in assets purchased in 1998 compared to 1997 and 1996, and the write-down of
capital assets as part of the restructuring in the third
quarter fiscal quarter of 1998, and the change in estimate identified in the
notes to the consolidated financial statements.
Loss (Gain) on Foreign Exchange
Foreign exchange gains or losses on non-US dollar transactions are due to
fluctuations in the value of those currencies relative to the value of the US
dollar between the time sales are recorded and the collection of the account
receivable, and revaluation gains or losses relating to short-term investments
held in a currency other than the financial measurement and reporting currency
due to fluctuations in the value of those currencies relative to the value of
the US dollar.
Interest Expense (Income)
Interest expense decreased in the third quarter of fiscal 1999 compared to the
third fiscal quarter of 1998. The decrease was primarily due to the decreased
balance in long term debt to Novell and the improved cash position of the
Company.
Income Taxes
Corel's effective tax rates were 4.0% and (23)% for the third quarter of fiscal
1999 and 1998, respectively. These rates vary from the Company's statutory tax
rate of 44%, primarily due to foreign tax rate differences associated with
Corel's international operations and the unrecorded tax benefit of accounting
losses in the 1999, 1998 and 1997 fiscal years. The accounting losses include
loss carry forwards for income tax purposes.
Liquidity and Capital Resources
As of August 31, 1999, Corel's principal sources of liquidity included cash and
short-term investments of approximately $23.8 million, and accounts receivable
of $49.9 million. Short-term investments consist of overnight call loans to a
major Canadian bank. Novell obligations of $20.9 million consists of the
outstanding royalty and product return obligations pursuant to the acquisition
of the WordPerfect family of software programs on March 1, 1996.
Cash provided by operations was $14.3 million for the first nine months of
fiscal 1999 compared to, $3.4 million for the first nine months of fiscal 1998.
The increase of $10.9 million was primarily due to the net income of $12.1
million in the first nine months of fiscal 1999 compared to the net loss of
$37.2 million in the first nine months of fiscal 1998 coupled with a significant
decline in accounts payable and accrued liabilities.
Accounts receivable increased in the third quarter of fiscal 1999, from the
third quarter of 1998, primarily due to increased sales levels in the third
quarter of fiscal 1999. The increase in sales and accounts receivable can be
attributed to the launch of the Company's latest versions of WordPerfect and
CorelDraw in the second quarter of 1999.
Financing activities provided cash of $6.0 million in the first nine months of
fiscal 1999 compared to a use of $8.1 million in the first nine months of fiscal
1998. The source of cash through financing activities was the exercise of
employee stock options for $6.7 million, and the issuance of shares for the
acquisition of the assets of GraphicCorp for $6.3 million. The use of cash in
the first nine months of 1999 was the repayment of the Novell obligations.
Investing activities, used $21.0 million in the first nine months of fiscal 1999
compared to $6.1 million in the first nine months of fiscal 1998, including
expenditures for capital assets of $17.8 million in the first nine months of
fiscal 1999 compared to $6.2 million in the first nine months of fiscal 1998. In
addition to capital asset additions, the Company completed the transfer to
Hardware Computing Canada (HCC) of all assets of Corel Computer supporting the
Netwinder family of Linux-based thin client/thin server computers and $1.3
million cash in exchange for a 25% equity stake in HCC in the second quarter of
1999. At August 31, 1999, Corel had no material commitments for capital
expenditures.
The Company believes that the existing sources of liquidity and anticipated
funds from operations will satisfy Corel's projected working capital, capital
expenditure and long-term debt repayment requirements for at least the next 12
months. The Company anticipates that subsequent to that time, its working
capital, capital expenditures and long-term debt repayments will be satisfied by
existing sources of liquidity, funds from operations and, if necessary,
additional financing.
Factors That May Affect Future Operating Results
Corel does not provide forecasts of future financial performance. While Corel's
management is confident about Corel's long-term performance prospects, the
following factors, among others, should be considered in evaluating its future
results of operations.
Competition
The PC software business is highly competitive and subject to rapid
technological change. Many of Corel's current and potential competitors have
larger technical staffs, more established and larger marketing and sales
organizations, and significantly greater financial resources than does Corel.
The rapid pace of technological change constantly creates new opportunities for
existing and new competitors and can quickly render existing technologies less
valuable. As the market for Corel's products continues to develop, additional
competitors may enter the market and competition may intensify.
Graphics. Corel's graphics software products face substantial competition from a
wide variety of companies. In the illustration graphics segment, Corel's
competitors include Adobe Systems Incorporated, Macromedia Inc., Micrografx,
Inc., and Microsoft. In the desktop publishing segment, its competitors include
Adobe. Corel's competitors include many other independent software vendors, such
as Autodesk, Inc., Borland International, Inc. and Apple Computer Inc.
Business Productivity. Corel's competitors in the productivity software
(primarily office suites) marketplace include Microsoft, IBM (Lotus), Sun,
Redhat and Applix. According to industry sources, Microsoft currently has the
largest overall market share for office suites. IBM has a large
installed base with its spreadsheet program. Also, IBM preinstalls some of its
software products on various models of its PCs, competing directly with Corel
productivity software.
Consumer Products. The Company competes with other participants in the Photo CD
market on the basis of price, the categories of photographs available, the
quality of the photographs and the nature of the rights attached to the photos
included on the Photo CD. The Company's competitors in this market include
Eyewire, Inc., Corbis Corporation and Getty Images, Inc. In the photo-editing
and painting graphics segments, its competitors include Adobe, Live Picture,
Meta Creations and The Learning Company. In the clipart segment, the Company's
competitors include Nova Corporation and The Learning Company. The Company
competes with Sierra/Cendant, Broderbund, The Learning Company and Microsoft in
the SOHO Graphics market. In addition to these direct competitors, the Company
competes with a number of personal computer manufacturers that devote
significant resources to creating personal computer software, including Apple,
Hewlett-Packard Company and IBM.
Video Products. The Company's communications applications products (CorelVIDEO)
compete against offerings from Intel Corporation, PictureTel Corporation,
C-Phone Corporation, White Pine Software, Inc. and many other companies. With
the intention to sell the Video division, it is expected that the above
mentioned organizations will not remain competitors of Corel.
The Company believes that the principal competitive factors in the PC software
markets include performance, product features, ease of use, reliability,
hardware compatibility, brand name recognition, product reputation, pricing,
levels of advertising, availability and quality of customer support, and
timeliness of product upgrades. Corel competes with other software vendors for
access to distribution channels, retail shelf space and the attention of
customers at the retail level and in corporate accounts. The Company also
competes with other software companies in its efforts to acquire software
technology developed by third parties.
Pricing
Pricing pressures continually intensify in the PC software applications market
and the Company believes that price competition, with its attendant reduced
profit margins, may become a more significant factor in the future. Corporate
licensing, discount pricing for large volume distributors and retailers, product
bundling promotions and competitive upgrade programs are forms of price
competition that may become more prevalent. In addition, enterprise wide
versions of products are generally priced lower per user than individual copies
of the same products. Corel also competes with companies that produce standalone
graphics and desktop publishing applications that might serve a specific need of
a user or class of users at a price below that of Corel's products.
Technological Change
The markets for Corel's products are characterized by rapidly changing
technology, frequent new product introductions and uncertainty due to new and
emerging technologies. Corel's future success is highly dependent upon the
timely completion and introduction of new or enhanced
products incorporating such emerging technologies at competitive
price/performance levels. The pace of change has recently accelerated due to the
Internet, corporate intranets and the acceptance of new operating systems such
as Windows 98 and Linux.
PC Growth Rates
The underlying PC unit growth rate, which may increase at a slower rate in the
future, impacts Corel's revenue growth.
Dependence on New Products
While Corel performs extensive usability and beta testing of new and enhanced
products, user acceptance and corporate penetration rates ultimately determine
the success of development and marketing efforts.
Product Ship Schedules
Delays in new product releases impact sales growth rates and can cause
operational inefficiencies that impact manufacturing and distribution logistics,
distributor, reseller and OEM relationships, and technical support and customer
service staffing.
Channel Mix
Average revenue per unit is lower from OEM licences than from retail versions,
reflecting the relatively low direct costs of operations in the OEM channel.
Potential Fluctuations in Quarterly Results
Corel's quarterly operating results fluctuate as a result of a number of
factors, including the timing of new product announcements and introductions by
Corel and its competitors, pricing, distributor ordering patterns, the relative
proportions of sales attributable to full kits and existing user upgrades,
product returns and reserves, advertising and other marketing expenditures, and
research and development expenditures. Revenues and earnings may be difficult to
predict due to shipment patterns. Products are generally shipped as orders are
received, and accordingly, Corel has historically operated with little backlog.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter.
Employee Compensation
The highly competitive market for qualified personnel, especially software
engineers and developers, could adversely affect Corel's ability to engage and
retain competent qualified personnel, particularly development professionals.
Corel believes that its employment policies in this regard are competitive
within the industry.
Dependence on Distributors
The distribution of Corel's products is carried out primarily through
distributors, certain of which are material to the competitive position of
Corel. The distribution channels through which software products for desktop
computers are sold have been characterized by rapid change, including
consolidations and financial difficulties of certain distributors and resellers,
the emergence of new retailers such as general mass merchandisers and
superstores, and the desire of large customers such as retail chains and
corporate users to purchase directly from software developers. The loss of, or a
significant reduction in sales volume attributable to any of Corel's principal
distributors or the insolvency or business failure of any such distributor could
have a material adverse effect on Corel's results of operations.
International Operations and Geographic Concentration
Currently, Corel markets its products in more than 60 countries. Corel
anticipates that sales outside North America will continue to account for a
significant portion of total sales. These sales are subject to certain risks
including imposition of government controls, export licence requirements,
restrictions on the export of technology, political instability, trade
restrictions, changes in tariffs, differences in copyright protection and
difficulties in managing accounts receivable. More than 45% of Corel's sales for
the past three fiscal years were made in the United States. As a result, adverse
developments in the United States markets for Corel's products could have a
material adverse effect on Corel's results of operations.
Dependence on Key Personnel
Corel's success depends to a significant extent upon the performance of Corel's
executive officers and key technical and marketing personnel. Corel has
agreements describing compensation arrangements and containing non-disclosure
covenants with all of its key employees. Corel believes that its future success
will also depend in large part on its ability to attract and retain highly
skilled technical, managerial, and sales and marketing personnel.
Saturation
Product upgrades, which enable users to upgrade from earlier versions of Corel's
products or from competitors' products, have lower prices and margins than new
products. The sales mix has shifted from full-kit products to upgrade products
as the market for Corel's products become saturated. This sales pattern is
likely to continue.
Corporate licenses
Average revenue per unit from corporate license programs is lower than average
revenue per unit from retail versions. Unit sales under licensing programs may
continue to increase.
Research and development investment cycle
Developing and localizing software is expensive and the investment in product
development often involves a lengthy payback cycle. The Company plans to
continue significant investments in product research and development from which
significant revenue is not assured.
Year 2000
Many software and hardware products were designed to store dates using a two-
digit year (e.g., 98) instead of a four-digit year (e.g., 1998). This was done
to save what was, at the time, valuable memory. As we make the transition to the
year 2000, some applications could misinterpret 00 as 1900, 1980 or some other
date.
In addition, 2000 is a leap year. A leap year occurs at the turn of the century
every 400 years, and some applications have failed to accommodate this.
There are three major risks for the Company from Year 2000 issues. Year 2000
compliance problems with Corel's products could have a material adverse effect
on sales and operations. Significant Year 2000 compliance problems with internal
systems could seriously affect the Company's ability to carry out its
operations. Corel also depends heavily on third parties for raw materials,
transportation utilities, and other key services. Interruption of supplier
operations due to Year 2000 issues could seriously disrupt the Company's
operations. In addition, if Corel's current or future customers do not achieve
Year 2000 compliance or if they divert expenditures previously reserved for
business software to address their Year 2000 compliance problems, Corel's
business, results of operations, or financial condition could be materially
adversely affected.
Addressing potential year 2000 issues is a high priority at Corel. In 1996,
Corel initiated a corporate-wide program to review, test and prepare Corel's
products and internal systems for the Year 2000 with the full support of the
Board of Directors. The Board of Directors is updated as to the status of
Corel's Year 2000 effort on a regular basis.
On the product side, Corel has established a comprehensive year 2000 Product
Evaluation Program. Corel conducts there product evaluations using real world
scenarios to determine if the applications will operate as designed using
various identified year 2000 critical dates where appropriate. Corel tests all
new products before they are released, as well as major upgrades of all existing
products. Corel has also completed testing on a number of historic products that
have a large user-base. Current information on the status of our products is
available on our Web site (http://www.corel.com/2000.htm). All upcoming product
releases are being tested for Year 2000 compliance and it is anticipated that
all upcoming releases will be Year 2000 compliant. Although Corel's testing
process is comprehensive, there can be no assurances that the Company's products
do not contain undetected errors or defects associated with year 2000 date
functions.
18
For internal systems, the Company has established a three phase testing program.
The inventory phase includes compiling a list of hardware and software systems
and suppliers that are critical to Corel's operations. Assessment includes the
evaluation of critical systems for Year 2000 compliance. The renovation phase
includes the resolution of all issues identified in the assessment phase.
The inventory phase is ongoing as additions to internal systems are made on a
regular basis. Corel has completed the assessment phase for all critical
internal hardware and software systems. The Company is also in the process of
implementing solutions to ensure Year 2000 compliance. As of the end of the
third quarter, ninety percent of critical systems are year 2000 compliant.
Implementation schedules for the remaining critical systems have been
established, and Corel expects they will all be renovated by October 31, 1999.
Non-critical systems will be tested and solutions implemented over the balance
of 1999. In addition, as part of ongoing business operations, the Company
strives to ensure that all current investments in new technology are Year 2000
compliant. Due to the nature of Corel's normal business practices, Corel is
continually upgrading many of its critical back-end systems with new hardware
and software. These practices help to ensure that Corel does not experience any
significant disruptions due to Year 2000 issues.
Corel's Year 2000 program also includes a full review of significant third
parties' Year 2000 compliance. Corel has been in contact with the majority of
these third parties and is currently conducting an in-depth risk analysis. This
includes assessing the extent of Year 2000 compliance for third parties as well
as reviewing their plans to address any Year 2000 issues through surveys and
discussions with company representatives. The Company fully expects to have
suitable solutions in place before 2000. There can be no guarantees, however,
that these third parties will be fully Year 2000 compliant.
Corel has designed a comprehensive contingency planning process to ensure the
continuity of business operations in the event of a disruption caused by Year
2000 issues. The four phases of this plan are I - business process definition,
II - business process analysis, III - scenario generation and contingency plan
determination and IV -validation and testing. The Company has completed phase
III of the plan, and expects completion of phase IV in the fourth quarter of
1999.
Corel expects to incur total costs of approximately $1.1 million from the fourth
quarter of 1999 through the second quarter of 2000 to operate Year 2000
programs. This amount includes the direct costs involved in running the Year
2000 department as well as costs associated with third party testing. These
amounts will be funded from operating cash flow and will be expensed as
incurred. There have also been substantial efforts expended by the Engineering,
MIS and Legal departments with regard to Year 2000 issues and by other
departments to a lesser degree. These costs are included in the salaries for
those departments. There is no assurance that the Company's financial position
may not be materially adversely affected if unanticipated problems occur.
Notwithstanding the efforts made to become Year 2000 compliant, there can be no
assurances that this program will ensure that all of Corel's internal systems,
products and third party systems will be Year 2000 compliant. Should these
systems not be compliant before 2000, there could be material adverse
consequences to the Company.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On or about February 23, 1998, the Company became aware that a class action
lawsuit had been filed against it by named Plaintiff Great Neck Capital
Appreciation Investment Partnership in the United States District Court for the
Eastern District of New York. The complaint also names as co-defendants Dr.
Michael C.J. Cowpland, Corel's Chairman, President and Chief Executive Officer,
and Mr. Charles Norris, Corel's former Vice President, Finance and Chief
Financial Officer. The complaint was filed on behalf of all persons who
purchased or otherwise acquired Corel common shares between March 26, 1997 and
January 20, 1998 (the "Class Period"). The complaint alleges that the defendants
violated various provisions of the federal securities laws, including Section
10(b) and 10(a) of the Securities Exchange Act of 1934, as amended, and
Securities and Exchange Commission Rule 10b-5, by misrepresenting or failing to
disclose material information about Corel's financial condition. The complaint
alleges that the defendants issued false and misleading press releases and
financial statements for the first three quarters of fiscal 1997. Plaintiff
alleges, in part, that defendants (a) failed to disclose that they were
overstating Corel's reported profits by, among other things, inflating reported
revenues and earnings through improperly recognizing revenue on Java technology
exchange transactions, and (b) overstated revenues and earnings by understating
reserves in connection with sales to distributors who had no obligation to keep
or pay for the products. The complaint also alleges that Corel insiders,
including the individual co-defendants, sold common shares during the Class
period at "artificially inflated prices". The complaint seeks an unspecified
amount of money damages.
The Great Neck complaint was consolidated by order date June 1, 1998 with four
other previously filed complaints: Giskan, Meyer, Mangold and Hagler. Also on
June 1, 1998, the court approved the plaintiff's motion for the appointment of
lead plaintiff and lead counsel. The firm of Weschsler Harwood Halebian & Feffer
is counsel of record. Great Neck (as lead plaintiff) filed a consolidated
amended complaint on behalf of lead plaintiff and the class on September 9, 1998
(the "Consolidated Complaint"). The Consolidated Complaint references a revised
Class Period (it has been filed on behalf of all persons who purchased or
otherwise acquired Corel common shares between January 15, 1997 and January 20,
1998); however, plaintiff's theories from the individual complaints (as
summarized above) remain the same.
On November 9, 1998, the Company filed a motion to Dismiss the Consolidated
Complaint in its entirety. On December 30, 1998, Plaintiffs filed a related
Motion to strike certain documents referred to in the Company's Motion to
Dismiss. Both motions were fully briefed by February 12, 1999. On June 18, 1999,
the Company filed a second Motion to Dismiss the Consolidated Complaint in its
entirety on the grounds of forum non conveniens. The plaintiffs have not yet
brought their motion to certify the class and the filing.
All three pending motions were stayed as a result of a Memorandum of
Understanding ("MOU") that was entered into by the parties on September 1, 1999.
The MOU must receive both preliminary and final court approval. Its terms and
conditions are confidential. The parties will likely finalize their submissions
to the court seeking preliminary court approval during the fourth quarter of
fiscal 1999.
The amount of the settlement fund will be disclosed by the parties when
preliminary court approval is sought. The settlement of this litigation is not
expected to have a material adverse effect on the Company's operating results
for the fourth quarter or any subsequent period.
On May 25, 1998, Revenue Canada advised the Company of proposed income tax
adjustments for fiscal years ended November 30, 1992 to 1995. The Company filed
a Response to Revenue Canada's Proposal on October 23, 1998 and has subsequently
continued a dialogue and exchange of correspondence in respect of a number of
particular issues in question. The company has recorded a provision of
$2,468,000, inclusive of interest and penalties, for certain adjustments.
However, it is not possible to accurately estimate the amount, if any, of
additional income taxes that may result from the remaining adjustments
identified and therefore, no further provision has been made.
On or about October 2, 1998, the Company became aware that a class action
lawsuit had been filed against it by plaintiff Karla A. Lyon in the Superior
Court of California, County of San Diego. The complaint also names as co-
defendants Corel Corporation (USA), Corel, Inc., Fry's Electronics, and David
Bicknell, a manager of one of Fry's Electronics' stores. The complaint was
filed on behalf of all persons whose photograph or likeness was, without that
person's consent, knowingly used by any of the defendants within the State of
California.
The complaint alleges that the defendants violated section 3344 of the
California Civil code, respecting commercial use of identifiable individuals'
photographs, and section 3294 of the California Civil Code, respecting
oppression, fraud, and malice. The complaint alleges that the defendants entered
into a common plan to obtain photographs of the class members and use, without
consent, such photographs for commercial purposes including incorporating the
photographs into products, merchandise, and on-line sales through the Internet.
The complaint alleges that the defendants evaded just debts and royalties
payable to the class members together with monetary damages for unauthorized use
of those photographs. The complaint further alleges that, to the extent
pecuniary compensation would not afford adequate relief, all class members are
entitled to an injunction preventing the defendants from further use of
identified photographs. The Company cannot identify which of its products
contain identified photographs until the class is certified, which certification
the Company contests. The complaint seeks an unspecified amount of monetary
damages together with injunctive relief.
In April of 1999, the plaintiff filed an amended complaint and added three new
plaintiffs (Kanter, Sundy and Wilkinson) and several new defendants. The Company
deposed plaintiffs Lyon and Kanter in March 1999 and Sundy and Wilkinson in May
1999. Plaintiffs brought a motion for summary adjudication for a permanent
injunction, which was scheduled to be heard on June 18, 1999. Prior to the
hearing of this motion, the Company learned that two of the plaintiffs had
executed model releases for the photos at issue. Following a settlement
conference on June 11, 1999, the parties agreed to a full and final settlement
of all outstanding issues. Pursuant to the settlement agreement, Corel obtained
an assignment of all of plaintiffs' photographs. The plaintiffs' individual
claims were dismissed by the court on June 17, 1999.
On October 14, 1999, the Ontario Securities Commission filed charges against
Michael Cowpland, the Company's chairman, president and chief executive officer
and his holding company, M.C.J.C. Holdings Inc., in the Ontario Court of
Justice. The charges include four counts of violating provisions of the Ontario
Securities Act related to insider trading. The Company and Michael Cowpland
continue to deny all allegations by the Ontario Securities Commission. The
investigation is a private matter between the Ontario Securities Commission and
Michael Cowpland as an individual. As such, it is not expected to affect the
Company's day-to-day activities or have any impact on Michael Cowpland's status
as the Company's chairman, president and chief executive officer.
The Company is a party to a number of additional claims arising in the ordinary
course of business relating to intellectual property and other matters. The
Company believes that the ultimate
resolution of these claims will not have a material adverse effect on its
business, financial position or results of operations.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 27
b) Reports on Form 8-K
The Company filed no reports on Form 8-K for the fiscal quarter ended
August 31, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the undersigned
hereunto duly authorized.
COREL CORPORATION
(Registrant)
Date: October 14, 1999 By: /s/ Michael C.J. Cowpland
--------------------------------
Michael C.J. Cowpland
Chairman, President, Chief
Executive Officer and Director
Date: October 14, 1999 By: /s/ Michael P. O'Reilly
--------------------------------
Michael P. O'Reilly
Vice-President, Finance and
Chief Financial Officer