<PAGE>
===============================================================================
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 February 28, 1998
----------------------------------------------------
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ________________ to _______________________
Commission File Number 0-20562
-------
COREL CORPORATION
-----------------
(Exact name of Registrant as specified in its Charter)
Canada NOT APPLICABLE
--------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1600 Carling Avenue, Ottawa, Ontario, Canada K1Z 8R7
-------------------------------------------- -------
(Address of principal executive offices) (Zip Code)
(613) 728-8200
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
------- _____
As of April 8,1998, the registrant had 59,346,209 Common Shares outstanding.
===============================================================================
1
<PAGE>
COREL CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as at November 30, 1997
and February 28, 1998......................................... 3
Consolidated Statements of Operations and Retained Earnings
(Deficit) for the three months ended February 28, 1997 and
February 28, 1998.............................................. 4
Consolidated Statements of Changes in Financial Position
for the three months ended February 28, 1997 and February 28,
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............................................... 21
Item 6. Exhibits and Reports on Form 8-K................................ 22
SIGNATURES................................................................. 23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1. FINANCIAL STATEMENTS
COREL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of U.S.$)
<TABLE>
<CAPTION>
November 30, February 28,
1997 1998
(unaudited)
-------------------- -------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and short-term investments................. $ 30,629 $ 18,948
Accounts receivable (note 2)
Trade....................................... 50,951 33,955
Other....................................... 2,310 2,961
Inventory (note 3).............................. 11,412 12,486
Deferred income taxes........................... 2,353 2,695
Prepaid expenses................................ 2,591 2,021
--------- ---------
100,246 73,066
Capital assets (note 4).............................. 63,497 57,397
--------- ---------
$ 163,743 $ 130,463
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................ $ 13,840 $ 6,457
Accrued liabilities............................. 34,223 32,431
Current portion of long-term debt............... 13,500 13,500
Income taxes payable............................ 4,203 5,077
Deferred revenue................................ 14,124 11,992
--------- ---------
79,890 69,457
Long-term debt (note 5).............................. 24,044 23,273
Shareholders' equity
Share capital (note 6).......................... 204,235 202,879
Contributed surplus............................. 730 1,099
Deficit......................................... (145,156) (166,245)
--------- ----------
59,809 37,733
--------- ----------
$ 163,743 $ 130,463
========= ==========
</TABLE>
(See accompanying Notes to Consolidated Financial Statements)
3
<PAGE>
COREL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND RETAINED EARNINGS (DEFICIT)
(in thousands of U.S.$, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
-------------------------------
February 28, February 28,
1997 1998
------------- ------------
<S> <C> <C>
Sales....................................................... $ 80,718 $ 45,460
Cost of sales (note 7)...................................... 24,023 10,442
--------- ---------
Gross profit............................................. 56,695 35,018
--------- ---------
Expenses:
Advertising.............................................. 19,873 11,168
Selling, general and administrative...................... 19,652 18,417
Research and development................................. 18,823 21,165
Depreciation and amortization............................ 6,894 4,391
Loss on foreign exchange................................. 183 283
--------- ---------
65,425 55,424
--------- ---------
Loss from operations........................................ (8,730) (20,406)
Interest expense............................................ 501 133
--------- ---------
Loss before income taxes.................................... (9,231) (20,539)
Income taxes:
Current................................................. 3,847 892
Deferred (reduction).................................... (1,824) (342)
--------- ---------
2,023 550
Net loss.................................................... (11,254) (21,089)
Retained earnings (deficit) at beginning of period.......... 86,955 (145,156)
--------- ----------
Retained earnings (deficit) at end of period................ $ 75,701 $(166,245)
========= =========
Loss per share: (note 6)
Net loss
Basic................................................ ($0.19) ($0.36)
Average number of Common Shares outstanding:
Basic................................................ 60,068 59,346
- --------------------------------------------------------------------------------------------------
</TABLE>
(See accompanying Notes to Consolidated Financial Statements)
4
<PAGE>
COREL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN FINANCIAL POSITION
(in thousands of U.S.$)
(unaudited)
<TABLE>
<CAPTION>
Three months ended
February 28, February 28,
1997 1998
-------------------- ------------------
<S> <C> <C>
Cash provided by (used for):
Operations:
Net loss.................................................. $(11,254) $(21,089)
Items which do not involve cash:
Depreciation and amortization........................ 20,756 7,548
Loss (gain) on disposal of assets.................... (1) (4)
Deferred income taxes................................ (1,824) (342)
Decrease in accounts receivable........................... 5,055 16,345
Increase in inventory..................................... (1,484) (1,074)
Decrease in prepaid expenses.............................. 838 570
Decrease in accounts payable.............................. (4,817) (7,383)
Increase (decrease) in other accrued liabilities.......... 4,111 (1,792)
Increase (decrease) in deferred revenue................... 1,931 (2,132)
Increase (decrease) in income taxes payable/recoverable... (595) 874
-------- --------
Cash provided by (used for) operations.................... 12,716 (8,479)
Financing:
Issue of share capital.................................... 241 -
Shares purchased for cancellation......................... - (987)
Repayment of long-term debt............................... (3,054) (771)
-------- --------
(2,813) (1,758)
Investments:
Purchase of capital assets................................ (4,845) (1,448)
Proceeds on disposal of assets............................ 34 4
-------- --------
(4,811) (1,444)
Net increase (decrease) in cash................................ 5,092 (11,681)
Cash at beginning of period.................................... 6,924 30,629
-------- --------
Cash at end of period.......................................... $ 12,016 $ 18,948
======== ========
Cash is defined as cash and short-term investments
</TABLE>
(See accompanying Notes to Consolidated Financial Statements)
5
<PAGE>
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 8. The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries, Corel Corporation Limited, Corel Computer Corp.,
Corel International Corporation, Corel, Inc. and its wholly-owned subsidiary,
Corel Corporation (U.S.A.).
In the opinion of Management, these unaudited interim consolidated financial
statements reflect all adjustments, which are of a normal and recurring nature,
necessary to state fairly the results for the periods presented.
These financial statements should be read in conjunction with the Company's
audited financial statements as of November 30, 1996 and 1997 and for each of
the three years in the period ended November 30, 1997 including notes thereto,
included in the Company's Annual Report on Form 10-K for the year ended November
30, 1997. The consolidated results of operations for the first fiscal quarter
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:
<TABLE>
<CAPTION>
November 30, February 28,
1997 1998
------------ ------------
<S> <C> <C>
Promotional rebates................................... $11,396 $15,891
Sales reserve......................................... 54,413 36,414
Allowance for doubtful accounts....................... 5,466 5,786
</TABLE>
6
<PAGE>
3. INVENTORIES
<TABLE>
<CAPTION>
November 30, February 28,
1997 1998
------------ ------------
<S> <C> <C>
Raw materials......................................... $ 7,974 $ 9,768
Finished goods........................................ 3,438 2,718
------- -------
$11,412 $12,486
======= =======
</TABLE>
4. CAPITAL ASSETS
<TABLE>
<CAPTION>
FEBRUARY 28, 1998
-------------------------------------------------
ACCUMULATED
DEPRECIATION NET
AND NOVEMBER 30,
COST AMORTIZATION NET 1997
----------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Furniture and equipment.................... $ 15,592 $ 7,751 $ 7,841 $ 8,307
Computer equipment and software............ 61,581 54,621 6,960 9,423
Research and development equipment......... 12,622 5,568 7,054 7,398
Leasehold improvements..................... 3,625 2,103 1,522 1,674
Software licenses and purchased software,
clipart libraries and photo CD libraries. 94,560 60,540 34,020 36,695
-------- -------- ------- -------
$187,980 $130,583 $57,397 $63,497
======== ======== ======= =======
</TABLE>
At November 30, 1997, the cost amounted to $186,521,000 and accumulated
depreciation amounted to $123,024,000. The carrying amount of licenses not being
amortized at February 28, 1998 and November 30, 1997 amounted to $2,916,000 and
$2,425,000 respectively.
5. LONG-TERM DEBT
Long-term debt consists of the outstanding royalty and product return
obligations pursuant to the WordPerfect acquisition on March 1, 1996.
<TABLE>
<CAPTION>
As at November 30, 1997 As at February 28, 1998
------------------------------------ ------------------------------------
Product Product
Royalty Returns Total Royalty Returns Total
------- ------- ----- ------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Long-term debt........... $19,182 $18,362 $37,544 $18,906 $17,867 $36,773
Less: Current portion.... 6,500 7,000 13,500 6,500 7,000 13,500
---------- ---------- ---------- ----------- ---------- ----------
$12,682 $11,362 $24,044 $12,406 $10,867 $23,273
========== =========== =========== ============ ========== ==========
</TABLE>
7
<PAGE>
COREL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars, tabular amounts in thousands except per share data)
(Unaudited)
6. SHARE CAPITAL
During the three-month periods ended February 28, 1997 and February 28, 1998,
the Company issued 40,203 and 0 common shares, respectively, pursuant to its
Stock Option Plan, for proceeds of $241,000 and $0, respectively. In addition,
during the three month period ended February 28, 1998, the Company, pursuant to
its normal course issuer bid which commenced on March 5, 1997, purchased for
cancellation 393,500 common shares at a cost of $987,000.
7. COST OF SALES
<TABLE>
<CAPTION>
FISCAL QUARTER ENDED
---------------------------------------
FEBRUARY 28, FEBRUARY 28,
1997 1998
------------ -----------
<S> <C> <C>
Cost of goods sold................................................. $ 5,489 $ 5,408
Licence amortization............................................... 13,861 3,157
Royalties.......................................................... 4,673 1,877
------- -------
$24,023 $10,442
======= =======
</TABLE>
8. SIGNIFICANT DIFFERENCES BETWEEN CANADIAN AND UNITED STATES GAAP
The Company's financial statements are prepared on the basis of Canadian GAAP,
which is different in some respects from US GAAP. Significant differences
between Canadian GAAP and US GAAP are set forth below:
(a) Earnings per share calculations
The Company has considered the effect of the methodology for the calculation of
earnings per share prescribed under the Statement of Financial Accounting
Standards No. 128. The calculation of basic earnings per share for US GAAP
purposes is not different from the calculation of basic earnings per share for
Canadian GAAP. Under US and Canadian GAAP, where the impact of conversion or
exercise of stock options is anti-dilutive, they are not included in the
calculation of diluted earnings per share.
(b) Accounting for stock-based compensation
8
<PAGE>
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for its
employee stock option plan. Accordingly, no compensation expense has been
recognized for its stock-based plan. Had compensation cost for the Company's
employee stock option plan been determined based on the fair value at the grant
date for awards under the plan, consistent with the methodology prescribed under
the Statement of Financial Standards No. 123, Accounting for Stock-Based
Compensation, the Company's net loss would not have been changed significantly
from the amount reported on the Statement of Operations and Retained Earnings
(Deficit) for the three month period ended February 28, 1998.
(c) Deferred income taxes:
The Company follows the deferral method of accounting for income taxes. Under
US GAAP the asset and liability method is used. In the case of the Company, the
application of the asset and liability method does not result in a significant
difference in the amount of the deferred tax asset. US GAAP also requires the
disclosure of the tax effect of temporary differences that give rise to deferred
tax assets and liabilities. This information is provided in the following:
<TABLE>
<CAPTION>
NOVEMBER 30, FEBRUARY 28,
1997 1998
------------ ------------
<S> <C> <C>
Operating loss carryforwards....................................... $ 4,855 $ 8,258
Depreciation....................................................... 14,750 16,311
Reserves........................................................... 3,292 8,354
-------- --------
$ 22,897 $ 32,923
Valuation allowance (20,544) (30,228)
-------- --------
Net deferred tax assets $ 2,353 $ 2,695
======== ========
</TABLE>
(d) Consolidated statements of change in financial position
The Company defines cash for purposes of the consolidated statements of changes
in financial position as cash and short-term investments. Included in short-
term investments are $5,000,000 of marketable equity securities. Under US GAAP,
cash at the end of the first quarter ended February 28, 1998 would be reduced by
this amount.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following information must be read in conjunction with the unaudited
Consolidated Financial Statements and Notes thereto included in Item 1 of this
Quarterly Report and the audited Consolidated Financial Statements and Notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-K for
the year ended November 30, 1997 (the "1997 Form 10-K"). This Form 10-Q contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements involve
uncertainty and risk, and all assumptions, anticipations, and expectations
stated herein are forward-looking statements. The actual results that the
Company achieves may differ materially from any forward-looking statements made
herein due to such risks and uncertainties. The Company has identified by
italics various sentences within this Form 10-Q which contain such forward-
looking statements, and words such as "believes", "anticipates", "expects",
"intends" and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such statements. In
addition, the section labeled "Factors That May Affect Future Operating
Results", which is not italicized for improved readability, consists primarily
of forward-looking statements. The Company undertakes no obligation to revise
any forward-looking statements in order to reflect events or circumstances that
may arise after the date of this report. Readers are urged to carefully review
and consider the various disclosures made by the Company in this report and in
the Company's other reports filed with the Securities and Exchange Commission
that attempt to advise interested parties of the risks and factors that may
affect the Company's business. Therefore, historical results and percentage
relationships will not necessarily be indicative of the operating results of any
future period.
On January 20, 1998, the Company announced in a press release that it had
restated its financial results for the first three quarters of fiscal 1997, to
reflect a different accounting treatment of certain JAVA technologies exchange
transactions that had been entered into during those quarters. The effects of
the restatement were discussed in the press release and accompanying financial
summaries, which were filed as exhibits to the Company's Report on Form 8-K
filed with the Securities and Exchange Commission and with the Ontario
Securities Commission on January 21, 1998. Financial information in this Report
concerning fiscal 1997 reflects this restatement of the first quarter of fiscal
1997.
10
<PAGE>
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, certain statement of
income data expressed as a percentage of sales for the periods indicated, and
the percentage change of such items as they relate to the comparable period in
the previous year.
<TABLE>
<CAPTION>
PERCENT OF SALES PERIOD TO PERIOD
THREE MONTHS ENDED INCREASE (DECREASE)
--------------------------------- 1998
FEBRUARY 29, FEBRUARY 28, COMPARED TO
1997 1998 1997
------------ ------------ ------------------
<S> <C> <C> <C>
Sales..................................... 100% 100% (44)%
Cost of sales............................. 30 23 (57)
---- ---
Gross profit............................ 70 77 (38)
Expenses
Advertising............................. 25 25 (44)
Selling, general and administrative..... 24 40 (6)
Research and development................ 23 46 12
Depreciation and amortization........... 9 10 (36)
Loss on foreign exchange................ 0 1 55
---- ---
81 122 (15)
---- ---
Loss from operations...................... (11) (45) (134)
Interest expense.......................... 0 0 (73)
---- ---
Loss before income taxes.................. (11) (45) (123)
Income taxes.............................. 3 1 (73)
---- ---
Net loss.................................. (14)% (46)% (87)
==== ===
</TABLE>
SALES
Sales decreased 44% to $45.5 million in the first quarter of fiscal 1998 from
$80.7 million in the first quarter of fiscal 1997 primarily due to decreased
aggregate unit sales of Corel's products. In addition, the dollar amount of
sales in the first quarter of fiscal 1998 was also affected by a charge recorded
in the first quarter of fiscal 1998 relating to the announcement of Corel's new
WordPerfect Suite pricing strategy on March 9, 1998. That announcement outlined
the reduction in selling price of certain WordPerfect Suite products. The charge
recorded in the first quarter of fiscal 1998 was $11.2 million and related to
price protection allowances that the Company expects to credit its distributors
and resellers for the products affected by this announcement.
PRODUCT GROUPS. The table below shows sales for the first fiscal quarter ended
February 28, 1997 and 1998, consisting of graphics software new licenses (full
kits and competitive upgrades) and existing user upgrades, productivity software
new licenses (full kits and competitive upgrades) and existing user upgrades,
multimedia software (including sales from
11
<PAGE>
the Company's Professional Photo CD titles and CorelSCSI), and communication
applications (including CorelVIDEO):
12
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------
FEBRUARY 28, 1997 FEBRUARY 28, 1998
------------------------- ---------------------------
<S> <C> <C>
Graphics software - new licenses.......................... $ 26,455 $ 18,269
Graphics software - existing user upgrades................ 11,165 8,699
------------------------- ---------------------------
Total graphics software............................... 37,620 26,968
------------------------- ---------------------------
Productivity software - new licenses...................... 31,211 16,936
Productivity software - existing user upgrades............ 9,926 1,027
------------------------- ---------------------------
Total productivity software........................... 41,137 17,963
------------------------- ---------------------------
Multimedia software....................................... 1,598 426
Communications applications............................... 363 103
------------------------- ----------------------------
Total sales...................................... $ 80,718 $ 45,460
========================= ============================
</TABLE>
Graphics software revenues decreased in the first quarter of fiscal 1998, as
compared to the first quarter of fiscal 1997, primarily due to reduced unit
volumes of retail versions of CorelDRAW 7 and CorelDRAW 8.
Productivity software revenues decreased in the first quarter of fiscal 1998, as
compared to the first quarter of fiscal 1997, primarily due to reduced unit
volumes of retail versions of Corel WordPerfect Suite 8 and Corel WordPerfect
Suite 7 and the price protection allowances related to the new WordPerfect
pricing strategy, partially offset by revenues from sales of Corel WordPerfect
Suite 8 Professional, which was introduced in the third quarter of fiscal 1997,
and by increasing corporate licensing revenues.
Multimedia sales were lower in the first quarter of fiscal 1998, as compared to
the first quarter of fiscal 1997, primarily due to a decline in the unit sales
of the Corel Stock Photo Libraries and a decline in Corel CD HOME revenues
resulting from the sale of the Corel CD HOME COLLECTION and Corel Medical Series
to Hoffman + Associates Inc. in April 1997.
SALES CHANNELS. Corel distributes its products primarily through distributors
(as retail packaged products), OEM licences and corporate licences. The table
below shows sales through these channels for the first fiscal quarter ended
February 28, 1997 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FEBRUARY 28,
-----------------------------
1997 1998
------------- -------------
<S> <C> <C>
Retail packaged products.............................................. $56,081 $19,324
OEM licences.......................................................... 7,910 5,992
Corporate licences.................................................... 16,727 20,144
------------- -------------
Total sales........................................................... $80,718 $45,460
============= =============
</TABLE>
13
<PAGE>
Retail packaged products and corporate licences are sold primarily through
distributors. The three largest distributors accounted for $32.5 million (40%)
and $7.6 million (17%) of Corel's sales in the first quarter of fiscal 1997 and
1998, respectively. Packaged product volume decreased in the first quarter of
fiscal 1998 primarily because of a decrease in unit volume sales of the current
version of the WordPerfect Suite at that time.
Corporate licences, including maintenance revenues, increased in the first
quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, due to
increased unit volume sales resulting from the expanded marketing efforts in
this area.
OEM channel revenues decreased in the first quarter of fiscal 1998, as compared
to the first quarter of fiscal 1997, primarily due to a decline in unit volume
for OEM versions of CorelDRAW 5 and CorelDRAW 4.
The table below shows Corel's sales geographically for the first fiscal quarter
ended February 28, 1997 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FEBRUARY 28,
------------------------------
1997 1998
------------- -------------
<S> <C> <C>
North America....................................................... $44,679 $23,968
Europe.............................................................. 31,393 16,192
Other international................................................. 4,646 5,300
------------- -------------
Total sales......................................................... $80,718 $45,460
============= =============
</TABLE>
Sales outside North America, principally in Europe, were 45% and 47% of Corel's
sales for the first quarter of fiscal 1997 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 95% in the first quarter of both
fiscal 1997 and fiscal 1998.
GROSS PROFIT
Corel includes in cost of sales all costs associated with the acquisition of
components, the assembly of finished products, 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 was 77% of sales in the first quarter of
fiscal 1998 as compared to 70% in the first quarter of fiscal 1997. Gross profit
as a percentage of sales
14
<PAGE>
increased in the first quarter of fiscal 1998 compared to the first quarter of
fiscal 1997 primarily due to the reduction in quarterly amortization charges of
approximately $9 million pursuant to the technology write-down of $113.7 million
in the second quarter of fiscal 1997.
ADVERTISING EXPENSE
Advertising expenses include all marketing, advertising and trade show expenses.
Advertising expenses decreased by 44% to $11.2 million in the first quarter of
fiscal 1998 from $19.9 million in the first quarter of fiscal 1997. Advertising
expenses remained constant as a percentage of sales at 25% for the first
quarters ending February 28, 1997 and February 28, 1998. The decrease in
advertising expenses in the first quarter of fiscal 1998 was due to more
targeted marketing efforts and the implementation of various cost control
measures.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses include all general administrative
expenses as well as expenses associated with warehousing. Selling, general and
administrative expenses decreased by 6% to $18.4 million in the first quarter of
fiscal 1998 from $19.6 million in the first quarter of fiscal 1997. Selling,
general and administrative expenses increased as a percentage of sales from 24%
in the first quarter of fiscal 1997 to 40% in the first quarter of fiscal 1998.
The increase in the amount of such expenses as a percentage of sales was
primarily due to the level of sales achieved in the first quarter of fiscal 1997
compared to the first quarter of fiscal 1998.
RESEARCH AND DEVELOPMENT EXPENSE
The Company has expensed all of its internal software development costs as
incurred, in accordance with Canadian GAAP. Research and development expenses
are reported net of Canadian investment tax credits. The table below shows gross
research and development expenses, related tax credits, net research and
development expenses, and net research and development expenses as a percentage
of sales for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FEBRUARY 28,
--------------------------------
1997 1998
------------- ------------
<S> <C> <C>
Gross research and development expenses............................. $20,246 $21,165
Research and development tax credits................................ 1,423 -
------------- ------------
Net research and development expenses............................... $18,823 $21,165
Net research and development expenses
as a percentage of sales......................................... 23% 46%
</TABLE>
Net research and development expenses increased by 12% to $21.2 million in the
first quarter of fiscal 1998 from $18.8 million in the first quarter of fiscal
1997. Net research and development expenses as a percentage of sales increased
from 23% in the first quarter of fiscal 1997 to 46% in the first quarter of
fiscal 1998. The increase in net research and development
15
<PAGE>
expenses was primarily attributable to the inability to claim investment tax
credits in the first quarter of fiscal 1998. The Company will be in a position
to recognize the tax credits associated with these and future research and
development expenses as the Canadian operations become profitable.
DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation and amortization expenses, which do not include the amortization of
purchased software, decreased by 36% to $4.4 million in the first quarter of
fiscal 1998 from $6.9 million in the first quarter of fiscal 1997. Depreciation
and amortization expenses decreased in the first quarter of fiscal 1998
compared to the first fiscal quarter of 1997 primarily due to significant
capital expenditures coming to the end of their depreciation and amortization
periods throughout the quarter.
LOSS (GAIN) ON FOREIGN EXCHANGE
Foreign exchange gains or losses on non-US dollar transactions are due to
fluctuations in the value of those currencies relative to the value of the US
dollar between the time sales are recorded and the collection of the account
receivable, and revaluation gains or losses relating to short-term investments
held in a currency other than the financial measurement and reporting currency
due to fluctuations in the value of those currencies relative to the value of
the US dollar.
INTEREST EXPENSE
Interest expense decreased by $0.4 million to an expense of $0.1 million in the
first quarter of fiscal 1998 from $0.5 million in the first quarter of fiscal
1997. The decrease was primarily due to the lower level of long-term interest
bearing obligations resulting from the acquisition of the WordPerfect family of
software programs on March 1, 1996.
INCOME TAXES
Corel's effective tax rates were 22% and 3% for the first quarter of fiscal 1997
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 first quarter of fiscal 1998. The accounting losses reflect amounts which
may be carried forward for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
As of February 28, 1998, Corel's principal sources of liquidity included cash
and short-term investments of approximately $18.9 million, and accounts
receivable of $36.9 million. Short-term investments consist of overnight call
loans to a major Canadian bank and marketable securities. Long-term debt of
$36.8 million consists of the outstanding royalty and product
16
<PAGE>
return obligations pursuant to the acquisition of the WordPerfect family of
software programs on March 1, 1996.
Cash used by operations was $8.5 million for the first quarter of fiscal 1998
compared to cash provided of $12.7 million for the first quarter of fiscal
1997. The decrease of $21.2 million was primarily due to the net loss of $21.1
million in the first quarter of fiscal 1998 compared to the net loss of $11.3
million in the first quarter of fiscal 1997 and a decrease in depreciation and
amortization expense of $13.3 million from $20.8 million for the first quarter
of fiscal 1997 to $7.5 million for the first quarter of fiscal 1998.
Accounts receivable decreased in the first quarter of fiscal 1998 primarily due
to reduced sales levels in the third and fourth quarters of fiscal 1997.
Financing activities used cash of $1.7 million in the first quarter of fiscal
1998 compared to $2.8 million in the first quarter of fiscal 1997.
Investing activities, primarily the acquisition of capital assets, used $1.4
million in the first quarter of fiscal 1998 compared to $4.8 million in the
first quarter of fiscal 1997, including expenditures for acquired software of
$0.5 million in the first quarter of fiscal 1998 compared to $2.5 million in the
first quarter of fiscal 1997. At February 28, 1998, Corel had no material
commitments for capital expenditures. Corel anticipates that capital
expenditures for computer and office equipment for fiscal 1998 will remain
constant with fiscal 1997 levels as computer systems are upgraded to take
advantage of new technologies. Due to the rapidly changing technology in the
computer software industry, expenditures for technology acquisitions cannot be
predicted for future fiscal periods.
The Company believes that the existing sources of liquidity and anticipated
funds from operations will satisfy Corel's projected working capital, capital
expenditure and long-term debt repayment requirements for at least the next 12
months. The Company anticipates that subsequent to that time, its working
capital, capital expenditures and long-term debt repayments will be satisfied by
existing sources of liquidity, funds from operations and, if necessary,
additional financings.
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
17
<PAGE>
less valuable. As the market for Corel's products continues to develop,
additional competitors may enter the market and competition may intensify.
Graphics Software. Corel's graphics software products face substantial
competition from a wide variety of companies. In the illustration graphics
segment Corel's competitors include Adobe Systems Incorporated, Macromedia Inc.,
Deneba Systems Incorporated and Micrografx, Inc. In the photo editing and
painting graphics segment its competitors include Adobe and Micrografx. In the
charting and presentation segments its competitors include Software Publishing
Corporation, Microsoft, Corporation, Adobe, Micrografx and IBM (Lotus
Development Corporation). In the desktop publishing segment its competitors
include Adobe and Quark, Inc. Corel's competitors include many other independent
software vendors, such as Autodesk, Inc., Borland International, Inc., Claris
and Computer Associates, as well as a number of personal computer manufacturers
which devote significant resources to creating personal computer software,
including Apple, Hewlett-Packard Company and IBM.
Productivity Software. Corel's competitors in the productivity software
(primarily office suites) marketplace include Microsoft and IBM (Lotus).
According to industry sources, Microsoft currently has the largest overall
market share for office suites. IBM has a large installed base with its
spreadsheet program and has recently adopted aggressive pricing strategies.
Also, IBM preinstalls certain of its software products on various models of its
PCs, competing directly with Corel productivity software.
The Company believes that the principal competitive factors in the PC software
markets include performance, product features, ease of use, reliability,
hardware compatibility, brand name recognition, product reputation, pricing,
levels of advertising, availability and quality of customer support, and
timeliness of product upgrades. Corel competes with other software vendors for
access to distribution channels, retail shelf space and the attention of
customers at the retail level and in corporate accounts. The Company also
competes with other software companies in its efforts to acquire software
technology developed by first parties. The Company believes that, in the future,
competition in the industry will intensify as major software companies expand
their product lines.
Pricing
In the past year, pricing pressures have intensified in the PC software
applications market and the Company believes that price competition, with its
attendant reduced profit margins, may become a more significant factor in the
future. Corporate licensing, discount pricing for large volume distributors and
retailers, product bundling promotions and competitive upgrade programs are
forms of price competition that may become more prevalent. In addition, local
area network versions of products are generally priced lower per user than
individual copies of the same products. Corel also competes with companies that
produce standalone graphics and desktop publishing applications that might serve
a specific need of a user or class of users at a price below that of Corel's
products. Additionally, should competitive pressures in the industry increase,
Corel may have to increase its spending on advertising as a percentage of
revenues, resulting in lower profit margins.
18
<PAGE>
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, the
introduction of 32-bit operating systems, such as Windows 95 and Windows NT 4.0,
and new programming languages, such as Java.
PC Growth Rates
The underlying PC unit growth rate, which may increase at a slower rate in the
future, impacts Corel's revenue growth.
Dependence on New Products
While Corel performs extensive usability and beta testing of new and enhanced
products, user acceptance and corporate penetration rates ultimately determine
the success of development and marketing efforts.
Product Ship Schedules
Delays in new-product releases impact sales growth rates and can cause
operational inefficiencies that impact manufacturing and distribution logistics,
distributor, reseller and OEM relationships, and technical support and customer
service staffing.
Channel Mix
Average revenue per unit is lower from OEM licences than from retail versions,
reflecting the relatively low direct costs of operations in the OEM channel.
Potential Fluctuations in Quarterly Results
Corel's quarterly operating results fluctuate as a result of a number of
factors, including the timing of new product announcements and introductions by
Corel and its competitors, pricing, distributor ordering patterns, the relative
proportions of sales attributable to full kits and existing user upgrades,
product returns and reserves, advertising and other marketing expenditures, and
research and development expenditures. Revenues and earnings may be difficult to
predict due to shipment patterns. Products are generally shipped as orders are
received, and accordingly, Corel has historically operated with little backlog.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter. As is typical in the computer software industry, a high percentage
of Corel's revenues are expected to be earned in the third month of each fiscal
quarter and will tend to be concentrated in the latter half of that month.
Accordingly, quarterly financial results will be difficult to predict until the
end of the quarter and a shortfall in shipments at the end of any particular
quarter may cause the results of that quarter to fall significantly short of
anticipated levels.
19
<PAGE>
Employee Compensation
The highly competitive market for qualified personnel, especially software
engineers and developers, could adversely affect Corel's ability to engage and
retain competent qualified personnel, particularly development professionals.
Corel believes that its employment policies in this regard are competitive with
the industry norm. Effective December 1, 1997, Corel introduced an employee
bonus incentive plan.
Dependence on Distributors
The distribution of Corel's products is carried out primarily through
distributors, certain of which are material to the competitive position of
Corel. The distribution channels through which software products for desktop
computers are sold have been characterized by rapid change, including
consolidations and financial difficulties of certain distributors and resellers,
the emergence of new retailers such as general mass merchandisers and
superstores, and the desire of large customers such as retail chains and
corporate users to purchase directly from software developers. The loss of, or a
significant reduction in sales volume attributable to, any of Corel's principal
distributors or the insolvency or business failure of any such distributor could
have a material adverse effect on Corel's results of operations.
International Operations and Geographic Concentration
Currently, Corel markets its products in approximately 70 countries. Corel
anticipates that sales outside North America will continue to account for a
significant portion of total sales. These sales are subject to certain risks
including imposition of government controls, export licence requirements,
restrictions on the export of technology, political instability, trade
restrictions, changes in tariffs, differences in copyright protection and
difficulties in managing accounts receivable. More than 40% of Corel's sales for
the past three fiscal years were made in the United States. As a result, adverse
developments in the United States markets for Corel's products could have a
material adverse effect on Corel's results of operations.
Dependence on Key Personnel
Corel's success depends to a significant extent upon the performance of Corel's
executive officers and key technical and marketing personnel, particularly the
Company's founder and Chairman, President and Chief Executive Officer, Dr.
Michael C.J. Cowpland. Corel has agreements describing compensation arrangements
and containing non-disclosure covenants with certain of its key employees. Corel
does not have employment agreements with other key employees, including Dr.
Cowpland. 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.
20
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about January 12, 1998, the Company received notice that a complaint had
been filed against it by Micrografx, Inc. in the Northern District of Texas,
Dallas Division. The complaint alleges that the personal calendar included in
Corel Print House Magic is strikingly similar to and in some instances virtually
identical to the personal calendar found in the plaintiff's CreataCard Gold and
CreataCard Plus software products. The complaint includes causes of action for
copyright infringement, false designation of origin and false representations in
commerce, unfair competition and unjust enrichment. By motion filed January 20,
1998, the plaintiff seeks a preliminary injunction to stop the Company from
distributing or selling the personal calendar (Corel Family & Friends) included
in Corel Print House Magic. An attempt to mediate the matters at issue occurred
on February 12, 1998; however, this initiative was unsuccessful. Depositions of
various Corel representatives and various plaintiff representatives and experts
occurred in February and March of 1998. On April 10, 1998, the plaintiff's
motion for a preliminary injunction was denied. The Company considers the
complaint to be ill-founded and will continue to vigorously defend the action.
On or about March 5, 1998, Corel was served with a class action lawsuit filed
against it by named Plaintiff Great Neck Capital Appreciation Investment
Partnership in the United States District Court for the Eastern District of New
York. The complaint also names as co-defendants Dr. Michael C. J. Cowpland,
Corel's Chairman, President and Chief Executive Officer, and Mr. Charles Norris,
Corel's former Vice President, Finance and Chief Financial Officer. The
complaint was filed on behalf of all persons who purchased or otherwise acquired
Corel common shares between March 26, 1997 and January 20, 1998 (the "Class
Period"). The complaint alleges that the defendants violated various provisions
of the federal securities laws, including Section 10(b) and 10(a) of the
Securities Exchange Act of 1934, as amended, and Securities and Exchange
Commission Rule 10b-5, by misrepresenting or failing to disclose material
information about Corel's financial condition. The complaint alleges that the
defendants issued false and misleading press releases and financial statements
for the first three quarters of fiscal 1997. Plaintiff alleges, in part, that
defendants (a) failed to disclose that they were overstating Corel's reported
profits by, among other things, inflating reported revenues and earnings through
improperly recognizing revenue on Java technology exchange transactions, and (b)
overstated revenues and earnings by understating reserves in connection with
sales to distributors who had no obligation to keep or pay for the products. The
complaint also alleges that Corel insiders, including the individual co-
defendants, sold common shares during the Class Period at "artificially inflated
prices". The complaint seeks an unspecified amount of money damages.
On or about March 13, 1998, Corel was served with a class action lawsuit filed
against it by named Plaintiff Oren Giskan 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 and Mr. Charles Norris. The complaint is similar in
form and substance to the Great Neck complaint referred to above.
21
<PAGE>
On or about April 8, 1998, the Company received notice that a total of three
additional class action complaints had been filed against it. Corel has not yet
been served with copies of these additional actions.
No motions have been filed or discovery yet undertaken. Corel's answer to the
various class action complaints will not be filed until all such actions are
consolidated and a lead plaintiff/counsel is appointed. Corel intends to
defend the class action litigation vigorously. However, due to the inherent
uncertainties of litigation, Corel cannot accurately predict the ultimate
outcome of the litigation. Investigating and defending the complaint (once
consolidated) may require expenditure of material amounts of funds and may
require a significant amount of management's time and resources. An unfavorable
outcome in the litigation could have a material adverse effect on Corel's
business, financial condition and results of operations. Announcement of
material developments in the litigation prior to its resolution could adversely
affect the market price of Corel's common shares.
The Company is a party to a number of additional claims arising in the ordinary
course of business relating to intellectual property and other matters. The
Company believes that the ultimate resolution of these claims will not have a
material adverse effect on its business, financial position or results of
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
27.1 Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Report on Form 8-K in January 1998 concerning the
restatement of its financial statements for the first three quarters of fiscal
1997. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
COREL CORPORATION
(Registrant)
Date: April 8, 1998 By: /s/ Michael C.J. Cowpland
-------------------------
MICHAEL C. J. COWPLAND
Chairman, President, Chief
Executive Officer and Director
Date: April 8, 1998 By: /s/ Michael P. O'Reilly
--------------------------------
MICHAEL P. O'REILLY
Vice-President, Finance and
Chief Financial Officer
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-30-1998
<PERIOD-START> DEC-01-1997
<PERIOD-END> FEB-28-1998
<CASH> 18,948
<SECURITIES> 0
<RECEIVABLES> 36,916
<ALLOWANCES> 0
<INVENTORY> 12,486
<CURRENT-ASSETS> 73,066
<PP&E> 57,397
<DEPRECIATION> 0
<TOTAL-ASSETS> 130,463
<CURRENT-LIABILITIES> 69,457
<BONDS> 0
0
0
<COMMON> 202,879
<OTHER-SE> (165,146)
<TOTAL-LIABILITY-AND-EQUITY> 37,733
<SALES> 45,460
<TOTAL-REVENUES> 45,460
<CGS> 10,442
<TOTAL-COSTS> 55,424
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 133
<INCOME-PRETAX> (20,539)
<INCOME-TAX> 550
<INCOME-CONTINUING> (21,089)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (21,089)
<EPS-PRIMARY> (.36)
<EPS-DILUTED> (.36)
</TABLE>
