<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 May 31, 1998
-----------------------------------------------------------
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ______________________ to _______________________
COMMISSION FILE NUMBER 0-20562
-------
COREL CORPORATION
-----------------
(Exact name of Registrant as specified in its Charter)
CANADA NOT APPLICABLE
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1600 CARLING AVENUE, OTTAWA, ONTARIO, CANADA K1Z 8R7
-------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(613) 728-8200
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
------- -------
As of June 30 , 1998, the registrant had 59,346,217 Common Shares
outstanding.
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COREL CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as at November 30, 1997
and May 31, 1998........................................................3
Consolidated Statements of Operations and Retained Earnings (Deficit)
for the three months and for the six months ended May 31, 1997 and May
31, 1998................................................................4
Consolidated Statements of Changes in Financial Position
for the six months ended May 31, 1997 and May 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...................................................21
Item 6. Exhibits and Reports on Form 8-K....................................21
SIGNATURES....................................................................23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COREL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of U.S.$)
<TABLE>
<CAPTION>
November 30, May 31,
1997 1998
------------ -----------
<S> <C> <C>
ASSETS (unaudited)
Current assets
Cash and short-term investments............... $ 30,629 $ 17,304
Accounts receivable (note 2)
Trade..................................... 50,951 34,693
Other..................................... 2,310 2,742
Inventory (note 3)............................ 11,412 12,820
Deferred income taxes......................... 2,353 2,766
Prepaid expenses.............................. 2,591 2,255
--------- ---------
100,246 72,580
Capital assets (note 4)............................ 63,497 54,565
--------- ---------
$ 163,743 $ 127,145
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued liabilities
(note 5)..................................... $ 48,063 $ 46,760
Current portion of long-term debt............. 13,500 13,500
Income taxes payable.......................... 4,203 5,419
Deferred revenue.............................. 14,124 12,160
--------- ---------
79,890 77,839
Long-term debt (note 6)............................ 24,044 19,880
Shareholders' equity
Share capital (note 7)........................ 204,235 202,879
Contributed surplus........................... 730 1,099
Deficit....................................... (145,156) (174,552)
--------- ---------
59,809 29,426
--------- ---------
$ 163,743 $ 127,145
========= =========
</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 Six months ended
May 31, May 31,
---------------------- ----------------------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Sales............................................. $ 87,413 $ 63,042 $ 168,131 $ 108,502
Cost of sales (note 8)............................ 18,828 11,308 42,851 21,750
--------- --------- --------- ---------
Gross profit................................... 68,585 51,734 125,280 86,752
--------- --------- --------- ---------
Expenses
Advertising.................................... 20,529 11,801 40,402 22,969
Selling, general and administrative............ 22,059 19,098 41,711 37,515
Research and development....................... 22,298 21,765 41,121 42,930
Depreciation and amortization.................. 7,282 3,589 14,176 7,980
Write-down of purchased software
and royalties........................... 113,674 - 113,674 -
Loss on foreign exchange....................... 834 470 1,017 753
--------- --------- --------- ---------
186,676 56,723 252,101 112,147
--------- --------- --------- ---------
Loss from operations.............................. (118,091) (4,989) (126,821) (25,395)
Interest expense.................................. 337 707 838 840
--------- --------- --------- ---------
Loss before income taxes.......................... (118,428) (5,696) (127,659) (26,235)
Income taxes
Current....................................... (3,673) 2,682 174 3,574
Deferred (reduction).......................... 2,867 (71) 1,043 (413)
--------- --------- --------- ---------
(806) 2,611 1,217 3,161
Net loss.......................................... (117,622) (8,307) (128,876) (29,396)
Retained earnings (deficit) beginning of period... 75,701 (166,245) (86,955) (145,156)
Premium on cancellation of shares................. (269) - (269) -
--------- --------- --------- ---------
Deficit end of period............................. $ (42,190) $(174,552) $ (42,190) $(174,552)
========= ========= ========= =========
Loss per share:
Net loss
Basic...................................... $ (1.96) $ (0.14) $ (2.15) $ (0.49)
Average number of Common Shares
Basic...................................... 60,082 59,346 60,075 59,616
</TABLE>
(See accompanying Notes to Consolidated Financial Statements)
4
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COREL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES
IN FINANCIAL POSITION
(in thousands of U.S.$)
(unaudited)
<TABLE>
<CAPTION>
Six months ended
---------------------
May 31, May 31,
1997 1998
--------- --------
<S> <C> <C>
Cash provided by (used for):
Operations:
Net loss.......................................................... $(128,876) $(29,396)
Items which do not involve cash:
Depreciation and amortization................................ 30,769 14,349
Gain on disposal of assets................................... (61) (11)
Deferred income taxes........................................ 1,043 (413)
Write-down of purchased software and royalties............... 113,674 -
Decrease in accounts receivable................................... 3,902 15,826
Increase (decrease) in inventory.................................. 5,381 (1,408)
Decrease in prepaid expenses...................................... 5,399 336
Increase (decrease) in accounts payable and accrued liabilities... 11,601 (1,303)
Increase (decrease) in deferred revenue........................... 1,661 (1,964)
Increase (decrease) in income taxes payable/recoverable........... (10,377) 1,216
--------- --------
Cash provided by (used for) operations............................ 34,116 (2,768)
--------- --------
Financing:
Issue of share capital............................................ 275 -
Shares repurchased for cancellation............................... (660) (987)
Repayment of long-term debt....................................... (7,186) (4,164)
--------- --------
(7,571) (5,151)
--------- --------
Investments:
Purchase of investment............................................ (1,633) -
Purchase of capital assets........................................ (11,290) (5,417)
Proceeds on disposal of assets.................................... 88 11
--------- --------
(12,835) (5,406)
--------- --------
Net increase (decrease) in cash........................................ 13,710 (13,325)
Cash at beginning of period............................................ 6,924 30,629
--------- --------
Cash at end of period.................................................. $ 20,634 $ 17,304
========= ========
</TABLE>
Cash is defined as cash and short-term investments
(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 9. 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 two 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:
<TABLE>
<CAPTION>
November 30, May 31,
1997 1998
------------ -------------
<S> <C> <C>
Promotional rebates................... $11,396 $ 8,210
Sales reserve......................... 54,413 27,185
Allowance for doubtful accounts....... 5,466 6,180
</TABLE>
3. INVENTORIES
<TABLE>
<CAPTION>
November 30, May 31,
1997 1998
------------ --------
<S> <C> <C>
Raw materials.......................... $ 7,974 $ 6,080
Finished goods......................... 3,438 6,740
------- -------
$11,412 $12,820
======= =======
</TABLE>
6
<PAGE>
4. CAPITAL ASSETS
<TABLE>
<CAPTION>
May 31, 1998
--------------------------------------
Accumulated
Depreciation Net
and November 30,
Cost Amortization Net 1997
-------- ------------ ------- ------------
<S> <C> <C> <C> <C>
Furniture and equipment........................ $ 16,383 $ 8,225 $ 8,158 $ 8,307
Computer equipment and software................ 63,423 57,107 6,316 9,423
Research and development equipment............. 12,610 5,942 6,668 7,398
Leasehold improvements......................... 3,647 2,255 1,392 1,674
Software licenses and purchased software,
clipart libraries and photo CD libraries..... 95,753 63,722 32,031 36,695
-------- -------- ------- -------
$191,816 $137,251 $54,565 $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 May 31, 1998 and November 30, 1997 amounted to $3,960,000 and
$2,425,000 respectively.
5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
<TABLE>
<CAPTION>
November 30, May 31,
1997 1998
------------ --------
<S> <C> <C>
Trade accounts payable................ $13,840 $ 5,857
Accrued liabilities................... 34,223 40,903
------- -------
$48,063 $46,760
======= =======
</TABLE>
6. LONG-TERM DEBT
Long-term debt consists of the outstanding royalty and product return
obligations pursuant to the WordPerfect acquisition on March 1, 1996.
<TABLE>
<CAPTION>
As at November 30, 1997 As at May 31, 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 $17,915 $15,465 $33,380
Less: current portion.... 6,500 7,000 13,500 6,500 7,000 13,500
------- ------- ------- ------- ------- -------
$12,682 $11,362 $24,044 $11,415 $ 8,465 $19,880
======= ======= ======= ======= ======= =======
</TABLE>
7. SHARE CAPITAL
During the six-month periods ended May 31, 1997 and May 31, 1998, the Company
issued 45,701 and 0 common shares, respectively, pursuant to its Stock Option
Plan, for proceeds of $275,000 and $0, respectively.
7
<PAGE>
8. COST OF SALES
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, May 31,
------------------ -------------------
1997 1998 1997 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Cost of goods sold....... $13,380 $ 5,868 $18,868 $11,276
Licence amortization..... 2,731 3,212 16,593 6,369
Royalties................ 2,717 2,228 7,390 4,105
------- ------- ------- -------
$18,828 $11,308 $42,851 $21,750
======= ======= ======= =======
</TABLE>
9. SIGNIFICANT DIFFERENCES BETWEEN CANADIAN AND UNITED STATES GAAP
The Company's financial statements are prepared on the basis of Canadian GAAP,
which is different in some respects from US GAAP. Significant differences
between Canadian GAAP and US GAAP are set forth below:
(a) Earnings per share calculations
The Company has considered the effect of the methodology for the calculation of
earnings per share prescribed under the Statement of Financial Accounting
Standards No. 128. The calculation of basic earnings per share for US GAAP
purposes is not different from the calculation of basic earnings per share for
Canadian GAAP. Under US and Canadian GAAP, where the impact of conversion or
exercise of stock options is anti-dilutive, they are not included in the
calculation of diluted earnings per share.
(b) Accounting for stock-based compensation
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for its
employee stock option plan. Accordingly, no compensation expense has been
recognized for its stock-based plan. Had compensation for the Company's
employee stock option plan been determined based on the fair value at the grant
date for awards under the plan, consistent with the methodology prescribed under
the Statement of Financial Standards No. 123, Accounting for Stock-Based
Compensation, the Company's net loss would not have been changed significantly
from the amount reported on the Statement of Operations and Retained Earnings
(Deficit) for the six month period ended May 31, 1998.
8
<PAGE>
(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, 1997 May 31, 1998
----------------- ------------
<S> <C> <C>
Operating loss carryforwards............ $ 4,855 $ 11,141
Depreciation............................ 14,750 16,718
Reserves................................ 3,292 8,663
-------- --------
22,897 36,522
Valuation allowance..................... (20,544) (33,756)
-------- --------
Net deferred tax assets................. $ 2,353 $ 2,766
======== ========
</TABLE>
(d) Consolidated statements of changes in financial position
The Company defines cash for purposes of the consolidated statements of changes
in financial position as cash and short-term investments. Included in short-
term investments are $4,051,000 of marketable equity securities at May 31, 1998
($5,000,000 as at February 28, 1998). Under US GAAP, cash would be reduced by
the amount of short-term investments.
10. CONTINGENT LIABILITY
Revenue Canada has identified and advised the Company of proposed income tax
adjustments for fiscal years ended November 30, 1992 to 1995. In the opinion of
management, the proposed adjustments are substantially in excess of amounts
which may become payable on assessment. The Company has recorded a provision of
$ 2,468,000, inclusive of interest and penalties, for certain adjustments. It is
not possible to accurately estimate the amount, if any, of additional income
taxes that may result from the remaining adjustments identified and
accordingly, no provision has been made at this time.
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 June 24, 1998, the Company announced in a press release that it has adopted a
consolidation plan which will result in estimated savings of $33 million
annually. Under the plan, research and development in the Company's Orem, Utah
engineering center will be transferred to engineering facilities in Ottawa. This
move will reduce the total workforce by approximately 20%. At the same time
Corel Computer Corporation (CCC) will be reintegrated as a division of Corel
Corporation. These changes will be undertaken over the next quarter.
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 compared to the indicated prior period.
<TABLE>
<CAPTION>
Period to Period
Increase (Decrease)
---------------------------
2nd Qtr Six Months
Percent of Sales 1998 Ended
-------------------------------------
Three Months Ended Six Months Ended vs. May 31, 1997
May 31, May 31, 2nd Qtr vs.
----------------- ----------------
1997 1998 1997 1998 1997 May 31, 1998
------- -------- ------ ------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Sales...................................... 100 % 100 % 100 % 100 % (27.9)% (35.5)%
Cost of sales.............................. 22 % 18 % 25 % 20 % (39.9)% (49.2)%
------- -------- ------ -------
Gross profit............................. 78 % 82 % 75 % 80 % (24.6)% (30.8)%
------- -------- ------ -------
Expenses
Advertising.............................. 23 % 19 % 24 % 21 % (42.5)% (43.1)%
Selling, general and administrative...... 25 % 30 % 25 % 35 % (13.4)% (10.1)%
Research and development................. 26 % 34 % 24 % 39 % (2.4)% 4.4 %
Depreciation and amortization............ 8 % 6 % 8 % 7 % (50.7)% (43.7)%
Write-down of purchased
software and royalties............. 130 % 0 % 68 % 0 % N/A N/A
Loss on foreign exchange................. 1 % 1 % 1 % 1 % (43.6)% (26.0)%
------- -------- ------ -------
213 % 90 % 150 % 103 % (69.6)% (55.5)%
------- -------- ------ -------
Income (loss) from operations.............. (135)% (8)% (75)% (23)% 95.8 % 80.0 %
Interest expense (income).................. 0 % 1 % 1 % 1 % 109.8 % 0.2 %
------- -------- ------ -------
Income (loss) before income taxes.......... (135)% (9)% (76)% (24)% 95.2 % 79.4 %
Income taxes............................... (1)% 4 % (1)% (3)% 423.9 % 159.7 %
------- -------- ------ -------
Net income (loss).......................... (134)% (13)% (77)% (27)% 92.9 % 77.2 %
======= ======== ====== =======
</TABLE>
SALES
Sales decreased 27.9% to $63.0 million in the second quarter of fiscal 1998 from
$87.4 million in the second quarter of fiscal 1997 and decreased 35.5% to $108.5
million in the first six months of fiscal 1998 from $168.1 million in the first
six months of fiscal 1997 primarily due to decreased aggregate unit sales of
Corel's products. In addition, there was a charge of $11.2 million recorded in
the first quarter of 1998 relating to the announcement of Corel's new
WordPerfect Suite pricing strategy on March 9, 1998 which outlined the reduction
in selling price of certain WordPerfect Suite products.
11
<PAGE>
PRODUCT GROUPS. The table below shows sales for the first and second fiscal
quarters ended May 31, 1997 and 1998, consisting of graphics software new
licenses (full kits and competitive upgrades) and existing user upgrades,
productivity software new licenses (full kits and competitive upgrades) and
existing user upgrades, multimedia software (including sales from the Company's
Professional Photo CD titles and CorelSCSI), and network computing products
(including CorelVIDEO):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, May 31,
------------------ --------------------
1997 1998 1997 1998
------- ------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Graphics software - new licenses.................. $22,482 $19,913 $ 48,937 $ 38,182
Graphics software - existing user upgrades........ 5,129 8,577 16,294 17,276
------- ------- -------- --------
Total graphics software....................... 27,611 28,490 65,231 55,458
------- ------- -------- --------
Productivity software - new licenses.............. 31,278 22,863 62,489 39,799
Productivity software - existing user upgrades.... 27,557 10,951 37,483 11,978
------- ------- -------- --------
Total productivity software................... 58,835 33,814 99,972 51,777
------- ------- -------- --------
Multimedia software............................... 609 525 2,207 951
------- ------- -------- --------
Network computing products........................ 358 213 721 316
------- ------- -------- --------
Total sales....................................... $87,413 $63,042 $168,131 $108,502
======= ======= ======== ========
</TABLE>
Graphics software revenues in the second quarter of fiscal 1998 were comparable
to the second quarter of fiscal 1997. Graphics software revenue decreased in
the six month period ended May 31, 1998 compared to May 31, 1997 primarily due
to reduced revenues from the CorelDRAW versions available at the time.
Productivity software revenues decreased in the second quarter of fiscal 1998,
as compared to the second quarter of fiscal 1997, primarily due to reduced unit
volumes of retail versions of Corel WordPerfect Suite 8 and Corel WordPerfect
Suite 7 and a decline in average selling prices related to the new WordPerfect
pricing strategy.
Multimedia sales were lower in the second quarter of fiscal 1998, as compared to
the second 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.
12
<PAGE>
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 second fiscal quarters ended
May 31, 1997 and 1998, and for the six-month periods ended May 31, 1997 and
1998:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, May 31,
------------------ -------------------
1997 1998 1997 1998
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Retail packaged products.... $62,337 $41,836 $118,418 $ 61,160
OEM licences................ 8,289 4,732 16,199 10,724
Corporate licences.......... 16,787 16,474 33,514 36,618
------- ------- -------- --------
Total sales................. $87,413 $63,042 $168,131 $108,502
======= ======= ======== ========
</TABLE>
Retail packaged products and corporate licences are sold primarily through
distributors. The three largest distributors accounted for $41.0 million (41%)
and $22.8 million (36%) of Corel's sales in the second quarter of fiscal 1997
and 1998, respectively, and $72.8 million (38%) and $30.4 million (28%) of
Corel's sales in the first six months of fiscal 1997 and 1998, respectively.
Packaged product volume decreased in the second 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, decreased slightly in the
second quarter of fiscal 1998, as compared to the second quarter of fiscal 1997,
and increased in the first six months of fiscal 1998, as compared to the first
six months of fiscal 1997, due to increased unit volume sales resulting from the
expanded marketing efforts in this area.
OEM channel revenues decreased in the second quarter of fiscal 1998, as compared
to the second quarter of fiscal 1997, and in the first six months of fiscal 1998
as compared to the first six months of fiscal 1997, primarily due to a decline
in unit volume for OEM versions of CorelDraw 5 and CorelDraw 4.
13
<PAGE>
The table below shows Corel's sales geographically for the second fiscal
quarters ended May 31, 1997 and 1998, and for the six-month periods ended May
31, 1997 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, May 31,
------------------ --------------------
1997 1998 1997 1998
------- -------- ------- --------
(in thousands)
<S> <C> <C> <C> <C>
North America........... $57,622 $39,504 $102,301 $ 63,472
Europe.................. 18,155 17,777 49,548 33,969
Other international..... 11,636 5,761 16,282 11,061
------- ------- -------- --------
Total sales............. $87,413 $63,042 $168,131 $108,502
======= ======= ======== ========
</TABLE>
Sales outside North America, principally in Europe, were 34% and 37% of Corel's
sales for the second quarter of fiscal 1997 and 1998, respectively, and 39% and
41% of Corel's sales for the first six months of fiscal 1997 and 1998,
respectively. The increase in the respective three month and six month periods
was primarily due to increased marketing efforts throughout the rest of the
world.
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 second quarter of both
fiscal 1997 and fiscal 1998 and in the first six months of both fiscal 1997 and
fiscal 1998.
GROSS PROFIT
Corel includes in cost of sales all costs associated with the acquisition of
components, the assembly of finished products, the amortization of software
acquisition costs and shipping. Costs associated with warehousing are included
in selling, general and administrative expenses. Acquired software has been
capitalized and is currently being amortized over a 36-month period commencing
with the month of first shipment of the product incorporating such acquired
software, except for the cost of the WordPerfect family of software programs and
related technology, which is currently being amortized over a five year period.
Gross profit as a percentage of sales was 82% of sales in the second quarter of
fiscal 1998 as compared to 78% in the second quarter of fiscal 1997 and 80% of
sales in the first six months of fiscal 1998 as compared to 75% in the first six
months of fiscal 1997. Gross profit as a percentage of sales increased in the
second quarter of 1998 as compared to the second quarter of 1997 due to lower
product costs. The increase in gross profit as a percentage of sales in the six
month period of 1998 compared to 1997 is largely attributable to the reduction
in quarterly amortization charges of approximately $9 million pursuant to the
technology write-down of $113.7 million in the second quarter of fiscal 1997.
14
<PAGE>
ADVERTISING EXPENSE
Advertising expenses include all marketing, advertising and trade show expenses.
Advertising expenses decreased by 43% to $11.8 million in the second quarter of
fiscal 1998 from $20.5 million in the second quarter of fiscal 1997 and
decreased by 43% to $23.0 million in the first six months of 1998 from $40.4
million in the first six months of fiscal 1997. The decrease in advertising
expenditures was due to more targeted marketing efforts and the implementation
of various cost control measures. Advertising expenses decreased as a
percentage of sales from 23% in the second quarter of fiscal 1997 to 19% in the
second quarter of fiscal 1998. The decreases are primarily due to the level of
sales achieved in the second quarter of 1997 compared to the second quarter of
fiscal 1998.
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 13% to $19.1 million in the second quarter
of fiscal 1998 from $22.1 million in the second quarter of fiscal 1997 and by
10% to $37.5 million in the first six months of fiscal 1998 from $41.7 million
in the first six months of fiscal 1997. Selling, general and administrative
expenses increased as a percentage of sales from 25% in the second quarter of
fiscal 1997 to 30% in the second quarter of fiscal 1998 and from 25% in the
first six months of fiscal 1997 to 35% in the first six months 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 second quarter of fiscal
1997 compared to the second 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 Six Months Ended
May 31, May 31,
------------------ -------------------
1997 1998 1997 1998
------- -------- ------- --------
(in thousands)
<S> <C> <C> <C> <C>
Gross research and development expenses..... $25,417 $21,765 $45,663 $42,930
Research and development tax credits........ 3,119 - 4,542 -
------- ------- ------- -------
Net research and development expenses....... $22,298 $21,765 $41,121 $42,930
======= ======= ======= =======
Net research and development expenses
as a percentage of sales................. 26% 34% 24% 39%
</TABLE>
Net research and development expenses decreased by 2% to $21.8 million in the
second quarter of fiscal 1998 from $22.3 million in the second quarter of fiscal
1997 and increased by 4% to $42.9 million in the first six months of fiscal 1998
from $41.1 million in the first six months of fiscal 1997. Net research and
development expenses as a percentage of sales increased from 26% in the second
quarter of fiscal 1997 to
15
<PAGE>
34% in the second quarter of fiscal 1998, and from 24% in the first six months
of fiscal 1997 to 39% in the first six months of fiscal 1998. The increase in
net research and development expenses as a percentage of sales was primarily due
to the level of sales achieved in the second quarter of fiscal 1997 compared to
the second quarter of fiscal 1998. The Company was unable to claim investment
tax credits in the second quarter of 1998. The Company will be in a position to
recognize investment tax credits associated with research and development
expenses as the Canadian operations become profitable.
DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation and amortization expenses, which do not include the amortization of
purchased software, decreased by 51% to $3.6 million in the second quarter of
fiscal 1997 from $7.3 million in the second quarter of fiscal 1996 and by 43% to
$8.0 million in the first six months of fiscal 1998 from $14.2 million in the
first six months of fiscal 1997. Depreciation and amortization have decreased
in the second quarter of fiscal 1998 compared to the second quarter of fiscal
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 increased by $0.4 million to an expense of $0.7 million in the
second quarter of fiscal 1998 from $0.3 million in the second quarter of fiscal
1997 and was unchanged at $0.8 million in the first six months of fiscal 1998
compared to the first six months of fiscal 1997. The increase was primarily due
to the anticipated interest charges associated with proposed adjustments
identified as part of the Canadian operations' income tax audit.
INCOME TAXES
Corel's effective tax rates, on income from operations excluding the write-down
of purchased software and royalties, were (46%) and 42% for the second quarter
of fiscal 1998 and 1997, respectively, and, (12%) and 50% for the first six
months of fiscal 1998 and 1997, respectively. These rates vary from the
Company's statutory tax rate of 44%, primarily due to foreign tax rate
differences associated with Corel's international operations, the unrecorded tax
benefit of accounting losses in the first two quarters of fiscal 1998 and
proposed adjustments identified as part of the Canadian operations' income
tax audit. The accounting losses reflect amounts which may be carried forward
for income tax purposes.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of May 31, 1998, Corel's principal sources of liquidity included cash and
short-term investments of approximately $17.3 million, and accounts receivable
of $37.4 million. Short-term investments consist of overnight call loans to a
major Canadian bank and marketable securities. Long-term debt of $33.4 million
consists of the outstanding royalty and product return obligations pursuant to
the acquisition of the WordPerfect family of software programs on March 1, 1996.
Cash used by operations was $2.8 million for the first six months of fiscal 1998
compared to cash provided of $34.1 million for the first six months of fiscal
1997. The decrease of $36.9 million was primarily due to the net loss of $29.4
million in the first six months of 1998 compared to $15.2 million in the first
six months of 1997, net of write-downs of purchased software and royalties and
lower depreciation and amortization amount of $14.3 million compared to $30.8
million for the first six months of 1998 and 1997 respectively.
Accounts receivable decreased in the second quarter of fiscal 1998 primarily due
to reduced sales levels in the fourth quarter of fiscal 1997 and the first
quarter of fiscal 1998.
Financing activities used cash of $5.1 million in the first six months of fiscal
1998 compared to $7.6 million in the first six months of fiscal 1997, primarily
due to the outstanding royalty obligation pursuant to the acquisition of the
Wordperfect family of products, which is based on sales.
Investing activities, primarily the acquisition of capital assets, used $5.4
million in the first six months of fiscal 1998 compared to $12.8 million in the
first six months of fiscal 1997, including expenditures for acquired software of
$1.8 million in the first six months of fiscal 1998 compared to $4.6 million in
the first six months of fiscal 1997. At May 31, 1997, Corel had no material
commitments for capital expenditures.
The Company believes that the existing sources of liquidity and anticipated
funds from operations will satisfy Corel's projected working capital, capital
expenditure and long-term debt repayment requirements for at least the next 12
months. The Company anticipates that subsequent to that time, its working
capital, capital expenditures and long-term debt repayments will be satisfied by
existing sources of liquidity, funds from operations and, if necessary,
additional financings.
In 1996 Corel initiated a corporate wide program to review, test and prepare
Corel's internal systems for the Year 2000. Corel continues to assess, plan and
implement solutions that will prepare our internal systems for January 1, 2000
and believes that these solutions will not pose significant operational problems
for Corel, nor that the costs will be material.
Corel's current information on the status of our products can be obtained at
http://www.corel.com. This information is provided for the singular purpose of
- ---------------------
assisting our customers prepare for the Year 2000. The status of our products is
provided such that other products used in conjunction with Corel's product's
correctly exchange date information with Corel's products. Corel is committed to
providing quality Year 2000 tested solutions to our clients.
Corel has continued to expand and enhance these programs, adding resources as
required and will continue to evaluate resource requirements in an on-going
manner. Corel expects to continue to incur
17
<PAGE>
operational costs and external expenses in relation to preparing both Corel's
products and internal systems for the Year 2000.
Corel expects to have solutions implemented in a timely manner. There can be no
absolute assurance that the systems of Corel's data exchange partners will also
be converted in a timely manner, thus Corel may incur unanticipated future
expenses to remedy the such problems.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Corel does not provide forecasts of future financial performance. While Corel's
management is confident about Corel's long-term performance prospects, the
following factors, among others, should be considered in evaluating its future
results of operations.
Competition
The PC software business is highly competitive and subject to rapid
technological change. Many of Corel's current and potential competitors have
larger technical staffs, more established and larger marketing and sales
organizations, and significantly greater financial resources than does Corel.
The rapid pace of technological change constantly creates new opportunities for
existing and new competitors and can quickly render existing technologies less
valuable. As the market for Corel's products continues to develop, additional
competitors may enter the market and competition may intensify.
GRAPHICS SOFTWARE. Corel's graphics software products face substantial
competition from a wide variety of companies. In the illustration graphics
segment Corel's competitors include Adobe, Macromedia, Deneba Systems and
Micrografx. In the photo editing and painting graphics segment its competitors
include Adobe and Micrografx. In the charting and presentation segments its
competitors include Software Publishing Corporation, Microsoft, Adobe,
Micrografx and IBM (Lotus). In the desktop publishing segment its competitors
include Adobe and Quark. Corel's competitors include many other independent
software vendors, such as Autodesk, Borland, Apple (Claris) and Computer
Associates, as well as a number of personal computer manufacturers which devote
significant resources to creating personal computer software, including Apple,
Hewlett-Packard and IBM.
PRODUCTIVITY SOFTWARE. Corel's competitors in the productivity software
(primarily office suites) marketplace include Microsoft and IBM (Lotus).
According to industry sources, Microsoft currently has the largest overall
market share for office suites. IBM has a large installed base with its
spreadsheet program and has recently adopted aggressive pricing strategies.
Also, IBM preinstalls certain of its software products on various models of its
PCs, competing directly with Corel productivity software.
The Company believes that the principal competitive factors in the PC software
markets include performance, product features, ease of use, reliability,
hardware compatibility, brand name recognition, product reputation, pricing,
levels of advertising, availability and quality of customer support, and
timeliness of product upgrades. Corel competes with other software vendors for
access to distribution channels, retail shelf space and the attention of
customers at the retail level and in corporate accounts. The Company also
competes with other software companies in its efforts to acquire software
technology developed by third parties. The Company believes that, in the future,
competition in the industry will intensify as major software companies expand
their product lines.
18
<PAGE>
Pricing
In the past year, pricing pressures have intensified in the PC software
applications market and the Company believes that price competition, with its
attendant reduced profit margins, may become a more significant factor in the
future. Corporate licensing, discount pricing for large volume distributors and
retailers, product bundling promotions and competitive upgrade programs are
forms of price competition that may become more prevalent. In addition, local
area network versions of products are generally priced lower per user than
individual copies of the same products. Corel also competes with companies that
produce standalone graphics and desktop publishing applications that might serve
a specific need of a user or class of users at a price below that of Corel's
products. Additionally, should competitive pressures in the industry increase,
Corel may have to increase its spending on advertising as a percentage of
revenues, resulting in lower profit margins.
Technological Change
The markets for Corel's products are characterized by rapidly changing
technology, frequent new product introductions and uncertainty due to new and
emerging technologies. Corel's future success is highly dependent upon the
timely completion and introduction of new or enhanced products incorporating
such emerging technologies at competitive price/performance levels. The pace of
change has recently accelerated due to the Internet, corporate intranets, and
new programming languages, such as Java.
PC Growth Rates
The underlying PC unit growth rate, which may increase at a slower rate in the
future, impacts Corel's revenue growth.
Dependence on New Products
While Corel performs extensive usability and beta testing of new and enhanced
products, user acceptance and corporate penetration rates ultimately determine
the success of development and marketing efforts.
Product Ship Schedules
Delays in new-product releases impact sales growth rates and can cause
operational inefficiencies that impact manufacturing and distribution logistics,
distributor, reseller and OEM relationships, and technical support and customer
service staffing.
Channel Mix
Average revenue per unit is lower from OEM licences than from retail versions,
reflecting the relatively low direct costs of operations in the OEM channel.
Corel expects that OEM revenues will increase during future periods.
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
19
<PAGE>
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.
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>
ITEM 1. LEGAL PROCEEDINGS
On or about January 12, 1998, the Company received notice that a complaint had
been filed against it by Micrografx, Inc. in the Northern District of Texas,
Dallas Division. The complaint alleges that the personal calendar included in
Corel Print House Magic is strikingly similar to and in some instances
virtually identical to the personal calendar found in the plaintiff's
CreataCard Gold and CreataCard Plus software products. The complaint includes
causes of action for copyright infringement, false designation of origin and
false representations in commerce, unfair competition and unjust enrichment.
By motion filed January 20, 1998, the plaintiff sought a preliminary
injunction to stop the Company from distributing or selling the personal
calendar (Corel Family & Friends) included in Corel Print House Magic. By
order dated April 10, 1998, the court dismissed Micrografx Motton for
preliminary injunction. On May 8, 1998, Micrografx filed a Notice of Appeal.
Discovery of all parties will conclude in August of 1998 and a decision on the
appeal is likely in the late fall of 1998.
On or about March 5, 1998, Corel was served with a class action lawsuit filed
against it by Plaintiff Great Neck Capital Appreciation Investment
Partnership in the United States District Court for the Eastern District of New
York. The complaint also names as co-defendants Dr. Michael C. J. Cowpland,
Corel's Chairman, President and Chief Executive Officer, and Mr. Charles Norris,
Corel's former Vice President, Finance and Chief Financial Officer. The
complaint was filed on behalf of all persons who purchased or otherwise acquired
Corel common shares between March 26, 1997 and January 20, 1998 (the "Class
Period"). The complaint alleges that the defendants violated various provisions
of the federal securities laws, including Section 10(b) and 10(a) of the
Securities Exchange Act of 1934, as amended, and Securities and Exchange
Commission Rule 10b-5, by misrepresenting or failing to disclose material
information about Corel's financial condition. The complaint alleges that the
defendants issued false and misleading press releases and financial statements
for the first three quarters of fiscal 1997. Plaintiff alleges, in part, that
defendants (a) failed to disclose that they were overstating Corel's reported
profits by, among other things, inflating reported revenues and earnings through
improperly recognizing revenue on Java technology exchange transactions, and (b)
overstated revenues and earnings by understating reserves in connection with
sales to distributors who had no obligation to keep or pay for the products. The
complaint also alleges that Corel insiders, including the individual co-
defendants, sold common shares during the Class Period at "artificially inflated
prices". The complaint seeks an unspecified amount of money damages.
The Great Neck complaint was consolidated by Order dated June 1, 1998, with
four other previously filed complaints: Giskan, Meyer, Mangold and Hagler.
Also on June 1, 1998, the court approved the plaintiff's motion for the
appointment of lead plaintiff and lead counsel. The firm of Harwood Halebian &
Feffer is counsel of record. Great Neck (as lead plaintiff, on behalf of all
plaintiffs) will file a Consolidated Complaint with the court in early August
1998. Corel will have 30 days from the filing of the Consolidated Complaint to
answer this consolidated pleading.
21
<PAGE>
No motions have been filed or discovery yet undertaken.
Corel intends to defend this class action litigation vigorously. However, due
to the inherent uncertainties of litigation, Corel cannot accurately predict the
ultimate outcome of the litigation. Investigating and defending the consolidated
complaint may require the expenditure of a material amount 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
None
b) Reports on Form 8-K
The Company filed no reports on Form 8-K for the fiscal quarter ended
May 31, 1998.
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: July 14, 1998 By: /s/ Michael C.J. Cowpland
--------------------------------
MICHAEL C. J. COWPLAND
Chairman, President, Chief
Executive Officer and Director
Date: July 14, 1998 By: /s/ Michael P. O'Reilly
--------------------------------
MICHAEL P. O'REILLY
Vice-President, Finance and
Chief Financial Officer
23
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<PAGE>
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-START> MAR-01-1998
<PERIOD-END> MAY-31-1998
<CASH> 17,304
<SECURITIES> 0
<RECEIVABLES> 37,435
<ALLOWANCES> 0
<INVENTORY> 12,820
<CURRENT-ASSETS> 72,580
<PP&E> 54,565
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<CURRENT-LIABILITIES> 77,839
<BONDS> 0
0
0
<COMMON> 202,879
<OTHER-SE> (173,453)
<TOTAL-LIABILITY-AND-EQUITY> 127,145
<SALES> 63,042
<TOTAL-REVENUES> 63,042
<CGS> 11,308
<TOTAL-COSTS> 56,723
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 707
<INCOME-PRETAX> (5,696)
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</TABLE>
