<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the period ended May 31, 1999
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or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from _____________________ to ________________________
Commission File Number 0-20562
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COREL CORPORATION
-----------------
(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____
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As of July 13, 1999, the registrant had 62,790,478 Common Shares outstanding.
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COREL CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as at May 31, 1999
and November 30, 1998....................................... 3
Consolidated Statements of Operations and Deficit
for the three months and for the six months ended
May 31, 1999 and May 31, 1998............................... 4
Consolidated Statements of Changes in Financial Position
for the six months ended May 31, 1999 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............................................... 22
Item 6. Exhibits and Reports on Form 8-K................................ 23
SIGNATURES................................................................... 24
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
COREL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of U.S.$)
<TABLE>
<CAPTION>
May 31, November 30,
1999 1998
----------- ------------
ASSETS (unaudited) (audited)
<S> <C> <C>
Current assets:
Cash and short-term investments................ $ 16,465 $ 24,506
Accounts receivable (note 2)
Trade...................................... 37,686 45,789
Other...................................... 2,265 877
Inventory (note 3)............................. 14,068 17,098
Deferred income taxes.......................... 1,686 2,495
Prepaid expenses............................... 1,563 4,618
----------- ------------
Total current assets................................ 73,733 95,383
----------- ------------
Investments......................................... 3,351 -
Capital assets (note 4)............................. 53,306 44,776
----------- ------------
Total assets....................................... $ 130,390 $ 140,159
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities....... $ 52,618 $ 58,209
Current portion of Novell obligations.......... 11,800 11,800
Income taxes payable........................... 3,028 7,549
Deferred revenue............................... 18,053 17,933
----------- ------------
Total current liabilities........................... 85,499 95,491
Novell obligations.................................. 11,555 16,085
Shareholders' equity
Share capital.................................. 213,301 203,088
Contributed surplus............................ 1,099 1,099
Deficit........................................ (181,064) (175,604)
----------- ------------
Total shareholders' equity.......................... 33,336 28,583
----------- ------------
Total liability and shareholders' equity............ $ 130,390 $ 140,159
=========== ============
</TABLE>
(See accompanying Notes to Consolidated Financial Statements)
3
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COREL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND DEFICIT
(in thousands of U.S.$, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
May 31, May 31,
----------------------- ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales.............................................. $ 70,501 $ 63,042 $ 110,807 $ 108,502
Cost of sales...................................... 14,092 11,308 25,652 21,750
---------- ---------- ---------- ----------
Gross profit.................................... 56,409 51,734 85,155 86,752
Expenses
Advertising..................................... 11,946 11,801 20,717 22,969
Selling, general and administrative............. 21,618 19,098 40,557 37,515
Research and development........................ 12,395 21,765 25,855 42,930
Depreciation and amortization................... 1,043 3,589 2,673 7,980
Loss (gain) on foreign exchange................. (303) 470 (54) 753
---------- ---------- ---------- ----------
46,699 56,723 89,748 112,147
---------- ---------- ---------- ----------
Income (loss) from operations...................... 9,710 (4,989) (4,593) (25,395)
Interest expense................................... 192 707 329 840
---------- ---------- ---------- ----------
Income (loss) before income taxes.................. 9,518 (5,696) (4,922) (26,235)
Income taxes
Current........................................ (309) 2,682 (271) 3,574
Deferred (reduction)........................... 648 (71) 809 (413)
---------- ---------- ---------- ----------
339 2,611 538 3,161
Net income (loss).................................. 9,179 (8,307) (5,460) (29,396)
Deficit beginning of period........................ (190,243) (166,245) (175,604) (145,156)
---------- ---------- ---------- ----------
Deficit end of period.............................. $ (181,064) $ (174,552) $ (181,064) $ (174,552)
========== ========== ========== ==========
Earnings (loss) per share:
Net earnings (loss)
Basic....................................... $ 0.15 $ (0.14) $ (0.09) $ (0.49)
Fully diluted............................... $ 0.14 $ (0.14) $ (0.09) $ (0.49)
Weighted average number of Common Shares
outstanding (000s)
Basic....................................... 61,560 59,346 60,860 59,616
Fully diluted............................... 69,193 59,346 60,860 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,
1999 1998
----------- -----------
<S> <C> <C>
Cash provided by (used for):
Operations:
Net loss.................................................... $ (5,460) $ (29,396)
Items which do not involve cash:
Depreciation and amortization........................... 8,695 14,349
Gain on disposal of assets.............................. (47) (11)
Deferred income taxes................................... 809 (413)
Decrease in accounts receivable.............................. 6,715 15,826
Increase (decrease) in inventory............................. 3,030 (1,408)
Decrease in prepaid expenses................................. 3,055 336
Decrease in accounts payable and accrued liabilities......... (5,591) (1,303)
Increase (decrease) in deferred revenue...................... 120 (1,964)
Increase (decrease) in income taxes payable/recoverable...... (4,521) 1,216
----------- -----------
Cash provided by (used for) operations....................... 6,805 (2,768)
----------- -----------
Financing:
Issue of share capital....................................... 10,213 -
Shares repurchased for cancellation.......................... - (987)
Repayment of Novell obligations.............................. (4,530) (4,164)
----------- -----------
5,683 (5,151)
----------- -----------
Investments:
Purchase of investment....................................... (3,351) -
Purchase of capital assets................................... (17,241) (5,417)
Proceeds on disposal of assets............................... 63 11
----------- -----------
(20,529) (5,406)
----------- -----------
Net decrease in cash.............................................. (8,041) (13,325)
Cash at beginning of period....................................... 24,506 30,629
----------- -----------
Cash at end of period............................................. $ 16,465 $ 17,304
=========== ===========
</TABLE>
Cash is defined as cash and short-term investments
(See accompanying Notes to Consolidated Financial Statements)
5
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COREL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars, tabular amounts in thousands except per share data)
(unaudited)
1. Basis of Presentation
The accompanying unaudited interim consolidated financial statements of Corel
Corporation (the "Company") have been prepared by the Company in accordance with
accounting principles generally accepted in Canada. These principles are also
generally accepted in the United States except as disclosed in Note 6. The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries, Corel Corporation Limited, Corel International
Corporation, Corel, Inc. and its wholly-owned subsidiary, Corel Corporation
(U.S.A.). Corel Computer was amalgamated with Corel Corporation on December 1,
1998 and is no longer a subsidiary of the parent company.
In the opinion of Management, these unaudited interim consolidated financial
statements reflect all adjustments, which are of a normal and recurring nature,
necessary to state fairly the results for the periods presented.
These financial statements should be read in conjunction with the Company's
audited financial statements as of November 30, 1997 and 1998 and for each of
the three years in the period ended November 30, 1998 including notes thereto,
included in the Company's Annual Report on Form 10-K for the year ended November
30, 1998. The consolidated results of operations for the first 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>
May 31, November 30,
1999 1998
------------- ------------
<S> <C> <C>
Promotional rebates.................... $ 4,128 $ 6,197
Sales reserve.......................... 34,734 21,882
Allowance for doubtful accounts........ 6,771 6,804
<CAPTION>
3. Inventory
May 31, November 30,
1999 1998
------------- ------------
<S> <C> <C>
Product components..................... $ 10,429 $ 12,799
Finished goods......................... 3,639 4,299
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$ 14,068 $ 17,098
============= ============
</TABLE>
6
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4. Capital Assets
During the quarter, the company revised the estimated useful life of all
computer equipment and research and development equipment to 3 years. The
previous estimated useful life for computer equipment was 2 years and for
research and development equipment was approximately 7 years. This change in
estimate has been accounted for on a prospective basis.
5. Restructuring Charge
The Company proceeded with the implementation of a consolidation plan in the
third fiscal quarter of 1998. As at May 31, 1999, the restructuring accrual
included in accounts payable and accrued liabilities is comprised of the
following amounts:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Asset write - Severance Facilities Total
downs cost closure costs
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Restructuring charge........ $ 3,086 $10,104 $ 2,690 $ 15,880
Payments.................... - (8,495) (2,214) (10,709)
Reallocation................ - (1,609) 1,609 -
Non-cash asset write downs.. (3,086) - - (3,086)
- -----------------------------------------------------------------------------------------
Restructuring accrual - - $ 2,085 $ 2,085
=========================================================================================
</TABLE>
There was a $233,000 reallocation between severance costs and facilities closure
costs during the three month period ended May 31, 1999.
6. Significant Differences Between Canadian and United States Gaap
The Company's financial statements are prepared on the basis of Canadian GAAP,
which is different in some respects from US GAAP. Significant differences
between Canadian GAAP and US GAAP are set forth below:
(a) Calculation of earnings per share
The Company adopted Statement of Financial Accounting Standards (SFAS), No. 128,
"earnings per share" during the year ended November 30, 1998 and restated
earnings per share for all prior periods presented is required by such
statement.
7
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<TABLE>
<CAPTION>
Fiscal Quarter Ended Six months ended
May 31 May 31
--------------------- ---------------------
1999 1998 1999 1998
--------------------- ---------------------
<S> <C> <C> <C> <C>
US GAAP - basic and diluted
Net income (loss) per share - Basic...... $ 0.15 $ (0.14) (0.09) (0.49)
- Diluted.... $ 0.15 $ (0.14) (0.09) (0.49)
Weighted average number of
common shares - Basic.................. 61,560 59,346 60,860 59,616
- Diluted................ 62,818 59,346 60,860 59,616
</TABLE>
(b) Deferred income taxes:
The Company follows the deferral method of accounting for income taxes. Under
US GAAP the asset and liability method is used. In the case of the Company, the
application of the asset and liability method does not result in a significant
difference in the amount of the deferred tax asset. US GAAP also requires the
disclosure of the tax effect of temporary differences that give rise to deferred
tax assets and liabilities. This information is provided in the following:
<TABLE>
<CAPTION>
May 31, November 30,
1999 1998
---------- ------------
<S> <C> <C>
Operation loss carryforwards................. $ 15,238 $ 15,437
Depreciation................................. 6,493 10,246
Reserves..................................... 4,978 5,473
Royalties not yet deducted for
tax purposes............................... 1,530 1,556
---------- ------------
28,239 32,712
Valuation allowance.......................... (26,553) (30,217)
---------- ------------
Net deferred tax assets...................... $ 1,686 $ 2,495
========== ============
</TABLE>
The net current deferred tax assets relate to the operations in the United
States of America. These assets are temporary differences which the company
believes will reverse in the near future.
(c) Consolidated statements of changes in financial position
The Company defines cash for purposes of the consolidated statements of changes
in financial position as cash and short-term investments. As at May 31, 1999,
the Company had no short-term investments. All short-term investments held at
November 30, 1998 ($2,100,000), were sold or redeemed during the first fiscal
quarter of 1999. The short-term investments as at November 30, 1998 would not
qualify as cash equivalents under US GAAP, consequently cash flows from
operating activities under US GAAP would decrease by $800,000, and cash from
8
<PAGE>
investing activities under US GAAP would increase by $2,900,000 in the first
fiscal quarter of 1999.
Under US GAAP the issue of common shares for the acquisition of the assets of
GraphicCorp would be treated as a non-cash transaction and would be disclosed as
supplemental information. Any unpaid consideration at May 31, 1999 would be
similarly treated. Accordingly the cash flow from operations would decrease by
$2,500,000, cash from financing activities would decrease by $6,300,000 and cash
used for investments would decrease by $8,800,000.
(d) Recent accounting pronouncements
The Company has adopted the Financial Accounting Standards Board Issued
Statement (SFAS) No. 130, "Reporting Comprehensive Income". The adoption of SFAS
130 did not have an impact on the Company's financial disclosures for the three
months ended May 31, 1999.
The Company will adopt SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information" for its fiscal year ending November 30, 1999.
9
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
The following information must be read in conjunction with the unaudited
Consolidated Financial Statements and Notes thereto included in Item 1 of this
Quarterly Report and the audited Consolidated Financial Statements and Notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-K for
the year ended November 30, 1998 (the "1998 Form 10-K"). This Form 10-Q contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements involve
uncertainty and risk, and all assumptions, anticipations, and expectations
stated herein are forward-looking statements. The actual results that the
Company achieves may differ materially from any forward-looking statements made
herein due to such risks and uncertainties. The Company has identified by
italics various sentences within this Form 10-Q which contain such forward-
looking statements, and words such as "believes", "anticipates", "expects",
"intends" and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such statements. In
addition, the section labeled "Factors That May Affect Future Operating
Results", which is not italicized for improved readability, consists primarily
of forward-looking statements. The Company undertakes no obligation to revise
any forward-looking statements in order to reflect events or circumstances that
may arise after the date of this report. Readers are urged to carefully review
and consider the various disclosures made by the Company in this report and in
the Company's other reports filed with the Securities and Exchange Commission
that attempt to advise interested parties of the risks and factors that may
affect the Company's business. Therefore, historical results and percentage
relationships will not necessarily be indicative of the operating results of any
future period. All amounts in this report are in US dollars unless otherwise
indicated.
Overview
For the purposes of this discussion, unless the context otherwise requires
"Corel" refers to the consolidated operations of Corel Corporation and its
wholly owned subsidiaries, Corel Corporation Limited, Corel International
Corporation, Corel Inc. and Corel Corporation (U.S.A.), while the Company refers
to the parent, Corel Corporation. Corel Computer was amalgamated with Corel
Corporation on December 1, 1998, and is no longer a subsidiary of the parent
company.
Corel develops manufactures, licenses, sells and supports a wide range of
software products, including graphics, business productivity and consumer
product applications and video communications products.
On December 31, 1998, the Company transferred its Java-based jBridge solution in
exchange for a 25% equity stake in GraphOn, Corporation.
10
<PAGE>
On February 17, 1999, the Company transferred all of the assets of Corel
Computer supporting the Netwinder family of Linux-based thin client/thin server
computers and $1.3 million cash in exchange for a 25% equity stake in Hardware
Computing Canada.
On April 17, 1999 Corel acquired certain assets of GraphicCorp, a leading
supplier of clipart images, photographs and web images. The consideration paid
for the assets was $10.3 million. The consideration was paid in cash, $4.0
million and common shares of the Company $6.3 million.
Sales
Sales increased 12% to $70.5 million in the second quarter of fiscal 1999 from
$63.0 million in the second quarter of fiscal 1998 primarily due to the launch
of new versions of Corel's flagship products, Corel WordPerfect Office 2000(R)
and CorelDRAW 9(R).
Product Groups. The table below shows sales for the second fiscal quarter ended
May 31, 1999 and 1998, consisting of graphics software new licenses (full kits
and competitive upgrades) and existing user upgrades, productivity software new
licenses (full kits and competitive upgrades) and existing user upgrades,
consumer products software and video communications:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31 May 31
-------------------- --------------------
1999 1998 1999 1998
-------------------- --------------------
<S> <C> <C> <C> <C>
Graphics software - new licenses...... $13,734 $ 8,638 $ 21,588 $ 24,287
Graphics software - existing user 12,163 15,073 15,585 23,789
-------------------- --------------------
Total graphics software......... 25,897 23,711 37,173 48,076
Productivity software - new licenses.. 21,654 22,863 34,824 39,799
Productivity software - existing user 22,108 10,951 33,799 11,978
-------------------- --------------------
Total productivity software...... 43,762 33,814 68,623 51,777
Consumer products..................... 836 5,304 4,700 8,333
Network computing products............ 6 213 311 316
-------------------- --------------------
Total sales $70,501 $63,042 $110,807 $108,502
==================== ====================
</TABLE>
Graphics software revenues increased in the second quarter of fiscal 1999, as
compared to the second quarter of fiscal 1998, primarily due to the launch of
the most recent version of CorelDraw.
11
<PAGE>
Productivity software revenues increased in the second quarter of fiscal 1999,
as compared to the second quarter of fiscal 1998, primarily due to the launch of
WordPerfect Office 2000 during the second quarter of 1999.
Consumer products software revenues decreased in the second quarter of fiscal
1999 as compared to the second quarter of fiscal 1998, primarily due to the
product launch for Graphics Pack and the Gallery products being in an earlier
phase of the product life cycle; both of these events occured in the second
quarter of 1998.
Sales Channels. Corel distributes its products primarily through distributors
(as retail packaged products), OEM licenses and corporate licenses. The table
below shows sales through these channels for the second fiscal quarter ended May
31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31 May 31
-------------------- --------------------
1999 1998 1999 1998
-------------------- --------------------
<S> <C> <C> <C> <C>
Retail packaged products... $43,874 $41,836 $ 61,089 $ 61,160
OEM licenses............... 7,251 4,732 13,371 10,724
Corporate licenses......... 19,376 16,474 36,347 36,618
-------------------- --------------------
Total sales $70,501 $63,042 $110,807 $108,502
==================== ====================
</TABLE>
Retail packaged products and corporate licenses are sold primarily through
distributors. The three largest distributors accounted for $23.2(33%) million
and $22.8(36%) million of Corel's sales in the second quarter of fiscal 1999 and
1998, respectively. Packaged product volume increased in the second quarter of
fiscal 1999 primarily because of the product launches for Corel WordPerfect
Suite 2000 and CorelDRAW 9.
OEM licenses increased in the second quarter of fiscal 1999 as compared to the
second quarter of fiscal 1998, due primarily to increased contracts to bundle
WordPerfect Suite 8.
Corporate licenses, including maintenance revenues, increased in the second
quarter of fiscal 1999, as compared to the second quarter of fiscal 1998, due to
expanded marketing efforts in this area.
Sales By Region. The table below shows Corel's sales geographically for the
second fiscal quarter ended May 31, 1999 and 1998:
12
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31 May 31
-------------------- ------------------
1999 1998 1999 1998
-------------------- ------------------
<S> <C> <C> <C> <C>
North America........ $47,346 $39,504 $ 72,075 $ 63,472
Europe............... 17,685 17,777 31,247 33,969
Other international.. 5,470 5,761 7,485 11,061
-------------------- ------------------
Total sales $70,501 $63,042 $110,807 $108,502
==================== ==================
</TABLE>
Sales outside North America, principally in Europe, were 33% and 37% of Corel's
sales for the second quarter of fiscal 1999 and 1998, respectively.
Corel's products are sold primarily in US dollars in all countries other than
Canada and in US dollars to Canadian distributors. Sales in US dollars as a
percentage of total sales were in excess of 90% in the second quarter of both
fiscal 1999 and fiscal 1998.
Gross Profit
Corel includes in cost of sales all costs associated with the acquisition of
components, the assembly of finished products, product royalties, the
amortization of software acquisition costs and shipping. Costs associated with
warehousing are included in selling, general and administrative expenses.
Acquired software has been capitalized and is currently being amortized over a
36-month period commencing with the month of first shipment of the product
incorporating such acquired software, except for the cost of the WordPerfect
family of software programs and related technology, which is currently being
amortized over a five year period.
Gross profit as a percentage of sales decreased in the second quarter of fiscal
1999 compared to the second quarter of fiscal 1998 and is primarily attributable
to an inventory obsolescence charge of $2.2 million.
Advertising Expense
Advertising expenses include all marketing, advertising and trade show expenses.
Advertising expenses increased in the second quarter of fiscal 1999 compared to
the second quarter of fiscal 1998. The increase in advertising expenses was due
primarily to the Company supporting the launch of its two new products,
WordPerfect Suite 2000 and CorelDRAW 9.
Selling, General and Administrative Expense
13
<PAGE>
Selling, general and administrative expenses include all general administrative
expenses as well as expenses associated with warehousing. Selling, general and
administrative expenses increased in the second quarter of fiscal 1999 compared
to the second quarter of fiscal 1998 in order to support the product launch.
Research and Development Expense
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>
May 31, May 31,
1999 1998
----------- ----------
<S> <C> <C>
Gross research and development expenses..... $12,395 $21,765
Research and development tax credits........ - -
----------- ----------
Net research and development expenses $12,395 $21,765
=========== ==========
Net research and development expenses as a
% of sales 18% 35%
</TABLE>
Net research and development expenses decreased in the second quarter of fiscal
1999 compared to the second quarter of fiscal 1998. The decrease in net research
and development expenses was primarily attributable to the consolidation plan
initiated by the Company in the third fiscal quarter of 1998. The Company
transferred the research and development activity in the Orem, Utah engineering
centre to the engineering facilities in Ottawa, Ontario. As a result of this
transfer, approximately 550 employees were terminated in the Orem, Utah location
which significantly reduced research and development expenses.
Depreciation and Amortization Expense
Depreciation and amortization expenses, which do not include the amortization of
purchased software, decreased in the second quarter of fiscal 1999 compared to
the second quarter of fiscal 1998. Depreciation and amortization expenses have
decreased in the second quarter of fiscal 1999 compared to the second fiscal
quarter of 1998 primarily due to the decrease in assets purchased in 1998
compared to 1997 and 1996, and the write-down of capital assets as part of the
restructuring in the third quarter fiscal quarter of 1998, and the change in
estimate identified in the notes to the consolidated financial statements.
Loss (Gain) on Foreign Exchange
14
<PAGE>
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 in the second quarter of fiscal 1999 compared to the
second fiscal quarter of 1998. The decreased was primarily due to the
anticipated interest charges associated with proposed adjustments identified as
part of the Canadian operations income tax audit which was recorded in the
second quarter of fiscal 1998.
Income Taxes
Corel's effective tax rates were 3.6% and (45.8)% for the second quarter of
fiscal 1999 and 1998, respectively. These rates vary from the Company's
statutory tax rate of 44%, primarily due to foreign tax rate differences
associated with Corel's international operations and the unrecorded tax benefit
of accounting losses in the 1999, 1998 and 1997 fiscal years. The accounting
losses include loss carry forwards for income tax purposes.
Liquidity and Capital Resources
As of May 31, 1999, Corel's principal sources of liquidity included cash and
short-term investments of approximately $16.5 million, and accounts receivable
of $40.0 million. Short-term investments consist of overnight call loans to a
major Canadian bank. Novell obligations of $23.4 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 provided by operations was $6.8 million for the first six months of fiscal
1999 compared to, cash used by operations of $2.8 million for the first six
months of fiscal 1998. The increase of $9.6 million was primarily due to the net
loss of $5.5 million in the first six months of fiscal 1999 compared to the net
loss of $29.4 million in the first six months of fiscal 1998.
Accounts receivable increased in the second quarter of fiscal 1999, from the
first quarter of 1999, primarily due to increased sales levels in the second
quarter of fiscal 1999. The increase in sales and accounts receivable can be
attributed to the launch of the Company's latest versions of WordPerfect and
CorelDraw. The increase in accounts receivable was partially offset by prepaid
discounts offered to distributors for the launch of products.
Financing activities provided cash of $5.7 million in the first six months of
fiscal 1999 compared to a use of $5.2 million in the first six months of fiscal
1998. The source of cash through financing activities was the exercise of
employee stock options for $3.9 million, and the issuance of shares for the
acquisition of the assets of GraphicCorp. The use of cash in the first six
months of 1999 was the repayment of the Novell obligations.
15
<PAGE>
Investing activities, used $20.5 million in the first six months of fiscal 1999
compared to $5.4 million in the first six months of fiscal 1998, including
expenditures for capital assets of $17.2 million in the first six months of
fiscal 1999 compared to $5.4 million in the first six months of fiscal 1998. The
increase is primarily attributable to the GraphicCorp asset acquisition of $10.3
million. In addition to capital asset additions, the Company completed the
transfer to Hardware Computing Canada (HCC) of all assets of Corel Computer
supporting the Netwinder family of Linux-based thin client/thin server computers
and $1.3 million cash in exchange for a 25% equity stake in HCC. At May 31,
1999, Corel had no material commitments for capital expenditures.
The Company believes that the existing sources of liquidity and anticipated
funds from operations will satisfy Corel's projected working capital, capital
expenditure and long-term debt repayment requirements for at least the next 12
months. The Company anticipates that subsequent to that time, its working
capital, capital expenditures and long-term debt repayments will be satisfied by
existing sources of liquidity, funds from operations and, if necessary,
additional 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 less
valuable. As the market for Corel's products continues to develop, additional
competitors may enter the market and competition may intensify.
Graphics. Corel's graphics software products face substantial competition from
a wide variety of companies. In the illustration graphics segment, Corel's
competitors include Adobe Systems Incorporated, Macromedia Inc., Micrografx,
Inc., and Microsoft. In the desktop publishing segment, its competitors include
Adobe. Corel's competitors include many other independent software vendors, such
as Autodesk, Inc., Borland International, Inc. and Apple Computer Inc.
Business Productivity. Corel's competitors in the productivity software
(primarily office suites) marketplace include Microsoft 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. Also, IBM preinstalls certain of its software products on
various models of its PCs, competing directly with Corel productivity software.
Consumer Products. The Company competes with other participants in the Photo CD
16
<PAGE>
market on the basis of price, the categories of photographs available, the
quality of the photographs and the nature of the rights attached to the photos
included on the Photo CD. The Company's competitors in this market include
Eyewire, Inc., Corbis Corporation and Getty Images, Inc. In the photo-editing
and painting graphics segments, its competitors include Adobe, Live Picture,Meta
Creations and The Learning Company. In the clipart segment, the Company's
competitors include Nova Corporation and The Learning Company. The Company's
competes with Sierra/Cendant, Broderbund, The Learning Company and Microsoft in
the SOHO Graphics market. In addition to these direct competitors, the Company
competes with a number of personal computer manufacturers that devote
significant resources to creating personal computer software, including Apple,
Hewlett-Packard Company and IBM.
Video Products. The Company's communications applications products (CorelVIDEO)
compete against offerings from Intel Corporation, PictureTel Corporation, C-
Phone Corporation, White Pine Software, Inc. and many other companies. With the
intention to sell the Video division, it is expected that the above mentioned
organizations will not remain competitors of Corel.
The Company believes that the principal competitive factors in the PC software
markets include performance, product features, ease of use, reliability,
hardware compatibility, brand name recognition, product reputation, pricing,
levels of advertising, availability and quality of customer support, and
timeliness of product upgrades. Corel competes with other software vendors for
access to distribution channels, retail shelf space and the attention of
customers at the retail level and in corporate accounts. The Company also
competes with other software companies in its efforts to acquire software
technology developed by third parties.
Pricing
Pricing pressures continually intensify in the PC software applications market
and the Company believes that price competition, with its attendant reduced
profit margins, may become a more significant factor in the future. Corporate
licensing, discount pricing for large volume distributors and retailers, product
bundling promotions and competitive upgrade programs are forms of price
competition that may become more prevalent. In addition, enterprise wide
versions of products are generally priced lower per user than individual copies
of the same products. Corel also competes with companies that produce standalone
graphics and desktop publishing applications that might serve a specific need of
a user or class of users at a price below that of Corel's products.
Technological Change
The markets for Corel's products are characterized by rapidly changing
technology, frequent new product introductions and uncertainty due to new and
emerging technologies. Corel's future success is highly dependent upon the
timely completion and introduction of new or enhanced products incorporating
such emerging technologies at competitive price/performance levels. The pace of
change has recently accelerated due to the Internet, corporate intranets and the
acceptance of new operating systems such as Windows 98 and Linux.
17
<PAGE>
PC Growth Rates
The underlying PC unit growth rate, which may increase at a slower rate in the
future, impacts Corel's revenue growth.
Dependence on New Products
While Corel performs extensive usability and beta testing of new and enhanced
products, user acceptance and corporate penetration rates ultimately determine
the success of development and marketing efforts.
Product Ship Schedules
Delays in new product releases impact sales growth rates and can cause
operational inefficiencies that impact manufacturing and distribution
logistics,distributor, reseller and OEM relationships, and technical support and
customer service staffing.
Channel Mix
Average revenue per unit is lower from OEM licences than from retail versions,
reflecting the relatively low direct costs of operations in the OEM channel.
Potential Fluctuations in Quarterly Results
Corel's quarterly operating results fluctuate as a result of a number of
factors, including the timing of new product announcements and introductions by
Corel and its competitors, pricing, distributor ordering patterns, the relative
proportions of sales attributable to full kits and existing user upgrades,
product returns and reserves, advertising and other marketing expenditures, and
research and development expenditures. Revenues and earnings may be difficult to
predict due to shipment patterns. Products are generally shipped as orders are
received, and accordingly, Corel has historically operated with little backlog.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter.
Employee Compensation
The highly competitive market for qualified personnel, especially software
engineers and developers, could adversely affect Corel's ability to engage and
retain competent qualified personnel, particularly development professionals.
Corel believes that its employment policies in this regard are competitive
within the industry.
Dependence on Distributors
The distribution of Corel's products is carried out primarily through
distributors, certain of which are material to the competitive position of
Corel. The distribution channels through which software products for desktop
computers are sold have been characterized by rapid change, including
consolidations and financial difficulties of certain distributors and resellers,
18
<PAGE>
the emergence of new retailers such as general mass merchandisers and
superstores, and the desire of large customers such as retail chains and
corporate users to purchase directly from software developers. The loss of, or a
significant reduction in sales volume attributable to any of Corel's principal
distributors or the insolvency or business failure of any such distributor could
have a material adverse effect on Corel's results of operations.
International Operations and Geographic Concentration
Currently, Corel markets its products in more than 60 countries. Corel
anticipates that sales outside North America will continue to account for a
significant portion of total sales. These sales are subject to certain risks
including imposition of government controls, export licence requirements,
restrictions on the export of technology, political instability, trade
restrictions, changes in tariffs, differences in copyright protection and
difficulties in managing accounts receivable. More than 45% of Corel's sales for
the past three fiscal years were made in the United States. As a result, adverse
developments in the United States markets for Corel's products could have a
material adverse effect on Corel's results of operations.
Dependence on Key Personnel
Corel's success depends to a significant extent upon the performance of Corel's
executive officers and key technical and marketing personnel. Corel has
agreements describing compensation arrangements and containing non-disclosure
covenants with all of its key employees. Corel believes that its future success
will also depend in large part on its ability to attract and retain
highly skilled technical, managerial, and sales and marketing personnel.
Saturation
Product upgrades, which enable users to upgrade from earlier versions of Corel's
products or from competitors' products, have lower prices and margins than new
products. The sales mix has shifted from full-kit products to upgrade products
as the market for Corel's products become saturated. This sales pattern
is likely to continue.
Corporate licenses
Average revenue per unit from corporate license programs is lower than average
revenue per unit from retail versions. Unit sales under licensing programs may
continue to increase.
Research and development investment cycle
Developing and localizing software is expensive and the investment in product
development often involves a lengthy payback cycle. The Company plans to
continue significant investments in product research and development from which
significant revenue is not assured.
Year 2000
19
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Many software and hardware products were designed to store dates using a two-
digit year (e.g., 98) instead of a four-digit year (e.g., 1998). This was done
to save what was, at the time, valuable memory. As we make the transition to the
year 2000, some applications could misinterpret 00 as 1900, 1980 or some other
date.
In addition, 2000 is a leap year. A leap year occurs at the turn of the century
every 400 years, and some applications have failed to accommodate this.
There are three major risks for the Company from Year 2000 issues. Year 2000
compliance problems with Corel's products could have a material adverse effect
on sales and operations. Significant Year 2000 compliance problems with internal
systems could seriously affect the Company's ability to carry out its
operations. Corel also depends heavily on third parties for raw materials,
transportation, utilities, and other key services. Interruption of supplier
operations due to Year 2000 issues could seriously disrupt the Company's
operations. In addition, if Corel's current or future customers do not achieve
Year 2000 compliance or if they divert expenditures previously reserved for
business software to address their Year 2000 compliance problems, Corel's
business, results of operations, or financial condition could be materially
adversely affected.
Addressing potential year 2000 issues is a high priority at Corel. In 1996,
Corel initiated a corporate-wide program to review, test and prepare Corel's
products and internal systems for the Year 2000 with the full support of the
Board of Directors. The Board of Directors is updated as to the status of
Corel's Year 2000 effort on a regular basis.
On the product side, we have established a comprehensive year 2000 Product
Evaluation Program. We conduct our product evaluations using real world
scenarios to determine if the applications will operate as designed using
various identified year 2000 critical dates where appropriate. Corel tests all
new products before they are released, as well as major upgrades of all existing
products. Corel is also testing a number of historic products that have a large
user-base. Current information on the status of our products is available on our
Web site (http://www.corel.com/2000.htm). The Company expects to complete
testing of these products by the end of the third quarter of 1999. All upcoming
product releases are being tested for Year 2000 compliance and it is anticipated
that all upcoming releases will be Year 2000 compliant. Although Corel's testing
process is comprehensive, there can be no assurances that the Company's products
do not contain undetected errors or defects associated with year 2000 date
functions.
For internal systems, the Company has established a three phase testing program.
The inventory phase includes compiling a list of hardware and software systems
and suppliers that are critical to Corel's operations. Assessment includes the
evaluation of critical systems for Year 2000 compliance. The renovation phase
includes the resolution of all issues identified in the assessment phase.
The inventory phase is ongoing as additions to internal systems are made on a
regular basis. Corel expects to complete the assessment phase for all critical
internal hardware and software systems by the third quarter of 1999. The Company
is also in the process of implementing
20
<PAGE>
solutions to ensure Year 2000 compliance. It is expected that renovations, if
required, will be complete by the third quarter of 1999 for critical systems.
Non-critical systems will be tested and solutions implemented over the balance
of 1999. In addition, as part of ongoing business operations, the Company
strives to ensure that all current investments in new technology are Year 2000
compliant. Due to the nature of Corel's normal business practices, Corel is
continually upgrading many of its critical back-end systems with new hardware
and software. These practices help to ensure that Corel does not experience any
significant disruptions due to Year 2000 issues.
Corel's Year 2000 program also includes a full review of significant third
parties' Year 2000 compliance. Corel has been in contact with the majority of
these third parties and is currently conducting an in-depth risk analysis. This
includes assessing the extent of Year 2000 compliance for third parties as well
as reviewing their plans to address any Year 2000 issues through surveys and
discussions with company representatives. The Company fully expects to have
suitable solutions in place before 2000. There can be no guarantees, however,
that these third parties will be fully Year 2000 compliant.
Corel has designed a comprehensive contingency planning process to ensure the
continuity of business operations in the event of a disruption caused by Year
2000 issues. The four phases of this plan are I - business process definition,
II - business process analysis, III - scenario generation and contingency plan
determination and IV -validation and testing. The Company is currently in Phase
III of the plan. Phase III is expected to be complete in the third quarter of
1999 and phase IV completion is expected in the fourth quarter of 1999.
Corel expects to incur total costs of approximately $1.3 million from the third
quarter of 1999 through the second quarter of 2000 to operate Year 2000
programs. This amount includes the direct costs involved in running the Year
2000 department as well as costs associated with third party testing. These
amounts will be funded from operating cash flow and will be expensed as
incurred. There have also been substantial efforts expended by the Engineering,
MIS and Legal departments with regard to Year 2000 issues and by other
departments to a lesser degree. These costs are included in the salaries for
those departments. There is no assurance that the Company's financial position
may not be materially adversely affected if unanticipated problems occur.
Notwithstanding the efforts made to become Year 2000 compliant, there can be no
assurances that this program will ensure that all of Corel's internal systems,
products and third party systems will be Year 2000 compliant. Should these
systems not be compliant before 2000, there could be material adverse
consequences to the Company.
21
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On or about February 23, 1998, the Company became aware that a class action
lawsuit had been filed against it by named Plaintiff Great Neck Capital
Appreciation Investment Partnership in the United States District Court for the
Eastern District of New York. The complaint also names as co-defendants Dr.
Michael C.J. Cowpland, Corel's Chairman, President and Chief Executive Officer,
and Mr. Charles Norris, Corel's former Vice President, Finance and Chief
Financial Officer. The complaint was filed on behalf of all persons who
purchased or otherwise acquired Corel common shares between March 26, 1997 and
January 20, 1998 (the "Class Period"). The complaint alleges that the
defendants violated various provisions of the federal securities laws, including
Section 10(b) and 10(a) of the Securities Exchange Act of 1934, as amended, and
Securities and Exchange Commission Rule 10b-5, by misrepresenting or failing to
disclose material information about Corel's financial condition. The complaint
alleges that the defendants issued false and misleading press releases and
financial statements for the first three quarters of fiscal 1997. Plaintiff
alleges, in part, that defendants (a) failed to disclose that they were
overstating Corel's reported profits by, among other things, inflating reported
revenues and earnings through improperly recognizing revenue on Java technology
exchange transactions, and (b) overstated revenues and earnings by understating
reserves in connection with sales to distributors who had no obligation to keep
or pay for the products. The complaint also alleges that Corel insiders,
including the individual co-defendants, sold common shares during the Class
period at "artificially inflated prices". The complaint seeks an unspecified
amount of money damages.
The Great Neck complaint was consolidated by order date June 1, 1998 with four
other previously filed complaints: Giskan, Meyer, Mangold and Hagler. Also on
June 1, 1998, the court approved the plaintiff's motion for the appointment of
lead plaintiff and lead counsel. The firm of Weschsler Harwood Halebian &
Feffer is counsel of record. Great Neck (as lead plaintiff) filed a
consolidated amended complaint on behalf of lead plaintiff and the class on
September 9, 1998 (the "Consolidated Complaint"). The Consolidated Complaint
references a revised Class Period (it has been filed on behalf of all persons
who purchased or otherwise acquired Corel common shares between January 15, 1997
and January 20, 1998); however, plaintiff's theories from the individual
complaints (as summarized above) remain the same.
On November 9, 1998, the Company filed a motion to Dismiss the Consolidated
Complaint in its entirety. On December 30, 1998, Plaintiffs filed a related
Motion to strike certain documents referred to in the Company's Motion to
Dismiss. Both motions were fully briefed by February 12, 1999. The plaintiffs
have not yet brought their motion to certify the class and the filing.
On June 18, 1999, the Company filed a motion to dismiss on grounds of forum non
conveniens. Plaintiffs' opposition to this motion is due on July 20, 1999. This
motion will be fully briefed by August 10, 1999.
The Company intends to defend this class action litigation vigorously. However,
due to the inherent uncertainties of litigation, the Company cannot accurately
predict the ultimate outcome of the litigation. Investigating and defending the
Consolidated Complaint 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
22
<PAGE>
effect on the Company's business, financial condition and results of operations.
Announcement of material developments in the litigation prior to its resolution
could aversely affect the market price of Corel's common shares.
On May 25, 1998, Revenue Canada advised the Company of proposed income tax
adjustments for fiscal years ended November 30, 1992 to 1995. The Company filed
a Response to Revenue Canada's Proposal on October 23, 1998 and is awaiting
reply. The company has recorded a provision of $2,468,000, inclusive of interest
and penalties, for certain adjustments. However, it is not possible to
accurately estimate the amount, if any, of additional income taxes that may
result from the remaining adjustments identified and therefore, no further
provision has been made.
On or about October 2, 1998, the Company became aware that a class action
lawsuit had been filed against it by plaintiff Karla A. Lyon in the Superior
Court of California, County of San Diego. The complaint also names as co-
defendants Corel Corporation (USA), Corel, Inc., Fry's Electronics, and David
Bicknell, a manager of one of Fry's Electronics' stores. The complaint was filed
on behalf of all persons whose photograph or likeness was, without that person's
consent, knowingly used by any of the defendants within the State of California.
On June 16, 1999, Corel Corporation and Karla A. Lyon amended a settlement of
the lawsuit initiated by Ms. Lyon in October 1998. The settlement does not
result in any changes to the financial statements as reported.
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 no reports on Form 8-K for the fiscal quarter
ended May 31, 1999.
23
<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, 1999 By: /s/ Michael C.J. Cowpland
-------------------------
Michael C. J. Cowpland
Chairman, President, Chief
Executive Officer and Director
Date: July 14, 1999 By: /s/ Michael P. O'Reilly
--------------------------
Michael P. O'Reilly
Executive Vice-President,
Finance and Treasurer
Chief Financial Officer
24
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