Corel Corporation F3Q08 (Qtr End 08/31/08) Earnings Call Transcript

Corel Corporation (CREL)

F3Q08 Earnings Call

October 3, 2008 8:00 am ET

Executives

Todd Friedman – The Blueshirt Group

Kris Hagerman - Interim Chief Executive Officer

Doug McCollam - Chief Financial Officer

Analysts

Mike Olson - Piper Jaffray

Sterling Auty – JP Morgan

Presentation

Operator

At this time I would like to welcome everyone to Corel Corporation’s third quarter 2008 financial earnings results conference call. (Operator Instructions) Todd Friedman will begin the call.

Todd Friedman

A copy of our press release was posted on the wire this morning and is available on Corel's investor relations website at investor.corel.com. With me today to discuss the company’s financial results are Corel's Interim Chief Executive Officer, Kris Hagerman, and Chief Financial Officer, Doug McCollam.

Before we begin I need to remind everyone that the matters we’re discussing today include predictions, estimates, expectations, and other forward looking statements. These statements are subject to certain risks and uncertainties that could cause our actual results to differ materially, including competitive threats from other software and online services companies and our reliance on a small number of strategic relationships for a significant percentage of our revenue which relationships can be terminated at any time.

Please refer to Corel's most recent SEC filings for a more detailed discussion of these and other risk factors. Forward looking statements speak only as of the date they are made and we disclaim any obligation or undertaking to provide any updates or revisions to them. Corel's financial results are prepared according to US GAAP and are reported in US currency.

Additionally, this call will include a discussion of adjusted EBITDA and adjusted net income which are non-GAAP measures. The GAAP measures that correspond to non-GAAP financial measures, as well as the reconciliation between the two, are set forth in our press release and are available on our website and in our filings with the SEC.

Today’s call is being recorded and is the property of Corel Corporation. Any retransmission or rebroadcast without the express written consent of Corel is prohibited. With that, I will now turn the call over to Kris.

Kris Hagerman

I’d like to begin today by providing you with a brief update on some recent corporate developments followed by a discussion of third quarter highlights. Following my opening remarks, Corel’s CFO, Doug McCollam will provide a more detailed discussion of our financial performance.

As you are aware, on August 18^th we announced that Corel Holdings, LP or CHLP an affiliate of Vector Capital, was withdrawing its previously announced proposal to acquire the outstanding Corel shares not currently owned by CHLP for $11 US per share. Following the withdrawal of the CHLP proposal, Corel’s Board unanimously determined that there was no longer a need for the special committee that had been formed to assess the company’s strategic alternatives and that going forward the full Board would oversee the evaluation of such strategic alternatives in order to maximize value for all shareholders.

We further confirmed on August 20^th following certain media reports that Corel is in discussions with a third party regarding a potential sale. Discussions are ongoing, however, no agreement has been reached and there can be no assurance that any transaction will be completed or if completed, what it’s terms, price or timing might be. As always, if and when there is new information to report we will do so through the appropriate disclosure channels.

A second corporate development that I want to touch on prior to reviewing our results is the streamlining of Corel’s global operations which we announced on September 10^th. These actions are part of our ongoing commitment to regularly evaluate our business and to make adjustments as required. As we have communicated in previous updates emerging markets and e-commerce are two areas we have identified as growth opportunities.

By closely examining all aspects of our business and aligning our teams and resources to support our key priorities we believe we will be better positioned to differentiate Corel in the market, deliver value to our customers and partners, grow revenue and earnings, and provide meaningful long term opportunities to our employees.

As you’ll see from our financial results Q3 2008 was a very good quarter for Corel with both revenue and non-GAAP EPS coming in ahead of our guidance. Revenue in the third quarter was $66.2 million up 10% year over year. CorelDRAW Graphics Suite, WinDVD, Corel DESIGNER Technical Suite, Corel Painter, and iGraphics each grew by double digit percentages over the same period last year.

GAAP net income for the quarter was $1.6 million or $0.06 per share. Adjusted EBITDA was $15.8 million a 17% increase over the previous year and adjusted net income was $10.2 million or $0.39 per share. For the nine months ended August 31, 2008, adjusted EBITDA stood at $44 million or 22% of revenue while adjusted net income for the same period was $26.4 million or $1.01 per share.

Corel’s Digital Media Portfolio performed well this quarter with revenue up 6% year over year. As we have communicated previously, Digital Media represents an exciting growth opportunity for Corel and we believe we have the team, resources, and product roadmap in place to build on this quarter’s momentum.

Underlying the growth are a number of positive contributing factors including the expansion of our OEM relationships, key industry certifications, and new product releases. Solid performances from Paint Shop Pro, Photo, and WinDVD together with our broad geographic coverage more then offsets some of the downward pressure that resulted from the expected and previously communicated changes within certain OEM’s.

Other third quarter highlights from our Digital Media business included a strong showing at Computech’s Taipei, now one of the world’s largest technology trade shows, and a series of certification announcements that further solidified our technology leadership in this highly dynamic market. WinDVD recently received BD-Live Certification further enhancing WinDVD’s Blu-ray capabilities by enabling consumers to interact over the internet through popular social media sites while enjoying their favorite high definition Blu-ray videos.

WinDVD also receive DTS-HD Master Audio Certification providing users with the best possible audio experience when viewing Blu-ray discs and high definition videos. Also this quarter we expanded the list of Blu-ray skus available to our OEM partners and we completed DLNA 1.5 Certification for our digital media server. By meeting the industries stringent requirements we are ensuring that Corel remains at the forefront of offering consumers the latest, most advanced technology to enjoy their digital life.

At the start of Q4 we continued to enhance our digital media offerings as we launched new versions of two of our flagship digital media products. Corel VideoStudio Pro X2 is the markets most complete HD solution for video editing and authoring. Paint Shop Pro Photo X2 Ultimate Edition is an enhancement to our leading photo editing software that now provides more creative options and expanded raw support to both new users and photo enthusiasts. The early response to these releases has been very positive and we look forward to continuing to build on the launch momentum.

Turning now to a discussion of Corel’s Graphics and Productivity Portfolio, once again Corel’s Graphics and Productivity product lines performed very well in the quarter with revenue up 13% year over year. During the quarter we released localized versions of CorelDRAW Graphics Suite X4 in Japanese, Korean, Simplified and Traditional Chinese helping to drive upwards of 20% growth year over year for the third consecutive quarter. In its first two quarters following the launch the latest version of CorelDRAW continued to track well ahead of the previous two releases both in revenue and total units sold.

Painter X also performed extremely well in the quarter with revenue up more than 20% year over year further cementing its leadership position in the natural painting and illustration category. Other highlights from the portfolio include the launch of Corel Designer Technical Suite X4 and the strong performance of WordPerfect Office X4 which delivered 9% growth over the previous year. This is the second consecutive quarter that WordPerfect has outperformed its prior year results reflecting the positive reception the newest release has received since its launch earlier this year.

As we have communicated previously our focus for WordPerfect continues to be on supporting our core legal and government customers while identifying new business models and creative marketing initiatives to maintain the opportunities for Corel’s productivity software.

Looking briefly at WinZip and iGraphics, WinZip revenue was relatively flat year over year with a modest increase of 1% as we approach the end of the products current release cycle. We released WinZip 12 at the start of September featuring the industries first photo zip compression. iGraphics continued its consistent performance by once again posting double digit growth.

As we look to our regional performance I’m very pleased to report that Q3 revenue was up on a year over year basis in all three of Corel’s major geographies the Americas, EMEA and APAC reflecting the diversification of our distribution network and the solid execution of Corel’s global team. EMEA had a particularly quarter in spite of the seasonal slow down that typically occurs from June through August. Emerging markets continue to be an area of strength for Corel as revenue in this category was up 63% year over year reflecting strong growth in Eastern Europe, China and Latin America.

Corel will continue to enhance our sales and marketing activities in these key markets with a particular focus on expanding our e-commerce platform to better reach customers in these regions.

In summary, Corel delivered a strong third quarter as we continued to benefit from the strength and diversity of our products and channels and the ongoing focus and commitment of our team around the world. I would now like to turn the call over to Doug McCollam, who will provide a more detailed discussion of Corel’s financial performance in the third quarter.

Doug McCollam

Corel had a strong third quarter, revenues were $66.2 million compared to $60.4 million for the third quarter of 2007. As Kris described we are pleased in the quarter by continued broad based contribution of our products. GAAP net income for the third quarter 2008 was $1.6 million or $0.06 on a per share basis compared to a GAAP net loss of $6.8 million or a loss of $0.27 per share in the third quarter 2007.

Non-GAAP adjusted net income was $10.2 million in the third quarter of 2008 compared to $8.1 million in the third quarter 2007. Non-GAAP EPS was $0.39 in the third quarter 2008 compared to $0.31 in the same period of last year.

First let’s cover some of the detail on the revenue line, revenue in our Digital Media business was $28.3 million compared to $26.7 million in the third quarter last year, as Kris mentioned up 6%. Revenue in our Graphics and Productivity business was $37.9 million compared to $33.7 million in the third quarter last year. This increase is spread over a number of products with double digit increases in CorelDRAW Graphics Suite, WinDVD, Corel Designer Technical Suite, Corel Painter and iGraphics.

On a geographic basis the Americas made up 50% of revenue with EMEA contributing 27% and Asia Pacific contributing 23% for the third quarter 2008. Gross margin in the third quarter excluding the amortization of intangible assets for the quarter was 77%. As we explained on our last call this was expected as some of our top line strength continues to come from lower margin products. As the shift from standard to high definition solutions continue we should see a beneficial impact on our OEM margins over time.

Moving down the expense line, sales and marketing expenses for the quarter were $17.9 million or 27% of revenue compared to $17.6 million or 29% of revenue in Q3 2007. R&D was $10.6 million in Q3 or 16% of revenues compared to $11.9 million or 20% last year. G&A expenses were $8.4 million for the quarter or 13% of revenues compared to $7.8 million or 13% of revenues last year. We recorded other operating expense in the quarter of $293,000 related to restructuring.

Operating income was $7.3 million in the third quarter 2008 compared to operating income of $1.5 million in the same quarter of last year. Because of various acquisition related charges both cash and non-cash and the covenants that govern our debt we focus internally on non-GAAP adjusted EBITDA as a key operating metric.

Non-GAAP adjusted EBITDA in the third quarter was $15.8 million or 24% of revenue this compares to $13.5 million or 22% of revenue recorded in third quarter 2007. As we continue to leverage the scale in our business and grow we expect to continue to improve this EBITDA margin over time.

Working down the rest of the income statement there area couple of lines worth noting. Net interest expense in the quarter was $3.5 million. We also had costs related to our shareholders proposal of $992,000 for the quarter. Other non-operating expenses of $1 million related to foreign exchange losses on the strengthening of the US dollar against the Canadian dollar, Euro and Yen and also a loss of unused space in a leased facility in Ireland.

I want to take a minute to talk about the tax provision and Corel’s tax position. First, Corel had approximately $461 million of total tax shields of which our NOL balance was $247 million at the end of the third quarter. Current taxes were $1 million which was offset by a $1.2 million benefit for the recognition of a deferred tax asset. As I said earlier our non-GAAP adjusted net income for the third quarter of 2008 was $10.2 million or $0.39 per share.

Turning now to the balance sheet and cash flows, cash and cash equivalents at August 31^st were approximately $37.1 million. Cash from operations in the third quarter was approximately $6.2 million compared to $500,000 in the same quarter of last year. Trade account receivables at the end of the quarter were $28.5 million. Our trade DSO in the third quarter 2008 was 39 days, down one day from last quarter. Total debt including obligations under capital leases at the end of the quarter was $158.5 million.

Turning now to guidance, please remember that these forecasts are made as of today and Corel undertakes no obligation to update this information at any time. We expect revenue in the fourth quarter in the range of $71 to $75 million. Our previously announced restructuring will result in a charge of $2.5 million that will be recorded in the fourth quarter.

On a GAAP basis we expect net income in the range of $4 to $6 million or $0.15 to $0.22 per share. On a non-GAAP basis we expect adjusted net income to range between $14 and $16 million and non-GAAP EPS in the range of $0.52 to $0.60 per share.

For fiscal 2008 we expect a revenue range of $270 to $274 million. On a GAAP basis we are expecting net income of $6.5 to $8.5 million or $0.25 to $0.32 per share. On a non-GAAP basis we are expecting adjusted net income of $40.5 to $42.5 million or $1.54 to $1.62 per share. We expect weighted average diluted common shares will be approximately $26.3 million for the year.

With that I will turn the call back over to Kris for his closing thoughts.

Kris Hagerman

In conclusion, we are very pleased with our results for the third quarter which we believe demonstrates the strength of Corel’s business model even in a difficult economic environment. We are seeing nice upward momentum in our Digital Media portfolio, continued strong performances from our Graphics and Productivity product lines and revenue growth across all our major geographic regions.

We have taken proactive steps to further strengthen our operational performance and our competitive position by aligning our teams and resources with the opportunities we believe provide the greatest competitive advantage for Corel going forward. I am proud of the strong execution of our global team in Q3 and we are excited about the opportunity to build on our momentum to deliver a strong finish to the fiscal year.

Operator we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mike Olson - Piper Jaffray.

Mike Olson - Piper Jaffray

A quick question on emerging markets, if I remember right it grew 40% last quarter. What do you attribute the acceleration in growth to with emerging markets growth at 63% this quarter? Also, what percent of revenue was emerging markets?

Kris Hagerman

I don’t think there’s anything unusual or different in how we’re approaching emerging markets. I think it’s the manifestation of continued sales and marketing efforts in those regions and for us certainly many of those regions are under penetrated in terms of how long we’ve been there and the knowledge and awareness of the products that we have to make available to customers and partners. I think it’s been natural outcome of spending more time in those regions, working with partners and just getting the word out as to what our products do and how they can add value.

In terms of the actual percentage of revenue it continues to grow, it’s in double digits, low teens range at this point but we expect that to continue to grow over time. This is one of the areas where we think particularly given the nature of some of how these emerging markets operate and in many cases they’re quite cost conscious we think the value of our products can be a nice fit.

Mike Olson - Piper Jaffray

As far as Blu-ray, I think last quarter you’d given us a flavor for Blu-ray revenue as a percent of WinDVD revenue I think it was somewhere slightly higher than 5% last quarter. Is there anything you can give us this quarter?

Kris Hagerman

We’re not breaking it out specifically as a metric that we’re going to comment on every quarter but I can tell you that it continues to grow and the percentage that you’re referring continue to grow. What we’re seeing is that the manufacturers themselves they’re shipping more Blu-ray skus, the consumer price of Blu-ray drives is coming down and we’re just seeing higher and higher growth associated with Blu-ray. It’s not something that we want to comment on explicitly in terms of the percentage every quarter.

We like the trend and we think that the go forward picture for Blu-ray and Blu-ray adoption is going to be pretty much as we anticipated. We said it was going to be a second half thing then the real impact would be more in ’09 and we would stand by that.

Operator

Your next question comes from Sterling Auty – JP Morgan.

Sterling Auty – JP Morgan

Can you from a high level characterize your top line revenue performance in terms of where you are in the product cycles, how much of the strength was from where you are just in the product cycles of your major platforms, major products, how much of it was seasonality if there were seasonality in some of the regions and how much of it is just better execution.

Kris Hagerman

I would say that it’s certainly not seasonality. Q3 is for us and most software companies as you move into the summer months it’s usually a slower quarter. If anything seasonality would have been a mild headwind against a top line revenue performance of this caliber. It’s not that. In terms of product release cycles, we had the big launches for us in FY08 really took place at the beginning of the year, in particular with DRAW. We did launch Designer in Q3 but in terms of overall magnitude that’s a smaller product. I don’t think it’s directly associated with a specific launch that we did in the quarter.

Certainly what we are seeing is one of the best launch years for DRAW that we’ve ever had. When we launched the product in Q1, which was obviously before my time here at Corel, there was a sense that not only had we gotten the product features right but we had also done a nice job of messaging and positioning around the product and working with our field and distribution partners.

We have just continued to see the momentum of DRAW build during the course of the year as we launch new language versions as we have it up and running in new countries and geographies. That certainly has been a welcome trend for us and that momentum continues.

In terms of the Digital Media side we haven’t had a significant product launch in Q3. We just recently announced, as I mentioned in my comments, new released for Paint Shop Pro and for Video Studio but that happened in the September timeframe. I think what we’re seeing on the Digital Media side is continued strength through WinDVD both our presence as the default provider for some significant OEMs and divisions of those OEMs. We’re seeing a lot of strength with, for example, HP and Lenovo.

The Blu-ray component continues to grow so that helps. I think it has frankly more to do with continued execution against both the DRAW product that’s out there that’s doing very well and frankly as these acquisitions of IVI and Ulead and Jask it’s now been a year or a couple years since those have taken place we’re just getting more comfortable with them as a company. We’re getting comfortable with the product roadmaps and the differentiation and how to introduce them to our field and our channel partners.

Those things are coming together and as they do we should continue to see that Digital Media group improve.

Sterling Auty – JP Morgan

As we look at some of the commentary and things coming out of Dell and others looking about the concerns of a macro slow down bleeding into other regions and potentially even threatening some of the emerging markets are you doing anything proactively to prepare for that or what’s your anticipation of how that might impact Corel.

Kris Hagerman

It’s hard to say at this point. Number one, what you and all of us have heard from Dell is a little bit different than what you and the rest of us are hearing from companies like HP and Lenovo. There is some of this that is an overall economic impact but there’s also some company specific issues that will be unique to each of them.

It’s too early, frankly, for us to determine just what the nature of this overall economic headwind will deliver for us. We are intent at this point to just to continue to execute as well as we can and whether it’s a tough economic climate or not we’re always meeting with our OEMs on a regular basis. We’re also pursuing these partners and customers in emerging markets as aggressively as we can. I don’t know that there’s anything specifically we’re going to change because we think that the overall climate is difficult or may be getting more difficult.

The climate has been pretty tough over the last couple of months and we’ve done okay so we’re going to continue to just run as hard as we can. The things that we can’t control we’ll try to adjust to those as they develop.

Operator

There are no further questions at this time.

Kris Hagerman

Thank you everyone. We’re excited about Corel’s performance in the third quarter. We think it reflects well not only on the commitment and execution of the team but also on the value that Corel’s products deliver to our partners and our customers every day. Thanks very much and we’ll talk again soon.

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