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UNITED STATES
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 QUARTERLY PERIOD ENDED MARCH 5, 1999
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: 0-15175
ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 77-0019522
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
345 PARK AVENUE, SAN JOSE, CALIFORNIA 95110-2704
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 536-6000
Indicate by check mark whether the 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
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Shares Outstanding
Class April 2, 1999
----- -------------
Common stock, $0.0001 par value 61,009,148
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TABLE OF CONTENTS
Page No.
PART I -- FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Statements of Income
Quarter Ended March 5, 1999 and February 27, 1998 3
Condensed Consolidated Balance Sheets
March 5, 1999 and November 27, 1998 4
Condensed Consolidated Statements of Cash Flows
Quarter Ended March 5, 1999 and February 27, 1998 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on Form 8-K 30
Signature 34
Summary of Trademarks 35
EXHIBITS
Exhibit 27.1 Financial Data Schedule
Exhibit 27.2 Financial Data Schedule
2
PART I -- FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
QUARTER ENDED
---------------------------------
MARCH 5 FEBRUARY 27
1999 1998
--------------- ----------------
Revenue:
Licensing $ 38,099 $ 41,851
Application products 188,803 155,962
--------------- ----------------
Total revenue 226,902 197,813
Direct costs 22,499 27,805
--------------- ----------------
Gross margin 204,403 170,008
--------------- ----------------
Operating expenses:
Research and development 44,904 43,338
Sales and marketing 78,480 71,491
General and administrative 26,566 33,507
--------------- ----------------
Total operating expenses 149,950 148,336
--------------- ----------------
Operating income 54,453 21,672
--------------- ----------------
Nonoperating income:
Investment gain (loss) (20) 12,462
Interest and other income 5,886 8,501
--------------- ----------------
Total nonoperating income 5,866 20,963
--------------- ----------------
Income before income taxes 60,319 42,635
Provision for income taxes 22,043 15,891
--------------- ----------------
Net income $ 38,276 $ 26,744
--------------- ----------------
--------------- ----------------
Basic net income per share $ .63 $ .39
--------------- ----------------
--------------- ----------------
Shares used in computing basic
net income per share 60,973 67,762
--------------- ----------------
--------------- ----------------
Diluted net income per share $ .60 $ .38
--------------- ----------------
--------------- ----------------
Shares used in computing diluted
net income per share 63,384 69,585
--------------- ----------------
--------------- ----------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
MARCH 5 NOVEMBER 27
1999 1998
--------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 79,486 $ 110,871
Short-term investments 183,751 161,676
Receivables, net of allowances of $5,144 and
$6,399, respectively 132,042 141,180
Deferred income taxes 31,911 32,028
Other current assets 11,573 10,190
--------------- ----------------
Total current assets 438,763 455,945
Property and equipment 93,562 93,887
Deferred income taxes 2,128 16,647
Restricted funds and security deposits 130,029 130,260
Other assets 108,024 70,592
--------------- ----------------
$ 772,506 $ 767,331
--------------- ----------------
--------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade and other payables $ 29,250 $ 48,681
Accrued expenses 125,782 117,539
Accrued restructuring charges 6,975 8,867
Income taxes payable 47,659 64,546
Deferred revenue 17,970 11,333
--------------- ----------------
Total current liabilities 227,636 250,966
--------------- ----------------
Stockholders' equity:
Common stock, $0.0001 par value
and additional paid-in capital 315,370 306,859
Retained earnings 750,225 732,730
Accumulated other comprehensive income 16,830 (1,879)
Treasury stock, net of reissuances (13,526 and 13,050
shares in 1999 and 1998, respectively) (537,555) (521,345)
--------------- ----------------
Total stockholders' equity 544,870 516,365
--------------- ----------------
$ 772,506 $ 767,331
--------------- ----------------
--------------- ----------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
QUARTER ENDED
---------------------------------
MARCH 5 FEBRUARY 27
1999 1998
--------------- ----------------
Cash flows from operating activities:
Net income $ 38,276 $ 26,744
Adjustments to reconcile net income to net cash
provided by operating activities:
Stock compensation expense -- 875
Depreciation and amortization 12,393 17,426
Deferred income taxes 1,751 (969)
Provision for losses on accounts receivable (1,216) 770
Tax benefit from employee stock plans 7,533 2,617
Equity in net loss of Adobe Ventures (202) 525
Loss (gain) on sale and distribution of equity investments 192 (12,987)
Changes in operating assets and liabilities:
Receivables 10,354 15,185
Other current assets (1,382) (144)
Trade and other payables (18,756) (14,928)
Accrued expenses (336) 2,439
Accrued restructuring charges (1,892) (158)
Income taxes payable (16,887) (4,245)
Deferred revenue 6,637 (1,805)
--------------- ----------------
Net cash provided by operating activities 36,465 31,345
--------------- ----------------
Cash flows from investing activities:
Purchases of short-term investments (121,067) (392,262)
Maturities and sales of short-term investments 140,730 354,628
Purchases of property and equipment (7,520) (11,926)
Acquisitions, net of cash acquired (31,000) (1,968)
Additions to other assets (12,494) (28,748)
--------------- ----------------
Net cash used for investing activities (31,351) (80,276)
--------------- ----------------
(Continued)
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(CONTINUED)
(UNAUDITED)
QUARTER ENDED
---------------------------------
MARCH 5 FEBRUARY 27
1999 1998
--------------- ----------------
Cash flows from financing activities:
Proceeds from sale of put warrants $ 978 $ --
Purchase of treasury stock (69,864) (122,779)
Proceeds from reissuance of treasury stock 35,888 17,306
Payment of dividends (3,057) (6,281)
--------------- ----------------
Net cash used by financing activities (36,055) (111,754)
--------------- ----------------
Effect of foreign currency exchange rates on
cash and cash equivalents (444) (238)
--------------- ----------------
Net decrease in cash and cash equivalents (31,385) (160,923)
Cash and cash equivalents at beginning of period 110,871 267,576
--------------- ----------------
Cash and cash equivalents at end of period $ 79,486 $ 106,653
--------------- ----------------
--------------- ----------------
Supplemental disclosures:
Cash paid during the period for income taxes $ 28,394 $ 12,182
--------------- ----------------
--------------- ----------------
Noncash investing and financing activities:
Cash dividends declared but not paid $ 3,020 $ 3,333
--------------- ----------------
--------------- ----------------
Dividends in-kind distributed $ -- $ 7,197
--------------- ----------------
--------------- ----------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
reflect all normal recurring adjustments which are, in the opinion of
management, necessary to present a fair statement of the condensed
consolidated financial position at March 5, 1999, and the condensed
consolidated statements of income and cash flows for the three-month periods
ended March 5, 1999 and February 27, 1998.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions for Form 10-Q and,
therefore, do not include all information and footnotes necessary for a
complete presentation of the results of operations, the financial position,
and cash flows, in conformity with generally accepted accounting principles.
Adobe Systems Incorporated ("Adobe" or the "Company") filed audited
consolidated financial statements which included all information and
footnotes necessary for such a presentation of the results of operations,
financial position and cash flows for the years ended November 27, 1998,
November 28, 1997, and November 29, 1996, in the Company's 1998 Annual Report
on Form 10-K.
The results of operations for the interim period ended March 5, 1999,
are not necessarily indicative of the results to be expected for the full
year.
REVENUE RECOGNITION
During the first quarter of fiscal 1999, the Company adopted Statement
of Position (SOP) 97-2, "Software Revenue Recognition." The Company modified
certain aspects of its business model such that the impact of SOP 97-2 was
not significant.
RECENT ACCOUNTING PRONOUNCEMENTS
During the first quarter of fiscal 1999, the Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in the financial statements. It does
not, however, require a specific format for the disclosure but requires the
Company to display an amount representing total comprehensive income for the
period in its financial statements.
7
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," and in June 1998, issued SFAS No.
133 "Accounting for Derivative Instruments and Hedging Activities." Readers
can refer to the "Recent Accounting Pronouncements" section of the Company's
1998 Annual Report on Form 10-K for further discussion.
In December 1998, the AICPA issued SOP 98-9, "Modifications of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions." Readers
can refer to the "Recent Accounting Pronouncements" section of the Company's
1998 Annual Report on Form 10-K for further discussion.
RECLASSIFICATIONS
Certain reclassifications were made to the fiscal 1998 consolidated
financial statements to conform to the fiscal 1999 presentation, including
certain reclassifications within operating expenses and between operating
expenses and direct costs that were made to enable management to better
analyze financial results. These reclassifications did not impact total
operating profit for the first quarter of fiscal 1998.
NOTE 2. OTHER ASSETS
Other assets consisted of the following:
MARCH 5 NOVEMBER 27
1999 1998
----------------- ------------------
Equity investments $ 58,070 $ 56,332
Goodwill 26,442 3,190
Purchased technology and licensing
agreements 15,775 3,502
Miscellaneous other assets 28,564 24,337
----------------- ------------------
128,851 87,361
Less accumulated amortization 20,827 16,769
----------------- ------------------
$ 108,024 $ 70,592
----------------- ------------------
----------------- ------------------
8
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 3. ACCRUED EXPENSES
Accrued expenses consisted of the following:
MARCH 5 NOVEMBER 27
1999 1998
----------------- ------------------
Accrued compensation and benefits $ 46,600 $ 41,592
Sales and marketing allowances 14,780 13,439
Other 64,402 62,508
----------------- ------------------
$ 125,782 $ 117,539
----------------- ------------------
----------------- ------------------
NOTE 4. RESTRUCTURING AND OTHER CHARGES
In the third quarter of fiscal 1998, the Company implemented a
restructuring program aimed at streamlining its underlying cost structure to
better position the Company for growth and profitability. For a detailed
discussion on the restructuring program, the reader can refer to the
Company's 1998 Annual Report on Form 10-K.
The following table depicts the restructuring and other activity through
March 5, 1999:
ACCRUED ACCRUED
BALANCE AT TOTAL BALANCE AT
NOVEMBER 27 CHARGES CASH WRITE- MARCH 5
1998 (CREDITS) PAYMENTS DOWNS 1999
---------------- ------------- ------------- ------------- ----------------
Severance and
related charges $ 894 $ -- $ (462) $ -- $ 432
Lease termination
costs 4,062 -- (1,389) -- 2,673
Canceled contracts 943 -- -- -- 943
Other charges 276 -- (1) -- 275
---------------- ------------- -------------- ------------- ----------------
6,175 -- (1,852) -- 4,323
Accrual related
to previous
restructuring 2,692 -- (40) -- 2,652
---------------- ------------- -------------- ------------- ----------------
$ 8,867 $ -- $ (1,892) $ -- $ 6,975
---------------- ------------- -------------- ------------- ----------------
---------------- ------------- -------------- ------------- ----------------
Severance and related charges consists primarily of COBRA benefits and
outplacement costs. The remaining accrual balance of $0.4 million as of March
5, 1999 is expected to be paid by the third quarter of fiscal 1999.
9
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 4. RESTRUCTURING AND OTHER CHARGES (CONTINUED)
Lease termination costs include remaining lease liabilities, brokerage
fees, and legal fees offset by estimated sublease income related primarily to
facilities in San Jose, California that were vacated as part of the
restructuring program. As of March 5, 1999, $2.7 million of lease termination
costs, net of anticipated sublease income, remains accrued and is expected to
be utilized by the third quarter of fiscal 1999.
As of March 5, 1999, the remaining accrual in canceled contracts of $0.9
million is expected to be fully paid by the first quarter of fiscal 2000 in
accordance with the settlement agreement.
Other charges relate to legal fees associated with the divestiture of
two business units and employee terminations as part of the severance
program. The remaining $0.3 million accrual as of March 5, 1999 is expected
to be paid by the third quarter of fiscal 1999.
As of March 5, 1999, approximately $2.7 million in accrued restructuring
costs remain related to lease termination costs primarily in Europe resulting
from the mergers with Aldus and Frame in fiscal 1994 and fiscal 1995,
respectively.
NOTE 5. STOCKHOLDERS' EQUITY
STOCK REPURCHASE PROGRAM
In September 1997, the Company's Board of Directors authorized, subject
to certain business and market conditions, the purchase of up to 15.0 million
shares of the Company's common stock over a two-year period. This new stock
repurchase program was in addition to an existing program whereby the Company
has been authorized to repurchase shares to offset issuances under employee
stock option and stock purchase plans. The Company repurchased approximately
1.7 million shares in the first quarter of fiscal 1999 and 10.5 million
shares in fiscal 1998, at a cost of $69.9 million and $379.2 million,
respectively under its stock repurchase programs. As of March 5, 1999, there
are no remaining authorized shares to be repurchased under the 15.0 million
share repurchase program.
PUT WARRANTS AND CALL OPTIONS
To facilitate the Company's stock repurchase programs, the Company sold
put warrants to independent third parties. Each warrant entitles the holder
to sell one share of Adobe's common stock to the Company at a specified
price. On March 5, 1999, put warrants to sell approximately 779,500 shares of
the Company's common stock were outstanding that expire on various dates
through July 1999 with an average exercise price of $42.41 per share. Under
these put warrant arrangements, the Company, at its option,
10
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 5. STOCKHOLDERS' EQUITY (CONTINUED)
can settle with physical delivery or net shares equal to the difference
between the exercise price and market value at the date of exercise;
therefore the put warrants do not result in a liability on the balance sheet.
In addition, the Company purchased call options from independent third
parties that entitle the Company to buy its common stock on certain dates at
specified prices. On March 5, 1999, call options to purchase approximately
239,100 of the Company's common stock were outstanding that expire on various
dates through July 1999 with an average exercise price of $44.47 per share.
NOTE 6. COMPREHENSIVE INCOME
The following table sets forth the components of comprehensive income,
net of income tax expense:
QUARTER ENDED
-------------------------------------
MARCH 5 FEBRUARY 27
1999 1998
----------------- ------------------
Net income $ 38,276 $ 26,744
Change in cumulative translation
adjustment (444) (238)
Change in unrealized gains on
investments, net 19,153 (2,763)
----------------- ------------------
Total comprehensive income $ 56,985 $ 23,743
----------------- ------------------
----------------- ------------------
NOTE 7. NET INCOME PER SHARE
Basic net income per share is computed using the weighted average number of
common shares outstanding for the period, excluding unvested restricted stock.
Diluted net income per share is based upon the weighted average common shares
outstanding for the period plus dilutive common equivalent shares, including
unvested restricted common stock, stock options using the treasury stock method,
and put warrants using the reverse treasury stock method.
11
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 7. NET INCOME PER SHARE (CONTINUED)
(in thousands except per share data) QUARTER ENDED
-------------------------------------
MARCH 5 FEBRUARY 27
1999 1998
----------------- ------------------
Net income $ 38,276 $ 26,744
----------------- ------------------
----------------- ------------------
Shares used to compute basic net
income per share (weighted
average shares outstanding
during the period, excluding
unvested restricted stock) 60,973 67,762
Dilutive common equivalent
shares:
Unvested restricted stock 6 90
Stock options 2,405 1,591
Put warrants -- 142
----------------- ------------------
Shares used to compute diluted
net income per share 63,384 69,585
----------------- ------------------
----------------- ------------------
Basic net income per share $ .63 $ .39
----------------- ------------------
----------------- ------------------
Diluted net income per share $ .60 $ .38
----------------- ------------------
----------------- ------------------
NOTE 8. ACQUISITIONS
On January 4, 1999, the Company acquired substantially all of the
assets, consisting of intellectual property and a minimal amount of fixed
assets, of both GoLive Systems, Inc., a Delaware corporation, and GoLive
Systems GmbH and Co. KG, a German limited partnership (together "GoLive
Systems"). GoLive Systems creates Web site development software which enables
users to effectively use the Internet for professional publishing and
communication. The acquisition was accounted for under the purchase method of
accounting in accordance with Accounting Principles Board Opinions No. 16.
The purchase price of the acquisition was approximately $31.0 million, plus
additional contingency payments of $8.0 million based on achieving certain
technical and employment milestones. The Company determined that certain
milestones had been reached as of March 5, 1999 and, as such, $4.0 million in
contingent payments were recorded as purchase price.
12
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(CONTINUED)
NOTE 8. ACQUISITIONS (CONTINUED)
Based on an independent appraiser's valuation, $11.7 million of the
purchase price was allocated to purchased technology and $23.3 million of the
purchase price was allocated to goodwill. The intangible assets are being
amortized over a five-year period. The purchased technology consisted of
GoLive for the Macintosh which was being sold by GoLive Systems at the time
of the acquisition and GoLive for Windows, which the Company determined had
reached technological feasibility.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION (PRESENTED IN MILLIONS, EXCEPT SHARE AND PER
SHARE AMOUNTS) SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL
STATEMENTS AND NOTES THERETO.
IN ADDITION TO HISTORICAL INFORMATION, THIS QUARTERLY REPORT ON FORM
10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - FACTORS THAT MAY AFFECT
FUTURE RESULTS OF OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS
DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE ADDITIONAL QUARTERLY
REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 1999. READERS ARE
CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS,
WHICH SPEAK ONLY AS OF THE DATE OF THIS QUARTERLY REPORT ON FORM 10-Q. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE ANY REVISIONS TO THE
FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE
OF THIS DOCUMENT.
RESULTS OF OPERATIONS
OVERVIEW
Adobe Systems Incorporated ("Adobe" or the "Company") develops, markets,
and supports computer software products and technologies that enable users to
express and use information across both print and electronic media. The
Company offers a market-leading line of application software products, type
products, and content for creating, distributing, and managing information of
all types; licenses its technology to major hardware manufacturers, software
developers, and service providers; and offers integrated software solutions
to businesses of all sizes. The Company distributes its products through a
network of original equipment manufacturer ("OEM") customers, distributors
and dealers, and value-added resellers ("VARs") and system integrators, and
has operations in North America, Europe, Japan, and Asia Pacific and Latin
America.
14
The following table sets forth for the quarters ended March 5, 1999 and
February 27, 1998, the Company's condensed consolidated statements of income
expressed as a percentage of total revenue:
QUARTER ENDED
----------------------------------
MARCH 5 FEBRUARY 27
1999 1998
--------------- ---------------
Revenue:
Licensing 16.8% 21.2%
Application products 83.2 78.8
--------------- ---------------
Total revenue 100.0 100.0
Direct costs 9.9 14.1
--------------- ---------------
Gross margin 90.1 85.9
--------------- ---------------
Operating expenses:
Research and development 19.8 21.9
Sales and marketing 34.6 36.1
General and administrative 11.7 16.9
--------------- ---------------
Total operating expenses 66.1 75.0
--------------- ---------------
Operating income 24.0 10.9
--------------- ---------------
Nonoperating income, net:
Investment gain (loss) -- 6.3
Interest and other income 2.6 4.3
--------------- ---------------
Total nonoperating income 2.6 10.6
--------------- ---------------
Income before income taxes 26.6 21.5
Provision for income taxes 9.7 8.0
--------------- ---------------
Net income 16.9% 13.5%
--------------- ---------------
--------------- ---------------
15
REVENUE
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Total revenue $226.9 $197.8 14.7%
Total revenue increased $29.1 million, or 14.7%, from the same quarter last
year primarily due to the release of new and enhanced application products.
During the first quarter of fiscal 1999, the Company adopted Statement of
Position (SOP) 97-2, "Software Revenue Recognition." The Company modified
certain aspects of its business model such that the impact of SOP 97-2 was not
significant.
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Product revenue--Licensing $38.1 $41.8 (9.0)%
Percentage of total revenue 16.8% 21.2%
Licensing revenue is made up of royalties received from OEM customers
who ship products containing Adobe's PostScript technology, including Adobe
PostScript, Adobe PostScript 3, Adobe PrintGear, and PostScript Extreme.
Licensing revenue decreased $3.8 million, or 9.0%, in the first quarter
of fiscal 1999 compared to the same period last year primarily due to the
ongoing weakness in the Japanese personal computer and printer markets, as
well as the continuing decline in royalty revenue from Hewlett-Packard
Company's ("HP") desktop monochrome laser printer division which has been
incorporating a clone version of Adobe PostScript into its products since the
fall of 1997.
The Company continues to be cautious about licensing revenue in the
short term because of Japanese market conditions, the uncertain timing of OEM
customer introductions of products incorporating Adobe's latest technologies,
and the remaining impact of the loss of revenue from HP's monochrome laser
printer products, which is expected to occur in the second half of fiscal
1999. Exluding any shrinkwrap printing technology products, the Company
anticipates that its traditional licensing revenue will remain relatively
flat or decline in fiscal 1999.
16
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Product group revenue --
Application products $188.8 $156.0 21.1%
Percentage of total revenue 83.2% 78.8%
Application products revenue is derived predominantly from shipments of
application software programs marketed through retail and VAR distribution
channels, with the exception of Adobe PhotoDeluxe, which is primarily
distributed through OEM bundling agreements with digital camera, scanner, and
personal computer manufacturers.
Application products revenue increased $32.8 million, or 21.1%, in the
first quarter of fiscal 1999 compared to the same period last year due to a
number of factors. First, the introduction of GraphicStudio and DynamicStudio
in North America, Japan and Asia Pacific and Latin America contributed
significantly to revenue growth. GraphicStudio is a collection of Adobe
application products, which includes Photoshop, Illustrator, and Pagemaker.
DynamicStudio is also a suite of products, containing After Effects,
Premiere, Photoshop, and Illustrator. Second, the first quarter of fiscal
1999 benefited from revenue related to major upgrades of Photoshop,
Illustrator, and Premiere, all of which were released in mid-to-late fiscal
1998. Third, revenue from Acrobat 3.0 increased as demand for the product
continued to grow. These factors were partially offset by a decline in
revenue from PageMaker as a result of weakness in the Japanese economy and
the extended age of the current release. In addition, the increase was offset
by a decline in revenue from divested businesses of $6.4 million, and a
decline in PhotoDeluxe Home Edition, which was affected by lower OEM customer
pricing.
By comparison, application products revenue for the first quarter of
fiscal 1998 was adversely affected by weakness in the Japanese economy, the
absence of major product releases or upgrades, and a resulting decline in
end-user demand. Further, during the first quarter of fiscal 1998, the
Company worked proactively with its distributors in Japan to match lower
sell-through rates, thereby decreasing channel inventory levels in
anticipation of the new product release cycle.
Total application products revenue (excluding platform independent and
UNIX revenues) for the first quarter of fiscal 1999 was split 57% on Windows
and 43% on Macintosh as compared to 59% and 41%, respectively, for the first
quarter of fiscal 1998.
DIRECT COSTS
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Direct costs $22.5 $27.8 (19.1)%
Percentage of total revenue 9.9% 14.1%
Gross margin 90.1% 85.9%
Certain reclassifications that affected both direct costs and operating
expenses were made to the fiscal 1998 consolidated statements of income to
conform to the fiscal 1999 presentation. These reclassifications did not
impact total operating profit for fiscal 1998.
Direct costs decreased in the first quarter of fiscal 1999 compared to
the same period last year due to lower material costs as a result of an ongoing
cost improvement program that was implemented in late fiscal 1998, and improved
17
inventory management resulting in lower excess and obsolete inventory expenses.
The Company anticipates that gross margin throughout fiscal 1999 will be
between 89%-90%, due to cost reduction efforts in material costs and
management of excess and obsolete inventory. These reductions may be offset
by increases in direct costs related to product launches and the amortization
of capitalized software in accordance with Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed," as well as amortization of purchased
technologies associated with acquired products or technologies.
OPERATING EXPENSES
Certain reclassifications that affected both direct costs and operating
expenses were made to the fiscal 1998 consolidated statements of income to
conform to the fiscal 1999 presentation. These reclassifications did not impact
total operating profit for fiscal 1998.
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Research and development $44.9 $43.3 3.6%
Percentage of total revenue 19.8% 21.9%
Research and development expenses increased $1.6 million, or 3.6%,
primarily due to higher incentive compensation expenses as the Company's
financial performance exceeded that of the first quarter of fiscal 1998. In
addition, the increase was attributable to increased salaries and
employee-related costs associated with an additional week of operations in
the first quarter of fiscal 1999 compared to the same period last year.
The Company believes that investments in research and development,
including the recruiting and hiring of software developers, are critical to
remain competitive in the marketplace and are directly related to continued
timely development of new and enhanced products. The Company will continue to
make significant investments in the development of its application software
products, including those targeted for the growing Internet market. The
Company expects that research and development expenditures for the remainder
of fiscal 1999 will increase in absolute dollars. However, such expenditures
as a percentage of revenue are expected to remain relatively the same as the
first quarter of fiscal 1999.
18
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Sales and marketing $78.5 $71.5 9.8%
Percentage of total revenue 34.6% 36.1%
Sales and marketing expenses increased $7.0 million, or 9.8%, in fiscal
1999 compared to the same period last year, primarily due to increased
salaries and employee-related costs associated with an additional week of
operations in the first quarter of fiscal 1999, and higher incentive
compensation expenses as the Company's financial performance exceeded that of
the first quarter of fiscal 1998. In addition, a portion of the increase was
attributable to increased advertising and promotional spending for a national
publishing conference held during the quarter, and the Company's worldwide
sales meetings also held during the first quarter of fiscal 1999.
Sales and marketing expenses are expected to increase in absolute
dollars to support new products and upgrades scheduled to be released later
in fiscal 1999. However, sales and marketing expenses as a percentage of
revenue are expected to remain relatively the same as the first quarter of
fiscal 1998.
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
General and administrative $26.6 $33.5 (20.7)%
Percentage of total revenue 11.7% 16.9%
General and administrative expenses decreased $6.9 million, or 20.7%, in
fiscal 1999 compared to the same period last year, primarily due to lower
facilities costs related to buildings that were vacated in connection with
the 1998 restructuring program, and a reduction in bad debt expense
associated with the resolution of disputed items with certain customers and
an improved economic environment in Asia. Additionally, the decrease was
attributable to lower amortization of goodwill as the first quarter of fiscal
1998 included the write-off of goodwill associated with an acquisition that
took place in fiscal 1997. Further, the Company experienced an overall
decrease in general and administrative expenses due to cost-cutting measures
that were implemented as part of the 1998 restructuring program. These
decreases were partially offset by an increase to salaries and
employee-related expenses associated with an additional week of operations in
the first quarter of fiscal 1999, as well as an increase to incentive
compensation expense as the Company's financial performance exceeded that of
the first quarter of fiscal 1999.
The Company expects that general and administrative spending will
increase in absolute dollars for the remainder of fiscal 1999 to support
ongoing administrative infrastructure needs. However, as a percentage of
revenue such expenditures are expected to be lower than the first quarter of
fiscal 1999.
19
NONOPERATING INCOME
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Investment gain (loss) $ -- $12.5 (100.2)%
Percentage of total revenue -- 6.3%
During the first quarter of fiscal 1999, gains and losses resulting from
investment activity were minimal. In the first quarter of fiscal 1998, McQueen
International Limited ("McQueen"), a former investee of the Company, was
acquired by Sykes Enterprises, Incorporated ("Sykes"), a publicly traded
company. In connection with the acquisition, the Company exchanged its shares of
McQueen for approximately 487,000 shares of Sykes' restricted common stock and
recorded a gain on the exchange of $6.7 million.
Also, during the first quarter of fiscal 1998, the Company liquidated its
investment in Siebel Systems, Incorporated ("Siebel") through the distribution
to its stockholders of approximately 165,000 shares of Siebel as a
dividend-in-kind and the sale of its remaining Siebel shares. A gain was
recognized on the transaction of approximately $5.7 million.
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Interest and other income $5.9 $8.5 (30.8)%
Percentage of total revenue 2.6% 4.3%
Interest income decreased in the first quarter of fiscal 1999 compared to
fiscal 1998 due to lower average cash balances as a result of cash used for the
Company's stock repurchase program.
Interest and other income in the first quarter of fiscal 1998 included
foreign exchange gains in Europe offset by a decrease in interest income as a
result of lower average cash balances.
PROVISION FOR INCOME TAXES
1999 1998 CHANGE
---------------- --------------- ----------------
(Dollars in millions)
First quarter:
Provision for income taxes $22.0 $15.9 38.7%
Percentage of total revenue 9.7% 8.0%
Effective tax rate 36.5% 37.3%
The Company's effective tax rate decreased in the first quarter of
fiscal 1999 compared to fiscal 1998 primarily due to a decrease in
nondeductible goodwill amortization.
The Company expects that the effective tax rate for the remainder of
fiscal 1999 will be between 36% and 37%.
20
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
The Company believes that in the future its results of operations could be
affected by various factors, such as delays in shipment of the Company's new
products and major new versions of existing products, lack of market acceptance
of new products and upgrades, the introduction of competitive products by third
parties, weakness in demand for Macintosh application software and
Macintosh-related printers, renegotiation of royalty arrangements, growth in
worldwide personal computer and printer sales and sales price adjustments,
consolidation in the OEM printer business, ongoing weakness in the Company's
printing business due to product transitions, industry transitions to new
business and information delivery models, ongoing weakness in the Japanese and
other Asian economies, "Year 2000" issues (as discussed later under "Year 2000
Issues"), and adverse changes in general economic conditions in any of the
countries in which the Company does business.
The Company has stated that in fiscal 1999 its annual revenue growth target
is 15% and its operating margin target is 25% of total revenue. These targets
are used to assist the Company's management in making decisions about the
allocation of resources and investments, not as predictions of future results.
The targets reflect a number of assumptions, including assumptions about the
Company's pricing, manufacturing costs and volumes and the mix of application
products and licensing revenue, full and upgrade products, distribution
channels, and geographic distribution. These and many other factors described
herein affect the Company's financial performance and may cause the Company's
future results, including results for the current quarter, to vary materially
from these targets.
The Company's ability to develop and market products, including upgrades of
current products that successfully adapt to changing customer needs, may also
have an impact on the results of operations. The Company's ability to extend its
core technologies into new applications and to anticipate or respond to
technological changes could affect its ability to develop these products. A
portion of the Company's future revenue will come from these new applications.
Delays in product or upgrade introductions, whether by the Company or its OEM
customers, could have an adverse effect on the Company's revenue, earnings, or
stock price. The Company cannot determine the ultimate effect that these new
products or upgrades will have on its revenue or results of operations.
The market for the Company's graphics applications, particularly the
consumer products, is intensely and increasingly competitive and is
significantly affected by product introductions and market activities of
industry competitors. Additionally, Microsoft Corporation has stated its
intention to increase its presence in the digital imaging/graphics market by
mid-1999; the Company believes that, due to Microsoft's market dominance, any
new Microsoft digital imaging products will be highly competitive with the
Company's products. If competing new products achieve widespread acceptance, it
would have a significant adverse impact on the Company's operating results.
The Company generally offers its application products on Macintosh,
Windows, and UNIX platforms. To the extent that there is a slowdown of customer
purchases of personal computers in general, the Company's operating results
could be materially adversely affected. Also, as the Company seeks to further
broaden its customer base to achieve greater penetration in the corporate
business and consumer markets, the Company may not successfully adapt its
application software distribution channels, which could materially adversely
affect the Company's operating results. The Company could experience decreases
in average selling prices and some transitions in its distribution channels that
could materially adversely affect its operating results.
21
The Company's primary distribution channel for its application products
is currently through retail distributors, and a significant amount of its
revenue for application products is from a single distributor. In addition,
the Company continues to expand into third-party distribution channels,
including value-added resellers and systems integrators, in its effort to
further broaden its customer base. As a result, the financial health of these
third parties, and the Company's continuing relationships with them, are
becoming more important to the Company's success. Some of these companies are
thinly capitalized and may be unable to withstand changes in business
conditions. The Company's financial results could be adversely affected if
the financial condition of certain of these third parties substantially
weakens or if the Company's relationships with them deteriorate.
The Company's printing revenue experienced a 9.0% decline in the first
quarter of fiscal 1999 compared to the first quarter of fiscal 1998. If this
trend continues, the Company's financial results could be adversely affected.
The weakness in the Japanese market was a factor causing the revenue decline.
In addition, in the fall of fiscal 1997, HP began to ship a clone version of
Adobe PostScript in some printers, resulting in lower licensing revenue to
the Company in fiscal 1998, even though the Company continues to work with HP
printer operations to incorporate Adobe PostScript and other technologies in
other HP products. The Company expects continued lower licensing revenue from
HP in fiscal 1999. Further, OEM customers on occasion seek to renegotiate
their royalty arrangements. The Company evaluates these requests on a
case-by-case basis. If an agreement is not reached, a customer may decide to
pursue other options, which could result in lower licensing revenue for the
Company.
Since the end of fiscal 1997, the Company has experienced a decline in both
application and licensing revenue from the Japanese market due to a weak
Japanese computer market and general economic conditions in Japan. In addition,
at the end of fiscal 1997, inventory levels for application products at the
Company's Japanese distributors remained higher than what the Company considers
normal. During fiscal 1998, the Company worked with its major distributors in
Japan to reduce channel inventory to what the Company considers a reasonable
level. The Company expects these adverse economic conditions to continue in the
short term, and they may continue to adversely affect the Company's revenue and
earnings. Although there are also adverse conditions in other Asian and Latin
American economies, the countries affected represent a much smaller portion of
the Company's revenue and thus have less impact on the Company's operational
results.
The Company has recently implemented a restructuring of its business and
reduced its workforce by more than 10%. However, the Company plans to continue
to invest in certain areas, which will require it to hire additional employees.
Competition for high-quality personnel, especially highly skilled engineers, is
extremely intense. The Company's ability to effectively manage its growth will
require it to continue to improve its operational and financial controls and
information management systems, and to attract, retain, motivate, and manage
employees effectively. The failure of the Company to effectively manage growth
and transition in multiple areas of its business could have a material adverse
effect on its results of operations.
The Internet market is rapidly evolving and is characterized by an
increasing number of market entrants that have introduced or developed products
addressing authoring and communications over the Internet. As is typical in the
case of a new and evolving industry, demand and market acceptance for recently
introduced products and services are subject to a high level of uncertainty. The
software industry addressing authoring and communications over the Internet is
young and has few proven products. Standards defining Web graphics have not yet
been finally adopted. In addition, new models for licensing software will be
needed to accommodate new information delivery practices.
22
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, ease of use and access, cost, and quality
of service) remain unresolved and may affect the growth of Internet use,
together with the software standards and electronic media employed in such
markets.
The Company derives a significant portion of its revenue and operating
income from its subsidiaries located in Europe, Japan, and Asia Pacific and
Latin America. The Company generally experiences lower revenue from its European
operations in the third quarter because many customers reduce their purchasing
activities in the summer months. Additionally, the Company is uncertain whether
the recent weakness experienced in the Japan and Asia Pacific and Latin America
markets will continue in the foreseeable future due to possible currency
devaluation and liquidity problems in these regions. While most of the revenue
of the European subsidiaries is denominated in U.S. dollars, the majority of
revenue derived from Japan is denominated in yen and the majority of all
subsidiaries' operating expenses are denominated in their local currencies. As a
result, the Company's operating results are subject to fluctuations in foreign
currency exchange rates. To date, the accounting impact of such fluctuations has
been insignificant. The Company's hedging policy attempts to mitigate some of
these risks, based on management's best judgment of the appropriate trade-offs
among risk, opportunity, and expense. The Company has established a hedging
program to hedge its exposure to foreign currency exchange rate fluctuations,
primarily of the Japanese yen. The Company's hedging program is not
comprehensive, and there can be no assurance that the program will offset more
than a portion of the adverse financial impact resulting from unfavorable
movement in foreign currency exchange rates.
On January 1, 1999, eleven of the fifteen member countries of the European
Union adopted the euro as their common legal currency and established fixed
conversion rates between their existing sovereign currencies and the euro. The
euro trades on currency exchanges and is available for non-cash transactions.
Based on its preliminary assessment, the Company does not believe the conversion
will have a material impact on the competitiveness of its products in Europe,
where there already exists substantial price transparency, or increase the
likelihood of contract cancellations. Further, the Company expects that
modifications to comply with euro requirements have been and will continue to be
made to its business operations and systems on a timely basis and does not
believe that the cost of such modifications will have a material adverse impact
on the Company's results of operations or financial condition. There can be no
assurance, however, that the Company will be able to continue to complete such
modifications on a timely basis; any failure to do so could have a material
adverse effect on the Company's results of operations or financial condition. In
addition, the Company faces risks to the extent that suppliers, manufacturers,
distributors and other vendors upon whom the Company relies and their suppliers
are unable to make appropriate modifications to support euro transactions. The
inability of such third parties to support euro transactions could have a
material adverse effect on the Company's results of operations or financial
condition.
In connection with the enforcement of its own intellectual property rights
or in connection with disputes relating to the validity or alleged infringement
of third party rights, the Company has been and may in the future be subject to
complex, protracted litigation as part of its policy to vigorously defend its
intellectual property rights. Intellectual property litigation is typically very
costly and can be disruptive to business operations by diverting the attention
and energies of management and key technical personnel. Although the Company has
successfully defended past litigation, there can be no assurance that it will
prevail in any ongoing or future litigation. Adverse decisions in such
litigation could subject the Company to significant liabilities, require the
Company to seek licenses from others, prevent the Company from manufacturing or
selling certain
23
of its products, or cause severe disruptions to the Company's operations or
the markets in which it competes, any one of which could have a material
adverse effect on the results of operations or financial condition of the
Company.
The Company prepares its financial statements in conformity with generally
accepted accounting principles ("GAAP"). GAAP are subject to interpretation by
the American Institute of Certified Public Accountants (the "AICPA"), the
Securities and Exchange Commission (the "SEC"), and various bodies formed to
interpret and create appropriate accounting policies. A change in these policies
can have a significant effect on the Company's reported results, and may even
affect the reporting of transactions completed before a change is announced.
Accounting policies affecting many other aspects of the Company's business,
including rules relating to software revenue recognition, purchase and
pooling-of-interests accounting for business combinations, the valuation of
in-process research and development, employee stock purchase plans, and stock
option grants have recently been revised or are under review by one or more
groups. Changes to these rules, or the questioning of current practices, may
have a significant adverse effect on the Company's reported financial results or
in the way in which the Company conducts its business.
Due to the factors noted above, as well as the Year 2000 issues noted
below, the Company's future earnings and stock price may be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in
revenue or earnings from levels expected by securities analysts could have, and
has had in the past, an immediate and significant adverse effect on the trading
price of the Company's common stock in any given period. Additionally, the
Company may not learn of such shortfalls until late in the fiscal quarter, which
could result in an even more immediate and adverse effect on the trading price
of the Company's common stock. Finally, the Company participates in a highly
dynamic industry. In addition to factors specific to the Company, changes in
analysts' earnings estimates for the Company or its industry, and factors
affecting the corporate environment, the Company's industry or the securities
markets in general will often result in significant volatility of the Company's
common stock price.
"YEAR 2000" ISSUES
The Company is addressing a broad range of issues associated with the
programming code in existing computer systems as the year 2000 approaches. The
"Year 2000" problem is complex, as many computer systems will be affected in
some way by the rollover of the two-digit year value to 00. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 issue creates risk for the Company from unforeseen
problems in its products or its own computer and embedded systems and from third
parties with whom the Company deals on financial and other transactions
worldwide. Failure of the Company's and/or third parties' computer systems or
Year 2000 defects in the Company's products could have a material impact on the
Company's ability to conduct its business.
The Company has commenced a phased program to inventory, assess, remediate,
test, implement, and develop contingency plans for all mission-critical
applications and products potentially affected by the Year 2000 issue (the "Y2K
Program"). To accelerate overall completion, activities in each phase are often
concurrent rather than serial, but all phases, except developing contingency
plans, are expected to be completed by mid-1999. Additionally, the Company has
opened a dedicated Year 2000 test laboratory for both internal business process
and product testing. All Company business groups are involved in the Y2K Program
efforts.
24
The Company has identified three potential areas of impact for review: (1)
the software and systems, including embedded systems, used in the Company's
internal business processes; (2) third-party vendors, manufacturers and
suppliers, and (3) the Company's software products offered to customers. The
Company's current estimate of the aggregate costs to be incurred for the Y2K
Program is approximately $3.0 million, which is expected to be funded from
operating cash flows. If the Company encounters significant unforeseen Year 2000
problems, either in its products or internal business systems or in relation to
third party vendors, manufacturers or suppliers, actual costs could materially
exceed this estimate.
INTERNAL BUSINESS PROCESSES. The Company has substantially completed its
inventory of Year 2000 impacted software and is assessing its centralized
computer and embedded systems to identify any potential Year 2000 issues. The
Company's financial information systems include an SAP system recently
implemented in the United States, Japan, and Asia Pacific and Latin America, and
an Oracle system in Europe that has recently been upgraded to a recent version.
SAP and Oracle have informed the Company, and the Company believes, that these
systems are Year 2000 compliant. The Company has a number of projects underway
to replace or upgrade hardware and software that are known to be Year 2000
non-compliant. The Company currently expects to substantially complete
remediation, validation and implementation of its internal systems by mid-1999.
In addition, in order to protect against the acquisition of additional products
that may not be Year 2000 ready, the Company has implemented a policy requiring
Year 2000 review of products sold or licensed to the Company prior to their
acquisition. However, if implementation of replacement or upgraded systems or
software is delayed, or if significant new non-compliance issues are identified,
the Company's results of operations or financial condition could be materially
adversely affected.
THIRD-PARTY VENDORS, MANUFACTURERS AND SUPPLIERS. The Company is also in
the process of contacting its critical suppliers, manufacturers, distributors
and other vendors to determine that their operations and the products and
services that they provide to the Company are Year 2000 compliant. Where
practicable, the Company will attempt to mitigate its risks with respect to the
failure of third parties to be Year 2000 ready, including developing contingency
plans. However, such failures, including failures of any contingency plan,
remain a possibility and could have a materially adverse impact on the Company's
results of operations or financial condition.
PRODUCTS. In addition, the Year 2000 issue could affect the products that
the Company licenses. The Company is continuing to test its products and gather
information about Company technologies and products affected by the Year 2000
transition. Current information about the Company's products is available on the
Company's Year 2000 Web site (www.adobe.com/newsfeatures/year2000). Information
on the Company's Web site is provided to customers for the sole purpose of
assisting in planning for the transition to the Year 2000. Such information is
the most currently available concerning the Company's products and is provided
"as is" without warranty of any kind. There can be no assurance that the
Company's current products do not contain undetected errors or defects
associated with Year 2000 that may result in material costs to the Company.
CONTINGENCY PLANS. The Company has not yet developed contingency plans to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its critical operations, including operations under the control of
third parties. Additionally, the most reasonably likely worst-case scenario has
not yet been clearly identified. Development of such contingency plans is in
progress and is expected to be completed by September 1999. There can be no
assurance that the Company will be able to develop contingency plans that will
25
adequately address all Year 2000 issues that may arise.
Some commentators have stated that a significant amount of litigation will
arise out of Year 2000 compliance issues, and the Company is aware of a growing
number of lawsuits against other software vendors. Because of the unprecedented
nature of such litigation, it is uncertain whether or to what extent the Company
may be affected by it. The impact of the Year 2000 on future Company revenue is
difficult to discern but is a risk to be considered in evaluating future growth
of the Company.
26
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," and in June 1998, issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." Readers can
refer to the "Recent Accounting Pronouncements" section of the Company's 1998
Annual Report on Form 10-K for further discussion.
In December 1998, the AICPA issued SOP 98-9, "Modifications of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions." Readers can
refer to the "Recent Accounting Pronouncements" section of the Company's 1998
Annual Report on Form 10-K for further discussion.
LIQUIDITY AND CAPITAL RESOURCES
MARCH 5 NOVEMBER 27
1999 1998 CHANGE
---------------- ---------------- ----------------
(Dollars in millions)
Cash, cash equivalents and
short-term investments $263.2 $272.5 (3.4)%
Working capital $211.1 $205.0 3.0%
Stockholders' equity $544.9 $516.4 5.5%
The Company's cash, cash equivalents and short-term investments, consisting
principally of municipal bonds, and United States government and government
agency securities, decreased $9.3 million, or 3.4%, during the first quarter of
fiscal 1999 primarily due to the repurchase of Adobe common stock totaling $69.9
million and the purchase of the assets of GoLive Systems, Inc. for $31.0
million. Other uses of cash during the period included additional investments
made in Adobe Ventures in the amount of $6.8 million, capital expenditures of
$7.5 million, and the payment of dividends totaling $3.1 million. These factors
were partially offset by cash generated from operations of $36.5 million and
proceeds from the issuance of treasury stock, primarily related to the exercise
of stock options and sale of stock under the Employee Stock Purchase Program of
$35.9 million.
All of the Company's cash equivalents and short-term investments are
classified as available-for-sale under the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The securities are carried at fair value with the unrealized
gains and losses, net of tax, reported as a separate component of stockholders'
equity.
In September 1997, the Company's Board of Directors authorized, subject
to certain business and market conditions, the purchase of up to an additional
15 million shares of the Company's common stock over a two-year period. This new
stock repurchase program was in addition to an existing program whereby the
Company has been authorized to repurchase shares to offset issuances under
employee stock option and stock purchase plans. The Company repurchased
approximately 1.7 million shares in the first quarter of fiscal 1999 and 10.5
million shares in fiscal 1998, at a cost of $69.9 million and $379.2 million,
respectively, under its stock repurchase programs. As of March 5, 1999, there
are no remaining authorized shares to be repurchased under the 15.0
27
million share repurchase program. The timing and size of any future stock
repurchases are subject to market conditions, stock prices, and the Company's
cash position and other cash requirements going forward.
To facilitate the Company's stock repurchase programs, the Company sold put
warrants to independent third parties. Each warrant entitles the holder to sell
one share of Adobe's common stock to the Company at a specified price. On March
5, 1999, put warrants to sell approximately 779,500 shares of the Company's
common stock were outstanding that expire on various dates through July 1999
with an average exercise price of $42.41 per share. Under these put warrant
arrangements, the Company, at its option, can settle with physical delivery or
net shares equal to the difference between the exercise price and market value
at the date of exercise.
In addition, the Company purchased call options from independent third
parties that entitle the Company to buy its common stock on certain dates at
specified prices. On March 5, 1999, call options to purchase approximately
239,100 shares of the Company's common stock were outstanding that expire on
various dates through July 1999 with an average exercise price of $44.47 per
share.
The Board of Directors of the Company declared a cash dividend on the
Company's common stock of $0.05 per common share, for the first quarter of
fiscal 1999. The declaration of future dividends is within the discretion of the
Board of Directors of the Company and will depend upon business conditions,
results of operations, the financial condition of the Company and other factors.
The Company's principal commitments as of March 5, 1999 consisted of
obligations under operating leases, venture investing activities, real estate
development agreements, and various service agreements. These arrangements are
discussed in more detail in the Company's 1998 Annual Report filed on Form 10-K
for the year ended November 27, 1998.
The Company believes that existing cash, cash equivalents and short-term
investments, together with cash generated from operations, will provide
sufficient funds for the Company to meet its operating cash requirements in the
foreseeable future, including planned capital expenditure programs, working
capital requirements, the potential put warrant obligation, and the dividend
program.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk disclosures set forth in its 1998 Annual Report
filed on Form 10-K have not changed significantly.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 17, 1997, a derivative action was filed in the Superior Court of
the State of California, County of Santa Clara, against the current members of
Adobe's Board of Directors and Paul Brainerd, a former member of the Board. The
suit was filed by a stockholder purporting to assert on behalf of the Company
claims for alleged breach of the Directors' fiduciary duty and mismanagement
related to the Company's acquisition of Frame in October 1995. The Court granted
Adobe's demurrer to the suit, with leave to amend for the plaintiff. In January
1998, the plaintiff filed an amended complaint making substantially the same
claims but not including Mr. Brainerd. In March 1998, Adobe filed
28
a demurrer to the amended complaint, which was overruled by the trial court
in May 1998. In June 1998, Adobe filed a writ petition with the California
Court of Appeals for review of the trial court's decision, which was denied.
In July 1998, Adobe filed a petition for review of the Court of Appeals'
refusal to grant the writ with the Supreme Court of California, which was
denied in September 1998. The Company intends to continue vigorously
defending the action.
On February 6, 1996, a securities class action complaint was filed against
Adobe, certain of its officers and directors, certain former officers of Adobe
and Frame Technology Corporation ("Frame"), Hambrecht & Quist, LLP ("H&Q"),
investment banker for Frame, and certain H&Q employees, in connection with the
drop in the price of Adobe stock following its announcement of financial results
for the quarter ended December 1, 1995. The complaint was filed in the Superior
Court of the State of California, County of Santa Clara. The complaint alleges
that the defendants misrepresented material adverse information regarding Adobe
and Frame and engaged in a scheme to defraud investors. The complaint seeks
unspecified damages for alleged violations of California law. Adobe believes
that the allegations against it and its officers and directors are without merit
and intends to vigorously defend the lawsuit. The case is currently in the
discovery phase.
On October 29, 1998, Heidelberger Druckmaschinen AG, a German company,
filed a complaint alleging that Adobe is using Heidelberger's US patent number
4,393,399 for the partial electronic retouching of colors. The complaint was
filed in the United States District Court for the District of Delaware, and
seeks a permanent injunction and unspecified damages. Adobe believes that the
allegations against it are without merit and intends to vigorously defend the
lawsuit.
Management believes that the ultimate resolution of these matters will not
have a material impact on the Company's financial position or results of
operations.
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
------- ------------------- ----- --------- ------ --------
3.1 The Registrant's (as suc- 10-Q 05/30/97 3.1
cessor in-interest to Adobe
Systems (Delaware)
Incorporated by virtue of a
reincorporation effective
5/30/97) Certificate of
Incorporation, as filed with
the Secretary of State of the
State of Delaware on 5/9/97.
3.2.10 Amended and Restated 10-K 11/28/97 3.2.10
Bylaws as currently
in effect.
3.3 Certificate of Designation 10-K 11/28/97 3.3
of the Series A Preferred
Stock
3.4 Agreement and Plan of 10-Q 05/30/97 2.1
Merger effective 5/30/97
(by virtue of a reincorp-
oration), by and between Adobe
Systems Incorporated, a
California Corporation and
Adobe Systems (Delaware)
Incorporated, a Delaware
corporation.
4.1 Second Amended and 8-K 08/29/97 4
Restated Rights
Agreement between the
Company and Harris
Trust Company of
California
4.2 Third Amended and 8-K 12/15/98 1
Restated Rights
Agreement between the
Company and Harris
Trust Company of
California
Continued)
30
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
------- ------------------- ----- --------- ------ --------
10.1.6 1984 Stock Option Plan, 10-Q 07/02/93 10.1.6
as amended*
10.17.1 License Agreement 10-K 11/30/88 10.17.1
Restatement between the
Company and Apple
Computer, Inc., dated
April 1, 1987
(confidential treatment granted)
10.17.2 Amendment No. 1 to the 10-K 11/30/90 10.17.2
License Agreement
Restatement between the
Company and Apple
Computer, Inc., dated
November 27, 1990
(confidential treatment
granted)
10.21.3 Revised Bonus Plan* 10-Q 02/28/97 10.21.3
10.24.1 1994 Performance and S-8 07/27/94 10.1
Restricted Stock Plan*
10.25.0 Form of Indemnity 10-K 11/30/90 10.17.2
Agreement*
10.25.1 Form of Indemnity 10-Q 05/30/97 10.25.1
Agreement*
10.32 Sublease of the Land and 10-K 11/25/94 10.32
Lease of the Improvements
By and Between
Sumitomo Bank Leasing
and Finance Inc. and
Adobe Systems Incorporated
(Phase 1)
10.36 1996 Outside Directors 10-Q 05/31/96 10.36
Stock Option Plan*
10.37 Confidential Resignation 10-Q 05/31/96 10.37
Agreement*
(Continued)
31
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
------- ------------------- ----- --------- ------ --------
10.38 Sublease of the Land and 10-Q 08/30/96 10.38
Lease of the Improvements
By and Between
Sumitomo Bank Leasing
and Finance Inc. and
Adobe Systems Incorporated
(Phase 2)
10.39 1997 Employee Stock S-8 05/30/97 10.39
Purchase Plan, as amended*
10.40 1994 Stock Option S-8 05/30/97 10.40
Plan, as
amended*
10.42 Amended and Restated 10-K 11/28/97 10.42
Limited Partnership
Agreement of Adobe
Incentive Partners, L.P.*
10.43 Resignation Agreement* 10-K 11/28/97 10.43
10.44 Forms of Retention 10-K 11/28/97 10.44
Agreement*
10.45 Confidential Executive 10-Q 8/28/98 10.45
Resignation Agreement
And General Release of
Claims*
10.46 Confidential Executive 10-Q 8/28/98 10.46
Resignation Agreement
And General Release of
Claims*
10.47 Confidential Executive 10-Q 8/28/98 10.46
Resignation Agreement
And General Release of
Claims*
10.48 Letter of Release 10-K 11/27/98 10.48
and Waiver*
(Continued)
32
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
------- ------------------- ----- --------- ------ --------
10.49 Confidential Executive X
Resignation Agreement
And General Release of
Claims*
21 Subsidiaries of the 10-K 11/27/98 21
Registrant
27.1 Financial Data Schedule X
27.2 Financial Data Schedule X
------------------------------
*Compensatory plan or arrangement
(b) Reports on Form 8-K
DATE OF REPORT FILING DATE ITEM REPORTED
-------------- ----------- -------------
December 15, 1998 December 21, 1998 5
On December 21, 1998, the Company filed a Report on Form 8-K under
Item 5 to report that it had amended its Rights Agreement dated as of
July 11, 1990 by entering into the Third Amended and Restated Rights
Agreement, dated as of December 15, 1998, with Harris Trust Company of
California.
33
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ADOBE SYSTEMS INCORPORATED
By /S/ HAROLD L. COVERT
---------------------------------
Harold L. Covert,
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: April 8, 1999
34
SUMMARY OF TRADEMARKS
The following trademarks of Adobe Systems Incorporated, which may be registered
in certain jurisdictions, are referenced in this Form 10-Q:
Adobe
Acrobat
AfterEffects
DynamicStudio
FrameMaker
GoLive
GraphicStudio
Illustrator
PageMaker
PhotoDeluxe
Photoshop
PostScript
PostScript Extreme
Premiere
PrintGear
All other brand or product names are trademarks or registered trademarks of
their respective holders.
35