Prepared by MERRILL CORPORATION www.edgaradvantage.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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 June 4,September 3, 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 | ||
(State or other jurisdiction of incorporation or organization) |
77-0019522 (I.R.S. Employer Identification No.) |
|
345 Park Avenue, San Jose, California | ||
(Address of principal executive offices) | |
95110-2704 (Zip Code) |
Registrants
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___/x/ NO / /
Indicate the number of shares outstanding of each of the issuersissuer's classes of common stock, as of the latest practicable date:
Class | Shares Outstanding |
|||
---|---|---|---|---|
Common stock, $0.0001 par value | 60,098,712 |
TABLE OF CONTENTS
| | | Page No. | ||||||
---|---|---|---|---|---|---|---|---|---|
PART IFINANCIAL INFORMATION | |||||||||
Item 1. |
| Condensed Consolidated Financial Statements | | |
|||||
Condensed Consolidated Statements of Income Three Months Ended and |
| 3 |
|||||||
|
| | | Condensed Consolidated Balance Sheets |
| 4 |
|||
|
| | | Condensed Consolidated Statements of Cash Flows |
| 5 |
|||
|
| | | Notes to Condensed Consolidated Financial Statements |
6 |
||||
Item 2. |
|||||||||
Management's Discussion and Analysis of Financial Condition and Results of Operations |
13 |
||||||||
Item 3. |
|||||||||
Quantitative and Qualitative Disclosures About Market Risk |
28 |
||||||||
PART IIOTHER INFORMATION |
|||||||||
Item 1. |
| Legal Proceedings | | 29 |
|||||
Item 2. |
| Changes in Securities and Use of Proceeds | | 29 |
|||||
Item |
|||||||||
Exhibits and Reports on Form 8-K |
30 |
||||||||
Signature |
|
32 |
|||||||
Summary of Trademarks |
|
33 |
|||||||
EXHIBITS |
|||||||||
Exhibit 27.1 |
| Financial Data Schedule | | |
|
Exhibit 27.2 |
||||
| | Financial Data Schedule | ||
|
PART IFINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
| Three Months Ended | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 3 1999 | August 28 1998 | September 3 1999 | August 28 1998 | ||||||||||||||
Revenue: | ||||||||||||||||||
Licensing | $ | 30,151 | $ | 40,825 | $ | 104,416 | $ | 125,132 | ||||||||||
230,725 | 182,107 | 629,248 | 522,923 | |||||||||||||||
260,876 |
222,932 | 733,664 | 648,055 | |||||||||||||||
23,369 | 70,470 | 76,742 | ||||||||||||||||
Gross margin | 236,609 |
199,563 | 663,194 | 571,313 | ||||||||||||||
48,979 | 140,550 | 141,731 | ||||||||||||||||
84,125 | 242,826 | 240,749 | ||||||||||||||||
27,354 |
34,619 | 82,136 | 97,512 | |||||||||||||||
4,417 |
37,940 | 19,757 | 38,505 | |||||||||||||||
164,658 | 205,663 | 485,269 | 518,497 | |||||||||||||||
Operating income (loss) | 71,951 | (6,100 | ) | 177,925 | 52,816 | |||||||||||||
Nonoperating income, net: | ||||||||||||||||||
Investment gain | 13,151 | 215 | 27,145 | 12,489 | ||||||||||||||
Interest and other income | 4,926 |
6,127 | 16,065 | 22,217 | ||||||||||||||
Total nonoperating income, net | 18,077 |
6,342 | 43,210 | 34,706 | ||||||||||||||
Income before income taxes | 242 | 221,135 | 87,522 | |||||||||||||||
Provision for income taxes | 32,873 |
90 | 80,743 | 32,646 | ||||||||||||||
Net income | $ | 57,155 | $ | 152 | $ | 140,392 | $ | 54,876 | ||||||||||
Basic net income per |
$ |
.94 |
$ | | $ | 2.31 | $ | .82 | ||||||||||
Shares used in computing basic net income per |
67,278 | 60,672 | 67,271 | |||||||||||||||
Diluted net income per |
$ |
.88 |
$ | | $ | 2.18 | $ | .80 | ||||||||||
Shares used in computing diluted net income per |
68,412 | 64,479 | 68,850 | |||||||||||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In(In thousands, except per share data)
(Unaudited)
| 1999 | November 27 1998 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
ASSETS | ||||||||||
Current assets: | ||||||||||
$ | 145,834 | $ | 110,871 | |||||||
335,133 | 161,676 | |||||||||
Receivables, net of allowances of respectively |
133,674 | 141,180 | ||||||||
20,567 | 32,028 | |||||||||
12,052 | 10,190 | |||||||||
Total current assets | 647,260 | 455,945 | ||||||||
99,020 | 93,887 | |||||||||
| 16,647 | |||||||||
Restricted funds and security deposits | | 130,260 | ||||||||
Other assets | 92,167 | 70,592 | ||||||||
$ | 838,447 | $ | 767,331 | |||||||
LIABILITIES AND STOCKHOLDERS' EQUITY |
|
|||||||||
Current liabilities: | ||||||||||
Trade and other payables | $ | 34,205 | $ | 48,681 | ||||||
Accrued expenses | 142,245 | 117,539 | ||||||||
Accrued restructuring charges | 12,112 | 8,867 | ||||||||
Income taxes payable | 43,316 | 64,546 | ||||||||
Deferred revenue | 19,216 | 11,333 | ||||||||
251,094 | 250,966 | |||||||||
8,986 | | |||||||||
Stockholders' equity: | ||||||||||
Common stock, $0.0001 par value; Authorized: 200,000 shares; Outstanding: respectively; and additional paid-in capital |
363,014 | 306,859 | ||||||||
Retained earnings | 804,981 | 732,730 | ||||||||
Accumulated other comprehensive income | 45,415 | (1,879 | ) | |||||||
Treasury stock, at cost |
(635,043 | ) | (521,345 | ) | ||||||
Total stockholders' equity | 578,367 | 516,365 | ||||||||
$ | 838,447 | $ | 767,331 | |||||||
See accompanying Notes to Condensed Consolidated Financial Statements
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| Nine Months Ended | ||||||
---|---|---|---|---|---|---|---|
| September 3 1999 | August 28 1998 | |||||
Cash flows from operating activities: | |||||||
Net income | $ | 140,392 | $ | 54,876 | |||
Adjustments to reconcile net income to net cash provided by operating activities: |
|||||||
Stock compensation expense | 2,277 | 2,094 | |||||
39,569 | 44,974 | ||||||
37,094 | (2,811 | ) | |||||
Tax benefit from employee stock plans | 53,910 | 8,955 | |||||
(36,594 | ) | (12,327 | ) | ||||
3,712 | 9,337 | ||||||
Changes in operating assets and liabilities: | |||||||
Receivables | 7,506 | 16,404 | |||||
Other current assets | (1,862 | ) | 7,495 | ||||
Trade and other payables | (16,284 | ) | (10,452 | ) | |||
Accrued expenses | 20,594 | 14,448 | |||||
Accrued restructuring charges | (467 | ) | 19,329 | ||||
Income taxes payable | (21,230 | ) | (4,941 | ) | |||
Deferred revenue | 7,883 | (2,682 | ) | ||||
Net cash provided by operating activities | 236,500 | 144,699 | |||||
Cash flows from investing activities: | |||||||
Purchases of short-term investments | (180,770 | ) | (871,465 | ) | |||
Maturities and sales of short-term investments | 101,987 | 845,905 | |||||
Proceeds from the release of restricted funds | 130,260 | | |||||
Acquisitions of property and equipment | (30,151 | ) | (52,713 | ) | |||
Additions to other assets | (20,269 | ) | (43,972 | ) | |||
Proceeds from the sale of equity investments | 10,936 | | |||||
Acquisitions, net of cash acquired | (31,000 | ) | (3,544 | ) | |||
Net cash used for investing activities | (19,007 | ) | (125,789 | ) | |||
Cash flows from financing activities: | |||||||
Purchase of treasury stock | (303,555 | ) | (141,409 | ) | |||
Proceeds from reissuance of treasury stock | 129,898 | 49,081 | |||||
Proceeds from sale of put warrants | 978 | 2,768 | |||||
Payment of dividends | (9,222 | ) | (12,998 | ) | |||
Net cash used for financing activities | (181,901 | ) | (102,558 | ) | |||
Effect of foreign currency exchange rates on cash and cash equivalents | (629 | ) | (133 | ) | |||
Net increase (decrease) in cash and cash equivalents | 34,963 | (83,781 | ) | ||||
Cash and cash equivalents at beginning of period | 110,871 | 267,576 | |||||
Cash and cash equivalents at end of period | $ | 145,834 | $ | 183,795 | |||
Supplemental disclosures: | |||||||
Cash paid during the period for income taxes | $ | 33,184 | $ | 19,579 | |||
Noncash investing and financing activities: | |||||||
$ | 47,923 | $ | 3,351 | ||||
Adjustments related to the reissuance of treasury stock | $ | 47,923 | $ | | |||
Dividends declared but not paid | $ | 3,093 | $ | 7,197 | |||
See accompanying Notes to Condensed Consolidated Financial Statements.
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
Note 1. Significant Accounting Policies
Basis of presentationPresentation
The accompanying interim condensed consolidated financial statements of Adobe Systems Incorporated (Adobe("Adobe" or the Company"Company") have been prepared in conformity
with generally accepted accounting principles, consistent in all material respects with those applied in the CompanysCompany's Annual Report on Form 10-K for the year ended
November 27, 1998. The interim financial information is unaudited but reflects all normal adjustments which are, in the opinion of management, necessary to provide fair condensed consolidated
balance sheets and condensed consolidated statements of income and cash flows for the interim periods presented. The interim financial statements should be read in conjunction with the financial
statements in the CompanysCompany's Annual Report on Form 10-K for the year ended November 27, 1998.
The results of operations for the interim period ended June 4,September 3, 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"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 pronouncementsAccounting Pronouncements
In June 1997, the FASB issued SFAS No. 131, Disclosures"Disclosures about Segments of an Enterprise and Related Information," and in June 1998,
issued SFAS No. 133 Accounting"Accounting for Derivative Instruments and Hedging Activities." In May 1999, the FASB amended SFAS No. 133 to defer its effective date. The Company will
implement SFAS 133 in its fiscal year 2001. Also, in December 1998, the AICPA issued SOP 98-9, Modifications"Modifications of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions." Readers can refer to the Recent"Recent Accounting PronouncementsPronouncements" section of the CompanysCompany'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 secondthird quarter and first sixnine months of fiscal 1998.
Stock Dividend
On September 16, 1999, the Company's Board of Directors approved a two-for-one stock split, in the form of a stock dividend, of the Company's common stock that was applicable to stockholders of record on October 4, 1999 and will be effective on October 26, 1999. Share and per-share data have not been adjusted to give effect to this stock split.
Note 2. Other Assets
Other assets consisted of the following:
| 1999 | November 27 1998 | |||||||
---|---|---|---|---|---|---|---|---|---|
Equity investments | $ | 51,162 | $ | 56,332 | |||||
Goodwill | 26,442 | 3,190 | |||||||
Purchased technology and licensing agreements | |||||||||
17,505 |
3,502 | ||||||||
Miscellaneous other assets | 27,898 | 24,337 | |||||||
123,007 | 87,361 | ||||||||
Less accumulated amortization | 30,840 | 16,769 | |||||||
$ | 92,167 | $ | 70,592 | ||||||
Note 3. Accrued Expenses
Accrued expenses consisted of the following:
| 1999 | November 27 1998 | |||||||
---|---|---|---|---|---|---|---|---|---|
Accrued compensation and benefits | $ | 52,554 | $ | 41,592 | |||||
Sales and marketing allowances | 13,516 | 13,439 | |||||||
76,175 | 62,508 | ||||||||
$ | 142,245 | $ | 117,539 | ||||||
Note 4. Restructuring chargesand Other Charges
Fiscal 1999 Restructuring Program
In the second quarter of fiscal 1999, the Company implementedbegan the implementation of a Board approved restructuring program to further enhance the CompanysCompany's operating
model by improving productivity and efficiencies throughout the Company. The restructuring program was completed in the third quarter of fiscal 1999. As part of the restructuring program, the Company
implemented a reduction in force of 249216 positions, of which two were executive positions. The reduction in force primarily affected its European headquarters in Edinburgh, Scotland and its North
American headquarters in San Jose, California. In addition to severance and related charges associated with the reduction in force, the restructuring program included charges for vacating leased
facilities. These restructuring actions in the second and third quarter of fiscal 1999 resulted in total charges of $15.3$17.6 million, of which approximately $0.1 million were
non-cash charges. Of the $15.2$17.6 million in total cash charges, $14.5$10.7 million remains accrued at June 4,September 3, 1999.
In the third quarter of fiscal 1999, the Company revised its estimate of the total costs associated with the program described above resulting in an adjustment to the second-quarter restructuring accrual of approximately $2.5 million. Approximately $2.3 million of the adjustment reflects lower than estimated severance and related charges primarily attributable to employees impacted by the restructuring who were able to find alternative employment within the Company. The remaining adjustment was due to lower than expected charges related to vacating leased facilities.
The following table depicts the restructuring activity through June 4,September 3, 1999:
| Accrued Balance at November 27 1998 | Total Charges (Credits) | Cash Payments | Write- downs | Accrued Balance at June 4 1999 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Severance and related charges | $ | | $ | 14,641 | $ | (3,487 | ) | $ | | $ | (2,256 | ) | $ | 8,898 | ||||||||||
Lease termination costs | | 2,545 | (694 | ) | | (272 | ) | 1,579 | ||||||||||||||||
Impairment of leasehold improvements at vacated facilities | | 132 | | (132 | ) | | | |||||||||||||||||
Other charges | | 259 | (6 | ) | | | 253 | |||||||||||||||||
17,577 | (4,187 | ) | (132 | ) | (2,528 | ) | 10,730 | |||||||||||||||||
| (6,169 | ) | | (1,316 | ) | 1,382 | ||||||||||||||||||
$ |
8,867 |
$ | 17,577 | $ | (10,356 | ) | $ | (132 | ) | $ | (3,844 | ) | $ | 12,112 | ||||||||||
Severance and related charges include involuntary termination and COBRA benefits, outplacement costs, and payroll taxes for 249216 employees, or 9%8% of the worldwide workforce. The
terminations were in the following areas: 8542 in research and development, 107117 in sales and marketing, and 57 in general and administrative.
The reduction in force within research and development consisted of employees in the CompanysCompany's Printing Solutions business in San Jose, California and was implemented in order to
realign product development expense with the CompanysCompany's operating targets. The majority of these terminations will bewere completed by August 31, 1999, and the remaining termination benefits will be
paid through the first quarter of fiscal 2000.
The phasing out of the European headquarters in Edinburgh, Scotland was implemented to reduce redundancies within the organization and resulted in a reduction in force of 48 general
and administrative staff and 3743 sales and marketing staff. The closure of the European headquarters will be completed by December 31, 1999, and all termination benefits will be paid through the
first quarter of fiscal 2000.
In addition, the
The remaining terminations in the sales and marketing organization were primarily due to the centralization of the North America sales and marketing organization. The remaining
general and administrative reductions were due to the elimination of redundancies throughout the organization. The majority of these terminations were completed by June 30, 1999, and the
termination benefits will be paid through the fourth quarter of fiscal 1999.
Lease termination costs of $2.3$2.5 million include remaining lease liabilities, brokerage fees, restoration charges and legal fees offset by estimated sublease income related to
facilities in North America,the United States, Australia, Scotland, and Japan that will be vacated as part of the restructuring program. The facilities will be vacated as a result of the elimination of staff and
organizational decisions associated with the centralization of certain activities in San Jose, California. As of June 4,September 3, 1999, $2.0$1.6 million of lease termination costs, net of
sublease income, remains accrued and is expected to be utilized through the second quarter of fiscal 2000.
Charges related to the impairment of leasehold improvements at vacated facilities of $0.1 million included the write-down of the net book value of leasehold
improvements, furniture, and equipment used in the vacated facilities. These assets were written down in accordance with the provisions of SFAS No. 121, Accounting"Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The leasehold improvements, furniture, and equipment specifically identified under the restructuring program as
assets to be disposed of would have no future benefit to the Company as
these assets would not enhance the CompanysCompany's ability to sublease the facilities. Therefore, in accordance with SFAS No. 121, the leasehold improvements, furniture, and equipment were reported
at the lower of the carrying amount or fair value less costs to sell, which was zero. The related facility will bewas vacated byat the end of the third quarter of fiscal 1999.
In addition, as a result of the restructuring program,
the Company also identified leasehold improvements and other assets that will
be held for use in accordance with SFAS 121. Such assets are required for the
continuation of ongoing operations until the related facilities are vacated.
As the asset impairment recognition criterion of SFAS 121 was not met, the depreciable
lives of such assets were adjusted to reflect the change in useful life. The
assets will be fully depreciated upon vacating the related facilities. As such,
the accelerated amortization and depreciation expenses are not included in restructuring
charges.
Other charges of $0.3 million include legal and accounting fees incurred in Edinburgh and North America associated with employee terminations as part of the reduction in force.
The remaining accrual balance as of June
4,September 3, 1999 is expected to be paid by the fourth quarter of fiscal 1999.
Previously Announced Restructuring Programs
As of June 4September 3, 1999, approximately $2.8$1.4 million in accrued restructuring costs remainremains related to the CompanysCompany's previously announced
restructuring programs. This balance is comprised of $0.8 million related to the Company's restructuring program that was implemented in the third quarter of fiscal 1998.1998, and
$0.6 million related to lease termination costs resulting from the merger with Frame Technology Corporation ("Frame") in fiscal 1995. The remaining$0.8 million accrual related to the fiscal 1998
restructuring program consists of $0.4$0.3 million in severance and related charges $1.2and $0.1 million in lease termination costs, $0.9 million in cancelled contracts and $0.3 million in other
charges. Cash payments for the six months ended June 4, 1999 were $0.5 million
and $2.9 million for severance and related charges and lease termination costs,
respectively. The $1.9 million accrual remaining asboth of June 4, 1999 for severance
and related charges, lease termination costs and other charges iswhich are expected to be paid by the thirdfourth quarter
of fiscal 1999, and the $0.91999. The remaining accrual of $0.4 million forrelates to cancelled contracts, and is expected to be paid by the first quarter of fiscal 2000.
In addition, approximately $2.6Cash payments for the nine months ended
September 3, 1999 were $0.7 million, in accrued
restructuring costs remain$3.6 million, and $0.4 million for severance and related tocharges, lease termination costs, resulting fromand cancelled contracts costs, respectively.
In the mergersthird quarter of fiscal 1999, the Company recorded an adjustment to the accrual balance of approximately $1.3 million related to the Company's previously announced
restructuring programs. The adjustment consisted of $0.4 million related to estimated lease termination costs and $0.3 million related to other estimated charges as a result of the
Company's fiscal 1998 restructuring program. Additionally, the restructuring accrual established for lease payments related to idle facilities in Europe as a result of the fiscal 1994 merger with
Aldus and FrameCorporation ("Aldus") was reduced by $0.6 million in the third quarter of fiscal 1999 due to the Company's success in terminating the associated lease with the lessor earlier than the
contract term. As of September 3, 1999, no accrual balance remains related to the fiscal 1994 merger with Aldus.
Other Charges
During the third quarter of fiscal 1999, the Company recorded other charges of $6.0 million that were unusual in nature. These charges included
$2.0 million associated with the cancellation of a contract and fiscal 1995, respectively.$1.2 million for accelerated depreciation related to the adjustment of the useful life of certain assets as a result of
decisions made by management as part of the restructuring program. Additionally, the Company
incurred a non-recurring compensation charge totaling $2.6 million for a terminated employee, and incurred consulting fees of $0.2 million to assist in the restructuring of
the Company's operations.
Note 5. StockholdersStockholders' Equity
Stock Repurchase Programs
In September 1997, the CompanysCompany's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to
15.0 million shares of the CompanysCompany's common stock over a two-year period. Under this program, the Company repurchased approximately 0.8 million shares in the first quarter of
fiscal 1999, and 10.1 million shares in fiscal 1998, and 4.1 million shares in fiscal 1997, at a cost of $30.5 million, $362.4 million, and $362.4$188.6 million, respectively.
This program was completed during the first quarter of fiscal 1999.
In April 1999, the CompanysCompany's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to an additional 5.0 million shares of
the CompanysCompany'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. No purchases have been made under the 5.0 million share repurchase program.
Under the CompanysCompany's existing plan to repurchase shares to offset issuances under employee stock plans, the Company repurchased approximately 2.14.0 million shares in fiscal 1999
and 0.4 million shares in fiscal 1998, at a cost of $114.8$273.1 million and $16.8 million, respectively.
Put warrantsWarrants and call optionsCall Options
To facilitate the CompanysCompany's stock repurchase programs, the Company sold put warrants to independent third parties. Each warrant entitles the holder to sell one
share of AdobesAdobe's common stock to the Company at a specified price. On June 4,September 3, 1999, put warrants to sell approximately 222,100888,800 shares of the CompanysCompany's common stock were outstanding that
expire on various dates through July 1999January 2000 with an average exercise price of $41.26$80.33 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; 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
June 4,September 3, 1999, call options to purchase approximately 120,200440,000 shares of the CompanysCompany's common stock were outstanding that expire on various dates through July 1999January 2000 with an average
exercise price of $44.61$86.84 per share.
Note 6. Comprehensive income Income
The following table sets forth the components of comprehensive income, net of income tax expense:
| | Three Months Ended | | | ||||||||||||||
| September 3 1999 | August 28 1998 | September 3 1999 | August 28 1998 | ||||||||||||||
Net income | $ | 57,155 | $ | 152 | $ | 140,392 | $ | 54,876 | ||||||||||
Change in unrealized gains (losses) on investments: | ||||||||||||||||||
Unrealized gains |
596 | 59,667 | 10,488 | |||||||||||||||
Less: reclassification adjustment for gains realized in net income | (10,183 |
) | (202 | ) | (11,744 | ) | (13,203 | ) | ||||||||||
Net change in unrealized gains (losses), net of taxes | 26,565 |
394 | 47,923 | (2,715 | ) | |||||||||||||
Change in cumulative translation adjustment | (204 | ) | 520 | (629 | ) | (133 | ) | |||||||||||
Total comprehensive income, net of taxes | $ |
83,516 |
$ | 1,066 | $ | 187,686 | $ | 52,028 | ||||||||||
Note 7. Net incomeIncome per sharSharee
| | Three Months Ended | | | |||||||||||||
| September 3 1999 | August 28 1998 | September 3 1999 | August 28 1998 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net income | $ | 152 | $ | 140,392 | $ | 54,876 | |||||||||||
Shares used to compute basic net income per share (weighted average shares outstanding during the period) | 67,278 | 60,672 | 67,271 | ||||||||||||||
Dilutive common equivalent shares: | |||||||||||||||||
Unvested restricted stock | 265 | 67 | 265 | 67 | |||||||||||||
199 | 17 | 29 | |||||||||||||||
Stock options | 3,616 |
868 | 3,525 | 1,483 | |||||||||||||
Shares used to compute diluted net income per share | 64,829 | 68,412 | 64,479 | 68,850 | |||||||||||||
Basic net income per share | $ |
.94 |
$ | | $ | 2.31 | $ | .82 | |||||||||
Diluted net income per share | $ |
.88 |
$ | | $ | 2.18 | $ | .80 | |||||||||
Share and per share data presented do not reflect the two-for-one stock split, in the form of a stock dividend, effective October 26, 1999.
Note 8. Commitments and Contingencies
In August 1999, the Company entered into a $200,000,000 unsecured revolving line of credit with a group of 15 banks for general corporate purposes, subject to certain financial covenants. One-half of the facility expires in August 2000, the other $100,000,000 expires in August 2002. Outstanding balances accrue interest at LIBOR plus a margin that is based on the financial ratios of the Company. There were no outstanding balances on the credit facility as of September 3, 1999. In addition, as of September 3, 1999, the Company was in compliance with all financial covenants.
In August 1999, the Company restructured its current lease agreements for its corporate headquarters in San Jose, California. The amended and restated agreement replaces the two prior lease agreements entered into in 1996 and 1998. The lease is for a period of five years and is subject to standard covenants including financial ratios. The Company has an option to purchase the buildings at any time during the term for an amount equal to the total investment of the lessor. At the end of the lease term, the Company may exercise the purchase option or, with the mutual agreement of the lessor, renew the term of the lease. In addition to these possibilities, at the end of the term, the Company may elect to have the buildings sold to an unrelated third party. In such case, the Company is obligated to use its best efforts to arrange for such a sale and is obligated to pay the lessor the difference between the total investment in the buildings and the net sales proceeds; provided, however, that in no event would the Company be required to pay more than a maximum guaranteed residual amount as set forth in the lease. In the event of a default by the Company, during the term of the lease, the lessor could require the Company to purchase the buildings for an amount equal to the Company's option purchase price. As of September 3, 1999, the Company was in compliance with all financial covenants.
Under the terms of the line of credit and the lease agreements, the Company may pay cash dividends unless an event of default has occurred or it does not meet certain financial ratios.
Note 9. 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"). 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 initial purchase price of the acquisition was approximately $31.0 million, plus additional contingency payments of up
to $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 additional purchase price.
ITEM 2. MANAGEMENTSMANAGEMENT'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
Managements"Management's Discussion and Analysis of Financial Condition and Results of OperationsFactors 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
Founded in 1982, Adobe Systems Incorporated (Adobe("Adobe" or the "Company") is a provider of graphic design, publishing, and imaging software for Web and print
production. The Company) builds award-winning software solutions for Web
and print publishing. Its graphic design, imaging, dynamic media, and authoring
tools enable customers to create, publish, and deliver visually-rich content
for various types of media. The Companys products are used by Web and graphic designers, professional publishers, document-intensive organizations, business users, and consumers. Adobe's
products enable customers to create, publish, and deliver visually rich images and documents across virtually all print and electronic media. The Company distributes its products through a network of
original equipment manufacturer (OEM("OEM") customers, distributors and dealers, and value-added resellers (VARs("VARs") and system integrators, and has operations in North America, Europe, Japan, Asia
Pacific, and Latin America.
The following table sets forth for the three and sixnine month periods ended June 4,September 3, 1999 and May 29,August 28, 1998, the CompanysCompany's condensed consolidated statements of
income expressed as a percentage of total revenue:
| Three Months Ended | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 3 1999 | August 28 1998 | September 3 1999 | August 28 1998 | ||||||||||
Revenue: | ||||||||||||||
Licensing | % | 14.2 | % | 19.3 | % | |||||||||
Application products | 88.4 |
81.7 | 85.8 | 80.7 | ||||||||||
100.0 | 100.0 | |||||||||||||
9.3 |
10.5 | 9.6 | 11.8 | |||||||||||
90.7 |
89.5 | 90.4 | 88.2 | |||||||||||
Operating expenses: | ||||||||||||||
Research and development | 19.2 | 21.9 | ||||||||||||
Sales and marketing | 33.1 | 37.2 | ||||||||||||
General and administrative | 11.2 | 15.1 | ||||||||||||
Restructuring and other charges | 1.7 |
17.0 | 2.7 | 5.9 | ||||||||||
63.1 |
92.2 | 66.2 | 80.1 | |||||||||||
) | 24.2 | 8.1 | ||||||||||||
Nonoperating income, net: | ||||||||||||||
Investment gain | 5.0 | 0.1 | 3.7 | 1.9 | ||||||||||
Interest and other income | 1.9 |
2.7 | 2.2 | 3.5 | ||||||||||
Total nonoperating income, net | 6.9 |
2.8 | 5.9 | 5.4 | ||||||||||
Income before income taxes | 30.1 | 13.5 | ||||||||||||
11.0 | 5.0 | |||||||||||||
% | 19.1 | % | 8.5 | % | ||||||||||
Revenue
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Total revenue | $ |
260.9 | $ | 222.9 | 17.0 | % | |||
Nine months ended: |
| | | | | | | |
|
For the secondthird quarter and first sixnine months of fiscal 1999, revenue increased as a result of new product releasesapplication products and upgrades and an improvement in the CompanysCompany's Japanese
operation. These increases were partially offset by a decline in licensing revenue. Though the Company experienced an increase
in application revenue from Japan, the Company remains cautious in regard to
the Japanese economy over the second half of fiscal 1999.
Licensing revenue:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Licensing revenue | $ |
30.2 | $ | 40.8 | (26.1 | )% | |||
11.6 | % | 18.3 | % | ||||||
Nine months ended: |
| | | | | |
|||
Licensing revenue | $ |
$ | 125.1 | (16.6 | )% | ||||
Percentage of total revenue | |||||||||
% | |||||||||
% | |||||||||
Licensing revenue is made up of royalties received from OEM customers who ship products containing Adobes PostscriptAdobe's PostScript technology, including PostscriptPostScript 3, PrintGear, and Extreme.
Licensing revenue decreased in the secondthird quarter and first sixnine months of fiscal 1999 compared to the same periods last year primarily due to the ongoing weakness in the monochrome
laser printer and Japanese personal computer and printer markets. In addition, licensing revenue declined due to the loss of royalty revenue from Hewlett-Packard Companys (HPCompany's ("HP") desktop monochrome
laser printer division, which has been incorporating a clone version of Adobe PostScript software into its products since the fall of 1997.
The Company continues to be cautious about licensing revenue because of weakness in the short term because ofmonochrome laser printer segment, Japanese market conditions, and the uncertain timing of OEM
customer introductions of products incorporating AdobesAdobe's latest technologies. Excluding shrinkwrap printing technology products, the Company anticipates that its traditional OEM PostScript licensing
revenue will continue to decline in fiscal 1999.2000.
Application products revenue:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Application products revenue | $ |
230.7 | $ | 182.1 | 26.7 | % | |||
88.4 | % | 81.7 | % | ||||||
Nine months ended: |
| | | | | |
|||
Application products revenue | $ |
$ | 522.9 | 20.3 | % | ||||
Percentage of total revenue | |||||||||
% | |||||||||
% | |||||||||
Application products revenue is derived predominantly from shipments of application software programs marketed through retail, OEM, and VAR distribution channels, withchannels.
During 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 in the secondthird quarter and first sixnine months of fiscal 1999, compared toapplication products revenue was higher than that of the same periods last year primarily due to the release of a number of new
products and upgrades of existing products. The release of Acrobat 4.0 duringin the second quarterfirst half of fiscal 1999, and the introduction of the Company's product collections, including Adobe GraphicStudioPublishing
Collection, Adobe DynamicMedia Collection, Adobe Web Collection, and Adobe Dynamic Media
Studio in North America, Japan, Asia Pacific, and Latin America inDesign Collection, were the first
quarter of fiscal 1999. Adobe GraphicStudio is a collection of Adobe application
products, which includes Photoshop, Illustrator, and PageMaker. Adobe Dynamic
Media Studio isprimary factors contributing to the overall revenue growth. The Company also a suite of products, containing After Effects, Adobe Premiere,
Photoshop, and Illustrator. Applicationbenefited from
revenue also increased duerelated to the release in the secondthird quarter of fiscal 1999 of Photoshop 5.5, as well as revenue related to the recent releases of After Effects 4.1 and Adobe Type Manager Deluxe 4.5 in the
first half of fiscal 1999, and Illustrator 8.0, released in the fourth quarter of fiscal 1998.
In addition, the increase in application products revenue was due in part to the shipment of two new products: GoLive 4.0, the CompanysCompany's new professional web design and publishing
software. In addition, the second quarter of fiscal
1999 benefited from revenue related to major upgrades of After Effects and Adobe
Premieresoftware, which werewas released in the first quarterhalf of fiscal 1999, and Illustrator
and ImageReady,InDesign, the Company's new page-layout application software, which werewas released in mid-to-latethe third quarter of fiscal 1998.1999.
The increased revenue generated by these newly released products and upgrades was partially offset by the following factors: a decline in revenue from PhotoshopFramemaker and PageMaker due primarily towhich
are late in the productlife cycle of the current releases, as
well asversions of the products, and the absence of revenue from businesses divested in the third quarter of fiscal 1998.1998, totaling $6.6 million and
$20.1 million in the third quarter and first nine months of fiscal 1998, respectively.
Direct costs
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Direct costs | $ |
24.3 | $ | 23.4 | 3.8 | % | |||
9.3 | % | 10.5 | % | ||||||
Nine months ended: |
| | | | | |
|||
Direct costs | $ |
$ | 76.7 | (8.2 | )% | ||||
Percentage of total revenue | |||||||||
% | |||||||||
% | |||||||||
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 increased slightly in the third quarter of fiscal 1999 due to a higher unit volume shipped during the quarter compared to the same period last year. The increase was
partially offset by lower excess and obsolete inventory due to effective inventory management control and lower material costs as a result of the Company's ongoing cost improvement program.
Direct costs decreased in the second quarter and first sixnine months of fiscal 1999 compared to the same periodsperiod last year due primarily to effectiveimprovements in inventory management resulting inand lower excess and obsolete inventory expense,
as well as lower material costsunit cost of
materials as a result of the CompanysCompany's ongoing cost improvement program.
The Company anticipates that gross margin throughoutfor the remainder of fiscal 1999 will be consistent with the third quarter of fiscal 1999.
As a result of the ongoing cost improvement programs, the Company anticipates that gross margin will be approximately 90%, due to the management of excess and obsolete
inventory and cost reduction efforts in material costs. These91% during fiscal 2000. However, these cost reductions may be
partially offset by increases in direct costs related to product launches, the amortization of capitalized software in accordance with Statement of Financial Accounting Standards No. 86,
Accounting"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.
Research and development:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Research and development | $ |
48.0 | $ | 49.0 | (2.0 | )% | |||
18.4 | % | 22.0 | % | ||||||
Nine months ended: |
| | | | | |
|||
Research and development | $ |
$ | 141.7 | (0.8 | )% | ||||
Percentage of total revenue | |||||||||
% | |||||||||
Research and development expenses decreased in the secondthird quarter and first sixnine months of fiscal 1999 compared withto the same periods last year due to a decrease in salaries expense as a
result of lower headcount, and decreases in general office expense, travel and entertainment,expenses, depreciation, purchased software, and professional fees as a result of the CompanysCompany's fiscal 1998 restructuring program and other
cost reduction efforts implemented at that time. These decreases were partially offset by an increase inhigher incentive compensation expense asexpenses associated with the Companysimprovement in the Company's financial performance
exceeded that ofin fiscal 1999 over the secondthird quarter and first six
nine months of fiscal 1998.
The Company believes that continued 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 expenses for the remainder of fiscal 1999 and fiscal 2000 will increase
in absolute dollars. However, suchSuch expenditures as a percentageare targeted to be approximately 20% of revenue are expected to remain approximately the same as
the second quarter ofin fiscal 1999.2000.
Sales and marketing:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
Sales and marketing | $ |
84.9 | $ | 84.1 | 0.9 | % | |||
32.5 | % | 37.7 | % | ||||||
Nine months ended: |
| | | | | |
|||
Sales and marketing | $ |
$ | 240.7 | 0.9 | % | ||||
Percentage of total revenue | |||||||||
% | |||||||||
Sales
The slight increase in sales and marketing expenses decreased in the secondthird quarter and first nine months of fiscal 1999 compared toreflect the same period last year due to decreased
salaries expense as a result of lower headcount, and a decrease in advertising
fees, professional fees, and travel and entertainment, due to the Companys
fiscal 1998 restructuring program and other cost reduction efforts implemented
at that time. These decreases were partially offset by an increase in incentive compensation expense asassociated with
the Companysimprovement in the Company's financial performance exceeded that
of the second quarter of fiscal 1998, and an increase in trade show expenses
for shows that occurred in Europe during the second quarter of fiscal 1999.
Sales and marketing expenses increased slightly in
the first six months of fiscal 1999 compared toover the same periodperiods last year due
to higher incentive compensation expense,year. This increase was partially offset by a decrease in salaries expense
as a result of lower headcount, and decreases in brand advertising expenses, promotional
expenses, and professional fees and travel and entertainment as a result of the fiscal 1998 restructuring program, as well as a decrease in newsletter and other cost reduction efforts implemented at that time.catalog expenses as a result of the divestiture of a business unit in the
third quarter of fiscal 1998.
Sales and marketing expenses are expected to increase in absolute dollars over the remainder of fiscal 1999 and fiscal 2000 to support investments in e-commerce and
enhanced marketing activities, as well as new products and
upgrades scheduled to be released inactivities. For fiscal 2000, the second half of fiscal 1999. However,Company's sales and marketing expenses as a percentageexpense target is approximately 32% of revenue are expected to remain
approximately the same or slightly higher than the second quarter of fiscal
1999.revenue.
General and administrative:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
General and administrative | $ |
27.4 | $ | 34.6 | (21.0 | )% | |||
10.5 | % | 15.5 | % | ||||||
Nine months ended: |
| | | | | |
|||
General and administrative | $ |
$ | 97.5 | (15.8 | )% | ||||
Percentage of total revenue | |||||||||
% | |||||||||
General and administrative expenses decreased in the secondthird quarter of fiscal 1999 compared to the same period last year primarily due to lower professional fees and lower bad debt
expense. During the third quarter of fiscal 1998, professional fees were higher as the Company incurred increased investment-banking fees associated with an unsolicited acquisition proposal. Bad debt
expense was also higher in the third quarter of fiscal 1998 to reserve for certain accounts receivable in Asia that were deemed to be potentially uncollectible. In addition, general and administrative
expenses decreased in the third quarter of fiscal 1999 due to lower building expenses as a result of vacating certain leased facilities during the fourth quarter of fiscal 1998.
General and administrative expenses decreased for the first sixnine months of fiscal 1999 compared to the same periodsperiod last year primarily due to an overalla decrease in expenses, including legal and professional fees, travelbad debt
expense, building expenses, and entertainment, and office expenses, as a resultthe amortization of goodwill. In the Companys fiscal 1998 restructuring program and other cost reduction
efforts implemented at that time. In addition, the decrease in the secondthird quarter of fiscal 1999 is attributable to lower1998, amortization of goodwill as the second
quarter of fiscal 1998 included the write-off of $2.4 million of goodwill
associated with an acquisition that took place in 1997, and a reduction1997. These decreases were offset by an increase in bad debtincentive compensation expense associated with the resolution of disputed items with certain customers and
an improved economic environmentimprovement in Asia. The decrease was partially offset
by increased incentive compensation expense as the CompanysCompany's financial
performance exceeded that ofin the second quarter and first halfnine months of fiscal 1998.1999 over the same period last year.
The Company expects that general and administrative spending will remain flat or slightly increase in absolute dollars over the remainder of fiscal 1999 and fiscal 2000 to support
ongoing administrative
infrastructure needs. However, as a percentage of revenue such expenditures are expectedtargeted to be lower
than the second quarterdecrease to approximately 9% of revenue in fiscal 1999.2000.
Restructuring and other charges:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
$ | 4.4 | $ | 37.9 | (88.4 | )% | ||||
% | 17.0 | % | |||||||
Restructuring and other charges | $ | 19.8 | $ | 38.5 | (48.7 | )% | |||
Percentage of total revenue | |||||||||
% | |||||||||
In the second quarter of fiscal 1999, the Company implementedbegan the implementation of a Board approved restructuring program to further enhance the CompanysCompany's operating model by improving
productivity and efficiencies throughout the Company. The restructuring program was completed in the third quarter of
fiscal 1999. As part of the restructuring program, the Company implemented a reduction in force of 249216 positions, of which two were executive positions. The reduction in force primarily affected its
European headquarters in Edinburgh, Scotland and its North American headquarters in San Jose, California. In addition to severance and related charges associated with the reduction in force,
the restructuring program included charges for vacating leased facilities. These restructuring actions resulted in total charges of $15.3$15.4 million and $2.2 million, in the second and
third quarters of whichfiscal 1999, respectively. Of the total $17.6 million restructuring charge, approximately $0.1 million were non-cash charges.
The restructuring charge recorded in the third quarter of fiscal 1999 of $2.2 million represents the completion of the restructuring plan announced during the second quarter of
fiscal 1999. The $2.2 million charge was offset by adjustments made in the third quarter, totaling $3.8 million, which reflect revised estimates related to the Company's restructuring
charges incurred during the second quarter of fiscal 1999 and previous restructurings in both fiscal 1998 and 1994. For detailed information regarding the Companysadjustments and the Company's restructuring
program, see Note 4 of the Notes to Consolidated Financial Statements.
Based on
Additionally, during the reduction in forcethird quarter of 249 positions,fiscal 1999, the Company estimatesrecorded other charges of $6.0 million that annualized pretaxwere unusual in nature. These charges included
$2.0 million associated with the cancellation of a contract, and $1.2 million for accelerated depreciation related to the adjustment of the useful life of certain assets as a result of
decisions made by management as part of the restructuring program. Additionally, the Company incurred a non-recurring compensation charge totaling $2.6 million for a terminated
employee, and incurred consulting fees of $0.2 million to assist in the restructuring of the Company's operations.
The Company believes that the savings of approximately $19.0 million
will be realized. These savingsrealized under the restructuring program will be invested in programs and people to enhance revenue growth by significantly increasing its
investment in e-business and enhanced marketing activities, and to achieveactivities. The Company also believes that these savings will assist the Company in achieving its operating model targets of 20%, 35%32% and 9%
of revenue for research and development, sales and marketing, and general and administrative expenses, respectively, in fiscal 2000.
Restructuring charges in
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. As part of the restructuring program, the Company implemented a reduction in force of 364 positions, primarily in its North American operations. The reductions came predominantly
from overhead areas, divested business units, and redundant marketing activities, and as of August 31, 1998, the majority of these terminations were completed. In addition to severance and
related charges associated with the reduction in force, the restructuring program included charges for divesting two business units, vacating leased facilities, and canceling certain contracts. These
actions and other non-restructuring related items resulted in charges of $37.9 million, of which approximately $9.3 million were non-cash charges.
In addition to the aforementioned items, included in restructuring and other charges for the first nine months of fiscal 1998 are expenses associated with the reduction in force in
the CompanysCompany's Printing Solutionsand Systems business as part of the CompanysCompany's initiative to refocus resources on high
growthhigh-growth opportunities in the printing and digital copier markets.
Nonoperating income, net
Investment gain (loss):gain:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
$ | 13.2 | $ | 0.2 | 6016.7 | % | ||||
% | 0.1 | % | |||||||
Investment gain | $ | 27.1 | $ | 12.5 | 117.4 | % | |||
Percentage of total revenue | |||||||||
% | |||||||||
During the secondthird quarter of fiscal 1999, the Company recorded a net realized gain of $9.4 million related to the sale of a portion of its investment in Vignette Corporation
("Vignette"). The Company also recorded an investment gain totaling $7.0 million due to the mark-to-market adjustment of Tumbleweed Communications Corporation. These
investment gains were partially offset by investment losses totaling $3.2 million related to mark-to-market adjustments of various other Adobe Venture investments.
During the first nine months of fiscal 1999, the Company recorded investment gains from mark-to-market adjustments totaling $17.8 million and
$2.7 million related to investments in Electronic Submission Publishing Systems, Inc. and Salon.com, respectively. The Company also recorded a realized
gain of $1.0 million related to the sale of a portion of its investment in Vignette
Corporation. These gains were partially offset by an investment loss of
$5.2 million related to the acquisition of PointCast, Inc., a former investee of the Company, by idealab!. In connection with the acquisition, the Company exchanged its shares of
PointCast, Inc. for approximately 542,000 shares of idealab!s's Lauchpad Technologies, Inc. The
Additionally, for the first nine months of fiscal 1999, the Company also recorded a total of $10.4 million in net realized gains related to the sale of shares in Vignette in
addition to a total of $5.6 million in investment losses of approximately
$2.0 million related to mark-to-market adjustments of various other Adobe Venture investments.
During
For the first quarternine months of fiscal 1998, the investment gain consisted principally of two transactions. McQueen International Limited (McQueen("McQueen"), a former investee of the Company,
was acquired by Sykes Enterprises, Incorporated (Sykes("Sykes"), a publicly traded company. In connection with the acquisition, the Company exchanged its shares of McQueen for approximately 487,000 shares
of SykesSykes' restricted common stock and recorded a gain on the exchange of $6.7 million.
Also, during In the firstthird quarter of fiscal 1998, these shares were sold and an additional gain was recorded. In
addition, the Company liquidated its investment in Siebel Systems, Incorporated (Siebel("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.
Interest and other income:
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
$ | 4.9 | $ | 6.1 | (19.6 | )% | ||||
% | 2.7 | % | |||||||
Nine months ended: | |||||||||
Interest and other income | $ |
$ | 22.2 | (27.7 | )% | ||||
Percentage of total revenue | |||||||||
% | |||||||||
Interest and other income decreased in the secondthird quarter and first sixnine months of fiscal 1999 compared with the corresponding periods last year due to lower average cash and short-term investment balances as a
result of stock repurchases in fiscal 1999.
Provision for income taxes
| September 3 1999 | August 28 1998 | Change | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | |||||||
Three months ended: | |||||||||
$ | 32.9 | $ | 0.1 | NA | % | ||||
% | 0.0 | % | |||||||
Effective tax rate | 36.5 | % | 37.3 | % | |||||
Nine months ended: | |||||||||
Provision for income taxes | $ |
$ | 32.6 | 147.3 | % | ||||
Percentage of total revenue | 11.0 | % | 5.0 | % | |||||
Effective tax rate | |||||||||
% | |||||||||
The CompanysCompany's effective tax rate decreased in the secondthird quarter and first sixnine months of fiscal 1999 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%-37% and 37%will decrease in fiscal 2000 to 35%-36%.
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 CompanysCompany's new
products and major new versions of existing products, lack of market acceptance of new products and upgrades, the introduction of competitivenew products by third parties,major competitors, 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 CompanysCompany'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.business, and "Year 2000" issues (as discussed later under "Year 2000 Issues").
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 after consideration of businesses divested in the third quarter of fiscal 1998.1998; that it expects its
gross margin for the remainder of fiscal 1999 will be consistent with the third quarter of fiscal 1999; and that its operating margin target, after consideration of businesses divested in the third
quarter of fiscal 1998, is 27.8% of
total revenue based on actual results for the first three quarters of fiscal 1999 and the Company's fourth quarter operating margin target. The Company has also stated that in fiscal 2000 its annual
revenue growth target will be 20% over fiscal 1999 revenue, and that its gross margin and operating profit margin targets are 91% and 30%, respectively. Additionally, in fiscal 2000, operating model
targets for its research and development, sales and marketing, and general and administrative expenses are 20%, 35%32%, and 9% of revenue, respectively, for fiscal year 2000.respectively. These targets are used to assist the CompanysCompany'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
CompanysCompany'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 CompanysCompany's financial performance and may cause the CompanysCompany's future results, including results for the current quarter, to vary materially from these
targets.
The CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 increaseincreased its presence in the digital imaging/graphics market by
mid-1999;market; the Company believes that, due to
MicrosoftsMicrosoft's market dominance, any new Microsoft digital imaging products will be highly competitive with the CompanysCompany's products. If competing new products achieve widespread acceptance, it would have
a significant adverse impact on the CompanysCompany'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 on
a particular platform or in general, the CompanysCompany's operating results could be materially adversely affected.
Adobe distributes its application products primarily through distributors, resellers, and retailers (collectively referred to as "distributors"). A significant amount of the Company's revenue for application products is from a single distributor. The Company is in the process of revising its channel program to reduce the overall number of its distributors worldwide and focus its channel efforts on larger distributors. This revision of the channel program has resulted in an increase in the Company's dependence on such distributors selling through a larger amount of the Company's products. Additionally, the Company's goal is to increase its direct distribution of its products to end users through its on-line store located at Adobe.com, the Company's Internet site. Any such increase in the Company's direct revenue efforts will place the Company in increased competition with its channel distributors, and with newer types of distribution of the Company's products by online, Internet-based resellers of Adobe products. While it is anticipated that the restructuring and streamlining of the Company's product distribution channels and increasing the scope of its direct sales efforts will eventually lead to an increase in profitability as a result of decreases in discounts or rebate programs provided to distributors, decreases in product returns, and shorter inventory cycles, such restructuring could instead have an adverse material impact on future results of operations and revenues.
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. 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 CompanysCompany'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.
The Companys 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 Companys continuing relationships with them, are becoming
more important to the Companys success. Some of these companies are thinly
capitalized and may be unable to withstand changes in business conditions. The
Companys financial results could be adversely affected if the financial
condition of certain of these third parties substantially weakens or if the
Companys relationships with them deteriorate.
The Company currently relies on two manufacturers of its products, each located in a different region. In addition, the Company intends to add a third manufacturer in the first
quarter of fiscal 2000. If a manufacturer terminates its relationship with the Company or the CompanysCompany's supply from a manufacturer
is interrupted or terminated for any other reason, the Company may not have sufficient time to replace the supply of products manufactured by that manufacturer.
The Companys printingCompany's licensing revenue experienced an
11.9%a 16.6% decline in the first halfnine months of fiscal 1999 compared to the first halfnine months of fiscal 1998. IfThe Company expects this trend continues, the Companysto
continue, and believes that its financial results could be adversely affected. The weakness in the monochrome laser printer and 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. If other
significant customers also decide to incorporate a clone version instead of Adobe PostScript, it could adversely affect the Company's financial results. 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 through the first quarter of fiscal 1999, the Company 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. During the second quarterand third quarters of fiscal 1999, the Company experienced an increase in application revenue from its
Japanese operation, but still continued to experience a decline in licensing revenue. In addition, at the end of fiscal 1997, inventory levels for application products at the CompanysCompany'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. Despite the slight improvement in the Japanese economy in the second quarterand third quarters of fiscal 1999, these adverse economic conditions may continue in the short term,
and they may continue to adversely affect the CompanysCompany'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 CompanysCompany's revenue and thus have less impact on the CompanysCompany's operational results.
The Company has recently implemented a restructuringrestructurings of its business in the second and reduced its workforce by 9%; it also implementedthird quarters of fiscal 1999, resulting in a restructuring
and workforce reduction of 10% in the fall of 1998.8%. 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
CompanysCompany'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. 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 has stated that it intends to increase its investment in e-business and enhanced marketing activities in an effort to achieve revenue growth, but
there can be no assurance that such increased investment will result in increased revenue.
The Company derives a significant portion of its revenue and operating income from its subsidiaries located in Europe, Japan, 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, 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
subsidiaries' operating expenses are denominated in their local currencies. As a result, the CompanysCompany's operating results are subject to fluctuations in foreign currency exchange rates. To date, the
accountingfinancial impact of such fluctuations has been insignificant. The CompanysCompany's hedging policy attempts to mitigate some of these risks, based on managementsmanagement'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 CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 of its products, or cause severe disruptions to the CompanysCompany'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"). GAAP are subject to interpretation by the American Institute of
Certified Public Accountants (the AICPA"AICPA"), the Securities and Exchange Commission (the SEC"SEC"), and various bodies formed to interpret and create appropriate
accounting policies. A change in these
policies can have a significant effect on the CompanysCompany'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
Companys
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 CompanysCompany'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 CompanysCompany'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 CompanysCompany'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 CompanysCompany's common stock. Finally, the Company participates in a highly dynamic industry. In addition to factors specific to the Company, changes in analystsanalysts' earnings
estimates for the Company or its industry, and factors affecting the corporate environment, the CompanysCompany's industry or the securities markets in general will often result in significant volatility of
the CompanysCompany's common stock price.
"Year 20002000" 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"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 CompanysCompany's and/or third partiesparties' computer systems or
Year 2000 defects in the CompanysCompany's products could have a material impact on the CompanysCompany'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"Y2K Program"). To accelerate overall completion, activities in each phase are
often concurrent rather than serial, but allAll phases, except developing contingency plans, are expectedhave been substantially completed; contingency plans for high-impact
processes have been substantially drafted and will continue to be substantially completedrevised and updated through the end of the calendar year, and other contingency plans will be prepared and updated as deemed
practicable and appropriate by mid-1999.the Company. 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.
The Company has identified three potential areas of impact for review: (1) the software and systems, including embedded systems, used in the CompanysCompany's internal business
processes; (2) third-party vendors, manufacturers and suppliers, and (3) the
CompanysCompany's software products offered to customers. The CompanysCompany'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,
assessing its centralized computer and embedded systems to identify any potential Year 2000 issues, remediating, testing and remediatingimplementing solutions for any identified issues. The CompanysCompany's financial
information systems include an SAP system recently implementedupgraded in the United States, Japan, Asia Pacific, and Latin America, and an Oracle system in Europe that has recently been upgraded to a recent
version.version; in a transition unrelated to the Y2K Program, the Company intends to replace the Oracle system in Europe by integrating functions into its existing SAP system at the start of fiscal year
2000. SAP and
Oracle have informed the Company, and the Company believes, that these systems are Year 2000 compliant. The Company has substantially completed a number of projects to replace or upgrade hardware and
software that are known to be Year 2000 non-compliant. The Company
currently expects to complete the remaining mediation, validation and implementation
of its centralized computer and embedded systems by September 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 or upgrades 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 CompanysCompany's results of operations or financial condition could be materially adversely affected.
Third-party vendors, manufacturers and supplierssuppliers.. The Company is also in the process of contactinghas contacted its critical suppliers, manufacturers,
distributors and other vendors to determine thatwhether 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 CompanysCompany'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 CompanysCompany's products is available on
the CompanysCompany's Year 2000 Web site (www.adobe.com/newsfeatures/year2000). Information
on the CompanysCompany'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
CompanysCompany's products and is provided as is"as is" without warranty of any kind. There can be no assurance that the CompanysCompany'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's Y2K Program is designed to minimize the possibility of serious Year 2000
interruptions. However, since their possibility cannot be eliminated, the Company is in the process
of developing contingency plans to address situations that may result ifaddressing Year 2000 concerns in high impact areas of the Company, is unableand for other areas
as deemed practicable and advisable by the Company. Such plans for high-impact processes have now substantially been drafted but will continue to achieve Year 2000 readinessbe revised and updated, particularly in
light of its critical operations,
including operations underongoing process and structural changes within the controlCompany, through the end of third parties.
Additionally,the calendar year; such plans are still subject to internal approvals and will also be tested on an audit basis
as the end of the calendar year approaches. Other contingency plans will be prepared, tested, and updated as deemed practicable and appropriate by the Company.
The Company currently believes that the most reasonably likely worst-case scenario hasis that there will be some Year 2000 disruptions at individual locations that could
affect individual business processes, facilities or third parties for a short time. The Company does not yet been
clearly identified. Development ofexpect such contingency plans is expecteddisruptions to be completed by September 1999. There can be no assurance thatlong-term, or for the disruptions to affect the
operations of the Company will
be ableas a whole. Because of the uncertainty as to develop the exact nature or location of potential Year 2000-related problems that might arise, the business
continuity/contingency planning has focused on development of flexible plans that will adequately address allto minimize the scope, impact and duration of any Year 2000 issuesproblems that may arise.occur. The Company expects to have personnel and
resources available to deal with any Year 2000 problems that occur. Some of the currently planned contingency actions include designating emergency response teams, increasing staffing at critical
times, arranging for alternative suppliers of critical products and services, heightened proactive monitoring at likely dates of impact, and developing manual workarounds.
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, and the impact and cost of such litigation
is therefore not estimable.
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. Any costs associated with potential Year 2000
litigation exposure are not included in the total cost estimate above.
Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 131, Disclosures"Disclosures about Segments of an Enterprise and Related Information," and in June 1998,
issued SFAS No. 133, Accounting"Accounting for Derivative Instruments and Hedging Activities." In May 1999, the FASB amended SFAS No. 133 to defer its effective date. The Company will
implement SFAS 133 in its fiscal year 2001. Also, in December 1998, the AICPA issued SOP 98-9, Modifications"Modifications of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions." Readers can refer to the Recent"Recent Accounting PronouncementsPronouncements" section of the CompanysCompany's 1998 Annual Report on Form 10-K for further
discussion.
LIQUIDITY AND CAPITAL RESOURCES
| 1999 | November 27 1998 | Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in millions) | | ||||||||||
Cash, cash equivalents and short-term investments | $ |
481.0 | $ | 272.5 | 76.5 | % | ||||||
Working capital | $ | 396.2 | $ | 205.0 | 93.3 | % | ||||||
$ | ||||||||||||
$ |
||||||||||||
12.0 | ||||||||||||
The CompanysCompany's cash, cash equivalents and short-term investments consistingconsist principally of municipal bonds and United States government and government agency securities, increased $54.0 million, or 19.8%, during
the first six months of fiscal 1999 primarily due to cash generated from operations
of $143.3 million and proceeds from the issuance of treasury stock of $80.4
million, related to the exercise of employee stock options. These factors were
partially offset by the purchase of treasury stock totaling $145.3 million,
the purchase of the assets of GoLive Systems, Inc. for $31.0 million, capital
expenditures of $17.7 million, and the payment of dividends totaling $6.1 million.
securities. All
of the CompanysCompany'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"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 stockholdersstockholders' equity.
The Company's cash, cash equivalents, and short-term investments increased $208.4 million, or 76.5%, during the first nine months of fiscal 1999 primarily due to
cash generated from operations of $236.5 million, proceeds from the issuance of treasury stock of $129.9 million related to the exercise of employee stock options and the sale of stock
under the Employee Stock Purchase Program, the release of restricted funds totaling $130.3 million associated with the refinancing of the Company's corporate headquarters lease agreement, and
the proceeds from the sale of equity investments totaling $10.9 million. In addition, short-term investments increased due to a reclassification of $46.8 million of
investments classified as long-term to short-term, as well as mark-to-market adjustments totaling $80.6 million. These factors were partially
offset by the purchase of treasury stock totaling $303.6 million, the purchase of short-term investments of $78.8 million, the purchase of the assets of GoLive
Systems, Inc. and related entities for $31.0 million, and the payment of dividends totaling $9.2 million.
In September 1997, the CompanysCompany's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to 15.0 million shares of the
CompanysCompany's common stock over a two-year period. The Company repurchased approximately 0.8 million shares in the first quarter of fiscal 1999, and 10.1 million shares in fiscal
1998, and 4.1 million shares in fiscal 1997, at a cost of $30.5 million, $362.4 million, and $362.4$188.6 million, respectively. This program was completed during the first
quarter of fiscal 1999.
In April 1999, the CompanysCompany's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to an additional 5.0 million shares of
the CompanysCompany'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. No purchases have been made under the 5.0 million share repurchase program.
Under the CompanysCompany's existing plan to repurchase shares to offset issuances under employee stock plans, the Company repurchased approximately 2.14.0 million shares in fiscal 1999
and 0.4 million shares in fiscal 1998, at a cost of $114.8$273.1 million and $16.8 million, respectively.
To facilitate the CompanysCompany's stock repurchase programs, the Company sold put warrants to independent third parties. Each warrant entitles the holder to sell one share of AdobesAdobe's common
stock to the Company at a specified price. On June 4,September 3, 1999, put warrants to sell approximately 222,100888,800 shares of the CompanysCompany's common stock were outstanding that expire on various dates
through July 1999January 2000 with an average exercise price of $41.26$80.33 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; 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
June 4,September 3, 1999, call options to purchase approximately 120,200440,000 shares of the CompanysCompany's common stock were outstanding that expire on various dates through July 1999January 2000 with an average
exercise price of $44.61$86.84 per share.
The Board of Directors of the Company declared twothree cash dividends on the CompanysCompany's common stock of $.05 per common share, one for each of the first, second, and secondthird quarters of
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, compliance with the terms of the line of credit and lease agreement, and other factors.
The CompanysCompany's principal commitments as of June
4,September 3, 1999 consisted of obligations under operating leases, a line of credit agreement, venture investing activities, real
estate development agreements, and various service agreements. These arrangementsThe line of credit agreement and obligations under operating leases are described in more detail below. The Company's other principal
commitments are discussed in more detail in the CompanysCompany's Annual Report on Form 10-K for the year ended November 27, 1998.
In August 1999, the Company entered into a $200,000,000 unsecured revolving line of credit with a group of 15 banks for general corporate purposes, subject to certain
financial covenants. One-half of the facility expires in August 2000, the other $100,000,000 expires in August 2002. Outstanding balances accrue interest at LIBOR plus a
margin that is based on the financial ratios of the Company. There were no outstanding balances on the credit facility as of September 3, 1999. In addition, as of September 3, 1999, the
Company was in compliance with all financial covenants.
Management believes that if the line of credit is cancelled or amounts are not available under the line, there would not be a material adverse effect on the Company's financial results, liquidity, or capital resources.
In August 1999, the Company restructured its current lease agreements for its corporate headquarters in San Jose, California. The amended and restated agreement replaces the two prior lease agreements entered into in 1996 and 1998. The lease is for a period of five years and is subject to standard covenants including financial ratios. The Company has an option to purchase the buildings at any time during the term for an amount equal to the total investment of the lessor. At the end of the lease term, the Company may exercise the purchase option or, with the mutual agreement of the lessor, renew the term of the lease. In addition to these possibilities, at the end of the term, the Company may elect to have the buildings sold to an unrelated third party. In such case, the Company is obligated to use its best efforts to arrange for such a sale and is obligated to pay the lessor the difference between the total investment in the buildings and the net sales proceeds; provided however, that in no event would the Company be required to pay more than a maximum guaranteed residual amount as set forth in the lease. In the event of a default by the Company during the term of the lease, the lessor could require the Company to purchase the buildings for an amount equal to the Company's option price. As of September 3, 1999, the Company was in compliance with all financial covenants.
Under the terms of the line of credit and the lease agreement, the Company may pay cash dividends unless an event of default has occurred or it does not meet certain financial ratios.
The Company believes that existing cash, cash equivalents, and short-term investments, together with cash generated from operations and cash available under the line of
credit, 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 CompanysCompany's market risk disclosures set forth in Item 7a of its Annual Report on Form 10-K for the year ended November 27, 1998 have not changed
significantly.
PART IIOTHER 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 Adobes 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 Companys acquisition of
Frame in October 1995. The Court granted Adobes 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 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
courts 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. On April 15,
1999, this action was dismissed with prejudice without any payment by the Board
members or Adobe to the plaintiff or counsel for the plaintiff.
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("Frame"), Hambrecht & Quist, LLP (("H&QQ"), 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. The court granted plaintiffs' motion for class certification on September 22, 1999. 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 HeidelbergersHeidelberger'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 CompanysCompany's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Please see the Company's Report on Form 10-Q for the quarter ended June 4, 1999 for previously reported information.
The Annual MeetingITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In August 1999, the Company entered into a $200,000,000 unsecured revolving line of Stockholders was held on April 15, 1999.
A proposal to elect three (3) Class II Directorscredit and into an amendment and restatement of the leases for its corporate headquarters.
Under their terms, the Company may pay cash dividends unless an event of default has occurred or it does not meet certain financial ratios. In addition, half of the line of credit facility may be used
to serve
for a one-year term expiring atrepurchase shares of its common stock (to the Annual Meeting of Stockholders in 2000 was
approvedextent permitted by the stockholders. The nominees received the following votes:facility).
Introduced was a proposal to approve the amendment
of the Companys 1997 Employee Stock Purchase Plan, including an increase
of 2,500,000 in the number of shares reserved for issuance under the Amended
1997 Employee Stock Purchase Plan. This proposal was approved with the following
votes:
In addition, stockholders ratified the appointment
of KPMG LLP as independent public accountants of the Company for the fiscal
year ending December 3, 1999. This proposal received the following votes:
Abstentions and broker non-votes were each included
in the determination of the number of shares represented at the meeting for
purposes of determining the presence of a quorum at the Companys Annual
Meeting of Stockholders. Each was tabulated separately. Abstentions and broker
non-votes were not counted for purposes of determining the number of votes cast
for a proposal.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
| | Incorporated by Reference | | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Exhibit Number | | Filed Herewith | |||||||||||||
Exhibit Description | Form | Date | Number | ||||||||||||
3.1 |
|||||||||||||||
The |
10-Q | 05/30/97 |
3.1 | ||||||||||||
3.2.10 | Amended and Restated Bylaws as currently in effect. | 8-K | 9/3/98 |
3.2 | |||||||||||
3.3 | Certificate of Designation of the Series A Preferred Stock | 10-K | 05/30/97 |
2.1 | |||||||||||
3.4 | Agreement and Plan of Merger effective 5/30/97 (by virtue of a reincorporation), by and between Adobe Systems Incorporated, a California corporation and Adobe Systems (Delaware) Incorporated, a Delaware corporation. | 10-Q | 05/30/97 |
2.1 | |||||||||||
4.1 | Third Amended and Restated Rights Agreement between the Company and Harris Trust Company of California | 8-K | 12/15/98 |
1 | |||||||||||
10.1.6 | 1984 Stock Option Plan, as amended* | 10-Q | 07/02/93 |
10.1.6 | |||||||||||
10.21.3 | Revised Bonus Plan* | 10-Q | 02/28/97 | 10.21.3 | |||||||||||
1994 Performance and Restricted Stock Plan* | S-8 | 07/27/94 |
10.24.1 | ||||||||||||
10.24.2 | Amended 1994 Performance and Restricted Stock Plan* | 10-Q | 05/29/98 | 10.24.1 | |||||||||||
11/30/90 | 10.17.2 | ||||||||||||||
Form of Indemnity Agreement* | 05/30/97 | 10.25.1 | ||||||||
Sublease of the Land and Lease of the Improvements By and Between Sumitomo Bank Leasing and Finance Inc. and Adobe Systems Incorporated (Phase 1) | 10-K | 11/25/94 |
10.32 | |||||||
10.36 | 1996 Outside Directors Stock Option Plan* | 10-Q | 05/31/96 |
10.36 | ||||||
10.37 | Confidential Resignation Agreement* | 10-Q | 05/31/96 |
10.37 | ||||||
10.38 | Sublease of the Land and Lease of the Improvements By and Between Sumitomo Bank Leasing and Finance Inc. and Adobe Systems Incorporated (Phase 2) | 10-Q | 08/30/96 |
10.38 | ||||||
10.39 | 1997 Employee Stock Purchase Plan, * | S-8 | 05/30/97 |
10.39 | ||||||
10.40 | ||||||||||
1994 Stock Option Plan, as amended* | S-8 | 05/30/97 |
10.40 | |||||||
10.41 | ||||||||||
Amended and Restated Limited Partnership Agreement of Adobe Incentive Partners, L.P.* | 10-Q | 05/30/97 |
10.41 | |||||||
10.42 | Amended and Restated Limited Partnership Agreement of Adobe Incentive Partners, L.P.* | 10-Q | 8/28/98 | 10.42 | ||||||
10.43 | Resignation Agreement* | 10-K | 11/28/97 | 10.43 | ||||||
10.44 | Forms of Retention Agreement* | 10-K | 11/28/97 | 10.44 | ||||||
Confidential Executive Resignation Agreement And General Release of Claims* | 10-Q | 8/28/98 | 10.45 | |||||||
10.46 | ||||||||||
Confidential Executive Resignation Agreement And General Release of Claims* | 10-Q | 8/28/98 | 10.46 | |||||||
10.47 | ||||||||||
Confidential Executive Resignation Agreement And General Release of Claims* | 10-Q | 8/28/98 | 10.47 | |||||||
10.48 | ||||||||||
Letter of Release and Waiver* | 10-K | 11/27/98 | 10.48 | |||||||
Confidential Executive Resignation Agreement And General Release of Claims* | 10-Q | 3/5/99 | 10.49 | |||||||
10.50 | ||||||||||
Confidential Executive Separation Agreement And General Release of Claims* | 10-Q | 6/4/99 | 10.50 | |||||||
10.51 | ||||||||||
Amended 1997 Employee Stock Purchase Plan* | S-8 | 6/21/99 | 10.51 | |||||||
Amendment to Limited Partnership Agreement of Adobe Incentive Partners, L.P.* | 10-Q | 6/4/99 | 10.52 | |||||||
10.53 | Amended, Restated and Consolidated Master Lease of Land and Improvements By and between Sumitomo Bank Leasing and Finance, Inc. and Adobe Systems Incorporated | X | ||||||||
10.54 | Credit Agreement among Adobe Systems Incorporated, Lenders named therein and ABN AMRO Bank N.V., as Administrative Agent, with certain related Credit Documents | X |
||||||||
9/15/99 | 4.6 | |||||||||
21 | Subsidiaries of the Registrant | 10-K | 11/27/98 | 21 | ||||||
27.1 | Financial Data Schedule | X |
||||||||
27.2 | Financial Data Schedule | X |
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. | |||
Harold L. Covert, | |||
Date: JulyOctober 15, 1999
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
Adobe PhotoDeluxe
Adobe Publishing Collection
Adobe Type Manager
Acrobat
After Effects
Extreme
FrameMaker
GoLive
Illustrator
InDesign
PageMaker
Photoshop
PostScript
PrintGear
All other brand or product names are trademarks or registered trademarks of their respective holders.