Business Context and Reporting Period
Company: Adobe Systems Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2002 (Second Quarter of Fiscal Year 2002)
Business Overview: Adobe is a leader in network publishing, offering software for enterprise and creative professional customers to create, manage, and deliver content. Operations span the Americas, EMEA, and Asia.
Key Financial Metrics
| Metric (in thousands) | Q2 2002 | Q2 2001 | 6 Months 2002 | 6 Months 2001 |
|---|---|---|---|---|
| Revenue | $317,359 | $344,093 | $585,255 | $673,062 |
| Gross Profit | $292,226 | $321,734 | $539,125 | $630,687 |
| Gross Margin | 92.1% | 93.5% | 92.1% | 93.7% |
| Operating Income | $90,848 | $117,899 | $154,633 | $233,353 |
| Net Income | $54,301 | $61,305 | $104,109 | $131,061 |
| Diluted EPS | $0.22 | $0.25 | $0.42 | $0.52 |
| Cash & Equivalents | $231,252 | $218,662 | $231,252 | $218,662 |
| Short-term Investments | $468,660 | $362,951 | $468,660 | $362,951 |
| Working Capital | $561,123 | $453,713 | $561,123 | $453,713 |
Note: Cash flow from operating activities for the six months ended May 31, 2002, was $146.8 million.
Material Changes vs. Prior Period
- Revenue Decline: Revenue decreased 8% ($26.7 million) in Q2 2002 compared to Q2 2001, and 13% ($87.8 million) for the six-month period. This was attributed to global economic weakness and declines in the ePaper Solutions, Cross-media Publishing, and OEM PostScript segments.
- Segment Performance:
- Graphics: Increased 4% in Q2 2002, driven by the release of Photoshop 7.0.
- ePaper Solutions: Decreased 16% in Q2 2002 due to the lifecycle of Acrobat 5.0, partially offset by the Accelio acquisition.
- OEM PostScript: Decreased 26% in Q2 2002 due to weakness in the print business and OEM customers shifting to clone technologies.
- Investment Losses: Net investment loss was $13.7 million in Q2 2002, a significant improvement from $31.0 million in Q2 2001. The Q2 2002 loss included $8.8 million in other-than-temporary writedowns of short-term investments.
- Acquisitions: Adobe acquired Accelio Corporation in April 2002 for $70.2 million (mostly stock) to enhance ePaper solutions. Goodwill of $75.0 million was recorded and will not be amortized under SFAS 142.
- Restructuring: Incurred $1.6 million in restructuring charges in Q2 2002 related to eliminating 39 redundant positions following the Accelio acquisition.
Guidance, Outlook, and Risks
Guidance and Outlook
On June 13, 2002, management provided the following targets for the third quarter of fiscal 2002:
- Revenue: $300.0 million to $320.0 million.
- Pro Forma EPS: $0.24 to $0.27.
- Gross Margin: 92%.
- Operating Profit Margin: 28-30% (pro forma).
- Expense Targets: R&D (20-21% of revenue), Sales & Marketing (33-34% of revenue), G&A (9-10% of revenue).
Preliminary targets for the fourth quarter of fiscal 2002 include revenue of $315.0 million to $345.0 million and pro forma EPS of $0.26 to $0.29.
Risks and Contingencies
- Legal Proceedings: Ongoing patent litigation with Macromedia, Inc.
- Adobe won a verdict for ~$2.8 million in damages for Macromedia's infringement of the "tabbed palette" patent.
- Macromedia won a verdict for ~$5.0 million in damages for Adobe's infringement of "blending" and "sound" patents.
- Post-trial motions are pending; final amounts and injunctions are expected in summer/fall 2002.
- Font Licensing: Received claims from a third-party font licensor to terminate licenses. Adobe believes claims are invalid but notes potential revenue impact if litigation is unsuccessful.
- Market Risks: Exposure to foreign currency fluctuations (Yen, Euro) and volatility in equity investment portfolios. Management utilizes hedging strategies to mitigate these risks.
- Accounting Changes: Full adoption of SFAS 142 (Goodwill) and SFAS 144 (Impairment) beginning in fiscal year 2003.
Investor Verification Checklist
- Revenue Mix: Verify the sustainability of the Graphics segment growth (Photoshop 7.0) against the continued decline in the OEM PostScript segment.
- Investment Portfolio: Assess the remaining exposure to other-than-temporary writedowns in the short-term investment portfolio.
- Legal Exposure: Monitor the resolution of the Macromedia patent litigation to determine final liability and potential injunctions.
- Acquisition Integration: Evaluate the integration progress of Accelio and its contribution to the ePaper segment revenue.
- Stock Repurchase: Review the potential cash outlay from outstanding put warrants and call options related to the stock repurchase program (potential outlay of ~$261.6 million if all exercised).