Before we go on, I received a note from Adobe's senior director of investor relations, Mike Saviage. Unfortunately, Mike was writing to call to my attention a statistical error I committed in last Friday's article. (Sheesh, a Fool can't get away with anything anymore!) In addition, Mike provided some more insight into Adobe's "OEM (original equipment manufacturer) Postscript and Other" market segment. Let's do the correction first. In the previous article, concerning Adobe's revenue by segment, I wrote:
"The OEM and Other category accounted for about $210 million in 1999, although the company expects income from this source to dwindle over time." The OEM segment actually produced $138 million in revenues in 1999, a 34% decline from the $210 million in revenue from this segment in 1998.
In addition, Mike provided the following description of OEM revenues:
"Adobe's OEM PostScript and Other market segment... comes from our PostScript licensing business. This is royalty revenue, derived mostly from the sales of third-party printers which include Adobe PostScript technology."
The software that comes pre-loaded on computers is allocated to one of the other segments, depending upon which software title gets bundled, and does not go to the OEM category, as I incorrectly stated in my previous article.
So, with that out of the way, our next step in understanding the Web publishing software landscape is to assess Adobe's primary competitor, Macromedia. As we did with Adobe, let's take a look at the company's financials before we delve into the business.
What follows is a side-by-side comparison of Adobe and Macromedia. The first two columns present each company's most recent fiscal year, which for Adobe ended in December 1999 and for Macromedia ended in March 2000. That, of course, skews the comparison a bit in favor of Macromedia. But to even things out, the second two columns compare their most recent quarters. (If any of the terminology below throws you for a loop, please see our Rule Maker Criteria.)
($ Million) ADBE 99 MACR 00 ADBE Q1 MACR Q4 Annual sales $1,015 $264 $282 $89 Sales growth 13.5% 72.4% 27.1% 95.0% Gross margin 90.6% 89.1% 92.7% 88.5% Net income $237.5 $30.3 $64.6% $12.5 Net margin 23.3% 11.5% 22.9% 14.0% Cash $498.7 $187.0 $641.6 $187.0 Debt None None None None Flow Ratio 0.47 0.86 0.43 0.86 Cash King Mar. 24.5% -3.6% N/A N/A
Let me explain a couple of important things about the numbers before we draw any conclusions. First, the net income and net margins for Macromedia are on a pro forma basis, which excludes the non-cash charges associated with two acquisitions. On a reported basis, Macromedia's net income was only $6.2 million for 1999 and $5.5 million in the fourth quarter. Net margin would have been 2.3% and 6.2% for the full year and fourth quarter, respectively, on a reported basis. Finally, since Macromedia's 10-K is not yet available, the cash flow information was calculated through the first nine months only.
With that little explanation out of the way, let's see what the numbers are telling us. First of all, Adobe's sales for the 1999 fiscal year were about four times Macromedia's (keeping in mind that Macromedia's fiscal year ends one quarter later than that of Adobe; if we had taken Adobe's last four quarters instead of fiscal year 1999, it would've added about $55 million in revenue). By comparing revenue from each company's most recent quarter, we see that Macromedia has whittled Adobe's lead to just over a three-to-one ratio. Macromedia's year-over-year sales growth was an amazing 95% versus Adobe's merely excellent 27%.
Let's look at this another way. In fiscal 1999, Adobe's Web publishing software accounted for about 40% of revenues, or $394 million. Macromedia, on the other hand, derives something like 85-90% of revenues from Web publishing software. If we extend those percentages to the most recent quarters, Adobe's Web publishing revenues would be about $113 million, and Macromedia would be about $76 million. That's pretty darn close. So this battle over Web publishing software is much tighter than I originally thought. When you back out Adobe's Photoshop sales, the market for Web design tools becomes even closer. It is not by any means a foregone conclusion that Adobe is going to win the battle for the Web designer software market.
Of course, we have to remember that Adobe has, in addition to the Web design software, a huge share of the document publishing and photo-editing software markets, as well as chunks of additional markets. So, Web publishing isn't the only game in town for Adobe. It is, however, the company's largest revenue source. For Macromedia, the Web design market is pretty much the whole enchilada.
Web publishing happens to be one of the fastest-growing sectors in the packaged software industry. To get some sense of how fast this market is growing, I talked to Roger Lanctot, the director of research at PC Data, which is a market research company that tracks sales for virtually every computer-related product. According to Roger, this most recent quarter was one of flat and even negative growth for the vast majority of packaged software product categories. This is after a rather slow year in 1999 for retail software sales (please see this PC Data report on 1999 software sales). Within this low-growth scenario, the retail market for Web publishing software grew 67% year-over-year in the first quarter of 2000, according to data compiled by Scott Sutphin, a PC Data research analyst. "The category just jumps out at you due to the high growth for the sector as compared to the other categories" was Roger's comment on the Web publishing market.
There is a lot of other useful information on PC Data's website, some of which we will use in our analysis of companies we will be looking at later on in our software study. If you're interested in the software sector, you might enjoy perusing their site.
So, while Adobe has what looks like a hammerlock on the document management and photo-editing markets, Macromedia represents stiff competition in the Web design segment. Let's see what other conclusions we can draw from our head-to-head financial comparison. Gross margins are tremendous at both companies. Net income was six times larger at Adobe.
Additionally, Adobe really shines in the cash flow categories. With a 0.43 Flow Ratio, Adobe's Flowie was half that of Macromedia's. While I don't yet have full-year cash flow data for Macromedia, my guess is that the company will essentially have zero free cash flow for the most recent fiscal year. (Macromedia's 1999 free cash flow was $21 million.) Meanwhile, Adobe will have generated as much in free cash flow as Macromedia did in sales over the past 12 months. Adobe's free cash flow to fund new opportunities represents a source of tremendous advantage.
Still, Macromedia's growth is very impressive, and we'll be back to look at the company in more detail in next Friday's report. If you've got some insights on Macromedia, or if you know of any other potential competitors for Adobe's business, let's hear 'em on the Rule Maker Strategy discussion board.
Have a great weekend!
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