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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________________ TO ___________________
COMMISSION FILE NUMBER: 0-15175
ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 77-0019522
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
No.)
345 PARK AVENUE, SAN JOSE, 95110-2704
CALIFORNIA
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (408) 536-6000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K. [ ]
The aggregate market value of the common stock held by non-affiliates of the
registrant as of December 26, 1997 was $2,533,370,488.
The number of shares outstanding of the registrant's common stock as of
December 26, 1997 was 68,639,439.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement dated March 4, 1998 to be
delivered to stockholders in connection with the Notice of Annual Meeting of
Stockholders to be held on April 8, 1998 are incorporated by reference into Part
III.
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TABLE OF CONTENTS
PAGE NO.
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PART I
Item 1. Business.................................................................................... 3
Item 2. Properties.................................................................................. 12
Item 3. Legal Proceedings........................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......................................... 14
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters........................ 15
Item 6. Selected Financial Data..................................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 17
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.................................. 27
Item 8. Financial Statements and Supplementary Data................................................. 30
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure........ 31
PART III
Item 10. Directors and Executive Officers of the Registrant.......................................... 32
Item 11. Executive Compensation...................................................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................. 34
Item 13. Certain Relationships and Related Transactions.............................................. 35
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K............................. 36
Signatures.............................................................................................. 38
Summary of Trademarks................................................................................... 39
Financial Statements.................................................................................... 40
Financial Statement Schedule............................................................................ 67
Exhibits................................................................................................ 69
2
FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS DESCRIBED IN OTHER
DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE
COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE
COMPANY IN 1998. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL
REPORT ON FORM 10-K. 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.
PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEW
Adobe Systems Incorporated ("Adobe" or the "Company") develops, markets, and
supports computer software products and technologies that enable users to
express and use information across all print and electronic media. The Company
offers a market-leading line of application software and type products for
creating and distributing visually rich communication materials; licenses its
industry-standard technologies to major hardware manufacturers, software
developers, and service providers; and offers integrated software solutions to
businesses of all sizes. The Company's software runs on Microsoft Windows, Apple
Macintosh, and UNIX platforms.
The Company was originally incorporated in California in October 1983 and
was reincorporated in Delaware in May 1997. The Company maintains its executive
offices and principal facilities at 345 Park Avenue, San Jose, California
95110-2704. Its telephone number is 408-536-6000. The Company also maintains a
World Wide Web site at HTTP://WWW.ADOBE.COM.
PRODUCTS
In 1984, Adobe developed the software that initiated desktop publishing.
Today, Adobe is uniquely positioned to make a further dramatic impact not only
on how society creates visually rich information, but also on how it distributes
and accesses that information electronically.
While other major software companies' products deal in raw words, data, and
numbers, Adobe software helps people use the computer to express and share their
ideas in imaginative and meaningful new ways, whether the choice of media is
static or dynamic, paper or electronic. In the simplest terms, Adobe products
enable people to create, send, view, and print high-impact information, helping
them and their ideas stand out.
Adobe software enables users to work with professional creative tools;
assemble illustrations, images, and text into fully formatted documents; output
documents directly to any kind of printing device; and distribute documents on
paper, video, or compact disc, over the Internet, an e-mail system, or corporate
network. Moreover, Adobe software enables users to perform all of these tasks
across multiple computing environments, including Microsoft Windows, Apple
Macintosh, and UNIX.
3
GRAPHICS PRODUCTS
Adobe Photoshop--provides photo design enhancement, production for
print, the Internet, and multimedia used by graphic designers, Internet
content creators, Webmasters, and digital photographers.
Adobe Illustrator--an illustration and page design tool for print, the
Internet, and multimedia used by professional illustrators and Internet
content creators.
Adobe PageMaker--a tool for creating and producing professional-quality
printed and electronic pages used by designers, business people, publishers,
and prepress professionals around the world.
Adobe Premiere--provides non-linear digital video editing used in
multimedia and video production.
Adobe After Effects--provides two-dimensional (2D) animation, motion
compositing, and special effects used in multimedia, broadcast, and film
production.
Adobe Type Library--contains over 2,400 high-quality outline typefaces
used by graphics professionals and Internet content creators worldwide.
ENTERPRISE PRODUCTS
Adobe FrameMaker--an application for authoring and publishing long and
complex documents including books, technical manuals, and reports.
Adobe Acrobat--the fastest way to publish and distribute business
documents of any kind on corporate e-mail and intranets, the Internet, or
CD-ROM. Adobe Acrobat software includes everything needed to create and
distribute rich electronic documents that can be viewed seamlessly within
leading Web browsers. Adobe Acrobat Capture enables conversion of legacy
paper-based documents into indexable, searchable, platform-independent
electronic form for archiving and distribution purposes.
HOME & OFFICE PRODUCTS
Adobe PageMill--a tool used to create full-featured Web pages without
requiring user knowledge of hypertext mark-up language (HTML). Employing
easy drag-and-drop techniques simplifies operation, from creating or
importing text and images to adding audio, video, and animation.
Adobe PhotoDeluxe--software that allows consumers and small businesses
to easily enhance and personalize their photos for a wide variety of
applications in print and electronic media.
PRINTING SYSTEMS PRODUCTS
Adobe PostScript--a page description language that delivers high quality
output, cross-platform compatibility, and top performance for
graphically-rich printing output from corporate desktop printers to high-end
publishing printers.
Adobe PostScript 3--a page description language that takes digital
printing to a new level, providing an optimized printing environment
connected to corporate networks, the Internet, and digital document
distribution systems.
Adobe PrintGear--a printing architecture that redefines the standards
for high-throughput, low-cost, high-quality printing for the small
office/home office and small corporate workgroup environments.
4
Adobe PostScript Extreme--the innovative new production printing
architecture that integrates Adobe PostScript and the Portable Document
Format ("PDF"). This architecture has been endorsed by the printing industry
as the new standard for high-performance print-on-demand, direct-to-press,
and high-resolution imagesetter printing systems.
COMPETITION
The markets for Adobe products are characterized by intense competition,
evolving industry standards, rapid technology developments, and frequent new
product introductions. Adobe's future success will depend on its ability to
enhance its existing products, introduce new products on a timely and
cost-effective basis, meet changing customer needs, extend its core technology
into new applications, and anticipate or respond to emerging standards and other
technological changes.
GRAPHICS PRODUCTS
Within its Graphics Products area, Adobe markets six product families that
fall into two major groupings: professional publishing (Adobe Photoshop, Adobe
PageMaker, Adobe Illustrator, and Adobe Type Library) and dynamic media (Adobe
Premiere and Adobe After Effects). In these groupings, the individual products
compete favorably on the basis of features and functions, installed base, ease
of use, product reliability, and price and performance characteristics. In
addition, the products increasingly work well together, providing broader
functionality and minimizing product learning issues for the individual who uses
multiple applications to complete a project.
A number of companies currently offer one or more products that compete
directly or indirectly with one or more of Adobe's graphics products. These
companies include Quark, Macromedia, Corel, MetaCreations, Avid and Linotype.
With the advent of the World Wide Web, the needs of the graphics
professional are rapidly changing to encompass on-line publishing as well as
print-based publishing. These changing customer needs have created new
opportunities for Adobe's graphics products, drive the Company's product
development cycles, and introduce new potential competitors.
ENTERPRISE PRODUCTS
In the authoring and publishing market, the Company's Adobe FrameMaker
product faces competition from large-scale electronic publishing systems
developed by several companies, including Interleaf. Participants in this market
compete based on the quality and features of their products, the level of
customization and integration with other publishing system components, the
number of hardware platforms supported, service, and price. The Company believes
it can successfully compete in this market based upon the quality and features
of the Adobe FrameMaker product, its extensive application programming
interface, the large number of platforms supported, and other factors.
In the document transmission and archive area, the Company's Adobe Acrobat
family faces competition from entrenched office applications and internet
content creation tools that use HTML. The Company feels it competes favorably in
terms of the combined benefits of compression, visual fidelity, transmittal time
and security of documents expressed using Adobe Acrobat Portable Document Format
(PDF). Competitors include Microsoft and Corel.
HOME & OFFICE PRODUCTS
The consumer software market is characterized by intense competition, price
sensitivity, brand awareness, and strength in retail distribution. Adobe faces
direct and indirect competition in these markets from a number of companies,
including Microsoft and Broderbund. The Company believes it competes favorably
with its Adobe PhotoDeluxe product due to its strong relationships with critical
original
5
equipment manufacturers ("OEMs") and market influencers and its ability to
leverage core competencies from established products.
The Internet market is a constantly evolving and highly volatile market,
characterized by rapid technology developments and frequent new product
introductions. Adobe PageMill faces significant competition from companies
offering similar products and will continue to face competition from emerging
technologies and products. Some of these competitors include Macromedia,
Microsoft, and NetObjects.
PRINTING SYSTEMS PRODUCTS
Adobe believes that the principal competitive factors for OEMs in selecting
a page description language or a printing technology are product capabilities,
market leadership, reliability, support, engineering development assistance, and
price. The Company believes that its competitive advantages include its
technology competency, OEM relationships, and intellectual property portfolio.
Adobe PostScript and Adobe PrintGear software face competition from
Hewlett-Packard's proprietary PCL page description language, and from developers
of page description languages based on the PostScript language standard,
including Xionics and Harlequin.
OPERATIONS
MARKETING AND DISTRIBUTION
Adobe markets and distributes its products directly and through multiple
channels, including distributors, retailers, systems integrators, software
developers, and value-added resellers ("VARs"), as well as through OEM and
hardware bundle customers. Adobe supports its worldwide distribution network and
end-user customers through international subsidiaries. Adobe Systems Europe Ltd.
is headquartered in Edinburgh, Scotland, with subsidiaries in France, Germany,
Italy, the Netherlands, Spain, Sweden, Switzerland, and the United Kingdom.
Adobe's Pacific Rim presence includes Adobe Systems Company Ltd. in Japan as
well as operations in Asia, Pacific, and Latin America, including Australia,
Hong Kong, Korea, Singapore, India, and Mexico. The Company also has operations
in Canada. More than 6,000 resellers in the United States and Canada and more
than 300 distributors throughout Europe, Japan, and Asia, Pacific, and Latin
America offer Adobe software applications and type products.
Adobe licenses its Adobe PostScript software and other printing systems
technology to computer and printer manufacturers, who in turn distribute their
products worldwide. The Company derives a significant portion of Adobe
PostScript royalties from international sales of printers, imagesetters, and
other output devices by its OEM customers.
MANUFACTURING
Manufacturing operations include duplication of disks, assembly of purchased
parts, and final packaging for retail products. Adobe contracts a majority of
its manufacturing activities to third parties, both in the United States and in
Europe.
Disk duplication for European language versions of the Company's products is
managed through the European headquarters. The master disks of European-language
versions of products are forwarded to McQueen Holdings Limited ("McQueen") which
duplicates the disks, prints, and assembles the components and ships the
completed product. Quality control tests are performed on all duplicate disks
and finished products.
At November 28, 1997, the Company held a 13% equity interest in McQueen.
Effective December 31, 1997, McQueen was acquired by Sykes Enterprises, Inc.
("Sykes") and the Company exchanged its shares of McQueen for shares of Sykes
common stock. The Company expects to maintain its business relationship
6
with McQueen and that McQueen will continue to provide services to the Company
for the foreseeable future.
To date, Adobe has not experienced significant difficulties in obtaining raw
materials for the manufacture of its products or in the duplication of disks,
printing, and assembly of components, although an interruption in production by
a supplier could result in a delay in shipment of Adobe's products. There was no
material backlog of orders as of December 26, 1997.
CUSTOMER SUPPORT AND EDUCATION
For Adobe's application software, a technical support and services staff
responds to customer queries by phone and on-line. The Company also informs
customers through its ADOBE MAGAZINE and a growing series of how-to books
published by Adobe Press, a joint venture with Macmillan Computer Publishing. In
addition, Adobe prepares and authorizes independent trainers to teach Adobe
software classes in person or increasingly via computer-based and internet-based
training programs, sponsors workshops led by its own graphics staff, interacts
with independent user groups, and conducts regular seeding and testing programs.
INVESTMENT IN NEW MARKETS
The Company has invested in two venture capital limited partnerships that
are chartered to invest in innovative companies strategic to Adobe's software
business. Adobe Ventures L.P. and Adobe Ventures II L.P. enable the Company to
join other investors in making new products and services available to computer
users and in building new market opportunities. Adobe has thus invested in new
markets, and intends to continue investing in new markets, both through the
limited partnerships as well as by direct investments by the Company.
The Company owns a minority interest in certain companies and a majority
interest in Adobe Ventures L.P. and Adobe Ventures II L.P. Investments in
publicly traded equity securities that are free of trading restrictions, or will
become free of trading restrictions within one year, are carried at fair value
based on quoted market prices. Investments in equity securities that are not
publicly traded, or are restricted from trading for more than one year, are
carried at the lower of cost or market.
The investments in Adobe Ventures L.P. and Adobe Ventures II L.P. are
accounted for using the equity method of accounting, and, accordingly, the
investments are adjusted to reflect the Company's share of Adobe Ventures L.P.
and Adobe Ventures II L.P.'s investment income (loss) and dividend
distributions. Adobe Ventures L.P. and Adobe Ventures II L.P. carry their
investments in equity securities at an estimated fair market value and
unrealized gains and losses are included in investment income (loss).
Substantially all of the technology companies held by the limited partnerships
at November 28, 1997 are not publicly traded, and, therefore, there is no
established market for these investments. As such, these investments are valued
based on the most recent round of financing involving new non-strategic
investors and estimates made by the general partner, a third party. When
investments held by the limited partnerships are publicly traded, the fair value
of such investments is based on quoted market prices, and mark-to-market
adjustments are included in investment income. In general, as a matter of policy
of the limited partnerships, the investments in the technology companies held by
the limited partnerships will be distributed to the partners prior to the
investee company's initial public offering.
In March 1997, as part of its venture investing program, the Company
established an internal limited partnership, Adobe Incentive Partners L.P.
("AIP"), which allows certain of the Company's executive officers to participate
in cash or stock distributions from Adobe's venture investments. Assets held by
AIP include Adobe's entire interests in Adobe Ventures L.P. and Adobe Ventures
II L.P. and equity securities of privately-held companies. Adobe is both the
general partner and a limited partner. Other limited partners are executive
officers of the Company who are involved in Adobe's venture investing activities
and whose participation is deemed critical to the success of the program.
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Adobe's Class A senior limited partnership interest includes both a
liquidation preference and a preference in recovery of the cost basis of each
specific investment. The executives' Class B junior limited partnership interest
qualifies for partnership distributions only after: (a) Adobe has fully
recovered the cost basis of its investment in the specific investee company for
which a distribution is made; and (b) the participating executive has vested in
his or her distribution rights. The distribution rights generally vest on a
monthly basis over three years, such that the rights are 25% vested after one
year, 50% vested after two years and fully vested at the end of three years. The
limited partnership investments are restricted to investments in companies that
are private at the time of the establishment of AIP or when the investment is
made, whichever is later. Partnership interests may be allocated to designated
officers only while the investee company is still private. Class B interests may
not exceed a maximum of 20% of the venture investments included in AIP. No
distributions were made to the participating officers in fiscal 1997 and expense
related to AIP in fiscal 1997 was immaterial. At November 28, 1997, the minority
interest held by the participating officers was immaterial and is included in
accrued expenses on the balance sheet.
The Company's portfolio of equity investments including those held by AIP at
November 28, 1997, had a cost basis of $56.1 million and was valued at $46.9
million. Gross proceeds from the sale of equity securities during 1997 was $40.0
million. The Company's equity investments and Adobe Ventures L.P. and Adobe
Ventures II L.P.'s investments in equity securities at November 28, 1997
consisted of the following companies:
PRIVATE PUBLIC
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ADOBE EQUITY INVESTMENTS
Cascade Systems International.................................................................. X
Datalogics Incorporated........................................................................ X
McQueen International Ltd...................................................................... X
Objectivity Incorporated....................................................................... X
Pointcast Inc.................................................................................. X
Siebel Systems, Inc............................................................................ X
Tier Two Systems............................................................................... X
Vertec Solutions, Inc.......................................................................... X
ADOBE VENTURES L.P. EQUITY INVESTMENTS
Cogito Learning Media, Inc..................................................................... X
Crosswise Corporation.......................................................................... X
Digimarc Corporation........................................................................... X
Digital Think Inc.............................................................................. X
Electronic Submission Publishing Systems, Inc.................................................. X
Extensis Corporation........................................................................... X
Filenet Corporation............................................................................ X
Lantana Research............................................................................... X
Managing Editor Inc............................................................................ X
mFactory, Inc.................................................................................. X
Salon Internet, Inc............................................................................ X
ADOBE VENTURES II L.P. EQUITY INVESTMENTS
Extensis Corporation........................................................................... X
Tumbleweed Software Corporation................................................................ X
Vignette Corporation........................................................................... X
8
PRODUCT DEVELOPMENT
Since the personal computer software industry is characterized by rapid
technological change, a continuous high level of expenditures is required for
the enhancement of existing products and the development of new products. Adobe
primarily develops its software internally. The Company sometimes acquires
products developed by others by purchasing the stock or assets of the business
entity that held ownership rights to the technology. In other instances, Adobe
has licensed or purchased the intellectual property ownership rights of programs
developed by others with license or technology transfer agreements that may
obligate the Company to pay royalties, typically based on a percentage of the
revenues generated by those programs.
During the years ended November 28, 1997, November 29, 1996, and December 1,
1995, the Company's research and development expenses, including costs related
to contract development, were $170.9 million, $152.9 million, and $138.6
million, respectively. During each of the years 1997, 1996, and 1995, the
Company acquired through purchase transactions one or more software companies.
In each of these transactions, a portion of the purchase price was allocated to
in-process research and development and expensed at the time of the acquisition.
In 1997, 1996, and 1995, $6.0 million, $21.3 million, and $15.0 million was
expensed, respectively.
PRODUCT PROTECTION
Adobe regards its software as proprietary and protects it with copyrights,
patents, trademarks, trade secret laws, internal and external nondisclosure
precautions, and restrictions on disclosure and transferability that are
incorporated into its software license agreements. The Company protects the
source code of its software programs as trade secrets, and makes source code
available to OEM customers only under limited circumstances and specific
security and confidentiality constraints.
The Company's products are generally licensed to end users on a "right to
use" basis pursuant to a license that is nontransferable and restricts the use
of the products to the customer's internal purposes on a designated number of
printers or computers. The Company also relies on copyright laws and on "shrink
wrap" and electronic licenses that are not signed by the end user. Copyright
protection may be unavailable under the laws of certain countries. The
enforceability of "shrink wrap" and electronic licenses has not been
conclusively determined. Adobe has obtained many patents and has registered
numerous trademarks and logos in the United States and foreign countries.
Policing unauthorized use of computer software is difficult, and software
piracy is a persistent problem for the software industry. This problem is
particularly acute in international markets. Adobe conducts vigorous anti-piracy
programs. Adobe products do not contain copy protection, except on copies for
international distribution in certain countries. Many products, including Adobe
PageMaker, Adobe Photoshop, and Adobe Illustrator, incorporate network
copy-detection features. These capabilities help encourage compliance with the
Company's license agreements by alerting customers about certain concurrent
usage problems over a given network.
Adobe believes that, because computer software technology changes and
develops rapidly, patent, trade secret, and copyright protection are less
significant than factors such as the knowledge, ability, and experience of its
personnel, name recognition, contractual relationships, and ongoing product
development.
EMPLOYEES
As of December 26, 1997, Adobe employed 2,702 people, none of whom are
represented by a labor union. The Company has not experienced work stoppages and
believes its employee relations are good. Competition in recruiting personnel in
the software industry is intense. Adobe believes its future success will depend
in part on its continued ability to recruit and retain highly skilled
management, marketing, and technical personnel.
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EXECUTIVE OFFICERS
The executive officers of the Company as of February 16, 1998 are as
follows:
NAME AGE POSITIONS
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John E. Warnock 57 Chairman of the Board and Chief Executive Officer
Charles M. Geschke 58 Chairman of the Board and President
P. Jackson Bell 56 Executive Vice President, Chief Financial Officer, Chief Administrative
Officer, and Assistant Secretary
Ross A. Bott 46 Executive Vice President, Product Divisions
Robert A. Roblin 45 Executive Vice President, Marketing
Frederick A. Snow 61 Executive Vice President, Worldwide Field Operations
Hachiro Kimura 55 President, Adobe Systems Japan
Derek J. Gray 48 Senior Vice President and General Manager, Adobe Systems Europe
Colleen M. Pouliot 39 Senior Vice President, General Counsel, and Secretary
Fredrick A. Schwedner 56 Senior Vice President and General Manager, Printing and Systems Division
David P. Eichler 49 Vice President, Finance
A biography, including the principal occupations for the past five years of
each of the executive officers, is provided below.
Dr. Warnock was a founder of the Company and has been its Chairman of the
Board since April 1989. Beginning September 1997, he shares the position of
Chairman of the Board with Charles M. Geschke. He has been Chief Executive
Officer since 1982. Dr. Warnock received a Ph.D. in electrical engineering from
the University of Utah. He is a director of Evans & Sutherland Computer
Corporation, Netscape Communications Corporation, and Redbrick Systems.
Dr. Geschke was a founder of the Company and has been its President since
April 1989. In September 1997, Dr. Geschke assumed the position of Chairman of
the Board, sharing that office with Dr. Warnock. He was Chief Operating Officer
from December 1986 until July 1994. Dr. Geschke received a Ph.D. in computer
science from Carnegie Mellon University. Dr. Geschke is a director of Rambus
Incorporated.
Mr. Bell joined the Company in November 1996 as Executive Vice President,
Chief Financial Officer, Chief Administrative Officer, and Assistant Secretary.
From September 1993 to March 1996, Mr. Bell was Executive Vice President and
Chief Financial Officer of Conner Peripherals Incorporated. From 1991 through
September 1993, Mr. Bell was Senior Vice President of Planning and Senior Vice
President of Strategic Programs for American Airlines Incorporated.
Mr. Bott joined the Company in December 1996 as Senior Vice President and
General Manager, Graphics Division. He was promoted to Executive Vice President,
Product Divisions, in December 1997. From August 1996 to December 1996, he
served as Senior Vice President of Enterprise Technologies at Silicon Graphics
Incorporated. Prior to that time, he was Vice President and Chief Technology
Officer of Pyramid Technology Corporation.
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Mr. Roblin joined the Company in June 1996 as Senior Vice President,
Corporate Marketing. In December 1997, he was promoted to Executive Vice
President, Marketing. Prior to that time, Mr. Roblin served as Vice President of
Marketing for IBM Corporation's Consumer Division from April 1994 until joining
Adobe. Prior to IBM, Mr. Roblin was Vice President of Marketing for AT&T's EO
personal communicator company as a result of AT&T's acquisition of Pensoft
Corporation which he joined as Vice President of Marketing in 1992.
Mr. Snow joined the Company in February 1998 as Executive Vice President,
Worldwide Field Operations. Mr. Snow served as Chairman and Chief Executive
Officer of Kenwood Management Group from April 1997 until he joined the Company.
From November 1995 to April 1997, Mr. Snow was President and Chief Executive
Officer of SoftWorld Services Corporation. Prior to that time, Mr. Snow served
as Senior Vice President of Sales of Tech Data Corporation.
Mr. Kimura joined the Company in November 1993 as President and General
Manager of Adobe Systems Japan. In May 1996, Mr. Kimura was appointed as a
corporate officer of the Company. Mr. Kimura was President of SCI Japan, the
subsidiary of Systems Center Incorporated, from June 1992 until he joined the
Company. Prior to that time, Mr. Kimura was Vice President of Sales and Services
at Applied Materials Japan Corporation.
Mr. Gray joined the Company upon the closing of the acquisition of Aldus in
August 1994, at which time he was elected Senior Vice President of the Company
and General Manager, Adobe Systems Europe. Prior to that time, Mr. Gray served
as Managing Director of Aldus Europe Limited since 1986. Mr. Gray is a
co-founder and, for the ten years prior to joining Aldus, Managing Director of
McQueen International Limited, a distributor of computer hardware and software,
of which the Company was a 17% stockholder by virtue of the acquisition of
Aldus. Pursuant to a reorganization of the Company's Europe entity, Mr. Gray was
elected General Manager of Adobe Systems Europe in April 1995.
Ms. Pouliot joined the Company in July 1988 as Associate General Counsel and
became the Corporate Secretary in April 1989. In December 1990, she was promoted
to General Counsel. In December 1992, she was promoted to Vice President and in
December 1997, to Senior Vice President. Ms. Pouliot was an associate at the law
firm of Ware & Freidenrich from November 1983 until she joined the Company.
Mr. Schwedner joined the Company in August 1989 as Director of Engineering,
and in 1991 was promoted to Vice President of Engineering, Systems Product
Division. In May 1996, he was promoted to Senior Vice President and General
Manager of the Printing and Systems Division.
Mr. Eichler joined the Company in December 1997 as Vice President, Finance.
Mr. Eichler served as Senior Vice President, Finance and Administration, and
Chief Financial Officer of Hyundai Electronics America from March 1994 until he
joined the Company. From June 1993 to February 1994, Mr. Eichler was Chief
Financial and Chief Administrative Officer of Trident Systems. Prior to that
time, Mr. Eichler served as Assistant Corporate Treasurer of Syntex Corporation.
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ITEM 2. PROPERTIES
The following table sets forth the location, approximate square footage, and
use of each of the principal properties used by the Company. Except as where
indicated, all of the properties are leased or subleased by the Company. Such
leases expire at various times through January 2014. The annual base rent
expense for all facilities (including operating expenses, property taxes, and
assessments) is currently $22.3 million and is subject to annual adjustment.
APPROXIMATE
SQUARE
LOCATION FOOTAGE USE
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North America:
345 Park Avenue 354,000 Research, product development, sales, marketing
San Jose, California and administration
USA
333 West San Carlos Avenue 105,970 Sales and administration
San Jose, California
USA
303 Almaden Boulevard 134,627 Sales, administration, research and product
San Jose, California development
USA
411 First Avenue South 144,038 Product development, customer support, and
Seattle, Washington administration
USA (1)
Europe:
Five Mid New Cultins 22,000 Sales, marketing, and administration
Edinburgh EH11 4DU
Scotland, United Kingdom
(Owned)
Japan:
Yebisu Garden Place Tower 20,237 Sales, marketing, and administration
4-20-3 Ebisu, Shibuya-ku
Tokyo 150 Japan
Asia, Pacific, and Latin America:
18-20 Orion Road 4,277 Sales, marketing, and administration
Lane Cove, NSW 2066
Australia
In general, all facilities are in good condition and are operating at
capacities which range from 75% to 100%.
(1) The lease on this facility expires in July 1998 and is expected to be
replaced by a lease on a new 253,000 square foot facility in Seattle.
12
ITEM 3. LEGAL PROCEEDINGS
Quantel Limited, a U.K. corporation, filed and served on the Company in
January 1996 a complaint alleging that the Adobe Photoshop program infringed
five U.S. patents held by Quantel. The complaint was filed in the United States
District Court for the District of Delaware. On September 19, 1997, a jury in
federal court in Delaware found in favor of Adobe, finding that Adobe Photoshop
did not infringe the five patents held by Quantel Limited, and that the five
patents are invalid. Quantel has filed post-trial motions requesting a new
trial. Adobe is vigorously opposing the motions.
On February 6, 1996, a securities class action complaint was filed against
Adobe, certain of its officers and directors, certain former officers of Adobe
and Frame Technology Corporation ("Frame"), Hambrecht & Quist, LLP ("H&Q"),
investment banker for Frame, and certain H&Q employees, in connection with the
drop in the price of Adobe stock following its announcement of financial results
for the quarter ended December 1, 1995. The complaint was filed in the Superior
Court of the State of California, County of Santa Clara. The complaint alleges
that the defendants misrepresented material adverse information regarding Adobe
and Frame and engaged in a scheme to defraud investors. The complaint seeks
unspecified damages for alleged violations of California law. Adobe believes
that the allegations against it and its officers and directors are without merit
and intends to vigorously defend the lawsuit. The case is currently in the
discovery phase.
On April 17, 1997, a derivative action was filed in the Superior Court of
the State of California, County of Santa Clara, against the current members of
Adobe's Board of Directors and Paul Brainerd, a former member of the Board. The
suit was filed by a stockholder purporting to assert on behalf of the Company
claims for alleged breach of the Directors' fiduciary duty and mismanagement
related to the Company's acquisition of Frame in October 1995. The Court granted
Adobe's motion for dismissal of the suit, with leave to amend for the plaintiff.
In January 1998, the plaintiff filed an amended complaint making substantially
the same claims.
Management believes that the ultimate resolution of these matters will not
have a material impact on the Company's financial position or results of
operations.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on The Nasdaq National Stock Market
under the symbol "ADBE." On December 26, 1997, there were 2,084 holders of
record of the Company's common stock. Because many of such shares are held by
brokers and other institutions on behalf of stockholders, the Company is unable
to estimate the total number of stockholders represented by these record
holders. The following table sets forth the high and low sales price per share
of the Company's common stock, and the cash dividends paid per share, for the
periods indicated.
PRICE RANGE CASH
-------------------- DIVIDEND
HIGH LOW PER SHARE
--------- --------- -----------
Fiscal 1996:
First Quarter......................... $ 74.25 $ 30.00 $ 0.05
Second Quarter........................ 45.13 30.75 0.05
Third Quarter......................... 37.88 28.50 0.05
Fourth Quarter........................ 44.13 31.50 0.05
Fiscal Year........................... 74.25 28.50 0.20
Fiscal 1997:
First Quarter......................... $ 44.13 $ 34.63 $ 0.05
Second Quarter........................ 49.00 32.50 0.05
Third Quarter......................... 45.25 34.00 0.05
Fourth Quarter........................ 53.13 39.75 0.05
Fiscal Year........................... 53.13 32.50 0.20
The Company has paid cash dividends on its common stock each quarter since
the second quarter of 1988. In March 1997, the Company established the venture
stock dividend program under which the Company may, from time to time,
distribute as a dividend-in-kind shares of its equity holdings in investee
companies to Adobe stockholders. In 1997, the Company dividended one share of
Netscape Communications Corporation ("Netscape") common stock for each 100
shares of Adobe common stock held by stockholders of record on July 31, 1997. An
equivalent cash dividend was paid for holdings of less than 2,500 Adobe shares
and for fractional Netscape shares. Also, on December 1, 1997, the Company
dividended one share of Siebel Systems, Incorporated ("Siebel") common stock for
each 300 shares of Adobe common stock held by stockholders of record on October
31, 1997. An equivalent cash dividend was paid for holdings of less than 7,500
Adobe shares and for fractional Siebel shares. The declaration of future
dividends, whether in cash or in-kind, is within the discretion of the Board of
Directors of the Company and will depend upon business conditions, the Company's
results of operations, the financial condition of the Company, and other
factors.
15
ITEM 6. SELECTED FINANCIAL DATA
THE FOLLOWING SELECTED CONSOLIDATED FINANCIAL DATA (PRESENTED IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS AND EMPLOYEE DATA) ARE DERIVED FROM THE COMPANY'S
CONSOLIDATED FINANCIAL STATEMENTS. THIS DATA SHOULD BE READ IN CONJUNCTION WITH
THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO, AND WITH ITEM 7,
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
YEARS ENDED
----------------------------------------------------------
NOV. 28 NOV. 29 DEC. 1 NOV. 25 NOV. 26
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
Operations:
Revenue............................... $ 911,894 $ 786,563 $ 762,339 $ 675,617 $ 580,103
Merger transaction and restructuring
costs............................... -- 4,955 31,534 72,183 25,800
Income before income taxes............ 296,090 244,824 163,853 52,946 72,358
Net income (1)........................ 186,837 153,277 93,485 15,337 42,007
Net income per share (1).............. 2.52 2.04 1.26 0.22 0.62
Cash dividends declared per common
share (2)........................... 0.20 0.20 0.20 0.20 0.20
Financial position:
Cash and short-term investments....... 502,956 564,116 516,040 444,768 344,714
Working capital....................... 454,299 506,092 506,472 402,837 347,683
Total assets.......................... 940,071 1,001,393 872,827 710,000 597,696
Stockholders' equity.................. 715,424 706,514 698,417 514,315 457,216
Additional data:
Worldwide employees................... 2,654 2,222 2,322 2,055 2,500
- ------------------------
(1) In 1997, includes investment gains of $34.3 million, other non-recurring
gains of $0.6 million, and the write-off of $6.0 million of acquired
in-process research and development. In 1996, includes investment gains of
$68.9 million, the write-off of $21.3 million of acquired in-process
research and development, and restructuring charges related to divested
products of $5.0 million. In 1995, reflects restructuring charges of $31.5
million related to the acquisition of Frame and the write-off of $15.0
million of acquired in-process research and development. In 1994, reflects
restructuring charges of $72.2 million related to the acquisition of Aldus
Corporation ("Aldus") and the write-off of $15.5 million of acquired
in-process research and development. In 1993, reflects restructuring charges
of $25.8 million initiated by Frame and the write-off of $4.3 million of
acquired in-process research and development.
(2) Dividends prior to the acquisition of Frame on October 28, 1995 and Aldus on
August 31, 1994 have not been restated to reflect the effects of the
poolings of interest.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION (PRESENTED IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND
NOTES THERETO.
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS DESCRIBED IN OTHER
DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE
COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE
COMPANY IN 1998. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL
REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE
ANY REVISIONS TO THE FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
RESULTS OF OPERATIONS
OVERVIEW
Adobe Systems Incorporated ("Adobe" or the "Company") develops, markets, and
supports computer software products and technologies that enable users to
express and use information across all print and electronic media. The Company
licenses its technology to major computer, printing, and publishing suppliers,
and markets a line of application software products and type products for
authoring and editing visually rich documents. The Company distributes its
products through a network of original equipment manufacturer ("OEM") customers,
distributors and dealers, and value-added resellers ("VARs") and systems
integrators. The Company has operations in North America, Europe, Japan, and
Asia, Pacific, and Latin America.
In January 1996, the Company divested its prepress applications product
business to a newly established company, Luminous Corporation ("Luminous").
Under the terms of the agreement, Luminous continued to develop, market, and
distribute Adobe's prepress application products, and Adobe maintained ownership
of certain core technologies for Adobe prepress products. Revenue from the
prepress application business unit was approximately $10.4 million in fiscal
year 1995. In October 1996, the Company sold its remaining interest in Luminous
for approximately $6.8 million, which was recorded as a realized gain.
REVENUE
1997 CHANGE 1996 CHANGE 1995
--------- ------------- --------- ------------- ---------
Total revenue........................... $ 911.9 16% $ 786.6 3% $ 762.3
Revenue growth in 1997 is attributable primarily to increased application
products shipments resulting from the release of new and enhanced products. In
1996, revenue grew due to increases in both licensing activity related to the
Company's PostScript interpreter and application products. Product unit volume
(as opposed to price) growth was the principal factor in the Company's revenue
growth in application products revenue in both 1997 and 1996. No customer
accounted for more than 10% of the Company's total revenue in 1997, 1996, or
1995.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Product group revenue--Licensing........ $ 196.2 -- $ 196.7 7% $ 183.4
Percentage of total revenue............. 21.5% 25.0% 24.1%
17
Licensing revenue is derived from shipments by OEM customers of products
containing the Adobe PostScript interpreter, Adobe PrintGear software, and the
Display PostScript system. Such Adobe PostScript products include: (1) standard
roman printers as well as printers that work with Japanese, Chinese, and Korean
languages; (2) imagesetters; and (3) workstations. Licensing revenue is also
derived from shipments of products containing the Configurable PostScript
Interpreter ("CPSI") by OEM customers. CPSI is a fully functional Adobe
PostScript interpreter that resides on the host computer system rather than in a
dedicated controller integrated into an output device. The configuration
flexibility of CPSI allows OEMs and software developers to create and market a
variety of Adobe PostScript products independently of controller hardware
development. Adobe PostScript products sell to the small office/home office
("SOHO") market, as well as the corporate enterprise and high-end imagesetter
markets. Adobe PrintGear software is targeted to the SOHO and home computer
market.
Royalty per unit is generally calculated as a percentage of the end user
list price of a printer, although some components of licensing revenue based on
a flat dollar amount per unit typically do not change with list prices.
Licensing revenue in 1997 was unchanged from 1996 licensing revenue. Increased
demand for CPSI, color capability, and Adobe PrintGear products was offset by a
number of factors affecting OEMs, primarily in the Japanese and Macintosh
markets. These factors included, but were not limited to, continuing weakness in
Macintosh-related printer sales and in Japanese personal computer and printer
markets, as well as a slow pace of new Adobe PostScript 3 and Adobe PrintGear
products being brought to market by OEMs.
The Company has seen year-to-year increases in the number of OEM customers
from which it is receiving licensing revenue and believes that such increases
are attributable to the continued acceptance of Adobe PostScript software, as
well as the diversification of the Company's customer base across multiple
platforms. During 1997, a number of OEM customers introduced new Adobe PrintGear
products that serve the SOHO market. Late in 1997, some OEM customers began to
transition from Adobe PostScript Level 2 products to Adobe PostScript 3
products. This transition is expected to continue through 1998. Also in the fall
of 1997, one of Adobe's largest PostScript customers, Hewlett-Packard Company
("HP"), introduced a non-Adobe clone version of PostScript in one family of
monochrome laser printers. The Company continues to be cautious about licensing
revenue in the short term because of the factors identified in the previous
paragraph and the anticipated loss of revenue from monochrome laser printer
products from HP.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Product group revenue--Application
products.............................. $ 715.7 21% $ 589.9 2% $ 578.9
Percentage of total revenue............. 78.5% 75.0% 75.9%
Application products revenue is derived from shipments of application
software programs marketed primarily through retail and distribution channels;
however, Adobe PageMill, Adobe SiteMill, Adobe FrameMaker, and Adobe Acrobat
products are becoming more widely distributed through VARs and systems
integrators. Adobe PhotoDeluxe is primarily distributed through OEM bundling
agreements with digital camera, scanner, and personal computer manufacturers.
Application products revenue growth in 1997 was primarily due to increased
demand for Adobe Photoshop, the Adobe Acrobat family of products, Adobe
PhotoDeluxe, Adobe Illustrator, and Adobe PageMaker. A new version of Adobe
Photoshop was released in late fiscal 1996, and new versions of Adobe PageMaker
and Adobe Illustrator were released in the first and second quarters of fiscal
1997, respectively. In addition, during the second half of 1997, a new version
of Adobe FrameMaker across multiple platforms and in multiple languages, the
Windows version of Adobe PhotoDeluxe 2.0, and various other products in
localized international versions were released. The 1996 revenue growth in this
area resulted from increased demand for Adobe Photoshop, Adobe PageMill, Adobe
SiteMill, Adobe Illustrator, and the Adobe Acrobat family of products, as well
as demand for new products. The increase was partially offset by decreased
demand for Adobe FrameMaker and Adobe PageMaker products. The
18
Company released Adobe Photoshop 4.0 for both the Macintosh and Windows
platforms, and Adobe Acrobat 3.0 near the end of the fourth quarter of 1996. In
addition, Adobe PageMill and Adobe SiteMill, which were both released in late
1995, added revenue in 1996.
Overall, revenue from the Company's application products on the Windows
platform increased by 64% in 1997 over 1996, while application products revenue
from the Macintosh platform increased 1%. In 1997, the Windows and Macintosh
platforms accounted for 50.6% and 49.4%, respectively, of application products
revenue, excluding platform-independent and UNIX products, compared to 38.6% and
61.4%, respectively, in 1996. The Company expects this trend toward the Windows
platform to continue for the foreseeable future.
At the end of 1997, the Company experienced a decline in revenue from the
Japanese market, due to reductions in sell-through rates by the Company's
Japanese distributors and corresponding higher inventory levels. The Company
remains cautious about the economic conditions in Japan as well as the
fluctuating economic conditions in other Asian countries in the short term.
DIRECT COSTS
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Direct costs............................ $ 126.3 (11)% $ 141.1 8% $ 130.3
Percentage of total revenue............. 13.8% 17.9% 17.1%
Direct costs include direct product, packaging, and shipping costs, as well
as royalties, localization costs, and amortization of acquired technologies.
Gross margin (expressed as a percentage of revenue), in general, is affected
by the mix of licensing revenue versus application products revenue, as well as
the product mix within application products. Direct costs for application
products decreased during 1997 as the Company transitioned from distribution of
its products on disk to distribution on CD-ROM media, which has a lower cost per
unit. In addition, certain acquired technologies became fully amortized during
1997, and localization costs were lower in 1997 than in 1996. Localization costs
will vary from year-to-year depending on the timing of the release of new
versions of products. Direct costs were slightly higher in 1996 compared to 1995
as a percentage of revenue due to higher localization costs. Also, there was a
general decline in 1996 in Adobe FrameMaker revenue and associated gross
margins.
Gross margin in 1998 is expected to be approximately the same as in 1997 as
the cost savings from the continued shift to CD-ROM media is offset by higher
localization costs.
OPERATING EXPENSES
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Software development costs--Research and
development........................... $ 170.9 12% $ 152.9 10% $ 138.6
Percentage of total revenue............. 18.7% 19.4% 18.2%
Research and development expenses consist principally of salaries and
benefits for software developers, contracted development efforts, related
facilities costs, and expenses associated with computer equipment used in
software development.
Research and development expense has increased over the last three years as
the Company has invested in new technologies, new product development, and the
infrastructure to support such activities. The increase reflects the expansion
of the Company's engineering staff and related costs required to support these
efforts. The Company continues to make significant investments in the
development of its
19
Adobe PostScript and application software products, including those targeted for
the growing Internet market.
The Company believes that investments in research and development are
necessary to remain competitive in the marketplace and are directly related to
continued timely development of new and enhanced products. Accordingly, the
Company intends to continue recruiting and hiring experienced software
developers. While the Company expects that research and development expenditures
in 1998 will increase in absolute dollars, such expenditures are expected to
remain approximately the same as a percentage of revenue.
1997 CHANGE 1996 CHANGE 1995
----- ----------- --------- ----------- ---------
Software development costs--Amortization
of capitalized software development
costs................................. -- (100)% $ 2.5 (77 )% $ 11.1
Percentage of total revenue............. -- 0.3% 1.5%
During 1997, software development expenditures on all products, after
reaching technological feasibility, were immaterial and therefore were expensed
as incurred. Certain software development expenditures on products developed by
Frame Technology Corporation ("Frame") and Aldus Corporation ("Aldus") prior to
their acquisition by Adobe were capitalized and were amortized over the lives of
the respective products. Amortization of capitalized software development costs
decreased in 1997 and 1996 as a result of achieving full amortization of all
Frame products by the end of 1996 and all Aldus products by the end of 1995.
The Company expects that software development expenditures on all products,
after achieving technological feasibility, will continue to be immaterial in the
future and therefore will be expensed as incurred.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Sales, marketing, and customer
support............................... $ 303.3 19% $ 255.0 5% $ 242.7
Percentage of total revenue............. 33.3% 32.4% 31.8%
Sales, marketing, and customer support expenses generally include salaries
and benefits, sales commissions, travel expenses, and related facility costs for
the Company's sales, marketing, customer support, and distribution personnel.
Sales, marketing, and customer support expenses also include the costs of
programs aimed at increasing revenue, such as advertising, trade shows, and
other market development programs.
Increases in sales, marketing, and customer support expenses in both 1997
and 1996 are due to increased advertising and promotional expenditures for
upgrades of existing products and further development of customer and technical
support services to support a growing installed base of customers. In addition,
a portion of the 1997 increase relates to new product releases, increased
investment in the Windows market, and programs related to furthering worldwide
recognition of the Adobe brand.
For fiscal 1998, sales, marketing, and customer support expenditures are
expected to increase in absolute dollars and may increase as a percentage of
revenue.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
General and administrative.............. $ 75.4 21% $ 62.0 6% $ 58.5
Percentage of total revenue............. 8.3% 7.9% 7.7%
General and administrative expenses consist principally of salaries and
benefits, travel expenses, and related facility costs for the finance, human
resources, legal, information services, and executive and administrative
personnel of the Company. General and administrative expenses also include
outside legal
20
and accounting fees, provision for bad debts, and expenses associated with
computer equipment and software used in the administration of the business.
General and administrative expenses increased from 1997 compared to 1996 due
to higher information system costs, legal costs, and employee costs primarily
associated with a more comprehensive administrative infrastructure. The 1996
increase over 1995 resulted primarily from Frame integration costs in the first
quarter of 1996 and a higher headcount entering fiscal 1996. In addition, the
increase was driven by salary increases as well as higher systems and legal
costs in 1996.
The Company expects general and administrative spending in 1998 to be
slightly higher than 1997 levels in absolute dollars as the Company continues to
invest in an expanded and more comprehensive executive and administrative
infrastructure.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ------------- ---------
Write-off of acquired in-process
research and development.............. $ 6.0 (72)% $ 21.3 42% $ 15.0
Percentage of total revenue............. 0.7% 2.7% 2.0%
During 1997, 1996, and 1995, the Company acquired seven software companies,
in separate transactions, and accounted for them using the purchase method. In
each of these transactions, a portion of the purchase price was allocated to
in-process research and development and was expensed at the time of the
acquisitions.
1997 CHANGE 1996 CHANGE 1995
----- ----------- --------- ----------- ---------
Merger transaction and restructuring
costs................................. -- (100)% $ 5.0 (84 )% $ 31.5
Percentage of total revenue............. -- 0.6% 4.1%
Merger transaction and restructuring costs for 1996 were $5.0 million. This
represents charges of $5.7 million less the reversal of $0.7 million of excess
reserves related to restructuring costs recorded in prior years. The 1996
charges were recorded in connection with the disposition of two business units
previously owned by Frame.
During the fourth quarter of 1995, the Company recorded merger transaction
and restructuring costs primarily associated with the acquisition of Frame of
$32.5 million and reversed approximately $1.0 million of excess restructuring
reserves related to the acquisition of Aldus in 1994 as well as the remaining
accrued restructuring costs related to a 1993 restructuring implemented by
Frame.
At November 28, 1997, the remaining accrued restructuring balance of $8.4
million, included in other accrued expenses on the balance sheet, related to
lease and third-party contract termination payments, resulting from the planned
closure of duplicate offices in Europe and the United States. These payments are
expected to continue through the lease terms or negotiated early termination
date, if applicable.
1997 CHANGE 1996 CHANGE 1995
--------- ------------- ----- ------------- -----
Other nonrecurring items................ $ (0.6) -- -- -- --
Percentage of total revenue............. (0.1)% -- --
Nonrecurring items in 1997 included a gain of $2.4 million related to the
divestiture of a product line partially offset by a $1.8 million charge related
to the acquisition of an intellectual property.
NONOPERATING INCOME
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Investment gain (loss).................. $ 34.3 (50)% $ 68.9 9,223% $ (0.8)
Percentage of total revenue............. 3.8% 8.8% (0.1)%
21
Investment gain (loss) consists principally of realized gains or losses from
direct investments as well as mark-to-market valuation adjustments for Adobe
Ventures L.P. investments.
In 1997, the investment gain relates primarily to the Company's liquidation
of its investment in Netscape Communications Corporation ("Netscape") through
the distribution to its stockholders of 554,660 shares of Netscape as a
dividend-in-kind and the sale of its remaining Netscape shares. The 1996 gain
arose primarily as a result of realized gains of approximately $43.6 million and
approximately $6.8 million for the sale of a portion of the Company's investment
in Netscape and its entire investment in Luminous Corporation, respectively.
Also, a portion of one of the equity investments included in the Adobe Ventures
L.P. portfolio was sold for a gain of $13.9 million during 1996 and at November
29, 1996, the remaining portion of this investment was marked-to-market for an
unrealized gain of approximately $3.7 million. These and other gains were
partially offset by write-downs on certain other investments.
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Interest and other income............... $ 31.0 6% $ 29.2 (3)% $ 30.0
Percentage of total revenue............. 3.4% 3.7% 3.9%
Interest and other income consists principally of interest earned on cash,
cash equivalents, and short-term investments as well as foreign exchange
transaction gains and losses.
The increase in interest and other income in 1997 from 1996 is primarily due
to higher interest income in 1997 on higher average cash balances. The slight
decrease in 1996 from 1995 is primarily due to foreign exchange gains in 1995
compared to foreign exchange losses in 1996.
INCOME TAX PROVISION
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Income tax provision.................... $ 109.3 19% $ 91.5 30% $ 70.4
Percentage of total revenue............. 12.0% 11.6% 9.2%
Effective tax rate...................... 36.9% 37.4% 42.9%
The Company's effective tax rate decreased in 1997 from 1996 primarily due
to lower nondeductible charges for the write-off of acquired in-process research
and development and higher tax-exempt income. The 1996 tax rate decreased
significantly from 1995 primarily as a result of lower nondeductible charges,
including merger costs, goodwill, and the write-off of acquired in-process
research and development. An analysis of the differences between the statutory
and effective income tax rates is provided in Note 7 of Notes to Consolidated
Financial Statements.
The Company expects that the effective tax rate for fiscal 1998 will be
between 37% and 38% due to lower tax-exempt interest income as a result of cash
requirements for the Company's stock repurchase programs.
NET INCOME AND NET INCOME PER SHARE
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Net income.............................. $ 186.8 22% $ 153.3 64% $ 93.5
Percentage of total revenue............. 20.5% 19.5% 12.3%
Net income per share.................... $ 2.52 24% $ 2.04 62% $ 1.26
Weighted average shares (in
thousands)............................ 74,132 (1)% 75,064 1% 74,253
22
Net income in each of the three years included several one-time charges, and
in 1997 and 1996, significant investment gains that would not normally be
included in the Company's operating results. A reconciliation of the reported
results of operations to the results of operations excluding these one-time
charges for each of the years follows:
1997
-----------------------------------------------
INCOME
BEFORE INCOME NET
INCOME TAX NET INCOME
TAXES PROVISION INCOME PER SHARE
---------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reported results of operations.................................... $ 296,090 $ 109,253 $ 186,837 $ 2.52
Write-off of acquired in-process research and development costs... 5,969 -- 5,969 0.08
Other nonrecurring items.......................................... (590) (218) (372) --
Net investment gain............................................... (34,290) (11,255) (23,035) (0.31)
---------- ---------- ---------- -----------
Results of operations excluding one-time charges (gains).......... $ 267,179 $ 97,780 $ 169,399 $ 2.29
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
1996
-----------------------------------------------
INCOME
BEFORE INCOME NET
INCOME TAX NET INCOME
TAXES PROVISION INCOME PER SHARE
---------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reported results of operations.................................... $ 244,824 $ 91,547 $ 153,277 $ 2.04
Write-off of acquired in-process research and development costs... 21,251 1,837 19,414 0.26
Restructuring costs............................................... 4,955 1,505 3,450 0.05
Other one-time charges............................................ 2,917 886 2,031 0.03
Net investment gain............................................... (68,875) (18,873) (50,002) (0.67)
---------- ---------- ---------- -----------
Results of operations excluding one-time charges (gains).......... $ 205,072 $ 76,902 $ 128,170 $ 1.71
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
1995
------------------------------------------------
INCOME
BEFORE INCOME NET
INCOME TAX NET INCOME
TAXES PROVISION INCOME PER SHARE
---------- ----------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reported results of operations..................................... $ 163,853 $ 70,368 $ 93,485 $ 1.26
Write-off of acquired in-process research and development.......... 14,983 -- 14,983 0.20
Acquisition of Frame:
Merger transaction costs......................................... 11,399 -- 11,399 0.15
Restructuring costs.............................................. 20,135 6,086 14,049 0.19
Other one-time charges............................................. 3,160 1,484 1,676 0.02
Effect of fourth quarter antidilutive common stock equivalents..... -- -- -- (0.02)
---------- ----------- ---------- -----------
Results of operations excluding one-time charges................... $ 213,530 $ 77,938 $ 135,592 $ 1.80
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
The Company believes that in the future its results of operations could be
affected by various factors, such as delays in shipment of the Company's new
products and major new versions of existing products,
23
market acceptance of new products and upgrades, continuing 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, industry
transitions to new business and information delivery models, ongoing weakness in
the Japanese and other Asian economies, and adverse changes in general economic
conditions in any of the countries in which the Company does business.
The Company's ability to develop and market products, including upgrades of
current products that successfully adapt to changing customer needs, may also
have an impact on the results of operations. The Company's ability to extend its
core technologies into new applications and to anticipate or respond to
technological changes could affect its ability to develop these products. A
portion of the Company's future revenue will come from these products. Delays in
product introductions could have an adverse effect on the Company's revenue,
earnings, or stock price. The Company cannot determine the ultimate effect that
these new products or upgrades will have on its revenue or results of
operations.
Although the Company generally offers its application products on Macintosh,
Windows, and UNIX platforms, a majority of the overall revenue from these
products prior to 1997 has been for the Macintosh platform, particularly for the
higher end Macintosh computers. In 1997, Windows-based application revenue
exceeded that for the Macintosh platform for the first time. If there is a
continuing slowdown of customer purchases in the higher end Macintosh market, or
if the Company is unable to increase its sales to Windows customers, the
Company's operating results could be materially adversely affected. Also, if the
Company broadens its customer base to achieve greater penetration in the
corporate business and consumer markets, the Company may need to adapt its
application software distribution channels. The Company could experience
decreases in average selling prices and some transitions in its distribution
channel which could materially adversely affect its operating results. In
addition, to the extent that there is a slowdown of customer purchases of
personal computers in general, the Company's operating results could be
materially adversely affected.
The Company's 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. In the fall of
1997, HP began to ship non-Adobe clone software in some HP LaserJet printers,
resulting in somewhat lower licensing revenue to the Company, although the
impact was minimal. The Company expects a more significant impact on its 1998
licensing revenue, although it continues to work with HP printer operations to
incorporate Adobe PostScript and other technologies in other HP products.
During late 1997, 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. In addition, at the end of
fiscal 1997, inventory levels for application products at the Company's Japanese
distributors remained higher than what the Company considers normal. The Company
expects these adverse economic conditions to continue in the short term, and
they may adversely affect the Company's revenue and earnings. Although there are
also adverse conditions in other Asian economies, the countries affected
represent a much smaller portion of the Company's revenue and thus have less
impact on the Company's operational results.
Through its acquisitions, the Company has experienced significant growth.
The Company's ability to effectively manage its growth will require it to
continue to improve its operational and financial controls and information
management systems, and to attract, retain, motivate, and manage employees
effectively. The failure of the Company to effectively manage growth and
transition in multiple areas of its business could have a material adverse
effect on its results of operations.
The Internet market is rapidly evolving and is characterized by an
increasing number of market entrants that have introduced or developed products
addressing authoring and communications over the Internet. As is typical in the
case of a new and evolving industry, demand and market acceptance for
24
recently introduced products and services are subject to a high level of
uncertainty. The software industry addressing the authoring for and
communications over the Internet is young and has few proven products. 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 derives a significant portion of its revenue and operating
income from its subsidiaries located in Europe, Japan, and Asia, Pacific, and
Latin America. The Company generally experiences lower revenue from its European
operations in the third quarter because many customers reduce their business
activities in the summer months. While most of the revenue of the European
subsidiaries is denominated in U.S. dollars, the majority of revenue derived
from Japan is denominated in yen and the majority of all subsidiaries' operating
expenses are denominated in their local currencies. As a result, the Company's
operating results are subject to fluctuations in foreign currency exchange
rates. To date, the accounting impact of such fluctuations has been
insignificant. The Company's hedging policy attempts to mitigate some of these
risks, based on management's best judgment of the appropriate trade-offs among
risk, opportunity, and expense. The Company has established a hedging program as
described below in "Derivatives and Financial Instruments." The program is used
to hedge its exposure to foreign currency exchange rate fluctuations, primarily
of the Japanese yen. The Company's hedging program is not comprehensive, and
there can be no assurance that the program will offset more than a portion of
the adverse financial impact resulting from unfavorable movement in foreign
currency exchange rates.
Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by securities
analysts could have an immediate and significant adverse effect on the trading
price of the Company's common stock in any given period. Additionally, the
Company may not learn of such shortfalls until late in the fiscal quarter, which
could result in an even more immediate and adverse effect on the trading price
of the Company's common stock. Finally, the Company participates in a highly
dynamic industry. In addition to factors specific to the Company, changes in
analysts' earnings estimates for the Company or its industry and factors
affecting the corporate environment or the securities markets in general will
often result in significant volatility of the Company's common stock price.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 establishes a different method of computing net income per
share than is currently required under the provisions of Accounting Principles
Board Opinion No. 15. Under SFAS No. 128, the Company will be required to
present both basic net income per share and diluted net income per share. Basic
net income per share is expected to be higher than the currently presented net
income per share, as the effect of dilutive stock options will not be considered
in computing basic net income per share. Diluted net income per share is
expected to be comparable to the currently presented net income per share.
The Company plans to adopt SFAS No. 128 in its fiscal quarter ending
February 27, 1998, and at that time, all historical net income per share data
presented will be restated to conform to the provisions of SFAS No. 128.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in the financial statements. It does
not, however, require a specific format for the disclosure, but requires the
Company to display an amount representing total comprehensive income for the
period in its financial statements. The Company will be required to implement
SFAS No. 130 for its fiscal year 1999.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for the manner in which public companies
25
report information about operating segments in annual and interim financial
statements. The Company is currently evaluating the operating segment
information that it will be required to report. The Company will be required to
implement SFAS No. 131 for its fiscal year 1999.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." SOP
97-2 establishes standards relating to the recognition of all aspects of
software revenue. SOP 97-2 is effective for transactions entered into in fiscal
years beginning after December 15, 1997 and will require the Company to modify
certain aspects of its revenue recognition policies. The Company does not expect
the adoption of SOP 97-2 to have a material impact on the Company's consolidated
results of operations.
"YEAR 2000" ISSUES
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000" problem
is pervasive and 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 own computer systems and from third parties with whom the
Company deals on financial transactions worldwide. Failures of the Company's
and/or third parties' computer systems could have a material impact on the
Company's ability to conduct its business.
The Company's financial information systems include an SAP system recently
implemented in the United States and Japan and an Oracle system in Europe that
will be upgraded to the most recent version in the first quarter of fiscal 1998.
These systems are believed to be "Year 2000" compliant. The Company is analyzing
its remaining computer systems to identify any potential "Year 2000" issues and
will take appropriate corrective action based on the results of such analysis.
Management has not yet determined the cost related to achieving "Year 2000"
compliance.
In addition, the "Year 2000" issue could affect the products that the
Company sells. The Company believes that the current versions of its products
are "Year 2000" compliant. The Company's products are subject to ongoing
analysis and review.
FINANCIAL CONDITION
CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Cash, cash equivalents, and short-term
investments........................... $ 503.0 (11)% $ 564.1 9% $ 516.0
The Company's cash, cash equivalents, and short-term investments decreased
in 1997 from 1996 primarily as a result of cash expended for the Company's stock
repurchase program. These expenditures were partially offset by cash generated
from operations.
Cash equivalents consist of highly liquid money market instruments. All of
the Company's cash equivalents and short-term investments, consisting
principally of municipal bonds, auction rate certificate securities, United
States government and government agency securities, and asset-backed securities,
are classified as available-for-sale under the provisions of SFAS No. 115. The
securities are carried at fair value with the unrealized gains and losses, net
of tax, reported as a separate component of stockholders' equity.
NONCURRENT LIABILITIES AND STOCKHOLDERS' EQUITY
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Noncurrent liabilities and stockholders'
equity................................ $ 715.4 (8)% $ 781.7 12% $ 698.4
26
Included above is stockholders' equity, and at November 29, 1996, deferred
income taxes of $3.8 million related to unrealized gains and losses on equity
investments, and obligations for put warrants of $71.3 million. The Company has
no long-term debt. Stockholders' equity as of November 28, 1997 was $715.4
million, compared to $706.5 million as of November 29, 1996 and $698.4 million
as of December 1, 1995. The year-to-year increases in stockholders' equity
include issuances of common stock under the Company's stock option and employee
stock purchase plans and, in 1997, the reclassification of the put warrant
obligation back to stockholders' equity. In 1997 and 1996, the increase in
stockholders' equity was substantially offset by the repurchase of stock.
In September 1997, the Board of Directors authorized, subject to certain
business and market conditions, the purchase of up to 15,000,000 shares of the
Company's stock over the next two years. Under this program, as well as under
previously authorized programs, the Company repurchased 6,150,656 shares and
3,321,500 shares in 1997 and 1996, respectively. The Company may continue to
directly repurchase common shares and arrange options to purchase common shares,
depending on market conditions and the Company's cash requirements.
The Company has paid cash dividends on its common stock each quarter since
the second quarter of 1988. During 1997, the Company paid cash dividends of
$0.20 per common share. In addition, during 1997, the Company distributed its
holdings in Netscape Communications Corporation and Siebel Systems, Inc. to the
Company's stockholders as a dividend-in-kind. The declaration of future
dividends, whether in cash or in-kind, is within the discretion of the Company's
Board of Directors and will depend upon business conditions, the Company's
results of operations and financial condition, and other factors.
WORKING CAPITAL
1997 CHANGE 1996 CHANGE 1995
--------- ----------- --------- ----------- ---------
Working capital......................... $ 454.3 (10)% $ 506.1 -- $ 506.5
The decrease in working capital in fiscal 1997 from 1996 is primarily due to
lower cash and short-term investment balances as a result of the Company's stock
repurchase program. Cash flow provided by operations during fiscal 1997 was
$208.6 million compared to $198.1 million in fiscal 1996.
Expenditures for property and equipment in 1997 totaled $33.9 million. Such
expenditures are expected to continue, including expenditures for computer
systems for research and development, sales and marketing, product support, and
administrative staff. In the future, additional cash may be used to acquire
software products or technologies complementary to the Company's business. Net
cash used by financing activities during 1997 was $219.2 million, or $117.7
million greater than in fiscal 1996, primarily resulting from the repurchase of
common stock and payment of cash dividends partially offset by issuance of
common stock under employee stock plans.
The Company believes that existing cash, cash equivalents, and short-term
investments, together with cash generated from operations, will provide
sufficient funds for the Company to meet its operating cash requirements in the
foreseeable future.
DERIVATIVES AND FINANCIAL INSTRUMENTS
(ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK)
FOREIGN CURRENCY HEDGING INSTRUMENTS
The Company transacts business in various foreign currencies, primarily in
certain European countries and Japan. Accordingly, the Company is subject to
exposure from adverse movements in foreign currency exchange rates. This
exposure is primarily related to yen denominated sales in Japan and local
currency denominated operating expenses in Europe, where the Company sells
primarily in U.S. dollars.
27
The Company's Japanese operating expenses are in yen, which mitigates the
exposure related to yen denominated sales in Japan. In addition, the Company
hedges firmly committed transactions using primarily forward contracts with
maturities of less than three months. At November 28, 1997, the Company held
$1.9 million of aggregate foreign currency forward exchange contracts for the
sale of Japanese yen, all of which expire at various times through February 25,
1998. The unrealized gains and losses associated with these contracts are not
material.
The Company's accounting policies for these instruments are based on the
Company's designation of such instruments as hedging transactions. Gains and
losses associated with the mark-to-market of outstanding foreign exchange
forward contracts that are designated and effective as hedges of existing
transactions, for which a firm commitment has been attained, are recognized in
income in the current period. Corresponding gains and losses on the foreign
currency denominated transactions being hedged are recognized in income in that
same period. In this manner, the gains and losses on foreign currency
denominated transactions will be offset by the gains and losses on the foreign
currency contracts. The Company does not anticipate any material adverse effect
on its consolidated financial position, results of operations, or cash flows as
a result of these instruments.
The Company does not use derivative financial instruments for speculative
trading purposes, nor does the Company hedge its foreign currency exposure in a
manner that entirely offsets the effects of changes in foreign exchange rates.
The Company currently does not use financial instruments to hedge local
currency denominated operating expenses in Europe. Instead, the Company believes
that a natural hedge exists, in that local currency revenue from product
upgrades substantially offsets the local currency denominated operating
expenses. The Company assesses the need to utilize financial instruments to
hedge European currency exposure on an ongoing basis.
The Company regularly reviews its hedging program and may as part of this
review determine at any time to change its hedging program.
FIXED INCOME INVESTMENTS
At November 28, 1997, the Company had an investment portfolio of fixed
income securities, including those classified as cash equivalents, of $523.9
million. These securities are subject to interest rate fluctuations. An increase
in interest rates could affect the market value of the Company's fixed income
securities.
A sensitivity analysis was performed on the Company's investment portfolio
as of November 28, 1997. This sensitivity analysis is based on a modeling
technique that measures the hypothetical market value changes that would result
from a parallel shift in the yield curve of plus 50, plus 100, or plus 150 basis
points over a 12-month time horizon. The market value changes for a 50, 100, or
150 basis point increase in short-term treasury security yields were not
material due to the limited duration of the Company's portfolio.
The Company does not use derivative financial instruments in its investment
portfolio to manage interest rate risk. The Company does, however, limit its
exposure to interest rate and credit risk by establishing and strictly
monitoring clear policies and guidelines for its fixed income portfolios. At the
present time, the maximum duration of all portfolios is limited to 2.3 years.
The guidelines also establish credit quality standards, limits on exposure to
one issue, issuer, as well as the type of instrument. Due to the limited
duration and credit risk criteria established in the Company's guidelines, the
exposure to market and credit risk is not expected to be material.
PUT WARRANTS AND CALL OPTIONS
To facilitate the Company's stock repurchase program, the Company sold put
warrants in a series of private placements in 1997 and 1996. Each warrant
entitled the holder to sell one share of Adobe's
28
common stock to the Company at a specified price. Approximately 4.6 million and
4.5 million put warrants were written in 1997 and 1996, respectively. At
November 28, 1997, approximately 2.9 million put warrants were outstanding that
expire on various dates through May 1998 that have exercise prices ranging from
$37.07 to $47.98 per share, with an average exercise price of $43.09 per share.
In addition, in 1997 and 1996, the Company purchased call options from an
independent third party that entitled the Company to buy 2.3 million and 4.5
million shares, respectively, of its common stock. At November 28, 1997,
approximately 0.5 million call options were outstanding that expire on various
dates through April 1998 and have exercise prices ranging from $37.32 to $46.86
per share, with an average exercise price of $41.32 per share. Under these
arrangements, the Company, at its option, can settle with physical delivery or
net shares equal to the difference between the exercise price and the market
value at the date of exercise.
COMMITMENTS
The Company's principal commitments as of November 28, 1997 consisted of
obligations under operating leases, a real estate development agreement, and
various service agreements with a related party.
During 1994, the Company entered into a real estate development agreement
and an operating lease agreement in connection with the construction of an
office facility. In August 1996, the construction was completed and the
operating lease commenced. The Company will have the option to purchase the
facility at the end of the lease term, in October 2001. In the event the Company
chooses not to exercise this option, the Company is obligated to arrange for the
sale of the facility to an unrelated party and is required to pay the lessor any
difference between the net sales proceeds and the lessor's net investment in the
facility, in an amount not to exceed that which would preclude classification of
the lease as an operating lease, approximately $57.3 million. During the
construction period, the Company was required to pledge certain interest-bearing
instruments to the lessor as collateral to secure the performance of its
obligations under the lease. As of November 28, 1997, the Company's deposits
under this agreement totaled approximately $66.7 million in United States
government treasury notes and money market mutual funds. These deposits are
included in "Other assets" in the Consolidated Balance Sheets.
In 1996, the Company exercised its option under the development agreement to
begin a second phase of development for an additional office facility. In August
1996, the Company entered into a construction agreement and an operating lease
agreement for this facility. The operating lease will commence on completion of
construction in 1998. The Company will have the option to purchase the facility
at the end of the lease term (five years after occupancy). In the event the
Company chooses not to exercise this option, the Company is obligated to arrange
for the sale of the facility to an unrelated party and is required to pay the
lessor any difference between the net sales proceeds and the lessor's net
investment in the facility, in an amount not to exceed that which would preclude
classification of the lease as an operating lease, approximately $64.3 million.
The Company also is required, periodically during the construction period, to
deposit funds with the lessor as an interest-bearing security deposit to secure
the performance of its obligations under the lease. During 1997, the Company
deposited approximately $33.0 million and as of November 28, 1997, the Company's
deposits under this agreement totaled approximately $36.3 million. These
deposits are included in "Other assets" in the Consolidated Balance Sheets.
At November 28, 1997, the Company held a 13% equity interest in McQueen
International Limited ("McQueen") and accounted for the investment using the
cost method. During 1994, the Company entered into various agreements with
McQueen, whereby the Company contracted with McQueen to perform product
localization and technical support functions and to provide printing, assembly,
and warehousing services. Effective December 31, 1997, McQueen was acquired by
Sykes Enterprises, Incorporated ("Sykes"), a publicly traded company. In
connection with the acquisition, the Company exchanged its shares of McQueen for
486,676 shares of Sykes' restricted common stock and will record a gain on the
exchange of $6.7 million in fiscal 1998. The Company's equity interest in Sykes
is less than 2%. The Company expects that McQueen will continue to provide
services to the Company for the foreseeable future.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
The Company's financial statements required by this item are submitted as a
separate section of this Form 10-K. See Item 14.(a)1. for a listing of financial
statements provided in the section titled "FINANCIAL STATEMENTS".
SUPPLEMENTARY DATA
THE FOLLOWING TABLES (PRESENTED IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SET
FORTH QUARTERLY SUPPLEMENTARY DATA FOR EACH OF THE YEARS IN THE TWO-YEAR PERIOD
ENDED NOVEMBER 28, 1997.
1997
----------------------------------------------------------
QUARTER ENDED YEAR
---------------------------------------------- ENDED
FEB. 28 MAY 30 AUG. 29 NOV. 28 NOV. 28
---------- ---------- ---------- ---------- ----------
Revenue.............................................. $ 226,459 $ 228,264 $ 230,039 $ 227,132 $ 911,894
Gross profit......................................... 192,170 195,606 197,350 200,497 785,623
Income before income taxes........................... 73,167 63,204 85,528 74,191 296,090
Net income........................................... 46,484 40,106 53,428 46,819 186,837
Net income per share................................. 0.63 0.54 0.72 0.64 2.52
Shares used in computing net income
per share.......................................... 73,939 74,416 74,528 73,646 74,132
1996
----------------------------------------------------------
QUARTER ENDED YEAR
---------------------------------------------- ENDED
MAR. 1 MAY 31 AUG. 30 NOV. 29 NOV. 29
---------- ---------- ---------- ---------- ----------
Revenue.............................................. $ 193,642 $ 204,337 $ 180,909 $ 207,675 $ 786,563
Gross profit......................................... 158,434 168,259 147,292 171,431 645,416
Income before income taxes........................... 53,861 39,787 48,686 102,490 244,824
Net income........................................... 33,663 22,009 29,847 67,758 153,277
Net income per share................................. 0.44 0.29 0.40 0.92 2.04
Shares used in computing net income
per share.......................................... 76,394 75,638 74,309 73,913 75,064
30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no disagreements on any matter of accounting principles,
financial statement disclosure, or auditing scope or procedure to be reported
under this item.
31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Information with respect to Directors may be found in the section captioned
"Election of Directors" appearing in the definitive Proxy Statement to be
delivered to stockholders in connection with the Annual Meeting of Stockholders
to be held on April 8, 1998. Such information is incorporated herein by
reference.
EXECUTIVE OFFICERS
Information with respect to executive officers may be found in Item 1.
Business.
32
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item may be found in the section captioned
"Executive Compensation" appearing in the definitive Proxy Statement to be
delivered to stockholders in connection with the Annual Meeting of Stockholders
to be held on April 8, 1998. Such information is incorporated herein by
reference.
33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item may be found in the section captioned
"Security Ownership of Certain Beneficial Owners and Management" appearing in
the definitive Proxy Statement to be delivered to stockholders in connection
with the Annual Meeting of Stockholders to be held April 8, 1998. Such
information is incorporated herein by reference.
34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULE, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report
1. Financial statements
-
Management's Report
-
Independent Auditors' Report
-
Consolidated Balance Sheets
November 28, 1997 and November 29, 1996
-
Consolidated Statements of Income
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995
-
Consolidated Statements of Stockholders' Equity
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995
-
Consolidated Statements of Cash Flows
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995
-
Notes to Consolidated Financial Statements
2. Financial statement schedule
-
Schedule II--Valuation and Qualifying Accounts
3. Exhibits
(a) Index to Exhibits
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
- --------- ---------------------------------------------------------- --------- --------- --------- ---------
2.1 Agreement and Plan of Merger effective 5/30/97 (by virtue 10-Q 05/30/97 2.1
of a reincorporation), by and between Adobe Systems
Incorporated, a California Corporation and Adobe Systems
(Delaware) Incorporated, a Delaware corporation.
3.1 The Registrant's (as successor in-interest to Adobe 10-Q 05/30/97 3.1
Systems (Delaware) Incorporated by virtue of a
reincorporation effective 5/30/97) Certificate of
Incorporation, as filed with the Secretary of State of the
State of Delaware on 5/9/97.
3.2.10 Amended and Restated Bylaws as currently in effect. X
3.3 Certificate of Designation of the Series A Preferred Stock X
4.1 Second Amended and Restated Rights Agreement between the 8-K 08/29/97 4
Company and Harris Trust Company of California
10.1.6 1984 Stock Option Plan, as amended* 10-Q 07/02/93 10.1.6
10.1.7 1994 Stock Option Plan* 10-Q 05/27/94 10.1.7
36
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
- --------- ---------------------------------------------------------- --------- --------- --------- ---------
10.17.1 License Agreement Restatement between the Company and 10-K 11/30/88 10.17.1
Apple Computer, Inc., dated April 1, 1987 (confidential
treatment granted)
10.17.2 Amendment No. 1 to the License Agreement Restatement 10-K 11/30/90 10.17.2
between the Company and Apple Computer, Inc., dated
November 27, 1990 (confidential treatment granted)
10.21.3 Revised Bonus Plan* 10-Q 02/28/97 10.21.3
10.24.1 1994 Performance and Restricted Stock Plan* S-8 07/27/94 10.1
10.25.0 Form of Indemnity Agreement* 10-K 11/30/90 10.17.2
10.25.1 Form of Indemnity Agreement* 10-Q 05/30/97 10.25.1
10.32 Sublease of the Land and Lease of the Improvements By and 10-K 11/25/94 10.32
Between Sumitomo Bank Leasing and Finance Inc. and Adobe
Systems Incorporated (Phase 1)
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 10-Q 08/30/96 10.38
Between Sumitomo Bank Leasing and Finance Inc. and Adobe
Systems Incorporated (Phase 2)
10.39 1997 Employee Stock Purchase Plan, as amended* S-8 05/30/97 10.39
10.40 1994 Stock Option Plan Amendment, as amended* S-8 05/30/97 10.40
10.41 Amended and Restated Limited Partnership Agreement of 10-Q 05/30/97 10.41
Adobe Incentive Partners, L.P.*
10.42 Amended and Restated Limited Partnership Agreement of X
Adobe Incentive Partners, L.P.*
10.43 Resignation Agreement* X
10.44 Forms of Retention Agreement* X
11 Computation of Earnings Per Common Share X
21 Subsidiaries of the Registrant X
23 Consent of Independent Auditors X
27 Financial Data Schedule X
- ------------------------
*Compensatory plan or arrangement
(b)Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended November 28, 1997.
37
SIGNATURES
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/ P. JACKSON BELL
-----------------------------------------
P. Jackson Bell,
Executive Vice President,
Chief Financial Officer,
Chief Administrative Officer,
and Assistant Secretary
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 17th day of February, 1998.
SIGNATURE TITLE
- ------------------------------ --------------------------
/s/ JOHN E. WARNOCK Chairman of the Board of
- ------------------------------ Directors
John E. Warnock and Chief Executive
Officer
(Principal Executive
Officer)
/s/ CHARLES M. GESCHKE Chairman of the Board of
- ------------------------------ Directors
Charles M. Geschke and President
/s/ WILLIAM R. HAMBRECHT Director
- ------------------------------
William R. Hambrecht
/s/ ROBERT SEDGEWICK Director
- ------------------------------
Robert Sedgewick
/s/ DELBERT W. YOCAM Director
- ------------------------------
Delbert W. Yocam
/s/ WILLIAM J. SPENCER Director
- ------------------------------
William J. Spencer
/s/ GENE P. CARTER Director
- ------------------------------
Gene P. Carter
/s/ P. JACKSON BELL Executive Vice President,
- ------------------------------ Chief Financial Officer,
P. Jackson Bell Chief Administrative
Officer,
and Assistant Secretary
(Principal Financial
Officer)
/s/ DAVID P. EICHLER Vice President, Finance
- ------------------------------ (Principal Accounting
David P. Eichler Officer)
38
SUMMARY OF TRADEMARKS
The following trademarks of Adobe Systems Incorporated or its subsidiaries,
which may be registered in certain jurisdictions, are referenced in this Form
10-K:
Adobe
Acrobat
After Effects
Aldus
Frame
FrameMaker
Illustrator
PageMaker
PageMill
PhotoDeluxe
Photoshop
PostScript
Premiere
PrintGear
SiteMill
Type Library
All other brand or product names are trademarks or registered trademarks of
their respective holders.
39
FINANCIAL STATEMENTS
As required under Item 8. Financial Statements and Supplementary Data, the
consolidated financial statements of the Company are provided in this separate
section. The consolidated financial statements included in this section are as
follows:
FINANCIAL STATEMENT DESCRIPTION PAGE
- ------------------------------------------------------------------------------------------------------------------ -----
- Management's Report.................................................................................... 41
- Independent Auditors' Report........................................................................... 42
- Consolidated Balance Sheets
November 28, 1997 and November 29, 1996.............................................................. 43
- Consolidated Statements of Income
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995............................... 44
- Consolidated Statements of Stockholders' Equity
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995............................... 45
- Consolidated Statements of Cash Flows
Years Ended November 28, 1997, November 29, 1996, and December 1, 1995............................... 48
- Notes to Consolidated Financial Statements............................................................. 49
40
MANAGEMENT'S REPORT
Management is responsible for all the information and representations
contained in the consolidated financial statements and other sections of this
FORM 10-K. Management believes that the consolidated financial statements have
been prepared in conformity with generally accepted accounting principles
appropriate in the circumstances to reflect in all material respects the
substance of events and transactions that should be included, and that the other
information in this FORM 10-K is consistent with those statements. In preparing
the consolidated financial statements, management makes informed judgments and
estimates of the expected effects of events and transactions that are currently
being accounted for.
In meeting its responsibility for the reliability of the consolidated
financial statements, management depends on the Company's system of internal
accounting controls. This system is designed to provide reasonable assurance
that assets are safeguarded and transactions are executed in accordance with
management's authorization, and are recorded properly to permit the preparation
of consolidated financial statements in accordance with generally accepted
accounting principles. In designing control procedures, management recognizes
that errors or irregularities may nevertheless occur. Also, estimates and
judgments are required to assess and balance the relative cost and expected
benefits of the controls. Management believes that the Company's accounting
controls provide reasonable assurance that errors or irregularities that could
be material to the consolidated financial statements are prevented or would be
detected within a timely period by employees in the normal course of performing
their assigned functions.
The Board of Directors pursues its oversight role for these consolidated
financial statements through the Audit Committee, which is comprised solely of
Directors who are not officers or employees of the Company. The Audit Committee
meets with management periodically to review their work and to monitor the
discharge of each of their responsibilities. The Audit Committee also meets
periodically with KPMG Peat Marwick LLP, the independent auditors, who have free
access to the Audit Committee or the Board of Directors, without management
present, to discuss internal accounting control, auditing, and financial
reporting matters.
KPMG Peat Marwick LLP is engaged to express an opinion on our consolidated
financial statements. Their opinion is based on procedures believed by them to
be sufficient to provide reasonable assurance that the consolidated financial
statements are not materially misleading and do not contain material errors.
By: /s/ P. JACKSON BELL
-----------------------------------------
P. Jackson Bell
Executive Vice President,
Chief Financial Officer,
Chief Administrative Officer,
and Assistant Secretary
(Principal Financial Officer)
December 16, 1997
41
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Adobe Systems Incorporated:
We have audited the accompanying consolidated financial statements of Adobe
Systems Incorporated and subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the accompanying financial statement schedule. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Adobe
Systems Incorporated and subsidiaries as of November 28, 1997 and November 29,
1996, and the results of their operations and their cash flows for each of the
years in the three-year period ended November 28, 1997, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
KPMG Peat Marwick LLP
San Jose, California
December 16, 1997
42
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOVEMBER 28 NOVEMBER 29
1997 1996
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 267,576 $ 110,745
Short-term investments.............................................................. 235,380 453,371
Receivables, net of allowances for doubtful accounts of $3,634 and $5,196,
respectively...................................................................... 130,974 115,823
Other current assets................................................................ 45,016 45,875
------------ ------------
Total current assets.............................................................. 678,946 725,814
Property and equipment................................................................ 80,978 80,231
Deferred income taxes................................................................. 16,999 --
Other assets.......................................................................... 163,148 195,348
------------ ------------
$ 940,071 $1,001,393
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade and other payables............................................................ $ 57,857 $ 43,056
Accrued expenses.................................................................... 102,741 93,919
Income taxes payable................................................................ 48,343 67,210
Deferred revenue.................................................................... 15,706 15,537
------------ ------------
Total current liabilities......................................................... 224,647 219,722
------------ ------------
Deferred income taxes................................................................. -- 3,809
Put warrants.......................................................................... -- 71,348
Stockholders' equity:
Preferred stock, $0.0001 par value; 2,000 shares authorized; none issued............ -- --
Common stock, $0.0001 par value;
Authorized: 200,000 shares;
Issued: 73,941 and 71,476 shares in 1997 and 1996, respectively;
Outstanding: 68,765 and 71,476 shares in 1997 and 1996, respectively.............. 7 7
Additional paid-in capital.......................................................... 291,274 148,595
Retained earnings................................................................... 663,861 529,546
Unrealized gains on investments, net................................................ 3,590 33,514
Cumulative translation adjustment................................................... (4,620) (5,148)
Treasury stock, at cost (5,176 shares in 1997)...................................... (238,688) --
------------ ------------
Total stockholders' equity........................................................ 715,424 706,514
------------ ------------
$ 940,071 $1,001,393
------------ ------------
------------ ------------
See accompanying Notes to Consolidated Financial Statements.
43
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED
---------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------ ------------ -----------
Revenue:
Licensing............................................................. $ 196,230 $ 196,693 $ 183,437
Application products.................................................. 715,664 589,870 578,902
------------ ------------ -----------
Total revenue........................................................... 911,894 786,563 762,339
Direct costs............................................................ 126,271 141,147 130,301
------------ ------------ -----------
Gross profit............................................................ 785,623 645,416 632,038
------------ ------------ -----------
Operating expenses:
Software development costs:
Research and development............................................ 170,862 152,914 138,616
Amortization of capitalized software development costs.............. -- 2,504 11,095
Sales, marketing, and customer support................................ 303,268 254,972 242,713
General and administrative............................................ 75,358 62,034 58,526
Write-off of acquired in-process research and development............. 5,969 21,251 14,983
Merger transaction and restructuring costs............................ -- 4,955 31,534
Other nonrecurring items.............................................. (590) -- --
------------ ------------ -----------
Total operating expenses................................................ 554,867 498,630 497,467
------------ ------------ -----------
Operating income........................................................ 230,756 146,786 134,571
Nonoperating income:
Investment gain (loss)................................................ 34,290 68,875 (755)
Interest and other income............................................. 31,044 29,163 30,037
------------ ------------ -----------
Total nonoperating income............................................... 65,334 98,038 29,282
------------ ------------ -----------
Income before income taxes.............................................. 296,090 244,824 163,853
Income tax provision.................................................... 109,253 91,547 70,368
------------ ------------ -----------
Net income.............................................................. $ 186,837 $ 153,277 $ 93,485
------------ ------------ -----------
------------ ------------ -----------
Net income per share.................................................... $ 2.52 $ 2.04 $ 1.26
------------ ------------ -----------
------------ ------------ -----------
Shares used in computing net income per share........................... 74,132 75,064 74,253
------------ ------------ -----------
------------ ------------ -----------
See accompanying Notes to Consolidated Financial Statements.
44
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
UNREALIZED
COMMON STOCK ADDITIONAL GAINS ON CUMULATIVE TREASURY STOCK
-------------- PAID-IN RETAINED INVESTMENTS, TRANSLATION ---------------
SHARES AMOUNT CAPITAL EARNINGS NET ADJUSTMENT SHARES AMOUNT TOTAL
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
Balances as of
November 25, 1994...... 69,390 $ 7 $204,026 $315,611 $(1,277) $(4,052) -- $-- $514,315
Stock issued under
employee stock and
stock option plans..... 3,914 -- 70,367 -- -- -- -- -- 70,367
Tax benefit from employee
stock option plans..... -- -- 32,445 -- -- -- -- -- 32,445
Stock compensation
expense................ -- -- 4,433 -- -- -- -- -- 4,433
Adjustment for change in
Frame Technology
Corporation fiscal
year-end............... (10) -- (171) (1,784) -- -- -- -- (1,955)
Dividends declared....... -- -- -- (13,177) -- -- -- -- (13,177)
Subchapter S
distributions of
Mastersoft............. -- -- -- (3,342) -- -- -- -- (3,342)
Repurchase of common
stock.................. (460) -- (17,849) -- -- -- -- -- (17,849)
Unrealized gains on
investments, net....... -- -- -- -- 20,108 -- -- -- 20,108
Cumulative translation
adjustment............. -- -- -- -- -- (413) -- -- (413)
Net income............... -- -- -- 93,485 -- -- -- -- 93,485
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
Balances as of
December 1, 1995....... 72,834 $ 7 $293,251 $390,793 $18,831 $(4,465) -- $-- $698,417
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
(Continued)
See accompanying Notes to Consolidated Financial Statements
45
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(IN THOUSANDS)
UNREALIZED
COMMON STOCK ADDITIONAL GAINS ON CUMULATIVE TREASURY STOCK
-------------- PAID-IN RETAINED INVESTMENTS, TRANSLATION ---------------
SHARES AMOUNT CAPITAL EARNINGS NET ADJUSTMENT SHARES AMOUNT TOTAL
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
Balances as of
December 1, 1995..... 72,834 $ 7 $293,251 $390,793 $18,831 $(4,465) -- $-- $698,417
Stock issued under
employee stock and
stock option plans... 2,032 -- 39,870 -- -- -- -- -- 39,870
Tax benefit from
employee stock option
plans................ -- -- 10,828 -- -- -- -- -- 10,828
Stock compensation
expense.............. -- -- 2,772 -- -- -- -- -- 2,772
Dividends declared..... -- -- -- (14,524) -- -- -- -- (14,524)
Repurchase of common
stock................ (3,390) -- (126,778) -- -- -- -- -- (126,778)
Reclassification of put
warrant
obligations.......... -- -- (71,348) -- -- -- -- -- (71,348)
Unrealized gains on
investments, net..... -- -- -- -- 14,683 -- -- -- 14,683
Cumulative translation
adjustment........... -- -- -- -- -- (683) -- -- (683)
Net income............. -- -- -- 153,277 -- -- -- -- 153,277
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
Balances as of
November 29, 1996.... 71,476 $ 7 $148,595 $529,546 $33,514 $(5,148) -- $-- $706,514
------ ------ ---------- -------- ------------ ---------- ------ ------ --------
(Continued)
See accompanying Notes to Consolidated Financial Statements.
46
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
(IN THOUSANDS)
UNREALIZED
COMMON STOCK ADDITIONAL GAINS ON CUMULATIVE TREASURY STOCK
-------------- PAID-IN RETAINED INVESTMENTS, TRANSLATION -----------------
SHARES AMOUNT CAPITAL EARNINGS NET ADJUSTMENT SHARES AMOUNT TOTAL
------ ------ ---------- -------- ------------ ---------- ------ --------- --------
Balances as of
November 29,
1996............... 71,476 $ 7 $148,595 $529,546 $ 33,514 $(5,148) -- $ -- $706,514
Stock issued under
employee stock and
stock option
plans.............. 3,631 -- 70,995 -- -- -- -- -- 70,995
Tax benefit from
employee stock
option plans....... -- -- 29,607 -- -- -- -- -- 29,607
Stock compensation
expense............ -- -- 1,329 -- -- -- -- -- 1,329
Dividends declared... -- -- -- (52,522) -- -- -- -- (52,522)
Repurchase of common
stock.............. (1,166) -- (36,956) -- -- -- (5,176) (238,688) (275,644)
Proceeds from sale of
put warrants....... -- -- 6,356 -- -- -- -- -- 6,356
Reclassification of
expired put warrant
obligations........ -- -- 71,348 -- -- -- -- -- 71,348
Unrealized gains on
investments, net... -- -- -- -- (29,924) -- -- -- (29,924)
Cumulative
translation
adjustment......... -- -- -- -- -- 528 -- -- 528
Net income........... -- -- -- 186,837 -- -- -- -- 186,837
------ ------ ---------- -------- ------------ ---------- ------ --------- --------
Balances as of
November 28,
1997............... 73,941 $ 7 $291,274 $663,861 $ 3,590 $(4,620) (5,176) $(238,688) $715,424
------ ------ ---------- -------- ------------ ---------- ------ --------- --------
------ ------ ---------- -------- ------------ ---------- ------ --------- --------
See accompanying Notes to Consolidated Financial Statements
47
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED
----------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------ ------------ ------------
Cash flows from operating activities:
Net income......................................................................... $ 186,837 $ 153,277 $ 93,485
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization.................................................... 59,384 55,621 60,435
Deferred income taxes............................................................ (4,172) (9,420) (7,167)
Equity in net (income) loss of Adobe Ventures.................................... 1,326 (19,001) 755
Gains on sales of equity securities.............................................. (35,616) (53,216) --
Tax benefit from employee stock option plans..................................... 29,607 10,828 32,445
Stock compensation expense....................................................... 1,329 2,772 4,433
Write-off of acquired in-process research and development........................ 5,969 21,251 14,983
Noncash restructuring costs...................................................... -- 2,525 4,714
Changes in operating assets and liabilities:
Receivables.................................................................... (15,151) 8,556 (24,548)
Other current assets........................................................... (2,351) (1,173) 628
Trade and other payables....................................................... 14,802 8,534 (7,032)
Accrued expenses............................................................... (1,192) (27,427) 4,996
Income taxes payable........................................................... (32,294) 48,768 (4,845)
Deferred revenue............................................................... 169 (3,781) 4,474
------------ ------------ ------------
Net cash provided by operating activities............................................ 208,647 198,114 177,756
------------ ------------ ------------
Cash flows from investing activities:
Purchases of short-term investments................................................ (2,657,302) (2,363,993) (2,614,349)
Maturities and sales of short-term investments..................................... 2,875,294 2,363,793 2,403,631
Acquisitions of property and equipment............................................. (33,882) (45,869) (34,071)
Additions to other assets.......................................................... (42,122) (65,399) (96,721)
Acquisitions, net of cash acquired................................................. (6,121) (8,027) (15,158)
Proceeds from sales of equity securities........................................... 30,993 72,630 --
------------ ------------ ------------
Net cash provided by (used for) investing activities................................. 166,860 (46,865) (356,668)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock and put warrants............................ 77,351 39,870 70,367
Repurchase of common stock......................................................... (275,644) (126,778) (17,849)
Payment of dividends............................................................... (20,911) (14,586) (12,310)
Payment of Subchapter S distributions of Mastersoft................................ -- -- (3,342)
------------ ------------ ------------
Net cash provided by (used for) financing activities................................. (219,204) (101,494) 36,866
Effect of foreign currency exchange rates on cash and cash equivalents............... 528 2,497 10
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents................................. 156,831 52,252 (142,036)
Adjustment for change in acquired company's fiscal year-end.......................... -- -- (3,591)
Cash and cash equivalents at beginning of year....................................... 110,745 58,493 204,120
------------ ------------ ------------
Cash and cash equivalents at end of year............................................. $ 267,576 $ 110,745 $ 58,493
------------ ------------ ------------
------------ ------------ ------------
Supplemental disclosures:
Cash paid during the year for income taxes......................................... $ 85,062 $ 30,463 $ 44,470
------------ ------------ ------------
------------ ------------ ------------
Noncash investing and financing activities:
Cash dividends declared but not paid............................................. $ 3,558 $ 3,582 $ 3,645
------------ ------------ ------------
------------ ------------ ------------
Dividends in-kind declared but not distributed................................... $ 10,032 $ -- $ --
------------ ------------ ------------
------------ ------------ ------------
Dividends in-kind distributed.................................................... $ 21,603 $ -- $ --
------------ ------------ ------------
------------ ------------ ------------
Issuance of notes for acquisition................................................ $ -- $ 9,473 $ --
------------ ------------ ------------
------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements.
48
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS
Founded in 1982, Adobe Systems Incorporated ("Adobe" or the "Company")
develops, markets, and supports computer software products and technologies that
enable users to express and use information across all print and electronic
media. The Company licenses its technology to major computer, printing, and
publishing suppliers, and markets a line of application software products and
type products for authoring and editing visually rich documents. Additionally,
the Company markets a line of powerful, easy-to-use products for home and small
business users. The Company distributes its products through a network of
original equipment manufacturer ("OEM") customers, distributors and dealers, and
value-added resellers ("VARs") and systems integrators. The Company has
operations in North America, Europe, Japan, and Asia, Pacific, and Latin
America.
FISCAL YEAR
The Company's fiscal year is a 52/53 week year ending on the Friday closest
to November 30.
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements include those of Adobe
and its subsidiaries, after elimination of all significant intercompany accounts
and transactions.
RECAPITALIZATION
In May 1997, the Company was reincorporated in the State of Delaware. As
part of this reincorporation, each outstanding share of the predecessor
California Corporation preferred stock and common stock was converted
automatically to one share of the new Delaware Corporation $0.0001 par value
preferred stock and common stock. All prior periods presented have been restated
to reflect this change.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities, at the date of the financial statements,
and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents consist of instruments with maturities of three months or
less at the time of purchase.
All of the Company's cash equivalents and short-term investments, and
certain noncurrent investments in equity securities, free of trading
restrictions or to become free of trading restrictions within one year, are
classified as "available-for-sale." These investments are carried at fair value,
based on quoted market prices, and unrealized gains and losses, net of taxes,
are reported as a separate component of stockholders' equity. Realized gains and
losses upon sale or maturity of these investments are determined using the
specific identification method.
49
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of certain foreign subsidiaries, whose functional
currency is the local currency, are translated at year-end exchange rates.
Income and expense items are translated at the average rates of exchange
prevailing during the year. The adjustment resulting from translating the
financial statements of such foreign subsidiaries is reflected as a separate
component of stockholders' equity. Certain other transaction gains or losses,
which have not been material, are reported in results of operations.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and amortization
are calculated using the straight-line method over the shorter of the estimated
useful lives (thirty-five years for the building; two to seven years for
furniture and equipment) or lease terms (five to nine years for leasehold
improvements) of the respective assets.
OTHER ASSETS
Purchased technology, goodwill, and certain other intangible assets are
stated at cost less accumulated amortization. Amortization is provided on the
straight-line method over the estimated useful lives of the respective assets,
generally three to seven years. Capitalization of computer software development
costs, when material, begins upon the establishment of technological
feasibility. Such costs are amortized using the greater of the ratio of current
product revenue to the total current and anticipated product revenue or the
straight-line method over the software's estimated economic life, generally 9 to
36 months. The Company periodically reviews the net realizable value of its
intangible assets and adjusts the carrying amount accordingly.
The Company owns a minority interest in certain technology companies. Such
investments are accounted for under the cost method, as the Company does not
have significant influence or control over the investee companies. The Company
owns a majority interest in two limited partnerships that were established to
invest in technology companies. The limited partnership investments are
accounted for under the equity method because contractually the partnerships are
controlled by the general partner, a third party.
LONG-LIVED ASSETS
The Company reviews property and equipment for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of property and equipment is measured by
comparison of its carrying amount to future net cash flows the property and
equipment are expected to generate. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the property and equipment exceeds its fair market value, as
determined by discounted cash flows. The Company assesses the recoverability of
enterprise-level goodwill by determining whether the unamortized goodwill
balance can be recovered through undiscounted future results of the acquired
operation. The amount of enterprise-level goodwill impairment, if any, is
measured based on projected discounted future results using a discount rate
reflecting the Company's average cost of funds.
50
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EMPLOYEE STOCK PLANS
The Company accounts for its employee stock plans, which consist of fixed
stock option plans, an employee stock purchase plan, and a performance and
restricted stock plan, using the intrinsic value method.
REVENUE RECOGNITION
Application products revenue is recognized upon shipment. Revenue from
distributors is subject to agreements allowing limited rights of return and
price protection. The Company provides for estimated future returns at the time
the related revenue is recorded.
Licensing revenue is recognized when the Company's OEM customers ship their
products incorporating Adobe's software. Revenue associated with adapting the
Company's software products to an OEM customer's hardware products is recognized
based on the percentage-of-completion method and is included in licensing
revenue.
Deferred revenue includes customer advances under OEM licensing agreements.
Additionally, maintenance revenue for application products is deferred and
recognized ratably over the term of the contract, generally 12 months.
DIRECT COSTS
Direct costs include direct product, packaging, and shipping costs, as well
as royalties, localization costs, and amortization of acquired technologies.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts and the tax basis of existing
assets and liabilities. A valuation allowance is recorded to reduce tax assets
to an amount whose realization is more likely than not.
FOREIGN CURRENCY HEDGING INSTRUMENTS
The Company enters into foreign exchange contracts to hedge its foreign
currency risks. Such contracts must be effective at reducing the foreign
currency risk associated with the underlying transaction being hedged and must
be designated as a hedge at the inception of the contract. The Company, as a
matter of policy, does not engage in speculative transactions.
The Company currently uses forward contracts as hedges of firmly committed
transactions. For these contracts, mark-to-market gains and losses are
recognized as other income or expense in the current period, generally
consistent with the period in which the gain or loss of the underlying
transaction is
51
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recognized. All forward foreign currency contracts currently entered into by the
Company have maturities of 90 days or less.
PUT WARRANTS AND CALL OPTIONS
The Company utilizes put warrants and call option arrangements to facilitate
the repurchase of its common stock. In 1997, the Company can settle, at its
option, all outstanding puts and calls with physical delivery or net shares
equal to the difference between the exercise price and the market value at the
date of exercise. Accordingly, the potential repurchase obligation under these
arrangements is included in stockholders' equity. In 1996, the arrangements
required physical delivery, and accordingly, the potential buyback obligation
was removed from stockholders' equity and recorded as put warrants. Proceeds
from the sale of put warrants are recorded in stockholders' equity.
NET INCOME PER SHARE
Net income per share is based upon weighted average common and dilutive
common equivalent shares outstanding using the treasury stock method. Dilutive
common equivalent shares include stock options and restricted stock. The
difference between primary and fully diluted net income per share is not
significant in all periods presented.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 establishes a different method of computing net income per
share than is currently required under the provisions of Accounting Principles
Board Opinion No. 15. Under SFAS No. 128, the Company will be required to
present both basic net income per share and diluted net income per share. Basic
net income per share is expected to be higher than the currently presented net
income per share, as the effect of dilutive stock options will not be considered
in computing basic net income per share. Diluted net income per share is
expected to be comparable to the currently presented net income per share.
The Company plans to adopt SFAS No. 128 in its fiscal quarter ending
February 27, 1998, and at that time, all historical net income per share data
presented will be restated to conform to the provisions of SFAS No. 128.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in the financial statements. It does
not, however, require a specific format for the disclosure but requires the
Company to display an amount representing total comprehensive income for the
period in its financial statements. The Company will be required to implement
SFAS No. 130 for its fiscal year 1999.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." SFAS No. 131 establishes standards
for the manner in which public companies report information about operating
segments in annual and interim financial statements. The Company is currently
evaluating the operating segment information that it will be required to report.
The Company will be required to implement SFAS No. 131 for its fiscal year 1999.
52
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." SOP
97-2 establishes standards relating to the recognition of all aspects of
software revenue. SOP 97-2 is effective for transactions entered into in fiscal
years beginning after December 15, 1997 and will require the Company to modify
certain aspects of its revenue recognition policies. The Company does not expect
the adoption of SOP 97-2 to have a material impact on the Company's consolidated
results of operations.
RECLASSIFICATIONS
Certain reclassifications were made to the 1996 and 1995 consolidated
financial statements to conform to the 1997 presentation.
NOTE 2. ACQUISITIONS
During 1997, 1996, and 1995, the Company acquired seven software companies,
in separate transactions, for an aggregate consideration of approximately $45.8
million in cash, notes payable, and the assumption of certain liabilities. These
acquisitions were accounted for using the purchase method of accounting and
resulted in the write-off of acquired in-process research and development of
$6.0 million, $21.3 million, and $15.0 million during fiscal 1997, 1996, and
1995, respectively. The operating results of the acquired companies have been
included in the accompanying consolidated financial statements from their dates
of acquisition. The operating results of each company acquired are not
considered material to the consolidated financial statements of Adobe and,
accordingly, pro forma information has not been presented.
NOTE 3. CASH EQUIVALENTS AND INVESTMENTS
All cash equivalents, short-term investments, and certain noncurrent
investments consisted of the following:
AS OF NOVEMBER 28, 1997
----------------------------------------------
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
-------- ---------- ---------- ----------
Classified as current assets:
Money market mutual funds...................................... $ 53,051 $ -- $-- $ 53,051
State and municipal bonds and notes............................ 394,295 757 (36) 395,016
Corporate and bank notes....................................... 6,400 -- -- 6,400
Auction-rate securities........................................ 2,800 -- -- 2,800
Equity securities.............................................. 4,082 5,292 -- 9,374
-------- ---------- ----- ----------
Total current.................................................. 460,628 6,049 (36) 466,641
-------- ---------- ----- ----------
Classified as noncurrent assets:
Money market mutual funds...................................... 46 -- -- 46
United States government treasury notes........................ 66,607 9 (9) 66,607
-------- ---------- ----- ----------
Total noncurrent............................................... 66,653 9 (9) 66,653
-------- ---------- ----- ----------
Total securities............................................... $527,281 $ 6,058 $ (45) $ 533,294
-------- ---------- ----- ----------
-------- ---------- ----- ----------
53
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 3. CASH EQUIVALENTS AND INVESTMENTS (CONTINUED)
AS OF NOVEMBER 29, 1996
----------------------------------------------
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
-------- ---------- ---------- ----------
Classified as current assets:
Money market mutual funds...................................... $ 39,381 $ -- $-- $ 39,381
United States government treasury notes and agency discount
notes........................................................ 90,617 424 (247) 90,794
State and municipal bonds and notes............................ 358,612 1,894 (36) 360,470
Corporate and bank notes....................................... 38,598 405 (33) 38,970
Auction-rate securities........................................ 10,000 -- -- 10,000
Asset-backed securities........................................ 11,740 91 (110) 11,721
-------- ---------- ----- ----------
Total current.................................................. 548,948 2,814 (426) 551,336
-------- ---------- ----- ----------
Classified as noncurrent assets:
Money market mutual funds...................................... 15,977 -- -- 15,977
United States government treasury notes........................ 50,327 -- (183) 50,144
Equity securities.............................................. 3,882 54,216 (19) 58,079
-------- ---------- ----- ----------
Total noncurrent............................................... 70,186 54,216 (202) 124,200
-------- ---------- ----- ----------
Total securities............................................... $619,134 $57,030 $(628) $ 675,536
-------- ---------- ----- ----------
-------- ---------- ----- ----------
Approximately $231.2 million and $97.9 million in investments are classified
as cash equivalents as of November 28, 1997 and November 29, 1996, respectively,
and all noncurrent investments are included in other assets. Unrealized gains
(losses) on all securities are reported as a separate component of stockholders'
equity, net of taxes of $2.4 million and $23.0 million as of November 28, 1997
and November 29, 1996, respectively. Net realized gains for the years ended
November 28, 1997 and November 29, 1996 of $38.4 million and $48.4 million,
respectively, are included in nonoperating income.
As of November 28, 1997, the cost, which approximated fair value, of current
debt securities and money market mutual funds with a maturity of one year or
less was $257.0 million, and the cost and estimated fair value of current debt
securities with maturities ranging from one to five years was $196.7 million and
$197.4 million, respectively. Other debt securities include auction-rate
securities of $2.8 million. Included in auction-rate securities are Auction Rate
Certificate Securities whose stated maturities exceed ten years. However, the
Company has the option of adjusting the respective interest rates or liquidating
these investments at auction on stated auction dates every 35 days.
54
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
NOVEMBER 28 NOVEMBER 29
1997 1996
----------- -----------
Land.............................................................. $ 782 $ 782
Building.......................................................... 4,477 4,615
Equipment......................................................... 141,067 121,044
Furniture and fixtures............................................ 21,243 18,126
Leasehold improvements............................................ 19,916 13,036
----------- -----------
187,485 157,603
Less accumulated depreciation and amortization.................... 106,507 77,372
----------- -----------
$ 80,978 $ 80,231
----------- -----------
----------- -----------
NOTE 5. OTHER ASSETS
Other assets consisted of the following:
NOVEMBER 28 NOVEMBER 29
1997 1996
------------ ------------
Equity investments................................................ $ 35,689 $ 97,679
Purchased technology and licensing agreements..................... 5,043 32,211
Restricted funds and security deposits............................ 102,962 69,443
Intangibles and other assets...................................... 45,097 35,470
------------ ------------
188,791 234,803
Less accumulated amortization..................................... 25,643 39,455
------------ ------------
$ 163,148 $ 195,348
------------ ------------
------------ ------------
Included above in equity investments at November 29, 1996, are unrealized
gains and losses. The equity investment in Netscape Communications Corporation
("Netscape") was marked-to-market for an unrealized gain of $47.7 million in
1996.
In 1997, the Company recorded realized gains of $32.8 million related to the
disposal of its holdings in Netscape through the distribution of 554,660
Netscape shares to the Company's stockholders as a dividend-in-kind and the sale
of its remaining Netscape shares. The Company recorded additional realized gains
in 1997 of $4.5 million related to the sale of other equity investments. During
1996, the Company recorded realized gains of approximately $43.6 million and
approximately $6.8 million for the sale of a portion of its investment in
Netscape and its entire investment in Luminous, respectively.
Amortization expense related to purchased technology and other intangibles
was $26.2 million and $42.8 million in fiscal 1997 and fiscal 1996,
respectively.
55
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 6. ACCRUED EXPENSES
Accrued expenses consisted of the following:
NOVEMBER 28 NOVEMBER 29
1997 1996
------------ ------------
Accrued compensation and benefits................................. $ 37,833 $ 24,673
Sales and marketing allowances.................................... 13,028 13,753
Other............................................................. 51,880 55,493
------------ ------------
$ 102,741 $ 93,919
------------ ------------
------------ ------------
NOTE 7. INCOME TAXES
Income before income taxes includes net income from foreign operations of
approximately $59.3 million, $25.4 million, and $19.2 million for the years
ended November 28, 1997, November 29, 1996, and December 1, 1995, respectively.
The provision for income taxes consisted of the following:
YEARS ENDED
---------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------ ------------ -----------
Current:
United States federal................................................. $ 42,238 $ 65,118 $ 21,466
Foreign............................................................... 29,260 12,290 18,418
State and local....................................................... 12,320 12,731 5,206
------------ ------------ -----------
Total current........................................................... 83,818 90,139 45,090
------------ ------------ -----------
Deferred:
United States federal................................................. (1,721) (6,825) (6,305)
Foreign............................................................... (2,071) (780) (986)
State and local....................................................... (380) (1,815) 124
------------ ------------ -----------
Total deferred.......................................................... (4,172) (9,420) (7,167)
------------ ------------ -----------
Charge in lieu of taxes attributable to employee stock plans............ 29,607 10,828 32,445
------------ ------------ -----------
$ 109,253 $ 91,547 $ 70,368
------------ ------------ -----------
------------ ------------ -----------
56
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 7. INCOME TAXES (CONTINUED)
Total income tax expense differs from the expected tax expense (computed by
multiplying the United States federal statutory rate of approximately 35 percent
for 1997, 1996, and 1995 by income before income taxes) as a result of the
following:
YEARS ENDED
---------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------ ------------ -----------
Computed "expected" tax expense......................................... $ 103,632 $ 85,689 $ 57,349
State tax expense, net of federal benefit............................... 10,301 9,819 6,442
Nondeductible merger costs.............................................. -- -- 4,078
Nondeductible write-off of acquired in-process research and
development........................................................... 1,791 5,310 5,244
Nondeductible goodwill.................................................. 825 772 3,689
Tax-exempt income....................................................... (5,559) (3,304) (3,532)
Tax credits............................................................. (4,604) (4,912) (3,904)
Foreign losses, not benefited........................................... -- -- 2,706
Foreign tax rate differential........................................... 1,864 (4,003) 1,130
Other, net.............................................................. 1,003 2,176 (2,834)
------------ ------------ -----------
$ 109,253 $ 91,547 $ 70,368
------------ ------------ -----------
------------ ------------ -----------
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of 1997 and 1996 are
presented below:
NOVEMBER 28 NOVEMBER 29
1997 1996
------------ ------------
Deferred tax assets:
Acquired technology................................................................. $ 12,720 $ 12,037
Reserves and deferred revenue....................................................... 25,511 24,615
Depreciation and amortization....................................................... 3,558 7,662
Net operating loss carryforwards.................................................... 3,260 4,278
Tax credits and other carryforwards................................................. -- 1,614
Other............................................................................... 5,652 5,800
------------ ------------
Total gross deferred tax assets................................................... 50,701 56,006
Deferred tax asset valuation allowance............................................ (3,643) (5,950)
------------ ------------
Total deferred tax assets......................................................... 47,058 50,056
------------ ------------
Deferred tax liabilities:
Investments......................................................................... (2,423) (22,888)
Other............................................................................... (1,812) (1,943)
------------ ------------
Total deferred tax liabilities.................................................... (4,235) (24,831)
------------ ------------
Net deferred tax assets............................................................... $ 42,823 $ 25,225
------------ ------------
------------ ------------
The Company provides United States income taxes on the earnings of foreign
subsidiaries unless the subsidiaries' earnings are considered permanently
reinvested outside the United States. As of November 28, 1997, the cumulative
amount of earnings upon which United States income taxes have not been
57
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 7. INCOME TAXES (CONTINUED)
provided are approximately $32.7 million. The unrecognized deferred tax
liability for these earnings is approximately $4.0 million.
As of November 28, 1997, the Company has foreign operating loss carryovers
in various jurisdictions of approximately $3.1 million with various expiration
dates. For financial reporting purposes, a valuation allowance has been
established to fully offset the deferred tax assets related to foreign operating
losses due to uncertainties in utilizing these losses. A valuation allowance has
also been established for certain deductions related to investments. Management
believes that it is more likely than not that the results of future operations
will generate sufficient taxable income to realize the net deferred tax assets.
The Company's federal tax returns have been examined by the Internal Revenue
Service for all years through 1993. The Internal Revenue Service has proposed
assessments that the Company is contesting in Tax Court. Management believes
that any related adjustments that might be required will not have a material
effect on the Company's financial position or results of operations.
NOTE 8. BENEFIT PLANS
PRETAX SAVINGS PLAN
In 1987, the Company adopted an Employee Investment Plan, qualified under
Section 401(k) of the Internal Revenue Code, which is a pretax savings plan
covering substantially all of the Company's United States employees. Under the
plan, eligible employees may contribute up to 18% of their pretax salary,
subject to certain limitations. The Company matches approximately 25% of
employee contributions and contributed approximately $1.8 million, $1.6 million,
and $1.2 million in 1997, 1996, and 1995, respectively. Matching contributions
can be terminated at the Company's discretion.
ADOBE INCENTIVE PARTNERS
In March 1997, as part of its venture investing program, the Company
established an internal limited partnership, Adobe Incentive Partners L.P.
("AIP"), which allows certain of the Company's executive officers to participate
in cash or stock distributions from Adobe's venture investments. Adobe is both
the general partner and a limited partner. Other limited partners are executive
officers of the Company who are involved in Adobe's venture investing activities
and whose participation is deemed critical to the success of the program.
Adobe's Class A senior limited partnership interest includes both a
liquidation preference and a preference in recovery of the cost basis of each
specific investment. The executives' Class B junior limited partnership interest
qualifies for partnership distributions only after: (a) Adobe has fully
recovered the cost basis of its investment in the specific investee company for
which a distribution is made; and (b) the participating executive has vested in
his or her distribution rights. The distribution rights generally vest on a
monthly basis over three years, such that the rights are 25% vested after one
year, 50% vested after two years, and fully vested at the end of three years.
The limited partnership investments are restricted to investments in companies
that are private at the time of the establishment of AIP or when the investment
is made, whichever is later. Partnership interests may be allocated to
designated officers only while the investee company is still private. Class B
interests may not exceed a maximum of 20% of the venture investments included in
AIP.
Assets held by AIP include Adobe's entire interests in Adobe Ventures L.P.
and Adobe Ventures II L.P. and equity securities of privately held companies. At
November 28, 1997, the cost basis of all
58
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 8. BENEFIT PLANS (CONTINUED)
investments included in AIP was approximately $34.8 million. No distributions
were made to the participating officers in fiscal 1997, and expense related to
AIP in fiscal 1997 was immaterial. At November 28, 1997, the minority interest
held by the participating officers was immaterial and is included in accrued
expenses on the balance sheet.
NOTE 9. EMPLOYEE STOCK PLANS
STOCK OPTION PLANS
As of November 28, 1997, the Company has reserved 29,200,000 shares of
common stock for issuance under its employee stock option plan. The employee
stock option plan provides for the granting of stock options to employees and
officers at the fair market value of the Company's common stock at the grant
date. Options generally vest 25% after the first year and ratably thereafter
such that 50% and 100% are vested after the second and third year, respectively.
The option terms range from five to ten years.
The Company has reserved, as of November 28, 1997, 500,000 shares of common
stock for issuance under its Outside Directors Stock Option Plan, which provides
for the granting of nonqualified stock options to nonemployee directors. Option
grants are limited to 10,000 shares per person in each fiscal year, except for a
new nonemployee director, who may be granted 15,000 shares upon election as a
director. All options are immediately exercisable within a ten-year term. Any
exercised, unvested option shares are subject to repurchase by the Company at
the original purchase price upon termination of the director's service. Options
generally vest over three years: 25% in each of the first two years and 50% in
the third year.
On March 22, 1996, the Company offered its employees a stock option
repricing program that allowed the employees to exchange on a two-for-three
share basis any options priced above the March 29, 1996 closing price of Adobe
stock, which was $32.25. As a result, approximately 1,252,000 options were
surrendered by eligible employees for approximately 834,000 repriced options.
The repriced options were not exercisable until November 1, 1996.
Stock option activity for 1997, 1996, and 1995 is presented below:
YEARS ENDED
------------------------------------------------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------------------ ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
----------- ----------- ------------ ----------- ------------ -----------
Outstanding, beginning of year.................. 9,297,188 $ 25.68 10,125,792 $ 26.30 11,173,336 $ 19.61
Granted......................................... 2,452,117 $ 40.85 2,670,673 $ 33.53 2,391,568 $ 47.72
Exercised....................................... (3,063,778) $ 20.29 (1,470,762) $ 17.37 (3,008,917) $ 19.04
Canceled........................................ (539,292) $ 33.75 (2,028,515) $ 45.15 (430,195) $ 26.57
----------- ------------ ------------
Outstanding, end of year........................ 8,146,235 $ 31.74 9,297,188 $ 25.68 10,125,792 $ 26.30
----------- ------------ ------------
----------- ------------ ------------
Exercisable, end of year........................ 4,562,954 $ 26.50 6,057,500 $ 21.63 5,783,226 $ 18.71
----------- ------------ ------------
----------- ------------ ------------
Weighted-average fair value of options granted
during the year............................... $ 15.68 $ 12.91
59
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 9. EMPLOYEE STOCK PLANS (CONTINUED)
Information regarding the stock options outstanding at November 28, 1997 is
summarized below.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
SHARES CONTRACTUAL EXERCISE SHARES EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ---------------------------------------------------- ----------- ----------- ----------- ---------- -----------
$ 3.45--$ 9.45...................................... 480,163 1.67 years $ 8.64 477,979 $ 8.67
$10.13--$19.63...................................... 538,026 4.38 years $ 14.79 536,576 $ 14.78
$20.00--$29.88...................................... 1,927,381 5.18 years $ 25.15 1,883,067 $ 25.13
$30.00--$39.88...................................... 3,131,671 8.13 years $ 34.21 1,145,311 $ 32.97
$40.38--$49.81...................................... 1,724,524 8.72 years $ 42.44 313,080 $ 42.15
$50.75--$67.00...................................... 344,470 7.57 years $ 51.20 206,941 $ 51.14
----------- ----------
$ 3.45--$67.00...................................... 8,146,235 6.91 years $ 31.74 4,562,954 $ 26.50
----------- ----------
----------- ----------
PERFORMANCE AND RESTRICTED STOCK PLAN
The Performance and Restricted Stock Plan ("the Plan") provides for the
granting of restricted stock and/or performance units to officers and key
employees. As of November 28, 1997, the Company had reserved 1,500,000 shares of
its common stock for issuance under this plan. Restricted shares issued under
this plan generally vest annually over three years but are considered
outstanding at the time of grant, as the stockholders are entitled to dividends
and voting rights. As of November 28, 1997, 110,511 shares were outstanding and
not yet vested.
In fiscal 1997, the Company granted 129,550 shares of restricted stock with
a weighted-average fair value of $39.04, and in fiscal 1996, the Company granted
26,750 shares of restricted stock with a weighted-average fair value of $37.71.
Performance units issued under this plan entitle the recipient to receive,
at the discretion of the Company, shares or cash upon completion of the
performance period subject to attaining identified performance goals.
Performance units are generally earned over a three-year period, and shares
earned are issued at the end of the three-year period. The ultimate value of the
performance units is dependent upon the Company's revenue and operating margin
growth (as defined by the Plan) during the three-year performance period
adjusted by a factor determined in 1997 by comparing the Company's return on
equity to the return on equity of a group of comparable companies. In 1996 and
1995, the factor was determined by comparing the growth in the Company's stock
price to an index of comparable stocks. The projected value of these units is
accrued by the Company and charged to expense over the three-year performance
period. As of November 28, 1997, November 29, 1996, and December 1, 1995,
performance units for 170,874; 94,745; and 75,420 shares were outstanding,
respectively, and $(2.1) million, $(0.2) million and $2.5 million was charged
(credited) to expense in 1997, 1996, and 1995, respectively. In fiscal 1997 and
1996, performance units were granted for 156,500 and 48,965 shares,
respectively, and the weighted-average fair value of the shares were $39.04 and
$64.03, respectively.
EMPLOYEE STOCK PURCHASE PLAN
The Company's Employee Stock Purchase Plan allows eligible employee
participants to purchase shares of the Company's common stock at a discount
through payroll deductions. The plan consists of two-
60
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 9. EMPLOYEE STOCK PLANS (CONTINUED)
year offering periods with four six-month purchase periods in each offering
period. Employees purchase shares at 85% of the market value at either the
beginning of the offering period or the end of the purchase period, whichever
price is lower. As of November 28, 1997, the Company had reserved 7,000,000
shares of its common stock for issuance under this plan and 3,383,780 shares
remain available for future issuance.
The weighted-average fair value of the purchase rights granted in fiscal
1997 and 1996 was $16.36 and $14.01, respectively.
PRO FORMA FAIR VALUE DISCLOSURES
The Company accounts for its employee stock plans, consisting of fixed stock
option plans, an employee stock purchase plan, and a performance and restricted
stock plan, using the intrinsic value method. The table below sets forth the pro
forma amounts of net income and net income per share that would have resulted if
the Company accounted for its employee stock plans under the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation."
YEARS ENDED
--------------------------
NOVEMBER 28 NOVEMBER 29
1997 1996
------------ ------------
Net income:
As reported..................................................... $ 186,837 $ 153,277
Pro forma....................................................... $ 161,790 $ 144,368
Net income per share:
As reported..................................................... $ 2.52 $ 2.04
Pro forma....................................................... $ 2.21 $ 1.92
For purposes of computing pro forma net income, the fair value of each
option grant, restricted stock grant, and Employee Stock Purchase Plan purchase
right is estimated on the date of grant using the Black-Scholes option pricing
model. The assumptions used to value the option grants and purchase rights are
stated below:
YEARS ENDED
------------------------------
NOVEMBER 28 NOVEMBER 29
1997 1996
-------------- --------------
Expected life of options..................................... 3 years 3 years
Expected life of restricted stock............................ 3 years 3 years
Expected life of purchase rights............................. 1.25 years 1.25 years
Volatility................................................... 50% 50%
Risk-free interest rate...................................... 5.01--6.60% 5.54--6.66%
Dividend yield............................................... 0.5% 0.5%
Options and restricted stock grants vest over several years, and new option
and restricted stock grants are generally made each year. Because of this and
because the provisions of SFAS No. 123 are effective only for fiscal years 1996
and 1997, the pro forma amounts shown above may not be representative of the pro
forma effect on reported net income in future years.
61
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 10. STOCKHOLDERS' EQUITY
STOCKHOLDER RIGHTS PLAN
The Company's Stockholder Rights Plan is intended to protect stockholders
from unfair or coercive takeover practices. In accordance with this plan, the
Board of Directors declared a dividend distribution of one common stock purchase
right on each outstanding share of its common stock held as of July 24, 1990,
and on each share of common stock issued by the Company thereafter. Each right
entitles the registered holder to purchase from the Company a share of common
stock at $115. The rights become exercisable in certain circumstances including
upon an entity acquiring or announcing the intention to acquire beneficial
ownership of 20 percent or more of the Company's common stock without the
approval of the Board of Directors or upon the Company being acquired by any
person in a merger or business combination transaction. The rights are
redeemable by the Company prior to exercise at $0.01 per right and expire on
July 24, 2000.
STOCK REPURCHASE PROGRAM
In September 1997, the Board of Directors authorized, subject to certain
business and market conditions, the purchase of up to 15,000,000 shares of the
Company's stock over the next two years. The Company purchased 6,342,395 shares
and 3,390,240 shares of its common stock in 1997 and 1996,
respectively, at a cost of $275.6 million and $126.8 million, respectively,
under its stock repurchase programs as well as through employee stock option
exercise transactions. Prior to the Company's reincorporation in the State of
Delaware in May 1997, the shares purchased were returned to the status of
authorized and unissued as required by California law. The 5,175,851 shares
purchased at a cost of $238.7 million subsequent to the Company's
reincorporation are presented as treasury stock in the Stockholders' Equity
section of the balance sheet.
PUT WARRANTS
To facilitate the Company's stock repurchase programs, the Company sold put
warrants in a series of private placements in 1997 and 1996. Each warrant
entitled the holder to sell one share of Adobe's common stock to the Company at
a specified price. Approximately 4.6 million and 4.5 million put warrants were
written in 1997 and 1996, respectively. At November 28, 1997, approximately 2.9
million put warrants were outstanding that expire on various dates through May
1998 and have exercise prices ranging from $37.07 to $47.98 per share, with an
average exercise price of $43.09 per share. In addition, in 1997 and 1996, the
Company purchased call options from an independent third party that entitled the
Company to buy 2.3 million and 4.5 million shares, respectively, of its common
stock. At November 28, 1997, approximately 0.5 million call options were
outstanding that expire on various dates through April 1998 and have exercise
prices ranging from $37.32 to $46.86 per share, with an average exercise price
of $41.32 per share.
As part of the Company's current stock repurchase programs, the Company may,
from time to time, enter into additional put warrant and call option
arrangements. Under these 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. Accordingly, the
arrangements do not require the reclassification of the obligation under put
warrants from equity, and no such reclassification of the Company's obligation
at November 28, 1997 has been made. Such arrangements were not in place at
November 29, 1996, and therefore, the Company's potential buyback obligation of
$71.3 million as of
62
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 10. STOCKHOLDERS' EQUITY (CONTINUED)
November 29, 1996 was removed from stockholders' equity and recorded as put
warrants. In the future, the Company may consider other methods to acquire the
Company's stock including direct purchases, open market purchases, accelerated
stock purchase programs, and other potential methods.
VENTURE STOCK DIVIDEND PROGRAM
In March 1997, the Company established the venture stock dividend program
under which the Company may, from time to time, distribute as a dividend-in-kind
shares of its equity holdings in investee companies to Adobe stockholders. In
1997, the Company dividended one share of Netscape common stock for each 100
shares of Adobe common stock held by stockholders of record on July 31, 1997. An
equivalent cash dividend was paid for holdings of less than 2,500 Adobe shares
and for fractional Netscape shares. Also on December 1, 1997, the Company
dividended one share of Siebel common stock for each 300 shares of Adobe common
stock held by stockholders of record on October 31, 1997. An equivalent cash
dividend was paid for holdings of less than 7,500 Adobe shares and for
fractional Siebel shares. The declaration of future dividends under this program
is within the discretion of the Board of Directors of the Company and will
depend upon business conditions, the Company's results of operations and
financial condition, and other factors.
NOTE 11. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company has operating leases for its corporate headquarters, field sales
offices, and certain office equipment that expire at various dates through 2015.
Rent expense for these leases aggregated $17.8 million, $18.3 million, and $21.0
million during 1997, 1996, and 1995, respectively. As of November 28, 1997,
future minimum lease payments under noncancelable operating leases are as
follows: 1998 - $17.9 million; 1999 -$12.8 million; 2000--$9.3 million;
2001--$7.8 million; 2002--$3.0 million and $13.2 million, thereafter.
REAL ESTATE DEVELOPMENT AGREEMENT
During 1994, the Company entered into a real estate development agreement
and an operating lease agreement in connection with the construction of an
office facility. In August 1996, the construction was completed, and the
operating lease commenced. The Company will have the option to purchase the
facility at the end of the lease term in October 2001. In the event the Company
chooses not to exercise this option, the Company is obligated to arrange for the
sale of the facility to an unrelated party and is required to pay the lessor any
difference between the net sales proceeds and the lessor's net investment in the
facility, in an amount not to exceed that which would preclude classification of
the lease as an operating lease, approximately $57.3 million. During the
construction period, the Company was required to pledge certain interest-bearing
instruments to the lessor as collateral to secure the performance of its
obligations under the lease. As of November 28, 1997, the Company's deposits
under this agreement totaled approximately $66.7 million in United States
government treasury notes and money market mutual funds. These deposits are
included in "Other assets" in the Consolidated Balance Sheets.
In 1996, the Company exercised its option under the development agreement to
begin a second phase of development for an additional office facility. In August
1996, the Company entered into a construction
63
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
agreement and an operating lease agreement for this facility. The operating
lease will commence on completion of construction in 1998. The Company will have
the option to purchase the facility at the end of the lease term (five years
after occupancy). In the event the Company chooses not to exercise this option,
the Company is obligated to arrange for the sale of the facility to an unrelated
party and is required to pay the lessor any difference between the net sales
proceeds and the lessor's net investment in the facility, in an amount not to
exceed that which would preclude classification of the lease as an operating
lease, approximately $64.3 million. The Company also is required, periodically
during the construction period, to deposit funds with the lessor as an
interest-bearing security deposit to secure the performance of its obligations
under the lease. During 1997, the Company deposited approximately $33.0 million,
and as of November 28, 1997, the Company's deposits under this agreement totaled
approximately $36.3 million. These deposits are included in "Other assets" in
the Consolidated Balance Sheets.
ROYALTIES
The Company has certain royalty commitments associated with the shipment and
licensing of certain products. While royalty expense is generally based on a
dollar amount per unit shipped, ranging from $0.25 to $312, certain royalties
are based on a percentage, ranging from 0.03% to 12%, of the underlying revenue.
Royalty expense was approximately $25.0 million, $19.8 million, and $23.1
million in 1997, 1996, and 1995, respectively.
LEGAL ACTIONS
The Company is engaged in certain legal actions arising in the ordinary
course of business. The Company believes it has adequate legal defenses and that
the ultimate outcome of these actions will not have a material effect on the
Company's financial position and results of operations.
NOTE 12. TRANSACTIONS WITH AFFILIATE
At November 28, 1997, the Company held a 13% equity interest in McQueen
International Limited ("McQueen") and accounts for the investment using the cost
method. During 1994, the Company entered into various agreements with McQueen,
whereby the Company contracted with McQueen to perform product localization and
technical support functions and to provide printing, assembly, and warehousing
services. Adobe makes minimum annual payments to McQueen for certain services
which amounted to $5.2 million and $4.8 million in 1997 and 1996, respectively,
and will be approximately $1.4 million in 1998. Purchases from McQueen amounted
to $35.0 million, $34.3 million, and $23.6 million during 1997, 1996, and 1995,
respectively.
Effective December 31, 1997, McQueen was acquired by Sykes Enterprises,
Incorporated ("Sykes"), a publicly traded company. In connection with the
acquisition, the Company exchanged its shares of McQueen for 486,676 shares of
Sykes' restricted common stock and will record a gain on the exchange of $6.7
million in fiscal 1998. The Company's equity interest in Sykes is less than 2%.
64
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 13. FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's cash equivalents, short-term investments, restricted funds,
and marketable equity securities are carried at fair value, based on quoted
market prices for these or similar investments. (See Note 3.)
The Company's majority interest in Adobe Ventures L.P. and Adobe Ventures II
L.P. is carried at a combined value of $25.7 million which is believed to
approximate the fair value of underlying investments in technology companies.
Substantially all of the technology companies held by the limited partnerships
at November 28, 1997 are not publicly traded, and therefore there is no
established market for these investments. As such, these investments are valued
based on the most recent round of financing involving new non-strategic
investors and estimates made by the general partner, a third party. When
investments held by the limited partnerships are publicly traded, the fair value
of such investments is based on quoted market prices, and mark-to-market
adjustments are included in investment income. In general, as a matter of policy
of the limited partnerships, the investments in the technology companies held by
the limited partnerships will be distributed to the partners prior to the
investee company's initial public offering.
FOREIGN CURRENCY HEDGING INSTRUMENTS
The Company enters into forward exchange contracts to hedge foreign currency
exposures on a continuing basis for periods consistent with its committed
exposures. These transactions generally do not subject the Company to risk of
accounting loss because gains and losses on these contracts offset losses and
gains on the assets, liabilities, and transactions being hedged. However, the
Company is exposed to credit-related losses in the event of nonperformance by
the counterparties in these contracts. These contracts have maturities of less
than three months, and the amounts of unrealized gains and losses are
immaterial. The Company held $1.9 million of aggregate foreign currency forward
exchange contracts for the sale of the Japanese yen outstanding at the end of
fiscal year 1997. There were no foreign currency forward exchange contracts
outstanding at the end of fiscal 1996.
CONCENTRATION OF RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk are primarily cash, cash equivalents, short-term investments, and
accounts receivable. The Company's investment portfolio consists of
investment-grade securities diversified among security types, industries, and
issuers. The Company's investments are managed by recognized financial
institutions that follow the Company's investment policy. The Company's policy
limits the amount of credit exposure in any one issue, and the Company believes
no significant concentration of credit risk exists with respect to these
investments.
Credit risk in receivables is limited to OEM customers, and to dealers and
distributors of hardware and software products to the retail market. The Company
adopts credit policies and standards to keep pace with the evolving software
industry. Management believes that any risk of accounting loss is significantly
reduced due to the diversity of its products, end users, and geographic sales
areas. The Company performs ongoing credit evaluations of its customers'
financial condition and requires letters of credit or other guarantees, whenever
deemed necessary.
65
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 13. FINANCIAL INSTRUMENTS (CONTINUED)
A significant portion of the Company's licensing revenue is derived from a
small number of OEM customers. The Company's 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. Also, in the fall of 1997, one of Adobe's largest PostScript customers,
Hewlett-Packard Company ("HP"), introduced a non-Adobe clone version of
PostScript in one family of monochrome laser printers.
INDUSTRY SEGMENT
Adobe and its subsidiaries operate in one dominant industry segment, as
defined by SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." The Company is engaged principally in the design, development,
manufacture, and licensing of computer software. No customer accounted for more
than 10% of the Company's total revenue in 1997, 1996, or 1995.
NOTE 14. FOREIGN OPERATIONS
Geographic information for each of the years in the three-year period ended
November 28, 1997, is presented below:
YEARS ENDED
---------------------------------------
NOVEMBER 28 NOVEMBER 29 DECEMBER 1
1997 1996 1995
------------ ------------ -----------
Revenue:
North America....................................................... $ 606,633 $ 526,251 $ 533,332
Europe.............................................................. 226,557 134,879 133,982
Japan and Asia, Pacific, and Latin America.......................... 222,911 176,490 107,357
Eliminations........................................................ (144,207) (51,057) (12,332)
------------ ------------ -----------
$ 911,894 $ 786,563 $ 762,339
------------ ------------ -----------
------------ ------------ -----------
Operating income:
North America....................................................... $ 87,035 $ 31,186 $ 26,446
Europe.............................................................. 69,371 16,408 37,319
Japan and Asia, Pacific, and Latin America.......................... 135,657 103,002 70,416
Eliminations........................................................ (61,307) (3,810) 390
------------ ------------ -----------
$ 230,756 $ 146,786 $ 134,571
------------ ------------ -----------
------------ ------------ -----------
Identifiable assets:
North America....................................................... $ 923,704 $1,015,065 $ 934,705
Europe.............................................................. 79,291 67,506 62,993
Japan and Asia, Pacific, and Latin America.......................... 32,161 22,102 13,946
Eliminations........................................................ (95,085) (103,280) (138,817)
------------ ------------ -----------
$ 940,071 $1,001,393 $ 872,827
------------ ------------ -----------
------------ ------------ -----------
66
FINANCIAL STATEMENT SCHEDULE
As required under Item 8, Financial Statements and Supplementary Data, the
financial statement schedule of the Company is provided in this separate
section. The financial statement schedule included in this section is as
follows:
SCHEDULE
NUMBER FINANCIAL STATEMENT SCHEDULE DESCRIPTION
- -------------------------------------------------------- --------------------------------------------------------
Schedule II............................................. Valuation and Qualifying Accounts
67
ADOBE SYSTEMS INCORPORATED
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
VALUATION AND QUALIFYING ACCOUNTS WHICH ARE DEDUCTED IN THE
BALANCE SHEET FROM THE ASSETS TO WHICH THEY APPLY
ADDITIONS
--------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OPERATING OTHER END
OF PERIOD EXPENSES ACCOUNTS (1) DEDUCTIONS OF PERIOD
----------- ----------- ------------- ----------- -----------
Allowance for doubtful accounts:
Year Ended:
November 28, 1997............................. $ 5,196 $ (440) $ -- $ 1,122 $ 3,634
November 29, 1996............................. $ 3,698 $ 1,927 $ -- $ 429 $ 5,196
December 1, 1995.............................. $ 3,893 $ 2,038 $ (423) $ 1,810 $ 3,698
Deductions related to the allowance for doubtful accounts represent amounts
written off against the allowance.
- ------------------------
(1) The $423 reduction in 1995 reflects the effect of including Frame allowance
activity for the month ended December 31, 1994 in the years ended November
25, 1994 and December 1, 1995.
See accompanying Independent Auditors' Report.
68
EXHIBITS
As required under Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K, the exhibits filed as part of this report are provided in
this separate section. The exhibits included in this section are as follows:
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
3.2.10 Amended and Restated Bylaws as currently in effect
3.3 Certificate of Designation of the Series A Preferred Stock
10.42 Amended and Restated Limited Partnership Agreement of Adobe Incentive Partners, L.P.
10.43 Resignation Agreement
10.44 Forms of Retention Agreement
11 Computation of Earnings per Common Share
21 Subsidiaries of the Registrant
23 Consent of Independent Auditors
27 Financial Data Schedule
69