Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
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 27, 1998
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 (Zip Code)
(Address of principal executive
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 31, 1998 was $2,796,898,365.
The number of shares outstanding of the registrant's common stock as of
December 31, 1998 was 61,297,428.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to stockholders
in connection with the Notice of Annual Meeting of Stockholders to be held on
April 15, 1999 are incorporated by reference into Part III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE NO.
--------
PART I
Item 1. Business................................................................... 3
Item 2. Properties................................................................. 11
Item 3. Legal Proceedings.......................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders........................ 12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters....... 13
Item 6. Selected Financial Data.................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 15
Item 7a. Quantitative and Qualitative Disclosures About Market Risk................. 29
Item 8. Financial Statements and Supplementary Data................................ 31
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..................................................... 32
Item 12. Security Ownership of Certain Beneficial Owners and Management............. 32
Item 13. Certain Relationships and Related Transactions............................. 32
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K............ 33
Signatures........................................................................... 35
Summary of Trademarks................................................................ 37
Financial Statements................................................................. 38
Financial Statement Schedule......................................................... 69
Exhibits............................................................................. 71
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 1999. 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 print and electronic media. The Company
offers a market-leading line of application software products, type products,
and content for creating, distributing, and managing information of all types;
licenses its 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 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.
Adobe software helps people use the computer to express, share, and manage
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, print, and manage high-impact information,
thereby helping them and their ideas stand out. The Company's strategy is to
address the needs of professional publishers, business publishers, consumers,
and companies who need to solve document and printing problems.
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, compact disc, the Internet, an e-mail system, or a corporate
network. Moreover, Adobe software enables users to perform all of these tasks
across multiple computing environments, including Microsoft Windows, Apple
Macintosh, and UNIX.
APPLICATION PRODUCTS:
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 enables users to
3
easily convert any file from any application to Adobe's Portable Document
Format ("PDF"), a compact cross-platform electronic format that exactly
preserves layout fonts, colors, and images. 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.
Adobe After Effects--provides two-dimensional (2D) animation, motion
compositing, and special effects used in multimedia, broadcast, and film
production.
Adobe Dimensions--a 3D rendering tool for life-like modeling and
visualization. Brings 2D structures into 3D and applies textured surfaces,
custom lighting effects and more.
Adobe FrameMaker--an application for authoring and publishing long and
complex documents including books, technical manuals, and reports.
Adobe FrameMaker+SGML--integrates all of the features of FrameMaker with
features designed to simplify the SGML authoring, and publishing process.
Adobe Illustrator--an illustration and page design tool for print, the
Internet, and multimedia used by professional illustrators and Internet
content creators.
Adobe ImageReady--provides a comprehensive environment in which to refine
and prepare web graphics, which enables a user to quickly and easily assess
and balance the trade offs between size and quality before posting images to
a web site.
Adobe ImageStyler--a tool to create web graphics and publish them on a web
site efficiently. Introduces an innovative, object-based approach to web
graphics creation and production.
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 PageMill--a tool used to create full-featured Web pages without
requiring user knowledge of hypertext mark-up language (HTML), and employs
easy drag-and-drop techniques to simplify 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.
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 Premiere--provides non-linear digital video editing used in multimedia
and video production.
Adobe Streamline--converts bitmap shapes into smooth line art.
Adobe Type Library--contains over 2,500 Roman and almost 100 Japanese
high-quality outline typefaces used by graphics professionals and Internet
content creators worldwide.
Adobe Type Manager--provides powerful, easy management of all Type 1 and
TrueType fonts.
GoLive CyberStudio--professional Web design and publishing software.
Provides tools Web authors need to design and produce fully dynamic Web
sites without complex multimedia programming.
4
PRINTING TECHNOLOGIES:
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 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.
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.
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.
APPLICATION PRODUCTS:
In the publishing market, Adobe offers several products: Adobe Photoshop,
Adobe PageMaker, Adobe Illustrator, Adobe Dimensions, and Adobe Type Library. In
addition, the Company offers two dynamic media products: Adobe Premiere and
Adobe After Effects. The Company believes these 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 publishing products. These
companies include Microsoft, Quark, Macromedia, Corel, MetaCreations, Avid and
Linotype.
The Internet market is a constantly evolving and highly volatile market,
characterized by rapid technology developments and frequent new product
introductions. The needs of the graphics professional are rapidly changing to
encompass on-line publishing as well as print-based publishing. Two new
products, Adobe ImageStyler and Adobe ImageReady, and one recently acquired
product, Golive CyberStudio, fall in this category. These three products, as
well as Adobe PageMill face 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.
In the authoring and technical 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.
5
In the document exchange 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.
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, MGI Software, and Live Picture. The Company believes it
competes favorably with its Adobe PhotoDeluxe product due to its strong
relationships with critical original equipment manufacturer ("OEM") customers
and market influencers and its ability to leverage core competencies from
established products.
PRINTING TECHNOLOGIES:
Adobe believes that the principal competitive factors for OEM customers 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 customer relationships, and intellectual
property portfolio. Adobe PostScript and Adobe PrintGear software face
competition from Hewlett-Packard Company'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 Denmark, France,
Germany, Italy, the Netherlands, Norway, Spain, Sweden, Switzerland, and the
United Kingdom. Adobe's Pacific Rim presence includes Adobe Systems Kabushhiki
Kaisha in Japan as well as operations in Asia Pacific and Latin America,
including Australia, Brazil, Hong Kong, Korea, China, Singapore, India, and
Mexico.
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
The procurement of the various components of packaged products, including
CDs and printed materials, and the assembly of the packages for retail and other
applications products is controlled by manufacturing operations. Adobe
outsources a majority of its manufacturing activities to third parties, both in
the United States and in Europe.
To date, Adobe has not experienced significant difficulties in obtaining raw
materials for the manufacture of its products or in the replication of CDs,
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 31, 1998.
6
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 beta-testing programs.
INVESTMENT IN NEW MARKETS
The Company owns a majority interest in two venture capital limited
partnerships, Adobe Ventures L.P. and Adobe Ventures II, L.P., that invest in
early stage companies with innovative technologies. These companies may create
new market opportunities for Adobe or enhance the Company's existing business.
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 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 27, 1998
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 of AIP. 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 in AIP 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
were 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. In fiscal 1998, the
participating officers received aggregate cash distributions of $707,000. The
amount of cash distributed to the officers represents their vested portion of
investments that were liquidated by AIP. At November 27, 1998, the minority
interest held by the participating officers was $1.5 million and is included in
accrued expenses on the consolidated balance sheet.
The Company's portfolio of equity investments, including those held by AIP
at November 27, 1998, had a cost basis of $65.9 million and a recorded fair
market value of $56.3 million. In fiscal 1998, AIP
7
recorded net income of $2.2 million. Gross proceeds from the sale of equity
securities during fiscal 1998 were $17.0 million. The Company's equity
investments and Adobe Ventures L.P. and Adobe Ventures II, L.P.'s investments in
equity securities at November 27, 1998 consisted of the following companies:
PRIVATE PUBLIC
------------- -----------
ADOBE EQUITY INVESTMENTS
Cascade Systems International.............................................. X
Datalogics Incorporated.................................................... X
Objectivity Incorporated................................................... X
PointCast Inc.............................................................. X
Tier Two Systems........................................................... X
Vertec Solutions, Inc...................................................... X
Vignette Corporation....................................................... X
ADOBE VENTURES L.P. EQUITY INVESTMENTS
Cascade Systems International.............................................. X
Cogito Learning Media, Inc................................................. X
Digimarc Corporation....................................................... X
DigitalThink, Inc.......................................................... X
Electronic Submission Publishing Systems, Inc.............................. X
Extensis Corporation....................................................... X
FileNet Corporation........................................................ X
Managing Editor, Inc....................................................... X
mFactory, Inc.............................................................. X
Salon Internet, Inc........................................................ X
ADOBE VENTURES II, L.P. EQUITY INVESTMENTS
2Way Corporation........................................................... X
AvantGo, Inc............................................................... X
Cogito Learning Media, Inc................................................. X
Digital Intelligence, Inc.................................................. X
DigitalThink, Inc.......................................................... X
Extensis Corporation....................................................... X
Glyphica................................................................... X
HAHT Software, Inc......................................................... X
Salon Internet, Inc........................................................ X
Tumbleweed Software Corporation............................................ X
Vignette Corporation....................................................... X
Virage, Inc................................................................ X
The Company intends to continue investing in new markets, through limited
partnerships as well as through direct investments by the Company.
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
8
that may obligate the Company to pay royalties, typically based on a percentage
of the revenues generated by those programs.
During the fiscal years ended November 27, 1998, November 28, 1997, and
November 29, 1996, the Company's research and development expenses, including
costs related to contract development, were $207.3 million, $170.9 million, and
$155.4 million, respectively. During fiscal years 1997 and 1996, the Company
acquired through purchase transactions five software companies or technologies.
In fiscal 1997 and 1996, $6.0 million and $21.3 million, respectively, of the
purchase price was allocated to in-process research and development and expensed
at the time of the acquisition. See Management's Discussion and Analysis for
further information.
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 copyrights, 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 31, 1998, Adobe employed 2,680 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, especially highly skilled engineers, is intense. Adobe
believes its future success will depend in part on its continued ability to
recruit and retain highly skilled technical, management and marketing personnel.
9
EXECUTIVE OFFICERS
The executive officers of the Company as of February 16, 1999 are as
follows:
NAME AGE POSITIONS
- ----------------------------------------------------- --- -----------------------------------------------------
John E. Warnock...................................... 58 Chairman of the Board and Chief Executive Officer
Charles M. Geschke................................... 59 Chairman of the Board and President
Bruce Chizen......................................... 43 Executive Vice President, Worldwide Products and
Marketing
Frederick A. Snow.................................... 62 Executive Vice President, Worldwide Field Operations
Harold L. Covert..................................... 52 Senior Vice President and Chief Financial Officer
Derek J. Gray........................................ 49 Senior Vice President and General Manager, Adobe
Systems Europe
Colleen M. Pouliot................................... 40 Senior Vice President, General Counsel, and Secretary
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. Since September 1997, he has shared 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.
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. Chizen joined the Company upon the closing of the acquisition of Aldus
in August 1994 as Vice President and General Manager, Consumer Products
Division. In December 1997, he was promoted to Senior Vice President and General
Manager, Graphic Products Division, and in August 1998, Mr. Chizen was promoted
to Executive Vice President, Products and Marketing. Prior to joining the
Company, Mr. Chizen was Vice President and General Manager, Consumer Division of
Aldus Corporation from February 1994 to August 1994, and from November 1992 to
February 1994, he was Vice President and General Manager, Claris Clear Choice
for Claris Corp., a wholly owned subsidiary of Apple Computer, Inc., a
manufacturer of computers and software.
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. Covert joined the Company in April 1998 as Vice President Finance and
Operations for Worldwide Field Operations. In August 1998, Mr. Covert was
appointed Senior Vice President and Chief Financial Officer. From July 1997 to
April 1998, Mr. Covert was Vice President and Chief Financial Officer of Philips
Components NAFTA, an operating entity of Philips Electronic NV. From January
1991 to June 1997 Mr. Covert was a Partner in the firm of DHJ & Associates,
Inc., Consultants and Certified Public Accountants. During the last two and a
half years of this period he acted in a full time capacity as
10
Chief Financial Officer for two companies. Prior to that time Mr. Covert held
senior financial management positions with ISC Systems Corporation and Northern
Telecom Inc.
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 of Adobe Systems Europe. Prior to that time, Mr. Gray served
as Managing Director of Aldus Europe Limited since 1986. Mr. Gray was 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.
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.
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 $28.0 million and is subject to annual adjustment.
APPROXIMATE
SQUARE
LOCATION FOOTAGE USE
- ------------------------------------------------- ------------ -------------------------------------------------
North America:
345 Park Avenue 360,000 Research, product development, sales, marketing
San Jose, California and administration
USA
321 Park Avenue 280,000 Research, product development, sales, marketing
San Jose, California and administration
USA
801 N. 34(th) Street-Waterfront 254,328 Product development, customer support, and
Seattle, Washington administration
USA
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
11
In general, all facilities are in good condition and are operating at
capacities that range from 75% to 100%.
The Company owns land in Edinburgh, Scotland on which a building is being
constructed for future use as a sales, marketing and administration office. The
expected completion date of the building is August 1999.
The Company also leases office space in the United States and various other
countries under operating leases.
The Company has two leased office buildings in San Jose, California that
were vacated in connection with the restructuring program that was implemented
in the third quarter of fiscal 1998. The Company still has commitments under
these lease agreements, although the Company has already accrued these
commitments, net of anticipated sublease income, under its restructuring plan
(see Note 13 of the Consolidated Financial Statements).
ITEM 3. LEGAL PROCEEDINGS
On April 17, 1997, a derivative action was filed in the Superior Court of
the State of California, County of Santa Clara, against the current members of
Adobe's Board of Directors and Paul Brainerd, a former member of the Board. The
suit was filed by a stockholder purporting to assert on behalf of the Company
claims for alleged breach of the Directors' fiduciary duty and mismanagement
related to the Company's acquisition of Frame in October 1995. The Court granted
Adobe's demurrer to the suit, with leave to amend for the plaintiff. In January
1998, the plaintiff filed an amended complaint making substantially the same
claims but not including Mr. Brainerd. In March 1998, Adobe filed a demurrer to
the amended complaint, which was overruled by the trial court in May 1998. In
June 1998, Adobe filed a writ petition with the California Court of Appeals for
review of the trial court's decision, which was denied. In July 1998, Adobe
filed a petition for review of the Court of Appeals' refusal to grant the writ
with the Supreme Court of California, which was denied in September 1998. The
Company intends to continue vigorously defending the action.
On February 6, 1996, a securities class action complaint was filed against
Adobe, certain of its officers and directors, certain former officers of Adobe
and Frame Technology Corporation ("Frame"), Hambrecht & Quist, LLP ("H&Q"),
investment banker for Frame, and certain H&Q employees, in connection with the
drop in the price of Adobe stock following its announcement of financial results
for the quarter ended December 1, 1995. The complaint was filed in the Superior
Court of the State of California, County of Santa Clara. The complaint alleges
that the defendants misrepresented material adverse information regarding Adobe
and Frame and engaged in a scheme to defraud investors. The complaint seeks
unspecified damages for alleged violations of California law. Adobe believes
that the allegations against it and its officers and directors are without merit
and intends to vigorously defend the lawsuit. The case is currently in the
discovery phase.
On October 29, 1998, Heidelberger Druckmaschinen AG, a German company, filed
a complaint alleging that Adobe is using Heidelberger's US patent number
4,393,399 for the partial electronic retouching of colors. The complaint was
filed in the United States District Court for the District of Delaware, and
seeks a permanent injunction and unspecified damages. Adobe believes that the
allegations against it are without merit and intends to vigorously defend the
lawsuit.
Management believes that the ultimate resolution of these matters will not
have a material impact on the Company's financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
12
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 Market under the
symbol "ADBE." On December 31, 1998, there were 1,694 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 1998:
First Quarter.................................................................... $ 44.75 $ 33.50 $ 0.05
Second Quarter................................................................... 51.88 39.94 0.05
Third Quarter.................................................................... 45.13 24.06 0.05
Fourth Quarter................................................................... 48.00 23.63 0.05
Fiscal Year...................................................................... 51.88 23.63 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.
13
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. 27 NOV. 28 NOV. 29 DEC. 1 NOV. 25
1998 1997 1996 1995 1994
---------- ---------- ------------ ---------- ----------
Operations:
Revenue.......................................... $ 894,791 $ 911,894 $ 786,563 $ 762,339 $ 675,617
Income before income taxes....................... 167,694 296,090 244,824 163,853 52,946
Net income(1).................................... 105,144 186,837 153,277 93,485 15,337
Net income per share(1)
Basic.......................................... 1.58 2.60 2.12 1.31 0.23
Diluted........................................ 1.55 2.52 2.04 1.26 0.22
Cash dividends declared per common share(2)...... 0.20 0.20 0.20 0.20 0.20
Financial position:
Cash and short-term investments.................. 272,547 502,956 564,116 516,040 444,768
Working capital.................................. 204,979 454,299 506,092 506,472 402,837
Total assets..................................... 767,331 940,071 1,001,393 872,827 710,000
Stockholders' equity............................. 516,365 715,424 706,514 698,417 514,315
Additional data:
Worldwide employees.............................. 2,664 2,654 2,222 2,322 2,055
- ------------------------
(1) In 1998, includes investment gains of $15.0 million and restructuring and
other charges of $38.2 million. 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.
(2) Dividends prior to the acquisitions 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.
14
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 1999. 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 print and electronic media. The Company
offers a market-leading line of applications software products, type products,
and content for creating, distributing, and managing information of all types;
licenses its technology to major hardware manufacturers, software developers,
and service providers; and offers integrated software solutions to businesses of
all sizes. The Company distributes its products through a network of original
equipment manufacturer ("OEM") customers, distributors and dealers, and value-
added resellers ("VARs") and systems integrators and has operations in North
America, Europe, Japan, Asia Pacific and Latin America.
REVENUE
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ ------
Total revenue............................................... $894.8 (2)% $911.9 16% $786.6
Total revenue decreased $17.1 million, or 2%, in fiscal 1998 compared to
fiscal 1997, primarily due to the ongoing weakness in the Japanese economy and a
decline in licensing revenue related to the Company's PostScript technology. The
revenue growth in fiscal 1997 compared to fiscal 1996 was essentially
attributable to increased sales of application products resulting from the
release of new and enhanced products. In fiscal 1998, revenue from one major
distributor of application products accounted for 13.5% of the Company's total
revenue. No customer accounted for more than 10% of the Company's total revenue
in fiscal 1997 or 1996.
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ ------
Product revenue:
Licensing................................................. $164.1 (16)% $196.2 -- $196.7
Percentage of total revenue................................. 18.3% 21.5% 25.0%
Licensing revenue is made up of royalties received from OEM customers who
ship products containing Adobe's PostScript technology, including Adobe
PostScript, Adobe PostScript 3, Adobe PrintGear, and PostScript Extreme. Adobe
PostScript is a software language for describing to a printer the appearance of
a page, including text, graphics, and images. Products containing Adobe
PostScript technology that implement the language include: (1) black-and-white
printers; (2) color printers; (3) slide recorders;
15
(4) imagesetters; (5) screen displays; and (6) digital copiers. Adobe PostScript
products serve the corporate enterprise, graphic arts, production printing,
small office/home office markets, and high-volume production printing markets.
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 OEM customers and software developers
to create and market a variety of Adobe PostScript products independently of
controller hardware development.
Licensing revenue in fiscal 1998 decreased $32.1 million, or 16%, compared
to fiscal 1997, primarily due to weakness in the Japanese personal computer and
printer markets, as well as a reduction in royalty revenue from Hewlett-Packard
Company's ("HP") desktop monochrome laser printer division which has been
incorporating a clone version of Adobe PostScript into some of its products
since the fall of 1997.
Licensing revenue in fiscal 1997 was unchanged from fiscal 1996 as increased
demand for CPSI, color capability, and Adobe PrintGear products was offset by a
number of factors affecting OEM customers, 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 certain new technologies being
brought to market by OEM customers.
The Company continues to be cautious about licensing revenue in the short
term because of Japanese market conditions, the uncertain timing of new product
releases by OEM customers incorporating Adobe's latest technologies, and the
anticipated full impact of loss of revenue from HP's monchrome laser printer
products. In addition, 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 to the Company. As a
result of these conditions, the OEM licensing business is likely to decline in
fiscal 1999. However, the Company anticipates growth opportunities in the
digital copier marketplace that is expected to increase licensing revenue in the
long term.
1998 CHANGE 1997 CHANGE 1996
------ ------- ------ ------ ------
Product revenue:
Application products...................................... $730.6 2% $715.7 21% $589.9
Percentage of total revenue................................. 81.7% 78.5% 75.0%
Application products revenue is derived predominantly from shipments of
application software programs marketed through retail and VAR distribution
channels, with the exception of Adobe PhotoDeluxe, which is primarily
distributed through OEM bundling agreements with digital camera, scanner, and
personal computer manufacturers.
Application products revenue increased $15.0 million, or 2%, in fiscal 1998
compared to fiscal 1997, due primarily to the release of two major professional
publishing products, Adobe Photoshop 5.0 and Adobe Illustrator 8.0; increased
revenue from Acrobat 3.0, as the Portable Document Format ("PDF") upon which
Acrobat is based continued to gain acceptance worldwide; and increased revenues
from the Company's new Web products, Adobe ImageStyler and Adobe ImageReady,
which have received favorable reviews and market reception. In addition, the
release of Adobe PhotoDeluxe Business Edition and Adobe Premiere, the Company's
video editing product, contributed to the overall increase in application
products revenue. These increases were partially offset by a decline in revenues
from various products, primarily Adobe PageMaker, Adobe FrameMaker and Adobe
Type Manager, all of which did not release upgrades during the year. Overall,
the Company's revenue increase was smaller than expected as a result of adverse
economic conditions in Japan.
16
Application products revenue increased $125.8 million, or 21%, in fiscal
1997 compared to fiscal 1996, due to major product releases and upgrades, which
included Adobe PageMaker, Adobe Illustrator, and Adobe FrameMaker. In addition,
increased demand for Adobe Photoshop, the Adobe Acrobat family of products, and
Adobe PhotoDeluxe contributed to the increase.
Overall, revenue from the Company's applications products on the Windows
platform increased by 21% in fiscal 1998 over fiscal 1997, while application
products revenue from the Macintosh platform decreased 10% during the same
period. In fiscal 1998, the Windows and Macintosh platforms accounted for 58%
and 42%, respectively, of applications products revenue, excluding
platform-independent and UNIX products, compared to 51% and 49%, respectively,
in fiscal 1997. The Company expects this trend toward the Windows platform to
continue for the foreseeable future.
The Company remains cautious about the economic conditions in Japan as well
as the fluctuating economic conditions in other Asian and Latin American
countries.
DIRECT COSTS:
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ ------
Direct costs................................................ $111.4 (12)% $126.3 (11)% $141.1
Percentage of total revenue................................. 12.4% 13.8% 17.9%
Direct costs include product packaging, third party royalties, amortization
of localization costs and acquired technologies, and reserves for excess and
obsolete inventory.
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 decreased $14.9 million, or 12%, in fiscal 1998 compared to
fiscal 1997, due to lower packaging costs and the Company's full transition from
distribution of its products on disk to CD-ROM media. Direct costs also
decreased in fiscal 1998 and fiscal 1997 compared to fiscal 1996 as certain
acquired technologies became fully amortized in fiscal 1997 and the Company
incurred lower product localization costs.
The Company anticipates that direct costs will increase in fiscal 1999 due
to increased costs necessary to support higher anticipated application products
revenue. However, on a percentage of revenue basis, direct costs are expected to
be the same or slightly lower than fiscal 1998.
OPERATING EXPENSES:
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ ------
Research and development.................................... $207.3 21% $170.9 10% $155.4
Percentage of total revenue................................. 23.2% 18.7% 19.8%
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 expenses increased in absolute dollars over the
past three years due to the expansion of the Company's engineering staff and
related costs required to support its continued emphasis on developing new
products and enhancing existing products. The increase also reflects the
Company's increased investments in new technologies, new product development,
and the infrastructure to support such activities. The increase in research and
development expenses in fiscal 1998 was partially offset by certain cost
reduction initiatives related to the restructuring program that was implemented
during the
17
third quarter of fiscal 1998. The Company also experienced reduced outside labor
costs and professional fees as certain research and development programs were
discontinued (see Management's Discussion and Analysis of Restructuring and
other charges).
The Company believes that investments in research and development, including
the recruiting and hiring of software developers, are critical to remain
competitive in the marketplace and are directly related to continued timely
development of new and enhanced products. The Company will continue to make
significant investments in the development of its application software products,
including those targeted for the growing Internet market. While the Company
expects that research and development expenditures in fiscal 1999 will increase
in absolute dollars, such expenditures as a percentage of revenue are expected
to remain approximately the same or lower than fiscal 1998.
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ -----
Sales and marketing......................................... $316.7 4% $303.3 19% $255.0
Percentage of total revenue................................. 35.4% 33.3% 32.4%
Sales and marketing expenses include salaries and benefits, sales
commissions, travel expenses, and related facilities costs for the Company's
sales, marketing, customer support, and distribution personnel. Sales and
marketing expenses also include the costs of programs aimed at increasing
revenue, such as advertising, trade shows, and other market development
programs.
Sales and marketing expenses increased $13.4 million, or 4%, in fiscal 1998
compared to fiscal 1997, due to higher employee costs related to increased
staffing, increased customer support costs to support new products and
customers, and increased marketing and advertising activities. As a result of
the increase in sales and marketing staff, as well as the growth in application
products revenue, higher commissions were paid in fiscal 1998 compared to fiscal
1997. Additionally, sales and marketing expenses included higher outside labor
costs to support user education related to new product releases and for the
development of the Company's Web site, as well as new public relations
activities in connection with the employment of a national public relations
agency. These increased expenses were partially offset by cost reduction
initiatives related to the restructuring program implemented during the third
quarter of fiscal 1998 that eliminated certain advertising campaigns and other
marketing activities related to the divestiture of a business unit (see
Management's Discussion and Analysis of Restructuring and other charges).
Sales and marketing expenses increased in fiscal 1997 compared to fiscal
1996 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.
While the Company expects that sales and marketing expenditures will
increase in absolute dollars in fiscal 1999, such expenditures as a percentage
of revenue are expected to remain approximately the same or lower than fiscal
1998.
1998 CHANGE 1997 CHANGE 1996
----- ------ ----- ------ -----
General and administrative.................................. $95.7 27% $75.4 21% $62.0
Percentage of total revenue................................. 10.7% 8.3% 7.9%
General and administrative expenses consist principally of salaries and
benefits, travel expenses, and related facilities costs for the finance, human
resources, legal, information services, and executive personnel of the Company.
General and administrative expenses also include outside legal and accounting
fees, provision for bad debts, amortization of goodwill, and expenses associated
with computer equipment and software used in the administration of the business.
General and administrative expenses increased $20.4 million, or 27%, in
fiscal 1998 compared to fiscal 1997, due to increased expenses for outside legal
and investment banking services associated with
18
responding to an unsolicited acquisition proposal, as well as increased employee
costs and related depreciation and building expenses associated with increased
staff. Additionally, the provision for uncollectible accounts increased to
reserve for accounts receivable from certain customers that were deemed
potentially uncollectible. These increased expenses were partially offset by
cost reduction initiatives related to the restructuring program implemented in
the third quarter of fiscal 1998 that included a reduction in general office and
other administrative expenses (see Management's Discussion and Analysis of
Restructuring and other charges).
General and administrative expenses increased in fiscal 1997 compared to
fiscal 1996 due primarily to higher information system costs, legal costs, and
employee costs primarily associated with a more comprehensive administrative
infrastructure.
The Company expects general and administrative spending in fiscal 1999 to
increase in absolute dollars over fiscal 1998 to support future administrative
infrastructure needs. However, on a percentage of revenue basis, general and
administrative expenses are not expected to be materially different than fiscal
1998.
1998 CHANGE 1997 CHANGE 1996
---- ------ ---- ------ -----
Write off of acquired in-process research and development... -- (100)% $6.0 (72)% $21.3
Percentage of total revenue................................. -- 0.7% 2.7%
During fiscal 1997, the Company acquired three software companies, in
separate transactions, for an aggregate consideration of approximately $8.5
million. These acquisitions were accounted for using the purchase method of
accounting, and approximately $6.0 million of the purchase price was allocated
to in-process research and development and expensed at the time of the
acquisitions. One of the in-process technologies acquired for $2.5 million was
discontinued in fiscal 1998. The project associated with an additional $2.8
million of the purchased in-process technology was canceled as part of the
restructuring in the third quarter of fiscal 1998 and subsequently sold to a
management-led buyout group.
During fiscal 1996, the Company acquired Ares Software for approximately
$15.5 million. The acquisition was accounted for using the purchase method of
accounting and approximately $15.3 million of the purchase price was allocated
to in-process research and development and expensed at the time of the
acquisition. The value assigned to purchased in-process technology was based on
a valuation prepared by an independent third party, estimating both the cost of
developing and incorporating the in-process technology into future versions of
PostScript and the future cash flows from the enhanced PostScript product, using
a discount factor which takes into consideration the uncertainty surrounding the
successful development of the purchased in-process technology. The in-process
technology was completed in fiscal 1997 and incorporated into PostScript 3.
Actual revenues, in aggregate, to date, together with revised forcasted
revenues, are expected to exceed the original estimate of revenues used to value
the in-process technology.
In November 1996, the Company also acquired in-process research and
development from Swell Software for approximately $6.0 million. The research
project was discontinued prior to reaching technological feasibility in early
fiscal 1997.
The Company reclassified $3.4 million and $3.5 million of in-process
research and development recognized during the first half of fiscal 1998 to
research and development and general and administrative expenses, respectively,
for the fiscal year ending November 27, 1998 financial statements.
19
RESTRUCTURING AND OTHER CHARGES:
1998 CHANGE 1997 CHANGE 1996
----- ------ ----- ------ ----
Restructuring and other charges............................. $38.2 NA $(0.6) (112)% $5.0
Percentage of total revenue................................. 4.3% (0.1)% 0.6%
In the third quarter of fiscal 1998, the Company implemented a restructuring
program aimed at streamlining its underlying cost structure to better position
the Company for growth and profitability. As part of the restructuring program,
the Company implemented a reduction in force of 364 positions, primarily in its
North American operations. The reductions came predominantly from overhead
areas, divested business units and redundant marketing activities, and as of
August 31, 1998, the majority of these terminations were completed. In addition
to severance and related charges associated with the reduction in force, the
restructuring program included charges for divesting two business units,
vacating leased facilities, and canceling certain contracts. These actions and
other non-restructuring related items resulted in charges of $38.2 million, of
which approximately $9.1 million were non-cash charges. For detailed information
regarding the Company's restructuring program, see Note 7 of the Notes to the
Consolidated Financial Statements.
The Company estimates that, as a result of the restructuring program,
annualized pre-tax savings of $60.0 million will be realized. Approximately 50%
of the savings are the result of the reduction in force and the remaining 50%
savings are the result of reductions in marketing and facilities expense, as
well as other discretionary savings, such as travel and outside services.
Restructuring and other charges in fiscal 1997 include 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 intellectual property.
Restructuring and other charges in fiscal 1996 include charges of $5.7
million related to the disposition of two business units previously owned by an
acquired company less the reversal of $0.7 million of excess reserves related to
restructuring costs recorded in prior years.
NONOPERATING INCOME:
1998 CHANGE 1997 CHANGE 1996
----- ------ ----- ------ -----
Investment gain............................................. $15.0 (56)% $34.3 (50)% $68.9
Percentage of total revenue................................. 1.7% 3.8% 8.8%
Investment gain consists principally of realized gains or losses from direct
investments as well as mark-to-market valuation adjustments for investments held
by Adobe Incentive Partners, L.P. ("AIP").
In fiscal 1998, the Company recorded a realized gain of $6.7 million related
to the Company's investment in McQueen International Limited ("McQueen") due to
the acquisition of McQueen by Sykes Enterprises, Incorporated ("Sykes"), a
publicly traded company. In addition, the Company liquidated its investment in
Siebel Systems, Incorporated ("Siebel") through the distribution to its
stockholders of approximately 165,000 shares of Siebel common stock as a
dividend-in-kind and the sale of its remaining Siebel shares. A gain was
recognized on the transaction of approximately $5.7 million. The remaining net
realized gain recorded by the Company in fiscal 1998 represents valuation
adjustments recorded by the Company related to its venture investments held by
AIP.
In fiscal 1997, the investment gain related 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 common stock as a dividend-in-kind and the sale of its remaining
Netscape shares.
20
The fiscal 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 fiscal 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.
The Company is uncertain of future investment gains or losses as they are
primarily dependent upon the operations of the underlying investee companies.
1998 CHANGE 1997 CHANGE 1996
----- ------ ----- ------- -----
Interest and other income................................... $27.4 (12)% $31.0 6% $29.2
Percentage of total revenue................................. 3.1% 3.4% 3.7%
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 decrease in interest and other income during fiscal 1998 compared to
fiscal 1997 is due to lower average cash and short-term investment balances in
fiscal 1998, primarily as a result of cash used for stock repurchases in fiscal
1998 and late fiscal 1997. The increase in interest and other income in fiscal
1997 from fiscal 1996 is related to higher average cash balances.
Interest income is expected to decrease in fiscal 1999 due to lower average
cash balances resulting from stock repurchases conducted in fiscal 1998.
Further, the Company's cash balances could also be reduced in fiscal 1999 due to
the purchase of software companies, products, or technologies complementary to
the Company's business.
INCOME TAX PROVISION:
1998 CHANGE 1997 CHANGE 1996
----- ------ ------ ------ -----
Income tax provision........................................ $62.6 (43)% $109.3 19% $91.5
Percentage of total revenue................................. 7.0% 12.0% 11.6%
Effective tax rate.......................................... 37.3% 36.9% 37.4%
The Company's effective tax rate increased in fiscal 1998 from fiscal 1997
principally as a result of the nondeductible write-off of goodwill and lower
tax-exempt interest income. The fiscal 1997 tax rate decreased from fiscal 1996
primarily due to lower nondeductible charges for the write-off of acquired
in-process research and development and higher tax-exempt income.
The Company anticipates that the tax rate in fiscal 1999 will not be
materially different than the tax rate in fiscal 1998.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
The Company believes that in the future its results of operations could be
affected by various factors, such as delays in shipment of the Company's new
products and major new versions of existing products, lack of market acceptance
of new products and upgrades, the introduction of competitive products by third
parties, weakness in demand for Macintosh application software and
Macintosh-related printers, renegotiation of royalty arrangements, growth in
worldwide personal computer and printer sales and sales price adjustments,
consolidation in the OEM printer business, ongoing weakness in the Company's
printing business due to product transitions, industry transitions to new
business and information delivery models, ongoing weakness in the Japanese and
other Asian economies, "Year 2000" issues (as discussed later
21
under "Year 2000 Issues"), and adverse changes in general economic conditions in
any of the countries in which the Company does business.
The Company has stated that in fiscal 1999 its annual revenue growth target
is 15% and its operating margin target is 25% of total revenue. These targets
are used to assist the Company's management in making decisions about the
allocation of resources and investments, not as predictions of future results.
The targets reflect a number of assumptions, including assumptions about the
Company's pricing, manufacturing costs and volumes and the mix of application
products and licensing revenue, full and upgrade products, distribution channels
and geographic distribution. These and many other factors described herein
affect the Company's financial performance and may cause the Company's future
results, including results for the current quarter, to vary materially from
these targets.
The Company's ability to develop and market products, including upgrades of
current products that successfully adapt to changing customer needs, may also
have an impact on the results of operations. The Company's ability to extend its
core technologies into new applications and to anticipate or respond to
technological changes could affect its ability to develop these products. A
portion of the Company's future revenue will come from these new applications.
Delays in product or upgrade introductions, whether by the Company or its OEM
customers, could have an adverse effect on the Company's revenue, earnings, or
stock price. The Company cannot determine the ultimate effect that these new
products or upgrades will have on its revenue or results of operations.
The market for the Company's graphics applications, particularly the
consumer products, is intensely and increasingly competitive and is
significantly affected by product introductions and market activities of
industry competitors. Additionally, Microsoft Corporation has stated its
intention to increase its presence in the digital imaging/graphics market by
mid-1999; the Company believes that, due to Microsoft's market dominance, any
new Microsoft digital imaging products will be highly competitive with the
Company's products. If competing new products achieve widespread acceptance, it
would have a significant adverse impact on the Company's operating results.
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 fiscal 1997 has been from the Macintosh platform, particularly
for the higher end Macintosh computers. In the last two years, Windows-based
application revenue exceeded that from the Macintosh platform, and for the past
several quarters, Macintosh platform sales of application products have
continued to decline year over year while Windows platform sales have continued
to rise. If there is a continuing slowdown of customer purchases in the higher
end Macintosh market, or if the Company is unable to continue to increase its
revenue from Windows customers commensurate with such a slowdown, the Company's
operating results could be materially adversely affected. 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.
Also, as the Company seeks to further broaden its customer base to achieve
greater penetration in the corporate business and consumer markets, the Company
may not successfully adapt its application software distribution channels, which
could materially adversely affect the Company's operating results. The Company
could experience decreases in average selling prices and some transitions in its
distribution channels that could materially adversely affect its operating
results.
The Company continues to expand into third-party distribution channels,
including value-added resellers and systems integrators, in its effort to
further broaden its customer base. As a result, the financial health of these
third parties, and the Company's continuing relationships with them, are
becoming more important to the Company's success. Some of these companies are
thinly capitalized and may be unable to withstand changes in business
conditions. The Company's financial results could be adversely affected if the
financial condition of certain of these third parties substantially weakens or
if the Company's relationships with them deteriorate.
22
The Company's printing revenue experienced a 16% decline in fiscal 1998
compared to fiscal 1997. Product transitions, as the Company transitions its
customers from Adobe PostScript Level 2 to Adobe PostScript 3 and PostScript
Extreme, along with weakness in the Japanese market, primarily caused the
revenue decline. If this trend continues, the Company's financial results could
be adversely affected. In addition, in the fall of fiscal 1997, HP began to ship
a clone version of Adobe PostScript in some printers, resulting in lower
licensing revenue to the Company in fiscal 1998, even though the Company
continues to work with HP printer operations to incorporate Adobe PostScript and
other technologies in other HP products. The Company expects lower licensing
revenue from HP in fiscal 1999. Further, OEM customers on occasion seek to
renegotiate their royalty arrangements. The Company evaluates these requests on
a case-by-case basis. If an agreement is not reached, a customer may decide to
pursue other options, which could result in lower licensing revenue for the
Company.
During late fiscal 1997 and throughout fiscal 1998, 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 applications products
at the Company's Japanese distributors remained higher than what the Company
considers normal. During fiscal 1998, the Company worked with its major
distributors in Japan to reduce channel inventory to what the Company considers
a reasonable level. The Company expects these adverse economic conditions to
continue in the short term, and they may continue to adversely affect the
Company's revenue and earnings. Although there are also adverse conditions in
other Asian and Latin American economies, the countries affected represent a
much smaller portion of the Company's revenue and thus have less impact on the
Company's operational results.
The Company has recently implemented a restructuring of its business and
reduced its workforce by more than 10%. However, the Company plans to continue
to invest in certain areas, which will require it to hire additional employees.
Competition for high quality personnel, especially highly skilled engineers, is
extremely intense. The Company's ability to effectively manage its growth will
require it to continue to improve its operational and financial controls and
information management systems, and to attract, retain, motivate, and manage
employees effectively. The failure of the Company to effectively manage growth
and transition in multiple areas of its business could have a material adverse
effect on its results of operations.
The Internet market is rapidly evolving and is characterized by an
increasing number of market entrants that have introduced or developed products
addressing authoring and communications over the Internet. As is typical in the
case of a new and evolving industry, demand and market acceptance for recently
introduced products and services are subject to a high level of uncertainty. The
software industry addressing authoring and communications over the Internet is
young and has few proven products. Standards defining web graphics have not yet
been finally adopted. In addition, new models for licensing software will be
needed to accommodate new information delivery practices. Moreover, critical
issues concerning the commercial use of the Internet (including security,
reliability, ease of use and access, cost, and quality of service) remain
unresolved and may affect the growth of Internet use, together with the software
standards and electronic media employed in such markets.
The Company derives a significant portion of its revenue and operating
income from its subsidiaries located in Europe, Japan, and Asia Pacific and
Latin America. The Company generally experiences lower revenue from its European
operations in the third quarter because many customers reduce their purchasing
activities in the summer months. Additionally, the Company is uncertain whether
the recent weakness experienced in the Japan and Asia Pacific and Latin America
markets will continue in the foreseeable future due to possible currency
devaluation and liquidity problems in these regions. While most of the revenue
of the European subsidiaries is denominated in U.S. dollars, the majority of
revenue derived from Japan is denominated in yen and the majority of all
subsidiaries' operating expenses are denominated in their local currencies. As a
result, the Company's operating results are subject to fluctuations in foreign
currency exchange rates. To date, the accounting impact of such fluctuations has
been insignificant. The Company's hedging policy attempts to mitigate some of
these risks, based on management's best judgment
23
of the appropriate trade-offs among risk, opportunity, and expense. The Company
has established a hedging program to hedge its exposure to foreign currency
exchange rate fluctuations, primarily of the Japanese yen. The Company's hedging
program is not comprehensive, and there can be no assurance that the program
will offset more than a portion of the adverse financial impact resulting from
unfavorable movement in foreign currency exchange rates.
On January 1, 1999, eleven of the fifteen member countries of the European
Union adopted the euro as their common legal currency and established fixed
conversion rates between their existing sovereign currencies and the euro. The
euro trades on currency exchanges and is available for non-cash transactions.
Based on its preliminary assessment, the Company does not believe the conversion
will have a material impact on the competitiveness of its products in Europe,
where there already exists substantial price transparency, or increase the
likelihood of contract cancellations. Further, the Company expects that
modifications to comply with euro requirements have been and will continue to be
made to its business operations and systems on a timely basis and does not
believe that the cost of such modifications will have a material adverse impact
on the Company's results of operations or financial condition. There can be no
assurance, however, that the Company will be able to continue to complete such
modifications on a timely basis; any failure to do so could have a material
adverse effect on the Company's results of operations or financial condition. In
addition, the Company faces risks to the extent that suppliers, manufacturers,
distributors and other vendors upon whom the Company relies and their suppliers
are unable to make appropriate modifications to support euro transactions. The
inability of such third parties to support euro transactions could have a
material adverse effect on the Company's results of operations or financial
condition.
In connection with the enforcement of its own intellectual property rights
or in connection with disputes relating to the validity or alleged infringement
of third-party rights, the Company has been and may in the future be subject to
complex, protracted litigation as part of its policy to vigorously defend its
intellectual property rights. Intellectual property litigation is typically very
costly and can be disruptive to business operations by diverting the attention
and energies of management and key technical personnel. Although the Company has
successfully defended past litigation, there can be no assurance that it will
prevail in any ongoing or future litigation. Adverse decisions in such
litigation could subject the Company to significant liabilities, require the
Company to seek licenses from others, prevent the Company from manufacturing or
selling certain of its products, or cause severe disruptions to the Company's
operations or the markets in which it competes, any one of which could have a
material adverse effect on the results of operations or financial condition of
the Company.
The Company prepares its financial statements in conformity with generally
accepted accounting principles ("GAAP"). GAAP are subject to interpretation by
the American Institute of Certified Public Accountants (the "AICPA"), the
Securities and Exchange Commission (the "SEC") and various bodies formed to
interpret and create appropriate accounting policies. A change in these policies
can have a significant effect on the Company's reported results, and may even
affect the reporting of transactions completed before a change is announced.
Accounting policies affecting many other aspects of the Company's business,
including rules relating to software revenue recognition, purchase and
pooling-of-interests accounting for business combinations, the valuation of
in-process research and development, employee stock purchase plans and stock
option grants have recently been revised or are under review by one or more
groups. Changes to these rules, or the questioning of current practices, may
have a significant adverse effect on the Company's reported financial results or
in the way in which the Company conducts its business.
Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by securities
analysts could have, and has had in the past, an immediate and significant
adverse effect on the trading price of the Company's common stock in any given
period. Additionally, the Company may not learn of such shortfalls until late in
the fiscal quarter, which could result in an even
24
more immediate and adverse effect on the trading price of the Company's common
stock. Finally, the Company participates in a highly dynamic industry. In
addition to factors specific to the Company, changes in analysts' earnings
estimates for the Company or its industry and factors affecting the corporate
environment, the Company's industry or the securities markets in general will
often result in significant volatility of the Company's common stock price.
"YEAR 2000" ISSUES
The Company is addressing a broad range of issues associated with the
programming code in existing computer systems as the year 2000 approaches. The
"Year 2000" problem is complex, as many computer systems will be affected in
some way by the rollover of the two-digit year value to 00. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 issue creates risk for the Company from unforeseen
problems in its products or its own computer and embedded systems and from third
parties with whom the Company deals on financial and other transactions
worldwide. Failure of the Company's and/or third parties' computer systems or
Year 2000 defects in the Company's products could have a material impact on the
Company's ability to conduct its business.
The Company has commenced a phased program to inventory, assess, remediate,
test, implement and develop contingency plans for all mission-critical
applications and products potentially affected by the Year 2000 issue (the "Y2K
Program"). To accelerate overall completion, activities in each phase are often
concurrent rather than serial, but all phases, except developing contingency
plans, are expected to be completed by mid-1999. Additionally, the Company has
opened a dedicated Year 2000 test laboratory for both internal business process
and product testing. All Company business groups are involved in the Y2K Program
efforts.
The Company has identified three potential areas of impact for review: (1)
the software and systems, including embedded systems, used in the Company's
internal business processes; (2) third party vendors, manufacturers and
suppliers, and (3) the Company's software products offered to customers. The
Company's current estimate of the aggregate costs to be incurred for the Y2K
Program is approximately $3.0 million, which is expected to be funded from
operating cash flows. If the Company encounters significant unforeseen Year 2000
problems, either in its products or internal business systems or in relation to
third party vendors, manufacturers or suppliers, actual costs could materially
exceed this estimate.
INTERNAL BUSINESS PROCESSES. The Company has substantially completed its
inventory of Year 2000 impacted software and is assessing its centralized
computer and embedded systems to identify any potential Year 2000 issues. The
Company's financial information systems include an SAP system recently
implemented in the United States, Japan, and Asia Pacific and Latin America, and
an Oracle system in Europe that has recently been upgraded to a recent version.
SAP and Oracle have informed the Company, and the Company believes, that these
systems are Year 2000 compliant. The Company has a number of projects underway
to replace or upgrade hardware and software that are known to be Year 2000
non-compliant. The Company currently expects to substantially complete
remediation, validation and implementation of its internal systems by mid-1999.
In addition, in order to protect against the acquisition of additional products
that may not be Year 2000 ready, the Company has implemented a policy requiring
Year 2000 review of products sold or licensed to the Company prior to their
acquisition. However, if implementation of replacement or upgraded systems or
software is delayed, or if significant new non-compliance issues are identified,
the Company's results of operations or financial condition could be materially
adversely affected.
THIRD PARTY VENDORS, MANUFACTURERS AND SUPPLIERS. The Company is also in
the process of contacting its critical suppliers, manufacturers, distributors
and other vendors to determine that their operations and the products and
services that they provide to the Company are Year 2000 compliant. Where
practicable, the Company will attempt to mitigate its risks with respect to the
failure of third parties to be Year 2000
25
ready, including developing contingency plans. However, such failures, including
failures of any contingency plan, remain a possibility and could have a
materially adverse impact on the Company's results of operations or financial
condition.
PRODUCTS. In addition, the Year 2000 issue could affect the products that
the Company licenses. The Company is continuing to test its products and gather
information about Company technologies and products impacted by the Year 2000
transition. Current information about the Company's products is available on the
Company's Year 2000 Web site (www.adobe.com/newsfeatures/year2000). Information
on the Company's Web site is provided to customers for the sole purpose of
assisting in planning for the transition to the Year 2000. Such information is
the most currently available concerning the Company's products and is provided
"as is" without warranty of any kind. There can be no assurance that the
Company's current products do not contain undetected errors or defects
associated with Year 2000 that may result in material costs to the Company.
CONTINGENCY PLANS. The Company has not yet developed contingency plans to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its critical operations, including operations under the control of
third parties. Additionally, the most reasonably likely worst case scenario has
not yet been clearly identified. Development of such contingency plans is in
progress and is expected to be completed by September 1999. There can be no
assurance that the Company will be able to develop contingency plans that will
adequately address all Year 2000 issues that may arise.
Some commentators have stated that a significant amount of litigation will
arise out of Year 2000 compliance issues, and the Company is aware of a growing
number of lawsuits against other software vendors. Because of the unprecedented
nature of such litigation, it is uncertain whether or to what extent the Company
may be affected by it. The impact of the Year 2000 on future Company revenue is
difficult to discern but is a risk to be considered in evaluating future growth
of the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
displaying comprehensive income and its components in the financial statements.
It does not, however, require a specific format for the disclosure but requires
the Company to display an amount representing total comprehensive income for the
period in its financial statements. The Company will be required to implement
SFAS No. 130 for its first quarter of 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.
In October 1997, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 97-2, "Software Revenue
Recognition." SOP 97-2, as amended by SOP 98-4, establishes standards relating
to the recognition of all aspects of software revenue. Based on the Company's
ongoing assessment of the impact SOP 97-2 may have on its consolidated results
of operations, the Company is modifying certain aspects of its business model
such that any impact will not be significant. The Company will adopt SOP 97-2
for its fiscal year 1999.
In December 1998, the AICPA issued SOP 98-9, "Modifications of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions," which
amends SOP 97-2 and supercedes SOP 98-4. The Company will adopt SOP 98-9 in
fiscal 2000, with the exception of certain provisions of this SOP that extend
the deferral of the application of certain passages of SOP 97-2 which are
effective December 15, 1998. The adoption of SOP 98-9 is not expected to have a
significant impact on the Company.
26
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative financial instruments and for hedging
activities and requires the Company to recognize all derivatives as either
assets or liabilities on the balance sheet and measure them at fair value. Gains
and losses resulting from changes in fair value would be accounted for depending
on the use of the derivative and whether it is designated and qualifies for
hedge accounting. The Company will be required to implement SFAS No. 133 for its
fiscal year 2000. The Company has not determined the impact that SFAS No. 133
will have on its financial statements and believes that such determination will
not be meaningful until closer to the date of initial adoption.
LIQUIDITY AND CAPITAL RESOURCES
1998 CHANGE 1997 CHANGE 1996
------ ------ ------ ------ ------
Cash, cash equivalents, and short-term investments.......... $272.5 (46)% $503.0 (11)% $564.1
Working capital............................................. $205.0 (55)% $454.3 (10)% $506.1
Stockholders' equity........................................ $516.4 (28)% $715.4 1% $706.5
The Company's cash, cash equivalents, and short-term investments, consisting
principally of municipal bonds, money market mutual funds, U.S. Treasury notes,
and auction rate certificate securities, decreased $230.4 million in fiscal 1998
from fiscal 1997. All of the Company's cash equivalents and short-term
investments are classified as available-for-sale under the provisions of SFAS
No. 115, and accordingly, the securities are carried at fair value with the
unrealized gains and losses, net of tax, reported as a separate component of
stockholders' equity.
Major sources of cash during fiscal 1998 included cash generated from
operations of $203.5 million, sale of short-term investments, net of purchases,
of $69.6 million, and the proceeds from the reissuance of treasury stock of
$70.9 million, primarily related to the exercise of stock options and sale of
stock under the Employee Stock Purchase Plan. Major uses of cash during fiscal
1998 included $379.2 million to repurchase Adobe common stock, additions to
other assets of $57.5 million, capital expenditures totaling $59.7 million, and
the payment of dividends of $16.3 million.
The Company expects to continue its investing activities, including
expenditures for computer systems for research and development, sales and
marketing, product support, and administrative staff. Furthermore, cash reserves
may be used to acquire software companies, products, or technologies
complementary to the Company's business.
27
In September 1997, the Company's Board of Directors authorized, subject to
certain business and market conditions, the purchase of up to an additional 15
million shares of the Company's common stock over a two-year period. This new
stock repurchase program was in addition to an existing program, whereby the
Company has been authorized to repurchase shares to offset issuances under
employee stock option and stock purchase plans. The Company repurchased
approximately 10.5 million shares and approximately 6.3 million shares of its
common stock in fiscal 1998 and 1997, respectively. These stock repurchase
programs are intended to enhance stockholder value by reducing the number of
outstanding shares, absolutely, and, for the previously existing program, to net
offsetting increases due to employee stock purchases and stock option exercises.
As of November 27, 1998, management is authorized to repurchase an additional
836,000 shares under the 15 million share repurchase program. The Company has
sold put warrants which will expire in the first quarter of fiscal 1999 for all
but 228 of those remaining authorized shares. The timing and size of any future
stock repurchases are subject to market conditions, stock prices and Company's
cash position and other cash requirements going forward.
The Company has paid cash dividends on its common stock each quarter since
the second quarter of 1988. The Board of Directors of the Company declared a
cash dividend on the Company's common stock of $.05 per common share for each
quarter of fiscal 1998. 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 odd-lot and fractional Siebel shares. 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.
To facilitate the Company's stock repurchase program, the Company sold put
warrants in a series of private placements in fiscal 1998 and 1997. Each put
warrant entitles the holder to sell one share of Adobe's common stock to the
Company at a specified price. Approximately 4.0 million and 4.6 million put
warrants were written in fiscal 1998 and 1997, respectively. At November 27,
1998, approximately 836,000 put warrants were outstanding that expire on various
dates through February 1999 that have exercise prices ranging from $27.00 to
$32.38 per share, with an average exercise price of $30.30 per share.
In addition, in fiscal 1998 and 1997, the Company purchased call options
that entitle the Company to buy 1.6 million and 2.3 million shares,
respectively, of its common stock. At November 27, 1998, approximately 583,000
call options were outstanding that expire on various dates through February 1999
and have exercise prices ranging from $29.36 to $35.00 per share, with an
average exercise price of $32.24 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 value of the option as
determined by the contract.
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.
COMMITMENTS
The Company's principal commitments as of November 27, 1998 consisted of
obligations under operating leases, real estate development agreements, and
various service agreements with a previously related party.
During 1994, the Company entered into a real estate development agreement
and an operating lease agreement in connection with the construction of a
headquarters 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
28
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. Pursuant to the agreement, 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 27,
1998, the Company's collateral under this agreement totaled $66.0 million in
money market mutual funds. These deposits are included in "Other assets" on the
Consolidated Balance Sheet.
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 construction was completed and the operating
lease commenced in August 1998. The Company will have the option to purchase the
facility at the end of the lease term in August 2003. 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 was
required to deposit funds with the lessor as an interest-bearing security
deposit pursuant to its obligations under the lease. As of November 27, 1998,
the Company's deposits under this agreement totaled approximately $64.3 million.
These deposits are included in "Other assets" on the Consolidated Balance Sheet.
During 1998, the Company entered into a real estate development agreement
for the construction of an office building in Edinburgh, Scotland. As of
November 27, 1998, the Company has paid $11.5 million for land, fees, and
construction costs. The expected completion date of the building is August 1999.
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' common stock and recorded a gain on the exchange of
$6.7 million in fiscal 1998. In the third quarter of fiscal 1998, these shares
were sold. The Company expects that Sykes will continue to provide services to
the Company for 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 movements in foreign currency exchange rates. This exposure is
primarily related to yen denominated licenses in Japan and local currency
denominated operating expenses in Europe, where the Company licenses primarily
in U.S. Dollars.
The Company's Japanese operating expenses are in yen, which mitigates a
portion of the exposure related to yen denominated licenses in Japan. In
addition, the Company hedges firmly committed transactions using primarily
forward contracts with maturities of less than three months. The Company also
hedges a percentage of forecasted international revenue with purchased options.
At November 27, 1998, total outstanding contracts include $19.8 million in
foreign currency forward exchange contracts and purchased Japanese yen put
option contracts with a notional value of $12.5 million. All contracts expire at
various times through March 1999. The Company's hedging policy is designed to
reduce the impact of foreign currency exchange rate movements, and any gain or
loss in the hedging portfolio is expected to be offset by a corresponding gain
or loss in the underlying exposure being hedged.
29
A sensitivity analysis was performed on the Company's hedging portfolio as
of November 27, 1998. This sensitivity analysis is based on a modeling technique
that measures the hypothetical market value resulting from a 10% and 15% shift
in the value of exchange rates relative to the U.S. Dollar. An increase in the
value of the U.S. Dollar (and a corresponding decrease in the value of the
hedged foreign currency asset) would lead to an increase in the fair value of
the Company's financial hedging instruments by $1.9 million and $2.9 million,
respectively. Conversely, a decrease in the value of the U.S. Dollar would
result in a decrease in the fair value of these financial instruments by $1.2
million and $1.7 million, respectively.
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 uses yen options to hedge anticipated
exposures.
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 27, 1998, the Company had an investment portfolio of fixed
income securities, including those classified as cash equivalents, and
restricted funds and security deposits of $372.1 million. These securities are
subject to interest rate fluctuations. An increase in interest rates could
adversely 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 27, 1998. 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 six-month and twelve-month time horizons. 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.
30
FACILITY LEASES
The Company is exposed to interest rate risk associated with leases of on
its facilities whose payments are tied to the London Interbank Offered Rate
("LIBOR") and has evaluated the hypothetical changes in lease obligations
arising from selected hypothetical changes in the LIBOR rate. Market changes
reflected immediate hypothetical parallel shifts in the LIBOR curve of plus or
minus 50, 100, and 150 basis points for a twelve-month period. Based on this
analysis, such charges would not be material to the Company's results of
operations or financial position.
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 27, 1998.
1998
-----------------------------------------------------
QUARTER ENDED YEAR
------------------------------------------ ENDED
FEB. 27 MAY 29 AUG. 28 NOV. 27 NOV. 27
--------- --------- --------- --------- ---------
Revenue................................... $ 197,813 $ 227,310 $ 222,932 $ 246,736 $ 894,791
Gross profit.............................. 167,827 200,018 196,151 219,358 783,354
Income before income taxes................ 42,635 44,645 242 80,172 167,694
Net income................................ 26,744 27,980 152 50,268 105,144
Basic net income per share................ 0.39 0.42 -- 0.80 1.58
Shares used in computing basic net income
per share............................... 67,762 66,735 67,278 63,115 66,433
Diluted net income per share.............. 0.38 0.41 -- 0.78 1.55
Shares used in computing diluted net
income per share........................ 69,585 68,990 68,412 64,207 67,974
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
Basic net income per share................ 0.65 0.56 0.73 0.66 2.60
Shares used in computing basic net income
per share............................... 71,493 72,085 72,766 71,345 71,962
Diluted net income per share.............. 0.63 0.54 0.72 0.64 2.52
Shares used in computing diluted net
income per share........................ 73,939 74,416 74,528 73,651 74,160
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 15, 1999. Such information is incorporated herein by
reference.
EXECUTIVE OFFICERS
Information with respect to executive officers may be found in Item 1.
Business.
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 15, 1999. Such information is incorporated herein by
reference.
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 15, 1999. Such
information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
32
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 27, 1998 and November 28, 1997
- Consolidated Statements of Income
Years Ended November 27, 1998, November 28, 1997, and November 29,
1996
- Consolidated Statements of Stockholders' Equity
Years Ended November 27, 1998, November 28, 1997, and November 29,
1996
- Consolidated Statements of Cash Flows
Years Ended November 27, 1998, November 28, 1997, and November 29,
1996
- 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
- --------- -------------------------------------------------------------- --------- --------- --------- -------------
3.1 The Registrant's (as successor in-interest to Adobe Systems
(Delaware) Incorporated by virtue of a reincorporation
effective 5/30/97) Certificate of Incorporation, as filed
with the Secretary of State of the State of Delaware on
5/9/97. 10-Q 05/30/97 3.1
3.2.10 Amended and Restated Bylaws as currently in effect. 8-K 9/3/98 3.2
3.3 Certificate of Designation of the Series A Preferred Stock 10-K 05/30/97 2.1
3.4 Agreement and Plan of Merger effective 5/30/97 (by virtue of a
reincorporation), by and between Adobe Systems Incorporated,
a California corporation and Adobe Systems (Delaware)
Incorporated, a Delaware corporation. 10-Q 05/30/97 2.1
4.1 Third Amended and Restated Rights Agreement between the
Company and Harris Trust Company of California 8-K 12/15/98 1
10.1.6 1984 Stock Option Plan, as amended* 10-Q 07/02/93 10.1.6
10.21.3 Revised Bonus Plan* 10-Q 02/28/97 10.21.3
10.24.1 Amended 1994 Performance and Restricted Stock Plan* 10-Q 05/29/98 10.24.1
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
33
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
- --------- -------------------------------------------------------------- --------- --------- --------- -------------
10.32 Sublease of the Land and Lease of the Improvements By and
Between Sumitomo Bank Leasing and Finance Inc. and Adobe
Systems Incorporated (Phase 1) 10-K 11/25/94 10.32
10.36 1996 Outside Directors Stock Option Plan* 10-Q 05/31/96 10.36
10.37 Confidential Resignation Agreement* 10-Q 05/31/96 10.37
10.38 Sublease of the Land and Lease of the Improvements By and
Between Sumitomo Bank Leasing and Finance Inc. and Adobe
Systems Incorporated (Phase 2) 10-Q 08/30/96 10.38
10.39 1997 Employee Stock Purchase Plan, as amended* S-8 05/30/97 10.39
10.40 1994 Stock Option Plan, as amended* S-8 05/30/97 10.40
10.42 Amended and Restated Limited Partnership Agreement of Adobe
Incentive Partners, L.P.* 10-Q 8/28/98 10.42
10.43 Resignation Agreement* 10-K 11/28/97 10.43
10.44 Forms of Retention Agreement* 10-K 11/28/97 10.44
10.45 Confidential Executive Resignation Agreement And General
Release of Claims* 10-Q 8/28/98 10.45
10.46 Confidential Executive Resignation Agreement And General
Release of Claims* 10-Q 8/28/98 10.46
10.47 Confidential Executive Resignation Agreement And General
Release of Claims* 10-Q 8/28/98 10.46
10.48 Letter of Release and Waiver* X
21 Subsidiaries of the Registrant X
23 Consent of Independent Auditors X
27.1 Financial Data Schedule X
27.2 Financial Data Schedule X
27.3 Financial Data Schedule X
- ------------------------
* Compensatory plan or arrangement
The Company will furnish any exhibit listed above that is not included
herein upon the specific request of a stockholder, upon such stockholder's
payment of the Company's reasonable expenses in furnishing such exhibit.
Stockholders should call or write:
Investor Relations Department
345 Park Avenue
San Jose, CA 95110-2704
408-536-6000
Many of the above exhibits are also available through the Company's EDGAR
filings at www.sec.gov.
(b) Reports on Form 8-K
DATE OF REPORT FILING DATE ITEM REPORTED
- ---------------------- ---------------------- -------------------
September 3, 1998 September 3, 1998 5
On September 3, 1998 the Company filed a Report on Form 8-K under Item 5 to
report the amendment of the Company's Amended and Restated Bylaws related to (i)
the advance notice requirements for stockholder proposals to be brought before
meetings of stockholders, (ii) nominations of persons for election of directors,
and (ii) fixing record dates.
34
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/ HAROLD L. COVERT
-----------------------------------------
Harold L. Covert,
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL
OFFICER (PRINCIPAL FINANCIAL AND
ACCOUNTING 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 16th day of February, 1999.
SIGNATURE TITLE
- ------------------------------ --------------------------
Chairman of the Board of
/s/ JOHN E. WARNOCK Directors and Chief
- ------------------------------ Executive Officer
John E. Warnock (Principal Executive
Officer)
/s/ CHARLES M. GESCHKE
- ------------------------------ Chairman of the Board of
Charles M. Geschke Directors 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
35
SIGNATURE TITLE
- ------------------------------ --------------------------
/s/ CAROL MILLS BALDWIN
- ------------------------------ Director
Carol Mills Baldwin
Senior Vice President and
/s/ HAROLD L. COVERT Chief Financial Officer
- ------------------------------ (Principal Financial and
Harold L. Covert Accounting Officer)
36
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
GoLive CyberStudio
Illustrator
ImageReady
ImageStyler
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.
37
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.................................................................................... 39
- - Independent Auditors' Report........................................................................... 40
- - Consolidated Balance Sheets
November 27, 1998 and November 28, 1997................................................................ 41
- - Consolidated Statements of Income
Years Ended November 27, 1998, November 28, 1997, and November 29, 1996................................ 42
- - Consolidated Statements of Stockholders' Equity
Years Ended November 27, 1998, November 28, 1997, and November 29, 1996................................ 43
- - Consolidated Statements of Cash Flows
Years Ended November 27, 1998, November 28, 1997, and November 29, 1996................................ 44
- - Notes to Consolidated Financial Statements............................................................. 45
38
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 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 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/ HAROLD L. COVERT
-----------------------------------------
Harold L. Covert,
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL
OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
December 14, 1998
39
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 27, 1998 and November 28,
1997, and the results of their operations and their cash flows for each of the
years in the three-year period ended November 27, 1998, 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 LLP
Mountain View, California
December 14, 1998
40
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOVEMBER 27 NOVEMBER 28
1998 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 110,871 $ 267,576
Short-term investments.............................................................. 161,676 235,380
Receivables, net of allowances for doubtful accounts of $6,399 and $3,634,
respectively...................................................................... 141,180 130,974
Deferred income taxes............................................................... 32,028 25,824
Other current assets................................................................ 10,190 19,192
------------ ------------
Total current assets.............................................................. 455,945 678,946
Property and equipment, net........................................................... 93,887 80,978
Deferred income taxes................................................................. 16,647 16,999
Other assets.......................................................................... 200,852 163,148
------------ ------------
$ 767,331 $ 940,071
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade and other payables............................................................ $ 48,681 $ 57,857
Accrued expenses.................................................................... 117,539 97,295
Accrued restructuring charges....................................................... 8,867 8,383
Income taxes payable................................................................ 64,546 48,343
Deferred revenue.................................................................... 11,333 12,769
------------ ------------
Total current liabilities......................................................... 250,966 224,647
------------ ------------
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 shares
in 1998 and 1997; and additional paid-in capital.................................. 306,859 291,281
Retained earnings................................................................... 732,730 663,861
Unrealized gains on investments, net................................................ 823 3,590
Cumulative translation adjustment................................................... (2,702) (4,620)
Treasury stock, at cost (13,050 and 5,176 shares in 1998 and 1997, respectively),
net of reissuances................................................................ (521,345) (238,688)
------------ ------------
Total stockholders' equity........................................................ 516,365 715,424
------------ ------------
$ 767,331 $ 940,071
------------ ------------
------------ ------------
See accompanying Notes to Consolidated Financial Statements.
41
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED
-------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Revenue:
Licensing.............................................. $ 164,145 $ 196,230 $ 196,693
Application products................................... 730,646 715,664 589,870
----------- ----------- -----------
Total revenue............................................ 894,791 911,894 786,563
Direct costs............................................. 111,437 126,271 141,147
----------- ----------- -----------
Gross profit............................................. 783,354 785,623 645,416
----------- ----------- -----------
Operating expenses:
Research and development............................... 207,339 170,862 155,418
Sales and marketing.................................... 316,691 303,268 254,972
General and administrative............................. 95,732 75,358 62,034
Write-off of acquired in-process research and
development.......................................... -- 5,969 21,251
Restructuring and other charges........................ 38,245 (590) 4,955
----------- ----------- -----------
Total operating expenses................................. 658,007 554,867 498,630
----------- ----------- -----------
Operating income......................................... 125,347 230,756 146,786
----------- ----------- -----------
Nonoperating income, net:
Investment gain........................................ 14,994 34,290 68,875
Interest and other income.............................. 27,353 31,044 29,163
----------- ----------- -----------
Total nonoperating income, net........................... 42,347 65,334 98,038
----------- ----------- -----------
Income before income taxes............................... 167,694 296,090 244,824
Income tax provision..................................... 62,550 109,253 91,547
----------- ----------- -----------
Net income............................................... $ 105,144 $ 186,837 $ 153,277
----------- ----------- -----------
----------- ----------- -----------
Basic net income per share............................... $ 1.58 $ 2.60 $ 2.12
----------- ----------- -----------
----------- ----------- -----------
Shares used in computing basic net income per share...... 66,433 71,962 72,454
----------- ----------- -----------
----------- ----------- -----------
Diluted net income per share............................. $ 1.55 $ 2.52 $ 2.04
----------- ----------- -----------
----------- ----------- -----------
Shares used in computing diluted net income per share.... 67,974 74,160 75,132
----------- ----------- -----------
----------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements.
42
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK
AND ADDITIONAL UNREALIZED
PAID IN CAPITAL GAINS ON CUMULATIVE TREASURY STOCK
----------------- RETAINED INVESTMENTS, TRANSLATION ------------------
SHARES AMOUNT EARNINGS NET ADJUSTMENT SHARES AMOUNT TOTAL
------ --------- -------- ------------ ---------- ------- --------- ---------
Balances as of December 1, 1995.... 72,834 $ 293,258 $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)
Put warrant obligations............ -- (71,348) -- -- -- -- -- (71,348)
Adjustment to 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... 71,476 148,602 529,546 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 put warrant
obligations...................... -- 71,348 -- -- -- -- -- 71,348
Adjustment to 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... 73,941 291,281 663,861 3,590 (4,620) (5,176) (238,688) 715,424
Tax benefit from employee stock
option plans..................... -- 12,595 -- -- -- -- -- 12,595
Stock compensation expense......... -- 215 -- -- -- -- 2,298 2,513
Dividends declared................. -- -- (12,962) -- -- -- -- (12,962)
Purchase of treasury stock......... -- -- -- -- -- (10,513) (379,203) (379,203)
Reissuance of treasury stock under
employee stock and stock option
plans............................ -- -- (23,313) -- -- 2,639 94,248 70,935
Proceeds from sale of put
warrants......................... -- 2,768 -- -- -- -- 2,768
Adjustment to unrealized gains on
investments, net................. -- -- -- (2,767) -- -- -- (2,767)
Cumulative translation adjustment.. -- -- -- -- 1,918 -- -- 1,918
Net income......................... -- -- 105,144 -- -- -- -- 105,144
------ --------- -------- ------------ ---------- ------- --------- ---------
Balances as of November 27, 1998... 73,941 $ 306,859 $732,730 $ 823 $(2,702) (13,050) $(521,345) $ 516,365
------ --------- -------- ------------ ---------- ------- --------- ---------
------ --------- -------- ------------ ---------- ------- --------- ---------
See accompanying Notes to Consolidated Financial Statements.
43
ADOBE SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED
-------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income.............................................................. $ 105,144 $ 186,837 $ 153,277
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization......................................... 56,264 59,384 55,621
Deferred income taxes................................................. (6,774) (4,172) (9,420)
Equity in net (income) loss of Adobe Ventures I and II................ (2,365) 1,326 (19,001)
Gains on sales of equity securities................................... (12,972) (35,616) (53,216)
Tax benefit from employee stock option plans.......................... 12,595 29,607 10,828
Stock compensation expense............................................ 2,513 1,329 2,772
Write-off of acquired in-process research and development............. -- 5,969 21,251
Noncash restructuring and other charges............................... 9,077 -- 2,525
Changes in operating assets and liabilities:
Receivables......................................................... (11,054) (15,151) 8,556
Other current assets................................................ 6,886 (2,351) (1,173)
Trade and other payables............................................ (8,461) 14,802 8,534
Accrued expenses.................................................... 32,947 4,216 (7,198)
Accrued restructuring charges....................................... 3,914 (2,471) (20,229)
Income taxes payable................................................ 17,125 (32,294) 48,768
Deferred revenue.................................................... (1,370) (2,768) (3,781)
----------- ----------- -----------
Net cash provided by operating activities................................. 203,469 208,647 198,114
----------- ----------- -----------
Cash flows from investing activities:
Purchases of short-term investments..................................... (1,278,178) (2,657,302) (2,363,993)
Maturities and sales of short-term investments.......................... 1,347,800 2,875,294 2,363,793
Acquisitions of property and equipment.................................. (59,745) (33,882) (45,869)
Additions to other assets............................................... (57,520) (42,122) (65,399)
Acquisitions, net of cash acquired...................................... (3,544) (6,121) (8,027)
Proceeds from sales of equity securities................................ 10,886 30,993 72,630
----------- ----------- -----------
Net cash provided by (used for) investing activities...................... (40,301) 166,860 (46,865)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock.................................. -- 70,995 39,870
Purchase of treasury stock.............................................. (379,203) (275,644) (126,778)
Proceeds from reissuance of treasury stock.............................. 70,935 -- --
Proceeds from sale of put warrants...................................... 2,768 6,356 --
Payment of dividends.................................................... (16,291) (20,911) (14,586)
----------- ----------- -----------
Net cash used for financing activities.................................... (321,791) (219,204) (101,494)
Effect of foreign currency exchange rates on cash and cash equivalents.... 1,918 528 2,497
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents...................... (156,705) 156,831 52,252
Cash and cash equivalents at beginning of year............................ 267,576 110,745 58,493
----------- ----------- -----------
Cash and cash equivalents at end of year.................................. $ 110,871 $ 267,576 $ 110,745
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosures:
Cash paid during the year for income taxes.............................. $ 22,471 $ 85,062 $ 30,463
----------- ----------- -----------
----------- ----------- -----------
Noncash investing and financing activities:
Cash dividends declared but not paid.................................. $ 3,062 $ 3,558 $ 3,582
----------- ----------- -----------
----------- ----------- -----------
Dividends in-kind declared but not distributed........................ $ -- $ 10,032 $ --
----------- ----------- -----------
----------- ----------- -----------
Dividends in-kind distributed......................................... $ 7,197 $ 21,603 $ --
----------- ----------- -----------
----------- ----------- -----------
Issuance of notes for acquisition..................................... $ -- $ -- $ 9,473
----------- ----------- -----------
----------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements.
44
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 print and electronic media.
The Company licenses its technology to major computer, printing, and publishing
suppliers, and markets a line of application software products, type products,
and content for creating, distributing, and managing information of all types.
Additionally, the Company markets a line of 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 restricted funds and 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.
45
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign subsidiaries, whose functional currency is
the local currency, are translated at year-end exchange rates. Revenues and
expenses 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 recorded utilizing
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, which is generally the completion of a working prototype. 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.
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.
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.
46
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Application products revenue is recognized upon shipment, provided
collection is determined to be probable and no significant obligations remain.
The Company provides to application product customers free telephone support,
for which the expense is accrued, up to a maximum of 90 days beginning upon the
customer's first call. The cost of telephone support is deferred and recognized
as the obligation is fulfilled. Revenue from distributors is subject to
agreements allowing limited rights of return and price protection. The Company
provides for estimated future returns, and price protection when given, at the
time the related revenue is recorded.
Licensing revenue, primarily royalties, is recorded when the OEM customers
ship products incorporating Adobe software, provided collection of such revenue
is probable. The Company has no remaining obligation in relation to such
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 product packaging, third-party royalties, amortization
of localization costs and acquired technologies, and reserves for excess and
obsolete inventory.
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 recognized. As of November 27, 1998, all forward foreign currency
contracts entered into by the Company had maturities of 90 days or less.
47
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PUT WARRANTS AND CALL OPTIONS
The Company utilizes put warrants and call option arrangements to facilitate
the repurchase of its common stock. The puts and calls permit, at the Company's
option, physical delivery or net share settlement
equal to the difference between the exercise price and the value of the option
as determined by the contract. Accordingly, in-the-money put warrants do not
result in a liability on the balance sheet.
NET INCOME PER SHARE
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share." Basic earnings per share is
computed using the weighted average number of common shares outstanding during
the period. Diluted earnings per share is computed using the weighted average
number of common shares and dilutive potential common shares outstanding during
the period. Dilutive potential common shares consist of employee stock options
using the treasury stock method, unvested restricted stock, and assumed
net-share settlement of dilutive put warrants. All earnings per share amounts
for all periods presented have been restated to conform to SFAS No. 128
requirements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (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 implement SFAS No. 130 in the first quarter of 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.
In October 1997, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 97-2, "Software Revenue
Recognition." SOP 97-2, as amended by SOP 98-4, establishes standards relating
to the recognition of all aspects of software revenue. Based on the Company's
ongoing assessment of the impact SOP 97-2 may have on its consolidated results
of operations, the Company is modifying certain aspects of its business model
such that any impact will not be significant. The Company will adopt SOP 97-2
for its fiscal 1999.
In December 1998, the AICPA issued SOP 98-9, "Modifications of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions," which
amends SOP 97-2 and supercedes SOP 98-4. The Company will adopt SOP 98-9 in
fiscal 2000, with the exception of certain provisions of this SOP that extend
the deferral of the application of certain passages of SOP 97-2 which are
effective December 15, 1998. The adoption of SOP 98-9 is not expected to have a
significant impact on the Company.
48
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative financial instruments and hedging activities
and requires the Company to recognize all derivatives as either assets or
liabilities on the balance sheet and measure them at fair value. Gains and
losses resulting from changes in fair value would be accounted for depending on
the use of the derivative and whether it is designated and qualifies for hedge
accounting. The Company will be required to implement SFAS No. 133 for its
fiscal year 2000. The Company has not determined the impact that SFAS No. 133
will have on its financial statements and believes that such determination will
not be meaningful until closer to the date of initial adoption.
RECLASSIFICATIONS
Certain reclassifications were made to the fiscal 1997 and 1996 consolidated
financial statements to conform to the fiscal 1998 presentation. The Company
also reclassified $3.4 million and $3.5 million of in-process research and
development charges recognized during the first half of fiscal 1998 to research
and development and general and administrative expenses, respectively, for the
fiscal year ending November 27, 1998 financial statements.
NOTE 2. ACQUISITIONS
During fiscal 1997, the Company acquired three software companies, in
separate transactions, for an aggregate consideration of approximately $8.5
million. These acquisitions were accounted for using the purchase method of
accounting, and approximately $6.0 million of the purchase price was allocated
to in-process research and development and expensed at the time of the
acquisition. One of the in-process technologies acquired for $2.5 million was
discontinued in fiscal 1998. The project associated with an additional $2.8
million of the purchased in-process technology was canceled as part of the
restructuring in the third quarter of fiscal 1998 and subsequently sold to a
management-led buyout group.
During fiscal 1996, the Company acquired Ares Software for approximately
$15.5 million. The acquisition was accounted for using the purchase method of
accounting, and approximately $15.3 million of the purchase price was allocated
to in-process research and development and expensed at the time of the
acquisition. The value assigned to purchased in-process technology was based on
a valuation prepared by an independent third-party, estimating both the cost of
developing and incorporating the in-process technology into future versions of
PostScript and the future cash flows from the enhanced PostScript product, using
a discount factor which takes into consideration the uncertainty surrounding the
successful development of the purchased in-process technology. The in-process
technology was completed in fiscal 1997 and incorporated into PostScript 3.
In November 1996, the Company also acquired in-process research and
development from Swell Software for approximately $6.0 million. The research
project was discontinued prior to reaching technological feasibility early in
fiscal 1997.
49
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 3. CASH EQUIVALENTS AND INVESTMENTS
All cash equivalents, short-term investments, and certain noncurrent
investments consisted of the following:
AS OF NOVEMBER 27, 1998
--------------------------------------------------
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
-------- ---------- -------------- ----------
Classified as current assets:
Money market mutual funds................................. $ 34,583 $ -- $ -- $ 34,583
State and municipal bonds and notes....................... 201,877 1,435 (63) 203,249
United States government treasury notes................... 3,952 7 -- 3,959
-------- ---------- ----- ----------
Total current............................................. 240,412 1,442 (63) 241,791
Classified as noncurrent assets:
Money market mutual funds................................. 66,000 -- -- 66,000
-------- ---------- ----- ----------
Total securities............................................ $306,412 $ 1,442 $ (63) $ 307,791
-------- ---------- ----- ----------
-------- ---------- ----- ----------
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
-------- ---------- ----- ----------
-------- ---------- ----- ----------
Approximately $80.1 million and $231.2 million in investments are classified
as cash equivalents as of November 27, 1998 and November 28, 1997, 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 $0.6 million and $2.4 million as of November 27, 1998
and November 28, 1997, respectively. Net realized gains for the years ended
November 27, 1998 and November 28, 1997 of $7.0 million and $38.4 million,
respectively, are included in nonoperating income.
As of November 27, 1998, the cost and estimated fair value of current debt
securities and money market mutual funds with a maturity of one year or less was
$117.8 million and $118.0 million, respectively, and the cost and estimated fair
value of current debt securities with maturities ranging from one to five years
were $122.6 million and $123.8 million, respectively.
50
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
NOVEMBER 27 NOVEMBER 28
1998 1997
------------ ------------
Land........................................................................ $ 7,421 $ 782
Building.................................................................... 4,477 4,477
Equipment................................................................... 156,324 141,067
Furniture and fixtures...................................................... 28,464 21,243
Leasehold improvements...................................................... 24,829 19,916
------------ ------------
221,515 187,485
Less accumulated depreciation and amortization.............................. 127,628 106,507
------------ ------------
$ 93,887 $ 80,978
------------ ------------
------------ ------------
NOTE 5. OTHER ASSETS
Other assets consisted of the following:
NOVEMBER 27 NOVEMBER 28
1998 1997
------------ ------------
Investments................................................................. $ 56,332 $ 35,689
Purchased technology and licensing agreements............................... 3,502 5,043
Restricted funds and security deposits...................................... 130,260 102,962
Intangibles and other assets................................................ 27,527 45,097
------------ ------------
217,621 188,791
Less accumulated amortization............................................... 16,769 25,643
------------ ------------
$ 200,852 $ 163,148
------------ ------------
------------ ------------
The Company owns a minority interest in certain companies and a majority
interest in Adobe Ventures L.P. and Adobe Ventures II, L.P. The limited
partnership investments are accounted for under the equity method as
contractually the partnerships are controlled by the general partner, a third
party.
The investments in Adobe Ventures L.P. and Adobe Ventures II, L.P., which
were established to enable the Company to invest in emerging technology
companies strategic to Adobe's software business, totaled $20.0 million and
$22.3 million, respectively, as of November 27, 1998 and $18.9 million and $6.9
million, respectively, as of November 28, 1997. The investments in the limited
partnerships 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, which totaled $346,000, $(1.3) million, and $17.8 million in
fiscal years 1998, 1997, and 1996, respectively. 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 27, 1998 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
51
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 5. OTHER ASSETS (CONTINUED)
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.
The Company owns minority interests in certain technology companies totaling
$14.0 million and $10.0 million as of November 27, 1998 and November 28, 1997,
respectively. 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.
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. 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 recorded a gain on the exchange of
$6.7 million in fiscal 1998.
The Company's portfolio of equity investments at November 27, 1998 had a
cost basis of $65.9 million and a fair market value of $56.3 million (see Note
9).
The Company had deposited funds with a lessor as an interest-bearing
security deposit totaling $64.3 million and $36.3 million as of November 27,
1998 and November 28, 1997, respectively. The Company also had pledged
collateral with a lessor comprised of money market mutual funds totaling $66.0
million as of November 27, 1998, and United States government treasury notes and
money market mutual funds totaling $66.7 million as of November 28, 1997 (see
Note 13).
Amortization expense related to purchased technology and other intangibles
was $20.4 million and $26.2 million in fiscal 1998 and fiscal 1997,
respectively.
NOTE 6. ACCRUED EXPENSES
Accrued expenses consisted of the following:
NOVEMBER 27 NOVEMBER 28
1998 1997
------------ ------------
Accrued compensation and benefits........................................... $ 41,592 $ 37,833
Sales and marketing allowances.............................................. 13,439 15,965
Other....................................................................... 62,508 43,497
------------ ------------
$ 117,539 $ 97,295
------------ ------------
------------ ------------
NOTE 7. RESTRUCTURING AND OTHER CHARGES
In the third quarter of fiscal 1998, the Company implemented a restructuring
program aimed at streamlining its underlying cost structure to better position
the Company for growth and profitability. As part of the restructuring program,
the Company implemented a reduction in force of 364 positions, four of which
were executive positions, affecting mostly its North American operations. In
addition to severance and related charges associated with the reduction in
force, the restructuring program included charges for
52
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 7. RESTRUCTURING AND OTHER CHARGES (CONTINUED)
divesting two business units, vacating leased facilities, and canceling certain
contracts. These actions and other non-restructuring related items resulted in
charges of $38.2 million, of which approximately $9.1 million were non-cash
charges. Of the $28.6 million in total cash charges, $6.2 million remains
accrued at November 27, 1998.
The following table depicts the restructuring and other activity through
November 27, 1998:
ACCRUED ACCRUED
BALANCE AT TOTAL BALANCE AT
NOVEMBER 28 CHARGES CASH WRITE- NOVEMBER 27
1997 (CREDITS) PAYMENTS DOWNS 1998
------------ --------- ---------- ---------- ------------
Severance and related charges........... $ -- $ 14,264 $ (13,370) $ -- $ 894
Lease termination costs................. -- 4,526 (464) -- 4,062
Impairment of leasehold improvements at
vacated facilities.................... -- 6,382 -- (6,382) --
Divestiture of business units........... -- 5,958 -- (5,958) --
Canceled contracts...................... -- 6,178 (5,235) -- 943
Other charges........................... -- 4,367 (127) (3,964) 276
------------ --------- ---------- ---------- ------------
-- 41,675 (19,196) (16,304) 6,175
Accrual related to previous
restructuring......................... 8,383 (3,430) (2,261) -- 2,692
------------ --------- ---------- ---------- ------------
$ 8,383 $ 38,245 $ (21,457) $ (16,304) $ 8,867
------------ --------- ---------- ---------- ------------
------------ --------- ---------- ---------- ------------
Severance and related charges primarily include involuntary termination and
COBRA benefits, outplacement costs, and payroll taxes. The terminations were
comprised principally of engineering, marketing, and technical support staff and
came primarily from overhead areas, divested business units, and redundant
marketing activities. As of August 31, 1998, the majority of these terminations
were completed. Also included in severance and related charges are expenses
associated with a reduction in force in the Company's Printing and Systems
business that was implemented in the first half of fiscal 1998. This reduction
in force was part of the Company's initiative to refocus resources on
high-growth opportunities in the printing and digital copier markets. As of
November 27, 1998, the remaining accrual balance of $0.9 million in severance
and related charges consists primarily of COBRA benefits and outplacement costs
and is expected to be paid by the third quarter of fiscal 1999.
Lease termination costs of $4.5 million include remaining lease liabilities,
brokerage fees, and legal fees offset by estimated sublease income related
primarily to facilities in San Jose, California that were vacated as part of the
restructuring program. The estimated cost of vacating these two facilities,
including estimated costs to sublease, was provided by a commercial real estate
brokerage firm retained by the Company. As of November 27, 1998, $4.0 million of
lease termination costs, net of anticipated sublease income, remains accrued and
is expected to be utilized by the third quarter of fiscal 1999.
Charges related to the impairment of leasehold improvements at vacated
facilities of $6.4 million included the write-down of the net book value of
leasehold improvements, telecommunications equipments, and a minimal amount of
furniture and equipment used in the vacated facilities. Based on an
53
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 7. RESTRUCTURING AND OTHER CHARGES (CONTINUED)
analysis performed by a commercial real estate brokerage firm retained by the
Company to sublease the facilities, the leasehold improvements and other assets
specifically identified under the restructuring program as assets to be disposed
of would have no future benefit to the Company as these assets would not enhance
the Company's ability to sublease the facilities. Leasehold improvements
consisted principally of a product demonstration room, a computer room with a
raised floor, and a single building reception area, all of which would not be
used by smaller tenants. Therefore, in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," the leasehold improvements and telecommunications equipment were reported
at the lower of the carrying amount or fair value less costs to sell, which was
zero. As of September 30, 1998, both of these facilities were fully vacated.
Included in the restructuring charge is $6.0 million related to the
divestitute of two business units. Management and the Board of Directors
approved the plan to divest of its Adobe Enterprise Publishing Services, Inc.
("AEPS") subsidiary located in Grand Rapids, Michigan, which provided tools and
services to companies implementing solutions based on Adobe Acrobat, and the
Image Club Graphics business ("ICG") located in Calgary, Canada, which
specialized in the production, electronic distribution and marketing of visual
content and typefaces, as they were no longer strategic to the the Company's
future direction. The Company divested of these two business units with
aggregate net assets of approximately $6.0 million, including cash of $3.8
million, in exchange for $2.5 million in notes receivable and future royalties.
The Company fully offset the notes receivable with an allowance for doubtful
accounts due to significant uncertainties in collection. The two business units
generated combined annual revenues of approximately $25 million. Operating
losses associated with these two business units were not material.
Canceled contracts of $6.2 million included penalty fees paid to allow the
Company to end contractual obligations as part of the divestitute of the ICG
business unit, and the cancellation of an advertising campaign supporting the
Company's brand marketing strategy, which was discontinued as part of the
restructuring program. As of November 27, 1998, $0.9 million remains accrued and
is expected to be paid by the third quarter of fiscal 1999.
Also included in restructuring and other charges is $0.5 million related to
legal and public relations fees incurred in connection with the restructuring
program and $3.9 million of other charges not associated with the Company's
restructuring program. The $3.9 million charge primarily included the write-off
of fixed assets resulting from an adjustment related to a physical observation
of fixed assets, and the write-off of goodwill as a result of management's
strategic decision to change the business and legal function of a previously
acquired Japanese operation. The accounting for the write-off was in accordance
with SFAS 121. As of November 27, 1998, the remaining $0.3 million accrual
balance related to legal fees associated with the divestiture of the two
business units and employee terminations as part of the severance program, and
will be paid in the first half of fiscal 1999.
54
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 7. RESTRUCTURING AND OTHER CHARGES (CONTINUED)
As of November 28, 1997, approximately $8.4 million in accrued restructuring
costs remained resulting from the mergers with Aldus and Frame in fiscal 1994
and fiscal 1995, respectively. During fiscal 1998, lease payments of $2.3
million were made against the accrual and, as a result of the renegotiation of
certain facility leases and the sublease of certain facilities in fiscal 1998,
$3.4 million of the restructuring accrual related to the Aldus and Frame
acquisitions was reversed in the second half of fiscal 1998. The remaining
accrual of $2.7 million at November 27, 1998 relates to lease termination costs
primarily in Europe.
NOTE 8. INCOME TAXES
Income before income taxes includes net income from foreign operations of
approximately $18.8 million, $59.3 million, and $25.4 million for the years
ended November 27, 1998, November 28, 1997, and November 29, 1996, respectively.
The provision for income taxes consisted of the following:
YEARS ENDED
----------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
------------ ------------ ------------
Current:
United States federal...................................... $ 34,466 $ 42,238 $ 65,118
Foreign.................................................... 15,394 29,260 12,290
State and local............................................ 6,869 12,320 12,731
------------ ------------ ------------
Total current................................................ 56,729 83,818 90,139
------------ ------------ ------------
Deferred:
United States federal...................................... (4,312) (1,721) (6,825)
Foreign.................................................... (1,500) (2,071) (780)
State and local............................................ (962) (380) (1,815)
------------ ------------ ------------
Total deferred............................................... (6,774) (4,172) (9,420)
------------ ------------ ------------
Charge in lieu of taxes attributable to employee stock
plans...................................................... 12,595 29,607 10,828
------------ ------------ ------------
$ 62,550 $ 109,253 $ 91,547
------------ ------------ ------------
------------ ------------ ------------
55
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 8. 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% for
fiscal years 1998, 1997, and 1996 by income before income taxes) as a result of
the following:
YEARS ENDED
----------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
------------ ------------ ------------
Computed "expected" tax expense.............................. $ 58,693 $ 103,632 $ 85,689
State tax expense, net of federal benefit.................... 6,068 10,301 9,819
Nondeductible write-off of acquired in-process research and
development................................................ -- 1,791 5,310
Nondeductible goodwill....................................... 2,011 825 772
Tax-exempt income............................................ (4,190) (5,559) (3,304)
Tax credits.................................................. (4,708) (4,604) (4,912)
Foreign tax rate differential................................ 1,406 1,864 (4,003)
Other, net................................................... 3,270 1,003 2,176
------------ ------------ ------------
$ 62,550 $ 109,253 $ 91,547
------------ ------------ ------------
------------ ------------ ------------
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of fiscal 1998 and fiscal
1997 are presented below:
NOVEMBER 27 NOVEMBER 28
1998 1997
------------ ------------
Deferred tax assets:
Acquired technology....................................................... $ 14,099 $ 12,720
Reserves and deferred revenue............................................. 30,655 25,511
Depreciation and amortization............................................. -- 3,558
Net operating loss carryforwards.......................................... 2,171 3,260
Investments............................................................... 2,988 --
Other..................................................................... 2,562 3,532
------------ ------------
Total gross deferred tax assets......................................... 52,475 48,581
Deferred tax asset valuation allowance.................................. (2,696) (3,643)
------------ ------------
Total deferred tax assets............................................... 49,779 44,938
------------ ------------
Deferred tax liabilities:
Depreciation and amortization............................................. (1,076) --
Investments............................................................... -- (303)
Other..................................................................... (28) (1,812)
------------ ------------
Total deferred tax liabilities.......................................... (1,104) (2,115)
------------ ------------
Net deferred tax assets..................................................... $ 48,675 $ 42,823
------------ ------------
------------ ------------
56
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 8. INCOME TAXES (CONTINUED)
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 27, 1998, the Company has foreign operating loss carryovers
in various jurisdictions of approximately $2.2 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 9. 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 the
first 6% of employee contributions and contributed approximately $2.4 million,
$1.8 million, and $1.6 million in fiscal 1998, 1997, and 1996, respectively.
Matching contributions can be terminated at the Company's discretion.
PROFIT SHARING PLAN
The Company has a profit sharing plan that provides for profit sharing
payments to all eligible employees following each quarter in which the Company
achieves at least 70% of its budgeted earnings for the quarter. The plan, as
well as the annual operating budget on which the plan is based, is approved by
the Company's Board of Directors. The Company contributed approximately $6.8
million, $11.8 million, and $9.9 million to the plan in fiscal 1998, 1997, and
1996, respectively.
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 of AIP. 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
57
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 9. BENEFIT PLANS (CONTINUED)
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 27, 1998, the cost basis and recorded fair value of all investments
included in AIP were $65.9 million and $56.3 million, respectively. In fiscal
1998, AIP recorded net income of $2.2 million. The participating officers
received aggregate cash distributions of $707,000 in fiscal 1998. The amount of
cash distributed to the officers represents their vested portion of investments
that were liquidated by AIP. The participating officers receive quarterly cash
distributions as their partnership interests vest for investments that have been
liquidated by AIP. At November 27, 1998, the minority interest held by the
participating officers was $1.5 million and is included in accrued expenses on
the Consolidated Balance Sheet.
NOTE 10. EMPLOYEE STOCK PLANS
STOCK OPTION PLANS
As of November 27, 1998, the Company has reserved 29,200,000 shares of
common stock for issuance under its 1994 Stock Option Plan (the "Option Plan")
for employees which 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. Initial options granted under the Option Plan generally vest 25% after the
first year and ratably thereafter such that 50% and 100% are vested after the
second and third year, respectively; subsequent options granted under the Option
Plan generally vest ratably over the entire term such that 50% and 100% are
vested after the second and third year, respectively. Outstanding option terms
under all of the Company's employee stock option plans range from five to ten
years.
As of November 27, 1998, the Company has reserved, 500,000 shares of common
stock for issuance under its 1996 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 is granted 15,000 shares upon
election as a director. All options are exercisable as vested within a ten-year
term. Options generally vest over three years: 25% on the day preceding each of
the next two annual meetings of stockholders of the Company and 50% on the day
preceding the third annual meeting of stockholders of the Company after the
grant of the option. The exercise price of the options that are issued is equal
to the fair value on the date of grant. In fiscal 1998, the Company granted
options for 50,000 shares with exercise prices of $45.31 and an option for
15,000 shares to a new director with an exercise price of $42.06. In fiscal 1997
and 1996, options for 50,000 shares were granted each year with exercise prices
of $41.94 and $32.75, respectively.
58
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 10. EMPLOYEE STOCK PLANS (CONTINUED)
On September 23, 1998, the Board of Directors approved a stock option
repricing program whereby each eligible stock option was automatically amended
to have an exercise price equal to $33.8125. As a result, approximately
5,052,000 options were amended by eligible employees for an equal number of
repriced options. All other terms of the options, including expiration dates,
remain substantially the same.
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
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 fiscal 1998, 1997, and 1996 is presented below:
YEARS ENDED
------------------------------------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
-------------------- -------------------- --------------------
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..... 8,146,235 $ 31.74 9,297,188 $ 25.68 10,125,792 $ 26.30
Granted............................ 10,713,350 35.06 2,452,117 40.85 2,670,673 33.53
Exercised.......................... (1,988,977) 26.17 (3,063,778) 20.29 (1,470,762) 17.37
Canceled........................... (6,429,788) 39.08 (539,292) 33.75 (2,028,515) 45.15
---------- ---------- ----------
Outstanding, end of year........... 10,440,820 31.68 8,146,235 31.74 9,297,188 25.68
---------- ---------- ----------
---------- ---------- ----------
Exercisable, end of year........... 4,368,318 28.57 4,562,954 26.50 6,057,500 21.63
---------- ---------- ----------
---------- ---------- ----------
Weighted-average fair value of
options granted during the
year............................. $ 13.84 $ 15.68 $ 12.91
59
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 10. EMPLOYEE STOCK PLANS (CONTINUED)
Information regarding the stock options outstanding at November 27, 1998, 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.................................. 1,092 1.03 years $ 3.45 -- $ 3.45
$ 6.56 - $ 9.50......................... 249,598 1.34 years 8.96 249,598 8.96
$10.13 - $15.13......................... 269,252 3.74 years 14.18 269,247 14.18
$15.75 - $23.63......................... 395,597 2.99 years 20.62 394,292 20.62
$23.75 - $33.75......................... 2,519,330 6.33 years 30.72 2,054,649 30.33
$33.81.................................. 6,770,762 7.39 years 33.81 1,325,524 33.81
$34.25 - $50.75......................... 234,349 8.08 years 43.21 74,168 46.02
$51.75 - $67.00......................... 840 6.85 years 56.14 840 56.14
----------- -----------
$ 3.45 - $67.00......................... 10,440,820 6.75 years $ 31.68 4,368,318 $ 28.57
----------- -----------
----------- -----------
PERFORMANCE AND RESTRICTED STOCK PLAN
The Performance and Restricted Stock Plan (the "Plan") provides for the
granting of restricted stock and/or performance awards to officers and key
employees. As of November 27, 1998, the Company had reserved 2,000,000 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 27, 1998, 59,824 shares were outstanding and
not yet vested.
In fiscal 1998, 1997 and 1996, the Company granted 18,850, 129,550 and
26,750 shares of restricted stock, respectively, and the weighted-average fair
value of the shares was $41.47, $39.04, and $37.71, respectively.
Performance awards 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 awards are generally measured over a three-year period, and cliff
vest at the end of the three-year period. The projected value of these awards is
accrued by the Company and charged to expense over the three-year performance
period. As of November 27, 1998, November 28, 1997, and November 29, 1996,
performance awards for 201,870; 170,874; and 94,745 shares were outstanding,
respectively, and $(2.2) million, $1.5 million, and $(0.2) million was charged
(credited) to expense in fiscal 1998, 1997, and 1996, respectively. In fiscal
1998, 1997, and 1996, performance awards were granted for 121,820; 156,500; and
48,965 shares, respectively, and the weighted-average fair value of the shares
was $34.48, $39.04, and $64.03, respectively.
60
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 10. EMPLOYEE STOCK PLANS (CONTINUED)
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. For current offerings, the plan consists of two-year
offering periods with four six-month purchase periods in each offering period;
in September 1998, the Board of Directors reduced the offering periods of future
offering periods to one year with two 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 27, 1998, the Company had reserved
9,500,000 shares of its common stock for issuance under this plan; and 5,253,030
shares remain available for future issuance, although 2,500,000 shares of such
reserve were approved by the Board of Directors in September 1998 which are
subject to the approval of the Company's stockholders at the next annual
meeting.
The weighted-average fair value of the purchase rights granted in fiscal
1998, 1997, and 1996 was $15.86, $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 following table 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 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Net income:
As reported............................................ $ 105,144 $ 186,837 $ 153,277
Pro forma.............................................. $ 54,435 $ 161,790 $ 144,368
Net income per share:
As reported:
Basic................................................ $ 1.58 $ 2.60 $ 2.12
Diluted.............................................. $ 1.55 $ 2.52 $ 2.04
Pro forma:
Basic................................................ $ 0.82 $ 2.25 $ 1.99
Diluted.............................................. $ 0.82 $ 2.21 $ 1.93
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-
61
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 10. EMPLOYEE STOCK PLANS (CONTINUED)
Scholes option pricing model. The assumptions used to value the option grants
and purchase rights are stated as follows:
YEARS ENDED
-------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Expected life of options................................. 3 years 3 years 3 years
Expected life of restricted stock........................ 3 years 3 years 3 years
Expected life of purchase rights......................... 1.25 years 1.25 years 1.25 years
Volatility............................................... 53% 50% 50%
Risk-free interest rate.................................. 4.2-5.7% 5.0-6.6% 5.5-6.7%
Dividend yield........................................... 0.5% 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, the
pro forma amounts shown above may not be representative of the pro forma effect
on reported net income in future years.
NOTE 11. 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 million shares of the
Company's stock over a two-year period. This new stock repurchase program was in
addition to an existing program whereby the Company has been authorized to
repurchase shares to offset issuances under employee stock option and stock
purchase plans. The Company repurchased approximately 10.5 million shares and
approximately 6.3 million shares of its common stock in fiscal 1998 and 1997,
respectively, at a cost of $379.2 million and $275.6 million, respectively,
under its stock repurchase programs. As of November 27, 1998, management is
authorized to repurchase an additional 836,000 shares under the 15 million share
repurchase program. The Company has sold put warrants which will expire in the
first quarter of fiscal 1999 for all but 228 of those remaining shares. In
fiscal 1998, the Company reissued approximately 2.6 million treasury shares
under its employee
62
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 11. STOCKHOLDERS' EQUITY (CONTINUED)
stock option and purchase plans. The difference between the average repurchase
price of the treasury shares and the average price at which the shares are
reissued is treated as an adjustment to Retained Earnings.
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 in fiscal 1997 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 fiscal 1998 and 1997. Each put
warrant entitles the holder to sell one share of Adobe's common stock to the
Company at a specified price. Approximately 4.0 million and 4.6 million put
warrants were written in fiscal 1998 and 1997, respectively. At November 27,
1998, approximately 836,000 put warrants were outstanding that expire on various
dates through February 1999 with an average exercise price of $30.30 per share.
In addition, in fiscal 1998 and 1997, the Company purchased call options
that entitle the Company to buy 1.6 million and 2.3 million shares,
respectively, of its common stock. At November 27, 1998, approximately 583,000
call options were outstanding that expire on various dates through February 1999
with an average exercise price of $32.24 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 the value of the option as determined by the contract. 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
fiscal 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.
63
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 12. NET INCOME PER SHARE
The Company adopted SFAS No. 128, "Earnings per Share," in the fiscal year
ended November 27, 1998. All prior period share and per share amounts have been
restated to comply with SFAS No. 128. Basic net income per share is computed
using the weighted average number of common shares outstanding for the period,
excluding unvested restricted stock. Diluted net income per share is based upon
the weighted average common shares outstanding for the period plus dilutive
common equivalent shares including unvested restricted common stock, stock
options using the treasury stock method, and put warrants using the reverse
treasury stock method.
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEARS ENDED
-------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Net income............................................... $ 105,144 $ 186,837 $ 153,277
----------- ----------- -----------
----------- ----------- -----------
Shares used to compute basic net income per share
(weighted average shares outstanding during the period,
excluding unvested restricted stock)................... 66,433 71,962 72,454
Dilutive common equivalent shares:
Unvested restricted stock................................ 60 120 97
Stock options............................................ 1,481 2,055 2,581
Put warrants............................................. -- 23 --
----------- ----------- -----------
Shares used to compute diluted net income per share...... 67,974 74,160 75,132
----------- ----------- -----------
----------- ----------- -----------
Basic net income per share............................... $ 1.58 $ 2.60 $ 2.12
----------- ----------- -----------
----------- ----------- -----------
Diluted net income per share............................. $ 1.55 $ 2.52 $ 2.04
----------- ----------- -----------
----------- ----------- -----------
For the years ended November 27, 1998, November 28, 1997, and November 29,
1996, options to purchase approximately 177,000; 949,000; and 492,000 shares,
respectively, of common stock with exercise prices greater than the average fair
market value of the Company's stock for the period of $39.56, $41.44 and $38.46,
respectively, were not included in the calculation because the effect would have
been antidilutive.
NOTE 13. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company leases certain of its facilities and some of its equipment under
non-cancelable operating lease arrangements that expire at various dates through
2015. Rent expense for these leases aggregated $22.1 million, $17.8 million, and
$18.3 million during fiscal 1998, 1997, and 1996, respectively. As of November
27, 1998, future minimum lease payments under noncancelable operating leases,
net of sublease income, are as follows: 1999--$21.1 million; 2000--$16.7
million; 2001--$14.9 million; 2002--$3.3 million; 2003--$2.9 million; and $10.1
million thereafter.
Included in the future minimum lease payments are the following amounts for
leased facilities vacated in connection with the Restructuring plan implemented
in the third quarter of fiscal 1998: 1999--
64
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
$4.0 million; 2000--$2.1 million; 2001--$2.2 million; 2002--$2.3 million;
2003--$2.3 million and $7.3 million thereafter. These amounts, net of
anticipated sublease income, are included in accrued restructuring costs at
November 27, 1998.
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 a
headquarters 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.
Pursuant to the agreement, 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 27, 1998, the
Company's collateral under this agreement totaled $66.0 million in money market
mutual funds. These funds are included in "Other assets" on the Consolidated
Balance Sheet.
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 construction was completed and the operating
lease commenced in August 1998. The Company will have the option to purchase the
facility at the end of the lease term in August 2003. 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 was
required to deposit funds with the lessor as an interest-bearing security
deposit pursuant to its obligations under the lease. As of November 27, 1998,
the Company's deposits under this agreement totaled approximately $64.3 million.
These deposits are included in "Other assets" on the Consolidated Balance Sheet.
During 1998, the Company entered into a real estate development agreement
for the construction of an office building in Edinburgh, Scotland. As of
November 27, 1998, the Company has paid $11.5 million for land, fees, and
construction costs. The expected completion date of the building is August 1999.
ROYALTIES
The Company has certain royalty commitments associated with the shipment and
licensing of certain products. Royalty expense is generally based on a dollar
amount per unit shipped or a percentage of the underlying revenue. Royalty
expense was approximately $25.3 million, $25.0 million, and $19.8 million in
fiscal 1998, 1997, and 1996, respectively.
65
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 14. TRANSACTIONS WITH AFFILIATE
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 recorded a gain on the exchange of $6.7
million in fiscal 1998. Later in fiscal 1998, these shares were sold at a
minimal gain. The Company makes minimum annual payments to Sykes/McQueen for
certain services, which amounted to $2.4 million, $5.2 million, and $4.8 million
in fiscal 1998, 1997, and 1996, respectively. Purchases from Sykes/McQueen,
during the period in which they were an affiliate of the Company, amounted to
$15.7 million, $35.0 million, and $34.3 million for fiscal 1998, 1997, and 1996,
respectively.
NOTE 15. 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 portfolio of equity investments at November 27, 1998 had a
cost basis of $65.9 million and a fair market value of $56.3 million (see Note
5).
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 do subject the Company to risk of accounting gains
and losses; however, the gains and losses on these contracts offset gains and
losses on the assets, liabilities, and transactions being hedged. The Company is
exposed to credit-related losses in the event of nonperformance by the
counterparties in these contracts. These contracts generally have maturities of
less than three months, and the amounts of unrealized gains and losses are
immaterial. As of November 27, 1998 and November 28, 1997, the Company held
$19.8 million and $1.9 million, respectively, of aggregate foreign currency
forward exchange contracts for the sale of the Japanese yen. As of November 27,
1998 the Company held $12.5 million in option contracts also for the sale of
Japanese yen.
66
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 15. FINANCIAL INSTRUMENTS (CONTINUED)
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 to any one issue or issuer, 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.
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, introduced a clone version of Adobe 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. In fiscal 1998, sales of
application products to a major distributor accounted for 13.5% of the Company's
total revenue and 14.4% of total receivables. No customer accounted for more
than 10% of the Company's total revenue or total receivables in fiscal 1997 or
1996.
67
ADOBE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(CONTINUED)
NOTE 16. FOREIGN OPERATIONS
Geographic information for each of the years in the three-year period ended
November 27, 1998, is presented below:
YEARS ENDED
-------------------------------------
NOVEMBER 27 NOVEMBER 28 NOVEMBER 29
1998 1997 1996
----------- ----------- -----------
Revenue:
North America.......................... $ 667,566 $ 606,633 $ 526,251
Europe................................. 249,407 226,557 134,879
Japan and Asia Pacific and Latin
America.............................. 192,145 222,911 176,490
Eliminations........................... (214,327) (144,207) (51,057)
----------- ----------- -----------
$ 894,791 $ 911,894 $ 786,563
----------- ----------- -----------
----------- ----------- -----------
Operating income:
North America.......................... $ 21,928 $ 87,035 $ 31,186
Europe................................. 5,189 69,371 16,408
Japan and Asia Pacific and Latin
America.............................. 119,208 135,657 103,002
Eliminations........................... (20,978) (61,307) (3,810)
----------- ----------- -----------
$ 125,347 $ 230,756 $ 146,786
----------- ----------- -----------
----------- ----------- -----------
Identifiable assets:
North America.......................... $ 758,440 $ 923,704 $1,015,065
Europe................................. 105,172 79,291 67,506
Japan and Asia Pacific and Latin
America.............................. 28,968 32,161 22,102
Eliminations........................... (125,249) (95,085) (103,280)
----------- ----------- -----------
$ 767,331 $ 940,071 $1,001,393
----------- ----------- -----------
----------- ----------- -----------
NOTE 17. SUBSEQUENT EVENTS
On January 4, 1999, the Company announced the acquisition of substantially
all of the assets, including primarily intellectual property, of both GoLive
Systems, Inc., a Delaware corporation, and GoLive Systems GmbH and Co. KG, a
German limited partnership, for approximately $31.0 million, plus additional
contingency payments based on achieving certain technical and employment
milestones totaling $8.0 million. The acquisition will be accounted for under
the purchase method of accounting in accordance with Accounting Principles Board
Opinions No. 16.
68
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
69
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
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OPERATING END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
----------- ----------- ----------- -----------
Allowance for doubtful accounts:
Year Ended:
November 27, 1998........................................... $ 3,634 $ 3,336 $ 571 $ 6,399
November 28, 1997........................................... $ 5,196 $ (440) $ 1,122 $ 3,634
November 29, 1996........................................... $ 3,698 $ 1,927 $ 429 $ 5,196
Deductions related to the allowance for doubtful accounts represent amounts
written off against the allowance.
70
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
- ----------- --------------------------------------------------------------------------------------------------------
10.48 Letter of Release and Waiver
21 Subsidiaries of the Registrant
23 Consent of Independent Auditors
27.1 Financial Data Schedule
27.2 Financial Data Schedule
27.3 Financial Data Schedule
71