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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 30, 1996
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: 33-6885
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ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specifed in its charter)
CALIFORNIA 77-0019522
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
No.)
345 PARK AVENUE, SAN JOSE, CALIFORNIA 95110-2704
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 536-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES /X/ NO ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
SHARES OUTSTANDING
CLASS AUGUST 30, 1996
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Common stock, no par value 72,073,604
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TABLE OF CONTENTS
PAGE NO.
-------------
PART I--FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements............................................ 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................... 16
PART II--OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 33
Item 6. Exhibits and Reports on Form 8-K....................................................... 34
36
Signature...............................................................................................
37
Summary of Trademarks...................................................................................
EXHIBITS
Exhibit 10.38 Sublease of the Land and Lease of the Improvements By and Between
Sumitomo Bank and Leasing and Finance Inc. and Adobe Systems
Incorporated
Exhibit 11 Computation of Earnings per Common Share
Exhibit 27 Financial Data Schedules
2
PART I--FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The condensed consolidated financial statements included under this item are as
follows:
SEQUENTIALLY
NUMBERED
FINANCIAL STATEMENT DESCRIPTION PAGE
- ------------------------------------------------------------------------------------------------- -----------------
- - Condensed Consolidated Statements of Income
Quarters Ended August 30, 1996 and September 1, 1995
and Nine Months Ended August 30, 1996 and September 1, 1995........................... 4
- - Condensed Consolidated Balance Sheets
August 30, 1996 and December 1, 1995.................................................. 5
- - Condensed Consolidated Statements of Cash Flows
Nine Months Ended August 30, 1996 and September 1, 1995............................... 6
- - Notes to Condensed Consolidated Financial Statements.................................. 8
3
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED NINE MONTHS ENDED
------------------------ ------------------------
AUGUST 30, SEPTEMBER 1, AUGUST 30, SEPTEMBER 1,
1996 1995 1996 1995
---------- ------------ ---------- ------------
Revenue:
Licensing.................................................. $ 50,442 $ 45,053 $ 146,640 $ 136,398
Application products....................................... 130,467 138,067 432,248 425,065
---------- ------------ ---------- ------------
Total revenue.......................................... 180,909 183,120 578,888 561,463
Direct costs................................................. 33,617 27,483 104,903 93,647
---------- ------------ ---------- ------------
Gross margin................................................. 147,292 155,637 473,985 467,816
Operating expenses:
Software development costs:
Research and development................................. 36,301 34,871 111,172 99,116
Amortization of capitalized software development costs... 626 2,720 1,878 8,531
Sales, marketing and customer support.................... 60,621 59,841 188,963 174,504
General and administrative............................... 14,846 13,221 46,926 40,938
Write-off of acquired in-process research and
development............................................ -- -- 14,699 --
---------- ------------ ---------- ------------
Total operating expenses..................................... 112,394 110,653 363,638 323,089
---------- ------------ ---------- ------------
Operating income............................................. 34,898 44,984 110,347 144,727
Nonoperating income:
Investment gain (loss)..................................... 6,430 (96) 9,459 (691)
Interest and other income.................................. 7,358 7,466 22,528 21,477
---------- ------------ ---------- ------------
Total nonoperating income.................................... 13,788 7,370 31,987 20,786
Income before income taxes................................... 48,686 52,354 142,334 165,513
Provision for income taxes................................... 18,839 18,468 56,815 60,238
---------- ------------ ---------- ------------
Net income................................................... $ 29,847 $ 33,886 $ 85,519 $ 105,275
---------- ------------ ---------- ------------
---------- ------------ ---------- ------------
Net income per share......................................... $ .40 $ .44 $ 1.13 $ 1.41
---------- ------------ ---------- ------------
---------- ------------ ---------- ------------
Shares used in computing net income per share................ 74,309 76,325 75,447 74,845
---------- ------------ ---------- ------------
---------- ------------ ---------- ------------
See accompanying Notes to Condensed Consolidated Financial Statements.
4
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
AUGUST 30 DECEMBER 1
1996 1995
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents............................................................. $ 78,298 $ 58,493
Short-term investments................................................................ 411,196 457,547
Receivables........................................................................... 108,832 133,208
Inventories........................................................................... 5,619 7,277
Other current assets.................................................................. 10,745 11,924
Deferred income taxes................................................................. 24,932 24,338
---------- -----------
Total current assets.............................................................. 639,622 692,787
Property and equipment.................................................................. 74,116 51,708
Other assets............................................................................ 226,807 135,735
Deferred income taxes................................................................... -- 4,502
---------- -----------
$ 940,545 $ 884,732
---------- -----------
---------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade and other payables.............................................................. $ 39,666 $ 25,639
Accrued expenses...................................................................... 84,081 94,848
Accrued restructuring costs........................................................... 9,474 28,151
Income taxes payable.................................................................. 32,589 19,420
Deferred revenue...................................................................... 17,822 18,257
---------- -----------
Total current liabilities......................................................... 183,632 186,315
---------- -----------
Deferred income taxes................................................................... 12,776 --
Put warrants............................................................................ 118,081 --
Shareholders' equity:
Preferred stock, no par value; 2,000,000 shares authorized; none issued............... -- --
Common stock, no par value; 200,000,000 shares authorized; 72,073,604 and 72,834,444
shares issued and outstanding as of August 30, 1996, and December 1, 1995,
respectively........................................................................ 125,193 293,258
Unrealized gains on investments....................................................... 40,702 18,831
Retained earnings..................................................................... 465,370 390,793
Cumulative foreign currency translation adjustments................................... (5,209) (4,465)
---------- -----------
Total shareholders' equity........................................................ 626,056 698,417
---------- -----------
$ 940,545 $ 884,732
---------- -----------
---------- -----------
See accompanying Notes to Condensed Consolidated Financial Statements.
5
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
---------------------------
AUGUST 30 SEPTEMBER 1
1996 1995
------------- ------------
Cash flows from operating activities:
Net income......................................................................... $ 85,519 $ 105,275
Adjustments to reconcile net income to net cash provided by operating activities:
Stock compensation expense....................................................... 2,583 2,515
Depreciation and amortization.................................................... 21,027 42,128
Deferred income taxes............................................................ (3,504) (59)
Provision for losses on accounts receivable...................................... 605 1,761
Tax benefit from employee stock plans............................................ 8,550 21,158
Adobe Ventures valuation adjustment.............................................. (6,681) 691
Write-off of acquired in-process research and development........................ 14,699 --
Changes in operating assets and liabilities:
Receivables.................................................................... 24,708 (1,154)
Inventories.................................................................... 1,600 903
Other current assets........................................................... 2,168 (4,362)
Trade and other payables....................................................... 4,214 (7,791)
Accrued expenses............................................................... (10,198) (7,925)
Accrued restructuring costs.................................................... (18,752) (19,470)
Income taxes payable........................................................... 11,760 1,108
Deferred revenue............................................................... (1,495) 1,909
------------- ------------
Net cash provided by operating activities............................................ 136,803 136,687
------------- ------------
Cash flows from investing activities:
Purchases of short-term investments................................................ (1,238,181) (2,399,229)
Maturities and sales of short-term investments..................................... 1,281,152 2,240,580
Acquisitions of property and equipment............................................. (38,439) (23,537)
Additions to other assets.......................................................... (43,435) (71,331)
Acquisition, net of cash acquired.................................................. (4,527) --
------------- ------------
Net cash used for investing activities............................................... (43,430) (253,517)
------------- ------------
(CONTINUED)
See accompanying Notes to Condensed Consolidated Financial Statements.
6
ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
NINE MONTHS ENDED
---------------------------
AUGUST 30 SEPTEMBER 1
1996 1995
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock............................................. $ 28,738 $ 61,318
Repurchase of common stock......................................................... (90,871) (17,725)
Payment of dividends............................................................... (10,941) (9,532)
Payment of Subchapter S distributions of Mastersoft................................ -- (2,224)
------------- ------------
Net cash provided (used) by financing activities..................................... (73,074) 31,837
------------- ------------
Effect of foreign currency exchange rates on cash and cash equivalents............... (494) (573)
------------- ------------
Net increase/(decrease) in cash and cash equivalents................................. 19,805 (85,566)
Adjustment for change in Frame Technology Corporation's fiscal year-end.............. -- (3,591)
Cash and cash equivalents at beginning of period..................................... 58,493 204,120
------------- ------------
Cash and cash equivalents at end of period........................................... $ 78,298 $ 114,963
------------- ------------
------------- ------------
Supplemental disclosures:
Cash paid during the period for income taxes....................................... $ 23,398 $ 34,531
------------- ------------
------------- ------------
Noncash investing and financing activities:
Dividends declared but not paid.................................................. $ 3,622 $ 3,645
------------- ------------
------------- ------------
Reclassification of put warrants................................................. $ 118,081 $ 3,447
------------- ------------
------------- ------------
Issuance of notes for acquisition................................................ $ 9,473 $ --
------------- ------------
------------- ------------
See accompanying Notes to Condensed Consolidated Financial Statements.
7
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated balance sheets and
statements of income and cash flows reflect all normal recurring adjustments
which are, in the opinion of management, necessary to present a fair statement
of the condensed consolidated financial position at August 30, 1996, and the
condensed consolidated statements of income and cash flows for the interim
periods ended August 30, 1996 and September 1, 1995.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions for Form 10-Q and, therefore,
do not include all information and footnotes necessary for a complete
presentation of the results of operations, the financial position, and cash
flows, in conformity with generally accepted accounting principles. Adobe
Systems Incorporated ("Adobe" or the "Company") filed audited consolidated
financial statements which included all information and footnotes necessary for
such a presentation of the results of operations, financial position and cash
flows for the years ended December 1, 1995, November 25, 1994 and November 26,
1993, in the Company's 1995 Form 10-K.
The results of operations for the interim periods ended August 30, 1996, are
not necessarily indicative of the results to be expected for the full year.
NET INCOME PER SHARE
Net income per share is based upon weighted average common and dilutive
common equivalent shares outstanding using the treasury stock method. Dilutive
common equivalent shares include stock options and restricted stock. Fully
diluted earnings per share for the quarters and nine month periods ended August
30, 1996 and September 1, 1995 were not materially different from primary
earnings per share.
NOTE 2. ACQUISITIONS
POOLINGS OF INTERESTS
On October 28, 1995, the Company issued approximately 8.5 million shares of
its common stock in exchange for all of the common stock of Frame Technology
Corporation ("Frame"). Prior to its acquisition by the Company, on July 28,
1995, Frame acquired all of the common stock of Mastersoft, Inc. ("Mastersoft"),
in exchange for approximately 0.6 million equivalent shares of Adobe common
stock. These business combinations have been accounted for as poolings of
interests, and, accordingly, the consolidated financial statements for periods
prior to the combinations have been restated to include the results of
operations, financial position, and cash flows of Frame and Mastersoft.
Prior to the combinations, Frame's fiscal year ended on December 31. In
recording the business combination, Frame's financial statements for the 12
months ended December 1, 1995 were combined with the Company's consolidated
financial statements for the same period. Frame's financial statements for the
year ended December 31, 1994 were combined with the Company's consolidated
financial statements for the year ended November 25, 1994. Revenue and net
income of Frame for the month ended December 31, 1994 were $8.6 million and $2.3
million, respectively. Net income, Subchapter S distributions of Mastersoft, the
issuance of common stock, and the net decrease in cash and cash equivalents were
adjusted to
8
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. ACQUISITIONS (CONTINUED)
eliminate the effect of including Frame's results of operations, financial
position, and cash flows for the month ended December 31, 1994 in the years
ended December 1, 1995 and November 25, 1994.
PURCHASE
In May 1996, the Company acquired Ares Software Corporation ("Ares") for
approximately $15.5 million and accounted for the transaction by the purchase
method. Of this amount, the Company paid approximately $4.5 million in cash,
assumed $1.5 million of liabilities, and issued notes payable for $9.5 million.
Approximately $14.7 million was allocated to in-process research and
development, and was expensed at the time of the acquisition. The remainder of
the purchase price was allocated to current assets and goodwill. The operating
results of Ares have been included in the accompanying consolidated financial
statements from the date of acquisition. The operating results are not
considered material to the consolidated financial statements and accordingly,
pro forma information has not been presented.
NOTE 3. RECEIVABLES
Receivables consisted of the following:
AUGUST 30, DECEMBER 1,
1996 1995
---------- -----------
(IN THOUSANDS)
Trade receivables................................................... $ 63,271 $ 91,296
Royalty receivables................................................. 38,833 34,017
Interest and other receivables...................................... 11,886 11,593
---------- -----------
113,990 136,906
Less allowance for doubtful accounts................................ 5,158 3,698
---------- -----------
$ 108,832 $ 133,208
---------- -----------
---------- -----------
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
AUGUST 30, DECEMBER 1,
1996 1995
---------- -----------
(IN THOUSANDS)
Land................................................................ $ 782 $ 782
Building............................................................ 4,615 4,615
Equipment........................................................... 111,070 122,794
Furniture and fixtures.............................................. 18,448 18,962
Leasehold improvements.............................................. 15,304 8,790
---------- -----------
150,219 155,943
Less accumulated depreciation and amortization...................... 76,103 104,235
---------- -----------
$ 74,116 $ 51,708
---------- -----------
---------- -----------
9
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. OTHER ASSETS
Other assets consisted of the following:
AUGUST 30, DECEMBER 1,
1996 1995
---------- -----------
(IN THOUSANDS)
Licensing agreements................................................ $ 10,316 $ 16,319
Goodwill............................................................ 13,921 13,753
Purchased technology................................................ 36,301 35,626
Software development costs.......................................... 9,789 36,988
Equity investments.................................................. 122,712 53,091
Restricted funds.................................................... 66,593 35,634
Security deposits................................................... 162 --
Miscellaneous other assets.......................................... 20,163 11,363
---------- -----------
279,957 202,774
Less accumulated amortization....................................... 53,150 67,039
---------- -----------
$ 226,807 $ 135,735
---------- -----------
---------- -----------
Included above in gross other assets at August 30, 1996, are unrealized
gains and losses on equity investments. The equity investment in Netscape
Communications Corporation was marked-to-market for an unrealized gain of
approximately $58.1 million at August 30, 1996.
NOTE 6. ACCRUED EXPENSES
Accrued expenses consisted of the following:
AUGUST 30, DECEMBER 1,
1996 1995
----------- -----------
(IN THOUSANDS)
Royalties........................................................... $ 5,279 $ 7,194
Accrued compensation and benefits................................... 22,576 26,730
Sales and marketing allowances...................................... 21,476 24,586
Other............................................................... 34,750 36,338
----------- -----------
$ 84,081 $ 94,848
----------- -----------
----------- -----------
NOTE 7. ACCRUED RESTRUCTURING COSTS
On October 28, 1995, the Company acquired Frame, described in "Note
2--Acquisitions," and initiated a plan to combine the operations of the two
companies. On this date, the Company recorded a $32.5 million charge to
operating expenses related to merger transaction and restructuring costs. On
August 31, 1994, the Company merged with Aldus Corporation ("Aldus") and
initiated a plan to combine the operations of the two companies. On this date,
the Company recorded a $72.2 million charge to operating expenses related to
merger transaction and restructuring costs.
Merger transaction costs consist principally of transaction fees for
investment bankers, attorneys, accountants, financial printing, and other
related charges. Restructuring costs include the elimination of redundant
equipment, the write-off of certain intangible assets, severance and
outplacement of terminated employees, and cancellation of certain contractual
agreements.
10
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. ACCRUED RESTRUCTURING COSTS (CONTINUED)
Merger transaction and restructuring costs (in thousands) are summarized in
the table below:
NINE MONTHS ENDED AUGUST
30, 1996
ACCRUED AS ------------------------ ACCRUED AS OF
OF DECEMBER CASH CHANGE IN AUGUST 30,
1, 1995 PAYMENTS ESTIMATE 1996
------------ ----------- ----------- -------------
FRAME:
Merger transaction costs................................... $ 5,058 $ 4,702 $ 280 $ 76
Restructuring costs:
Severance and outplacement............................... 9,612 10,313 (912) 211
Cancellation of facility leases and other contracts...... 5,402 686 632 4,084
------------ ----------- ----- ------
$ 20,072 $ 15,701 $ -- $ 4,371
------------ ----------- ----- ------
------------ ----------- ----- ------
ALDUS:
Restructuring costs:
Cancellation of facility leases and other contracts...... 6,983 2,886 -- 4,097
------------ ----------- ----- ------
$ 6,983 $ 2,886 $ -- $ 4,097
------------ ----------- ----- ------
------------ ----------- ----- ------
In addition, Frame undertook certain restructuring measures in 1993 due to
lower than anticipated revenues. As of August 30, 1996 and December 1, 1995,
$1.0 million and $1.1 million, respectively, remained accrued and represented
anticipated future cash outflows related to lease payments on vacated
facilities.
The nature, timing, and extent of restructuring costs follow:
SEVERANCE AND OUTPLACEMENT
As a result of the merger, certain technical support, customer service,
distribution, and administrative functions were combined and reduced.
Restructuring included severance and outplacement charges related to
approximately 200 terminated employees for Frame. Affected employees had
received notification of their termination by November 8, 1995, and final
assignments have been substantially completed as of August 30, 1996 .
CANCELLATION OF FACILITY LEASES AND OTHER CONTRACTS
The Company has consolidated duplicate offices in Europe, Japan, Canada, and
the United States. Lease and third-party contract termination payments,
resulting from the planned closure of these facilities, are expected to continue
through the lease term or negotiated early termination date, if applicable.
NOTE 8. COMMITMENTS AND CONTINGENCIES
REAL ESTATE DEVELOPMENT AGREEMENTS
During 1994, the Company entered into a real estate development agreement
and an operating lease agreement in connection with the construction of an
office facility. In August 1996, the construction was completed and the
operating lease commenced. The Company will have the option to purchase the
facility at the end of the lease term. In 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
11
ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
to exceed that which would preclude classification of the lease as an operating
lease, approximately $57.3 million. The Company was required, periodically
during the construction period, to deposit funds with the lessor to secure the
performance of its obligations under the lease. During the third quarter of
1996, the Company increased its deposits by approximately $3.6 million, and as
of August 30, 1996, the Company's deposits under this agreement totaled
approximately $66.6 million in United States government treasury notes and money
market mutual funds. These deposits are included in "Other assets" in the
Condensed Consolidated Balance Sheets.
During the third quarter of 1996, the Company exercised its option under the
development agreement to begin a second phase of development for an office
facility. In August 1996, the Company entered into a construction agreement and
an operating lease agreement for this facility. The operating lease will
commence on completion of construction in 1998. The Company will have the option
to purchase the facility at the end of the lease term. In the event the Company
chooses not to exercise this option, the Company is obligated to arrange for the
sale of the facility to an unrelated party and is required to pay the lessor any
difference between the net sales proceeds and the lessor's net investment in the
facility, in an amount not to exceed that which would preclude classification of
the lease as an operating lease, approximately $64.3 million. The Company also
is required, periodically during the construction period, to deposit funds with
the lessor to secure the performance of its obligations under the lease. During
the third quarter of 1996, the Company deposited approximately $.2 million.
These deposits are included in "Other assets" in the Condensed Consolidated
Balance Sheets.
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 9. CAPITAL STOCK
PUT WARRANTS
In a series of private placements during the third quarter of 1996, the
Company sold put warrants entitling the holder of each warrant to sell one share
of common stock to the Company at a specified price. The Company's $118.1
million potential buyback obligation, as of August 30, 1996, was removed from
shareholders' equity and recorded as put warrants. The 3,730,000 put warrants
outstanding at August 30, 1996 expire on various dates between October 1996 and
April 1997 and have exercise prices ranging from $29.65 to $34.49 per share,
with an average exercise price of $31.66 per share.
STOCK OPTION REPRICING
On March 22, 1996, the Company offered its employees a stock option
repricing program which allowed the employees to exchange on a two for three
share basis any options priced above the March 29, 1996 closing price of Adobe
stock, which was $32.25. As a result, approximately 1,252,000 options were
surrendered by eligible employees for approximately 834,000 repriced options.
The repriced options may not be exercised for six months commencing on May 1,
1996.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO.
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS REPORT ON FORM
10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES.
THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT COULD CAUSE
OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN THE SECTION ENTITLED "FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS," AS WELL AS THOSE DISCUSSED ELSEWHERE IN THE COMPANY'S SEC REPORTS
(INCLUDING WITHOUT LIMITATION, ITS REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED
DECEMBER 1, 1995).
RESULTS OF OPERATIONS
OVERVIEW
Adobe Systems Incorporated ("Adobe" or the "Company") develops, markets, and
supports computer software products and technologies that enable users to
create, display, manage, communicate, and print electronic documents. The
Company licenses its technology to major computer, printing, and publishing
suppliers, and markets a line of application software products and type products
for authoring and editing visually rich documents. The Company distributes its
products through a network of original equipment manufacturer ("OEM") customers,
distributors and dealers, and value-added resellers ("VARs") and system
integrators. The Company has operations in the Americas, Europe, and the Pacific
Rim.
In October 1995, the Company acquired Frame Technology Corporation
("Frame"). Frame, established in 1986, developed, marketed, and supported
writing and publishing software for the creation and distribution of critical
business and technical documents. To effect the combination, approximately 8.5
million shares of Adobe's common stock were issued in exchange for all of the
outstanding common stock of Frame. The merger was accounted for by the pooling
of interests method, and accordingly, all annual and interim financial
information prior to the merger has been restated to combine the results of the
Company and Frame.
In January 1996, the Company divested its prepress applications product
business to a newly established company, Luminous Corporation ("Luminous").
Under the terms of the agreement, Luminous has acquired or licensed and will
continue to develop, market, and distribute Adobe's prepress application
products. Adobe retained a minority equity interest in Luminous and will
maintain ownership of certain core technologies for Adobe prepress products.
Luminous will pay royalties to Adobe based on a percentage of revenue from
certain products for the next two years. Revenue from prepress application
products was approximately $10.4 million in fiscal year 1995. The Company has
signed a letter of intent to dispose of its minority interest in Luminous, which
is expected to occur in the fourth quarter of 1996.
Effective March 2, 1996, the Company sold its investment in Datalogics, a
business unit previously owned by Frame, to a newly established company. This
business primarily involved consulting and development of high-end customized
publishing software. Adobe will retain a minority equity interest in the new
company. Revenue from this business unit was approximately $8.9 million in
fiscal year 1995.
13
The following table sets forth for the quarter and nine months ended August
30, 1996 and September 1, 1995 the Company's condensed consolidated statements
of income expressed as a percentage of total revenue:
QUARTER ENDED NINE MONTHS ENDED
-------------------------- --------------------------
AUGUST 30 SEPTEMBER 1 AUGUST 30 SEPTEMBER 1
1996 1995 1996 1995
----------- ------------- ----------- -------------
Revenue:
Licensing.................................................... 27.9% 24.6% 25.3% 24.3%
Application products......................................... 72.1 75.4 74.7 75.7
----- ----- ----- -----
Total revenue.............................................. 100.0 100.0 100.0 100.0
Direct costs................................................... 18.6 15.0 18.1 16.7
----- ----- ----- -----
Gross margin................................................... 81.4 85.0 81.9 83.3
----- ----- ----- -----
Operating expenses:
Software development costs:
Research and development................................... 20.1 19.0 19.2 17.7
Amortization of capitalized software development costs..... 0.3 1.5 0.3 1.5
Sales, marketing and customer support........................ 33.5 32.7 32.6 31.1
General and administrative................................... 8.2 7.2 8.2 7.2
Write-off of acquired in-process research and development.... -- -- 2.5 --
----- ----- ----- -----
Total operating expenses....................................... 62.1 60.4 62.8 57.5
----- ----- ----- -----
Operating income............................................... 19.3 24.6 19.1 25.8
Nonoperating income:
Investment gain/(loss)....................................... 3.5 -- 1.6 --
Interest and other income.................................... 4.1 4.0 3.9 3.7
----- ----- ----- -----
Total nonoperating income...................................... 7.6 4.0 5.5 3.7
----- ----- ----- -----
Income before income taxes..................................... 26.9 28.6 24.6 29.5
Provision for income taxes..................................... 10.4 10.1 9.8 10.7
----- ----- ----- -----
Net income..................................................... 16.5% 18.5% 14.8% 18.8%
----- ----- ----- -----
----- ----- ----- -----
REVENUE
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Total revenue.............................................. $ 181.0 $ 183.1 (1)%
Nine month period:
Total revenue.............................................. $ 578.9 $ 561.5 3%
Revenue decreased from the same quarter last year due to delays in product
releases, a slowdown in customer purchases of Macintosh versions of Adobe
software, and a decrease in Adobe FrameMaker and associated revenues. Product
unit volume (as opposed to price) decline was the principal factor in the
Company's revenue decrease in application product revenue. The decrease was
partially offset by an
14
increase in licensing activity. Revenue for the first nine months of 1996 grew
from the same period last year resulting from increased license revenue and
demand for several application products.
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Product group revenue--Licensing........................... $ 50.4 $ 45.1 12%
Percentage of total revenue................................ 27.9% 24.6%
Nine month period:
Product group revenue--Licensing........................... $ 146.6 $ 136.4 8%
Percentage of total revenue................................ 25.3% 24.3%
Licensing revenue is derived from shipments by OEMs of products containing
the Adobe PostScript interpreter and the Display PostScript system. Such
products include printers in both Roman and Japanese languages, imagesetters and
workstations. Licensing revenue is also derived from shipments of products
containing the Configurable PostScript Interpreter ("CPSI") by OEM customers.
CPSI is a fully functional PostScript interpreter that resides on the host
computer system rather than in a dedicated controller integrated into an output
device. The configuration flexibility of CPSI allows OEMs and software
developers to create and market a variety of PostScript products independently
of controller hardware development.
The number of units shipped by OEMs remained flat on a quarterly basis.
Royalty per unit is generally calculated as a percentage of the end user list
price of a printer, although there are some components of licensing revenue
based on a flat dollar amount per unit which typically do not change with list
price changes. Some OEMs continued to reduce list prices on their lower-end
printers, which resulted in lower royalties per unit on such printers. However,
in the third quarter and first nine months of 1996, this trend was offset by
increased demand for CPSI and color capability, as well as increased products
shipping into the Japanese market, all of which have higher royalties per unit.
In addition, the Company has seen year-to-year increases in the number of OEM
customers from which it is receiving licensing revenue.
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Product group revenue--Application products................ $ 130.5 $ 138.1 (6)%
Percentage of total revenue................................ 72.1% 75.4%
Nine month period:
Product group revenue--Application products................ $ 432.2 $ 425.1 2%
Percentage of total revenue................................ 74.7% 75.7%
Application products revenue is derived from shipments of application
software programs marketed through retail and distribution channels; however,
Adobe PageMill, Adobe SiteMill, and Adobe Acrobat products are being more widely
distributed through VARs and systems integrators.
Application products revenue for the third quarter of 1996 was lower than
anticipated because of lower than expected European revenues and delays in
product releases. The decrease from quarter to quarter resulted from decreased
demand for Macintosh versions of Adobe applications, as well as decreased demand
for FrameMaker and Acrobat products. In addition, the Company believes that
customers may have deferred purchases of Adobe Photoshop, Adobe PageMaker and
Acrobat products in anticipation of new versions expected to ship in the next
few months. Application products revenue increased for the first nine months of
1996 compared to the same period last year resulting from increased demand for
Photoshop, Adobe Illustrator, and Acrobat products partially offset by decreased
demand for FrameMaker and PageMaker. In addition, PageMill and SiteMill which
were both released in late 1995, added revenue in both the third quarter and
first nine months of 1996.
15
The Company expects 1996 to be a transition year for application products as
customers determine which computer platform to use and as the Internet market
develops. In general, the Company's application products on the Windows platform
have experienced greater growth than those on the Macintosh platform during the
first nine months of 1996. The Company expects this trend to continue for the
foreseeable future.
DIRECT COSTS
1996 1995 CHANGE
--------- --------- -----------
(DOLLARS IN
MILLIONS)
Third quarter period:
Direct costs............................................... $ 33.6 $ 27.5 22%
Percentage of total revenue................................ 18.6% 15.0%
Nine month period:
Direct costs............................................... $ 104.9 $ 93.6 12%
Percentage of total revenue................................ 18.1% 16.7%
Direct costs include royalties; amortization of acquired technologies; and
direct product, packaging and shipping costs.
Gross margins, in general, are affected by the mix of licensing revenue
versus application products revenue as well as the product mix within
application products. Direct costs were higher in the third quarter of 1996
compared with the same quarter last year due to higher localization costs and
inventory charges for several application products. Also, there was a general
decline in FrameMaker revenue and associated gross margins. In addition, direct
costs increased in the third quarter and first nine months of 1996 compared to
the same periods last year due to a change in geographic product mix towards
higher sales in Japan which have a higher direct cost.
OPERATING EXPENSES
1996 1995 CHANGE
--------- --------- -----------
(DOLLARS IN
MILLIONS)
Third quarter period:
Software development costs--Research and development....... $ 36.3 $ 34.9 4%
Percentage of total revenue................................ 20.1% 19.0%
Nine month period:
Software development costs--Research and development....... $ 111.2 $ 99.1 12%
Percentage of total revenue................................ 19.2% 17.7%
Research and development expenses consist principally of salaries and
benefits for software developers, contracted development efforts, related
facilities costs, and expenses associated with computer equipment used in
software development.
Research and development expense has increased as the Company invested in
new technologies, new product development, and the infrastructure to support
such activities. The increase reflects the expansion of the Company's
engineering staff and related costs required to support its continued emphasis
on developing new products and enhancing existing products. Many of these
engineers are working with OEM customers to design and implement Adobe
PostScript Level 2 devices and, for the future, Adobe Postscript level 3
devices. The Company continued working with many of its OEM customers in a
co-development program. This allows customers to be more self-sufficient in new
device development by taking on more of the implementation tasks themselves
rather than relying so heavily on the Company's engineers. While this mitigates
certain costs, the Company continues to make significant investments in
development of its Adobe PostScript and application software products, including
those targeted for the emerging internet market.
16
The Company believes that continued investment in research and development
is necessary to remain competitive in the marketplace, and is directly related
to continued, timely development of new and enhanced products. Accordingly, the
Company intends to continue recruiting and hiring experienced software
developers. While the Company expects that research and development expenditures
in 1996 will continue to increase in absolute dollars, such expenditures for all
of 1996 will approximate current year-to-date spending levels as a percentage of
revenue.
1996 1995 CHANGE
----------- ----------- -----------
(DOLLARS IN MILLIONS)
Third quarter period:
Software development costs--Amortization of capitalized
software development costs............................... $ 0.6 $ 2.7 (77)%
Percentage of total revenue................................ 0.3% 1.5%
Nine month period:
Software development costs--Amortization of capitalized
software development costs............................... $ 1.9 $ 8.5 (78)%
Percentage of total revenue................................ 0.3% 1.5%
In the implementation of Statement of Financial Accounting Standards ("
SFAS") No. 86, "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed," software development expenditures on Adobe
products, after achieving technological feasibility, were deemed to be
immaterial. Certain software development expenditures on Frame and Aldus
products have been capitalized and are being amortized over the lives of the
respective products. In the third quarter and first nine months of 1996,
software development expenditures on all products, after reaching technological
feasibility, were immaterial and the Company expects this trend to continue in
the future.
Amortization of capitalized software development costs decreased in the
third quarter and first nine months of 1996 as a result of achieving full
amortization of all Aldus products by the end of 1995. Amortization of software
development costs are expected to remain relatively constant during the
remainder of 1996 as the software products acquired with Frame become fully
amortized.
1996 1995 CHANGE
--------- --------- -----------
(DOLLARS IN
MILLIONS)
Third quarter period:
Sales, marketing and customer support...................... $ 60.6 $ 59.8 1%
Percentage of total revenue................................ 33.5% 32.7%
Nine month period:
Sales, marketing and customer support...................... $ 189.0 $ 174.5 8%
Percentage of total revenue................................ 32.6% 31.1%
Sales, marketing and customer support expenses generally include salaries
and benefits, sales commissions, travel expenses and related facilities costs
for the CompanyOs sales, marketing, customer support and distribution personnel.
Sales, marketing and customer support expenses also include the cost of programs
aimed at increasing revenues such as advertising, trade shows and other market
development programs.
Sales, marketing and customer support expenses increased in the third
quarter and first nine months of 1996 compared with the same periods of 1995.
The increase resulted primarily from Frame integration costs in the first
quarter of 1996 and a higher headcount entering fiscal 1996, and higher rent
expense. In addition, more trade show and marketing activity, particularly in
Japan and Europe in the second quarter of 1996, increased expenditures during
1996. Costs related to continuing efforts to expand markets and increase
penetration into targeted software markets, as well as responding to increased
competition in the software industry, will be partially offset by decreased
costs resulting from the restructuring of the combined company after the
acquisition of Frame. As a result, for all of 1996, sales, marketing and
customer support expenditures are expected to increase in absolute dollars and
increase slightly from 1995 spending levels as a percentage of revenue.
17
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
General and administrative.................................. $ 14.8 $ 13.2 12%
Percentage of total revenue................................. 8.2% 7.2%
Nine month period:
General and administrative.................................. $ 46.9 $ 40.9 15%
Percentage of total revenue................................. 8.2% 7.2%
General and administrative expenses consist principally of salaries and
benefits, travel expenses, and related facility costs for the finance, human
resources, legal, information services and administrative personnel of the
Company. General and administrative expenses also include outside legal and
accounting fees, bad debts and expenses associated with computer equipment and
software used in the administration of the business.
In the third quarter and first nine months of 1996, general and
administrative expenses increased compared with the same periods of 1995. The
increase resulted primarily from Frame integration costs in the first quarter of
1996 and a higher headcount entering fiscal 1996. In addition, the increase for
the third quarter of 1996 resulted from 1996 salary increases and higher rent
expense, as well as higher systems and legal costs. While the Company expects
that general and administrative expenditures in 1996 will continue to increase
in absolute dollars, such expenditures for the fourth quarter of 1996 are
expected to remain approximately the same as total 1995 spending levels as a
percentage of revenue.
1996 1995 CHANGE
--------- --------- -----------
(DOLLARS IN
MILLIONS)
Nine month period:
Write-off of acquired in-process research and development.... $ 14.7 $ -- 100%
Percentage of total revenue.................................. 2.5% --
In May 1996, the Company acquired Ares Software Corporation ("Ares") for
approximately $15.5 million and accounted for the transaction by the purchase
method. Of this amount, the Company paid approximately $4.5 million in cash,
assumed $1.5 million of liabilities, and issued notes payable for $9.5 million.
Approximately $14.7 million was allocated to in-process research and
development, and was expensed at the time of the acquisition. The remainder of
the purchase price was allocated to current assets and goodwill.
NONOPERATING INCOME
1996 1995 CHANGE
--------- --------- -----------
(DOLLARS IN
MILLIONS)
Third quarter period:
Investment gain/(loss)..................................... $ 6.4 $ (0.1) 6,798%
Percentage of total revenue................................ 3.5%
Nine month period:
Investment gain/(loss)..................................... $ 9.5 $ (0.7) 1,469%
Percentage of total revenue................................ 1.6% --
Investment gain/(loss) consists principally of mark-to-market valuation
adjustments of Adobe Ventures investments, as well as any realized gains from
direct investments.
In the third quarter of 1996, one of the equity investments included in
Adobe Ventures porfolio was marked-to-market for an unrealized gain of
approximately $8.9 million. This unrealized gain was partially
18
offset by unrealized losses related to mark-to-market adjustments for other
equity investments within the Adobe Ventures portfolio.
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Interest and other income................................... $ 7.4 $ 7.5 (1)%
Percentage of total revenue................................. 4.1% 4.0%
Nine month period:
Interest and other income................................... $ 22.5 $ 21.5 5%
Percentage of total revenue................................. 3.9% 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.
In the first nine months of 1996, interest and other income increased
compared with the same period of 1995. The increase is primarily due to a
significantly larger investment base.
PROVISION FOR INCOME TAXES
1996 1995 CHANGE
--------- --------- -------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Provision for income taxes.................................. $ 18.8 $ 18.5 2%
Percentage of total revenue................................. 10.4% 10.1%
Effective tax rate.......................................... 38.7% 35.3%
Nine month period:
Provision for income taxes.................................. $ 56.8 $ 60.2 (6)%
Percentage of total revenue................................. 9.8% 10.7%
Effective tax rate.......................................... 39.9% 36.4%
The effective tax rate for the third quarter and first nine months of 1996
was higher than the same periods in 1995 due to the limited benefit in 1996 from
the federal research experimentation credit, which was reinstated on July 1,
1996. The credit was not renewed retroactively and therefore is only effective
for the last five months of fiscal 1996. In addition, the nondeductible
write-off of acquired in-process research and development associated with the
May 1996 acquisition of Ares increased the effective rate for the second quarter
as well as subsequent quarters of 1996.
NET INCOME AND NET INCOME PER SHARE
1996 1995 CHANGE
--------- --------- ------------
(DOLLARS IN
MILLIONS)
Third quarter period:
Net income................................................. $ 29.8 $ 33.9 (12)%
Percentage of total revenue................................ 16.5% 18.5%
Net income per share....................................... $ .40 $ .44 (9)%
Weighted shares (In thousands)............................. 74,309 76,325 (3)%
Nine month period:
Net income................................................. $ 85.5 $ 105.3 (19)%
Percentage of total revenue................................ 14.8% 18.8%
Net income per share....................................... $ 1.13 $ 1.41 (20)%
Weighted shares (In thousands)............................. 75,447 74,845 1%
19
Net income for the third quarter of 1996 decreased 12% from the third
quarter of 1995. Earnings per share were $.40, a 9% decrease from the third
quarter of 1995. Net income for the nine months ended August 30, 1996 decreased
19% from the same period in 1995 and earnings per share decreased 20% for the
same period. The decrease from quarter to quarter was caused primarily by lower
revenues and higher direct costs and operating expenses partially offset by
increased nonoperating income and reduced shares outstanding. The decrease for
the first nine months of fiscal 1996 compared to the same period last year was
caused primarily by higher operating expenses which includes the write off of
in-process research and development cost in the second quarter of 1996. The
increase was partially offset by an increase in nonoperating income.
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 the ability of the Company to integrate
Adobe and Frame product lines; renegotiation of royalty arrangements; delays in
shipment of the Company's new products and major new versions of existing
products; market acceptance of new products and upgrades; growth in worldwide
personal computer and printer sales and sales price adjustments; consolidation
in the OEM printer business; industry transitions to new business and
information delivery models; and adverse changes in general economic conditions
in any of the countries in which the Company does business.
In connection with the merger with Frame, the Company has sought to reduce
combined expenses by the elimination of duplicate or unnecessary facilities,
employees, marketing programs, and other expenses. The Company believes that the
major impact of such reductions occurred in the first six months of 1996. The
Company expects that these reductions will benefit future operating results, but
the reductions could adversely impact the earnings of the combined company. In
addition, the integration of the product lines of the two companies could have a
material adverse effect on the results of operations, including the potential
for charges for certain discontinued business components.
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,
including licensing a PostScript language compatible interpreter from a third
party, which could result in lower licensing revenue for the Company. During the
first quarter of 1996, there was a change in part of the Company's business
relationship with Hewlett-Packard Company (Hewlett-Packard). Beginning in the
second half of 1997, Hewlett-Packard plans not to incorporate PostScript
software in some Hewlett-Packard LaserJet printers. The Company expects to
continue working with Hewlett-Packard printer operations to incorporate Adobe
PostScript and other technologies in other Hewlett-Packard products.
The Company derives a significant portion of its revenue and operating
income from its subsidiaries located in Europe and the Pacific Rim. While most
of the revenue of these subsidiaries is denominated in U.S. dollars, the
majority of their expense transactions are denominated in foreign currencies,
including the Japanese yen and most major European currencies. As a result, the
Company's operating results are subject to fluctuations in foreign currency
exchange rates. To date, the impact of such fluctuations has been insignificant
and the Company has not engaged in any significant activities to hedge its
exposure to foreign currency exchange rate fluctuations. In addition, the
Company generally experiences lower revenue from its European operations in the
third quarter because many customers reduce their business activities in the
summer months.
The Company's ability to develop and market products, including upgrades of
currently shipping products, that successfully adapt to current market needs may
also have an impact on the results of operations. A portion of the Company's
future revenue will come from these products. Delays in product introductions
could have an adverse effect on the Company's revenue, earnings, or stock price.
The
20
Company cannot determine the ultimate effect that these new products or upgrades
will have on its sales or results of operations.
Although the Company generally offers its application products on Macintosh,
Windows, and UNIX platforms, a majority of the overall sales of these products
to date has been for the Macintosh platform, particularly for the higher end
Macintosh computers. To the extent that there is a slowdown of customer
purchases in the higher end Macintosh market or if other operating systems, such
as Windows 95 or NT, become more prevalent among the Company's customers, the
Company's operating results could be materially adversely affected. Also, if the
Company broadens its customer base to achieve greater penetration in the
corporate business and consumer markets, the Company may need to adapt its
application software distribution channels. The Company could experience
decreases in average selling prices and some transitions in its distribution
channel which could materially adversely affect its operating results. In
addition, to the extent that there is a slowdown of customer purchases of
personal computers in general, the Company's operating results could be
materially adversely affected.
During 1995, the Company entered the Internet market, which has only
recently begun to develop. The Internet market is rapidly evolving and is
characterized by an increasing number of market entrants who have introduced or
developed products addressing authoring and communication 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 the authoring and
electronic publishing requirements of the Internet is young and has few proven
products. 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 impact the growth of Internet use,
together with the software standards and electronic media employed in such
markets.
Through its acquisitions in 1994 and 1995, the Company has experienced
significant growth. The Company's ability to effectively manage its growth and
the industry transition to the Internet will require it to continue to improve
its operational and financial controls and information management systems, to
develop new models for licensing its software to accommodate new information
delivery practices, and to attract, retain, motivate and manage employees
effectively. The failure of the Company to manage effectively growth and
transition in multiple areas of its business could have a material adverse
effect on its results of operations.
Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by securities
analysts could have an immediate and significant adverse effect on the trading
price of the Company's common stock in any given period. Additionally, the
Company may not learn of such shortfalls until late in the fiscal quarter, which
could result in an even more immediate and adverse effect on the trading price
of the Company's common stock. Finally, the Company participates in a highly
dynamic industry. In addition to factors specific to the Company, changes in
analysts' earnings estimates for the Company or its industry and factors
affecting the corporate environment or the securities markets in general will
often result in significant volatility of the Company's common stock price.
21
FINANCIAL CONDITION
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
AUGUST 30, DECEMBER 1,
1996 1995 CHANGE
----------- ------------- -------------
(DOLLARS IN MILLIONS)
Cash, cash equivalents and short-term investments......... $ 489.5 $ 516.0 (5)%
The Company's cash balances and short term investments have decreased due to
the repurchase of stock, capital outlays, other investments, and deposits
required under real estate development agreements.
Cash equivalents consist of highly liquid money market instruments. All of
the Company's cash equivalents and short-term investments, consisting
principally of municipal bonds, commercial paper, auction rate securities,
United States government and government agency securities, and asset-backed
securities, are classified as available-for-sale under the provisions of
Statement of Financial Accounting Standards No. 115. The securities are carried
at fair value with the unrealized gains and losses, net of tax, reported as a
separate component of shareholders' equity.
OTHER ASSETS
AUGUST 30, DECEMBER 1,
1996 1995 CHANGE
----------- ------------- -------------
(DOLLARS IN MILLIONS)
Other assets (gross)...................................... $ 280.0 $ 202.8 38%
Included above in gross other assets at August 30, 1996 are unrealized gains
and losses on equity investments. The equity investment in Netscape
Communications Corporation Communications was marked-to-market for an unrealized
gain of approximately $58.1 million at August 30, 1996.
NONCURRENT LIABILITIES AND SHAREHOLDERS' EQUITY
AUGUST 30, DECEMBER 1,
1996 1995 CHANGE
----------- ------------- -------------
(DOLLARS IN MILLIONS)
Noncurrent liabilities and shareholders' equity........... $ 756.9 $ 698.4 8%
Included above is shareholders' equity and at August 30, 1996, deferred
income taxes related to unrealized gains and losses on equity investments and
obligations for put warrants. The Company has no long-term debt. A significant
portion of the increase in shareholders' equity is attributable to the
unrealized gain on the equity investment in Netscape Communications Corporation.
The Board of Directors of the Company declared a cash dividend on the
Company's common stock of $.05 per common share on September 18, 1996, for the
third quarter of 1996. The dividend will be for shareholders of record as of
October 2, 1996, and will be paid on October 16, 1996. The declaration of future
dividends is within the discretion of the Board of Directors of the Company and
will depend upon business conditions, results of operations, the financial
condition of the Company and other factors.
Under its stock repurchase program, the Company repurchased 1,320,500 shares
at a cost of $48.9 million in the third quarter of 1996. The Company intends to
continue to directly repurchase common shares and arrange options to purchase
common shares to fund the Company's employee stock purchase and stock option
plans.
22
WORKING CAPITAL
AUGUST 30, DECEMBER 1,
1996 1995 CHANGE
----------- ------------- ------------
(DOLLARS IN MILLIONS)
Working capital........................................... $ 456.0 $ 506.5 (10)%
Net working capital decreased to $456.0 million as of August 30, 1996,
compared to $506.5 million as of December 1, 1995. The decline was due to the
repurchase of stock, capital outlays, other investments, and deposits required
under real estate development agreements. Cash flow provided by operations
during the first nine months of 1996 was $136.8 million. This was offset by cash
used for investing and financing activities.
Expenditures during the first nine months of 1996 for property and equipment
totaled $38.4 million. Such expenditures are expected to continue, including
computer systems for development, sales and marketing, product support, and
administrative staff. In the future, additional cash may be used to acquire
software products or technologies complementary to the Company's business. Net
cash used by financing activities during the first nine months of 1996 was $73.1
million, primarily resulting from the repurchase of common stock and payment of
dividends partially offset by issuance of common stock under employee stock
plans.
The Company's principal commitments as of August 30, 1996 consisted of
obligations under operating leases, real estate development agreements, and
various service and lease guarantee agreements with a related party.
During 1994, the Company entered into a real estate development agreement
and an operating lease agreement in connection with the construction of an
office facility. In Ausust 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 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. The Company was required,
periodically during the construction period, to deposit funds with the lessor to
secure the performance of its obligations under the lease. During the third
quarter of 1996, the Company increased its deposits by approximately $3.6
million, and as of August 30, 1996, the Company's deposits under this agreement
totaled approximately $66.6 million in United States government treasury notes
and money market mutual funds. These deposits are included in "Other assets" in
the Condensed Consolidated Balance Sheets.
During the third quarter of 1996, the Company exercised its option under the
development agreement to begin a second phase of development for an office
facility. In August 1996, the Company entered into a construction agreement and
an operating lease agreement for this facility. The operating lease will
commence on completion of construction in 1998. The Company will have the option
to purchase the facility at the end of the lease term. In the event the Company
chooses not to exercise this option, the Company is obligated to arrange for the
sale of the facility to an unrelated party and is required to pay the lessor any
difference between the net sales proceeds and the lessor's net investment in the
facility, in an amount not to exceed that which would preclude classification of
the lease as an operating lease, approximately $64.3 million. The Company also
is required, periodically during the construction period, to deposit funds with
the lessor to secure the performance of its obligations under the lease. During
the third quarter of 1996, the Company deposited approximately $.2 million.
These deposits are included in "Other assets" in the Condensed Consolidated
Balance Sheets.
The Company has also entered into various agreements with McQueen Holdings
Limited ("McQueen"), a European operating entity, whereby the Company has agreed
to guarantee obligations
23
under operating leases for certain European facilities utilized by McQueen, and
to guarantee certain levels of business between Adobe and McQueen. The Company
owns 16% of the outstanding stock in McQueen.
During the third quarter of 1996, the Company repurchased 1,320,500 shares
of its common stock at a cost of $48.9 million. In addition, in a series of
private placements, the Company sold put warrants entitling the holder of each
warrant to sell one share of common stock to the Company at a specified price.
The Company's $118.1 million potential buyback obligation, as of August 30,
1996, was removed from shareholders' equity and recorded as put warrants. The
3,730,000 put warrants outstanding at August 30, 1996 expire on various dates
between October 1996 and April 1997 and have exercise prices ranging from $29.65
to $34.49 per share, with an average exercise price of $31.66 per share. The
Company intends to continue to directly repurchase common shares and arrange
options to purchase common shares to fund the Company's employee stock purchase
and stock option plans.
The Company believes that existing cash, cash equivalents, and short-term
investments, together with cash generated from operations, will provide
sufficient funds for the Company to meet its operating cash requirements in the
foreseeable future.
24
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Quantel Limited, a U.K. corporation, has filed and served on the Company a
complaint alleging that the Adobe Photoshop program infringes five U.S. patents
held by Quantel. The complaint was filed in the United States District Court for
the District of Delaware. The complaint seeks a permanent injunction and
unspecified damages. The Company has analyzed the patents and believes it has
adequate legal defenses to the major causes of action and intends to vigorously
defend the lawsuit.
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, 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. Adobe has filed a demurrer in the
Superior Court seeking to dismiss the complaint in its entirety.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) INDEX TO EXHIBITS
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
- --------- ----------------------------------------------------------- --------- --------- --------- ---------
3.2.9 Restated Bylaws 10-Q 05/31/96 3.2.9
4.1 Shareholders Rights Plan, as amended* 10-Q 05/31/96 4.1
10.1.6 1984 Stock Option Plan, as amended* 10-Q 07/02/93 10.1.6
10.1.7 1994 Stock Option Plan* 10-Q 05/27/94 10.1.7
10.12.1 1988 Employee Stock Purchase Plan, as amended* 10-Q 07/06/94 10.12.1
10.17.1 License Agreement Restatement between the Company and Apple
Computer, Inc., dated April 1, 1987 (confidential treatment
granted) 10-K 11/30/88 10.17.1
10.17.2 Amendment No. 1 to the License Agreement Restatement
between the Company and Apple Computer, Inc., dated
November 27, 1990 (confidential treatment granted) 10-K 11/30/90 10.17.2
10.21.2 Revised Bonus Plan* 10-K 11/26/93 10.21.2
10.24.1 1994 Performance and Restricted Stock Plan* S-4 07/27/94 10.1
10.25 Form of Indemnity Agreement* 10-K 11/30/88 10.25
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
10.33 Sale of Rights under Software Development and Acquisition
Agreement By and Between Adobe Systems Incorporated and
Thomas Knoll and John Knoll (confidential treatment
granted) 10-Q 06/02/95 10.33
25
INCORPORATED BY REFERENCE
EXHIBIT ------------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH
- --------- ----------------------------------------------------------- --------- --------- --------- ---------
10.34 Agreement and Plan of Merger and Reorganization By and
Among Adobe Systems Incorporated, J Acquisition Corporation
and Frame Technology Corporation S-4 08/18/95 2.1
10.35 Form of Executive Severance and Change of Control
Agreement* 10-K 12/01/95 10.35
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) X
11 Computation of Earnings Per Common Share X
27 Financial Data Schedule X
- ------------------------
* Compensatory plan or arrangement
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed in the quarter ended August 30, 1996.
26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ADOBE SYSTEMS INCORPORATED
By /s/ CHARLES M. GESCHKE
------------------------------------
Charles M. Geschke,
PRESIDENT, DIRECTOR, AND ACTING
CHIEF FINANCIAL OFFICER (PRINCIPAL
FINANCIAL OFFICER)
Date: October 10, 1996
27
SUMMARY OF TRADEMARKS
The following trademarks of Adobe Systems Incorporated, which may be
registered in certain jurisdictions, are referenced in this Form 10-Q:
Acrobat
Adobe
Display PostScript
Illustrator
FrameMaker
PageMaker
PageMill
Photoshop
PostScript
Premiere
SiteMill
All other brand or product names are trademarks or registered trademarks of
their respective holders.
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