Adobe Inc. is an American software company registered in the state of Delaware. It was founded in 1982 by John Warnock and Charles Geschke, the inventors of the PostScript page description language.
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES 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 MAY 29, 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, 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: <TABLE> <CAPTION> Shares Outstanding Class June 26, 1998 ----- ------------- <S> <C> Common stock, $0.0001 par value 67,198,400 </TABLE> - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
TABLE OF CONTENTS <TABLE> <CAPTION> Page No. PART I -- FINANCIAL INFORMATION <S> <C> Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Statements of Income Three Months Ended May 29, 1998 and May 30, 1997 and Six Months Ended May 29, 1998 and May 30, 1997 3 Condensed Consolidated Balance Sheets May 29, 1998 and November 28, 1997 4 Condensed Consolidated Statements of Cash Flows Six Months Ended May 29, 1998 and May 30, 1997 5 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 PART II -- OTHER INFORMATION Item 1. Legal Proceedings 26 Item 4. Submission of Matters to a Vote of Security Holders 27 Item 6. Exhibits and Reports on Form 8-K 28 Signatures 30 Summary of Trademarks 31 </TABLE> EXHIBITS Exhibit 27.1 Financial Data Schedule Exhibit 27.2 Financial Data Schedule 2
PART I -- FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ------------------------ ------------------------ MAY 29 MAY 30 MAY 29 MAY 30 1998 1997 1998 1997 --------- --------- --------- --------- <S> <C> <C> <C> <C> Revenue: Licensing $ 42,456 $ 53,261 $ 84,307 $ 104,721 Application products 184,854 175,003 340,816 350,002 --------- --------- --------- --------- Total revenue 227,310 228,264 425,123 454,723 Direct costs 27,292 32,658 57,278 66,947 --------- --------- --------- --------- Gross margin 200,018 195,606 367,845 387,776 --------- --------- --------- --------- Operating expenses: Research and development 53,310 41,253 99,737 79,450 Sales and marketing 86,827 75,179 158,661 147,217 General and administrative 20,892 21,106 44,968 38,602 Acquired in-process technology 1,180 3,157 4,998 3,157 Other non-recurring items 565 -- 565 (2,359) --------- --------- --------- --------- Total operating expenses 162,774 140,695 308,929 266,067 --------- --------- --------- --------- Operating income 37,244 54,911 58,916 121,709 --------- --------- --------- --------- Nonoperating income, net: Investment gain (loss) (188) 34 12,274 (590) Interest and other income 7,589 8,259 16,090 15,252 --------- --------- --------- --------- Total nonoperating income, net 7,401 8,293 28,364 14,662 --------- --------- --------- --------- Income before income taxes 44,645 63,204 87,280 136,371 Provision for income taxes 16,665 23,098 32,556 49,781 --------- --------- --------- --------- Net income $ 27,980 $ 40,106 $ 54,724 $ 86,590 --------- --------- --------- --------- --------- --------- --------- --------- Basic net income per share $ .42 $ .56 $ .81 $ 1.21 --------- --------- --------- --------- --------- --------- --------- --------- Shares used in computing basic net income per share 66,735 72,085 67,257 71,780 --------- --------- --------- --------- --------- --------- --------- --------- Diluted net income per share $ .41 $ .54 $ .79 $ 1.17 --------- --------- --------- --------- --------- --------- --------- --------- Shares used in computing diluted net income per share 68,990 74,416 69,453 74,199 --------- --------- --------- --------- --------- --------- --------- --------- </TABLE> SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 3
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> MAY 29 NOVEMBER 28 1998 1997 ----------- ----------- ASSETS <S> <C> <C> Current assets: Cash and cash equivalents $ 115,358 $ 267,576 Short-term investments 277,246 235,380 Receivables, net of allowances of $4,544 and $3,634, respectively 151,886 130,974 Other current assets 44,674 45,016 ----------- ----------- Total current assets 589,164 678,946 Property and equipment 99,914 80,978 Other assets 191,744 163,148 Deferred income taxes 17,231 16,999 ----------- ----------- $ 898,053 $ 940,071 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade and other payables $ 44,506 $ 57,857 Accrued expenses 108,759 102,741 Income taxes payable 45,965 48,343 Deferred revenue 14,585 15,706 ----------- ----------- Total current liabilities 213,815 224,647 ----------- ----------- Stockholders' equity: Preferred stock, $0.0001 par value; 2,000 shares authorized; none issued or outstanding at May 29, 1998 and November 28, 1997 -- -- Common stock, $0.0001 par value; Authorized: 200,000 shares; Issued: 75,350 and 73,941 shares at May 29, 1998 and November 28, 1997, respectively; Outstanding: 67,154 and 68,765 shares at May 29, 1998 and November 28, 1997, respectively 7 7 Additional paid-in capital 338,656 291,274 Retained earnings 711,983 663,861 Unrealized gains on investments, net 481 3,590 Cumulative translation adjustment (5,273) (4,620) Treasury stock, at cost (8,196 and 5,176 shares at May 29, 1998 and November 28, 1997, respectively) (361,616) (238,688) ----------- ----------- Total stockholders' equity 684,238 715,424 ----------- ----------- $ 898,053 $ 940,071 ----------- ----------- ----------- ----------- </TABLE> SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED ---------------------- MAY 29 MAY 30 1998 1997 --------- --------- <S> <C> <C> Cash flows from operating activities: Net income $ 54,724 $ 86,590 Adjustments to reconcile net income to net cash provided by operating activities: Stock compensation expense 1,484 3,711 Depreciation and amortization 27,969 21,649 Deferred income taxes 1,292 (2,651) Provision for losses on accounts receivable 1,087 308 Tax benefit from employee stock plans 8,190 17,369 Equity in net loss of Adobe Ventures 703 658 Gain on sale and distribution of equity investments (12,987) -- Write-off of acquired in-process technology 4,998 3,157 Changes in operating assets and liabilities: Receivables (21,999) (15,121) Other current assets (1,182) (5,144) Trade and other payables (13,351) 18,739 Accrued expenses 16,231 (2,073) Income taxes payable (2,378) (26,832) Deferred revenue (1,121) 4,014 --------- --------- Net cash provided by operating activities 63,660 104,374 --------- --------- Cash flows from investing activities: Purchases of short-term investments (508,156) (1,748,497) Maturities and sales of short-term investments 464,822 1,761,554 Acquisitions of property and equipment (36,527) (16,610) Additions to other assets (40,525) (22,487) Acquisitions, net of cash acquired -- (2,121) --------- --------- Net cash used for investing activities (120,386) (28,161) --------- --------- </TABLE> (Continued) SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (CONTINUED) (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED ---------------------- MAY 29 MAY 30 1998 1997 --------- --------- <S> <C> <C> Cash flows from financing activities: Proceeds from issuance of common stock $ 37,708 $ 42,816 Repurchase of common stock (122,928) (36,957) Payment of dividends (9,619) (7,249) --------- --------- Net cash provided (used) by financing activities (94,839) (1,390) --------- --------- Effect of foreign currency exchange rates on cash and cash equivalents (653) 19 --------- --------- Net increase (decrease) in cash and cash equivalents (152,218) 74,842 Cash and cash equivalents at beginning of period 267,576 110,745 --------- --------- Cash and cash equivalents at end of period $ 115,358 $ 185,587 --------- --------- --------- --------- Supplemental disclosures: Cash paid during the period for income taxes $ 16,794 $ 56,844 --------- --------- --------- --------- Noncash investing and financing activities: Dividends declared but not paid $ 3,376 $ 3,660 --------- --------- --------- --------- Dividend in-kind declared but not issued $ -- $ 21,560 --------- --------- --------- --------- </TABLE> SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 6
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying interim condensed consolidated financial statements of Adobe Systems Incorporated ("Adobe" or the "Company") have been prepared in conformity with generally accepted accounting principles, consistent in all material respects with those applied in the Company's Annual Report on Form 10-K for the year ended November 28, 1997. The interim financial information is unaudited but reflects all normal adjustments which are, in the opinion of management, necessary to provide fair condensed consolidated balance sheets and condensed consolidated statements of income and cash flows for the interim periods presented. The interim financial statements should be read in conjunction with the financial statements in the Company's Annual Report on Form 10-K for the year ended November 28, 1997. The results of operations for the interim period ended May 29, 1998, are not necessarily indicative of the results to be expected for the full year. NET INCOME PER SHARE Basic net income per share is computed using the weighted average number of common shares outstanding for the period. 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 written by the Company using the reverse treasury stock method. <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ------------------------ ------------------------ MAY 29 MAY 30 MAY 29 MAY 30 1998 1997 1998 1997 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net income $27,980 $40,106 $54,724 $86,590 --------- --------- --------- --------- --------- --------- --------- --------- Shares used to compute basic net income per share (weighted average shares outstanding during the period) 66,735 72,085 67,257 71,780 Dilutive common equivalent shares: Unvested restricted stock 78 173 78 173 Stock options 2,177 2,158 2,118 2,246 --------- --------- --------- --------- Shares used to compute diluted net income per share 68,990 74,416 69,453 74,199 --------- --------- --------- --------- --------- --------- --------- --------- Basic net income per share $ .42 $ .56 $ .81 $ 1.21 --------- --------- --------- --------- --------- --------- --------- --------- Diluted net income per share $ .41 $ .54 $ .79 $ 1.17 --------- --------- --------- --------- --------- --------- --------- --------- </TABLE> 7
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (CONTINUED) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION In October 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 establishes standards relating to the recognition of all aspects of software revenue. Based on the Company's initial assessment of the impact SOP 97-2 may have on its consolidated results of operations, the Company intends to modify 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. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board ("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 periods presented in its financial statements. The Company will be required to implement SFAS No. 130 for its fiscal year 1999. SEGMENT REPORTING 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 to determine whether this will have an impact on its financial statement reporting. The Company will be required to implement SFAS No. 131 for its fiscal year 1999. RECLASSIFICATIONS Certain amounts in the 1997 Condensed Consolidated Statement of Cash Flows have been reclassified to conform to the 1998 presentation. 8
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA) (CONTINUED) NOTE 2. OTHER ASSETS Other assets consisted of the following: <TABLE> <CAPTION> MAY 29 NOVEMBER 28 1998 1997 ----------- ----------- <S> <C> <C> Equity investments $ 53,220 $ 35,689 Purchased technology and licensing agreements 4,963 5,043 Restricted funds and security deposits 117,426 102,962 Miscellaneous other assets 36,425 45,097 ----------- ----------- 212,034 188,791 Less accumulated amortization 20,290 25,643 ----------- ----------- $ 191,744 $ 163,148 ----------- ----------- ----------- ----------- </TABLE> NOTE 3. ACCRUED EXPENSES Accrued expenses consisted of the following: <TABLE> <CAPTION> MAY 29 NOVEMBER 28 1998 1997 ----------- ----------- <S> <C> <C> Accrued compensation and benefits $ 38,859 $ 37,833 Sales and marketing allowances 13,784 13,028 Other 56,116 51,880 ----------- ----------- $ 108,759 $ 102,741 ----------- ----------- ----------- ----------- </TABLE> NOTE 4. STOCKHOLDERS' EQUITY STOCK REPURCHASE PROGRAMS In September 1997, the Company's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to an additional 15.0 million shares of the Company's common stock over a two-year period. During the fourth quarter of fiscal 1997 and the first quarter of fiscal 1998, the Company repurchased approximately 4.7 and 3.0 million shares of its common stock, respectively. No stock repurchases were made during the second quarter of fiscal 1998. PUT WARRANTS AND CALL OPTIONS To facilitate the Company's stock repurchase programs, the Company sold put warrants to independent third parties. Each warrant entitles the holder to sell one share of Adobe's common stock to the Company at a specified price. On May 29, 1998, put warrants to sell approximately 3.2 million shares of the Company's common stock were outstanding that expire on various dates through November 1998 with an average exercise price of $39.26 per share. Under these put warrant arrangements, the Company, at its option, can settle with physical delivery or net 9
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA) (CONTINUED) NOTE 4. STOCKHOLDERS' EQUITY (CONTINUED) shares equal to the difference between the exercise price and market value at the date of exercise; therefore the put warrants do not result in a liability on the balance sheet. In addition, the Company purchased call options from independent third parties that entitle the Company to buy its common stock on certain dates at specified prices. On May 29, 1998, call options to purchase approximately 1.0 million shares of the Company's common stock were outstanding that expire on various dates through November 1998 with an average exercise price of $40.49 per share. 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION (PRESENTED IN MILLIONS, EXCEPT SHARE AND PER SHARE AMOUNTS) SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO. IN ADDITION TO HISTORICAL INFORMATION, THIS QUARTERLY REPORT ON FORM 10-Q 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 ADDITIONAL QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 1998. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS QUARTERLY REPORT ON FORM 10-Q. 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 both print and electronic media. The Company offers a market-leading line of application software and type products for creating and distributing visually rich communication materials; licenses its industry-standard technologies to major hardware manufacturers, software developers, and service providers; and offers integrated software solutions to businesses of all sizes. The Company distributes its products through a network of original equipment manufacturer ("OEM") customers, distributors and dealers, value-added resellers ("VARs"), and system integrators and has operations in North America, Europe, Japan, and Asia, Pacific and Latin America. 11
The following table sets forth for the three and six month periods ended May 29, 1998 and May 30, 1997, the Company's condensed consolidated statements of income expressed as a percentage of total revenue: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ------------------------ ------------------------ MAY 29 MAY 30 MAY 29 MAY 30 1998 1997 1998 1997 --------- --------- --------- --------- <S> <C> <C> <C> <C> Revenue: Licensing 18.7% 23.3% 19.8% 23.0% Application products 81.3 76.7 80.2 77.0 --------- --------- --------- --------- Total revenue 100.0 100.0 100.0 100.0 Direct costs 12.0 14.3 13.5 14.7 --------- --------- --------- --------- Gross margin 88.0 85.7 86.5 85.3 --------- --------- --------- --------- Operating expenses: Research and development 23.5 18.1 23.5 17.5 Sales and marketing 38.2 32.9 37.3 32.4 General and administrative 9.2 9.2 10.6 8.5 Acquired in-process technology 0.5 1.4 1.2 0.7 Other non-recurring items 0.2 -- 0.1 (0.6) --------- --------- --------- --------- Total operating expenses 71.6 61.6 72.7 58.5 --------- --------- --------- --------- Operating income 16.4 24.1 13.8 26.8 Nonoperating income, net: Investment gain (loss) (0.1) -- 2.9 (0.1) Interest and other income 3.3 3.6 3.8 3.3 --------- --------- --------- --------- Total nonoperating income, net 3.2 3.6 6.7 3.2 --------- --------- --------- --------- Income before income taxes 19.6 27.7 20.5 30.0 Provision for income taxes 7.3 10.1 7.6 11.0 --------- --------- --------- --------- Net income 12.3% 17.6% 12.9% 19.0% --------- --------- --------- --------- --------- --------- --------- --------- </TABLE> 12
REVENUE <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE --------- --------- --------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Total revenue $227.3 $228.3 (0.4)% Six months ended: Total revenue $425.1 $454.7 (6.5)% </TABLE> For the second quarter and first six months of 1998, revenue decreased from the same periods last year due primarily to weakness in the Japanese economy and a decline in licensing revenue. A decrease in product unit volume (as opposed to price) was the principal factor in the Company's revenue decline. LICENSING REVENUE: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE --------- --------- --------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Licensing revenue $42.4 $53.3 (20.3)% Percentage of total revenue 18.7% 23.3% Six months ended: Licensing revenue $84.3 $104.7 (19.5)% Percentage of total revenue 19.8% 23.0% </TABLE> Licensing revenue is derived from shipments by OEM customers of products containing Adobe PostScript and Adobe PrintGear technology. Adobe PostScript is a software language for describing to a printer the appearance of a page, including text, graphics, and images. Products that contain PostScript technology include: (1) black-and-white printers; (2) color printers; (3) slide recorders; (4) imagesetters; (5) screen displays; and (6) digital copiers. Adobe PostScript technology includes Adobe PostScript, Adobe PostScript Level 2, and Adobe PostScript 3, all of which serve the enterprise, graphic arts, and production printing markets, and Adobe PostScript Extreme, a solution for high-volume production printing. Adobe PrintGear is an architecture for printers targeted at the small office/home office market. Licensing revenue decreased $10.9 million or 20.3% in the second quarter of 1998 compared to the same period last year and $20.4 million or 19.5% in the first six months of 1998 compared to the same period last year primarily due to three factors: (1) weakness in the Japanese personal computer and printer markets, (2) weakness in the color copier business due to product transitions, and (3) a reduction in royalty revenue from Hewlett-Packard Company's ("HP") desktop monochrome laser printer division which is now incorporating a non-Adobe clone version of Adobe PostScript into its products. The Company continues to be cautious about licensing revenue in the short term because of Japanese market conditions and because of uncertain timing of OEM customer introductions of products incorporating Adobe's latest technologies. Based on a strategic review of the Company's printing systems division, the Company is now refocusing its resources on high 13
growth revenue opportunities in digital color, color inkjet, short-run on-demand digital printing, and digital copiers. This strategic refocusing is intended to increase licensing revenue growth in the long term, although the Company anticipates that its licensing revenue in the remainder of fiscal 1998 will be below fiscal 1997 levels. <TABLE> <CAPTION> APPLICATIONS PRODUCTS REVENUE: MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Application products revenue $184.9 $175.0 5.6% Percentage of total revenue 81.3% 76.7% Six months ended: Application products revenue $340.8 $350.0 (2.6)% Percentage of total revenue 80.2% 77.0% </TABLE> Application products revenue is derived predominantly from shipments of application software programs marketed through distribution channels, with the exception of Adobe FrameMaker and Adobe Acrobat products which are more widely distributed through VARs and systems integrators. Adobe PhotoDeluxe is primarily distributed through OEM bundling agreements with digital camera, scanner, and personal computer manufacturers. Application products revenue increased $9.9 million or 5.6% in the second quarter of 1998 compared to the same period last year primarily due to the release of three new products, Photoshop 5.0, which began shipping in English, French and German just prior to quarter end, Premiere 5.0, and PhotoDeluxe Business Edition. Also, revenue from Acrobat 3.0 increased compared to the same quarter last year due to more widespread acceptance of the portable document format. The increased revenue generated by these newly released products and Acrobat 3.0 in 1998 was partially offset by a decline in Japanese revenues due to poor economic conditions, a decline in Macintosh platform revenues and a decline in Illustrator 7.0 revenues in anticipation of the release of a new version later in fiscal 1998. For the first six months of 1998, application products revenue decreased $9.2 million or 2.6% compared to the same period last year due mainly to the absence of recent major product releases or upgrades until late in the second quarter of 1998, weakness in the Japanese economy, and a continuing decline in applications product revenue for the Macintosh platform. By comparison, the first half of 1997 benefited from several product releases as well as continuing strength of a major product release in the last quarter of fiscal 1996. 14
DIRECT COSTS <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Direct costs $27.3 $32.7 (16.4)% Percentage of total revenue 12.0% 14.3% Six months ended: Direct costs $57.3 $66.9 (14.4)% Percentage of total revenue 13.5% 14.7% </TABLE> Direct costs include product, packaging, and shipping costs, as well as royalties and amortization of localization costs and acquired technologies. Direct costs were lower in the second quarter and first six months of 1998 compared with the same periods last year due to lower royalty payments and less product inventory subject to obsolescence. 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 and the mix of full and upgrade products sold. OPERATING EXPENSES RESEARCH AND DEVELOPMENT: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Research and development $53.3 $41.3 29.2% Percentage of total revenue 23.5% 18.1% Six months ended: Research and development $99.7 $79.5 25.5% Percentage of total revenue 23.5% 17.5% </TABLE> 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 the second quarter and first six months of 1998 compared with the same periods last year due to increased investment 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. The Company continues to make significant investments in development of its software products, including those targeted for the growing Internet market. 15
The Company believes that continued investments in research and development are necessary to remain competitive in the marketplace, and are directly related to continued, timely development of new and enhanced products. Accordingly, the Company intends to continue recruiting and hiring software developers. Research and development expenses are expected to increase in absolute dollars, however at a slower rate than revenue growth. SALES AND MARKETING: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Sales and marketing $86.8 $75.2 15.5% Percentage of total revenue 38.2% 32.9% Six months ended: Sales and marketing $158.7 $147.2 7.8% Percentage of total revenue 37.3% 32.4% </TABLE> Sales and marketing expenses include salaries and benefits, sales commissions, travel expenses, and related facility 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 in the second quarter and first six months of 1998 compared with the same periods last year due to increased advertising and promotional expenditures in connection with the commencement of the Company's new product release cycle and brand advertising campaign as well as increased sales and marketing staff to support a growing base of customers. Sales and marketing expenses are expected to increase in absolute dollars for the remainder of 1998, however at a slower rate than revenue growth. GENERAL AND ADMINISTRATIVE: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> General and administrative $20.9 $21.1 (1.0)% Percentage of total revenue 9.2% 9.2% Six months ended: General and administrative $45.0 $38.6 16.5% Percentage of total revenue 10.6% 8.5% </TABLE> 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. 16
General and administrative expenses decreased in absolute dollars for the second quarter of 1998 compared with the same period last year primarily due to the reversal of an incentive bonus program accrual in the second quarter of 1998 that was based on various revenue and operating margin targets that have not been attained as of May 29, 1998. The decrease was partially offset by increased employee costs and depreciation and building expenses associated with increased staff and a more comprehensive administrative infrastructure. For the first six months of 1998, general and administrative costs increased in absolute dollars and as a percentage of revenue due to increased employee costs and depreciation and building expenses primarily associated with increased staff and a more comprehensive administrative infrastructure. Additionally, general and administrative expenses in the first six months of 1998 include the write-off of $2.4 million of goodwill associated with an acquisition that took place in 1997. The Company expects general and administrative spending in 1998 to increase in absolute dollars, however at a slower rate than revenue growth. ACQUIRED IN-PROCESS TECHNOLOGY: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Acquired in-process technology $1.2 $3.2 (62.6)% Percentage of total revenue 0.5% 1.4% Six months ended: Acquired in-process technology $5.0 $3.2 58.3% Percentage of total revenue 1.2% 0.7% </TABLE> For the second quarter and first six months of 1998, acquired in-process technology includes several acquired technologies associated with Adobe products that have yet to reach technological feasibility as defined within SFAS No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," and for which no alternative uses have been established by the Company. During the second quarter of 1997, the Company acquired two software companies and accounted for the transactions using the purchase method. The aggregate purchase price was principally allocated to in-process research and development and, accordingly, $3.2 million was expensed at the time of the acquisitions. OTHER NON-RECURRING ITEMS: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Other non-recurring items $0.6 $-- -- Percentage of total revenue 0.2% -- Six months ended: Other non-recurring items $ 0.6 $(2.4) 124% Percentage of total revenue 0.1% (0.6)% </TABLE> 17
During the second quarter of 1998, the Company recognized a restructuring charge associated with a reduction in force in the Company's Printing Systems Division as part of a strategic initiative to refocus resources on high-growth opportunities in the printing and digital copier markets. The non-recurring item which occurred during the first quarter of 1997 represents proceeds on the divestiture of a product line. NONOPERATING INCOME, NET INVESTMENT GAIN (LOSS): <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Investment gain (loss) $(0.2) $-- -- Percentage of total revenue (0.1)% -- Six months ended: Investment gain (loss) $12.3 $(0.6) 2180.3% Percentage of total revenue 2.9% (0.1)% </TABLE> Investment gain (loss) consists principally of realized gains or losses from direct investments as well as mark-to-market valuation adjustments for Adobe Ventures L.P. investments. During the first quarter of 1998, McQueen International Limited ("McQueen"), a former investee of the Company, was acquired by Sykes Enterprises, Incorporated ("Sykes"), a publicly traded company. In connection with the acquisition, the Company exchanged its shares of McQueen for approximately 487,000 shares of Sykes' restricted common stock and recorded a gain on the exchange of $6.7 million. Also, during the first quarter of 1998, the Company liquidated its investment in Siebel Systems, Incorporated ("Siebel") through the distribution to its stockholders of approximately 165,000 shares of Siebel 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. INTEREST AND OTHER INCOME: <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Interest and other income $7.6 $8.3 (8.1)% Percentage of total revenue 3.3% 3.6% Six months ended: Interest and other income $16.1 $15.3 5.5% Percentage of total revenue 3.8% 3.3% </TABLE> 18
Interest and other income consists principally of interest earned on cash, cash equivalents, and short-term investments. The decrease in interest and other income in the second quarter of 1998 compared with the same quarter last year is due to lower average cash balances in 1998. The increase in interest and other income in the first six months of 1998 compared to the same period last year is due primarily to foreign exchange gains in Europe offset by a decline in interest income as a result of lower average cash balances. PROVISION FOR INCOME TAXES <TABLE> <CAPTION> MAY 29 MAY 30 1998 1997 CHANGE ---------- ---------- ---------- Three months ended: (Dollars in millions) <S> <C> <C> <C> Provision for income taxes $16.7 $23.1 (27.9)% Percentage of total revenue 7.3% 10.1% Effective tax rate 37.3% 36.5% Six months ended: Provision for income taxes $32.6 $49.8 (34.6)% Percentage of total revenue 7.6% 11.0% Effective tax rate 37.3% 36.5% </TABLE> The Company's effective tax rate increased in the second quarter and first six months of 1998 primarily due to the nondeductible write-off of goodwill relating to an acquisition which took place in 1997, a decrease in research and experimentation tax credits (the federal credit expired on June 30, 1998), and lower tax-exempt interest income. The Company expects that the effective tax rate for the remainder of fiscal 1998 will be between 37% and 38% due to lower tax-exempt interest income as a result of cash requirements for the Company's stock repurchase programs and the expiration of the federal research and experimentation tax credit on June 30, 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, 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 color copier business due to product transitions, industry transitions to new business and information delivery models, ongoing weakness in the Japanese and other Asian economies, and adverse changes in general economic conditions in any of the countries in which the Company does business. The Company's ability to develop and market products, including upgrades of current products that successfully adapt to changing customer needs, may also have an impact on the results of operations. The Company's ability to extend its core technologies into new applications and to anticipate or respond to technological changes could affect its ability to 19
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 1997 has been for the Macintosh platform, particularly for the higher end Macintosh computers. In 1997, Windows-based application revenue exceeded that from the Macintosh platform for the first time, 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. 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. In addition, to the extent that there is a slowdown of customer purchases of personal computers in general, the Company's operating results could be materially adversely affected. The Company's OEM customers on occasion seek to renegotiate their royalty arrangements. The Company evaluates these requests on a case-by-case basis. If an agreement is not reached, a customer may decide to pursue other options, which could result in lower licensing revenue for the Company. In the fall of 1997, HP began to ship non-Adobe clone software in some printers, resulting in lower licensing revenue to the Company in fiscal 1998. The Company expects additional impact on its remaining 1998 licensing revenue, although it continues to work with HP printer operations to incorporate Adobe PostScript and other technologies in other HP products. During late 1997 and the first half of 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 application products at the Company's Japanese distributors remained higher than what the Company considers normal. During the first half of 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 economies, the countries 20
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 experienced, and expects to continue to experience, significant growth. 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. 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. While most of the revenue of the European subsidiaries is denominated in U.S. dollars, the majority of revenue derived from Japan is denominated in yen and the majority of all subsidiaries' operating expenses are denominated in their local currencies. As a result, the Company's operating results are subject to fluctuations in foreign currency exchange rates. To date, the accounting impact of such fluctuations has been insignificant. The Company's hedging policy attempts to mitigate some of these risks, based on management's best judgment of the appropriate trade-offs among risk, opportunity, and expense. The Company has established a hedging program to hedge its exposure to foreign currency exchange rate fluctuations, primarily of the Japanese yen. The Company's hedging program is not comprehensive, and there can be no assurance that the program will offset more than a portion of the adverse financial impact resulting from unfavorable movement in foreign currency exchange rates. Due to the factors noted above, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Any shortfall in revenue or earnings from levels expected by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's common stock in any given period. Additionally, the Company may not learn of such shortfalls until late in the fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's common stock. Finally, the Company participates in a highly dynamic industry. In addition to factors specific to the Company, changes in analysts' earnings estimates for the Company or its industry and factors affecting the corporate environment, the Company's industry or the securities markets in general will often result in significant volatility of the Company's common stock price. 21
RECENT ACCOUNTING PRONOUNCEMENTS In October 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 establishes standards relating to the recognition of all aspects of software revenue. Based on the Company's initial assessment of the impact SOP 97-2 may have on its consolidated results of operations, the Company intends to modify certain aspects of its business model such that any impact will not be significant. The Company intends to adopt SOP 97-2 for its fiscal year 1999. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in the financial statements. It does not, however, require a specific format for the disclosure, but requires the Company to display an amount representing total comprehensive income for the periods presented in its financial statements. The Company will be required to implement SFAS No. 130 for its fiscal year 1999. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. The Company is currently evaluating the operating segment information to determine whether this will have an impact on its financial statement reporting. The Company will be required to implement SFAS No. 131 for its fiscal year 1999. "YEAR 2000" ISSUES The Company is aware of and 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 own computer systems and from third parties with whom the Company deals on financial and other transactions worldwide. Failures of the Company's and/or third parties' computer systems could have a material impact on the Company's ability to conduct its business. The Company's financial information systems include an SAP system recently implemented in the United States, Japan and Asia, Pacific and Latin America, and an Oracle system in Europe that will be upgraded to the most recent version later in fiscal 1998. These systems are believed to be "Year 2000" compliant. The Company is analyzing its remaining computer systems to identify any potential "Year 2000" issues and will take appropriate corrective action based on the results of such analysis. Management has not yet determined the cost related to achieving "Year 2000" compliance. In addition, the "Year 2000" issue could affect the products that the Company sells. The Company believes that the current versions of its products are "Year 2000" compliant. The Company's products are subject to ongoing analysis and review. 22
LIQUIDITY AND CAPITAL RESOURCES <TABLE> <CAPTION> MAY 29 NOVEMBER 28 1998 1997 CHANGE ---------- ----------- ---------- (Dollars in millions) <S> <C> <C> <C> Cash, cash equivalents and short-term investments $392.6 $503.0 (21.9)% Working capital $375.3 $454.3 (17.4)% Stockholders' equity $684.2 $715.4 (4.4)% </TABLE> The Company's cash, cash equivalents and short-term investments, consisting principally of municipal bonds, auction rate certificate securities, United States government and government agency securities, and asset-backed securities, decreased $110.4 million or 21.9% during the first six months of 1998. All of the Company's cash equivalents and short-term investments are classified as available-for-sale under the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." 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 the first six months of 1998 included cash generated from operations of $63.7 million and proceeds from the issuance of common stock primarily related to the exercise of stock options of $37.7 million. Major uses of cash during the period included $122.9 million to repurchase Adobe common stock, net purchases of short-term investments of $43.3 million, additions to other assets of $40.5 million, capital expenditures totaling $36.5 million for property and equipment, and the payment of dividends of $9.6 million. In September 1997, the Company's Board of Directors authorized, subject to certain business and market conditions, the purchase of up to an additional 15.0 million shares of the Company's common stock over a two-year period. During the fourth quarter of fiscal 1997 and the first quarter of fiscal 1998, the Company repurchased approximately 4.7 and 3.0 million shares of its common stock, respectively. These stock repurchase programs are intended to enhance stockholder value by reducing the number of outstanding shares net of offsetting increases due to employee stock purchases and stock option exercises. The timing and size of any future stock repurchases are subject to market conditions, stock prices and Adobe's cash position and other cash requirements going forward. To facilitate the Company's stock repurchase programs, the Company sold put warrants to independent third parties. Each warrant entitles the holder to sell one share of Adobe's common stock to the Company at a specified price. On May 29, 1998, put warrants to sell approximately 3.2 million shares of the Company's common stock were outstanding that expire on various dates through November 1998 with an average exercise price of $39.26 per share. Under these put warrant arrangements, the Company, at its option, can settle with physical delivery or net shares equal to the difference between the exercise price and market value at the date of exercise; therefore the put warrants do not result in a liability on the balance sheet. In addition, the Company purchased call options from independent third parties that entitle the Company to buy its common stock on certain dates at specified prices. On May 29, 1998, call 23
options to purchase approximately 1.0 million shares of the Company's common stock were outstanding that expire on various dates through November 1998 with an average exercise price of $40.49 per share. The Board of Directors of the Company declared two cash dividends on the Company's common stock of $.05 per common share, one for each of the first and second quarters of 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 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. Expenditures for property and equipment are expected to continue as staff increases and as the Company continues the construction of facilities both in the United States as well as in Europe. Furthermore, additional cash may be used to acquire software products or technologies complementary to the Company's business. The Company's principal commitments as of May 29, 1998 consisted of obligations under operating leases, venture investing activities, real estate development agreements, and various service agreements. These arrangements are discussed in more detail in the Company's Annual Report on Form 10-K for the year ended November 28, 1997. 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, including planned capital expenditure programs, working capital requirements, the potential put warrant obligation and the dividend program. 24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures set forth in Item 7a of its Annual Report on Form 10-K for the year ended November 28, 1997 have not changed significantly. 25
PART II -- OTHER INFORMATION ITEM 1. 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 for review of the trial court's decision. Quantel Limited, a U.K. corporation, filed and served on the Company in January 1996 a complaint alleging that the Adobe Photoshop program infringed five U.S. patents held by Quantel. The complaint was filed in the United States District Court for the District of Delaware. In September 1997, a jury in federal court in Delaware found in favor of Adobe, finding that Adobe Photoshop did not infringe the five patents held by Quantel Limited, and that the five patents are invalid. In June 1998, Quantel filed a notice of appeal of the trial court's decision. The Company intends to vigorously defend any appeal. Management believes that the ultimate resolution of this matter and other matters discussed in the Company's Annual Report on Form 10-K for the year ended November 28, 1997 will not have a material impact on the Company's financial position or results of operations. 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders was held on April 8, 1998. A proposal to elect three (3) Class I directors of the Company to serve for a two-year term expiring at the Annual Meeting of Stockholders in 2000 was approved by the stockholders. The nominees received the following votes: <TABLE> <CAPTION> For Withheld ---------- -------- <S> <C> <C> Charles M. Geschke 59,208,723 785,193 William R. Hambrecht 59,298,821 695,095 Delbert W. Yocum 59,280,806 713,110 </TABLE> In June 1998, the total number of directors was increased to eight and Carol Mills was elected as a Class I director with a term expiring at the Annual Meeting of Stockholders in 2000. Incumbent Class II directors John E. Warnock, Gene P. Carter, Robert Sedgewick and William J. Spencer are currently serving for a term expiring at the Annual Meeting of Stockholders in 1999. Introduced was a proposal to approve the Company's Amended 1994 Performance and Restricted Stock Plan (the "Performance Plan"), including an increase of 500,000 in the number of shares reserved for issuance under the Performance Plan and increases in the per-participant annual limits from 50,000 shares to 200,000 shares and from $2,500,000 to $10,000,000. This proposal received the following votes: <TABLE> <CAPTION> <S> <C> For: 31,470,000 Against: 28,280,885 Withheld: 243,031 </TABLE> In addition, stockholders ratified the appointment of KPMG Peat Marwick LLP as independent public accountants of the Company for the fiscal year ending November 27, 1998. This proposal received the following votes: <TABLE> <CAPTION> <S> <C> For: 59,433,105 Against: 59,064 Withheld: 501,747 </TABLE> Abstentions and broker non-votes were each included in the determination of the number of shares represented at the meeting for purposes of determining the presence of a quorum at the Company's Annual Meeting of Stockholders. Each was tabulated separately. Abstentions and broker non-votes were not counted for purposes of determining the number of votes cast for a proposal. 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Index to Exhibits <TABLE> <CAPTION> INCORPORATED BY REFERENCE EXHIBIT ------------------------------------- FILED NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH ---------- ------------------------------ ------- --------- -------- ---------- <C> <S> <C> <C> <C> <C> 3.1 The Registrant's (as suc- 10-Q 05/30/97 3.1 cessor in-interest to Adobe Systems (Delaware) Incorporated by virtue of a reincorporation effective 5/30/97) Certif- icate of Incorporation, as filed with the Secretary of State of the State of Delaware on 5/9/97. 3.2.10 Amended and Restated 10-K 11/28/97 3.2.10 Bylaws as currently in effect. 3.3 Certificate of Designation 10-K 11/28/97 3.3 of the Series A Preferred Stock 3.4 Agreement and Plan of 10-Q 05/30/97 2.1 Merger effective 5/30/97 (by virtue of a reincorp- oration), by and between Adobe Systems Incorpor- ated, a California corp- oration and Adobe Systems (Delaware) Incorporated, a Delaware corporation. 4.1 Second Amended and 8-K 08/29/97 4 Restated Rights Agreement between the Company and Harris Trust Company of California 10.1.6 1984 Stock Option Plan, 10-Q 07/02/93 10.1.6 as amended* 10.21.3 Revised Bonus Plan* 10-Q 02/28/97 10.21.3 10.24.1 Amended 1994 Performance X and Restricted Stock Plan* 10.25.0 Form of Indemnity 10-K 11/30/90 10.17.2 Agreement* 10.25.1 Form of Indemnity 10-Q 05/30/97 10.25.1 Agreement* </TABLE> (Continued) 28
<TABLE> <CAPTION> INCORPORATED BY REFERENCE EXHIBIT ---------------------------------- FILED NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH ------------- ------------------------------- ------ -------- -------- -------- <C> <S> <C> <C> <C> <C> 10.32 Sublease of the Land and 10-K 11/25/94 10.32 Lease of the Improvements By and Between Sumitomo Bank Leasing and Finance Inc. and Adobe Systems Incorporated (Phase 1) 10.36 1996 Outside Directors 10-Q 05/31/96 10.36 Stock Option Plan* 10.37 Confidential Resignation 10-Q 05/31/96 10.37 Agreement* 10.38 Sublease of the Land and 10-Q 08/30/96 10.38 Lease of the Improvements By and Between Sumitomo Bank Leasing and Finance Inc. and Adobe Systems Incorporated (Phase 2) 10.39 1997 Employee Stock S-8 05/30/97 10.39 Purchase Plan, as amended* 10.40 1994 Stock Option S-8 05/30/97 10.40 Plan, as amended* 10.42 Amended and Restated 10-K 11/28/97 10.42 Limited Partnership Agreement of Adobe Incentive Partners, L.P.* 10.43 Resignation Agreement* 10-K 11/28/97 10.43 10.44 Forms of Retention 10-K 11/28/97 10.44 Agreement* 21 Subsidiaries of the 10-K 11/28/97 21 Registrant 27.1 Financial Data Schedule X 27.2 Financial Data Schedule X </TABLE> --------------------------------------- *Compensatory plan or arrangement (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended May 29, 1998. 29
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ADOBE SYSTEMS INCORPORATED By /s/ P. Jackson Bell ------------------------------ P. Jackson Bell, Executive Vice President, Chief Financial Officer, Chief Administrative Officer, and Assistant Secretary (Principal Financial Officer) By /s/ Harold L. Covert ------------------------------ Harold L. Covert Vice President, Finance and Operations (Principal Accounting Officer) Date: July 9, 1998 30
SUMMARY OF TRADEMARKS The following trademarks of Adobe Systems Incorporated, which may be registered in certain jurisdictions, are referenced in this Form 10-Q: Adobe Acrobat FrameMaker Illustrator PhotoDeluxe Photoshop PostScript Premiere PrintGear All other brand or product names are trademarks or registered trademarks of their respective holders. 31