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.
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NUMBER: 33-6885 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: Shares Outstanding Class May 30, 1997 ----- ------------ Common stock, $0.0001 par value 72,881,490 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
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 13 PART II -- OTHER INFORMATION Item 1. Legal Proceedings 29 Item 4. Submission of Matters to a Vote of Security Holders 30 Item 6. Exhibits and Reports on Form 8-K 32 Signature 36 Summary of Trademarks 37 EXHIBITS Exhibit 2.1 Agreement and Plan of Merger Exhibit 3.1 Certificate of Incorporation Exhibit 3.2.10 Bylaws Exhibit 10.25.1 Form of Idemnity Agreement Exhibit 10.41 Amended and Restated Limited Partnership Agreement of Adobe Incentive Partners, L.P. 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 May 30, 1997 and May 31, 1996 and Six Months Ended May 30, 1997 and May 31, 1996 4 - - Condensed Consolidated Balance Sheets May 30, 1997 and November 29, 1996 5 - - Condensed Consolidated Statements of Cash Flows Six Months Ended May 30, 1997 and May 31, 1996 6 - - Notes to Condensed Consolidated Financial Statements 8 3
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> QUARTERS ENDED SIX MONTHS ENDED ------------------------- ------------------------- MAY 30 MAY 31 MAY 30 MAY 31 1997 1996 1997 1996 ---------- ---------- ---------- ----------- <S> <C> <C> <C> <C> Revenue: Licensing $ 53,261 $ 49,287 $ 104,721 $ 96,198 Application products 175,003 155,050 350,002 301,781 ---------- ---------- ---------- ----------- Total revenue 228,264 204,337 454,723 397,979 Direct costs 32,658 36,078 66,947 71,286 ---------- ---------- ---------- ----------- Gross margin 195,606 168,259 387,776 326,693 ---------- ---------- ---------- ----------- Operating expenses: Software development costs: Research and development 41,253 37,664 79,450 74,871 Amortization of capitalized software development costs -- 626 -- 1,252 Sales, marketing and customer support 75,179 65,738 147,217 128,342 General and administrative 21,106 16,429 38,602 32,080 Write-off of acquired in- process research and development 3,157 14,699 3,157 14,699 Other non-recurring items -- -- (2,359) -- ---------- ---------- ---------- ----------- Total operating expenses 140,695 135,156 266,067 251,244 ---------- ---------- ---------- ----------- Operating income 54,911 33,103 121,709 75,449 Nonoperating income, net: Investment gain/(loss) 34 297 (590) 3,029 Interest and other income 8,259 6,387 15,252 15,170 ---------- ---------- ---------- ----------- Total nonoperating income 8,293 6,684 14,662 18,199 ---------- ---------- ---------- ----------- Income before income taxes 63,204 39,787 136,371 93,648 Provision for income taxes 23,098 17,778 49,781 37,976 ---------- ---------- ---------- ----------- Net income $ 40,106 $ 22,009 $ 86,590 $ 55,672 ---------- ---------- ---------- ----------- ---------- ---------- ---------- ----------- Net income per share $ .54 $ .29 $ 1.17 $ . 73 ---------- ---------- ---------- ----------- ---------- ---------- ---------- ----------- Shares used in computing net income per share 74,416 75,638 74,178 76,016 ---------- ---------- ---------- ----------- ---------- ---------- ---------- ----------- </TABLE> SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> <CAPTION> MAY 30 NOVEMBER 29 1997 1996 ----------- ----------- ASSETS <S> <C> <C> Current assets: Cash and cash equivalents $ 185,587 $ 110,745 Short-term investments 461,874 453,371 Receivables, net of allowances of $4,825 and $5,196, respectively 130,984 115,823 Other current assets 49,232 45,875 ----------- ----------- Total current assets 827,677 725,814 Property and equipment 82,917 80,231 Other assets 169,785 195,348 ----------- ----------- $ 1,080,379 $ 1,001,393 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade and other payables $ 61,601 $ 43,056 Accrued expenses 102,296 83,065 Accrued restructuring costs 8,931 10,854 Income taxes payable 40,454 67,210 Deferred revenue 19,964 15,537 ----------- ----------- Total current liabilities 233,246 219,722 ----------- ----------- Deferred income taxes -- 3,809 Put warrants -- 71,348 Stockholders' equity: Preferred stock, $0.0001 par value; 2,000 shares authorized; none issued -- -- Common stock, $0.0001 par value; 200,000 shares authorized; 72,881 and 71,476 shares issued and outstanding, respectively 7 7 Additional paid-in capital 246,882 148,595 Retained earnings 587,310 529,546 Unrealized gains on investments 18,306 33,514 Cumulative translation adjustment (5,372) (5,148) ----------- ----------- Total stockholders' equity 847,133 706,514 ----------- ----------- $ 1,080,379 $ 1,001,393 ----------- ----------- ----------- ----------- </TABLE> SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5
ADOBE SYSTEMS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) SIX MONTHS ENDED ----------------------- MAY 30 MAY 31 1997 1996 ---------- ---------- Cash flows from operating activities: Net income $ 86,590 $ 55,672 Adjustments to reconcile net income to net cash provided by operating activities: Stock compensation expense 3,711 5,502 Depreciation and amortization 21,649 12,865 Deferred income taxes (2,651) (7,722) Provision for losses on accounts receivable 308 (687) Equity in net income of Adobe Ventures 658 -- Write-off of acquired in-process research and development 3,157 14,699 Changes in operating assets and liabilities: Receivables (15,121) 17,117 Other current assets (5,144) 1,242 Trade and other payables 18,739 5,775 Accrued expenses (247) 3,588 Accrued restructuring costs (1,826) (17,191) Income taxes payable (26,832) 12,492 Deferred revenue 4,014 326 ---------- ---------- Net cash provided by operating activities 87,005 103,678 ---------- ---------- Cash flows from investing activities: Purchases of short-term investments (1,748,497) (648,925) Maturities and sales of short-term investments 1,761,554 656,176 Acquisitions of property and equipment (16,610) (16,867) Additions to other assets (22,487) (33,494) Acquisitions, net of cash acquired (2,121) (4,527) ---------- ---------- Net cash used for investing activities (28,161) (47,637) ---------- ---------- (Continued) SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (CONTINUED) SIX MONTHS ENDED ------------------------- MAY 30 MAY 31 1997 1996 ---------- ---------- Cash flows from financing activities: Proceeds from issuance of common stock $ 60,185 $ 13,092 Repurchase of common stock (36,957) (41,971) Payment of dividends (7,249) (7,319) ---------- ---------- Net cash provided (used) by financing activities 15,979 (36,198) ---------- ---------- Effect of foreign currency exchange rates on cash and cash equivalents 19 (620) ---------- ---------- Net increase in cash and cash equivalents 74,842 19,223 Cash and cash equivalents at beginning of period 110,745 58,493 ---------- ---------- ---------- ---------- Cash and cash equivalents at end of period $ 185,587 $ 77,716 ---------- ---------- ---------- ---------- Supplemental disclosures: Cash paid during the period for income taxes $ 56,844 $ 21,278 ---------- ---------- ---------- ---------- Noncash investing and financing activities: Dividends declared but not paid $ 3,660 $ 3,632 ---------- ---------- ---------- ---------- Dividend in-kind declared but not issued $ 21,560 $ -- ---------- ---------- ---------- ---------- Put warrants written $ 43,767 $ 29,483 ---------- ---------- ---------- ---------- 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 May 30, 1997, and the condensed consolidated statements of income and cash flows for the interim periods ended May 30, 1997 and May 31, 1996. 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 November 29, 1996, December 1, 1995 and November 25, 1994, in the Company's 1996 Form 10-K. The results of operations for the interim periods ended May 30, 1997 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. Fully diluted earnings per share for the quarters ended May 30, 1997 and May 31, 1996 were not materially different from primary earnings per share. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.128, "Earnings Per Share." SFAS No.128 establishes a different method of computing net income per share than is currently required under the provisions of Accounting Principles Board Opinion No. 15. Under SFAS No.128, the Company will be required to present both basic net income per share and diluted net income per share. Basic net income per share is expected to be higher than the currently presented net income per share as the effect of dilutive stock options will not be considered in computing basic net income per share. Diluted net income per share is expected to be comparable or slightly lower than the currently presented net income per share. 8
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (CONTINUED) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET INCOME PER SHARE (CONTINUED) The Company plans to adopt SFAS No.128 in its fiscal quarter ending February 27, 1998 and at that time all historical net income per share data presented will be restated to conform to the provisions of SFAS No.128. RECLASSIFICATIONS Certain reclassifications have been made to the November 29, 1996 balances to conform to the presentation at May 30, 1997. NOTE 2. PROPERTY AND EQUIPMENT Property and equipment consisted of the following: MAY 30 NOVEMBER 29 1997 1996 --------- --------- Land $ 782 $ 782 Building 4,478 4,615 Equipment 128,675 121,044 Furniture and Fixtures 20,520 18,126 Leasehold improvements 19,641 13,036 --------- --------- 174,096 157,603 Less accumulated depreciation and amortization 91,179 77,372 --------- --------- $ 82,917 $ 80,231 --------- --------- --------- --------- 9
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (CONTINUED) NOTE 3. OTHER ASSETS Other assets consisted of the following: MAY 30 NOVEMBER 29 1997 1996 ----------- ----------- Equity investments $ 52,254 $ 97,679 Purchased technology and licensing agreements 32,636 32,211 Restricted funds and security deposits 81,775 69,443 Miscellaneous other assets 48,996 35,470 ----------- ----------- 207,066 234,803 Less accumulated amortization 45,876 39,455 ----------- ----------- $ 169,785 $ 195,348 ----------- ----------- ----------- ----------- Included above in other assets, as equity investments, at May 30, 1997, are equity securities and related unrealized gains and losses thereon. Equity investments included an investment in Netscape Communications Corporation ("Netscape") at November 26, 1996. However, during the second quarter of fiscal 1997, the investment in Netscape was reclassified to short-term investments when Adobe announced the dividend of most of the Netscape shares. NOTE 4. ACCRUED EXPENSES Accrued expenses consisted of the following: MAY 30 NOVEMBER 29 1997 1996 ---------- ---------- Accrued compensation and benefits $ 32,340 $ 24,673 Sales and marketing allowances 13,582 13,753 Other 56,374 44,639 ---------- ---------- $ 102,296 $ 83,065 ---------- ---------- ---------- ---------- 10
ADOBE SYSTEMS INCORPORATED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (CONTINUED) NOTE 5. ACCRUED RESTRUCTURING COSTS In 1995 and 1994, the Company acquired Frame Technology Corporation ("Frame") and Aldus Corporation ("Aldus"), respectively, and initiated a plan to combine the operations of the companies. In connection with these acqusitions, in 1995 and 1994 the Company recorded charges of $31.5 million and $72.2 million, respectively, to operating expenses related to merger transaction and restructuring costs. In addition, Frame undertook certain restructuring measures in 1993 due to lower than anticipated revenues. As of May 30, 1997 and November 29, 1996, $8.9 million and $10.9 million, respectively, remained accrued and primarily relates to lease and third-party contract termination payments, resulting from the planned closure of duplicate offices in Europe and the United States. These payments are expected to continue through the contract terms or negotiated early termination date, if applicable. NOTE 6. CAPITAL STOCK RECAPITALIZATION In May 1997, the Company was reincorporated in the State of Delaware. As part of this reincorporation, each outstanding share of the old California Corporation preferred stock and common stock was converted automatically to one share of the new Delaware Corporation $0.0001 par value preferred stock and common stock. This change resulted in a transfer from the common stock account to the additional paid-in capital account totaling $246.9 million in the period ending May 30, 1997. All prior periods presented have been restated to reflect this change. NOTE 7. COMMITMENTS AND CONTINGENCIES REAL ESTATE DEVELOPMENT AGREEMENT During 1994, the Company entered into a real estate development agreement and an operating lease agreement in connection with the construction of an office facility in San Jose, California. In August 1996, the construction was completed and the operating lease commenced. The Company has 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 11
ADOBE SYSTEMS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (CONTINUED) NOTE 7. COMMITMENTS AND CONTINGENCIES (CONTINUED) REAL ESTATE DEVELOPMENT AGREEMENT (CONTINUED) any difference between the net sales proceeds and the lessor's net investment in the facility, in an amount not to exceed that which would preclude classification of the lease as an operating lease, approximately $57.3 million. During the construction period, the Company was required to pledge certain interest bearing financial investments to the lessor as collateral to secure the performance of its obligations under the lease. As of May 30, 1997, the Company's deposits under this agreement totaled approximately $68.2 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 additional office facility. In August 1996, the Company entered into a construction agreement and an operating lease agreement for this facility. The operating lease will commence on completion of construction in 1998. The Company will have the option to purchase the facility at the end of the lease term. In the event the Company chooses not to exercise this option, the Company is obligated to arrange for the sale of the facility to an unrelated party and is required to pay the lessor any difference between the net sales proceeds and the lessor's net investment in the facility, in an amount not to exceed that which would preclude classification of the lease as an operating lease, approximately $64.3 million. The Company also is required, periodically during the construction period, to deposit funds with the lessor as an interest bearing security deposit to secure the performance of its obligations under the lease. During the second quarter of 1997, the Company deposited approximately $5.2 million, and as of May 30, 1997, the Company's deposits under this agreement totaled approximately $13.6 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. 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION (PRESENTED IN MILLIONS, EXCEPT PER SHARE AMOUNTS) SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO. IN ADDITION TO HISTORICAL INFORMATION, THIS 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 QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 1997AND THE 1996 ANNUAL REPORT ON FORM 10-K . 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 create, display, assemble and communicate images and documents in electronic and printed formats. The Company licenses its technology to major computer, printing, and publishing suppliers, and markets application software products and type products for authoring, editing, distributing and printing 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 North America, Europe, Japan, Asia-Pacific and Latin America regions. 13
The following table sets forth for the quarters and six months ended May 30, 1997, and May 31, 1996, the Company's condensed consolidated statements of income expressed as a percentage of total revenue: <TABLE> <CAPTION> QUARTERS ENDED NINE MONTHS ENDED ------------------------- ------------------------- MAY 30 MAY 31 MAY 30 MAY 31 1997 1996 1997 1996 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Revenue: Licensing 23.3% 24.1% 23.0% 24.2% Application products 76.7 75.9 77.0 75.8 ---------- ---------- ---------- ---------- Total revenue 100.0 100.0 100.0 100.0 Direct costs 14.3 17.7 14.7 17.9 ---------- ---------- ---------- ---------- Gross margin 85.7 82.3 85.3 82.1 ---------- ---------- ---------- ---------- Operating expenses: Software development costs: Research and development 18.1 18.4 17.5 18.8 Amortization of capitalized software development costs -- 0.3 -- 0.3 Sales, marketing and customer support 32.9 32.2 32.4 32.2 General and administrative 9.2 8.0 8.5 8.1 Write-off of acquired in- process research and development 1.4 7.2 0.7 3.7 Other non-recurring items -- -- (0.5) -- ---------- ---------- ---------- ---------- Total operating expenses 61.6 66.1 58.5 63.1 ---------- ---------- ---------- ---------- Operating income 24.1 16.2 26.8 19.0 Nonoperating income: Investment gain (loss) -- 0.2 (0.1) 0.7 Interest and other income 3.6 3.1 3.4 3.8 ---------- ---------- ---------- ---------- Total nonoperating income 3.6 3.3 3.2 4.5 ---------- ---------- ---------- ---------- Income before income taxes 27.7 19.5 30.0 23.5 Provision for income taxes 10.1 8.7 10.9 9.5 ---------- ---------- ---------- ---------- Net income 17.6% 10.8% 19.0% 14.0% ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- </TABLE> 14
REVENUE 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Total revenue $228.3 $204.3 11.7% Six month period: Total revenue $454.7 $398.0 14.3% Revenue increased significantly from last year due to the release of new products. Product unit volume (as opposed to price) increase was the principal factor in the Company's revenue growth. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Product group revenue -- Licensing $53.3 $49.3 8.1% Percentage of total revenue 23.3% 24.1% Six month period: Product group revenue -- Licensing $104.7 $96.2 8.9% Percentage of total revenue 23.0% 24.2% Licensing revenue is derived from shipments by OEM customers of products containing the Adobe PostScript interpreter, Adobe PrintGear software and the Display PostScript system. Such PostScript products include: (1) standard roman printers as well as printers that work with Japanese, Chinese, and Korean languages; (2) imagesetters; and (3) workstations. Licensing revenue is also derived from shipments of products containing the Configurable PostScript Interpreter ("CPSI") by OEM customers. CPSI is a fully functional 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. Adobe PostScript products sell to the small office/home office ("SOHO") market, as well as the corporate enterprise and high-end imagesetter markets. PrintGear software is targeted to the SOHO and home computer market. The number of units shipped by OEMs continued to grow 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. In the second quarters and six month periods of 1997 and 1996, licensing revenue was driven by increased demand for CPSI and by increased demand for color capability, shipments of PrintGear products, as well as greater penetration into the Japanese market. 15
The Company has seen year-to-year increases in the number of OEM customers from which it is receiving licensing revenue and believes that such increases are attributable to the continued acceptance of PostScript software, as well as to the diversification of the Company's customer base across multiple platforms. In 1997, Adobe expects additional customers to introduce new PrintGear products that will serve the SOHO market. Also in 1997, one of Adobe's largest PostScript customers, Hewlett-Packard Company ("HP"), plans to introduce monochrome laser printer products that will not contain Adobe PostScript software. These products are expected to contain a non-Adobe clone version of PostScript and are expected to reach the market in the fall of 1997. While the Company expects overall licensing revenue growth to continue over the longer term, the anticipated loss of such revenue from HP will impact the Company's revenue growth during the short term. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Product group revenue -- Application products $175.0 $155.1 12.9% Percentage of total revenue 76.7% 75.9% Six month period: Product group revenue -- Application products $350.0 $301.8 16.0% Percentage of total revenue 77.0% 75.8% Application products revenue is derived predominantly from shipments of application software programs marketed through retail distribution channels; however, Adobe PageMill, Adobe SiteMill, Adobe FrameMaker, and Adobe Acrobat products are becoming more widely distributed through VARs and systems integrators. Adobe PhotoDeluxe is primarily distributed through OEM bundling agreements with digital camera, scanner, and personal computer manufacturers. During the second quarter and first six months of 1997, application products revenue was significantly higher than that of the same periods in 1996. This increase reflected continued demand for Adobe Photoshop 4.0, Acrobat 3.0, and PhotoDeluxe which were all released in the second half of 1996. In addition, the Company released Adobe Illustrator 7.0 in multiple languages on both the Macintosh and Windows platforms late in the second quarter of 1997. Also during the second quarter of 1997, the Company began shipping new versions of Adobe Type Manager Deluxe 4.0 for Windows NT, Adobe Dimensions 3.0, Adobe Streamline 4.0, and Acrobat Capture 2.0 for Windows. These increases were partially offset by decreased revenue for Adobe PageMaker, FrameMaker, Adobe Premiere, SiteMill and PageMill. In general, the Company's application products on the Windows platform have experienced greater growth than those on the Macintosh platform during the second 16
quarter and first six months of 1997. During the second quarter of 1997, revenue from Windows-based products exceeded that from Macintosh-based products for the first time. Total Macintosh applications revenue decreased 12 percent year over year, all of which was related to new unit sales as opposed to sale of upgrades. DIRECT COSTS 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Direct costs $32.7 $36.1 (9.5)% Percentage of total revenue 14.3% 17.7% Six month period: Direct costs $66.9 $71.3 (6.1)% Percentage of total revenue 14.7% 17.9% Direct costs include royalties; amortization of acquired technologies; and direct product, localization, 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 lower in the second quarter and first six months of 1997 compared with the same periods last year due to the distribution of more application products via CD-ROM media and lower royalty payments on licensing related to products being shipped. Gross margins for application products are expected to vary for the remainder of 1997 depending on the product mix sold during the period. OPERATING EXPENSES 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Software development costs -- Research and development $41.3 $37.7 9.5% Percentage of total revenue 18.1% 18.4% Six month period: Software development costs -- Research and development $79.5 $74.9 6.1% Percentage of total revenue 17.5% 18.8% 17
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 increased in absolute dollars 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. The Company continues to make significant investments in development of all of its software products, including those targeted for the Internet and professional and personal publishing markets. 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 experienced software developers. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Software development costs -- Amortization of capitalized software development costs $ -- $0.6 -- Percentage of total revenue -- 0.3% Six month period: Software development costs -- Amortization of capitalized software development costs $ -- $1.3 -- Percentage of total revenue -- 0.3% 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 products had been capitalized and were being amortized over the lives of the respective products. Full amortization of all Frame products was achieved by the end of 1996. In the second quarter and first six months of 1997, software development expenditures on all products, after reaching technological feasibility, were immaterial and the Company expects this trend to continue in the future. 18
1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Sales, marketing and customer support $75.2 $65.7 14.4% Percentage of total revenue 32.9% 32.2% Six month period: Sales, marketing and customer support $147.2 $128.3 14.7% Percentage of total revenue 32.4% 32.2% Sales, marketing, and customer support expenses generally include salaries and benefits, sales commissions, travel expenses, and related facility costs for the Company's sales, marketing, customer support, and distribution personnel. Sales, marketing, and customer support expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows, and other market development programs. Sales, marketing, and customer support expenses increased in the second quarter and first six months of 1997 compared with the same periods of 1996. The increases are due to increased advertising and promotional expenditures for upgrades of existing products and further development of customer and technical support services to support a growing base of customers. The increase in absolute dollars for the remainder of 1997 will be due to new product releases, increased investment in the Windows market and programs related to furthering worldwide recognition of the Adobe brand. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) General and administrative $21.1 $16.4 28.5% Percentage of total revenue 9.2% 8.0% Six month period: General and administrative $38.6 $32.1 20.3% Percentage of total revenue 8.5% 8.1% 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 19
associated with computer equipment and software used in the administration of the business. General and administrative expenses increased in absolute dollars for the second quarter and first six months of 1997 compared with the same periods last year. The increase resulted primarily from higher information systems costs, legal costs, employee benefits costs, and costs associated with the implementaion of a more comprehensive administrative infrastructure. Because of the investments the Company is making in product development, marketing and sales efforts and in infrastructure development, operating expenses are expected to increase in absolute terms and may increase as a percentage of revenues, depending on the revenue levels achieved in any particular quarter. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Write-off of acquired in- process research and development $3.2 $14.7 (78.5)% Percentage of total revenue 1.4% 7.2% Six month period: Write-off of acquired in- process research and development $3.2 $14.7 (78.5)% Percentage of total revenue 0.7% 3.7% During the second quarter of 1997, the Company acquired two software companies and accounted for the transactions by 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. 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. 20
1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Other non-recurring items $ -- $ -- -- Percentage of total revenue -- -- Six month period: Other non-recurring items $(2.4) $ -- -- Percentage of total revenue (0.5)% -- The non-recurring item which occurred during the first quarter of 1997 represents proceeds on the divestiture of a product line. NONOPERATING INCOME 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Investment gain/(loss) $ -- $0.3 -- Percentage of total revenue -- 0.2% Six month period Investment gain/(loss) $(0.6) $3.0 (119.5)% Percentage of total revenue (0.1)% 0.8% 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. 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Interest and other income $8.3 $6.4 29.3% Percentage of total revenue 3.6% 3.1% Six month period Interest and other income $15.3 $15.2 0.5% Percentage of total revenue 3.4% 3.8% Interest and other income consists principally of interest earned on cash, cash equivalents, and short-term investments. In the second quarter of 1997, interest and other income was higher than the second 21
quarter of 1996 as a result of a significantly higher cash and short term investments base. Interest and other income for the first six months of 1997 was consistent with the same period of 1996 primarily as a result of a gain realized in the first quarter of 1996 on the disposition of a part of the Company's short-term portfolio. PROVISION FOR INCOME TAXES 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Provision for income taxes $23.1 $17.8 29.9% Percentage of total revenue 10.1% 8.7% Effective tax rate 36.5% 44.7% Six month period: Provision for income taxes $49.8 $38.0 31.1% Percentage of total revenue 10.9% 9.5% Effective tax rate 36.5% 40.6% The effective tax rate for the second quarter and first six months of 1997 was lower than the same periods in 1996 as a result of the absence of significant non-deductible one-time charges in 1997. NET INCOME AND NET INCOME PER SHARE 1997 1996 CHANGE ---------- --------- ----------- Second quarter period: (Dollars in millions) Net income $40.1 $22.0 82.2% Percentage of total revenue 17.6% 10.8% Net income per share $0.54 $0.29 86.2% Weighted shares (In thousands) 74,416 75,638 (1.6)% Six month period: Net income $86.6 $55.7 55.5% Percentage of total revenue 19.0% 14.0% Net income per share $1.17 $0.73 60.3% Weighted shares (In thousands) 74,178 76,016 (2.4)% Net income for the second quarter of 1997 increased 82.2 percent from the second quarter of 1996. Earnings per share were $.54, a 86.2 percent increase from the second 22
quarter of 1996. Net income for the six months ended May 30, 1997 increased 55.5 percent from the same period in 1996 and earnings per share increased 60.3 percent for the same period. The increase was caused primarily by higher revenues and improved operating margins. 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; market acceptance of new products and upgrades; renegotiation of royalty arrangements; growth in worldwide personal computer and printer sales and sales price adjustments; consolidation in the OEM printer business; industry transitions to new business and information delivery models; adverse changes in general economic conditions in any of the countries in which the Company does business; the introduction of new competitive products; and the prices of new or existing competitive products. The markets for the Company's products are characterized by rapidly changing technology and customer needs, evolving industry standards and frequent new product introductions. The Company's success will depend upon its ability to develop and market products, including upgrades of currently shipping products, that successfully adapt to changing customer needs. The Company's ability to extend its core technologies into new applications and to anticipate or respond to technological changes could affect its ability to develop these products. A portion of the Company's future revenue will come from these products. Delays in product introductions, including delays in providing localized products for international 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 sales or results of operations. The Company generally offers its application products on Windows, Macintosh and for some products, Unix platforms. In the second quarter of fiscal 1997, Windows-based application revenue exceeded that for the Macintosh platform for the first time. Total Macintosh-based applications revenue decreased 12 percent year over year, all of which occurred in new unit sales. Upgrade revenue on the Macintosh platform increased 34% year over year. If there is a continued or accelerated slowdown of Macintosh applications revenue and if the Company is unable to continue to increase its revenue from Windows customers, the Company's operating results could be materially adversely affected. Also, as the Company broadens its customer base to achieve greater penetration in the corporate business, consumer or personal publishing markets, the Company may need to adapt its application software distribution channels. The Company could experience decreases in average selling prices and some loss of revenues in its distribution channel which could materially adversely affect its operating results. In addition, to the extent that there is a slowdown of customer purchases of personal computers in general, the Company's operating results could be materially adversely affected. The Company's OEM customers on occasion seek to renegotiate their royalty arrangements. The Company evaluates these requests on a case-by-case basis. If an agreement is not reached, a customer may decide to pursue other options, including licensing a PostScript language compatible interpreter from a third party, which could 23
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 fall of 1997, Hewlett-Packard plans not to incorporate Adobe PostScript software in some of its Hewlett-Packard LaserJet printers. The Company estimates the revenue impact of this action will be approximately $6.0 million per quarter. 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 expects to increase its overall licensing revenue in the second half of 1997, but if it is unsuccessful, the loss of the HP revenue from monochrome laser printers would adversely affect its licensing revenue. Prior to 1996, the Company experienced significant revenue and headcount growth. The Company's ability to effectively manage its revenue and headcount growth will require it to continue to plan and manage its operational and financial controls and management information systems, and to attract, retain, motivate and manage employees effectively. The Company is investing significantly in upgrading its management information systems worldwide. The failure of the Company to effectively manage growth could have a material adverse effect on its results of operations. The internet and intranet markets are rapidly evolving and are characterized by an increasing number of market entrants who have introduced or developed products addressing authoring and communication over the internet and intranet. 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. In addition, new models for licensing software to accommodate new information delivery practices will be needed. 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 this market 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, Asia-Pacific and Latin America. 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. 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 24
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. FINANCIAL CONDITION CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS MAY 30 NOVEMBER 29 1997 1996 CHANGE ------ ----------- ------ (Dollars in millions) Cash, cash equivalents and short-term investments $647.5 $564.1 14.8% The Company's cash balances and short term investments have increased due to profitable operations, partially offset by expenditures for the repurchase of stock, capital outlays, other investments, and deposits required under real estate development agreements. Short-term investments also increased due to a $20.7 million reclassification, from other assets, of a significant portion of the Company's investment in Netscape Communications Corporation ("Netscape"). This amount was reclassified because, during the second quarter of fiscal 1997, the Company announced the dividend of a portion of its investment in Netscape under the Company's venture stock dividend program. The Company plans to dividend one share of Netscape common stock on August 27, 1997, for every one hundred shares of Adobe common stock held by stockholders' of record on July 31, 1997. Cash equivalents consist of highly liquid money market instruments. All of the Company's cash equivalents and short-term investments, consisting principally of municipal bonds, auction rate certificate securities, United States government and government agency securities, and asset-backed securities, are classified as available-for-sale under the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and 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. 25
OTHER ASSETS MAY 30 NOVEMBER 29 1997 1996 CHANGE ------ ----------- ------ (Dollars in millions) Other assets $169.8 $195.3 (13.1)% Included above in other assets at May 30, 1997 are purchased technology and licensing agreements, restricted funds and security deposits, equity securities and unrealized gains and losses thereon. The decline in other assets is primarily due to the reclassification of the Netscape common stock to short-term investments. NONCURRENT LIABILITIES AND STOCKHOLDERS' EQUITY MAY 30 NOVEMBER 29 1997 1996 CHANGE ------ ----------- ------ (Dollars in millions) Noncurrent liabilities and stockholders' equity $847.1 $781.7 8.4% At November 29, 1996, deferred income taxes related to unrealized gains and losses on equity investments and obligations for put warrants are included in noncurrent liabilities and stockholders' equity. The Company has no long-term debt. The increase from November 29, 1996 to May 30, 1997 results from net income and the issuances of common stock under the Company's stock option and employee stock purchase plans partially offset by a decrease in the unrealized gain on the equity investment in Netscape and the repurchase of stock. Also, as a result of changes made during the second quarter of 1997 to settlement terms in option contracts, the Company no longer reclassifies the potential obligations for put warrants as a reduction of stockholders' equity. Under its stock repurchase program, the Company repurchased 3,321,500 shares at a cost of $124.5 million in 1996. During the second quarter and first six months of 1997, the Company repurchased 500,000 shares at a cost of $20.8 million and 977,000 shares at a cost of $36.9 million, respectively. The Company intends to continue to directly repurchase common shares and arrange options to purchase common shares to partially offset the effects of the Company's employee stock purchase and stock option plans. The Board of Directors of the Company declared a cash dividend on the Company's common stock of $.05 per common share on June 16, 1997, for the second quarter of 1997. The dividend will be for stockholders of record as of July 7, 1997, and will be paid on July 21, 1997. 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. In addition, on April 24, 1997, the Company announced the first dividend of venture investment stock under the venture stock dividend program. Adobe plans to dividend one share of Netscape 26
common stock on August 27, 1997 for each one hundred shares of Adobe common stock held by stockholders of record on July 31, 1997; an equivalent cash dividend will be paid for holdings of less than twenty-five hundred Adobe shares and for odd lots less than one hundred Adobe shares, based on the Netscape closing price on July 31, 1997. WORKING CAPITAL MAY 30 NOVEMBER 29 1997 1996 CHANGE ------ ----------- ------ (Dollars in millions) Working capital $594.2 $506.1 17.4% Net working capital grew to $594.2 million as of May 30, 1997, compared to $506.1 million as of November 29, 1996. Cash flow provided by operations during the first six months of 1997 was $87.0 million. Expenditures during the first six months of 1997 for property and equipment totaled $16.6 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 six months of 1997 was $16.0 million primarily resulting from the issuance of common stock under employee stock plans partially offset by repurchase of common stock and payment of dividends. The Company's principal commitments as of May 30, 1997 consisted of obligations under operating leases, venture investing activities, real estate development agreements, and various service and lease guarantee agreements with a related party. REAL ESTATE DEVELOPMENT 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 has 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. During the construction period, the Company was required to pledge certain interest bearing intruments to the lessor as collateral to secure the performance of its obligations under the lease. As of May 30, 1997, the Company's deposits under this agreement totaled approximately $68.2 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 additional office facility. In August 1996, the Company entered into a construction agreement and an 27
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 as an interest bearing security deposit to secure the performance of its obligations under the lease. During the second quarter of 1997, the Company deposited approximately $5.2 million, and as of May 30, 1997 the Company's deposits under this agreement totaled approximately $13.6 million. These deposits are included in "Other assets" in the Condensed Consolidated Balance Sheets. SERVICE AND LEASE GUARANTEES The Company holds a 14 percent equity interest in McQueen Holdings Limited ("McQueen"), a U.K. Company, and accounts for the investment at cost. During 1994, the Company entered into various agreements with McQueen, whereby the Company contracted with McQueen to perform product localization and technical support functions and to provide printing, assembly, and warehousing services. 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. 28
PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Quantel Limited, a U.K. corporation, filed and served on the Company in January 1996 a complaint alleging that the Adobe Photoshop program 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. The case is currently in the discovery phase. 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. The case is currently in the discovery phase. On April 17, 1997, a derivative action was filed in the Superior Court of the State of California, County of Santa Clara, against the current members of Adobe's Board of Directors and Paul Brainerd, a former member of the Board. The suit was filed by a shareholder 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 Company has moved for dismissal of the suit on the ground that the shareholder was required to make a demand on the Board to bring this litigation before the shareholder proceeded with his own lawsuit on behalf of Adobe, and he failed to make such a demand. Management believes that the ultimate resolution of these matters will not have a material impact on the Company's financial position or results of operations. 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of shareholders was held on April 9, 1997. A proposal to elect four (4) Class II directors of the Company to serve for a two-year term expiring at the Annual Meeting of Stockholders in 1999 was approved by the shareholders. This proposal received the following votes: For Withheld ---------- --------- John E. Warnock 64,105,752 2,314,499 Gene P. Carter 64,460,643 1,959,608 Robert Sedgewick 64,460,643 1,959,608 William J. Spencer 64,459,783 1,960,468 Incumbent Class I directors Charles M. Geschke, William R. Hambrecht, and Delbert W. Yocam are currently serving for a term expiring at the Annual Meeting of Stockholders in 1998. Introduced was a proposal to approve the reincorporation of the Company in the State of Delaware and related changes to the rights of stockholders. This proposal received the following votes: For: 36,866,839 Against: 15,737,065 Abstain: 952,533 Introduced was a proposal to approve an increase in the Company's share reserve under the 1994 Stock Option Plan by 5,600,000 shares to a total of 29,200,000 shares and a decrease in the option term period to eight years from ten years for all options granted after approval of this proposal. This proposal received the following votes: For: 37,479,997 Against: 15,520,571 Abstain: 555,868 Also, there was a proposal to approve the 1997 Employee Stock Purchase Plan. This proposal received the following votes: For: 44,117,138 Against: 10,533,352 Abstain: 217,905 (Continued) 30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (Continued) In addition, shareholders ratified the appointment of KPMG Peat Marwick LLP as independent public accountants of the Company for fiscal 1997. This proposal received the following votes: For: 66,262,620 Against: 77,150 Abstain: 80,481 Abstentions and broker non-votes were each included in the determination of the number of shares present and voting for purposes of determining the presence of a quorum at the Company's annual meeting of stockholders. Each was tabulated separately. Abstentions were included in tabulations of the votes cast for purposes of determining whether a proposal had been approved. Broker non-votes however, were not counted for purposes of determining the number of votes cast for a proposal. 31
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 ------- ------------------- ---- ---- ------ -------- <S> <C> <C> <C> <C> <C> 2.1 Agreement and Plan of X 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. 3.1 The Registrant's (as successor- X in-interest to Adobe Systems Incorporation by virtue of a reincorporation effective 5/30/97), Certificate of of Incorporation, as filed with the Secretary of State of the State of Delaware on 5/9/97. 3.2.10 The Registrant's, (as X (successor-in-interest to Adobe Systems (Delaware) Incorporated by virtue of a reincorporation) Bylaws as currently in effect. 4.1 Shareholders Rights 10-Q 05/31/96 4.1 Plan, as amended 10.1.6 1984 Stock Option Plan, 10-Q 07/02/93 10.1.6 as amended* 10.1.7 1994 Stock Option Plan* 10-Q 05/27/94 10.1.7 10.1.8 1994 Stock Option Plan, S-8 05/30/97 10.1.8 as amended* 10.12.1 1988 Employee Stock 10-Q 07/06/94 10.12.1 Purchase Plan, as amended* </TABLE> (Continued) 32
3. Index to Exhibits (Continued) <TABLE> <CAPTION> INCORPORATED BY REFERENCE EXHIBIT ----------------------------- FILED NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH ------- ------------------- ---- -------- ------- -------- <S> <C> <C> <C> <C> <C> 10.17.1 License Agreement 10-K 11/30/88 10.17.1 Restatement between the Company and Apple Computer, Inc., dated April 1, 1987 (confidential treatment granted) 10.17.2 Amendment No. 1 to the 10-K 11/30/90 10.17.2 License Agreement Restatement between the Company and Apple Computer, Inc., dated November 27, 1990 (confidential treatment granted) 10.21.3 Revised Bonus Plan* 10-Q 02/28/97 10.21.3 10.24.1 1994 Performance and S-4 07/27/94 10.1 Restricted Stock Plan* 10.25.0 Form of Indemnity 10-K 11/30/90 10.17.2 Agreement* 10.25.1 Form of Indemnity X Agreement* 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) </TABLE> (Continued) 33
3. Index to Exhibits (Continued) <TABLE> <CAPTION> INCORPORATED BY REFERENCE EXHIBIT ----------------------------- FILED NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH ------- ------------------- ---- -------- ------- -------- <S> <C> <C> <C> <C> <C> 10.33 Sale of Rights under 10-Q 06/02/95 10.33 Software Development and Acquisition Agreement By and Between Adobe Systems Incorporated and Thomas Knoll and John Knoll (confidential treatment granted) 10.34 Agreement and Plan of S-4 08/18/95 2.1 Merger and Reorganization By and Among Adobe Systems Incorporated, J Acquisition Corporation and Frame Technology Corporation 10.35 Form of Executive 10-K 12/01/95 10.35 Severance and Change of Control Agreement* 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 Purchase S-8 05/30/97 10.39 Plan 10.40 Amended and Restated X Limited Partnership Agreement of Adobe Incentive Partners, L.P. </TABLE> (Continued) 34
3. Index to Exhibits (Continued) <TABLE> <CAPTION> INCORPORATED BY REFERENCE EXHIBIT ----------------------------- FILED NUMBER EXHIBIT DESCRIPTION FORM DATE NUMBER HEREWITH ------- ------------------- ---- -------- ------- -------- <S> <C> <C> <C> <C> <C> 11 Computation of Net Income X Per Common Share 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 May 30, 1997. </TABLE> 35
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 Date: July 14, 1997 By /s/ P. JACKSON BELL ------------------------------ P. Jackson Bell, Executive Vice President, Chief Financial Officer, Chief Administrative Officer, and Assistant Secretary (Principal Financial Officer) 36
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 Capture Dimensions Illustrator FrameMaker PageMaker PageMill PhotoDeluxe Photoshop PostScript Premiere PrintGear SiteMill Streamline Type Manager All other brand or product names are trademarks or registered trademarks of their respective holders. 37