| ADOBE SYSTEMS INC Item 1A Risk Factors 30 ITEM 1A RISK FACTORS As previously discussed, our actual results could differ materially from our forward looking statements |
| Factors that might cause or contribute to such differences include, but are not limited to, those discussed below |
| These and many other factors described in this report could adversely affect our operations, performance and financial condition |
| Adverse changes in general economic or political conditions in any of the major countries in which we do business could adversely affect our operating results |
| If the economy worsens in any geographic areas where we do business, it would likely cause our future results to vary materially from our targets |
| A slower economy also may adversely affect our ability to grow |
| Political instability in any of the major countries in which we do business also may adversely affect our business |
| Delays in development or shipment of new products or major new versions of existing products could cause a decline in our revenue |
| As part of our transition to new business models and markets, we are planning the release of new products and new versions of current products |
| Additionally, following our acquisition of Macromedia, we plan to release products that integrate our existing products with products acquired in the Macromedia acquisition |
| Any delays or failures in developing and marketing our products, including upgrades of current products and the integration of Macromedia products into our product line, may have a harmful impact on our results of operations |
| We may have particular difficulty and delays developing products that integrate Adobe and Macromedia products, since our products are highly complex, have been designed independently and were designed without regard to such integration |
| Our inability to extend our core technologies into new applications and new platforms and to anticipate or respond to technological changes could affect continued market acceptance of our products and our ability to develop new products |
| 30 _________________________________________________________________ Delays in product or upgrade introductions could cause a decline in our revenue, earnings or stock price |
| We cannot determine the ultimate effect these delays or the introduction of new products or upgrades will have on our revenue or results of operations |
| Introduction of new products by existing and new competitors could harm our competitive position and results of operations |
| The end markets for our software products are intensely and increasingly competitive, and are significantly affected by product introductions and market activities of industry competitors |
| If these competing products achieve widespread acceptance, our operating results could suffer |
| In addition, consolidation has occurred among some of the competitors in our markets |
| Any further consolidations among our competitors may result in stronger competitors and may therefore harm our results of operations |
| For information regarding our competition and the risks arising out of the competitive environment in which we operate, see the section entitled "e Competition "e contained in Item 1 of this report |
| If we fail to successfully manage transitions to new business models and markets, our results of operations could be negatively impacted |
| We are devoting significant resources to the development of technologies and service offerings where we have a limited operating history, including the enterprise and government markets and the mobile and device markets |
| In the enterprise and government markets, we intend to increase our focus on vertical markets such as education, financial services, manufacturing, and the architecture, engineering and construction markets |
| With our Breeze product line, we intend to increase awareness in targeted horizontal markets such as training and marketing and vertical markets such as manufacturing, financial services and telecommunications |
| These new offerings and markets require a considerable investment of technical, financial and sales resources, and a scaleable organization |
| Many of our competitors may have advantages over us due to their larger presence, larger developer network, deeper experience in the enterprise and government markets and the mobile and device markets, and greater sales and marketing resources |
| In the mobile and device markets, our intent is to license our technology to device makers manufacturers and telecommunications carriers that embed our technology on their platforms, and in the enterprise and government market our intent is to form strategic alliances with leading enterprise and government solutions and service providers to provide additional resources to further enable penetration of such markets |
| If we are unable to successfully enter into strategic alliances with device maker manufacturers, telecommunication carriers and leading enterprise and government solutions and service providers, or if they are not as productive as we anticipate, our market penetration may not proceed as rapidly as we anticipate and our results of operations could be negatively impacted |
| Revenues from our new business segments may be difficult to predict |
| As previously discussed, we are devoting significant resources to the development of product and service offerings where we have a limited operating history |
| This makes it difficult to predict revenues |
| For example, we intend to expand the use of our Mobile and Device Solutions by licensing our products for use in mobile phones, set-top boxes, game devices, personal digital assistants, hand-held computers and other consumer electronic devices; however, we have a limited history of licensing products in these markets and may experience a number of factors that will make our revenue less predictable, including longer than expected sales and implementation cycles, potential deferral of revenue due to multiple-element revenue arrangements and alternate licensing arrangements |
| 31 _________________________________________________________________ If we fail to anticipate and develop new products in response to changes in demand for application software, computers and printers, our business could be harmed |
| Any failure to anticipate changing customer requirements and develop and deploy new products in response to changing market conditions may have a material impact on our results of operations |
| As previously discussed, we plan to release numerous new product offerings and upgrade versions of our current products in connection with our transition to new business models and the acquisition of Macromedia |
| Market acceptance of our new product or version releases will be dependent on our ability to include functionality and usability in such releases that address the requirements of customer demographics with which we have limited prior experience |
| To the extent we incorrectly estimate customer requirements for such products and version releases or if there is a delay in market acceptance of such products and version releases, our business could be harmed |
| We offer our Creative Solutions and Knowledge Worker Solutions application-based products primarily on Windows and Macintosh platforms and on some UNIX platforms |
| We generally offer our server-based products, but not desktop application products, on the Linux platform as well as the Windows and UNIX platforms |
| To the extent that there is a slowdown of customer purchases of personal computers on either the Windows or Macintosh platform or in general, or to the extent that significant demand arises for our products or competitive products on the Linux desktop platform before we choose and are able to offer our products on this platform, our business could be harmed |
| Additionally, to the extent that we have difficulty transitioning product or version releases to new Windows and Macintosh operating systems or to the extent new releases of operating systems or other third party products make it more difficult for our products to perform, our business could be harmed |
| We may incur substantial costs enforcing our intellectual property rights and defending against third-party claims as a result of litigation or other proceedings |
| In connection with the enforcement of our own intellectual property rights or in connection with disputes relating to the validity or alleged infringement of third-party rights, including patent rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation |
| Intellectual property disputes and litigation are typically very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel |
| Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes |
| Adverse decisions in such litigation or disputes could have negative results, including subjecting us to significant liabilities, requiring us to seek licenses from others, preventing us from manufacturing or licensing certain of our products, or causing severe disruptions to our operations or the markets in which we compete, any one of which could seriously harm our business |
| We may not be able to protect our intellectual property rights, including our source code, from third-party infringers, or unauthorized copying, use, disclosure or malicious attack |
| Although we defend our intellectual property rights and combat unlicensed copying and use of software and intellectual property rights through a variety of techniques, preventing unauthorized use or infringement of our rights is inherently difficult |
| We actively pursue software pirates as part of our enforcement of our intellectual property rights, but we nonetheless lose revenue due to illegal use of our software |
| If piracy activities increase, it may further harm our business |
| Additionally, we take significant measures to protect the secrecy of large portions of our source code, the detailed program commands for our software programs |
| If unauthorized disclosure of a significant portion of our source code occurs, we could potentially lose future trade secret protection for that source code |
| The loss of future trade secret protection could make it easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins |
| 32 _________________________________________________________________ We also devote significant resources to maintaining the security of our products from malicious hackers who develop and deploy viruses, worms, and other malicious software programs that attack our products |
| Nevertheless, actual or perceived security vulnerabilities in our products could harm our reputation and lead some customers to seek to return products, to reduce or delay future purchases, to use competitive products or to make claims against us |
| Also, with the introduction of hosted services with some of our product offerings, our customers may use such services to share confidential and sensitive information |
| Additionally, such breaches could lead to interruptions, delays and data loss and protection concerns as well as harm our reputation |
| We may not realize the anticipated benefits of past or future acquisitions, and integration of these acquisitions may disrupt our business and management |
| We have in the past and may in the future acquire additional companies, products or technologies |
| Most recently, we completed the acquisition of Macromedia in December 2005 |
| We may not realize the anticipated benefits of this or any other acquisition and each acquisition has numerous risks |
| These risks include: • difficulty in assimilating the operations and personnel of the acquired company; • difficulty in effectively integrating the acquired technologies or products with our current products and technologies; • difficulty in maintaining controls, procedures and policies during the transition and integration; • disruption of our ongoing business and distraction of our management and employees from other opportunities and challenges due to integration issues; • difficulty integrating the acquired companyapstas accounting, management information, human resources and other administrative systems; • inability to retain key technical and managerial personnel of the acquired business; • inability to retain key customers, distributors, vendors and other business partners of the acquired business; • inability to achieve the financial and strategic goals for the acquired and combined businesses; • incurring acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results; • potential impairment of our relationships with employees, customers, partners, distributors or third-party providers of technology or products; • potential failure of the due diligence processes to identify significant issues with product quality, architecture and development, or legal and financial contingencies, among other things; • incurring significant exit charges if products acquired in business combinations are unsuccessful; • potential inability to assert that internal controls over financial reporting are effective; • potential inability to obtain, or obtain in a timely manner, approvals from governmental authorities, which could delay or prevent such acquisitions; and • potential delay in customer and distributor purchasing decisions due to uncertainty about the direction of our product offerings Mergers and acquisitions of high technology companies are inherently risky, and ultimately, if we do not complete the integration of acquired businesses successfully and in a timely manner, we may not 33 _________________________________________________________________ realize the anticipated benefits of the acquisitions to the extent anticipated, which could adversely affect our business, financial condition or results of operations |
| We rely on distributors to sell our products and any adverse change in our relationship with our distributors could result in a loss of revenue and harm our business |
| We distribute our application products primarily through distributors, resellers, retailers and increasingly systems integrators, ISVs and VARs (collectively referred to as "e distributors "e ) |
| A significant amount of our revenue for application products is from two distributors, Ingram Micro, Inc |
| and Tech Data Corporation |
| In addition, our channel program focuses our efforts on larger distributors, which has resulted in our dependence on a relatively small number of distributors licensing a large amount of our products |
| Our distributors also sell our competitors &apos products, and if they favor our competitors &apos products for any reason, they may fail to market our products as effectively or to devote resources necessary to provide effective sales, which would cause our results to suffer |
| In addition, the financial health of these distributors and our continuing relationships with them are important to our success |
| Some of these distributors may be unable to withstand adverse changes in business conditions |
| Our business could be seriously harmed if the financial condition of some of these distributors substantially weakens |
| Catastrophic events may disrupt our business |
| We are a highly automated business and rely on our network infrastructure and enterprise applications, internal technology systems and our Website for our development, marketing, operational, support and sales activities |
| A disruption or failure of these systems in the event of a major earthquake, fire, telecommunications failure, cyber-attack, terrorist attack, or other catastrophic event could cause system interruptions, delays in our product development and loss of critical data and could prevent us from fulfilling our customers &apos orders |
| Our corporate headquarters, a significant portion of our research and development activities, and certain other critical business operations are located in San Jose, California, which is near major earthquake faults |
| We have developed disaster recovery plans and backup systems to reduce the potentially adverse effect of such events, but a catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could severely affect our ability to conduct normal business operations and, as a result, our future operating results could be adversely affected |
| We rely on turnkey assemblers and any adverse change in our relationship with our turnkey assemblers could result in a loss of revenue and harm our business |
| We currently rely on six turnkey assemblers of our products, with at least two turnkeys located in each major region we serve |
| If any significant turnkey assembler terminates its relationship with us, or if our supply from any significant turnkey assembler is interrupted or terminated for any other reason, we may not have enough time or be able to replace the supply of products replicated by that turnkey assembler to avoid serious harm to our business |
| Our future operating results are difficult to predict and are likely to fluctuate substantially from quarter to quarter and as a result the market price of our common stock may be volatile and our stock price could decline |
| As a result of a variety of factors discussed herein, our quarterly revenues and operating results for a particular period are difficult to predict |
| Our revenues may grow at a slower rate than experienced in previous periods and, in particular periods, may decline |
| Additionally, we periodically provide operating model targets |
| These targets reflect a number of assumptions, including assumptions about product pricing and demand, economic and seasonal trends, manufacturing costs and volumes, the mix of shrink-wrap and licensing revenue, full and upgrade products, distribution channels and geographic markets |
| If one or more 34 _________________________________________________________________ of these assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated or projected |
| Due to the factors noted above, our future earnings and stock price may be subject to volatility, particularly on a quarterly basis |
| Shortfalls in revenue or earnings or delays in the release of products or upgrades compared to analysts &apos or investors &apos expectations have caused and could cause in the future an immediate and significant decline in the trading price of our common stock |
| Additionally, we may not learn of such shortfalls or delays until late in the fiscal quarter, which could result in an even more immediate and greater decline in the trading price of our common stock |
| Finally, we participate in a highly dynamic industry |
| In addition to factors specific to us, changes in analysts &apos earnings estimates for us or our industry, and factors affecting the corporate environment, our industry, or the securities markets in general, have resulted, and may in the future result, in volatility of our common stock price |
| We typically generate over 50prca of our total revenue from sales to customers outside of the Americas |
| Sales to these customers subject us to a number of risks, including (i) foreign currency fluctuations, (ii) changes in government preferences for software procurement, (iii) international economic and political conditions, (iv) unexpected changes in, or impositions of, international legislative or regulatory requirements, (v) inadequate local infrastructure, (vi) delays resulting from difficulty in obtaining export licenses for certain technology, tariffs, quotas and other trade barriers and restrictions, (vii) transportation delays, (viii) the burdens of complying with a variety of foreign laws, including more stringent consumer and data protection laws, and other factors beyond our control, including terrorism, war, natural disasters and diseases |
| If sales to any of our customers outside of the Americas are delayed or cancelled because of any of the above factors, our revenue may be negatively impacted |
| We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure |
| Our operating results are subject to fluctuations in foreign currency exchange rates |
| We attempt to mitigate a portion of these risks through foreign currency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense |
| We have established a hedging program to partially hedge our exposure to foreign currency exchange rate fluctuations, primarily the Japanese yen and the euro |
| We regularly review our hedging program and will make adjustments as necessary based on the judgment factors discussed above |
| Our hedging activities may not offset more than a portion of the adverse financial impact resulting from unfavorable movement in foreign currency exchange rates, which could adversely affect our financial condition or results of operations |
| Changes in, or interpretations of, accounting principles, such as expensing of stock options, could result in unfavorable accounting charges |
| We prepare our consolidated financial statements in conformity with US generally accepted accounting principles |
| These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting principles |
| A change in these principles can have a significant effect on our reported results and may even retroactively affect previously reported transactions |
| Our accounting principles that recently have been or may be affected by changes in the accounting principles are as follows: • software revenue recognition • accounting for share-based payments • accounting for income taxes • accounting for business combinations and related goodwill 35 _________________________________________________________________ In particular, the FASB recently issued SFAS 123R which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our consolidated statements of income |
| The accounting provisions of SFAS 123R are effective for annual periods beginning after June 15, 2005 |
| We are required to adopt SFAS 123R in the first quarter of fiscal year 2006 |
| We believe that the adoption of SFAS 123R will have a significant adverse effect on our reported financial results and may impact the way in which we conduct our business |
| Please refer to the section entitled "e Recent Accounting Pronouncements "e for further information regarding SFAS 123R If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings |
| Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable |
| Goodwill is required to be tested for impairment at least annually |
| Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, future cash flows, and slower growth rates in our industry |
| We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined resulting in an impact on our results of operations |
| Changes in, or interpretations of, tax rules and regulations may adversely affect our effective tax rates |
| Unanticipated changes in our tax rates could affect our future results of operations |
| Our future effective tax rates could be unfavorably affected by changes in tax laws or the interpretation of tax laws, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities In addition, we are subject to the continual examination of our income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities |
| We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes |
| Any adverse outcome from these continual examinations may have an adverse effect on our operating results and financial position |
| If we are unable to recruit and retain key personnel our business may be harmed |
| Much of our future success depends on the continued service and availability of our senior management, including our Chief Executive Officer and other members of our executive team |
| These individuals have acquired specialized knowledge and skills with respect to Adobe |
| The loss of any of these individuals could harm our business |
| Our business is also dependent on our ability to retain, hire and motivate talented, highly skilled personnel |
| Experienced personnel in the information technology industry are in high demand and competition for their talents is intense, especially in the Silicon Valley, where the majority of our employees are located |
| We have relied on our ability to grant equity compensation as one mechanism for recruiting and retaining such highly skilled personnel |
| Recently enacted accounting regulations requiring the expensing of equity compensation may impair our ability to provide these incentives without incurring significant compensation costs |
| If we are unable to continue to successfully attract and retain key personnel, our business may be harmed |
| We may suffer losses from our equity investments which could harm our business |
| We hold equity investments in public companies that have experienced significant declines in market value |
| We also have investments and may continue to make future investments in privately held companies, many of which are considered in the start-up or development stages |
| These investments are inherently 36 _________________________________________________________________ risky, as the market for the technologies or products these companies have under development is typically in the early stages and may never materialize |
| Our investment activities can impact our net income |
| Future price fluctuations in these securities and any significant long-term declines in value of any of our investments could reduce our net income in future periods |