Adobe’s Pride in its Headquarters Fails To Make the Balance Sheet

| About: Adobe Systems (ADBE)

Design software maker Adobe Systems (NASDAQ:ADBE) is rightly proud of its headquarters building, which it lauded last December in a press release:

Adobe Systems Incorporated today announced the U.S. Green Building Council [USGBC] has awarded Leadership in Energy and Environmental Design-Existing Building [LEED®] Platinum certifications for Adobe’s East and Almaden headquarters towers in downtown San Jose, distinguishing Adobe as the world’s first commercial enterprise to achieve a total of three Platinum certifications under the LEED program.

However, the pride in its building is more muted when it comes to showing the property and its associated debt on the balance sheet, as disclosed in a recent SEC filing:

On March 26, 2007, Adobe Systems Incorporated (the “Company”) renewed its lease arrangement for one of three buildings the Company occupies as part of its corporate headquarters, known as the Almaden Tower, located in San Jose, California (the “Property”).

Pursuant to a lease agreement (the “Lease”), dated March 26, 2007, between the Company as Lessee and SELCO Service Corporation as Lessor, the Company has leased the Property for a new five year term that extends to March 26, 2012, with an option to extend for an additional five years at the Company’s sole discretion. Rent payments under the Lease are a function of LIBOR; payments for the initial term are currently estimated to be $29.7 million. The Company has the option to purchase the Property at any time during the term of the Lease for approximately $103.6 million. The maximum recourse amount (or residual value guarantee) under this obligation is approximately $89.5 million. The Lease will continue to qualify for operating lease treatment under Statement of Financial Accounting Standards No. 13, “Accounting for Leases,” and as such, the Property and related obligations will not be included on the Company’s consolidated balance sheet.

With a value of $104 million and annual lease payments of approximately $6 million, the payments do not appear all that different from those the company would pay in a mortgage. It’s not like Adobe needs creative financing arrangements, either. With $2.2 billion in cash and short-term investments as of December, they could buy 20 such buildings without taking out a mortgage against any of them. We’re actually more concerned that management is spending time drafting arrangements like this than we are about the arrangement itself. But that’s not the least of it:

As part of the financing of the Lease, the Company purchased a portion of the Lessor’s receivable under the Lease for approximately $80.4 million, which will be recorded as an investment in lease receivable on the Company’s consolidated balance sheet for the quarter ended June 1, 2007. This purchase may be credited against the purchase price if the Company purchases the Property, or may be repaid from the sale proceeds if the Property is sold to a third party.

So rather than carrying the property on the balance sheet and taking a charge for depreciation and interest expense, the company keeps it off the balance sheet and pays rent. With the investment in the lease receivable, it makes us wonder why they even bothered.