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Adobe Systems 10-Q 2010

Documents found in this filing:

form_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_________________________

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 5, 2010

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 0-15175

ADOBE SYSTEMS INCORPORATED

(Exact name of registrant as specified in its charter)

_________________________

Delaware

(State or other jurisdiction of

incorporation or organization)

77-0019522

(I.R.S. Employer

Identification No.)

345 Park Avenue, San Jose, California 95110-2704

(Address of principal executive offices and zip code)

(408) 536-6000

(Registrant’s telephone number, including area code)

_________________________

Indicate by checkmark 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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

(Do not check if a smaller

reporting company)

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

The number of shares outstanding of the registrant’s common stock as of April 2, 2010 was 526,422,951.

ADOBE SYSTEMS INCORPORATED

FORM 10-Q

TABLE OF CONTENTS

			Page No.
PART I—FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements:		3
		Condensed Consolidated Balance Sheets March 5, 2010 and November 27, 2009	3
		Condensed Consolidated Statements of Income Three Months Ended March 5, 2010 and February 27, 2009	4
		Condensed Consolidated Statements of Cash Flows Three Months Ended March 5, 2010 and February 27, 2009	5
		Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		45
Item 4.	Controls and Procedures		46

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		46
Item 1A.	Risk Factors		46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		57
Item 6.	Exhibits		58
Signature			68
Summary of Trademarks			69

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)

		March 5, 2010			November 27, 2009
ASSETS
Current assets:
Cash and cash equivalents	$	1,589,442		$	999,487
Short-term investments		1,082,942			904,986
Trade receivables, net of allowances for doubtful accounts of $14,602 and $15,225, respectively		350,577			410,879
Deferred income taxes		67,265			77,417
Prepaid expenses and other current assets		86,993			80,855
Total current assets		3,177,219			2,473,624
Property and equipment, net		386,205			388,132
Goodwill		3,494,073			3,494,589
Purchased and other intangibles, net		487,605			527,388
Investment in lease receivable		207,239			207,239
Other assets		192,728			191,265
Total assets	$	7,945,069		$	7,282,237

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade payables	$	44,188		$	58,904
Accrued expenses		364,437			419,646
Accrued restructuring		19,773			37,793
Income taxes payable		151,841			46,634
Deferred revenue		320,535			281,576
Total current liabilities		900,774			844,553
Long-term liabilities:
Debt		1,493,546			1,000,000
Deferred revenue		39,208			36,717
Accrued restructuring		6,104			6,921
Income taxes payable		224,273			223,528
Deferred income taxes		79,670			252,486
Other liabilities		30,074			27,464
Total liabilities		2,773,649			2,391,669
Stockholders’ equity:
Preferred stock, $0.0001 par value; 2,000 shares authorized, none issued		—			—
Common stock, $0.0001 par value; 900,000 shares authorized; 600,834 shares issued; 525,782 and 522,657 shares outstanding, respectively		61			61
Additional paid-in-capital		2,339,965			2,390,061
Retained earnings		5,427,068			5,299,914
Accumulated other comprehensive income		29,109			24,446
Treasury stock, at cost (75,052 and 78,177 shares, respectively), net of reissuances		(2,624,783	)		(2,823,914	)
Total stockholders’ equity		5,171,420			4,890,568
Total liabilities and stockholders’ equity	$	7,945,069		$	7,282,237

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

		Three Months Ended
		March 5, 2010			February 27, 2009
Revenue:
Products	$	703,938		$	729,861
Subscription		95,507			12,338
Services and support		59,255			44,191
Total revenue		858,700			786,390
Cost of revenue:
Products		23,510			51,435
Subscription		45,735			7,483
Services and support		20,123			18,435
Total cost of revenue		89,368			77,353
Gross profit		769,332			709,037
Operating expenses:
Research and development		174,340			149,917
Sales and marketing		297,294			249,491
General and administrative		91,046			74,051
Restructuring charges		11,622			12,270
Amortization of purchased intangibles		18,197			15,392
Total operating expenses		592,499			501,121
Operating income		176,833			207,916
Non-operating income (expense):
Interest and other income, net		611			13,284
Interest expense		(7,695	)		(792	)
Investment gains (losses), net		(3,534	)		(17,246	)
Total non-operating income (expense), net		(10,618	)		(4,754	)
Income before income taxes		166,215			203,162
Provision for income taxes		39,061			46,727
Net income	$	127,154		$	156,435
Basic net income per share	$	0.24		$	0.30
Shares used in computing basic net income per share		524,173			524,268
Diluted net income per share	$	0.24		$	0.30
Shares used in computing diluted net income per share		532,645			527,830

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

		Three Months Ended
		March 5, 2010			February 27, 2009
Cash flows from operating activities:
Net income	$	127,154		$	156,435
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		68,581			68,740
Stock-based compensation		64,480			45,618
Deferred income taxes		(157,932	)		26,518
Unrealized losses on investments		2,331			15,784
Retirements of property and equipment		130			3,157
Tax benefit from employee stock option plans		35,609			2,711
Provision for losses on trade receivables		816			2,701
Other non-cash items		5,025			1,567
Excess tax benefits from stock-based compensation		(7,058	)		(84	)
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Trade receivables, net		59,601			164,484
Prepaid expenses and other current assets		4,180			7,859
Trade payables		(14,716	)		(14,424	)
Accrued expenses		(59,008	)		(53,098	)
Accrued restructuring		(18,716	)		(16,656	)
Income taxes payable		106,740			4,465
Deferred revenue		42,586			(50,034	)
Net cash provided by operating activities		259,803			365,743
Cash flows from investing activities:
Purchases of short-term investments		(400,054	)		(435,171	)
Maturities of short-term investments		140,611			137,900
Proceeds from sales of short-term investments		78,958			189,432
Purchases of property and equipment		(25,547	)		(15,916	)
Purchases of long-term investments and other assets		(5,747	)		(9,201	)
Proceeds from sale of long-term investments		719			1,394
Other		2,341			—
Net cash used for investing activities		(208,719	)		(131,562	)
Cash flows from financing activities:
Purchases of treasury stock		(20	)		(13	)
Proceeds from issuance of treasury stock		49,824			28,604
Excess tax benefits from stock-based compensation		7,058			84
Proceeds from debt		1,493,439			—
Repayment of debt		(1,000,000	)		—
Debt issuance costs		(10,142	)		—
Net cash provided by financing activities		540,159			28,675
Effect of foreign currency exchange rates on cash and cash equivalents		(1,288	)		(381	)
Net increase in cash and cash equivalents		589,955			262,475
Cash and cash equivalents at beginning of period		999,487			886,450
Cash and cash equivalents at end of period	$	1,589,442		$	1,148,925
Supplemental disclosures:
Cash paid for income taxes, net of refunds	$	54,664		$	4,631
Cash paid for interest	$	2,617		$	892

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

We have prepared the accompanying unaudited Condensed Consolidated Financial Statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Pursuant to these rules and regulations, we have condensed or omitted certain information and footnote disclosures we normally include in our annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In management’s opinion, we have made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present our financial position, results of operations and cash flows. Our interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009 on file with the SEC. Our first quarter fiscal 2010 financial results benefitted from an extra week in the quarter due to our 52/53 week financial calendar whereby fiscal 2010 is a 53-week year compared with fiscal 2009 which was a 52-week year.

With the exception of the adoption of an accounting pronouncement related to revenue recognition, discussed below, there have been no material changes to our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009.

Recent Accounting Pronouncements

There have also been no new recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 5, 2010, with the exception of those discussed below, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009, that are of significance, or potential significance, to us.

Revenue Recognition

In October 2009, the FASB amended the accounting standards for certain multiple deliverable revenue arrangements to:

·	provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

·	require an entity to allocate revenue in an arrangement using the best estimated selling price (“BESP”) of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) of selling price or third-party evidence (“TPE”) of selling price; and

·	eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

We elected to early adopt this accounting guidance at the beginning of our first quarter of fiscal 2010 on a prospective basis for applicable transactions originating or materially modified after November 27, 2009.

Multiple Element Arrangements

We enter into multiple element revenue arrangements in which a customer may purchase a combination of software, upgrades, hosting services, maintenance and support, and consulting.

For multiple element arrangements that contain non-software related elements, for example our software as a service (“SaaS”) offerings, we allocate revenue to each non-software element based upon the relative selling price of each and if software and software-related elements are also included in the arrangement, to those elements as a group based on our BESP for the group. When applying the relative selling price method, we determine the selling price for each deliverable using VSOE of selling price, if it exists, or TPE of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, we use our BESP for that deliverable. Revenue allocated to each element is then recognized when the basic revenue recognition criteria is met for each element. The manner in which we account for multiple element arrangements that contain only software and software-related elements remains unchanged.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Consistent with our methodology under previous accounting guidance, we determine VSOE of fair value for each element based on historical stand-alone sales to third-parties or from the stated renewal rate for the elements contained in the initial software license arrangement.

In certain instances, we were not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to us infrequently selling each element separately, not pricing products or services within a narrow range, or only having a limited sales history. When VSOE cannot be established, we attempt to establish the selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our offerings contain significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. Therefore, we typically are not able to obtain TPE of selling price.

When we are unable to establish selling prices using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly customized offerings.

We determine BESP for a product or service by considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. The determination of BESP is made through consultation with and formal approval by our management, taking into consideration our go-to-market strategy.

We regularly review VSOE and have established a review process for TPE and BESP and maintain internal controls over the establishment and updates of these estimates. There was no material impact to revenue during the three months ended March 5, 2010 resulting from changes in VSOE, TPE or BESP, nor do we expect a material impact from such changes in the near term.

Given the nature of our transactions, which are primarily software and software-related, our go-to-market strategies and our pricing practices, total net revenue as reported during the three months ended March 5, 2010 is materially consistent with total net revenue that would have been reported if the transactions entered into or materially modified after November 27, 2009 were subject to previous accounting guidance.

The new accounting standards for revenue recognition, if applied in the same manner to the year ended November 27, 2009, would not have had a material impact on total net revenues for that fiscal year. In terms of the timing and pattern of revenue recognition, the new accounting guidance for revenue recognition is not expected to have a significant effect on total net revenues in periods after the initial adoption.

Variable Interest Entities

In June 2009, the FASB issued amended standards for determining whether to consolidate a variable interest entity. These new standards amend the evaluation criteria to identify the primary beneficiary of a variable interest entity and requires ongoing reassessment of whether an enterprise is the primary beneficiary of the variable interest entity. The provisions of the new standards are effective for annual reporting periods beginning after November 15, 2009 and interim periods within those fiscal years. These standards were effective for us beginning in the first quarter of fiscal 2010. The adoption of the new standards did not have an impact on our consolidated financial position, results of operations and cash flows.

Intangible Assets Useful Lives

In April 2008, the FASB issued new standards which provided guidance on how to determine the useful life of intangible assets by amending the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. These standards are effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years and was effective for us beginning in the first quarter of fiscal 2010. There was no impact to our current consolidated financial statements as we did not purchase any intangible assets during the quarter.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Business Combinations and Non-Controlling Interests

In December 2007, the FASB revised their guidance for business combinations and non-controlling interests. The new standards change how business acquisitions are accounted for and impact financial statements both on the acquisition date and in subsequent periods. The changes also impact the accounting and reporting for minority interests, which are recharacterized as non-controlling interests and classified as a component of equity. The new standards were effective for us beginning in the first quarter of fiscal 2010. We currently believe that depending on the size and frequency of acquisitions, the adoption of these standards may have a material effect on our future consolidated financial statements. There was no impact to our current consolidated financial statements as we did not have any business combinations during the quarter.

NOTE 2. ACQUISITIONS

On October 23, 2009, we completed the acquisition of Omniture, Inc. (“Omniture”), an industry leader in Web analytics and online business optimization based in Orem, Utah, for approximately $1.8 billion. Under the terms of the agreement, we completed our tender offer to acquire all of the outstanding shares of Omniture common stock at a price of $21.50 per share, net to the seller in cash, without interest. Acquiring Omniture accelerates our strategy of delivering more effective solutions for assembling, delivering, targeting and optimizing Web content and applications. The transaction was accounted for using the purchase method of accounting. We have included the financial results of Omniture in our Condensed Consolidated Financial Statements beginning on the acquisition date. Following the closing, we integrated Omniture as a new reportable segment for financial reporting purposes.

The total purchase price for Omniture was approximately $1.8 billion which consisted of $1.7 billion in cash paid for outstanding common stock, $85.0 million for the estimated fair value of earned stock options and restricted stock units assumed and converted and $14.4 million for direct transaction costs. The preliminary allocation of the purchase price was based upon a preliminary valuation and our estimates and assumptions. In the first quarter of fiscal 2010, adjustments were made to the preliminary purchase price allocation to reflect the finalization of the valuation of intangible assets and deferred revenue. Additional adjustments were also made to restructuring liabilities, taxes and residual goodwill. Of the total purchase price, a preliminary estimate of $1.3 billion has been allocated to goodwill, $436.1 million to identifiable intangible assets, $35.0 million to net tangible assets and $11.7 million to restructuring liabilities. We also expensed $4.6 million for in-process research and development charges. The primary areas of the purchase price allocation that are not yet finalized relate to certain restructuring liabilities, income and non-income based taxes and residual goodwill.

The following table presents the results of Adobe and Omniture for the three months ended February 27, 2009, on a pro forma basis, as though the companies had been combined as of the beginning fiscal 2009. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of fiscal 2009 or of results that may occur in the future.

		Three Months Ended
		February 27, 2009
Net revenues	$	843,706
Net income	$	120,929
Basic net income per share	$	0.23
Shares used in computing basic net income per share		524,268
Diluted net income per share	$	0.23
Shares used in computing diluted net income per share		529,305

NOTE 3. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase. We classify all of our cash equivalents and short-term investments as “available-for-sale.” These investments are free of trading restrictions. We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. Gains and losses are recognized when realized in our Condensed Consolidated Statements of Income. When we have determined that an other-

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in earnings. Gains and losses are determined using the specific identification method.

Cash, cash equivalents and short-term investments consisted of the following as of March 5, 2010 (in thousands):

		Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	81,729	$	—	$	—		$	81,729
Cash equivalents:
Money market mutual funds		1,444,137		—		—			1,444,137
Bank time deposits		47,701		—		—			47,701
United States treasury notes		6,999		—		—			6,999
United States local government municipal bonds		1,500		—		—			1,500
Government guaranteed bonds(1)		4,999		—		—			4,999
Corporate bonds		2,379		—		(2	)		2,377
Total cash equivalents		1,507,715		—		(2	)		1,507,713
Total cash and cash equivalents		1,589,444		—		(2	)		1,589,442
Short-term investments:
United States treasury notes		392,963		2,243		(12	)		395,194
United States government agency bonds		87,626		257		(13	)		87,870
United States local government municipal bonds		88,451		4		—			88,455
Government guaranteed bonds(1)		214,081		2,641		(10	)		216,712
Corporate bonds		240,423		3,783		(47	)		244,159
Obligations of foreign governments		30,869		307		—			31,176
Multi-lateral government agencies bonds		11,333		189		—			11,522
Subtotal		1,065,746		9,424		(82	)		1,075,088
Other marketable equity securities		2,508		5,346		—			7,854
Total short-term investments		1,068,254		14,770		(82	)		1,082,942
Total cash, cash equivalents and short-term investments	$	2,657,698	$	14,770	$	(84	)	$	2,672,384

Cash, cash equivalents and short-term investments consisted of the following as of November 27, 2009 (in thousands):

		Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	75,110	$	—	$	—		$	75,110
Cash equivalents:
Money market mutual funds		884,240		—		—			884,240
Bank time deposits		40,137		—		—			40,137
Total cash equivalents		924,377		—		—			924,377
Total cash and cash equivalents		999,487		—		—			999,487
Short-term investments:
United States treasury notes		373,180		3,199		(1	)		376,378
United States government agency bonds		59,447		273		—			59,720
Government guaranteed bonds(2)		221,730		3,409		(1	)		225,138
Corporate bonds		185,735		4,702		—			190,437
Obligations of foreign governments		23,022		397		—			23,419
Multi-lateral government agencies bonds		24,598		269		—			24,867
Subtotal		887,712		12,249		(2	)		899,959
Other marketable equity securities		2,527		2,500		—			5,027
Total short-term investments		890,239		14,749		(2	)		904,986
Total cash, cash equivalents and short-term investments	$	1,889,726	$	14,749	$	(2	)	$	1,904,473

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

_________________________________________

(1)	Includes approximately 86% in U.S. government guaranteed corporate bonds and 14% in foreign government guaranteed corporate bonds.

(2)	Includes approximately 85% in U.S. government guaranteed corporate bonds and 15% in foreign government guaranteed corporate bonds.

See Note 4 for further information regarding the fair value of our financial instruments.

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category that have been in a continuous unrealized loss position for less than twelve months, as of March 5, 2010 and November 27, 2009 (in thousands):

		2010					2009
		Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
United States treasury notes and agency bonds	$	72,841	$	(25	)	$	11,179	$	(1	)
Government guaranteed bonds		5,033		(1	)		5,041		(1	)
Foreign government guaranteed bonds		4,774		(9	)		—		—
Corporate bonds		44,490		(49	)		—		—
Total	$	127,138	$	(84	)	$	16,220	$	(2	)

As of March 5, 2010 and November 27, 2009, there were no securities in a continuous unrealized loss position for more than twelve months. There were 34 securities and 4 securities that were in an unrealized loss position at March 5, 2010 and at November 27, 2009, respectively.

The following table summarizes the cost and estimated fair value of debt securities classified as short-term investments based on stated maturities as of March 5, 2010 (in thousands):

		Amortized Cost		Estimated Fair Value
Due within one year	$	599,178	$	600,819
Due within two years		266,888		270,525
Due within three years		148,113		150,220
Due after three years		51,567		53,524
Total	$	1,065,746	$	1,075,088

As of March 5, 2010, we did not consider any of our investments to be other-than-temporarily impaired.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 4. FAIR VALUE MEASUREMENTS

We measure certain financial assets and liabilities at fair value on a recurring basis. The fair value of these financial assets and liabilities was determined using the following inputs at March 5, 2010 (in thousands):

		Fair Value Measurements at Reporting Date Using
				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Current assets:
Money market funds and overnight deposits(1)	$	1,491,837	$	1,491,837	$	—	$	—
Fixed income available-for-sale securities(2)		1,090,964		—		1,090,964		—
Available-for-sale equity securities(3)		7,854		7,854		—		—
Total current assets		2,590,655		1,499,691		1,090,964		—
Non-current assets:
Investments of limited partnership(4)		33,855		—		—		33,855
Foreign currency derivatives(5)		18,645		—		18,645		—
Deferred compensation plan assets(4):
Money market funds		716		716		—		—
Equity and fixed income mutual funds		8,456		—		8,456		—
Subtotal for deferred compensation plan assets		9,172		716		8,456		—
Total non-current assets		61,672		716		27,101		33,855
Total assets	$	2,652,327	$	1,500,407	$	1,118,065	$	33,855
Liabilities:
Foreign currency derivatives(6)	$	462	$	—	$	462	$	—
Total liabilities	$	462	$	—	$	462	$	—

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(Unaudited)

		Fair Value Measurements at Reporting Date Using
				Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Current assets:
Money market funds and overnight deposits(1)	$	924,378	$	924,378	$	—	$	—
Fixed income available-for-sale securities(2)		899,960		—		899,960		—
Available-for-sale equity securities(3)		5,026		5,026		—		—
Total current assets		1,829,364		929,404		899,960		—
Non-current assets:
Investments of limited partnership(4)		37,121		—		—		37,121
Foreign currency derivatives(5)		4,307		—		4,307		—
Deferred compensation plan assets(4):
Money market funds		717		717		—		—
Equity and fixed income mutual funds		8,328		—		8,328		—
Subtotal for deferred compensation plan assets		9,045		717		8,328		—
Total non-current assets		50,473		717		12,635		37,121
Total assets	$	1,879,837	$	930,121	$	912,595	$	37,121
Liabilities:
Foreign currency derivatives(6)	$	1,589	$	—	$	1,589	$	—
Total liabilities	$	1,589	$	—	$	1,589	$	—

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(1)	Included in cash and cash equivalents on our Condensed Consolidated Balance Sheets.

(2)	Included in either cash and cash equivalents or short-term investments on our Condensed Consolidated Balance Sheets.

(3)	Included in short-term investments on our Condensed Consolidated Balance Sheets.

(4)	Included in other assets on our Condensed Consolidated Balance Sheets.

(5)	Included in prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.

(6)	Included in accrued expenses on our Condensed Consolidated Balance Sheets.

See Note 3 for further information regarding the fair value of our financial instruments.

Fixed income available-for-sale securities include U.S. treasury securities, Agency or U.S. government guaranteed securities, or U.S. municipal bonds (71% of total), corporate bonds (23% of total), obligations of foreign governments and their agencies (5% of total), and obligations of multi-lateral government agencies (1% of total) at March 5, 2010 and U.S. treasury securities, Agency or U.S. government guaranteed securities (70% of total), corporate bonds (21% of total), obligations of foreign governments and their agencies (6% of total), and obligations of multi-lateral government agencies (3% of total) at November 27, 2009. These are all high quality, investment grade securities with a minimum credit rating of A- and a weighted average credit rating of AA+. We value these securities based on pricing from pricing vendors, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. However, we classify all of our fixed income available-for-sale securities as having Level 2 inputs. Our procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources.

The investments of limited partnership relate to our interest in Adobe Ventures IV L.P. (“Adobe Ventures”), which are consolidated in our Condensed Consolidated Financial Statements. The Level 3 investments consist of investments in

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privately-held companies. These investments are remeasured at fair value each period with any gains or losses recognized in investment gains (losses), net in our Condensed Consolidated Statements of Income. We estimated fair value of the Level 3 investments by considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data.

A reconciliation of the beginning and ending balances for investments of limited partnership using significant unobservable inputs (Level 3) as of March 5, 2010 and November 27, 2009 was as follows (in thousands):

Balance as of November 28, 2008	$	38,753
Purchases and sales of investments, net		1,921
Unrealized net investment losses included in earnings		(3,553	)
Balance as of November 27, 2009		37,121
Purchases and sales of investments, net		268
Unrealized net investment losses included in earnings		(3,534	)
Balance as of March 5, 2010	$	33,855

We also have direct investments in privately-held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write-down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. For the three months ended March 5, 2010, we determined that there were no other-than-temporary impairments on our cost method investments.

See Note 7 for further information regarding our limited partnership interest in Adobe Ventures and our cost method investments.

NOTE 5. DERIVATIVES AND HEDGING ACTIVITIES

In countries outside the U.S., we transact business in U.S. dollars and in various other currencies. Therefore, we are subject to exposure from movements in foreign currency rates. We may use foreign exchange option contracts or forward contracts to hedge certain operational (“cash flow”) exposures resulting from changes in foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. The maximum original duration of any contract is twelve months. We enter into these foreign exchange contracts to hedge a portion of our forecasted foreign currency denominated revenue in the normal course of business and accordingly, they are not speculative in nature.

We recognize derivative instruments and hedging activities as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income on our Condensed Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction occurs, we reclassify the related gain or loss on the cash flow hedge to revenue. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, we reclassify the gain or loss on the related cash flow hedge from accumulated other comprehensive income to interest and other income, net on our Condensed Consolidated Statements of Income at that time.

We also hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with changes in the fair value recorded to interest and other income, net on our Condensed Consolidated Statement of Income. These derivative instruments do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.

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We mitigate concentration of risk related to foreign currency hedges as well as interest rate hedges through a policy that establishes counterparty limits. The bank counterparties in these contracts expose us to credit-related losses in the event of their nonperformance. However, to mitigate that risk, we only contract with counterparties who meet our minimum requirements under our counterparty risk assessment process. In addition, our hedging policy establishes maximum limits for each counterparty. We monitor ratings, credit spreads and potential downgrades on at least a quarterly basis. Based on our on-going assessment of counterparty risk, we will adjust our exposure to various counterparties.

The aggregate fair value of derivative instruments in net asset positions as of March 5, 2010 and November 27, 2009 was $18.6 million and $4.3 million, respectively. These amounts represent the maximum exposure to loss at the reporting date as a result of all of the counterparties failing to perform as contracted. This exposure could be reduced by up to $0.5 million and $1.6 million, respectively, of liabilities included in master netting arrangements with those same counterparties.

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of March 5, 2010 and November 27, 2009 were as follows (in thousands):

		2010				2009
		Fair Value Asset Derivatives(1)		Fair Value Liability Derivatives(2)		Fair Value Asset Derivatives(1)		Fair Value Liability Derivatives(2)
Derivatives designated as hedging instruments:
Foreign exchange option contracts(3)	$	15,711	$	—	$	4,175	$	—

Derivatives not designated as hedging instruments:
Foreign exchange forward contracts		2,934		462		132		1,589
Total derivatives	$	18,645	$	462	$	4,307	$	1,589

_________________________________________

(1)	Included in prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.

(2)	Included in accrued expenses on our Condensed Consolidated Balance Sheets.

(3)	Hedging effectiveness expected to be recognized to income within the next twelve months.

The effect of derivative instruments designated as cash flow hedges and of derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for three months ended March 5, 2010 and February 27, 2009 was as follows (in thousands):

		2010					2009
		Foreign Exchange Option Contracts			Foreign Exchange Forward Contracts		Foreign Exchange Option Contracts			Foreign Exchange Forward Contracts
Derivatives in cash flow hedging relationships:
Net gain (loss) recognized in OCI, net of tax(1)	$	10,364		$	—	$	(5,450	)	$	—
Net gain (loss) reclassified from accumulated OCI into income, net of tax(2)	$	—		$	—	$	20,476		$	—
Net gain (loss) recognized in income(3)Net gain (loss) recognized in income(3)	$	(3,921	)	$	—	$	(1,632	)	$	—

Derivatives not designated as hedging relationships:
Net gain (loss) recognized in income(4)Net gain (loss) recognized in income(4)	$	—		$	11,040	$	—		$	(3,245	)

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(Unaudited)

_________________________________________

(1)	Net change in the fair value of the effective portion classified in other comprehensive income (“OCI”).

(2)	Effective portion classified as revenue.

(3)	Ineffective portion and amount excluded from effectiveness testing classified in interest and other income, net.

(4)	Classified in interest and other income, net.

NOTE 6. GOODWILL AND PURCHASED AND OTHER INTANGIBLES

Goodwill as of March 5, 2010 and November 27, 2009 was $3.494 billion and $3.495 billion, respectively. The change includes adjustments to our Omniture purchase price allocation in addition to foreign currency translation adjustments.

Purchased and other intangible assets subject to amortization as of March 5, 2010 were as follows (in thousands):

		Cost		Accumulated Amortization			Net
Purchased technology	$	220,272	$	(31,094	)	$	189,178
Localization	$	10,948	$	(2,175	)	$	8,773
Trademarks		172,020		(112,820	)		59,200
Customer contracts and relationships		364,369		(168,392	)		195,977
Other intangibles		47,162		(12,685	)		34,477
Total other intangible assets	$	594,499	$	(296,072	)	$	298,427
Purchased and other intangible assets	$	814,771	$	(327,166	)	$	487,605

Purchased and other intangible assets subject to amortization as of November 27, 2009 were as follows (in thousands):

		Cost		Accumulated Amortization			Net
Purchased technology	$	586,952	$	(387,731	)	$	199,221
Localization	$	20,284	$	(15,222	)	$	5,062
Trademarks		172,030		(104,953	)		67,077
Customer contracts and relationships		363,922		(159,450	)		204,472
Other intangibles		54,535		(2,979	)		51,556
Total other intangible assets	$	610,771	$	(282,604	)	$	328,167
Purchased and other intangible assets	$	1,197,723	$	(670,335	)	$	527,388

During the three months ended March 5, 2010, purchased and other intangible assets from prior acquisitions, primarily Macromedia, became fully amortized and were removed from the balance sheet. Amortization expense related to purchased and other intangible assets was $36.9 million and $39.0 million for the three months ended March 5, 2010 and February 27, 2009, respectively. Of these amounts, $18.7 million and $23.6 million was included in cost of sales for the three months ended March 5, 2010 and February 27, 2009, respectively.

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As of March 5, 2010, we expect amortization expense in future periods to be as follows (in thousands):

Fiscal Year		Purchased Technology		Other Intangible Assets
Remainder of 2010	$	26,968	$	74,161
2011		32,573		54,693
2012		30,967		22,407
2013		27,008		21,681
2014		25,293		21,281
Thereafter		46,369		104,204
Total expected amortization expense	$	189,178	$	298,427

NOTE 7. OTHER ASSETS

Other assets as of March 5, 2010 and November 27, 2009 consisted of the following (in thousands):

		2010		2009
Acquired rights to use technology	$	81,299	$	84,313
Investments		60,760		63,526
Security and other deposits		11,067		11,692
Prepaid royalties		11,536		12,059
Debt issuance costs		10,598		—
Deferred compensation plan assets		9,172		9,045
Restricted cash		2,308		4,650
Prepaid land lease		3,200		3,209
Prepaid rent		1,229		1,377
Other		1,559		1,394
Other assets	$	192,728	$	191,265

Included in investments are our indirect investments through our limited partnership interest in Adobe Ventures of approximately $33.9 million and $37.1 million as of March 5, 2010 and November 27, 2009, respectively. We consolidate Adobe Ventures in accordance with the provisions for consolidating variable interest entities as we have determined we have the power to direct the activities that most significantly impact the entity’s economic performance and we have the obligation to absorb losses or the right to receive benefits through our limited partnership interest in Adobe Ventures. The partnership is controlled by Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures. We are the primary beneficiary of Adobe Ventures and bear virtually all of the risks and rewards related to our ownership. Our investment in Adobe Ventures does not have a significant impact on our consolidated financial position, results of operations or cash flows.

The primary purpose of our limited partnership interest in Adobe Ventures is to invest in securities of private companies which either operate in, or are expected to operate in, industries where technology and business model trends are expected to have an impact on our core business. Our maximum capital commitment to Adobe Ventures is $104.6 million, of which, approximately $95.0 million has been invested.

Adobe Ventures carries its investments in equity securities at estimated fair value and investment gains and losses are included in our Condensed Consolidated Statements of Income. Substantially all of the investments held by Adobe Ventures at March 5, 2010 and November 27, 2009 are not publicly traded and, therefore, there is no established market for these securities. In order to determine the fair value of these investments, we use the most recent round of financing involving new non-strategic investors or estimates of fair value made by Granite Ventures. We evaluate the fair value of these investments held by Adobe Ventures on a regular basis. This evaluation includes, but is not limited to, reviewing each company’s cash position, financing needs, earnings and revenue outlook, operational performance, management and ownership changes and competition. In the case of privately-held companies, this evaluation is based on information that we request from these companies. This information is not subject to the same disclosure regulations as U.S. publicly traded companies and as such, the basis for these evaluations is subject to the timing and the accuracy of the data received from these companies.

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Also included in investments are our direct investments in privately-held companies of approximately $26.9 million and $26.4 million as of March 5, 2010 and November 27, 2009, respectively, which are accounted for based on the cost method. We assess these investments for impairment in value as circumstances dictate.

NOTE 8. ACCRUED EXPENSES

Accrued expenses as of March 5, 2010 and November 27, 2009 consisted of the following (in thousands):

		2010		2009
Accrued compensation and benefits	$	133,044	$	164,352
Taxes payable		9,474		11,879
Sales and marketing allowances		28,419		32,774
Other		193,500		210,641
Accrued expenses	$	364,437	$	419,646

Other primarily includes general corporate accruals for corporate marketing programs, local and regional expenses, and technical support. Other is also comprised of deferred rent related to office locations with rent escalations, accrued royalties, foreign currency derivatives and accrued interest on our outstanding debt.

NOTE 9. INCOME TAXES

The gross liability for unrecognized tax benefits at March 5, 2010 was $217.5 million, exclusive of interest and penalties. If the total unrecognized tax benefits at March 5, 2010 were recognized in the future, $200.2 million of unrecognized tax benefits would decrease the effective tax rate, which is net of an estimated $17.3 million federal benefit related to deducting certain payments on future tax returns.

As of March 5, 2010, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns was approximately $16.2 million. This amount is included in non-current income taxes payable.

The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits equal to $0 to approximately $13 million. These amounts would decrease income tax expense as a result of our adoption of new accounting standards related to business combinations in fiscal 2010.

In December 2009, we repatriated $700 million of undistributed foreign earnings for which a deferred tax liability had been previously accrued. As such, a long-term deferred tax liability of approximately $200 million was reclassified from deferred income taxes to income taxes payable.

NOTE 10. STOCK-BASED COMPENSATION

The assumptions used to value option grants during the three months ended March 5, 2010 and February 27, 2009 were as follows:

	2010		2009
Expected life (in years)	3.8 – 4.1		3.7 – 3.8
Volatility	31 – 36	%	50 – 57	%
Risk free interest rate	1.76 – 1.97	%	1.16 – 1.40	%

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(Unaudited)

The expected term of employee stock purchase plan (“ESPP”) shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three months ended March 5, 2010 and February 27, 2009 were as follows:

	2010		2009
Expected life (in years)	0.5 – 2.0		0.5 – 2.0
Volatility	32	%	49 – 57	%
Risk free interest rate	0.18 – 1.09	%	0.27 – 0.88	%

Summary of Stock Options

Option activity for the three months ended March 5, 2010 and the fiscal year ended November 27, 2009 was as follows (in thousands):

	2010		2009
Beginning outstanding balance	41,251		40,704
Granted	3,027		5,758
Exercised	(2,300	)	(7,560	)
Cancelled	(622	)	(3,160	)
Increase due to acquisition	—		5,509
Ending outstanding balance	41,356		41,251

Information regarding stock options outstanding at March 5, 2010 and February 27, 2009 is summarized below:

	Number of Shares (thousands)		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value(*) (millions)
2010
Options outstanding	41,356	$	30.27	4.29	$	254.7
Options vested and expected to vest	39,258	$	30.32	4.19	$	241.2
Options exercisable	26,270	$	30.55	3.39	$	158.9

2009
Options outstanding	42,773	$	28.96	4.12	$	18.8
Options vested and expected to vest	40,561	$	28.90	4.00	$	18.8
Options exercisable	27,635	$	27.40	3.19	$	18.8

_________________________________________

(*)	The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of March 5, 2010 and February 27, 2009 were $35.16 and $16.70, respectively.

Summary of Employee Stock Purchase Plan Shares

Employees purchased 1.3 million shares at an average price of $20.20 and 1.2 million shares at an average price of $18.10 for the three months ended March 5, 2010 and February 27, 2009, respectively. The intrinsic value of shares purchased during the three months ended March 5, 2010 and February 27, 2009 was $21.4 million and $3.7 million, respectively. The intrinsic value is calculated as the difference between the market value on the date of purchase and the purchase price of the shares.

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(Unaudited)

Summary of Restricted Stock Units

Restricted stock unit activity for the three months ended March 5, 2010 and the fiscal year ended November 27, 2009 was as follows (in thousands):

	2010		2009
Beginning outstanding balance	10,433		4,261
Awarded	5,548		6,176
Released	(1,523	)	(1,162	)
Forfeited	(316	)	(401	)
Increase due to acquisition	—		1,559
Ending outstanding balance	14,142		10,433

Information regarding restricted stock units outstanding at March 5, 2010 and February 27, 2009 is summarized below:

	Number of Shares (thousands)	Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value(*) (millions)
2010
Restricted stock units outstanding	14,142	2.08	$	497.2
Restricted stock units vested and expected to vest	10,527	1.90	$	369.8

2009
Restricted stock units outstanding	6,269	2.13	$	104.7
Restricted stock units vested and expected to vest	4,638	1.94	$	77.4

_________________________________________

(*)	The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of March 5, 2010 and February 27, 2009 were $35.16 and $16.70, respectively.

Summary of Performance Shares

Effective January 25, 2010, the Executive Compensation Committee adopted the 2010 Performance Share Program (the “2010 Program”). The purpose of the 2010 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2010 Program is our fiscal 2010 year. All members of our executive management and other key senior leaders are participating in the 2010 Program. Awards granted under the 2010 Program were granted in the form of performance shares pursuant to the terms of our 2003 Equity Incentive Plan. If pre-determined performance goals are met, shares of stock will be granted to the recipient, with one third vesting on the later of the date of certification of achievement or the first anniversary date of the grant, and the remaining two thirds vesting evenly on the following two annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2010 Program have the ability to receive up to 150% of the target number of shares originally granted.

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The following table sets forth the summary of performance share activity under our 2010 Program for the three months ended March 5, 2010 (in thousands):

	Shares Granted	Maximum Shares Eligible to Receive
Beginning outstanding balance	—	—
Awarded	263	394
Forfeited	—	—
Ending outstanding balance	263	394

The performance metrics under the 2009 Performance Share Program were not achieved and therefore no shares were awarded. The following table sets forth the summary of performance share activity under our 2007 and 2008 programs, based upon share awards actually achieved, for the three months ended March 5, 2010 and the fiscal year ended November 27, 2009 (in thousands):

	2010		2009
Beginning outstanding balance	950		383
Achieved	—		1,022
Released	(327	)	(382	)
Forfeited	(16	)	(73	)
Ending outstanding balance

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