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 August 28, 2009
 
 
or
 
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 Web site, 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 September 25, 2009 was 523,760,118.
 


 
 

 


ADOBE SYSTEMS INCORPORATED
FORM 10-Q
 
TABLE OF CONTENTS
 
     
Page No.
PART I—FINANCIAL INFORMATION
 
 
Item 1.
3
       
   
3
       
   
4
       
   
5
       
   
6
     
Item 2.
29
     
Item 3.
40
     
Item 4.
40
   
PART II—OTHER INFORMATION
 
Item 1.
40
     
Item 1A.
40
     
Item 2.
49
     
Item 6.
49
   
58
   
59


PART I—FINANCIAL INFORMATION
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(In thousands, except par value)
 
(Unaudited)
 
   
August 28,
2009
   
November 28,
2008
 
ASSETS
Current assets:
           
Cash and cash equivalents
  $ 1,132,144     $ 886,450  
Short-term investments
    1,424,317       1,132,752  
Trade receivables, net of allowances for doubtful accounts of $6,153 and $4,128, respectively
    281,807       467,234  
Deferred income taxes
    72,163       110,713  
Prepaid expenses and other current assets
    80,503       137,954  
Total current assets
    2,990,934       2,735,103  
Property and equipment, net
    335,752       313,037  
Goodwill
    2,125,946       2,134,730  
Purchased and other intangibles, net
    117,384       214,960  
Investment in lease receivable
    207,239       207,239  
Other assets
    184,705       216,529  
Total assets
  $ 5,961,960     $ 5,821,598  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Trade payables
  $ 48,416     $ 55,840  
Accrued expenses
    349,077       399,969  
Accrued restructuring
    8,230       35,690  
Income taxes payable
    20,332       27,136  
Deferred revenue
    188,328       243,964  
Total current liabilities
    614,383       762,599  
Long-term liabilities:
               
Debt
    350,000       350,000  
Deferred revenue
    29,866       31,356  
Accrued restructuring
    4,967       6,214  
Income taxes payable
    137,296       123,182  
Deferred income taxes
    105,597       117,328  
Other liabilities
    25,293       20,565  
Total liabilities
    1,267,402       1,411,244  
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; 524,665 and 526,111 shares outstanding, respectively
    61       61  
Additional paid-in-capital
    2,303,342       2,396,819  
Retained earnings
    5,331,957       4,913,406  
Accumulated other comprehensive income
    21,728       57,222  
Treasury stock, at cost (76,169 and 74,723 shares, respectively), net of reissuances
    (2,962,530 )     (2,957,154 )
Total stockholders’ equity
    4,694,558       4,410,354  
Total liabilities and stockholders’ equity
  $ 5,961,960     $ 5,821,598  
 
See accompanying Notes to Condensed Consolidated Financial Statements.


ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
(In thousands, except per share data)
 
(Unaudited)
 
   
Three Months Ended
   
Nine Months Ended
 
   
August 28,
 2009
   
August 29,
 2008
   
August 28,
 2009
   
August 29,
 2008
 
Revenue:
                       
Products
  $ 649,865     $ 838,813     $ 2,052,119     $ 2,532,076  
Services and support
    47,642       48,444       136,451       132,512  
Total revenue
    697,507       887,257       2,188,570       2,664,588  
Cost of revenue:
                               
Products
    49,365       84,623       164,041       202,657  
Services and support
    15,682       26,228       50,367       73,535  
Total cost of revenue
    65,047       110,851       214,408       276,192  
Gross profit
    632,460       776,406       1,974,162       2,388,396  
Operating expenses:
                               
Research and development
    138,902       170,124       427,289       508,909  
Sales and marketing
    231,320       271,439       724,020       813,399  
General and administrative
    79,593       97,156       224,462       257,163  
Restructuring charges
    65       1,194       15,866       2,625  
Amortization of purchased intangibles
    14,978       17,024       45,654       51,222  
Total operating expenses
    464,858       556,937       1,437,291       1,633,318  
Operating income
    167,602       219,469       536,871       755,078  
 
Non-operating income (expense):
                               
Interest and other income, net
    6,667       9,338       24,753       34,778  
Interest expense
    (460 )     (2,390 )     (1,872 )     (8,027 )
Investment gains (losses), net
    607       2,097       (18,444 )     20,335  
Total non-operating income (expense), net
    6,814       9,045       4,437       47,086  
Income before income taxes
    174,416       228,514       541,308       802,164  
Provision for income taxes
    38,371       36,906       122,757       176,267  
Net income
  $ 136,045     $ 191,608     $ 418,551     $ 625,897  
Basic net income per share
  $ 0.26     $ 0.36     $ 0.79     $ 1.15  
Shares used in computing basic net income per share
    525,911       531,060       528,015       542,624  
Diluted net income per share
  $ 0.26     $ 0.35     $ 0.79     $ 1.13  
Shares used in computing diluted net income per share
    531,809       541,311       532,846       552,739  

 

 

 
See accompanying Notes to Condensed Consolidated Financial Statements.


ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
(Unaudited)
 
   
Nine Months Ended
 
   
August 28,
2009
   
August 29,
2008
 
Cash flows from operating activities:
           
Net income
  $ 418,551     $ 625,897  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, amortization and accretion
    197,386       202,841  
Stock-based compensation
    126,231       137,613  
Deferred income taxes
    22,671       34,336  
Unrealized losses (gains) on investments
    13,308       (9,690 )
Retirements of property and equipment
    3,435       185  
Tax benefit from employee stock option plans
    2,711       83,740  
Provision for losses on trade receivables
    3,049       3,870  
Other non-cash items
    2,464       2,709  
Excess tax benefits from stock-based compensation
    (84 )     (23,635 )
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
               
Trade receivables
    182,377       (13,695 )
Prepaid expenses and other current assets
    15,663       2,044  
Trade payables
    (7,424 )     (3,574 )
Accrued expenses
    (44,351 )     (43,996 )
Accrued restructuring
    (27,527 )     (5,418 )
Income taxes payable
    12,619       (73,957 )
Deferred revenue
    (57,126 )     23,163  
Net cash provided by operating activities
    863,953       942,433  
Cash flows from investing activities:
               
Purchases of short-term investments
    (1,142,015 )     (840,782 )
Maturities of short-term investments
    333,219       520,784  
Proceeds from sales of short-term investments
    504,958       486,904  
Purchases of property and equipment
    (84,659 )     (88,481 )
Acquisitions, net of cash acquired
          485  
Purchases of long-term investments and other assets
    (24,891 )     (102,085 )
Proceeds from sale of long-term investments
    4,909       18,085  
Other
    3,271        
Net cash used for investing activities
    (405,208 )     (5,090 )
Cash flows from financing activities:
               
Purchases of treasury stock
    (350,013 )     (1,422,735 )
Proceeds from issuance of treasury stock
    122,219       301,454  
Excess tax benefits from stock-based compensation
    84       23,635  
Proceeds from borrowings under credit facility
          450,000  
Repayments of borrowings under credit facility
          (100,000 )
Net cash used for financing activities
    (227,710 )     (747,646 )
Effect of foreign currency exchange rates on cash and cash equivalents
    14,659       (1,856 )
Net increase in cash and cash equivalents
    245,694       187,841  
Cash and cash equivalents at beginning of period
    886,450       946,422  
Cash and cash equivalents at end of period
  $ 1,132,144     $ 1,134,263  
Supplemental disclosures:
               
Cash paid for income taxes, net of refunds
  $ 78,635     $ 129,320  
Cash paid for interest
  $ 453     $ 2,311  

See accompanying Notes to Condensed Consolidated Financial Statements.

 
5

 
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 28, 2008 on file with the SEC.
 
There have been no material changes in 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 28, 2008.
 
Recent Accounting Pronouncements
 
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended August 28, 2009, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 28, 2008, that are of significance, or potential significance, to us.
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards Codification and the Hierarchy of GAAP, a replacement of SFAS No. 162” (“SFAS 168”). SFAS 168 will become the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009 and will be effective for us beginning in the fourth quarter of fiscal 2009. On the effective date of SFAS 168, it will supersede all then-existing non-SEC accounting and reporting standards. As SFAS 168 is not intended to change or alter existing GAAP, it is not expected to have any impact on our consolidated financial statements and will only impact references for accounting guidance.
 
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation (“FIN”) No. 46(R)” (“SFAS 167”), which amends 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 SFAS 167 are effective for interim and annual reporting periods ending after November 15, 2009 and will be effective for us beginning in the fourth quarter of fiscal 2009. We are currently evaluating the impact of adopting SFAS 167 on our consolidated financial position, results of operations and cash flows.
 
In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The provisions of SFAS 165 are effective for interim and annual reporting periods ending after June 15, 2009. We adopted SFAS 165 during the third quarter of fiscal 2009 and as the pronouncement only requires additional disclosures, the adoption did not have an impact on our consolidated financial position, results of operations or cash flows. We have evaluated subsequent events through October 1, 2009, the date that these financial statements were issued.
 
In April 2009, the FASB issued three related FASB Staff Positions (“FSP”): (i) FSP Financial Accounting Standard (“FAS”) No. 115-2 and FAS No. 124-2, “Recognition of Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”), (ii) FSP FAS No. 107-1 and Accounting Principles Board Opinion (“APB”) No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”), and (iii) FSP FAS No. 157-4, “Determining the Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4), which are effective for interim and annual reporting periods ending after June 15, 2009. FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in GAAP for  debt  securities to  modify the requirement for recognizing other-than-temporary impairments, change the existing
 
 
6

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


impairment model, and modify the presentation and frequency of related disclosures. FSP FAS 107-1 and APB 28-1 requires disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). We adopted these FSPs during the third quarter of fiscal 2009 and they did not have a material effect on our consolidated financial position, results of operations or cash flows.
 
In September 2008, the FASB issued FSP FAS No. 133-1 and FIN No. 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of SFAS No. 133 and FIN No. 45; and Clarification of the Effective Date of SFAS No. 161” (“FSP FAS 133-1 and FIN 45-4”).  FSP FAS 133-1 and FIN 45-4 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. FSP FAS 133-1 and FIN 45-4 also amend FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of SFAS No. 5, 57, and 107 and rescission of  FIN No. 34” (“FIN 45”), to require additional disclosure about the current status of the payment/performance risk of a guarantee.  The provisions of the FSP that amend SFAS 133 and FIN 45 are effective for reporting periods ending after November 15, 2008. FSP FAS 133-1 and FIN 45-4 also clarifies the effective date in SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133” (“SFAS 161”). We adopted the disclosures required by SFAS 161 in the first quarter of fiscal 2009. Since FSP FAS 133-1 and FIN 45-4 only required additional disclosures, the adoption did not impact our consolidated financial position, results of operations or cash flows.
 
In April 2008, the FASB issued FSP FAS No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, “Goodwill and Other 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. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. FSP FAS 142-3 is effective for us beginning in the first quarter of fiscal 2010. Early adoption is not permitted. As this guidance is to be applied prospectively, on adoption, there is no impact to our current consolidated financial statements.
 
In March 2008, the FASB issued SFAS 161 which requires companies with derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. We adopted SFAS 161 in the first quarter of fiscal 2009. Since SFAS 161 only required additional disclosure, the adoption did not impact our consolidated financial position, results of operations or cash flows.
 
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin (“ARB”) No. 51” (“SFAS 160”). SFAS 141R will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 are effective for us beginning in the first quarter of fiscal 2010. Early adoption is not permitted. We are currently evaluating the impact that SFAS 141R and SFAS 160 will have on our consolidated financial statements.
 
In September 2006, the FASB issued SFAS 157, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements and is effective for fiscal years beginning after November 15, 2007. Effective November 29, 2008, we adopted SFAS 157 for all nonfinancial assets and nonfinancial liabilities measured at fair value on a non-recurring basis. Examples include goodwill, intangibles, and other long-lived assets. The adoption of SFAS 157 did not have a material impact on our consolidated financial position, results of operations or cash flows.
 
 
7

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


NOTE 2. 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 or become free of trading restrictions within one year. 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. Gains are recognized when realized in our Condensed Consolidated Statements of Income. Losses are recognized as realized or when we have determined that an other-than-temporary decline in fair value has occurred. Gains and losses are determined using the specific identification method.
 
 
 Cash, cash equivalents and short-term investments consisted of the following as of August 28, 2009 (in thousands):
 
   
Carrying 
Value
   
Unrealized
Gains
   
Unrealized
Losses
   
Estimated
Fair Value
 
Current assets:
                       
Cash
  $ 33,923     $     $     $ 33,923  
Cash equivalents:
                               
Money market mutual funds
    1,043,750                   1,043,750  
Bank deposits
    49,451                   49,451  
United States treasury notes
    5,021             (1 )     5,020  
Total cash equivalents
    1,098,222             (1 )     1,098,221  
Total cash and cash equivalents
    1,132,145             (1 )     1,132,144  
Short-term investments:
                               
United States treasury notes
    749,616       5,164       (10 )     754,770  
United States government agency bonds
    133,164       127       (21 )     133,270  
Government guaranteed bonds 
    265,448       1,724       (73 )     267,099  
Corporate bonds
    204,126       3,626       (2 )     207,750  
Obligations of foreign governments
    28,222       488             28,710  
Bonds of multi-lateral government agencies
    27,434       340             27,774  
Subtotal
    1,408,010       11,469       (106 )     1,419,373  
Other marketable equity securities
    2,504       2,440             4,944  
Total short-term investments
    1,410,514       13,909       (106 )     1,424,317  
Total cash, cash equivalents and short-term investments
  $ 2,542,659     $ 13,909     $ (107 )   $ 2,556,461  

 
8

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
Cash, cash equivalents and short-term investments consisted of the following as of November 28, 2008 (in thousands):
 
   
Carrying 
Value
   
Unrealized
Gains
   
Unrealized
Losses
   
Estimated
Fair Value
 
Current assets:
                       
Cash
  $ 117,681     $     $     $ 117,681  
Cash equivalents:
                               
Money market mutual funds
    682,148                   682,148  
Bank deposits
    40,594                   40,594  
United States treasury notes
    35,992       7             35,999  
Corporate bonds
    10,028                   10,028  
Total cash equivalents
    768,762       7             768,769  
Total cash and cash equivalents
    886,443       7             886,450  
Short-term investments:
                               
United States treasury notes
    863,772       14,384       (1 )     878,155  
Corporate bonds
    109,415       219       (997 )     108,637  
Obligations of foreign governments
    115,316       811       (33 )     116,094  
Bonds of multi-lateral government agencies
    26,559       260             26,819  
Subtotal
    1,115,062       15,674       (1,031 )     1,129,705  
Other marketable equity securities
    2,773       274             3,047  
Total short-term investments
    1,117,835       15,948       (1,031 )     1,132,752  
Total cash, cash equivalents and short-term investments
  $ 2,004,278     $ 15,955     $ (1,031 )   $ 2,019,202  
 
See Note 3 for further information regarding our financial instruments.
 
The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at August 28, 2009 (in thousands):
 
   
Less Than 12 Months
   
Total
 
   
Fair Value
   
Gross
Unrealized
Losses
   
Fair Value
   
Gross
Unrealized
Losses
 
United States treasury notes and agency bonds
  $ 108,878     $ (32 )   $ 108,878     $ (32 )
Government guaranteed bonds
    23,084       (73 )     23,084       (73 )
Corporate bonds
    3,473       (2 )     3,473       (2 )
Total
  $ 135,435     $ (107 )   $ 135,435     $ (107 )
 
As of August 28, 2009, there were no securities in a continuous loss position for more than twelve months. There were 18 securities that were in an unrealized loss position at August 28, 2009.
 
The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at November 28, 2008 (in thousands):
 
   
Less Than 12 Months
   
Total
 
   
Fair Value
   
Gross
Unrealized
Losses
   
Fair Value
   
Gross
Unrealized
Losses
 
United States treasury notes
  $ 37,400     $ (1 )   $ 37,400     $ (1 )
Corporate bonds
    67,606       (997 )     67,606       (997 )
Obligations of foreign governments
    28,033       (33 )     28,033       (33 )
Total
  $ 133,039     $ (1,031 )   $ 133,039     $ (1,031 )

 
9

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
As of November 28, 2008, there were no securities in a continuous loss position for more than twelve months. There were 33 securities that were in an unrealized loss position at November 28, 2008.
 
The following table summarizes the cost and estimated fair value of debt securities classified as short-term investments based on stated maturities as of August 28, 2009 (in thousands):
 
   
Cost
   
Estimated
Fair Value
 
Due within one year
  $ 772,898     $ 775,869  
Due within two years
    317,246       320,399  
Due within three years
    241,150       243,434  
Due after three years
    76,716       79,671  
Total
  $ 1,408,010     $ 1,419,373  
 
We review our debt and marketable equity securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell, the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. The portion of the write-down related to credit loss would be recorded to investment gains (losses), net on our Condensed Consolidated Statements of Income for equity securities and to interest and other income, net for debt securities. Any portion of the other-than-temporary decline not related to credit loss would be recorded to accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity on our Condensed Consolidated Balance Sheets.  As of August 28, 2009, we do not consider any of our investments to be other-than-temporarily impaired.
 
NOTE 3. FINANCIAL INSTRUMENTS
 
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 August 28, 2009 (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)
  $ 1,093,201     $ 1,093,201     $     $  
Fixed income available-for-sale securities(2)
    1,424,393             1,424,393        
Available-for-sale equity securities(3) 
    4,944       4,944              
Total current assets
    2,522,538       1,098,145       1,424,393        
Non-current assets:
                               
Investments of limited partnership(4) 
    34,705                   34,705  
Foreign currency derivatives(5) 
    4,688             4,688        
Deferred compensation plan assets(4): 
                               
Money market funds
    770       770              
Equity and fixed income mutual funds
    7,754             7,754        
Subtotal for deferred compensation plan assets
    8,524       770       7,754        
Total non-current assets
    47,917       770       12,442       34,705  
Total assets
  $ 2,570,455     $ 1,098,915     $ 1,436,835     $ 34,705  
Liabilities:
                               
Foreign currency derivatives(6) 
  $ 729     $     $ 729     $  
Total liabilities
  $ 729     $     $ 729     $  
 
 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

   
     The fair value of these financial assets and liabilities was determined using the following inputs at November 28, 2008 (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)
  $ 722,742     $ 722,742     $     $  
Fixed income available-for-sale securities(2)
    1,175,732             1,175,732        
Available-for-sale equity securities(3) 
    3,047       3,047              
Total current assets
    1,901,521       725,789       1,175,732        
Non-current assets:
                               
Investments of limited partnership(4) 
    39,004       251             38,753  
Foreign currency derivatives(5) 
    49,848             49,848        
Deferred compensation plan assets(4):
                               
Money market funds
    704       704              
Equity and fixed income mutual funds
    6,856             6,856        
Subtotal for deferred compensation plan assets
    7,560       704       6,856        
Total non-current assets
    96,412       955       56,704       38,753  
Total assets
  $ 1,997,933     $ 726,744     $ 1,232,436     $ 38,753  
Liabilities:
                               
Foreign currency derivatives(6) 
  $ 1,739     $     $ 1,739     $  
Total liabilities
  $ 1,739     $     $ 1,739     $  
_________________________________________
 
(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 2 for further information regarding our financial instruments.
 
Fixed income available-for-sale securities include United States (“U.S.”) treasury securities, Agency or U.S. government guaranteed securities (75% of total), corporate bonds (15% of total), obligations of foreign governments and their agencies (8% of total), and obligations of multi-lateral government agencies (2% of total) at August 28, 2009 and U.S. treasury securities, Agency or U.S. government guaranteed securities (78% of total), corporate bonds (10% of total), obligations of foreign governments and their agencies (10% of total), and obligations of multi-lateral government agencies (2% of total) at November 28, 2008. These are all high quality, investment grade securities with a minimum credit rating of A- and a weighted average credit rating better than 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.
 
 
11

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


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 1 investments of limited partnership relate to investments in publicly-traded companies and the Level 3 investments consist of investments in 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 August 28, 2009 and November 28, 2008 was as follows (in thousands):
 
Balance as of November 28, 2008
  $ 38,753  
Purchases and sales of investments, net
    966  
Unrealized net investment losses included in earnings
    (5,014 )
Balance as of August 28, 2009
  $ 34,705  
 
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 estimated 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. During the nine months ended August 28, 2009, we determined that certain of our cost method investments were other-than-temporarily impaired which resulted in a charge of $13.9 million, included in investment gains (losses), net in our Condensed Consolidated Statements of Income.  The fair value of cost method investments that were impaired was estimated using Level 3 inputs. We did not have any other-than-temporary impairments of our cost method investments during the three months ended August 28, 2009.
 
See Note 6 for further information regarding our limited partnership interest in Adobe Ventures and our cost method investments.
 
In countries outside the U.S., we transact business in U.S. dollars and in various other currencies. In Europe and Japan, transactions that are denominated in Euro and Yen are subject to exposure from movements in exchange rates. We may use foreign exchange option contracts or forward contracts to hedge operational (“cash flow”) exposures resulting from changes in these foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and 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.

In accordance with SFAS 133, 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 Statements 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.

 
12

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


We mitigate concentration of risk related to foreign currency 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 August 28, 2009 was $4.7 million. This amount represents 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 $0.7 million of liabilities included in master netting arrangements with those same counterparties.
 
The fair value of derivative instruments in our Condensed Consolidated Balance Sheets as of August 28, 2009 were as follows (in thousands):
 
 
Fair Values of Derivative Instruments
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
Derivatives designated as hedging instruments:
               
Foreign exchange option contracts(*) 
Prepaid expense
and other
current assets
  $ 4,507  
Accrued
expenses
  $  
 
Derivatives not designated as hedging instruments:
                   
Foreign exchange forward contracts
Prepaid expense
and other
current assets
    181  
Accrued
expenses
     729  
Total derivatives
    $ 4,688       $ 729  
_________________________________________
(*)           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 on our Condensed Consolidated Statements of Income for the three and nine months ended August 28, 2009 were as follows (in thousands):

   
Three Months
   
Nine Months
 
   
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(1) 
  $ (329 )   $     $ (14,516 )   $  
Net gain (loss) reclassified from accumulated OCI into income(2) 
  $ 749     $     $ 27,138     $  
Net gain (loss) recognized in income(3) 
  $ (3,734 )   $     $ (12,782 )   $  
                                 
Derivatives not designated as hedging relationships:
                               
Net gain (loss) recognized in income(4) 
  $     $ (1,650 )   $     $ (10,200 )
_________________________________________
 
(1)
Net change in the fair value of the effective portion classified in other comprehensive income (“OCI”).
 
(2)
Effective portion classified as revenue.

 
13

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
(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 4. ACQUISTIONS
 
On August 13, 2009, we entered into a definitive agreement related to a potential business combination. We completed this business combination subsequent to our quarter ended August 28, 2009 for cash consideration of approximately $35.3 million. This acquisition was not material to our consolidated balance sheets and results of operations. See Note 18 for further discussion of this transaction and for a discussion of the planned acquisition of Omniture, Inc. ("Omniture").

NOTE 5. GOODWILL AND PURCHASED AND OTHER INTANGIBLES
 
Goodwill as of August 28, 2009 and November 28, 2008 was $2.126 billion and $2.135 billion, respectively. The change includes reductions in goodwill of $7.5 million related to the release of tax reserves associated with the acquisitions of Accelio and Macromedia in addition to a facility lease obligation adjustment of $1.7 million related to Macromedia, offset in part by small foreign currency translation adjustments.
 
Purchased and other intangible assets subject to amortization as of August 28, 2009 were as follows (in thousands):
 
   
Cost
   
Accumulated
Amortization
   
Net
 
Purchased technology
  $ 405,830     $ (375,412 )   $ 30,418  
Localization
  $ 24,441     $ (16,567 )   $ 7,874  
Trademarks
    130,925       (97,940 )     32,985  
Customer contracts and relationships
    196,617       (150,754 )     45,863  
Other intangibles
    800       (556 )     244  
Total other intangible assets
  $ 352,783     $ (265,817 )   $ 86,966  
Total purchased and other intangible assets
  $ 758,613     $ (641,229 )   $ 117,384  
 
            Purchased and other intangible assets subject to amortization as of November 28, 2008 were as follows (in thousands):
 
   
Cost
   
Accumulated
Amortization
   
Net
 
Purchased technology
  $ 411,408     $ (338,608 )   $ 72,800  
Localization
  $ 23,751     $ (6,156 )   $ 17,595  
Trademarks
    130,925       (78,181 )     52,744  
Customer contracts and relationships
    198,891       (127,520 )     71,371  
Other intangibles
    800       (350 )     450  
Total other intangible assets
  $ 354,367     $ (212,207 )   $ 142,160  
Total purchased and other intangible assets
  $ 765,775     $ (550,815 )   $ 214,960  
 
Amortization expense related to purchased and other intangible assets was $34.4 million and $109.7 million for the three and nine months ended August 28, 2009, respectively. Comparatively, amortization expense was $43.2 million and $140.7 million for the three and nine months ended August 29, 2008, respectively. Of these amounts, $19.4 million and $64.1 million were included in cost of sales for the three and nine months ended August 28, 2009, respectively, and $26.2 million and $89.5 million were included in cost of sales for the three and nine months ended August 29, 2008, respectively.
 
 
14

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


As of August 28, 2009, we expect amortization expense in future periods to be as follows (in thousands):
 
 
Fiscal year
 
 
Purchased
Technology
   
Other Intangible
Assets
 
Remainder of 2009
  $ 13,736     $ 20,133  
2010
    8,301       52,202  
2011
    4,994       12,444  
2012
    3,387       1,009  
2013
          789  
Thereafter
          389  
Total expected amortization expense
  $ 30,418     $ 86,966  

NOTE 6. OTHER ASSETS
 
Other assets as of August 28, 2009 and November 28, 2008 consisted of the following (in thousands):
 
   
2009
   
2008
 
Acquired rights to use technology
  $ 87,806     $ 90,643  
Investments
    61,110       76,589  
Security and other deposits
    8,655       16,087  
Deferred compensation plan assets
    8,524       7,560  
Prepaid royalties
    8,191       9,026  
Restricted cash
    4,089       7,361  
Prepaid land lease
    3,156       3,185  
Prepaid rent
    1,524       2,658  
Other
    1,650       3,420  
Total other assets
  $ 184,705     $ 216,529  

Included in investments are our indirect investments through our limited partnership interest in Adobe Ventures of approximately $34.7 million and $39.0 million as of August 28, 2009 and November 28, 2008, respectively, which is consolidated in accordance with FIN No. 46R, a revision to FIN No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” 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 condensed consolidated financial position, results of operations or cash flows. See Note 3 for further information regarding Adobe Ventures.
 
Also included in investments are our direct investments in privately-held companies of approximately $26.4 million and $37.6 million as of August 28, 2009 and November 28, 2008, respectively, which are accounted for based on the cost method. We assess these investments for impairment in value as circumstances dictate. See Note 3 for further information regarding our cost method investments.
 
We entered into a Purchase and Sale Agreement, effective May 12, 2008, for the acquisition of real property located in Waltham, Massachusetts. We purchased the property upon completion of construction of an office building shell and core, parking structure, and site improvements. The purchase price for the property was $44.7 million and closed on June 16, 2009. We made an initial deposit of $7.0 million which was included in security and other deposits as of November 28, 2008 and the remaining balance was paid at closing. This deposit was held in escrow until closing and then applied to the purchase price.
 
 
15

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


NOTE 7. ACCRUED EXPENSES
 
Accrued expenses as of August 28, 2009 and November 28, 2008 consisted of the following (in thousands):
 
   
2009
   
2008
 
Accrued compensation and benefits
  $ 141,814     $ 177,760  
Taxes payable
    7,924       21,760  
Sales and marketing allowances
    22,888       28,127  
Other
    176,451       172,322  
Total accrued expenses
  $ 349,077     $ 399,969  
 
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 the credit facility.
 
NOTE 8. STOCK-BASED COMPENSATION
 
The assumptions used to value option grants during the three and nine months ended August 28, 2009 and August 29, 2008 were as follows:
 
   
Three Months
   
Nine Months
 
   
2009
   
2008
   
2009
   
2008
 
Expected life (in years)
    3.7 – 3.8       3.5 – 3.6       3.0 – 3.8       2.3 – 4.7  
Volatility
    37 – 43 %     34 – 37 %     37 – 57 %     32 – 39 %
Risk free interest rate
    1.93 – 2.24 %     2.79 – 3.50 %     1.16 – 2.24 %     1.70 – 3.50 %

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 and nine months ended August 28, 2009 and August 29, 2008 were as follows:

   
Three Months
   
Nine Months
 
   
2009
   
2008
   
2009
   
2008
 
Expected life (in years)
    0.5 – 2.0       0.5 – 2.0       0.5 – 2.0       0.5 – 2.0  
Volatility
    40 %     34 – 36 %     40 – 57 %     30 – 36 %
Risk free interest rate
    0.33 – 1.05 %     2.12 – 2.66 %     0.27 – 1.05 %     2.12 – 3.29 %
 
Summary of Stock Options
 
Option activity for the nine months ended August 28, 2009 and the fiscal year ended November 28, 2008 was as follows (in thousands):
 
   
2009
   
2008
 
Beginning outstanding balance
    40,704       47,742  
Granted
    4,914       5,462  
Exercised
    (4,370 )     (9,983 )
Cancelled
    (2,699 )     (2,517 )
Ending outstanding balance
    38,549       40,704  

 
16

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
Information regarding stock options outstanding at August 28, 2009 and August 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Life
(years)
   
Aggregate
Intrinsic
Value(*)
(millions)
 
2009
                       
Options outstanding
    38,549     $ 29.75       3.92     $ 176.9  
Options vested and expected to vest
    36,986     $ 29.78       3.84     $ 168.5  
Options exercisable
    26,573     $ 29.21       3.23     $ 127.8  
                                 
2008
                               
Options outstanding
    42,070     $ 29.67       4.16     $ 554.5  
Options vested and expected to vest
    39,936     $ 29.29       4.07     $ 541.2  
Options exercisable
    27,252     $ 25.94       3.35     $ 460.3  
_________________________________________
 
(*)
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 August 28, 2009 and August 29, 2008 were $31.73 and $42.83, respectively.
 
Summary of Employee Stock Purchase Plan Shares
 
The weighted average subscription date fair value of shares under the ESPP during the nine months ended August 28, 2009 and August 29, 2008 was $5.40 and $9.03, respectively. Employees purchased 3.2 million shares at an average price of $19.04 and 2.4 million shares at an average price of $30.40 for the nine months ended August 28, 2009 and August 29, 2008, respectively. The intrinsic value of shares purchased during the nine months ended August 28, 2009 and August 29, 2008 was $21.7 million and $25.0 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.
 
Summary of Restricted Stock Units
 
Restricted stock unit activity for the nine months ended August 28, 2009 and the fiscal year ended November 28, 2008 was as follows (in thousands):
 
   
2009
   
2008
 
Beginning outstanding balance
    4,261       1,701  
Awarded
    3,333       3,177  
Released
    (984 )     (422 )
Forfeited
    (291 )     (195 )
Ending outstanding balance
    6,319       4,261  

 
17

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
Information regarding restricted stock units outstanding at August 28, 2009 and August 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
   
Weighted
Average
Remaining
Contractual
Life
(years)
   
Aggregate
Intrinsic
Value(*)
(millions)
 
2009
                 
Restricted stock units outstanding
    6,319       1.70     $ 200.5  
Restricted stock units vested and expected to vest
    4,978       1.52     $ 157.8  
                         
2008
                       
Restricted stock outstanding
    4,025       1.91     $ 172.4  
Restricted stock units vested and expected to vest
    3,083       1.69     $ 132.0  
_________________________________________
 
(*)
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 August 28, 2009 and August 29, 2008 were $31.73 and $42.83, respectively.
 
Summary of Performance Shares
 
Effective January 26, 2009, the Executive Compensation Committee adopted the 2009 Performance Share Program (the “2009 Program”). The purpose of the 2009 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2009 Program is our fiscal 2009 year. All members of our executive management and other key senior leaders are participating in the 2009 Program. Awards granted under the 2009 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 25% vesting on the later of the date of certification of achievement or the first anniversary date of the grant, and the remaining 75% vesting evenly on the following three annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2009 Program have the ability to receive up to 115% of the target number of shares originally granted.
 
The following table sets forth the summary of performance share activity under our 2009 Program for the nine months ended August 28, 2009 (in thousands):
 
   
Shares
Granted
   
Maximum
Shares Eligible
to Receive
 
Beginning outstanding balance
           
Awarded
    558       642  
Forfeited
    (3 )     (4 )
Ending outstanding balance
    555       638  
 
In the first quarter of fiscal 2009, the Executive Compensation Committee certified the actual performance achievement of participants in the 2008 Performance Share Program (the “2008 Program”). Based upon the achievement of goals outlined in the 2008 Program, participants had the ability to receive up to 200% of the target number of shares originally granted. Actual performance resulted in participants achieving approximately 124% of target or approximately 1.0 million shares for the 2008 Program. Shares under the 2008 Program vested 25% in the first quarter of fiscal 2009, and the remaining 75% vest evenly on the following three annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe.
 
 
18

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


The following table sets forth the summary of performance share activity under our 2006 through 2008 programs, based upon share awards actually achieved, for the nine months ended August 28, 2009 and the fiscal year ended November 28, 2008 (in thousands):
 
   
2009
   
2008
 
Beginning outstanding balance
    383        
Achieved
    1,022       993  
Released
    (382 )     (480 )
Forfeited
    (59 )     (130 )
Ending outstanding balance
    964       383  

Information regarding performance shares outstanding at August 28, 2009 and August 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
   
Weighted
Average
Remaining
Contractual
Life
(years)
   
Aggregate
Intrinsic
Value (*)
(millions)
 
2009
                 
Performance shares outstanding
    964       1.30     $ 30.6  
Performance shares vested and expected to vest
    801       1.21     $ 25.3  
                         
2008
                       
Performance shares outstanding
    454       1.44     $ 19.4  
Performance shares vested and expected to vest
    369       1.34     $ 15.8  
_________________________________________
 
(*)
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 August 28, 2009 and August 29, 2008 were $31.73 and $42.83, respectively.
 
Compensation Costs
 
As of August 28, 2009, there was $225.4 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards which will be recognized over a weighted average period of 2.5 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
 
 
19

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the three months ended August 28, 2009 and August 29, 2008 were as follows (in thousands):
 
   
2009
   
2008
 
 
Income Statement Classifications
 
 
Option Grants
and Stock
Purchase Rights(*)
   
Restricted
Stock and
Performance
Share
Awards(*)
   
Option Grants
and Stock
Purchase Rights(*)
   
Restricted
Stock and
Performance
Share
Awards(*)
 
Cost of revenue—services and support
  $ 437     $ 190     $ 1,189     $ 230  
Research and development
    11,922       6,338       15,612       6,377  
Sales and marketing
    9,100       4,730       10,576       5,370  
General and administrative
    4,938       2,087       6,113       2,793  
Total                                                              
  $ 26,397     $ 13,345     $ 33,490     $ 14,770  
_________________________________________
(*)
For the three months ended August 28, 2009 and August 29, 2008, we recorded $0.1 million and $2.1 million, respectively, associated with cash recoveries of fringe benefit tax from employees in India.
 
Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the nine months ended August 28, 2009 and August 29, 2008 were as follows (in thousands):
 
   
2009
   
2008
 
 
Income Statement Classifications
 
 
Option Grants
and Stock
Purchase Rights(*)
   
Restricted
Stock and
Performance
Share
Awards(*)
   
Option Grants
and Stock
Purchase Rights(*)
   
Restricted
Stock and
Performance
Share
Awards(*)
 
Cost of revenue—services and support
  $ 1,595     $ 527     $ 2,968     $ 483  
Research and development
    35,317       21,271       43,382       16,380  
Sales and marketing
    27,681       14,565       31,701       15,558  
General and administrative
    19,220       6,962       18,841       10,368  
Total                                                              
  $ 83,813     $ 43,325     $ 96,892     $ 42,789  
_________________________________________
(*)           For the nine months ended August 28, 2009 and August 29, 2008, we recorded $0.9 million and $2.1 million, respectively, associated with cash recoveries of fringe benefit tax from employees in India.

NOTE 9. EMPLOYEE BENEFIT PLAN
 
Deferred Compensation Plan
 
As of August 28, 2009 and November 28, 2008, the invested amounts under our Deferred Compensation Plan totaled $8.5 million and $7.6 million, respectively, and are recorded as other assets on our Condensed Consolidated Balance Sheets. As of August 28, 2009 and November 28, 2008, we recorded $8.5 million and $7.6 million, respectively, as a long-term liability to recognize undistributed deferred compensation due to employees.
 
NOTE 10. RESTRUCTURING CHARGES
 
Fiscal 2008 Restructuring Charges
 
In the fourth quarter of fiscal 2008, we initiated a restructuring program, consisting of reductions in workforce of approximately 560 full-time positions globally and the consolidation of facilities, in order to reduce our operating costs and focus our resources on key strategic priorities. In connection with this restructuring program, we recorded restructuring charges in the fourth quarter of fiscal 2008 totaling $29.2 million related to termination benefits for the elimination of approximately 460 of the 560 full-time positions globally. Charges associated with these ongoing termination benefits were recorded in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits.” As of November 28, 2008, $0.4 million was paid.
 
 
20

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


In the first quarter of fiscal 2009, we continued to implement restructuring activities under this program. We vacated approximately 89,000 square feet of research and development and sales facilities in the U.S., the United Kingdom and Canada.  In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” we accrued $8.5 million for the fair value of our future contractual obligations under these operating leases using our credit-adjusted risk-free interest rate, estimated at approximately 6% as of the date we ceased to use the leased properties. This amount is net of the fair value of future estimated sublease income of approximately $4.4 million. We also recorded charges of $3.4 million for termination benefits for the elimination of approximately 43 of the remaining 100 full-time positions expected to be terminated.
 
In the second quarter of fiscal 2009, we accrued an additional $3.0 million under this program for termination benefits related to the elimination of approximately 48 of the remaining 57 full-time positions expected to be terminated.
 
In the third quarter of fiscal 2009, we accrued an additional $0.4 million under this program for termination benefits related to the elimination of substantially all of the remaining full-time positions expected to be terminated.
 
The following table sets forth a summary of Adobe restructuring activities during the nine months ended August 28, 2009 (in thousands):
 
   
November 28,
2008
   
Costs Incurred
   
Cash
Payments
   
Other Adjustments
   
August 28,
2009
   
Total Costs
Incurred to
Date
   
Total
Costs
Expected
to be
Incurred
 
Termination benefits
  $ 28,759     $ 6,722     $ (34,042 )   $ 174     $ 1,613     $ 36,102     $ 36,121  
Cost of closing redundant facilities
           8,514       (4,488 )     613       4,639       9,127       9,601  
Total
  $ 28,759     $ 15,236     $ (38,530 )   $ 787     $ 6,252     $ 45,229     $ 45,722  

 
Accrued restructuring charges of approximately $6.3 million at August 28, 2009 include $3.3 million recorded in accrued restructuring, current and $3.0 million related to long-term facilities obligations recorded in accrued restructuring, non-current in the accompanying Condensed Consolidated Balance Sheets. We expect to pay substantially all of the accrued termination benefits during the remainder of fiscal 2009. We expect to pay facilities-related liabilities through fiscal 2013.
 
Included in the other adjustments column are foreign currency translation adjustments of $0.5 million and small changes to previous estimates.
 
Macromedia Merger Restructuring Charges
 
We completed our acquisition of Macromedia on December 3, 2005. In connection with this acquisition, we initiated plans to restructure both the pre-merger operations of Adobe and Macromedia to eliminate certain duplicative activities, focus our resources on future growth opportunities and reduce our cost structure. In connection with the worldwide restructuring plan, we recognized costs related to termination benefits for employee positions that were eliminated and for the closure of duplicative facilities. We also recognized costs related to the cancellation of certain contracts associated with the wind-down of subsidiaries and other service contracts held by Macromedia.  Costs for termination benefits and contract terminations were completed during fiscal 2007. Total costs incurred were $27.0 million and $3.2 million, respectively.

The following table sets forth a summary of Macromedia restructuring activities during the nine months ended August 28, 2009 (in thousands):
 
   
November 28,
2008
   
Cash
Payments
   
Other Adjustments
   
August 28,
2009
   
Total Costs
Incurred to
Date
   
Total
Costs
Expected
to be
Incurred
 
Cost of closing redundant facilities
  $ 12,168     $ (3,986 )   $ (1,255 )   $ 6,927     $ 41,060     $ 41,060  
Other
    977       (879 )     (80 )     18       2,277       2,277  
Total
  $ 13,145     $ (4,865 )   $ (1,335 )   $ 6,945     $ 43,337     $ 43,337  

 
21

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
Accrued restructuring charges of approximately $6.9 million at August 28, 2009 related to facilities obligations include $5.0 million recorded in accrued restructuring, current and $1.9 million recorded in accrued restructuring, non-current in the accompanying Condensed Consolidated Balance Sheets. We expect to pay these liabilities through fiscal 2012. At November 28, 2008, accrued restructuring charges of $13.1 million related to long-term facilities obligations included $6.9 million recorded in accrued restructuring, current and $6.2 million recorded in accrued restructuring, non-current in the accompanying Condensed Consolidated Balance Sheets.
 
Included in the other adjustments column is a change to previous estimates of $1.3 million and small foreign currency translation adjustments. Included in the change in previous estimates of $1.3 million is an adjustment of $1.7 million associated with an accrual for a leased facility that was included in the purchase price of Macromedia as an assumed liability. During the third quarter of fiscal 2009, adjustments were made to the liability for this lease facility that were recorded as a reduction to Macromedia goodwill. Accordingly, during the nine months ended August 28, 2009, only $0.4 million represents adjustments recorded as an increase to restructuring charges.
 
NOTE 11.  STOCKHOLDERS’ EQUITY

Stock Repurchase Program I
 
To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we repurchase shares in the open market and also enter into structured repurchases with third-parties.
 
During the nine months ended August 28, 2009 and August 29, 2008, we entered into several structured repurchase agreements with large financial institutions, whereupon we provided the financial institutions with prepayments of $350.0 million and $325.0 million, respectively. We entered into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is higher than the foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.
 
The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. During the nine months ended August 28, 2009, we repurchased approximately 9.9 million shares at an average price of $25.31 through structured repurchase agreements, which included prepayments from fiscal 2008 and 2009. During the nine months ended August 29, 2008, we repurchased 19.0 million shares at an average price of $37.12 through structured repurchase agreements, which included prepayments from fiscal 2007.  During the nine months ended August 29, 2008, we also repurchased 0.75 million shares at an average price of $39.19 in open market transactions.
 
As of August 28, 2009 and November 28, 2008, prepayments were classified as treasury stock on our Condensed Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by the financial statement date are excluded from the denominator in the computation of earnings per share. As of August 28, 2009 and August 29, 2008, approximately $233.9 million and $41.0 million, respectively, of up-front payments remained under the agreements.
 
Stock Repurchase Program II
 
Under this stock repurchase program, we had authorization to repurchase 50.0 million shares of our common stock. From the inception of the 50.0 million share authorization under this program, we provided prepayments of $1.9 billion under structured share repurchase agreements to large financial institutions. During the third quarter of fiscal 2008, the remaining authorized number of shares were repurchased.
 
During the nine months ended August 29, 2008, we provided prepayments of $1.0 billion and repurchased 31.9 million shares through structured share repurchase agreements at an average price of $37.15. As of August 29, 2008, there

 
22

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
were no up-front payments remaining under these agreements. During the nine months ended August 29, 2008, we also repurchased 0.5 million shares at an average price of $39.79 in open market transactions.
 
NOTE 12.  COMPREHENSIVE INCOME
 
The following table sets forth the activity for each component of other comprehensive income, net of related taxes (income tax effects were insignificant for all periods presented), for the three and nine months ended August 28, 2009 and August 29, 2008 (in thousands):
 
   
Three Months
   
Nine Months
 
   
2009
   
2008
   
2009
   
2008
 
Net income
  $ 136,045     $ 191,608     $ 418,551     $ 625,897  
Other comprehensive income (loss):
                               
Unrealized gains (losses) on available-for-sale securities
    278       (1,954 )     1,856       (11,158 )
Reclassification adjustment for (gains) losses on available-for-sale securities recognized during the period
    (2,449 )     (44 )     (5,026 )     157  
Unrealized (losses) gains on derivative instruments
    (329 )     10,494       (14,516 )     10,776  
Reclassification adjustment for gains on derivative instruments recognized during the period
    (749 )           (27,138 )      
Foreign currency translation adjustments
    (2,333 )     (6,358 )     9,330       (4,284 )
Other comprehensive (loss) income
    (5,582 )     2,138       (35,494 )     (4,509 )
Total other comprehensive income, net of taxes
  $ 130,463     $ 193,746     $ 383,057     $ 621,388  
 
The following table sets forth the components of accumulated other comprehensive income, net of related taxes, as of August 28, 2009 and November 28, 2008 (in thousands):
 
   
2009
   
2008
 
Net unrealized gains on available-for-sale securities:
           
Unrealized gains on available-for-sale securities
  $ 12,844     $ 16,062  
Unrealized losses on available-for-sale securities
    (107 )     (155 )
Total net unrealized gains on available-for-sale securities
    12,737       15,907  
Net unrealized gains on derivative instruments
    96       41,750  
Cumulative foreign currency translation adjustments
    8,895       (435 )
Total accumulated other comprehensive income, net of taxes
  $ 21,728     $ 57,222  
 
NOTE 13.  NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the three and nine months ended August 28, 2009 and August 29, 2008 (in thousands, except per share data):
 
   
Three Months
   
Nine Months
 
   
2009
   
2008
   
2009
   
2008
 
Net income
  $ 136,045     $ 191,608     $ 418,551     $ 625,897  
Shares used to compute basic net income per share
    525,911       531,060       528,015       542,624  
Dilutive potential common shares:
                               
Unvested restricted stock and performance share awards
    1,940       1,063       1,696       991  
Stock options
    3,958       9,188       3,135       9,124  
Shares used to compute diluted net income per share
    531,809       541,311       532,846       552,739  
Basic net income per share
  $ 0.26     $ 0.36     $ 0.79     $ 1.15  
Diluted net income per share
  $ 0.26     $ 0.35     $ 0.79     $ 1.13  

 
23

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
For the three and nine months ended August 28, 2009, options to purchase approximately 24.5 million and 30.6 million shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock of $30.40 and $24.99, respectively, were not included in the calculation because the effect would have been anti-dilutive. Comparatively, for the three and nine months ended August 29, 2008, options to purchase approximately 14.4 million and 15.4 million shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock of $42.06 and $39.21, respectively, were not included in the calculation because the effect would have been anti-dilutive.
 
NOTE 14.  COMMITMENTS AND CONTINGENCIES
 
Lease Commitments
 
We occupy three office buildings in San Jose, California where our corporate headquarters are located. We reference these office buildings as the Almaden Tower and the East and West Towers.
 
In August 2004, we extended the lease agreement for our East and West Towers for an additional five years with an option to extend for an additional five years solely at our election. In June 2009, we submitted notice to the lessor that we intended to exercise our option to renew this agreement for an additional five years effective August 2009.  As stated in the original lease agreement, in conjunction with the lease renewal, we were required to obtain a standby letter of credit for approximately $16.5 million which enabled us to secure a lower interest rate and reduce the number of covenants. As defined in the lease agreement, the standby letter of credit primarily represents the lease investment balance equity which is callable in the event of default.  In March 2007, the Almaden Tower lease was extended for five years, with a renewal option for an additional five years solely at our election. As part of the lease extensions, we purchased the lease receivable from the lessor of the East and West Towers for $126.8 million and a portion of the lease receivable from the lessor of the Almaden Tower for $80.4 million, both of which are recorded as investments in lease receivables on our Condensed Consolidated Balance Sheets. This purchase may be credited against the residual value guarantee if we purchase the properties or will be repaid from the sale proceeds if the properties are sold to third-parties. Under the agreement for the East and West Towers and the agreement for the Almaden Tower, we have the option to purchase the buildings at any time during the lease term for approximately $143.2 million and $103.6 million, respectively. The residual value guarantees under the East and West Towers and the Almaden Tower obligations are $126.8 million and $89.4 million, respectively.
 
These two leases are both subject to standard covenants including certain financial ratios that are reported to the lessors quarterly. As of August 28, 2009, we were in compliance with all covenants. In the case of a default, the lessor may demand we purchase the buildings for an amount equal to the lease balance, or require that we remarket or relinquish the buildings. Both leases qualify for operating lease accounting treatment under SFAS No. 13, “Accounting for Leases,” and, as such, the buildings and the related obligations are not included on our Condensed Consolidated Balance Sheets. We utilized this type of financing in order to access bank-provided funding at the most favorable rates and to provide the lowest total cost of occupancy for the headquarter buildings. At the end of the lease term, we can extend the lease for an additional five year term, purchase the buildings for the lease balance, remarket or relinquish the buildings. If we choose to remarket or are required to do so upon relinquishing the buildings, we are bound to arrange the sale of the buildings to an unrelated party and will be required to pay the lessor any shortfall between the net remarketing proceeds and the lease balance, up to the residual value guarantee amount.
 
Guarantees
 
The lease agreements for our corporate headquarters provide for residual value guarantees as noted above. Under FIN 45, the fair value of a residual value guarantee in lease agreements entered into after December 31, 2002 must be recognized as a liability on our Condensed Consolidated Balance Sheets. As such, we recognized $5.2 million and $3.0 million in liabilities, related to the East and West Towers and Almaden Tower leases, respectively. These liabilities are recorded in other long-term liabilities with the offsetting entry recorded as prepaid rent in other assets. The balance will be amortized to the income statement over the life of the leases. As of August 28, 2009 and November 28, 2008, the unamortized portion of the fair value of the residual value guarantees, for both leases, remaining in other long-term liabilities and prepaid rent was $1.5 million and $2.6 million, respectively.

 
24

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)
 
 
Royalties
 
We have royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.
 
Indemnifications
 
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third-parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.
 
To the extent permitted under Delaware law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.
 
As part of our limited partnership interest in Adobe Ventures, we have provided a general indemnification to Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures, for certain events or occurrences while Granite Ventures is, or was serving, at our request in such capacity provided that Granite Ventures acts in good faith on behalf of the partnership. We are unable to develop an estimate of the maximum potential amount of future payments that could potentially result from any hypothetical future claim, but believe the risk of having to make any payments under this general indemnification to be remote.
 
Legal Proceedings
 
On September 23, 2009, Richard Miner on behalf of himself and all similarly situated stockholders of Omniture, Inc. filed a class action lawsuit captioned Miner v. Omniture, Inc.,  et. al., Case No. 090403559 (the “Miner Lawsuit”) against Omniture, the members of Omniture’s board of directors (collectively, the “Omniture Defendants”) and Adobe in the United States Fourth Judicial District Court for Utah County, Provo Department, State of Utah seeking to enjoin the proposed acquisition between Omniture and Adobe.  In the event the acquisition is consummated, the plaintiff seeks to recover an unspecified amount of damages. The plaintiff alleges that the members of Omniture’s board of directors breached their fiduciary duties to Omniture’s stockholders by failing to seek the highest possible price for Omniture and that Adobe induced or aided and abetted in the alleged breach of such fiduciary duties. Also on September 23, 2009, Christopher R. Barrell filed a substantially similar lawsuit to the Miner Lawsuit in the United States Fourth Judicial District Court for Utah County, Provo Department, State of Utah, captioned Barrell v. Omniture, Inc. et. al., Case No. 090403560 (the “Barrell Lawsuit”). The Barrell Lawsuit names the same defendants as the Miner Lawsuit, and also names Snowbird Acquisition Corporation as an additional defendant. Subsequently, on September 24, 2009, the plaintiff in the Barrell Lawsuit filed an amended complaint, which added allegations that the Schedule 14D-9 Solicitation/Recommendation Statement filed by Omniture on September 24, 2009 contained inadequate disclosures and was materially misleading.  On September 25, 2009, the Omniture Defendants filed a motion requesting that the court consolidate the Barrell Lawsuit, Miner Lawsuit and a substantially similar lawsuit captioned Lodhia v. Omniture, Inc. et al., Case No. 090403499 (the “Lodhia Lawsuit”) in which the Omniture Defendants, but not Adobe, were named. Additionally, on September 30, 2009, the plaintiff in the Lodhia Lawsuit filed a response to defendants’ motion to consolidate, agreeing consolidation is appropriate, and also filed a motion seeking appointment as lead plaintiff in the consolidated action. The plaintiff in the Lodhia Lawsuit also filed a motion for preliminary injunction, expedited discovery and expedited proceedings. We have not yet responded to the complaints, but intend to defend the lawsuits vigorously.
 
       In connection with our anti-piracy efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other local laws. We believe we have valid defenses with
 
 
25

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
respect to such counter-claims; however, it is possible that our condensed consolidated financial position, cash flows or results of operations could be affected in any particular period by the resolution of one or more of these counter-claims.
 
From time to time, Adobe is subject to legal proceedings, claims and investigations in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. We believe that we have valid defenses with respect to the legal matters pending against Adobe; however, litigation is inherently unpredictable and it is possible that our condensed consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.
 
NOTE 15.  CREDIT AGREEMENT
 
In August 2007, we entered into an Amendment to our Credit Agreement dated February 2007 (the “Amendment”), which increased the total senior unsecured revolving facility from $500.0 million to $1.0 billion. The Amendment also permits us to request one-year extensions effective on each anniversary of the closing date of the original agreement, subject to the majority consent of the lenders. We also retain an option to request an additional $500.0 million in commitments, for a maximum aggregate facility of $1.5 billion.
 
In February 2008, we entered into a Second Amendment to the Credit Agreement dated February 26, 2008, which extended the maturity date of the facility by one year to February 16, 2013. The facility would terminate at this date if no additional extensions have been requested and granted. All other terms and conditions remain the same.
 
The facility contains a financial covenant requiring us not to exceed a certain maximum leverage ratio. At the Company’s option, borrowings under the facility accrue interest based on either the London interbank offered rate (“LIBOR”) for one, two, three or six months, or longer periods with bank consent, plus a margin according to a pricing grid tied to this financial covenant, or a base rate. The margin is set at rates between 0.20% and 0.475%. Commitment fees are payable on the facility at rates between 0.05% and 0.15% per year based on the same pricing grid. The facility is available to provide loans to us and certain of our subsidiaries for general corporate purposes. As of both August 28, 2009 and November 28, 2008, the amount outstanding under the credit facility was $350.0 million, which is included in long-term liabilities on our Condensed Consolidated Balance Sheets. As of August 28, 2009, we were in compliance with all of the covenants. Subsequent to August 28, 2009, we borrowed an additional $650.0 million under the credit facility. See Note 18 for further discussion of this transaction. The carrying value of the outstanding liability approximates fair value.
 
 
26

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
NOTE 16.  NON-OPERATING INCOME (EXPENSE)
 
Non-operating income (expense) for the three and nine months ended August 28, 2009 and August 29, 2008 included the following (in thousands):
 
   
Three Months
   
Nine Months
 
   
2009
   
2008
   
2009
   
2008
 
Interest and other income, net:
                       
Interest income
  $ 7,616     $ 14,407     $ 28,655     $ 45,110  
Foreign exchange losses
    (3,545 )     (5,967 )     (9,621 )     (11,901 )
Realized gains on fixed income investment
    2,449       85       5,027       1,184  
Realized losses on fixed income investment
          (41 )     (1 )     (1,340 )
Other, net
    147       854       693       1,725  
Interest and other income, net
  $ 6,667     $ 9,338     $ 24,753     $ 34,778  
Interest expense
  $ (460 )   $ (2,390 )   $ (1,872 )   $ (8,027 )
Investment gains (losses), net:
                               
Realized investment gains
  $     $ 2,861     $ 52     $ 18,298  
Unrealized investment gains
    2,019       2,882       3,396       7,840  
Realized investment losses
    (1,362 )     (353 )     (3,347 )     (989 )
Unrealized investment losses
    (50 )     (3,293 )     (18,545 )     (4,814 )
Investment gains (losses), net
  $ 607     $ 2,097     $ (18,444 )   $ 20,335  
Total non-operating income (expense), net
  $ 6,814     $ 9,045     $ 4,437     $ 47,086  

NOTE 17.  SEGMENTS
 
We have the following reportable segments: Creative Solutions, Knowledge Worker, Enterprise, Platform and Print and Publishing. Our Creative Solutions segment focuses on delivering a complete professional line of integrated tools for a full range of creative and developer tasks to an extended set of customers. The Knowledge Worker segment focuses on the needs of knowledge worker customers, providing essential applications and services to help them share information and collaborate. This segment contains revenue generated by Acrobat Connect and our Acrobat family of products. Our Enterprise segment provides server-based enterprise interaction solutions that automate people-centric processes and contains revenue generated by our LiveCycle line of products. The Platform segment includes client and developer technologies, such as Adobe Flash Player, Adobe Flash Lite, Adobe AIR, Adobe Flex and Adobe Flex Builder, and also encompasses products and technologies created and managed in other Adobe segments. Finally, the Print and Publishing segment addresses market opportunities ranging from the diverse publishing needs of technical and business publishing, to our legacy type and original equipment manufacturer (“OEM”) printing businesses.
 
Effective in the first quarter of fiscal 2009, our former Mobile and Devices Solutions segment, was integrated into our Platform business unit to better align our engineering and marketing efforts and is now reported as part of the Platform segment. Prior year information in the table below has been reclassified to reflect the integration of these business units.
 
We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments.
 
Our chief operating decision maker reviews revenue and gross margin information for each of our reportable segments. Operating expenses are not reviewed on a segment by segment basis. In addition, with the exception of goodwill and intangible assets, we do not identify or allocate our assets by the reportable segments.
 
 
27

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
(in thousands)
 
Creative
Solutions
   
Knowledge
Worker
   
Enterprise
   
Platform(*)
   
Print and
Publishing
   
Total
 
Three months ended August 28, 2009
                                   
Revenue
  $ 400,360     $ 154,517     $ 55,488     $ 44,935     $ 42,207     $ 697,507  
Cost of revenue
    34,903       9,870       10,957       4,946       4,371       65,047  
Gross profit
  $ 365,457     $ 144,647     $ 44,531     $ 39,989     $ 37,836     $ 632,460  
Gross profit as a percentage of revenue
    91 %     94 %     80 %     89 %     90 %     91 %
                                                 
Three months ended August 29, 2008
                                               
Revenue
  $ 493,615     $ 217,988     $ 65,491     $ 59,077     $ 51,086     $ 887,257  
Cost of revenue
    53,716       15,762       20,727       14,137       6,509       110,851  
Gross profit
  $ 439,899     $ 202,226     $ 44,764     $ 44,940     $ 44,577     $ 776,406  
Gross profit as a percentage of revenue
    89 %     93 %     68 %     76 %     87 %     88 %

_________________________________________
(*)           Platform revenue includes revenue related to our Mobile client products of $8.4 million and $27.5 million for the three months ended August 28, 2009 and August 29, 2008, respectively, or 19% and 47% of Platform revenues, respectively.

 
(in thousands)
 
Creative
Solutions
   
Knowledge
Worker
   
Enterprise
   
Platform(*)
   
Print and
Publishing
   
Total
 
Nine months ended August 28, 2009
                                   
Revenue
  $ 1,272,837     $ 473,670     $ 173,039     $ 134,053     $ 134,971     $ 2,188,570  
Cost of revenue
    117,225       30,088       36,175       16,420       14,500       214,408  
Gross profit
  $ 1,155,612     $ 443,582     $ 136,864     $ 117,633     $ 120,471     $ 1,974,162  
Gross profit as a percentage of revenue
    91 %     94 %     79 %     88 %     89 %     90 %
                                                 
Nine months ended August 29, 2008
                                               
Revenue
  $ 1,564,334     $ 611,925     $ 174,011     $ 155,037     $ 159,281     $ 2,664,588  
Cost of revenue
    124,024       39,475       56,308       35,347       21,038       276,192  
Gross profit
  $ 1,440,310     $ 572,450     $ 117,703     $ 119,690     $ 138,243     $ 2,388,396  
Gross profit as a percentage of revenue
    92 %     94 %     68 %     77 %     87 %     90 %

_________________________________________
(*)
Platform revenue includes revenue related to our Mobile client products of $42.9 million and $64.9 million for the nine months ended August 28, 2009 and August 29, 2008, respectively, or 32% and 42% of Platform revenues, respectively.
 
NOTE 18.  SUBSEQUENT EVENTS
 
Subsequent to August 28, 2009, we completed a business combination for cash consideration of approximately $35.3 million. This acquisition was not material to our consolidated balance sheets and results of operations. See Note 4 for further discussion of this transaction.
 
In September 2009, we entered into a definitive agreement with Omniture under which we expect to acquire Omniture for approximately $1.8 billion. Under the terms of the agreement, we have commenced a tender offer to acquire all of the outstanding common stock of Omniture for $21.50 per share in cash.  Omniture is an industry leader in Web analytics and online business optimization based in Orem, Utah. The transaction is subject to customary regulatory approvals and closing conditions and is expected to close in the fourth quarter of our fiscal 2009. Following the closing, we intend to integrate Omniture as a new reportable segment for financial reporting purposes.
 
Subsequent to August 28, 2009, we borrowed an additional $650.0 million under our credit facility to be used to fund a portion of our pending acquisition of Omniture. See Note 15 for further discussion of our credit facility.
 
 
28

 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion (unaudited and presented in millions, except share and per share amounts) should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.
 
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth and market opportunities, which involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors” in Part II, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission (the “SEC”), including the Annual Report on Form 10-K for fiscal 2008. When used in this report, the words “expects,” “could,” “would,” “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,”  “targets,” “estimates,” “looks for,” “looks to” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.
 
BUSINESS OVERVIEW
 
Founded in 1982, Adobe Systems Incorporated is one of the largest and most diversified software companies in the world. We offer a line of creative, business and mobile software and services used by creative professionals, designers, knowledge workers, consumers, original equipment manufacturers (“OEM”) partners, developers and enterprises for creating, managing, delivering and engaging with compelling content and experiences across multiple operating systems, devices and media. We distribute our products through a network of distributors and dealers, value-added resellers (“VARs”), systems integrators, independent software vendors (“ISVs”) and OEMs, direct to end users and through our Web site at www.adobe.com. We also license our technology to hardware manufacturers, software developers and service providers, and we offer integrated software solutions to businesses of all sizes. We have operations in the Americas, Europe, the Middle East and Africa (“EMEA”) and Asia. Our software runs on personal computers with Microsoft Windows, Apple OS, Linux, UNIX and various non-PC platforms, depending on the product.
 
We maintain executive offices and principal facilities at 345 Park Avenue, San Jose, California 95110-2704. Our telephone number is 408-536-6000. We maintain a Web site at www.adobe.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC Web site at www.sec.gov.
 
PENDING ACQUISITION
 
In September 2009, we entered into a definitive agreement with Omniture, Inc. ("Omniture") under which we expect to acquire Omniture for approximately $1.8 billion. Under the terms of the agreement, we have commenced a tender offer to acquire all of the outstanding common stock of Omniture for $21.50 per share in cash. Omniture is an industry leader in Web analytics and online business optimization based in Orem, Utah. The transaction is subject to customary regulatory approvals and closing conditions and is expected to close in the fourth quarter of our fiscal 2009. Following the closing, we intend to integrate Omniture as a new reportable segment for financial reporting purposes. We expect the acquisition to have a significant impact on our consolidated financial position, results of operations and cash flows. The discussions in this Quarterly Report on Form 10-Q relate to Adobe as a standalone entity and do not reflect the impact of the acquisition.
 
OPERATIONS OVERVIEW
 
Effective in the first quarter of fiscal 2009, our former Mobile and Devices Solutions segment, which was integrated into our Platform business unit to better align our engineering and marketing efforts, is now reported as part of the Platform segment. Prior year information has been updated to reflect the integration of these business units.
 
During the third quarter of fiscal 2009, our worldwide business continued to be impacted by the generally weak macro-economic environment. Although we believe our business in the United States (“U.S.”) has stabilized since our first fiscal quarter of this year, overall end-user demand for most of our products, particularly our Adobe Creative Suite family of products and our Adobe Acrobat family of products, remains weaker than comparable periods during fiscal 2008. Despite this impact on our overall revenue achievement, we continued to proactively control our costs to deliver earnings per share and profit margin results within the target ranges we publicly provided at the outset of the quarter.
 
 
29

 
In our Creative Solutions segment, revenue for our CS4 family of products continues to fall behind the revenue achieved for the equivalent CS3 products for the comparable period of time. We attribute this weakness to the economic conditions affecting the business of our creative professional customers. Based on economic predictions and market trends such as marketing and ad spending, we do not expect the market environment for creative products to improve materially in the near term.
 
Our Knowledge Worker segment also continued to be affected by a slow-down in demand, resulting in a year-over-year revenue decline. We attribute this weakness to reduced corporate spending due to the economy. We do not expect the market environment to improve materially in the near term.
 
In our Enterprise segment, although third quarter fiscal 2009 revenue grew sequentially from the revenue achieved in the second quarter of fiscal 2009, our revenue declined significantly on a year-over-year basis. We attribute this year-over-year decline to the macro impact from the economy which has resulted in reduced spending by our enterprise customers.
 
Our Platform segment revenue grew sequentially but declined on a year-over-year basis primarily due to lower revenue from licensing of our Flash Lite client technologies by mobile handset OEM and consumer electronic device manufacturers. We have stated we expect the May 1, 2008 announcement of the Open Screen Project to substantially reduce our mobile and device revenue this fiscal year due to the removal of licensing fees for Open Screen Project members on the next major releases of our Adobe Flash Platform technologies. Partially offsetting this revenue decline within our Platform segment is the build out of OEM relationships with companies in which we offer their applications as part of the download of our client technologies such as Adobe Reader, Adobe Flash Player and Adobe Shockwave Player.
 
Product revenues reported in our Print and Publishing business segment were also affected by end-user demand weakness because of economic conditions. We expect end-user demand weakness to continue in the near term.
 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
In preparing our Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.
 
We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, stock-based compensation, goodwill impairment and income taxes have the greatest potential impact on our Condensed Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules which require us to make judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
 
There have been no significant changes in our critical accounting policies and estimates during the nine months ended August 28, 2009 as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 28, 2008.
 
RESULTS OF OPERATIONS
 
Revenue for the Three and Nine Months Ended August 28, 2009 and August 29, 2008 (dollars in millions)
 
   
Three Months
   
Percent
   
Nine Months
   
Percent
 
   
2009
   
2008
   
Change
   
2009
   
2008
   
Change
 
Product
  $ 649.9     $ 838.9       (23 )%   $ 2,052.1     $ 2,532.1       (19 )%
Percentage of total revenue
    93 %     95 %             94 %     95 %        
Services and support
    47.6       48.4       (2 )%     136.5       132.5       3 %
Percentage of total revenue
    7 %     5 %             6 %     5 %        
Total revenue
  $ 697.5     $ 887.3       (21 )%   $ 2,188.6     $ 2,664.6       (18 )%

 
30

 
As described in Note 17 of our Notes to Condensed Consolidated Financial Statements, we have the following segments: Creative Solutions, Knowledge Worker, Enterprise, Platform and Print and Publishing.
 
Our services and support revenue is comprised of consulting, training, and maintenance and support, primarily related to the licensing of our enterprise, developer and platform products. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products. Our maintenance and support offerings which entitle customers to receive product upgrades and enhancements or technical support, depending on the offering, are recognized ratably over the term of the arrangement.
 
Segment Information (dollars in millions)
 
   
Three Months
   
Percent
   
Nine Months
   
Percent
 
   
2009
   
2008
   
Change
   
2009
   
2008
   
Change
 
Creative Solutions
  $ 400.4     $ 493.6       (19 )%   $ 1,272.8     $ 1,564.3       (19 )%
Percentage of total revenue
    57 %     56 %             58 %     59 %        
Knowledge Worker
    154.5       218.0       (29 )%     473.7       612.0       (23 )%
Percentage of total revenue
    22 %     25 %             22 %     23 %        
Enterprise
    55.5       65.5       (15 )%     173.0       174.0       (1 )%
Percentage of total revenue
    8 %     7 %             8 %     7 %        
Platform
    44.9       59.1       (24 )%     134.1       155.0       (13 )%
Percentage of total revenue
    7 %     7 %             6 %     5 %        
Print and Publishing
    42.2       51.1       (17 )%     135.0       159.3       (15 )%
Percentage of total revenue
    6 %     5 %             6 %     6 %        
Total revenue
  $ 697.5     $ 887.3       (21 )%   $ 2,188.6     $ 2,664.6       (18 )%

Revenue from Creative Solutions decreased $93.2 million and $291.5 million during the three and nine months ended August 28, 2009, respectively, as compared to the three and nine months ended August 29, 2008. This decrease during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008 was driven largely by a 15% and 16% decline in Creative Suites related revenue and a decline of 28% and 27% in Photoshop point product revenue, respectively. Also contributing to the decrease during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008 was an overall decline in the number of units licensed. Average unit selling prices have remained relatively consistent.

Revenue from Knowledge Worker decreased $63.5 million and $138.3 million during the three and nine months ended August 28, 2009, respectively, as compared to the three and nine months ended August 29, 2008, primarily due to a decrease in revenue from our Acrobat family of products. We attribute the decline in revenue during the three and nine months ended August 28, 2009 compared to the three and nine months ended August 29, 2008 to lower volume licensing by our enterprise customers, as well as a decrease in the number of units sold through our shrink-wrap distribution channel. Average unit selling prices have remained relatively consistent.

Revenue from Enterprise decreased $10.0 million during the three months ended August 28, 2009, as compared to the three months ended August 29, 2008. Revenue from Enterprise was relatively consistent during the nine months ended August 28, 2009, as compared to the nine months ended August 29, 2008. The decrease in Enterprise revenue during the three months ended August 28, 2009, as compared to the three months ended August 29, 2008 was primarily due to the economy’s impact on corporate spending in the markets we target with our LiveCycle product line.
 
Revenue from Platform decreased $14.2 million and $20.9 million during the three and nine months ended August 28, 2009, respectively, compared to the three and nine months ended August 29, 2008. The decrease was primarily due to lower mobile revenue from OEM partners who license our Flash Lite product.
 
Revenue from Print and Publishing decreased $8.9 million and $24.3 million during the three and nine months ended August 28, 2009, respectively, compared to the three and nine months ended August 29, 2008. The decrease resulted principally from a slight decline in revenue associated with our PostScript products.
 
 
 
31

 
Geographical Information (dollars in millions)
 
   
Three Months
   
Percent
   
Nine Months
   
Percent
 
   
2009
   
2008
   
Change
   
2009
   
2008
   
Change
 
Americas
  $ 354.6     $ 429.6       (17 )%   $ 998.5     $ 1,210.3       (18 )%
Percentage of total revenue
    51 %     49 %             46 %     46 %        
EMEA
    196.2       296.0       (34 )%     688.9       914.5       (25 )%
Percentage of total revenue
    28 %     33 %             31 %     34 %        
Asia
    146.7       161.7       (9 )%     501.2       539.8       (7 )%
Percentage of total revenue
    21 %     18 %             23 %     20 %        
Total revenue
  $ 697.5     $ 887.3       (21 )%   $ 2,188.6     $ 2,664.6       (18 )%
 
Overall revenue for the three and nine months ended August 28, 2009 decreased when compared to the three and nine months ended August 29, 2008 primarily due to a reduction in the adoption and licensing of our Creative Suite and Acrobat families of products.
 
Revenue in the Americas decreased $75.0 million and $211.8 million during the three and nine months ended August 28, 2009, respectively, compared to the three and nine months ended August 29, 2008, primarily due to economic conditions resulting in weaker demand for our creative and knowledge worker products.
 
Revenue in EMEA decreased $99.8 million and $225.6 million during the three and nine months ended August 28, 2009, respectively, compared to the three and nine months ended August 29, 2008, primarily due to weaker demand with our creative and knowledge worker products.
 
Revenue in Asia decreased $15.0 million and $38.6 million during the three and nine months ended August 28, 2009, respectively, compared to the three and nine months ended August 29, 2008, primarily due to economic conditions resulting in weaker demand and normal seasonal declines.
 
Included in the overall decrease in revenue were impacts associated with foreign currency. Revenue in EMEA measured in U.S. dollars decreased approximately $15.1 million and $63.1 million, due to the strength of the U.S. dollar against the Euro, during the three and nine months ended August 28, 2009, respectively, over the same reporting period last year. Our currency hedging program is used to mitigate a portion of the foreign currency impact to revenue. During the three and nine months ended August 28, 2009, our currency hedging program resulted in hedging gains of $0.2 million and $25.8 million, respectively. Revenue in Asia measured in U.S. dollars was favorably impacted by approximately $8.0 million and $26.5 million due to the strength of the Yen against the U.S. dollar during the three and nine months ended August 28, 2009, respectively, over the same reporting period last year.
 
Product Backlog
 
The actual amount of product backlog at any particular time may not be a meaningful indicator of future business prospects. Backlog is comprised of unfulfilled orders, excluding those associated with new product releases, those pending credit review and those not shipped due to the application of our global inventory policy. As of August 28, 2009, our backlog was approximately 2% of third quarter fiscal 2009 revenue as compared to backlog of approximately 4% of second quarter fiscal 2009 revenue.
 
Cost of Revenue for the Three and Nine Months Ended August 28, 2009 and August 29, 2008 (dollars in millions)
 
   
Three Months
   
Percent
   
Nine Months
   
Percent
 
   
2009
   
2008
   
Change
   
2009
   
2008
   
Change
 
Product
  $ 49.3     $ 84.7       (42 )%   $ 164.0     $ 202.7       (19 )%
Percentage of total revenue
    7 %     10 %             7 %     8 %        
Services and support
    15.7       26.2       (40 )%     50.4       73.5       (31 )%
Percentage of total revenue
    2 %     3 %             2 %     3 %        
Total cost of revenue
  $ 65.0     $ 110.9       (41 )%   $ 214.4     $ 276.2       (22 )%
 
 
32

 
Product
 
Cost of product revenue includes product packaging, third-party royalties, excess and obsolete inventory, amortization related to localization costs and acquired rights to use technology and the costs associated with the manufacturing of our products.
 
Cost of product revenue increased (decreased) due to the following:
 
   
Percent Change
2008 to 2009
QTD
   
Percent Change
2008 to 2009
YTD
 
Hosted services
    4 %     5 %
Royalty cost
    1       3  
Excess and obsolete inventory
    (3 )      
Amortization of acquired rights to use technology
    (31 )     (11 )
Localization costs related to our product launches
    2       (1 )
Amortization of purchased intangibles
    (10 )     (12 )
Various individually insignificant items
    (5 )     (3 )
Total change
    (42 )%     (19 )%

The increase in hosted service costs was primarily related to the amortization of capitalized infrastructure costs for the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008.
 
The decrease in amortization of acquired rights to use technology primarily relates to a charge for historical use of licensing rights associated with certain technology licensing arrangements entered into in the third quarter of fiscal 2008 that did not recur in the third quarter of fiscal 2009.
 
Amortization of purchased intangibles decreased during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008, primarily due to a decrease in amortization expense associated with intangible assets purchased through the Macromedia acquisition, which are expected to be fully amortized at the end of fiscal 2009.
 
Services and Support
 
Cost of services and support revenue is primarily comprised of employee-related costs and associated costs incurred to provide consulting services, training and product support.
 
Cost of services and support revenue decreased during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008, primarily due to decreases in compensation and related benefits driven by headcount reductions.
 
Operating Expenses for the Three and Nine Months Ended August 28, 2009 and August 29, 2008 (dollars in millions)
 
Research and Development, Sales and Marketing, and General and Administrative Expenses
 
Compensation costs decreased for the three and nine months ended August 28, 2009 primarily due to lower profit sharing and employee bonuses based on company performance to date, when compared to the three and nine months ended August 29, 2008.
 
Research and Development
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Expenses
  $ 138.9     $ 170.1       (18 )%   $ 427.3     $ 508.9       (16 )%
Percentage of total revenue
    20 %     19 %             20 %     19 %        
 
Research and development expenses consist primarily of salary and benefit expenses for software developers, contracted development efforts, related facilities costs and expenses associated with computer equipment used in software development.
 
 
33

 
Research and development expenses decreased due to the following:
 
   
Percent Change
2008 to 2009
QTD
   
Percent Change
2008 to 2009
YTD
 
Compensation associated with incentive compensation and stock-based compensation
    (16 )%     (13 )%
Various individually insignificant items
    (2 )     (3 )
Total change
    (18 )%     (16 )%
 
We believe that investments in research and development, including the recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced products. We will continue to focus on long-term opportunities available in our end markets and make significant investments in the development of our desktop application and server-based software products.
 
Sales and Marketing
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Expenses
  $ 231.3     $ 271.4       (15 )%   $ 724.0     $ 813.4       (11 )%
Percentage of total revenue
    33 %     31 %             33 %     31 %        
 
Sales and marketing expenses consist primarily of salary and benefit expenses, sales commissions, travel expenses and related facilities costs for our sales, marketing, order management and global supply chain management personnel. Sales and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows, public relations and other market development programs.
 
Sales and marketing expenses decreased due to the following:
 
   
Percent Change
2008 to 2009
QTD
   
Percent Change
2008 to 2009
YTD
 
Marketing spending related to product launches and overall marketing efforts to further increase revenue
    (3 )%     %
Compensation associated with incentive compensation and stock-based compensation
    (8 )     (7 )
Various individually insignificant items
    (4 )     (4 )
Total change
    (15 )%     (11 )%
 
General and Administrative
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Expenses
  $ 79.6     $ 97.2       (18 )%   $ 224.5     $ 257.2       (13 )%
Percentage of total revenue
    11 %     11 %             10 %     10 %        
 
General and administrative expenses consist primarily of compensation and benefit expenses, travel expenses and related facilities costs for our finance, facilities, human resources, legal, information services and executive personnel. General and administrative expenses also include outside legal and accounting fees, provision for bad debts, expenses associated with computer equipment and software used in the administration of the business, charitable contributions and various forms of insurance.
 
 
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General and administrative expenses increased (decreased) due to the following:
 
   
Percent Change
2008 to 2009
QTD
   
Percent Change
2008 to 2009
YTD
 
Provision for bad debts
    (5 )%     %
Facilities and telecommunication
    (2 )     (2 )
Professional and consulting fees
    (18 )     (6 )
Compensation associated with incentive compensation and stock-based compensation
    (8 )     (8 )
Charitable contributions
    10        
Various individually insignificant items
    5       3  
Total change
    (18 )%     (13 )%

The decrease in professional and consulting fees during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008 was primarily due to additional fees incurred in the third quarter of fiscal 2008 to avoid litigation costs in connection with intellectual property arrangements that did not recur during fiscal 2009.
 
The increase in charitable contributions during the three months ended August 28, 2009 reflects a change in the timing of contributions to the Adobe Foundation.
 
Restructuring Charges
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Expenses
  $
    $ 1.2       *     $ 15.9     $ 2.6       *  
Percentage of total revenue
    *       *               1 %     *          
_________________________________________
 
*
Percentage is not meaningful.
 
In the fourth quarter of fiscal 2008, we initiated a restructuring program, consisting of reductions in workforce of approximately 560 full-time positions globally and the consolidation of facilities, in order to reduce our operating costs and focus our resources on key strategic priorities. In connection with this restructuring program, we recorded restructuring charges totaling $29.2 million related to termination benefits for the elimination of approximately 460 of the 560 full-time positions globally. As of November 28, 2008, $0.4 million was paid.
 
In the first quarter of fiscal 2009, we continued to implement restructuring activities under this program. We vacated approximately 89,000 square feet of research and development and sales facilities in the U.S., the United Kingdom and Canada.  In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146”), we accrued $8.5 million for the fair value of our future contractual obligations under these operating leases using our credit-adjusted risk-free interest rate, estimated at approximately 6% as of the date we ceased to use the leased properties. This amount is net of the fair value of future estimated sublease income of approximately $4.4 million. We also recorded charges of $3.4 million for termination benefits for the elimination of approximately 43 of the remaining 100 full-time positions expected to be terminated.
 
In the second quarter of fiscal 2009, we accrued an additional $3.0 million under this program for termination benefits related to the elimination of approximately 48 of the remaining 57 full-time positions expected to be terminated.
 
In the third quarter of fiscal 2009, we accrued an additional $0.4 million under this program for termination benefits related to the elimination of substantially all of the remaining full-time positions expected to be terminated.
 
As of August 28, 2009, accrued restructuring charges related to the 2008 restructuring program and the Macromedia acquisition totaled approximately $6.3 million and $6.9 million, respectively. We expect to pay these liabilities through fiscal 2013 and fiscal 2012, respectively.
 
Amortization of Purchased Intangibles
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Expenses
  $ 15.0     $ 17.0       (12 )%   $ 45.7     $ 51.2       (11 )%
Percentage of total revenue
    2 %     2 %             2 %     2 %        
 
 
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Amortization expense decreased during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008, due to a decrease in amortization expense associated with intangible assets purchased through the Macromedia acquisition.
 
Non-Operating Income (Expense) for the Three and Nine Months Ended August 28, 2009 and August 29, 2008 (dollars in millions)
 
   
Three Months
   
Percent
   
Nine Months
   
Percent
 
   
2009
   
2008
   
Change
   
2009
   
2008
   
Change
 
Interest and other income, net
  $ 6.7     $ 9.3       (28 )%   $ 24.8     $ 34.8       (29 )%
Percentage of total revenue
    1 %     1 %             1 %     1 %        
Interest expense
    (0.5 )     (2.4 )     (79 )%     (1.9 )     (8.0 )     (76 )%
Percentage of total revenue
    *       *               *       *          
Investment gains (losses), net
    0.6       2.1       (71 )%     (18.5 )     20.3       (191 )%
Percentage of total revenue
    *       *               (1 )%     1 %        
Total non-operating income, net
  $ 6.8     $ 9.0       (24 )%   $ 4.4     $ 47.1       (91 )%
_________________________________________
 
*
Percentage is not meaningful.
 
Interest and Other Income, Net
 
Interest and other income, net, consists primarily of interest earned on cash, cash equivalents and short-term fixed income investments. Interest and other income, net also includes foreign exchange gains and losses, including those from hedging revenue transactions primarily denominated in Japanese Yen and Euro currencies.
 
Interest and other income, net, decreased during the three and nine months ended August 28, 2009 as compared to the three and nine months ended August 29, 2008 primarily due to lower interest rates, partially offset by realized gains on sales of fixed income securities and lower foreign exchange losses.
 
Interest Expense
 
Interest expense for the three and nine months ended August 28, 2009, primarily represents interest associated with our credit facility. The outstanding balance as of August 28, 2009 was $350.0 million. Interest due under the credit facility is paid upon expiration of the LIBOR contract or at a minimum, quarterly. The decline in interest expense was primarily due to lower interest rates.
 
Investment Gains (Losses), Net
 
Investment gains (losses), net, consist principally of realized gains or losses from the sale of marketable equity investments, other-than-temporary declines in the value of marketable and non-marketable equity securities, unrealized holding gains and losses associated with our deferred compensation plan assets (classified as trading securities), and gains and losses of Adobe Ventures. Net investment gains for the three months ended August 28, 2009 were primarily due to unrealized gains related to our Adobe Ventures. Net investment losses for the nine months ended August 28, 2009 were primarily due to unrealized losses related to our Adobe Ventures and direct investments.  Investment gains for the three and nine months ended August 29, 2008 were principally due to gains from a direct investment. Additionally, during the nine months ended August 29, 2008, we received cash and recognized a gain resulting from the expiration of the escrow period related to the sale of our investment in Atom Entertainment, Inc. that occurred during the fourth quarter of fiscal 2006.
 
Provision for Income Taxes for the Three and Nine Months Ended August 28, 2009 and August 29, 2008 (dollars in millions)
 
   
Three Months
 
Percent
 
Nine Months
 
Percent
   
2009
   
2008
 
Change
 
2009
   
2008
 
Change
Provision
  $ 38.4     $ 36.9       4 %   $ 122.8     $ 176.3       (30 )%
Percentage of total revenue
    6 %     4 %             6 %     7 %        
Effective tax rate
    22 %     16 %             23 %     22 %        
 
Our effective tax rates increased approximately 6% and 1% during the three and nine months ended August 28, 2009, respectively, as compared to the three and nine months ended August 29, 2008. These increases were primarily related
 
 
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to the completion during the third quarter of fiscal 2008 of a U.S. income tax examination covering our fiscal years 2001 through 2004, partially offset by the availability of the U.S. research and development credit during fiscal 2009, which was not in effect during fiscal 2008 until our fourth quarter.
 
Summary of FIN 48
 
Under FIN No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109” (“FIN 48”), the gross unrecognized tax benefits at August 28, 2009 were $137.3 million, exclusive of interest and penalties. If the total unrecognized tax benefits at August 28, 2009 were recognized in the future, the following amounts, net of an estimated $10.1 million federal benefit related to deducting certain payments on future tax returns, would result: $53.7 million of unrecognized tax benefits would decrease the effective tax rate and $73.5 million would decrease goodwill.
 
As of August 28, 2009, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns and included in non-current income taxes payable was approximately $15.7 million.
 
The accounting treatment related to certain unrecognized tax benefits from acquired companies, including Macromedia, will change when SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) becomes effective. SFAS 141R will be effective in the first quarter of our fiscal 2010. At such time, any changes to the recognition or measurement of these unrecognized tax benefits will be recorded through income tax expense, where currently the accounting treatment would require any adjustment to be recognized through the purchase price as an adjustment to goodwill.

The timing of the resolution of income tax examinations is highly uncertain and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. While it is reasonably possible that some issues in the IRS and other examinations could be resolved within the next twelve months, based upon the current facts and circumstances, we cannot estimate the timing of such resolution or range of potential changes as it relates to the unrecognized tax benefits that are recorded as part of our financial statements. We do not expect any material settlements in the next twelve months but it is inherently uncertain to determine.
 
LIQUIDITY AND CAPITAL RESOURCES
 
This data should be read in conjunction with our Condensed Consolidated Statements of Cash Flows.
 

(in millions)
 
August 28,
2009
   
November 28,
2008
 
Cash, cash equivalents and short-term investments
  $ 2,556.5     $ 2,019.2  
Working capital
  $ 2,376.6     $ 1,972.5  
Stockholders’ equity
  $ 4,694.6     $ 4,410.4  
 
Summary of our cash flows (in millions):
 
   
August 28,
2009
   
August 29,
2008
 
Net cash provided by operating activities
  $ 863.9     $ 942.4  
Net cash used for investing activities
    (405.2 )     (5.1 )
Net cash used for financing activities
    (227.7 )     (747.6 )
Effect of foreign currency exchange rates on cash and cash equivalents
    14.7       (1.9 )
Net increase in cash and cash equivalents
  $ 245.7     $ 187.8  
 
Our primary source of cash is receipts from revenue. The primary uses of cash are payroll related expenses; general operating expenses including marketing, travel and office rent; and cost of product revenue. Another source of cash is proceeds from the exercise of employee options and participation in the employee stock purchase plan (“ESPP”).
 
Cash Flows from Operating Activities
 
Net cash provided by operating activities of $863.9 million for the nine months ended August 28, 2009, was primarily comprised of net income plus the net effect of non-cash expenses. The primary working capital sources of cash were net income coupled with decreases in trade receivables, prepaid expenses and other current assets. Trade receivables
 
 
37

 
decreased primarily from CS4 revenue that was shipped in the latter half of the fourth quarter of fiscal 2008 and collected during the first quarter of fiscal 2009, in addition to lower overall gross revenue and improved collections.

The primary working capital uses of cash were decreases in deferred revenue, accrued expenses, accrued restructuring and trade payables. Decreases in deferred revenue related primarily to deferred revenue that was recognized in the first quarter of fiscal 2009 associated with our free of charge upgrades for CS4 and Adobe Photoshop Lightroom products, as well as declines in maintenance and support orders. Accrued expenses decreased primarily due to payments for employee bonuses and commissions related to fiscal 2008. Accrued restructuring decreased primarily due to payments related to the 2008 restructuring program that was initiated in the fourth quarter of fiscal 2008, offset in part by new charges.
 
Cash Flows from Investing Activities
 
Net cash used for investing activities of $405.2 million for the nine months ended August 28, 2009 was primarily due to purchases of short-term investments and property and equipment, offset in part by maturities and sales of short-term investments. Purchases of long-term investments and other assets during the nine months ended August 28, 2009 were less than those in the corresponding period of fiscal 2008 primarily due to $56.0 million paid in the third quarter of fiscal 2008 for future licensing rights acquired through certain technology licensing arrangements.
 
Cash Flows from Financing Activities
 
Net cash used for financing activities decreased $519.9 million for a total of $227.7 million for the nine months ended August 29, 2009 as compared to cash used for the same period last year. The decrease during the nine months ended August 28, 2009 as compared to the corresponding period in fiscal 2008 was primarily due to lower purchases of treasury stock offset in part by proceeds related to the issuance of treasury stock. (See the sections titled “Stock Repurchase Program I” and “Stock Repurchase Program II” discussed below). The nine months ended August 29, 2008 also included net borrowings under our credit facility that did not recur during the nine months ended August 28, 2009.
 
We expect to continue our investing activities, including short-term and long-term investments, venture capital, facilities expansion and purchases of computer systems for research and development, sales and marketing, product support and administrative staff. Furthermore, cash reserves may be used to repurchase stock under our stock repurchase programs and to strategically acquire software companies, products or technologies that are complementary to our business.
 
In September 2009, we entered into a definitive agreement with Omniture under which we expect to acquire Omniture for approximately $1.8 billion. Under the terms of the agreement, we have commenced a tender offer to acquire all of the outstanding common stock of Omniture for $21.50 per share in cash. We expect to finance the acquisition using existing cash, cash equivalents and short term investment balances, and current availability under our credit facility. We believe that these resources in addition to cash generated from operations will be sufficient to fund the acquisition as well as to continue to provide a supplemental source of near term liquidity. Also, we believe that our banking relationships and good credit should afford us the opportunity to raise additional capital in the private or public markets, if required.
 
In addition, our existing cash, cash equivalents and investment balances may further decline during the remainder of fiscal 2009 in the event of a further weakening of the economy or significant changes in our planned cash outlay, including changes in incremental costs such as direct and integration costs related to the acquisition. Cash from operations could also be affected by various risks and uncertainties, including, but not limited to the risks detailed in Part II, Item 1A titled “Risk Factors.” However, based on our current business plan and revenue prospects, we believe that our existing balances and anticipated cash flows from operations will be sufficient to meet our working capital and operating resource expenditure requirements for the next twelve months. At August 28, 2009, our existing credit facility is currently $1.0 billion of which we had borrowed $350.0 million. Subsequent to August 28, 2009, we borrowed an additional $650.0 million under the credit facility. See Note 15 of our Notes to Condensed Consolidated Financial Statements for more detailed information.
 
We use professional investment management firms to manage a large portion of our invested cash. External investment firms managed, on average, 58% of our consolidated invested balances during the third quarter of fiscal 2009. Within the U.S., the portfolio is invested primarily in money market funds for working capital purposes. Outside of the U.S., our fixed income portfolio is primarily invested in U.S. Treasury securities.
 
 
38

 
Stock Repurchase Program I
 
During the nine months ended August 28, 2009, we entered into structured repurchase agreements with large financial institutions, whereupon we provided the financial institutions with prepayments of $350.0 million. We entered into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is higher than the foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.
 
The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval, and the average VWAP of our stock during the interval less the agreed upon discount. During the nine months ended August 28, 2009, we repurchased approximately 9.9 million shares at an average price per share of $25.31 through structured repurchase agreements entered into during fiscal 2008 and fiscal 2009.
 
Stock Repurchase Program II
 
Under this stock repurchase program, we had authorization to repurchase 50.0 million shares of our common stock. From the inception of the 50.0 million share authorization under this program, we provided prepayments of $1.9 billion under structured share repurchase agreements to large financial institutions. During the third quarter of fiscal 2008, the remaining authorized number of shares were repurchased.
 
Refer to Part II, Item 2 in this report for share repurchases during the quarter ended August 28, 2009.
 
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
 
Our principal commitments as of August 28, 2009 consist of obligations under operating leases, royalty agreements and various service agreements. See Note 14 of our Notes to Condensed Consolidated Financial Statements for more detailed information.
 
Financial Covenants
 
Our credit facility contains a financial covenant requiring us not to exceed a certain maximum leverage ratio. Our leases for the East and West Towers and the Almaden Tower are both subject to standard covenants including certain financial ratios as defined in the lease agreements that are reported to the lessors quarterly. As of August 28, 2009, we were in compliance with all of our covenants. We believe these covenants will not impact our credit or cash in the coming fiscal year or restrict our ability to execute our business plan.
 
Royalties
 
We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.
 
Guarantees
 
The lease agreements for our corporate headquarters provide for residual value guarantees. Under FIN No. 45, “Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of SFAS No. 5, 57, and 107 and rescission of FIN No. 34,” the fair value of a residual value guarantee in lease agreements entered into after December 31, 2002 must be recognized as a liability on our Condensed Consolidated Balance Sheets. As such, we recognized $5.2 million and $3.0 million in liabilities, related to the East and West Towers and Almaden Tower leases, respectively. These liabilities are recorded in other long-term liabilities with the offsetting entry recorded as prepaid rent in other assets. The balance will be amortized to the income statement over the life of the leases. As of August 28, 2009, the unamortized portion of the fair value of the residual value guarantees remaining in other long-term liabilities and prepaid rent was $1.5 million.
 
 
39

 
Indemnifications
 
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third-parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.
 
To the extent permitted under Delaware law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that limits our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.
 
As part of our limited partnership interest in Adobe Ventures, we have provided a general indemnification to Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures, for certain events or occurrences while Granite Ventures is, or was serving, at our request in such capacity provided that Granite Ventures acts in good faith on behalf of the partnership. We are unable to develop an estimate of the maximum potential amount of future payments that could potentially result from any hypothetical future claim, but believe the risk of having to make any payments under this general indemnification to be remote.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We believe that there have been no significant changes in our market risk exposures for the three and nine months ended August 28, 2009.
 
ITEM 4.  CONTROLS AND PROCEDURES
 
Based on their evaluation as of August 28, 2009, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective at the reasonable assurance level to ensure that the information required to be disclosed by us in this quarterly report on Form 10-Q was (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
 
There were no changes in our internal control over financial reporting during the quarter ended August 28, 2009 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
 
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Adobe have been detected.
 
PART II—OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS
 
See Note 14 “Commitments and Contingencies” of our Notes to Condensed Consolidated Financial Statements regarding our legal proceedings.
 
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.
 
 
40

 
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.
 
As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic and political conditions. Uncertainty about future economic and political conditions makes it difficult for us to forecast operating results and to make decisions about future investments. For example, the direction and relative strength of the global economy has recently been increasingly uncertain due to softness in the real estate and mortgage markets, volatility in fuel and other energy costs, difficulties in the financial services sector and credit markets, continuing geopolitical uncertainties and other macroeconomic factors affecting spending behavior. If economic growth in the U.S. and other countries’ economies is slowed, many customers may delay or reduce technology purchases, advertising spending or marketing spending. This could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition.
 
The current global financial crisis affecting the banking system and financial markets and the possibility that financial institutions may consolidate or go out of business have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. There could be a number of follow-on effects from the credit crisis on our business, including insolvency of certain of our key distributors, resellers, OEMs, retailers and systems integrators, ISVs and VARs (collectively referred to as “distributors”), which could impair our distribution channels, inability of customers, including our distributors, to obtain credit to finance purchases of our products, and failure of derivative counterparties and other financial institutions, which could negatively impact our treasury operations. Other income and expense could also vary from expectations depending on gains or losses realized on the sale or exchange of financial instruments, impairment charges related to investment securities as well as equity and other investments, interest rates, cash balances, and changes in fair value of derivative instruments. Any of these events would likely harm our business, results of operations and financial condition.
 
Political instability in any of the major countries we do business in would also likely harm our business, results of operations and financial condition.
 
If we cannot continue to develop, market and distribute new products or upgrades to existing products that meet customer requirements, our operating results could suffer.

The process of developing new high technology products and enhancing existing products is complex, costly and uncertain, and any failure by us to anticipate customers’ changing needs and emerging technological trends accurately could significantly harm our market share and results of operations. We must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products. Our inability to extend our core technologies into new applications and new platforms, including the mobile and embedded devices market, and to anticipate or respond to technological changes could affect continued market acceptance of our products and our ability to develop new products and services. Additionally, any delay in the development, production, marketing or distribution of a new product or upgrade to an existing product could cause a decline in our revenue, earnings or stock price and could harm our competitive position.
 
We offer our desktop application-based products primarily on Windows and Macintosh platforms. We generally offer our server-based 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 other platforms before we choose and are able to offer our products on these platforms 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.

Introduction of new products and business models by existing and new competitors could harm our competitive position and results of operations.
 
The markets for our products are characterized by intense competition, evolving industry standards and business models, disruptive software and hardware technology developments, frequent new product introductions, short product life cycles, price cutting, with resulting downward pressure on gross margins, and price sensitivity on the part of consumers. Our future success will depend on our ability to enhance our existing products, introduce new products and services on a timely and cost-effective basis, meet changing customer needs, extend our core technology into new applications, and anticipate and respond to emerging standards, business models, software delivery methods and other technological changes. For example,
 
 
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Microsoft Windows Vista operating system which contains a fixed document format, XPS, competes with Adobe PDF. Additionally, Microsoft Office 2007, which offers a feature to save Microsoft Office documents as PDF files, competes with Adobe PDF creation. Microsoft Expression Studio competes with our Adobe Creative Suite family of products and Microsoft Silverlight and Visual Studio, Web development tools for RIAs, compete with Adobe Flash, Adobe Flex and Adobe AIR. Google Gears and Sun’s JavaFX, alternative approaches to deploying RIAs compete with Adobe Flash and Adobe AIR. Additionally, HTML 5 specifies scripting applications programming interfaces which if broadly implemented in browsers could compete with Adobe Flash. Companies, such as Google, Sun, Apple and Microsoft, may introduce competing software offerings for free or open source vendors may introduce competitive products. In addition, recent advances in computing and communications technologies have made the software as a service (“SaaS”) business model viable. SaaS allows companies to provide applications, data and related services over the Internet. Providers use primarily advertising or subscription-based revenue models. We are exploring the deployment of our own SaaS strategies, but may not be able to develop the infrastructure and business models as quickly as our competitors. If any of these competing products or services 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 additional information regarding our competition and the risks arising out of the competitive environment in which we operate, see the section entitled “Competition” contained in Item 1 of our Annual Report on Form 10-K for fiscal 2008.
 
If we fail to successfully manage transitions to new business models and markets, our results of operations could be negatively impacted.
 
We plan to release numerous new product and service offerings and employ new software delivery methods in connection with our transition to new business models. It is uncertain whether these strategies will prove successful or that we will be able to develop the infrastructure and business models as quickly as our competitors. Market acceptance of these new product and service offerings will be dependent on our ability to include functionality and usability in such releases that address certain customer requirements with which we have limited prior experience and operating history. Some of these new product and service offerings could subject us to increased risk of legal liability related to the provision of services as well as cause us to incur significant technical, legal or other costs. As our business continues to transition to new business models that may be more highly regulated for privacy and data security, and to countries outside the U.S. that have more strict data protection laws, our compliance requirements and costs may increase. In addition, laws in the areas of privacy and behavioral tracking are likely to be passed in the future, which could result in significant limitations on or changes to the ways in which we can collect, use, store or transmit the personal information of our customers or employees, communicate with our customers, and deliver products and services.
 
Additionally, customer requirements for open standards or open source products could impact adoption or use with respect to some of our products. To the extent we incorrectly estimate customer requirements for such products or services or if there is a delay in market acceptance of such products or services, our business could be harmed.
 
From time to time we open source certain of our technology initiatives, provide broader open access to certain of our technology, such as our Open Screen Project, and release selected technology for industry standardization. These changes may have negative revenue implications and make it easier for our competitors to produce products similar to ours. If we are unable to respond to these competitive threats, our business could be harmed.
 
We are also devoting significant resources to the development of technologies and service offerings in markets where we have a limited operating history, including the enterprise, government and 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 and horizontal markets such as training and marketing. These new offerings and markets require a considerable investment of technical, financial and sales resources, and a scalable organization. Many of our competitors may have advantages over us due to their larger presence, larger developer network, deeper experience in the enterprise, government and mobile and device markets, and greater sales and marketing resources. In the mobile and device markets, our intent is to partner with device makers, manufacturers and telecommunications carriers to 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 makers, 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.
 
 
42

 
Revenue from our new businesses 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 revenue and revenue may decline quicker than anticipated. Additionally, we have a limited history of licensing products in certain markets such as the government and enterprise market and may experience a number of factors that will make our revenue less predictable, including longer than expected sales and implementation cycles, decision to open source certain of our technology initiatives, potential deferral of revenue due to multiple-element revenue arrangements and alternate licensing arrangements. If any of our assumptions about revenue from our new businesses prove incorrect, our actual results may vary materially from those anticipated, estimated or projected.
 
We may incur substantial costs enforcing or acquiring 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, the acquisition of third-party intellectual property rights, or disputes relating to the validity or alleged infringement of third-party intellectual property 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. Third-party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from manufacturing or licensing certain of our products, subject us to injunctions restricting our sale of products, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements. In addition, we may incur significant costs in acquiring the necessary third-party intellectual property rights for use in our products. Any of these 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 significant 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 our confidential information and trade secrets, including our source code. If unauthorized disclosure 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. We also seek to protect our confidential information and trade secrets through the use of non-disclosure agreements with our customers, contractors, vendors, and partners. However there is a risk that our confidential information and trade secrets may be disclosed or published without our authorization, and in these situations it may be difficult and or costly for us to enforce our rights.

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. If a breach of security occurs on these hosted systems, we could be held liable to our customers or be subject to governmental complaints. Additionally, such breaches could lead to interruptions, delays and data loss and protection concerns as well as harm to 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 announced an agreement to acquire Omniture in September 2009. We may not realize the anticipated benefits of an
 
 
43

  
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;
 
 
·
difficulty integrating the acquired company’s 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;
 
 
·
inability to take advantage of anticipated tax benefits as a result of unforeseen difficulties in our integration activities;
 
 
·
incurring acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results;
 
 
·
potential additional exposure to fluctuations in currency exchange rates;
 
 
·
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 problems, liabilities or other shortcomings or challenges of an acquired company or technology, including but not limited to, issues with the acquired company’s intellectual property, product quality or product architecture, data back-up and security, revenue recognition or other accounting practices, employee, customer or partner issues or legal and financial contingencies;
 
 
·
exposure to litigation or other claims in connection with, or inheritance of claims or litigation risk as a result of, an acquisition, including but not limited to, claims from terminated employees, customers, former stockholders or other third-parties;
 
 
·
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 an announced acquisition transaction or integrate an acquired business successfully and in a timely manner, we may not realize the benefits of the acquisition to the extent anticipated.

Failure to manage our sales and distribution channels effectively could result in a loss of revenue and harm to our business.
 
A significant amount of our revenue for application products is from two distributors, Ingram Micro, Inc. and Tech Data Corporation, which represented 16% and 7% of our net revenue for the third quarter of fiscal 2009, respectively. We have multiple non-exclusive, independently negotiated distribution agreements with Ingram Micro and Tech Data and their subsidiaries covering our arrangements in specified countries and regions. Each of these contracts has an independent duration, is independent of any other agreement (such as a master distribution agreement) and any termination of one agreement does not affect the status of any of the other agreements. In the third quarter of fiscal 2009, no single agreement with these distributors was responsible for over 10% of our total net revenue. If any one of our agreements with these distributors were terminated, we believe we could make arrangements with new or existing distributors to distribute our
 
 
44

 
products without a substantial disruption to our business; however, any prolonged delay in securing a replacement distributor could have a negative short-term impact on our results of operations.
  
        Successfully managing our indirect channel efforts to reach various potential customer segments for our products and services is a complex process. Our distributors are independent businesses that we do not control. We cannot be certain that our distribution channel will continue to market or sell our products effectively. If we are not successful, we may lose sales opportunities, customers and revenues.
 
Our distributors also sell our competitors’ products, and if they favor our competitors’ 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. We also distribute some products through our OEM channel, and if our OEM partners decide not to bundle our applications on their devices, our results could suffer.
 
In addition, the financial health of our distributors and our continuing relationships with them are important to our success. Some of these distributors may be unable to withstand adverse changes in current economic conditions, which could result in insolvency of certain of our distributors and/or the inability of our distributors to obtain credit to finance purchases of our products. In addition, weakness in the end-user market could further negatively affect the cash flow of our distributors who could, in turn, delay paying their obligations to us, which would increase our credit risk exposure. Our business could be harmed if the financial condition of some of these distributors substantially weakens and we were unable to timely secure replacement distributors.

We also sell certain of our products through our direct sales force. Risks associated with this sales channel include a longer sales cycle associated with direct sales efforts, difficulty in hiring, retaining and motivating our direct sales force, and substantial amounts of training for sales representatives, including regular updates to cover new and upgraded products.
 
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 Web site for our development, marketing, operational, support, hosted services and sales activities. A disruption or failure of these systems in the event of a major earthquake, fire, telecommunications failure, cyber-attack, war, terrorist attack, or other catastrophic event could cause system interruptions, reputational harm, delays in our product development, breaches of data security and loss of critical data and could prevent us from fulfilling our customers’ orders. Our corporate headquarters, a significant portion of our research and development activities, our data centers, and certain other critical business operations are located in San Jose, California, which is near major earthquake faults. We have developed certain disaster recovery plans and certain 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 data centers or 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.
 
Net revenue, margin or earnings shortfalls or the volatility of the market generally may cause the market price of our stock to decline.
 
The market price for our common stock has experienced significant fluctuations and may continue to fluctuate significantly. The market price for our common stock may be affected by a number of factors, including shortfalls in our net revenue, margins, earnings or key performance metrics, changes in estimates or recommendations by securities analysts, the announcement of new products or product enhancements by us or our competitors, quarterly variations in our or our competitors’ results of operations, developments in our industry; unusual events such as significant acquisitions, divestitures and litigation, general socio-economic, political or market conditions and other factors, including factors unrelated to our operating performance.
 
We are subject to risks associated with international operations which may harm our business.
 
We generate almost 50% of our total revenue from sales to customers outside of the Americas. Sales to these customers subject us to a number of risks, including:
 
 
·
foreign currency fluctuations;
 
 
·
changes in government preferences for software procurement;
 
 
45

 
 
·
international economic, political and labor conditions;
 
 
·
tax laws (including U.S. taxes on foreign subsidiaries);
 
 
·
unexpected changes in, or impositions of, international legislative or regulatory requirements;
 
 
·
failure of foreign laws to protect our intellectual property rights adequately;
 
 
·
inadequate local infrastructure;
 
 
·
delays resulting from difficulty in obtaining export licenses for certain technology, tariffs, quotas and other trade barriers and restrictions;
 
 
·
transportation delays;
 
 
·
the burdens of complying with a variety of foreign laws, including 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.
 
In addition, approximately 46% of our employees are located outside the U.S. This means we have exposure to changes in foreign laws governing our relationships with our employees, including wage and hour laws and regulations, fair labor standards, unemployment tax rates, workers’ compensation rates, citizenship requirements and payroll and other taxes, which likely would have a direct impact on our operating costs. We also intend to continue expansion of our international operations and international sales and marketing activities. Expansion in international markets has required, and will continue to require, significant management attention and resources. We may be unable to scale our infrastructure effectively, or as quickly as our competitors, in these markets, which would cause our results to suffer. Moreover, local laws and customs in many countries differ significantly from those in the U.S. We incur additional legal compliance costs associated with our international operations and could become subject to legal penalties in foreign countries if we do not comply with local laws and regulations, which may be substantially different from those in the U.S. In many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by U.S. regulations applicable to us such as the Foreign Corrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws, there can be no assurance that all of our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, including those based in or from countries where practices which violate such U.S. laws may be customary, will not take actions in violation of our internal policies. Any such violation, even if prohibited by our internal policies, could have an adverse effect on our business.
 
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 for the Japanese Yen and the Euro. We regularly review our hedging program and 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 could result in unfavorable accounting charges.
 
We prepare our Condensed Consolidated Financial Statements in accordance GAAP. 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 stock-based compensation;
 
 
·
accounting for income taxes; and
 
 
·
accounting for business combinations and related goodwill.
 
 
46

 
In December 2007, the FASB issued SFAS 141R which changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition related restructuring liabilities, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. We are in the process of evaluating the impact of the pending adoption of Statement 141R. We currently believe that the adoption of Statement 141R will result in the recognition of certain types of expenses in our results of operations that we currently capitalize pursuant to existing accounting standards and may also impact our financial statements in other ways.
 
If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.
 
Under GAAP, we review our goodwill and 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. For example, our Mobile and Device Solutions business, which is now reported as part of our Platform segment in fiscal 2009, is in an emerging market with high growth potential. We recently announced the Open Screen Project. As part of the project, we will be removing the license fees on the next major releases of Adobe Flash Player and Adobe AIR for devices. Revenue from this segment has begun to decrease. Although we would expect this decrease to be offset in time by an increased demand for tooling products, server technologies, hosted services and applications, if future revenue or revenue forecasts for our Platform segment do not meet our expectations, we may be required to record a charge to earnings reflecting an impairment of recorded goodwill or intangible assets.
 
Changes in, or interpretations of, tax rules and regulations may adversely affect our effective tax rates.
 
We are a U.S. based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. 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, or interpretation of, tax rules and regulations in the jurisdictions in which we do business, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, by lapses of the availability of the U.S. research and development tax credit, 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 IRS and other domestic and foreign tax authorities, including a current examination by the IRS for our fiscal 2005, 2006 and 2007 tax returns. These examinations are expected to focus on our intercompany transfer pricing practices as well as other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from the current examination. We believe such estimates to be reasonable; however, there can be no assurance that the final determination of any of these examinations will not 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. 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 Bay Area, where many 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. Additionally, the recent significant adverse volatility in our stock price has resulted in many employees’ stock option exercise prices exceeding the underlying stock’s market value as well as deterioration in the value of employees’ restricted stock units granted, thus lessening the effectiveness of retaining employees through stock-based awards. If we are unable to continue to successfully attract and retain key personnel, our business may be harmed.
 
 
47


Our investment portfolio may become impaired by deterioration of the capital markets.
 
Our cash equivalent and short-term investment portfolio as of August 28, 2009 consisted of US treasury securities, bonds of government agencies, obligations of foreign governments, corporate bonds and taxable money market mutual funds. We follow an established investment policy and set of guidelines to monitor and help mitigate our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer, as well as our maximum exposure to various asset classes.
 
As a result of current adverse financial market conditions, investments in some financial instruments may pose risks arising from recent market liquidity and credit concerns. As of August 28, 2009, we had no material impairment charges associated with our short-term investment portfolio relating to such adverse financial market conditions. Although we believe our current investment portfolio has very little risk of material impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain materially unimpaired.
 
We may suffer losses from our equity investments which could harm our business.
 
We have investments and plan to 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 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.
 
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.
 
 
48

 
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Below is a summary of stock repurchases for the three months ended August 28, 2009. See Note 11 of our Notes to Condensed Consolidated Financial Statements for information regarding our stock repurchase programs.
 
 
Plan/Period (1)
 
 
Shares
Repurchased (2)
   
Average
Price Per
Share
 
Maximum Number
of Shares that May
Yet be Purchased
Under the Plan
   
Stock Repurchase Program I
                 
Beginning shares available to be repurchased as of  May 29, 2009
            129,677,547   (3)
May 30—June 26, 2009
                 
From employees (4) 
    7     $ 30.15        
Structured repurchases
        $        
June 27—July 24, 2009
                     
From employees (4) 
        $        
Structured repurchases
    2,127,383     $ 27.42        
July 25—August 28, 2009
                     
From employees (4) 
        $        
Structured repurchases
    1,850,895     $ 31.23        
Adjustments to repurchase authority for net dilution
        $   6,155,922   (5)
Total shares repurchased
    3,978,285           (3,978,285 )  
Ending shares available to be repurchased under Program I as of August 28, 2009
                131,855,184   (6)
                       
_________________________________________
 
 (1)
In December 1997, our Board of Directors authorized Stock Repurchase Program I which is not subject to expiration. However, this repurchase program is limited to covering net dilution from stock issuances and is subject to business conditions and cash flow requirements as determined by our Board of Directors from time to time.
 
(2)
All shares were purchased as part of publicly announced plans.
 
(3)
Additional 109.0 million shares were issued for the acquisition of Macromedia which accounted for the majority of the repurchase authorization.
 
(4)
The repurchases from employees represent shares cancelled when surrendered in lieu of cash payments for withholding taxes due.
 
(5)
Adjustment of authority to reflect changes in the dilution from outstanding shares and options.
 
(6)
The remaining authorization for the ongoing stock repurchase program is determined by combining all stock issuances, net of any cancelled, surrendered or exchanged shares less all stock repurchases under the ongoing plan, beginning in the first quarter of fiscal 1998.
 

ITEM 6.  EXHIBITS
 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
3.1
 
Amended and Restated Bylaws
 
8-K
 
1/13/09
 
3.1
   
                     
3.2
 
Restated Certificate of Incorporation of Adobe Systems Incorporated
 
10-Q
 
7/16/01
 
3.6
   
                     
3.2.1
 
Certificate of Correction of Restated Certificate of Incorporation of Adobe Systems Incorporated
 
10-Q
 
4/11/03
 
3.6.1
   
 
 
49

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
3.3
 
Certificate of Designation of Series A Preferred Stock of Adobe Systems Incorporated
 
10-Q
 
7/08/03
 
3.3
   
                     
4.1
 
Fourth Amended and Restated Rights Agreement between Adobe Systems Incorporated and Computershare Investor Services, LLC
 
8-K
 
7/03/00
 
1
   
                     
4.1.1
 
Amendment No. 1 to Fourth Amended and Restated Rights Agreement between Adobe Systems Incorporated and Computershare Investor Services, LLC
 
 8-A/2G/A
 
5/23/03
 
7
   
                     
10.1
 
1984 Stock Option Plan, as amended*
 
10-Q
 
7/02/93
 
10.1.6
   
                     
10.2
 
Amended 1994 Performance and Restricted Stock Plan*
 
10-Q
 
4/4/08
 
10.2
   
                     
10.3
 
Form of Restricted Stock Agreement used in connection with the Amended 1994 Performance and Restricted Stock Plan*
 
10-K
 
1/23/09
 
10.3
   
                     
10.4
 
1994 Stock Option Plan, as amended*
 
S-8
 
5/30/97
 
10.40
   
                     
10.5
 
1997 Employee Stock Purchase Plan, as amended*
 
10-K
 
1/24/08
 
10.5
   
                     
10.6
 
1996 Outside Directors Stock Option Plan, as amended*
 
10-Q
 
4/12/06
 
10.6
   
                     
10.7
 
Forms of Stock Option Agreements used in connection with the 1996 Outside Directors Stock Option Plan*
 
S-8
 
6/16/00
 
4.8
   
                     
10.8
 
1999 Nonstatutory Stock Option Plan, as amended*
 
S-8
 
10/29/01
 
4.6
   
                     
10.9
 
1999 Equity Incentive Plan, as amended*
 
10-K
 
2/26/03
 
10.37
   
                     
10.10
 
2003 Equity Incentive Plan, as amended and restated*
 
DEF 14A
 
2/20/09
 
Appendix A
   
 
 
50

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
10.11
 
Form of Stock Option Agreement used in connection with the 2003 Equity Incentive Plan*
 
10-Q
 
4/4/08
 
10.11
   
                     
10.12
 
Form of Indemnity Agreement*
 
10-Q
 
6/26/09
 
10.12
   
                     
10.13
 
Forms of Retention Agreement*
 
10-K
 
11/28/97
 
10.44
   
                     
10.14
 
Second Amended and Restated Master Lease of Land and Improvements by and between SMBC Leasing and Finance, Inc. and Adobe Systems Incorporated
 
10-Q
 
10/07/04
 
10.14
   
                     
10.15
 
Lease between Adobe Systems Incorporated and Selco Service Corporation, dated March 26, 2007
 
8-K
 
3/28/07
 
10.1
   
                     
10.16
 
Participation Agreement among Adobe Systems Incorporated, Selco Service Corporation, et al. dated March 26, 2007
 
8-K
 
3/28/07
 
10.2
   
                     
10.17
 
Lease Agreement by and between Allaire Corporation and EOP Riverside Project LLC dated November 23, 1999
 
10-K
 
3/30/00
 
10.23
   
                     
10.18
 
First Amendment to Lease Agreement by and between Allaire Corporation and EOP Riverside Project LLC dated May 31, 2000
 
10-Q
 
8/14/00
 
10.3
   
                     
10.19
 
Form of Restricted Stock Unit Agreement used in connection with the Amended 1994 Performance and Restricted Stock Plan*
 
10-K
 
1/23/09
 
10.19
   
                     
10.20
 
Form of Restricted Stock Unit Agreement used in connection with the 2003 Equity Incentive Plan*
 
10-K
 
1/23/09
 
10.20
   
                     
10.21
 
Form of Restricted Stock Agreement used in connection with the 2003 Equity Incentive Plan*
 
10-Q
 
10/07/04
 
10.11
   
 
 
51

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
10.22
 
2008 Executive Officer Annual Incentive Plan*
 
8-K
 
1/30/08
 
10.4
   
                     
10.23
 
2005 Equity Incentive Assumption Plan, as amended*
 
10-Q
 
4/4/08
 
10.23
   
                     
10.24
 
Form of Stock Option Agreement used in connection with the 2005 Equity Incentive Assumption Plan*
 
10-Q
 
4/4/08
 
10.24
   
                     
10.25
 
Allaire Corporation 1997 Stock Incentive Plan*
 
S-8
 
03/27/01
 
4.06
   
                     
10.26
 
Allaire Corporation 1998 Stock Incentive Plan*
 
S-8
 
03/27/01
 
4.07
   
                     
10.27
 
Allaire Corporation 2000 Stock Incentive Plan*
 
S-8
 
03/27/01
 
4.08
   
                     
10.28
 
Andromedia, Inc. 1996 Stock Option Plan*
 
S-8
 
12/07/99
 
4.07
   
                     
10.29
 
Andromedia, Inc. 1997 Stock Option Plan*
 
S-8
 
12/07/99
 
4.08
   
                     
10.30
 
Andromedia, Inc. 1999 Stock Plan*
 
S-8
 
12/07/99
 
4.09
   
                     
10.31
 
ESI Software, Inc. 1996 Equity Incentive Plan*
 
S-8
 
10/18/99
 
4.08
   
                     
10.32
 
eHelp Corporation 1999 Equity Incentive Plan*
 
S-8
 
12/29/03
 
4.08
   
                     
10.33
 
Blue Sky Software Corporation 1996 Stock Option Plan*
 
S-8
 
12/29/03
 
4.07
   
                     
10.34
 
Bright Tiger Technologies, Inc. 1996 Stock Option Plan*
 
S-8
 
03/27/01
 
4.11
   
                     
10.35
 
Live Software, Inc. 1999 Stock Option/Stock Issuance Plan*
 
S-8
 
03/27/01
 
4.10
   
                     
10.36
 
Macromedia, Inc. 1999 Stock Option Plan*
 
S-8
 
08/17/00
 
4.07
   
                     
10.37
 
Macromedia, Inc. 1992 Equity Incentive Plan*
 
10-Q
 
08/03/01
 
10.01
   
 
 
52

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
10.38
 
Macromedia, Inc. 2002 Equity Incentive Plan*
 
S-8
 
08/10/05
 
4.08
   
                     
10.39
 
Form of Macromedia, Inc. Stock Option Agreement*
 
S-8
 
08/10/05
 
4.09
   
                     
10.40
 
Middlesoft, Inc. 1999 Stock Option Plan*
 
S-8
 
08/17/00
 
4.09
   
                     
10.41
 
Form of Macromedia, Inc. Revised Non-Plan Stock Option Agreement*
 
S-8
 
11/23/04
 
4.10
   
                     
10.42
 
Form of Macromedia, Inc. Restricted Stock Purchase Agreement*
 
10-Q
 
2/08/05
 
10.01
   
                     
10.43
 
Adobe Systems Incorporated Form of Performance Share Program pursuant to the 2003 Equity Incentive Plan*
 
8-K
 
1/30/08
 
10.1
   
                     
10.44
 
Form of Award Grant Notice and Performance Share Award Agreement used in connection with grants under the Adobe Systems Incorporated 2008 Performance Share Program pursuant to the 2003 Equity Incentive Plan*
 
8-K
 
1/30/08
 
10.2
   
                     
10.45
 
2008 Award Calculation Methodology Exhibit A to the 2008 Performance Share Program pursuant to the 2003 Equity Incentive Plan*
 
8-K
 
1/30/08
 
10.3
   
                     
10.46
 
Adobe Systems Incorporated Deferred Compensation Plan*
 
10-K
 
1/24/08
 
10.52
   
                     
10.47
 
Adobe Systems Incorporated 2007 Performance Share Program pursuant to the 2003 Equity Incentive Plan*
 
8-K
 
1/30/07
 
10.1
   
                     
10.48
 
Form of Award Grant Notice and Performance Share Award Agreement used in connection with grants under the Adobe Systems Incorporated 2007 Performance Share Program pursuant to the 2003 Equity Incentive Plan*
 
8-K
 
1/30/07
 
10.2
   
 
 
53

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
10.49
 
Adobe Systems Incorporated 2007 Performance Share Program pursuant to the Amended 1994 Performance and Restricted Stock Plan*
 
8-K
 
1/30/07
 
10.3
   
                     
10.50
 
Form of Award Grant Notice and Performance Share Award Agreement used in connection with grants under the Adobe Systems Incorporated 2007 Performance Share Program pursuant to the Amended 1994 Performance and Restricted Stock Plan*
 
8-K
 
1/30/07
 
10.4
   
                     
10.51
 
Adobe Systems Incorporated Executive Cash Bonus Plan*
 
DEF 14A
 
2/24/06
 
Appendix B
   
                     
10.52
 
First Amendment to Retention Agreement between Adobe Systems Incorporated and Shantanu Narayen, effective as of February 11, 2008*
 
8-K
 
2/13/08
 
10.1
   
                     
10.53
 
Adobe Systems Incorporated Executive Severance Plan in the Event of a Change of Control*
 
8-K
 
2/13/08
 
10.2
   
                     
10.54
 
Employment offer letter between Adobe Systems Incorporated and Richard Rowley, dated October 30, 2006*
 
8-K
 
11/16/06
 
10.1
   
                     
10.55
 
Employment offer letter between Adobe Systems Incorporated and Mark Garrett dated January 5, 2007*
 
8-K
 
1/26/07
 
10.1
   
 
 
54

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
10.56
 
Credit Agreement, dated as of February 16, 2007, among Adobe Systems Incorporated and Certain Subsidiaries as Borrowers; BNP Paribas, Keybank National Association, and UBS Loan Finance LLC as Co-Documentation Agents; JPMorgan Chase Bank, N.A. as Syndication Agent; Bank of America, N.A. as Administrative Agent and Swing Line Lender; the Other Lenders Party Thereto; and Banc of America Securities LLC and J.P. Morgan Securities Inc. as Joint Lead Arrangers and Joint Book Managers
 
8-K
 
8/16/07
 
10.1
   
                     
10.57
 
Amendment to Credit Agreement, dated as of August 13, 2007, among Adobe Systems Incorporated, as Borrower; each Lender from time to time party to the Credit Agreement; and Bank of America, N.A. as Administrative Agent
 
8-K
 
8/16/07
 
10.2
   
                     
10.58
 
Second Amendment to Credit Agreement, dated as of February 26, 2008, among Adobe Systems Incorporated, as Borrower; each Lender from time to time party to the Credit Agreement; and Bank of America, N.A. as Administrative Agent
 
8-K
 
2/29/08
 
10.1
   
                     
10.59
 
Purchase and Sale Agreement, by and between NP Normandy Overlook, LLC, as Seller and Adobe Systems Incorporated as Buyer, effective as of May 12, 2008
 
8-K
 
5/15/08
 
10.1
   
                     
10.60
 
Form of Director Annual Grant Stock Option Agreement used in connection with the 2003 Equity Incentive Plan*
 
10-K
 
1/23/09
 
10.60
   
 
 
55

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
10.61
 
Form of Director Initial Grant Restricted Stock Unit Agreement in connection with the 2003 Equity Incentive Plan*
 
10-K
 
1/23/09
 
10.61
   
                     
10.62
 
Form of Director Annual Grant Restricted Stock Unit Agreement in connection with the 2003 Equity Incentive Plan*
 
10-K
 
1/23/09
 
10.62
   
                     
10.63
 
Description of 2009 Director Compensation*
 
10-K
 
1/23/09
 
10.63
   
                     
10.64
 
2009 Performance Share Program Award Calculation Methodology*
 
8-K
 
1/29/09
 
10.3
   
                     
10.65
 
2009 Executive Annual Incentive Plan*
 
8-K
 
1/29/09
 
10.4
   
                     
31.1
 
Certification of Chief Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934
             
X
                     
31.2
 
Certification of Chief Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934
             
X
                     
32.1
 
Certification of Chief Executive Officer, as required by Rule 13a-14(b) of the Securities Exchange Act of 1934†
             
X
                     
32.2
 
Certification of Chief Financial Officer, as required by Rule 13a-14(b) of the Securities Exchange Act of 1934†
             
X
                     
101.INS
 
XBRL Instance††
             
X
                     
101.SCH
 
XBRL Taxonomy Extension Schema††
             
X
                     
101.CAL
 
XBRL Taxonomy Extension Calculation††
             
X
                     
101.LAB
 
XBRL Taxonomy Extension Labels††
             
X
 
 
56

 
Exhibit
     
Incorporated by Reference**
 
Filed
Number
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
                     
101.PRE
 
XBRL Taxonomy Extension Presentation††
             
X
                     
101.DEF
 
XBRL Taxonomy Extension Definition††
             
X

_________________________________________
 
*
Compensatory plan or arrangement.
 
**
References to Exhibits 10.17 and 10.18 are to filings made by the Allaire Corporation. References to Exhibits 10.25 through 10.42 are to filings made by Macromedia, Inc.
 
The certifications attached as Exhibits 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q, are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Adobe Systems Incorporated under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.
 
††
Furnished, not filed.
 
 
57

 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
ADOBE SYSTEMS INCORPORATED
   
   
 
By
 /s/ Mark Garrett
 
   
Mark Garrett
   
Executive Vice President and
   
Chief Financial Officer
   
(Principal Financial Officer)
 
Date: October 1, 2009
 
 
58

 
SUMMARY OF TRADEMARKS
 
The following trademarks of Adobe Systems Incorporated or its subsidiaries, which may be registered in the U.S. and/or other countries, are referenced in this Form 10-Q:
 
Adobe
Adobe AIR
Acrobat
Acrobat Connect
Creative Suite
Flash
Flash Lite
Flex
Flex Builder
Lightroom
LiveCycle
Macromedia
Photoshop
PostScript
Reader
Shockwave
 
               All other trademarks are the property of their respective owners.
 
59