-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q2I0jCVu+WiA1ityuSlxhe/5swU2s5nD/NXtG6V180A9YCflB6W0uxE8UzOsLaqP BenVlBllxRxvuon8YhcHMg== 0000796343-10-000011.txt : 20100702 0000796343-10-000011.hdr.sgml : 20100702 20100701200236 ACCESSION NUMBER: 0000796343-10-000011 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20100604 FILED AS OF DATE: 20100702 DATE AS OF CHANGE: 20100701 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADOBE SYSTEMS INC CENTRAL INDEX KEY: 0000796343 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770019522 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15175 FILM NUMBER: 10932285 BUSINESS ADDRESS: STREET 1: 345 PARK AVE CITY: SAN JOSE STATE: CA ZIP: 95110-2704 BUSINESS PHONE: 4085366000 MAIL ADDRESS: STREET 1: 345 PARK AVENUE CITY: SAN JOSE STATE: CA ZIP: 95110-2704 10-Q 1 form_10q.htm FORM 10-Q Q210 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 June 4, 2010
 
 
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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
 
    Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller
reporting company)
Smaller reporting company o
 
    Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No x
 
    The number of shares outstanding of the registrant’s common stock as of June 25, 2010 was 525,224,418.
 



 
 

 

FORM 10-Q
 
TABLE OF CONTENTS
 
     
Page No.
PART I—FINANCIAL INFORMATION
 
Item 1.
3
   
3
   
4
   
5
   
6
Item 2.
31
Item 3.
46
Item 4.
46
   
PART II—OTHER INFORMATION
 
Item 1.
47
Item 1A.
47
Item 2.
58
Item 6.
58
59
60
61


PART I—FINANCIAL INFORMATION
 
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(In thousands, except par value)
 
(Unaudited)
 
     
June 4,
2010
     
November 27,
2009
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 1,137,606     $ 999,487  
Short-term investments
    1,507,116       904,986  
Trade receivables, net of allowances for doubtful accounts of $14,295 and $15,225, respectively
    439,151       410,879  
Deferred income taxes
    70,955       77,417  
Prepaid expenses and other current assets
    121,243       80,855  
Total current assets
    3,276,071       2,473,624  
Property and equipment, net
    407,621       388,132  
Goodwill
    3,488,252       3,494,589  
Purchased and other intangibles, net
    447,372       527,388  
Investment in lease receivable
    207,239       207,239  
Other assets
    180,376       191,265  
Total assets
  $ 8,006,931     $ 7,282,237  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Trade payables
  $ 50,273     $ 58,904  
Accrued expenses
    468,587       419,646  
Accrued restructuring
    16,504       37,793  
Income taxes payable
    71,978       46,634  
Deferred revenue
    362,566       281,576  
Total current liabilities
    969,908       844,553  
Long-term liabilities:
               
Debt
    1,493,651       1,000,000  
Deferred revenue
    41,777       36,717  
Accrued restructuring
    7,729       6,921  
Income taxes payable
    218,153       223,528  
Deferred income taxes
    66,142       252,486  
Other liabilities
    30,816       27,464  
Total liabilities
    2,828,176       2,391,669  
Stockholders’ equity:
               
Preferred stock, $0.0001 par value; 2,000 shares authorized, none issued
           
Common stock, $0.0001 par value; 900,000 shares authorized; 600,834 shares issued; 525,068 and 522,657 shares outstanding, respectively
    61       61  
Additional paid-in-capital
    2,376,202       2,390,061  
Retained earnings
    5,570,097       5,299,914  
Accumulated other comprehensive income
    39,995       24,446  
Treasury stock, at cost (75,766 and 78,177 shares, respectively), net of reissuances
    (2,807,600 )     (2,823,914 )
Total stockholders’ equity
    5,178,755       4,890,568  
Total liabilities and stockholders’ equity
  $ 8,006,931     $ 7,282,237  
 
See accompanying Notes to Condensed Consolidated Financial Statements.


 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
(In thousands, except per share data)
 
(Unaudited)
 
        Three Months Ended         Six Months Ended  
                                 
     
June 4,
 2010
     
May 29,
 2009
     
June 4,
 2010
     
May 29,
 2009
 
Revenue:
                               
Products
  $ 795,260     $ 647,985     $ 1,499,198     $ 1,377,846  
Subscription
    92,279       12,070       187,786       24,408  
Services and support
    55,496       44,618       114,751       88,809  
Total revenue
    943,035       704,673       1,801,735       1,491,063  
Cost of revenue:
                               
Products
    39,645       47,678       63,155       99,113  
Subscription
    50,190       8,080       95,925       15,563  
Services and support
    17,998       16,250       38,121       34,685  
Total cost of revenue
    107,833       72,008       197,201       149,361  
Gross profit
    835,202       632,665       1,604,534       1,341,702  
 
Operating expenses:
                               
Research and development
    167,318       138,470       341,658       288,387  
Sales and marketing
    320,976       243,209       618,270       492,700  
General and administrative
    89,953       70,818       180,999       144,869  
Restructuring charges
    11,541       3,531       23,163       15,801  
Amortization of purchased intangibles
    18,129       15,284       36,326       30,676  
Total operating expenses
    607,917       471,312       1,200,416       972,433  
Operating income
    227,285       161,353       404,118       369,269  
 
Non-operating income (expense):
                               
Interest and other income (expense), net
    (6,313 )     4,802       (5,702 )     18,086  
Interest expense
    (16,076 )     (620 )     (23,771 )     (1,412 )
Investment gains (losses), net
    (10,723 )     (1,805 )     (14,257 )     (19,051 )
Total non-operating income (expense), net
    (33,112 )     2,377       (43,730 )     (2,377 )
Income before income taxes
    194,173       163,730       360,388       366,892  
Provision for income taxes
    45,562       37,659       84,623       84,386  
Net income
  $ 148,611     $ 126,071     $ 275,765     $ 282,506  
Basic net income per share
  $ 0.28     $ 0.24     $ 0.53     $ 0.54  
Shares used in computing basic net income per share
    526,148       524,159       525,124       524,219  
Diluted net income per share
  $ 0.28     $ 0.24     $ 0.52     $ 0.53  
Shares used in computing diluted net income per share
    533,259       528,013       533,305       528,233  

 

 

 
See accompanying Notes to Condensed Consolidated Financial Statements.


 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
(Unaudited)
 
        Six Months Ended  
     
June 4,
2010
     
May 29,
2009
 
Cash flows from operating activities:
               
Net income
  $ 275,765     $ 282,506  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, amortization and accretion
    143,487       133,465  
Stock-based compensation
    124,577       86,577  
Deferred income taxes
    (178,038 )     19,984  
Unrealized losses on investments
    12,222       16,498  
Tax benefit from employee stock option plans
    38,743       2,711  
Other non-cash items
    21,158       7,773  
Excess tax benefits from stock-based compensation
    (8,485 )     (84 )
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
               
Trade receivables, net
    (27,999 )     201,354  
Prepaid expenses and other current assets
    (8,808 )     13,210  
Trade payables
    (8,631 )     (13,582 )
Accrued expenses
    33,098       (32,639 )
Accrued restructuring
    (18,962 )     (24,139 )
Income taxes payable
    25,580       (4,357 )
Deferred revenue
    87,186       (62,005 )
Net cash provided by operating activities
    510,893       627,272  
Cash flows from investing activities:
               
Purchases of short-term investments
    (1,202,326 )     (782,362 )
Maturities of short-term investments
    285,889       197,709  
Proceeds from sales of short-term investments
    318,092       273,243  
Purchases of property and equipment
    (75,175 )     (26,228 )
Purchases of long-term investments and other assets
    (18,998 )     (16,580 )
Proceeds from sale of long-term investments
    719       1,904  
Other
    2,177       3,000  
Net cash used for investing activities
    (689,622 )     (349,314 )
Cash flows from financing activities:
               
Purchases of treasury stock
    (250,020 )     (13 )
Proceeds from issuance of treasury stock
    84,060       48,819  
Excess tax benefits from stock-based compensation
    8,485       84  
Proceeds from debt
    1,493,439        
Repayment of debt
    (1,000,000 )      
Debt issuance costs
    (10,662 )      
Net cash provided by financing activities
    325,302       48,890  
Effect of foreign currency exchange rates on cash and cash equivalents
    (8,454 )     13,482  
Net increase in cash and cash equivalents
    138,119       340,330  
Cash and cash equivalents at beginning of period
    999,487       886,450  
Cash and cash equivalents at end of period
  $ 1,137,606     $ 1,226,780  
Supplemental disclosures:
               
Cash paid for income taxes, net of refunds
  $ 198,512     $ 58,024  
Cash paid for interest
  $ 2,742     $ 1,488  

See accompanying Notes to Condensed Consolidated Financial Statements.

 
5

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

 
 
    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 n ot necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009 on file with the SEC. The three months ended March 5, 2010 and the six months ended June 4, 2010 financial results benefitted from an extra week in the first quarter of fiscal 2010 due to our 52/53 week financial calendar whereby fiscal 2010 is a 53-week year compared with fiscal 2009 which was a 52-week year.
 
With the exception of the adoption of an accounting pronouncement related to revenue recognition, discussed below, there have been no material changes to our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009.
 
In October 2009, the FASB amended the accounting standards for certain multiple deliverable revenue arrangements to:

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

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

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

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

Multiple Element Arrangements

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

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

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

In certain instances, we were not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to us infrequently selling each element separately, not pricing products or services within a narrow range, or

 
6

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


only having a limited sales history. When VSOE cannot be established, we attempt to establish the selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our offerings contain significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. Therefore, we typically are not able to obtain TPE of selling price.

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

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

We regularly review VSOE and have established a review process for TPE and BESP and maintain internal controls over the establishment and updates of these estimates. There was no material impact to revenue during the three and six months ended June 4, 2010 resulting from changes in VSOE, TPE or BESP, nor do we expect a material impact from such changes in the near term.

Given the nature of our transactions, which are primarily software and software-related, our go-to-market strategies and our pricing practices, total net revenue as reported during the three and six months ended June 4, 2010 is materially consistent with total net revenue that would have been reported if the transactions entered into or materially modified after November 27, 2009 were subject to previous accounting guidance.

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

Recent Accounting Pronouncements
 
There have also been no new accounting pronouncements during the six months ended June 4, 2010, with the exception of those discussed below, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 27, 2009, that are of significance, or potential significance, to us.
 
Fair Value Measurements
 
In January 2010, the FASB issued new accounting guidance related to the disclosure requirements for fair value measurements and provided clarification for existing disclosures requirements. More specifically, this update will require an entity to disclose separately (a) the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This guidance clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosure requirements related to the purchases, sales, issuances and settlements in the rollforward activity of Level 3 fair value measurements. Those disclosure requirements are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. We adopted the new disclosures in the second quarter of fiscal 2010, which included changing the description of certain asset classes in the tables in Notes 3 and 4 to conform with the requirements of the new guidance. We will adopt the Level 3 requirements in the first quarter of fiscal 2012. Since the adoption of the new standards only required additiona l disclosure, the adoption did not have an impact on our consolidated financial position, results of operations and cash flows.
 
 
7

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
Variable Interest Entities
 
In June 2009, the FASB issued amended standards for determining whether to consolidate a variable interest entity. These new standards amend the evaluation criteria to identify the primary beneficiary of a variable interest entity and requires ongoing reassessment of whether an enterprise is the primary beneficiary of the variable interest entity. The provisions of the new standards are effective for annual reporting periods beginning after November 15, 2009 and interim periods within those fiscal years. These standards were effective for us beginning in the first quarter of fiscal 2010. The adoption of the new standards did not have an impact on our consolidated financial position, results of operations and cash flows.
 
Intangible Assets Useful Lives
 
In April 2008, the FASB issued new standards which provided guidance on how to determine the useful life of intangible assets by amending the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. These standards are effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years and was effective for us beginning in the first quarter of fiscal 2010. There was no impact to our current consolidated financial statements as we did not purchase any intangible assets during the three and six months ende d June 4, 2010.
 
Business Combinations and Non-Controlling Interests
 
In December 2007, the FASB revised their guidance for business combinations and non-controlling interests. The new standards change how business acquisitions are accounted for and impact financial statements both on the acquisition date and in subsequent periods. The changes also impact the accounting and reporting for minority interests, which are recharacterized as non-controlling interests and classified as a component of equity. The new standards were effective for us beginning in the first quarter of fiscal 2010. We currently believe that depending on the size and frequency of acquisitions, the adoption of these standards may have a material effect on our future consolidated financial statements. There was no impact to our current consolidated financial statements as we did not have any business combinations during the three and six months ended June 4, 2010.
 
 
NOTE 2.  ACQUISITIONS
 
On October 23, 2009, we completed the acquisition of Omniture, Inc. (“Omniture”), an industry leader in Web analytics and online business optimization based in Orem, Utah, for approximately $1.8 billion. Under the terms of the agreement, we completed our tender offer to acquire all of the outstanding shares of Omniture common stock at a price of $21.50 per share, net to the seller in cash, without interest. Acquiring Omniture accelerates our strategy of delivering more effective solutions for creating, delivering, measuring and optimizing Web content and applications. The transaction was accounted for using the purchase method of accounting. We have included the financial results of Omniture in our Condensed Consolidated Financial Statements beginning on the acquisition date. Following the closing, we integrated Omniture a s a new reportable segment for financial reporting purposes.
 
The total purchase price for Omniture was approximately $1.8 billion which consisted of $1.7 billion in cash paid for outstanding common stock, $85.0 million for the estimated fair value of earned stock options and restricted stock units assumed and converted and $14.4 million for direct transaction costs. The preliminary allocation of the purchase price was based upon a preliminary valuation and our estimates and assumptions. During the six months ended June 4, 2010, we finalized our purchase accounting after adjustments were made to the preliminary purchase price allocation to reflect the finalization of the valuation of intangible assets and deferred revenue. Additional adjustments were also made to restructuring liabilities, taxes and residual goodwill. Of the total final purchase price, $1.34 billion has been allocated to goodwil l, $436.1 million to identifiable intangible assets, $33.4 million to net tangible assets and $11.3 million to restructuring liabilities. We also expensed $4.6 million for in-process research and development charges.
 
 
8

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
   The following table presents the results of Adobe and Omniture for the three and six months ended May 29, 2009, on a pro forma basis, as though the companies had been combined as of the beginning fiscal 2009. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of fiscal 2009 or of results that may occur in the future.
 
     
Three
Months Ended
     
Six
Months Ended
 
     
May 29, 2009
     
May 29, 2009
 
Net revenues
  $ 758,405     $ 1,631,952  
Net income
  $ 88,191     $ 230,016  
Basic net income per share
  $ 0.17     $ 0.44  
Shares used in computing basic net income per share
    524,159       524,219  
Diluted net income per share
  $ 0.17     $ 0.43  
Shares used in computing diluted net income per share
    529,488       529,553  

 
NOTE 3.  CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
 
Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase. We classify all of our cash equivalents and short-term investments as “available-for-sale.” In general, these investments are free of trading restrictions. We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. Gains and losses are recognized when realized in our Condensed Consolidated Statements of Income. When we have determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is relat ed to a credit loss is recognized in earnings. Gains and losses are determined using the specific identification method.

Cash, cash equivalents and short-term investments consisted of the following as of June 4, 2010 (in thousands):

     
Amortized
Cost
     
Unrealized
Gains
     
Unrealized
Losses
     
Estimated
Fair Value
 
Current assets:
                               
Cash
  $ 101,436     $     $     $ 101,436  
Cash equivalents:
                               
Money market mutual funds
    876,042                   876,042  
Time deposits
    44,915                   44,915  
U.S. Treasury securities
    54,998       1             54,999  
U.S. agency securities
    14,999                   14,999  
Municipal securities
    1,295                   1,295  
Corporate bonds
    43,920                   43,920  
Total cash equivalents
    1,036,169       1             1,036,170  
Total cash and cash equivalents
    1,137,605       1             1,137,606  
Short-term fixed income investments:
                               
U.S. Treasury securities
    414,286       2,668       (4 )     416,950  
U.S. agency securities
    268,304       447       (5 )     268,746  
Municipal securities
    118,697       31       (6 )     118,722  
Corporate bonds
    627,916       5,819       (845 )     632,890  
Foreign government securities
    51,709       404       (5 )     52,108  
Subtotal
    1,480,912       9,369       (865 )     1,489,416  
Marketable equity securities
    6,680       11,020             17,700  
Total short-term investments
    1,487,592       20,389       (865 )     1,507,116  
Total cash, cash equivalents and short-term investments
  $ 2,625,197     $ 20,390     $ (865 )   $ 2,644,722  
 
 
9

 
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 27, 2009 (in thousands):

     
Amortized
Cost
     
Unrealized
Gains
     
Unrealized
Losses
     
Estimated
Fair Value
 
Current assets:
                               
Cash
  $ 75,110     $     $     $ 75,110  
Cash equivalents:
                               
Money market mutual funds
    884,240                   884,240  
Time deposits
    40,137                   40,137  
Total cash equivalents
    924,377                   924,377  
Total cash and cash equivalents
    999,487                   999,487  
Short-term fixed income investments:
                               
U.S. Treasury securities
    373,180       3,199       (1 )     376,378  
U.S. agency securities
    59,447       273             59,720  
Corporate bonds
    407,465       8,111       (1 )     415,575  
Foreign government securities
    47,620       666             48,286  
Subtotal
    887,712       12,249       (2 )     899,959  
Marketable equity securities
    2,527       2,500             5,027  
Total short-term investments
    890,239       14,749       (2 )     904,986  
Total cash, cash equivalents and short-term investments
  $ 1,889,726     $ 14,749     $ (2 )   $ 1,904,473  

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

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category that have been in a continuous unrealized loss position for less than twelve months, as of June 4, 2010 and November 27, 2009 (in thousands):
 
        2010         2009  
     
Fair 
Value
     
Gross
Unrealized
Losses
     
Fair 
Value
     
Gross
Unrealized
Losses
 
U.S. Treasury and agency securities
  $ 44,430     $ (9 )   $ 11,179     $ (1 )
Corporate bonds
    225,694       (845 )     5,041       (1 )
Foreign government securities
    994       (5 )            
Municipal securities
    22,225       (6 )            
Total
  $ 293,343     $ (865 )   $ 16,220     $ (2 )
 
As of June 4, 2010 and November 27, 2009, there were no securities in a continuous unrealized loss position for more than twelve months. There were 102 securities and 4 securities that were in an unrealized loss position at June 4, 2010 and at November 27, 2009, respectively.
 
The following table summarizes the cost and estimated fair value of debt securities classified as short-term investments based on stated maturities as of June 4, 2010 (in thousands):

     
Amortized
Cost
     
Estimated
Fair Value
 
Due within one year
  $ 846,670     $ 847,886  
Due within two years
    384,145       387,736  
Due within three years
    183,702       185,288  
Due after three years
    66,395       68,506  
Total
  $ 1,480,912     $ 1,489,416  

As of June 4, 2010, we did not consider any of our investments to be other-than-temporarily impaired.
 
 
10

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
NOTE 4.  FAIR VALUE MEASUREMENTS
 
We measure certain financial assets and liabilities at fair value on a recurring basis.
 
The fair value of these financial assets and liabilities was determined using the following inputs at June 4, 2010 (in thousands):
 
        Fair Value Measurements at Reporting Date Using  
             
Quoted Prices
in Active
Markets for
Identical Assets
     
Significant
Other
Observable
Inputs
     
Significant
Unobservable
Inputs
 
     
Total
     
(Level 1)
     
(Level 2)
     
(Level 3)
 
Assets:
                               
Money market mutual funds
  $ 876,624     $ 876,624     $     $  
Time deposits
    44,915       44,915              
U.S. Treasury securities
    471,949             471,949        
U. S. agency securities
    283,745             283,745        
Municipal securities
    120,017             120,017        
Corporate bonds
    676,810             676,810        
Foreign government securities
    52,108             52,108        
Marketable equity securities
    17,700       17,700              
Investments of limited partnership
    24,130                   24,130  
Foreign currency derivatives
    46,671             46,671        
Equity and fixed income mutual funds
    8,556             8,556        
Total assets
  $ 2,623,225     $ 939,239     $ 1,659,856     $ 24,130  
Liabilities:
                               
Foreign currency derivatives
  $ 617     $     $ 617     $  
Total liabilities
  $ 617     $     $ 617     $  

There have been no transfers between fair value measurement levels during the three months ended June 4, 2010.

The fair value of these financial assets and liabilities was determined using the following inputs at November 27, 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)
 
Assets:
                               
Money market mutual funds
  $ 884,958     $ 884,958     $     $  
Time deposits
    40,137       40,137              
U.S. Treasury securities 
    376,379             376,379        
U.S. agency securities
    59,720             59,720        
Municipal securities
                       
Corporate bonds 
    415,575             415,575        
Foreign government securities
    48,286             48,286        
Marketable equity securities
    5,026       5,026              
Investments of limited partnership
    37,121                   37,121  
Foreign currency derivatives
    4,307             4,307        
Equity and fixed income mutual funds
    8,328             8,328        
Total assets
  $ 1,879,837     $ 930,121     $ 912,595     $ 37,121  
Liabilities:
                               
Foreign currency derivatives
  $ 1,589     $     $ 1,589     $  
Total liabilities
  $ 1,589     $     $ 1,589     $  
 
 
11

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
The following table summarizes our assets and liabilities measured at fair value on a recurring basis as presented on our Condensed Consolidated Balance Sheets as of June 4, 2010 (in thousands):
 
             
Quoted Prices
in Active
Markets for
Identical Assets
     
Significant
Other
Observable
Inputs
     
Significant
Unobservable
Inputs
 
     
Total
     
(Level 1)
     
(Level 2)
     
(Level 3)
 
Assets:
                               
Cash equivalents
  $ 1,036,170     $ 920,957     $ 115,213     $  
Short-term investments 
    1,507,116       17,700       1,489,416        
Prepaid expenses and other current assets 
    46,671             46,671        
Other assets
    33,268       582       8,556       24,130  
Total assets measured  at fair value 
  $ 2,623,225     $ 939,239     $ 1,659,856     $ 24,130  
                                 
Liabilities:
                               
Other current liabilities
  $ 617     $     $ 617     $  
Total liabilities measured at fair value
  $ 617     $     $ 617     $  

The following table summarizes our assets and liabilities measured at fair value on a recurring basis as presented on our Condensed Consolidated Balance Sheets as of November 27, 2009 (in thousands):
 
             
Quoted Prices
in Active
Markets for
Identical Assets
     
Significant
Other
Observable
Inputs
     
Significant
Unobservable
Inputs
 
     
Total
     
(Level 1)
     
(Level 2)
     
(Level 3)
 
Assets:
                               
Cash equivalents
  $ 925,095     $ 925,095     $     $  
Short-term investments 
    904,986       5,026       899,960        
Prepaid expenses and other current assets
    4,307             4,307        
Other assets
    45,449             8,328       37,121  
Total assets measured  at fair value
  $ 1,879,837     $ 930,121     $ 912,595     $ 37,121  
                                 
Liabilities:
                               
Other current liabilities
  $ 1,589     $     $ 1,589     $  
Total liabilities measured at fair value
  $ 1,589     $     $ 1,589     $  

See Note 3 for further information regarding the fair value of our financial instruments.
 
Our fixed income available-for-sale securities consist of high quality, investment grade securities from diverse industries with a minimum credit rating of A- and a weighted average credit rating of AA+. We value these securities based on pricing from pricing vendors, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. However, we classify all of our fixed income available-for-sale securities as having Level 2 inputs. The valuation techniques used to measure the fair value of our financial instruments having Level 2 inputs were derived from non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricin g models, such as discounted cash flow techniques. Our procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources.
 
The investments of limited partnership relate to our interest in Adobe Ventures IV L.P. (“Adobe Ventures”), which are consolidated in our Condensed Consolidated Financial Statements. The Level 3 investments consist of investments in 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. There was no impact to other comprehensive income (“OCI”) related to our Level 3 investments. We estimated fair value of the Level 3 investments by
 
 
12

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
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 June 4, 2010 and November 27, 2009 was as follows (in thousands):
 
Balance as of November 28, 2008
  $ 38,753  
Purchases and sales of investments, net
    1,921  
Unrealized net investment losses included in earnings
    (3,553 )
Balance as of November 27, 2009
    37,121  
Purchases and sales of investments, net
    268  
Unrealized net investment losses included in earnings
    (13,259 )
Balance as of June 4, 2010
  $ 24,130  
 
We also have direct investments in privately-held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write-down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. During the three and six months ended June 4, 2010, we determined that certain of our direct cost method investments were other-than-temporarily impaired which resulted in a charge of $0.4 million for both per iods which is included in investment gains (losses), net in our Condensed Consolidated Statements of Income.
 
See Note 7 for further information regarding our limited partnership interest in Adobe Ventures and our cost method investments.
 
 
NOTE 5.  DERIVATIVES AND HEDGING ACTIVITIES
 
In countries outside the U.S., we transact business in U.S. dollars and in various other currencies. Therefore, we are subject to exposure from movements in foreign currency rates. We may use foreign exchange option contracts or forward contracts to hedge certain operational (“cash flow”) exposures resulting from changes in foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. The maximum original duration of any contract is twelve months. We enter into these foreign exchange contracts to hedge a portion of our forecasted foreign currency denominated revenue in the normal course of business and accordingly, they are not speculative in nature.

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

We also hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with changes in the fair value recorded to interest and other income, net on our Condensed Consolidated Statement of Income. These derivative instruments do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.
 
 
13

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

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

The aggregate fair value of derivative instruments in net asset positions as of June 4, 2010 and November 27, 2009 was $46.7 million and $4.3 million, respectively. These amounts represent the maximum exposure to loss at the reporting date as a result of all of the counterparties failing to perform as contracted. This exposure could be reduced by up to $0.6 million and $1.6 million, respectively, of liabilities included in master netting arrangements with those same counterparties.

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of June 4, 2010 and November 27, 2009 were as follows (in thousands):

        2010         2009  
     
Fair Value
Asset
Derivatives(1)
     
Fair Value
Liability
Derivatives(2)
     
Fair Value
Asset
Derivatives(1)
     
Fair Value
Liability
Derivatives(2)
 
Derivatives designated as hedging instruments:
                               
Foreign exchange option contracts(3)
  $ 38,918     $     $ 4,175     $  
                                 
Derivatives not designated as hedging instruments:
                               
Foreign exchange forward contracts
    7,753       617       132       1,589  
Total derivatives
  $ 46,671     $ 617     $ 4,307     $ 1,589  
 
_________________________________________
(1)
Included in prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.
 
(2)
Included in accrued expenses on our Condensed Consolidated Balance Sheets.
 
(3)
Hedging effectiveness expected to be recognized to income within the next twelve months.

  The effect of derivative instruments designated as cash flow hedges and of derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for three and six months ended June 4, 2010 was as follows (in thousands):

        Three Months         Six 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, net of tax(1) 
  $ 28,425     $     $ 38,789     $  
Net gain (loss) reclassified from accumulated OCI into income, net of tax(2)
  $ 6,206     $     $ 6,206     $  
Net gain (loss) recognized in income(3) 
  $ (5,845 )   $     $ (9,766 )   $  
                                 
Derivatives not designated as hedging relationships:
                               
Net gain (loss) recognized in income(4) 
  $     $ 10,761     $     $ 21,801  
 
 
14

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

The effect of derivative instruments designated as cash flow hedges and of derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for three and six months ended May 29, 2009 was as follows (in thousands):

        Three Months         Six 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, net of tax(1) 
  $ (8,737 )   $     $ (14,187 )   $  
Net gain (loss) reclassified from accumulated OCI into income, net of tax(2)
  $ 5,913     $     $ 26,389     $  
Net gain (loss) recognized in income(3) 
  $ (7,416 )   $     $ (9,048 )   $  
                                 
Derivatives not designated as hedging relationships:
                               
Net gain (loss) recognized in income(4) 
  $     $ (5,305 )   $     $ (8,550 )

_________________________________________
(1)
Net change in the fair value of the effective portion classified in OCI.
 
(2)
Effective portion classified as revenue.
 
(3)
Ineffective portion and amount excluded from effectiveness testing classified in interest and other income, net.
 
(4)
Classified in interest and other income, net.
 
 
NOTE 6.  GOODWILL AND PURCHASED AND OTHER INTANGIBLES
 
Goodwill as of June 4, 2010 and November 27, 2009 was $3.488 billion and $3.495 billion, respectively. The change includes adjustments to our Omniture and Macromedia purchase price allocation in addition to foreign currency translation adjustments. During the second quarter of fiscal 2010, we completed our annual goodwill impairment test. Based on this analysis, we determined that there was no impairment of goodwill.
 
  Purchased and other intangible assets subject to amortization as of June 4, 2010 and November 27, 2009 were as follows (in thousands):
 
        2010         2009  
     
Cost
     
Accumulated Amortization
     
Net
     
Cost
     
Accumulated Amortization
     
Net
 
Purchased technology
  $ 219,298     $ (40,455 )   $ 178,843     $ 586,952     $ (387,731 )   $ 199,221  
Localization
  $ 13,181     $ (7,494 )   $ 5,687     $ 20,284     $ (15,222 )   $ 5,062  
Trademarks
    172,009       (120,687 )     51,322       172,030       (104,953 )     67,077  
Customer contracts and relationships
    364,057       (177,846 )     186,211       363,922       (159,450 )     204,472  
Other intangibles
    47,069       (21,760 )     25,309       54,535       (2,979 )     51,556  
Total other intangible assets
  $ 596,316     $ (327,787 )   $ 268,529     $ 610,771     $ (282,604 )   $ 328,167  
Purchased and other intangible assets
  $ 815,614     $ (368,242 )   $ 447,372     $ 1,197,723     $ (670,335 )   $ 527,388  
 
During the six months ended June 4, 2010, purchased and other intangible assets from prior acquisitions, primarily Macromedia, became fully amortized and were removed from the balance sheet. Amortization expense related to purchased and other intangible assets was $42.2 million and $79.1 million for the three and six months ended June 4, 2010, respectively. Comparatively, amortization expense was $36.4 million and $75.4 million for the three and six months ended May 29, 2009, respectively. Of these amounts, $24.0 million and $42.7 million were included in cost of sales for the three and six months ended June 4, 2010, respectively, and $21.1 million and $44.7 million were included in cost of sales for the three and six months ended May 29, 2009, respectively.
 
 
15

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
    As of June 4, 2010, we expect amortization expense in future periods to be as follows (in thousands):
 
 
Fiscal Year
 
   
Purchased
Technology
     
Other Intangible
Assets
 
Remainder of 2010
  $ 17,842     $ 46,521  
2011
    32,301       52,526  
2012
    30,694       22,338  
2013
    26,766       21,674  
2014
    25,144       21,274  
Thereafter
    46,096       104,196  
Total expected amortization expense                                                                                         
  $ 178,843     $ 268,529  

 
NOTE 7.  OTHER ASSETS
 
Other assets as of June 4, 2010 and November 27, 2009 consisted of the following (in thousands):
 
     
2010
     
2009
 
Acquired rights to use technology
  $ 77,917     $ 84,313  
Investments
    42,157       63,526  
Security and other deposits
    10,927       11,692  
Prepaid royalties
    10,404       12,059  
Debt issuance costs
    10,228        
Deferred compensation plan assets
    9,138       9,045  
Restricted cash
    2,470       4,650  
Prepaid land lease
    14,207       3,209  
Prepaid rent
    1,082       1,377  
Other
    1,846       1,394  
Other assets
  $ 180,376     $ 191,265  
 
Included in investments are our indirect investments through our limited partnership interest in Adobe Ventures of approximately $24.1 million and $37.1 million as of June 4, 2010 and November 27, 2009, respectively. We consolidate Adobe Ventures in accordance with the provisions for consolidating variable interest entities as we have determined we have the power to direct the activities that most significantly impact the entity’s economic performance and we have the obligation to absorb losses or the right to receive benefits through our limited partnership interest in Adobe Ventures. The partnership is controlled by Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures. We are the primary beneficiary of Adobe Ventures and bear virtually all of the risks and rewards related to our owne rship. Our investment in Adobe Ventures does not have a significant impact on our consolidated financial position, results of operations or cash flows.

The primary purpose of our limited partnership interest in Adobe Ventures is to invest in securities of private companies which either operate in, or are expected to operate in, industries where technology and business model trends are expected to have an impact on our core business. Our maximum capital commitment to Adobe Ventures is $104.6 million, of which, approximately $95.4 million has been invested.
 
  Adobe Ventures carries its investments in equity securities at estimated fair value and investment gains and losses are included in our Condensed Consolidated Statements of Income. Substantially all of the investments held by Adobe Ventures at June 4, 2010 and November 27, 2009 are not publicly traded and, therefore, there is no established market for these securities. In order to determine the fair value of these investments, we use the most recent round of financing involving new non-strategic investors or estimates of fair value made by Granite Ventures. We evaluate the fair value of these investments held by Adobe Ventures on a regular basis. This evaluation includes, but is not limited to, reviewing each company’s cash position, financing needs, earnings and revenue outlook, operational performance, management and ownership changes and competition. In the case of privately-held companies, this evaluation is based on information that we request from these companies. This information is not subject to the same disclosure regulations as U.S. publicly traded companies and as such, the basis for these evaluations is subject to the timing and the accuracy of the data received from these companies.
 
 
16

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
    Also included in investments are our direct investments in privately-held companies of approximately $18.1 million and $26.4 million as of June 4, 2010 and November 27, 2009, respectively, which are accounted for based on the cost method. We assess these investments for impairment in value as circumstances dictate.
 
 
NOTE 8.  ACCRUED EXPENSES
 
Accrued expenses as of June 4, 2010 and November 27, 2009 consisted of the following (in thousands):
 
     
2010
     
2009
 
Accrued compensation and benefits
  $ 199,570     $ 164,352  
Taxes payable
    19,627       11,879  
Sales and marketing allowances
    28,643       32,774  
Other
    220,747       210,641  
Accrued expenses                                                                                         
  $ 468,587     $ 419,646  

Other primarily includes general corporate accruals for corporate marketing programs, local and regional expenses, and technical support. Other is also comprised of deferred rent related to office locations with rent escalations, accrued royalties, foreign currency derivatives and accrued interest on our outstanding debt.
 
 
NOTE 9.  INCOME TAXES
 
The gross liability for unrecognized tax benefits at June 4, 2010 was $210.1 million, exclusive of interest and penalties. If the total unrecognized tax benefits at June 4, 2010 were recognized in the future, $192.9 million of unrecognized tax benefits would decrease the effective tax rate, which is net of an estimated $17.2 million federal benefit related to deducting certain payments on future state tax returns.
 
As of June 4, 2010, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns was approximately $17.5 million. This amount is included in non-current income taxes payable.
 
The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits equal to $0 to approximately $10 million. These amounts would decrease income tax expense.
 
In December 2009, we repatriated $700 million of undistributed foreign earnings for which a deferred tax liability had been previously accrued. As such, a long-term deferred tax liability of approximately $200 million was reclassified from deferred income taxes to income taxes payable. During the second quarter of fiscal 2010, a portion of these liabilities in income taxes payable were paid.
 
 
NOTE 10.  STOCK-BASED COMPENSATION
 
The assumptions used to value option grants during the three and six months ended June 4, 2010 and May 29, 2009 were as follows:
 
        Three Months         Six Months  
     
2010
     
2009
     
2010
     
2009
 
Expected life (in years)
    3.9 – 5.1       3.0 – 3.8       3.8 – 5.1       3.0 – 3.8  
Volatility
    29 – 30 %     48 – 55     29 – 36 %     48 – 57 %
Risk free interest rate
    2.06 – 2.66 %     1.27 – 1.61     1.76 – 2.66 %     1.16 – 1.61 %
 
 
17

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

  The expected term of employee stock purchase plan (“ESPP”) shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three and six months ended June 4, 2010 and May 29, 2009 were as follows:

        Three Months         Six Months  
     
2010
     
2009
     
2010
     
2009
 
Expected life (in years)
    0.5 – 2.0       0.5 – 2.0       0.5 – 2.0       0.5 – 2.0  
Volatility
    32 %     49 – 57 %     32 %     49 – 57  %
Risk free interest rate
    0.18 – 1.09 %     0.27 – 0.88 %     0.18 – 1.09 %     0.27 – 0.88  %
 
Summary of Stock Options
 
Option activity for the six months ended June 4, 2010 and the fiscal year ended November 27, 2009 was as follows (in thousands):
 
     
2010
     
2009
 
Beginning outstanding balance
    41,251       40,704  
Granted
    3,094       5,758  
Exercised
    (3,936 )     (7,560 )
Cancelled
    (1,121 )     (3,160 )
Increase due to acquisition
          5,509  
Ending outstanding balance
    39,288       41,251  
 
Information regarding stock options outstanding at June 4, 2010 and May 29, 2009 is summarized below:
 
     
Number of
Shares
(thousands)
     
Weighted
Average
Exercise
Price
     
Weighted
Average
Remaining
Contractual
Life
(years)
     
Aggregate
Intrinsic
Value(*)
(millions)
 
2010
                               
Options outstanding
    39,288     $ 30.52       4.15     $ 153.5  
Options vested and expected to vest
    37,542     $ 30.58       4.05     $ 145.5  
Options exercisable
    26,486     $ 30.88       3.38     $ 96.6  
                                 
2009
                               
Options outstanding
    40,803     $ 29.20       4.01     $ 143.8  
Options vested and expected to vest
    38,951     $ 29.19       3.92     $ 137.3  
Options exercisable
    27,319     $ 28.19       3.23     $ 108.7  
 
_________________________________________
(*)
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 June 4, 2010 and May 29, 2009 were $31.59 and $28.18, respectively.
 
Summary of Employee Stock Purchase Plan Shares
 
Employees purchased 1.3 million shares at an average price of $20.20 and 1.2 million shares at an average price of $18.10 for the six months ended June 4, 2010 and May 29, 2009, respectively. The intrinsic value of shares purchased during the six months ended June 4, 2010 and May 29, 2009 was $21.4 million and $3.7 million, respectively. The intrinsic value is calculated as the difference between the market value on the date of purchase and the purchase price of the shares.
 
 
18

 
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(Unaudited)
 
 
Summary of Restricted Stock Units
 
Restricted stock unit activity for the six months ended June 4, 2010 and the fiscal year ended November 27, 2009 was as follows (in thousands):
 
     
2010
     
2009
 
Beginning outstanding balance
    10,433       4,261  
Awarded
    6,197       6,176  
Released
    (1,743 )     (1,162 )
Forfeited
    (523 )     (401 )
Increase due to acquisition
          1,559  
Ending outstanding balance
    14,364       10,433  
 
Information regarding restricted stock units outstanding at June 4, 2010 and May 29, 2009 is summarized below:
 
     
Number of
Shares
(thousands)
     
Weighted
Average
Remaining
Contractual
Life
(years)
     
Aggregate
Intrinsic
Value(*)
(millions)
 
2010
                       
Restricted stock units outstanding
    14,364       1.88     $ 453.8  
Restricted stock units vested and expected to vest
    11,016       1.71     $ 347.8  
                         
2009
                       
Restricted stock units outstanding
    6,272       1.89     $ 176.8  
Restricted stock units vested and expected to vest
    4,805       1.72     $ 135.3  
 
_________________________________________
(*)
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 June 4, 2010 and May 29, 2009 were $31.59 and $28.18, respectively.
 
Summary of Performance Shares
 
Effective January 25, 2010, the Executive Compensation Committee adopted the 2010 Performance Share Program (the “2010 Program”). The purpose of the 2010 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2010 Program is our fiscal 2010 year. All members of our executive management and other key senior leaders are participating in the 2010 Program. Awards granted under the 2010 Program were granted in the form of performance shares pursuant to the terms of our 2003 Equity Incentive Plan. If pre-determined performance goals are met, shares of stock will be granted to the recipient, with one third vesting on the later of the date of certification of achievement or the first anniversary date of the grant, and the rem aining two thirds vesting evenly on the following two annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2010 Program have the ability to receive up to 150% of the target number of shares originally granted.
 
The following table sets forth the summary of performance share activity under our 2010 Program for the six months ended June 4, 2010 (in thousands):
 
     
Shares
Granted
     
Maximum
Shares Eligible
to Receive
 
Beginning outstanding balance
           
Awarded
    263       394  
Forfeited
           
Ending outstanding balance
    263       394  
 
 
19

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

The performance metrics under the 2009 Performance Share Program were not achieved and therefore no shares were awarded. The following table sets forth the summary of performance share activity under our 2007 and 2008 programs, based upon share awards actually achieved, for the six months ended June 4, 2010 and the fiscal year ended November 27, 2009 (in thousands):
 
     
2010
     
2009
 
Beginning outstanding balance
    950       383  
Achieved
          1,022  
Released
    (339 )     (382 )
Forfeited
    (18 )     (73 )
Ending outstanding balance
    593       950  
 
Information regarding performance shares outstanding at June 4, 2010 and May 29, 2009 is summarized below:
 
     
Number of
Shares
(thousands)
     
Weighted
Average
Remaining
Contractual
Life
(years)
     
Aggregate
Intrinsic
Value(*)
(millions)
 
2010
                       
Performance shares outstanding
    593       1.06     $ 18.7  
Performance shares vested and expected to vest
    509       1.01     $ 15.9  
                         
2009
                       
Performance shares units outstanding
    1,005       1.53     $ 28.3  
Performance shares vested and expected to vest
    807       1.44     $ 22.7  
 
_________________________________________
(*)
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 June 4, 2010 and May 29, 2009 were $31.59 and $28.18, respectively.
 
Compensation Costs
 
As of June 4, 2010, there was $396.7 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 2.8 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the three months ended June 4, 2010 and May 29, 2009 were as follows (in thousands):
 
        2010