10-Q 1 adbe10qq113.htm 10-Q ADBE 10Q Q113
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 1, 2013

 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 check mark 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 March 22, 2013 was 501,936,172.
 



ADOBE SYSTEMS INCORPORATED
FORM 10-Q
 
TABLE OF CONTENTS
 
 
 
Page No.

PART I—FINANCIAL INFORMATION
 
Item 1.

 

 

 

 

 

Item 2.

Item 3.

Item 4.
 
 
 
 

 PART II—OTHER INFORMATION
 
Item 1.

Item 1A.

Item 2.

Item 4.
Item 6.






 

2


PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
March 1,
2013
 
November 30,
2012
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,306,382

 
$
1,425,052

Short-term investments
2,354,307

 
2,113,301

   Trade receivables, net of allowances for doubtful accounts of $12,715 and $12,643, respectively
485,801

 
617,233

Deferred income taxes
64,930

 
59,537

Prepaid expenses and other current assets
161,663

 
116,237

Total current assets
4,373,083

 
4,331,360

Property and equipment, net
686,014

 
664,302

Goodwill
4,221,487

 
4,133,259

Purchased and other intangibles, net
580,568

 
545,036

Investment in lease receivable
207,239

 
207,239

Other assets
97,320

 
93,327

Total assets
$
10,165,711

 
$
9,974,523

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 

 
 

Trade payables
$
72,725

 
$
49,759

Accrued expenses
505,465

 
590,140

Capital lease obligations
22,406

 
11,217

Accrued restructuring
6,767

 
9,287

Income taxes payable
11,126

 
49,886

Deferred revenue
645,834

 
561,463

Total current liabilities
1,264,323

 
1,271,752

Long-term liabilities:
 

 
 

Debt and capital lease obligations
1,509,003

 
1,496,938

Deferred revenue
54,197

 
58,102

Accrued restructuring
10,053

 
12,263

Income taxes payable
159,859

 
155,096

Deferred income taxes
292,770

 
265,106

Other liabilities
70,168

 
50,084

Total liabilities
3,360,373

 
3,309,341

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; 
   501,045 and 494,132 shares outstanding, respectively
61

 
61

Additional paid-in-capital
3,116,471

 
3,038,665

Retained earnings
6,808,489

 
7,003,003

Accumulated other comprehensive income
40,110

 
30,712

Treasury stock, at cost (99,789 and 106,702 shares, respectively), net of reissuances
(3,159,793
)
 
(3,407,259
)
Total stockholders’ equity
6,805,338

 
6,665,182

Total liabilities and stockholders’ equity
$
10,165,711

 
$
9,974,523

_________________________________________ 
(*)
The Condensed Consolidated Balance Sheet as of November 30, 2012 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
See accompanying Notes to Condensed Consolidated Financial Statements.

3


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
 
March 1,
2013
 
March 2,
2012
Revenue:
 
 
 
Products
$
675,789

 
$
808,521

Subscription
224,266

 
146,230

Services and support
107,818

 
90,469

Total revenue
1,007,873

 
1,045,220

 
Cost of revenue:
 

 
 
Products
51,982

 
25,668

Subscription
62,580

 
48,780

Services and support
42,122

 
33,817

Total cost of revenue
156,684

 
108,265

 
Gross profit
851,189

 
936,955

 
Operating expenses:
 

 
 
Research and development
209,638

 
177,728

Sales and marketing
398,033

 
358,963

General and administrative
132,853

 
102,681

Restructuring charges
2

 
(2,825
)
Amortization of purchased intangibles
12,439

 
11,429

Total operating expenses
752,965

 
647,976

 
Operating income
98,224

 
288,979

 
Non-operating income (expense):
 

 
 
Interest and other income (expense), net
1,246

 
(2,785
)
Interest expense
(16,834
)
 
(16,838
)
Investment gains (losses), net
848

 
1,021

Total non-operating income (expense), net
(14,740
)
 
(18,602
)
Income before income taxes
83,484

 
270,377

Provision for income taxes
18,367

 
85,168

Net income
$
65,117

 
$
185,209

Basic net income per share
$
0.13

 
$
0.37

Shares used to compute basic net income per share
498,607

 
494,016

Diluted net income per share
$
0.13

 
$
0.37

Shares used to compute diluted net income per share
507,840

 
500,378



  See accompanying Notes to Condensed Consolidated Financial Statements.


4


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
Three Months Ended
 
March 1,
2013
 
March 2,
2012
 
Increase/(Decrease)
Net income
$
65,117

 
$
185,209

Other comprehensive income, net of taxes:
 
 
 
Available-for-sale securities:
 
 
 
Unrealized gains / losses on available-for-sale securities
702

 
12,864

Reclassification adjustment for gains on available-for-sale securities recognized during
   the period
(1,584
)
 
(497
)
Net increase (decrease) from available-for-sale securities
(882
)
 
12,367

Derivatives designated as hedging instruments:
 
 
 
Unrealized gains on derivative instruments
21,776

 
12,581

Reclassification adjustment for gains on derivative instruments recognized during the
   period
(7,094
)
 
(10,348
)
Net increase from derivatives designated as hedging instruments
14,682

 
2,233

Foreign currency translation adjustments
(4,402
)
 
2,198

Other comprehensive income
9,398

 
16,798

Total comprehensive income, net of taxes
$
74,515

 
$
202,007



See accompanying Notes to Condensed Consolidated Financial Statements.



5


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Three Months Ended
 
March 1,
2013
 
March 2,
2012
Cash flows from operating activities:
 
 
 
Net income
$
65,117

 
$
185,209

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 
Depreciation, amortization and accretion
76,752

 
69,861

Stock-based compensation
84,196

 
71,582

Deferred income taxes
15,176

 
63,377

Unrealized (gains) losses on investments
(418
)
 
(3,168
)
Other non-cash items
(4,647
)
 
(6,650
)
Excess tax benefits from stock-based compensation

 
(2,670
)
Changes in operating assets and liabilities, net of acquired assets and assumed
      liabilities:
 
 
 
Trade receivables, net
131,511

 
152,721

Prepaid expenses and other current assets
(35,447
)
 
(15,080
)
Trade payables
22,477

 
(42,542
)
Accrued expenses
(78,966
)
 
(116,908
)
Accrued restructuring
(4,047
)
 
(39,057
)
Income taxes payable
(29,187
)
 
(19,051
)
Deferred revenue
79,514

 
16,739

Net cash provided by operating activities
322,031

 
314,363

Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(723,541
)
 
(352,179
)
Maturities of short-term investments
110,958

 
112,089

Proceeds from sales of short-term investments
366,808

 
207,672

Acquisitions, net of cash acquired
(96,356
)
 
(353,184
)
Purchases of property and equipment
(60,190
)
 
(51,088
)
Purchases of long-term investments and other assets
(46,633
)
 
(5,203
)
Proceeds from sale of long-term investments
2,840

 
4,186

Net cash used for investing activities
(446,114
)
 
(437,707
)
Cash flows from financing activities:
 

 
 

Purchases of treasury stock
(100,000
)
 
(80,000
)
Proceeds from issuance of treasury stock
88,566

 
13,366

Excess tax benefits from stock-based compensation

 
2,670

Proceeds from debt and capital lease obligations
25,703

 

Repayment of debt and capital lease obligations
(2,507
)
 
(2,264
)
Debt issuance costs
(357
)
 
(2,297
)
Net cash provided by (used for) financing activities
11,405

 
(68,525
)
Effect of foreign currency exchange rates on cash and cash equivalents
(5,992
)
 
3,632

Net decrease in cash and cash equivalents
(118,670
)
 
(188,237
)
Cash and cash equivalents at beginning of period
1,425,052

 
989,500

Cash and cash equivalents at end of period
$
1,306,382

 
$
801,263

Supplemental disclosures:
 

 
 
Cash paid for income taxes, net of refunds
$
49,863

 
$
51,397

Cash paid for interest
$
31,960

 
$
33,883

Non-cash investing activities:
 
 
 
Issuance of common stock and stock awards assumed in business acquisitions
$
661

 
$
4,265


See accompanying Notes to Condensed Consolidated Financial Statements.

6


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

NOTE 1.  BASIS OF PRESENTATION AND 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 30, 2012 on file with the SEC (our “Annual Report”).
With the exception of the discussion below, there have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our Annual Report.
Recent Accounting Pronouncements 
In December 2011, the FASB amended the accounting standards to increase the prominence of other comprehensive income (“OCI”) by eliminating the option to present components of OCI as part of the statement of changes in shareholders’ equity and requires the components of OCI to be presented either in a single continuous statement of comprehensive income or in two consecutive statements. We adopted the amended accounting standards at the beginning of our first quarter of fiscal 2013 by electing to present separate consolidated statements of comprehensive income from the consolidated statements of income. The amended accounting standards only impact the financial statement presentation of OCI and do not change the components that are recognized in net income or OCI. The adoption had no impact on the Company’s financial position or results of operations.
NOTE 2.  ACQUISITIONS
On December 20, 2012, we completed our acquisition of privately held Behance, an online social media platform to showcase and discover creative work. During the first quarter of fiscal 2013, we began integrating Behance into our Digital Media reportable segment. Behance’s community and portfolio capabilities will accelerate our strategy to bring additional community features to the Creative Cloud. We have included the financial results of Behance in our condensed consolidated financial statements beginning on the acquisition date.
Under the acquisition method of accounting, the total preliminary purchase price was allocated to Behance’s net tangible and intangible assets based upon their estimated fair values as of December 20, 2012. The total adjusted preliminary purchase price for Behance was approximately $111.1 million of which approximately $90.5 million was allocated to goodwill, $28.5 million to identifiable intangible assets and $7.9 million to net liabilities assumed. The impact of this acquisition was not material to our condensed consolidated financial statements.
On January 13, 2012, we completed our acquisition of privately held Efficient Frontier, a multi-channel digital ad buying and optimization company. During the first quarter of fiscal 2012, we began integrating Efficient Frontier into our Digital Marketing reportable segment. The Efficient Frontier business adds cross-channel digital ad campaign forecasting, execution and optimization capabilities to our Adobe Marketing Cloud, along with a social marketing engagement platform and social ad buying capabilities. We have included the financial results of Efficient Frontier in our condensed consolidated financial statements beginning on the acquisition date.
Under the acquisition method of accounting, the total purchase price was allocated to Efficient Frontier’s net tangible and intangible assets based upon their estimated fair values as of January 13, 2012. The total final purchase price for Efficient Frontier was approximately $374.7 million of which approximately $291.4 million was allocated to goodwill, $122.7 million to identifiable intangible assets and $39.4 million to net liabilities assumed. The impact of this acquisition was not material to our condensed consolidated financial statements.


7


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 related to a credit loss is recognized in income. Gains and losses are determined using the specific identification method.
Cash, cash equivalents and short-term investments consisted of the following as of March 1, 2013 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
247,671

 
$

 
$

 
$
247,671

Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
9,514

 
1

 
(2
)
 
9,513

Money market mutual funds
895,845

 

 

 
895,845

Municipal securities
1,498

 

 
(1
)
 
1,497

Time deposits
63,956

 

 

 
63,956

U.S. Treasury securities
87,900

 
1

 
(1
)
 
87,900

Total cash equivalents
1,058,713

 
2

 
(4
)
 
1,058,711

Total cash and cash equivalents
1,306,384

 
2

 
(4
)
 
1,306,382

Short-term fixed income securities:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,195,722

 
10,379

 
(165
)
 
1,205,936

Foreign government securities
12,492

 
64

 
(1
)
 
12,555

Municipal securities
185,907

 
386

 
(11
)
 
186,282

U.S. agency securities
506,699

 
2,024

 
(20
)
 
508,703

U.S. Treasury securities
439,712

 
926

 
(1
)
 
440,637

Subtotal
2,340,532

 
13,779

 
(198
)
 
2,354,113

Marketable equity securities
194

 

 

 
194

Total short-term investments
2,340,726

 
13,779

 
(198
)
 
2,354,307

Total cash, cash equivalents and short-term investments
$
3,647,110

 
$
13,781

 
$
(202
)
 
$
3,660,689



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 30, 2012 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
200,771

 
$

 
$

 
$
200,771

Cash equivalents:
 

 
 
 
 
 
 

Corporate bonds and commercial paper
3,998

 

 

 
3,998

Money market mutual funds and repurchase agreements
1,171,270

 

 

 
1,171,270

Municipal securities
3,895

 

 

 
3,895

Time deposits
45,118

 

 

 
45,118

Total cash equivalents
1,224,281

 

 

 
1,224,281

Total cash and cash equivalents
1,425,052

 

 

 
1,425,052

Short-term fixed income securities:
 
 
 
 
 
 
 

Corporate bonds and commercial paper
1,059,158

 
11,415

 
(133
)
 
1,070,440

Foreign government securities
6,919

 
45

 
(12
)
 
6,952

Municipal securities
180,488

 
97

 
(60
)
 
180,525

Time deposits
20,113

 

 

 
20,113

U.S. agency securities
501,863

 
2,346

 
(18
)
 
504,191

U.S. Treasury securities
330,072

 
801

 
(37
)
 
330,836

Subtotal
2,098,613

 
14,704

 
(260
)
 
2,113,057

Marketable equity securities
237

 
7

 

 
244

Total short-term investments
2,098,850

 
14,711

 
(260
)
 
2,113,301

Total cash, cash equivalents and short-term investments
$
3,523,902

 
$
14,711

 
$
(260
)
 
$
3,538,353


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 an unrealized loss position for less than twelve months, as of March 1, 2013 and November 30, 2012 (in thousands):
 
2013
 
2012
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
191,986

 
$
(167
)
 
$
95,489

 
$
(132
)
Foreign government securities
3,599

 
(1
)
 
2,105

 
(12
)
Municipal securities
14,950

 
(12
)
 
40,524

 
(60
)
U.S. Treasury and agency securities
102,862

 
(19
)
 
48,203

 
(55
)
Total
$
313,397

 
$
(199
)
 
$
186,321

 
$
(259
)
 
There were 153 securities and 65 securities that were in an unrealized loss position for less than twelve months at March 1, 2013 and at November 30, 2012, respectively.

9


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 more than twelve months, as of March 1, 2013 and November 30, 2012 (in thousands):
 
2013
 
2012
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$

 
$

 
$
2,999

 
$
(1
)
U.S. Treasury and agency securities
8,209

 
(3
)
 

 

Total
$
8,209

 
$
(3
)
 
$
2,999

 
$
(1
)
There was one security in an unrealized loss position for more than twelve months at March 1, 2013 and November 30, 2012.
The following table summarizes the cost and estimated fair value of short-term fixed income securities classified as short-term investments based on stated effective maturities as of March 1, 2013 (in thousands):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
549,442

 
$
550,707

Due between one and two years
701,820

 
706,425

Due between two and three years
728,813

 
732,718

Due after three years
360,457

 
364,263

Total
$
2,340,532

 
$
2,354,113

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. For debt securities, the portion of the write-down related to credit loss would be recorded to interest and other income, net in our Condensed Consolidated Statements of Income. Any portion not related to credit loss would be recorded to accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. For equity securities, the write-down would be recorded to investment gains (losses), net in our Condensed Consolidated Statements of Income. During the three months ended March 1, 2013, 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
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
We measure certain financial assets and liabilities at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the three months ended March 1, 2013.
The fair value of our financial assets and liabilities at March 1, 2013 was determined using the following inputs (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:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
$
9,513

 
$

 
$
9,513

 
$

Money market mutual funds
895,845

 
895,845

 

 

Municipal securities
1,497

 

 
1,497

 

Time deposits
63,956

 
63,956

 

 

U.S. Treasury securities
87,900

 

 
87,900

 

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,205,936

 

 
1,205,936

 

Foreign government securities
12,555

 

 
12,555

 

Marketable equity securities
194

 
194

 

 

Municipal securities
186,282

 

 
186,282

 

U.S. agency securities
508,703

 

 
508,703

 

U.S. Treasury securities
440,637

 

 
440,637

 

Prepaid expenses and other current assets:
 
 
 

 
 

 
 

Foreign currency derivatives
32,466

 

 
32,466

 

Other assets:
 
 
 

 
 

 
 

Deferred compensation plan assets
17,456

 
506

 
16,950

 

Total assets
$
3,462,940

 
$
960,501

 
$
2,502,439

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
3,251

 
$

 
$
3,251

 
$

Total liabilities
$
3,251

 
$

 
$
3,251

 
$



11


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of our financial assets and liabilities at November 30, 2012 was determined using the following inputs (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:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
$
3,998

 
$

 
$
3,998

 
$

Money market mutual funds and repurchase
    agreements
1,171,270

 
1,171,270

 

 

Municipal securities
3,895

 

 
3,895

 

Time deposits
45,118

 
45,118

 

 

Short-term investments:
 

 


 


 


Corporate bonds and commercial paper
1,070,440

 

 
1,070,440

 

Foreign government securities
6,952

 

 
6,952

 

Marketable equity securities
244

 
244

 

 

Municipal securities
180,525

 

 
180,525

 

Time deposits
20,113

 

 
20,113

 

U.S. agency securities
504,191

 

 
504,191

 

U.S. Treasury securities 
330,836

 

 
330,836

 

Prepaid expenses and other current assets:
 

 
 

 
 

 
 

Foreign currency derivatives
13,513

 

 
13,513

 

Other assets:
 

 
 

 
 

 
 

Deferred compensation plan assets
15,094

 
436

 
14,658

 

Total assets
$
3,366,189

 
$
1,217,068

 
$
2,149,121

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
998

 
$

 
$
998

 
$

Total liabilities
$
998

 
$

 
$
998

 
$


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 issuers with a minimum credit rating of BBB 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 pricing 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.
Our deferred compensation plan assets consist of prime money market funds and mutual funds.


12


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We also have direct investments in privately held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. For the three months ended March 1, 2013, we determined there were no material other-than-temporary impairments on our cost method investments.
As of March 1, 2013, the carrying value of our lease receivables approximated fair value, based on Level 2 valuation inputs which include Treasury rates, LIBOR rates and applicable credit spreads. See Note 12 for further details regarding our investment in lease receivables. The fair value of our long-term debt was approximately $1.6 billion as of March 1, 2013, based on Level 2 quoted prices in inactive markets. See Note 13 for further details regarding our debt.
NOTE 5.  DERIVATIVES AND HEDGING ACTIVITIES
In countries outside the U.S., we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option contracts or forward contracts to hedge certain cash flow exposures resulting from changes in these foreign currency exchange rates. These foreign exchange contracts, carried at fair value, have maturities up to 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 these contracts as derivative instruments and they are classified as either assets or liabilities on the balance sheet and measured 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 in 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 in our Condensed Consolidated Statements of Income at that time. If we do not elect hedge accounting, or the derivative does not qualify for hedge accounting, the changes in fair market value from period to period are recorded in interest and other income (expense), net in our Condensed Consolidated Statements of Income.
We also hedge our net recognized foreign currency denominated assets and liabilities with foreign exchange forward contracts to reduce the risk that the value of these assets and liabilities 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 (expense), net in 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.
The bank counterparties to 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 as determined by our counterparty risk assessment process. We monitor ratings, credit spreads and potential downgrades on at least a quarterly basis. Based on our ongoing assessment of counterparty risk, we may adjust our exposure to various counterparties. In addition, our hedging policy establishes maximum limits for each counterparty to mitigate any concentration of risk.
The aggregate fair value of derivative instruments in net asset positions as of March 1, 2013 and November 30, 2012 was $32.5 million and $13.5 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 $3.3 million and $1.0 million, respectively, of liabilities included in master netting arrangements with those same counterparties.

13


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of March 1, 2013 and November 30, 2012 were as follows (in thousands):
 
2013
 
2012
 
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) 
$
25,521

 
$

 
$
10,897

 
$

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 Foreign exchange forward contracts
6,945

 
3,251

 
2,616

 
998

Total derivatives
$
32,466

 
$
3,251

 
$
13,513

 
$
998

_________________________________________ 
(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 into income within the next twelve months.
 
The effect of derivative instruments designated as cash flow hedges and of derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for three months ended March 1, 2013 and March 2, 2012 was as follows (in thousands):
 
2013
 
2012
 
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) 
$
21,776

 
$

 
$
12,581

 
$

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
7,094

 
$

 
$
10,348

 
$

Net gain (loss) recognized in income(3) 
$
(4,668
)
 
$

 
$
(8,245
)
 
$

Derivatives not designated as hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in income(4) 
$

 
$
1,478

 
$

 
$
8,150

_________________________________________ 
(1) 
Net change in the fair value of the effective portion classified in other comprehensive income (“OCI”).
(2) 
Effective portion classified as revenue.
(3) 
Ineffective portion and amount excluded from effectiveness testing classified in interest and other income (expense), net.
(4) 
Classified in interest and other income (expense), net.

14


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 6.  GOODWILL AND PURCHASED AND OTHER INTANGIBLES
Goodwill as of March 1, 2013 and November 30, 2012 was $4.221 billion and $4.133 billion, respectively. The increase was primarily due to our acquisition of Behance.
Purchased and other intangible assets subject to amortization as of March 1, 2013 and November 30, 2012 were as follows (in thousands): 
 
2013
 
2012
 
Cost
 
Accumulated Amortization
 
Net
 
Cost
 
Accumulated Amortization
 
Net
Purchased technology
$
358,612

 
$
(162,882
)
 
$
195,730

 
$
366,574

 
$
(161,538
)
 
$
205,036

Customer contracts and relationships
$
324,221

 
$
(82,802
)
 
$
241,419

 
$
318,027

 
$
(74,214
)
 
$
243,813

Trademarks
66,551

 
(21,249
)
 
45,302

 
53,293

 
(19,171
)
 
34,122

Acquired rights to use technology
147,397

 
(61,222
)
 
86,175

 
104,402

 
(56,782
)
 
47,620

Localization
8,423

 
(5,369
)
 
3,054

 
8,586

 
(4,654
)
 
3,932

Other intangibles
17,646

 
(8,758
)
 
8,888

 
18,742

 
(8,229
)
 
10,513

Total other intangible assets
$
564,238

 
$
(179,400
)
 
$
384,838

 
$
503,050

 
$
(163,050
)
 
$
340,000

Purchased and other intangible
    assets, net
$
922,850

 
$
(342,282
)
 
$
580,568

 
$
869,624

 
$
(324,588
)
 
$
545,036

 
During the three months ended March 1, 2013, we acquired rights to use certain technology for approximately $51.8 million. Of this cost, an estimated $25.3 million was related to future licensing rights and has been capitalized and will be amortized on a straight-line basis over the estimated useful lives ranging from five to ten years. We estimated that the remaining cost of approximately $26.5 million was related to historical use of licensing rights and was expensed as cost of product revenue.   

During the three months ended March 1, 2013, certain purchased intangibles associated with our Omniture acquisition became fully amortized and were removed from the balance sheet. Excluding the expense associated with historical use of the acquired rights to use the technology discussed above, amortization expense related to purchased and other intangible assets was $36.9 million and $33.1 million for the three months ended March 1, 2013 and March 2, 2012, respectively. Of these amounts, $26.4 million and $21.6 million were included in cost of sales for the three months ended March 1, 2013 and March 2, 2012, respectively.
As of March 1, 2013, we expect amortization expense in future periods to be as follows (in thousands):
Fiscal Year
 
Purchased
Technology
 
Other Intangible
Assets
Remainder of 2013
$
54,114

 
$
55,222

2014
66,501

 
66,192

2015
51,804

 
60,216

2016
13,140

 
54,621

2017
6,736

 
46,275

Thereafter
3,435

 
102,312

Total expected amortization expense
$
195,730

 
$
384,838


15


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7.  ACCRUED EXPENSES
Accrued expenses as of March 1, 2013 and November 30, 2012 consisted of the following (in thousands):
 
2013
 
2012
Accrued compensation and benefits
$
171,123

 
$
242,887

Sales and marketing allowances 
79,081

 
87,916

Accrued corporate marketing
40,574

 
39,503

Taxes payable
16,724

 
26,164

Royalties payable
8,154

 
10,040

Accrued interest expense
5,039

 
20,796

Other
184,770

 
162,834

Accrued expenses                                                                                         
$
505,465

 
$
590,140


Other primarily includes general corporate accruals for local and regional expenses and technical support. Other is also comprised of deferred rent related to office locations with rent escalations and foreign currency liability derivatives.
NOTE 8.  STOCK-BASED COMPENSATION
Summary of Restricted Stock Units
Restricted stock unit activity for the three months ended March 1, 2013 and the fiscal year ended November 30, 2012 was as follows (in thousands):
 
2013
 
2012
Beginning outstanding balance
18,415

 
16,871

Awarded
5,807

 
9,431

Released
(4,904
)
 
(5,854
)
Forfeited
(382
)
 
(2,147
)
Increase due to acquisition

 
114

Ending outstanding balance
18,936

 
18,415


 Information regarding restricted stock units outstanding at March 1, 2013 and March 2, 2012 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2013
 
 
 
 
 
Restricted stock units outstanding
18,936

 
1.66
 
$
754.2

Restricted stock units vested and expected to vest
16,279

 
1.59
 
$
646.5

2012
 

 
 
 
 

Restricted stock units outstanding
18,350

 
1.90
 
$
618.9

Restricted stock units vested and expected to vest
15,432

 
1.79
 
$
519.6

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of March 1, 2013 and March 2, 2012 were $39.83 and $33.73, respectively. 

16


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Performance Shares 
The following table sets forth the summary of performance share activity under our Performance Share Program for fiscal 2013 (the “2013 Program”) for the three months ended March 1, 2013 (in thousands): 
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
Beginning outstanding balance

 

Awarded
945

 
1,891

Forfeited
(4
)
 
(9
)
Ending outstanding balance
941

 
1,882


Effective January 24, 2013, our Executive Compensation Committee modified our Performance Share Program by eliminating the use of qualitative performance objectives, with 100% of shares to be earned based on the achievement of an objective total stockholder return measure over a three-year performance period. Performance awards will be granted under the 2013 Program pursuant to the terms of our 2003 Equity Incentive Plan. The purpose of the 2013 Program is to align key management and senior leadership with stockholders’ interests over the long term and to retain key employees. Performance share awards will be awarded and fully vest upon the Executive Compensation Committee's certification of the level of achievement following the three-year anniversary of the grant date on January 24, 2016. Participants in the 2013 Program generally have the ability to receive up to 200% of the target number of shares originally granted.
In the first quarter of fiscal 2013, the Executive Compensation Committee certified the actual performance achievement of participants in the 2012 Performance Share Program (the “2012 Program”). Based upon the achievement of specific and/or market-based performance goals outlined in the 2012 Program, participants had the ability to receive up to 150% of the target number of shares originally granted. Actual performance resulted in participants achieving 116% of target or approximately 1.3 million shares for the 2012 Program. One third of the shares under the 2012 Program vested in the first quarter of fiscal 2013 and the remaining two thirds vest evenly on the following two anniversaries of the grant, contingent upon the recipient's continued service to Adobe.
In the first quarter of fiscal 2012, the Executive Compensation Committee certified the actual performance achievement of participants in the 2011 Performance Share Program (the “2011 Program”). Based upon the achievement of goals outlined in the 2011 Program, participants had the ability to receive up to 150% of the target number of shares originally granted. Actual performance resulted in participants achieving 130% of target or approximately 0.5 million shares for the 2011 Program. One third of the shares under the 2011 Program vested in the first quarter of fiscal 2012 and the remaining two thirds vest evenly on the following two anniversaries of the grant, contingent upon the recipient's continued service to Adobe.
The following table sets forth the summary of performance share activity under our 2010, 2011 and 2012 programs, based upon share awards actually achieved, for the three months ended March 1, 2013 and the fiscal year ended November 30, 2012 (in thousands):
 
2013
 
2012
Beginning outstanding balance
388

 
405

Achieved
1,279

 
492

Released
(657
)
 
(464
)
Forfeited
(32
)
 
(45
)
Ending outstanding balance
978

 
388

 

17


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding performance shares outstanding at March 1, 2013 and March 2, 2012 is summarized below: 
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2013
 
 
 
 
 
Performance shares outstanding
978

 
1.32
 
$
38.9

Performance shares vested and expected to vest
865

 
1.29
 
$
34.4

2012
 

 
 
 
 

Performance shares outstanding
453

 
1.23
 
$
15.3

Performance shares vested and expected to vest
403

 
1.20
 
$
13.5

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of March 1, 2013 and March 2, 2012 were $39.83 and $33.73, respectively.     
Summary of Stock Options 
There were no option grants during the three months ended March 1, 2013. The assumptions used to value option grants during the three months ended March 2, 2012 were as follows: 
 
Three Months
 
2012
Expected life (in years)
3.9

Volatility
34
%
Risk free interest rate
0.54
%

The expected life of employee stock purchase plan (“ESPP”) shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three months ended March 1, 2013 and March 2, 2012 were as follows:
 
Three Months
 
2013
 
2012
Expected life (in years)
0.5 - 2.0
 
0.5 - 2.0

Volatility
26 - 30%
 
36
%
Risk free interest rate
0.12 - 0.27%
 
0.06 - 0.27%

 

Option activity for the three months ended March 1, 2013 and the fiscal year ended November 30, 2012 was as follows (in thousands):
 
2013
 
2012
Beginning outstanding balance
24,517

 
34,802

Granted

 
57

Exercised
(4,869
)
 
(6,754
)
Cancelled
(1,242
)
 
(4,692
)
Increase due to acquisition
129

 
1,104

Ending outstanding balance
18,535

 
24,517

 

18


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding stock options outstanding at March 1, 2013 and March 2, 2012 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2013
 
 
 
 
 
 
 
Options outstanding
18,535

 
$
32.56

 
2.76
 
$
139.3

Options vested and expected to vest
18,250

 
$
32.66

 
2.71
 
$
135.3

Options exercisable
15,495

 
$
33.71

 
2.25
 
$
99.4

2012
 

 
 

 
 
 
 

Options outstanding
32,594

 
$
30.97

 
3.14
 
$
148.4

Options vested and expected to vest
31,783

 
$
31.08

 
3.07
 
$
142.4

Options exercisable
25,490

 
$
32.61

 
2.39
 
$
85.2

_________________________________________ 
(*) 
The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of March 1, 2013 and March 2, 2012 were $39.83 and $33.73, respectively.
Summary of Employee Stock Purchase Plan Shares
Employees purchased 1.2 million shares at an average price of $25.49 and 1.1 million shares at an average price of $23.64 for the three months ended March 1, 2013 and March 2, 2012, respectively. The intrinsic value of shares purchased during the three months ended March 1, 2013 and March 2, 2012 was $14.5 million and $5.0 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.
Compensation Costs
As of March 1, 2013, there was $607.8 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 2.4 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 March 1, 2013 and March 2, 2012 were as follows (in thousands):
 
 
2013
 
2012
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—subscription
$
637

 
$
1,063

 
$
742

 
$
603

Cost of revenue—services and support
855

 
2,450

 
1,116

 
2,070

Research and development
5,820

 
25,731

 
7,199

 
18,081

Sales and marketing
6,667

 
23,752

 
8,780

 
16,916

General and administrative
2,514

 
14,707

 
4,500

 
11,574

Total
$
16,493

 
$
67,703

 
$
22,337

 
$
49,244



19


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 9.  RESTRUCTURING CHARGES
Fiscal 2011 Restructuring Plan
In the fourth quarter of fiscal 2011, we initiated a restructuring plan consisting of reductions in workforce and the consolidation of facilities in order to better align our resources around our Digital Media and Digital Marketing strategies.
During the three months ended March 1, 2013, we continued to implement restructuring activities under this plan. Total costs incurred to date and expected to be incurred for closing redundant facilities are $10.9 million as all facilities under this plan have been exited as of March 1, 2013.
Other Restructuring Plans
Other restructuring plans include other Adobe plans and other plans associated with certain of our acquisitions that are substantially complete. We continue to make cash outlays to settle obligations under these plans, however the current impact to our condensed consolidated financial statements is not significant. Our other restructuring plans primarily consist of the 2009 Restructuring Plan, which was implemented in the fourth quarter of fiscal 2009, in order to appropriately align our costs in connection with our fiscal 2010 operating plan.
During the three months ended March 1, 2013 we vacated approximately 21,000 square feet of sales facilities in Australia in connection with our other restructuring plans.
Summary of Restructuring Plans
The following table sets forth a summary of restructuring activities related to all of our restructuring plans described above during the three months ended March 1, 2013 (in thousands):
 
November 30,
2012
 
Costs
Incurred
 
Cash
Payments
 
Other
Adjustments*
 
March 1,
2013
Fiscal 2011 Restructuring Plan:
 
 
 
 
 
 
 
 
 
Termination benefits
$
1,248

 
$

 
$
(722
)
 
$
105

 
$
631

Cost of closing redundant facilities
9,623

 

 
(274
)
 
(3,687
)
 
5,662

Other Restructuring Plans:
 
 
 
 
 
 
 
 
 
Termination benefits
991

 

 
(198
)
 
(8
)
 
785

Cost of closing redundant facilities
9,688

 
4,328

 
(2,851
)
 
(1,423
)
 
9,742

Total restructuring plans
$
21,550

 
$
4,328

 
$
(4,045
)
 
$
(5,013
)
 
$
16,820

_________________________________________ 
(*) 
Included in Other Adjustments are foreign currency translation adjustments and goodwill adjustments of $0.5 million and $0.2 million, respectively.
Accrued restructuring charges of approximately $16.8 million as of March 1, 2013 includes $6.8 million recorded in accrued restructuring, current and $10.0 million related to long-term facilities obligations recorded in accrued restructuring, non-current on our Condensed Consolidated Balance Sheets. We expect to pay accrued termination benefits through fiscal 2013 and facilities-related liabilities under contract through fiscal 2021.

20


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 10.  STOCKHOLDERS’ EQUITY
Retained Earnings
The changes in retained earnings for the three months ended March 1, 2013 were as follows (in thousands): 
Balance as of November 30, 2012
$
7,003,003

Net income
65,117

Re-issuance of treasury stock
(259,631
)
Balance as of March 1, 2013
$
6,808,489

We account for treasury stock under the cost method. When treasury stock is re-issued at a price higher than its cost, the difference is recorded as a component of additional paid-in-capital in our Condensed Consolidated Balance Sheets. When treasury stock is re-issued at a price lower than its cost, the difference is recorded as a component of additional paid-in-capital to the extent that there are gains to offset the losses. If there are no treasury stock gains in additional paid-in-capital, the losses upon re-issuance of treasury stock are recorded as a component of retained earnings in our Condensed Consolidated Balance Sheets.
The components of accumulated other comprehensive income and activity, net of related taxes, for the three months ended March 1, 2013 was as follows (in thousands):
 
November 30,
2012
 
Increase / Decrease
 
Reclassification Adjustments
 
March 1,
2013
Net unrealized gains on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
$
14,699

 
$
659

 
$
(1,599
)
 
$
13,759

Unrealized losses on available-for-sale securities
(260
)
 
43

 
15

 
(202
)
Total net unrealized gains on available-for-sale securities
14,439

 
702

 
(1,584
)
(1) 
13,557

Net unrealized gains on derivative instruments designated as hedging instruments
6,604

 
21,776

 
(7,094
)
(2) 
21,286

Cumulative foreign currency translation adjustments
9,669

 
(4,402
)
 

 
5,267

Total accumulated other comprehensive income, net of taxes
$
30,712

 
$
18,076

 
$
(8,678
)
 
$
40,110

_________________________________________
(1) 
Classified in interest and other income (expense), net.
(2) 
Classified as revenue.
Stock Repurchase Program 
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 repurchase agreements with third parties.
We currently have authority granted by our Board of Directors to repurchase up to $2.0 billion in common stock through the end of fiscal 2015. This stock repurchase program is similar to our previous $1.6 billion stock repurchase program which we exhausted during the second quarter of fiscal 2012.

During the three months ended March 1, 2013 and March 2, 2012, we entered into structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments of $100.0 million and $80.0 million, respectively. The $100.0 million prepayments during the first quarter of fiscal 2013 were under the new $2.0 billion stock repurchase authority while the $80.0 million prepayments during the first quarter of fiscal 2012 were under the previous $1.6 billion authority. We enter 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.

21


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 three months ended March 1, 2013, we repurchased approximately 2.7 million shares at an average price of $37.32 through structured repurchase agreements entered into during fiscal 2012 and the three months ended March 1, 2013. During the three months ended March 2, 2012, we repurchased approximately 1.8 million shares at an average price of $30.07 through structured repurchase agreements entered into during the three months ended March 2, 2012.
As of March 1, 2013, the 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 were excluded from the computation of earnings per share. As of March 1, 2013, $32.8 million of prepayment remained under this agreement.

NOTE 11.  NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the three months ended March 1, 2013 and March 2, 2012 (in thousands, except per share data):
 
Three Months
 
2013
 
2012
Net income
$
65,117

 
$
185,209

Shares used to compute basic net income per share
498,607

 
494,016

Dilutive potential common shares:
 
 
 
Unvested restricted stock and performance share awards
6,526

 
4,280

Stock options
2,707

 
2,082

Shares used to compute diluted net income per share
507,840

 
500,378

Basic net income per share
$
0.13

 
$
0.37

Diluted net income per share
$
0.13

 
$
0.37

For the three months ended March 1, 2013, options to purchase approximately 6.8 million shares of common stock with exercise prices greater than the average fair market value of our stock of $37.82, were not included in the calculation because the effect would have been anti-dilutive. Comparatively, for the three months ended March 2, 2012, options to purchase approximately 26.1 million shares of common stock with exercise prices greater than the average fair market value of our stock of $30.16 were not included in the calculation because the effect would have been anti-dilutive.
NOTE 12.  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.
The lease agreements for the East and West Towers and the Almaden Tower are effective through August 2014 and March 2017, respectively. We are the investors in the lease receivables related to these leases for the East and West Towers and the Almaden Tower in the amount of $126.8 million and $80.4 million, respectively, which is recorded as investment in lease receivables on our Condensed Consolidated Balance Sheets. As of March 1, 2013, the carrying value of the lease receivables related to the towers approximated fair value. 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. If we purchase the properties, the investments in the lease receivables may be credited against the purchase price.

22


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

These two leases are both subject to standard covenants including certain financial ratios that are reported to the lessors quarterly. In addition, we are required to maintain a standby letter of credit for approximately $16.6 million for one of the leases which enables 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 equity balance which is callable in the event of default. As of March 1, 2013, we were in compliance with all of the 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. 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 less our investment in the lease receivables. Both leases qualify for operating lease accounting treatment and, as such, the buildings and the related obligations are not included in our Condensed Consolidated Balance Sheets. 
In the first quarter of fiscal 2013, we entered into a sale-leaseback agreement totaling $25.7 million over a period of 24 months. This transaction was classified as a capital lease obligation and recorded at fair value. See Note 13 for further information regarding of our capital lease obligations.
The following are our future minimum lease payments under our non-cancellable capital leases for each of the next five years and thereafter as of March 1, 2013 (in thousands):
Fiscal Year
 
Capital Lease Obligations
Remainder of 2013
 
$
23,011

2014
 
13,660

2015
 

2016
 

2017
 

Thereafter

Gross lease commitment
 
$
36,671

Less: interest
 
(748
)
     Net lease commitment
 
$
35,923

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 and from time to time, we are subject to claims by our customers under these indemnification provisions. 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.

23


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Legal Proceedings
In connection with 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 may be 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 licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, 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 and service agreements.
In addition to intellectual property disputes, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We consider all claims on a quarterly basis in accordance with GAAP and based on known facts assess whether potential losses are considered reasonably possible, probable and estimable. Based upon this assessment, we then evaluate disclosure requirements and whether to accrue for such claims in our financial statements. This determination is then reviewed and discussed with our Audit Committee and our independent registered public accounting firm.
We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in this note, we have determined that no provision for liability nor disclosure is required related to any claim against us because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial.
All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our 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.
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 laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our 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.
NOTE 13.  DEBT
Notes
In February 2010, we issued $600.0 million of 3.25% senior notes due February 1, 2015 (the “2015 Notes”) and $900.0 million of 4.75% senior notes due February 1, 2020 (the “2020 Notes” and, together with the 2015 Notes, the “Notes”). Our proceeds were approximately $1.5 billion and were net of an issuance discount of $6.6 million. The Notes rank equally with our other unsecured and unsubordinated indebtedness. In addition, we incurred issuance costs of approximately $10.7 million. Both the discount and issuance costs are being amortized to interest expense over the respective terms of the Notes using the effective interest method. The effective interest rate including the discount and issuance costs is 3.45% for the 2015 Notes and 4.92% for the 2020 Notes. Interest is payable semi-annually, in arrears, on February 1 and August 1, commencing on August 1, 2010. In February 2013, we made a semi-annual interest payment of $31.1 million. The proceeds from the Notes are available for general corporate purposes, including repayment of any balance outstanding on our credit facility. Based on quoted prices in inactive markets, the fair value of the Notes was approximately $1.6 billion as of March 1, 2013.

24


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

We may redeem the Notes at any time, subject to a make-whole premium. In addition, upon the occurrence of certain change of control triggering events, we may be required to repurchase the Notes, at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The Notes also include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances. As of March 1, 2013, we were in compliance with all of the covenants.
Credit Agreement
On March 2, 2012, we entered into a five-year $1.0 billion senior unsecured revolving credit agreement (the “Credit Agreement”), providing for loans to us and certain of our subsidiaries. Pursuant to the terms of the Credit Agreement, we may, subject to the agreement of the applicable lenders, request up to an additional $500.0 million in commitments, for a maximum aggregate commitment of $1.5 billion. Loans under the Credit Agreement will bear interest at either (i) the London Interbank Offered Rate (“LIBOR”) plus a margin, based on our debt ratings, ranging from 0.795% and 1.30% or (ii) the base rate, which is defined as the highest of (a) the agent’s prime rate, (b) the federal funds effective rate plus 0.50% or (c) LIBOR plus 1.00% plus a margin, based on our debt ratings, ranging from 0.00% to 0.30%. Commitment fees are payable quarterly at rates between 0.08% and 0.20% per year also based on our public debt ratings. Subject to certain conditions stated in the Credit Agreement, we and any of our subsidiaries designated as additional borrowers may borrow, prepay and re-borrow amounts under the revolving credit facility at any time during the term of the Credit Agreement.
The Credit Agreement contains customary representations, warranties, affirmative and negative covenants, including a financial covenant, events of default and indemnification provisions in favor of the lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, certain merger and acquisition transactions, dispositions and other matters, all subject to certain exceptions. The financial covenant, based on a quarterly financial test, requires us not to exceed a maximum leverage ratio.
On March 1, 2013, we exercised an option under the Credit Agreement to extend the maturity date of the Credit Agreement by one year to March 2, 2018. The facility will terminate and all amounts owing thereunder will be due and payable on the maturity date unless (a) the commitments are terminated earlier upon the occurrence of certain events, including an event of default, or (b) the maturity date is further extended upon our request, subject to the agreement of the lenders.
As of March 1, 2013, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants.
Capital Lease Obligations
In January 2013, we entered into a sale-leaseback agreement totaling $25.7 million over a period of 24 months. As of March 1, 2013, our capital lease obligations of $35.9 million includes $22.4 million of current debt.

25


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 14.  NON-OPERATING INCOME (EXPENSE)

 Non-operating income (expense), net for the three months ended March 1, 2013 and March 2, 2012 included the following (in thousands):
 
Three Months
 
2013
 
2012
Interest and other income (expense), net:
 
 
 
Interest income
$
5,681

 
$
6,193

Foreign exchange gains (losses)
(6,174
)
 
(9,721
)
Realized gains on fixed income investment
1,598

 
702

Realized losses on fixed income investment
(14
)
 
(205
)
Other
155

 
246

Interest and other income (expense), net
$
1,246

 
$
(2,785
)
Interest expense
$
(16,834
)
 
$
(16,838
)
Investment gains (losses), net:
 

 
 
Realized investment gains
$
418

 
$
245

Unrealized investment gains
444

 
810

Realized investment losses
(14
)
 
(34
)
Investment gains (losses), net
$
848

 
$
1,021

Non-operating income (expense), net
$
(14,740
)
 
$
(18,602
)
NOTE 15.  SEGMENTS

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 CEO, the chief operating decision maker, reviews revenue and gross margin information for each of our reportable segments, but does not review operating expenses 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.
Effective in the first quarter of fiscal 2013, we moved our video server solutions products from our Digital Media segment to our Digital Marketing segment to better align the role of how Adobe can help its customers monetize their video assets with our Digital Marketing solutions. Prior year information in the table below has been updated to reflect this change.

We have the following reportable segments:
Digital Media—Our Digital Media segment provides tools and solutions that enable individuals, small businesses and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include traditional content creators, web application developers and digital media professionals, as well as their management in marketing departments and agencies, companies and publishers.
Digital Marketing—Our Digital Marketing segment provides solutions and services for how digital advertising and marketing are created, managed, executed, measured and optimized. Our customers include digital marketers, advertisers, publishers, merchandisers, web analysts, chief marketing officers and chief revenue officers.
Print and Publishing—Our Print and Publishing segment addresses market opportunities ranging from the diverse publishing needs of technical and business publishing to our legacy type and OEM printing businesses.

26


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(in thousands)
Digital
Media
 
Digital
Marketing
 
Print and
Publishing
 
Total
Three months ended March 1, 2013
 

 
 
 
 

 
 

Revenue
$
688,400

 
$
267,700

 
$
51,773

 
$
1,007,873

Cost of revenue
53,709

 
98,279

 
4,696

 
156,684

Gross profit
$
634,691

 
$
169,421

 
$
47,077

 
$
851,189

Gross profit as a percentage of revenue
92
%
 
63
%
 
91
%
 
84
%
Three months ended March 2, 2012
 

 
 
 
 

 
 

Revenue
$
724,353

 
$
265,837

 
$
55,030

 
$
1,045,220

Cost of revenue
25,625

 
79,547

 
3,093

 
108,265

Gross profit