10-Q 1 adbe10qq318.htm 10-Q Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2018

 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,” “smaller reporting company,” and “emerging growth 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
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares outstanding of the registrant’s common stock as of September 21, 2018 was 488,133,527.
 



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 5.

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)
 
August 31,
2018
 
December 1,
2017
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,747,144

 
$
2,306,072

Short-term investments
3,197,326

 
3,513,702

Trade receivables, net of allowances for doubtful accounts of $12,034 and $9,151, respectively
1,044,507

 
1,217,968

Prepaid expenses and other current assets
311,936

 
210,071

Total current assets
6,300,913

 
7,247,813

Property and equipment, net
1,019,260

 
936,976

Goodwill
7,136,853

 
5,821,561

Purchased and other intangibles, net
669,476

 
385,658

Deferred income taxes
85,297

 

Other assets
183,821

 
143,548

Total assets
$
15,395,620

 
$
14,535,556

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 

 
 

Trade payables
$
145,566

 
$
113,538

Accrued expenses
1,020,047

 
993,773

Income taxes payable
11,222

 
14,196

Deferred revenue
2,615,192

 
2,405,950

Total current liabilities
3,792,027

 
3,527,457

Long-term liabilities:
 
 
 

Debt
1,874,654

 
1,881,421

Deferred revenue
92,182

 
88,592

Income taxes payable
622,411

 
173,088

Deferred income taxes

 
279,941

Other liabilities
152,421

 
125,188

Total liabilities
6,533,695

 
6,075,687

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; 
489,007 and 491,262 shares outstanding, respectively
61

 
61

Additional paid-in-capital
5,549,322

 
5,082,195

Retained earnings
11,137,357

 
9,573,870

Accumulated other comprehensive income (loss)
(128,048
)
 
(111,821
)
Treasury stock, at cost (111,827 and 109,572 shares, respectively), net of reissuances
(7,696,767
)
 
(6,084,436
)
Total stockholders’ equity
8,861,925

 
8,459,869

Total liabilities and stockholders’ equity
$
15,395,620

 
$
14,535,556

_________________________________________ 
(*)
The condensed consolidated balance sheet as of December 1, 2017 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.

3


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
August 31,
2018
 
September 1,
2017
 
August 31,
2018
 
September 1,
2017
Revenue:
 
 
 
 
 
 
 
Subscription
$
2,021,505

 
$
1,570,336

 
$
5,737,994

 
$
4,437,882

Product
149,127

 
158,961

 
471,728

 
513,891

Services and support
120,444

 
111,777

 
355,661

 
343,137

Total revenue
2,291,076

 
1,841,074

 
6,565,383

 
5,294,910

 
Cost of revenue:
 
 
 
 
 
 
 
Subscription
199,157

 
168,915

 
550,197

 
452,830

Product
11,454

 
11,709

 
35,110

 
41,530

Services and support
84,881

 
82,298

 
250,431

 
245,259

Total cost of revenue
295,492

 
262,922

 
835,738

 
739,619

Gross profit
1,995,584

 
1,578,152

 
5,729,645

 
4,555,291

 
Operating expenses:
 

 
 
 
 
 
 
Research and development
398,957

 
315,555

 
1,121,854

 
900,033

Sales and marketing
670,084

 
550,093

 
1,897,256

 
1,623,488

General and administrative
184,063

 
147,402

 
532,543

 
455,139

Amortization of purchased intangibles
23,874

 
19,428

 
58,169

 
57,876

Total operating expenses
1,276,978

 
1,032,478

 
3,609,822

 
3,036,536

 Operating income
718,606

 
545,674

 
2,119,823

 
1,518,755

 
Non-operating income (expense):
 

 
 
 
 
 
 
Interest and other income (expense), net
1,608

 
13,539

 
29,879

 
25,899

Interest expense
(21,107
)
 
(18,809
)
 
(61,369
)
 
(55,286
)
Investment gains (losses), net
2,251

 
975

 
6,326

 
5,261

Total non-operating income (expense), net
(17,248
)
 
(4,295
)
 
(25,164
)
 
(24,126
)
Income before income taxes
701,358

 
541,379

 
2,094,659

 
1,494,629

Provision for income taxes
35,067

 
121,810

 
182,125

 
302,224

Net income
$
666,291

 
$
419,569

 
$
1,912,534

 
$
1,192,405

Basic net income per share
$
1.36

 
$
0.85

 
$
3.89

 
$
2.41

Shares used to compute basic net income per share
490,025

 
493,426

 
491,336

 
494,138

Diluted net income per share
$
1.34

 
$
0.84

 
$
3.84

 
$
2.38

Shares used to compute diluted net income per share
496,866

 
500,398

 
498,587

 
501,060

 
 
 
 
 
 
 
 




4


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
August 31,
2018
 
September 1,
2017
 
August 31,
2018
 
September 1,
2017
 
Increase/(Decrease)
 
Increase/(Decrease)
Net income
$
666,291

 
$
419,569

 
$
1,912,534

 
$
1,192,405

Other comprehensive income (loss), net of taxes:
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses on available-for-sale securities
5,849

 
3,545

 
(19,020
)
 
13,234

Reclassification adjustment for recognized gains / losses on available-for-sale securities
9,645

 
(488
)
 
9,842

 
(894
)
Net increase (decrease) from available-for-sale securities
15,494

 
3,057

 
(9,178
)
 
12,340

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Unrealized gains / losses on derivative instruments
17,524

 
1,483

 
47,290

 
3,613

Reclassification adjustment for recognized gains / losses on derivative instruments
(16,494
)
 
30

 
(18,671
)
 
(31,219
)
Net increase (decrease) from derivatives designated as hedging instruments
1,030

 
1,513

 
28,619

 
(27,606
)
Foreign currency translation adjustments
(15,341
)
 
43,552

 
(35,668
)
 
90,238

Other comprehensive income (loss), net of taxes
1,183

 
48,122

 
(16,227
)
 
74,972

Total comprehensive income, net of taxes
$
667,474

 
$
467,691

 
$
1,896,307

 
$
1,267,377






5


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
 
August 31,
2018
 
September 1,
2017
Cash flows from operating activities:
 
 
 
Net income
$
1,912,534

 
$
1,192,405

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

 
 
Depreciation, amortization and accretion
239,772

 
244,763

Stock-based compensation
439,941

 
334,728

Deferred income taxes
(418,114
)
 
47,859

Unrealized losses (gains) on investments, net
(3,115
)
 
(3,243
)
Other non-cash items
4,844

 
2,606

Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
 
 
 
Trade receivables, net
199,002

 
26,461

Prepaid expenses and other current assets
(89,823
)
 
31,824

Trade payables
25,362

 
(68,397
)
Accrued expenses
4,099

 
78,297

Income taxes payable
433,559

 
6,880

Deferred revenue
173,250

 
185,450

Net cash provided by operating activities
2,921,311

 
2,079,633

Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(541,878
)
 
(1,419,411
)
Maturities of short-term investments
606,594

 
601,130

Proceeds from sales of short-term investments
238,303

 
978,737

Acquisitions, net of cash acquired
(1,633,041
)
 
(459,626
)
Purchases of property and equipment
(204,016
)
 
(140,438
)
Purchases of long-term investments and other assets
(15,288
)
 
(25,669
)
Proceeds from sale of long-term investments and other assets
2,909

 
2,034

Net cash used for investing activities
(1,546,417
)
 
(463,243
)
Cash flows from financing activities:
 

 
 

Purchases of treasury stock
(1,750,000
)
 
(800,000
)
Proceeds from reissuance of treasury stock
189,743

 
157,682

Taxes paid related to net share settlement of equity awards
(368,910
)
 
(220,580
)
Repayment of capital lease obligations
(1,132
)
 
(1,328
)
Net cash used for financing activities
(1,930,299
)
 
(864,226
)
Effect of foreign currency exchange rates on cash and cash equivalents
(3,523
)
 
11,071

Net increase (decrease) in cash and cash equivalents
(558,928
)
 
763,235

Cash and cash equivalents at beginning of period
2,306,072

 
1,011,315

Cash and cash equivalents at end of period
$
1,747,144

 
$
1,774,550

Supplemental disclosures:
 

 
 
Cash paid for income taxes, net of refunds
$
141,674

 
$
211,343

Cash paid for interest
$
61,754

 
$
59,769

Non-cash investing activities:
 
 
 
Investment in lease receivable applied to building purchase
$

 
$
80,439

Issuance of common stock and stock awards assumed in business acquisitions
$
2,784

 
$
10,348




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 U.S. 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 December 1, 2017 on file with the SEC (our “Annual Report”).
Reclassifications
Certain immaterial prior year amounts have been reclassified to conform to current year presentation in the condensed consolidated statements of cash flows.
Recently Adopted Accounting Guidance
On January 26, 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2017-04, Simplifying the Test for Goodwill Impairment, which eliminated step two from the goodwill impairment test. In assessing impairment of goodwill, if it is concluded that it is more likely than not that the carrying amount of a reportable segment exceeds its fair value during the qualitative assessment, a one-step goodwill impairment test will be performed. If it is concluded during the quantitative test that the carrying amount of a reportable segment exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reportable segment. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted.

In the first quarter of 2018, we early adopted ASU 2017-04. The standard did not have an impact to our qualitative assessment for goodwill impairment that we performed in the second quarter of fiscal 2018.
Significant Accounting Policies
There have been no other material changes to our significant accounting policies during the nine months ended August 31, 2018, as compared to the significant accounting policies described in our Annual Report.
Recent Accounting Pronouncements Not Yet Effective
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the full retrospective or modified retrospective transition method. The updated standard is effective for us in the first quarter of fiscal 2019. We expect to adopt this updated standard in the first quarter of fiscal 2019 on a modified retrospective basis. We are currently evaluating the effect that the updated standard will have on our condensed consolidated financial statements and related disclosures.
While we are continuing to assess all potential impacts of the new standard, we believe there should not be a material change to the amount of consolidated revenues on an annual basis.
We expect revenue related to our cloud offerings, including Creative Cloud and Document Cloud for business enterprises, individuals and teams, to remain substantially unchanged. When sold with cloud-enabled services, Creative Cloud and Document Cloud require a significant level of integration and interdependency with software and the individual components are not considered distinct. Revenue for these offerings will continue to be recognized over the period in which the cloud services are provided.

7


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

We believe the most significant revenue-related impact relates to our accounting for arrangements that include on-premise term-based software licenses bundled with maintenance and support. Under current GAAP, the revenue attributable to these software licenses is recognized ratably over the term of the arrangement because vendor-specific objective evidence (“VSOE”) does not exist for the undelivered maintenance and support element as it is not sold separately. The requirement to have VSOE for undelivered elements to enable the separation of revenue for the delivered software licenses is eliminated under the new standard. Accordingly, under the new standard we will be required to recognize as revenue a portion of the arrangement fee upon delivery of the software licenses and potentially classify such revenue as “product” instead of “subscription” revenue on the income statement. We offer on-premise term-based software licenses bundled with maintenance and support as a deployment model for certain offerings within our Digital Experience, Digital Media, and Publishing business units. We do not expect these arrangements to have a material impact to revenue reported in annual reporting periods subsequent to adoption, however they may result in a material balance sheet impact on the date of adoption due to the application of the modified retrospective transition method. The modified retrospective method requires upon adoption that we recognize the impact of applying the new standard to contracts that are not completed at the date of initial adoption, but do not restate prior financial statements. We will record a cumulative effect of initially applying the provisions of the new standard as an adjustment to increase the opening retained earnings balance and reduce the opening deferred revenue balance. Further, some of our enterprise agreements allow our customers to renew on-premise term-based licenses on a monthly basis. Revenue associated with these arrangements would be recognized monthly.
Other expected impacts to our policies and disclosures include: earlier recognition of revenue for certain contracts due to the elimination of contingent revenue limitations, an unbilled receivable balance on our balance sheets, the requirement to estimate variable consideration for certain arrangements, increased allocation of revenue to and from professional services and other offerings, and changes to our financial statement disclosures such as remaining performance obligations.
Under current GAAP, we expense costs related to the acquisition of revenue-generating contracts as incurred. Under the new standard, we will be required to capitalize certain costs incremental to contract acquisition and amortize them over the expected period of benefit. There may be a material balance sheet impact at the period of adoption to capitalize costs of obtaining the contract as an asset, with a corresponding adjustment to opening retained earnings at the date of initial adoption. Additionally, we may have to record related deferred income taxes. We continue to evaluate the magnitude of the impact and the period over which these capitalized costs will be amortized.
Due to the complexity of certain of our contracts, the actual accounting treatment required under the new standard for these arrangements may be dependent on contract-specific terms and therefore may vary in some instances.
On February 24, 2016, the FASB issued ASU No. 2016-02, Leases, requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases with a lease term of twelve months or less. For lessees, leases will continue to be classified as either operating or finance leases in the income statement. Lessor accounting is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition and allows for the application of the new guidance at the beginning of the earliest comparative period presented or at the adoption date. The updated standard is effective for us beginning in the first quarter of fiscal 2020 and we do not plan to early adopt. We are currently evaluating the effect that the updated standard will have on our condensed consolidated financial statements and related disclosures.
On August 28, 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging, requiring expanded hedge accounting for both non-financial and financial risk components and refining the measurement of hedge results to better reflect an entity's hedging strategies. The updated standard also amends the presentation and disclosure requirements and changes how entities assess hedge effectiveness. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition with a cumulative effect adjustment recorded to opening retained earnings as of the initial adoption date. The updated standard is effective for us beginning in the first quarter of fiscal 2020 and we do not plan to early adopt. We are currently evaluating the effect that the updated standard will have on our condensed consolidated financial statements and related disclosures.

8


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

With the exception of the new standards discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the nine months ended August 31, 2018, as compared to the recent accounting pronouncements described in our Annual Report, that are of significance or potential significance to us.
NOTE 2. ACQUISITIONS
Magento
On June 18, 2018, we completed our acquisition of Magento Commerce (“Magento”), a privately-held commerce platform company. During the third quarter of fiscal 2018, we began integrating Magento into our Digital Experience reportable segment.
The table below represents the preliminary purchase price allocation to the acquired net assets of Magento based on their estimated fair values as of June 18, 2018 and the associated estimated useful lives at that date. The fair values assigned to assets acquired and liabilities assumed are based on management’s best estimates and assumptions as of the reporting date and are considered preliminary pending finalization of valuation analyses pertaining to intangible assets acquired and tax liabilities assumed including the calculation of deferred tax assets and liabilities.
(in thousands)
Amount
 
Weighted Average Useful Life (years)
Customer contracts and relationships
$
208,000

 
8
Purchased technology
84,200

 
5
In-process research and development (1)
39,100

 
N/A
Trademarks
21,100

 
3
Other intangibles
43,400

 
3
Total identifiable intangible assets
395,800

 
 
Net liabilities assumed
(67,417
)
 
N/A
Goodwill (2)
1,316,217

 
N/A
Total estimated purchase price
$
1,644,600

 
 

_________________________________________ 
(1) 
Capitalized as purchased technology and are considered indefinite lived until the completion or abandonment of the associated research and development efforts.
(2) 
Non-deductible for tax-purposes.

TubeMogul
On December 19, 2016, we completed our acquisition of TubeMogul, a publicly held video advertising platform company. Under the acquisition method of accounting, the total purchase price was allocated to TubeMogul’s net tangible and intangible assets based upon their estimated fair values as of December 19, 2016. The total final purchase price for TubeMogul was $560.8 million of which $348.4 million, was allocated to goodwill that was non-deductible for tax purposes, $113.1 million to identifiable intangible assets and $99.3 million to net assets acquired.
Proforma financial information has not been presented as the impact of the acquisitions discussed above was not material to our condensed consolidated financial statements.
Marketo
Subsequent to August 31, 2018, we entered into a definitive agreement to acquire Marketo, Inc. (“Marketo”), a privately-held marketing cloud platform company, for approximately $4.75 billion, subject to customary purchase price adjustments. The transaction is subject to regulatory approvals and customary closing conditions and is expected to close in the fourth quarter of our fiscal 2018. Following the closing, we intend to integrate Marketo into our Digital Experience reportable segment for financial reporting purposes.

9


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 August 31, 2018 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
386,927

 
$

 
$

 
$
386,927

Cash equivalents:
 
 
 
 
 
 
 
Corporate debt securities
24,012

 

 
(1
)
 
24,011

Money market mutual funds
1,302,801

 

 

 
1,302,801

Time deposits
33,405

 

 

 
33,405

Total cash equivalents
1,360,218

 

 
(1
)
 
1,360,217

Total cash and cash equivalents
1,747,145

 

 
(1
)
 
1,747,144

Short-term fixed income securities:
 
 
 
 
 
 
 
Asset-backed securities
77,393

 
2

 
(385
)
 
77,010

Corporate debt securities
2,471,739

 
614

 
(20,590
)
 
2,451,763

Foreign government securities
4,178

 

 
(29
)
 
4,149

Municipal securities
19,223

 

 
(306
)
 
18,917

U.S. Treasury securities
645,487

 

 

 
645,487

Total short-term investments
3,218,020

 
616

 
(21,310
)
 
3,197,326

Total cash, cash equivalents and short-term investments
$
4,965,165

 
$
616

 
$
(21,311
)
 
$
4,944,470



10


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Cash, cash equivalents and short-term investments consisted of the following as of December 1, 2017 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
280,488

 
$

 
$

 
$
280,488

Cash equivalents:
 

 
 
 
 
 
 

Money market mutual funds
2,006,741

 

 

 
2,006,741

Time deposits
18,843

 

 

 
18,843

Total cash equivalents
2,025,584

 

 

 
2,025,584

Total cash and cash equivalents
2,306,072

 

 

 
2,306,072

Short-term fixed income securities:
 
 
 
 
 
 
 

Asset-backed securities
98,403

 
1

 
(403
)
 
98,001

Corporate debt securities
2,461,691

 
2,694

 
(10,125
)
 
2,454,260

Foreign government securities
2,396

 

 
(8
)
 
2,388

Municipal securities
21,189

 
8

 
(132
)
 
21,065

U.S. Treasury securities
941,538

 
2

 
(3,552
)
 
937,988

Total short-term investments
3,525,217

 
2,705

 
(14,220
)
 
3,513,702

Total cash, cash equivalents and short-term investments
$
5,831,289

 
$
2,705

 
$
(14,220
)
 
$
5,819,774


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 August 31, 2018 and December 1, 2017 (in thousands):
 
2018
 
2017
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate debt securities
$
1,218,367

 
$
(16,414
)
 
$
1,338,232

 
$
(5,459
)
Asset-backed securities
28,820

 
(240
)
 
64,618

 
(193
)
Municipal securities
17,975

 
(281
)
 
11,805

 
(115
)
Foreign government securities
4,149

 
(29
)
 
2,388

 
(8
)
U.S. Treasury securities

 

 
593,296

 
(2,087
)
Total
$
1,269,311

 
$
(16,964
)
 
$
2,010,339

 
$
(7,862
)
 
There were 767 securities and 894 securities in an unrealized loss position for less than twelve months at August 31, 2018 and at December 1, 2017, respectively.

11


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 were in a continuous unrealized loss position for more than twelve months, as of August 31, 2018 and December 1, 2017 (in thousands):
 
2018
 
2017
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate debt securities
$
312,698

 
$
(4,176
)
 
$
500,689

 
$
(4,666
)
Asset-backed securities
17,560

 
(145
)
 
32,383

 
(210
)
Municipal securities
942

 
(25
)
 
598

 
(17
)
U.S. Treasury securities

 

 
338,950

 
(1,465
)
Total
$
331,200

 
$
(4,346
)
 
$
872,620

 
$
(6,358
)
There were 197 securities and 360 securities in an unrealized loss position for more than twelve months at August 31, 2018 and at December 1, 2017, respectively.
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 August 31, 2018 (in thousands):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
1,643,049

 
$
1,640,836

Due between one and two years
788,794

 
782,312

Due between two and three years
608,978

 
600,690

Due after three years
177,199

 
173,488

Total
$
3,218,020

 
$
3,197,326

We review our debt securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. The portion of the write-down related to credit loss would be recorded to 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. During the nine months ended August 31, 2018 and September 1, 2017, we did not consider any of our investments to be other-than-temporarily impaired.

12


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 nine months ended August 31, 2018.
The fair value of our financial assets and liabilities at August 31, 2018 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 debt securities
$
24,011

 
$

 
$
24,011

 
$

Money market mutual funds
1,302,801

 
1,302,801

 

 

Time deposits
33,405

 
33,405

 

 

Short-term investments:
 
 
 
 
 
 
 
Asset-backed securities
77,010

 

 
77,010

 

Corporate debt securities
2,451,763

 

 
2,451,763

 

Foreign government securities
4,149

 

 
4,149

 

Municipal securities
18,917

 

 
18,917

 

U.S. Treasury securities
645,487

 

 
645,487

 

Prepaid expenses and other current assets:
 
 
 

 
 

 
 

Foreign currency derivatives
43,084

 

 
43,084

 

Other assets:
 
 
 

 
 
 
 
Deferred compensation plan assets
69,705

 
3,192

 
66,513

 

Total assets
$
4,670,332

 
$
1,339,398

 
$
3,330,934

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
2,463

 
$

 
$
2,463

 
$

Other liabilities:
 
 
 
 
 
 
 
Interest rate swap derivatives
10,312

 

 
10,312

 

Total liabilities
$
12,775

 
$

 
$
12,775

 
$



13


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of our financial assets and liabilities at December 1, 2017 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:
 
 
 
 
 
 
 
Money market mutual funds
$
2,006,741

 
$
2,006,741

 
$

 
$

Time deposits
18,843

 
18,843

 

 

Short-term investments:
 

 
 
 
 
 
 
Asset-backed securities
98,001

 

 
98,001

 

Corporate debt securities
2,454,260

 

 
2,454,260

 

Foreign government securities
2,388

 

 
2,388

 

Municipal securities
21,065

 

 
21,065

 

U.S. Treasury securities 
937,988

 

 
937,988

 

Prepaid expenses and other current assets:
 

 
 

 
 

 
 

Foreign currency derivatives
14,198

 

 
14,198

 

Other assets:
 

 
 

 
 

 
 

Deferred compensation plan assets
56,690

 
2,573

 
54,117

 

Total assets
$
5,610,174

 
$
2,028,157

 
$
3,582,017

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
1,598

 
$

 
$
1,598

 
$

Other liabilities:
 
 
 
 
 
 
 
Interest rate swap derivatives
1,058

 

 
1,058

 

Total liabilities
$
2,656

 
$

 
$
2,656

 
$


Our fixed income available-for-sale debt securities consist of high quality, investment grade securities from diverse issuers with a weighted average credit rating of A+. We value these securities based on pricing from independent pricing vendors who use matrix pricing valuation techniques including market approach methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Inputs include quoted prices in active markets for identical assets or inputs other than quoted prices that are observable either directly or indirectly in determining fair value, including benchmark yields, issuer spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. We therefore classify all of our fixed income available-for-sale securities as Level 2. We perform routine procedures such as comparing prices obtained from multiple independent sources to ensure that appropriate fair values are recorded.
The fair values of our money market mutual funds and time deposits are based on the closing price of these assets as of the reporting date. We classify our money market mutual funds and time deposits as Level 1.
Our Level 2 over-the-counter foreign currency and interest rate swap derivatives are valued using pricing models and discounted cash flow methodologies based on observable foreign exchange and interest rate data at the measurement date.
Our deferred compensation plan assets consist of money market mutual funds and other mutual funds.

14


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 and equity 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 and equity 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 and nine months ended August 31, 2018 and September 1, 2017, we determined there were no other-than-temporary impairments of our cost and equity method investments.
The fair value of our senior notes was $1.91 billion as of August 31, 2018, based on observable market prices in less active markets and categorized as Level 2. See Note 13 for further details regarding our debt.
NOTE 5.  DERIVATIVES AND HEDGING ACTIVITIES
Hedge Accounting and Hedging Programs
We recognize derivative instruments and hedging activities as either assets or liabilities in our condensed consolidated balance sheets 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.
We evaluate hedge effectiveness at the inception of the hedge prospectively as well as retrospectively, and record any ineffective portion of the hedging instruments in interest and other income (expense), net on our condensed consolidated statements of income. The net gain (loss) recognized in interest and other income (expense), net for cash flow hedges due to hedge ineffectiveness was insignificant for all fiscal years presented. The time value of purchased contracts is recorded in interest and other income (expense), net in our condensed consolidated statements of income.
The bank counterparties to these contracts expose us to credit-related losses in the event of their nonperformance which are largely mitigated with collateral security agreements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. In addition, we enter into master netting arrangements which have the ability to further limit credit-related losses with the same counterparty by permitting net settlement of transactions.
Balance Sheet HedgingHedges of Foreign Currency Assets and Liabilities
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 contracts 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 contracts 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.
Cash Flow Hedging—Hedges of Forecasted Foreign Currency Revenue and Interest Rate Risk
In countries outside the United States, 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 of 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.

15


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 (loss) 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 (loss) to interest and other income (expense), net in our condensed consolidated statements of income at that time. If we do not elect hedge accounting, or the contract does not qualify for hedge accounting treatment, the changes in fair value from period to period are recorded in interest and other income (expense), net in our condensed consolidated statements of income.
Fair Value Hedging - Hedges of Interest Rate Risk
In fiscal 2014, we entered into interest rate swaps designated as fair value hedges related to our $900 million of 4.75% fixed interest rate senior notes due February 1, 2020. In effect, the interest rate swaps convert the fixed interest rate on these senior notes to a floating interest rate based on LIBOR. Under the terms of the swaps, we will pay monthly interest at the one-month LIBOR interest rate plus a fixed number of basis points on the $900 million notional amount through February 1, 2020. In exchange, we will receive 4.75% fixed rate interest from the swap counterparties. See Note 13 for further details regarding our debt.
The interest rate swaps are accounted for as fair value hedges and substantially offset the changes in fair value of the hedged portion of the underlying debt that are attributable to the changes in market risk. Therefore, the gains and losses related to changes in the fair value of the interest rate swaps are included in interest and other income (expense), net in our condensed consolidated statements of income. The fair value of the interest rate swaps is reflected in other liabilities or other assets in our condensed consolidated balance sheets.
The fair value of derivative instruments on our condensed consolidated balance sheets as of August 31, 2018 and December 1, 2017 were as follows (in thousands):
 
2018
 
2017
 
Fair Value
Asset
Derivatives
 
Fair Value
Liability
Derivatives
 
Fair Value
Asset
Derivatives
 
Fair Value
Liability
Derivatives
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange option contracts(1) (2) 
$
41,862

 
$

 
$
12,918

 
$

Interest rate swap (3)

 
10,312

 

 
1,058

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 Foreign exchange forward contracts (1)
1,222

 
2,463

 
1,280

 
1,598

Total derivatives
$
43,084

 
$
12,775

 
$
14,198

 
$
2,656


_________________________________________ 
(1) 
Fair value asset derivatives included in prepaid expenses and other current assets and fair value liability derivatives included in accrued expenses on our consolidated balance sheets.
(2) 
Hedging effectiveness expected to be recognized into income within the next twelve months.
(3) 
Included in other liabilities on our condensed consolidated balance sheets.

16


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The effect of foreign currency derivative instruments designated as cash flow hedges and of foreign currency derivative instruments not designated as hedges in our condensed consolidated statements of income for the three and nine months ended August 31, 2018 was as follows (in thousands):
 
Three Months
 
Nine Months
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax(1) 
$
17,523

 
$

 
$
47,290

 
$

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
16,797

 
$

 
$
18,156

 
$

Net gain (loss) recognized in income(3) 
$
(9,281
)
 
$

 
$
(31,690
)
 
$

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

 
$
(1,695
)
 
$

 
$
(2,572
)
The effect of foreign currency derivative instruments designated as cash flow hedges and of foreign currency derivative instruments not designated as hedges in our condensed consolidated statements of income for the three and nine months ended September 1, 2017 was as follows (in thousands):
 
Three Months
 
Nine Months
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax(1) 
$
1,483

 
$

 
$
3,613

 
$

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
221

 
$

 
$
31,845

 
$

Net gain (loss) recognized in income(3) 
$
(6,190
)
 
$

 
$
(21,842
)
 
$

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

 
$
2,920

 
$

 
$
6,456

_________________________________________ 
(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.

17


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 6.  GOODWILL AND PURCHASED AND OTHER INTANGIBLES
Goodwill as of August 31, 2018 and December 1, 2017 was $7.14 billion and $5.82 billion, respectively. The increase was primarily due to our acquisition of Magento in the third quarter of fiscal 2018.
Purchased and other intangible assets subject to amortization as of August 31, 2018 and December 1, 2017 were as follows (in thousands): 
 
2018
 
2017
 
Cost
 
Accumulated Amortization
 
Net
 
Cost
 
Accumulated Amortization
 
Net
Purchased technology
$
307,101

 
$
(100,832
)
 
$
206,269

 
$
223,252

 
$
(110,433
)
 
$
112,819

Customer contracts and relationships
$
753,870

 
$
(387,091
)
 
$
366,779

 
$
577,484

 
$
(356,613
)
 
$
220,871

Trademarks
56,355

 
(20,016
)
 
36,339

 
76,255

 
(56,094
)
 
20,161

Acquired rights to use technology
58,966

 
(47,097
)
 
11,869

 
71,130

 
(54,223
)
 
16,907

Other intangibles
81,357

 
(33,137
)
 
48,220

 
39,296

 
(24,396
)
 
14,900

Total other intangible assets
$
950,548

 
$
(487,341
)
 
$
463,207

 
$
764,165

 
$
(491,326
)
 
$
272,839

Purchased and other intangible assets, net
$
1,257,649

 
$
(588,173
)
 
$
669,476

 
$
987,417

 
$
(601,759
)
 
$
385,658

Amortization expense related to purchased and other intangible assets was $47.0 million and $115.5 million for the three and nine months ended August 31, 2018, respectively. Comparatively, amortization expense related to purchased and other intangible assets was $39.1 million and $116.3 million for the three and nine months ended September 1, 2017, respectively. Of these amounts, $23.1 million and $57.1 million were included in cost of sales for the three and nine months ended August 31, 2018, respectively, and $19.5 million and $57.7 million the three and nine months ended September 1, 2017, respectively.
During the nine months ended August 31, 2018, purchased and other intangible assets, net increased primarily due to identifiable intangible assets acquired through Magento, offset in part by write-offs of fully amortized purchased intangibles associated with our acquisitions of Omniture, Inc. and Day Software Holding AG from the condensed consolidated balance sheets. See Note 2 for details regarding our acquisitions.
As of August 31, 2018, we expect amortization expense in future periods to be as follows (in thousands):
Fiscal Year
 
Purchased
Technology
 
Other Intangible
Assets
Remainder of 2018
$
13,596

 
$
36,274

2019
51,112

 
118,652

2020
48,820

 
86,498

2021
26,369

 
54,119

2022
18,610

 
39,749

Thereafter
47,762

 
127,915

Total expected amortization expense
$
206,269

 
$
463,207


18


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7.  ACCRUED EXPENSES
Accrued expenses as of August 31, 2018 and December 1, 2017 consisted of the following (in thousands):
 
2018
 
2017
Accrued compensation and benefits
$
428,575

 
$
417,742

Accrued media costs
103,470

 
134,525

Sales and marketing allowances
46,432

 
47,389

Accrued corporate marketing
76,574

 
72,087

Taxes payable
50,149

 
49,550

Royalties payable
42,742

 
46,411

Accrued interest expense
10,469

 
25,594

Other
261,636

 
200,475

Accrued expenses
$
1,020,047

 
$
993,773

Accrued media costs primarily relate to our advertising platform offerings which are part of the Advertising Cloud. We accrue for media costs related to impressions purchased from third-party ad inventory sources. Other primarily includes general corporate accruals for local and regional expenses. Other is also comprised of deferred rent related to office locations with rent escalations and foreign currency liability derivatives.

NOTE 8.  INCOME TAXES
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law, which significantly changes existing U.S. tax law and includes many provisions applicable to us, such as reducing the U.S. federal statutory tax rate, imposing a one-time transition tax on deemed repatriation of deferred foreign income, and adopting a territorial tax system. The Tax Act reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. For fiscal 2018, our blended U.S. federal statutory tax rate is 22.2%. This is the result of using the tax rate of 35% for the first month of fiscal 2018 and the reduced tax rate of 21% for the remaining eleven months of fiscal 2018. The Tax Act also required us to incur a one-time transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income, in each case reduced by certain foreign tax credits. The Tax Act also includes a provision to tax global intangible low-taxed income of foreign subsidiaries, a special tax deduction for foreign-derived intangible income, and a base erosion anti-abuse tax measure that may tax certain payments between a U.S. corporation and its subsidiaries. These additional provisions of the Tax Act will be effective for us beginning December 1, 2018.
The Tax Act was effective in the first quarter of our fiscal 2018. As of August 31, 2018, we have not completed our accounting for the tax effects of the Tax Act. During the quarter, we recorded an adjustment to the provisional tax charge based on reasonable estimates for those tax effects using the current available information and technical guidance on the interpretations of the Tax Act. In order to complete our accounting for the impact of the Tax Act, we continue to obtain, analyze and interpret additional guidance as such guidance becomes available from the U.S. Treasury Department, the Internal Revenue Service (“IRS”), state taxing jurisdictions, the FASB, and other standard-setting and regulatory bodies. New guidance or interpretations may materially impact our provision for income taxes in future periods. Additional information that is needed to complete the analysis but is currently unavailable includes, but is not limited to, the amount of earnings of certain subsidiaries as well as the amount of foreign taxes paid on such earnings for our fiscal 2018, the final determination of certain net deferred tax assets subject to remeasurement and when the related temporary differences will be settled or realized, and the tax treatment of such provisions of the Tax Act by various state tax authorities. In addition, we do not currently have sufficient information and guidance to determine the impact of certain changes to the taxation of our foreign earnings that will become effective for us in fiscal 2019. The provisional accounting impacts may change in the subsequent reporting period when our accounting analysis is finalized, as permitted by SEC Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act.

19


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

As a result of the reduction in the federal corporate tax rate, we remeasured our deferred taxes as of the date of enactment of the Tax Act and recorded a provisional tax charge of $10 million based on the tax rate that is expected to apply when such deferred taxes are settled or realized in future periods. We have not completed our accounting for the measurement of deferred taxes. To calculate the remeasurement of deferred taxes, we estimated when the existing deferred taxes will be settled or realized. The remeasurement of deferred taxes included in our financial statements will be subject to further revisions if our current estimates are different from our actual future operating results.
As part of the adoption of a new territorial tax system we recorded a provisional transition tax expense of $118 million on deferred foreign earnings, which was comprised of $86 million for fiscal 2018 plus other ancillary effects recorded in the first fiscal quarter, long-term income taxes payable of $533 million, and a reduction in our deferred tax liability of $415 million. As a result of a change to our corporate tax structure that provided us the ability to deduct more expenses against our earnings in the U.S., we updated our Tax Act calculation during the three months ended June 1, 2018. This included an additional provisional transition tax expense of $28 million on deferred foreign earnings, a decrease of deferred tax assets by $72 million which also included utilization of credits that we estimate will be available to reduce the transition tax, and a reduction of long-term income tax payable by $44 million. As a result of technical guidance updates on the interpretations of the Tax Act available in the quarter, we updated our Tax Act calculation during the three months ended August 31, 2018. The application of this guidance resulted in an additional net provisional tax expense of $24 million, a decrease of net deferred tax assets by $25 million, an increase in unrecognized tax benefits included in the long-term income tax payable of $69 million, a reduction of the short-term income taxes payable of $7 million, and a reduction to the long-term income tax payable of $62 million. To calculate the transition tax, we estimated our deferred foreign income for fiscal 2018 because the information needed to complete the calculation will not be known until our taxable income is known. In addition, U.S. and foreign audit settlements may significantly impact the estimated transition tax. The impact of the U.S. and foreign audits on the transition tax will be known as the audits are concluded. We intend to elect to pay the federal transition tax over a period of eight years as permitted by the Tax Act. As a result, in the second quarter of fiscal 2018, we reclassified $39 million from long-term income taxes payable to short-term income taxes payable for the first installment payment due in fiscal 2019. During the three months ended August 31, 2018, we reclassified $5 million from short-term income taxes payable to long-term income taxes payable as a result of the updated technical guidance on the interpretations of the Tax Act.
Certain international provisions introduced in the Tax Act will be effective for us in fiscal 2019. We need additional information to complete our analysis on whether to adopt an accounting policy to account for the tax effects of these provisions in the period that it is subject to such tax, or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to these taxes. Accordingly, we have not recorded any tax with respect to these provisions in the nine months ended August 31, 2018. We will make an accounting policy election and complete the required accounting no later than the first quarter of fiscal 2019.
NOTE 9.  STOCK-BASED COMPENSATION
Summary of Restricted Stock Units
Restricted stock unit activity for the nine months ended August 31, 2018 and the fiscal year ended December 1, 2017 was as follows (in thousands):
 
2018
 
2017
Beginning outstanding balance
9,304

 
8,316

Awarded
3,742

 
5,018

Released
(3,686
)
 
(3,859
)
Forfeited
(525
)
 
(766
)
Increase due to acquisition

 
595

Ending outstanding balance
8,835

 
9,304


20


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding restricted stock units outstanding at August 31, 2018 and September 1, 2017 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2018
 
 
 
 
 
Restricted stock units outstanding
8,835

 
1.23
 
$
2,328.1

Restricted stock units vested and expected to vest
8,104

 
1.18
 
$
2,135.7

2017
 

 
 
 
 

Restricted stock units outstanding
9,443

 
1.27
 
$
1,464.2

Restricted stock units vested and expected to vest
8,636

 
1.22
 
$
1,339.1

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of August 31, 2018 and September 1, 2017 were $263.51 and $155.06, respectively. 
Summary of Performance Shares 
Our Performance Share Programs aim to help focus key employees on building stockholder value, provide significant award potential for achieving outstanding Company performance and enhance the ability of the Company to attract and retain highly talented and competent individuals. The Executive Compensation Committee of our Board of Directors approves the terms of each of our Performance Share Programs, including the award calculation methodology, under the terms of our 2003 Equity Incentive Plan. Shares may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period. 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 each grant date. Program participants generally have the ability to receive up to 200% of the target number of shares originally granted.
In the first quarter of fiscal 2018, the Executive Compensation Committee approved the 2018 Performance Share Program.
In the first quarter of fiscal 2018, the Executive Compensation Committee also certified the actual performance achievement of participants in the 2015 Performance Share Program. Actual performance resulted in participants achieving 200% of target or approximately 1.0 million shares. The shares granted and achieved under the 2015 Performance Share Program fully vested on the three-year anniversary of the grant on January 24, 2018, if not forfeited.
In the first quarter of fiscal 2017, the Executive Compensation Committee certified the actual performance achievement of participants in the 2014 Performance Share Program. Actual performance resulted in participants achieving 198% of target or approximately 1.1 million shares. The shares granted and achieved under the 2014 Performance Share Program fully vested on the three-year anniversary of the grant on January 24, 2017, if not forfeited.
As of August 31, 2018, the shares awarded under our 2018, 2017 and 2016 Performance Share Programs are yet to be achieved.

21


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table sets forth the summary of performance share activity under our Performance Share Programs for the nine months ended August 31, 2018 and the fiscal year ended December 1, 2017 (in thousands): 
 
2018
 
2017
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
Beginning outstanding balance
1,534

 
3,068

 
1,630

 
3,261

Awarded
837

(1) 
628

 
1,082

(2) 
1,040

Achieved
(1,050
)
 
(1,053
)
 
(1,135
)
 
(1,147
)
Forfeited
(165
)
 
(331
)
 
(43
)
 
(86
)
Ending outstanding balance
1,156

 
2,312

 
1,534

 
3,068

_________________________________________ 
(1) 
Included in the 0.8 million shares awarded during the nine months ended August 31, 2018 were 0.5 million shares awarded for the final achievement of the 2015 Performance Share program. The remaining awarded shares were for the 2018 Performance Share Program.
(2) 
Included in the 1.1 million shares awarded during the fiscal year ended December 1, 2017 were 0.6 million shares awarded for the final achievement of the 2014 Performance Share program. The remaining awarded shares were for the 2017 Performance Share Program.

Summary of Employee Stock Purchase Plan Shares
The expected life of the ESPP shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three and nine months ended August 31, 2018 and September 1, 2017 were as follows:
 
Three Months
 
Nine Months
 
2018
 
2017
 
2018
 
2017
Expected life (in years)
0.5 - 2.0

 
0.5 - 2.0
 
0.5 - 2.0
 
0.5 - 2.0
Volatility
29
%
 
25% - 27%
 
26% - 29%
 
22% - 27%
Risk free interest rate
2.09% - 2.52%

 
1.12% - 1.41%
 
1.54% - 2.52%
 
0.62% - 1.41%
 

Employees purchased 1.8 million shares at an average price of $104.94 and 1.9 million shares at an average price of $77.63 for the nine months ended August 31, 2018 and September 1, 2017, respectively. The intrinsic value of shares purchased during the nine months ended August 31, 2018 and September 1, 2017 was $198.9 million and $97.7 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.
Summary of Stock Options 
The Executive Compensation Committee of Adobe’s Board of Directors eliminated the use of stock option grants for all employees and the Board of Directors effective fiscal 2012 and fiscal 2014, respectively. However, we may assume the stock option plans of certain companies we acquire. As of August 31, 2018 and December 1, 2017, we had 0.3 million stock options outstanding at each period end.


22


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Compensation Costs
As of August 31, 2018, there was $1.09 billion 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 1.9 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
Total stock-based compensation costs included in our condensed consolidated statements of income for the three months ended August 31, 2018 and September 1, 2017 were as follows (in thousands):
 
 
2018
 
2017
Income Statement Classifications
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock Units and
Performance
Share
Awards
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock Units and
Performance
Share
Awards 
Cost of revenue—subscription
$
934

 
$
4,509

 
$
628

 
$
3,633

Cost of revenue—services and support
1,930

 
2,789

 
1,626

 
2,409

Research and development
6,347

 
66,308

 
4,608

 
43,243

Sales and marketing
7,551

 
47,885

 
4,658

 
36,064

General and administrative
2,932

 
17,853

 
1,140

 
19,033

Total
$
19,694

 
$
139,344

 
$
12,660

 
$
104,382

Total stock-based compensation costs included in our condensed consolidated statements of income for the nine months ended August 31, 2018 and September 1, 2017 were as follows (in thousands):
 
 
2018
 
2017
Income Statement Classifications
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock Units and
Performance
Share
Awards
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock Units and
Performance
Share
Awards 
Cost of revenue—subscription
$
2,431

 
$
12,979

 
$
1,899

 
$
10,467

Cost of revenue—services and support
5,593

 
8,455

 
4,850

 
7,151

Research and development
16,997

 
183,989

 
12,884

 
119,068

Sales and marketing
18,314

 
129,480

 
13,832

 
103,982

General and administrative
5,762

 
55,941

 
3,623

 
56,972

Total
$
49,097

 
$
390,844

 
$
37,088

 
$
297,640

NOTE 10.  STOCKHOLDERS’ EQUITY
Retained Earnings
The changes in retained earnings for the nine months ended August 31, 2018 were as follows (in thousands): 
Balance as of December 1, 2017
$
9,573,870

Net income
1,912,534

Reissuance of treasury stock
(348,729
)
Adjustments to equity as a result of the Tax Act
(318
)
Balance as of August 31, 2018
$
11,137,357


23


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 treasury stock 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 reduction of retained earnings in our condensed consolidated balance sheets.
The components of accumulated other comprehensive income (loss) and activity, net of related taxes, as of August 31, 2018 were as follows (in thousands):
 
December 1,
2017
 
Increase / Decrease
 
Reclassification Adjustments
 
August 31,
2018
Net unrealized gains / losses on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
$
2,704

 
$
(1,836
)
 
$
(252
)
 
$
616

Unrealized losses on available-for-sale securities
(14,220
)
 
(17,184
)
 
10,094

 
(21,310
)
Total net unrealized gains / losses on available-for-sale securities
(11,516
)
 
(19,020
)
 
9,842

(1) 
(20,694
)
Net unrealized gains / losses on derivative instruments designated as hedging instruments
(3,367
)
 
47,290

 
(18,671
)
(2) 
25,252

Cumulative foreign currency translation adjustments
(96,938
)
 
(35,668
)
 

 
(132,606
)
Total accumulated other comprehensive income (loss), net of taxes
$
(111,821
)
 
$
(7,398
)
 
$
(8,829
)
 
$
(128,048
)
_________________________________________ 
(1) 
Reclassification adjustments for gains / losses on available-for-sale securities are classified in interest and other income (expense), net.
(2) 
Reclassification adjustments for gains / losses on derivative instruments are classified in revenue.

The following table sets forth the taxes related to each component of other comprehensive income for the three and nine months ended August 31, 2018 and September 1, 2017 (in thousands):
 
Three Months
 
Nine Months
 
2018
 
2017
 
2018
 
2017
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses
$

 
$
235

 
$

 
$
523

Reclassification adjustments

 
(214
)
 

 
(323
)
Subtotal available-for-sale securities

 
21

 

 
200

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Reclassification adjustments on derivative instruments
(101
)
 
(149
)
 
(1,726
)
 
(582
)
Foreign currency translation adjustments

 
1,434

 
(1,742
)
 
3,081

Total taxes, other comprehensive income
$
(101
)
 
$
1,306

 
$
(3,468
)
 
$
2,699



24


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Stock Repurchase Program 
To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase shares in the open market or enter into structured repurchase agreements with third parties. In January 2017, our Board of Directors approved our current stock repurchase program granting us authority to repurchase up to $2.5 billion in common stock through the end of fiscal 2019. In May 2018, our Board of Directors granted us another authority to repurchase up to $8 billion in common stock through the end of fiscal 2021.
During the nine months ended August 31, 2018 and September 1, 2017, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $1.75 billion and $800 million, respectively. 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.
The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. During the nine months ended August 31, 2018, we repurchased approximately 7.1 million shares at an average price of $225.15 through structured repurchase agreements entered into during fiscal 2017 and the nine months ended August 31, 2018. During the nine months ended September 1, 2017 we repurchased approximately 6.3 million shares at an average price of $126.58 through structured repurchase agreements entered into during fiscal 2016 and the nine months ended September 1, 2017.
For the nine months ended August 31, 2018, 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 August 31, 2018 were excluded from the computation of earnings per share. As of August 31, 2018, $247.3 million of prepayment remained under this agreement.
As of August 31, 2018, $150 million remains under the $2.5 billion authority and we have not drawn from our $8 billion authority.
NOTE 11.  NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income per share for the three and nine months ended August 31, 2018 and September 1, 2017 (in thousands, except per share data):
 
Three Months
 
Nine Months
 
2018
 
2017
 
2018
 
2017
Net income
$
666,291

 
$
419,569

 
$
1,912,534

 
$
1,192,405

Shares used to compute basic net income per share
490,025

 
493,426

 
491,336

 
494,138

Dilutive potential common shares:
 
 
 
 
 
 
 
Unvested restricted stock units and performance share awards
6,716

 
6,664

 
7,109

 
6,574

Stock options
125

 
308

 
142

 
348

Shares used to compute diluted net income per share
496,866

 
500,398

 
498,587

 
501,060

Basic net income per share
$
1.36

 
$
0.85

 
$
3.89

 
$
2.41

Diluted net income per share
$
1.34

 
$
0.84

 
$
3.84

 
$
2.38


25


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 12.  COMMITMENTS AND CONTINGENCIES
Royalties
We have royalty commitments associated with the licensing of certain offerings. Royalty expense is generally based on a dollar amount per unit sold or a percentage of the underlying revenue.
Indemnifications
In the ordinary course of business, we provide indemnifications of varying scope to customers and channel partners 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 officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.
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.

26


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 negatively 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 $900 million of 4.75% senior notes due February 1, 2020 (the “2020 Notes”). Our proceeds were $900 million and were net of an issuance discount of $5.5 million. In addition, we incurred issuance costs of $6.4 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2020 Notes using the effective interest method. The effective interest rate including the discount and issuance costs is 4.92%. Interest is payable semi-annually, in arrears, on February 1 and August 1, and commenced on August 1, 2010.
In June 2014, we entered into interest rate swaps with a total notional amount of $900 million designated as a fair value hedge related to our 2020 Notes. The interest rate swaps effectively convert the fixed interest rate on our 2020 Notes to a floating interest rate based on LIBOR. Under the terms of the swap, we will pay monthly interest at the one-month LIBOR interest rate plus a fixed number of basis points on the $900 million notional amount. In exchange, we will receive 4.75% fixed rate interest from the swap counterparties. See Note 5 for further details regarding our interest rate swap derivatives.
In January 2015, we issued $1 billion of 3.25% senior notes due February 1, 2025 (the “2025 Notes”). Our proceeds were approximately $989.3 million which is net of an issuance discount of $10.7 million. In addition, we incurred issuance costs of $7.9 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2025 Notes using the effective interest method. The effective interest rate including the discount, issuance costs and interest rate agreement is 3.67%. Interest is payable semi-annually, in arrears on February 1 and August 1, and commenced on August 1, 2015.
As of August 31, 2018, our outstanding notes payable consist of the 2020 Notes and 2025 Notes (the “Notes”) with a total carrying value of $1.87 billion which includes the fair value of the interest rate swap and is net of debt issuance costs. Based on quoted prices in inactive markets, the total fair value of the Notes was $1.91 billion as of August 31, 2018 and excludes the effect of the fair value hedge of the 2020 Notes for which we entered into interest rate swaps as described above.
The Notes rank equally with our other unsecured and unsubordinated indebtedness. 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 August 31, 2018, we were in compliance with all of the covenants.
In February and August 2018, we made semi-annual interest payments on our 2020 and 2025 Notes each totaling $37.6 million.
Credit Agreement
On March 2, 2012, we entered into a five-year $1 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 million in commitments, for a maximum aggregate commitment of $1.5 billion. Loans under the Credit Agreement will bear interest at either (i) LIBOR plus a margin, based on our public 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%