Edgar Filing: ADOBE SYSTEMS INC

ADBE 10Q Q114

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 February 28, 2014



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 21, 2014 was 497,730,431.

ADOBE SYSTEMS INCORPORATED

FORM 10-Q

TABLE OF CONTENTS



		Page No.
PART I—FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements:	3
	Condensed Consolidated Balance Sheets February 28, 2014 and November 29, 2013	3
	Condensed Consolidated Statements of Income Three Months Ended February 28, 2014 and March 1, 2013	4
	Condensed Consolidated Statements of Comprehensive Income Three Months Ended February 28, 2014 and March 1, 2013	5
	Condensed Consolidated Statements of Cash Flows Three Months Ended February 28, 2014 and March 1, 2013	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41
Item 4.	Controls and Procedures	41

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 4.	Mine Safety Disclosures	54
Item 5.	Other Information	54
Item 6.	Exhibits	54
Signature		55
Summary of Trademarks		56
Index to Exhibits		57

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)



	February 28, 2014			November 29, 2013
	(Unaudited)			(*)
ASSETS
Current assets:
Cash and cash equivalents	$	733,916		$	834,556
Short-term investments	2,398,176			2,339,196
Trade receivables, net of allowances for doubtful accounts of $8,637 and $10,228, respectively	510,507			599,820
Deferred income taxes	91,149			102,247
Prepaid expenses and other current assets	208,643			170,110
Total current assets	3,942,391			4,045,929
Property and equipment, net	651,083			659,774
Goodwill	4,782,448			4,771,981
Purchased and other intangibles, net	570,171			605,254
Investment in lease receivable	207,239			207,239
Other assets	92,550			90,121
Total assets	$	10,245,882		$	10,380,298

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade payables	$	64,508		$	62,096
Accrued expenses	584,273			656,939
Debt and capital lease obligations	613,310			14,676
Accrued restructuring	6,193			6,171
Income taxes payable	12,986			10,222
Deferred revenue	831,077			775,544
Total current liabilities	2,112,347			1,525,648
Long-term liabilities:
Debt and capital lease obligations	896,418			1,499,297
Deferred revenue	50,010			53,268
Accrued restructuring	6,992			7,717
Income taxes payable	135,202			132,545
Deferred income taxes	362,859			375,634
Other liabilities	71,171			61,555
Total liabilities	3,634,999			3,655,664
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; 498,501 and 496,261 shares outstanding, respectively	61			61
Additional paid-in-capital	3,475,186			3,392,696
Retained earnings	6,734,701			6,928,964
Accumulated other comprehensive income	56,592			46,103
Treasury stock, at cost (102,333 and 104,573 shares, respectively), net of reissuances	(3,655,657		)	(3,643,190		)
Total stockholders’ equity	6,610,883			6,724,634
Total liabilities and stockholders’ equity	$	10,245,882		$	10,380,298

^{_________________________________________}


(*)	The Condensed Consolidated Balance Sheet as of November 29, 2013 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.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)



	Three Months Ended
	February 28, 2014			March 1, 2013
Revenue:
Products	$	471,454		$	675,789
Subscription	423,563			224,266
Services and support	105,103			107,818
Total revenue	1,000,120			1,007,873
Cost of revenue:
Products	27,498			51,982
Subscription	76,732			62,580
Services and support	44,279			42,122
Total cost of revenue	148,509			156,684
Gross profit	851,611			851,189
Operating expenses:
Research and development	209,525			209,638
Sales and marketing	410,141			398,033
General and administrative	138,984			132,853
Restructuring and other charges	663			2
Amortization of purchased intangibles	13,552			12,439
Total operating expenses	772,865			752,965
Operating income	78,746			98,224
Non-operating income (expense):
Interest and other income (expense), net	3,145			1,246
Interest expense	(16,590		)	(16,834		)
Investment gains (losses), net	(409		)	848
Total non-operating income (expense), net	(13,854		)	(14,740		)
Income before income taxes	64,892			83,484
Provision for income taxes	17,846			18,367
Net income	$	47,046		$	65,117
Basic net income per share	$	0.09		$	0.13
Shares used to compute basic net income per share	496,948			498,607
Diluted net income per share	$	0.09		$	0.13
Shares used to compute diluted net income per share	508,340			507,840

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)



	Three Months Ended
	February 28, 2014			March 1, 2013
	Increase/(Decrease)
Net income	$	47,046		$	65,117
Other comprehensive income, net of taxes:
Available-for-sale securities:
Unrealized gains / losses on available-for-sale securities	1,510			702
Reclassification adjustment for gains / losses on available-for-sale securities recognized	(637		)	(1,584		)
Net increase (decrease) from available-for-sale securities	873			(882		)
Derivatives designated as hedging instruments:
Unrealized gains / losses on derivative instruments	(29		)	21,776
Reclassification adjustment for gains / losses on derivative instruments recognized	(2,798		)	(7,094		)
Net increase (decrease) from derivatives designated as hedging instruments	(2,827		)	14,682
Foreign currency translation adjustments	12,443			(4,402		)
Other comprehensive income, net of taxes	10,489			9,398
Total comprehensive income, net of taxes	$	57,535		$	74,515

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Three Months Ended
	February 28, 2014			March 1, 2013
Cash flows from operating activities:
Net income	$	47,046		$	65,117
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion	77,636			76,752
Stock-based compensation	82,788			84,196
Deferred income taxes	(3,341		)	15,176
Unrealized (gains) losses on investments	975			(418		)
Other non-cash items	(719		)	(4,647		)
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Trade receivables, net	90,492			131,511
Prepaid expenses and other current assets	(43,559		)	(35,447		)
Trade payables	2,412			22,477
Accrued expenses	(60,140		)	(78,966		)
Accrued restructuring	(528		)	(4,047		)
Income taxes payable	6,336			(29,187		)
Deferred revenue	52,275			79,514
Net cash provided by operating activities	251,673			322,031
Cash flows from investing activities:
Purchases of short-term investments	(377,598		)	(723,541		)
Maturities of short-term investments	46,120			110,958
Proceeds from sales of short-term investments	269,732			366,808
Acquisitions, net of cash acquired	—			(96,356		)
Purchases of property and equipment	(29,393		)	(60,190		)
Purchases of long-term investments and other assets	(4,062		)	(46,633		)
Proceeds from sale of long-term investments	779			2,840
Net cash used for investing activities	(94,422		)	(446,114		)
Cash flows from financing activities:
Purchases of treasury stock	(200,000		)	(100,000		)
Proceeds from (cost of) issuance of treasury stock, net	(53,776		)	88,566
Proceeds from debt and capital lease obligations	—			25,703
Repayment of debt and capital lease obligations	(4,433		)	(2,507		)
Debt issuance costs	—			(357		)
Net cash (used for) provided by financing activities	(258,209		)	11,405
Effect of foreign currency exchange rates on cash and cash equivalents	318			(5,992		)
Net decrease in cash and cash equivalents	(100,640		)	(118,670		)
Cash and cash equivalents at beginning of period	834,556			1,425,052
Cash and cash equivalents at end of period	$	733,916		$	1,306,382
Supplemental disclosures:
Cash paid for income taxes, net of refunds	$	16,401		$	49,863
Cash paid for interest	$	31,740		$	31,960
Non-cash investing activities:
Issuance of common stock and stock awards assumed in business acquisitions	$	—		$	661

See accompanying Notes to Condensed Consolidated Financial Statements.

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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 29, 2013 on file with the SEC (our “Annual Report”).

There have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our Annual Report.

NOTE 2. ACQUISITIONS

On July 22, 2013, we completed our acquisition of privately held Neolane, a leader in cross-channel campaign management technology. During the third quarter of fiscal 2013, we began integrating Neolane into our Digital Marketing reportable segment. Neolane brings a platform for automation and execution of marketing campaigns across the web, e-mail, social, mobile, call center, direct mail, point of sale and other emerging channels which will drive consistent brand experiences and personalized campaigns for our customers.

Under the acquisition method of accounting, the total preliminary purchase price was allocated to Neolane's net tangible and intangible assets based upon their estimated fair values as of July 22, 2013. The total preliminary purchase price for Neolane was $616.7 million of which $515.2 million was allocated to goodwill (non-deductible for tax purposes), $115.0 million to identifiable intangible assets and $13.5 million to net liabilities assumed. The impact of this acquisition was not material to our Condensed Consolidated Financial Statements.

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 has brought additional community features to Creative Cloud since its acquisition. 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 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 final purchase price for Behance was $111.1 million of which $91.4 million was allocated to goodwill, $28.5 million to identifiable intangible assets and $8.8 million to net liabilities assumed. The impact of this acquisition was not material to our Condensed Consolidated Financial Statements.

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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 February 28, 2014 (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	289,712	$	—	$	—		$	289,712
Cash equivalents:
Money market mutual funds	388,448		—		—			388,448
Municipal securities	6,000		—		—			6,000
Time deposits	32,757		—		—			32,757
U.S. Treasury securities	16,997		2		—			16,999
Total cash equivalents	444,202		2		—			444,204
Total cash and cash equivalents	733,914		2		—			733,916
Short-term fixed income securities:
Corporate bonds and commercial paper	1,343,106		7,847		(382		)	1,350,571
Foreign government securities	11,188		59		—			11,247
Municipal securities	177,752		623		(4		)	178,371
U.S. agency securities	430,012		1,371		(169		)	431,214
U.S. Treasury securities	425,669		759		(111		)	426,317
Subtotal	2,387,727		10,659		(666		)	2,397,720
Marketable equity securities	178		278		—			456
Total short-term investments	2,387,905		10,937		(666		)	2,398,176
Total cash, cash equivalents and short-term investments	$	3,121,819	$	10,939	$	(666	)	$	3,132,092

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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 29, 2013 (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	286,221	$	—	$	—		$	286,221
Cash equivalents:
Money market mutual funds	429,373		—		—			429,373
Time deposits	104,711		—		—			104,711
U.S. Treasury securities	14,251		—		—			14,251
Total cash equivalents	548,335		—		—			548,335
Total cash and cash equivalents	834,556		—		—			834,556
Short-term fixed income securities:
Corporate bonds and commercial paper	1,261,375		7,116		(631		)	1,267,860
Foreign government securities	11,213		56		—			11,269
Municipal securities	186,320		328		(24		)	186,624
U.S. agency securities	446,615		1,516		(186		)	447,945
U.S. Treasury securities	424,076		799		(97		)	424,778
Subtotal	2,329,599		9,815		(938		)	2,338,476
Marketable equity securities	177		543		—			720
Total short-term investments	2,329,776		10,358		(938		)	2,339,196
Total cash, cash equivalents and short-term investments	$	3,164,332	$	10,358	$	(938	)	$	3,173,752

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 February 28, 2014 and November 29, 2013 (in thousands):



	2014					2013
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate bonds and commercial paper	$	194,460	$	(382	)	$	225,759	$	(631	)
Municipal securities	6,082		(4		)	13,522		(24		)
U.S. Treasury and agency securities	94,326		(280		)	105,278		(283		)
Total	$	294,868	$	(666	)	$	344,559	$	(938	)

There were 155 securities and 177 securities in an unrealized loss position for less than twelve months at February 28, 2014 and at November 29, 2013, respectively.

As of February 28, 2014, there was one security with a fair value of $0.6 million in an unrealized loss position for more than twelve months. The gross unrealized loss for this security was immaterial. As of November 29, 2013, there were no securities in an unrealized loss position for more than twelve months.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 February 28, 2014 (in thousands):



	Amortized Cost		Estimated Fair Value
Due within one year	$	595,088	$	596,510
Due between one and two years	881,962		885,816
Due between two and three years	697,464		701,525
Due after three years	213,213		213,869
Total	$	2,387,727	$	2,397,720

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 February 28, 2014, we did not consider any of our investments to be other-than-temporarily impaired.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 4. FAIR VALUE MEASUREMENTS

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 February 28, 2014.

The fair value of our financial assets and liabilities at February 28, 2014 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	$	388,448	$	388,448	$	—	$	—
Municipal securities	6,000		—		6,000		—
Time deposits	32,757		32,757		—		—
U.S. Treasury securities	16,999		—		16,999		—
Short-term investments:
Corporate bonds and commercial paper	1,350,571		—		1,350,571		—
Foreign government securities	11,247		—		11,247		—
Marketable equity securities	456		456		—		—
Municipal securities	178,371		—		178,371		—
U.S. agency securities	431,214		—		431,214		—
U.S. Treasury securities	426,317		—		426,317		—
Prepaid expenses and other current assets:
Foreign currency derivatives	6,725		—		6,725		—
Other assets:
Deferred compensation plan assets	22,709		529		22,180		—
Total assets	$	2,871,814	$	422,190	$	2,449,624	$	—



Liabilities:
Accrued expenses:
Foreign currency derivatives	$	1,608	$	—	$	1,608	$	—
Total liabilities	$	1,608	$	—	$	1,608	$	—

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of our financial assets and liabilities at November 29, 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:
Money market mutual funds	$	429,373	$	429,373	$	—	$	—
Time deposits	104,711		104,711		—		—
U.S. Treasury securities	14,251		—		14,251		—
Short-term investments:
Corporate bonds and commercial paper	1,267,860		—		1,267,860		—
Foreign government securities	11,269		—		11,269		—
Marketable equity securities	720		720		—		—
Municipal securities	186,624		—		186,624		—
U.S. agency securities	447,945		—		447,945		—
U.S. Treasury securities	424,778		—		424,778		—
Prepaid expenses and other current assets:
Foreign currency derivatives	11,891		—		11,891		—
Other assets:
Deferred compensation plan assets	19,816		894		18,922		—
Total assets	$	2,919,238	$	535,698	$	2,383,540	$	—



Liabilities:
Accrued expenses:
Foreign currency derivatives	$	1,067	$	—	$	1,067	$	—
Total liabilities	$	1,067	$	—	$	1,067	$	—

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.

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

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. During the three months ended February 28, 2014, we determined there were no other-than-temporary impairments on our cost method investments.

As of February 28, 2014, 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 debt was $1.6 billion as of February 28, 2014, based on Level 2 quoted prices in inactive markets. See Note 13 for further details regarding our debt.

NOTE 5. DERIVATIVES AND HEDGING ACTIVITIES

Hedge Accounting

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.

Economic Hedging—Hedges of Forecasted Transactions

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 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.

We recognize these contracts as derivative instruments and they are classified as either assets or liabilities on the balance sheet and measured on a recurring basis at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the contract 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 (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 market value from period to period are recorded in interest and other income (expense), net in our Condensed Consolidated Statements of Income.

Balance Sheet Hedging—Hedging 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.

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.

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, net on our Condensed Consolidated Statements of

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Income. The net gain (loss) recognized in interest and other income, net for cash flow hedges due to hedge ineffectiveness was insignificant for the periods presented. The time value of purchased contracts is recorded in interest and other income, net in our Condensed Consolidated Statements of Income.

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of February 28, 2014 and November 29, 2013 were as follows (in thousands):



	2014				2013
	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⁾	$	5,549	$	—	$	8,913	$	—
Derivatives not designated as hedging instruments:
Foreign exchange forward contracts	1,176		1,608		2,978		1,067
Total derivatives	$	6,725	$	1,608	$	11,891	$	1,067

^{_________________________________________}


⁽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 aggregate fair value of derivative instruments in net asset positions 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 the fair value of liabilities included in master netting arrangements with those same counterparties.

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 the three months ended February 28, 2014 and March 1, 2013 were as follows (in thousands):



	2014					2013
	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⁾	$	(29	)	$	—	$	21,776		$	—
Net gain (loss) reclassified from accumulated OCI into income, net of tax⁽²⁾	$	2,798		$	—	$	7,094		$	—
Net gain (loss) recognized in income⁽³⁾	$	(3,543	)	$	—	$	(4,668	)	$	—
Derivatives not designated as hedging relationships:
Net gain (loss) recognized in income⁽⁴⁾	$	—		$	1,235	$	—		$	1,478

^{_________________________________________}


⁽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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 6. GOODWILL AND PURCHASED AND OTHER INTANGIBLES

Goodwill as of February 28, 2014 and November 29, 2013 was $4.782 billion and $4.772 billion, respectively.

Purchased and other intangible assets subject to amortization as of February 28, 2014 and November 29, 2013 were as follows (in thousands):



	2014							2013
	Cost		Accumulated Amortization			Net		Cost		Accumulated Amortization			Net
Purchased technology	$	404,493	$	(218,930	)	$	185,563	$	423,237	$	(220,414	)	$	202,823
Customer contracts and relationships	$	391,338	$	(121,813	)	$	269,525	$	389,800	$	(111,416	)	$	278,384
Trademarks	67,273		(30,077		)	37,196		67,546		(27,933		)	39,613
Acquired rights to use technology	155,322		(82,099		)	73,223		155,322		(76,740		)	78,582
Localization	3,257		(2,044		)	1,213		3,404		(2,172		)	1,232
Other intangibles	16,474		(13,023		)	3,451		16,447		(11,827		)	4,620
Total other intangible assets	$	633,664	$	(249,056	)	$	384,608	$	632,519	$	(230,088	)	$	402,431
Purchased and other intangible assets, net	$	1,038,157	$	(467,986	)	$	570,171	$	1,055,756	$	(450,502	)	$	605,254

In the first quarter of fiscal 2013, we acquired rights to use certain technology for $51.8 million. Of this cost, an estimated $25.3 million was related to future licensing rights that has been capitalized and is being amortized on a straight-line basis over the estimated useful lives ranging from five to ten years. We estimated that the remaining cost of $26.5 million was related to historical use of licensing rights and was expensed as cost of product revenue.

Excluding the expense associated with historical use of the acquired rights to use the technology discussed in the paragraph above, amortization expense related to purchased and other intangible assets was $41.1 million and $38.6 million for the three months ended February 28, 2014 and March 1, 2013, respectively. Of these amounts, $26.8 million and $26.4 million were included in cost of sales for the three months ended February 28, 2014 and March 1, 2013, respectively. As of February 28, 2014, we expect amortization expense in future periods to be as follows (in thousands):



Fiscal Year	Purchased Technology		Other Intangible Assets
Remainder of 2014	$	56,202	$	56,297
2015	61,572		68,180
2016	22,999		62,234
2017	15,541		52,932
2018	9,144		41,868
Thereafter	20,105		103,097
Total expected amortization expense	$	185,563	$	384,608

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7. ACCRUED EXPENSES

Accrued expenses as of February 28, 2014 and November 29, 2013 consisted of the following (in thousands):



	2014		2013
Accrued compensation and benefits	$	236,607	$	318,219
Sales and marketing allowances	71,175		66,502
Accrued corporate marketing	29,574		22,801
Taxes payable	28,301		18,225
Royalties payable	12,727		14,778
Accrued interest expense	4,833		20,613
Other	201,056		195,801
Accrued expenses	$	584,273	$	656,939

Other primarily includes general corporate accruals for technical support and local and regional expenses, including our accrual for a loss contingency as of February 28, 2014. Other is also comprised of deferred rent related to office locations with rent escalations and foreign currency liability derivatives. See Note 12 for further information regarding the loss contingency.

NOTE 8. STOCK-BASED COMPENSATION

Summary of Restricted Stock Units

Restricted stock unit activity for the three months ended February 28, 2014 and the fiscal year ended November 29, 2013 was as follows (in thousands):



	2014		2013
Beginning outstanding balance	17,948		18,415
Awarded	3,327		7,236
Released	(5,870	)	(6,224	)
Forfeited	(361	)	(1,479	)
Ending outstanding balance	15,044		17,948

Information regarding restricted stock units outstanding at February 28, 2014 and March 1, 2013 is summarized below:



	Number of Shares (thousands)	Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value^(*) (millions)
2014
Restricted stock units outstanding	15,044	1.45	$	1,032.5
Restricted stock units vested and expected to vest	13,177	1.39	$	899.0
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

^{_________________________________________}


^(*)	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 February 28, 2014 and March 1, 2013 were $68.63 and $39.83, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Performance Shares

On January 24, 2014, our Executive Compensation Committee approved the 2014 Performance Share Program, including the award calculation methodology, under the terms of our 2003 Equity Incentive Plan. Under our 2014 Performance Share Program (“2014 Program”), shares may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period. The purpose of the 2014 Program is 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. 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, 2017. Participants in the 2014 Program generally have the ability to receive up to 200% of the target number of shares originally granted.

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 relative total stockholder return measured over a three-year performance period. Performance awards were granted under the 2013 Performance Share Program (“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.

As of February 28, 2014, the shares awarded under our 2013 and 2014 Performance Share Programs are yet to be achieved. The following table sets forth the summary of performance share activity under our 2013 and 2014 Performance Share Programs for the three months ended February 28, 2014 (in thousands):



	Shares Granted		Maximum Shares Eligible to Receive
Beginning outstanding balance	854		1,707
Awarded	709		1,417
Forfeited	(9	)	(18	)
Ending outstanding balance	1,554		3,106

In the first quarter of fiscal 2013, the Executive Compensation Committee certified the actual performance achievement of participants in the 2012 Performance Share Program (“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 date, contingent upon the recipient's continued service to Adobe.

The following table sets forth the summary of performance share activity under our 2011 and 2012 Programs, based upon share awards actually achieved, for the three months ended February 28, 2014 and the fiscal year ended November 29, 2013 (in thousands):



	2014		2013
Beginning outstanding balance	861		388
Achieved	—		1,279
Released	(486	)	(665	)
Forfeited	(10	)	(141	)
Ending outstanding balance	365		861

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding performance shares outstanding at February 28, 2014 and March 1, 2013 is summarized below:



	Number of Shares (thousands)	Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value^(*) (millions)
2014
Performance shares outstanding	365	0.90	$	25.1
Performance shares vested and expected to vest	336	0.90	$	22.9
2013
Performance shares outstanding	978	1.32	$	38.9
Performance shares vested and expected to vest	865	1.29	$	34.4

^{_________________________________________}


^(*)	The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of February 28, 2014 and March 1, 2013 were $68.63 and $39.83, respectively.

Summary of Stock Options

There were no option grants during the three months ended February 28, 2014 and March 1, 2013. Option activity for the three months ended February 28, 2014 and the fiscal year ended November 29, 2013 was as follows (in thousands):



	2014		2013
Beginning outstanding balance	7,359		24,517
Granted	—		25
Exercised	(1,477	)	(15,872	)
Cancelled	(75	)	(1,584	)
Increase due to acquisition	—		273
Ending outstanding balance	5,807		7,359

Information regarding stock options outstanding at February 28, 2014 and March 1, 2013 is summarized below:



	Number of Shares (thousands)	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value^(*) (millions)
2014
Options outstanding	5,807	$	29.46	3.21	$	227.5
Options vested and expected to vest	5,730	$	29.57	3.18	$	223.8
Options exercisable	4,681	$	30.64	2.73	$	177.9
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

^{_________________________________________}


^(*)	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 February 28, 2014 and March 1, 2013 were $68.63 and $39.83, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Employee Stock Purchase Plan Shares

The expected life of the 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 February 28, 2014 and March 1, 2013 were as follows:



	Three Months
	2014	2013
Expected life (in years)	0.5 - 2.0	0.5 - 2.0
Volatility	27% - 28%	26 - 30%
Risk free interest rate	0.09% - 0.39%	0.12 - 0.27%

Employees purchased 1.2 million shares at an average price of $27.84 and 1.2 million shares at an average price of $25.49 for the three months ended February 28, 2014 and March 1, 2013, respectively. The intrinsic value of shares purchased during the three months ended February 28, 2014 and March 1, 2013 was $39.0 million and $14.5 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 February 28, 2014, there was $580.3 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 2.1 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 February 28, 2014 and March 1, 2013 were as follows (in thousands):



	2014				2013
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	$	461	$	1,369	$	637	$	1,063
Cost of revenue—services and support	731		1,538		855		2,450
Research and development	4,257		26,557		5,820		25,731
Sales and marketing	4,763		25,731		6,667		23,752
General and administrative	1,786		15,595		2,514		14,707
Total	$	11,998	$	70,790	$	16,493	$	67,703

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 9. RESTRUCTURING CHARGES

Restructuring Plans

Our restructuring plans consist of reductions in workforce and the consolidation of facilities to better align our resources around our business strategies. As of February 28, 2014, we considered our restructuring plans to be 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.

Summary of Restructuring Plans

The following table sets forth a summary of restructuring activities related to all of our restructuring plans during the three months ended February 28, 2014 (in thousands):



	November 29, 2013		Costs Incurred		Cash Payments			Other Adjustments			February 28, 2014
Termination benefits	$	2,232	$	—	$	(145	)	$	(13	)	$	2,074
Cost of closing redundant facilities	11,655		528		(1,046		)	(26		)	11,111
Total restructuring plans	$	13,887	$	528	$	(1,191	)	$	(39	)	$	13,185

Accrued restructuring charges of $13.2 million as of February 28, 2014 includes $6.2 million recorded in accrued restructuring, current and $7.0 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 2014 and facilities-related liabilities under contract through fiscal 2021 of which approximately 53% will be paid through 2015.

NOTE 10. STOCKHOLDERS’ EQUITY

Retained Earnings

The changes in retained earnings for the three months ended February 28, 2014 were as follows (in thousands):



Balance as of November 29, 2013	$	6,928,964
Net income	47,046
Re-issuance of treasury stock	(241,309		)
Balance as of February 28, 2014	$	6,734,701

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 component of retained earnings in our Condensed Consolidated Balance Sheets.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The components of accumulated other comprehensive income and activity, net of related taxes, as of February 28, 2014 was as follows (in thousands):



	November 29, 2013			Increase / Decrease			Reclassification Adjustments				February 28, 2014
Net unrealized gains on available-for-sale securities:
Unrealized gains on available-for-sale securities	$	10,178		$	1,271		$	(670	)		$	10,779
Unrealized losses on available-for-sale securities	(937		)	239			33				(665		)
Net unrealized gains on available-for-sale securities	9,241			1,510			(637		)	⁽¹⁾	10,114
Net unrealized gains on derivative instruments designated as hedging instruments	5,367			(29		)	(2,798		)	⁽²⁾	2,540
Cumulative foreign currency translation adjustments	31,495			12,443			—				43,938
Total accumulated other comprehensive income, net of taxes	$	46,103		$	13,924		$	(3,435	)		$	56,592

^{_________________________________________}


⁽¹⁾	Classified in interest and other income (expense), net.


⁽²⁾	Classified as revenue.

The following table sets forth the taxes related to each component of other comprehensive income for the three months ended February 28, 2014 and March 1, 2013 (in thousands):



	Three Months
	2014			2013
Available-for-sale securities:
Unrealized gains / losses	$	(20	)	$	9
Reclassification adjustments	(1		)	—
Subtotal available-for-sale securities	(21		)	9
Derivatives designated as hedging instruments:
Unrealized gains on derivative instruments^*	—			—
Reclassification adjustments^*	—			—
Subtotal derivatives designated as hedging instruments	—			—
Foreign currency translation adjustments	1			—
Total taxes, other comprehensive income	$	(20	)	$	9

^{_________________________________________}


^(*)	Taxes related to derivative instruments were zero based on the tax jurisdiction where the derivative instruments were executed.

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. We are currently repurchasing common stock under our $2.0 billion authority granted by our Board of Directors in April 2012, which can be used through the end of fiscal 2015.

During the three months ended February 28, 2014 and March 1, 2013, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $200.0 million and $100.0 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.

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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 February 28, 2014, we repurchased approximately 4.5 million shares at an average price of $58.27 through structured repurchase agreements entered into during fiscal 2013 and the three month ended February 28, 2014. 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 2012 and the three months ended March 1, 2013.

As of February 28, 2014, the prepayments were classified as treasury stock on our Condensed Consolidated Balance Sheets at the payment date, though only shares delivered to us by the financial statement date were excluded from the computation of earnings per share. As of February 28, 2014, $66.6 million of prepayment remained under this agreement.

Subsequent to February 28, 2014, as part of our $2.0 billion stock repurchase program, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $150.0 million. This amount will be classified as treasury stock on our Condensed Consolidated Balance Sheets. Upon completion of the $150.0 million stock repurchase agreement, $450.0 million remains under our current 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 three months ended February 28, 2014 and March 1, 2013 (in thousands, except per share data):



	Three Months
	2014		2013
Net income	$	47,046	$	65,117
Shares used to compute basic net income per share	496,948		498,607
Dilutive potential common shares:
Unvested restricted stock and performance share awards	8,897		6,526
Stock options	2,495		2,707
Shares used to compute diluted net income per share	508,340		507,840
Basic net income per share	$	0.09	$	0.13
Diluted net income per share	$	0.09	$	0.13

For the three months ended February 28, 2014, there were no options to purchase shares of common stock with exercise prices greater than the average fair market value of our stock of $60.85 that would have been anti-dilutive. Comparatively, 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 February 28, 2014, 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 $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.

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 $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 February 28, 2014, 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.

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.

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

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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.

Between May 4, 2011 and July 14, 2011, five putative class action lawsuits were filed in Santa Clara Superior Court and Alameda Superior Court in California. On September 12, 2011, the cases were consolidated into In Re High-Tech Employee Antitrust Litigation (“HTEAL”) pending in the United States District Court for the Northern District of California, San Jose Division. In the consolidated complaint, Plaintiffs alleged that Adobe, along with Apple, Google, Intel, Intuit, Lucasfilm and Pixar, agreed not to recruit each other's employees in violation of Federal and state antitrust laws. Plaintiffs claim the alleged agreements suppressed employee compensation and deprived employees of career opportunities. Plaintiffs seek injunctive relief, monetary damages, treble damages, costs and attorneys fees. All defendants deny the allegations and that they engaged in any wrongdoing of any kind. On October 24, 2013, the court certified a class of all persons who worked in the technical, creative, and/or research and development fields on a salaried basis in the United States for one or more of the following: (a) Apple from March 2005 through December 2009; (b) Adobe from May 2005 through December 2009; (c) Google from March 2005 through December 2009; (d) Intel from March 2005 through December 2009; (e) Intuit from June 2007 through December 2009; (f) Lucasfilm from January 2005 through December 2009; or (g) Pixar from January 2005 through December 2009, excluding retail employees, corporate officers, members of the boards of directors, and senior executives of all defendants. In our fiscal quarter ended February 28, 2014 we accrued a loss contingency of $10.0 million associated with this matter. Trial in this matter is scheduled for May 2014.

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.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 $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 $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 2014, we made a semi-annual interest payment of $31.1 million. Based on quoted prices in inactive markets, the fair value of the Notes was $1.6 billion as of February 28, 2014.

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 February 28, 2014, we were in compliance with all of the covenants.

During the first quarter of fiscal 2014, we reclassified $599.8 million as current debt on our Condensed Consolidated Balance Sheets, which represents the 2015 Notes, net of unamortized original issuance discount. We intend to refinance the current portion of our debt on or before the due date.

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 February 28, 2014, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants.

Capital Lease Obligations

In fiscal 2013, we entered into a sale-leaseback agreement totaling $25.7 million over a period of 24 months. As of February 28, 2014, our capital lease obligations of $13.5 million are presented as current debt in our Condensed Consolidated Balance Sheets.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 14. NON-OPERATING INCOME (EXPENSE)

Non-operating income (expense) for the three months ended February 28, 2014 and March 1, 2013 included the following (in thousands):



	Three Months
	2014			2013
Interest and other income (expense), net:
Interest income	$	5,134		$	5,681
Foreign exchange gains (losses)	(2,803		)	(6,174		)
Realized gains on fixed income investment	670			1,598
Realized losses on fixed income investment	(33		)	(14		)
Other	177			155
Interest and other income (expense), net	$	3,145		$	1,246
Interest expense	$	(16,590	)	$	(16,834	)
Investment gains (losses), net:
Realized investment gains	$	550		$	418
Unrealized investment gains	95			444
Realized investment losses	(1,054		)	(14		)
Investment gains (losses), net	$	(409	)	$	848
Non-operating income (expense), net	$	(13,854	)	$	(14,740	)

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.

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, chief information officer and chief revenue officers.


•	Print and Publishing—Our Print and Publishing segment addresses market opportunities ranging from the diverse authoring and publishing needs of technical and business publishing to our legacy type and OEM printing businesses.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Our segment results for the three months ended February 28, 2014 and March 1, 2013 were as follows (dollars in thousands):



	Digital Media			Digital Marketing			Print and Publishing			Total
Three months ended February 28, 2014
Revenue	$	641,103		$	314,431		$	44,586		$	1,000,120
Cost of revenue	38,087			108,017			2,405			148,509
Gross profit	$	603,016		$	206,414		$	42,181		$	851,611
Gross profit as a percentage of revenue	94		%	66		%	95		%	85		%
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		%

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth and market opportunities which involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors” in Part II, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with the U.S. Securities and Exchange Commission (“the SEC”), including our Annual Report on Form 10-K for fiscal 2013. When used in this report, the words “will,” “expects,” “could,” “would,” “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” “continues” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document, except as required by law.

BUSINESS OVERVIEW

Founded in 1982, Adobe Systems Incorporated is one of the largest and most diversified software companies in the world. We offer a line of software and services used by creative professionals, marketers, knowledge workers, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing and engaging with compelling content and experiences across multiple operating systems, devices and media. We market and license our software directly to enterprise customers through our sales force and to end users through app stores and our own website at www.adobe.com. We also distribute our products through a network of distributors, value-added resellers (“VARs”), systems integrators, independent software vendors (“ISVs”), retailers and original equipment manufacturers (“OEMs”). In addition, we license our technology to hardware manufacturers, software developers and service providers for use in their products and solutions. We offer some of our products via a Software-as-a-Service (“SaaS”) model or a managed services model (both of which are referred to as a hosted or “cloud-based” model) as well as through term subscription and pay-per-use models. Our software runs on personal computers (“PCs”) and server-based computers, as well as on mobile, tablets and other devices, depending on the product. We have operations in the Americas, Europe, Middle East and Africa (“EMEA”) and Asia-Pacific (“APAC”).

We maintain executive offices and principal facilities at 345 Park Avenue, San Jose, California 95110-2704. Our telephone number is 408-536-6000. We maintain a website at www.adobe.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC website at www.sec.gov.

OPERATIONS OVERVIEW

For our first quarter of fiscal 2014, we reported financial results consistent with the continued execution of our long-term plans for our two strategic growth areas, Digital Media and Digital Marketing, while continuing to market and license a broad portfolio of products and solutions.

In our Digital Media segment, we are a market leader with Creative Cloud, our subscription-based offering for creating and publishing content and applications. Creative Cloud, first delivered in May 2012, is our next-generation offering that supersedes our historical model of licensing our creative products with perpetual licenses. Creative Cloud delivers value through more frequent product updates, storage and access to user files stored in the cloud with syncing of files across users' machines, community-based features and services through our acquisition of Behance in December 2012, digital publishing and app creation capabilities, and lower entry point pricing for cost-sensitive customers.

We offer Creative Cloud for individuals and for teams, and we enable larger enterprise customers to acquire Creative Cloud capabilities through Enterprise Term License Agreements (“ETLAs”). The three Creative Cloud offerings address the multiple routes to market we use to license our creative software to targeted customers. Adoption of Creative Cloud is transforming our business model and we continue to expect this to drive higher long-term revenue growth through an expansion of our customer base by acquiring new users through a lower cost of entry and delivery of additional features and value, as well as keeping existing customers current on our latest release. This model drives our revenue to be more recurring and predictable as revenue is recognized ratably.

We continue to implement strategies that will accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offering. These strategies include increasing the value Creative Cloud users receive, as well as targeted promotions

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and offers that attract past customers and potential users to try out and ultimately subscribe to Creative Cloud. Additionally, in May 2013 we announced we would exclusively deliver new creative product innovations and features to Creative Cloud subscribers, and that Adobe Creative Suite 6 (“CS6”), which was released in May 2012, would be the last major update we provide for perpetual licensees. More recently, we announced the removal of general availability of CS6 on a perpetual licensing basis from legacy shrinkwrap and volume licensing channels. We will still offer CS6 through our Adobe.com website and in certain markets.

Because of the shift towards Creative Cloud subscriptions and ETLAs, we have stated we expect perpetual revenue for CS6 to sequentially decline, and in the second half of fiscal 2014 we expect revenue from perpetual licensing of our creative professional products to be immaterial.

Total Digital Media revenue declined during the first quarter of fiscal 2014 compared to the year ago period as adoption of our Creative Cloud subscription offering continued to increase while CS6 perpetual revenue continued to decline as expected. This resulted in a milestone where reported revenue from subscriptions and ETLA adoption exceeded that of perpetual licenses of our creative professional products for the first time during the first quarter of fiscal 2014.

To assist with the understanding of this transition and the related shift in revenue described above, we are using certain performance metrics to assess the health and trajectory of our overall Digital Media segment. These metrics include the total number of current paid subscriptions and Annualized Recurring Revenue (“ARR”). ARR should be viewed independently of revenue, deferred revenue and unbilled deferred revenue as ARR is a performance metric and is not intended to be combined with any of these items.

For our Creative business, we define Creative ARR as the sum of:


•	the number of current paid subscriptions, multiplied by the average subscription price paid per user per month, multiplied by twelve months; plus,

•twelve months of contract value of ETLAs where the revenue is ratably recognized over the life of the contract; plus

•twelve months of Adobe Digital Publishing Suite contract value where the revenue is ratably recognized.

We exited the first quarter fiscal 2014 with 1.844 million paid Creative Cloud subscriptions, up 28% from 1.439 million at the end fiscal 2013. Total Creative ARR exiting the first quarter of fiscal 2014 was $987.0 million, up from $801.0 million as of November 29, 2013.

Our Digital Media segment also includes our Document Services products and solutions, including Acrobat, Acrobat cloud services and EchoSign e-signing solution. In the first quarter of fiscal 2014 we continued to drive solid adoption of our Acrobat family of products primarily through license agreements with enterprise customers. During the first quarter of fiscal 2014, a higher percentage of these agreements were ETLAs, which like ETLAs with our creative customers, cause more revenue to be recognized over time rather than at the time of contract signing. This has caused a decline in Acrobat revenue which was partially offset by increases associated with our Acrobat cloud services and EchoSign during the first quarter of fiscal 2014.

We expect that the benefit of ETLAs will improve our growth potential over time. In addition to Acrobat, we also drove strong adoption of subscription based services including our Acrobat cloud services and EchoSign. Combined, adoption of Acrobat through ETLAs and our Document Services subscription offerings helped grow Document Services ARR to $164.0 million exiting the first quarter of fiscal 2014, up from $63.0 million at the end of the first quarter of fiscal 2013.

Total Digital Media ARR, which we define as the sum of Creative ARR and Document Services ARR, grew to $1.15 billion at the exit of the first quarter of fiscal 2014, up from $300.0 million at the end of the first quarter fiscal 2013, demonstrating the progress we have made with our transformation of our business to a more recurring, ratable and predictable revenue model.

We are a market leader in the fast-growing category addressed by our Digital Marketing segment. Our Adobe Marketing Cloud includes six solutions addressing the expanding needs of marketers, the newest of which is Adobe Campaign—a cross-channel campaign management tool that we added to our portfolio with the acquisition of Neolane during our third quarter of fiscal 2013.

Revenue from Adobe Marketing Cloud increased 24% during the three months ended February 28, 2014 compared to the year ago period. Helping to drive this performance was strong adoption of our Adobe Experience Manager (“AEM”) offering and the addition of Neolane in mid-third quarter of fiscal 2013.

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AEM, our fastest growing digital marketing solution, has typically been licensed by our customers as an on-premise offering where license revenue is recognized at the time of the transaction. In the past year, we introduced a managed services offering of AEM for which revenue is recognized ratably. We expect continued adoption of the newer managed services offering, which will increasingly migrate AEM revenue in this segment to be recurring. Given the comparisons involving more new license revenue being recognized over time versus past license revenue being recognized up front, we anticipate this trend may impact overall Adobe Marketing Cloud reported revenue growth in the near term.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing our Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.

We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, business combinations, goodwill impairment and income taxes have the greatest potential impact on our Condensed Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules requiring us to make judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.

There have been no significant changes in our critical accounting policies and estimates during the three months ended February 28, 2014, as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 29, 2013.

Recent Accounting Pronouncements Not Yet Effective

There have been no new accounting pronouncements not yet effective that have significance, or potential significance, to our Condensed Consolidated Financial Statements.

RESULTS OF OPERATIONS

Financial Performance Summary for the First Quarter of Fiscal 2014


•	Consistent with our strategy, during the three months ended February 28, 2014, our subscription revenue as a percentage of total revenue increased to 42% compared with 22%, in the year ago period, as we transition more of our business to a subscription-based model.


•	We exited the first quarter of fiscal 2014 with 1.844 million paid Creative Cloud subscriptions, up 28% from 1.439 million at the end of fiscal 2013.


•	Total Digital Media ARR of approximately $1.15 billion as of February 28, 2014 increased by $207.0 million, or 22%, from $944.0 million as of November 29, 2013. The change in our Digital Media ARR is primarily due to increases in the number of paid Creative Cloud individual and team subscriptions and continued adoption of our enterprise Creative Cloud offering through our ETLAs.


•	Adobe Marketing Cloud revenue of $267.0 million during the three months ended February 28, 2014 increased by $51.6 million, or 24% compared to the three months ended March 1, 2013. The increase was primarily due to strong adoption of our AEM offering and the addition of Neolane in the third quarter of fiscal 2013.


•	Our total deferred revenue of $881.1 million as of February 28, 2014 increased by $52.3 million, or 6% from November 29, 2013, primarily due to increases in subscriptions, ETLAs and renewals for our Adobe Marketing Cloud services.


•	Cost of revenue of $148.5 million during the three months ended February 28, 2014 decreased by $8.2 million, or 5%, compared to the three months ended March 1, 2013. The decrease is primarily due to a one-time charge associated with technology license arrangements during the three months ended March 1, 2013. This decline was offset by increased

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hosting and server costs associated with our subscription and SaaS offerings and costs associated with compensation and related benefits driven by additional headcount.


•