ADBE 10Q Q314

 
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 29, 2014

 or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   
 
Commission File Number: 0-15175
 
ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
_________________________
Delaware
(State or other jurisdiction of
incorporation or organization)
77-0019522
(I.R.S. Employer
Identification No.)

345 Park Avenue, San Jose, California 95110-2704
(Address of principal executive offices and zip code)

(408) 536-6000
(Registrant’s telephone number, including area code)
 _________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller
reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No x
The number of shares outstanding of the registrant’s common stock as of September 19, 2014 was 498,738,874.
 


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
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)
 
August 29,
2014
 
November 29,
2013
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
903,329

 
$
834,556

Short-term investments
2,616,868

 
2,339,196

Trade receivables, net of allowances for doubtful accounts of $7,879 and $10,228, respectively
528,331

 
599,820

Deferred income taxes
79,713

 
102,247

Prepaid expenses and other current assets
151,227

 
170,110

Total current assets
4,279,468

 
4,045,929

Property and equipment, net
785,856

 
659,774

Goodwill
4,746,781

 
4,771,981

Purchased and other intangibles, net
490,839

 
605,254

Investment in lease receivable
80,439

 
207,239

Other assets
110,297

 
90,121

Total assets
$
10,493,680

 
$
10,380,298

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 

 
 

Trade payables
$
53,791

 
$
62,096

Accrued expenses
630,679

 
656,939

Debt and capital lease obligations
606,426

 
14,676

Accrued restructuring
2,351

 
6,171

Income taxes payable
4,438

 
10,222

Deferred revenue
947,563

 
775,544

Total current liabilities
2,245,248

 
1,525,648

Long-term liabilities:
 

 
 

Debt and capital lease obligations
901,830

 
1,499,297

Deferred revenue
48,975

 
53,268

Accrued restructuring
5,776

 
7,717

Income taxes payable
141,473

 
132,545

Deferred income taxes
344,715

 
375,634

Other liabilities
74,403

 
61,555

Total liabilities
3,762,420

 
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; 
 498,599 and 496,261 shares outstanding, respectively
61

 
61

Additional paid-in-capital
3,675,629

 
3,392,696

Retained earnings
6,850,790

 
6,928,964

Accumulated other comprehensive income
20,067

 
46,103

Treasury stock, at cost (102,235 and 104,573 shares, respectively), net of reissuances
(3,815,287
)
 
(3,643,190
)
Total stockholders’ equity
6,731,260

 
6,724,634

Total liabilities and stockholders’ equity
$
10,493,680

 
$
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.

3
Table of Contents

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
August 29,
2014
 
August 30,
2013
 
August 29,
2014
 
August 30,
2013
Revenue:
 
 
 
 
 
 
 
Products
$
349,151

 
$
582,178

 
$
1,299,852

 
$
1,902,866

Subscription
547,373

 
299,346

 
1,447,630

 
778,133

Services and support
108,885

 
113,595

 
326,255

 
332,542

Total revenue
1,005,409

 
995,119

 
3,073,737

 
3,013,541

 
Cost of revenue:
 

 
 
 
 
 
 
Products
23,172

 
32,564

 
75,169

 
111,351

Subscription
86,670

 
71,656

 
247,549

 
200,763

Services and support
47,882

 
42,856

 
138,419

 
126,927

Total cost of revenue
157,724

 
147,076

 
461,137

 
439,041

Gross profit
847,685

 
848,043

 
2,612,600

 
2,574,500

 
Operating expenses:
 

 
 
 
 
 
 
Research and development
212,049

 
208,700

 
630,666

 
621,435

Sales and marketing
406,475

 
388,673

 
1,243,446

 
1,188,914

General and administrative
141,676

 
128,043

 
409,798

 
381,766

Restructuring and other charges
201

 
(791
)
 
498

 
24,203

Amortization of purchased intangibles
13,108

 
13,064

 
40,012

 
38,295

Total operating expenses
773,509

 
737,689

 
2,324,420

 
2,254,613

 Operating income
74,176

 
110,354

 
288,180

 
319,887

 
Non-operating income (expense):
 

 
 
 
 
 
 
Interest and other income (expense), net
1,454

 
1,732

 
7,162

 
4,246

Interest expense
(13,361
)
 
(16,747
)
 
(47,054
)
 
(50,786
)
Investment gains (losses), net
669

 
(2,079
)
 
813

 
(5,476
)
Total non-operating income (expense), net
(11,238
)
 
(17,094
)
 
(39,079
)
 
(52,016
)
Income before income taxes
62,938

 
93,260

 
249,101

 
267,871

Provision for income taxes
18,252

 
10,258

 
68,842

 
43,206

Net income
$
44,686

 
$
83,002

 
$
180,259

 
$
224,665

Basic net income per share
$
0.09

 
$
0.16

 
$
0.36

 
$
0.45

Shares used to compute basic net income per share
498,468

 
504,116

 
497,782

 
502,039

Diluted net income per share
$
0.09

 
$
0.16

 
$
0.35

 
$
0.44

Shares used to compute diluted net income per share
507,811

 
514,058

 
508,575

 
513,155



  See accompanying Notes to Condensed Consolidated Financial Statements.


4
Table of Contents

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
August 29,
2014
 
August 30,
2013
 
August 29,
2014
 
August 30,
2013
 
Increase/(Decrease)
 
Increase/(Decrease)
Net income
$
44,686

 
$
83,002

 
$
180,259

 
$
224,665

Other comprehensive income, net of taxes:
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses on available-for-sale
securities
(1,822
)
 
(7,757
)
 
1,666

 
(12,310
)
Reclassification adjustment for gains / losses on
available-for-sale securities recognized
(1,592
)
 
46

 
(3,480
)
 
(2,326
)
Net increase (decrease) from available-for-sale
securities
(3,414
)
 
(7,711
)
 
(1,814
)
 
(14,636
)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Unrealized gains / losses on derivative instruments
10,003

 
(2,947
)
 
11,976

 
29,713

Reclassification adjustment for gains / losses on
derivative instruments recognized
(1,075
)
 
(10,487
)
 
(6,490
)
 
(32,880
)
Net increase (decrease) from derivatives designated as hedging instruments
8,928

 
(13,434
)
 
5,486

 
(3,167
)
Foreign currency translation adjustments
(32,090
)
 
6,651

 
(29,708
)
 
57

Other comprehensive income, net of taxes
(26,576
)
 
(14,494
)
 
(26,036
)
 
(17,746
)
Total comprehensive income, net of taxes
$
18,110

 
$
68,508

 
$
154,223

 
$
206,919



See accompanying Notes to Condensed Consolidated Financial Statements.



5
Table of Contents

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
 
August 29,
2014
 
August 30,
2013
Cash flows from operating activities:
 
 
 
Net income
$
180,259

 
$
224,665

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

 
 
Depreciation, amortization and accretion
235,443

 
239,877

Stock-based compensation
248,811

 
244,090

Deferred income taxes
(7,912
)
 
41,002

Write down of assets held for sale
—

 
23,838

Unrealized (gains) losses on investments
47

 
6,719

Tax benefit (shortfall) from employee stock option plans
31,883

 
(17,186
)
Other non-cash items
829

 
2,972

Excess tax benefits from stock-based compensation
(31,953
)
 
—

Changes in operating assets and liabilities, net of acquired assets and assumed
      liabilities:
 
 
 
Trade receivables, net
71,973

 
112,015

Prepaid expenses and other current assets
13,352

 
(13,669
)
Trade payables
(8,305
)
 
16,106

Accrued expenses
(13,749
)
 
(65,992
)
Accrued restructuring
(5,627
)
 
(8,454
)
Income taxes payable
4,952

 
(75,908
)
Deferred revenue
167,726

 
106,629

Net cash provided by operating activities
887,729

 
836,704

Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(1,412,539
)
 
(1,635,999
)
Maturities of short-term investments
913,308

 
292,374

Proceeds from sales of short-term investments
209,172

 
1,084,873

Acquisitions, net of cash acquired
—

 
(704,375
)
Purchases of property and equipment
(111,557
)
 
(153,237
)
Purchases of long-term investments and other assets
(12,496
)
 
(64,820
)
Proceeds from sale of long-term investments
1,364

 
3,396

Net cash used for investing activities
(412,748
)
 
(1,177,788
)
Cash flows from financing activities:
 

 
 

Purchases of treasury stock
(475,000
)
 
(700,000
)
Proceeds from issuance of treasury stock
213,841

 
526,240

Cost of issuance of treasury stock
(163,293
)
 
(90,356
)
Excess tax benefits from stock-based compensation
31,953

 
—

Proceeds from debt and capital lease obligations
—

 
25,703

Repayment of debt and capital lease obligations
(11,431
)
 
(19,838
)
Debt issuance costs
—

 
(357
)
Net cash used for financing activities
(403,930
)
 
(258,608
)
Effect of foreign currency exchange rates on cash and cash equivalents
(2,278
)
 
(6,275
)
Net decrease in cash and cash equivalents
68,773

 
(605,967
)
Cash and cash equivalents at beginning of period
834,556

 
1,425,052

Cash and cash equivalents at end of period
$
903,329

 
$
819,085

Supplemental disclosures:
 

 
 
Cash paid for income taxes, net of refunds
$
7,114

 
$
110,697

Cash paid for interest
$
61,562

 
$
64,334

Non-cash investing activities:
 
 
 
Investment in lease receivable applied to building purchase
$
126,800

 
$
—

Issuance of common stock and stock awards assumed in business acquisitions
$
—

 
$
1,160



See accompanying Notes to Condensed Consolidated Financial Statements.

6
Table of Contents

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.
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 U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for us in the first quarter of fiscal 2018. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.
With the exception of the new revenue standard discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the nine months ended August 29, 2014, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 29, 2013, that are of significance or potential significance to us.
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 final 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 final purchase price for Neolane was $616.7 million of which $515.2 million was allocated to goodwill that was 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.

7
Table of Contents

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 29, 2014 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
274,463

 
$
—

 
$
—

 
$
274,463

Cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
565,996

 
—

 
—

 
565,996

Time deposits
62,870

 
—

 
—

 
62,870

Total cash equivalents
628,866

 
—

 
—

 
628,866

Total cash and cash equivalents
903,329

 
—

 
—

 
903,329

Short-term fixed income securities:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,456,706

 
5,955

 
(425
)
 
1,462,236

Foreign government securities
23,128

 
40

 
(3
)
 
23,165

Municipal securities
185,634

 
543

 
(5
)
 
186,172

U.S. agency securities
506,227

 
881

 
(260
)
 
506,848

U.S. Treasury securities
437,362

 
580

 
(122
)
 
437,820

Subtotal
2,609,057

 
7,999

 
(815
)
 
2,616,241

Marketable equity securities
174

 
453

 
—

 
627

Total short-term investments
2,609,231

 
8,452

 
(815
)
 
2,616,868

Total cash, cash equivalents and short-term investments
$
3,512,560

 
$
8,452

 
$
(815
)
 
$
3,520,197



8
Table of Contents

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 August 29, 2014 and November 29, 2013 (in thousands):
 
2014
 
2013
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
256,849

 
$
(289
)
 
$
225,759

 
$
(631
)
Foreign government securities
7,595

 
(3
)
 
—

 
—

Municipal securities
9,837

 
(5
)
 
13,522

 
(24
)
U.S. Treasury and agency securities
169,621

 
(232
)
 
105,278

 
(283
)
Total
$
443,902

 
$
(529
)
 
$
344,559

 
$
(938
)
 
There were 208 securities and 177 securities in an unrealized loss position for less than twelve months at August 29, 2014 and at November 29, 2013, respectively.

9
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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 29, 2014 (in thousands):
 
2014
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
18,577

 
$
(136
)
U.S. Treasury and agency securities
29,416

 
(150
)
Total
$
47,993

 
$
(286
)
As of August 29, 2014, there were 16 securities in an unrealized loss position for more than twelve months. As of November 29, 2013, there were no securities in an unrealized loss position for more than twelve months.
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 29, 2014 (in thousands):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
629,477

 
$
630,712

Due between one and two years
808,082

 
810,830

Due between two and three years
915,643

 
918,119

Due after three years
255,855

 
256,580

Total
$
2,609,057

 
$
2,616,241

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 nine months ended August 29, 2014, we did not consider any of our investments to be other-than-temporarily impaired.

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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 29, 2014.
The fair value of our financial assets and liabilities at August 29, 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
$
565,996

 
$
565,996

 
$
—

 
$
—

Time deposits
62,870

 
62,870

 
—

 
—

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,462,236

 
—

 
1,462,236

 
—

Foreign government securities
23,165

 
—

 
23,165

 
—

Marketable equity securities
627

 
627

 
—

 
—

Municipal securities
186,172

 
—

 
186,172

 
—

U.S. agency securities
506,848

 
—

 
506,848

 
—

U.S. Treasury securities
437,820

 
—

 
437,820

 
—

Prepaid expenses and other current assets:
 
 
 

 
 

 
 

Foreign currency derivatives
14,384

 
—

 
14,384

 
—

Other assets:
 
 
 

 
 

 
 

Deferred compensation plan assets
24,821

 
536

 
24,285

 
—

Interest rate swap derivatives
5,146

 
—

 
5,146

 
—

Total assets
$
3,290,085

 
$
630,029

 
$
2,660,056

 
$
—

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
969

 
$
—

 
$
969

 
$
—

Total liabilities
$
969

 
$
—

 
$
969

 
$
—



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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 and derivatives 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.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We also have direct investments in privately held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. For the three and nine months ended August 29, 2014, we determined there were no other-than-temporary impairments on our cost method investments. Comparatively, for the three and nine months ended August 30, 2013, we determined there were other-than-temporary impairments of $2.0 million and $7.0 million, respectively, on our cost method investments which were written down to fair value.
As of August 29, 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 senior notes was $1.6 billion as of August 29, 2014, based on observable market prices in less active market and categorized as Level 2. 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.
Fair Value Hedging—Interest Rate Swap
During the third quarter of fiscal 2014, we entered into interest rate swaps designated as a fair value hedge related to our $900.0 million of 4.75% fixed interest rate senior notes due February 1, 2020 (the “2020 Notes”). In effect, the interest rate swaps convert the fixed interest rate on our 2020 Notes to a floating interest rate based on the London Interbank Offered Rate (“LIBOR”). Under the terms of the swaps, we will pay monthly interest at the one-month LIBOR 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 Statement of Income. The fair value of the interest rate swaps is reflected in other assets in our Condensed Consolidated Balance Sheets.
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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 (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 the periods presented. The time value of purchased contracts is recorded in interest and other income (expense), net in our Condensed Consolidated Statements of Income.
The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of August 29, 2014 and November 29, 2013 were as follows (in thousands):
 
2014
 
2013
 
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) (3) 
$
13,153

 
$
—

 
$
8,913

 
$
—

Interest rate swap (2)
5,146

 
—

 
—

 
—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 Foreign exchange forward contracts (1)
1,231

 
969

 
2,978

 
1,067

Total derivatives
$
19,530

 
$
969

 
$
11,891

 
$
1,067

_________________________________________ 
(1) 
Included in prepaid expenses and other current assets and accrued expenses for asset derivatives and liability derivatives, respectively, on our Condensed Consolidated Balance Sheets.
(2) 
Included in other assets 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.


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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 29, 2014 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) 
$
10,003

 
$
—

 
$
11,976

 
$
—

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
1,075

 
$
—

 
$
6,490

 
$
—

Net gain (loss) recognized in income(3) 
$
(4,676
)
 
$
—

 
$
(11,871
)
 
$
—

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

 
$
(1,575
)
 
$
—

 
$
(855
)

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 and nine months ended August 30, 2013 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) 
$
(2,947
)
 
$
—

 
$
29,713

 
$
—

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
10,487

 
$
—

 
$
32,880

 
$
—

Net gain (loss) recognized in income(3) 
$
(3,989
)
 
$
—

 
$
(13,656
)
 
$
—

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

 
$
(2,028
)
 
$
—

 
$
2,768

_________________________________________ 
(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 August 29, 2014 and November 29, 2013 was $4.747 billion and $4.772 billion, respectively. During the second quarter of fiscal 2014, we completed our annual goodwill impairment test associated with our three reporting units—Digital Media, Digital Marketing and Print and Publishing—and determined there was no impairment of goodwill.
Purchased and other intangible assets subject to amortization as of August 29, 2014 and November 29, 2013 were as follows (in thousands): 
 
2014
 
2013
 
Cost
 
Accumulated Amortization
 
Net
 
Cost
 
Accumulated Amortization
 
Net
Purchased technology
$
400,114

 
$
(254,595
)
 
$
145,519

 
$
423,237

 
$
(220,414
)
 
$
202,823

Customer contracts and relationships
$
380,753

 
$
(134,892
)
 
$
245,861

 
$
389,800

 
$
(111,416
)
 
$
278,384

Trademarks
67,105

 
(34,496
)
 
32,609

 
67,546

 
(27,933
)
 
39,613

Acquired rights to use technology
157,827

 
(92,948
)
 
64,879

 
155,322

 
(76,740
)
 
78,582

Localization
1,442

 
(956
)
 
486

 
3,404

 
(2,172
)
 
1,232

Other intangibles
12,473

 
(10,988
)
 
1,485

 
16,447

 
(11,827
)
 
4,620

Total other intangible assets
$
619,600

 
$
(274,280
)
 
$
345,320

 
$
632,519

 
$
(230,088
)
 
$
402,431

Purchased and other intangible assets, net
$
1,019,714

 
$
(528,875
)
 
$
490,839

 
$
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.   

In the second quarter of fiscal 2014, certain purchased intangibles associated with our acquisitions of Efficient Frontier and Day Software Holding AG became fully amortized and were removed from the Condensed Consolidated Balance Sheets. Amortization expense related to purchased and other intangible assets was $39.1 million and $115.1 million for the three and nine months ended August 29, 2014, respectively. Comparatively, excluding the expense associated with historical use of the acquired rights to use the technology discussed in the paragraph above, amortization expense was $42.2 million and $117.1 million for the three and nine months ended August 30, 2013, respectively. Of these amounts, $26.0 million and $75.1 million were included in cost of sales for the three and nine months ended August 29, 2014, respectively, and $29.4 million and $79.6 million for the three and nine months ended August 30, 2013, respectively.
As of August 29, 2014, we expect amortization expense in future periods to be as follows (in thousands):
Fiscal Year
 
Purchased
Technology
 
Other Intangible
Assets
Remainder of 2014
$
18,692

 
$
18,196

2015
61,000

 
68,267

2016
22,646

 
62,298

2017
15,197

 
52,916

2018
8,803

 
42,021

Thereafter
19,181

 
101,622

Total expected amortization expense
$
145,519

 
$
345,320


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7.  ACCRUED EXPENSES
Accrued expenses as of August 29, 2014 and November 29, 2013 consisted of the following (in thousands):
 
2014
 
2013
Accrued compensation and benefits
$
309,507

 
$
318,219

Sales and marketing allowances 
73,792

 
66,502

Accrued corporate marketing
27,522

 
22,801

Taxes payable
17,241

 
18,225

Royalties payable
12,300

 
14,778

Accrued interest expense
7,295

 
20,613

Other
183,022

 
195,801

Accrued expenses
$
630,679

 
$
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 August 29, 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 nine months ended August 29, 2014 and the fiscal year ended November 29, 2013 was as follows (in thousands):
 
2014
 
2013
Beginning outstanding balance
17,948

 
18,415

Awarded
4,054

 
7,236

Released
(7,085
)
 
(6,224
)
Forfeited
(1,072
)
 
(1,479
)
Ending outstanding balance
13,845

 
17,948

Information regarding restricted stock units outstanding at August 29, 2014 and August 30, 2013 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2014
 
 
 
 
 
Restricted stock units outstanding
13,845

 
1.12
 
$
995.5

Restricted stock units vested and expected to vest
12,367

 
1.05
 
$
882.4

2013
 

 
 
 
 

Restricted stock units outstanding
18,163

 
1.29
 
$
831

Restricted stock units vested and expected to vest
16,159

 
1.22
 
$
736.8

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of August 29, 2014 and August 30, 2013 were $71.90 and $45.75, 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 August 29, 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 nine months ended August 29, 2014 (in thousands): 
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
Beginning outstanding balance
854

 
1,707

Awarded
709

 
1,417

Forfeited
(46
)
 
(90
)
Ending outstanding balance
1,517

 
3,034

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 2010, 2011 and 2012 Programs, based upon share awards actually achieved, for the nine months ended August 29, 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
(21
)
 
(141
)
Ending outstanding balance
354

 
861

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding performance shares outstanding at August 29, 2014 and August 30, 2013 is summarized below: 
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2014
 
 
 
 
 
Performance shares outstanding
354

 
0.41
 
$
25.4

Performance shares vested and expected to vest
339

 
0.41
 
$
24.2

2013
 

 
 
 
 

Performance shares outstanding
868

 
0.83
 
$
39.7

Performance shares vested and expected to vest
804

 
0.81
 
$
36.7

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of August 29, 2014 and August 30, 2013 were $71.90 and $45.75, respectively.     
Summary of Stock Options 
There were no option grants during the three and nine months ended August 29, 2014 and the three months ended August 30, 2013. The assumptions used to value the option grants during the nine months ended August 30, 2013 were as follows:
 
Nine Months
 
2013
Expected life (in years)
3.2

Volatility
27
%
Risk free interest rate
0.36
%

Option activity for the nine months ended August 29, 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
(3,585
)
 
(15,872
)
Cancelled
(134
)
 
(1,584
)
Increase due to acquisition
—

 
273

Ending outstanding balance
3,640

 
7,359

 

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Information regarding stock options outstanding at August 29, 2014 and August 30, 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
3,640

 
$
28.98

 
3.33
 
$
156.2

Options vested and expected to vest
3,610

 
$
29.08

 
3.31
 
$
154.5

Options exercisable
3,056

 
$
30.26

 
2.99
 
$
127.3

2013
 

 
 

 
 
 
 

Options outstanding
9,525

 
$
30.80

 
3.10
 
$
142.6

Options vested and expected to vest
9,359

 
$
30.93

 
3.05
 
$
138.9

Options exercisable
7,489

 
$
32.23

 
2.49
 
$
101.5

_________________________________________ 
(*) 
The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of August 29, 2014 and August 30, 2013 were $71.90 and $45.75, respectively.
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 and nine months ended August 29, 2014 and August 30, 2013 were as follows:
 
Three Months
 
Nine Months
 
2014
 
2013
 
2014
 
2013
Expected life (in years)
0.5 - 2.0
 
0.5 - 2.0
 
0.5 - 2.0
 
0.5 - 2.0
Volatility
 26 - 27%
 
 27 - 29%
 
 26 - 28%
 
26 - 30%
Risk free interest rate
 0.06 - 0.47%
 
 0.09 - 0.34%
 
 0.06 - 0.47%
 
 0.09 - 0.34%
 

Employees purchased 2.9 million shares at an average price of $34.76 and 3.4 million shares at an average price of $25.71 for the nine months ended August 29, 2014 and August 30, 2013, respectively. The intrinsic value of shares purchased during the nine months ended August 29, 2014 and August 30, 2013 was $93.4 million and $58.5 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 August 29, 2014, there was $468.0 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 1.7 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

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Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the three months ended August 29, 2014 and August 30, 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
$
458

 
$
1,451

 
$
380

 
$
1,245

Cost of revenue—services and support
1,064

 
1,666

 
878

 
2,609

Research and development
4,151

 
26,100

 
4,786

 
25,736

Sales and marketing
4,492

 
25,447

 
4,617

 
24,309

General and administrative
1,682

 
16,502

 
1,858

 
14,606

Total
$
11,847

 
$
71,166

 
$
12,519

 
$
68,505

Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the nine months ended August 29, 2014 and August 30, 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
$
1,424

 
$
4,261

 
$
1,463

 
$
3,489

Cost of revenue—services and support
2,759

 
4,886

 
2,559

 
7,419

Research and development
12,397

 
78,567

 
15,340

 
74,677

Sales and marketing
13,571

 
76,541

 
16,177

 
72,087

General and administrative
4,962

 
49,443

 
6,518

 
44,361

Total
$
35,113

 
$
213,698

 
$
42,057

 
$
202,033

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 August 29, 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 nine months ended August 29, 2014 (in thousands):
 
November 29,
2013
 
Costs
Incurred
 
Cash
Payments
 
Other
Adjustments
 
August 29,
2014
Termination benefits
$
2,233

 
$
—

 
$
(1,363
)
 
$
(262
)
 
$
608

Cost of closing redundant facilities
11,655

 
528

 
(4,761
)
 
97

 
7,519

Total restructuring plans
$
13,888

 
$
528

 
$
(6,124
)
 
$
(165
)
 
$
8,127


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Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Accrued restructuring charges of $8.1 million as of August 29, 2014 includes $2.3 million recorded in accrued restructuring, current and $5.8 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 40% will be paid through 2015.
NOTE 10.  STOCKHOLDERS’ EQUITY
Retained Earnings
The changes in retained earnings for the nine months ended August 29, 2014 were as follows (in thousands): 
Balance as of November 29, 2013
$
6,928,964

Net income
180,259

Re-issuance of treasury stock
(258,433
)
Balance as of August 29, 2014
$
6,850,790

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 and activity, net of related taxes, as of August 29, 2014 were as follows (in thousands):
 
November 29,
2013
 
Increase / Decrease
 
Reclassification Adjustments
 
August 29,
2014
Net unrealized gains on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
$
10,178

 
$
1,596

 
$
(3,534
)
 
$
8,240

Unrealized losses on available-for-sale securities
(937
)
 
70

 
54

 
(813
)
Net unrealized gains on available-for-sale securities
9,241

 
1,666

 
(3,480
)
(1) 
7,427

Net unrealized gains on derivative instruments designated as
hedging instruments
5,367

 
11,976

 
(6,490
)
(2) 
10,853

Cumulative foreign currency translation adjustments
31,495

 
(29,708
)
 
—

 
1,787

Total accumulated other comprehensive income, net of taxes
$
46,103

 
$
(16,066
)
 
$
(9,970
)
 
$
20,067

_________________________________________ 
(1) 
Classified in interest and other income (expense), net.
(2) 
Classified as revenue.


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Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table sets forth the taxes related to each component of other comprehensive income for the three and nine months ended August 29, 2014 and August 30, 2013 (in thousands):
 
Three Months
 
Nine Months Ended
 
2014
 
2013
 
2014
 
2013
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses
$
68

 
$
117

 
$
37

 
$
151

Reclassification adjustments
(3
)
 
(2
)
 
(6
)
 
(2
)
Subtotal available-for-sale securities
65

 
115

 
31

 
149

Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Unrealized gains on derivative instruments*
—

 
—

 
—

 
—

Reclassification adjustments*
—

 
—

 
—

 
—

Subtotal derivatives designated as hedging instruments
—

 
—

 
—

 
—

Foreign currency translation adjustments
(1,577
)
 
372

 
(474
)
 
(128
)
Total taxes, other comprehensive income
$
(1,512
)
 
$
487

 
$
(443
)
 
$