10-Q

 
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 28, 2015

 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 18, 2015 was 498,799,349.
 


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 28,
2015
 
November 28,
2014
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
829,292

 
$
1,117,400

Short-term investments
2,839,441

 
2,622,091

Trade receivables, net of allowances for doubtful accounts of $7,255 and $7,867, respectively
593,554

 
591,800

Deferred income taxes
82,438

 
95,279

Prepaid expenses and other current assets
181,163

 
175,758

Total current assets
4,525,888

 
4,602,328

Property and equipment, net
797,464

 
785,123

Goodwill
5,402,159

 
4,721,962

Purchased and other intangibles, net
556,810

 
469,662

Investment in lease receivable
80,439

 
80,439

Other assets
145,635

 
126,315

Total assets
$
11,508,395

 
$
10,785,829

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 

 
 

Trade payables
$
69,823

 
$
68,377

Accrued expenses
658,342

 
683,866

Debt and capital lease obligations
—

 
603,229

Accrued restructuring
1,450

 
17,120

Income taxes payable
71,487

 
23,920

Deferred revenue
1,259,712

 
1,097,923

Total current liabilities
2,060,814

 
2,494,435

Long-term liabilities:
 

 
 

Debt
1,906,094

 
911,086

Deferred revenue
46,317

 
57,401

Accrued restructuring
3,142

 
5,194

Income taxes payable
250,569

 
125,746

Deferred income taxes
316,142

 
342,315

Other liabilities
83,985

 
73,747

Total liabilities
4,667,063

 
4,009,924

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; 
 498,705 and 497,484 shares outstanding, respectively
61

 
61

Additional paid-in-capital
4,094,133

 
3,778,495

Retained earnings
7,049,629

 
6,924,294

Accumulated other comprehensive income (loss)
(140,831
)
 
(8,094
)
Treasury stock, at cost (102,129 and 103,350 shares, respectively), net of reissuances
(4,161,660
)
 
(3,918,851
)
Total stockholders’ equity
6,841,332

 
6,775,905

Total liabilities and stockholders’ equity
$
11,508,395

 
$
10,785,829

_________________________________________ 
(*)
The Condensed Consolidated Balance Sheet as of November 28, 2014 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 28,
2015
 
August 29,
2014
 
August 28,
2015
 
August 29,
2014
Revenue:
 
 
 
 
 
 
 
Subscription
$
829,065

 
$
547,373

 
$
2,316,470

 
$
1,447,630

Products
275,338

 
349,151

 
840,650

 
1,299,852

Services and support
113,365

 
108,885

 
331,987

 
326,255

Total revenue
1,217,768

 
1,005,409

 
3,489,107

 
3,073,737

 
Cost of revenue:
 

 
 
 
 
 
 
Subscription
103,605

 
86,670

 
302,826

 
247,549

Products
24,545

 
23,172

 
65,715

 
75,169

Services and support
62,835

 
47,882

 
174,415

 
138,419

Total cost of revenue
190,985

 
157,724

 
542,956

 
461,137

Gross profit
1,026,783

 
847,685

 
2,946,151

 
2,612,600

 
Operating expenses:
 

 
 
 
 
 
 
Research and development
218,660

 
212,049

 
642,216

 
630,666

Sales and marketing
422,031

 
406,475

 
1,241,770

 
1,243,446

General and administrative
122,578

 
141,676

 
397,867

 
409,798

Restructuring and other charges
(751
)
 
201

 
1,038

 
498

Amortization of purchased intangibles
18,246

 
13,108

 
50,599

 
40,012

Total operating expenses
780,764

 
773,509

 
2,333,490

 
2,324,420

 Operating income
246,019

 
74,176

 
612,661

 
288,180

 
Non-operating income (expense):
 

 
 
 
 
 
 
Interest and other income (expense), net
4,433

 
1,454

 
11,510

 
7,162

Interest expense
(16,519
)
 
(13,361
)
 
(47,669
)
 
(47,054
)
Investment gains (losses), net
(1,314
)
 
669

 
339

 
813

Total non-operating income (expense), net
(13,400
)
 
(11,238
)
 
(35,820
)
 
(39,079
)
Income before income taxes
232,619

 
62,938

 
576,841

 
249,101

Provision for income taxes
58,154

 
18,252

 
169,995

 
68,842

Net income
$
174,465

 
$
44,686

 
$
406,846

 
$
180,259

Basic net income per share
$
0.35

 
$
0.09

 
$
0.82

 
$
0.36

Shares used to compute basic net income per share
498,630

 
498,468

 
498,891

 
497,782

Diluted net income per share
$
0.34

 
$
0.09

 
$
0.80

 
$
0.35

Shares used to compute diluted net income per share
505,809

 
507,811

 
507,124

 
508,575

 
 
 
 
 
 
 
 


  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 28,
2015
 
August 29,
2014
 
August 28,
2015
 
August 29,
2014
 
Increase/(Decrease)
 
Increase/(Decrease)
Net income
$
174,465

 
$
44,686

 
$
406,846

 
$
180,259

Other comprehensive income (loss), net of taxes:
 
 
 
 
 
 
 
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses on available-for-sale
securities
(8,334
)
 
(1,822
)
 
(8,275
)
 
1,666

Reclassification adjustment for recognized gains / losses on available-for-sale securities
(570
)
 
(1,592
)
 
(2,130
)
 
(3,480
)
Net increase (decrease) from available-for-sale
securities
(8,904
)
 
(3,414
)
 
(10,405
)
 
(1,814
)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Unrealized gains / losses on derivative instruments
(1,874
)
 
10,003

 
18,480

 
11,976

Reclassification adjustment for recognized gains / losses on derivative instruments
(8,899
)
 
(1,075
)
 
(54,478
)
 
(6,490
)
Net increase (decrease) from derivatives designated as hedging instruments
(10,773
)
 
8,928

 
(35,998
)
 
5,486

Foreign currency translation adjustments
8,318

 
(32,090
)
 
(86,334
)
 
(29,708
)
Other comprehensive income (loss), net of taxes
(11,359
)
 
(26,576
)
 
(132,737
)
 
(26,036
)
Total comprehensive income, net of taxes
$
163,106

 
$
18,110

 
$
274,109

 
$
154,223



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 28,
2015
 
August 29,
2014
Cash flows from operating activities:
 
 
 
Net income
$
406,846

 
$
180,259

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

 
 
Depreciation, amortization and accretion
253,114

 
235,443

Stock-based compensation
254,836

 
248,811

Deferred income taxes
(47,769
)
 
(7,912
)
Unrealized (gains) losses on investments
(8,548
)
 
47

Tax benefit from stock-based compensation
58,326

 
31,883

Excess tax benefits from stock-based compensation
(58,345
)
 
(31,953
)
Other non-cash items
260

 
829

Changes in operating assets and liabilities, net of acquired assets and assumed
      liabilities:
 
 
 
Trade receivables, net
(104
)
 
71,973

Prepaid expenses and other current assets
(24,453
)
 
13,352

Trade payables
(614
)
 
(8,305
)
Accrued expenses
(26,581
)
 
(13,749
)
Accrued restructuring
(16,824
)
 
(5,627
)
Income taxes payable
83,307

 
4,952

Deferred revenue
141,536

 
167,726

Net cash provided by operating activities
1,014,987

 
887,729

Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(1,424,288
)
 
(1,412,539
)
Maturities of short-term investments
254,020

 
209,172

Proceeds from sales of short-term investments
931,267

 
913,308

Acquisitions, net of cash acquired
(826,004
)
 
—

Purchases of property and equipment
(120,260
)
 
(111,557
)
Purchases of long-term investments and other assets
(20,853
)
 
(12,496
)
Proceeds from sale of long-term investments
3,747

 
1,364

Net cash used for investing activities
(1,202,371
)
 
(412,748
)
Cash flows from financing activities:
 

 
 

Purchases of treasury stock
(500,000
)
 
(475,000
)
Proceeds from issuance of treasury stock
154,759

 
213,841

Cost of issuance of treasury stock
(176,904
)
 
(163,293
)
Excess tax benefits from stock-based compensation
58,345

 
31,953

Proceeds from debt issuance
989,280

 
—

Repayment of debt and capital lease obligations
(602,189
)
 
(11,431
)
Debt issuance costs
(8,828
)
 
—

Net cash used for financing activities
(85,537
)
 
(403,930
)
Effect of foreign currency exchange rates on cash and cash equivalents
(15,187
)
 
(2,278
)
Net (decrease) increase in cash and cash equivalents
(288,108
)
 
68,773

Cash and cash equivalents at beginning of period
1,117,400

 
834,556

Cash and cash equivalents at end of period
$
829,292

 
$
903,329

Supplemental disclosures:
 

 
 
Cash paid for income taxes, net of refunds
$
61,546

 
$
7,114

Cash paid for interest
$
48,920

 
$
61,562

Non-cash investing activities:
 
 
 
Issuance of common stock and stock awards assumed in business acquisitions
$
677

 
$
—

Investment in lease receivable applied to building purchase
$
—

 
$
126,800



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 28, 2014 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.
Assets Held-For-Sale
Included in property and equipment, net in the Condensed Consolidated Balance sheets as of August 28, 2015 are certain land, with a carrying value of $35.5 million, and an unoccupied building with a net carrying value of $0.8 million, both located in San Jose, California and are classified as held-for-sale. During the second quarter of fiscal 2015, management approved a plan to sell these property assets largely based upon a general lack of operational needs for the building and land, and recent improvements in market conditions for commercial real estate in the area. We began to actively market the assets during the second quarter of fiscal 2015 and finalized the sale of these assets on September 23, 2015.

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. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of the new revenue standard for periods beginning after December 15, 2016 to December 15, 2017, with early adoption permitted but not earlier than the original effective date. Accordingly, the updated standard is effective for us in the first quarter of fiscal 2019. 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 standard discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the nine months ended August 28, 2015, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 28, 2014, that are of significance or potential significance to us.
NOTE 2.  ACQUISITIONS
On January 27, 2015, we completed our acquisition of privately held Fotolia, a leading marketplace for royalty-free photos, images, graphics and HD videos. During the first quarter of fiscal 2015, we began integrating Fotolia into our Digital Media reportable segment.
Under the acquisition method of accounting, the total preliminary purchase price was allocated to Fotolia's net tangible and intangible assets based upon their estimated fair values as of January 27, 2015. During the nine months ended August 28, 2015, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to assumed intangible assets, liabilities and equity awards. The total adjusted preliminary purchase price for Fotolia was $807.5 million of which $747.9 million was allocated to goodwill that was non-deductible for tax purposes, $204.4 million to identifiable intangible assets and $144.8 million to net liabilities assumed. The fair values assigned to assets acquired and liabilities assumed are based on management’s best estimates and assumptions as of the reporting date and are considered preliminary pending finalization of valuation analyses pertaining to tax liabilities assumed including calculation of deferred tax assets and liabilities. Pro forma information has not been presented as the impact to our Condensed Consolidated Financial Statements was not material.

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 28, 2015 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
345,625

 
$
—

 
$
—

 
$
345,625

Cash equivalents:
 
 
 
 
 
 
 
Money market mutual funds
447,303

 
—

 
—

 
447,303

Time deposits
36,364

 
—

 
—

 
36,364

Total cash equivalents
483,667

 
—

 
—

 
483,667

Total cash and cash equivalents
829,292

 
—

 
—

 
829,292

Short-term fixed income securities:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,732,496

 
1,596

 
(4,891
)
 
1,729,201

Asset-backed securities
67,307

 
40

 
(32
)
 
67,315

Municipal securities
164,449

 
221

 
(60
)
 
164,610

U.S. agency securities
207,550

 
182

 
(3
)
 
207,729

U.S. Treasury securities
670,367

 
363

 
(144
)
 
670,586

Total short-term investments
2,842,169

 
2,402

 
(5,130
)
 
2,839,441

Total cash, cash equivalents and short-term investments
$
3,671,461

 
$
2,402

 
$
(5,130
)
 
$
3,668,733



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 28, 2014 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
348,283

 
$
—

 
$
—

 
$
348,283

Cash equivalents:
 

 
 
 
 
 
 

Money market mutual funds
705,978

 
—

 
—

 
705,978

Time deposits
63,139

 
—

 
—

 
63,139

Total cash equivalents
769,117

 
—

 
—

 
769,117

Total cash and cash equivalents
1,117,400

 
—

 
—

 
1,117,400

Short-term fixed income securities:
 
 
 
 
 
 
 

Corporate bonds and commercial paper
1,514,632

 
5,253

 
(509
)
 
1,519,376

Foreign government securities
4,499

 
12

 
—

 
4,511

Municipal securities
174,775

 
438

 
(12
)
 
175,201

U.S. agency securities
497,154

 
1,295

 
(64
)
 
498,385

U.S. Treasury securities
423,075

 
1,080

 
(28
)
 
424,127

Subtotal
2,614,135

 
8,078

 
(613
)
 
2,621,600

Marketable equity securities
153

 
338

 
—

 
491

Total short-term investments
2,614,288

 
8,416

 
(613
)
 
2,622,091

Total cash, cash equivalents and short-term investments
$
3,731,688

 
$
8,416

 
$
(613
)
 
$
3,739,491


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 28, 2015 and November 28, 2014 (in thousands):
 
2015
 
2014
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
1,213,183

 
$
(4,871
)
 
$
291,890

 
$
(443
)
Asset-backed securities
35,502

 
(32
)
 
—

 
—

Municipal securities
24,143

 
(60
)
 
21,759

 
(12
)
U.S. Treasury and agency securities
345,982

 
(144
)
 
43,507

 
(64
)
Total
$
1,618,810

 
$
(5,107
)
 
$
357,156

 
$
(519
)
 
There were 885 securities and 213 securities in an unrealized loss position for less than twelve months at August 28, 2015 and at November 28, 2014, respectively.

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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 28, 2015 and November 28, 2014 (in thousands):
 
2015
 
2014
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
1,416

 
$
(20
)
 
$
8,636

 
$
(66
)
U.S. Treasury and agency securities
650

 
(3
)
 
5,884

 
(28
)
Total
$
2,066

 
$
(23
)
 
$
14,520

 
$
(94
)
There were two securities and eight securities in an unrealized loss position for more than twelve months at August 28, 2015 and at November 28, 2014, respectively.
The following table summarizes the cost and estimated fair value of short-term fixed income securities classified as short-term investments based on stated effective maturities as of August 28, 2015 (in thousands):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
791,191

 
$
791,528

Due between one and two years
1,036,774

 
1,036,349

Due between two and three years
761,569

 
759,576

Due after three years
252,635

 
251,988

Total
$
2,842,169

 
$
2,839,441

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 28, 2015, 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 nine months ended August 28, 2015.
The fair value of our financial assets and liabilities at August 28, 2015 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
447,303

 
447,303

 
—

 
—

Time deposits
36,364

 
36,364

 
—

 
—

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,729,201

 
—

 
1,729,201

 
—

Asset-backed securities
67,315

 
—

 
67,315

 
—

Municipal securities
164,610

 
—

 
164,610

 
—

U.S. agency securities
207,729

 
—

 
207,729

 
—

U.S. Treasury securities
670,586

 
—

 
670,586

 
—

Prepaid expenses and other current assets:
 
 
 

 
 

 
 

Foreign currency derivatives
8,162

 
—

 
8,162

 
—

Other assets:
 
 
 

 
 

 
 

Deferred compensation plan assets
30,379

 
531

 
29,848

 
—

Interest rate swap derivatives
19,051

 
—

 
19,051

 
—

Total assets
$
3,380,700

 
$
484,198

 
$
2,896,502

 
$
—

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
1,914

 
$
—

 
$
1,914

 
$
—

Total liabilities
$
1,914

 
$
—

 
$
1,914

 
$
—



11
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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 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
$
705,978

 
$
705,978

 
$
—

 
$
—

Time deposits
63,139

 
63,139

 
—

 
—

Short-term investments:
 

 
 
 


 


Corporate bonds and commercial paper
1,519,376

 
—

 
1,519,376

 
—

Foreign government securities
4,511

 
—

 
4,511

 
—

Marketable equity securities
491

 
491

 
—

 
—

Municipal securities
175,201

 
—

 
175,201

 
—

U.S. agency securities
498,385

 
—

 
498,385

 
—

U.S. Treasury securities 
424,127

 
—

 
424,127

 
—

Prepaid expenses and other current assets:
 

 
 

 
 

 
 

Foreign currency derivatives
32,991

 
—

 
32,991

 
—

Other assets:
 

 
 

 
 

 
 

Deferred compensation plan assets
25,745

 
549

 
25,196

 
—

Interest rate swap derivatives
14,268

 
—

 
14,268

 
—

Total assets
$
3,464,212

 
$
770,157

 
$
2,694,055

 
$
—

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
663

 
$
—

 
$
663

 
$
—

Total liabilities
$
663

 
$
—

 
$
663

 
$
—


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.


12
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We also have direct investments in privately held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. For the three and nine months ended August 28, 2015 and August 29, 2014, we determined there were no other-than-temporary impairments on our cost method investments.
As of August 28, 2015, the carrying value of our lease receivables approximated fair value, based on Level 2 valuation inputs which include Treasury rates, London Interbank Offered Rate (“LIBOR”) interest rates and applicable credit spreads. See Note 12 for further details regarding our investment in lease receivable.
The fair value of our senior notes was $2 billion as of August 28, 2015, based on observable market prices in less active markets and categorized as Level 2. See Note 13 for further details regarding our debt.
NOTE 5.  DERIVATIVES
Hedge Accounting and Hedging Programs
We recognize all derivative instruments as either assets or liabilities in our Condensed Consolidated Balance Sheets and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting.

We evaluate hedge effectiveness on our hedges that are designated and qualify for hedge accounting 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 time value of purchased contracts is recorded in interest and other income (expense), net in our Condensed Consolidated Statements of Income.

The bank counterparties to these contracts expose us to credit-related losses in the event of their nonperformance which are largely mitigated with collateral security agreements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. In addition, the Company enters into master netting arrangements which have the ability to further limit credit related losses with the same counterparty by permitting net settlement of transactions. Our hedging policy also establishes maximum limits for each counterparty to mitigate any concentration of risk.
Balance Sheet Hedging—Hedges of Foreign Currency Assets and Liabilities
We 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 as either assets or liabilities on the Condensed Consolidated Balance Sheet with changes in the fair value recorded to interest and other income (expense), net in our Condensed Consolidated Statements of Income. These contracts do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.

Cash Flow Hedging—Hedges of Forecasted Foreign Currency Revenue and Interest Rate Risk

In countries outside the 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.

13
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income 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 value from period to period are recorded in interest and other income (expense), net in our Condensed Consolidated Statements of Income.
In December 2014, prior to issuing new long-term fixed rate debt, we entered into an interest rate lock agreement on a notional amount of $600 million to hedge against the variability of future interest payments due to changes in the benchmark interest rate. This instrument was designated as a cash flow hedge. Upon issuance of our $1 billion of 3.25% senior notes due February 1, 2025 (the “2025 Notes”) in January 2015, we terminated the instrument and incurred a loss of $16.2 million. This loss is recorded in the stockholders’ equity section in our Condensed Consolidated Balance Sheets in accumulated other comprehensive income and will be reclassified to interest expense over a ten-year term consistent with the impact of the hedged item. See Note 13 for further details regarding our debt.

Fair Value Hedging - Hedges of Interest Rate Risk

During the third quarter of fiscal 2014, we entered into interest rate swaps designated as fair value hedges related to our $900 million of 4.75% fixed interest rate senior notes due February 1, 2020 (the “2020 Notes”). The interest rate swaps effectively convert the fixed interest rate on our 2020 Notes to a floating interest rate based on LIBOR. Under the terms of the swaps, we will pay monthly interest at the one-month LIBOR interest rate plus a fixed number of basis points on the $900 million notional amount through February 1, 2020. In exchange, we will receive 4.75% fixed rate interest from the swap counterparties. See Note 13 for further details regarding our debt.

The interest rate swaps are accounted for as fair value hedges and substantially offset the changes in fair value of the hedged portion of the underlying debt that are attributable to the changes in market risk. Therefore, the gains and losses related to changes in the fair value of the interest rate swaps are included in interest and other income (expense), net in our Condensed Consolidated Statement of Income. The fair value of the interest rate swaps is reflected as either an asset or liability in our Condensed Consolidated Balance Sheets.

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of August 28, 2015 and November 28, 2014 were as follows (in thousands):
 
2015
 
2014
 
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) 
$
6,952

 
$
—

 
$
31,275

 
$
—

Interest rate swap (2)
19,051

 
—

 
14,268

 
—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 Foreign exchange forward contracts (1)
1,210

 
1,914

 
1,716

 
663

Total derivatives
$
27,213

 
$
1,914

 
$
47,259

 
$
663

_________________________________________ 
(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 or other liabilities on our Condensed Consolidated Balance Sheets.
(3) 
Hedging effectiveness expected to be recognized into income within the next twelve months.
 

14
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The effect of foreign currency derivative instruments designated as cash flow hedges and of foreign currency derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for the three and nine months ended August 28, 2015 was as follows (in thousands):
 
Three Months
 
Nine Months
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax(1) 
$
(1,874
)
 
$
—

 
$
28,509

 
$
—

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
9,146

 
—

 
55,068

 
—

Net gain (loss) recognized in income(3) 
$
(3,933
)
 
$
—

 
$
(11,074
)
 
$
—

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

 
$
628

 
$
—

 
$
4,703

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
)
_________________________________________ 
(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.

15
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 6.  GOODWILL AND PURCHASED AND OTHER INTANGIBLES
Goodwill as of August 28, 2015 and November 28, 2014 was $5.40 billion and $4.72 billion, respectively. The increase was primarily due to our acquisition of Fotolia and was offset in part by foreign currency translation adjustments. During the second quarter of fiscal 2015, we completed our annual goodwill impairment test associated with our reporting units and determined there was no impairment of goodwill.
Purchased and other intangible assets subject to amortization as of August 28, 2015 and November 28, 2014 were as follows (in thousands): 
 
2015
 
2014
 
Cost
 
Accumulated Amortization
 
Net
 
Cost
 
Accumulated Amortization
 
Net
Purchased technology
$
393,820

 
$
(282,737
)
 
$
111,083

 
$
405,208

 
$
(264,697
)
 
$
140,511

Customer contracts and relationships
$
510,956

 
$
(188,484
)
 
$
322,472

 
$
376,994

 
$
(143,330
)
 
$
233,664

Trademarks
87,050

 
(44,035
)
 
43,015

 
67,268

 
(36,516
)
 
30,752

Acquired rights to use technology
144,202

 
(95,147
)
 
49,055

 
148,836

 
(86,258
)
 
62,578

Localization
1,300

 
(684
)
 
616

 
549

 
(382
)
 
167

Other intangibles
36,535

 
(5,966
)
 
30,569

 
3,163

 
(1,173
)
 
1,990

Total other intangible assets
$
780,043

 
$
(334,316
)
 
$
445,727

 
$
596,810

 
$
(267,659
)
 
$
329,151

Purchased and other intangible assets, net
$
1,173,863

 
$
(617,053
)
 
$
556,810

 
$
1,002,018

 
$
(532,356
)
 
$
469,662

 
Amortization expense related to purchased and other intangible assets was $46.3 million and $131.6 million for the three and nine months ended August 28, 2015, respectively. Comparatively, 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. Of these amounts $27.7 million and $80.0 million were included in cost of sales for the three and nine months ended August 28, 2015, respectively, and $26.0 million and $75.1 million for the three and nine months ended August 29, 2014.
As of August 28, 2015, we expect amortization expense in future periods to be as follows (in thousands):
Fiscal Year
 
Purchased
Technology
 
Other Intangible
Assets
Remainder of 2015
$
14,526

 
$
28,425

2016
31,229

 
108,276

2017
23,868

 
98,147

2018
16,866

 
87,206

2019
10,096

 
60,636

Thereafter
14,498

 
63,037

Total expected amortization expense
$
111,083

 
$
445,727


16
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7.  ACCRUED EXPENSES
Accrued expenses as of August 28, 2015 and November 28, 2014 consisted of the following (in thousands):
 
2015
 
2014
Accrued compensation and benefits
$
287,310

 
$
320,679

Sales and marketing allowances 
59,194

 
75,627

Accrued corporate marketing
47,926

 
28,369

Taxes payable
19,825

 
24,658

Royalties payable
19,762

 
15,073

Accrued interest expense
7,761

 
22,621

Other
216,564

 
196,839

Accrued expenses
$
658,342

 
$
683,866


Other primarily includes general corporate accruals and local and regional expenses. Other is also comprised of deferred rent related to office locations with rent escalations and foreign currency liability derivatives.
NOTE 8.  STOCK-BASED COMPENSATION
Summary of Restricted Stock Units
Restricted stock unit activity for the nine months ended August 28, 2015 and the fiscal year ended November 28, 2014 was as follows (in thousands):
 
2015
 
2014
Beginning outstanding balance
13,564

 
17,948

Awarded
3,670

 
4,413

Released
(6,242
)
 
(7,502
)
Forfeited
(704
)
 
(1,295
)
Ending outstanding balance
10,288

 
13,564

Information regarding restricted stock units outstanding at August 28, 2015 and August 29, 2014 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2015
 
 
 
 
 
Restricted stock units outstanding
10,288

 
1.10
 
$
816.9

Restricted stock units vested and expected to vest
9,320

 
1.03
 
$
730.3

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

_________________________________________ 
(*) 
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 28, 2015 and August 29, 2014 were $79.40 and $71.90, respectively. 

17
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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Performance Shares 
On January 26, 2015, our Executive Compensation Committee approved the 2015 Performance Share Program, including the award calculation methodology, under the terms of our 2003 Equity Incentive Plan. Under our 2015 Performance Share Program (“2015 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 2015 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, 2018. Participants in the 2015 Program generally have the ability to receive up to 200% of the target number of shares originally granted.
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 28, 2015, the shares awarded under our 2015, 2014, and 2013 Performance Share Programs are yet to be achieved. The following table sets forth the summary of performance share activity under our 2015, 2014, and 2013 Performance Share Programs for the nine months ended August 28, 2015 and the fiscal year ended November 28, 2014 (in thousands): 
 
2015
 
2014
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
Beginning outstanding balance
1,517

 
3,034

 
854

 
1,707

Awarded
671

 
1,342

 
709

 
1,417

Forfeited
(101
)
 
(201
)
 
(46
)
 
(90
)
Ending outstanding balance
2,087

 
4,175

 
1,517

 
3,034

The following table sets forth the summary of performance share activity under our performance share programs prior to fiscal 2013, based upon share awards actually achieved, for the nine months ended August 28, 2015 and the fiscal year ended November 28, 2014 (in thousands):
 
2015
 
2014
Beginning outstanding balance
354

 
861

Released
(354
)
 
(486
)
Forfeited
—

 
(21
)
Ending outstanding balance
—

 
354


18
Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 
Information regarding performance shares outstanding at August 29, 2014 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

_________________________________________ 
(*) 
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 value as of August 29, 2014 was $71.90.     
Summary of Stock Options 
There were no option grants during the nine months ended August 28, 2015 and the nine months ended August 29, 2014. Option activity for the nine months ended August 28, 2015 and the fiscal year ended November 28, 2014 was as follows (in thousands):
 
2015
 
2014
Beginning outstanding balance
3,173

 
7,359

Exercised
(1,557
)
 
(4,055
)
Cancelled
(32
)
 
(153
)
Increase due to acquisition
88

 
22

Ending outstanding balance
1,672

 
3,173

 
Information regarding stock options outstanding at August 28, 2015 and August 29, 2014 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2015
 
 
 
 
 
 
 
Options outstanding
1,672

 
$
28.14

 
2.72
 
$
85.7

Options vested and expected to vest
1,659

 
$
28.26

 
2.70
 
$
84.9

Options exercisable
1,539

 
$
29.64

 
2.44
 
$
76.6

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

_________________________________________ 
(*) 
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 28, 2015 and August 29, 2014 were $79.40 and $71.90, respectively.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Employee Stock Purchase Plan Shares
The expected life of the ESPP shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the nine months ended August 28, 2015 and August 29, 2014 were as follows:
 
Three Months
 
Nine Months
 
2015
 
2014
 
2015
 
2014
Expected life (in years)
0.5 - 2.0
 
0.5 - 2.0
 
0.5 - 2.0
 
0.5 - 2.0
Volatility
 26 - 27%
 
 26 - 27%
 
 26 - 30%
 
 26 - 28%
Risk free interest rate
 0.11 - 0.64%
 
 0.06 - 0.47%
 
 0.11 - 0.67%
 
 0.06 - 0.47%
 

Employees purchased 2.1 million shares at an average price of $52.37 and 2.9 million shares at an average price of $34.76 for the nine months ended August 28, 2015 and August 29, 2014, respectively. The intrinsic value of shares purchased during the nine months ended August 28, 2015 and August 29, 2014 was $54.0 million and $93.4 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 28, 2015, there was $464.3 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 1.7 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
Total stock-based compensation costs included in our Condensed Consolidated Statements of Income for the three months ended August 28, 2015 and August 29, 2014 were as follows (in thousands):
 
 
2015
 
2014
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
$
258

 
$
1,637

 
$
458

 
$
1,451

Cost of revenue—services and support
1,277

 
1,425

 
1,064

 
1,666

Research and development
3,468

 
26,378

 
4,151

 
26,100

Sales and marketing
4,540

 
29,146

 
4,492

 
25,447

General and administrative
1,056

 
16,792

 
1,682

 
16,502

Total
$
10,599

 
$
75,378

 
$
11,847

 
$
71,166

Total stock-based compensation costs included in our Condensed Consolidated Statements of Income for the nine months ended August 28, 2015 and August 29, 2014 were as follows (in thousands):
 
 
2015
 
2014
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
$
1,070

 
$
4,946

 
$
1,424

 
$
4,261

Cost of revenue—services and support
3,897

 
4,711

 
2,759

 
4,886

Research and development
11,162

 
78,375

 
12,397

 
78,567

Sales and marketing
13,768

 
84,686

 
13,571

 
76,541

General and administrative
3,652

 
50,744

 
4,962

 
49,443

Total
$
33,549

 
$
223,462

 
$
35,113

 
$
213,698


20
Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 9.  RESTRUCTURING CHARGES
Fiscal 2014 Restructuring Plan
In the fourth quarter of fiscal 2014, in order to better align our global resources for Digital Media and Digital Marketing, we initiated a restructuring plan to vacate our Research and Development facility in China and our Sales and Marketing facility in Russia. This plan consisted of reductions of approximately 350 full-time positions and we recorded restructuring charges of approximately $21.0 million through the third quarter of fiscal 2015 related to ongoing termination benefits for the positions eliminated. The amount accrued for the fair value of future contractual obligations under these operating leases was insignificant. During the first quarter of fiscal 2015 we vacated both of these facilities and as of August 28, 2015 we consider the Fiscal 2014 Restructuring Plan to be substantially complete.
Other Restructuring Plans
During the past several years, we have implemented Other Restructuring Plans consisting of reductions in workforce and the consolidation of facilities to better align our resources around our business strategies. As of August 28, 2015, we considered our Other 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 28, 2015 (in thousands):
 
November 28,
2014
 
Costs
Incurred
 
Cash
Payments
 
Other
Adjustments
 
August 28,
2015
Fiscal 2014 Restructuring Plan:
 
 
 
 
 
 
 
 
 
   Termination benefits
$
14,461

 
$
773

 
$
(16,455
)
 
$
1,287

 
$
66

   Cost of closing redundant facilities
472

 
—

 
(417
)
 
(55
)
 
—

Other Restructuring Plans:
 
 
 
 
 
 
 
 
 
   Termination benefits
537

 
—

 
(120
)
 
(303
)
 
114

   Cost of closing redundant facilities
6,844

 
—

 
(870
)
 
(1,562
)
 
4,412

Total restructuring plans
$
22,314

 
$
773

 
$
(17,862
)
 
$
(633
)
 
$
4,592

Accrued restructuring charges of $4.6 million as of August 28, 2015 includes $1.5 million recorded in accrued restructuring, current and $3.1 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 2016 and facilities-related liabilities under contract through fiscal 2021 of which approximately 34% will be paid through fiscal 2016.
NOTE 10.  STOCKHOLDERS’ EQUITY
Retained Earnings
The changes in retained earnings for the nine months ended August 28, 2015 were as follows (in thousands): 
Balance as of November 28, 2014
$
6,924,294

Net income
406,846

Re-issuance of treasury stock
(281,511
)
Balance as of August 28, 2015
$
7,049,629

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

21
Table of Contents

ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

that there are treasury stock gains to offset the losses. If there are no treasury stock gains in additional paid-in-capital, the losses upon re-issuance of treasury stock are recorded as a reduction of retained earnings in our Condensed Consolidated Balance Sheets.
The components of accumulated other comprehensive income (loss) and activity, net of related taxes, as of August 28, 2015 were as follows (in thousands):
 
November 28,
2014
 
Increase / Decrease
 
Reclassification Adjustments
 
August 28,
2015
Net unrealized gains on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
$
8,237

 
$
(3,565
)
 
$
(2,323
)
 
$
2,349

Unrealized losses on available-for-sale securities
(609
)
 
(4,710
)
 
193

 
(5,126
)
Total net unrealized gains on available-for-sale securities
7,628

 
(8,275
)
 
(2,130
)
(1) 
(2,777
)
Net unrealized gains / losses on derivative instruments designated as hedging instruments
28,655

 
18,480

 
(54,478
)
(2) 
(7,343
)
Cumulative foreign currency translation adjustments
(44,377
)
 
(86,334
)
 
—

 
(130,711
)
Total accumulated other comprehensive income (loss), net of taxes
$
(8,094
)
 
$
(76,129
)
 
$
(56,608
)
 
$
(140,831
)
_________________________________________ 
(1) 
Reclassification adjustments for gains / losses on available-for-sale securities are classified in interest and other income (expense), net.
(2) 
Reclassification adjustments for loss on the interest rate lock agreement and gains / losses on other derivative instruments are classified in interest and other income (expense), net and revenue, respectively.

The following table sets forth the taxes related to each component of other comprehensive income (loss) for the three and nine months ended August 28, 2015 and August 29, 2014 (in thousands):
 
Three Months
 
Nine Months
 
2015
 
2014
 
2015
 
2014
Available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains / losses
$
30

 
$
68

 
$
(126
)
 
$
37

Reclassification adjustments
—

 
(3
)
 
—

 
(6
)
Subtotal available-for-sale securities
30

 
65

 
(126
)
 
31

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

 
—

 
6,147

 
—

Reclassification adjustments*
(152
)
 
—

 
(362
)
 
—

Subtotal derivatives designated as hedging instruments
(152
)
 
—

 
5,785

 
—

Foreign currency translation adjustments
(8
)
 
(1,577
)
 
(2,439
)
 
(474
)
Total taxes, other comprehensive income (loss)
$
(130
)
 
$
(1,512
)
 
$
3,220

 
$
(443
)
_________________________________________ 
(*)  
Taxes r