Edgar Filing: ADOBE SYSTEMS INC

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 March 4, 2016



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

For the transition period from to

Commission File Number: 0-15175

ADOBE SYSTEMS INCORPORATED

(Exact name of registrant as specified in its charter)

_________________________



Delaware (State or other jurisdiction of incorporation or organization)	77-0019522 (I.R.S. Employer Identification No.)

345 Park Avenue, San Jose, California 95110-2704

(Address of principal executive offices and zip code)

(408) 536-6000

(Registrant’s telephone number, including area code)

_________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer o	Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

The number of shares outstanding of the registrant’s common stock as of March 25, 2016 was 500,209,547.

ADOBE SYSTEMS INCORPORATED

FORM 10-Q

TABLE OF CONTENTS



		Page No.
PART I—FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements:	3
	Condensed Consolidated Balance Sheets March 4, 2016 and November 27, 2015	3
	Condensed Consolidated Statements of Income Three Months Ended March 4, 2016 and February 27, 2015	4
	Condensed Consolidated Statements of Comprehensive Income (Loss) Three Months Ended March 4, 2016 and February 27, 2015	5
	Condensed Consolidated Statements of Cash Flows Three Months Ended March 4, 2016 and February 27, 2015	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40
Item 4.	Controls and Procedures	40

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 4.	Mine Safety Disclosures	54
Item 5.	Other Information	54
Item 6.	Exhibits	54
Signature		55
Summary of Trademarks		56
Index to Exhibits		57

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)



	March 4, 2016			November 27, 2015
	(Unaudited)			(*)
ASSETS
Current assets:
Cash and cash equivalents	$	830,696		$	876,560
Short-term investments	3,267,192			3,111,524
Trade receivables, net of allowances for doubtful accounts of $5,359 and $7,293, respectively	599,207			672,006
Prepaid expenses and other current assets	238,295			161,802
Total current assets	4,935,390			4,821,892
Property and equipment, net	794,876			787,421
Goodwill	5,389,000			5,366,881
Purchased and other intangibles, net	518,686			510,007
Investment in lease receivable	80,439			80,439
Other assets	178,291			159,832
Total assets	$	11,896,682		$	11,726,472

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade payables	$	71,706		$	93,307
Accrued expenses	591,821			679,884
Income taxes payable	4,458			6,165
Deferred revenue	1,563,821			1,434,200
Total current liabilities	2,231,806			2,213,556
Long-term liabilities:
Debt	1,916,831			1,907,231
Deferred revenue	44,839			51,094
Income taxes payable	261,305			256,129
Deferred income taxes	265,748			208,209
Other liabilities	94,951			88,673
Total liabilities	4,815,480			4,724,892
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; 500,693 and 497,809 shares outstanding, respectively	61			61
Additional paid-in-capital	4,292,486			4,184,883
Retained earnings	7,221,083			7,253,431
Accumulated other comprehensive income (loss)	(151,679		)	(169,080		)
Treasury stock, at cost (100,141 and 103,025 shares, respectively), net of reissuances	(4,280,749		)	(4,267,715		)
Total stockholders’ equity	7,081,202			7,001,580
Total liabilities and stockholders’ equity	$	11,896,682		$	11,726,472

^{_________________________________________}


(*)	The Condensed Consolidated Balance Sheet as of November 27, 2015 has been derived from the audited Consolidated Financial Statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)



	Three Months Ended
	March 4, 2016			February 27, 2015
Revenue:
Subscription	$	1,070,250		$	713,442
Product	201,112			290,774
Services and support	111,973			104,965
Total revenue	1,383,335			1,109,181
Cost of revenue:
Subscription	107,275			95,527
Product	20,299			19,703
Services and support	70,998			51,568
Total cost of revenue	198,572			166,798
Gross profit	1,184,763			942,383
Operating expenses:
Research and development	237,204			215,509
Sales and marketing	474,891			392,741
General and administrative	146,935			145,081
Restructuring and other charges	(419		)	1,755
Amortization of purchased intangibles	18,394			14,272
Total operating expenses	877,005			769,358
Operating income	307,758			173,025
Non-operating income (expense):
Interest and other income (expense), net	4,187			3,338
Interest expense	(18,469		)	(14,545		)
Investment gains (losses), net	(1,169		)	1,430
Total non-operating income (expense), net	(15,451		)	(9,777		)
Income before income taxes	292,307			163,248
Provision for income taxes	38,000			78,360
Net income	$	254,307		$	84,888
Basic net income per share	$	0.51		$	0.17
Shares used to compute basic net income per share	499,125			498,754
Diluted net income per share	$	0.50		$	0.17
Shares used to compute diluted net income per share	505,676			507,526

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)



	Three Months Ended
	March 4, 2016			February 27, 2015
	Increase/(Decrease)
Net income	$	254,307		$	84,888
Other comprehensive income (loss), net of taxes:
Available-for-sale securities:
Unrealized gains / losses on available-for-sale securities	(1,627		)	(817		)
Reclassification adjustment for recognized gains / losses on available-for-sale securities	(44		)	(927		)
Net increase (decrease) from available-for-sale securities	(1,671		)	(1,744		)
Derivatives designated as hedging instruments:
Unrealized gains / losses on derivative instruments	(1,711		)	12,296
Reclassification adjustment for recognized gains / losses on derivative instruments	(2,935		)	(23,712		)
Net increase (decrease) from derivatives designated as hedging instruments	(4,646		)	(11,416		)
Foreign currency translation adjustments	23,718			(82,556		)
Other comprehensive income (loss), net of taxes	17,401			(95,716		)
Total comprehensive income (loss), net of taxes	$	271,708		$	(10,828	)

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Three Months Ended
	March 4, 2016			February 27, 2015
Cash flows from operating activities:
Net income	$	254,307		$	84,888
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion	81,200			79,635
Stock-based compensation	92,310			84,208
Deferred income taxes	56,906			4,879
Unrealized losses (gains) on investments	2,047			(9,687		)
Tax benefit from stock-based compensation	14,855			33,584
Excess tax benefits from stock-based compensation	(14,859		)	(33,599		)
Other non-cash items	(1,420		)	(1,241		)
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Trade receivables, net	74,274			62,058
Prepaid expenses and other current assets	(84,832		)	(23,912		)
Trade payables	(21,601		)	1,368
Accrued expenses	(81,111		)	(139,820		)
Income taxes payable	2,085			21,610
Deferred revenue	123,366			19,044
Net cash provided by operating activities	497,527			183,015
Cash flows from investing activities:
Purchases of short-term investments	(534,310		)	(318,938		)
Maturities of short-term investments	178,939			88,729
Proceeds from sales of short-term investments	194,515			382,611
Acquisitions, net of cash acquired	—			(800,342		)
Purchases of property and equipment	(46,200		)	(35,546		)
Purchases of long-term investments and other assets	(51,892		)	(16,031		)
Proceeds from sale of long-term investments	106			1,146
Net cash used for investing activities	(258,842		)	(698,371		)
Cash flows from financing activities:
Purchases of treasury stock	(150,000		)	(200,000		)
Proceeds from issuance of treasury stock	45,544			56,320
Cost of issuance of treasury stock	(194,795		)	(150,017		)
Excess tax benefits from stock-based compensation	14,859			33,599
Proceeds from debt issuance	—			989,280
Repayment of debt and capital lease obligations	—			(602,189		)
Debt issuance costs	—			(7,718		)
Net cash provided by (used for) financing activities	(284,392		)	119,275
Effect of foreign currency exchange rates on cash and cash equivalents	(157		)	(8,435		)
Net decrease in cash and cash equivalents	(45,864		)	(404,516		)
Cash and cash equivalents at beginning of period	876,560			1,117,400
Cash and cash equivalents at end of period	$	830,696		$	712,884
Supplemental disclosures:
Cash paid for income taxes, net of refunds	$	15,973		$	5,994
Cash paid for interest	$	26,077		$	16,885

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

We have prepared the accompanying unaudited Condensed Consolidated Financial Statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Pursuant to these rules and regulations, we have condensed or omitted certain information and footnote disclosures we normally include in our annual Consolidated Financial Statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In management’s opinion, we have made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present our financial position, results of operations and cash flows. Our interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the Consolidated Financial Statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended November 27, 2015 on file with the SEC (our “Annual Report”).

Fiscal Year

Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Our first quarter of fiscal 2016 financial results benefited from an extra week in the quarter due to our 52/53 week financial calendar whereby fiscal 2016 is a 53-week year compared with fiscal 2015 which was a 52-week year.

Reclassifications

Certain prior year amounts have been reclassified to conform to current year presentation in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows.

Significant Accounting Policies

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 Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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.

On February 24, 2016, the FASB issued ASU No. 2016-02, Leases, requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. For lessees, leases will continue to be classified as either operating or finance leases in the income statement. Lessor accounting is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition and requires application of the new guidance at the beginning of the earliest comparative period presented. The updated standard is effective for us beginning in the first quarter of fiscal 2020. 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 standards discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 4, 2016, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 27, 2015, that are of significance or potential significance to us.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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 final purchase price was allocated to Fotolia's net tangible and intangible assets based upon their estimated fair values as of January 27, 2015. The total final purchase price for Fotolia was $807.5 million of which $745.1 million was allocated to goodwill that was non-deductible for tax purposes, $204.4 million to identifiable intangible assets and $142.0 million to net liabilities assumed. Pro forma information has not been presented as the impact to our Condensed Consolidated Financial Statements was not material.

NOTE 3. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase. We classify all of our cash equivalents and short-term investments as “available-for-sale.” In general, these investments are free of trading restrictions. We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. Gains and losses are recognized when realized in our Condensed Consolidated Statements of Income. When we have determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in income. Gains and losses are determined using the specific identification method.

Cash, cash equivalents and short-term investments consisted of the following as of March 4, 2016 (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	423,341	$	—	$	—		$	423,341
Cash equivalents:
Money market mutual funds	399,846		—		—			399,846
Time deposits	7,509		—		—			7,509
Total cash equivalents	407,355		—		—			407,355
Total cash and cash equivalents	830,696		—		—			830,696
Short-term fixed income securities:
Asset-backed securities	92,112		108		(49		)	92,171
Corporate bonds and commercial paper	2,033,037		2,361		(8,322		)	2,027,076
Foreign government securities	1,277		—		(2		)	1,275
Municipal securities	141,396		182		(20		)	141,558
U.S. agency securities	111,407		50		(6		)	111,451
U.S. Treasury securities	894,140		287		(766		)	893,661
Total short-term investments	3,273,369		2,988		(9,165		)	3,267,192
Total cash, cash equivalents and short-term investments	$	4,104,065	$	2,988	$	(9,165	)	$	4,097,888

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Cash, cash equivalents and short-term investments consisted of the following as of November 27, 2015 (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
Current assets:
Cash	$	352,371	$	—	$	—		$	352,371
Cash equivalents:
Money market mutual funds	482,479		—		—			482,479
Municipal Securities	1,850		—		(1		)	1,849
Time deposits	13,461		—		—			13,461
U.S. Treasury securities	26,400		—		—			26,400
Total cash equivalents	524,190		—		(1		)	524,189
Total cash and cash equivalents	876,561		—		(1		)	876,560
Short-term fixed income securities:
Asset-backed securities	83,449		11		(146		)	83,314
Corporate bonds and commercial paper	1,890,253		2,273		(5,612		)	1,886,914
Foreign government securities	1,276		—		(8		)	1,268
Municipal securities	137,280		101		(49		)	137,332
U.S. agency securities	130,397		85		(14		)	130,468
U.S. Treasury securities	873,400		101		(1,273		)	872,228
Total short-term investments	3,116,055		2,571		(7,102		)	3,111,524
Total cash, cash equivalents and short-term investments	$	3,992,616	$	2,571	$	(7,103	)	$	3,988,084

See Note 4 for further information regarding the fair value of our financial instruments.

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category, that have been in an unrealized loss position for less than twelve months, as of March 4, 2016 and November 27, 2015 (in thousands):



	2016					2015
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate bonds and commercial paper	$	1,405,679	$	(7,818	)	$	1,112,883	$	(5,377	)
Asset-backed securities	46,133		(49		)	60,057		(147		)
Municipal securities	14,000		(19		)	35,594		(50		)
Foreign government securities	1,275		(2		)	1,268		(8		)
U.S. Treasury and agency securities	713,723		(772		)	820,570		(1,287		)
Total	$	2,180,810	$	(8,660	)	$	2,030,372	$	(6,869	)

There were 1,103 securities and 914 securities in an unrealized loss position for less than twelve months at March 4, 2016 and at November 27, 2015, 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 March 4, 2016 and November 27, 2015 (in thousands):



	2016					2015
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate bonds and commercial paper	$	43,488	$	(504	)	$	30,218	$	(233	)
Municipal securities	551		(1		)	1,300		(1		)
Total	$	44,039	$	(505	)	$	31,518	$	(234	)

There were 25 securities and 15 securities in an unrealized loss position for more than twelve months at March 4, 2016 and at November 27, 2015, 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 March 4, 2016 (in thousands):



	Amortized Cost		Estimated Fair Value
Due within one year	$	945,345	$	945,015
Due between one and two years	1,224,030		1,221,301
Due between two and three years	744,427		741,925
Due after three years	359,567		358,951
Total	$	3,273,369	$	3,267,192

We review our debt and marketable equity securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. For debt securities, the portion of the write-down related to credit loss would be recorded to interest and other income, net in our Condensed Consolidated Statements of Income. Any portion not related to credit loss would be recorded to accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. For equity securities, the write-down would be recorded to investment gains (losses), net in our Condensed Consolidated Statements of Income. During the three months ended March 4, 2016, we did not consider any of our investments to be other-than-temporarily impaired.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 4. FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

We measure certain financial assets and liabilities at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the three months ended March 4, 2016.

The fair value of our financial assets and liabilities at March 4, 2016 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	399,846		399,846		—		—
Time deposits	7,509		7,509		—		—
Short-term investments:
Asset-backed securities	92,171		—		92,171		—
Corporate bonds and commercial paper	2,027,076		—		2,027,076		—
Foreign government securities	1,275		—		1,275		—
Municipal securities	141,558		—		141,558		—
U.S. agency securities	111,451		—		111,451		—
U.S. Treasury securities	893,661		—		893,661		—
Prepaid expenses and other current assets:
Foreign currency derivatives	13,500		—		13,500		—
Other assets:
Deferred compensation plan assets	37,660		1,052		36,608		—
Interest rate swap derivatives	29,019		—		29,019		—
Total assets	$	3,754,726	$	408,407	$	3,346,319	$	—



Liabilities:
Accrued expenses:
Foreign currency derivatives	$	1,600	$	—	$	1,600	$	—
Total liabilities	$	1,600	$	—	$	1,600	$	—

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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 27, 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	$	482,479	$	482,479	$	—	$	—
Municipal securities	1,849		—		1,849		—
Time deposits	13,461		13,461		—		—
U.S. Treasury securities	26,400		—		26,400		—
Short-term investments:
Asset-backed securities	83,314		—		83,314		—
Corporate bonds and commercial paper	1,886,914		—		1,886,914		—
Foreign government securities	1,268		—		1,268		—
Municipal securities	137,332		—		137,332		—
U.S. agency securities	130,468		—		130,468		—
U.S. Treasury securities	872,228		—		872,228		—
Prepaid expenses and other current assets:
Foreign currency derivatives	19,126		—		19,126		—
Other assets:
Deferred compensation plan assets	32,063		971		31,092		—
Interest rate swap derivatives	19,821		—		19,821		—
Total assets	$	3,706,723	$	496,911	$	3,209,812	$	—



Liabilities:
Accrued expenses:
Foreign currency derivatives	$	2,154	$	—	$	2,154	$	—
Total liabilities	$	2,154	$	—	$	2,154	$	—

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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(Unaudited)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We also have direct investments in privately held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. For the three months ended March 4, 2016 we determined there was an immaterial other-than-temporary impairment on certain of our cost method investments and wrote down the investments to fair value. For the three months ended February 27, 2015, we determined there were no other-than-temporary impairments on our cost method investments.

As of March 4, 2016, 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 11 for further details regarding our investment in lease receivable.

The fair value of our senior notes was $1.99 billion as of March 4, 2016, based on observable market prices in less active markets and categorized as Level 2. See Note 12 for further details regarding our debt.

NOTE 5. DERIVATIVES AND HEDGING ACTIVITIES

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 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 with changes in the fair value recorded to interest and other income (expense), net in our Condensed Consolidated Statements of Income. These contracts do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.

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

In countries outside the United States, we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option contracts or forward contracts to hedge certain cash flow exposures resulting from changes in these foreign currency exchange rates. These foreign exchange contracts, carried at fair value, have maturities of up to twelve months. We enter into these foreign exchange contracts to hedge a portion of our forecasted foreign currency denominated revenue in the normal course of business and accordingly, they are not speculative in nature.

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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 12 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”). In effect, the interest rate swaps 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 12 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 March 4, 2016 and November 27, 2015 were as follows (in thousands):



	2016				2015
	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)}	$	11,986	$	—	$	16,979	$	—
Interest rate swap ⁽²⁾	29,019		—		19,821		—
Derivatives not designated as hedging instruments:
Foreign exchange forward contracts ⁽¹⁾	1,514		1,600		2,147		2,154
Total derivatives	$	42,519	$	1,600	$	38,947	$	2,154

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(Unaudited)

^{_________________________________________}


⁽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.

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 months ended March 4, 2016 and February 27, 2015 was as follows (in thousands):



	2016						2015
	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⁾	$	(1,711	)	$	—		$	22,239		$	—
Net gain (loss) reclassified from accumulated OCI into income, net of tax⁽²⁾	$	3,220		$	—		$	23,712		$	—
Net gain (loss) recognized in income⁽³⁾	$	(5,140	)	$	—		$	(2,935	)	$	—
Derivatives not designated as hedging relationships:
Net gain (loss) recognized in income⁽⁴⁾	$	—		$	(965	)	$	—		$	2,070

^{_________________________________________}


⁽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.

NOTE 6. GOODWILL AND PURCHASED AND OTHER INTANGIBLES

Goodwill as of March 4, 2016 and November 27, 2015 was $5.39 billion and $5.37 billion, respectively.

Purchased and other intangible assets subject to amortization as of March 4, 2016 and November 27, 2015 were as follows (in thousands):



	2016							2015
	Cost		Accumulated Amortization			Net		Cost		Accumulated Amortization			Net
Purchased technology	$	199,662	$	(113,047	)	$	86,615	$	199,053	$	(104,704	)	$	94,349
Customer contracts and relationships	$	551,008	$	(224,024	)	$	326,984	$	506,639	$	(204,578	)	$	302,061
Trademarks	81,256		(43,921		)	37,335		81,219		(41,175		)	40,044
Acquired rights to use technology	145,083		(105,408		)	39,675		144,202		(100,278		)	43,924
Localization	904		(358		)	546		1,500		(358		)	1,142
Other intangibles	37,481		(9,950		)	27,531		36,280		(7,793		)	28,487
Total other intangible assets	$	815,732	$	(383,661	)	$	432,071	$	769,840	$	(354,182	)	$	415,658
Purchased and other intangible assets, net	$	1,015,394	$	(496,708	)	$	518,686	$	968,893	$	(458,886	)	$	510,007

Amortization expense related to purchased and other intangible assets was $37.6 million and $39.5 million for the three months ended March 4, 2016 and February 27, 2015, respectively. Of these amounts $19.0 million and $24.9 million were included in cost of sales for the three months ended March 4, 2016 and February 27, 2015, respectively.

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(Unaudited)

As of March 4, 2016, we expect amortization expense in future periods to be as follows (in thousands):



Fiscal Year	Purchased Technology		Other Intangible Assets
Remainder of 2016	$	22,405	$	85,073
2017	23,568		103,535
2018	16,441		92,171
2019	10,074		65,345
2020	7,865		35,220
Thereafter	6,262		50,727
Total expected amortization expense	$	86,615	$	432,071

NOTE 7. ACCRUED EXPENSES

Accrued expenses as of March 4, 2016 and November 27, 2015 consisted of the following (in thousands):



	2016		2015
Accrued compensation and benefits	$	251,250	$	312,776
Sales and marketing allowances	57,569		66,876
Accrued corporate marketing	47,117		38,512
Taxes payable	29,405		27,996
Royalties payable	19,040		23,334
Accrued interest expense	7,335		26,538
Other	180,105		183,852
Accrued expenses	$	591,821	$	679,884

Other primarily includes general corporate accruals including accrued restructuring charges, 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 three months ended March 4, 2016 and the fiscal year ended November 27, 2015 was as follows (in thousands):



	2016		2015
Beginning outstanding balance	10,069		13,564
Awarded	3,325		4,012
Released	(4,288	)	(6,561	)
Forfeited	(255	)	(946	)
Ending outstanding balance	8,851		10,069

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Information regarding restricted stock units outstanding at March 4, 2016 and February 27, 2015 is summarized below:



	Number of Shares (thousands)	Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value^(*) (millions)
2016
Restricted stock units outstanding	8,851	1.52	$	762.7
Restricted stock units vested and expected to vest	7,716	1.45	$	654.2
2015
Restricted stock units outstanding	11,002	1.39	$	870.2
Restricted stock units vested and expected to vest	9,557	1.33	$	746.7

^{_________________________________________}


^(*)	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 March 4, 2016 and February 27, 2015 were $86.18 and $79.10, respectively.

Summary of Performance Shares

Our 2016, 2015 and 2014 Performance Share Programs aim to help focus key employees on building stockholder value, provide significant award potential for achieving outstanding Company performance and enhance the ability of the Company to attract and retain highly talented and competent individuals. The Executive Compensation Committee of our Board of Directors approves the terms of each of our Performance Share Programs, including the award calculation methodology, under the terms of our 2003 Equity Incentive Plan. Shares may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period. Performance share awards will be awarded and fully vest upon the Executive Compensation Committee's certification of the level of achievement following the three-year anniversary of each grant date. Program participants generally have the ability to receive up to 200% of the target number of shares originally granted.

In the first quarter of fiscal 2016, the Executive Compensation Committee approved the 2016 Performance Share Program, the terms of which are similar to prior year performance share programs as discussed above.

In the first quarter of fiscal 2016, the Executive Compensation Committee also certified the actual performance achievement of participants in the 2013 Performance Share Program. Actual performance resulted in participants achieving 198% of target or approximately 1.4 million shares. The shares granted and achieved under the 2013 Performance Share Program fully vested on the third-year anniversary of the grant on January 24, 2016, if not forfeited. As of March 4, 2016, the shares awarded under our 2016, 2015 and 2014 Performance Share Programs are yet to be achieved.

The following table sets forth the summary of performance share activity under our Performance Share Programs for the three months ended March 4, 2016 and the fiscal year ended November 27, 2015 (in thousands):



	2016					2015
	Shares Granted			Maximum Shares Eligible to Receive		Shares Granted		Maximum Shares Eligible to Receive
Beginning outstanding balance	1,940			3,881		1,517		3,034
Achieved	(1,373	)		(1,387	)	—		—
Awarded	1,206		⁽¹⁾	1,053		671		1,342
Forfeited	(50	)		(101	)	(248	)	(495	)
Ending outstanding balance	1,723			3,446		1,940		3,881

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^{_________________________________________}


⁽¹⁾	Included in the 1.2 million shares awarded during the three months ended March 4, 2016 were 0.7 million shares awarded for the final achievement of the 2013 Performance Share program. The remaining awarded shares were for the 2016 Performance Share Program.

Summary of Employee Stock Purchase Plan Shares

The expected life of the ESPP shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three months ended March 4, 2016 and February 27, 2015 were as follows:



	Three Months
	2016	2015
Expected life (in years)	0.5 - 2.0	0.5 - 2.0
Volatility	27% - 29%	27% - 30%
Risk free interest rate	0.49% - 1.06%	0.12% - 0.67%

Employees purchased 0.7 million shares at an average price of $58.79 and 0.7 million shares at an average price of $50.31 for the three months ended March 4, 2016 and February 27, 2015, respectively. The intrinsic value of shares purchased during the three months ended March 4, 2016 and February 27, 2015 was $23.7 million and $16.0 million, respectively. The intrinsic value is calculated as the difference between the market value on the date of purchase and the purchase price of the shares.

Summary of Stock Options

The Executive Compensation Committee of Adobe’s Board of Directors eliminated the use of stock option grants for all employees and the Board of Directors effective fiscal 2012 and fiscal 2014, respectively. As of March 4, 2016 and November 27, 2015, we had 1.1 million and 3.2 million stock options outstanding, respectively.

Compensation Costs

As of March 4, 2016, there was $623.3 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards which will be recognized over a weighted average period of 2.2 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 March 4, 2016 and February 27, 2015 were as follows (in thousands):



	2016				2015
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	$	373	$	1,803	$	441	$	1,529
Cost of revenue—services and support	1,433		1,895		1,216		1,857
Research and development	3,874		29,484		4,056		26,705
Sales and marketing	4,550		29,356		4,598		27,285
General and administrative	1,233		18,747		1,463		16,761
Total	$	11,463	$	81,285	$	11,774	$	74,137

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(Unaudited)

NOTE 9. STOCKHOLDERS’ EQUITY

Retained Earnings

The changes in retained earnings for the three months ended March 4, 2016 were as follows (in thousands):



Balance as of November 27, 2015	$	7,253,431
Net income	254,307
Re-issuance of treasury stock	(286,655		)
Balance as of March 4, 2016	$	7,221,083

We account for treasury stock under the cost method. When treasury stock is re-issued at a price higher than its cost, the difference is recorded as a component of additional paid-in-capital in our Condensed Consolidated Balance Sheets. When treasury stock is re-issued at a price lower than its cost, the difference is recorded as a component of additional paid-in-capital to the extent that there are treasury stock gains to offset the losses. If there are no treasury stock gains in additional paid-in-capital, the losses upon re-issuance of treasury stock are recorded as a reduction of retained earnings in our Condensed Consolidated Balance Sheets.

The components of accumulated other comprehensive income (loss) and activity, net of related taxes, as of March 4, 2016 were as follows (in thousands):



	November 27, 2015			Increase / Decrease			Reclassification Adjustments				March 4, 2016
Net unrealized gains on available-for-sale securities:
Unrealized gains on available-for-sale securities	$	2,542		$	727		$	(333	)		$	2,936
Unrealized losses on available-for-sale securities	(7,095		)	(2,354		)	289				(9,160		)
Total net unrealized gains on available-for-sale securities	(4,553		)	(1,627		)	(44		)	⁽¹⁾	(6,224		)
Net unrealized gains / losses on derivative instruments designated as hedging instruments	2,915			(1,711		)	(2,935		)	⁽²⁾	(1,731		)
Cumulative foreign currency translation adjustments	(167,442		)	23,718			—				(143,724		)
Total accumulated other comprehensive income (loss), net of taxes	$	(169,080	)	$	20,380		$	(2,979	)		$	(151,679	)

^{_________________________________________}


⁽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.

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(Unaudited)

The following table sets forth the taxes related to each component of other comprehensive income (loss) for the three months ended March 4, 2016 and February 27, 2015 (in thousands):



	Three Months
	2016			2015
Available-for-sale securities:
Unrealized gains / losses	$	28		$	(107	)
Reclassification adjustments	—			—
Subtotal available-for-sale securities	28			(107		)
Derivatives designated as hedging instruments:
Unrealized gains / losses on derivative instruments⁽¹⁾	—			6,147
Reclassification adjustments⁽¹⁾	(151		)	(53		)
Subtotal derivatives designated as hedging instruments	(151		)	6,094
Foreign currency translation adjustments	633			(2,095		)
Total taxes, other comprehensive income (loss)	$	510		$	3,892

^{_________________________________________}


⁽¹⁾	Taxes related to derivative instruments other than the interest rate lock agreement were zero based on the tax jurisdiction where these derivative instruments were executed.

Stock Repurchase Program

To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase shares in the open market or enter into structured repurchase agreements with third parties. In the first quarter of fiscal 2015, the Board of Directors approved a new stock repurchase program granting the Company authority to repurchase up to $2 billion in common stock through the end of fiscal 2017.

During the three months ended March 4, 2016 and February 27, 2015, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $150 million and $200 million, respectively. The prepayment of $150 million during the three months ended March 4, 2016 was under the current $2 billion authority while the prepayment of $200 million during the three months ended February 27, 2015 was under the previous $2 billion authority. We enter into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is higher than the foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.

The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. During the three months ended March 4, 2016, we repurchased approximately 1.5 million shares at an average price of $88.67 through structured repurchase agreements entered into during fiscal 2015 and the three months ended March 4, 2016. During the three months ended February 27, 2015, we repurchased approximately 2.4 million shares at an average price of $72.39 through structured repurchase agreements entered into during fiscal 2014 and the three months ended February 27, 2015.

For the three months ended March 4, 2016, the prepayments were classified as treasury stock on our Condensed Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by March 4, 2016 were excluded from the computation of earnings per share. As of March 4, 2016, $54.8 million of prepayment remained under this agreement.

Subsequent to March 4, 2016, as part of our $2 billion stock repurchase program, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $225 million. This amount will be classified as treasury stock on our Condensed Consolidated Balance Sheets. Upon completion of the $225 million stock repurchase agreement, $1.2 billion remains under our current authority.

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(Unaudited)

NOTE 10. NET INCOME PER SHARE

The following table sets forth the computation of basic and diluted net income per share for the three months ended March 4, 2016 and February 27, 2015 (in thousands, except per share data):



	Three Months
	2016		2015
Net income	$	254,307	$	84,888
Shares used to compute basic net income per share	499,125		498,754
Dilutive potential common shares:
Unvested restricted stock and performance share awards	5,922		7,479
Stock options	629		1,293
Shares used to compute diluted net income per share	505,676		507,526
Basic net income per share	$	0.51	$	0.17
Diluted net income per share	$	0.50	$	0.17

For the three months ended March 4, 2016 and February 27, 2015, there were no options to purchase shares of common stock with exercise prices greater than the average fair market value of our stock of $87.98 and $73.38, respectively that would have been anti-dilutive.

NOTE 11. COMMITMENTS AND CONTINGENCIES

Lease Commitments

We occupy three office buildings in San Jose, California where our corporate headquarters are located. We reference these office buildings as the Almaden Tower and the East and West Towers. We own the East and West Tower buildings, lease the Almaden Tower building and own the land under each of them.

The lease agreement for the Almaden Tower is effective through March 2017. We are the investors in the lease receivable related to the Almaden Tower lease in the amount of $80.4 million, which is recorded as investment in lease receivable on our Condensed Consolidated Balance Sheets. As of March 4, 2016, the carrying value of the lease receivable related to the Almaden Tower approximated fair value. Under the agreement for the Almaden Tower, we have the option to purchase the building at any time during the lease term for $103.6 million. If we purchase the building, the investment in the lease receivables may be credited against the purchase price. The residual value guarantee under the Almaden Tower obligation is $89.4 million.

The Almaden Tower lease is subject to standard covenants including certain financial ratios that are reported to the lessor quarterly. As of March 4, 2016, we were in compliance with all of the covenants. In the case of a default, the lessor may demand we purchase the building for an amount equal to the lease balance, or require that we remarket or relinquish the building. If we choose to remarket or are required to do so upon relinquishing the building, we are bound to arrange the sale of the building to an unrelated party and will be required to pay the lessor any shortfall between the net remarketing proceeds and the lease balance, up to the residual value guarantee amount less our investment in lease receivable. The Almaden Tower lease qualifies for operating lease accounting treatment and, as such, the building and the related obligation are not included in our Condensed Consolidated Balance Sheets.

Royalties

We have royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit sold or a percentage of the underlying revenue.

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(Unaudited)

Indemnifications

In the ordinary course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products and from time to time, we are subject to claims by our customers under these indemnification provisions. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

To the extent permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

Legal Proceedings

In connection with disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation may be very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Third-party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements and service agreements.

In addition to intellectual property disputes, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We consider all claims on a quarterly basis in accordance with GAAP and based on known facts assess whether potential losses are considered reasonably possible, probable and estimable. Based upon this assessment, we then evaluate disclosure requirements and whether to accrue for such claims in our financial statements. This determination is then reviewed and discussed with our Audit Committee and our independent registered public accounting firm.

We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in this note, we have determined that no provision for liability nor disclosure is required related to any claim against us because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial.

All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.

In connection with our anti-piracy efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be negatively affected in any particular period by the resolution of one or more of these counter-claims.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 12. DEBT

Notes

In February 2010, we issued $600 million of 3.25% senior notes due February 1, 2015 (the “2015 Notes”) and $900 million of 4.75% senior notes due February 1, 2020 (the “2020 Notes”). Our proceeds were $1.5 billion and were net of an issuance discount of $6.6 million. In addition, we incurred issuance costs of $10.7 million. Both the discount and issuance costs were or are being amortized to interest expense over the respective terms of the 2015 and 2020 Notes using the effective interest method. The 2015 Notes ranked, and 2020 Notes rank, equally with our other unsecured and unsubordinated indebtedness. The effective interest rate including the discount and issuance costs was 3.45% for the 2015 Notes and is 4.92% for the 2020 Notes. Interest is payable semi-annually, in arrears, on February 1 and August 1, and commenced on August 1, 2010. The 2015 Notes were settled on February 1, 2015, as discussed below.

In June 2014, we entered into interest rate swaps with a total notional amount of $900 million designated as a fair value hedge related to our 2020 Notes. The interest rate swaps effectively convert the fixed interest rate on our 2020 Notes to a floating interest rate based on LIBOR plus a fixed number of basis points. Under the terms of the swap, we will pay monthly interest at the one-month LIBOR floating interest rate plus a spread of a fixed number of basis points on the $900 million notional amount. In exchange, we will receive 4.75% fixed rate interest from the swap counterparties. See Note 5 for further details regarding our interest rate swap derivatives.

In January 2015, we issued $1 billion of 3.25% senior notes due February 1, 2025 (the “2025 Notes”). Our proceeds were approximately $989.3 million which is net of an issuance discount of $10.7 million. In addition, we incurred issuance costs of $7.9 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2025 Notes using the effective interest method. The 2025 Notes rank equally with our other unsecured and unsubordinated indebtedness. The effective interest rate including the discount, issuance costs and interest rate agreement is 3.67% for the 2025 Notes. Interest is payable semi-annually, in arrears on February 1 and August 1, commencing on August 1, 2015. A portion of the proceeds from this offering was used to repay $600 million in aggregate principal amount of the 2015 Notes plus accrued and unpaid interest due February 1, 2015. The remaining proceeds were used for general corporate purposes.

As of March 4, 2016, our outstanding notes payable consists of the 2020 Notes and 2025 Notes (the “Notes”) with a total carrying value of $1.92 billion. Based on quoted prices in inactive markets, the fair value of the Notes was $1.99 billion as of March 4, 2016. The total fair value of $1.99 billion excludes the effect of fair value hedge of the 2020 Notes for which we entered into interest rate swaps as described above.

We may redeem the Notes at any time, subject to a make-whole premium. In addition, upon the occurrence of certain change of control triggering events, we may be required to repurchase the Notes, at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The Notes also include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances. As of March 4, 2016, we were in compliance with all of the covenants.

In February 2016, we made semi-annual interest payments on our 2020 and 2025 Notes totaling $37.6 million.

Credit Agreement

On March 2, 2012, we entered into a five-year $1 billion senior unsecured revolving credit agreement (the “Credit Agreement”), providing for loans to us and certain of our subsidiaries. Pursuant to the terms of the Credit Agreement, we may, subject to the agreement of the applicable lenders, request up to an additional $500 million in commitments, for a maximum aggregate commitment of $1.5 billion. Loans under the Credit Agreement will bear interest at either (i) LIBOR plus a margin, based on our public debt ratings, ranging from 0.795% and 1.30% or (ii) the base rate, which is defined as the highest of (a) the agent’s prime rate, (b) the federal funds effective rate plus 0.50% or (c) LIBOR plus 1.00% plus a margin, based on our debt

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

ratings, ranging from 0.00% to 0.30%. Commitment fees are payable quarterly at rates between 0.08% and 0.20% per year, also based on our debt ratings. Subject to certain conditions stated in the Credit Agreement, we and any of our subsidiaries designated as additional borrowers may borrow, prepay and re-borrow amounts under the revolving credit facility at any time during the term of the Credit Agreement.

The Credit Agreement contains customary representations, warranties, affirmative and negative covenants, including a financial covenant, events of default and indemnification provisions in favor of the lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, certain merger and acquisition transactions, dispositions and other matters, all subject to certain exceptions. The financial covenant, based on a quarterly financial test, requires us not to exceed a maximum leverage ratio.

On March 1, 2013, we exercised an option under the Credit Agreement to extend the maturity date of the Credit Agreement by one year to March 2, 2018.

On July 27, 2015, we entered into an amendment to further extend the maturity date of the Credit Agreement to July 27, 2020 and reallocated the facility among the syndicate of lenders that are parties to the Credit Agreement.

The facility will terminate and all amounts owing thereunder will be due and payable on the maturity date unless (a) the commitments are terminated earlier upon the occurrence of certain events, including an event of default, or (b) the maturity date is further extended upon our request, subject to the agreement of the lenders.

As of March 4, 2016, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants.

NOTE 13. NON-OPERATING INCOME (EXPENSE)

Non-operating income (expense) for the three months ended March 4, 2016 and February 27, 2015 included the following (in thousands):



	Three Months
	2016			2015
Interest and other income (expense), net:
Interest income	$	10,677		$	6,288
Foreign exchange gains (losses)	(6,530		)	(4,247		)
Realized gains on fixed income investment	333			967
Realized losses on fixed income investment	(289		)	(40		)
Other	(4		)	370
Interest and other income (expense), net	$	4,187		$	3,338
Interest expense	$	(18,469	)	$	(14,545	)
Investment gains (losses), net:
Realized investment gains	$	1,055		$	1,695
Realized investment losses	(125		)	—
Unrealized investment losses	(2,099		)	(265		)
Investment gains (losses), net	$	(1,169	)	$	1,430
Non-operating income (expense), net	$	(15,451	)	$	(9,777	)

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 14. SEGMENTS

We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments.

Our CEO, the chief operating decision maker, reviews revenue and gross margin information for each of our reportable segments, but does not review operating expenses on a segment by segment basis. In addition, with the exception of goodwill and intangible assets, we do not identify or allocate our assets by the reportable segments.

We have the following reportable segments:

•

Digital Media—Our Digital Media segment provides tools and solutions that enable individuals, small and medium businesses and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include traditional content creators, web application developers and digital media professionals, as well as their management in marketing departments and agencies, companies and publishers. Our customers also include knowledge workers who create, collaborate and distribute documents.


•	Digital Marketing—Our Digital Marketing segment provides solutions and services for how digital advertising and marketing are created, managed, executed, measured and optimized. Our customers include digital marketers, advertisers, publishers, merchandisers, web analysts, chief marketing officers, chief information officers and chief revenue officers.


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

Our segment results for the three months ended March 4, 2016 and February 27, 2015 were as follows (dollars in thousands):



	Digital Media			Digital Marketing			Print and Publishing			Total
Three months ended March 4, 2016
Revenue	$	931,718		$	406,246		$	45,371		$	1,383,335
Cost of revenue	54,547			141,917			2,108			198,572
Gross profit	$	877,171		$	264,329		$	43,263		$	1,184,763
Gross profit as a percentage of revenue	94		%	65		%	95		%	86		%
Three months ended February 27, 2015
Revenue	$	702,773		$	357,167		$	49,241		$	1,109,181
Cost of revenue	44,345			120,375			2,078			166,798
Gross profit	$	658,428		$	236,792		$	47,163		$	942,383
Gross profit as a percentage of revenue	94		%	66		%	96		%	85		%

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

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

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth, market opportunities, strategic initiatives, industry positioning, customer acquisition, the amount of recurring revenue and revenue growth. In addition, when used in this report, the words “will,” “expects,” “could,” “would,” “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” “continues” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Each of the forward-looking statements we make in this report involves risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors” in Part II, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with the U.S. Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for fiscal 2015. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document, except as required by law.

BUSINESS OVERVIEW

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

Adobe was originally incorporated in California in October 1983 and was reincorporated in Delaware in May 1997. We maintain executive offices and principal facilities at 345 Park Avenue, San Jose, California 95110-2704. Our telephone number is 408-536-6000 and our website is www.adobe.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC website at www.sec.gov. The information posted to our website is not incorporated into this Quarterly Report on Form 10-Q.

OPERATIONS OVERVIEW

For our first quarter of fiscal 2016, we reported strong financial results consistent with the continued execution of our long-term plans for our two strategic growth areas, Digital Media and Digital Marketing, while continuing to market and license a broad portfolio of products and solutions. Our first quarter of fiscal 2016 financial results benefited from an extra week in the quarter due to our 52/53 week financial calendar whereby fiscal 2016 is a 53-week year compared with fiscal 2015 which was a 52-week year.

In our Digital Media segment, we are a market leader with Adobe Creative Cloud, our subscription-based offering for creating and publishing content and applications. Creative Cloud delivers value through more frequent product updates, storage and access to user files stored in the cloud with syncing of files across users' machines, access to marketplace, social and community-based features with our Adobe Stock and Behance services, app creation capabilities and lower entry point pricing for cost-sensitive customers.

We offer Creative Cloud for individuals, teams and enterprises, and we enable larger enterprise customers to acquire Creative Cloud desktop apps through Enterprise Term License Agreements (“ETLAs”). These Creative Cloud offerings address the multiple routes to market we use to license our creative software to targeted customers. Adoption of Creative Cloud has transformed our business model, and we continue to expect this to drive higher long-term revenue growth through an expansion of our customer base by acquiring new users through a lower cost of entry and delivery of additional features and value, as well as keeping existing

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customers current on our latest release. We have also built out a marketplace for Creative Cloud subscribers to enable the delivery and purchase of stock content in our new service called Adobe Stock. Overall, our strategy with Creative Cloud is designed to enable us to increase our revenue with users, attract more new customers, and shift our revenue to be more recurring and predictable as revenue is recognized ratably.

We continue to implement strategies that will accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offering. These strategies include increasing the value Creative Cloud users receive, such as offering new mobile applications, as well as targeted promotions and offers that attract past customers and potential users to try out and ultimately subscribe to Creative Cloud. Because of the shift towards Creative Cloud subscriptions and ETLAs, perpetual revenue for older Creative products has continued to decline, and revenue from perpetual licensing of these products was immaterial for the first quarter of fiscal 2016.

We are also a market leader with our Adobe Document Cloud offerings built around our Acrobat family of products, the Adobe Reader and a set of integrated cloud-based document services, including Adobe eSign. Adobe Acrobat provides reliable creation and exchange of electronic documents, regardless of platform or application source type. In the second quarter of fiscal 2015, we delivered the next generation of this offering called Adobe Document Cloud, which we believe enhances the way people manage critical documents at home, in the office and across devices. Adobe Document Cloud includes Adobe Acrobat DC and Adobe eSign, and a set of integrated services enables users to create, review, approve, sign and track documents whether on a desktop or mobile device. Adobe Acrobat DC, with a touch-enabled user interface, is licensed both through subscription and perpetual pricing.

Annualized Recurring Revenue (“ARR”) is currently our key performance metric to assess the health and trajectory of our overall Digital Media segment. ARR should be viewed independently of revenue, deferred revenue and unbilled deferred revenue as ARR is a performance metric and is not intended to be combined with any of these items. We adjust our reported ARR on an annual basis to reflect any material exchange rates changes. Our reported ARR results in the first quarter of fiscal 2016 are based on currency rates set at the start of fiscal 2016 and held constant throughout the year.We calculate ARR as follows:



Creative ARR	Annual Value of Creative Cloud Subscriptions and Services + Annual Digital Publishing Suite Contract Value + Annual Creative ETLA Contract Value
Document Cloud ARR	Annual Value of Document Cloud Subscriptions and Services + Annual Document Cloud ETLA Contract Value
Digital Media ARR	Creative ARR + Document Cloud ARR

Creative ARR exiting the first quarter of fiscal 2016 was $2.74 billion, up from $2.50 billion at the end of fiscal 2015. Document Cloud ARR exiting the first quarter fiscal 2016 was $393.0 million, up from $385.0 million at the end of fiscal 2015. Total Digital Media ARR grew to $3.13 billion at the end of the first quarter of fiscal 2016, up from $2.88 billion at the end of fiscal 2015.

Our success in driving growth in ARR has begun to positively affect our revenue growth. Creative revenue in the first quarter of fiscal 2016 was $732.9 million, up from $509.4 million in the first quarter of fiscal 2015 and representing 44% year-over-year growth. Document Cloud revenue in the first quarter of fiscal 2016 was $198.8 million, up from $193.4 million in the first quarter of fiscal 2015 and representing 3% year-over-year growth. Total Digital Media segment revenue grew to $931.7 million in first quarter of fiscal 2016, up from $702.8 million in the first quarter of fiscal 2015 and representing 33% year-over-year growth.

We are a market leader in the fast-growing category addressed by our Digital Marketing segment. Our Digital Marketing business provides comprehensive solutions that include analytics, social marketing, targeting, media optimization, digital

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experience management, cross-channel campaign management, audience management, premium video delivery and monetization. We deliver these capabilities through our Adobe Marketing Cloud, an integrated offering enabling marketers to measure, personalize and optimize marketing campaigns and digital experiences across channels for optimal marketing performance. With its broad set of solutions, including Adobe Analytics, Adobe Target, Adobe Social, Adobe Media Optimizer, Adobe Experience Manager, Adobe Campaign, Adobe Audience Manager and Adobe Primetime, as well as real-time dashboards and a collaborative interface, customers of Adobe Marketing Cloud are able to combine data, insights and digital content to deliver a personalized, relevant experience to their constituents.

In addition to chief marketing officers and digital marketers, users of our Adobe Marketing Cloud solutions include marketing professionals such as search engine marketers, media managers, media buyers and marketing research analysts. Customers also include web content editors, web analysts and web marketing managers. These customers often are involved in workflows that utilize other Adobe products, such as our Digital Media offerings and our video workflow and delivery technologies. By combining the creativity of our Digital Media business with the science of our Digital Marketing business, we help our customers to more efficiently and effectively make, manage, measure and monetize their content across every channel with an end-to-end workflow and feedback loop.

We utilize a direct salesforce to market and license our Adobe Marketing Cloud solutions, as well as an extensive ecosystem of partners including marketing agencies, systems integrators and developers that help license and deploy our solutions to their customers. We have made significant investments to broaden the scale and size of all of these routes to market, and our recent financial results reflect the success of these investments. In the first quarter of fiscal 2016, we achieved record Marketing Cloud revenue of $377.3 million, which represents 21% year-over-year revenue growth. In addition, we drove strong demand for our Marketing Cloud solutions, which we expect will positively benefit revenue growth in future quarters.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

There have been no significant changes in our critical accounting policies and estimates during the three months ended March 4, 2016, as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 27, 2015.

Recent Accounting Pronouncements Not Yet Effective

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sales-type leases. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition and requires application of the new guidance at the beginning of the earliest comparative period presented. The updated standard is effective for us beginning in the first quarter of fiscal 2020. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

RESULTS OF OPERATIONS

Financial Performance Summary for the First Quarter of Fiscal 2016


•	Our results of operations for the first quarter of fiscal 2016 were impacted by an extra week due to our first quarter of fiscal 2016 having 14 weeks as compared to 13 weeks in the year-ago period.


•	During the three months ended March 4, 2016, our subscription revenue as a percentage of total revenue increased to 77% compared to 64% in the year-ago period as we transitioned more of our business to a subscription-based model.


•	Total Digital Media ARR of approximately $3.13 billion as of March 4, 2016 increased by $249 million, or 9%, from $2.88 billion as of November 27, 2015. The change in our Digital Media ARR is primarily due to increases in the number of paid Creative Cloud and Document Cloud subscriptions.


•	Digital Media revenue of $931.7 million during the three months ended March 4, 2016 increased by $228.9 million, or 33%, compared with the year-ago period primarily due to the increase in subscription revenue associated with our Creative Cloud offering.


•	Adobe Marketing Cloud revenue of $377.3 million during the three months ended March 4, 2016 increased by $65.9 million, or 21%, compared with the year-ago period. The increase was primarily due to continued adoption of our Adobe Experience Manager (“AEM”) offering and increases in Adobe Campaign and Adobe Analytics revenue.


•	Our total deferred revenue of $1.61 billion as of March 4, 2016 increased by $123.4 million, or 8%, from $1.49 billion as of November 27, 2015 primarily due to new contracts and existing renewals for our Adobe Marketing Cloud services and increases in Creative Cloud individual and team subscriptions.

•

Cost of revenue of $198.6 million during the three months ended March 4, 2016 increased by $31.8 million, or 19%, compared with the year-ago period primarily due to increases in costs associated with compensation and related benefits driven by increased headcount and higher incentive compensation program achievement, and royalty costs including royalty payments related to our stock photography offering from the acquisition of Fotolia during the first quarter of fiscal 2015. Also contributing to the overall increase in cost of revenue was the increase in costs associated with training and consulting services provided to our customers.

•

Operating expenses of $877.0 million during the three months ended March 4, 2016 increased by $107.6 million, or 14%, compared with the year-ago period primarily due to increases in costs associated with compensation and related benefits driven by increased headcount and higher incentive compensation costs. Also contributing to the overall increase in operating expenses are higher corporate marketing expenses driven by increased marketing activities during the first quarter of fiscal 2016.


•	Net income of $254.3 million during the three months ended March 4, 2016 increased by $169.4 million, or 200%, compared with the year-ago period primarily due to revenue increases.


•	Net cash flow from operations of $497.5 million during the three months ended March 4, 2016 increased by $314.5 million, or 172%, compared to the three months ended February 27, 2015 primarily due to higher net income, increases in deferred revenue and decreases in accounts receivable.

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Revenue for the Three Months Ended March 4, 2016 and February 27, 2015 (dollars in millions)



	Three Months
	2016			2015			% Change
Subscription	$	1,070.2		$	713.4		50	%
Percentage of total revenue	77		%	64		%
Product	201.1			290.8			(31	)%
Percentage of total revenue	15		%	26		%
Services and support	112.0			105.0			7	%
Percentage of total revenue	8		%	9		%
Total revenue	$	1,383.3		$	1,109.2		25	%

Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings including Creative Cloud and certain of our Adobe Marketing Cloud and Document Cloud services. We recognize subscription revenue ratably over the term of agreements with our customers, beginning on the commencement of the service. We expect our subscription revenue will continue to increase as a result of our investments in new SaaS and subscription models.

As described in Note 14 of our Notes to Condensed Consolidated Financial Statements, we have the following segments: Digital Media, Digital Marketing and Print and Publishing. Subscription revenue by reportable segment for the three months ended March 4, 2016 and February 27, 2015 are as follows (dollars in millions):



	Three Months
	2016		2015		% Change
Digital Media	$	781.9	$	483.8	62	%
Digital Marketing	280.9		224.9		25	%
Print and Publishing	7.4		4.7		57	%
Total subscription revenue	$	1,070.2	$	713.4	50	%

Our services and support revenue is comprised of consulting, training and maintenance and support, primarily related to the licensing of our enterprise, developer and platform products and the sale of our hosted Adobe Marketing Cloud services. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products. Our maintenance and support offerings, which entitle customers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement.

Segment Information (dollars in millions)



	Three Months
	2016			2015			% Change
Digital Media	$	931.7		$	702.8		33	%
Percentage of total revenue	68		%	63		%
Digital Marketing	406.2			357.2			14	%
Percentage of total revenue	29		%	32		%
Print and Publishing	45.4