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 September 2, 2005

OR

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

For the transition period from ________________ to ________________

Commission file Number: 0-15175


ADOBE SYSTEMS INCORPORATED

(Exact name of registrant as specified in its charter)


Delaware
(State or other jurisdiction of
incorporation or organization)

 

77-0019522
(I.R.S. Employer
Identification No.)

 

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

(408) 536-6000
(Registrant’s telephone number, including area code)

 


Indicate by checkmark 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 (the “Act”) 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 is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x     No o

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

The number of shares outstanding of the registrant’s common stock as of September 30, 2005 was 494,127,574.

 




ADOBE SYSTEMS INCORPORATED
FORM 10-Q

TABLE OF CONTENTS

 

 

Page No.

PART I—FINANCIAL INFORMATION

Item 1.

Condensed Consolidated Financial Statements:

 

 

 

 

 

Condensed Consolidated Balance Sheets
September 2, 2005 and December 3, 2004

 

3

 

 

 

Condensed Consolidated Statements of Income
Three and Nine Months Ended September 2, 2005 and September 3, 2004

 

4

 

 

 

Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 2, 2005 and September 3, 2004

 

5

 

 

 

Notes to Condensed Consolidated Financial Statements

 

6

 

Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

 

25

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

47

 

Item 4.

Controls and Procedures

 

47

 

PART II—OTHER INFORMATION

Item 1.

Legal Proceedings

 

48

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

49

 

Item 5.

Other Information

 

49

 

Item 6.

Exhibits

 

50

 

Signature

 

52

 

Summary of Trademarks

 

53

 

 

2




PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)

 

 

September 2,
2005

 

December 3,
2004

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

454,168

 

$

259,061

 

Short-term investments

 

1,438,617

 

1,054,160

 

Trade receivables, net

 

157,236

 

141,945

 

Other receivables

 

39,889

 

25,495

 

Deferred income taxes

 

55,018

 

51,751

 

Prepaid expenses and other current assets

 

35,751

 

18,617

 

Total current assets

 

2,180,679

 

1,551,029

 

Property and equipment, net

 

103,663

 

99,675

 

Goodwill

 

118,683

 

110,287

 

Purchased and other intangibles, net

 

16,804

 

15,513

 

Investment in lease receivable

 

126,800

 

126,800

 

Other assets

 

58,966

 

55,328

 

 

 

$

2,605,595

 

$

1,958,632

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Trade and other payables

 

$

37,428

 

$

43,192

 

Accrued expenses

 

207,355

 

202,762

 

Income taxes payable

 

174,292

 

145,913

 

Deferred revenue

 

60,010

 

59,541

 

Total current liabilities

 

479,085

 

451,408

 

Other long-term liabilities

 

4,476

 

4,838

 

Deferred income taxes

 

41,883

 

78,909

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.0001 par value

 

29,600

 

29,576

 

Additional paid-in-capital

 

1,290,905

 

1,164,643

 

Retained earnings

 

2,682,315

 

2,238,807

 

Accumulated other comprehensive loss

 

(2,811

)

(2,289

)

Treasury stock, at cost (98,589 and 107,154 shares in 2005 and 2004, respectively), net of re-issuances

 

(1,919,858

)

(2,007,260

)

Stockholders’ equity

 

2,080,151

 

1,423,477

 

 

 

$

2,605,595

 

$

1,958,632

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

3




ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 2,
2005

 

September 3,
2004

 

September 2,
2005

 

September 3,
2004

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

 

$

476,054

 

 

 

$

395,450

 

 

$

1,424,821

 

$

1,213,755

 

Services and support

 

 

10,985

 

 

 

8,263

 

 

31,129

 

23,324

 

Total revenue

 

 

487,039

 

 

 

403,713

 

 

1,455,950

 

1,237,079

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

 

21,593

 

 

 

19,035

 

 

65,222

 

62,685

 

Services and support

 

 

5,887

 

 

 

4,534

 

 

16,661

 

12,321

 

Total cost of revenue

 

 

27,480

 

 

 

23,569

 

 

81,883

 

75,006

 

Gross profit

 

 

459,559

 

 

 

380,144

 

 

1,374,067

 

1,162,073

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

94,586

 

 

 

80,072

 

 

270,681

 

231,196

 

Sales and marketing

 

 

143,748

 

 

 

122,939

 

 

446,094

 

380,854

 

General and administrative

 

 

37,637

 

 

 

36,819

 

 

120,788

 

104,608

 

Total operating expenses

 

 

275,971

 

 

 

239,830

 

 

837,563

 

716,658

 

Operating income

 

 

183,588

 

 

 

140,314

 

 

536,504

 

445,415

 

Non-operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment loss, net

 

 

(2,044

)

 

 

(1,494

)

 

(6,299

)

(1,652

)

Interest and other income, net

 

 

12,420

 

 

 

2,343

 

 

28,352

 

11,502

 

Total non-operating income

 

 

10,376

 

 

 

849

 

 

22,053

 

9,850

 

Income before income taxes

 

 

193,964

 

 

 

141,163

 

 

558,557

 

455,265

 

Provision for income taxes

 

 

49,048

 

 

 

36,702

 

 

111,969

 

118,368

 

Net income

 

 

$

144,916

 

 

 

$

104,461

 

 

$

446,588

 

$

336,897

 

Basic net income per share

 

 

$

0.29

 

 

 

$

0.22

 

 

$

0.91

 

$

0.71

 

Shares used in computing basic net income per share

 

 

491,710

 

 

 

476,942

 

 

489,017

 

476,982

 

Diluted net income per share

 

 

$

0.29

 

 

 

$

0.21

 

 

$

0.88

 

$

0.68

 

Shares used in computing diluted net income per share

 

 

507,821

 

 

 

494,226

 

 

507,860

 

493,498

 

Cash dividends declared per share

 

 

$

 

 

 

$

0.00625

 

 

$

0.00625

 

$

0.01875

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

4




ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 

 

Nine Months Ended

 

 

 

September 2,
2005

 

September 3,
2004

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

446,588

 

$

336,897

 

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

 

 

 

 

 

Depreciation and amortization

 

47,880

 

43,007

 

Stock compensation expense

 

292

 

294

 

Deferred income taxes

 

(40,293

)

48,442

 

Recovery of losses on receivables

 

(678

)

(2,152

)

Tax benefit from employee stock option plans

 

63,802

 

29,972

 

Net losses on sales and impairments of investments

 

6,318

 

1,645

 

Retirements of property and equipment

 

1,115

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables

 

(28,096

)

39,518

 

Other current assets

 

(16,106

)

(1,509

)

Trade and other payables

 

(6,070

)

(776

)

Accrued expenses

 

4,500

 

12,814

 

Income taxes payable

 

28,379

 

(16,793

)

Deferred revenue

 

469

 

1,548

 

Net cash provided by operating activities

 

508,100

 

492,907

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of short-term investments

 

(1,571,668

)

(1,477,361

)

Maturities of short-term investments

 

217,855

 

47,217

 

Sales of short-term investments

 

966,312

 

1,397,524

 

Acquisitions of property and equipment

 

(38,106

)

(41,352

)

Purchases of long-term investments and other assets

 

(24,338

)

(19,024

)

Cash paid for acquisitions

 

(9,541

)

(15,545

)

Investment in lease receivable

 

 

(126,800

)

Proceeds from sale of equity securities

 

1,241

 

3,145

 

Net cash used for investing activities

 

(458,245

)

(232,196

)

Cash flows from financing activities:

 

 

 

 

 

Purchase of treasury stock

 

(100,092

)

(408,666

)

Proceeds from issuance of treasury stock

 

249,665

 

174,960

 

Payment of dividends

 

(3,044

)

(8,960

)

Net cash provided by (used for) financing activities

 

146,529

 

(242,666

)

Effect of foreign currency exchange rates on cash and cash equivalents

 

(1,277

)

(166

)

Net increase in cash and cash equivalents

 

195,107

 

17,879

 

Cash and cash equivalents at beginning of period

 

259,061

 

126,522

 

Cash and cash equivalents at end of period

 

$

454,168

 

$

144,401

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for income taxes

 

$

52,574

 

$

59,426

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

5




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying condensed consolidated financial statements include those of Adobe Systems Incorporated (“Adobe”) and our subsidiaries, after elimination of all intercompany accounts and transactions. Adobe has prepared the accompanying interim condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles, consistent in all material respects with those applied in our Annual Report on Form 10-K for the year ended December 3, 2004. The interim financial information is unaudited but reflects all adjustments which are, in the opinion of management, necessary to provide fair consolidated balance sheets, consolidated statements of income and cash flows for the interim periods presented. Such adjustments are normal and recurring except as otherwise noted. The Condensed Consolidated Balance Sheet as of December 3, 2004 is derived from the December 3, 2004 audited consolidated financial statements. You should read these interim condensed consolidated financial statements in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 3, 2004.

Our fiscal year is a 52/53-week year. As a result, the nine months ended September 3, 2004 had an additional week as compared to the nine months ended September 2, 2005.

Reclassification

Certain amounts in fiscal 2004 as reported on the Condensed Consolidated Balance Sheet and Condensed Consolidated Statements of Cash Flows have been reclassified to conform to the current year presentation. We reclassified $117.1 million in auction rate securities and variable rate demand obligations from cash and cash equivalents to short-term investments in the December 3, 2004, Condensed Consolidated Balance Sheet. The reclassification to short-term investments is based on the latest interpretation of cash equivalents pursuant to Statement of Financial Accounting Standards No. 95 (“SFAS 95”), “Statement of Cash Flows.”

Stock Dividend

On March 16, 2005, our Board of Directors approved a two-for-one stock split, in the form of a stock dividend, of our common stock payable on May 23, 2005 to stockholders of record as of May 2, 2005. Share and per share data, for all periods presented, have been adjusted to give effect to this stock split.

Revenue Recognition

Our revenue is derived from the licensing of desktop and server-based application software products, professional services, and maintenance and support. We recognize revenue when persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is probable.

Product revenue

We recognize our product revenue upon shipment, provided collection is determined to be probable and no significant obligations remain. Our desktop application products revenue from distributors is

6




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

subject to agreements allowing limited rights of return, rebates, and price protection. Our direct sales and OEM sales are also subject to limited rights of return. Accordingly we reduce revenue recognized for estimated future returns, price protection and rebates at the time the related revenue is recorded. The estimates for returns are adjusted periodically based upon historical rates of returns, inventory levels in the distribution channel and other related factors.

We record the estimated costs of providing free technical phone support to customers for our shrink-wrapped application products under warranty.

We record OEM licensing revenue, primarily royalties, when OEM partners ship products incorporating Adobe software, provided collection of such revenue is deemed probable.

Our product-related deferred revenue includes maintenance upgrade revenue and customer advances under OEM license agreements. Our maintenance upgrade revenue for our desktop application products is included in our product revenue line item as the maintenance primarily entitles customers to receive product upgrades. In cases where we provide a specified free upgrade to an existing product, we defer the fair value for the specified upgrade right until the future obligation is fulfilled or when the right to the specified free upgrade expires.

Services and support revenue

Our services and support revenue is composed of professional services (such as consulting services and training) and maintenance and support, primarily related to the licensing of our Intelligent Documents server solution products. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products.

Our professional services revenue is recognized using the proportionate performance method and is measured monthly based on input measures, such as on hours incurred to date compared to total estimated hours to complete, with consideration given to output measures, such as contract milestones when applicable. Our maintenance and support offerings, which entitle customers to receive product upgrades and enhancements or technical support, depending on the offering, are recognized ratably over the term of the arrangement.

Multiple element arrangements

We enter into revenue arrangements in which a customer may purchase a combination of software, upgrades, maintenance and support, and professional services (multiple-element arrangements). When vendor-specific objective evidence (“VSOE”) of fair value exists for all elements, we allocate revenue to each element based on the relative fair value of each of the elements. VSOE of fair value is established by the price charged when that element is sold separately. For maintenance and support, VSOE of fair value is established by renewal rates. For arrangements where VSOE of fair value exists only for the undelivered elements, we defer the full fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue, assuming all other criteria for revenue recognition have been met.

7




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

We perform ongoing credit evaluations of our customers’ financial condition and in some cases we require various forms of security. We also maintain allowances for estimated losses on receivables.

Stock-Based Incentive Compensation

We account for our stock option plans and our employee stock purchase plan using the intrinsic value method under Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.” The following table sets forth the pro forma amounts of net income and net income per share, for the three and nine months ended September 2, 2005 and September 3, 2004, that would have resulted if we accounted for our employee stock plans under the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation.”

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

2005

 

2004

 

2005

 

2004

 

Net income:

 

 

 

 

 

 

 

 

 

As reported

 

$

144,916

 

$

104,461

 

$

446,588

 

$

336,897

 

Add: Stock-based compensation expense for employees included in reported net income, net of related tax effects

 

72

 

31

 

189

 

191

 

Less: Total stock-based compensation expense for employees determined under the fair value based method, net of related tax effects

 

(24,531

)

(22,186

)

(66,550

)

(84,445

)

Pro forma

 

$

120,457

 

$

82,306

 

$

380,227

 

$

252,643

 

Basic net income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.29

 

$

0.22

 

$

0.91

 

$

0.71

 

Pro forma

 

$

0.24

 

$

0.17

 

$

0.78

 

$

0.53

 

Diluted net income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.29

 

$

0.21

 

$

0.88

 

$

0.68

 

Pro forma

 

$

0.24

 

$

0.17

 

$

0.75

 

$

0.51

 

 

For purposes of computing pro forma net income, we estimate the fair value of option grants and employee stock purchase plan purchase rights using the Black-Scholes option pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in our option grants and employee stock purchase plan shares. Additionally, option valuation models require the input of highly subjective assumptions, including the expected volatility of the stock price. Because our employee stock options and employee stock purchase plan shares have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimates, in management’s opinion, the existing models do not provide a reliable single measure of the fair value of its stock-based awards.

8




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

For purposes of determining expected volatility, we consider implied volatility in market-traded options on our common stock as well as third party volatility quotes. In addition, we consider historical volatility. We will continue to monitor these and other relevant factors used to measure expected volatility for future option grants.

The assumptions used to value the option grants for the three and nine months ended September 2, 2005 and September 3, 2004, are as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

2005

 

2004

 

2005

 

2004

 

Expected life (in years)

 

3.0

 

2.5

 

3.0

 

2.5

 

Volatility

 

34-37

%

37

%

30-37

%

37-40

%

Risk free interest rate

 

3.90

%

2.68-2.85

%

3.38-3.90

%

2.18-3.11

%

Dividend yield

 

 

0.11

%

 

0.11-0.13

%

 

The assumptions used to value the purchase rights for the three and nine months ended September 2, 2005 and September 3, 2004, are as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

  2005  

 

2004

 

2005

 

2004

 

Expected life (in years)

 

 

1.25

 

 

1.24

 

1.25

 

1.24

 

Volatility

 

 

37

%

 

37

%

32-37

%

37-40

%

Risk free interest rate

 

 

3.58

%

 

1.24-1.76

%

3.03-3.58

%

1.24-1.76

%

Dividend yield

 

 

 

 

0.11

%

 

0.11-0.13

%

 

Option grants vest over several years and new option grants are generally made each year. Because of this, the amounts shown above may not be representative of the pro forma effect on reported net income in future years.

Income Taxes

We use the asset and liability method of accounting for income taxes. Under the asset and liability method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not. We also account for any income tax contingencies in accordance with Statement of Financial Accounting Standards No. 5 (“SFAS 5”), “Accounting for Contingencies.”

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 123—revised 2004 (“SFAS 123R”), “Share-Based Payment” which replaced SFAS 123 and supersedes APB 25. SFAS 123R requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and

9




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the recording of such expense in our consolidated statements of income. SFAS 123R allows either the modified prospective or the modified retrospective method as the method of transition. Under the modified prospective method, compensation cost is recognized beginning with the effective date of adoption (i) for all share-based payments granted after the effective date of adoption and (ii) for all stock options and restricted stock granted prior to the effective date of adoption and that remain unvested on the date of adoption. Under the modified retrospective method, prior periods may be restated for all periods presented.

In April 2005, the Securities and Exchange Commission (the “SEC”) announced that the accounting provisions of SFAS 123R are effective at the beginning of a company’s next fiscal year that begins after June 15, 2005. We are now required to adopt SFAS 123R in the first quarter of fiscal 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. See “Stock-Based Incentive Compensation” above for the pro forma net income and net income per share amounts, for the three and nine months ended September 2, 2005 and September 3, 2004, as if we had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although we have not yet determined the transition method or whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123R and expect the adoption to have a significant adverse impact on our consolidated statements of income and net income per share.

In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (“FAS 109-1”), “Application of FASB Statement No. 109, “Accounting for Income Taxes,” to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (“AJCA”).” The AJCA introduces a special 9% tax deduction on qualified production activities. FAS 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with Statement 109. Pursuant to the AJCA, Adobe will not be able to claim this tax benefit until the first quarter of fiscal 2006. We do not expect the adoption of these new tax provisions to have a material impact on our consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued FASB Staff Position No. FAS 109-2 (“FAS 109-2”), “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004.” The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. Starting in the first quarter of fiscal 2005, Adobe has adopted the accounting and disclosure requirements as outlined in FAS 109-2. See Note 6 for further information.

NOTE 2. ACQUISITIONS

On April 17, 2005, we entered into a definitive agreement to acquire Macromedia, Inc. (“Macromedia”) in an all-stock transaction valued at approximately $3.4 billion. Under the terms of the agreement, which has been approved by the boards of directors and stockholders of both companies, Macromedia stockholders will receive, at a fixed exchange ratio, 1.38 shares of Adobe common stock for

10




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 2. ACQUISITIONS (Continued)

every share of Macromedia common stock in a tax-free exchange. This fixed exchange ratio gives effect to the two-for-one stock split in the form of a stock dividend paid on May 23, 2005 to the stockholders of Adobe. The $3.4 billion estimated purchase price for the acquisition includes the estimated fair value of Adobe common stock issued, stock options and restricted stock assumed, as well as estimated direct transaction costs. We derived this estimate using an average market price per share of Adobe common stock of $29.43, which was based on an average of the closing prices for a range of trading days (April 14, 2005 through April 20, 2005) around the announcement date (April 18, 2005) of the proposed transaction. The final purchase price will be determined based upon the number of Macromedia shares and options outstanding at the closing date. We anticipate that the transaction will close in Fall 2005, subject to appropriate regulatory approvals and the satisfaction of other closing conditions.

On May 3, 2004, we acquired Q-Link Technologies, Inc (“Q-Link”), a privately held company, for $15.9 million in cash. In connection with the acquisition, $14.3 million of the purchase price was allocated to goodwill. Additionally, we acquired $1.4 million in purchased technology which is being amortized, using the straight-line method, over its estimated useful life of three years. We integrated Q-Link’s Java-based workflow technology with our Intelligent Documents platform to enable customers to integrate document process management with core applications.

NOTE 3. GOODWILL AND PURCHASED AND OTHER INTANGIBLES

Below is our goodwill reported by segment as of September 2, 2005 and December 3, 2004:

 

 

2005

 

2004

 

Digital Imaging and Video

 

$

14,112

 

$

14,112

 

Creative Professional

 

4,650

 

4,650

 

Intelligent Documents

 

99,921

 

91,525

 

Total goodwill

 

$

118,683

 

$

110,287

 

 

During fiscal 2005, our goodwill increased due to the acquisition of OKYZ S.A. (“OKYZ”). OKYZ provides three dimensional (“3D”) technology and expertise to our Intelligent Documents platform.

In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” we review our goodwill periodically for impairment. We completed our annual goodwill impairment test during the second quarter of fiscal 2005 and determined that the carrying amount of goodwill was not impaired.

11




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 3. GOODWILL AND PURCHASED AND OTHER INTANGIBLES (Continued)

Purchased and other intangible assets, subject to amortization, were as follows as of September 2, 2005:

 

 

Cost

 

Accumulated
Amortization

 

Net

 

Purchased technology

 

$

24,285

 

 

$

(15,298

)

 

$

8,987

 

Localization

 

15,292

 

 

(7,751

)

 

7,541

 

Trademarks

 

225

 

 

(77

)

 

148

 

Other intangibles

 

301

 

 

(173

)

 

128

 

Total other intangible assets

 

15,818

 

 

(8,001

)

 

7,817

 

Total purchased and other intangible assets

 

$

40,103

 

 

$

(23,299

)

 

$

16,804

 

 

Purchased and other intangible assets, subject to amortization, were as follows as of December 3, 2004:

 

 

Cost

 

Accumulated
Amortization

 

Net

 

Purchased technology

 

$

41,009

 

 

$

(29,266

)

 

$

11,743

 

Localization

 

10,404

 

 

(7,109

)

 

3,295

 

Trademarks

 

300

 

 

(133

)

 

167

 

Other intangibles

 

1,105

 

 

(797

)

 

308

 

Total other intangible assets

 

11,809

 

 

(8,039

)

 

3,770

 

Total purchased and other intangible assets

 

$

52,818

 

 

$

(37,305

)

 

$

15,513

 

 

Amortization expense related to purchased and other intangible assets was $6.2 million and $14.9 million for the three and nine months ended September 2, 2005. Amortization expense related to purchased and other intangible assets was $4.7 million and $13.7 million for the three and nine months ended September 3, 2004. As of September 2, 2005, we expect amortization expense in future periods to be as shown below:

Fiscal year

 

 

 

Purchased
Technology

 

Other Intangible
Assets

 

Remainder of 2005

 

 

$

1,310

 

 

 

$

3,321

 

 

2006

 

 

3,790

 

 

 

4,324

 

 

2007

 

 

2,338

 

 

 

43

 

 

2008

 

 

559

 

 

 

38

 

 

2009

 

 

316

 

 

 

18

 

 

2010

 

 

316

 

 

 

18

 

 

Thereafter

 

 

358

 

 

 

55

 

 

Total expected amortization expense

 

 

$

8,987

 

 

 

$

7,817

 

 

 

12




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 4. OTHER ASSETS

Other assets consisted of the following as of September 2, 2005 and December 3, 2004:

 

 

2005

 

2004

 

Investments

 

$

44,412

 

$

41,382

 

Security deposits and other

 

7,182

 

5,768

 

Prepaid land lease

 

3,311

 

3,340

 

Prepaid rent

 

4,061

 

4,838

 

Total other assets

 

$

58,966

 

$

55,328

 

 

We own limited partnership interests in Adobe Ventures which are consolidated in accordance with FASB Interpretation No. 46R a revision to FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” The partnerships are controlled by Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures.

The following table summarizes the net realized gains and losses from our investments for the three and nine months ended September 2, 2005 and September 3, 2004:

 

 

Three Months

 

Nine Months

 

 

 

2005

 

2004

 

2005

 

2004

 

Net losses related to our investments in Adobe Ventures and cost method investments

 

$

(2,081

)

$

(1,582

)

$

(5,906

)

$

(2,927

)

Write-downs due to other-than-temporary declines in value of our marketable equity securities

 

 

 

(558

)

 

Gains from sales of short-term investments

 

143

 

 

85

 

1,001

 

Gains (losses) on stock warrants

 

(124

)

88

 

62

 

274

 

Other investment gains

 

18

 

 

18

 

 

Total investment loss

 

$

(2,044

)

$

(1,494

)

$

(6,299

)

$

(1,652

)

 

NOTE 5. ACCRUED EXPENSES

Accrued expenses consisted of the following as of September 2, 2005 and December 3, 2004:

 

 

2005

 

2004

 

Compensation and benefits

 

$

98,100

 

$

98,108

 

Sales and marketing allowances

 

14,585

 

11,857

 

Other

 

94,670

 

92,797

 

Total accrued expenses

 

$

207,355

 

$

202,762

 

 

NOTE 6. INCOME TAXES

During the first quarter of fiscal 2005, we completed our evaluation of the repatriation provisions of the AJCA. The AJCA introduced a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. Although the AJCA

13




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 6. INCOME TAXES (Continued)

contained a number of limitations related to the repatriation and some uncertainty remains on key elements of the provision, we made a determination for a planned repatriation of $555.0 million of certain foreign earnings, of which $500.0 million qualifies for the 85% dividends received deduction.

In the first quarter of fiscal 2005, we recorded an estimated tax provision of $52.4 million for the repatriation of certain foreign earnings. Additionally, we recorded a reversal of $71.7 million for income taxes on certain foreign earnings for which a deferred tax liability had been previously accrued. As a result, a net income tax benefit of $19.3 million was recognized for the difference between income taxes previously provided on certain foreign earnings at the federal statutory tax rate and income taxes at the lower rate under the repatriation provisions of the AJCA. The estimated tax provision of $52.4 million for the repatriation of certain foreign earnings was based upon available U.S. Treasury Department guidance at that time.

In May 2005, the U.S. Treasury Department issued clarifying guidance documents related to the repatriation provisions of the AJCA. Based upon this guidance, we revised our estimated tax provision from $52.4 million to $43.5 million for the repatriation of certain foreign earnings. Thus, the second quarter of fiscal 2005 tax provision of $38.0 million includes an additional tax benefit of $8.9 million for income taxes related to the repatriation of certain foreign earnings that was previously accrued during our first quarter.

During the second and third quarter of fiscal 2005, a total of $355.0 million of certain foreign earnings was repatriated. The remaining repatriation will occur during the fourth quarter of fiscal 2005. At that time, further adjustments to the remaining repatriation could be required depending upon a number of factors, including required estimates of fiscal 2005 foreign earnings, 2005 foreign taxes, and statutory tax rates in effect at the time of the repatriation. We will invest these earnings pursuant to an approved Domestic Reinvestment Plan that conforms to the AJCA guidelines.

NOTE 7. STOCKHOLDERS’ EQUITY

Stock Repurchase Program I—On-going Dilution Coverage

To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we repurchase shares in the open market and from time to time enter into structured stock repurchase agreements with third parties.

Authorization to repurchase shares to cover on-going dilution is not subject to expiration. However, this repurchase program is limited to covering net dilution from stock issuances and is subject to business conditions and cash flow requirements as determined by our Board of Directors from time to time.

On April 17, 2005, the Board of Directors approved the use of $1.0 billion for stock repurchases commencing upon the close of the Macromedia acquisition.

During the nine months ended September 2, 2005, we entered into several structured stock repurchase agreements with large financial institutions. Under these agreements, we provided the financial institutions with up-front payments totaling $100.0 million. The financial institutions agreed to deliver to

14




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 7. STOCKHOLDERS’ EQUITY (Continued)

us, at certain intervals during the contract term, a certain number of our shares based on the volume weighted average price during such intervals less a specified discount. Upon payment, the $100.0 million was classified as treasury stock on our balance sheet. As of September 2, 2005, no upfront payments remained under these agreements. As of December 3, 2004, approximately $127.7 million of up-front payments remained under agreements entered into during fiscal 2004.

During the nine months ended September 2, 2005, we repurchased 7.5 million shares at an average price of $30.36 through these structured stock repurchase agreements which included prepayments remaining from fiscal 2004, as described above. During the nine months ended September 3, 2004, we repurchased 12.4 million shares at an average price of $20.82 through open market repurchases and 4.5 million shares at an average price of $21.51 through these structured stock repurchase agreements.

Stock Repurchase Program II—Additional Authorization above Dilution Coverage

On September 25, 2002, our Board of Directors authorized a program to purchase up to an additional 10.0 million shares of our common stock over a three-year period, subject to certain business and cash flow requirements. We did not make any purchases under this 10.0 million share repurchase program. The authorization for this program expired in September 2005.

NOTE 8. COMPREHENSIVE INCOME

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Items of other comprehensive income that we currently report are unrealized gains and losses on marketable securities categorized as available-for-sale and foreign currency translation adjustments. We also report gains and losses on derivative instruments qualifying as cash flow hedges such as (i) hedging a forecasted foreign currency transaction and (ii) the variability of cash flows to be received or paid related to a recognized asset or liability.

The following table sets forth the components of comprehensive income, net of income tax expense, for the three and nine months ended September 2, 2005 and September 3, 2004:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

2005

 

2004

 

2005

 

2004

 

Net income as reported

 

$

144,916

 

$

104,461

 

$

446,588

 

$

336,897

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on available-for-sale securities, net of tax

 

(292

)

3,024

 

(194

)

(4,002

)

Currency translation adjustments

 

1,973

 

(11

)

(1,277

)

(165

)

Net gain (loss) in derivative instruments, net of taxes

 

(5,015

)

850

 

949

 

4,609

 

Other comprehensive income (loss)

 

(3,334

)

3,863

 

(522

)

442

 

Total comprehensive income, net of taxes

 

$

141,582

 

$

108,324

 

$

446,066

 

$

337,339

 

 

15




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 9. NET INCOME PER SHARE

Basic net income per share is computed using the weighted average number of common shares outstanding for the period, excluding unvested restricted stock. Diluted net income per share is based upon the weighted average common shares outstanding for the period plus dilutive potential common shares, including unvested restricted common stock and stock options using the treasury stock method.

The following table sets forth the computation of basic and diluted net income per share for the three and nine months ended September 2, 2005 and September 3, 2004:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

2005

 

2004

 

2005

 

2004

 

Net income

 

$

144,916

 

$

104,461

 

$

446,588

 

$

336,897

 

Shares used to compute basic net income per share (weighted average shares outstanding during the period, excluding unvested restricted stock)

 

491,710

 

476,942

 

489,017

 

476,982

 

Dilutive common equivalent shares:

 

 

 

 

 

 

 

 

 

Unvested restricted stock

 

36

 

22

 

36

 

22

 

Stock options

 

16,075

 

17,262

 

18,807

 

16,494

 

Shares used to compute diluted net income per share

 

507,821

 

494,226

 

507,860

 

493,498

 

Basic net income per share

 

$

0.29

 

$

0.22

 

$

0.91

 

$

0.71

 

Diluted net income per share

 

$

0.29

 

$

0.21

 

$

0.88

 

$

0.68

 

 

NOTE 10. COMMITMENTS AND CONTINGENCIES

Lease Commitments

We lease certain of our facilities and some of our equipment under noncancelable operating lease arrangements that expire at various dates through 2025. We also have one land lease that expires in 2091.

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.”

In December 2003, upon completion of construction of the Almaden tower, we began a five year lease agreement. Under the agreement, we have the option to purchase the building at any time during the lease term for the lease balance, which is approximately $103.0 million. The maximum recourse amount (“residual value guarantee”) under this obligation is $90.8 million.

In August 2004, we extended the lease agreement for our East and West towers for an additional five years with an option to extend for an additional five years solely at Adobe’s election. As part of the lease extension, we purchased a portion of the lease receivable of the lessor for $126.8 million, which is recorded as an investment in lease receivable on our consolidated balance sheet. This purchase may be credited against the residual value guarantee if we purchase the properties or repaid from the sale proceeds if the properties are sold to third parties. Under the agreement for the East and West towers, we have the option to purchase the buildings at any time during the lease term for the lease balance, which is approximately $143.2 million. The residual value guarantee under this obligation is $126.8 million.

16




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)

These two leases are both subject to standard covenants including liquidity, leverage and profitability ratios that are reported to the lessors quarterly. As of September 2, 2005, we were in compliance with all covenants. In the case of a default, the lessor may demand we purchase the buildings for an amount equal to the lease balance, or require that we remarket or relinquish the buildings. Both leases qualify for operating lease accounting treatment under Statement of Financial Accounting Standards No. 13, “Accounting for Leases,” and, as such, the buildings and the related obligations are not included on our consolidated balance sheet. We utilized this type of financing in order to access bank-provided funding at the most favorable rates and to provide the lowest total cost of occupancy for the headquarter buildings. At the end of the current lease term, we can extend the lease for an additional five year term (for the East and West towers lease only), purchase the buildings for the lease balance, remarket or relinquish the buildings. If we choose to remarket or are required to do so upon relinquishing the buildings, we are bound to arrange the sale of the buildings to an unrelated party and will be required to pay the lessor any shortfall between the net remarketing proceeds and the lease balance, up to the maximum recourse amount.

Royalties

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

Guarantees

The lease agreements for our corporate headquarters provide for residual value guarantees. Under FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” the fair value of a residual value guarantee in lease agreements entered into after December 31, 2002, must be recognized as a liability on our consolidated balance sheet. As such, we have recognized a $5.2 million liability related to the East and West towers lease that was extended in August 2004. This liability is recorded in other long-term liabilities with the offsetting entry recorded as prepaid rent in other assets. The balance will be amortized to the income statement over the life of the lease. As of September 2, 2005, the unamortized portion of the fair value of the residual value guarantee remaining in other long-term liabilities and prepaid rent was $4.1 million.

In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. 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.

17




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)

We have commitments to make certain milestone and/or retention payments typically entered into in conjunction with various acquisitions, for which we have made accruals in our consolidated financial statements. In connection with certain acquisitions and purchases of technology assets, we entered into employee retention agreements and are required to make payments upon satisfaction of certain conditions in the agreements. These costs are being amortized over the retention period to compensation expense. As of September 2, 2005, we have $0.7 million remaining to be paid under our retention agreements.

As 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 limits 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.

As part of our limited partnership interests in Adobe Ventures, we have provided a general indemnification to Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures, for certain events or occurrences while Granite Ventures is, or was serving, at our request in such capacity provided that Granite Ventures acts in good faith on behalf of the partnerships. We are unable to develop an estimate of the maximum potential amount of future payments that could potentially result from any hypothetical future claim, but believe the risk of having to make any payments under this general indemnification to be remote.

Legal Actions

On September 6, 2002, Plaintiff Fred B. Dufresne filed suit against Adobe, Microsoft Corporation, Macromedia, Inc. and Trellix Corporation in the U.S. District Court, District of Massachusetts, alleging infringement of U.S. Patent No. 5,835,712, entitled “Client-Server System Using Embedded Hypertext Tags for Application and Database Development.” The Plaintiff’s complaint asserts that “defendants have infringed, and continue to infringe, one or more claims of the ‘712 patent by making, using, selling and/or offering for sale, inter alia, products supporting Microsoft Active Server Pages technology.” Plaintiff seeks unspecified compensatory damages, preliminary and permanent injunctive relief, trebling of damages for “willful infringement,” and fees and costs. We believe the action has no merit and are vigorously defending against it. We cannot estimate any possible loss at this time.

On June 13, 2005, Plaintiff Steve Staehr filed a shareholder derivative action entitled “Steve Staehr, Derivatively on Behalf of Adobe Systems Incorporated v. Bruce R. Chizen, et. al.,” in the Superior Court of the State of California for the County of Santa Clara against Adobe’s directors and naming Adobe as a nominal defendant. The complaint alleges that the defendants breached their fiduciary duties of loyalty and due care and caused Adobe to waste corporate assets by failing to renegotiate or terminate the acquisition agreement with Macromedia following the announcement by Macromedia that it would restate its financial results for the fiscal years ended March 31, 1999 through 2004 and by failing to conduct

18




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)

sufficient due diligence prior to entering into the acquisition agreement. The complaint seeks, among other things, unspecified monetary damages, attorneys’ fees and certain forms of equitable relief, including preliminarily and permanently enjoining the consummation of the acquisition. On August 18, 2005, Plaintiff amended his complaint to add a purported class action. Adobe has obligations under certain circumstances to hold harmless and indemnify each of the defendant directors against judgments, fines, settlements and expenses related to claims against such directors and otherwise to the fullest extent permitted under Delaware law and Adobe’s bylaws and certificate of incorporation. Such obligations may apply to this lawsuit. We believe the action has no merit and are vigorously defending against it. We cannot estimate any possible loss at this time.

In connection with our anti-piracy efforts, conducted both internally and through 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 local law and have recently increased in frequency, especially in Latin American countries. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be affected in any particular period by the resolution of one or more of these counter-claims.

One such case is Consultores en Computación y Contabilidad, S.C. (“CCC”) v. Microsoft, Adobe, Symantec, and Autodesk (the “Defendants”). On March 1, 2002, CCC, a Mexican hardware/software reseller, filed a lawsuit in the Mexico Court of First Instance against the Defendants (all members of the Business Software Alliance). CCC had previously been the target of a criminal anti-piracy enforcement action carried out by the Mexican police authorities on the basis of a piracy complaint filed by the Defendants based on evidence provided to the Defendants. CCC alleged in the lawsuit that it had suffered damages to its reputation as a result of the enforcement action. CCC did not claim economic damages. On November 11, 2002, the trial court judge ruled in favor of the Defendants, holding that no moral damage occurred. After subsequent appeals which were favorable to the Defendants, a court of appeals held that the Defendants were liable to CCC for “moral” damages, and the court remanded the case to the Court of First Instance for a determination of the amount. On September 9, 2005, CCC filed its damages brief, claiming moral damages in excess of $800 million. We believe that the damages claim has no merit and are vigorously defending against it. We cannot estimate any possible loss at this time.

From time to time, in addition to those identified above, Adobe is subject to legal proceedings, claims, investigations and proceedings in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. In accordance with U.S. generally accepted accounting principles, Adobe makes 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. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against Adobe. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be affected by the resolution of one or more of

19




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)

such contingencies. No amount has been accrued for these matters as a loss is not considered probable or estimable.

NOTE 11. FINANCIAL INSTRUMENTS

In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” we recognize derivative instruments as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting.

Economic Hedging—Hedges of Forecasted Transactions

We use option and forward foreign exchange contracts to hedge certain operational (“cash flow”) exposures resulting from changes in foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. Such cash flow exposures result from portions of our forecasted revenues denominated in currencies other than the U.S. dollar, primarily the Japanese yen and the euro. We enter into these foreign exchange contracts to hedge forecasted product licensing revenue in the normal course of business, and accordingly, they are not speculative in nature.

We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income, 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 on the consolidated statement of income at that time. For the three and nine months ended September 2, 2005, there were no such net gains or losses recognized in other income relating to hedges of forecasted transactions that did not occur.

The critical terms of the cash flow hedging instruments are the same as the underlying forecasted transactions. The changes in fair value of the derivatives are intended to offset changes in the expected cash flows from the forecasted transactions. We record any ineffective portion of the hedging instruments in other income on the consolidated statement of income. The time value of purchased derivative instruments, including premium costs on option contracts, is deemed to be ineffective and is recorded in other income over the life of the contract.

Gain (Loss) on Hedges of Forecasted Transactions:

 

 

Other Comprehensive
Loss

 

 

 

September 2,

 

December 3,

 

Balance Sheet

 

 

 

2005

 

2004

 

Recognized but Unrealized—Open Transactions:

 

 

 

 

 

 

 

 

 

Unrealized net gain remaining in other comprehensive loss

 

 

$

949

 

 

 

$

 

 

 

20




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 11. FINANCIAL INSTRUMENTS (Continued)

 

 

 

Three Months Ended

 

 

 

September 2, 2005

 

September 3, 2004

 

Income Statement

 

 

 

Revenue

 

Other
Income

 

Revenue

 

Other
Income

 

Realized—Closed Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized net gain reclassified from other comprehensive loss to revenue

 

 

$

5,351

 

 

$

 

 

$

1,055

 

 

$

 

Realized net loss from the cost of purchased options and gains or losses from any ineffective portion of hedges

 

 

 

 

(1,061

)

 

 

 

(1,718

)

Recognized but Unrealized—Open Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net gain (loss) from time value degradation and any ineffective portion of hedges

 

 

 

 

233

 

 

 

 

(555

)

 

 

 

$

5,351

 

 

$

(828

)

 

$

1,055

 

 

$

(2,273

)

 

 

 

Nine Months Ended

 

 

 

September 2, 2005

 

September 3, 2004

 

 

 

Revenue

 

Other
Income

 

Revenue

 

Other
Income

 

Realized—Closed Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized net gain (loss) reclassified from other comprehensive loss to revenue

 

 

$

5,351

 

 

$

 

 

$

(514

)

 

$

 

Realized net loss from the cost of purchased options and gains or losses from any ineffective portion of hedges

 

 

 

 

(5,567

)

 

 

 

(4,793

)

Recognized but Unrealized—Open Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net gain (loss) from time value degradation and any ineffective portion of hedges

 

 

 

 

2,915

 

 

 

 

(648

)

 

 

 

$

5,351

 

 

$

(2,652

)

 

$

(514

)

 

$

(5,441

)

 

Balance Sheet Hedging—Hedging of Foreign Currency Assets and Liabilities

We hedge our net recognized foreign currency assets and liabilities with forward foreign exchange contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with changes in the fair value recorded as other income. These derivative instruments 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. At September 2, 2005, the outstanding balance sheet hedging derivatives had maturities of 90 days or less.

21




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 11. FINANCIAL INSTRUMENTS (Continued)

Net gains recognized in other income relating to balance sheet hedging for the three and nine months ended September 2, 2005 and September 3, 2004 were as follows:

 

 

Three Months

 

Nine Months

 

 

 

2005

 

2004

 

2005

 

2004

 

Gain (loss) on foreign currency assets and liabilities:

 

 

 

 

 

 

 

 

 

Net realized gain (loss) recognized in other income

 

$

19

 

$

(1,222

)

$

(5,434

)

$

(2,050

)

Net unrealized gain (loss) recognized in other income

 

1,280

 

(640

)

(1,099

)

1,533

 

 

 

1,299

 

(1,862

)

(6,533

)

(517

)

Gain (loss) on hedges of foreign currency assets and liabilities:

 

 

 

 

 

 

 

 

 

Net realized gain (loss) recognized in other income

 

3,956

 

(1,110

)

6,521

 

(7,062

)

Net unrealized gain (loss) recognized in other income

 

(4,281

)

2,276

 

1,860

 

7,405

 

 

 

(325

)

1,166

 

8,381

 

343

 

Net gain (loss) recognized in other income

 

$

974

 

$

(696

)

$

1,848

 

$

(174

)

 

Fair Value Hedges—Hedging of Foreign Currency Denominated Available for Sale Securities

During fiscal 2004, a portion of our investment portfolio was invested in euro denominated securities. In order to mitigate the currency risk of those euro denominated securities, we entered into forward currency contracts designated as fair value hedges. During fiscal 2005, we did not invest in euro denominated securities.

Net gains recognized in other income relating to fair value hedges for the three and nine months ended September 3, 2004 were as follows:

 

 

Three

 

Nine

 

 

 

Months

 

Months

 

Gain (loss) on foreign currency assets and liabilities:

 

 

 

 

 

Net realized gain recognized in other income

 

$

297

 

$

2,234

 

Net unrealized loss recognized in other income

 

(1,755

)

(1,935

)

 

 

(1,458

)

299

 

Gain (loss) on hedges of foreign currency assets and liabilities:

 

 

 

 

 

Net realized gain (loss) recognized in other income

 

(317

)

3,026

 

Net unrealized gain (loss) recognized in other income

 

1,663

 

(3,482

)

 

 

1,346

 

(456

)

Net loss recognized in other income

 

$

(112

)

$

(157

)

 

NOTE 12. INDUSTRY SEGMENTS

We have four reportable segments: Digital Imaging and Video, Creative Professional, Intelligent Documents, and OEM PostScript and Other. The Digital Imaging and Video segment provides users with software for creating, editing, enhancing and sharing digital images and photographs, digital video, audio and animations. The Creative Professional segment provides software for professional page layout,

22




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 12. INDUSTRY SEGMENTS (Continued)

professional Web page layout, graphic and illustration creation, technical document publishing and business publishing. Additionally, this segment includes Photoshop and Acrobat Professional as part of its Adobe Creative Suite products. The Intelligent Documents segment provides electronic document distribution software that allows users to create, enhance, annotate and securely send Adobe PDF files that can be shared, viewed, navigated and printed exactly as intended on a broad range of hardware and software platforms. In addition, this segment provides server-based solutions for enterprises, in the areas of document generation, document process management, document collaboration, document workflow and document control and security. The OEM PostScript and Other segment includes printing technology used to create and print simple or visually rich documents with precision.

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. With the exception of goodwill, we do not identify or allocate our assets by operating segments. See Note 3 for the allocation of goodwill to our reportable segments.

 

 

 

 

 

 

 

 

OEM

 

 

 

 

 

Digital

 

 

 

 

 

PostScript

 

 

 

 

 

Imaging and

 

Creative

 

Intelligent

 

and

 

 

 

Three Months

 

 

 

Video

 

Professional

 

Documents

 

Other

 

Total

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

$

95,589

 

 

 

$

206,308

 

 

 

$

165,850

 

 

 

$

19,292

 

 

$

487,039

 

Cost of revenue

 

 

8,325

 

 

 

7,037

 

 

 

10,864

 

 

 

1,254

 

 

27,480

 

Gross profit

 

 

$

87,264

 

 

 

$

199,271

 

 

 

$

154,986

 

 

 

$

18,038

 

 

$

459,559

 

Gross profit as a percentage of revenues

 

 

91

%

 

 

97

%

 

 

93

%

 

 

93

%

 

94

%

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

$

98,449

 

 

 

$

150,395

 

 

 

$

135,548

 

 

 

$

19,321

 

 

$

403,713

 

Cost of revenue

 

 

7,984

 

 

 

5,847

 

 

 

8,323

 

 

 

1,415

 

 

23,569

 

Gross profit

 

 

$

90,465

 

 

 

$

144,548

 

 

 

$

127,225

 

 

 

$

17,906

 

 

$

380,144

 

Gross profit as a percentage of revenues

 

 

92

%

 

 

96

%

 

 

94

%

 

 

93

%

 

94

%

                                                                                                                                               

23




ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share data)
(Unaudited)

NOTE 12. INDUSTRY SEGMENTS (Continued)

 

 

 

 

 

 

 

 

OEM

 

 

 

 

 

Digital

 

 

 

 

 

PostScript

 

 

 

 

 

Imaging and

 

Creative

 

Intelligent

 

and

 

 

 

Nine Months

 

 

 

Video

 

Professional

 

Documents

 

Other

 

Total

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

$

318,113

 

 

 

$

551,421

 

 

 

$

526,955

 

 

 

$

59,461

 

 

$

1,455,950

 

Cost of revenue

 

 

26,185

 

 

 

17,037

 

 

 

34,750

 

 

 

3,911

 

 

81,883

 

Gross profit

 

 

$

291,928

 

 

 

$

534,384

 

 

 

$

492,205

 

 

 

$

55,550

 

 

$

1,374,067

 

Gross profit as a percentage of revenues

 

 

92

%

 

 

97

%

 

 

93

%

 

 

93

%

 

94

%

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

$

312,228

 

 

 

$

461,924

 

 

 

$

401,923

 

 

 

$

61,004

 

 

$

1,237,079

 

Cost of revenue

 

 

27,072

 

 

 

16,140

 

 

 

27,974

 

 

 

3,820

 

 

75,006

 

Gross profit

 

 

$

285,156

 

 

 

$

445,784

 

 

 

$

373,949

 

 

 

$

57,184

 

 

$

1,162,073

 

Gross profit as a percentage of revenues

 

 

91

%

 

 

97

%

 

 

93

%

 

 

94

%

 

94

%

 

A reconciliation of the totals reported for the operating segments to the applicable line items in the condensed consolidated financial statements for the three and nine months ended September 2, 2005 and September 3, 2004 is as follows:

 

 

Three Months

 

Nine Months

 

 

 

2005

 

2004

 

2005

 

2004

 

Total gross profit from operating segments above

 

$

459,559

 

$

380,144

 

$

1,374,067

 

$

1,162,073

 

Total operating expenses*

 

275,971

 

239,830

 

837,563

 

716,658

 

Total operating income

 

183,588

 

140,314

 

536,504

 

445,415

 

Other income, net

 

10,376

 

849

 

22,053

 

9,850

 

Income before income taxes

 

$

193,964

 

$

141,163

 

$

558,557

 

$

455,265

 


*                     Total operating expenses include research and development, sales and marketing, and general and administrative.

NOTE 13. SUBSEQUENT EVENT

In September 2005, we entered into additional structured stock repurchase agreements with large financial institutions. Under these agreements, we provided the financial institutions with up-front payments totaling $500.0 million. The financial institutions agreed to deliver to us, at certain intervals during the contract term, a certain number of shares based on the volume weighted average price during such intervals less a specified discount. The $500.0 million will be classified as treasury stock on our balance sheet. No shares have been delivered under these agreements.

24




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

The following discussion (presented in millions, except share and per share amounts, and is unaudited) should be read in conjunction with the condensed consolidated financial statements and notes thereto. The share and per share data below have been adjusted to give effect to our stock split as of May 23, 2005.

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, acquisitions and investing activities, that involve risks and uncertainties that could cause actual results to differ materially. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Factors That May Affect Future Performance.” You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission, including the Annual Report on Form 10-K for fiscal 2004  and the Quarterly Report on Form 10-Q filed by us in fiscal 2005. When used in this report, the words “expects,” “could,” “would,” “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” and similar expressions, as well as statements regarding Adobe’s focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

PENDING ACQUISITION

On April 17, 2005, we entered into a definitive agreement to acquire Macromedia in an all-stock transaction valued at approximately $3.4 billion. Under the terms of the agreement, which has been approved by the boards of directors and the stockholders of both companies, Macromedia stockholders will receive, at a fixed exchange ratio, 1.38 shares of Adobe common stock for every share of Macromedia common stock in a tax-free exchange. This fixed exchange ratio gives effect to the two-for-one stock split in the form of a stock dividend paid on May 23, 2005 to the stockholders of Adobe. We anticipate that the transaction will close in Fall 2005, subject to appropriate regulatory approvals and the satisfaction of other closing conditions. We expect the acquisition to have a significant impact on our consolidated financial position, results of operations and cash flows. The discussions in this Quarterly Report on Form 10-Q relate to Adobe as a standalone entity and do not reflect the impact of the acquisition.

BUSINESS OVERVIEW

Founded in 1982, Adobe Systems Incorporated offers a line of software and services for consumers, creative professionals and enterprises, in both public and private sectors. Our products are digital imaging, design, and document technology platforms which enable customers to create, manage and deliver visually rich, compelling and reliable content. We distribute our products through a network of distributors and dealers, value-added resellers (“VARs”), systems integrators, independent software vendors (“ISVs”) and original equipment manufacturers (“OEMs”); direct to end users; and through our own Web site at www.adobe.com. We also license our technology to major hardware manufacturers, software developers and service providers and we offer integrated software solutions to businesses of all sizes. We have operations in the Americas; Europe, Middle East and Africa (“EMEA”); and Asia. Our software runs on Microsoft Windows, Apple Macintosh, Linux, UNIX and various non-personal computer platforms, depending on the product.

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

25




CRITICAL ACCOUNTING ESTIMATES

In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our consolidated financial statements. 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 and make changes accordingly. We also discuss our critical accounting 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 and income taxes have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. We discuss below the critical accounting estimates associated with these policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, see the discussion in the section titled “Recent Accounting Pronouncements” below and Note 1 of our Notes to Condensed Consolidated Financial Statements.

Revenue Recognition

We recognize revenue in accordance with current U.S. generally accepted accounting principles that have been prescribed for the software industry. Revenue recognition requirements in the software industry are very complex and are subject to change. Our revenue recognition policy is one of our critical accounting policies because revenue is a key component of our results of operations and is based on complex rules which require us to make judgments and estimates. In applying our revenue recognition policy we must determine which portions of our revenue are recognized currently and which portions, if any, must be deferred. In order to determine current and deferred revenue, we make judgments and estimates with regard to future deliverable products and services and the appropriate pricing for those products and services. Our assumptions and judgments regarding future products and services could differ from actual events, thus materially impacting our financial position and results of operations.

We have to estimate provisions for returns which are recorded against our revenues. In determining our estimate for returns, and in accordance with our internal policy regarding global channel inventory which is used to determine the level of product held by our distributors on which we have recognized revenue, we rely upon historical data, the estimated amount of product inventory in our distribution channel, the rate at which our product sells through to the end user, product plans and other factors. Our estimated provisions for returns can vary from what actually occurs. More or less product may be returned from what was estimated. The amount of inventory in the channel could be different than what is estimated. Our estimate of the rate of sell through for product in the channel could be different than what actually occurs. There could be a delay in the release of our products. These factors and unanticipated changes in the economic and industry environment could make our return estimates differ from actual returns, thus materially impacting our financial position and results of operations.

Accounting for Income Taxes

We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year and for deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax

26




authorities. Changes in tax law or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements. Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued SFAS 123R which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our consolidated statements of income. In April 2005, the SEC announced that the accounting provisions of SFAS 123R are effective at the beginning of a company’s next fiscal year that begins after June 15, 2005. We are now required to adopt SFAS 123R in the first quarter of fiscal 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. See Note 1 in our Notes to Condensed Consolidated Financial Statements for the pro forma net income and net income per share amounts as if we had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123R and expect the adoption to have a significant adverse impact on our consolidated statements of income and net income per share.

In December 2004, the FASB issued FAS 109-2. See “Provision for Income Taxes” under “Results of Operations” and Note 6 in our Notes to Condensed Consolidated Financial Statements for further information.

See Note 1 in our Notes to Condensed Consolidated Financial Statements for information regarding other recent accounting pronouncements.

RESULTS OF OPERATIONS

Overview of the Three and Nine Months Ended September 2, 2005

During the third quarter of fiscal 2005, we continued to focus on delivering comprehensive technology platforms to our customers to drive revenue and earnings growth. We released version 2 of our Adobe Creative Suite products in non-English languages during the quarter. Creative Suite 2.0 integrates new full-versions of Adobe’s design and publishing software, along with Version Cue CS2 and a new visual file browser called Adobe Bridge. Momentum continued in the quarter for InDesign CS2, which also was launched in non-English languages during the third quarter. In our Intelligent Documents business, we achieved year-over-year growth with our Acrobat 7.0 family of products which began shipping in the first quarter. Acrobat 7.0 has numerous new features to help drive increased adoption by users in enterprises, governments, and specialized vertical markets such as architecture, engineering and construction. We also achieved year-over-year growth in our Intelligent Document server-based business, offset slightly by a year-over-year decline in our Digital Imaging and Video business.

We continue to focus on delivering innovative products and solutions for our customers. Our success could be limited by several factors, including the timely release of new products, continued market acceptance of our products, the introduction of new products by existing or new competitors and unfavorable exchange rate fluctuations. For a further discussion of these and other risk factors, see the section titled “Factors That May Affect Future Performance.”

27




Revenue for the Three and Nine Months Ended September 2, 2005 and September 3, 2004

 

 

Three Months

 

Percent

 

Nine Months

 

Percent

 

 

 

2005

 

2004

 

Change

 

2005

 

2004

 

Change

 

Product

 

$

476.0

 

$

395.4

 

 

20

%

 

$

1,424.9

 

$

1,213.8

 

 

17

%

 

Percentage of total revenues

 

98

%

98

%

 

 

 

 

98

%

98

%

 

 

 

 

Services and support

 

11.0

 

8.3

 

 

33

%

 

31.1

 

23.3

 

 

34

%

 

Percentage of total revenues

 

2

%

2

%

 

 

 

 

2

%

2

%

 

 

 

 

Total revenues

 

$

487.0

 

$

403.7

 

 

21

%

 

$

1,456.0

 

$

1,237.1

 

 

18

%

 

 

We have four reportable segments that offer different product lines: Digital Imaging and Video, Creative Professional, Intelligent Documents, and OEM PostScript and Other. The Digital Imaging and Video segment provides users with software for creating, editing, enhancing and sharing digital images and photographs, digital video, audio and animations. The Creative Professional segment provides software for professional page layout, professional Web page layout, graphic and illustration creation, technical document publishing and business publishing. Additionally, this segment includes Photoshop and Acrobat Professional as part of its Adobe Creative Suite products. The Intelligent Documents segment provides electronic document distribution software that allows users to create, enhance, annotate and securely send Adobe PDF files that can be shared, viewed, navigated and printed exactly as intended on a broad range of hardware and software platforms. In addition, this segment provides server-based solutions for private and public sector enterprises, in the areas of document generation, document process management, document collaboration, document workflow and document control and security. The OEM PostScript and Other segment includes printing technology used to create and print simple or visually rich documents with precision.

Our services and support revenue is composed of professional services (such as consulting services and training) and maintenance and support, primarily related to the licensing of our Intelligent Documents server solution products. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products. Our professional services revenue is recognized using the proportionate performance method and is measured monthly based on input measures, such as hours incurred to date compared to total estimated hours to complete, with consideration given to output measures, such as contract milestones, when applicable. Our maintenance and support offerings, which entitle customers to receive product upgrades and enhancements or technical support, depending on the offering, are recognized ratably over the term of the arrangement.

Segment Information

 

 

Three Months

 

Percent

 

Nine Months

 

Percent

 

 

 

2005

 

2004

 

Change

 

2005

 

2004

 

Change

 

Digital Imaging and Video

 

$

95.6

 

$

98.4

 

 

(3

)%

 

$

318.1

 

$

312.2

 

 

2

%

 

Percentage of total revenues

 

20

%

24

%

 

 

 

 

22

%

25

%

 

 

 

 

Creative Professional

 

206.3

 

150.4

 

 

37

%

 

551.4

 

461.9

 

 

19

%

 

Percentage of total revenues

 

42

%

37

%

 

 

 

 

38

%

37

%

 

 

 

 

Intelligent Documents

 

165.8

 

135.5

 

 

22

%

 

527.0

 

401.9

 

 

31

%

 

Percentage of total revenues

 

34

%

34

%

 

 

 

 

36

%

33

%

 

 

 

 

OEM PostScript and Other

 

19.3

 

19.4

 

 

%

 

59.5

 

61.1

 

 

(3

)%

 

Percentage of total revenues

 

4

%

5

%

 

 

 

 

4

%

5

%

 

 

 

 

Total revenues

 

$

487.0

 

$

403.7

 

 

21

%

 

$

1,456.0

 

$

1,237.1

 

 

18

%

 

 

Revenue from our Digital Imaging and Video segment decreased slightly during the three months ended September 2, 2005 primarily due to a 23% decrease in revenues from our digital video software

28




products as a result of product lifecycle timing. This decrease was partially offset by a 3% increase in revenues from our digital imaging software products which was attributable to the continuing success of releases earlier in the year and at the end of fiscal 2004. Revenue from our Digital Imaging and Video segment increased slightly during the nine months ended September 2, 2005 primarily due to a 5% increase in revenues from our digital imaging software products which was attributable to the continuing success of releases earlier in the year and at the end of fiscal 2004. This increase was partially offset by a 10% decrease in revenues from our digital video software products as a result of product lifecycle timing.

Revenue from our Creative Professional segment increased during the three and nine months ended September 2, 2005 primarily due to a 54% and 29% increase in revenues, respectively, from the new versions of our Adobe Creative Suite products which were released in the second quarter of fiscal 2005. There were no notable decreases for the three and nine months ended September 2, 2005.

Revenue from our Intelligent Documents segment increased during the three and nine months ended September 2, 2005 primarily due to the 28% and 36% increase in revenues, respectively, from our Acrobat desktop products. The increase in revenues from our Acrobat desktop products is due to continued adoption of Acrobat desktop products and the release of Acrobat 7.0 during the first quarter of fiscal 2005. Revenue from our Intelligent Documents server-based products increased approximately 3% and 9%, respectively, during the three and nine months ended September 2, 2005 due to increased licensing and server support revenue, as we continue to focus on both the government sector and financial services. Additionally, revenue from our Intelligent Documents segment increased for the nine months ended September 2, 2005 due to an increase in revenues from our Professional Services.

Revenue from our OEM PostScript and Other segment remained relatively flat for the three months ended September 2, 2005. Revenue from this segment decreased during the nine months ended September 2, 2005 primarily due to a decline in pricing resulting from competition from clone PostScript technologies. Revenue from this segment has declined over the last few years and we expect this trend to continue, but if the decline significantly exceeds our expectations, it may harm our future results.

Geographic Information

 

 

Three Months

 

Percent

 

Nine Months

 

Percent

 

 

 

2005

 

2004

 

Change

 

2005

 

2004

 

Change

 

Americas

 

$

228.3

 

$

195.9

 

 

17

%

 

$

688.7

 

$

561.9

 

 

23

%

 

Percentage of total revenues

 

47

%

48

%

 

 

 

 

47

%

45

%

 

 

 

 

EMEA

 

153.0

 

123.5

 

 

24

%

 

448.6

 

401.9

 

 

12

%

 

Percentage of total revenues

 

31

%

31

%

 

 

 

 

31

%

33

%

 

 

 

 

Asia

 

105.7

 

84.3

 

 

25

%

 

318.7

 

273.3

 

 

17

%

 

Percentage of total revenues

 

22

%

21

%

 

 

 

 

22

%

22

%

 

 

 

 

Total revenues

 

$

487.0

 

$

403.7

 

 

21

%

 

$

1,456.0

 

$

1,237.1

 

 

18

%

 

 

Revenue in the Americas increased during the three months ended September 2, 2005 due to the strength of our Creative Professional and Intelligent Document products. Revenue in the Americas increased during the nine months ended September 2, 2005 due to the strength of our Digital Imaging and Video, Creative Professional and Intelligent Document products.

Revenue in EMEA increased during the three months ended September 2, 2005 due to the strength of our Digital Imaging and Video, Creative Professional and Intelligent Document products. Revenue in EMEA increased during the nine months ended September 2, 2005 due to the strength of our Creative Professional and Intelligent Document products.

Revenue in Asia increased during the three months ended September 2, 2005 due to the strength of our Digital Imaging and Video, Creative Professional and Intelligent Document products. Revenue in Asia

29




increased during the nine months ended September 2, 2005 due to the strength of our Creative Professional and Intelligent Document products.

Additionally, revenues in EMEA and Asia increased approximately $2.9 million and $24.3 million during the three and nine months ended September 2, 2005, respectively, over the same reporting periods last year due to the strength of the euro and the yen as compared to the U.S. dollar.

Platform Information

 

 

Three Months

 

Nine Months

 

 

 

2005

 

2004

 

2005

 

2004

 

Windows

 

 

73

%

 

 

73

%

 

 

74

%

 

 

72

%

 

Macintosh

 

 

27

%

 

 

27