Edgar Filing: ADOBE SYSTEMS INC

form10-q.htm

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 May 30, 2008

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 a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the 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 June 27, 2008 was 530,454,186.

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 May 30, 2008 and November 30, 2007	3
		Condensed Consolidated Statements of Income Three and Six Months Ended May 30, 2008 and June 1, 2007	4
		Condensed Consolidated Statements of Cash Flows Six Months Ended May 30, 2008 and June 1, 2007	5
		Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		32
Item 4.	Controls and Procedures		32

PART II—OTHER INFORMATION
Item 1.	Legal Proceedings		33
Item 1A.	Risk Factors		33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		40
Item 4.	Submission of Matters to a Vote of Security Holders		41
Item 5.	Other Information		41
Item 6.	Exhibits		41
Signature			49
Summary of Trademarks			50

Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)

	May 30, 2008			November 30, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	1,162,453		$	946,422
Short-term investments		702,283			1,047,432
Trade receivables, net of allowances for doubtful accounts of $4,026 and $4,398, respectively		321,150			318,145
Other receivables		46,980			44,666
Deferred income taxes		100,206			171,472
Prepaid expenses and other assets		48,397			44,840
Total current assets		2,381,469			2,572,977
Property and equipment, net		300,371			289,758
Goodwill		2,135,167			2,148,102
Purchased and other intangibles, net		313,245			402,619
Investment in lease receivable		207,239			207,239
Other assets		122,926			92,984
Total assets	$	5,460,417		$	5,713,679

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade and other payables	$	60,961		$	66,867
Accrued expenses		377,572			383,436
Accrued restructuring		5,573			3,731
Income taxes payable		37,065			215,058
Deferred revenue		191,594			183,318
Total current liabilities		672,765			852,410
Long-term liabilities:
Debt		350,000			—
Accrued restructuring		10,152			13,987
Income taxes payable		200,111			—
Deferred income taxes		137,852			148,943
Deferred revenue		24,819			25,950
Other liabilities		24,061			22,407
Total liabilities		1,419,760			1,063,697
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; 530,194 and 571,409 shares outstanding, respectively		61			61
Additional paid-in-capital		2,308,054			2,340,969
Retained earnings		4,475,880			4,041,592
Accumulated other comprehensive income		21,301			27,948
Treasury stock, at cost (70,640 and 29,425 shares, respectively), net of reissuances		(2,764,639	)		(1,760,588	)
Total stockholders’ equity		4,040,657			4,649,982
Total liabilities and stockholders’ equity	$	5,460,417		$	5,713,679

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						Six Months
	May 30, 2008			June 1, 2007			May 30, 2008			June 1, 2007
Revenue:
Products	$	841,301		$	713,469		$	1,693,263		$	1,333,767
Services and support		45,585			32,108			84,068			61,217
Total revenue		886,886			745,577			1,777,331			1,394,984
Total cost of revenue:
Products		58,229			70,715			118,034			124,530
Services and support		24,637			20,499			47,307			38,947
Total cost of revenue		82,866			91,214			165,341			163,477
Gross profit		804,020			654,363			1,611,990			1,231,507
Operating expenses:
Research and development		170,300			150,049			338,785			287,178
Sales and marketing		279,365			236,402			541,960			451,080
General and administrative		77,078			68,597			160,007			129,872
Restructuring and other charges		—			—			1,431			—
Amortization of purchased intangibles and incomplete technology		17,099			18,924			34,198			36,649
Total operating expenses		543,842			473,972			1,076,381			904,779
Operating income		260,178			180,391			535,609			326,728
Non-operating income (expense):
Interest and other income, net		12,150			20,618			25,440			43,133
Interest expense		(3,828	)		(55	)		(5,637	)		(106	)
Investment gains, net		9,506			4,162			18,238			9,763
Total non-operating income, net		17,828			24,725			38,041			52,790
Income before income taxes		278,006			205,116			573,650			379,518
Provision for income taxes		63,096			52,611			139,361			83,162
Net income	$	214,910		$	152,505		$	434,289		$	296,356
Basic net income per share	$	0.40		$	0.26		$	0.79		$	0.50
Shares used in computing basic net income per share		533,391			587,929			547,996			588,536
Diluted net income per share	$	0.40		$	0.25		$	0.78		$	0.49
Shares used in computing diluted net income per share		542,376			603,417			557,703			604,373

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended
	May 30, 2008			June 1, 2007
Cash flows from operating activities:
Net income	$	434,289		$	296,356
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		137,858			155,547
Stock-based compensation		91,421			71,489
Deferred income taxes		69,655			16,029
Provision for estimated returns		35,584			81,678
Tax benefit from employee stock option plans		9,329			52,121
Other non-cash items		(7,767	)		400
Gains on sales of investments, net of impairments		(8,579	)		(9,923	)
Excess tax benefits from stock-based compensation		(9,329	)		(37,422	)
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Receivables		(31,583	)		(41,039	)
Prepaid expenses and other current assets		(3,359	)		(14,640	)
Trade and other payables		(5,906	)		(290	)
Accrued expenses		(8,139	)		22,721
Accrued restructuring		(3,479	)		(8,704	)
Income taxes payable		23,951			(10,609	)
Deferred revenue		7,145			42,805
Net cash provided by operating activities		731,091			616,519
Cash flows from investing activities:
Purchases of short-term investments		(466,226	)		(820,411	)
Maturities of short-term investments		353,534			223,825
Sales of short-term investments		448,184			679,697
Purchases of property and equipment		(48,671	)		(71,784	)
Purchases of long-term investments and other assets		(36,672	)		(32,681	)
Investment in lease receivable		—			(80,439	)
Cash received from acquisitions		—			868
Cash paid for acquisitions		—			(68,237	)
Issuance costs for credit facility		—			(602	)
Proceeds from sale of equity securities		9,520			11,320
Net cash provided by (used for) investing activities		259,669			(158,444	)
Cash flows from financing activities:
Purchases of treasury stock		(1,300,183	)		(601,481	)
Proceeds from issuance of treasury stock		162,467			231,833
Excess tax benefits from stock-based compensation		9,329			37,422
Proceeds from borrowings under credit facility		450,000			—
Repayments of borrowings under credit facility		(100,000	)		—
Net cash used for financing activities		(778,387	)		(332,226	)
Effect of foreign currency exchange rates on cash and cash equivalents		3,658			3,268
Net increase in cash and cash equivalents		216,031			129,117
Cash and cash equivalents at beginning of period		946,422			772,500
Cash and cash equivalents at end of period	$	1,162,453		$	901,617
Supplemental disclosures:
Cash paid for income taxes, net of refunds	$	35,001		$	28,889

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

NOTE 1. 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 30, 2007 on file with the SEC.

There have been no material changes in our significant accounting policies, except for the adoption of the Financial Accounting Standards Board (“FASB”) Financial Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” on December 1, 2007 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended November 30, 2007.

Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended May 30, 2008, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 30, 2007, that are of significance, or potential significance, to us.

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets”. FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. We are currently evaluating the impact, if any, that FSP 142-3 will have on our consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161 (“SFAS 161”), “Disclosures about Derivative Instruments and Hedging Activities”. SFAS 161 requires companies with derivative instruments to disclose information that should enable financial-statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We are currently evaluating the impact, if any, that SFAS 161 will have on our consolidated financial statements.

In June 2007, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 07-1 (“SOP 07-1”), “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies”. SOP 07-1 defines investment companies for purposes of applying the related AICPA Audit and Accounting Guide. SOP 07-1 provides guidance on whether an investment company’s parent or equity-method investor should retain investment-company accounting in its financial statements. SOP 07-1 would have been effective beginning in the first quarter of fiscal 2009; however, in February 2008, the FASB issued FSP SOP 07-1-1 which indefinitely delayed the effective date of SOP 07-1.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

In February 2007, the FASB issued FASB Statement No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities”. Under SFAS 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings and disclosed. SFAS 159 was effective for us beginning in the first quarter of fiscal 2008. We currently do not have any instruments for which we have elected the fair value option. Therefore, the adoption of SFAS 159 has not impacted our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued FASB Statement No. 157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements and is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB FSP 157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Effective December 1, 2007, we adopted SFAS 157 for financial assets and liabilities recognized at fair value on a recurring basis. The partial adoption of SFAS 157 for financial assets and liabilities did not have a material impact on our consolidated financial position, results of operations or cash flows. See Note 2 for information and related disclosures regarding our fair value measurements.

In July 2006, the FASB issued FIN 48 which clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Additionally, in May 2007, the FASB published FSP No. FIN 48-1 (“FSP FIN 48-1”), “Definition of Settlement in FASB Interpretation No. 48”. FSP FIN 48-1 is an amendment to FIN 48. It clarifies how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. We adopted both FIN 48 and FSP FIN 48-1 on December 1, 2007. The adoption of FIN 48 resulted in an increase to both assets and liabilities in our condensed consolidated balance sheet as of the beginning of fiscal 2008. See Note 6 for additional information regarding income taxes, including the effects of adoption on our condensed consolidated financial statements.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 2. FINANCIAL INSTRUMENTS

We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, available-for-sale fixed income and equity securities, other equity securities and foreign currency derivatives. The fair value of these certain financial assets and liabilities was determined using the following inputs at May 30, 2008:

	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
Money market funds and overnight deposits(1)	$	1,041,382	$	1,041,382	$	—	$	—
Fixed income available-for-sale securities(2)		700,774		—		700,774		—
Equity available-for-sale securities(3)		11,495		11,495		—		—
Investments of limited partnership(4)		34,344		476		—		33,868
Foreign currency derivatives(5)		6,964		—		6,964		—
Total	$	1,794,959	$	1,053,353	$	707,738	$	33,868
Liabilities
Foreign currency derivatives(6)		514		—		514		—
Total	$	514	$	—	$	514	$	—

_________________________________________

(1) Included in cash and cash equivalents on our condensed consolidated balance sheet.

(2) Included in either cash and cash equivalents or short-term investments on our condensed consolidated balance sheet.

(3) Included in short-term investments on our condensed consolidated balance sheet.

(4) Included in other assets on our condensed consolidated balance sheet.

(5) Included in prepaid expenses and other assets on our condensed consolidated balance sheet.

(6) Included in accrued expenses on our condensed consolidated balance sheet.

Fixed income available-for-sale securities include United States treasury securities (81% of total), corporate bonds (1% of total) and obligations of foreign governments and their agencies (18% of total).

The investments of limited partnership relate to our interest in Adobe Ventures IV L.P. (“Adobe Ventures”) which was $34.3 million and $30.6 million as of May 30, 2008 and November 30, 2007, respectively. The level 1 investments of limited partnership relate to investments in publically traded companies and the level 3 investments relate to investments in privately-held companies. Our evaluation of fair value includes, but is not limited to, reviewing each company’s cash position, financing needs, earnings and revenue outlook, operational performance, management and ownership changes and competition. The change in this asset balance relates primarily to investment gains included in earnings during the three and six months ended May 30, 2008. All other activity during the quarter was insignificant both individually and in the aggregate. See Note 4 for further information regarding Adobe Ventures and related accounting policies.

Foreign currency derivatives include option and forward foreign exchange contracts primarily for the Japanese Yen and the Euro.

NOTE 3. GOODWILL AND PURCHASED AND OTHER INTANGIBLES

Goodwill as of May 30, 2008 and November 30, 2007 was $2.135 billion and $2.148 billion, respectively. The change includes net reductions in goodwill of $9.6 million related to deferred tax assets associated with our acquisition of Scene7 and $4.2 million related to the tax reserve associated with the acquisition of Macromedia, offset in part by foreign currency changes. During the second quarter of fiscal 2008, we completed our annual goodwill impairment test. Based on this analysis, we determined that there was no impairment of goodwill.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

Purchased and other intangible assets subject to amortization were as follows as of May 30, 2008:

	Cost		Accumulated Amortization			Net
Purchased technology	$	466,995	$	(317,122	)	$	149,873
Localization	$	33,574	$	(27,060	)	$	6,514
Trademarks		131,225		(65,537	)		65,688
Customer contracts and relationships		197,220		(106,525	)		90,695
Other intangibles		800		(325	)		475
Total other intangible assets	$	362,819	$	(199,447	)	$	163,372
Total purchased and other intangible assets	$	829,814	$	(516,569	)	$	313,245

Purchased and other intangible assets subject to amortization were as follows as of November 30, 2007:

	Cost		Accumulated Amortization			Net
Purchased technology	$	464,639	$	(271,275	)	$	193,364
Localization	$	45,854	$	(27,676	)	$	18,178
Trademarks		131,225		(52,443	)		78,782
Customer contracts and relationships		197,220		(85,529	)		111,691
Other intangibles		800		(196	)		604
Total other intangible assets	$	375,099	$	(165,844	)	$	209,255
Total purchased and other intangible assets	$	839,738	$	(437,119	)	$	402,619

Amortization expense related to purchased and other intangible assets was $51.0 million and $101.4 million for the three and six months ended May 30, 2008, respectively. Comparatively, amortization expense was $65.0 million and $113.7 million for the three and six months ended June 1, 2007, respectively. Of these amounts, $33.9 million and $67.2 million were included in cost of sales for the three and six months ended May 30, 2008, respectively, and $47.5 million and $78.5 million were included in cost of sales for the three and six months June 1, 2007, respectively.

Purchased and other intangible assets are amortized over their estimated useful lives of up to 15 years. As of May 30, 2008, we expect amortization expense in future periods to be as shown below:

Fiscal year	Purchased Technology		Other Intangible Assets
Remainder of 2008	$	45,798	$	37,877
2009		59,826		62,748
2010		11,210		48,644
2011		7,448		11,917
2012		5,999		1,009
Thereafter		19,592		1,177
Total expected amortization expense	$	149,873	$	163,372

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 4. OTHER ASSETS

Other assets consisted of the following as of May 30, 2008 and November 30, 2007:

	2008		2007
Investments	$	65,630	$	52,830
Prepaid royalty		16,996		13,289
Security and other deposits		15,345		6,650
Deferred compensation plan assets		9,105		3,145
Restricted cash		7,366		7,367
Prepaid rent		3,472		4,285
Prepaid land lease		3,205		3,224
Other		1,807		2,194
Total other assets	$	122,926	$	92,984

Included in investments is our limited partnership interest in Adobe Ventures which is consolidated in accordance with FASB Interpretation No. 46R, a revision to FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”.

The partnership is controlled by Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures. Investments also include our direct investments which are accounted for under the cost method.

The increase in security and other deposits relates primarily to the purchase of a real property in Massachusetts. We have entered into a Purchase and Sale Agreement, effective as of May 12, 2008, for the acquisition of real property located in Waltham, Massachusetts. We will purchase the property subject to completion of construction of an office building shell and core, parking structure and site improvements. The purchase price for the property will be $44.7 million. We made an initial deposit of $7.0 million to be held in escrow until closing and then applied to the purchase price. Closing is expected to occur in May 2009 and the remaining balance is due at such time.

NOTE 5. TRADE AND OTHER PAYABLES AND ACCRUED EXPENSES

Trade and other payables consisted of the following as of May 30, 2008 and November 30, 2007:

	2008		2007
Trade payables	$	37,453	$	41,724
Sales and use tax and other payables		23,508		25,143
Total trade and other payables	$	60,961	$	66,867

Accrued expenses consisted of the following as of May 30, 2008 and November 30, 2007:

	2008		2007
Accrued compensation and benefits	$	201,222	$	205,018
Sales and marketing allowances		24,830		21,231
Other		151,520		157,187
Total accrued expenses	$	377,572	$	383,436

Other primarily includes general corporate accruals for corporate marketing programs, local and regional expenses, charitable contributions and technical support. Other is also comprised of deferred rent related to office locations with rent escalations, accrued royalties, foreign currency derivatives and accrued interest on the credit facility.

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 6. INCOME TAXES

We adopted both FIN 48 and FSP FIN 48-1 on December 1, 2007. The adoption of FIN 48 resulted in an increase of $3.9 million to both assets and liabilities in our condensed consolidated balance sheet as of the beginning of fiscal 2008. Upon adoption, the gross liability for unrecognized tax benefits at December 1, 2007 was $218.4 million, exclusive of interest and penalties. The total amount of gross FIN 48 liabilities includes $57.7 million that relates to certain tax attributes from acquired companies, including Macromedia. These liabilities from acquired companies are not recorded on our balance sheet because they are related to positions that have not yet been claimed on our income tax returns. If the total FIN 48 gross liability for unrecognized tax benefits at December 1, 2007 were recognized in the future, the following amounts, net of an estimated $22.2 million benefit related to deducting such payments on future tax returns, would result: $99.0 million of unrecognized tax benefits would decrease the effective tax rate, $82.8 million would decrease goodwill and $14.4 million would increase additional paid-in-capital.

We have historically presented our estimated liability for unrecognized tax benefits as a current liability. FIN 48 requires liabilities for unrecognized tax benefits to be classified based on whether a payment is expected to be made within the next 12 months. That is, amounts expected to be paid within the next 12 months are to be classified as a current liability and all other amounts are to be classified as a non-current liability. As a result of adopting FIN 48, we reclassified $197.7 million from current income taxes payable to long-term income taxes payable, including accrued interest on the balance.

We have historically presented our estimated state, local and interest liabilities net of the estimated benefit we expect to receive from deducting such payments on future tax returns (i.e., on a “net” basis). FIN 48 requires this estimated benefit to be classified as a deferred tax asset instead of a reduction of the overall liability (i.e., on a “gross” basis). Thus, we recognized additional deferred income tax assets of $3.9 million to present the unrecognized tax benefits as gross amounts on our condensed consolidated balance sheet.

Our policy to classify interest and penalties on unrecognized tax benefits as income tax expense did not change upon the adoption of FIN 48. As of December 1, 2007, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns and included in non-current income taxes payable was approximately $42.8 million.

We file income tax returns in the U.S. on a federal basis and in many U.S. state and foreign jurisdictions. We are subject to the continual examination of our income tax returns by the Internal Revenue Service (“IRS”) and other domestic and foreign tax authorities. Our major tax jurisdictions are the U.S., Ireland and California. For U.S. and California, our fiscal 2001 through fiscal 2008 years are open for examination. A current examination by the IRS for our fiscal 2001, 2002 and 2003 tax returns, is primarily related to our intercompany transfer pricing. For Ireland, our fiscal 2002 through fiscal 2008 years are open for examination.

The timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. While it is reasonably possible that some issues in the IRS and other examinations could be resolved within the next 12 months, based upon the current facts and circumstances, we cannot estimate the timing of such resolution or range of potential changes as it relates to the unrecognized tax benefits that are recorded as part of our financial statements.

During the six months ended May 30, 2008, the gross liability for unrecognized tax benefits and related accrued interest and penalties did not significantly change from the balance ended November 30, 2007.

NOTE 7. STOCK-BASED COMPENSATION

The assumptions used to value option grants, restricted stock units and performance shares during the three and six months ended May 30, 2008 and June 1, 2007 are as follows:

	Three Months Ended						Six Months Ended
	2008			2007			2008			2007
Expected life (in years)		3.5 – 4.7			3.6 – 4.8			2.3 – 4.7			3.5 – 4.8
Volatility		32 – 39	%		30 – 33	%		32 – 39	%		30 – 33	%
Risk free interest rate		1.70 – 2.83	%		4.45 – 4.69	%		1.70 – 3.35	%		4.45 – 4.83	%

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

The expected term of employee stock purchase plan (“ESPP”) shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three and six months ended May 30, 2008 and June 1, 2007 are as follows:

	Three Months Ended						Six Months Ended
	2008			2007			2008			2007
Expected life (in years)		0.5 – 2.0			0.5 – 2.0			0.5 – 2.0			0.5 – 2.0
Volatility		30 – 31	%		31 – 33	%		30 – 31	%		31 – 33	%
Risk free interest rate		2.82 – 3.29	%		4.79 – 5.11	%		2.82 – 3.29	%		4.79 – 5.11	%

Summary of Stock Options

Information regarding the stock options outstanding at May 30, 2008 and June 1, 2007 is summarized below.

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value* (millions)
2008
Options outstanding		45,769	$	29.47	4.31 years	$	668.0
Options vested and expected to vest		41,257	$	28.74	4.14 years	$	632.1
Options exercisable		28,957	$	25.49	3.41 years	$	537.9

2007
Options outstanding		58,112	$	27.03	4.03 years	$	1,016.8
Options vested and expected to vest		52,874	$	26.29	3.88 years	$	964.7
Options exercisable		35,568	$	22.20	3.07 years	$	794.3

_________________________________________

*	The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of May 30, 2008 and June 1, 2007 were $44.06 and $44.53, respectively.

Summary of Restricted Stock Units

Restricted stock unit activity for the six months ended May 30, 2008 and June 1, 2007 is as follows:

	2008			2007
Beginning balance		1,701			—
Awarded		2,587			1,296
Released		(310	)		—
Forfeited		(87	)		(18	)
Ending balance		3,891			1,278

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(In thousands, except per share data)

(Unaudited)

Information regarding restricted stock units outstanding at May 30, 2008 and June 1, 2007 is summarized below.

	Number of Shares		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value* (millions)
2008
Restricted stock units outstanding		3,891	2.10 years	$	171.4
Restricted stock units vested and expected to vest		2,649	1.89 years	$	116.7

2007
Restricted stock units outstanding		1,278	2.22 years	$	56.9
Restricted stock units vested and expected to vest		935	1.99 years	$	41.6

_________________________________________

*	The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of May 30, 2008 and June 1, 2007 were $44.06 and $44.53, respectively.

Summary of Performance Shares

Effective January 24, 2008, the Executive Compensation Committee adopted the 2008 Performance Share Program (the “2008 Program”). The purpose of the 2008 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2008 Program is our fiscal 2008 year. All members of our executive management and other key senior leaders are participating in the 2008 Program. Awards granted under the 2008 Program were granted in the form of performance shares pursuant to the terms of our 2003 Equity Incentive Plan. If pre-determined performance goals are met, shares of stock will be granted to the recipient, with 25% vesting on the later of the date of certification of achievement or the first anniversary date of the grant, and the remaining 75% vest evenly on the following three annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2008 Program have the ability to receive up to 200% of the target number of shares originally granted.

The following table sets forth the summary of performance share activity under our 2008 Program for the six months ended May 30, 2008.

	Shares Granted			Maximum Shares Eligible to Receive
Beginning balance		—			—
Awarded		931			1,863
Forfeited		(58	)		(116	)
Ending balance		873			1,747

In the first quarter of fiscal 2008, the Executive Compensation Committee certified the actual performance achievement of participants in the 2006 Performance Share Program (the “2006 Program”) and the 2007 Performance Share Program (the “2007 Program”). Based upon the achievement of goals outlined in the 2006 Program and 2007 Program, participants had the ability to receive up to 150% and 200%, respectively, of the target number of shares originally granted. Actual performance resulted in participants achieving approximately 105% of target or 0.3 million shares for the 2006 Program and 200% of target or 0.7 million shares for the 2007 Program. Shares awarded under the 2006 Program vested 100% and were released in the first quarter of fiscal 2008. Shares under the 2007 Program vested 25% in the first quarter of fiscal 2008, and the remaining 75% vest evenly on the following three annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe.

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(In thousands, except per share data)

(Unaudited)

The following table sets forth the summary of performance share activity under our 2007 Program, based upon share awards actually achieved, for the six months ended May 30, 2008:

	Shares
Shares achieved		718
Released		(196	)
Forfeited		(42	)
Ending balance		480

Compensation Costs

As of May 30, 2008, there was $294.8 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 2.8 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

Total stock-based compensation costs that have been included in our consolidated statements of income for the three months ended May 30, 2008 and June 1, 2007 are as follows:

	2008				2007
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—services and support	$	975	$	213	$	1,446	$	93
Research and development		12,844		6,608		14,791		2,585
Sales and marketing		10,218		6,647		10,540		1,762
General and administrative		6,786		4,096		7,446		974
Total	$	30,823	$	17,564	$	34,223	$	5,414

Total stock-based compensation costs that have been included in our consolidated statements of income for the six months ended May 30, 2008 and June 1, 2007 are as follows:

	2008				2007
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—services and support	$	1,779	$	253	$	2,616	$	127
Research and development		27,770		10,004		27,528		3,735
Sales and marketing		21,125		10,188		20,657		2,624
General and administrative		12,728		7,574		13,109		1,093
Total	$	63,402	$	28,019	$	63,910	$	7,579

NOTE 8. EMPLOYEE BENEFIT PLAN

Deferred Compensation Plan

As of May 30, 2008 and November 30, 2007, the invested amounts under our Deferred Compensation Plan total $9.1 million and $3.1 million, respectively, and are recorded as long-term other assets on our balance sheet. As of May 30, 2008 and November 30, 2007, we recorded $9.1 million and $3.1 million, respectively, as a long-term liability to recognize undistributed deferred compensation due to employees.

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(In thousands, except per share data)

(Unaudited)

NOTE 9. RESTRUCTURING AND OTHER CHARGES

Macromedia Merger Restructuring Charges

We completed our acquisition of Macromedia on December 3, 2005. We recognized costs related to the cancellation of certain contracts associated with the wind-down of subsidiaries and other service contracts held by Macromedia.

The following table sets forth a summary of Macromedia restructuring activities as of November 30, 2007 and May 30, 2008:

	November 30, 2007		Cash Payments			Adjustments			May 30, 2008		Total Costs Incurred To Date		Total Costs Expected to be Incurred
Termination benefits	$	—	$	—		$	—		$	—	$	26,986	$	26,986
Cost of closing redundant facilities		16,283		(3,400	)		1,768			14,651		26,360		41,011
Cost of contract termination		—		—			—			—		3,238		3,238
Other		1,435		(79	)		(282	)		1,074		1,302		2,376
Total	$	17,718	$	(3,479	)	$	1,486		$	15,725	$	57,886	$	73,611

Included in the adjustments column is a change to previous estimates associated with closing redundant facilities totaling $1.4 million as well as the effect of foreign currency changes. Accrued restructuring charges of $15.7 million at May 30, 2008 included $5.6 million recorded in accrued restructuring, current and $10.1 million related to long-term facilities obligations recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets. We expect to pay these liabilities through fiscal 2011. At November 30, 2007, accrued restructuring charges of $17.7 million included $3.7 million recorded in accrued restructuring, current and $14.0 million related to long-term facilities obligations recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets.

NOTE 10. STOCKHOLDERS’ EQUITY

Stock Repurchase Program I

During the six months ended May 30, 2008 and June 1, 2007, we entered into several structured repurchase agreements with large financial institutions, whereupon we provided the financial institutions with prepayments of $250.0 and $600.0 million, respectively. We entered 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 six months ended May 30, 2008, we repurchased 16.6 million shares at an average price of $36.58 through structured repurchase agreements which included prepayments from fiscal 2007. During the six months ended June 1, 2007, we repurchased 10.7 million shares at an average price of $39.00 through structured repurchase agreements which included prepayments from fiscal 2006.

As of May 30, 2008 and November 30, 2007, the prepayments were classified as treasury stock on our balance sheet at the payment date, though only shares physically delivered to us by May 30, 2008 and November 30, 2007 are excluded from the denominator in the computation of earnings per share. All outstanding structured repurchase agreements as of May 30, 2008 under this program will expire on or before September 19, 2008. As of May 30, 2008 and June 1, 2007, approximately $66.1 million and $386.9 million, respectively, of up-front payments remained under the agreements.

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(In thousands, except per share data)

(Unaudited)

Subsequent to May 30, 2008, we entered into additional structured stock repurchase agreements with large financial institutions whereupon we provided the financial institutions with prepayments of $75.0 million. The $75.0 million will be classified as treasury stock on our balance sheet. See Note 17 for further discussion of our stock repurchase programs.

Stock Repurchase Program II

Under this stock repurchase program, we have authorization to repurchase 50.0 million shares of our common stock. From the inception of this program, we have repurchased 49.5 million shares and provided prepayments of $1.9 billion under structured share repurchase agreements to large financial institutions. During the six months ended May 30, 2008, we provided prepayments of $1.05 billion and repurchased 31.9 million shares under these structured agreements at an average price of $37.15. As of May 30, 2008, there are no up-front payments remaining under these agreements. There were no prepayments under this program as of June 1, 2007.

Subsequent to May 30, 2008, as part of Stock Repurchase Program II, we repurchased 0.5 million shares for $18.2 million through open market repurchases. This amount will be classified as treasury stock on our balance sheet. See Note 17 for further discussion of our stock repurchase programs.

NOTE 11. COMPREHENSIVE INCOME

The following table sets forth the components of comprehensive income for the three and six months ended May 30, 2008 and June 1, 2007:

	Three Months					Six Months
	2008			2007		2008			2007
Net income	$	214,910		$	152,505	$	434,289		$	296,356
Other comprehensive income (loss):
Change in unrealized gain on available-for-sale securities, net of taxes		(5,924	)		2,975		(9,003	)		4,868
Currency translation adjustments		696			2,985		2,074			1,725
Net gain in derivative instruments, net of taxes		313			3,692		282			3,818
Other comprehensive income (loss)		(4,915	)		9,652		(6,647	)		10,411
Total comprehensive income, net of taxes	$	209,995		$	162,157	$	427,642		$	306,767

NOTE 12. NET INCOME PER SHARE

The following table sets forth the computation of basic and diluted net income per share for the three and six months ended May 30, 2008 and June 1, 2007:

	Three Months				Six Months
	2008		2007		2008		2007
Net income	$	214,910	$	152,505	$	434,289	$	296,356
Shares used to compute basic net income per share		533,391		587,929		547,996		588,536
Dilutive potential common shares:
Unvested restricted stock and performance share awards		361		11		682		12
Stock options		8,624		15,477		9,025		15,825
Shares used to compute diluted net income per share		542,376		603,417		557,703		604,373
Basic net income per share	$	0.40	$	0.26	$	0.79	$	0.50
Diluted net income per share	$	0.40	$	0.25	$	0.78	$	0.49

For the three and six months ended May 30, 2008, options to purchase approximately 17.9 million and 16.7 million shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock of $37.29 and $37.75, respectively, were not included in the calculation because the effect would have been anti-dilutive.

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(In thousands, except per share data)

(Unaudited)

Comparatively, for the three and six months ended June 1, 2007, options to purchase approximately 11.9 million and 10.0 million shares, respectively, of common stock with exercise prices greater than the average fair market value of our stock of $41.80 and $40.77, respectively, were not included in the calculation because the effect would have been anti-dilutive.

NOTE 13. 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.

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 our election. In March 2007, the Almaden Tower lease was extended for five years, with a renewal option for an additional five years solely at our election. As part of the lease extensions, we purchased the lease receivable from the lessor of the East and West Towers for $126.8 million and a portion of the lease receivable from the lessor of the Almaden Tower for $80.4 million, both of which are recorded as investments in lease receivables on our consolidated balance sheet. This purchase may be credited against the residual value guarantee if we purchase the properties or will be repaid from the sale proceeds if the properties are sold to third parties. Under the agreement for the East and West Towers and the agreement for the Almaden Tower, we have the option to purchase the buildings at any time during the lease term for approximately $143.2 million and $103.6 million, respectively. The residual value guarantees under the East and West Towers and the Almaden Tower obligations are $126.8 million and $89.4 million, respectively.

These two leases are both subject to standard covenants including certain financial ratios that are reported to the lessors quarterly. As of May 30, 2008, 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 SFAS 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 lease term, we can extend the lease for an additional five year term, 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 residual value guarantee amount.

Guarantees

The lease agreements for our corporate headquarters provide for residual value guarantees as noted above. Under FASB Interpretation No. 45, (“FIN 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 recognized $5.2 million and $3.0 million in liabilities, related to the East and West Towers and Almaden Tower leases, respectively. These liabilities are 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 leases. As of May 30, 2008 and November 30, 2007, the unamortized portion of the fair value of the residual value guarantees, for both leases, remaining in other long-term liabilities and prepaid rent was $3.4 million and $4.2 million, respectively.

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.

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(In thousands, except per share data)

(Unaudited)

Indemnifications

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

To the extent permitted under Delaware law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that 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.

As part of our limited partnership interest 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 partnership. 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 Proceedings

On October 13, 2006, a purported shareholder derivative action entitled Steven Staehr v. Bruce R. Chizen, et al was filed in the Superior Court of California for the County of Santa Clara against certain of our current and former officers and directors and against Adobe as a nominal defendant. The complaint asserts that stock option grants to executives were priced retroactively by Adobe and were improperly accounted for and alleges various causes of action based on that assertion. The complaint seeks payment by the defendants to Adobe of damages allegedly suffered by it and disgorgement of profits, as well as injunctive relief. On November 27, 2007 the Court granted defendants’ demurrer to the second amended complaint and dismissed it without leave to amend. On December 11, 2007, plaintiff filed a motion for reconsideration of the Court’s order sustaining the demurrer without leave to amend, but that motion was denied by the Court on January 29, 2008. The Court issued a final judgment dismissing the complaint on April 7, 2008.

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 local laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be affected in any particular period by the resolution of one or more of these counter-claims.

From time to time, in addition to those identified above, Adobe is subject to legal proceedings, claims and investigations 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 GAAP, 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 negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.

NOTE 14. CREDIT AGREEMENT

In August 2007, we entered into the Amendment to our Credit Agreement dated February 2007 (the “Amendment”), which increased the total senior unsecured revolving facility from $500.0 million to $1.0 billion. The Amendment also permits us to request one-year extensions effective on each anniversary of the closing date of the original agreement, subject

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(In thousands, except per share data)

(Unaudited)

to the majority consent of the lenders. We also retain an option to request an additional $500.0 million in commitments, for a maximum aggregate facility of $1.5 billion.

In February 2008, we entered into the Second Amendment to the Credit Agreement dated February 26, 2008, which extended the maturity date of the facility by one year to February 16, 2013. The facility would terminate at this date if no additional extensions have been requested and granted. All other terms and conditions remain the same.

The facility contains a financial covenant requiring us not to exceed a certain maximum leverage ratio. At the Company’s option, borrowings under the facility accrue interest based on either the London interbank offered rate (“LIBOR”) for one, two, three or six months, or longer periods with bank consent, plus a margin according to a pricing grid tied to this financial covenant, or a base rate. The margin is set at rates between 0.20% and 0.475%. Commitment fees are payable on the facility at rates between 0.05% and 0.15% per year based on the same pricing grid. The facility is available to provide loans to us and certain of our subsidiaries for general corporate purposes. During the six months ended May 30, 2008, we borrowed $450.0 million and made repayments of $100.0 million under this facility. As of May 30, 2008 and November 30, 2007, the amount outstanding under the credit facility was $350.0 million and zero, respectively, which is included in long-term liabilities on our condensed consolidated balance sheet. As of May 30, 2008, we were in compliance with all of the covenants.

NOTE 15. NON-OPERATING INCOME (EXPENSE)

Non-operating income (expense) for the three and six months ended May 30, 2008 and June 1, 2007 includes the following:

	Three Months						Six Months
	2008			2007			2008			2007
Interest and other income, net:
Interest income	$	13,192		$	25,020		$	30,703		$	48,488
Foreign exchange losses		(1,234	)		(2,764	)		(5,934	)		(4,271	)
Fixed income investment losses		(200	)		(2,126	)		(200	)		(2,387	)
Other		392			488			871			1,303
Interest and other income, net	$	12,150		$	20,618		$	25,440		$	43,133
Interest expense	$	(3,828	)	$	(55	)	$	(5,637	)	$	(106	)
Investment gains, net:
Realized investment gains	$	10,040		$	304		$	15,437		$	9,110
Unrealized investment gains		1,044			4,868			4,958			5,091
Realized investment losses		(254	)		(602	)		(637	)		(1,160	)
Unrealized investment losses		(1,324	)		(408	)		(1,520	)		(3,278	)
Investment gains, net	$	9,506		$	4,162		$	18,238		$	9,763
Total non-operating income, net	$	17,828		$	24,725		$	38,041		$	52,790

NOTE 16. INDUSTRY SEGMENTS

We have the following segments: Creative Solutions, Knowledge Worker Solutions, Enterprise Solutions, Mobile and Device Solutions, Platform and Print Publishing. Our Creative Solutions segment focuses on delivering a complete professional line of integrated tools for a full range of creative and developer tasks to an extended set of customers. The Knowledge Worker Solutions segment focuses on the needs of knowledge worker customers, providing essential applications and services to help them share information and collaborate. This segment contains revenue generated by Acrobat Connect and our Acrobat family of products. Our Enterprise Solutions segment provides server-based enterprise interaction solutions that automate people-centric processes and contains revenue generated by our LiveCycle line of products. The Mobile and Device Solutions segment provides solutions that deliver compelling experiences through rich content, user interfaces and data services on mobile and non-PC devices such as cellular phones, consumer devices and Internet connected hand-held devices. The Platform segment provides developer solutions and technologies, including Adobe Flash Player, Adobe AIR and Flex Builder which are used to build rich application experiences. Finally, the Print Publishing segment addresses market

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(In thousands, except per share data)

(Unaudited)

opportunities ranging from the diverse publishing needs of technical and business publishing, to our legacy type and original equipment manufacturer (“OEM”) printing businesses.

Effective in the first quarter of fiscal 2008, to better align our engineering and marketing efforts, we merged our Knowledge Worker Solutions segment with our Enterprise Solutions segment (formerly “Enterprise and Developer Solutions”) to form our new Business Productivity Solutions business unit. However, under the requirements of SFAS No. 131, (“SFAS 131”), “Disclosures about Segments of an Enterprise and Related Information,” Knowledge Worker Solutions and Enterprise Solutions are separate reportable segments. In addition, we moved responsibility for Flex Builder, Flex SDK and our ColdFusion product line to our Platform segment from our Enterprise Solutions segment. The prior year information in the table below has also been updated to reflect this product movement.

Our chief operating decision maker reviews revenue and gross margin information for each of our operating segments. Operating expenses are not reviewed 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 operating segments.

	Creative Solutions			Knowledge Worker Solutions			Enterprise Solutions			Mobile and Device Solutions			Platform			Print Publishing			Total
Three months ended May 30, 2008
Revenue	$	527,244		$	198,402		$	54,356		$	22,212		$	30,404		$	54,268		$	886,886
Cost of revenue		34,260			12,032			18,590			6,791			4,455			6,738			82,866
Gross profit	$	492,984		$	186,370		$	35,766		$	15,421		$	25,949		$	47,530		$	804,020
Gross profit as a percentage of revenue		94	%		94	%		66	%		69	%		85	%		88	%		91	%
Three months ended June 1, 2007
Revenue	$	436,619		$	184,791		$	43,952		$	12,283		$	18,882		$	49,050		$	745,577
Cost of revenue		32,809			20,831			21,046			6,807			3,704			6,017			91,214
Gross profit	$	403,810		$	163,960		$	22,906		$	5,476		$	15,178		$	43,033		$	654,363
Gross profit as a percentage of revenue		92	%		89	%		52	%		45	%		80	%		88	%		88	%

	Creative Solutions			Knowledge Worker Solutions			Enterprise Solutions			Mobile and Device Solutions			Platform			Print Publishing			Total
Six months ended May 30, 2008
Revenue	$	1,070,719		$	393,937		$	108,520		$	37,424		$	58,536		$	108,195		$	1,777,331
Cost of revenue		70,308			23,713			35,581			12,782			8,428			14,529			165,341
Gross profit	$	1,000,411		$	370,224		$	72,939		$	24,642		$	50,108		$	93,666		$	1,611,990
Gross profit as a percentage of revenue		93	%		94	%		67	%		66	%		86	%		87	%		91	%
Six months ended June 1, 2007
Revenue	$	783,010		$	359,619		$	86,417		$	26,016		$	34,664		$	105,258		$	1,394,984
Cost of revenue		62,909			31,505			34,999			13,687			6,605			13,772			163,477
Gross profit	$	720,101		$	328,114		$	51,418		$	12,329		$	28,059		$	91,486		$	1,231,507
Gross profit as a percentage of revenue		92	%		91	%		59	%		47	%		81	%		87	%		88	%

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ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 17. SUBSEQUENT EVENTS

Stock Repurchase Programs

Subsequent to May 30, 2008, as part of Stock Repurchase Program I, we entered into additional structured stock repurchase agreements with large financial institutions whereupon we provided the financial institutions with prepayments of $75.0 million. This amount will be classified as treasury stock on our balance sheet. See Note 10 for further discussion of our stock repurchase programs.

Subsequent to May 30, 2008, as part of Stock Repurchase Program II, we repurchased 0.5 million shares for $18.2 million through open market repurchases. This amount will be classified as treasury stock on our balance sheet. See Note 10 for further discussion of our stock repurchase programs.

Intellectual Property Rights

In June 2008, we acquired certain intellectual property rights totaling $90.0 million. To the extent the intellectual property rights will benefit future periods, we will capitalize such amounts and amortize them over their useful life.

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

The following discussion (unaudited and presented in millions, except share and per share amounts) should be read in conjunction with the condensed consolidated financial statements and notes thereto.

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth and market opportunities, which involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors” in Part II, Item 1A. You should carefully review the risks described herein and in other documents we file from time to time with the SEC, including the Annual Report on Form 10-K for fiscal 2007 and the other Quarterly Reports on Form 10-Q to be filed by us in fiscal 2008. 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 our focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

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 creative, business and mobile software and services used by creative professionals, designers, knowledge workers, high-end consumers, OEM partners, developers and enterprises for creating, managing, delivering and engaging with compelling content and experiences across multiple operating systems, devices and media. We distribute our products through a network of distributors and dealers, value-added resellers (“VARs”), systems integrators, independent software vendors (“ISVs”) and OEMs, direct to end users and through our Web site at www.adobe.com. We also license our technology to 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, the Middle East and Africa (“EMEA”) and Asia. Our software runs on personal computers with Microsoft Windows, Apple OS, Linux, UNIX and various non-PC 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.

OPERATIONS OVERVIEW

Effective in the first quarter of fiscal 2008, to better align our engineering and marketing efforts, we merged our Knowledge Worker Solutions segment with our Enterprise Solutions segment to form our new Business Productivity Solutions business unit. However, under the requirements of SFAS 131, Knowledge Worker Solutions and Enterprise Solutions are separate reportable segments. In addition, we moved responsibility for Flex Builder, Flex SDK and our ColdFusion product line to our Platform segment from our Enterprise Solutions segment. The prior year information has been updated to reflect this product movement.

During the second quarter of fiscal 2008, we continued to focus on driving revenue growth and increasing market share of our products through the continued delivery of comprehensive software and technology solutions that meet the evolving needs of our customers.

In our Creative Solutions segment, we grew revenue substantially on a year-over-year basis as we continued to increase the penetration of our Creative Suite 3 (“CS3”) family of products during the second quarter. This growth was driven by strong CS3 results in Japan as well as continued solid CS3 demand in Europe. Our digital video products, our hobbyist products and our Scene7 business all achieved strong results in the second quarter.

In our Knowledge Worker Solutions segment, we achieved record revenue with our Acrobat family of products in the second quarter of fiscal 2008. Helping drive this success was continued strong licensing of Acrobat products due to ongoing adoption by users in enterprises, governments and other vertical markets.

In our Enterprise Solutions segment, we achieved strong year-over-year revenue growth as we continued to focus on delivering innovative products and solutions for our customers.

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Our Mobile and Device Solutions segment achieved record revenue in Q2 due to the success we have had targeting mobile operators, handset manufacturers and consumer electronic device manufactures with our Flash Lite and Flash Cast technologies. Our strong Mobile and Device results included a large transaction with a consumer electronics device manufacturer. On May 1, 2008, we announced the Open Screen Project. The project aims to enable a consistent runtime environment that will remove barriers for developers and designers as they publish content and applications across desktops and consumer devices, including phones, mobile internet devices (“MIDs”) and set top boxes. As part of the project, we will be removing some restrictions on the use of some of our technology specifications and publishing several technology protocols. We will also be removing the license fees on the next major releases of Adobe Flash Player and Adobe AIR for devices. Accordingly, we expect revenue from Mobile and Device Solutions to decrease following the next major release of these products scheduled for fiscal 2009. We would expect this decrease to be offset in time by an increased demand for tooling products, server technologies, hosted services and applications.

Our Platform business performed strongly, resulting in significant year-over-year revenue growth and our Print Publishing business segment also achieved modest year-over-year revenue growth.

CRITICAL ACCOUNTING ESTIMATES

In preparing our condensed consolidated financial statements in accordance with 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 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, stock-based compensation, 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 which require 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.

With the exception of our adoption of FIN 48, there have been no other significant changes in our critical accounting estimates during the six months ended May 30, 2008 as compared to the critical accounting 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 30, 2007.

RESULTS OF OPERATIONS

Revenue for the Three and Six Months Ended May 30, 2008 and June 1, 2007

	Three Months						Percent			Six Months						Percent
	2008			2007			Change			2008			2007			Change
Product	$	841.3		$	713.5			18	%	$	1,693.2		$	1,333.8			27	%
Percentage of total revenue		95	%		96	%					95	%		96	%
Services and support		45.6			32.1			42	%		84.1			61.2			37	%
Percentage of total revenue		5	%		4	%					5	%		4	%
Total revenue	$	886.9		$	745.6			19	%	$	1,777.3		$	1,395.0			27	%

As described in Note 16 of our Notes to Condensed Consolidated Financial Statements, we have the following segments: Creative Solutions, Knowledge Worker Solutions, Enterprise Solutions, Mobile and Device Solutions, Platform and Print Publishing products.

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. 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 product upgrades and enhancements or technical support, depending on the offering, are recognized ratably over the term of the arrangement.

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Segment Information

	Three Months						Percent			Six Months						Percent
	2008			2007			Change			2008			2007			Change
Creative Solutions	$	527.2		$	436.6			21	%	$	1,070.7		$	783.0			37	%
Percentage of total revenue		59	%		58	%					60	%		56	%
Knowledge Worker Solutions		198.4			184.8			7	%		393.9			359.6			10	%
Percentage of total revenue		23	%		25	%					22	%		26	%
Enterprise Solutions		54.4			44.0			24	%		108.6			86.5			26	%
Percentage of total revenue		6	%		6	%					6	%		6	%
Mobile and Device Solutions		22.2			12.3			80	%		37.4			26.0			44	%
Percentage of total revenue		3	%		2	%					2	%		2	%
Platform		30.4			18.9			61	%		58.5			34.7			69	%
Percentage of total revenue		3	%		3	%					3	%		2	%
Print Publishing		54.3			49.0			11	%		108.2			105.2			3	%
Percentage of total revenue		6	%		6	%					7	%		8	%
Total revenue	$	886.9		$	745.6			19	%	$	1,777.3		$	1,395.0			27	%

Revenue from Creative Solutions increased $90.6 million during the three months ended May 30, 2008 as compared to the three months ended June 1, 2007, of which approximately 50% related to an increase in Creative Suites revenue and approximately 25% related to an increase in Photoshop revenue. Revenue from Creative Solutions increased $287.7 million during the six months ended May 30, 2008 as compared to the six months ended June 1, 2007, of which approximately 70% related to an increase in Creative Suites revenue and approximately 20% related to an increase in Photoshop revenue.

The increase in Creative Suites revenue was due primarily to the release of localized versions of our CS3 family of products during the third quarter of fiscal 2007 and to a lesser extent the launch of the English versions of our CS3 family of products in the second quarter of fiscal 2007. As a result of the launch of the CS3 family of products, there was an increase in the number of units sold as well as an increase in certain unit average selling prices as compared to the second quarter of fiscal 2007. The increase in average selling price was due in part to an increase in comparable per unit pricing year-over-year and Adobe’s ability to move some customers to higher-priced product suites. The increase in Photoshop revenue primarily related to the launch of new Photoshop offerings during fiscal 2008.

Revenue from Knowledge Worker Solutions increased $13.6 million and $34.3 million during the three and six months ended May 30, 2008, respectively, compared to the three and six months ended June 1, 2007, primarily due to higher average selling prices associated with continued licensing of our Acrobat 8 family of products. The volume remained relatively stable compared with fiscal 2007.

Revenue from Enterprise Solutions increased $10.4 million and $22.1 million during the three and six months ended May 30, 2008, respectively, compared to the three and six months ended June 1, 2007. The increase was primarily due to continued adoption of our LiveCycle family of products.

Revenue from Mobile and Device Solutions increased $9.9 million and $11.4 million during the three and six months ended May 30, 2008, respectively, compared to the three and six months ended June 1, 2007. The increase was primarily due to increased consulting revenue in Mobile Applications and continued strong unit shipments of our Flash enabled devices including a large transaction with a gaming console manufacturer. On May 1, 2008, we announced the Open Screen Project. The project aims to enable a consistent runtime environment that will remove barriers for developers and designers as they publish content and applications across desktops and consumer devices, including phones, MIDs and set top boxes. As part of the project, we will be removing some restrictions on the use of some of our technology specifications and publishing several technology protocols. We will also be removing the license fees on the next major releases of Adobe Flash Player and Adobe AIR for devices. Accordingly, we expect revenue from Mobile and Device Solutions to decrease following the next major release of these products scheduled for fiscal 2009. We would expect this decrease to be offset in time by an increased demand for tooling products, server technologies, hosted services and applications.

Revenue from Platform increased $11.5 million and $23.8 million during the three and six months ended May 30, 2008, respectively, compared to the three and six months ended June 1, 2007. The increase was primarily due to increased revenue from our Flex Builder, Flash Player and ColdFusion products, each of which contributed relatively evenly to the revenue growth.

Revenue from Print Publishing increased $5.3 million and $3.0 million during the three and six months ended May 30, 2008, respectively, compared to the three and six months ended June 1, 2007. The increase resulted principally from increased revenue associated with our legacy products, the introduction of Technical Suite and increased adoption of Shockwave.

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Geographical Information

	Three Months				Percent		Six Months				Percent
	2008		2007		Change		2008		2007		Change
Americas	$	383.8	$	383.5		*	$	780.7	$	681.8		15	%
Percentage of total revenue		43