form_10q.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 February 27, 2009
 
 
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 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 March 27, 2009 was 523,737,172.


 
 
 


ADOBE SYSTEMS INCORPORATED
FORM 10-Q
 
TABLE OF CONTENTS
 
     
Page No.
PART I—FINANCIAL INFORMATION
  
Item 1.
3
   
3
   
4
   
5
   
6
Item 2.
24
Item 3.
34
Item 4.
34
   
PART II—OTHER INFORMATION
  
Item 1.
35
Item 1A.
35
Item 2.
43
Item 5.
43
Item 6.
44
52
53


PART I—FINANCIAL INFORMATION
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(In thousands, except per share data)
 
(Unaudited)
 
   
February 27,
2009
    
November 28,
2008
  
ASSETS
Current assets:
            
Cash and cash equivalents
   $ 1,148,925     $ 886,450  
Short-term investments
     1,234,769       1,132,752  
Trade receivables, net of allowances for doubtful accounts of $5,796 and $4,128, respectively
     300,048       467,234  
Deferred income taxes
     81,125       110,713  
Prepaid expenses and other assets
     104,124       137,954  
Total current assets
     2,868,991       2,735,103  
Property and equipment, net
     300,376       313,037  
Goodwill
     2,132,375       2,134,730  
Purchased and other intangibles, net
     181,468       214,960  
Investment in lease receivable
     207,239       207,239  
Other assets
     197,147       216,529  
Total assets
   $ 5,887,596     $ 5,821,598  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
                
Trade payables
   $ 41,416     $ 55,840  
Accrued expenses
     345,677       399,969  
Accrued restructuring
     18,352       35,690  
Income taxes payable
     33,107       27,136  
Deferred revenue
     198,313       243,964  
Total current liabilities
     636,865       762,599  
Long-term liabilities:
                
Debt
     350,000       350,000  
Deferred revenue
     26,973       31,356  
Accrued restructuring
     6,995       6,214  
Income taxes payable
     120,289       123,182  
Deferred income taxes
     114,603       117,328  
Other liabilities
     20,711       20,565  
Total liabilities
     1,276,436       1,411,244  
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; 524,095 and 526,111 shares outstanding, respectively
     61       61  
Additional paid-in-capital
     2,352,383       2,396,819  
Retained earnings
     5,069,840       4,913,406  
Accumulated other comprehensive income
     25,095       57,222  
Treasury stock, at cost (76,739 and 74,723 shares, respectively), net of reissuances
     (2,836,219 )     (2,957,154 )
Total stockholders’ equity
     4,611,160       4,410,354  
Total liabilities and stockholders’ equity
   $ 5,887,596     $ 5,821,598  
 
See accompanying Notes to Condensed Consolidated Financial Statements.


ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
(In thousands, except per share data)
 
(Unaudited)
 
   
Three Months Ended
  
   
February 27,
2009
    
February 29,
2008
  
Revenue:
            
Products
   $ 742,199     $ 851,962  
Services and support
     44,191       38,483  
Total revenue
     786,390       890,445  
Total cost of revenue:
                
Products
     58,918       59,805  
Services and support
     18,435       22,670  
Total cost of revenue
     77,353       82,475  
Gross profit
     709,037       807,970  
Operating expenses:
                
Research and development
     149,917       168,485  
Sales and marketing
     249,491       262,595  
General and administrative
     74,051       82,929  
Restructuring charges
     12,270       1,431  
Amortization of purchased intangibles
     15,392       17,099  
Total operating expenses
     501,121       532,539  
Operating income
     207,916       275,431  
 
Non-operating income (expense):
                
Interest and other income, net
     13,284       13,290  
Interest expense
     (792 )     (1,809 )
Investment gains (losses), net
     (17,246 )     8,732  
Total non-operating income (expense), net
     (4,754 )     20,213  
Income before income taxes
     203,162       295,644  
Provision for income taxes
     46,727       76,265  
Net income
   $ 156,435     $ 219,379  
Basic net income per share
   $ 0.30     $ 0.39  
Shares used in computing basic net income per share
     524,268       561,113  
Diluted net income per share
   $ 0.30     $ 0.38  
Shares used in computing diluted net income per share
     527,830       571,259  

 

 

 
See accompanying Notes to Condensed Consolidated Financial Statements.


ADOBE SYSTEMS INCORPORATED
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
(Unaudited)
 
   
Three Months Ended
  
   
February 27,
2009
    
February 29,
2008
  
Cash flows from operating activities:
            
Net income
   $ 156,435     $ 219,379  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation, amortization and accretion
     68,740       69,202  
Stock-based compensation
     45,618       43,034  
Deferred income taxes
     26,518       35,844  
Losses (gains) on investments
     15,784       (9,493 )
Retirements of property and equipment
     3,157       99  
Tax benefit from employee stock option plans
     2,711       —  
Provision for losses on trade receivables
     2,701       (224 )
Other non-cash items
     1,567       1,716  
Excess tax benefits from stock-based compensation
     (84 )     —  
Changes in operating assets and liabilities, net of acquired assets and liabilities:
                
Trade receivables
     164,484       25,103  
Prepaid expenses and other current assets
     7,859       4,565  
Trade payables
     (14,424 )     (2,906 )
Accrued expenses
     (53,098 )     (16,733 )
Accrued restructuring
     (16,656 )     274  
Income taxes payable
     4,465       24,090  
Deferred revenue
     (50,034 )     5,350  
Net cash provided by operating activities
     365,743       399,300  
Cash flows from investing activities:
                
Purchases of short-term investments
     (435,171 )     (224,645 )
Maturities of short-term investments
     137,900       197,379  
Proceeds from sales of short-term investments
     189,432       389,858  
Purchases of property and equipment
     (15,916 )     (26,268 )
Purchases of long-term investments and other assets
     (9,201 )     (14,400 )
Proceeds from sale of long-term investments
     1,394       6,847  
Net cash (used for) provided by investing activities
     (131,562 )     328,771  
Cash flows from financing activities:
                
Purchases of treasury stock
     (13 )     (1,150,022 )
Proceeds from issuance of treasury stock
     28,604       53,510  
Excess tax benefits from stock-based compensation
     84       —  
Proceeds from borrowings under credit facility
     —       450,000  
Net cash provided by (used for) financing activities
     28,675       (646,512 )
Effect of foreign currency exchange rates on cash and cash equivalents
     (381 )     4,752  
Net increase in cash and cash equivalents
     262,475       86,311  
Cash and cash equivalents at beginning of period
     886,450       946,422  
Cash and cash equivalents at end of period
   $ 1,148,925     $ 1,032,733  
Supplemental disclosures:
                
Cash paid for income taxes, net of refunds
   $ 4,631     $ 12,894  
Cash paid for interest
   $ 892     $ —  

See accompanying Notes to Condensed Consolidated Financial Statements.


ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 (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 28, 2008 on file with the SEC.
 
There have been no material changes in our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended November 28, 2008.
 
Recent Accounting Pronouncements
 
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended February 27, 2009, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 28, 2008, that are of significance, or potential significance, to us.
 
In December 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 140-4 and FASB Interpretation (“FIN”) FIN 46R-8 (“FSP 140-4 and FIN 46R-8”), “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” FSP 140-4 and FIN 46R-8 require additional disclosures about transfers of financial assets and involvement with variable interest entities. The requirements apply to transferors, sponsors, servicers, primary beneficiaries and holders of significant variable interests in a variable interest entity or qualifying special purpose entity. FSP 140-4 and FIN 46R-8 was effective for us in the first quarter of fiscal 2009. However, no additional significant disclosures were required and the adoption did not impact our consolidated financial position, results of operations or cash flows.
 
In September 2008, the FASB issued FSP No. 133-1 and FIN 45-4 (“FSP FAS 133-1 and FIN 45-4”), “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Financial Accounting Standard (“SFAS”) No. 133 and FIN No. 45; and Clarification of the Effective Date of SFAS No. 161.”  FSP FAS 133-1 and FIN 45-4 amends SFAS No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities,” to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments.  FSP FAS 133-1 and FIN 45-4 also amend FIN No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” to require additional disclosure about the current status of the payment/performance risk of a guarantee.  The provisions of the FSP that amend SFAS 133 and FIN 45 are effective for reporting periods ending after November 15, 2008. FSP FAS 133-1 and FIN 45-4 also clarifies the effective date in SFAS No. 161 (“SFAS 161”), “Disclosures about Derivative Instruments and Hedging Activities.” We adopted the disclosures required by SFAS 161 in the first quarter of fiscal 2009. Since FSP FAS 133-1 and FIN 45-4 only required additional disclosures, the adoption did not impact our consolidated financial position, results of operations or cash flows.
 

 
6
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


In April 2008, the FASB issued FSP No. 142-3 (“FSP 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 SFAS 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. FSP 142-3 is effective for us beginning in the second quarter of fiscal 2009. Early adoption is prohibited.  Since this guidance will be applied prospectively, on adoption, there will be no impact to our current consolidated financial statements.
 
In March 2008, the FASB issued SFAS 161 which 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 SFAS 133 and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. We adopted SFAS 161 in the first quarter of fiscal 2009. Since SFAS 161 only required additional disclosure, the adoption did not impact our consolidated financial position, results of operations or cash flows.
 
In September 2006, the FASB issued SFAS 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. Effective November 29, 2008, we adopted SFAS 157 for all nonfinancial assets and nonfinancial liabilities measured at fair value on a non-recurring basis. Examples include goodwill, intangibles, and other long-lived assets. The adoption of SFAS 157 did not have a material impact on our consolidated financial position, results of operations or cash flows.
 
In December 2007, the FASB issued SFAS No. 141 (revised 2007) (“SFAS 141R”), “Business Combinations” and SFAS No. 160 (“SFAS 160”), “Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51.” SFAS 141R will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity.  SFAS 141R and SFAS 160 are effective for us beginning in the first quarter of fiscal 2010. Early adoption is not permitted. We are currently evaluating the impact that SFAS 141R and SFAS 160 will have on our consolidated financial statements.
 
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 financial assets and liabilities was determined using the following inputs at February 27, 2009 (in thousands):
 
   
Fair Value Measurements at Reporting Date Using
  
         
Quoted Prices in
Active Markets for
Identical Assets
    
Significant
Other
Observable
Inputs
    
Significant
Unobservable
Inputs
  
   
Total
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
Assets:
                        
Money market funds and overnight deposits(1)
   $ 1,025,810     $ 1,025,810     $ —     $ —  
Fixed income available-for-sale securities(2)
     1,263,366       —       1,263,366       —  
Available-for-sale equity securities(3)
     3,399       3,399       —       —  
Investments of limited partnership(4)
     33,192       279       —       32,913  
Foreign currency derivatives(5)
     29,009       —       29,009       —  
Deferred compensation plan assets(4)
                                
Money market funds
     772       772       —       —  
Equity and fixed income mutual funds
     7,281       —       7,281       —  
Subtotal for deferred compensation plan assets
     8,053       772       7,281       —  
Total
   $ 2,362,829     $ 1,030,260     $ 1,299,656     $ 32,913  
Liabilities:
                                
Foreign currency derivatives(6)
     965       —       965       —  
Total
   $ 965     $ —     $ 965     $ —  
 
 
7
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
The fair value of these financial assets and liabilities was determined using the following inputs at November 28, 2008 (in thousands):
 
   
Fair Value Measurements at Reporting Date Using
  
         
Quoted Prices in
Active Markets for
Identical Assets
    
Significant
Other
Observable
Inputs
    
Significant
Unobservable
Inputs
  
   
Total
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
Assets:
                        
Money market funds and overnight deposits(1)
   $ 722,742     $ 722,742     $ —     $ —  
Fixed income available-for-sale securities(2)
     1,175,732       —       1,175,732       —  
Available-for-sale equity securities(3)
     3,047       3,047       —       —  
Investments of limited partnership(4)
     39,004       251       —       38,753  
Foreign currency derivatives(5)
     49,848       —       49,848       —  
Deferred compensation plan assets(4)
                                
Money market funds
     704       704       —       —  
Equity and fixed income mutual funds
     6,856       —       6,856       —  
Subtotal for deferred compensation plan assets
     7,560       704       6,856       —  
Total
   $ 1,997,933     $ 726,744     $ 1,232,436     $ 38,753  
Liabilities:
                                
Foreign currency derivatives(6)
     1,739       —       1,739       —  
Total
   $ 1,739     $ —     $ 1,739     $ —  
_________________________________________
 
(1)
Included in cash and cash equivalents on our condensed consolidated balance sheets.
 
(2)
Included in either cash and cash equivalents or short-term investments on our condensed consolidated balance sheets.
 
(3)
Included in short-term investments on our condensed consolidated balance sheets.
 
(4)
Included in other assets on our condensed consolidated balance sheets.
 
(5)
Included in prepaid expenses and other assets on our condensed consolidated balance sheets.
 
(6)
Included in accrued expenses on our condensed consolidated balance sheets.
 
Fixed income available-for-sale securities include United States (“U.S.”) treasury securities, Agency or U.S. Government guaranteed securities (86% of total), corporate bonds (9% of total) and obligations of foreign governments and their agencies (5% of total).
 
The investments of limited partnership relate to our interest in Adobe Ventures IV L.P. (“Adobe Ventures”), which are consolidated in our condensed consolidated financial statements. The Level 1 investments of limited partnership relate to investments in publicly-traded companies and the Level 3 investments relate to investments in privately-held companies. These investments are remeasured at fair value each period with any gains or losses recognized in investment gains (losses), net in our condensed consolidated statements of income. We estimated fair value of the Level 3 investments by considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data.
 
A reconciliation of the beginning and ending balances for investments of limited partnership using significant unobservable inputs as of February 27, 2009 and November 28, 2008 was as follows (in thousands):
 
Balance as of November 28, 2008
   $ 38,753  
Purchases and sales of investments, net
     (603 )
Unrealized net investment losses included in earnings
     (5,237 )
Balance as of February 27, 2009
   $ 32,913  
 

 

 
8
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
Investment gains and losses of our limited partnership are included in our condensed consolidated statements of income as a component of investment gain (loss). See Note 4 for further information regarding our limited partnership interest in Adobe Ventures.
 
We also have direct investments in privately-held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment.  If we determine that an other-than-temporary impairment has occurred, we write-down the investment to its fair value. We estimated fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. During the first quarter of 2009, we determined that certain of our cost method investments were other-than-temporarily impaired which resulted in a charge of $10.6 million included in investment gains (losses), net in the condensed consolidated statements of income.  The fair value of cost method investments that were impaired was estimated using Level 3 inputs.
 
In countries outside the U.S., we transact business in U.S. dollars and in various other currencies. In Europe and Japan, transactions that are denominated in Euro and Yen are subject to exposure from movements in exchange rates. We may use foreign exchange option contracts or forward contracts to hedge operational (“cash flow”) exposures resulting from changes in these foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. We enter into these foreign exchange contracts to hedge a portion of our forecasted foreign currency denominated revenue in the normal course of business and accordingly, they are not speculative in nature.
 
We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income (loss), 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 (loss) to interest and other income, net on our condensed consolidated statement of income at that time.

We also hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in 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 to interest and other income, net on our condensed consolidated statement of 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.
 
We mitigate concentration of risk related to foreign currency hedges as well as interest rate hedges through a policy that establishes counterparty limits. The bank counterparties in these contracts expose us to credit-related losses in the event of their nonperformance. However, to mitigate that risk, we only contract with counterparties who meet our minimum requirements under our counterparty risk assessment process. In addition, our hedging policy establishes maximum limits for each counterparty. We monitor ratings, credit spreads and potential downgrades on at least a quarterly basis. Based on our on-going assessment of counterparty risk, we will adjust our exposure to various counterparties.

 
9
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


The fair value of derivative instruments in our condensed consolidated balance sheets as of February 27, 2009 was as follows (in thousands):
 
 
Fair Values of Derivative Instruments
  
 
Asset Derivatives
  
Liability Derivatives
  
 
Balance Sheet Location
  
Fair Value
  
Balance Sheet Location
  
Fair Value
  
Derivatives designated as hedging instruments:
                
Foreign exchange option contracts
Prepaid expense and other assets
   $ 25,213  
Accrued expenses
   $ —  
 
Derivatives not designated as hedging instruments:
                    
Foreign exchange forward contracts
Prepaid expense and other assets
     3,796  
Accrued expenses
     (965 )
Total derivatives
     $ 29,009       $ (965 )

The effect of derivative instruments designated as cash flow hedges on our condensed consolidated statement of income for the three months ended February 27, 2009 was as follows (in thousands):

Derivatives in Cash Flow Hedging Relationships
  
Gain (Loss) Recognized (1)
    
Gain (Loss) Reclassified (2)
    
Gain (Loss) Recognized (3)
  
 
Foreign exchange option contracts
   $ (5,450 )   $ 20,476     $ (1,632 )
_________________________________________
 
(1)
Amount recognized in OCI (effective portion).
 
(2)
Amount of gain (loss) reclassified from accumulated OCI into income (effective portion) located in revenue.
 
(3)
Amount of gain (loss) recognized in income on derivative (ineffective portion and amount excluded from effectiveness testing) located in interest and other income, net.
 
The effect of derivative instruments not designated as hedges on our condensed consolidated statement of income for the three months ended February 27, 2009 was as follows (in thousands):
 
 
Derivatives Not Designated as Hedging Instruments
  
Gain (Loss) Recognized (*)
  
       
Foreign exchange forward contracts                                                                                                                          
   $ (3,245 )
_________________________________________
 
(*)
Amount of gain (loss) recognized in income located in interest and other income, net.
 
NOTE 3. GOODWILL AND PURCHASED AND OTHER INTANGIBLES
 
Goodwill as of February 27, 2009 and November 28, 2008 was $2.132 billion and $2.135 billion, respectively. The change includes reductions in goodwill primarily related to the unrecognized tax benefits associated with the acquisition of Macromedia in addition to foreign currency translation adjustments.
 

 
10
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


Purchased and other intangible assets subject to amortization as of February 27, 2009 were as follows (in thousands):
 
   
Cost
    
Accumulated
Amortization
    
Net
  
Purchased technology
   $ 411,493     $ (352,998 )   $ 58,495  
Localization
   $ 28,655     $ (14,851 )   $ 13,804  
Trademarks
     130,925       (84,767 )     46,158  
Customer contracts and relationships
     198,889       (136,255 )     62,634  
Other intangibles
     800       (423 )     377  
Total other intangible assets
   $ 359,269     $ (236,296 )   $ 122,973  
Total purchased and other intangible assets
   $ 770,762     $ (589,294 )   $ 181,468  
 
Purchased and other intangible assets subject to amortization as of November 28, 2008 were as follows (in thousands):
 
   
Cost
    
Accumulated
Amortization
    
Net
  
Purchased technology
   $ 411,408     $ (338,608 )   $ 72,800  
Localization
   $ 23,751     $ (6,156 )   $ 17,595  
Trademarks
     130,925       (78,181 )     52,744  
Customer contracts and relationships
     198,891       (127,520 )     71,371  
Other intangibles
     800       (350 )     450  
Total other intangible assets
   $ 354,367     $ (212,207 )   $ 142,160  
Total purchased and other intangible assets
   $ 765,775     $ (550,815 )   $ 214,960  
 
Amortization expense related to purchased and other intangible assets was $39.0 million and $49.5 million for the three months ended February 27, 2009 and February 29, 2008, respectively. Of these amounts, $23.6 million and $32.4 million was included in cost of sales for the three months ended February 27, 2009 and February 29, 2008, respectively.
 
Amortization expense decreased during the three months ended February 27, 2009 as compared to the three months ended February 29, 2008, due to a decrease in amortization expense associated with intangible assets purchased through the Macromedia acquisition.
 
Purchased and other intangible assets are amortized over their estimated useful lives of 1 to 13 years. As of February 27, 2009, we expect amortization expense in future periods to be as follows (in thousands):
 
Fiscal year
  
Purchased
Technology
    
Other Intangible
Assets
  
Remainder of 2009
   $ 41,869     $ 59,306  
2010
     8,273       49,564  
2011
     4,966       11,917  
2012
     3,387       1,009  
2013
     —       789  
Thereafter
     —       388  
Total expected amortization expense
   $ 58,495     $ 122,973  
 

 

 
11
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
NOTE 4. OTHER ASSETS
 
Other assets as of February 27, 2009 and November 28, 2008 consisted of the following (in thousands):
 
   
2009
    
2008
  
Acquired rights to use technology
   $ 88,572     $ 90,643  
Investments
     61,178       76,589  
Security and other deposits
     15,779       16,087  
Deferred compensation plan assets
     8,053       7,560  
Prepaid royalties
     7,646       9,026  
Restricted cash
     7,359       7,361  
Prepaid land lease
     3,176       3,185  
Prepaid rent
     2,251       2,658  
Other
     3,133       3,420  
Total other assets
   $ 197,147     $ 216,529  

Included in investments are our indirect investments through our limited partnership interest in Adobe Ventures, which is consolidated in accordance with FIN No. 46R, a revision to FIN 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. See Note 2 for further information regarding Adobe Ventures.
 
Also included in investments are our direct investments in privately-held companies which are accounted for based on the cost method. We assess these investments for impairment in value as circumstances dictate.
 
 We entered into a Purchase and Sale Agreement, effective 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 which is included in security and other deposits. This deposit will 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. ACCRUED EXPENSES
 
Accrued expenses as of February 27, 2009 and November 28, 2008 consisted of the following (in thousands):
 
   
2009
    
2008
  
Accrued compensation and benefits
   $ 133,817     $ 177,760  
Taxes payable
     15,579       21,760  
Sales and marketing allowances
     29,594       28,127  
Other
     166,687       172,322  
Total accrued expenses
   $ 345,677     $ 399,969  
 
Other primarily includes general corporate accruals for corporate marketing programs, local and regional expenses, 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.

 
12
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
NOTE 6. STOCK-BASED COMPENSATION
 
The assumptions used to value option grants during the three months ended February 27, 2009 and February 29, 2008 were as follows:
 
   
2009
    
2008
  
Expected life (in years)
     3.7 – 3.8       2.27 – 4.64  
Volatility
     50 – 57 %     33 – 35 %
Risk free interest rate
     1.16 – 1.40 %     2.37 – 3.35 %

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 months ended February 27, 2009 and February 29, 2008 were as follows:

   
2009
    
2008
  
Expected life (in years)
     0.5 – 2.0       0.5 – 2.0  
Volatility
     49 – 57 %     30 – 31 %
Risk free interest rate
     0.27 – 0.88 %     2.82 – 3.29 %
 
Summary of Stock Options
 
Information regarding stock options outstanding at February 27, 2009 and February 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
    
Weighted
Average
Exercise
Price
    
Weighted
Average
Remaining
Contractual
Life
(years)
    
Aggregate
Intrinsic
Value*
(millions)
  
2009
                        
Options outstanding
     42,773     $ 28.96       4.12     $ 18.8  
Options vested and expected to vest
     40,561     $ 28.90       4.00     $ 18.8  
Options exercisable
     27,635     $ 27.40       3.19     $ 18.8  
                                 
2008
                                
Options outstanding
     50,247     $ 29.08       4.41     $ 313.2  
Options vested and expected to vest
     45,200     $ 28.33       4.23     $ 308.0  
Options exercisable
     30,625     $ 24.63       3.35     $ 294.7  
_________________________________________
 
*
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 February 27, 2009 and February 29, 2008 were $16.70 and $33.65, respectively.
 
Summary of Restricted Stock Units
 
Restricted stock unit activity for the three months ended February 27, 2009 and February 29, 2008 was as follows (in thousands):
 
   
2009
    
2008
  
Beginning balance
     4,261       1,701  
Awarded
     2,979       2,395  
Released
     (814 )     (292 )
Forfeited
     (157 )     (36 )
Ending balance
     6,269       3,768  
 
 
13
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
      Information regarding restricted stock units outstanding at February 27, 2009 and February 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
    
Weighted
Average
Remaining
Contractual
Life
(years)
    
Aggregate
Intrinsic
Value*
(millions)
  
2009
                  
Restricted stock units outstanding
     6,269       2.13     $ 104.7  
Restricted stock units vested and expected to vest
     4,638       1.94     $ 77.4  
                         
2008
                        
Restricted stock units outstanding
     3,768       2.31     $ 126.8  
Restricted stock units vested and expected to vest
     2,567       2.11     $ 86.3  
_________________________________________
 
*
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of February 27, 2009 and February 29, 2008 were $16.70 and $33.65, respectively.
 
Summary of Performance Shares
 
Effective January 26, 2009, the Executive Compensation Committee adopted the 2009 Performance Share Program (the “2009 Program”). The purpose of the 2009 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2009 Program is our fiscal 2009 year. All members of our executive management and other key senior leaders are participating in the 2009 Program. Awards granted under the 2009 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% vesting evenly on the following three annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2009 Program have the ability to receive up to 115% of the target number of shares originally granted.
 
The following table sets forth the summary of performance share activity under our 2009 Program for the three months ended February 27, 2009 (in thousands):
 
   
Shares
Granted
    
Maximum
Shares Eligible
to Receive
  
Beginning balance
     —       —  
Awarded
     533       613  
Forfeited
     —       —  
Ending balance
     533       613  
 
In the first quarter of fiscal 2009, the Executive Compensation Committee certified the actual performance achievement of participants in the 2008 Performance Share Program (the “2008 Program”). Based upon the achievement of goals outlined in the 2008 Program, participants had the ability to receive up to 200% of the target number of shares originally granted. Actual performance resulted in participants achieving approximately 124% of target or approximately 1.0 million shares for the 2008 Program. Shares under the 2008 Program vested 25% in the first quarter of fiscal 2009, 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.
 

 
14
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


The following table sets forth the summary of performance share activity under our 2007 and 2008 programs, based upon share awards actually achieved, for the three months ended February 27, 2009 and February 29, 2008 (in thousands):
 
   
2009
    
2008
  
Beginning balance
     383       —  
Achieved
     1,022       717  
Released
     (354 )     (189 )
Forfeited
     (6 )     (24 )
Ending balance
     1,045       504  

Information regarding performance shares outstanding at February 27, 2009 and February 29, 2008 is summarized below:
 
   
Number of
Shares
(thousands)
    
Weighted
Average
Remaining
Contractual
Life
(years)
    
Aggregate
Intrinsic
Value*
(millions)
  
2009
                  
Performance shares outstanding
     1,045       1.76     $ 17.5  
Performance shares vested and expected to vest
     811       1.67     $ 13.5  
                         
2008
                        
Performance shares units outstanding
     504       1.88     $ 17.0  
Performance shares vested and expected to vest
     330       1.77     $ 11.0  
_________________________________________
 
*
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of February 27, 2009 and February 29, 2008 were $16.70 and $33.65, respectively.
 
Compensation Costs
 
As of February 27, 2009, there was $296.3 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards which will be recognized over a weighted average period of 2.8 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
 

 
15
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


Total stock-based compensation costs that have been included in our condensed consolidated statements of income for the three months ended February 27, 2009 and February 29, 2008 were as follows (in thousands):
 
   
2009
    
2008
  
Income Statement Classifications
  
Option Grants
and Stock
Purchase Rights (1)
    
Restricted
Stock and
Performance
Share
Awards (1) (2)
    
Option Grants
and Stock
Purchase Rights
    
Restricted
Stock and
Performance
Share
Awards
  
Cost of revenue—services and support
   $ (91 )   $ 194     $ 804     $ 40  
Research and development
     14,132       8,444       14,926       3,396  
Sales and marketing
     8,867       5,237       10,907       3,541  
General and administrative
     6,188       2,866       5,942       3,478  
Total
   $ 29,096     $ 16,741     $ 32,579     $ 10,455  
_________________________________________
(1)
For the three months ended February 27, 2009, we recorded $0.2 million associated with cash recoveries of fringe benefit tax from employees in India. For the three months ended February 29, 2008 there were no amounts associated with cash recoveries of fringe benefit tax from employees in India.
 
(2)
For the three months ended February 27, 2009, we recorded $0.4 million associated with the performance shares awarded under the 2009 Program. These shares are liability–classified for financial statement purposes until the metrics under the program have been achieved.
 
NOTE 7. EMPLOYEE BENEFIT PLAN
 
Deferred Compensation Plan
 
As of February 27, 2009 and November 28, 2008, the invested amounts under our Deferred Compensation Plan totaled $8.1 million and $7.6 million, respectively, and are recorded as long-term other assets on our condensed consolidated balance sheets. As of February 27, 2009 and November 28, 2008, we recorded $8.1 million and $7.6 million, respectively, as a long-term liability to recognize undistributed deferred compensation due to employees.
 
NOTE 8. RESTRUCTURING CHARGES
 
Fiscal 2008 Restructuring Charges
 
In the fourth quarter of fiscal 2008, we initiated a restructuring program, consisting of reductions in workforce of approximately 560 full-time positions globally and the consolidation of facilities, in order to reduce our operating costs and focus our resources on key strategic priorities. In connection with this restructuring program, we recorded restructuring charges in the fourth quarter of fiscal 2008 totaling $29.2 million related to termination benefits for the elimination of approximately 460 of the 560 full-time positions globally. Charges associated with these ongoing termination benefits were recorded in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” As of November 28, 2008, $0.4 million was paid.
 
In the first quarter of fiscal 2009, we continued to implement restructuring activities under this program. We vacated approximately 89,000 square feet of research and development and sales facilities in the U.S., the United Kingdom and Canada.  In accordance with SFAS No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities,” we accrued $8.5 million for the fair value of our future contractual obligations under the operating lease using our credit-adjusted risk-free interest rate, estimated at approximately 6% as of the date we ceased to use the leased property. This amount is net of estimated sublease income. We also recorded charges of $3.4 million for termination benefits for the elimination of approximately 43 of the remaining 100 full-time positions expected to be terminated.
 

 
16
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


The following table sets forth a summary of Adobe restructuring activities during the three months ended February 27, 2009 (in thousands):
 

   
November 28,
2008
    
Costs Incurred
    
Cash
Payments
    
Other Adjustments
    
February 27,
2009
    
Total Costs
Incurred to
Date
    
Total
Costs
Expected
to be
Incurred
  
Termination benefits
   $ 28,759     $ 3,394     $ (24,481 )   $ 102     $ 7,774     $ 24,928     $ 32,702  
Cost of closing redundant facilities
     —       8,514       (2,684 )     8       5,838       2,684       8,522  
Total
   $ 28,759     $ 11,908     $ (27,165 )   $ 110     $ 13,612     $ 27,612     $ 41,224  

 
Accrued restructuring charges of $13.6 million at February 27, 2009 include $11.1 million recorded in accrued restructuring, current and $2.5 million related to long-term facilities obligations recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets. We expect to pay substantially all of the accrued termination benefits during the remainder of fiscal 2009. We expect to pay facilities-related liabilities through fiscal 2013.
 
Included in the other adjustments column is a foreign currency translation adjustment of $0.1 million offset by a small change to previous estimates.
 
Macromedia Merger Restructuring Charges
 
We completed our acquisition of Macromedia on December 3, 2005. In connection with this acquisition, we initiated plans to restructure both the pre-merger operations of Adobe and Macromedia to eliminate certain duplicative activities, focus our resources on future growth opportunities and reduce our cost structure. In connection with the worldwide restructuring plan, we recognized costs related to termination benefits for employee positions that were eliminated and for the closure of duplicative facilities. We also recognized costs related to the cancellation of certain contracts associated with the wind-down of subsidiaries and other service contracts held by Macromedia.  Costs for termination benefits and contract terminations were completed during fiscal 2007.  Total costs incurred were $27.0 million and $3.2 million, respectively.

The following table sets forth a summary of Macromedia restructuring activities during the three months ended February 27, 2009 (in thousands):
 
   
November 28,
2008
    
Cash
Payments
    
Other Adjustments
    
February 27,
2009
    
Total Costs
Incurred to
Date
    
Total
Costs
Expected
to be
Incurred
  
Cost of closing redundant facilities
   $ 12,168     $ (1,753 )   $ 351     $ 10,766     $ 31,901     $ 42,667  
Other
     977       (8 )     —       969       1,387       2,356  
Total
   $ 13,145     $ (1,761 )   $ 351     $ 11,735     $ 33,288     $ 45,023  
 
Accrued restructuring charges of $11.7 million at February 27, 2009 include $7.2 million recorded in accrued restructuring, current and $4.5 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 28, 2008, accrued restructuring charges of $13.1 million included $6.9 million recorded in accrued restructuring, current and $6.2 million related to long-term facilities obligations recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets.
 
Included in the other adjustments column is a change to previous estimates of $0.4 million offset by a small foreign currency translation adjustment.

 
17
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
NOTE 9.  STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program I
 
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 also enter into structured repurchases with third parties.
 
We did not enter into any new structured repurchase agreements during the three months ended February 27, 2009. During the three months ended February 29, 2008, we entered into several structured repurchase agreements with large financial institutions, whereupon we provided the financial institutions with prepayments of $150.0 million. 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 three months ended February 27, 2009, we repurchased approximately 5.0 million shares at an average price of $22.79 through structured repurchase agreements entered into during fiscal 2008. During the three months ended February 29, 2008, we repurchased 6.7 million shares at an average price of $36.78 through structured repurchase agreements which included prepayments from fiscal 2007.
 
As of February 27, 2009 and November 28, 2008, the prepayments were classified as treasury stock on our balance sheets at the payment date, though only shares physically delivered to us by February 27, 2009 are excluded from the denominator in the computation of earnings per share. As of February 27, 2009 and February 29, 2008, approximately $19.7 million and $325.8 million, respectively, of up-front payments remained under the agreements. All outstanding structured repurchase agreements as of February 27, 2009 under this program expired on March 19, 2009.
 
Stock Repurchase Program II
 
Under this stock repurchase program, we had authorization to repurchase 50.0 million shares of our common stock. From the inception of the 50.0 million share authorization under this program, we provided prepayments of $1.9 billion under structured share repurchase agreements to large financial institutions. During the third quarter of fiscal 2008, the remaining authorized number of shares were repurchased.
 
During the first quarter of fiscal 2008, we provided prepayments of $1.0 billion and repurchased 26.6 million shares through structured share repurchase agreements at an average price of $37.56. As of February 29, 2008, approximately $133.3 million of up-front payments remained under these agreements and were utilized during the remainder of fiscal 2008.
 

 
18
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)

 
NOTE 10.  OTHER COMPREHENSIVE INCOME (LOSS)
 
The following table sets forth the components of other comprehensive income (loss) for the three months ended February 27, 2009 and February 29, 2008 (in thousands):
 
   
2009
    
2008
  
Net income
   $ 156,435     $ 219,379  
Other comprehensive income (loss):
                
Unrealized (losses) on derivative instruments
     (5,450 )     (31 )
Reclassification adjustment for gains (losses) on derivative instruments recognized during the period
     (20,476 )     —  
Unrealized (losses) on available-for-sale securities, net of taxes
     (1,969 )     (3,079 )
Reclassification adjustment for gains on available-for-sale securities recognized during the period
     (1,310 )     —  
Foreign currency translation adjustments
     (2,922 )     1,378  
Other comprehensive loss
     (32,127 )     (1,732 )
Total other comprehensive income, net of taxes
   $ 124,308     $ 217,647  
 
NOTE 11.  NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the three months ended February 27, 2009 and February 29, 2008 (in thousands, except per share data):
 
   
2009
    
2008
  
Net income
   $ 156,435     $ 219,379  
Shares used to compute basic net income per share
     524,268       561,113  
Dilutive potential common shares:
                
Unvested restricted stock and performance share awards
     854       680  
Stock options
     2,708       9,466  
Shares used to compute diluted net income per share
     527,830       571,259  
Basic net income per share
   $ 0.30     $ 0.39  
Diluted net income per share
   $ 0.30     $ 0.38  
 
For the three months ended February 27, 2009, options to purchase approximately 32.2 million shares of common stock with exercise prices greater than the average fair market value of our stock of $20.98 were not included in the   calculation because the effect would have been anti-dilutive. Comparatively, for the three months ended February 29, 2008, options to purchase approximately 15.5 million shares of common stock with exercise prices greater than the average fair market value of our stock of $38.22 were not included in the calculation because the effect would have been anti-dilutive.
 
NOTE 12.  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 condensed consolidated balance sheets. 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 February 27, 2009, 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 condensed consolidated balance sheets. 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 FIN 45, 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 condensed consolidated balance sheets. 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 February 27, 2009 and November 28, 2008, 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 $2.2 million and $2.6 million, respectively.
 
Royalties
 
We have royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.
 
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.
 

 
20
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


Legal Proceedings
 
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, 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. We believe that we have valid defenses with respect to the legal matters pending against Adobe; however, litigation is inherently unpredictable and it is possible 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 13.  CREDIT AGREEMENT
 
In August 2007, we entered into an 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 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 a 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. As of both February 27, 2009 and November 28, 2008, the amount outstanding under the credit facility was $350.0 million, which is included in long-term liabilities on our condensed consolidated balance sheets. As of February 27, 2009, we were in compliance with all of the covenants.
 

 
21
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


NOTE 14.  NON-OPERATING INCOME (EXPENSE)
 
Non-operating income (expense) for the three months ended February 27, 2009 and February 29, 2008 included the following (in thousands):
 
   
2009
    
2008
  
Interest and other income, net:
            
Interest income
   $ 11,118     $ 17,511  
Foreign exchange gains (losses)
     634       (4,700 )
Realized gains on fixed income investment
     1,311       —  
Other, net
     221       479  
Interest and other income, net
   $ 13,284     $ 13,290  
Interest expense
   $ (792 )   $ (1,809 )
Investment gains (losses), net:
                
Realized investment gains
   $ 103     $ 5,397  
Unrealized investment gains
     124       3,914  
Realized investment losses
     (1,295 )     (383 )
Unrealized investment losses
     (16,178 )     (196 )
Investment (losses) gains, net
   $ (17,246 )   $ 8,732  
Total non-operating income (expense), net
   $ (4,754 )   $ 20,213  
 
NOTE 15.  SEGMENTS
 
We have the following reportable segments: Creative Solutions, Knowledge Worker, Enterprise, Platform and Print and 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 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 segment provides server-based enterprise interaction solutions that automate people-centric processes and contains revenue generated by our LiveCycle line of products. The Platform segment includes client and developer technologies, such as Adobe Flash Player, Adobe Flash Lite, Adobe AIR, Adobe Flex and Adobe Flex Builder, and also encompasses products and technologies created and managed in other Adobe segments. Finally, the Print and Publishing segment addresses market 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 2009, our former Mobile and Devices Solutions segment, was integrated into our Platform business unit to better align our engineering and marketing efforts and will be reported as part of the Platform segment.  Prior year information in the table below has been reclassified to reflect the integration of these business units.
 
We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments.
 

 
22
ADOBE SYSTEMS INCORPORATED
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 (Unaudited)


Our chief operating decision maker reviews revenue and gross margin information for each of our reportable 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 reportable segments.
 
(in thousands)
  
Creative
Solutions
    
Knowledge
Worker
    
Enterprise
    
Platform*
    
Print and
Publishing
    
Total
  
Three months ended February 27, 2009
                                    
Revenue
   $ 460,728     $ 163,130     $ 63,855     $ 52,299     $ 46,378     $ 786,390  
Cost of revenue
     42,750       9,921       13,341       6,056       5,285       77,353  
Gross profit
   $ 417,978     $ 153,209     $ 50,514     $ 46,243     $ 41,093     $ 709,037  
Gross profit as a percentage of revenue
     91 %     94 %     79 %     88 %     89 %     90 %
Three months ended February 29, 2008
                                                
Revenue
   $ 543,475     $ 195,535     $ 54,164     $ 43,344     $ 53,927     $ 890,445  
Cost of revenue
     36,048       11,681       16,991       9,964       7,791       82,475  
Gross profit
   $ 507,427     $ 183,854     $ 37,173     $ 33,380     $ 46,136     $ 807,970  
Gross profit as a percentage of revenue
     93 %     94 %     69 %     77 %     86 %     91 %
_________________________________________
*
Platform revenue includes revenue related to our Mobile client products of $26.1 million and $15.2 million for the three months ended February 27, 2009 and February 29, 2008, respectively, or 50% and 35% of Platform revenues, respectively.

 


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 of this report. 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 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 2009, our former Mobile and Devices Solutions segment, which was integrated into our Platform business unit to better align our engineering and marketing efforts, will be reported as part of the Platform segment. Prior year information has been updated to reflect the integration of these business units.
 
During the first quarter of fiscal 2009, our worldwide business continued to be impacted by the global financial crisis and the general macro economic environment.  End-user demand for most of our products, including our Adobe Creative Suite family of products and our Adobe Acrobat family of products, was weaker than expected in the quarter and contributed to revenue results that were below our expectations for the quarter.  Despite the revenue weakness, we were able to proactively manage our expenses to deliver earnings per share and profit margin results within the target ranges we publicly provided at the outset of the quarter.
 
In our Creative Solutions segment, revenue for our CS4 family of products, which began shipping in our fourth quarter of fiscal 2008, lags the revenue achieved for the equivalent CS3 products for the comparable period of time by more than 20%. We attribute this weakness to the economic conditions affecting the business of our creative professional customers, as well as job losses in the creative marketplace.  Based on economic predictions and market trends such as ad spending, we do not expect the market environment for creative products to improve in the near term.
 
Our Knowledge Worker segment experienced a slow down in demand year-over-year, resulting in revenue below our expectations in the first quarter.  We attribute this weakness to a slow down in corporate spending, as well as job losses in the markets we target with our Acrobat family of products, and we do not expect the market environment to improve in the near term.
 


In our Enterprise segment, despite the slow down in corporate spending, we achieved 18% year-over-year growth.  We attribute this success to our focus on delivering innovative products and solutions for our enterprise customers that helps them reduce costs and improve customer service. Currently, we do not anticipate any significant deterioration associated with corporate spending that may affect this segment.
 
Our Platform segment revenue achieved 21% year-over-year growth due to increased revenue for licensing of our Flash Lite client technologies by mobile handset OEMs and consumer electronic device manufacturers. We expect the May 1, 2008 announcement of the Open Screen Project (“OSP”) to substantially reduce our mobile and device revenue this fiscal year due to the removal of licensing fees on the next major releases of our Adobe Flash Platform technologies. We negotiated new contracts with a few OEMs during the first quarter of fiscal 2009 to help bridge their distribution abilities for existing solutions until newer, free versions based on the OSP are available for them to ship towards the end of the fiscal year.  Platform segment revenue also grew year-over-year due to an increase in revenue generated through OEM relationships with companies  in which we include their technologies as part of the download offerings of our client technologies such as Adobe Reader, Adobe Flash Player and Adobe Shockwave Player.
 
Product revenues reported in our Print and Publishing business segment were also affected by end-user demand weakness because of economic conditions, and declined by 14% year-over-year. We expect end-user demand weakness to continue in the near term.
 

CRITICAL ACCOUNTING POLICIES AND 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 policies and estimates with the Audit Committee of the Board of Directors.
 
We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, 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.
 
There have been no significant changes in our critical accounting policies and estimates during the three months ended February 27, 2009 as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 28, 2008.
 
RESULTS OF OPERATIONS
 
Revenue for the Three Months Ended February 27, 2009 and February 29, 2008 (in millions)
 
   
2009
    
2008
  
Product
   $ 742.2     $ 852.0  
Percentage of total revenue
     94 %     96 %
Services and support
     44.2       38.4  
Percentage of total revenue
     6 %     4 %
Total revenue
   $ 786.4     $ 890.4  

 
As described in Note 15 of our Notes to Condensed Consolidated Financial Statements, we have the following segments: Creative Solutions, Knowledge Worker, Enterprise, Platform and Print and Publishing.
 
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.
 
Segment Information (in millions)
 
   
2009
    
2008
    
Percent Change
  
Creative Solutions
   $ 460.7     $ 543.5       (15 )%
Percentage of total revenue
     59 %     61 %        
Knowledge Worker
     163.1       195.5       (17 )%
Percentage of total revenue
     21 %     22 %        
Enterprise
     63.9       54.2       18 %
Percentage of total revenue
     8 %     6 %        
Platform
     52.3       43.3       21 %
Percentage of total revenue
     7 %     5 %        
Print and Publishing
     46.4       53.9       (14 )%
Percentage of total revenue
     5 %     6 %        
Total revenue
   $ 786.4     $ 890.4       (12 )%

Revenue from Creative Solutions decreased $82.8 million during the three months ended February 27, 2009 as compared to the three months ended February 29, 2008.  This year-over-year decrease was driven largely by a 17% decline in Creative Suites related revenue and a decline of 12% in Photoshop revenue. Also contributing to the decrease was an overall decline in the number of units licensed. Unit average selling prices remained relatively stable.

Revenue from Knowledge Worker decreased $32.4 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008, primarily due to a decrease in revenue from our Acrobat family of products. We attribute the decline in revenue to lower volume licensing through our licensing programs by our enterprise customers, as well as a decrease in the number of units licensed through our shrinkwrap distribution channel. This lower demand was offset in part by an increase in overall unit average selling prices for the three months ended February 27, 2009 as compared to the three months ended February 29, 2008.
 
Revenue from Enterprise increased $9.7 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008. The increase was primarily due to an increase in average transaction size, offset in part by a decrease in the number of enterprise solution transactions during the three months ended February 27, 2009 compared with the corresponding period in the prior fiscal year.
 
Revenue from Platform increased $9.0 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008. The increase was primarily due to increased revenue from our Mobile Client products.
 
Revenue from Print and Publishing decreased $7.5 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008. The decrease resulted principally from a slight decline in revenue associated with our legacy products.
 
Geographical Information (in millions)
 
   
2009
    
2008
    
Percent Change
  
Americas
   $ 326.1     $ 396.9       (18 )%
Percentage of total revenue
     41 %     45 %        
EMEA
     277.5       323.9       (14 )%
Percentage of total revenue
     35 %     36 %        
Asia
     182.8       169.6       8 %
Percentage of total revenue
     24 %     19 %        
Total revenue
   $ 786.4     $ 890.4       (12 )%

 
Overall revenue for the three months ended February 27, 2009 decreased when compared to the three months ended February 29, 2008 primarily due to a reduction in the adoption and licensing of our CS4 and Acrobat families of products.
 
 
Success with our LiveCycle business and a year-over-year increase in OEM licensing of our Mobile Client products offset part of the decline in the other businesses.
 
Revenue in the Americas decreased $70.8 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008, due primarily to weaker demand with our creative and knowledge worker products.  Continued success with our LiveCycle enterprise business helped to offset some of this weakness.
 
Revenue in EMEA decreased $46.4 million during the three months ended February 27, 2009, compared to the three months ended February 29, 2008, due primarily to weaker demand with our creative and knowledge worker products, similar to the impact noted in the Americas.
 
Revenue in Asia increased $13.2 million during the three months ended February 27, 2009 compared to the three months ended February 29, 2008, due primarily to the timing of the release of new product versions of our CS4 family of products.
 
Included in the overall decrease in revenue were impacts associated with foreign currency. Revenue in EMEA measured in U.S. dollars decreased approximately $22.9 million, due to the strength of the U.S. dollar against the Euro, during the three months ended February 27, 2009, over the same reporting period last year. Although the U.S. dollar strengthened significantly against the Euro year-over-year, during the three months ended February 27, 2009, we were able to mitigate all but $2.5 million of this impact to our reported revenue with our currency hedging program which resulted in hedging gains of $20.4 million. Revenue in Asia measured in U.S. dollars was favorably impacted by approximately $14.9 million due to the strength of the Yen against the U.S. dollar during the three months ended February 27, 2009, over the same reporting period last year.
 
Product Backlog
 
The actual amount of product backlog at any particular time may not be a meaningful indicator of future business prospects. Backlog is comprised of unfulfilled orders, excluding those associated with new product releases, those pending credit review and those not shipped due to the application of our global inventory policy.  We had minimal backlog at the end of both the first quarter of fiscal 2009 and the fourth quarter of fiscal 2008.
 
Cost of Revenue for the Three Months Ended February 27, 2009 and February 29, 2008 (in millions)
 
   
2009
    
2008
    
Percent Change
  
Product
   $ 58.9     $ 59.8       (2 )%
Percentage of total revenue
     7 %     7 %        
Services and support
     18.5       22.7       (19 )%
Percentage of total revenue
     2 %     3 %        
Total cost of revenue
   $ 77.4     $ 82.5       (6 )%
 
Product
 
Cost of product revenue includes product packaging, third-party royalties, excess and obsolete inventory, amortization related to localization costs and acquired rights to use technology and the costs associated with the manufacturing of our products.
 
Cost of product revenue increased (decreased) due to the following:
 
   
Percent Change
2008 to 2009
QTD
  
Hosted services
     6 %
Excess and obsolete inventory
     5  
Amortization of acquired rights to use technology
     3  
Localization costs related to our product launches
     (2 )
Amortization of purchased intangibles
     (13 )
Various individually insignificant items
     (1 )
Total change
     (2 )%



The increase in hosted service costs was primarily related to the amortization of capitalized infrastructure costs for the three months ended February 27, 2009 as compared to the three months ended February 29, 2008.
 
The increase in excess and obsolete inventory was primarily related to certain localized languages of our CS3 products, which became obsolete and were disposed of.
 
Amortization expense decreased during the three months ended February 27, 2009 as compared to the three months ended February 29, 2008, due to a decrease in amortization expense primarily associated with intangible assets purchased through the Macromedia acquisition.
 
Services and Support
 
Cost of services and support revenue is primarily comprised of employee-related costs and associated costs incurred to provide consulting services, training and product support.
 
Cost of services and support revenue decreased during the three months ended February 27, 2009 as compared to the three months ended February 29, 2008, primarily due to decreases in compensation and related benefits driven by reduced headcount.
 
Operating Expenses for the Three Months Ended February 27, 2009 and February 29, 2008
 
Research and Development, Sales and Marketing and General and Administrative Expenses
 
Compensation costs decreased for the three months ended February 27, 2009 primarily due to lower profit sharing and employee bonuses based on company performance to date, when compared to the three months ended February 29, 2008.
 
Research and Development (in millions)
 
   
2009
    
2008
    
Percent Change
  
Expenses
   $ 149.9     $ 168.5       (11 )%
Percentage of total revenue
     19 %     19 %        
 
Research and development expenses consist primarily of salary and benefit expenses for software developers, contracted development efforts, related facilities costs and expenses associated with computer equipment used in software development.
 
Research and development expenses decreased due to the following:
 
   
Percent Change
2008 to 2009
QTD
  
Compensation associated with incentive compensation and stock-based compensation
     (6 )%
Various individually insignificant items
     (5 )
Total change
     (11 )%
 
We believe that investments in research and development, including the recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced products. We will continue to focus on long-term opportunities available in our end markets and make significant investments in the development of our desktop application and server-based software products.
 
Sales and Marketing (in millions)
 
   
2009
    
2008
    
Percent Change
  
Expenses
   $ 249.5     $ 262.6       (5 )%
Percentage of total revenue
     32 %     29 %        
 
Sales and marketing expenses consist primarily of salary and benefit expenses, sales commissions, travel expenses and related facilities costs for our sales, marketing, order management and global supply chain management personnel. Sales
 
 
and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows, public relations and other market development programs.
 
Sales and marketing expenses increased (decreased) due to the following:
 
   
Percent Change
2008 to 2009
QTD
  
Marketing spending related to product launches and overall marketing efforts to further increase revenue
     3 %
Compensation associated with incentive compensation and stock-based compensation
     (6 )