Adobe 2006 Annual Report Download - page 82

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82
relating to fulfilling the obligation plus a normal profit margin. The sum of the costs and operating profit
approximates, in theory, the amount that we would be required to pay a third party to assume the support
obligation. The estimated costs to fulfill the support obligation were based on the historical direct costs
related to providing the support. As a result, we recorded an adjustment to reduce Macromedia’s carrying
value of deferred revenue by $49.1 million to $14.9 million, which represents our estimate of the fair value
of the contractual obligations assumed.
Identifiable intangible assets – Acquired product rights include developed and core technology and
patents. Developed technology relates to Macromedia products across all of their product lines that have
reached technological feasibility. Core technology and patents represent a combination of Macromedia's
processes, patents and trade secrets developed through years of experience in design and development of its
products. We will amortize the fair value of the acquired product rights based on the pattern in which the
economic benefits of the intangible asset will be consumed.
Customer contracts and relationships represent existing contracts and the underlying customer
relationships. We will amortize the fair value of these assets based on the pattern in which the economic
benefits of the intangible asset will be consumed.
Trademarks primarily relate to the Flash trade name and other product names, which will be amortized
based on the pattern in which the economic benefits of the intangible asset will be consumed.
In-process research and development – As of the acquisition date, no amounts were allocated to in-
process research and development. In-process research and development is dependent on the status of new
projects on the date the acquisition is consummated. Prior to the acquisition date, Macromedia had released
new versions of its software products. Accordingly, there were no substantive research and development
projects in process on the date the acquisition was consummated.
Goodwill – Approximately $2.0 billion has been allocated to goodwill. Goodwill represents the excess of
the purchase price over the fair value of the underlying acquired net tangible and intangible assets. In
accordance with SFAS 142, goodwill will not be amortized but instead will be tested for impairment at least
annually (more frequently if certain indicators are present). The factors that contributed to the recognition of
goodwill included securing buyer-specific synergies that increase revenue and profits and are not otherwise
available to a marketplace participant, acquiring a talented workforce, and significant cost savings
opportunities.
Taxes – As part of our accounting for the Macromedia acquisition, a portion of the overall purchase price
was allocated to goodwill and acquired intangible assets. Amortization expense associated with acquired
intangible assets is not deductible for tax purposes. Thus, approximately $186.9 million was established as a
deferred tax liability for the future amortization of the intangible assets. In accordance with Statement of
Financial Accounting Standards No. 109, “Accounting for Income Taxes,” the valuation allowance on
Macromedia's financial statements as of December 3, 2005 was reduced by $237.8 million to $16.1 million, to
the extent the deferred tax assets are more likely than not realizable.
Any impairment charges made in the future associated with goodwill will not be tax deductible and will
result in an increased effective income tax rate in the quarter the impairment is recorded.
Deferred stock-based compensation – Deferred stock-based compensation represents the estimated fair
value, measured as of December 3, 2005, of unvested Macromedia stock options and restricted stock
assumed. The fair value of unvested options assumed was $117.3 million using the Black Scholes valuation
model. The stock price used in the valuation is $34.97, which was the closing price of Adobe shares on
December 2, 2005, the last trading day before the close of the acquisition. The risk-free interest rate was the
zero coupon yield on December 2, 2005 implied from U.S. Treasury securities with equivalent remaining
terms. We do not anticipate paying any cash dividends in the foreseeable future and therefore used an
expected dividend yield of zero. We estimate the expected term by taking the average of the vesting term
remaining and the contractual term of the option, as illustrated in SAB 107. The implied volatility of Adobe