ADOBE INC. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page No. Consolidated Balance Sheets 62 Consolidated Statements of Income 63 Consolidated Statements of Comprehensive Income 64 Consolidated Statements of Stockholders' Equity 65 Consolidated Statements of Cash Flows 66 Notes to Consolidated Financial Statements 67 Report of KPMG LLP, Independent Registered Public Accounting Firm 107 All financial statement schedules have been omitted, since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Consolidated Financial Statements and Notes thereto. 61 Table of Contents ADOBE INC. CONSOLIDATED BALANCE SHEETS (In millions, except par value) November 27, 2020 November 29, 2019 ASSETS Current assets: Cash and cash equivalents $ 4,478 $ 2,650 Short-term investments 1,514 1,527 Trade receivables, net of allowances for doubtful accounts of $ 21 and of $ 10 , respectively 1,398 1,535 Prepaid expenses and other current assets 756 783 Total current assets 8,146 6,495 Property and equipment, net 1,517 1,293 Operating lease right-of-use assets, net 487 — Goodwill 10,742 10,691 Other intangibles, net 1,359 1,721 Deferred income taxes 1,370 — Other assets 663 562 Total assets $ 24,284 $ 20,762 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Trade payables $ 306 $ 209 Accrued expenses 1,422 1,399 Debt — 3,149 Deferred revenue 3,629 3,378 Income taxes payable 63 56 Operating lease liabilities 92 — Total current liabilities 5,512 8,191 Long-term liabilities: Debt 4,117 989 Deferred revenue 130 123 Income taxes payable 529 616 Deferred income taxes 10 140 Operating lease liabilities 499 — Other liabilities 223 173 Total liabilities 11,020 10,232 Commitments and contingencies Stockholders’ equity: Preferred stock, $ 0.0001 par value; 2 shares authorized; none issued — — Common stock, $ 0.0001 par value; 900 shares authorized; 601 shares issued; 479 and 483 shares outstanding, respectively — — Additional paid-in-capital 7,357 6,504 Retained earnings 19,611 14,829 Accumulated other comprehensive income (loss) ( 158 ) ( 188 ) Treasury stock, at cost ( 122 and 118 shares, respectively) ( 13,546 ) ( 10,615 ) Total stockholders’ equity 13,264 10,530 Total liabilities and stockholders’ equity $ 24,284 $ 20,762 See accompanying Notes to Consolidated Financial Statements. 62 Table of Contents ADOBE INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share data) Years Ended November 27, 2020 November 29, 2019 November 30, 2018 Revenue: Subscription $ 11,626 $ 9,634 $ 7,604 Product 507 648 622 Services and other 735 889 804 Total revenue 12,868 11,171 9,030 Cost of revenue: Subscription 1,108 926 574 Product 36 40 46 Services and other 578 707 575 Total cost of revenue 1,722 1,673 1,195 Gross profit 11,146 9,498 7,835 Operating expenses: Research and development 2,188 1,930 1,538 Sales and marketing 3,591 3,244 2,621 General and administrative 968 881 745 Amortization of intangibles 162 175 91 Total operating expenses 6,909 6,230 4,995 Operating income 4,237 3,268 2,840 Non-operating income (expense): Interest expense ( 116 ) ( 157 ) ( 89 ) Investment gains (losses), net 13 52 3 Other income (expense), net 42 42 40 Total non-operating income (expense), net ( 61 ) ( 63 ) ( 46 ) Income before income taxes 4,176 3,205 2,794 Provision for (benefit from) income taxes ( 1,084 ) 254 203 Net income $ 5,260 $ 2,951 $ 2,591 Basic net income per share $ 10.94 $ 6.07 $ 5.28 Shares used to compute basic net income per share 481 486 491 Diluted net income per share $ 10.83 $ 6.00 $ 5.20 Shares used to compute diluted net income per share 485 492 498 See accompanying Notes to Consolidated Financial Statements. 63 Table of Contents ADOBE INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Years Ended November 27, 2020 November 29, 2019 November 30, 2018 Increase/(Decrease) Net income $ 5,260 $ 2,951 $ 2,591 Other comprehensive income (loss), net of taxes: Available-for-sale securities: Unrealized gains / losses on available-for-sale securities 3 29 ( 24 ) Reclassification adjustment for recognized gains / losses on available-for-sale securities ( 1 ) — 11 Net increase (decrease) from available-for-sale securities 2 29 ( 13 ) Derivatives designated as hedging instruments: Unrealized gains / losses on derivative instruments ( 44 ) — 74 Reclassification adjustment for realized gains / losses on derivative instruments 6 ( 44 ) ( 49 ) Net increase (decrease) from derivatives designated as hedging instruments ( 38 ) ( 44 ) 25 Foreign currency translation adjustments 66 ( 25 ) ( 48 ) Other comprehensive income (loss), net of taxes 30 ( 40 ) ( 36 ) Total comprehensive income, net of taxes $ 5,290 $ 2,911 $ 2,555 See accompanying Notes to Consolidated Financial Statements. 64 Table of Contents ADOBE INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In millions) Common Stock Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Shares Amount Shares Amount Total Balances at December 1, 2017 601 $ — $ 5,082 $ 9,574 $ ( 112 ) ( 109 ) $ ( 6,085 ) $ 8,459 Net income — — — 2,591 — — — 2,591 Other comprehensive income (loss), net of taxes — — — — ( 36 ) — — ( 36 ) Re-issuance of treasury stock under stock compensation plans — — ( 1 ) ( 349 ) — 5 148 ( 202 ) Purchase of treasury stock — — — — — ( 9 ) ( 2,050 ) ( 2,050 ) Equity awards assumed for acquisition — — 3 — — — — 3 Stock-based compensation — — 601 — — — — 601 Value of shares in deferred compensation plan — — — — — — ( 4 ) ( 4 ) Balances at November 30, 2018 601 $ — $ 5,685 $ 11,816 $ ( 148 ) ( 113 ) $ ( 7,991 ) $ 9,362 Impacts of adoption of the new revenue standard — — — 442 — — — 442 Net income — — — 2,951 — — — 2,951 Other comprehensive income (loss), net of taxes — — — — ( 40 ) — — ( 40 ) Re-issuance of treasury stock under stock compensation plans — — 48 ( 380 ) — 5 125 ( 207 ) Purchase of treasury stock — — — — — ( 10 ) ( 2,750 ) ( 2,750 ) Stock-based compensation — — 771 — — — — 771 Value of shares in deferred compensation plan — — — — — — 1 1 Balances at November 29, 2019 601 $ — $ 6,504 $ 14,829 $ ( 188 ) ( 118 ) $ ( 10,615 ) $ 10,530 Net income — — — 5,260 — — — 5,260 Other comprehensive income (loss), net of taxes — — — — 30 — — 30 Re-issuance of treasury stock under stock compensation plans — — ( 56 ) ( 478 ) — 4 123 ( 411 ) Purchase of treasury stock — — — — — ( 8 ) ( 3,050 ) ( 3,050 ) Stock-based compensation — — 909 — — — — 909 Value of shares in deferred compensation plan — — — — — — ( 4 ) ( 4 ) Balances at November 27, 2020 601 $ — $ 7,357 $ 19,611 $ ( 158 ) ( 122 ) $ ( 13,546 ) $ 13,264 See accompanying Notes to Consolidated Financial Statements. 65 Table of Contents ADOBE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Years Ended November 27, 2020 November 29, 2019 November 30, 2018 Cash flows from operating activities: Net income $ 5,260 $ 2,951 $ 2,591 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion 757 757 346 Stock-based compensation 909 788 610 Reduction of operating lease right-of-use assets 87 — — Deferred income taxes ( 1,501 ) 3 ( 469 ) Unrealized losses (gains) on investments, net ( 11 ) ( 48 ) 1 Other non-cash items 40 14 7 Changes in operating assets and liabilities, net of acquired assets and assumed liabilities: Trade receivables, net 106 ( 188 ) ( 2 ) Prepaid expenses and other assets ( 288 ) ( 551 ) ( 77 ) Trade payables 96 23 55 Accrued expenses and other liabilities 86 172 44 Income taxes payable ( 72 ) 4 479 Deferred revenue 258 497 444 Net cash provided by operating activities 5,727 4,422 4,029 Cash flows from investing activities: Purchases of short-term investments ( 1,071 ) ( 700 ) ( 566 ) Maturities of short-term investments 915 700 766 Proceeds from sales of short-term investments 167 86 1,709 Acquisitions, net of cash acquired — ( 101 ) ( 6,314 ) Purchases of property and equipment ( 419 ) ( 395 ) ( 267 ) Purchases of long-term investments, intangibles and other assets ( 15 ) ( 49 ) ( 18 ) Proceeds from sales of long-term investments and other assets 9 3 5 Net cash used for investing activities ( 414 ) ( 456 ) ( 4,685 ) Cash flows from financing activities: Purchases of treasury stock ( 3,050 ) ( 2,750 ) ( 2,050 ) Proceeds from re-issuance of treasury stock 270 233 191 Taxes paid related to net share settlement of equity awards ( 681 ) ( 440 ) ( 393 ) Proceeds from issuance of debt 3,144 — 2,248 Repayment of debt ( 3,150 ) — — Other financing activities, net ( 21 ) 11 ( 1 ) Net cash used for financing activities ( 3,488 ) ( 2,946 ) ( 5 ) Effect of foreign currency exchange rates on cash and cash equivalents 3 ( 13 ) ( 2 ) Net increase (decrease) in cash and cash equivalents 1,828 1,007 ( 663 ) Cash and cash equivalents at beginning of year 2,650 1,643 2,306 Cash and cash equivalents at end of year $ 4,478 $ 2,650 $ 1,643 Supplemental disclosures: Cash paid for income taxes, net of refunds $ 469 $ 352 $ 210 Cash paid for interest $ 88 $ 152 $ 81 Non-cash investing activities: Issuance of common stock and stock awards assumed in business acquisitions $ — $ — $ 3 See accompanying Notes to Consolidated Financial Statements. 66 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Operations Founded in 1982, Adobe Inc. is one of the largest and most diversified software companies in the world. We offer a line of products and services used by creative professionals, marketers, knowledge workers, students, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing, engaging and transacting with compelling content and experiences across personal computers, devices and media. We market our products and services directly to enterprise customers through our sales force and local field offices. We license our products to end users through app stores and our own website at www.adobe.com. We offer many of our products via a Software-as-a-Service (“SaaS”) model or a managed services model, both of which are referred to as hosted or cloud-based, as well as through term subscription and pay-per-use models. We also distribute certain products and services through a network of distributors, value-added resellers, systems integrators, independent software vendors, retailers, software developers and original equipment manufacturers (“OEMs”). In addition, we license our technology to hardware manufacturers, software developers and service providers for use in their products and solutions. Our products run on personal and server-based computers, as well as on smartphones, tablets and other devices, depending on the product. We have operations in the Americas; Europe, Middle East and Africa (“EMEA”); and Asia-Pacific (“APAC”). Basis of Presentation The accompanying Consolidated Financial Statements include those of Adobe and its subsidiaries, after elimination of all intercompany accounts and transactions. We have prepared the accompanying Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Use of Estimates In preparing Consolidated Financial Statements and related disclosures in conformity with GAAP and pursuant to the rules and regulations of the SEC, we must make estimates and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, sales allowances and programs, bad debts, stock-based compensation, determining the fair value of acquired assets and assumed liabilities, impairment of goodwill and intangible assets, litigation and income taxes. Actual results may differ materially from these estimates. In March 2020, the World Health Organization declared the outbreak of a disease caused by a novel strain of the coronavirus (COVID-19) to be a pandemic. This pandemic has created and may continue to create significant uncertainty in the macroeconomic environment which, in addition to other unforeseen effects of this pandemic, may adversely impact our results of operations. As a result, most of our estimates and assumptions may require increased judgment and carry a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods. Fiscal Year Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Fiscal years 2020, 2019 and 2018 were 52 -week years. 67 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Reclassifications In the fourth quarter of fiscal 2020, we moved our Advertising Cloud offerings from our Digital Experience segment into our new Publishing and Advertising segment, which combined our Advertising Cloud offerings with our previous Publishing segment. This realignment is consistent with how we manage our Digital Experience segment to better reflect the strategic shift related to Advertising Cloud and to align with our overall core value proposition of delivering on customer experience management. Further, we reclassified revenue and related cost of revenue of our Advertising Cloud offerings from subscription to services and other on our Consolidated Statements of Income. Financial information for all fiscal years presented has been updated in our Consolidated Financial Statements to reflect these reclassifications. If the change was made at the beginning of fiscal 2020, reported revenue and cost of revenue in our income statements for each quarter of fiscal 2020 would have been as follows: 2020 Quarter Ended Year Ended (in millions) February 28 May 29 August 28 November 27 November 27 Revenue: Subscription $ 2,732 $ 2,831 $ 2,948 $ 3,115 $ 11,626 Product 143 128 109 127 507 Services and other 216 169 168 182 735 Total revenue 3,091 3,128 3,225 3,424 12,868 Cost of revenue: Subscription 274 269 282 283 1,108 Product 7 9 10 10 36 Services and other 171 137 135 135 578 Total cost of revenue $ 452 $ 415 $ 427 $ 428 $ 1,722 Certain other immaterial prior year amounts have been reclassified to conform to current year presentation in the Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements. Significant Accounting Policies Revenue Recognition Our revenue is derived from the sale of cloud-enabled software subscriptions, cloud-hosted offerings, term-based, royalty, and perpetual software licenses, associated software maintenance and support plans, consulting services, training and technical support. Most of our enterprise customer arrangements involve multiple promises to our customers. Revenue is recognized when a contract exists between us and a customer and upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which may be capable of being distinct and accounted for as separate performance obligations, or in the case of offerings such as cloud-enabled Creative Cloud and Document Cloud, accounted for as a single performance obligation. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Subscription, Product and Services Offerings We enter into revenue arrangements in which a customer may purchase a combination of cloud-enabled subscriptions, cloud-hosted offerings, term-based, royalty, and perpetual software licenses, associated software maintenance and support plans, consulting services, training and technical support. 68 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Fully hosted subscription services (SaaS) allow customers to access hosted software during the contractual term without taking possession of the software. Cloud-hosted subscription services may be sold on a fee-per-subscription period basis or based on consumption or usage. We recognize revenue ratably over the contractual service term for hosted services that are priced based on a committed number of transactions where the delivery and consumption of the benefit of the services occur evenly over time, beginning on the date the services associated with the committed transactions are first made available to the customer and continuing through the end of the contractual service term. Over-usage fees and fees based on the actual number of transactions are billed in accordance with contract terms as these fees are incurred and are included in the transaction price of an arrangement as variable consideration. Fees based on a number of transactions, where invoicing is aligned to the pattern of performance, customer benefit and consumption, are typically accounted for utilizing the “as-invoiced” practical expedient. Revenue for subscriptions sold as a fee per period is recognized ratably over the contractual term as the customer simultaneously receives and consumes the benefit of the underlying service. When cloud-enabled services are highly integrated and interrelated with on-premise software, such as in our cloud-enabled Creative Cloud and Document Cloud offerings, the individual components are not considered distinct and revenue is recognized ratably over the subscription period for which the cloud-enabled services are provided. The subscription support plans related to those customer arrangements whose revenues we classify as subscription revenues represent stand-ready performance obligations. Revenue from these subscription support plans is recognized ratably over their respective contractual terms and classified as subscription revenue. Licenses for on-premise software may be purchased on a perpetual basis, as a subscription for a fixed period of time or based on usage for certain of our OEM and royalty agreements. Revenue from distinct on-premise licenses is recognized at the point in time the software is available to the customer, provided all other revenue recognition criteria are met, and classified as product revenue on our Consolidated Statements of Income. Some of our enterprise license arrangements allow customers to commit non-cancellable funds. These non-cancellable committed funds are nonrefundable and provide our customers options to either renew monthly on-premise term-based licenses or use some or all funds to purchase other Adobe products or services. Revenue associated with these monthly term-based licenses and associated maintenance and support is classified as subscription revenue. Our services and other revenue is comprised primarily of fees related to consulting, training, maintenance and support and our advertising offerings. We typically sell our consulting contracts on a time-and-materials and fixed-fee basis. These revenues are recognized as the services are performed for time and materials contracts and on a relative performance basis for fixed-fee contracts. Training revenues are recognized as the services are performed. Our maintenance and support offerings, which entitle customers, partners and developers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement. Our transaction-based advertising offerings, where fees are based on a number of impressions per month and invoicing is aligned to the pattern of performance, customer benefit and consumption, are typically accounted for utilizing the “as-invoiced” practical expedient. We exclude from the transaction price sales and other taxes collected from customers on behalf of the relevant government authority. Most of our products are delivered electronically, however in instances where shipping and handling costs are incurred, we treat these amounts as costs to fulfill the contract and they are not considered a performance obligation and the associated fees are not included in the transaction price. Judgments Our contracts with customers may include multiple goods and services. For example, some of our offerings include both on-premise and/or on-device software licenses and cloud services. Determining whether the software licenses and the cloud services are distinct from each other, and therefore performance obligations to be accounted for separately, or not distinct from each other, and therefore part of a single performance obligation, may require significant judgment. We have concluded that the on-premise/on-device software licenses and cloud services provided in our Creative Cloud and Document Cloud subscription offerings are not distinct from each other such that revenue from each offering should be recognized ratably over the subscription period for which the cloud services are provided. In reaching this conclusion, we considered the nature of our promise to Creative Cloud and Document Cloud customers, which is to provide a complete end-to-end creative design or 69 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) document workflow solution that operates seamlessly across multiple devices and teams. We fulfill this promise by providing access to a solution that integrates cloud-based and on-premise/on-device features that, together through their integration, provide functionalities, utility and workflow efficiencies that could not be obtained from either the on-premise/on-device software or cloud services on their own. Cloud-based features that are integral to our Creative Cloud and Document Cloud offerings and that work together with the on-premise/on-device software include, but are not limited to: Creative Cloud Libraries, which enable customers to access their work, settings, preferences and other assets seamlessly across desktop and mobile devices and collaborate across teams in real time; shared reviews which enable simultaneous editing and commenting of PDFs across desktop, mobile and web; automatic cloud rendering of a design which enables it to be worked on in multiple mediums; and Sensei, Adobe’s cloud-hosted artificial intelligence and machine learning framework, which enables features such as automated photo-editing, photograph content-awareness, natural language processing, optical character recognition and automated document tagging. Standalone selling price is established by maximizing the amount of observable inputs, primarily actual historical selling prices for performance obligations where available, and includes consideration of factors such as go-to-market model and geography. Individual products may have multiple values for standalone selling price depending on factors such as where they are sold and what channel they are sold through. Where standalone selling price may not be directly observable (e.g., the performance obligation is not sold separately), we maximize the use of observable inputs by using information that may include reviewing pricing practices, performance obligations with similar customers and selling models. Capitalized costs to obtain a contract are amortized over the expected period of benefit, which we have determined, based on analysis, to be 5 years. We evaluated qualitative and quantitative factors to determine the period of amortization, including contract length, renewals, customer life and the useful lives of our products and acquired products. When the expected period of benefit of an asset which would be capitalized is less than one year, we expense the amount as incurred, utilizing the practical expedient. We regularly evaluate whether there have been changes in the underlying assumptions and data used to determine the amortization period. When revenue arrangements include components of third-party goods and services, for example in transactions which involve resale, fulfillment or providing advertising impressions to our end customer, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer by evaluating indicators such as which party is primarily responsible for fulfilling the promise to provide the goods or services, which party has discretion in establishing price and the underlying terms and conditions between the parties to the transaction. We offer limited rights of return, rebates and price protection of our products under various policies and programs with our distributors, resellers and/or end-user customers. We estimate and record reserves for these programs as variable consideration when estimating transaction price. Returns, rebates and other offsets to transaction price are estimated at contract inception on a portfolio basis and assessed for reasonableness each reporting period when additional information becomes available. General Contract Provisions We maintain revenue reserves for rebates, rights of return and other limited price adjustments. Distributors are allowed limited rights of return of products purchased during the previous quarter. In addition, distributors are allowed to return products that have reached the end of their lives, as defined by us, and for products that are being replaced by new versions. We offer rebates to our distributors, resellers and/or end-user customers. Transaction price is reduced for these amounts based on actual performance against objectives set forth by us for a particular reporting period, such as volume and timely reporting. On a quarterly basis, the amount of revenue that is reserved is calculated based on our historical trends and data specific to each reporting period. The primary method of establishing these reserves is to review historical data from prior periods as a percent of revenue to determine a historical reserve rate. We then apply the historical rate to the current period revenue as a basis for estimating future returns. When necessary, we also provide a specific reserve in excess of portfolio-level estimated 70 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) requirements. This estimate can be affected by the amount of a particular product in the channel, the rate of sell-through, product plans and other factors. Although our subscription contracts are generally non-cancellable, a limited number of customers have the right to cancel their contracts by providing prior written notice to us of their intent to cancel the remainder of the contract term and consumers have a period of time to terminate certain agreements without penalty. In the event a customer cancels their contract, they are generally not entitled to a refund for prior services we have provided to them. Contracts that include termination rights without substantive penalty are accounted for as contracts only for the committed period. Periods of time after the right of termination are accounted for as optional purchases when they do not represent material rights. For certain of our usage-based license agreements, typically in our royalty and OEM businesses, reporting may be received after the end of a fiscal period. In such instances, we estimate and accrue license revenue. We base our estimates on multiple factors, including historical sales information, seasonality and other business information which may impact our estimates. We do not estimate variable consideration for our sales and usage-based license royalty agreements, consistent with the associated exception for sales and usage-based royalties for the license of intellectual property under the revenue recognition standard. Property and Equipment We record property and equipment at cost less accumulated depreciation and amortization. Property and equipment are depreciated using the straight-line method over their estimated useful lives ranging from 1 to 20 years for computers and other equipment, which includes our corporate jet, 1 to 6 years for furniture and fixtures, 5 to 20 years for building improvements and up to 40 years for buildings. Leasehold improvements are amortized using the straight-line method over the lesser of the remaining respective lease term or estimated useful lives ranging from 1 to 15 years. Leases We determine if an arrangement is or contains a lease at contract inception. In certain of our lease arrangements, primarily those related to our data center arrangements, judgment is required in determining if a contract contains a lease. For these arrangements, there is judgment in evaluating if the arrangement involves an identified asset that is physically distinct or whether we have the right to substantially all of the capacity of an identified asset that is not physically distinct. In arrangements that involve an identified asset, there is also judgment in evaluating if we have the right to direct the use of that asset. We do not have any finance leases. Operating leases are recorded in our Consolidated Balance Sheets. Right-of-use (“ROU”) assets and lease liabilities are measured at the lease commencement date based on the present value of the remaining lease payments over the lease term, determined using the discount rate for the lease at the commencement date. Because the rate implicit in our leases is not readily determinable, we use our incremental borrowing rate as the discount rate, which approximates the interest rate at which we could borrow on a collateralized basis with similar terms and payments and in similar economic environments. As of November 27, 2020, our leases have remaining lease terms of up to 11 years, some of which include options to extend the lease for up to 14 years and options to terminate the lease within 1 year. Optional periods to extend the lease, including by not exercising a termination option, are included in the lease term when it is reasonably certain that the option will be exercised. We also have one land lease that expires in 2091. Operating lease expense is recognized on a straight-line basis over the lease term. We account for lease and non-lease components, principally common area maintenance for our facilities leases, as a single lease component for our facilities and data center leases. Goodwill, Intangibles and Other Long-Lived Assets Goodwill is assigned to one or more reporting segments on the date of acquisition. We review our goodwill for impairment annually during our second quarter of each fiscal year and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of any one of our reporting units below its respective carrying amount. In performing our goodwill impairment test, we first perform a qualitative assessment, which requires that we consider events or circumstances including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting segment’s net assets and changes in our stock price. If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair values of our reporting segments are greater than the carrying amounts, then the quantitative goodwill impairment test is not performed. 71 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) If the qualitative assessment indicates that the quantitative analysis should be performed, we then evaluate goodwill for impairment by comparing the fair value of each of our reporting segments to its carrying value, including the associated goodwill. To determine the fair values, we use the equal weighting of the market approach based on comparable publicly traded companies in similar lines of businesses and the income approach based on estimated discounted future cash flows. Our cash flow assumptions consider historical and forecasted revenue, operating costs and other relevant factors. We completed our annual goodwill impairment test in the second quarter of fiscal 2020. We determined, after performing a qualitative review of each reporting segment, that it is more likely than not that the fair value of each of our reporting segments substantially exceeds the respective carrying amounts. Accordingly, there was no indication of impairment and the quantitative goodwill impairment test was not performed. We did not identify any events or changes in circumstances since the performance of our annual goodwill impairment test that would require us to perform another goodwill impairment test during the fiscal year. We amortize intangible assets with finite lives over their estimated useful lives and review them for impairment whenever an impairment indicator exists. We continually monitor events and changes in circumstances that could indicate that the carrying amounts of our long-lived assets, including our intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, we recognize an impairment loss based on any excess of the carrying amount over the fair value of the assets. We did not recognize any intangible asset impairment charges in fiscal 2020, 2019 or 2018. During fiscal 2020, our intangible assets were amortized over their estimated useful lives ranging from 3 to 15 years. Amortization is based on the pattern in which the economic benefits of the intangible asset will be consumed or on a straight-line basis when the consumption pattern is not apparent. The weighted average useful lives of our intangible assets were as follows: Weighted Average Useful Life (years ) Customer contracts and relationships 10 Purchased technology 6 Trademarks 9 Other 6 Income Taxes We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not. During fiscal 2020, we completed intra-entity transfers of certain intellectual property rights (“IP rights”) which resulted in the establishment of deferred tax assets, net of valuation allowance, and related tax benefits of $ 224 million and $ 1.13 billion based on the fair value of the IP rights transferred in April and November 2020, respectively. The determination of the fair value involves significant judgment on future revenue growth, operating margins and discount rates. The tax-deductible amortization related to the transferred IP rights will be recognized over the period of economic benefit. Taxes Collected from Customers We net taxes collected from customers against those remitted to government authorities in our financial statements. Accordingly, taxes collected from customers are not reported as revenue. 72 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Treasury Stock We account for treasury stock under the cost method. When treasury stock is re-issued at a price higher than its cost, the difference is recorded as a component of additional paid-in-capital in our Consolidated Balance Sheets. When treasury stock is re-issued at a price lower than its cost, the difference is recorded as a component of additional paid-in-capital to the extent that there are previously recorded gains to offset the losses. If there are no treasury stock gains in additional paid-in-capital, the losses upon re-issuance of treasury stock are recorded as a reduction of retained earnings in our Consolidated Balance Sheets. Advertising Expenses Advertising costs are expensed as incurred. Advertising expenses for fiscal 2020, 2019 and 2018 were $ 362 million, $ 221 million and $ 174 million, respectively. Foreign Currency Translation We translate assets and liabilities of foreign subsidiaries, whose functional currency is their local currency, at exchange rates in effect at the balance sheet date. We translate revenue and expenses at the monthly average exchange rates. We include accumulated net translation adjustments in stockholders’ equity as a component of accumulated other comprehensive income (loss). Derivative Financial Instruments In countries outside the United States, we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option contracts or forward contracts to hedge a portion of our forecasted foreign currency denominated revenue primarily in Euros, British Pounds, Japanese Yen and Australian Dollars. Additionally, we hedge our net recognized foreign currency monetary 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. We recognize all derivative instruments as either assets or liabilities in our Consolidated Balance Sheets and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. Contracts that do not qualify for hedge accounting are adjusted to fair value through earnings. Gains and losses related to changes in the fair value of interest rate swaps and foreign exchange forward contracts which hedge certain balance sheet positions are recorded each period as a component of other income (expense), net in our Consolidated Statements of Income. Foreign exchange option contracts hedging forecasted foreign currency revenue and Treasury lock agreements are designated as cash flow hedges with gains and losses recorded net of tax as a component of accumulated other comprehensive income (loss) in our Consolidated Balance Sheets until the forecasted transaction occurs. When the forecasted transaction affects earnings, we reclassify the related gain or loss on the foreign currency and Treasury lock cash flow hedges to revenue and interest expense, respectively. Concentration of Risk Financial instruments that potentially subject us to concentrations of credit risk are short-term fixed-income investments, structured repurchase transactions, foreign currency and interest rate hedge contracts and trade receivables. Our investment portfolio consists of investment-grade securities diversified among security types, industries and issuers. Our cash and investments are held and primarily managed by recognized financial institutions that follow our investment policy. Our policy limits the amount of credit exposure to any one security issue or issuer and we believe no significant concentration of credit risk exists with respect to these investments. We enter into master netting arrangements to mitigate credit risk in derivative transactions by permitting net settlement of transactions with the same counterparty. We also enter into collateral security agreements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. 73 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Credit risk in receivables is limited to OEMs, dealers and distributors of hardware and software products to the retail market, customers to whom we license software directly and our SaaS offerings. A credit review is completed for our new distributors, dealers and OEMs. We also perform ongoing credit evaluations of our customers’ financial condition and require letters of credit or other guarantees, whenever deemed necessary. The credit limit given to the customer is based on our risk assessment of their ability to pay, country risk and other factors and is not contingent on the resale of the product or on the collection of payments from their customers. Certain contracts with advertising agencies contain sequential liability provisions, under which the agency is not required to pay until payment is received from the agency’s customers. In these circumstances, we evaluate the credit-worthiness of the agency’s customers in addition to the agency itself. If we license our software or provide SaaS services to a customer where we have a reason to believe the customer’s ability and intention to pay is not probable, the arrangement is not considered to be a revenue contract. Accordingly, we will not recognize any consideration received as revenue until termination or substantive completion of the services. Recently Adopted Accounting Guidance On February 24, 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), (“ASC 842”), a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of ROU assets and lease liabilities on the balance sheet for all leases with terms greater than twelve months, including for those leases classified as operating leases under the legacy standard (“ASC 840”). Under ASC 842, added disclosures are required as compared to ASC 840 to meet the objective of enabling users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. On November 30, 2019, the beginning of our fiscal year 2020, we adopted ASC 842 using the alternative modified retrospective transition method provided in ASU 2018-11, Leases (Topic 842): Targeted Improvements. Under this method, we recorded ROU assets and lease liabilities of approximately $ 519 million and $ 618 million, respectively, at the adoption date and did not include any retrospective adjustments to comparative periods to reflect the adoption of ASC 842. The lease liabilities reflect the remaining minimum rental payments for our existing leases as of the adoption date, discounted using our incremental borrowing rate for each lease. The standard had no impact on our consolidated net income or cash flows. We elected the package of practical expedients permitted under the transition guidance, which allowed us to carry forward our assessments on whether a contract was or contains a lease, our historical lease classification and our initial direct costs for any leases that existed prior to adoption date. We also elected the practical expedient that allowed us to carry forward our accounting treatment for existing land easements. We did not elect the hindsight practical expedient to determine the lease term for existing leases. On August 28, 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging, requiring expanded hedge accounting for both non-financial and financial risk components and refining the measurement of hedge results to better reflect an entity’s hedging strategies. The updated standard also amends the presentation and disclosure requirements and changes how entities assess hedge effectiveness. On November 30, 2019, the beginning of our fiscal year 2020, we adopted the accounting requirements of the updated standard utilizing the modified retrospective method of transition. The adoption of this standard did not have a material impact on our Consolidated Financial Statements and related disclosures. Recent Accounting Pronouncements Not Yet Effective On June 16, 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses, requiring the measurement and recognition of expected credit losses for financial assets held at amortized cost, which include our accounts receivable and contract assets. The standard also requires that we recognize credit impairment losses related to our available-for-sale debt securities through an allowance for credit losses instead of a reduction in the cost basis. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition with a cumulative effect adjustment recorded to opening retained earnings as of the initial adoption date. The updated standard is effective for us beginning in the first quarter of fiscal 2021, and will not have a material impact on our Consolidated Financial Statements and related disclosures. With the exception of the new standards discussed above, there have been no other new accounting pronouncements that have significance, or potential significance, to our Consolidated Financial Statements. 74 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 2. REVENUE Segment Information We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments. Our Chief Executive Officer, the chief operating decision maker, reviews revenue and gross margin information for each of our reportable segments, but does not review operating expenses on a segment by segment basis. In addition, with the exception of goodwill, we do not identify or allocate our assets by the reportable segments. Following the move of our Advertising Cloud offerings from our Digital Experience segment into the Publishing segment, our business is organized into three reportable segments: Digital Media, Digital Experience, and Publishing and Advertising. These segments provide our senior management with a comprehensive financial view of our key businesses. Our segments are aligned around our two strategic growth opportunities as described in the “Business Overview” within Part I, Item 1, placing our Publishing and Advertising business in a third segment that contains some of our legacy products and solutions. We categorize our products into the following reportable segments: • Digital Media —Our Digital Media segment provides tools and solutions that enable individuals, teams and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include content creators, experience designers, app developers, enthusiasts, students, social media users and creative professionals, as well as marketing departments and agencies, companies and publishers. Our customers also include knowledge workers who create, collaborate on and distribute documents and creative content. • Digital Experience —Our Digital Experience segment provides products, services and solutions for creating, managing, executing, measuring, monetizing and optimizing customer experiences from analytics to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers, marketing executives, information management and technology executives, product development executives, and sales and support executives. • Publishing and Advertising —Our Publishing and Advertising segment addresses market opportunities ranging from the diverse authoring and publishing needs of technical and business publishing to our legacy type and OEM printing businesses. It also includes our platforms for Advertising Cloud, web conferencing, document and forms, and Primetime. Financial results for fiscal 2020 and 2019 are presented below in accordance with ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40), which was adopted under the modified retrospective method at the beginning of fiscal 2019. Fiscal 2018 revenue has not been restated. 75 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Our segment revenue and results for fiscal 2020, 2019 and 2018, updated for segment reclassifications discussed above, were as follows: (dollars in millions) Digital Media Digital Experience Publishing and Advertising Total Fiscal 2020 Revenue $ 9,233 $ 3,125 $ 510 $ 12,868 Cost of revenue 352 1,126 244 1,722 Gross profit $ 8,881 $ 1,999 $ 266 $ 11,146 Gross profit as a percentage of revenue 96 % 64 % 52 % 87 % Fiscal 2019 Revenue $ 7,707 $ 2,795 $ 669 $ 11,171 Cost of revenue 290 1,056 327 1,673 Gross profit $ 7,417 $ 1,739 $ 342 $ 9,498 Gross profit as a percentage of revenue 96 % 62 % 51 % 85 % Fiscal 2018 Revenue $ 6,325 $ 2,073 $ 632 $ 9,030 Cost of revenue 249 679 267 1,195 Gross profit $ 6,076 $ 1,394 $ 365 $ 7,835 Gross profit as a percentage of revenue 96 % 67 % 58 % 87 % Revenue by geographic area for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Americas: United States $ 6,746 $ 5,904 $ 4,633 Other 708 602 484 Total Americas 7,454 6,506 5,117 EMEA: United Kingdom 880 794 653 Other 2,520 2,181 1,897 Total EMEA 3,400 2,975 2,550 APAC: Japan 893 751 609 Other 1,121 939 754 Total APAC 2,014 1,690 1,363 Revenue $ 12,868 $ 11,171 $ 9,030 Revenue by major offerings in our Digital Media reportable segment for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Creative Cloud $ 7,736 $ 6,482 $ 5,343 Document Cloud 1,497 1,225 982 Total $ 9,233 $ 7,707 $ 6,325 76 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Further, we reclassified revenue of our Advertising Cloud offerings from subscription to services and other on our Consolidated Statements of Income. Subscription revenue by segment for fiscal 2020, 2019 and 2018, updated for the reclassifications discussed above, were as follows: (in millions) 2020 2019 2018 Digital Media $ 8,813 $ 7,208 $ 5,858 Digital Experience 2,660 2,280 1,600 Publishing and Advertising 153 146 146 Total $ 11,626 $ 9,634 $ 7,604 Contract Balances Trade Receivables A receivable is recorded when an unconditional right to invoice and receive payment exists, such that only the passage of time is required before payment of consideration is due. Timing of revenue recognition may differ from the timing of invoicing to customers. Certain performance obligations may require payment before delivery of the license or service to the customer. Included in trade receivables on the Consolidated Balance Sheets are unbilled receivable balances which have not yet been invoiced, and are typically related to license revenue or services which are delivered prior to invoicing. As of November 27, 2020, the balance of trade receivables, net of allowances for doubtful accounts, was $ 1.40 billion, inclusive of unbilled receivables of $ 84 million. As of November 29, 2019, the balance of trade receivables, net of allowance for doubtful accounts, was $ 1.53 billion, inclusive of unbilled receivables of $ 149 million. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts which reflects our best estimate of potentially uncollectible trade receivables. The allowance is based on both specific and general reserves. We regularly review our trade receivables allowance by considering factors such as historical experience, credit-worthiness, the age of the trade receivable balances and current economic conditions that may affect a customer’s ability to pay and we specifically reserve for those deemed uncollectible. During fiscal 2020, 2019 and 2018, our allowance for doubtful accounts activities were as follows: (in millions) 2020 2019 2018 Beginning balance $ 10 $ 15 $ 9 Increase due to acquisition — — 6 Charged to operating expenses 31 5 6 Deductions (1) ( 20 ) ( 10 ) ( 6 ) Ending balance $ 21 $ 10 $ 15 ________________________________________ (1) Deductions related to the allowance for doubtful accounts represent amounts written off against the allowance, less recoveries. Contract Assets A contract asset is recognized when a conditional right to consideration exists and transfer of control has occurred. Contract assets are typically related to subscription and hosted service contracts where the transaction price allocated to the satisfied performance obligations exceeds the value of billings to date. Contract assets are included in prepaid expenses and other current assets for the current portion and other assets for the long-term portion on the Consolidated Balance Sheets. We regularly review contract asset balances for impairment, considering factors such as historical experience, credit-worthiness, age of the balance and other economic or business factors. Contract asset impairments were not material in fiscal 2020. Contract assets were $ 81 million and $ 64 million as of November 27, 2020 and November 29, 2019, respectively. 77 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Deferred Revenue and Remaining Performance Obligations Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription services, including non-cancellable and non-refundable committed funds and refundable customer deposits. Deferred revenue is recognized as revenue when transfer of control to customers has occurred. Customers are typically invoiced for these agreements in regular installments and revenue is recognized ratably over the contractual subscription period. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing, size and new business linearity within the quarter. Deferred revenue does not represent the total contract value of annual or multi-year non-cancellable subscription agreements. Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, such as invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and not to receive financing from our customers. Any potential financing fees are considered insignificant in the context of our contracts. As of November 27, 2020, the balance of deferred revenue was $ 3.76 billion, which includes $ 64 million of refundable customer deposits. Refundable customer deposits represent arrangements in which the customer has a unilateral cancellation right for which we are obligated to refund amounts paid related to products or services not yet delivered or provided at the time of cancellation on a prorated basis. Arrangements with some of our enterprise customers with non-cancellable and non-refundable committed funds provide options to either renew monthly on-premise term-based licenses or use some or all funds to purchase other Adobe products or services. Non-cancellable and non-refundable committed funds related to these agreements comprised approximately 6 % of the total deferred revenue. As of November 29, 2019, the balance of deferred revenue was $ 3.50 billion. Significant movements in the deferred revenue balance during the period consisted of increases due to payments received prior to transfer of control of the underlying performance obligations to the customer, which were offset by decreases due to revenue recognized in the period. During the year ended November 27, 2020, approximately $ 3.22 billion of revenue was recognized that was included in the balance of deferred revenue as of November 29, 2019. Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes deferred revenue and unbilled amounts that will be recognized as revenue in future periods. Transaction price allocated to the remaining performance obligation is influenced by several factors, including the timing of renewals and average contract term. We applied practical expedients to exclude amounts related to performance obligations that are billed and recognized as they are delivered, optional purchases that do not represent material rights, sales- and usage-based royalties not yet consumed and any estimated amounts of variable consideration that are subject to constraint. Remaining performance obligations were approximately $ 11.34 billion as of November 27, 2020. Non-cancellable and non-refundable committed funds related to some of our enterprise customer agreements referred to in the paragraph above comprised approximately 6 % of the total remaining performance obligations. Approximately 73 % of the remaining performance obligations, excluding the aforementioned enterprise customer agreements, are expected to be recognized over the next 12 months with the remainder recognized thereafter. 78 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Contract Acquisition Costs We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. The costs capitalized are primarily sales commissions paid to our sales force personnel. Capitalized costs may also include portions of fringe benefits and payroll taxes associated with compensation for incremental costs to acquire customer contracts and incentive payments to partners. Capitalized costs to obtain a contract are amortized over the expected period of benefit, which we have determined, based on analysis, to be 5 years. Amortization of capitalized costs are included in sales and marketing expense in our Consolidated Statements of Income. During fiscal 2020 and 2019, we amortized $ 186 million and $ 171 million of capitalized contract acquisition costs into sales and marketing expense, respectively. We did not incur any impairment losses in fiscal 2020 and 2019. Capitalized contract acquisition costs was $ 530 million and $ 474 million as of November 27, 2020 and November 29, 2019, of which $ 352 million and $ 315 million was long-term and included in other assets in the Consolidated Balance Sheets, respectively. The remaining balance of the capitalized costs to obtain contracts was current and included in prepaid expenses and other current assets. Revenue Reserve During fiscal 2020, 2019 and 2018, our revenue reserve activities were as follows: (in millions) 2020 2019 2018 Beginning balance $ 7 $ 25 $ 22 Impacts of adoption of the new revenue standard — ( 15 ) — Amount charged to revenue 24 19 65 Actual returns ( 21 ) ( 22 ) ( 62 ) Ending balance $ 10 $ 7 $ 25 Refund Liabilities As part of our revenue reserves, we record refund liabilities for amounts that may be subject to future refunds, which include sales returns reserves and customer rebates and credits. Refund liabilities are included in accrued expenses on the Consolidated Balance Sheets. Refund liabilities were $ 127 million and $ 126 million as of November 27, 2020 and November 29, 2019, respectively. Significant Customers For fiscal 2020, 2019 and 2018 there were no customers that represented at least 10% of net revenue. As of fiscal year end 2020 and 2019, no single customer was responsible for over 10% of our trade receivables. NOTE 3. ACQUISITIONS Workfront Subsequent to November 27, 2020, we completed our acquisition of Workfront, a privately held company that provides a work management platform for marketers, for approximately $ 1.50 billion in cash consideration. The initial purchase accounting for this transaction has not yet been completed given the short period of time between the acquisition date and issuance of these financial statements. Workfront will be integrated into our Digital Experience reportable segment for financial reporting purposes in the first quarter of fiscal 2021. 79 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Allegorithmic On January 23, 2019, we completed the acquisition of Allegorithmic, a privately held 3D editing and authoring software company for gaming and entertainment, and integrated it into our Digital Media reportable segment. Prior to the acquisition, we held an equity interest that was accounted for as an equity-method investment. We acquired the remaining equity interest for approximately $ 106 million in cash consideration. The total purchase price, inclusive of the acquisition-date fair-value of our pre-existing equity interest, was approximately $ 161 million. In conjunction with the Allegorithmic acquisition, we separately recognized an investment gain of approximately $ 42 million, which represents the difference between the $ 55 million acquisition-date fair value of our pre-existing equity interest and our previous carrying amount. Under the acquisition method of accounting, the total final purchase price was allocated to Allegorithmic’s net tangible and intangible assets based upon their estimated fair values as of the acquisition date. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. Of the total purchase price, $ 126 million was allocated to goodwill that was non-deductible for tax purposes, $ 45 million to identifiable intangible assets and the remainder to net liabilities assumed. Pro forma financial information has not been presented for the Allegorithmic acquisition as the impact to our Consolidated Financial Statements was not material. Marketo On October 31, 2018, we completed the acquisition of Marketo, a privately held marketing cloud platform company, for approximately $ 4.73 billion of cash consideration. Adding Marketo’s engagement platform to Adobe Experience Cloud furthers our long-term plan for strategic growth in the Digital Experience segment and enables us to offer a comprehensive set of solutions to enable customers across industries and companies automate and orchestrate their marketing activities. Under the terms of the Share Purchase Agreement (“Purchase Agreement”), we acquired all of the issued and outstanding shares of capital stock of Milestone Topco, Inc., a Delaware corporation (“Topco”) and indirect parent company of Marketo, and other equity interests in Marketo. In connection with the acquisition, each Marketo equity award that was issued and outstanding was cancelled and extinguished in exchange for cash consideration. Also pursuant to the Purchase Agreement, upon closing of the transaction, cash was paid for the settlement of Marketo’s long-term incentive plan, the settlement of Marketo’s indebtedness and the acquisition of all remaining equity interests in Marketo K.K., a Japanese corporation and joint venture. In connection with the acquisition, we entered into a credit agreement providing for a $ 2.25 billion senior unsecured term loan (“Term Loan”). The proceeds of the Term Loan were used to fund a portion of the purchase price of the acquisition and pay fees and expenses incurred in connection with the acquisition. The Term Loan funds were received on October 31, 2018 upon closing of the acquisition. See Note 17 for further details regarding our Term Loan. We integrated Marketo into our Digital Experience reportable segment and have included the financial results of Marketo in our Consolidated Financial Statements beginning on the acquisition date. The amounts of net revenue and net loss of Marketo included in our Consolidated Statements of Income from the acquisition date through November 30, 2018 were not material. The direct transaction costs associated with the acquisition were also not material. Purchase Price Allocation Under the purchase accounting method, the total final purchase price was allocated to Marketo’s net tangible and intangible assets based upon their estimated fair values as of the acquisition date. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. 80 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The table below represents the final purchase price allocation to the acquired net tangible and intangible assets of Marketo based on their estimated fair values as of October 31, 2018 and the associated estimated useful lives at that date. During fiscal 2019, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to total purchase price, intangible assets, deferred revenue, tax liabilities assumed and their related impact to goodwill. (in millions) Amount Weighted Average Useful Life (years) Customer contracts and relationships $ 578 11 Purchased technology 444 7 Backlog 105 2 Non-competition agreements 12 2 Trademarks 329 9 Total identifiable intangible assets 1,468 Net liabilities assumed ( 194 ) N/A Goodwill (1) 3,459 N/A Total purchase price $ 4,733 _________________________________________ (1) Non-deductible for tax-purposes. Identifiable intangible assets — Customer relationships consist of Marketo’s contractual relationships and customer loyalty related to their enterprise and commercial customers as well as technology partner relationships. The estimated fair value of the customer contracts and relationships was determined based on projected cash flows attributable to the asset. Purchased technology acquired primarily consists of Marketo’s cloud-based engagement marketing software platform. The estimated fair value of the purchased technology was determined based on the expected future cost savings resulting from ownership of the asset. Backlog relates to subscription contracts and professional services. Non-compete agreements include agreements with key Marketo employees that preclude them from competing against Marketo for a period of two years from the acquisition date. Trademarks include the Marketo trade name, which is well known in the marketing ecosystem. We amortize the fair value of these intangible assets on a straight-line basis over their respective estimated useful lives. Goodwill — Approximately $ 3.46 billion of goodwill has been allocated entirely to our Digital Experience reportable segment. Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. 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 cost savings opportunities. Net liabilities assumed — Marketo’s tangible assets and liabilities as of October 31, 2018 were reviewed and adjusted to their fair value as necessary. The net liabilities assumed included, among other items, $ 103 million in accrued expenses, $ 75 million in deferred revenue and $ 183 million in deferred tax liabilities, which were partially offset by $ 55 million in cash and cash equivalents and $ 72 million in trade receivables acquired. Deferred revenue — Included in net liabilities assumed is Marketo’s deferred revenue which represents advance payments from customers related to subscription contracts and professional services. We estimated our obligation related to the deferred revenue using the cost build-up approach. The cost build-up approach determines fair value by estimating the direct and indirect costs related to supporting the obligation plus an assumed operating margin. The sum of the costs and assumed operating profit approximates, in theory, the amount that Marketo would be required to pay a third party to assume the obligation. The estimated costs to fulfill the obligation were based on the near-term projected cost structure for subscription and professional services. As a result, we recorded an adjustment to reduce Marketo’s carrying value of deferred revenue to $ 75 million, which represents our estimate of the fair value of the contractual obligations assumed. Taxes — As part of our accounting for the Marketo 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 $ 349 million, included in the net liabilities assumed, was established as a deferred tax 81 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) liability for the future amortization of the intangible assets, and was partially offset by other tax assets of $ 166 million, which primarily consist of net operating loss carryforwards. 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. Unaudited Pro Forma Results The financial information in the table below summarizes the combined results of operations of Adobe and Marketo, on a pro forma basis, as though the companies had been combined as of the beginning of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place on the earliest period presented or of results that may occur in the future. The following unaudited pro forma financial information for fiscal 2018 combines the historical results for Adobe for the year ended November 30, 2018 and the historical results of Marketo for the period January 1, 2018 through October 31, 2018: (in millions) 2018 Net revenues $ 9,339 Net income $ 2,362 Magento On June 18, 2018, we completed our acquisition of Magento Commerce (“Magento”), a privately held commerce platform company, and integrated it into our Digital Experience reportable segment. The table below represents the final purchase price allocation to the acquired net assets of Magento based on their estimated fair values as of June 18, 2018 and the associated estimated useful lives at that date. During fiscal 2019, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to net liabilities assumed and their related impact to goodwill. (in millions) Amount Weighted Average Useful Life (years) Customer contracts and relationships $ 208 8 Purchased technology 84 5 In-process research and development (1) 39 N/A Trademarks 21 3 Other intangibles 44 3 Total identifiable intangible assets 396 Net liabilities assumed ( 68 ) N/A Goodwill (2) 1,317 N/A Total purchase price $ 1,645 _________________________________________ (1) Capitalized as purchased technology and are considered indefinite lived until the completion or abandonment of the associated research and development efforts. Subsequent to the acquisition, the associated in-process research and development efforts for certain projects were completed and the rest were abandoned. The respective related amortization and write-off were each immaterial. (2) Substantially non-deductible for tax purposes . Pro forma financial information has not been presented for the Magento acquisition as the impact to our Consolidated Financial Statements was not material. 82 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Other We also completed other immaterial business acquisitions during the fiscal years presented. Pro forma information has not been presented for these acquisitions as the impact to our Consolidated Financial Statements was not material. NOTE 4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS Cash equivalents consist of all highly liquid debt investments with remaining maturities of three months or less at the date of purchase. We classify our investments in marketable debt securities as “available-for-sale.” We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity in our Consolidated Balance Sheets. Gains and losses are determined using the specific identification method and recognized when realized in our Consolidated Statements of Income. When we have determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in income. Cash, cash equivalents and short-term investments consisted of the following as of November 27, 2020: (in millions) Amortized Cost Unrealized Gains Unrealized Losses Estimated Fair Value Current assets: Cash $ 849 $ — $ — $ 849 Cash equivalents: Corporate debt securities 28 — — 28 Money market mutual funds 3,483 — — 3,483 Time deposits 118 — — 118 Total cash equivalents 3,629 — — 3,629 Total cash and cash equivalents 4,478 — — 4,478 Short-term fixed income securities: Asset-backed securities 105 1 — 106 Corporate debt securities 1,378 8 — 1,386 Foreign government securities 3 — — 3 Municipal securities 19 — — 19 Total short-term investments 1,505 9 — 1,514 Total cash, cash equivalents and short-term investments $ 5,983 $ 9 $ — $ 5,992 83 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Cash, cash equivalents and short-term investments consisted of the following as of November 29, 2019: (in millions) Amortized Cost Unrealized Gains Unrealized Losses Estimated Fair Value Current assets: Cash $ 467 $ — $ — $ 467 Cash equivalents: Corporate debt securities 46 — — 46 Money market mutual funds 2,049 — — 2,049 Time deposits 88 — — 88 Total cash equivalents 2,183 — — 2,183 Total cash and cash equivalents 2,650 — — 2,650 Short-term fixed income securities: Asset-backed securities 89 — — 89 Corporate debt securities 1,408 4 — 1,412 Municipal securities 18 — — 18 U.S. Treasury securities 8 — — 8 Total short-term investments 1,523 4 — 1,527 Total cash, cash equivalents and short-term investments $ 4,173 $ 4 $ — $ 4,177 See Note 5 for further information regarding the fair value of our financial instruments. We had immaterial gross unrealized losses related to our available-for-sale securities as of November 27, 2020 and November 29, 2019. The following table summarizes the fair value of our available-for-sale securities that have been in a continuous unrealized loss position as of November 27, 2020 and November 29, 2019: (in millions) 2020 2019 Less Than Twelve Months More Than Twelve Months Less Than Twelve Months More Than Twelve Months Corporate debt securities $ 207 $ — $ 235 $ 44 Asset-backed securities 22 — 7 7 Municipal securities — — 3 — Foreign government securities 3 — — — Total $ 232 $ — $ 245 $ 51 There were 99 securities and 115 securities in an unrealized loss position for less than twelve months at November 27, 2020 and November 29, 2019, respectively. There were no securities and 38 securities in an unrealized loss position for more than twelve months at November 27, 2020 and November 29, 2019, respectively. The following table summarizes the cost and estimated fair value of the fixed income securities classified as short-term investments based on stated effective maturities as of November 27, 2020: (in millions) Amortized Cost Estimated Fair Value Due within one year $ 841 $ 843 Due between one and two years 428 433 Due between two and three years 185 186 Due after three years 51 52 Total $ 1,505 $ 1,514 84 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) We review our debt securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. The portion of the write-down related to credit loss would be recorded to other income (expense), net in our Consolidated Statements of Income. Any portion not related to credit loss would be recorded to accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity in our Consolidated Balance Sheets. During fiscal 2020, 2019 and 2018, we did not consider any of our investments to be other-than-temporarily impaired. NOTE 5. FAIR VALUE MEASUREMENTS Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis We measure certain financial assets and liabilities at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the year ended November 27, 2020. The fair value of our financial assets and liabilities at November 27, 2020 was determined using the following inputs: (in millions) Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets Significant Other Observable Inputs Significant Unobservable Inputs Total (Level 1) (Level 2) (Level 3) Assets: Cash equivalents: Corporate debt securities $ 28 $ — $ 28 $ — Money market mutual funds 3,483 3,483 — — Time deposits 118 118 — — Short-term investments: Asset-backed securities 106 — 106 — Corporate debt securities 1,386 — 1,386 — Foreign government securities 3 — 3 — Municipal securities 19 — 19 — Prepaid expenses and other current assets: Foreign currency derivatives 15 — 15 — Other assets: Deferred compensation plan assets 116 7 109 — Total assets $ 5,274 $ 3,608 $ 1,666 $ — Liabilities: Accrued expenses: Foreign currency derivatives $ 4 $ — $ 4 $ — 85 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The fair value of our financial assets and liabilities at November 29, 2019 was determined using the following inputs: (in millions) Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets Significant Other Observable Inputs Significant Unobservable Inputs Total (Level 1) (Level 2) (Level 3) Assets: Cash equivalents: Corporate debt securities $ 46 $ — $ 46 $ — Money market mutual funds 2,049 2,049 — — Time deposits 88 88 — — Short-term investments: Asset-backed securities 89 — 89 — Corporate debt securities 1,412 — 1,412 — Municipal securities 18 — 18 — U.S. Treasury securities 8 — 8 — Prepaid expenses and other current assets: Foreign currency derivatives 29 — 29 — Other assets: Deferred compensation plan assets 94 5 89 — Total assets $ 3,833 $ 2,142 $ 1,691 $ — Liabilities: Accrued expenses: Treasury lock derivatives $ 30 $ — $ 30 $ — Foreign currency derivatives 3 — 3 — Total liabilities $ 33 $ — $ 33 $ — See Note 4 for further information regarding the fair value of our financial instruments. Our fixed income available-for-sale debt securities consist of high quality, investment grade securities from diverse issuers with a weighted average credit rating of A+. We value these securities based on pricing from independent pricing vendors who use matrix pricing valuation techniques including market approach methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Inputs include quoted prices in active markets for identical assets or inputs other than quoted prices that are observable either directly or indirectly in determining fair value, including benchmark yields, issuer spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. We therefore classify all of our fixed income available-for-sale securities as Level 2. We perform routine procedures such as comparing prices obtained from multiple independent sources to ensure that appropriate fair values are recorded. The fair values of our money market mutual funds and time deposits are based on the closing price of these assets as of the reporting date. We classify our money market mutual funds and time deposits as Level 1. Our Level 2 over-the-counter foreign currency derivatives are valued using pricing models and discounted cash flow methodologies based on observable foreign exchange and interest rate data at the measurement date. The invested amounts under our deferred compensation plan consist of money market mutual funds and other mutual funds, which are recorded as other assets on our Consolidated Balance Sheets with a corresponding offset to long-term liabilities. 86 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Our other current financial assets and current financial liabilities have fair values that approximate their carrying values. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis The fair value of our senior notes was $ 4.48 billion as of November 27, 2020, based on observable market prices in less active markets and categorized as Level 2. See Note 17 for further details regarding our debt. NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS We may use derivatives to partially offset our business exposure to foreign currency and interest rate risk on expected future cash flows, and certain existing assets and liabilities. We do not use any of our derivative instruments for trading purposes. We enter into master netting arrangements to mitigate credit risk in derivative transactions by permitting net settlement of transactions with the same counterparty. We do not offset fair value amounts recognized for derivative instruments under master netting arrangements. We also enter into collateral security agreements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. Collateral posted is included in prepaid expenses and other current assets and collateral received is included in accrued expenses on our Consolidated Balance Sheets. Cash Flow Hedges In countries outside the United States, we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option contracts or forward contracts to hedge a portion of our forecasted foreign currency denominated revenue. These foreign exchange contracts, carried at fair value, have maturities of up to twelve months . As of November 27, 2020, total notional amounts of outstanding cash flow hedges were $ 1.53 billion, hedging exposures denominated in Euros, British Pounds, Japanese Yen and Australian Dollars. As of November 29, 2019, total notional amounts of outstanding cash flow hedges were $ 1.20 billion, hedging exposures denominated in Euros, British Pounds and Japanese Yen. In June 2019, in anticipation of refinancing our $ 2.25 billion term loan due April 30, 2020 (“Term Loan”) and $ 900 million 4.75 % fixed interest rate senior notes due February 1, 2020 (“2020 Notes”), we entered into Treasury lock agreements with large financial institutions which fixed benchmark U.S. Treasury rates for an aggregate notional amount of $ 1 billion of our future debt issuance. These derivative instruments hedged the impact of changes in the benchmark interest rate to future interest payments and were settled upon debt issuance in the first quarter of fiscal 2020. We incurred a loss related to the settlement of the instruments which is amortized to interest expense over the term of our debt due February 1, 2030. See Note 17 for further details regarding our debt. As of November 27, 2020, we had net derivative losses on our foreign exchange option contracts expected to be recognized within the next 18 months, of which $ 28 million of losses are expected to be recognized into revenue within the next 12 months. In addition, we had net derivative losses on our Treasury lock agreements, of which $ 4 million is expected to be recognized into interest expense within the next 12 months. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in fair value of these cash flow hedges in accumulated other comprehensive income (loss) in our Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction affects earnings, we reclassify the related gain or loss on the foreign currency and Treasury lock cash flow hedges to revenue and interest expense, respectively. 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 the same income statement line item as the hedged item. We evaluate hedge effectiveness at the inception of the hedge prospectively, and on an ongoing basis both retrospectively and prospectively. If we do not elect hedge accounting, or the contract does not qualify for hedge accounting treatment, the changes in fair value from period to period are recorded in the same income statement line item as the hedged item. Effective in the third quarter of fiscal 2019, all changes in fair value of our foreign currency cash flow hedges are recorded in accumulated other comprehensive income (loss). Prior to this, we recorded the time value of purchased contracts in 87 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) other income (expense), net in our Consolidated Statements of Income. The impact of the de-designation of our hedges due to the change in methodology in the third quarter of fiscal 2019 was immaterial. For fiscal 2020, 2019 and 2018, there were no net gains or losses recognized in income relating to hedges of forecasted transactions that did not occur. Fair Value Hedges During the third quarter of fiscal 2014, we entered into interest rate swaps designated as a fair value hedge related to our 2020 Notes. The interest rate swaps converted the fixed interest rate on our 2020 Notes to a floating interest rate based on the London Interbank Offered Rate (“LIBOR”). See Note 17 for further details regarding our debt. The interest rate swaps were accounted for as fair value hedges and substantially offset the changes in fair value of the hedged portion of the underlying debt that were attributable to the changes in interest rate. Therefore, the gains and losses related to changes in the fair value of the interest rate swaps were included in other income (expense), net in our Consolidated Statements of Income. During the first quarter of fiscal 2020, our 2020 Notes became due and were paid in conjunction with our debt refinancing. As of November 27, 2020, the interest rate swap agreements had matured and were no longer recognized in our Consolidated Financial Statements. Non-Designated Hedges Our derivatives not designated as hedging instruments consist of foreign currency forward contracts that we primarily use to hedge monetary assets and liabilities denominated in non-functional currencies. The changes in fair value of these contracts is recorded to other income (expense), net in our Consolidated Statements of Income. Changes in the fair value of the underlying assets and liabilities associated with the hedged risk are generally offset by the changes in the fair value of the related contracts. As of November 27, 2020, total notional amounts of outstanding foreign currency forward contracts were $ 492 million, primarily hedging exposures denominated in Euros, British Pounds, Japanese Yen, Indian Rupees and Australian Dollars. As of November 29, 2019, total notional amounts of outstanding contracts were $ 702 million, primarily hedging exposures denominated in Euros, British Pounds, Japanese Yen and Indian Rupees. At November 27, 2020 and November 29, 2019, the outstanding balance sheet hedging derivatives had maturities of 180 days or less. The fair value of derivative instruments on our Consolidated Balance Sheets as of November 27, 2020 and November 29, 2019 were as follows: (in millions) 2020 2019 Fair Value Asset Derivatives Fair Value Liability Derivatives Fair Value Asset Derivatives Fair Value Liability Derivatives Derivatives designated as hedging instruments: Foreign exchange option contracts (1) $ 12 $ — $ 26 $ — Treasury lock (1) — — — 30 Derivatives not designated as hedging instruments: Foreign exchange forward contracts (1) 3 4 3 3 Total derivatives $ 15 $ 4 $ 29 $ 33 _________________________________________ (1) Fair value asset derivatives are included in prepaid expenses and other current assets and fair value liability derivatives are included in accrued expenses on our Consolidated Balance Sheets. 88 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Gains (losses) on derivative instruments, net of tax, recognized in our Consolidated Statements of Comprehensive Income for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Derivatives in cash flow hedging relationships: Foreign exchange option contracts $ ( 43 ) $ 23 $ 74 Treasury lock $ ( 1 ) $ ( 23 ) $ — The effects of derivative instruments on our Consolidated Statements of Income for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Revenue Interest Expense Other Income (Expense), Net Revenue Interest Expense Other Income (Expense), Net Revenue Other Income (Expense), Net Derivatives in cash flow hedging relationships: Foreign exchange option contracts (1) Net gain (loss) reclassified from accumulated OCI into income, net of tax $ 3 $ — $ — $ 39 $ — $ — $ 49 $ — Amount excluded from effectiveness testing and ineffective portion $ — $ — $ — $ — $ — $ ( 24 ) $ — $ ( 41 ) Treasury lock Net gain (loss) reclassified from accumulated OCI into income, net of tax $ — $ ( 3 ) $ — $ — $ ( 1 ) $ — $ — $ — Derivatives not designated as hedging relationships: Foreign exchange option contracts $ — $ — $ — $ 1 $ — $ — $ — $ — Foreign exchange forward contracts $ — $ — $ 5 $ — $ — $ 4 $ — $ 2 _________________________________________ (1) Starting the third quarter of fiscal 2019, all changes in fair value of our foreign currency cash flow hedges are recorded in accumulated other comprehensive income (loss) (“OCI”). Net gains (losses) recognized in other income (expense), net relating to foreign currency derivatives not designated as hedging instruments for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Gain (loss) on foreign currency assets and liabilities: Net realized gain (loss) recognized in other income $ ( 2 ) $ ( 14 ) $ 1 Net unrealized gain (loss) recognized in other income ( 5 ) 8 ( 4 ) Gain (loss) on foreign currency assets and liabilities ( 7 ) ( 6 ) ( 3 ) Gain (loss) on hedges of foreign currency assets and liabilities: Net realized gain (loss) recognized in other income 6 7 ( 2 ) Net unrealized gain (loss) recognized in other income ( 1 ) ( 3 ) 4 Gain (loss) on hedges of foreign currency assets and liabilities 5 4 2 Net gain (loss) recognized in other income (expense), net $ ( 2 ) $ ( 2 ) $ ( 1 ) 89 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 7. PROPERTY AND EQUIPMENT Property and equipment, net consisted of the following as of November 27, 2020 and November 29, 2019: (in millions) 2020 2019 Computers and other equipment $ 1,287 $ 1,424 Buildings 561 483 Building improvements 340 308 Leasehold improvements 284 246 Land 145 145 Furniture and fixtures 159 144 Capital projects in-progress 199 112 Total 2,975 2,862 Less: Accumulated depreciation and amortization ( 1,458 ) ( 1,569 ) Property and equipment, net $ 1,517 $ 1,293 Depreciation and amortization expense of property and equipment for fiscal 2020, 2019 and 2018 was $ 192 million, $ 173 million and $ 157 million, respectively. Property and equipment, net, by geographic area as of November 27, 2020 and November 29, 2019 was as follows: (in millions) 2020 2019 Americas: United States $ 1,328 $ 1,126 Other 2 3 Total Americas 1,330 1,129 EMEA 64 54 APAC 123 110 Property and equipment, net $ 1,517 $ 1,293 NOTE 8. GOODWILL AND OTHER INTANGIBLES Goodwill by reportable segment and activity for fiscal 2020 and 2019 was as follows: (in millions) 2018 Acquisitions Other (1) 2019 Reclassification (2) Other (1) 2020 Digital Media $ 2,740 $ 126 $ ( 1 ) $ 2,865 $ — $ 3 $ 2,868 Digital Experience 7,463 — ( 15 ) 7,448 ( 20 ) 48 7,476 Publishing and Advertising 378 — — 378 20 — 398 Goodwill $ 10,581 $ 126 $ ( 16 ) $ 10,691 $ — $ 51 $ 10,742 _________________________________________ (1) Amounts consist of foreign currency translation adjustments. (2) In the fourth quarter of fiscal 2020, we moved our Advertising Cloud offerings from our Digital Experience segment into our new Publishing and Advertising segment, which combined Advertising Cloud with our previous Publishing segment. Certain goodwill balances were misclassified between our reportable segments, which have been updated in the above tables. The impact to our prior year disclosures was immaterial and there was no impact to the Consolidated Financial Statements resulting from the change in classification. 90 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Other intangibles, net, as of November 27, 2020 and November 29, 2019 were as follows: (in millions) 2020 2019 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Customer contracts and relationships $ 958 $ ( 289 ) $ 669 $ 1,219 $ ( 436 ) $ 783 Purchased technology 756 ( 347 ) 409 759 ( 223 ) 536 Trademarks 384 ( 122 ) 262 384 ( 73 ) 311 Other 84 ( 65 ) 19 227 ( 136 ) 91 Other intangibles, net $ 2,182 $ ( 823 ) $ 1,359 $ 2,589 $ ( 868 ) $ 1,721 In fiscal 2020, and 2019, certain intangibles associated with our acquisitions in prior years became fully amortized and were removed from the Consolidated Balance Sheets. Amortization expense related to other intangibles was $ 367 million, $ 402 million and $ 183 million for fiscal 2020, 2019 and 2018 respectively. Of these amounts, $ 205 million, $ 227 million and $ 91 million were included in cost of sales for fiscal 2020, 2019 and 2018 respectively. Other intangibles are amortized over their estimated useful lives of 3 to 15 years. As of November 27, 2020, we expect the estimated aggregate amortization expense for each of the five succeeding fiscal years to be as follows: (in millions) Other Intangibles 2021 $ 254 2022 224 2023 215 2024 202 2025 183 Thereafter 281 Total expected amortization expense $ 1,359 91 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 9. ACCRUED EXPENSES Accrued expenses as of November 27, 2020 and November 29, 2019 consisted of the following: (in millions) 2020 2019 Accrued compensation and benefits $ 375 $ 318 Accrued bonuses 330 222 Refund liabilities 127 126 Accrued corporate marketing 134 80 Accrued media costs 55 118 Taxes payable 95 83 Accrued hosting fees 66 36 Royalties payable 34 62 Accrued interest expense 32 29 Fair value of derivatives 4 33 Accrued building rent — 99 Other 170 193 Accrued expenses $ 1,422 $ 1,399 Accrued media costs primarily relate to our transaction-driven Advertising Cloud offerings which we began to discontinue during the second quarter of fiscal 2020. Other primarily includes general corporate accruals for local and regional expenses, including accruals for fees associated with the cancellation of corporate events. Beginning the first quarter of fiscal 2020, as a result of ASC 842 adoption, accrued building rent is recorded as a reduction to our operating lease right-of-use assets on our Consolidated Balance Sheets. See Note 1 for further information regarding our adoption of ASC 842 . NOTE 10. INCOME TAXES Income before income taxes for fiscal 2020, 2019 and 2018 consisted of the following: (in millions) 2020 2019 2018 Domestic $ 1,090 $ 438 $ 543 Foreign 3,086 2,767 2,251 Income before income taxes $ 4,176 $ 3,205 $ 2,794 The provision for (benefit from) income taxes for fiscal 2020, 2019 and 2018 consisted of the following: (in millions) 2020 2019 2018 Current: United States federal $ 119 $ 7 $ 501 Foreign 222 211 140 State and local 79 31 29 Total current 420 249 670 Deferred: United States federal ( 123 ) 23 ( 466 ) Foreign ( 1,313 ) ( 12 ) ( 10 ) State and local ( 68 ) ( 6 ) 9 Total deferred ( 1,504 ) 5 ( 467 ) Provision for (benefit from) income taxes $ ( 1,084 ) $ 254 $ 203 92 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Intra-Entity Transfers of Certain Intellectual Property Rights (“IP rights”) During fiscal 2020, we completed intra-entity transfers of certain IP rights to our Irish subsidiary in order to better align the ownership of these rights with how our business operates. The transfers did not result in taxable gains; however, our Irish subsidiary recognized deferred tax assets for the book and tax basis difference of the transferred IP rights. As a result of these transactions, we recorded deferred tax assets, net of valuation allowance, and related tax benefits of $ 224 million and $ 1.13 billion, based on the fair value of the IP rights transferred in April and November 2020, respectively. The determination of the fair value involves significant judgment on future revenue growth, operating margins and discount rates. The tax-deductible amortization related to the transferred IP rights will be recognized over the period of economic benefit. U.S. Tax Reform On December 22, 2017, the U.S. Tax Cuts and Jobs Act (“U.S. Tax Act”) was enacted into law, which significantly changed existing U.S. tax law and included many provisions applicable to us, such as reducing the U.S. federal statutory tax rate to 21% and imposing a one-time transition tax on deferred foreign income not previously subject to U.S. income tax and certain international provisions. During fiscal 2018, we recorded tax charges for the impact of the U.S. Tax Act using the available information and technical guidance as of November 30, 2018. Certain international provisions introduced in the U.S. Tax Act, such as a tax on global intangible low-tax income, a base erosion and anti-abuse tax and a special tax deduction for foreign-derived intangible income, took effect in fiscal 2019. As the U.S. Treasury releases regulations that impact these provisions, we account for finalized regulations in the period of enactment. Reconciliation of Provision for (Benefit from) Income Taxes Total income tax expense differs from the expected tax expense, computed by multiplying the U.S. federal statutory rate of 21 % in both fiscal 2020 and 2019 and 22.2 % in fiscal 2018 by income before income taxes, as a result of the following: (in millions) 2020 2019 2018 Computed “expected” tax expense $ 877 $ 673 $ 620 State tax expense, net of federal benefit 10 24 25 Impacts of intra-entity IP transfers ( 1,360 ) — — Tax credits ( 101 ) ( 100 ) ( 111 ) Effects of non-U.S. operations ( 337 ) ( 224 ) ( 384 ) Stock-based compensation, net of tax deduction ( 154 ) ( 86 ) ( 95 ) Resolution of income tax examinations ( 23 ) ( 39 ) ( 42 ) Impacts of the U.S. Tax Act — 3 186 Other 4 3 4 Provision for (benefit from) income taxes $ ( 1,084 ) $ 254 $ 203 93 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Deferred Tax Assets and Liabilities The tax effects of the temporary differences that gave rise to significant portions of the deferred tax assets and liabilities as of November 27, 2020 and November 29, 2019 are presented below: (in millions) 2020 2019 Deferred tax assets: Intangible assets $ 1,368 $ 5 Reserves and accruals 71 54 Stock-based compensation 92 107 Net operating loss carryforwards of acquired companies 54 137 Credit carryforwards 218 252 Capitalized expenses 292 45 Benefits relating to tax positions 44 47 Operating lease liabilities 131 — Other 37 45 Total gross deferred tax assets 2,307 692 Valuation allowance ( 276 ) ( 245 ) Total deferred tax assets 2,031 447 Deferred tax liabilities: Depreciation and amortization 52 36 Undistributed earnings of foreign subsidiaries 51 52 Prepaid expenses 107 86 Acquired intangible assets 330 413 Operating lease right-of-use assets 131 — Total deferred tax liabilities 671 587 Net deferred tax assets (liabilities) $ 1,360 $ ( 140 ) Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. In assessing the realizability of deferred tax assets, management determined that it is not more likely than not that we will have sufficient taxable income in certain states and foreign jurisdictions to fully utilize available tax credits and other attributes. The deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized. We provide U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States or are exempted from further taxation. To the extent that the foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings. As of November 27, 2020, the cumulative amount of foreign earnings upon which U.S. income taxes have not been provided, and the corresponding unrecognized deferred tax liability, is not material. As of November 27, 2020, we have net operating loss carryforwards of approximately $ 39 million for federal, $ 367 million for state and $ 75 million for foreign. We also have federal, state and foreign tax credit carryforwards of approximately $ 16 million, $ 236 million and $ 16 million, respectively. The net operating loss carryforward assets and tax credits will expire in various years from fiscal 2021 through 2038. The majority of the state tax credit carryforwards can be carried forward indefinitely. Certain net operating loss carryforward assets and tax credits are reduced by a valuation allowance and/or are subject to an annual limitation under Internal Revenue Code Section 382. The carrying amount of such assets and credits is expected to be fully realized. 94 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of November 27, 2020, a valuation allowance of $ 276 million has been established for certain deferred tax assets related to certain state and foreign assets. For fiscal 2020, the total change in the valuation allowance was $ 31 million. Accounting for Uncertainty in Income Taxes During fiscal 2020 and 2019, our aggregate changes in our total gross amount of unrecognized tax benefits are summarized as follows: (in millions) 2020 2019 Beginning balance $ 173 $ 196 Gross increases in unrecognized tax benefits – prior year tax positions 14 15 Gross decreases in unrecognized tax benefits – prior year tax positions — ( 2 ) Gross increases in unrecognized tax benefits – current year tax positions 44 18 Gross decreases in unrecognized tax benefits – current year tax positions — ( 3 ) Settlements with taxing authorities ( 11 ) — Lapse of statute of limitations ( 23 ) ( 50 ) Foreign exchange gains and losses 4 ( 1 ) Ending balance $ 201 $ 173 The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately $ 26 million and $ 25 million for fiscal 2020 and 2019, respectively. These amounts were included in long-term income taxes payable in their respective years. While we file federal, state and local income tax returns globally, our major tax jurisdictions are Ireland, California and the United States. We are subject to the continual examination of our income tax returns by the U.S. Internal Revenue Service and other domestic and foreign tax authorities. These tax examinations are expected to focus on our intercompany transfer pricing practices, application of tax rules and other matters. For Ireland, California and the United States, the earliest fiscal years open for examination are 2008, 2016 and 2017, respectively. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. We believe such estimates to be reasonable; however, we cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position. The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of our tax assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from $ 0 to approximately $ 20 million over the next 12 months. NOTE 11. BENEFIT PLANS Retirement Savings Plan In 1987, we adopted an Employee Investment Plan, qualified under Section 401(k) of the Internal Revenue Code, which is a retirement savings plan covering substantially all of our U.S. employees, now referred to as the Adobe Inc. 401(k) Retirement Savings Plan. Under the plan, eligible employees may contribute up to 65 % of their pretax or after-tax salary, subject to the IRS annual contribution limits. In fiscal 2020, we matched 50 % of the first 6 % of the employee’s eligible compensation. We contributed $ 59 million, $ 52 million and $ 41 million in fiscal 2020, 2019 and 2018, respectively. We are under no obligation to continue matching future employee contributions and, at our discretion, may change our practices at any time. 95 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Deferred Compensation Plan On September 21, 2006, the Board of Directors approved the Adobe Inc. Deferred Compensation Plan, effective December 2, 2006 (the “Deferred Compensation Plan”). The Deferred Compensation Plan is an unfunded, non-qualified, deferred compensation arrangement under which certain executives are able to defer a portion of their annual compensation. Participants may elect to contribute up to 75 % of their base salary and 100 % of other specified compensation, including commissions, bonuses and directors’ fees. Participants are able to elect the payment of benefits to begin on a specified date at least three years after the end of the plan year in which election is made or vests. Members of the Board of Directors are also eligible to participate in the Plan and are able to defer cash compensation and elect cash benefit distributions in the same manner as executives. Beginning January 1, 2020, only members of the Board are permitted to defer vested equity awards. For cash benefit elections, distributions are made in cash and in the form of a lump sum, or five, ten, or fifteen-year annual installments. For equity award elections, distributions are settled in stock and in the form of a lump sum payment only. As of November 27, 2020 and November 29, 2019, the invested amounts under the Deferred Compensation Plan total $ 117 million and $ 94 million, respectively and were recorded as other assets on our Consolidated Balance Sheets. As of November 27, 2020 and November 29, 2019, $ 137 million and $ 109 million, respectively, were recorded as long-term liabilities to recognize undistributed deferred compensation due to employees. NOTE 12. STOCK-BASED COMPENSATION Our stock-based compensation programs are long-term retention programs that are intended to attract, retain and provide incentives for employees, officers and directors, and to align stockholder and employee interests. We have the following stock-based compensation plans and programs: Restricted Stock Units and Performance Share Programs We grant restricted stock units and performance awards to eligible employees under our 2019 Equity Incentive Plan (“2019 Plan”). Restricted stock units generally vest over four years . Certain grants have other vesting periods approved by the Executive Compensation Committee of our Board of Directors. As of November 27, 2020, we had reserved 46.0 million shares of common stock for issuance under our 2019 Plan and had 38.1 million shares available for grant. Our Performance Share Programs aim to help focus key employees on building stockholder value, provide significant award potential for achieving outstanding Company performance and enhance the ability of the Company to attract and retain highly talented and competent individuals. The Executive Compensation Committee of our Board of Directors approves the terms of each of our Performance Share Programs, including the award calculation methodology. Shares may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period. Performance share awards will be awarded and cliff-vest upon the later of the Executive Compensation Committee's certification of the level of achievement or the three -year anniversary of each grant. Participants can earn between 0 % and 200 % of the target number of performance shares. On January 24, 2020, the Executive Compensation Committee approved the 2020 Performance Share Program, the terms of which are similar to prior year performance share programs as discussed above. As of November 27, 2020, the shares awarded under our 2020, 2019 and 2018 Performance Share Programs remain outstanding and are yet to be achieved. Employee Stock Purchase Plan Our Employee Stock Purchase Plan (“ESPP”) allows eligible employee participants to purchase shares of our common stock at a discount through payroll deductions. The ESPP consists of twenty-four -month offering periods with four six -month purchase periods in each offering period. Employees purchase shares in each purchase period at 85 % of the market value of our common stock at either the beginning of the offering period or the end of the purchase period, whichever price is lower. The ESPP will continue until the earlier of termination by the Board of Directors or the date on which all of the shares available for issuance under the plan have been issued. 96 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In April 2020, our stockholders approved the 2020 Employee Stock Purchase Plan (“2020 ESPP”) which amended and restated the 1997 ESPP to increase the maximum number of shares of our common stock that may be issued under the plan. As of November 27, 2020, we had reserved 103.0 million shares of our common stock for issuance under the 2020 ESPP and approximately 12.6 million shares remain available for future issuance. Issuance of Shares Upon vesting of restricted stock units and performance shares or purchase of shares under the ESPP, we will issue treasury stock. If treasury stock is not available, common stock will be issued. In order to minimize the impact of on-going dilution from issuance of shares, we instituted a stock repurchase program. See Note 14 for information regarding our stock repurchase programs. Valuation of Stock-Based Compensation Stock-based compensation cost is measured at the grant date based on the fair value of the award. Our performance share awards are valued using a Monte Carlo Simulation model. The fair value of the awards are fixed at grant date and amortized over the longer of the remaining performance or service period. We use the Black-Scholes option pricing model to determine the fair value of ESPP shares. The determination of the fair value of stock-based payment awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, a risk-free interest rate and any expected dividends. Summary of Restricted Stock Units Restricted stock unit activity for fiscal 2020 was as follows: Number of Shares (in millions) Weighted Average Grant Date Fair Value Aggregate Fair Value (1) (in millions) Weighted Average Remaining Contractual Life (years) Beginning outstanding balance 8.6 $ 211.95 Awarded 3.1 $ 358.68 Released ( 4.2 ) $ 193.08 Forfeited ( 0.5 ) $ 255.16 Ending outstanding balance 7.0 $ 285.69 $ 3,322 1.15 Expected to vest 6.4 $ 283.77 $ 3,066 1.09 _________________________________________ (1) The aggregate fair value is calculated using the closing stock price as of November 27, 2020 of $ 477.03 . The weighted average grant date fair values of restricted stock units granted during fiscal 2020, 2019 and 2018 were $ 358.68 , $ 253.91 and $ 208.73 , respectively. The total fair value of restricted stock units vested during fiscal 2020, 2019 and 2018 was $ 1.61 billion, $ 970 million and $ 837 million, respectively. 97 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Summary of Performance Shares Performance share activity for fiscal 2020 was as follows: Number of Shares (in millions) Weighted Average Grant Date Fair Value Aggregate Fair Value (1) (in millions) Weighted Average Remaining Contractual Life (years) Beginning outstanding balance 1.0 $ 199.78 Awarded 0.6 $ 271.62 Achieved ( 0.8 ) $ 118.84 Forfeited ( 0.1 ) $ 303.13 Ending outstanding balance 0.7 $ 333.85 $ 342 1.16 Expected to vest 0.7 $ 327.36 $ 315 1.12 _________________________________________ (1) The aggregate fair value is calculated using the closing stock price as of November 27, 2020 of $ 477.03 . Shares awarded during fiscal 2020 include 0.4 million additional shares awarded for the final achievement of the 2017 Performance Share Program which was certified in the first quarter of fiscal 2020. The remaining awarded shares were for the 2020 Performance Share Program. Shares achieved during fiscal 2020 resulted from 200 % achievement of target for the 2017 Performance Share Program. The weighted average grant date fair values of performance awards granted during fiscal 2020, 2019 and 2018 were $ 271.62 , $ 177.33 and $ 123.78 , respectively. The total fair value of performance awards achieved during fiscal 2020, 2019 and 2018 was $ 273 million, $ 204 million and $ 208 million, respectively. Summary of Employee Stock Purchase Plan Shares Employees purchased 1.2 million shares at an average price of $ 218.37 , 1.5 million shares at an average price of $ 150.55 , and 1.8 million shares at an average price of $ 104.94 for fiscal 2020, 2019 and 2018, respectively. The intrinsic value of shares purchased during fiscal 2020, 2019 and 2018 was $ 216 million, $ 179 million and $ 199 million, respectively. The intrinsic value is calculated as the difference between the market value on the date of purchase and the purchase price of the shares. Compensation Costs We recognize the estimated compensation cost of restricted stock units, net of estimated forfeitures, on a straight-line basis over the requisite service period of the entire award, which is generally the vesting period. The estimated compensation cost is based on the fair value of our common stock on the date of grant. We also recognize the estimated compensation cost of performance shares, net of estimated forfeitures, on a straight-line basis over the requisite performance period or service period of the entire award, whichever is longer. Our performance share awards are earned upon achievement of an objective total stockholder return measure at the end of the three-year performance period, as described above. We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate forfeitures and record stock-based compensation expense only for those awards that are expected to vest. As of November 27, 2020, there was $ 1.57 billion of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards and purchase rights which will be recognized over a weighted average period of 2.04 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. 98 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Total stock-based compensation costs that have been included in our Consolidated Statements of Income for fiscal 2020, 2019 and 2018 were as follows: (in millions) 2020 2019 2018 Cost of revenue $ 61 $ 55 $ 42 Research and development 467 375 277 Sales and marketing 261 249 206 General and administrative 120 109 85 Total (1) $ 909 $ 788 $ 610 _________________________________________ (1) During fiscal 2020, 2019 and 2018, we recorded tax benefits related to stock-based compensation costs of $ 352 million, $ 248 million and $ 222 million, respectively. NOTE 13. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The components of accumulated other comprehensive income (loss) and activity, net of related taxes, for fiscal 2020 were as follows: (in millions) November 29, 2019 Increase / Decrease Reclassification Adjustments November 27, 2020 Unrealized gains on available-for-sale securities $ 4 $ 3 $ ( 1 ) (1) $ 6 Net unrealized gains / losses on derivative instruments designated as hedging instruments ( 22 ) ( 44 ) 6 (2) ( 60 ) Cumulative foreign currency translation adjustments ( 170 ) 66 — ( 104 ) Total accumulated other comprehensive income (loss), net of taxes $ ( 188 ) $ 25 $ 5 $ ( 158 ) _________________________________________ (1) Reclassification adjustments for gains / losses on available-for-sale securities are classified in other income (expense), net. (2) Reclassification adjustments for gains / losses on foreign currency hedges are classified in revenue and reclassification adjustments for gains / losses on Treasury lock hedges are classified in interest expense. Taxes related to each component of other comprehensive income (loss) were immaterial for the fiscal years presented. NOTE 14. STOCK REPURCHASE PROGRAM To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase shares in the open market or enter into structured repurchase agreements with third parties. In May 2018, our Board of Directors granted us an authority to repurchase up to $ 8 billion in common stock through the end of fiscal 2021. During fiscal 2020, 2019 and 2018, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $ 3.05 billion, $ 2.75 billion, and $ 2.05 billion, respectively. We enter into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is expected to be 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. We repurchased approximately 8.0 million shares at an average price of $ 376.38 per share in fiscal 2020, 9.9 million shares at an average price of $ 270.23 per share in fiscal 2019, and 8.7 million shares at an average price of $ 230.43 per share in fiscal 2018. 99 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For fiscal 2020, 2019 and 2018, the prepayments were classified as treasury stock on our Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by November 27, 2020, November 29, 2019 and November 30, 2018 were excluded from the computation of earnings per share. As of November 27, 2020, $ 255 million of prepayments remained under the agreement. Subsequent to November 27, 2020, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $ 950 million. This amount will be classified as treasury stock on our Consolidated Balance Sheets. Upon completion of the $ 950 million stock repurchase agreement, $ 1.1 billion remains under our May 2018 authority. Further, in December 2020, our Board of Directors granted us additional authority to repurchase up to $ 15 billion in common stock through the end of fiscal 2024. We have not drawn from our new $ 15 billion authority as of the issuance of these financial statements. NOTE 15. NET INCOME PER SHARE Basic net income per share is computed using the weighted average number of common shares outstanding for the period, excluding unvested restricted stock units and performance awards. Diluted net income per share is based upon the weighted average common shares outstanding for the period plus dilutive potential common shares, including unvested restricted stock units, stock purchase rights, performance share awards and stock options using the treasury stock method. The following table sets forth the computation of basic and diluted net income per share for fiscal 2020, 2019 and 2018: (in millions, except per share data) 2020 2019 2018 Net income $ 5,260 $ 2,951 $ 2,591 Shares used to compute basic net income per share 480.9 486.3 490.6 Dilutive potential common shares 4.6 5.3 7.2 Shares used to compute diluted net income per share 485.5 491.6 497.8 Basic net income per share $ 10.94 $ 6.07 $ 5.28 Diluted net income per share $ 10.83 $ 6.00 $ 5.20 Anti-dilutive potential common shares (1) 0.5 0.2 0.2 _________________________________________ (1) Potential common stock equivalents not included in the calculation of diluted net income per share as the effect would have been anti-dilutive. 100 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 16. COMMITMENTS AND CONTINGENCIES Unconditional Purchase Obligations Our purchase obligations consist of agreements to purchase goods and services entered into in the ordinary course of business. The following table summarizes our non-cancellable unconditional purchase obligations for each of the next five years and thereafter as of November 27, 2020: (in millions) Fiscal Year Purchase Obligations 2021 $ 872 2022 484 2023 528 2024 1 2025 — Thereafter — Total $ 1,885 Royalties We have royalty commitments associated with the licensing of certain offerings and products. Royalty expense is generally based on a dollar amount per unit or a percentage of the underlying revenue. Royalty expense, which was recorded under our cost of revenue on our Consolidated Statements of Income, was approximately $ 176 million, $ 154 million and $ 119 million in fiscal 2020, 2019 and 2018, respectively. Indemnifications In the ordinary course of business, we provide indemnifications of varying scope to customers and channel partners against claims of intellectual property infringement made by third parties arising from the use of our products and from time to time, we are subject to claims by our customers under these indemnification provisions. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations. To the extent permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Legal Proceedings In connection with disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation may be very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Third-party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements and service agreements. 101 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In addition to intellectual property disputes, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We consider all claims on a quarterly basis in accordance with GAAP and based on known facts assess whether potential losses are considered reasonably possible or probable and estimable. Based upon this assessment, we then evaluate disclosure requirements and whether to accrue for such claims in our financial statements. This determination is then reviewed and discussed with the Audit Committee of the Board of Directors. We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in this note, we have determined that no provision for liability nor disclosure is required related to any claim against us because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial. All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations. In connection with our anti-piracy efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be negatively affected in any particular period by the resolution of one or more of these counter-claims. NOTE 17. DEBT The carrying value of our borrowings as of November 27, 2020 and November 29, 2019 were as follows: (dollar in millions) Issuance Date Due Date Effective Interest Rate 2020 2019 4.75% 2020 Notes February 2010 February 2020 4.92 % $ — $ 900 1.70% 2023 Notes February 2020 February 2023 1.92 % 500 — 1.90% 2025 Notes February 2020 February 2025 2.07 % 500 — 3.25% 2025 Notes January 2015 February 2025 3.67 % 1,000 1,000 2.15% 2027 Notes February 2020 February 2027 2.26 % 850 — 2.30% 2030 Notes February 2020 February 2030 2.69 % 1,300 — Term Loan October 2018 April 2020 2.47 % — 2,250 Total debt outstanding, at par $ 4,150 $ 4,150 Less: Current portion of debt — ( 3,150 ) Unamortized discount and debt issuance costs ( 33 ) ( 11 ) Carrying value of long-term debt $ 4,117 $ 989 Current portion of debt, at par $ — $ 3,150 Unamortized discount and debt issuance costs — ( 1 ) Carrying value of current debt $ — $ 3,149 102 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Term Loan In October 2018, we entered into a credit agreement providing a $ 2.25 billion senior unsecured term loan (“Term Loan") with a maturity date of April 30, 2020. The Term Loan ranked equally with our other unsecured and unsubordinated indebtedness. There were no scheduled principal amortization payments prior to maturity and the Term Loan could be prepaid and terminated at our election at any time without penalty or premium. At our election, the Term Loan bore interest at either (i) LIBOR plus a margin, based on our debt ratings, ranging from 0.500 % to 1.000 % or (ii) a base rate plus a margin, based on our debt ratings, ranging from 0.040 % to 0.110 %. The related issuance costs were amortized to interest expense over the Term Loan period using the effective interest method. Interest was payable periodically, in arrears, at the end of each interest period we elect. The Term Loan was paid and terminated in conjunction with our debt refinancing during the first quarter of fiscal 2020. 2020 Notes In February 2010, we issued $ 900 million of 4.75 % senior notes due February 1, 2020 (“2020 Notes"). The related discount and issuance costs were amortized to interest expense over the term of the 2020 Notes using the effective interest method. The 2020 Notes became due and were paid in conjunction with our debt refinancing during the first quarter of fiscal 2020. We entered into interest rate swaps with a total notional amount of $ 900 million designated as a fair value hedge related to our 2020 Notes in fiscal 2014. The interest rate swaps effectively converted the fixed interest rate on our 2020 Notes to a floating interest rate based on LIBOR. The interest rate swap agreements also matured during the first quarter of fiscal 2020. See Note 6 for further details regarding our interest rate swap derivatives. Debt Refinancing In February 2020, we issued $ 500 million of 1.70 % senior notes due February 1, 2023 (“2023 Notes”), $ 500 million of 1.90 % senior notes due February 1, 2025 (“1.90% 2025 Notes”), $ 850 million of 2.15 % senior notes due February 1, 2027 (“2027 Notes”) and $ 1.30 billion of 2.30 % senior notes due February 1, 2030 (“2030 Notes”). Interest is payable semi-annually, in arrears on February 1 and August 1 commencing on August 1, 2020. Our total proceeds were approximately $ 3.14 billion, used for general corporate purposes including repayment of the 2020 Notes and Term Loan, and were net of an issuance discount of $ 6 million. In addition, we incurred total issuance costs of approximately $ 21 million. Both the discount and issuance costs are being amortized to interest expense over the respective terms of the senior notes using the effective interest method. In June 2019, in anticipation of our debt refinancing, we entered into Treasury lock agreements with large financial institutions which fixed benchmark U.S. Treasury rates for an aggregate notional amount of $ 1 billion of our future debt issuance. These derivative instruments hedged the impact of changes in the benchmark interest rate to future interest payments. Upon debt issuance, the Treasury lock agreements were settled and we incurred a loss which is amortized to interest expense over the term of our 2030 Notes using the effective interest method. See Note 6 for further details regarding our Treasury lock agreement. 3.25% 2025 Notes In January 2015, we issued $ 1 billion of 3.25 % senior notes due February 1, 2025 (the “3.25% 2025 Notes”) which remain outstanding as of November 27, 2020. The related discount and issuance costs are being amortized to interest expense over the term of the 3.25% 2025 Notes using the effective interest method. Interest is payable semi-annually, in arrears on February 1 and August 1. As of November 27, 2020, our outstanding notes payable consists of the 2023 Notes, 1.90% 2025 Notes, 3.25% 2025 Notes, 2027 Notes and 2030 Notes (collectively, the “Notes”). Based on quoted prices in inactive markets, the total fair value of our outstanding Notes was $ 4.48 billion as of November 27, 2020. Our Notes rank equally with our other unsecured and unsubordinated indebtedness. We may redeem the Notes at any time, subject to a make-whole premium. In addition, upon the occurrence of certain change of control triggering events, we may be required to repurchase the Notes, at a price equal to 101 % of their principal amount, plus accrued and unpaid interest to the 103 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) date of repurchase. The Notes also include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances. As of November 27, 2020, we were in compliance with all of the covenants. Revolving Credit Agreement In October 2018, we entered into a credit agreement (“Revolving Credit Agreement”), providing for a five-year $ 1 billion senior unsecured revolving credit facility, which replaced our previous five-year $ 1 billion senior unsecured revolving credit agreement dated as of March 2, 2012 (as amended, the “Prior Revolving Credit Agreement”). In addition, we incurred issuance costs of $ 1 million which is amortized to interest expense over the term using the straight-line method. The Revolving Credit Agreement provides for loans to Adobe and certain of its subsidiaries that may be designated from time to time as additional borrowers. Pursuant to the terms of the Revolving Credit Agreement, we may, subject to the agreement of lenders to provide additional commitments, obtain up to an additional $ 500 million in commitments, for a maximum aggregate commitment of $ 1.5 billion. At our election, loans under the Revolving Credit Agreement will bear interest at either (i) LIBOR plus a margin, based on our debt ratings, ranging from 0.585 % to 1.015 % or (ii) a base rate, which is defined as the highest of (a) the agent’s prime rate, (b) the federal funds effective rate plus 0.500 % or (c) LIBOR plus 1.00 % plus a margin, based on our debt ratings, ranging from 0.000 % to 0.015 %. In addition, facility fees determined according to our debt ratings are payable on the aggregate commitments, regardless of usage, quarterly in an amount ranging from 0.04 % to 0.11 % per annum. We are permitted to permanently reduce the aggregate commitment under the Revolving Credit Agreement at any time. Subject to certain conditions stated in the Revolving Credit Agreement, Adobe and any of its subsidiaries designated as additional borrowers may borrow, prepay and re-borrow amounts at any time during the term of the Revolving Credit Agreement. The Revolving Credit Agreement contains customary representations, warranties, affirmative and negative covenants, including a financial covenant, events of default and indemnification provisions in favor of the lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, certain merger and acquisition transactions, dispositions and other matters, all subject to certain exceptions. The financial covenant, based on a quarterly financial test, requires us not to exceed a maximum leverage ratio. The facility will terminate and all amounts owing thereunder will be due and payable on the maturity date unless (a) the commitments are terminated earlier upon the occurrence of certain events, including an event of default, or (b) the maturity date is further extended upon our request, subject to the agreement of the lenders. As of November 27, 2020, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants. NOTE 18. LEASES We lease certain facilities and data centers under non-cancellable operating lease arrangements that expire at various dates through 2031. We also have one land lease that expires in 2091. We account for lease and non-lease components as a single lease component for our facilities and data center leases. We apply the accounting requirements of ASC 842 to short-term leases. Therefore, leases with an initial term of 12 months or less are recorded on the balance sheet, with lease expense for these leases recognized on a straight-line basis over the lease term. Our lease agreements do not contain any material residual value guarantees, material variable payment provisions or material restrictive covenants. After our adoption of ASC 842, operating lease expense was $ 119 million for fiscal 2020. Operating lease expense was $ 170 million and $ 137 million for fiscal 2019 and 2018, respectively. We recognized operating lease expense in cost of revenue and operating expenses in our Consolidated Statements of Income. Our operating lease expense is net of sublease income and includes variable lease costs, both of which are not material. Supplemental cash flow information for fiscal 2020 related to operating leases was as follows: (in millions) Cash paid for amounts included in the measurement of operating lease liabilities $ 99 Right-of-use assets obtained in exchange for operating lease liabilities $ 52 104 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The weighted-average remaining lease term and weighted-average discount rate for our operating lease liabilities as of November 27, 2020 were 9 years and 2.32 %, respectively. As of November 27, 2020, the maturities of lease liabilities under operating leases are as follows: (in millions) Fiscal Year Operating Leases (1) 2021 $ 104 2022 90 2023 72 2024 59 2025 60 Thereafter 272 Total lease liabilities $ 657 Less: Imputed interest 66 Present value of lease liabilities $ 591 _________________________________________ (1) Operating lease payments exclude $ 17 million of legally binding minimum lease payments for leases signed but not yet commenced. Future minimum rental payments and future minimum sublease income for our operating leases as of November 29, 2019, prior to our adoption of the new leases standard, were as follows: (in millions) Operating Leases Fiscal Year Future Minimum Rental Payments Future Minimum Sublease Income 2020 $ 98 $ 10 2021 92 9 2022 81 6 2023 69 2 2024 61 — Thereafter 338 — Total $ 739 $ 27 105 Table of Contents ADOBE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 19. NON-OPERATING INCOME (EXPENSE) Non-operating income (expense) for fiscal 2020, 2019 and 2018 included the following: (in millions) 2020 2019 2018 Interest expense $ ( 116 ) $ ( 157 ) $ ( 89 ) Investment gains (losses), net: Realized investment gains $ 5 $ 46 $ 6 Realized investment losses ( 1 ) — — Unrealized investment gains (losses), net 9 6 ( 3 ) Investment gains (losses), net $ 13 $ 52 $ 3 Other income (expense), net: Interest income $ 43 $ 68 $ 93 Foreign exchange gains (losses) ( 2 ) ( 26 ) ( 42 ) Realized gains on fixed income investments 1 — — Realized losses on fixed income investments — — ( 11 ) Other income (expense), net $ 42 $ 42 $ 40 Non-operating income (expense), net $ ( 61 ) $ ( 63 ) $ ( 46 ) NOTE 20. SELECTED QUARTERLY FINANCIAL DATA (unaudited) 2020 (in millions, except per share data) Quarter Ended February 28 May 29 August 28 November 27 Revenue $ 3,091 $ 3,128 $ 3,225 $ 3,424 Gross profit $ 2,639 $ 2,713 $ 2,798 $ 2,996 Income before income taxes $ 919 $ 1,000 $ 1,060 $ 1,197 Net income $ 955 $ 1,100 $ 955 $ 2,250 Basic net income per share $ 1.98 $ 2.28 $ 1.99 $ 4.69 Diluted net income per share $ 1.96 $ 2.27 $ 1.97 $ 4.64 2019 (in millions, except per share data) Quarter Ended March 1 May 31 August 30 November 29 Revenue $ 2,601 $ 2,744 $ 2,834 $ 2,992 Gross profit $ 2,204 $ 2,337 $ 2,418 $ 2,540 Income before income taxes $ 702 $ 711 $ 835 $ 957 Net income $ 674 $ 633 $ 793 $ 852 Basic net income per share $ 1.38 $ 1.30 $ 1.63 $ 1.76 Diluted net income per share $ 1.36 $ 1.29 $ 1.61 $ 1.74 Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Each of the fiscal quarters presented were comprised of 13 weeks. 106 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Adobe Inc.: Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying consolidated balance sheets of Adobe Inc. and subsidiaries (the Company) as of November 27, 2020 and November 29, 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the fiscal years in the three fiscal year period ended November 27, 2020, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of November 27, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of November 27, 2020 and November 29, 2019, and the results of its operations and its cash flows for each of the fiscal years in the three fiscal year period ended November 27, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of November 27, 2020 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Change in Accounting Principle As discussed in Note 1 and Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases as of November 30, 2019 due to the adoption of Financial Accounting Standards Board’s (FASB) Accounting Standards Update (ASU) 2016-02, “ Leases (Topic 842),” and changed its method of accounting for revenue from contracts with customers and sales commissions as of December 1, 2018 due to the adoption of FASB’s Accounting Standards Codification (ASC) Topic 606, “ Revenue from Contracts with Customers (ASC 606),” and Subtopic 340-40, “ Other Assets and Deferred Costs - Contracts with Customers (ASC 340-40).” Basis for Opinions The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures 107 Table of Contents that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Performance obligations in cloud-enabled software subscriptions As discussed in Note 1 to the consolidated financial statements, cloud-enabled services are highly integrated and interrelated with on-premise or on-device software licenses in the Company’s Creative Cloud and Document Cloud subscription offerings. Because of this, the cloud-based services and the on-premise/on-device software licenses are not considered distinct from each other and the applicable subscription is accounted for as a single performance obligation. We identified the assessment of performance obligations in these cloud-enabled software subscription offerings as a critical audit matter. A high degree of subjective auditor judgment was required to assess the nature of the Company’s Creative Cloud and Document Cloud offerings, their intended benefit to customers as an integrated offering, and the level of integration that exists between the cloud-enabled services and the on-premise/on-device licenses. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control related to the assessment of distinct performance obligations. We read the Creative Cloud and Document Cloud subscription offering agreements to understand the contractual terms and conditions. We participated in product demonstrations, examined marketing materials, and performed interviews with the Company’s product and engineering department to both understand and observe specific functionalities of the integrated offering and evaluate the nature of the promise made to the Company’s Creative Cloud and Document Cloud customers. We evaluated the features and functionalities of the Creative Cloud and Document Cloud subscription that can be accessed only when using the on-premise/on-device software while connected to the Adobe Cloud to assess that customers receive the intended benefit from each solution only as an integrated offering. Fair value of the intra-entity transfer of certain intellectual property rights As discussed in Note 10 to the consolidated financial statements, the Company completed an intra-entity transfer of certain intangible property rights (“IP rights”) to one of its foreign subsidiaries during the fourth quarter of fiscal 2020. As a result of this transaction, the Company recorded a deferred tax asset, net of valuation allowance, and related tax benefit of $1.13 billion as of and for the period ended November 27, 2020 based on the fair value of the IP rights transferred. The tax-deductible amortization related to the transferred IP rights will be recognized over the period of economic benefit. We identified the fair value of transferred IP rights as a critical audit matter. We performed sensitivity analyses to determine the significant assumptions used to value the transferred IP rights. Subjective auditor judgment was required to evaluate management’s estimates and assumptions used to determine the fair value of the transferred IP rights, including the near-term revenue growth rate, operating margin, terminal growth rate, and discount rate assumptions. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s income tax process. This included controls related to the development of the near-term revenue growth rate, operating margin, terminal growth rate, and discount rate assumptions. We assessed the near-term revenue growth rate by comparing it to historical 108 Table of Contents results and comparing it to third-party analyst expectations for the industry. We assessed the operating margin assumption by comparing it to historical results. We assessed the terminal growth rate by comparing it to third-party analyst expectations for the industry. We involved valuation professionals with specialized skills and knowledge who assisted in assessing the discount rate assumption by comparing it to a discount rate range that was independently developed using publicly available market data for comparable entities. (signed) KPMG LLP We have served as the Company’s auditor since 1983. Santa Clara, California January 15, 2021 109 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.