ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto. Discussion regarding our financial condition and results of operations for fiscal 2021 as compared to fiscal 2020 is included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 3, 2021, filed with the SEC on January 21, 2022.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our Consolidated Financial Statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. We evaluate our assumptions, judgments and estimates on a regular basis. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.
We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, business combinations and income taxes have the greatest potential impact on our Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules requiring us to make judgments and estimates, and consequently, we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
Revenue Recognition
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 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 digital assets 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.
Business Combinations
We allocate the purchase price of acquired companies to tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets and deferred revenue obligations. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience, market conditions and information obtained from management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to:
•future expected cash flows from software license sales, subscriptions, support agreements, consulting contracts and acquired developed technologies and patents;
•expected costs to develop acquired technologies and patents internally into commercially viable products;
•historical and expected customer attrition rates and anticipated growth in revenue from acquired customers;
•the acquired company’s trade name and trademarks as well as assumptions about the period of time the acquired trade name and trademarks will continue to be used in the combined company’s product portfolio;
•the expected use of the acquired assets; and
•discount rates.
In connection with the purchase price allocations for our acquisitions, we estimate the fair value of the deferred revenue obligations assumed. The estimated fair value of these obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin.
Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.
Accounting for Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, 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 loss and tax credit carryforwards. Significant judgment is required in determining our current provision for income taxes and deferred tax assets or liabilities. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account our interpretation and application of current tax laws and possible outcomes of current and future examinations conducted by domestic and foreign tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and associated reserves. To the extent that the final determination of any of these examinations is different from the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made.
Recent Accounting Pronouncements
ACQUISITIONS
In the fourth quarter of fiscal 2021, we completed the acquisition of Frame.io, a privately held company that provides a cloud-based video collaboration platform, for approximately $1.24 billion and we began integrating Frame.io into our Digital Media reportable segment. In the first quarter of fiscal 2021, we completed the acquisition of Workfront, a privately held company that provides a workflow platform, for approximately $1.52 billion in cash consideration and we began integrating Workfront into our Digital Experience reportable segment. See Note 3 of our Notes to Consolidated Financial Statements for further information regarding these acquisitions. RESULTS OF OPERATIONS
Overview of 2022
For our fiscal 2022, we experienced strong demand across our Digital Media and Digital Experience offerings, driven by the ongoing shift towards a digital-first world. As we execute on our long-term growth initiatives, we have continued to experience growth in software-based subscription revenue across our portfolio of offerings.
Digital Media
In our Digital Media segment, we are a market leader with Creative Cloud, our subscription-based offering which provides desktop tools, mobile apps and cloud-based services for designing, creating and publishing rich content and immersive 3D experiences. Starting in December 2021, Creative Cloud includes Adobe Express, a web and mobile application designed to enable a broad spectrum of users, including novice content creators, communicators and creative professionals, to create, edit and customize content quickly and easily with content-first, task-based solutions. Creative Cloud delivers value with deep, cross-product integration, frequent product updates and feature enhancements, cloud-enabled services including storage and
syncing of files across users’ devices, machine learning and artificial intelligence, access to marketplace, social and community-based features with our Adobe Stock and Behance services, app creation capabilities, tools which assist with enterprise deployments and team collaboration, and affordable pricing for cost-sensitive customers.
We offer Creative Cloud for individuals, students, teams and enterprises. We expect Creative Cloud will drive sustained long-term revenue growth through a continued expansion of our customer base by attracting new users with new features and products like Adobe Express that make creative tools accessible to first-time creators and communicators, and delivering new features and technologies to existing customers with our latest releases such as share for review. We have also built out a marketplace for Creative Cloud subscribers to enable the delivery and purchase of stock content in our Adobe Stock service. Overall, our strategy with Creative Cloud is designed to enable us to increase our revenue with users, attract more new customers, and grow our recurring and predictable revenue stream that is recognized ratably.
We continue to implement strategies that are designed to accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offerings. These strategies include increasing the value Creative Cloud users receive, such as offering new desktop, web and mobile applications, as well as targeted promotions and offers that attract past customers and potential users to experience and ultimately subscribe to Creative Cloud. Because of the shift towards Creative Cloud subscriptions and Enterprise Term License Agreements (“ETLAs”), revenue from perpetual licensing of our Creative products has been immaterial to our business.
We are also a market leader with our Document Cloud offerings built around our Adobe Acrobat family of products, with a set of integrated mobile apps and cloud-based document services which enable users to create, review, approve, sign and track documents regardless of platform or application source type. Document Cloud, which enhances the way people manage critical documents at home, in the office and across devices, includes Adobe Acrobat, Adobe Acrobat Sign and Adobe Scan. Adobe Acrobat is offered both through subscription and perpetual licenses.
As part of our Creative Cloud and Document Cloud strategies, we utilize a data-driven operating model (“DDOM”) and our Adobe Experience Cloud solutions to raise awareness of our products, drive new customer acquisition, engagement and retention, and optimize customer journeys, and it continues to contribute strong growth in the business.
Annualized Recurring Revenue (“ARR”) is currently the key performance metric our management uses to assess the health and trajectory of our overall Digital Media segment. ARR should be viewed independently of revenue, deferred revenue and remaining performance obligations as ARR is a performance metric and is not intended to be combined with any of these items. We adjust our reported ARR on an annual basis to reflect any exchange rate changes. Our reported ARR results in the current fiscal year are based on currency rates set at the beginning of the year and held constant throughout the year for measurement purposes. We calculate ARR as follows:
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Creative ARR | Annual Value of Creative Cloud Subscriptions and Services + Annual Creative ETLA Contract Value |
Document Cloud ARR | Annual Value of Document Cloud Subscriptions and Services + Annual Document Cloud ETLA Contract Value |
Digital Media ARR | Creative ARR + Document Cloud ARR |
In March 2022, in response to the Russia-Ukraine war, we announced a halt of all new sales of our products and services in Russia and Belarus. As a result, we reduced our Digital Media ARR balance by $75 million, which represented our Digital Media ARR for existing business in Russia and Belarus. While we continued to provide Digital Media services in Ukraine, we also reduced our Digital Media ARR balance by an additional $12 million, which represented our Digital Media business in Ukraine. This resulted in a total ARR reduction of $87 million taken at the beginning of the second quarter of fiscal 2022.
Creative ARR exiting fiscal 2022 was $11.60 billion, up from $10.22 billion at the end of fiscal 2021. Document Cloud ARR exiting fiscal 2022 was $2.37 billion, up from $1.93 billion at the end of fiscal 2021. Total Digital Media ARR grew to $13.97 billion at the end of fiscal 2022, up from $12.15 billion at the end of fiscal 2021. Revaluing our ending ARR for fiscal 2022 using currency rates at the beginning of fiscal 2023, our Digital Media ARR at the end of fiscal 2022 would be $13.26 billion or approximately $712 million lower than the ARR reported above.
Our success in driving growth in ARR has positively affected our revenue growth. Creative revenue in fiscal 2022 was $10.46 billion, up from $9.55 billion in fiscal 2021 and representing 10% year-over-year growth. Document Cloud revenue in fiscal 2022 was $2.38 billion, up from $1.97 billion in fiscal 2021 and representing 21% year-over-year growth. Total Digital Media segment revenue grew to $12.84 billion in fiscal 2022, up from $11.52 billion in fiscal 2021 and representing 11% year-over-year growth driven by strong net new user growth.
Digital Experience
We are a market leader in the fast-growing category addressed by our Digital Experience segment. The Adobe Experience Cloud applications, services and platform are designed to manage customer journeys, enable personalized experiences at scale and deliver intelligence for businesses of any size in any industry. Our differentiation and competitive advantage are strengthened by our ability to use the Adobe Experience Platform to integrate our comprehensive set of solutions.
Adobe Experience Cloud delivers solutions for our customers across the following strategic growth pillars:
•Data insights and audiences. Our solutions, including Adobe Analytics, Adobe Experience Platform, Customer Journey Analytics, Adobe Audience Manager and our Real-time Customer Data Platform, deliver robust customer profiles and AI-powered analytics across the customer journey to provide timely, relevant experiences across platforms.
•Content and commerce. Our solutions help customers manage, deliver and optimize content delivery through Adobe Experience Manager, and enable shopping experiences that scale from mid-market to enterprise businesses with Adobe Commerce.
•Customer journeys. Our solutions help businesses manage, test, target, personalize and orchestrate campaigns and customer journeys across B2E use cases, including through Marketo Engage, Adobe Campaign, Adobe Target and Journey Optimizer.
•Marketing workflow. We offer Adobe Workfront, a work management platform directed toward marketers to orchestrate campaign workflows.
In addition to chief marketing officers, chief revenue officers and digital marketers, users of our Digital Experience solutions include advertisers, campaign managers, publishers, data analysts, content managers, social marketers, marketing executives and information management and technology executives. These customers often are involved in workflows that utilize other Adobe products, such as our Digital Media offerings. By combining the creativity of our Digital Media business with the science of our Digital Experience business, we help our customers to more efficiently and effectively make, manage, measure and monetize their content across every channel with an end-to-end workflow and feedback loop.
We utilize a direct sales force to market and license our Digital Experience solutions, as well as an extensive ecosystem of partners, including marketing agencies, systems integrators and independent software vendors that help license and deploy our solutions to their customers. We have made significant investments to broaden the scale and size of all of these routes to market, and our recent financial results reflect the success of these investments.
Digital Experience revenue was $4.42 billion in fiscal 2022, up from $3.87 billion in fiscal 2021 which represents 14% year-over-year growth. Driving this increase was the increase in subscription revenue across our offerings which grew to $3.88 billion in fiscal 2022 from $3.38 billion in fiscal 2021, representing 15% year-over-year growth.
Macroeconomic Conditions
As a corporation with an extensive global footprint, we are subject to risks and exposures from foreign currency exchange rate fluctuations caused by significant events with macroeconomic impacts, including, but not limited to, the Russia-Ukraine war, COVID-19 pandemic and actions taken by central banks to counter inflation. We continuously monitor the direct and indirect impacts of these circumstances on our business and financial results, as well as the overall global economy and geopolitical landscape. Foreign currency exchange rate fluctuations have negatively impacted our revenue and earnings during fiscal 2022, and are expected to continue to negatively impact our financial results in fiscal 2023.
Financial Performance Summary for Fiscal 2022
•Total Digital Media ARR of approximately $13.97 billion as of December 2, 2022 increased by $1.82 billion, or 15%, from $12.15 billion as of December 3, 2021. The change in our Digital Media ARR was primarily due to new user adoption of our Creative Cloud and Document Cloud offerings, partially offset by an $87 million ARR reduction taken in March 2022 in response to the Russia-Ukraine war.
•Creative revenue of $10.46 billion increased by $913 million, or 10%, during fiscal 2022, from $9.55 billion in fiscal 2021. Document Cloud revenue of $2.38 billion increased by $409 million, or 21%, during fiscal 2022, from $1.97 billion in fiscal 2021. The increases were primarily due to subscription revenue growth associated with our Creative Cloud and Document Cloud offerings.
•Digital Experience revenue of $4.42 billion increased by $555 million, or 14%, during fiscal 2022, from $3.87 billion in fiscal 2021. The increase was primarily due to subscription revenue growth across our offerings.
•Remaining performance obligations of $15.19 billion as of December 2, 2022 increased by $1.20 billion, or 9%, from $13.99 billion as of December 3, 2021, primarily due to new contracts and renewals for our Digital Media and Digital Experience offerings, partially offset by the impact of foreign currency exchange rate fluctuations.
•Cost of revenue of $2.17 billion increased by $300 million, or 16%, during fiscal 2022, from $1.87 billion in fiscal 2021 primarily due to increases in hosting services and data center costs, as well as increases in base and incentive compensation and related benefits costs.
•Operating expenses of $9.34 billion increased by $1.23 billion, or 15%, during fiscal 2022, from $8.12 billion in fiscal 2021 primarily due to increases in base and incentive compensation and related benefits costs, as well as increased marketing spend.
•Cash flows from operations of $7.84 billion during fiscal 2022 increased by $608 million, or 8%, from $7.23 billion in fiscal 2021 primarily due to higher net income after adjustment for non-cash items.
Revenue
Revenue for fiscal 2021 benefited from an extra week in the first quarter of fiscal 2021 due to our 52/53 week financial calendar whereby fiscal 2021 was a 53-week year compared with fiscal 2022 and 2020 which were 52-week years.
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Subscription | | $ | 16,388 | | | $ | 14,573 | | | $ | 11,626 | | | 12 | % | | |
Percentage of total revenue | | 93 | % | | 92 | % | | 90 | % | | | | |
Product | | 532 | | | 555 | | | 507 | | | (4) | % | | |
Percentage of total revenue | | 3 | % | | 4 | % | | 4 | % | | | | |
Services and other | | 686 | | | 657 | | | 735 | | | 4 | % | | |
Percentage of total revenue | | 4 | % | | 4 | % | | 6 | % | | | | |
Total revenue | | $ | 17,606 | | | $ | 15,785 | | | $ | 12,868 | | | 12 | % | | |
Subscription
Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings, and related support, including Creative Cloud and certain of our Adobe Experience Cloud and Document Cloud services. We primarily recognize subscription revenue ratably over the term of agreements with our customers, beginning with commencement of service. Subscription revenue related to certain offerings, where fees are based on a number of transactions and invoicing is aligned to the pattern of performance, customer benefit and consumption, are recognized on a usage basis.
We have the following reportable segments: Digital Media, Digital Experience, and Publishing and Advertising. Subscription revenue by reportable segment for fiscal 2022, 2021 and 2020 is as follows:
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Digital Media | | $ | 12,385 | | | $ | 11,048 | | | $ | 8,813 | | | 12 | % | | |
Digital Experience | | 3,880 | | | 3,379 | | | 2,660 | | | 15 | % | | |
Publishing and Advertising | | 123 | | | 146 | | | 153 | | | (16) | % | | |
Total subscription revenue | | $ | 16,388 | | | $ | 14,573 | | | $ | 11,626 | | | 12 | % | | |
Product
Our product revenue is comprised primarily of fees related to licenses for on-premise software purchased on a perpetual basis, for a fixed period of time or based on usage for certain of our OEM and royalty agreements. We primarily recognize product revenue at the point in time the software is available to the customer, provided all other revenue recognition criteria are met.
Services and Other
Our services and other revenue is comprised primarily of fees related to consulting, training, maintenance and support for certain on-premise licenses that are recognized at a point in time and our advertising offerings. We typically sell our consulting contracts on a time-and-materials or 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. Transaction-based advertising revenue is recognized on a usage basis as we satisfy the performance obligations to our customers.
Segments
In fiscal 2022, we categorized our products into the following reportable segments:
•Digital Media—Our Digital Media segment provides products, services and solutions that enable individuals, teams and enterprises to create, publish and promote their content anywhere and accelerate their productivity by modernizing how they view, share, engage with and collaborate on documents and creative content. Our customers include creative professionals, including photographers, video editors, graphic and experience designers and game developers, communicators, including content creators, students, marketers and knowledge workers, and consumers.
•Digital Experience—Our Digital Experience segment provides an integrated platform and set of applications and services that enable brands and businesses to create, manage, execute, measure, monetize and optimize customer experiences that span from analytics to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers and executives across the C-suite.
•Publishing and Advertising—Our Publishing and Advertising segment contains legacy products and services that address diverse market opportunities, including eLearning solutions, technical document publishing, web conferencing, document and forms platform, web application development, high-end printing and our Adobe Advertising Cloud offerings.
Segment Information
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Digital Media | | $ | 12,842 | | | $ | 11,520 | | | $ | 9,233 | | | 11 | % | | |
Percentage of total revenue | | 73 | % | | 73 | % | | 72 | % | | | | |
Digital Experience | | 4,422 | | | 3,867 | | | 3,125 | | | 14 | % | | |
Percentage of total revenue | | 25 | % | | 24 | % | | 24 | % | | | | |
Publishing and Advertising | | 342 | | | 398 | | | 510 | | | (14) | % | | |
Percentage of total revenue | | 2 | % | | 3 | % | | 4 | % | | | | |
Total revenue | | $ | 17,606 | | | $ | 15,785 | | | $ | 12,868 | | | 12 | % | | |
Digital Media
Revenue by major offerings in our Digital Media reportable segment for fiscal 2022, 2021 and 2020 were as follows:
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 |
Creative Cloud | | $ | 10,459 | | | $ | 9,546 | | | $ | 7,736 | | | 10 | % |
Document Cloud | | 2,383 | | | 1,974 | | | 1,497 | | | 21 | % |
Total Digital Media revenue | | $ | 12,842 | | | $ | 11,520 | | | $ | 9,233 | | | 11 | % |
Revenue from Digital Media increased $1.32 billion during fiscal 2022 as compared to fiscal 2021, driven by increases in revenue associated with our Creative and Document Cloud subscription offerings due to continued demand amid an increasingly digital environment and strong customer acquisition and engagement, partially offset by the impact of foreign currency exchange rate fluctuations.
Digital Experience
Revenue from Digital Experience increased $555 million during fiscal 2022 as compared to fiscal 2021 primarily due to net new additions across our subscription offerings, partially offset by the impact of foreign currency exchange rate fluctuations.
Geographical Information
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Americas | | $ | 10,251 | | | $ | 8,996 | | | $ | 7,454 | | | 14 | % | | |
Percentage of total revenue | | 58 | % | | 57 | % | | 58 | % | | | | |
EMEA | | 4,593 | | | 4,252 | | | 3,400 | | | 8 | % | | |
Percentage of total revenue | | 26 | % | | 27 | % | | 26 | % | | | | |
APAC | | 2,762 | | | 2,537 | | | 2,014 | | | 9 | % | | |
Percentage of total revenue | | 16 | % | | 16 | % | | 16 | % | | | | |
Total revenue | | $ | 17,606 | | | $ | 15,785 | | | $ | 12,868 | | | 12 | % | | |
Overall revenue during fiscal 2022 increased in all geographic regions as compared to fiscal 2021 primarily due to increases in Digital Media revenue and, to a lesser extent, increases in Digital Experience revenue. Within each geographic region, the fluctuations in revenue by reportable segment were attributable to the factors noted in the segment information above.
Included in the overall change in revenue for fiscal 2022 as compared to fiscal 2021 were impacts associated with foreign currency which were mitigated in part by our foreign currency hedging program. During fiscal 2022, the U.S. Dollar primarily strengthened against EMEA and APAC foreign currencies as compared to fiscal 2021, which decreased revenue in U.S. Dollar equivalents by approximately $486 million. During fiscal 2022, the foreign currency impacts to revenue were offset in part by net hedging gains from our cash flow hedging program of $176 million.
Cost of Revenue
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Subscription | | $ | 1,646 | | | $ | 1,374 | | | $ | 1,108 | | | 20 | % | | |
Percentage of total revenue | | 9 | % | | 9 | % | | 9 | % | | | | |
Product | | 35 | | | 41 | | | 36 | | | (15) | % | | |
Percentage of total revenue | | * | | * | | * | | | | |
Services and other | | 484 | | | 450 | | | 578 | | | 8 | % | | |
Percentage of total revenue | | 3 | % | | 3 | % | | 4 | % | | | | |
Total cost of revenue | | $ | 2,165 | | | $ | 1,865 | | | $ | 1,722 | | | 16 | % | | |
_________________________________________
(*) Percentage is less than 1%
Subscription
Cost of subscription revenue consists of third-party hosting services and data center costs, including expenses related to operating our network infrastructure. Cost of subscription revenue also includes compensation costs associated with network operations, implementation, account management and technical support personnel, royalty fees, software costs and amortization of certain intangible assets.
Cost of subscription revenue increased due to the following:
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| Components of % Change 2022-2021 | | |
Hosting services and data center costs | 9 | % | | |
Amortization of intangibles | 4 | | | |
Base compensation and related benefits | 3 | | | |
Incentive compensation, cash and stock-based | 1 | | | |
Royalty costs | 2 | | | |
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| | | |
Various individually insignificant items | 1 | | | |
Total change | 20 | % | | |
Product
Cost of product revenue is primarily comprised of third-party royalties, localization costs and the costs associated with the manufacturing of our products.
Services and Other
Cost of services and other revenue is primarily comprised of compensation and contracted costs incurred to provide consulting services, training and product support, and hosting services and data center costs. Cost of services and other also includes media costs related to impressions purchased from third-party ad inventory sources for our transaction-based Adobe Advertising Cloud offerings.
Cost of services and other revenue increased during fiscal 2022 as compared to fiscal 2021 primarily due to increases in compensation costs and professional fees.
Operating Expenses
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Research and development | | $ | 2,987 | | | $ | 2,540 | | | $ | 2,188 | | | 18 | % | | |
Percentage of total revenue | | 17 | % | | 16 | % | | 17 | % | | | | |
Sales and marketing | | 4,968 | | | 4,321 | | | 3,591 | | | 15 | % | | |
Percentage of total revenue | | 28 | % | | 27 | % | | 28 | % | | | | |
General and administrative | | 1,219 | | | 1,085 | | | 968 | | | 12 | % | | |
Percentage of total revenue | | 7 | % | | 7 | % | | 8 | % | | | | |
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Amortization of intangibles | | 169 | | | 172 | | | 162 | | | (2) | % | | |
Percentage of total revenue | | 1 | % | | 1 | % | | 1 | % | | | | |
Total operating expenses | | $ | 9,343 | | | $ | 8,118 | | | $ | 6,909 | | | 15 | % | | |
Research and Development
Research and development expenses consist primarily of compensation and contracted costs associated with software development, third-party hosting services and data center costs, related facilities costs and expenses associated with computer equipment and software used in development activities.
Research and development expenses increased due to the following:
| | | | | | | |
| Components of % Change 2022-2021 | | |
Incentive compensation, cash and stock-based | 7 | % | | |
Base compensation and related benefits | 7 | | | |
Professional and consulting fees | 2 | | | |
Various individually insignificant items | 2 | | | |
| | | |
Total change | 18 | % | | |
We believe that investments in research and development, including the recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced offerings and solutions. We will continue to focus on long-term opportunities available in our end markets and make significant investments in the development of our subscription and service offerings, applications and tools.
Sales and Marketing
Sales and marketing expenses consist primarily of compensation costs, amortization of contract acquisition costs, including sales commissions, travel expenses and related facilities costs for our sales, marketing, order management and global supply chain management personnel. Sales and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows and events, public relations and other market development programs.
Sales and marketing expenses increased due to the following:
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| Components of % Change 2022-2021 | | |
Marketing spend related to campaigns, events and overall marketing efforts | 5 | % | | |
Base compensation and related benefits | 4 | | | |
Incentive compensation, cash and stock-based | 3 | | | |
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Various individually insignificant items | 3 | | | |
Total change | 15 | % | | |
General and Administrative
General and administrative expenses consist primarily of compensation and contracted costs, travel expenses and related facilities costs for our finance, facilities, human resources, legal, information services and executive personnel. General and administrative expenses also include outside legal and accounting fees, provision for bad debts, expenses associated with computer equipment and software used in the administration of the business, charitable contributions and various forms of insurance.
General and administrative expenses increased due to the following:
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| Components of % Change 2022-2021 | | |
Professional and consulting fees | 4 | % | | |
Incentive compensation, cash and stock-based | 4 | | | |
Base compensation and related benefits | 3 | | | |
Charitable contributions | 2 | | | |
Charges related to cancellation of corporate events, net of recoveries | (2) | | | |
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| | | |
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Various individually insignificant items | 1 | | | |
Total change | 12 | % | | |
Professional and consulting fees increased from fiscal 2022 as compared to fiscal 2021 primarily due to incurred transaction costs associated with our planned acquisition of Figma.
Non-Operating Income (Expense), Net
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(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Interest expense | | $ | (112) | | | $ | (113) | | | $ | (116) | | | (1) | % | | |
Percentage of total revenue | | (1) | % | | (1) | % | | (1) | % | | | | |
Investment gains (losses), net | | (19) | | | 16 | | | 13 | | | ** | | |
Percentage of total revenue | | * | | * | | * | | | | |
Other income (expense), net | | 41 | | | — | | | 42 | | | ** | | |
Percentage of total revenue | | * | | * | | * | | | | |
Total non-operating income (expense), net | | $ | (90) | | | $ | (97) | | | $ | (61) | | | (7) | % | | |
_________________________________________
(*) Percentage is less than 1%.
(**) Percentage is not meaningful.
Interest Expense
Interest expense represents interest associated with our debt instruments. Interest on our senior notes is payable semi-annually, in arrears, on February 1 and August 1.
Investment Gains (Losses), Net
Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets, and gains and losses associated with our direct and indirect investments in privately held companies.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest earned on cash, cash equivalents and short-term fixed income investments. Other income (expense), net also includes realized gains and losses on fixed income investments and foreign exchange gains and losses.
Other income (expense), increased during fiscal 2022 primarily due to increases in interest income driven by higher average interest rates.
Provision for (Benefit from) Income Taxes
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in millions) | | 2022 | | 2021 | | 2020 | | % Change 2022-2021 | | |
Provision for (benefit from) income taxes | | $ | 1,252 | | | $ | 883 | | | $ | (1,084) | | | 42 | % | | |
Percentage of total revenue | | 7 | % | | 6 | % | | (8) | % | | | | |
Effective tax rate | | 21 | % | | 15 | % | | (26) | % | | | | |
Our effective tax rate increased by approximately six percentage points during fiscal 2022 as compared to fiscal 2021, primarily due to lower tax benefits related to stock-based compensation in fiscal 2022.
Our effective tax rate for fiscal 2022 was the same as the U.S. federal statutory tax rate primarily due to the impact of the U.S. federal research tax credit, largely offset by state taxes.
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 totaling $1.35 billion, based on the fair value of the IP rights transferred. The tax-deductible amortization related to the transferred IP rights is recognized over the period of economic benefit.
We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized based on evaluation of all available positive and negative evidence. On the basis of this evaluation, we continue to maintain a valuation allowance to reduce our deferred tax assets to the amount realizable. The total valuation allowance was $402 million as of December 2, 2022, primarily related to certain state credits.
We are a United States-based multinational company subject to tax in multiple domestic and foreign tax jurisdictions. The current U.S. tax law subjects the earnings of certain foreign subsidiaries to U.S. tax and generally allows an exemption from taxation for distributions from foreign subsidiaries.
In the current global tax policy environment, the domestic and foreign governing bodies continue to consider, and in some cases introduce, changes in regulations applicable to corporate multinationals such as Adobe. As regulations are issued, we account for finalized regulations in the period of enactment.
Accounting for Uncertainty in Income Taxes
The gross liabilities for unrecognized tax benefits excluding interest and penalties were $321 million, $289 million and $201 million for fiscal 2022, 2021 and 2020, respectively. If the total unrecognized tax benefits as of December 2, 2022, December 3, 2021 and November 27, 2020 were recognized, $203 million, $199 million and $136 million would decrease the respective effective tax rates.
As of December 2, 2022 and December 3, 2021, the combined amounts of accrued interest and penalties related to tax positions taken on our tax returns were approximately $17 million and $22 million, respectively. These amounts were included in long-term income taxes payable in their respective years.
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. Although the timing of resolution, settlement and closing of audits is not certain, it is reasonably possible that the underlying unrecognized tax benefits may decrease by up to $25 million over the next 12 months.
Our future effective tax rates may be materially affected by changes in the tax rates in jurisdictions where our income is earned, changes in jurisdictions in which our profits are determined to be earned and taxed, changes in the valuation of our deferred tax assets and liabilities, changes in or interpretation of tax rules and regulations in the jurisdictions in which we do business, or unexpected changes in business and market conditions that could reduce certain tax benefits.
In addition, the United States and other countries and jurisdictions in which we conduct business, including those covered by governing bodies that enact tax laws applicable to us, such as the European Commission of the European Union, could make changes to relevant tax, accounting or other laws and interpretations thereof that have a material impact to us. These countries, governmental bodies and intergovernmental economic organizations such as the Organization for Economic Cooperation and Development, have or could make unprecedented assertions about how taxation is determined and, in some cases, have proposed or enacted new laws that are contrary to the way in which rules and regulations have historically been interpreted and applied. In the current global tax policy environment, any changes in laws, regulations and interpretations could adversely affect our effective tax rates, cause us to respond by making changes to our business structure, or result in other costs to us which could adversely affect our operations and financial results.
Moreover, we are subject to the examination of our income tax returns by domestic and foreign tax authorities. 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. Our policy is to record interest and penalties related to unrecognized tax benefits in income tax expense. We believe our tax 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 financial position and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
This data should be read in conjunction with our Consolidated Statements of Cash Flows.
| | | | | | | | | | | |
| As of |
(in millions) | December 2, 2022 | | December 3, 2021 |
Cash and cash equivalents | $ | 4,236 | | | $ | 3,844 | |
Short-term investments | $ | 1,860 | | | $ | 1,954 | |
Working capital | $ | 868 | | | $ | 1,737 | |
Stockholders’ equity | $ | 14,051 | | | $ | 14,797 | |
A summary of our cash flows for fiscal 2022, 2021 and 2020 is as follows:
| | | | | | | | | | | | | | | | | |
(in millions) | 2022 | | 2021 | | 2020 |
Net cash provided by operating activities | $ | 7,838 | | | $ | 7,230 | | | $ | 5,727 | |
Net cash used for investing activities | (570) | | | (3,537) | | | (414) | |
Net cash used for financing activities | (6,825) | | | (4,301) | | | (3,488) | |
Effect of foreign currency exchange rates on cash and cash equivalents | (51) | | | (26) | | | 3 | |
Net change in cash and cash equivalents | $ | 392 | | | $ | (634) | | | $ | 1,828 | |
Our primary source of cash is receipts from revenue. Our primary uses of cash are our stock repurchase program as described below and general business expenses including payroll, marketing and third-party hosting services. Other sources of cash include proceeds from participation in the employee stock purchase plan. Other uses of cash include business acquisitions, purchases of property and equipment and payments for taxes related to net share settlement of equity awards.
Cash Flows from Operating Activities
For fiscal 2022, net cash provided by operating activities of $7.84 billion was primarily comprised of net income adjusted for the net effect of non-cash items. The primary working capital sources of cash were increases in deferred revenue driven by Digital Media and Digital Experience offerings, partially offset by increases in trade receivables attributable to the timing of billings.
Cash Flows from Investing Activities
Cash Flows from Financing Activities
For fiscal 2022, net cash used for financing activities of $6.83 billion was primarily due to payments for our common stock repurchases and taxes paid related to the net share settlement of equity awards, offset in part by proceeds from re-issuance of treasury stock mainly for our employee stock purchase plan. See the section titled “Stock Repurchase Program” below.
Liquidity and Capital Resources Considerations
Our existing cash, cash equivalents and investment balances may fluctuate during fiscal 2023 due to changes in our planned cash outlay.
Cash from operations could also be affected by various risks and uncertainties, including, but not limited to, risks detailed in the section titled “Risk Factors” in Part I, Item 1A of this report. Based on our current business plan and revenue prospects, we believe that our existing cash, cash equivalents and investment balances, our anticipated cash flows from operations and our available credit facility will be sufficient to meet our working capital, operating resource expenditure and capital expenditure requirements for the next twelve months.
Our cash equivalent and short-term investment portfolio as of December 2, 2022 consisted of asset-backed securities, corporate debt securities, foreign government securities, money market funds, municipal securities, time deposits, U.S. agency
securities and U.S. Treasury securities. We use professional investment management firms to manage a large portion of our invested cash.
We expect to continue our investing activities, including short-term and long-term investments, purchases of computer systems for research and development, sales and marketing, product support and administrative staff, and facilities expansion. Furthermore, cash reserves may be used to repurchase stock under our stock repurchase program and to strategically acquire companies, products or technologies that are complementary to our business.
On September 15, 2022, we entered into a definitive agreement under which we intend to acquire Figma, Inc. (“Figma”) for approximately $20 billion, comprised of approximately half cash and half stock, subject to customary purchase price adjustments. Approximately 6 million additional restricted stock units will be granted to Figma’s Chief Executive Officer and employees that will vest over four years subsequent to closing. The transaction is subject to regulatory approvals and customary closing conditions, and is expected to close in 2023. We will be required to pay Figma a reverse termination fee of $1 billion if the transaction fails to receive regulatory clearance, assuming all other closing conditions have been satisfied or waived, or if it fails to close within 18 months from September 15, 2022. We expect to finance the cash portion of the consideration using cash on hand and short-term debt instruments. While the transaction is pending, at a minimum we expect to maintain share repurchases sufficient to offset the dilution of equity issuances to our employees.
Revolving Credit Agreement
During 2022, we entered into a credit agreement (the “Revolving Credit Agreement”) with a syndicate of lenders, providing for a five-year $1.5 billion senior unsecured revolving credit facility through June 30, 2027, which replaces our previous five-year $1 billion senior unsecured revolving credit agreement dated as of October 17, 2018. Subject to the agreement of lenders, we may obtain up to an additional $500 million in commitments, for a maximum aggregate commitment of $2 billion. As of December 2, 2022, there were no outstanding borrowings under this credit agreement and the entire $1.5 billion credit line remains available for borrowing.
Under the terms of our Revolving Credit Agreement, we are not prohibited from paying cash dividends unless payment would trigger an event of default or if one currently exists. We do not anticipate paying any cash dividends in the foreseeable future.
Senior Notes
We have $4.15 billion senior notes outstanding, which rank equally with our other unsecured and unsubordinated indebtedness. As of December 2, 2022, the carrying value of our senior notes was $4.13 billion and our maximum commitment for interest payments was $416 million for the remaining duration of our outstanding senior notes. Interest is payable semi-annually, in arrears on February 1 and August 1. Our senior notes do not contain any financial covenants. See Note 17 of our Notes to Consolidated Financial Statements for further details regarding our debt. During the first quarter of fiscal 2022, we reclassified the senior notes due February 1, 2023 as current debt in our Consolidated Balance Sheets. As of December 2, 2022, the carrying value of our current debt was $500 million, net of the related discount and issuance costs. We intend to repay the current portion of our debt on or before the due date.
Contractual Obligations
Other
Our transition tax liability related to historical undistributed foreign earnings, which was accrued as a result of the U.S. Tax Act, was approximately $313 million as of December 2, 2022 and is payable in installments through fiscal 2026. As we repatriate foreign earnings for use in the United States, the distributions will generally be exempt from federal income taxes. In addition, the U.S. Tax Act requires companies to capitalize and amortize research and development expenditures starting fiscal 2023. If not modified, we anticipate an adverse impact to our effective rates for income taxes paid, which will be partially offset by the increase in the foreign-derived intangible income deduction, for fiscal 2023 and beyond.
The Inflation Reduction Act enacted on August 16, 2022 introduced new provisions including a corporate book minimum tax effective for us beginning in fiscal 2024 and an excise tax on net stock repurchases made after December 31, 2022. We continue to monitor developments and evaluate impacts, if any, of these provisions to our results of operations and cash flows.
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 our shares in the open market or enter into structured repurchase agreements with third parties. In December 2020, our Board of Directors granted authority to repurchase up to $15 billion in our common stock through the end of fiscal 2024.
During fiscal 2022, we repurchased a total of 15.7 million shares, including approximately 10.4 million shares at an average price of $375.03 through structured repurchase agreements entered into during fiscal 2021 and fiscal 2022, as well as 5.3 million shares at an average purchase price of $451.55 through an accelerated share repurchase agreement entered into during the first quarter of fiscal 2022.
During the fourth quarter of fiscal 2022, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $1.75 billion. As of December 2, 2022, $583 million of prepayment remained under our outstanding structured stock repurchase agreement.
Subsequent to December 2, 2022, as part of the December 2020 stock repurchase authority, we entered into an accelerated share repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $1.4 billion and received an initial delivery of 3.2 million shares, which represents approximately 75% of our prepayment. Upon completion of the $1.4 billion accelerated share repurchase agreement, $5.15 billion remains under our December 2020 authority.
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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.
ADOBE INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
| | | | | | | | | | | |
| December 2, 2022 | | December 3, 2021 |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 4,236 | | | $ | 3,844 | |
Short-term investments | 1,860 | | | 1,954 | |
Trade receivables, net of allowances for doubtful accounts of $23 and of $16, respectively | 2,065 | | | 1,878 | |
Prepaid expenses and other current assets | 835 | | | 993 | |
Total current assets | 8,996 | | | 8,669 | |
Property and equipment, net | 1,908 | | | 1,673 | |
Operating lease right-of-use assets, net | 407 | | | 443 | |
Goodwill | 12,787 | | | 12,668 | |
Other intangibles, net | 1,449 | | | 1,820 | |
Deferred income taxes | 777 | | | 1,085 | |
Other assets | 841 | | | 883 | |
Total assets | $ | 27,165 | | | $ | 27,241 | |
| | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Trade payables | $ | 379 | | | $ | 312 | |
Accrued expenses | 1,790 | | | 1,736 | |
Debt | 500 | | | — | |
Deferred revenue | 5,297 | | | 4,733 | |
Income taxes payable | 75 | | | 54 | |
Operating lease liabilities | 87 | | | 97 | |
Total current liabilities | 8,128 | | | 6,932 | |
Long-term liabilities: | | | |
Debt | 3,629 | | | 4,123 | |
Deferred revenue | 117 | | | 145 | |
Income taxes payable | 530 | | | 534 | |
| | | |
Operating lease liabilities | 417 | | | 453 | |
Other liabilities | 293 | | | 257 | |
Total liabilities | 13,114 | | | 12,444 | |
| | | |
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; 462 and 475 shares outstanding, respectively | — | | | — | |
Additional paid-in-capital | 9,868 | | | 8,428 | |
Retained earnings | 28,319 | | | 23,905 | |
Accumulated other comprehensive income (loss) | (293) | | | (137) | |
Treasury stock, at cost (139 and 126 shares, respectively) | (23,843) | | | (17,399) | |
Total stockholders’ equity | 14,051 | | | 14,797 | |
Total liabilities and stockholders’ equity | $ | 27,165 | | | $ | 27,241 | |
See accompanying Notes to Consolidated Financial Statements.
ADOBE INC.
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
| | | | | | | | | | | | | | | | | |
| Years Ended |
| December 2, 2022 | | December 3, 2021 | | November 27, 2020 |
Revenue: | | | | | |
Subscription | $ | 16,388 | | | $ | 14,573 | | | $ | 11,626 | |
Product | 532 | | | 555 | | | 507 | |
Services and other | 686 | | | 657 | | | 735 | |
Total revenue | 17,606 | | | 15,785 | | | 12,868 | |
Cost of revenue: | | | | | |
Subscription | 1,646 | | | 1,374 | | | 1,108 | |
Product | 35 | | | 41 | | | 36 | |
Services and other | 484 | | | 450 | | | 578 | |
Total cost of revenue | 2,165 | | | 1,865 | | | 1,722 | |
Gross profit | 15,441 | | | 13,920 | | | 11,146 | |
Operating expenses: | | | | | |
Research and development | 2,987 | | | 2,540 | | | 2,188 | |
Sales and marketing | 4,968 | | | 4,321 | | | 3,591 | |
General and administrative | 1,219 | | | 1,085 | | | 968 | |
| | | | | |
Amortization of intangibles | 169 | | | 172 | | | 162 | |
Total operating expenses | 9,343 | | | 8,118 | | | 6,909 | |
Operating income | 6,098 | | | 5,802 | | | 4,237 | |
Non-operating income (expense): | | | | | |
Interest expense | (112) | | | (113) | | | (116) | |
Investment gains (losses), net | (19) | | | 16 | | | 13 | |
Other income (expense), net | 41 | | | — | | | 42 | |
Total non-operating income (expense), net | (90) | | | (97) | | | (61) | |
Income before income taxes | 6,008 | | | 5,705 | | | 4,176 | |
Provision for (benefit from) income taxes | 1,252 | | | 883 | | | (1,084) | |
Net income | $ | 4,756 | | | $ | 4,822 | | | $ | 5,260 | |
Basic net income per share | $ | 10.13 | | | $ | 10.10 | | | $ | 10.94 | |
Shares used to compute basic net income per share | 470 | | | 477 | | | 481 | |
Diluted net income per share | $ | 10.10 | | | $ | 10.02 | | | $ | 10.83 | |
Shares used to compute diluted net income per share | 471 | | | 481 | | | 485 | |
See accompanying Notes to Consolidated Financial Statements.
ADOBE INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
| | | | | | | | | | | | | | | | | |
| Years Ended |
| December 2, 2022 | | December 3, 2021 | | November 27, 2020 |
| Increase/(Decrease) |
Net income | $ | 4,756 | | | $ | 4,822 | | | $ | 5,260 | |
Other comprehensive income (loss), net of taxes: | | | | | |
Available-for-sale securities: | | | | | |
Unrealized gains / losses on available-for-sale securities | (39) | | | (8) | | | 3 | |
Reclassification adjustment for recognized gains / losses on available-for-sale securities | — | | | — | | | (1) | |
Net increase (decrease) from available-for-sale securities | (39) | | | (8) | | | 2 | |
Derivatives designated as hedging instruments: | | | | | |
Unrealized gains / losses on derivative instruments | 139 | | | 69 | | | (44) | |
Reclassification adjustment for realized gains / losses on derivative instruments | (151) | | | 20 | | | 6 | |
Net increase (decrease) from derivatives designated as hedging instruments | (12) | | | 89 | | | (38) | |
Foreign currency translation adjustments | (105) | | | (60) | | | 66 | |
Other comprehensive income (loss), net of taxes | (156) | | | 21 | | | 30 | |
Total comprehensive income, net of taxes | $ | 4,600 | | | $ | 4,843 | | | $ | 5,290 | |
See accompanying Notes to Consolidated Financial Statements.
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 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) | |
Repurchases of common 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 | |
| | | | | | | | | | | | | | | | |
Net income | | — | | | — | | | — | | | 4,822 | | | — | | | — | | | — | | | 4,822 | |
Other comprehensive income (loss), net of taxes | | — | | | — | | | — | | | — | | | 21 | | | — | | | — | | | 21 | |
Re-issuance of treasury stock under stock compensation plans | | — | | | — | | | — | | | (528) | | | — | | | 3 | | | 100 | | | (428) | |
Repurchases of common stock | | — | | | — | | | — | | | — | | | — | | | (7) | | | (3,950) | | | (3,950) | |
Equity awards assumed for acquisition | | — | | | — | | | 2 | | | — | | | — | | | — | | | — | | | 2 | |
Stock-based compensation | | — | | | — | | | 1,069 | | | — | | | — | | | — | | | — | | | 1,069 | |
Value of shares in deferred compensation plan | | — | | | — | | | — | | | — | | | — | | | — | | | (3) | | | (3) | |
Balances at December 3, 2021 | | 601 | | | $ | — | | | $ | 8,428 | | | $ | 23,905 | | | $ | (137) | | | (126) | | | $ | (17,399) | | | $ | 14,797 | |
Net income | | — | | | — | | | — | | | 4,756 | | | — | | | — | | | — | | | 4,756 | |
Other comprehensive income (loss), net of taxes | | — | | | — | | | — | | | — | | | (156) | | | — | | | — | | | (156) | |
Re-issuance of treasury stock under stock compensation plans | | — | | | — | | | — | | | (342) | | | — | | | 3 | | | 102 | | | (240) | |
Repurchases of common stock | | — | | | — | | | — | | | — | | | — | | | (16) | | | (6,550) | | | (6,550) | |
| | | | | | | | | | | | | | | | |
Stock-based compensation | | — | | | — | | | 1,440 | | | — | | | — | | | — | | | — | | | 1,440 | |
Value of shares in deferred compensation plan | | — | | | — | | | — | | | — | | | — | | | — | | | 4 | | | 4 | |
| | | | | | | | | | | | | | | | |
Balances at December 2, 2022 | | 601 | | | $ | — | | | $ | 9,868 | | | $ | 28,319 | | | $ | (293) | | | (139) | | | $ | (23,843) | | | $ | 14,051 | |
See accompanying Notes to Consolidated Financial Statements.
ADOBE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
| | | | | | | | | | | | | | | | | |
| Years Ended |
| December 2, 2022 | | December 3, 2021 | | November 27, 2020 |
Cash flows from operating activities: | | | | | |
Net income | $ | 4,756 | | | $ | 4,822 | | | $ | 5,260 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation, amortization and accretion | 856 | | | 788 | | | 757 | |
Stock-based compensation | 1,440 | | | 1,069 | | | 909 | |
Reduction of operating lease right-of-use assets | 83 | | | 73 | | | 87 | |
Deferred income taxes | 328 | | | 183 | | | (1,501) | |
| | | | | |
| | | | | |
Unrealized losses (gains) on investments, net | 29 | | | (4) | | | (11) | |
| | | | | |
| | | | | |
Other non-cash items | 10 | | | 7 | | | 40 | |
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities: | | | | | |
Trade receivables, net | (198) | | | (430) | | | 106 | |
Prepaid expenses and other assets | (94) | | | (475) | | | (288) | |
Trade payables | 66 | | | (20) | | | 96 | |
Accrued expenses and other liabilities | 7 | | | 162 | | | 86 | |
| | | | | |
Income taxes payable | 19 | | | 2 | | | (72) | |
Deferred revenue | 536 | | | 1,053 | | | 258 | |
Net cash provided by operating activities | 7,838 | | | 7,230 | | | 5,727 | |
Cash flows from investing activities: | | | | | |
Purchases of short-term investments | (909) | | | (1,533) | | | (1,071) | |
Maturities of short-term investments | 683 | | | 877 | | | 915 | |
Proceeds from sales of short-term investments | 270 | | | 191 | | | 167 | |
Acquisitions, net of cash acquired | (126) | | | (2,682) | | | — | |
Purchases of property and equipment | (442) | | | (348) | | | (419) | |
| | | | | |
Purchases of long-term investments, intangibles and other assets | (46) | | | (42) | | | (15) | |
Proceeds from sales of long-term investments and other assets | — | | | — | | | 9 | |
Net cash used for investing activities | (570) | | | (3,537) | | | (414) | |
Cash flows from financing activities: | | | | | |
Repurchases of common stock | (6,550) | | | (3,950) | | | (3,050) | |
Proceeds from re-issuance of treasury stock | 278 | | | 291 | | | 270 | |
Taxes paid related to net share settlement of equity awards | (518) | | | (719) | | | (681) | |
| | | | | |
Proceeds from issuance of debt | — | | | — | | | 3,144 | |
Repayment of debt | — | | | — | | | (3,150) | |
Other financing activities, net | (35) | | | 77 | | | (21) | |
| | | | | |
Net cash used for financing activities | (6,825) | | | (4,301) | | | (3,488) | |
Effect of foreign currency exchange rates on cash and cash equivalents | (51) | | | (26) | | | 3 | |
Net change in cash and cash equivalents | 392 | | | (634) | | | 1,828 | |
Cash and cash equivalents at beginning of year | 3,844 | | | 4,478 | | | 2,650 | |
Cash and cash equivalents at end of year | $ | 4,236 | | | $ | 3,844 | | | $ | 4,478 | |
Supplemental disclosures: | | | | | |
Cash paid for income taxes, net of refunds | $ | 778 | | | $ | 843 | | | $ | 469 | |
Cash paid for interest | $ | 103 | | | $ | 100 | | | $ | 88 | |
| | | | | |
| | | | | |
| | | | | |
See accompanying Notes to Consolidated Financial Statements.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Operations
Founded in 1982, Adobe 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, including photographers, video editors, graphic and experience designers and game developers; communicators, including content creators, students, marketers and knowledge workers; businesses of all sizes; and consumers for creating, managing, delivering, measuring, optimizing, engaging and transacting with compelling content and experiences across personal computers, smartphones, other electronic devices and digital media formats.
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 (“VARs”), systems integrators (“SIs”), independent software vendors (“ISVs”), 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 desktop and laptop computers, smartphones, tablets, other devices and the web, 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, litigation and income taxes. Actual results may differ materially from these estimates.
Fiscal Year
Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Our financial results for fiscal 2021 benefited from an extra week in the first quarter of fiscal 2021 due to our 52/53 week financial calendar whereby fiscal 2021 was a 53-week year compared with fiscal 2022 and 2020 which were 52-week years.
Reclassifications
Certain prior year amounts, which are not material, have been reclassified to conform to current year presentation in the Consolidated Balance Sheets 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. Certain revenue arrangements provide customers with unilateral cancellation rights, or options to either renew monthly on-premise term-based licenses or use committed funds to purchase other Adobe products or services.
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 non-cloud enabled on-premise licenses without unilateral cancellation rights or monthly renewal options 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. Revenue from on-premise term license or term licensing arrangements with unilateral cancellation rights or monthly renewal options, and any 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 for certain on-premise licenses that are recognized at a point in time and our advertising offerings. We typically sell our consulting contracts on a time-and-materials or 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.
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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 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 digital assets 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
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 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 3 to 20 years for computers and other equipment, which includes our corporate jet, 2 to 5 years for furniture and fixtures, 5 to 25 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 2 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 December 2, 2022, our leases had remaining lease terms of up to 9 years, some of which included 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.
In accordance with accounting requirements, 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.
Goodwill, Intangibles and Other Long-Lived Assets
Goodwill is assigned to one or more reporting units 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
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 unit’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 units are greater than the carrying amounts, then the quantitative goodwill impairment test is not performed.
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 units 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 2022. We determined, after performing a qualitative review of each reporting unit, that it is more likely than not that the fair value of each of our reporting units 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 for all periods presented.
Our intangible assets are amortized over their estimated useful lives ranging from 2 to 14 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 | 5 |
Trademarks | 9 |
| |
| |
Other | 4 |
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 the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating loss and tax credit carryforwards. Significant judgment is required in determining our current provision for income taxes and deferred tax assets or liabilities. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account our interpretation and application of current tax laws and possible outcomes of current and future examinations conducted by domestic and foreign tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and associated reserves. Our policy is to record interest and penalties related to unrecognized tax benefits in income tax expense.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
Treasury Stock
Prepayments made for repurchases of our common stock are classified as treasury stock on our Consolidated Balance Sheets and only shares physically delivered to us at period ends are excluded from the computation of earnings per share.
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 2022, 2021 and 2020 were $1.04 billion, $865 million and $592 million, respectively. Prior year amounts have been recast to conform to current year presentation, which reflect changes to modernize the categorization of costs reported as advertising expenses, primarily associated with the inclusion of certain digital advertising costs. There was no impact to the Consolidated Statements of Income resulting from this change.
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 and expenses primarily in Euros, British Pounds, Japanese Yen, Australian Dollars and Indian Rupees. 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 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 and forward contracts hedging forecasted foreign currency revenue and expenses 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 revenue, foreign currency expense or Treasury lock cash flow hedge to revenue, operating expense or interest expense, as applicable.
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.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
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.
Adopted Accounting Guidance and Accounting Pronouncements Not Yet Effective
There have been no recent accounting pronouncements, changes in accounting pronouncements or recently adopted accounting guidance during fiscal 2022 that are of significance or potential significance to us.
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.
Our business is organized into the following reportable segments:
•Digital Media—Our Digital Media segment provides products, services and solutions that enable individuals, teams and enterprises to create, publish and promote their content anywhere and accelerate their productivity by modernizing how they view, share, engage with and collaborate on documents and creative content. Our customers include creative professionals, including photographers, video editors, graphic and experience designers and game developers, communicators, including content creators, students, marketers and knowledge workers, and consumers.
•Digital Experience—Our Digital Experience segment provides an integrated platform and set of applications and services that enable brands and businesses to create, manage, execute, measure, monetize and optimize customer experiences that span from analytics to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers and executives across the C-suite.
•Publishing and Advertising—Our Publishing and Advertising segment contains legacy products and services that address diverse market opportunities, including eLearning solutions, technical document publishing, web conferencing, document and forms platform, web application development, high-end printing and our Adobe Advertising Cloud offerings.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our segment revenue and results for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(dollars in millions) | Digital Media | | Digital Experience | | Publishing and Advertising | | Total |
Fiscal 2022 | | | | | | | |
Revenue | $ | 12,842 | | | $ | 4,422 | | | $ | 342 | | | $ | 17,606 | |
Cost of revenue | 561 | | | 1,502 | | | 102 | | | 2,165 | |
Gross profit | $ | 12,281 | | | $ | 2,920 | | | $ | 240 | | | $ | 15,441 | |
Gross profit as a percentage of revenue | 96 | % | | 66 | % | | 70 | % | | 88 | % |
Fiscal 2021 | | | | | | | |
Revenue | $ | 11,520 | | | $ | 3,867 | | | $ | 398 | | | $ | 15,785 | |
Cost of revenue | 429 | | | 1,321 | | | 115 | | | 1,865 | |
Gross profit | $ | 11,091 | | | $ | 2,546 | | | $ | 283 | | | $ | 13,920 | |
Gross profit as a percentage of revenue | 96 | % | | 66 | % | | 71 | % | | 88 | % |
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 | % |
We generally categorize revenue by geographic area based on where the customer manages their utilization of our offerings. Revenue by geographic area for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Americas: | | | | | | |
United States | | $ | 9,217 | | | $ | 8,104 | | | $ | 6,745 | |
Other | | 1,034 | | | 892 | | | 709 | |
Total Americas | | 10,251 | | | 8,996 | | | 7,454 | |
| | | | | | |
| | | | | | |
| | | | | | |
EMEA | | 4,593 | | | 4,252 | | | 3,400 | |
| | | | | | |
| | | | | | |
| | | | | | |
APAC | | 2,762 | | | 2,537 | | | 2,014 | |
Revenue | | $ | 17,606 | | | $ | 15,785 | | | $ | 12,868 | |
Revenue by major offerings in our Digital Media reportable segment for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Creative Cloud | | $ | 10,459 | | | $ | 9,546 | | | $ | 7,736 | |
Document Cloud | | 2,383 | | | 1,974 | | | 1,497 | |
Total Digital Media revenue | | $ | 12,842 | | | $ | 11,520 | | | $ | 9,233 | |
Subscription revenue by segment for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Digital Media | | $ | 12,385 | | | $ | 11,048 | | | $ | 8,813 | |
Digital Experience | | 3,880 | | | 3,379 | | | 2,660 | |
Publishing and Advertising | | 123 | | | 146 | | | 153 | |
Total subscription revenue | | $ | 16,388 | | | $ | 14,573 | | | $ | 11,626 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 December 2, 2022, the balance of trade receivables, net of allowances for doubtful accounts, was $2.07 billion, inclusive of unbilled receivables of $93 million. As of December 3, 2021, the balance of trade receivables, net of allowance for doubtful accounts, was $1.88 billion, inclusive of unbilled receivables of $82 million.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts which reflects our best estimate of potentially uncollectible trade receivables and is based on both specific and general reserves. We maintain general reserves on a collective basis by considering factors such as historical experience, credit-worthiness, the age of the trade receivable balances, current economic conditions and a reasonable and supportable forecast of future economic conditions. The allowance for doubtful accounts was $23 million and $16 million as of December 2, 2022 and December 3, 2021, respectively.
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, current economic conditions and a reasonable and supportable forecast of future economic conditions. Contract asset impairments were not material in fiscal 2022 and 2021. Contract assets were $97 million and $85 million as of December 2, 2022 and December 3, 2021, respectively.
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 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 December 2, 2022, the balance of deferred revenue was $5.41 billion, which includes $99 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 5% of the total deferred revenue.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 3, 2021, the balance of deferred revenue was $4.88 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 and deferred revenue assumed through acquisition, which were offset by decreases due to revenue recognized in the period. During the year ended December 2, 2022, approximately $4.72 billion of revenue was recognized that was included in the balance of deferred revenue as of December 3, 2021.
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 remaining performance obligations 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 $15.19 billion as of December 2, 2022. Non-cancellable and non-refundable committed funds related to some of our enterprise customer agreements referred to in the paragraph above comprised approximately 5% of the total remaining performance obligations. Approximately 72% 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.
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 2022, 2021 and 2020, we amortized $238 million, $212 million and $186 million of capitalized contract acquisition costs into sales and marketing expense, respectively. We did not incur any impairment losses for all periods presented.
Capitalized contract acquisition costs were $629 million and $611 million as of December 2, 2022 and December 3, 2021, of which $406 million was long-term and included in other assets in the Consolidated Balance Sheets for both periods presented. The remaining balance of the capitalized costs to obtain contracts was current and included in prepaid expenses and other current assets.
Refund Liabilities
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 $106 million and $128 million as of December 2, 2022 and December 3, 2021, respectively.
Significant Customers
For all periods presented, there were no customers that represented at least 10% of net revenue or that were responsible for over 10% of our trade receivables.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. ACQUISITIONS
Figma
On September 15, 2022, we entered into a definitive agreement under which we intend to acquire Figma, Inc. (“Figma”) for approximately $20 billion, comprised of approximately half cash and half stock, subject to customary purchase price adjustments. Approximately 6 million additional restricted stock units will be granted to Figma’s Chief Executive Officer and employees that will vest over four years subsequent to closing. The transaction is subject to regulatory approvals and customary closing conditions, and is expected to close in 2023. We will be required to pay Figma a reverse termination fee of $1 billion if the transaction fails to receive regulatory clearance, assuming all other closing conditions have been satisfied or waived, or if it fails to close within 18 months from September 15, 2022.
Figma is a privately held company that provides a web-first collaborative product design platform. Following the closing, we intend to integrate Figma into our Digital Media reportable segment for financial reporting purposes.
Frame.io
On October 7, 2021, we completed the acquisition of Frame.io, a privately held company that provides a cloud-based video collaboration platform, for approximately $1.24 billion, primarily in cash consideration. The financial results of Frame.io have been included in our Consolidated Financial Statements since the date of the acquisition. Frame.io is reported as part of our Digital Media reportable segment.
During fiscal 2022, we recorded purchase accounting adjustments that were not material based on changes to management’s estimates and assumptions primarily in regards to the total purchase price and its related impact to goodwill. The table below represents the final purchase price allocation to total identifiable intangible assets acquired and net liabilities assumed based on their respective estimated fair values as of October 7, 2021.
| | | | | | | | | | | |
(dollars in millions) | Amount | | Weighted Average Useful Life (years) |
Purchased technology | $ | 331 | | | 4 |
In-process research and development (1) | 19 | | | N/A |
Trademarks | 4 | | | 3 |
Customer contracts and relationships | 3 | | | 10 |
| | | |
| | | |
Total identifiable intangible assets | 357 | | | |
Net liabilities assumed | (36) | | | N/A |
Goodwill (2) | 915 | | | N/A |
Total purchase price | $ | 1,236 | | | |
_________________________________________
(1) Capitalized as purchased technology and considered indefinite lived until the completion or abandonment of the associated research and development efforts.
(2) Non-deductible for tax purposes.
Workfront
On December 7, 2020, we completed the acquisition of Workfront, a privately held company that provides a workflow platform, for approximately $1.52 billion in cash consideration. The financial results of Workfront have been included in our Consolidated Financial Statements since the date of the acquisition. Workfront is reported as part of our Digital Experience reportable segment.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The table below represents the final purchase price allocation to total identifiable intangible assets acquired and net liabilities assumed based on their respective estimated fair values as of December 7, 2020.
| | | | | | | | | | | |
(dollars in millions) | Amount | | Weighted Average Useful Life (years) |
Customer contracts and relationships | $ | 290 | | | 10 |
Purchased technology | 100 | | | 3 |
Backlog | 40 | | | 2 |
Trademarks | 30 | | | 5 |
Total identifiable intangible assets | 460 | | | |
Net liabilities assumed | (31) | | | N/A |
Goodwill (1) | 1,095 | | | N/A |
Total purchase price | $ | 1,524 | | | |
_________________________________________
(1) Non-deductible for tax purposes.
NOTE 4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents consist of highly liquid marketable securities 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 unrealized non-credit-related losses of marketable debt securities are included in accumulated other comprehensive income, net of taxes, in our Consolidated Balance Sheets. Unrealized credit-related losses are recorded to other income (expense), net in our Consolidated Statements of Income with a corresponding allowance for credit-related losses 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.
Cash, cash equivalents and short-term investments consisted of the following as of December 2, 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | Amortized Cost | | Unrealized Gains | | Unrealized Losses | | Estimated Fair Value |
Current assets: | | | | | | | |
Cash | $ | 657 | | | $ | — | | | $ | — | | | $ | 657 | |
Cash equivalents: | | | | | | | |
Corporate debt securities | 39 | | | — | | | — | | | 39 | |
Money market funds | 3,479 | | | — | | | — | | | 3,479 | |
| | | | | | | |
Time deposits | 61 | | | — | | | — | | | 61 | |
| | | | | | | |
| | | | | | | |
Total cash equivalents | 3,579 | | | — | | | — | | | 3,579 | |
Total cash and cash equivalents | 4,236 | | | — | | | — | | | 4,236 | |
Short-term fixed income securities: | | | | | | | |
Asset-backed securities | 98 | | | — | | | (1) | | | 97 | |
Corporate debt securities | 1,290 | | | — | | | (24) | | | 1,266 | |
Foreign government securities | 5 | | | — | | | — | | | 5 | |
Municipal securities | 24 | | | — | | | — | | | 24 | |
| | | | | | | |
U.S. agency securities | 34 | | | — | | | — | | | 34 | |
U.S. Treasury securities | 450 | | | — | | | (16) | | | 434 | |
| | | | | | | |
| | | | | | | |
Total short-term investments | 1,901 | | | — | | | (41) | | | 1,860 | |
Total cash, cash equivalents and short-term investments | $ | 6,137 | | | $ | — | | | $ | (41) | | | $ | 6,096 | |
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Cash, cash equivalents and short-term investments consisted of the following as of December 3, 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | Amortized Cost | | Unrealized Gains | | Unrealized Losses | | Estimated Fair Value |
Current assets: | | | | | | | |
Cash | $ | 750 | | | $ | — | | | $ | — | | | $ | 750 | |
Cash equivalents: | | | | | | | |
Corporate debt securities | 5 | | | — | | | — | | | 5 | |
Money market funds | 2,914 | | | — | | | — | | | 2,914 | |
| | | | | | | |
Time deposits | 175 | | | — | | | — | | | 175 | |
| | | | | | | |
Total cash equivalents | 3,094 | | | — | | | — | | | 3,094 | |
Total cash and cash equivalents | 3,844 | | | — | | | — | | | 3,844 | |
Short-term fixed income securities: | | | | | | | |
Asset-backed securities | 124 | | | — | | | — | | | 124 | |
Corporate debt securities | 1,426 | | | 2 | | | (3) | | | 1,425 | |
| | | | | | | |
Municipal securities | 28 | | | — | | | — | | | 28 | |
| | | | | | | |
| | | | | | | |
U.S. Treasury securities | 378 | | | — | | | (1) | | | 377 | |
| | | | | | | |
| | | | | | | |
Total short-term investments | 1,956 | | | 2 | | | (4) | | | 1,954 | |
Total cash, cash equivalents and short-term investments | $ | 5,800 | | | $ | 2 | | | $ | (4) | | | $ | 5,798 | |
The following table summarizes the estimated fair value of short-term fixed income debt securities classified as short-term investments based on stated effective maturities as of December 2, 2022:
| | | | | | | |
(in millions) | | | Estimated Fair Value |
Due within one year | | | $ | 989 | |
Due between one and two years | | | 614 | |
Due between two and three years | | | 248 | |
Due after three years | | | 9 | |
Total | | | $ | 1,860 | |
We review our debt securities classified as short-term investments on a regular basis for impairment. For debt securities in unrealized loss positions, we determine whether any portion of the decline in fair value below the amortized cost basis is due to credit-related factors if we neither intend to sell nor anticipate that it is more likely than not that we will be required to sell prior to recovery of the amortized cost basis. We consider factors such as the extent to which the market value has been less than the cost, any noted failure of the issuer to make scheduled payments, changes to the rating of the security and other relevant credit-related factors in determining whether or not a credit loss exists. During fiscal 2022 and 2021, we did not recognize an allowance for credit-related losses on any of our investments.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
The fair value of our financial assets and liabilities at December 2, 2022 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 | $ | 39 | | | $ | — | | | $ | 39 | | | $ | — | |
Money market funds | 3,479 | | | 3,479 | | | — | | | — | |
| | | | | | | |
Time deposits | 61 | | | 61 | | | — | | | — | |
| | | | | | | |
| | | | | | | |
Short-term investments: | | | | | | | |
Asset-backed securities | 97 | | | — | | | 97 | | | — | |
Corporate debt securities | 1,266 | | | — | | | 1,266 | | | — | |
Foreign government securities | 5 | | | — | | | 5 | | | — | |
| | | | | | | |
Municipal securities | 24 | | | — | | | 24 | | | — | |
U.S. agency securities | 34 | | | — | | | 34 | | | — | |
U.S. Treasury securities | 434 | | | — | | | 434 | | | — | |
Prepaid expenses and other current assets: | | | | | | | |
Foreign currency derivatives | 51 | | | — | | | 51 | | | — | |
Other assets: | | | | | | | |
Deferred compensation plan assets | 160 | | | 160 | | | — | | | — | |
Total assets | $ | 5,650 | | | $ | 3,700 | | | $ | 1,950 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | |
Accrued expenses: | | | | | | | |
| | | | | | | |
Foreign currency derivatives | $ | 15 | | | $ | — | | | $ | 15 | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair value of our financial assets and liabilities at December 3, 2021 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 | $ | 5 | | | $ | — | | | $ | 5 | | | $ | — | |
Money market funds | 2,914 | | | 2,914 | | | — | | | — | |
Time deposits | 175 | | | 175 | | | — | | | — | |
Short-term investments: | | | | | | | |
Asset-backed securities | 124 | | | — | | | 124 | | | — | |
Corporate debt securities | 1,425 | | | — | | | 1,425 | | | — | |
| | | | | | | |
Municipal securities | 28 | | | — | | | 28 | | | — | |
U.S. Treasury securities | 377 | | | — | | | 377 | | | — | |
Prepaid expenses and other current assets: | | | | | | | |
Foreign currency derivatives | 98 | | | — | | | 98 | | | — | |
Other assets: | | | | | | | |
Deferred compensation plan assets | 151 | | | 151 | | | — | | | — | |
Total assets | $ | 5,297 | | | $ | 3,240 | | | $ | 2,057 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | |
Accrued expenses: | | | | | | | |
| | | | | | | |
Foreign currency derivatives | $ | 8 | | | $ | — | | | $ | 8 | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
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 AA-. 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 categorize 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 funds, time deposits and deferred compensation plan assets, which consist of money market and other mutual funds, are based on quoted prices in active markets at the measurement date.
Our 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.
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
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 and expenses. These foreign exchange contracts, carried at fair value, have maturities of up to twelve months. As of December 2, 2022 and December 3, 2021, total notional amounts of outstanding cash flow hedges were $2.43 billion and $2.06 billion, respectively, hedging exposures denominated in Euros, Indian Rupees, British Pounds, Japanese Yen and Australian Dollars.
In June 2019, 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 December 2, 2022, we had net derivative gains on our foreign exchange option contracts expected to be recognized within the next 18 months, of which $53 million of gains are expected to be recognized into revenue within the next 12 months. In addition, we had net derivative losses on our foreign exchange forward contracts, of which $7 million of losses are expected to be recognized into operating expenses within the next 12 months, and net derivative losses on our Treasury lock agreements, of which $5 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 revenue, foreign currency expense or Treasury lock cash flow hedge to revenue, operating expense or interest expense, as applicable. 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.
For fiscal 2022, 2021 and 2020, there were no net gains or losses recognized in income relating to hedges of forecasted transactions that did not occur.
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 are 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.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 2, 2022, total notional amounts of outstanding foreign currency forward contracts hedging monetary assets and liabilities were $814 million, primarily hedging exposures denominated in Euros, British Pounds, Indian Rupees and Australian Dollars. As of December 3, 2021, total notional amounts of outstanding contracts were $973 million, primarily hedging exposures denominated in Euros, British Pounds, Japanese Yen, Indian Rupees and Australian Dollars. At December 2, 2022 and December 3, 2021, the outstanding balance sheet hedging derivatives had maturities of 180 days or less.
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. The fair value of derivative instruments on our Consolidated Balance Sheets as of December 2, 2022 and December 3, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | 2022 | | 2021 |
| 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 | $ | 36 | | | $ | — | | | $ | 91 | | | $ | — | |
Foreign exchange forward contracts | — | | | 7 | | | — | | | — | |
| | | | | | | |
| | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | |
Foreign exchange forward contracts | 15 | | | 8 | | | 7 | | | 8 | |
Total derivatives | $ | 51 | | | $ | 15 | | | $ | 98 | | | $ | 8 | |
Gains (losses) on derivative instruments, net of tax, recognized in our Consolidated Statements of Comprehensive Income for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | |
(in millions) | 2022 | | 2021 | | 2020 |
Derivatives in cash flow hedging relationships: | | | | | |
Foreign exchange option contracts | $ | 144 | | | $ | 69 | | | $ | (43) | |
Foreign exchange forward contracts | $ | (5) | | | $ | — | | | $ | — | |
Treasury lock | $ | — | | | $ | — | | | $ | (1) | |
The effects of derivative instruments on our Consolidated Statements of Income for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | Financial Statement Classification | | 2022 | | 2021 | | 2020 |
Derivatives in cash flow hedging relationships: | | | | | | |
Foreign exchange option contracts | | | | | | |
Net gain (loss) reclassified from accumulated OCI into income | Revenue | | $ | 176 | | | $ | (16) | | | $ | 3 | |
| | | | | | | |
Treasury lock | | | | | | |
Net gain (loss) reclassified from accumulated OCI into income | Interest expense | | $ | (4) | | | $ | (4) | | | $ | (3) | |
Derivatives not designated as hedging relationships: | | | | | | |
| | | | | | | |
Foreign exchange forward contracts | Other income (expense), net | | $ | (29) | | | $ | (3) | | | $ | 5 | |
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 7. PROPERTY AND EQUIPMENT
Property and equipment, net consisted of the following as of December 2, 2022 and December 3, 2021:
| | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 |
Computers and other equipment | | $ | 1,352 | | | $ | 1,255 | |
Buildings | | 555 | | | 560 | |
Building improvements | | 347 | | | 344 | |
Leasehold improvements | | 259 | | | 268 | |
Land | | 144 | | | 145 | |
Furniture and fixtures | | 145 | | | 150 | |
Capital projects in-progress | | 675 | | | 402 | |
Total | | 3,477 | | | 3,124 | |
Less: Accumulated depreciation and amortization | | (1,569) | | | (1,451) | |
Property and equipment, net | | $ | 1,908 | | | $ | 1,673 | |
Depreciation and amortization expense of property and equipment for fiscal 2022, 2021 and 2020 was $189 million, $207 million and $192 million, respectively.
Property and equipment, net, by geographic area as of December 2, 2022 and December 3, 2021 was as follows:
| | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | |
Americas: | | | | | | |
United States | | $ | 1,690 | | | $ | 1,480 | | | |
Other | | 1 | | | 1 | | | |
Total Americas | | 1,691 | | | 1,481 | | | |
EMEA | | 69 | | | 63 | | | |
APAC | | 148 | | | 129 | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Property and equipment, net | | $ | 1,908 | | | $ | 1,673 | | | |
NOTE 8. GOODWILL AND OTHER INTANGIBLES
Goodwill by reportable segment and activity for fiscal 2022 and 2021 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2020 | | Acquisitions | | Other(1) | | 2021 | | Acquisitions | | Other(1) | | 2022 |
Digital Media | | $ | 2,868 | | | $ | 865 | | | $ | (2) | | | $ | 3,731 | | | $ | 161 | | | $ | (3) | | | $ | 3,889 | |
Digital Experience | | 7,476 | | | 1,095 | | | (32) | | | 8,539 | | | — | | | (39) | | | 8,500 | |
Publishing and Advertising | | 398 | | | — | | | — | | | 398 | | | — | | | — | | | 398 | |
Goodwill | | $ | 10,742 | | | $ | 1,960 | | | $ | (34) | | | $ | 12,668 | | | $ | 161 | | | $ | (42) | | | $ | 12,787 | |
_________________________________________
(1)Amounts consist of foreign currency translation adjustments.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other intangibles, net, as of December 2, 2022 and December 3, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | 2022 | | 2021 |
| Gross Carrying Amount | | Accumulated Amortization | | Net | | Gross Carrying Amount | | Accumulated Amortization | | Net |
Customer contracts and relationships | $ | 1,204 | | | $ | (495) | | | $ | 709 | | | $ | 1,213 | | | $ | (379) | | | $ | 834 | |
Purchased technology | 1,060 | | | (530) | | | 530 | | | 1,053 | | | (344) | | | 709 | |
Trademarks | 375 | | | (172) | | | 203 | | | 376 | | | (128) | | | 248 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Other | 61 | | | (54) | | | 7 | | | 60 | | | (31) | | | 29 | |
Other intangibles, net | $ | 2,700 | | | $ | (1,251) | | | $ | 1,449 | | | $ | 2,702 | | | $ | (882) | | | $ | 1,820 | |
Amortization expense related to other intangibles was $405 million, $354 million and $367 million for fiscal 2022, 2021 and 2020 respectively. Of these amounts, $236 million, $181 million and $205 million were included in cost of sales for fiscal 2022, 2021 and 2020 respectively.
Other intangibles are amortized over their estimated useful lives of 2 to 14 years. As of December 2, 2022, the estimated aggregate amortization expense for each of the five succeeding fiscal years was as follows:
| | | | | | | | |
(in millions) | | |
Fiscal Year | | Other Intangibles (1) |
2023 | | $ | 376 | |
2024 | | 331 | |
2025 | | 295 | |
2026 | | 142 | |
2027 | | 104 | |
Thereafter | | 182 | |
Total expected amortization expense | | $ | 1,430 | |
_________________________________________
(1)Excludes capitalized in-process research and development which is considered indefinite lived until the completion or abandonment of the associated research and development efforts.
NOTE 9. ACCRUED EXPENSES
Accrued expenses as of December 2, 2022 and December 3, 2021 consisted of the following:
| | | | | | | | | | | |
(in millions) | 2022 | | 2021 |
Accrued bonuses | $ | 489 | | | $ | 455 | |
Accrued compensation and benefits | 485 | | | 490 | |
Accrued corporate marketing | 154 | | | 96 | |
Taxes payable | 117 | | | 119 | |
Refund liabilities | 106 | | | 128 | |
| | | |
| | | |
| | | |
| | | |
| | | |
Other | 439 | | | 448 | |
Accrued expenses | $ | 1,790 | | | $ | 1,736 | |
Other primarily includes general accruals for local and regional expenses, derivative collateral liabilities and royalties payable.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 10. INCOME TAXES
Income before income taxes for fiscal 2022, 2021 and 2020 consisted of the following:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Domestic | | $ | 1,958 | | | $ | 1,736 | | | $ | 1,090 | |
Foreign | | 4,050 | | | 3,969 | | | 3,086 | |
Income before income taxes | | $ | 6,008 | | | $ | 5,705 | | | $ | 4,176 | |
The provision for (benefit from) income taxes for fiscal 2022, 2021 and 2020 consisted of the following:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Current: | | | | | | |
United States federal | | $ | 465 | | | $ | 391 | | | $ | 119 | |
Foreign | | 329 | | | 197 | | | 222 | |
State and local | | 132 | | | 103 | | | 79 | |
Total current | | 926 | | | 691 | | | 420 | |
Deferred: | | | | | | |
United States federal | | (45) | | | (148) | | | (123) | |
Foreign | | 360 | | | 359 | | | (1,313) | |
State and local | | 11 | | | (19) | | | (68) | |
Total deferred | | 326 | | | 192 | | | (1,504) | |
| | | | | | |
Provision for (benefit from) income taxes | | $ | 1,252 | | | $ | 883 | | | $ | (1,084) | |
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 totaling $1.35 billion, based on the fair value of the IP rights transferred. 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 is recognized over the period of economic benefit.
Reconciliation of Provision for (Benefit from) Income Taxes
Total income tax expense differed from the income tax expense computed at the U.S. federal statutory rate of 21% as a result of the following:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Tax expense computed at U.S. federal statutory rate | | $ | 1,262 | | | $ | 1,198 | | | $ | 877 | |
Tax credits | | (116) | | | (149) | | | (101) | |
| | | | | | |
Tax settlements | | (14) | | | (58) | | | (23) | |
Effects of non-U.S. operations | | (7) | | | (23) | | | (337) | |
State tax expense, net of federal benefit | | 113 | | | 66 | | | 10 | |
| | | | | | |
| | | | | | |
Other | | 14 | | | 6 | | | 4 | |
Stock-based compensation | | — | | | (157) | | | (154) | |
Impacts of intra-entity IP transfers | | — | | | — | | | (1,360) | |
Provision for (benefit from) income taxes | | $ | 1,252 | | | $ | 883 | | | $ | (1,084) | |
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 December 2, 2022 and December 3, 2021 were as follows:
| | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 |
Deferred tax assets: | | | | |
Intangible assets | | $ | 653 | | | $ | 997 | |
Capitalized expenses | | 298 | | | 355 | |
Credit carryforwards | | 333 | | | 287 | |
Operating lease liabilities | | 104 | | | 122 | |
Net operating loss carryforwards of acquired companies | | 88 | | | 131 | |
Stock-based compensation | | 108 | | | 91 | |
Reserves and accruals | | 98 | | | 89 | |
Benefits relating to tax positions | | 56 | | | 39 | |
Other | | 41 | | | 34 | |
Total gross deferred tax assets | | 1,779 | | | 2,145 | |
Valuation allowance | | (402) | | | (335) | |
Total deferred tax assets | | 1,377 | | | 1,810 | |
Deferred tax liabilities: | | | | |
Acquired intangible assets | | 354 | | | 447 | |
Operating lease right-of-use assets | | 97 | | | 111 | |
Prepaid expenses | | 110 | | | 123 | |
Depreciation and amortization | | 67 | | | 49 | |
| | | | |
Total deferred tax liabilities | | 628 | | | 730 | |
Net deferred tax assets | | $ | 749 | | | $ | 1,080 | |
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 loss and tax credit carryforwards.
As of December 2, 2022, we had federal and state net operating loss carryforwards of approximately $202 million and $467 million, respectively. We also had federal and state tax credit carryforwards of approximately $39 million and $362 million, respectively. The majority of the federal net operating loss and state tax credit carryforwards can be carried forward indefinitely, and the remaining will expire in various years from fiscal 2023 through 2040. Certain net operating loss and tax credit carryforwards are subject to an annual limitation and/or are reduced by a valuation allowance. The net carrying amount of such assets is expected to be fully realized.
In assessing the realizability of deferred tax assets, management determined that it is more likely than not that we will not fully realize certain available tax attributes and other tax assets in domestic and foreign jurisdictions. 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. As of December 2, 2022, we continue to maintain a valuation allowance of $402 million primarily related to certain state credits. For fiscal 2022, the increase in the valuation allowance was $67 million.
As we repatriate foreign earnings for use in the United States, the distributions will generally be exempt from federal income taxes. As of December 2, 2022, the cumulative amount of foreign earnings considered permanently reinvested upon which taxes have not been provided, and the corresponding unrecognized deferred tax liability, was not material.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Accounting for Uncertainty in Income Taxes
During fiscal 2022 and 2021, the aggregate changes in our total gross amount of unrecognized tax benefits were as follows:
| | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 |
Beginning balance | | $ | 289 | | | $ | 201 | |
Gross increases in unrecognized tax benefits – prior year tax positions | | 20 | | | 30 | |
Gross decreases in unrecognized tax benefits – prior year tax positions | | (18) | | | — | |
Gross increases in unrecognized tax benefits – current year tax positions | | 53 | | | 86 | |
| | | | |
Lapse of statute of limitations | | (4) | | | (21) | |
Tax settlements | | (18) | | | (4) | |
Foreign exchange gains and losses | | (1) | | | (3) | |
Ending balance | | $ | 321 | | | $ | 289 | |
Our policy is to record interest and penalties related to uncertain tax positions within the provision for (benefit from) income taxes. The combined amount of accrued interest and penalties included in long-term income taxes payable related to tax positions taken on our tax returns were approximately $17 million and $22 million for fiscal 2022 and 2021, respectively.
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 examination of our income tax returns by various domestic and foreign tax authorities with 2018 being the earliest fiscal year open for examination in all of our major tax jurisdictions. 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 our tax 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 financial position and results of operations.
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. Although the timing of resolution, settlement and closing of audits is not certain, it is reasonably possible that the underlying unrecognized tax benefits may decrease by up to $25 million over the next 12 months.
NOTE 11. BENEFIT PLANS
Retirement Savings Plan
The Adobe Inc. 401(k) Retirement Savings Plan, qualified under Section 401(k) of the Internal Revenue Code, is a retirement savings plan covering substantially all of our U.S. employees. 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 2022, we matched 50% of the first 6% of the employee’s eligible compensation. We contributed $76 million, $64 million and $59 million in fiscal 2022, 2021 and 2020, respectively. We are under no obligation to continue matching future employee contributions and, at our discretion, may change our practices at any time.
Deferred Compensation Plan
The Adobe Inc. 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, with respect to equity awards, vests. Members of the Board of Directors are also eligible to participate 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 equity awards. For cash benefit elections, distributions are made in
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
cash in the form of a lump sum, or five, ten, or fifteen-year annual installments. For equity award elections, distributions are made in stock in the form of a lump sum payment only.
Certain deferred compensation is invested in money market and other mutual funds and subsequently recorded as other assets on our Consolidated Balance Sheets, with corresponding unrealized holding gains and losses recorded as investment gains (losses) in our Consolidated Statements of Income. Undistributed deferred compensation is recorded as long-term liabilities on our Consolidated Balance Sheets.
As of December 2, 2022 and December 3, 2021, the invested amounts under the plan totaled $160 million and $151 million, respectively. As of December 2, 2022 and December 3, 2021, undistributed deferred compensation due to participants totaled $178 million and $174 million, respectively.
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 share 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 (the “ECC”).
As of December 2, 2022, we had reserved 52.0 million shares of our common stock for issuance under our 2019 Plan and had 30.5 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 our ability to attract and retain highly talented and competent individuals. The ECC approves the terms of each of our Performance Share Programs, including the award calculation methodology.
In January 2022, the ECC approved the 2022 Performance Share Program. Shares outstanding under our 2022 Performance Share Program may be earned based on the achievement of (i) an objective relative total stockholder return measured over a three-year performance period, as well as (ii) revenue-based financial metrics measured over three one-year performance periods. Each type of performance goal is weighted 50% and achievement of each performance goal is determined independently of the other. Shares associated with each performance goal are not awarded until the corresponding performance targets are defined.
Shares outstanding under our 2021 and 2020 Performance Share Programs may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period.
Performance share awards in each of our 2022, 2021 and 2020 Performance Share Programs will be earned and cliff-vest upon the later of (i) the three-year anniversary of the earliest vesting commencement date in the respective Performance Share Program, or (ii) the ECC's certification of the level of achievement of the final performance period in the respective Performance Share Program, contingent upon the participant’s continued service. Participants can earn between 0% and 200% of the target number of performance shares.
As of December 2, 2022, the shares awarded under our 2022, 2021 and 2020 Performance Share Programs remained outstanding and were yet to be earned.
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
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
common stock at either the beginning of the offering period or the end of the purchase period, whichever price is lower. If the market value of our common stock at the end of a purchase period is lower than the market value at the beginning of the offering period, participants are rolled over into the subsequent offering, resulting in a reset of the offering price and the twenty-four month offering period.
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.
As of December 2, 2022, we had reserved 103.0 million shares of our common stock for issuance under the ESPP and approximately 10.7 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 restricted stock units are valued based on the fair market value of the award on the grant date. Our performance share awards which are contingent upon achievement of relative total stockholder return are valued using a Monte Carlo Simulation model. Our performance share awards which are contingent upon achievement of revenue-based financial metrics are valued based on the fair market value of the award on the grant date.
We use the Black-Scholes option pricing model to determine the fair value of ESPP purchase rights. The determination of the grant date fair value of our ESPP purchase rights 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 2022 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 | 6.6 | | | $ | 411.52 | | | | | |
Awarded | 4.5 | | | $ | 457.96 | | | | | |
Released | (3.0) | | | $ | 381.22 | | | | | |
Forfeited | (0.7) | | | $ | 441.41 | | | | | |
| | | | | | | |
Ending outstanding balance | 7.4 | | | $ | 449.94 | | | $ | 2,511 | | | 1.33 |
| | | | | | | |
Expected to vest | 6.7 | | | $ | 449.35 | | | $ | 2,287 | | | 1.26 |
_________________________________________
(1) The aggregate fair value is calculated using the closing stock price as of December 2, 2022 of $341.53.
The weighted average grant date fair values of restricted stock units granted during fiscal 2022, 2021 and 2020 were $457.96, $504.69 and $358.68, respectively. The total fair value of restricted stock units vested during fiscal 2022, 2021 and 2020 was $1.30 billion, $1.83 billion and $1.61 billion, respectively.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Summary of Performance Shares
Performance share activity for fiscal 2022 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 | 0.6 | | | $ | 408.84 | | | | | |
Awarded | 0.3 | | | $ | 402.24 | | | | | |
Released | (0.4) | | | $ | 291.15 | | | | | |
Forfeited | (0.1) | | | $ | 490.50 | | | | | |
Ending outstanding balance | 0.4 | | | $ | 495.23 | | | $ | 146 | | | 1.02 |
| | | | | | | |
Expected to vest | 0.4 | | | $ | 494.38 | | | $ | 136 | | | 0.98 |
_________________________________________
(1) The aggregate fair value is calculated using the closing stock price as of December 2, 2022 of $341.53.
Shares awarded during fiscal 2022 include 0.2 million additional shares awarded for the final achievement of the 2019 Performance Share Program which was certified in the first quarter of fiscal 2022. The remaining awarded shares were for the 2022 Performance Share Program. Shares released during fiscal 2022 resulted from 168% achievement of target for the 2019 Performance Share Program.
The weighted average grant date fair values of performance share awards granted during fiscal 2022, 2021 and 2020 were $402.24, $325.24 and $271.62, respectively. The total fair value of performance share awards vested during fiscal 2022, 2021 and 2020 was $192 million, $212 million and $273 million, respectively.
Summary of Employee Stock Purchase Plan Shares
Employees purchased 0.8 million shares at an average price of $333.92, 1.0 million shares at an average price of $294.15, and 1.2 million shares at an average price of $218.37 for fiscal 2022, 2021 and 2020, respectively. The intrinsic value of shares purchased during fiscal 2022, 2021 and 2020 was $73 million, $256 million and $216 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.
During fiscal 2022, the rollover provision of our ESPP was triggered and resulted in incremental expense to be recognized over the new twenty-four-month offering period, which did not have a material impact on our Consolidated Statements of Income.
Compensation Costs
We recognize the estimated compensation costs 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.
Compensation costs for our performance share awards which are contingent upon achievement of relative total stockholder return are recognized, net of estimated forfeitures, on a straight-line basis over the requisite performance period or service period of the entire award, whichever is longer. Compensation costs for our performance share awards which are contingent upon achievement of revenue-based financial metrics are recognized, net of estimated forfeitures, based upon the expected levels of achievement, which are assessed periodically until certification by the ECC.
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.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 2, 2022, there was $2.83 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 2.29 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.
Total stock-based compensation costs included in our Consolidated Statements of Income for fiscal 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Cost of revenue | $ | 97 | | | $ | 70 | | | $ | 61 | |
Research and development | 726 | | | 549 | | | 467 | |
Sales and marketing | 417 | | | 307 | | | 261 | |
General and administrative | 200 | | | 164 | | | 120 | |
Total (1) | $ | 1,440 | | | $ | 1,090 | | | $ | 909 | |
_________________________________________
(1)During fiscal 2022, 2021 and 2020, we recorded tax benefits related to stock-based compensation costs of $291 million, $395 million and $352 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 2022 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | December 3, 2021 | | Increase / Decrease | | Reclassification Adjustments | | December 2, 2022 |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Net unrealized gains / losses on available-for-sale securities | $ | (2) | | | $ | (39) | | | $ | — | | (1) | $ | (41) | |
Net unrealized gains / losses on derivative instruments designated as hedging instruments | 29 | | | 139 | | | (151) | | (2) | 17 | |
Cumulative foreign currency translation adjustments | (164) | | | (105) | | | — | | | (269) | |
Total accumulated other comprehensive income (loss), net of taxes | $ | (137) | | | $ | (5) | | | $ | (151) | | | $ | (293) | |
_________________________________________
(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 our shares in the open market or enter into structured repurchase agreements with third parties. In December 2020, our Board of Directors granted additional authority to repurchase up to $15 billion in common stock through the end of fiscal 2024.
During fiscal 2022, we entered into an accelerated share repurchase agreement (“ASR”) with a large financial institution whereupon we provided them with a prepayment of $2.4 billion. Under the terms of the ASR, the financial institution agreed to deliver a portion of shares to us at contract inception and the remaining shares at settlement, which occurred in fiscal 2022. The total number of shares delivered and average purchase price paid per share were determined upon settlement based on the Volume Weighted Average Price (“VWAP”) over the term of the ASR, less an agreed upon discount.
During fiscal 2022, 2021 and 2020, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $4.15 billion, $3.95 billion and $3.05 billion, respectively. Under the terms of these structured stock repurchase agreements, the financial institutions agreed to deliver shares to us at monthly intervals during the respective contract terms, and the number of shares delivered each month was determined based
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
on the total notional amount of the contracts, the number of trading days in the intervals and the VWAP of our stock during the intervals less an agreed upon discount.
We enter into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the 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.
During fiscal 2022, we repurchased a total of 15.7 million shares, including approximately 10.4 million shares at an average price of $375.03 through structured repurchase agreements, as well as 5.3 million shares at an average purchase price of $451.55 through the ASR described above. Comparatively, we repurchased approximately 7.2 million shares at an average price of $536.17 per share in fiscal 2021 and 8.0 million shares at an average price of $376.38 per share in fiscal 2020.
For fiscal 2022, 2021 and 2020, the prepayments were classified as treasury stock on our Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by December 2, 2022, December 3, 2021 and November 27, 2020 were excluded from the computation of earnings per share. As of December 2, 2022, $583 million of prepayment remained under our outstanding structured stock repurchase agreement.
Subsequent to December 2, 2022, as part of the December 2020 stock repurchase authority, we entered into an accelerated share repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $1.4 billion and received an initial delivery of 3.2 million shares, which represents approximately 75% of our prepayment. Upon completion of the $1.4 billion accelerated share repurchase agreement, $5.15 billion remains under our December 2020 authority.
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 and performance share awards using the treasury stock method. Performance share awards are included based on the number of shares that would be issued as if the end of the reporting period was the end of the performance period and the result was dilutive.
The following table sets forth the computation of basic and diluted net income per share for fiscal 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | |
(in millions, except per share data) | | 2022 | | 2021 | | 2020 |
Net income | | $ | 4,756 | | | $ | 4,822 | | | $ | 5,260 | |
| | | | | | |
Shares used to compute basic net income per share | | 469.5 | | | 477.3 | | | 480.9 | |
Dilutive potential common shares from stock plans and programs | | 1.4 | | | 3.7 | | | 4.6 | |
Shares used to compute diluted net income per share | | 470.9 | | | 481.0 | | | 485.5 | |
| | | | | | |
Basic net income per share | | $ | 10.13 | | | $ | 10.10 | | | $ | 10.94 | |
Diluted net income per share | | $ | 10.10 | | | $ | 10.02 | | | $ | 10.83 | |
| | | | | | |
Anti-dilutive potential common shares | | 4.2 | | | 0.2 | | | 0.5 | |
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 December 2, 2022, primarily relating to contracts with vendors for third-party hosting and data center services:
| | | | | | | | | | | | |
(in millions) | | | | | | |
Fiscal Year | | Purchase Obligations | | | | |
2023 | | $ | 1,632 | | | | | |
2024 | | 921 | | | | | |
2025 | | 775 | | | | | |
2026 | | 753 | | | | | |
2027 | | 783 | | | | | |
Thereafter | | 1,226 | | | | | |
Total | | $ | 6,090 | | | | | |
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 in our cost of revenue on our Consolidated Statements of Income, was approximately $228 million, $202 million and $176 million in fiscal 2022, 2021 and 2020, 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.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In addition to intellectual property disputes, we are subject to legal proceedings, claims, including claims relating to commercial, employment and other matters, and investigations, including government investigations. Some of these disputes, legal proceedings and investigations 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, results of operations or cash flows 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, results of operations or cash flows 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 December 2, 2022 and December 3, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in millions) | Issuance Date | | Due Date | | Effective Interest Rate | | 2022 | | 2021 |
1.70% 2023 Notes | February 2020 | | February 2023 | | 1.92% | | $ | 500 | | | $ | 500 | |
1.90% 2025 Notes | February 2020 | | February 2025 | | 2.07% | | 500 | | | 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 | | | 850 | |
2.30% 2030 Notes | February 2020 | | February 2030 | | 2.69% | | 1,300 | | | 1,300 | |
Total debt outstanding, at par | | $ | 4,150 | | | $ | 4,150 | |
Less: Current portion of debt | | (500) | | | — | |
Unamortized discount and debt issuance costs | | (21) | | | (27) | |
Carrying value of long-term debt | | $ | 3,629 | | | $ | 4,123 | |
| | | | | | | | | |
| | | | |
| | | | |
Carrying value of current debt, net of unamortized discount and debt issuance costs | | $ | 500 | | | $ | — | |
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Senior Notes
In January 2015, we issued $1 billion of senior notes due February 1, 2025. The related discount and issuance costs are amortized to interest expense over the term of the notes using the effective interest method. Interest is payable semi-annually, in arrears on February 1 and August 1.
In February 2020, we issued $500 million of senior notes due February 1, 2023, $500 million of senior notes due February 1, 2025, $850 million of senior notes due February 1, 2027, and $1.30 billion of senior notes due February 1, 2030. Our total proceeds of approximately $3.14 billion, net of issuance discount, were used for general corporate purposes including repayment of debt instruments due in fiscal 2020. The related discount and issuance costs are amortized to interest expense over the respective terms of the notes using the effective interest method. Interest is payable semi-annually, in arrears on February 1 and August 1.
During the first quarter of fiscal 2022, we reclassified the senior notes due February 1, 2023 as current debt in our Consolidated Balance Sheets. As of December 2, 2022, the carrying value of our current debt was $500 million, net of the related discount and issuance costs. We intend to repay the current portion of our debt on or before the due date.
Our senior 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 date of repurchase. The notes do not contain financial covenants but include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances.
Revolving Credit Agreement
In June 2022, we entered into a credit agreement (“Revolving Credit Agreement”), providing for a five-year $1.5 billion senior unsecured revolving credit facility, which replaced our previous five-year $1 billion senior unsecured revolving credit agreement entered into in October 2018 (the “Prior Revolving Credit Agreement”). 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 $2 billion. At our election, loans under the Revolving Credit Agreement will bear interest at either the (i) term Secured Overnight Financing Rate (“SOFR”), plus a margin, (ii) adjusted daily SOFR rate, plus a margin, (iii) alternative currency rate, plus a margin, or (iv) base rate, which is defined as the highest of (a) the federal funds rate plus 0.500%, (b) the agent’s prime rate, or (c) term SOFR plus 1.00%. The margin for term SOFR, adjusted daily SOFR, and alternative currency rate loans is based on our debt ratings, and ranges from 0.460% to 0.900%. 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 0.10% 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 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 transactions, dispositions and other matters, all subject to certain exceptions.
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 December 2, 2022, there were no outstanding borrowings under this Revolving Credit Agreement.
In connection with and at the time that we entered into the Revolving Credit Agreement, the Prior Revolving Credit Agreement originally scheduled to expire in October 2023 was terminated. There were no outstanding borrowings or letters of credit issued under the Prior Revolving Credit Agreement at the time of termination. There were no penalties paid as a result of the termination of the Prior Revolving Credit Agreement.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 18. LEASES
We lease certain facilities and data centers under non-cancellable operating lease arrangements that expire at various dates through 2032. We also have one land lease that expires in 2091. Our lease agreements do not contain any material residual value guarantees, material variable payment provisions or material restrictive covenants.
Operating lease expense was $121 million for fiscal 2022 and $119 million for both fiscal 2021 and 2020. We recognized operating lease expense in cost of revenue and operating expenses in our Consolidated Statements of Income. Our operating lease expense includes variable lease costs and is net of sublease income, both of which are not material.
Supplemental cash flow information for fiscal 2022, 2021 and 2020 related to operating leases was as follows:
| | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2022 | | 2021 | | 2020 |
Cash paid for amounts included in the measurement of operating lease liabilities | $ | 107 | | | $ | 116 | | | $ | 99 | |
Right-of-use assets obtained in exchange for operating lease liabilities | $ | 59 | | | $ | 60 | | | $ | 52 | |
The weighted-average remaining lease term and weighted-average discount rate for our operating lease liabilities as of December 2, 2022 were 7 years and 2.37%, respectively.
As of December 2, 2022, the maturities of lease liabilities under operating leases were as follows:
| | | | | | | | |
(in millions) | | |
Fiscal Year | Operating Leases (1) |
2023 | $ | 95 | |
2024 | 78 | |
2025 | 74 | |
2026 | 67 | |
2027 | 67 | |
Thereafter | 167 | |
Total lease liabilities | $ | 548 | |
Less: Imputed interest | 44 | |
Present value of lease liabilities | $ | 504 | |
_________________________________________
(1) Legally binding minimum lease payments for leases signed but not yet commenced as of December 2, 2022 were not material.
ADOBE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. NON-OPERATING INCOME (EXPENSE)
Non-operating income (expense) for fiscal 2022, 2021 and 2020 included the following:
| | | | | | | | | | | | | | | | | |
(in millions) | 2022 | | 2021 | | 2020 |
Interest expense | $ | (112) | | | $ | (113) | | | $ | (116) | |
Investment gains (losses), net: | | | | | |
Realized investment gains | $ | 11 | | | $ | 9 | | | $ | 5 | |
| | | | | |
Realized investment losses | (1) | | | — | | | (1) | |
| | | | | |
Unrealized investment gains (losses), net | (29) | | | 7 | | | 9 | |
Investment gains (losses), net | $ | (19) | | | $ | 16 | | | $ | 13 | |
Other income (expense), net: | | | | | |
Interest income | $ | 61 | | | $ | 17 | | | $ | 43 | |
Foreign exchange gains (losses) | (21) | | | (17) | | | (2) | |
| | | | | |
| | | | | |
Other | 1 | | | — | | | 1 | |
Other income (expense), net | $ | 41 | | | $ | — | | | $ | 42 | |
Non-operating income (expense), net | $ | (90) | | | $ | (97) | | | $ | (61) | |
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 December 2, 2022 and December 3, 2021, 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 December 2, 2022, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 2, 2022, 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 December 2, 2022 and December 3, 2021, and the results of its operations and its cash flows for each of the fiscal years in the three fiscal year period ended December 2, 2022, 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 December 2, 2022 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
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 Control 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 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 Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates 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 a critical audit matter 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 matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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 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.
/s/ KPMG LLP
We have served as the Company’s auditor since 1983.
Santa Clara, California
January 17, 2023