ADOBE INC. 
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto. In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth, market opportunities, strategic initiatives, industry positioning, customer acquisition, the amount of recurring revenue, revenue growth and the anticipated impact on our business of the COVID-19 pandemic and related public health measures. In addition, when used in this report, the words "will," "expects," "could," "would," "may," "anticipates," "intends," "plans," "believes," "seeks," "targets," "estimates," "looks for," "looks to," "continues" and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Each of the forward-looking statements we make in this report involves risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Risk Factors" in Part II, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with theU.S. Securities and Exchange Commission ("SEC"), including our Annual Report on Form 10-K for fiscal 2019. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document, except as required by law. BUSINESS OVERVIEW Founded in 1982,Adobe Inc. is one of the largest and most diversified software companies in the world. We offer a line of products and services used by creative professionals, marketers, knowledge workers, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing and engaging with compelling content and experiences across personal computers, devices and media. We market our products and services directly to enterprise customers through our sales force and certain 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 personal and server-based computers, as well as on smartphones, tablets and other devices, depending on the product. We have operations in theAmericas ,Europe ,Middle East andAfrica ("EMEA") andAsia-Pacific ("APAC"). Adobe was originally incorporated inCalifornia inOctober 1983 and was reincorporated inDelaware inMay 1997 . Our executive offices and principal facilities are located at345 Park Avenue ,San Jose, California 95110-2704. Our telephone number is 408-536-6000 and our website is www.adobe.com. Investors can obtain copies of ourSEC filings from this site free of charge, as well as from theSEC website at www.sec.gov. The information posted to our website is not incorporated into this Quarterly Report on Form 10-Q. OPERATIONS OVERVIEW For our third quarter of fiscal 2020, we experienced strong demand across our Digital Media offerings consistent with the continued execution of our long-term plans with respect to this segment. In our Digital Experience segment, we continued to experience growth in software-based subscription revenue across our portfolio of offerings. In addition, we continued to wind down our transaction-driven Advertising Cloud offerings during the third quarter of fiscal 2020, which, as expected, continued to negatively impact Digital Experience revenue growth during the quarter. 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 and immersive content. 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' machines, 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. 32 -------------------------------------------------------------------------------- Table of Contents 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 acquiring new users as a result of low cost of entry and delivery of additional features and value to Creative Cloud, as well as keeping existing customers current on our latest release. 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 will 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 and mobile applications, as well as targeted promotions and offers that attract past customers and potential users to try out 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 Adobe Document Cloud offerings built around our Adobe Acrobat family of products, including Adobe Acrobat Reader DC, and a set of integrated mobile apps and cloud-based document services, including Adobe Scan and Adobe Sign. Acrobat provides reliable creation and exchange of electronic documents, regardless of platform or application source type. Document Cloud, which we believe enhances the way people manage critical documents at home, in the office and across devices, includes Adobe Acrobat DC and Adobe Sign, and a set of integrated services enabling users to create, review, approve, sign and track documents whether on a desktop or mobile device. Adobe Acrobat DC is offered both through subscription and perpetual licenses. 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, unbilled backlog and remaining performance obligation 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 material exchange rates 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. We calculate ARR as follows: Annual Value of Creative Cloud Subscriptions and Services Creative ARR + Annual Creative ETLA Contract Value Annual Value of Document Cloud Subscriptions and Services Document Cloud ARR + Annual Document Cloud ETLA Contract Value Creative ARR Digital Media ARR + Document Cloud ARR Creative ARR exiting the third quarter of fiscal 2020 was$8.29 billion , up from$7.25 billion at the end of fiscal 2019. Document Cloud ARR exiting the third quarter of fiscal 2020 was$1.34 billion , up from$1.08 billion at the end of fiscal 2019. Total Digital Media ARR grew to$9.63 billion at the end of the third quarter of fiscal 2020, up from$8.33 billion at the end of fiscal 2019. Our success in driving growth in ARR has positively affected our revenue growth. Creative revenue in the third quarter of fiscal 2020 was$1.96 billion , up from$1.65 billion in the third quarter of fiscal 2019, representing 19% year-over-year growth. Document Cloud revenue in the third quarter of fiscal 2020 was$375 million , up from$307 million in the third quarter of fiscal 2019, representing 22% year-over-year growth and reflecting an increase in demand driven by the shift to remote work as well as our continued efforts to transition Document Cloud to a subscription-based model. Total Digital Media segment revenue grew to$2.34 billion in the third quarter of fiscal 2020, up from$1.96 billion in the third quarter of fiscal 2019, representing 19% year-over-year growth. These increases were driven by strong net new user growth, including those resulting from the current work-from-home environment reflecting expanded digital engagement. 33 -------------------------------------------------------------------------------- Table of Contents 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 shoppable experiences and deliver intelligence for businesses of any size in any industry. Our differentiation and competitive advantage is strengthened by our ability to use the Adobe Experience Platform to connect our comprehensive set of solutions. Adobe Experience Cloud is focused on delivering solutions for our enterprise customers across the following strategic growth pillars: •Data and insights. Our solutions deliver real-time customer profiles and intelligence across the customer journey. Our offerings include Adobe Analytics, Adobe Audience Manager, Adobe Experience Platform, Customer Journey Analytics and Real-time Customer Data Platform. •Content and commerce. We offer solutions to help customers manage, deliver, test, target and optimize content delivery and enable shopping experiences that scale from mid-market to enterprise businesses. Our offerings include Adobe Experience Manager, Adobe Target and Magento Commerce. •Customer journey management. Our solutions help businesses manage, personalize and orchestrate campaigns and customer journeys across B2E use cases. Our offerings include Adobe Campaign, Marketo Engage and Journey Orchestration. During the second quarter of fiscal 2020, we began to discontinue our transaction-driven Advertising Cloud offerings, allowing us to focus our investment on strategic growth initiatives. We continue to offer our Advertising Cloud software solutions, but they are not expected to be areas of revenue growth. 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$838 million in the third quarter of fiscal 2020, up from$821 million in the third quarter of fiscal 2019, representing 2% year-over-year growth. Driving this slight increase was the increase in subscription revenue, which grew to$729 million in the third quarter of fiscal 2020 from$679 million in the third quarter of fiscal 2019, representing 7% year-over-year growth. Excluding Advertising Cloud, Digital Experience subscription revenue grew 14% year-over-year. We continue to wind down our transaction-driven Advertising Cloud offerings which we expect to continue to negatively impact revenue growth and result in reductions in the related cost of revenue and improved Digital Experience gross margin percentage. COVID-19 UPDATE InMarch 2020 , theWorld Health Organization declared the outbreak of a disease caused by a novel strain of the coronavirus (COVID-19) to be a pandemic. This global pandemic has had widespread, rapidly-evolving and unpredictable impacts on global societies, economies, financial markets and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including physical distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes and closure of non-essential businesses. Our focus remains on promoting employee health and safety, serving our customers and ensuring business continuity. As a result, we have taken action to direct our teams to work from home, suspend travel and replace in-person events such as Adobe Summit and MAX, with digital events throughJune 2021 . The broader implications of the pandemic on our results of operations and overall financial performance remain uncertain. The pandemic and its adverse effects have become more prevalent in the locations where we, our customers, suppliers or third-party business partners conduct business and as a result, we are experiencing more pronounced disruptions in our operations. We have experienced and may continue to experience constrained supply or curtailed customer demand that could materially adversely impact our business, results of operations and overall financial performance in future periods. 34 -------------------------------------------------------------------------------- Table of Contents We continue to experience some impact from delays in enterprise transactions and consulting services implementations due to continued economic challenges with enterprise customers in certain verticals, as well as weakness in our commercial segment that targets small- and medium-sized businesses. In addition, the significant global decline in advertising spending and the wind-down of our transaction-based Advertising Cloud offerings has impacted our Advertising Cloud revenue. While our revenue and earnings are relatively predictable as a result of our subscription-based business model, the effect of the pandemic will not be fully reflected in our results of operations and overall financial performance until future periods. See Risk Factors for further discussion of the possible impact of the pandemic on our business. CRITICAL ACCOUNTING POLICIES AND ESTIMATES In preparing our condensed consolidated financial statements in accordance with accounting principles generally accepted inthe United States of America ("GAAP") and pursuant to the rules and regulations of theSEC , we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, business combinations and income taxes have the greatest potential impact on our condensed consolidated financial statements. These areas are key components of our results of operations and are based on complex rules 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. There have been no significant changes in our critical accounting policies and estimates during the nine months endedAugust 28, 2020 , as compared to the critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year endedNovember 29, 2019 . The pandemic has created and may continue to create significant uncertainty in the macroeconomic environment which, in addition to other unforeseen effects of this pandemic, may adversely impact our results of operations. As a result, most of our estimates and assumptions may require increased judgment and carry a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, our estimates may change materially in future periods.
Recent Accounting Pronouncements
See Note 1 of our notes to condensed consolidated financial statements for
information regarding recent accounting pronouncements that are of significance
or potential significance to us.
RESULTS OF OPERATIONS
Financial Performance Summary
•Total Digital Media ARR of approximately $9.63 billion as of August 28, 2020
increased by $1.30 billion , or 16%, from $8.33 billion as of November 29, 2019 .
The change in our Digital Media ARR is primarily due to new user adoption of our
Creative Cloud and Adobe Document Cloud offerings.
•Creative revenue during the three months ended August 28, 2020 of $1.96 billion
increased by $307 million , or 19%, compared to the year-ago period. Document
Cloud revenue during the three months ended August 28, 2020 of $375 million
increased by $68 million , or 22%, compared to the year-ago period. The increases
were primarily due to the increase in subscription revenue associated with our
Creative Cloud and Document Cloud offerings.
•Digital Experience revenue of $838 million during the three months ended
August 28, 2020 increased slightly by $17 million , or 2%, compared to the
year-ago period. The increase was primarily due to the increase in subscription
revenue across our offerings, offset in part by decreases in revenue associated
with our transaction-driven Advertising Cloud offerings which we began to
discontinue during the second quarter of fiscal 2020.
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•Remaining performance obligation of $10.34 billion as of August 28, 2020
increased by $518 million , or 5%, from $9.82 billion as of November 29, 2019
primarily due to increases in new contracts and renewals for our Digital Media
offerings.
•Cost of revenue of $427 million during the three months ended August 28, 2020
increased slightly by $11 million , or 3%, compared to the year-ago period
primarily due to increases in hosting services and data center costs, offset in
large part by decreases in Advertising Cloud media costs.
•Operating expenses of $1.73 billion during the three months ended August 28,
2020 increased by $165 million , or 11%, compared to the year-ago period
primarily due to increases in base compensation and related benefits costs and
stock-based compensation expense associated with headcount growth, as well as
increased marketing spend. These increases were offset in part by decreases in
travel-related expenses.
•Net income of $955 million during the three months ended August 28, 2020
increased by $162 million , or 20%, compared to the year-ago period primarily due
to increases in revenue, offset in part by increases in operating expenses.
•Net cash flows from operations of $3.95 billion during the nine months ended
August 28, 2020 increased by $900 million , or 30%, compared to the year-ago
period primarily due to higher net income adjusted for the net effect of
non-cash items.
Revenue for the Three and Nine Months Ended
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Subscription $ 3,000 $ 2,547 18 % $ 8,699 $ 7,308 19 %
Percentage of total revenue 93 % 90 % 92 % 89 %
Product 109 157 (31) % 380 480 (21) %
Percentage of total revenue 3 % 6 % 4 % 6 %
Services and support 116 130 (11) % 365 391 (7) %
Percentage of total revenue 4 % 4 % 4 % 5 %
Total revenue $ 3,225 $ 2,834 14 % $ 9,444 $ 8,179 15 %
Subscription Revenue by Segment
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
our agreements with customers, beginning with commencement of service.
Subscription revenue related to certain offerings, where fees are based on a
number of transactions or impressions per month 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. Subscription revenue by reportable segment for the three and nine
months ended August 28, 2020 and August 30, 2019 is as follows:
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Digital Media $ 2,240 $ 1,841 22 % $ 6,433 $ 5,278 22 %
Digital Experience 729 679 7 % 2,175 1,945 12 %
Publishing 31 27 15 % 91 85 7 %
Total subscription revenue $ 3,000 $ 2,547 18 % $ 8,699 $ 7,308 19 %
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.
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Our services and support revenue is comprised of consulting, training and
maintenance and support, primarily related to the licensing of our enterprise
offerings. Our support revenue also includes technical support and developer
support to partners and developer organizations related to our desktop products.
We typically sell our consulting contracts on a time-and-materials and fixed fee
basis. These revenues are recognized as the services are performed for time and
materials contracts and on a relative performance basis for fixed fee contracts.
Training revenues are recognized as the services are performed. Our maintenance
and support offerings, which entitle customers to receive desktop product
upgrades and enhancements or technical support, depending on the offering, are
generally recognized ratably over the term of the arrangement as we satisfy the
performance obligations to our customers.
Segment Information
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Digital Media $ 2,337 $ 1,962 19 % $ 6,738 $ 5,629 20 %
Percentage of total revenue 72 % 69 % 71 % 69 %
Digital Experience 838 821 2 % 2,522 2,348 7 %
Percentage of total revenue 26 % 29 % 27 % 29 %
Publishing 50 51 (2) % 184 202 (9) %
Percentage of total revenue 2 % 2 % 2 % 2 %
Total revenue $ 3,225 $ 2,834 14 % $ 9,444 $ 8,179 15 %
Digital Media
Revenue from Digital Media increased $375 million and $1.11 billion during the
three and nine months ended August 28, 2020 , as compared to the three and nine
months ended August 30, 2019 driven by increases in revenue associated with our
Creative and Document Cloud offerings due to increased demand and digital
engagement amid the work-from-home environment.
Revenue associated with our Creative offerings increased during the three and
nine months ended August 28, 2020 as compared to the year-ago periods primarily
due to increases in net new subscriptions across our Creative Cloud offerings.
Document Cloud revenue increased during the three and nine months ended
August 28, 2020 as compared to the year-ago periods primarily due to increases
in subscription revenue driven by strong adoption of our Document Cloud
offerings including Adobe Sign.
Digital Experience
Revenue from Digital Experience increased $17 million and $174 million during
the three and nine months ended August 28, 2020 , as compared to the three and
nine months ended August 30, 2019 primarily due to increases in subscription
revenue across our offerings. These subscription revenue increases were offset
in part by decreases in revenue associated with our transaction-driven
Advertising Cloud offerings which we began to discontinue during the second
quarter of fiscal 2020. We expect that the wind-down of these offerings will
negatively impact Digital Experience revenue growth.
Geographical Information
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Americas $ 1,873 $ 1,639 14 % $ 5,481 $ 4,748 15 %
Percentage of total revenue 58 % 58 % 58 % 58 %
EMEA 851 755 13 % 2,493 2,187 14 %
Percentage of total revenue 26 % 27 % 26 % 27 %
APAC 501 440 14 % 1,470 1,244 18 %
Percentage of total revenue 16 % 15 % 16 % 15 %
Total revenue $ 3,225 $ 2,834 14 % $ 9,444 $ 8,179 15 %
Overall revenue during the three and nine months ended
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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 the three and nine months ended
August 28, 2020 were impacts associated with foreign currency as shown below.
Our currency hedging program is used to mitigate a portion of the foreign
currency impact to revenue.
(in millions) Three Months Nine Months
Revenue impact: Increase/(Decrease)
Euro $ (5) $ (41)
British Pound (2) (9)
Japanese Yen 4 10
Australian Dollar (4) (19)
Brazilian Real (5) (9)
Other currencies (2) (10)
Total revenue impact (14) (78)
Hedging impact:
Euro - 11
Japanese Yen (1) -
Total hedging impact (1) 11
Total impact $ (15) $ (67)
During the three and nine months ended August 28, 2020 , the U.S. Dollar
primarily strengthened against EMEA currencies and the Australian Dollar as
compared to the three and nine months ended August 30, 2019 , which decreased
revenue in U.S. Dollar equivalents. For the nine months ended August 28, 2020 ,
the foreign currency impact to revenue was offset in part by hedging gains
primarily from our EMEA currencies hedging program.
Cost of Revenue for the Three and Nine Months Ended
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Subscription $ 328 $ 304 8 % $ 1,000 $ 888 13 %
Percentage of total revenue 10 % 11 % 11 % 11 %
Product 10 9 11 % 26 31 (16) %
Percentage of total revenue * * * *
Services and support 89 103 (14) % 268 302 (11) %
Percentage of total revenue 3 % 4 % 3 % 4 %
Total cost of revenue $ 427 $ 416 3 % $ 1,294 $ 1,221 6 %
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(*) Percentage is less than 1%.
Subscription
Cost of subscription revenue consists of third-party royalties and expenses
related to operating our network infrastructure, including depreciation expense,
data center costs, salaries and related expenses of network operations,
implementation, account management and technical support personnel, amortization
of certain intangible assets and allocated overhead. We enter into contracts
with third parties for hosting services and use of data center facilities. Our
data center costs largely consist of the amounts we pay to these third parties
for rack space, power and similar items. Cost of subscription revenue also
includes media costs related to impressions purchased from third-party ad
inventory sources. We began to discontinue our transaction-driven Advertising
Cloud offerings in the second quarter of fiscal 2020, which we expect will
result in reductions to media costs.
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Cost of subscription revenue increased during the three and nine months ended
August 28, 2020 as compared to the three and nine months ended August 30, 2019
due to the following:
Components of Components of
% Change 2020-2019 % Change 2020-2019
QTD YTD
Hosting services and data center costs 10 % 8 %
Base compensation and related benefits associated with headcount 3 2
Incentive compensation, cash and stock-based 1 3
Royalty costs - 2
Media costs (5) (2)
Various individually insignificant items (1) -
Total change 8 % 13 %
Product
Cost of product revenue is primarily comprised of third-party royalties,
amortization related to purchased intangibles and acquired rights to use
technology, excess and obsolete inventory, localization costs and the costs
associated with the manufacturing of our products.
Services and Support
Cost of services and support revenue is primarily comprised of employee-related
costs and other costs incurred to provide consulting services, training and
product support.
Cost of services and support revenue decreased during the three and nine months
ended August 28, 2020 as compared to the three and nine months ended August 30,
2019 primarily due to decreases in base compensation and related benefits
associated with headcount.
Operating Expenses for the Three and Nine Months Ended August 28, 2020 and
August 30, 2019
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Research and development $ 566 $ 490 16 % $ 1,630 $ 1,430 14 %
Percentage of total revenue 18 % 17 % 17 % 17 %
Sales and marketing 892 812 10 % 2,650 2,443 8 %
Percentage of total revenue 28 % 29 % 28 % 30 %
General and administrative 230 219 5 % 725 654 11 %
Percentage of total revenue 7 % 8 % 8 % 8 %
Amortization of intangibles 41 43 (5) % 123 133 (8) %
Percentage of total revenue 1 % 2 % 1 % 2 %
Total operating expenses $ 1,729 $ 1,564 11 % $ 5,128 $ 4,660 10 %
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Research and Development
Research and development expenses consist primarily of salary and benefit
expenses for software developers, contracted development efforts, third party
fees for hosting services, related facilities costs and expenses associated with
computer equipment used in software development.
Research and development expenses increased during the three and nine months
ended August 28, 2020 as compared to the three and nine months ended August 30,
2019 primarily due to the following:
Components of Components of
% Change 2020-2019 % Change 2020-2019
QTD YTD
Incentive compensation, cash and stock-based 13 % 11 %
Base compensation and related benefits associated with headcount 2 3
Various individually insignificant items 1 -
Total change 16 % 14 %
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 salary and benefit expenses,
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, public relations and other market development programs.
Sales and marketing expenses increased during the three and nine months ended
August 28, 2020 as compared to the three and nine months ended August 30, 2019
primarily due to the following:
Components of Components of
% Change 2020-2019 % Change 2020-2019
QTD YTDMarketing spend related to campaigns, events and overall marketing efforts
9 % 6 %
Incentive compensation, cash and stock-based 4 3
Base compensation and related benefits associated with headcount - 1
Transaction fees 3 2
Travel (4) (3)
Various individually insignificant items (2) (1)
Total change 10 % 8 %
General and Administrative
General and administrative expenses consist primarily of compensation and
benefit expenses, 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.
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General and administrative expenses increased during the three and nine months
ended August 28, 2020 as compared to the three and nine months ended August 30,
2019 primarily due to the following:
Components of Components of
% Change % Change
2020-2019 2020-2019
QTD YTD
Bad debt expense 6 % 5 %
Incentive compensation, cash and stock-based 6 4
Base compensation and related benefits associated with headcount
1 1
Charges related to cancellation of corporate events (7) 3
Travel (2) (2)
Charitable contributions 5 3
Various individually insignificant items (4) (3)
Total change 5 % 11 %
Bad debt expense increased during the three and nine months ended August 28,
2020 as compared to the three and nine months ended August 30, 2019 primarily
due to specific reserves for certain categories of customers that were more
impacted by the changes in the macroeconomic environment as a result of the
pandemic.
During the nine months ended August 28, 2020 , we recorded charges related to the
cancellation of our corporate events due to concerns over the pandemic. During
the three months ended August 28, 2020 , certain of these charges were reversed
as we successfully negotiated the right to apply certain commitments to other
events.
Amortization of Intangibles
Amortization expenses decreased during the three and nine months ended
August 28, 2020 as compared to the three and nine months ended August 30, 2019
primarily due to certain acquired intangible assets becoming fully amortized
during the current period.
Non-Operating Income (Expense), Net for the Three and Nine Months Ended
(dollars in millions) Three Months Nine Months
2020 2019 % Change 2020 2019 % Change
Interest expense $ (28) $ (40) (30) % $ (89) $ (121) (26) %
Percentage of total revenue (1) % (1) % (1) % (1) %
Investment gains (losses), net 10 4 ** 7 47 **
Percentage of total revenue * * * 1 %
Other income (expense), net 9 17 ** 39 24 **
Percentage of total revenue * 1 % * *
Total non-operating income
(expense), net $ (9) $ (19) ** $ (43) $ (50) **
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(*) Percentage is less than 1%. (**) Percentage is not meaningful. Interest Expense Interest expense represents interest associated with our debt instruments. Interest on our Notes is payable semi-annually, in arrears, onFebruary 1 andAugust 1 . Interest on our Term Loan, which was terminated in the first quarter of fiscal 2020, was payable periodically at the end of each interest period. Floating interest payments on the interest rate swaps, which matured in the first quarter of fiscal 2020, was paid monthly and the fixed-rate interest receivable on the swaps was received semi-annually concurrent with the Notes interest payments. Interest expense decreased during the three and nine months endedAugust 28, 2020 as compared to the three and nine months endedAugust 30, 2019 primarily due to lower average interest rates on our debt instruments that were refinanced in the first quarter of fiscal 2020. See Note 15 of our notes to condensed consolidated financial statements for further details regarding our debt instruments. 41 -------------------------------------------------------------------------------- Table of Contents Investment Gains (Losses), Net Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets which are classified as trading securities, and gains and losses associated with our direct and indirect investments in privately held companies. Investment gains (losses), net decreased during the nine months endedAugust 28, 2020 as compared to the nine months endedAugust 30, 2019 primarily due to the gain recognized upon our acquisition of the remaining interest in Allegorithmic inJanuary 2019 . 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), net decreased during the three months endedAugust 28, 2020 as compared to the three months endedAugust 30, 2019 primarily due to decreases in interest income driven by lower average interest rates. Other income (expense), net increased during the nine months endedAugust 28, 2020 as compared to the nine months endedAugust 30, 2019 primarily due to our change in methodology of accounting for foreign currency cash flow hedges. Effective in the third quarter of fiscal 2019, expenses associated with the option premiums, which were previously recorded in other income (expense), net, are recorded in accumulated other comprehensive income. Provision for (Benefit from) Income Taxes for the Three and Nine Months EndedAugust 28, 2020 andAugust 30, 2019 (dollars in millions) Three Months Nine Months 2020 2019 % Change 2020 2019 % Change Provision for (benefit from) income taxes$ 105 $ 42 150 %$ (31) $ 148 (121) % Percentage of total revenue 3 % 1 % - % 2 % Effective tax rate 10 % 5 % (1) % 7 % Our effective tax rate increased by approximately 5 percentage points for the three months endedAugust 28, 2020 , as compared to the three months endedAugust 30, 2019 , primarily due to certain tax benefits that we were entitled to upon filing and concluding examinations of our income tax returns in the three months endedAugust 30, 2019 . Our effective tax rate decreased by approximately 8 percentage points for the nine months endedAugust 28, 2020 , as compared to the nine months endedAugust 30, 2019 , primarily due to the tax benefit resulting from an intra-entity transfer of certain intellectual property rights ("IP rights"). Our effective tax rates for the three and nine months endedAugust 28, 2020 were lower than theU.S. federal statutory tax rate of 21% primarily due to a favorable geographic mix of earnings and tax benefits related to stock-based compensation. Our effective tax rate for the nine months endedAugust 28, 2020 also included a tax benefit for the intra-entity transfer of IP rights. InApril 2020 , we completed an intra-entity transfer of certain IP rights in order to better align the ownership of these rights with how our business operates. The transfer did not result in a taxable gain; however, our foreign subsidiary recognized a deferred tax asset for the book and tax basis difference of the transferred IP rights. As a result of this transaction, we recorded a deferred tax asset, net of valuation allowance, and related tax benefit of$224 million based on the fair value of the transferred IP rights. The tax-deductible amortization related to the transferred IP rights will be recognized over the period of economic benefit. Certain international provisions of theU.S. Tax Act, such as a tax on global intangible low-tax income, a base erosion and anti-abuse tax and a special tax deduction for foreign-derived intangible income, took effect in fiscal 2019. As theU.S. Treasury releases regulations that impact these provisions, we account for finalized regulations in the period of enactment. We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, we considered all available positive and negative evidence, including our past operating results, forecasted earnings, future taxable income and prudent and feasible tax planning strategies. 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$289 million as ofAugust 28, 2020 and is primarily attributable to certain state and foreign credits. 42 -------------------------------------------------------------------------------- Table of Contents We are aUnited States -based multinational company subject to tax in multipleU.S. and foreign tax jurisdictions. A significant portion of our foreign earnings for the current fiscal year were earned by our Irish subsidiaries. The currentU.S. tax law provides an exemption from federal income taxes for distributions from foreign subsidiaries made afterDecember 31, 2017 , including certain earnings that were not subject to the one-time transition or global intangible low-tax income tax. As we repatriate the undistributed foreign earnings for use in theU.S. , the distributions will generally not be subject to furtherU.S. federal tax. InJune 2020 ,California enacted legislation which includes a limitation on the utilization of research and development tax credits for a three-year period beginning in fiscal 2021. As we are still in the process of evaluating the legislation, the net impact of the legislation is uncertain but is anticipated to increase ourCalifornia tax and, consequently, adversely impact our effective tax rates for the three-year period beginning in fiscal 2021. During the fourth quarter of fiscal 2020, we anticipate making an additional change to our international trading structure, which is also aimed to better align our ownership of certain IP rights with how our business operates. Under the current rules, this change, if completed, will result in the recording of an additional discrete tax benefit in the fiscal 2020 effective income tax rate related to the transferred IP rights, which is deductible in future periods. The net impact of such change is uncertain but is anticipated to adversely affect our effective income tax rate and cash flows in years beyond fiscal 2020. However, we expect cash paid for income taxes will be at a lower effective rate than our effective income tax rate for the provision for income taxes due to the future deductions on the transferred IP rights. Accounting for Uncertainty in Income Taxes The gross liabilities for unrecognized tax benefits excluding interest and penalties were$169 million and$171 million as ofAugust 28, 2020 andAugust 30, 2019 , respectively. If the total unrecognized tax benefits atAugust 28, 2020 andAugust 30, 2019 were recognized in the future,$121 million and$112 million would decrease the respective effective tax rates. The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately$25 million and$23 million as ofAugust 28, 2020 andAugust 30, 2019 , 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. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from$0 to approximately$10 million over the next 12 months. In addition, in countries where we conduct business and in jurisdictions in which we are subject to tax, including those covered by governing bodies that enact tax laws applicable to us, such as theEuropean Commission of theEuropean Union , we are subject to potential changes in relevant tax, accounting and other laws, regulations and interpretations, including changes to tax laws applicable to corporate multinationals such as Adobe. These countries, other governmental bodies and intergovernmental economic organizations such as theOrganization for Economic Cooperation and Development , have or could make unprecedented assertions about how taxation is determined in their jurisdictions that are contrary to the way in which we have interpreted and historically applied the rules and regulations described above in such jurisdictions. In the current global tax policy environment, any changes in laws, regulations and interpretations related to these assertions could adversely affect our effective tax rates or result in other costs to us which could adversely affect our operations and financial results. Moreover, we are subject to the continual examination of our income tax returns by theU.S. Internal Revenue Service and other domestic and foreign tax authorities. These tax examinations are expected to focus on our intercompany transfer pricing practices, application of tax rules and other matters. 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 adjustments that may result from these examinations. We cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position. 43 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES This data should be read in conjunction with our condensed consolidated statements of cash flows. As of (in millions) August 28, 2020 November 29, 2019 Cash and cash equivalents $ 3,767 $ 2,650 Short-term investments $ 1,497 $ 1,527 Working capital $ 2,257 $ (1,696) Stockholders' equity $ 11,713 $ 10,530 Working Capital Working capital was$2.26 billion of a surplus as ofAugust 28, 2020 and$1.70 billion of a deficit as ofNovember 29, 2019 . During the first quarter of fiscal 2020, we refinanced our$2.25 billion term loan dueApril 30, 2020 ("Term Loan") and$900 million 4.75% senior notes dueFebruary 1, 2020 ("2020 Notes"). See the section titled "Cash Flows from Financing Activities" below. A summary of our cash flows is as follows: Nine Months Ended (in millions) August 28, 2020 August 30, 2019 Net cash provided by operating activities $ 3,945 $ 3,045 Net cash used for investing activities (283) (287) Net cash used for financing activities (2,548) (2,180)
Effect of foreign currency exchange rates on cash and cash equivalents
3 (12)
Net increase in cash and cash equivalents $ 1,117 $ 566
Our primary source of cash is receipts from revenue and, to a lesser extent,
proceeds from participation in the employee stock purchase plan. The primary
uses of cash are payroll-related expenses, general operating expenses including
marketing, travel and office rent, and cost of revenue. Other uses of cash
include our stock repurchase program as described below, business acquisitions,
purchases of property and equipment and payments for taxes related to net share
settlement of equity awards.
Cash Flows from Operating Activities
Net cash provided by operating activities of $3.95 billion for the nine months
ended August 28, 2020 was primarily comprised of net income adjusted for the net
effect of non-cash items. The primary working capital sources of cash were net
income together with decreases in trade receivables, which were offset in part
by increases in prepaid expenses and other assets. Decreases in trade
receivables were largely attributable to strong collections during the first
quarter of fiscal 2020. The primary working capital use of cash was due to
increases in prepaid expenses and other assets driven by sales commissions paid
and capitalized, increases in prepaid expenses due to the timing of billings and
payments associated with certain vendors, and increases in prepaid payroll
related to employee benefits.
Cash Flows from Investing Activities
Net cash used for investing activities of $283 million for the nine months ended
August 28, 2020 was primarily due to ongoing capital expenditures. These cash
outflows were offset in part by proceeds from sales and maturities of short-term
investments, net of purchases.
Cash Flows from Financing Activities
Net cash used for financing activities of $2.55 billion for the nine months
ended August 28, 2020 was primarily due to payments for our treasury stock
repurchases and taxes paid related to the net share settlement of equity awards,
which were offset by proceeds from re-issuance of treasury stock mainly for our
employee stock purchase plan. See the section titled "Stock Repurchase Program"
below.
In February 2020 , we issued $500 million of 1.70% senior notes due February 1,
2023 ("2023 Notes"), $500 million of 1.90% senior notes due February 1, 2025
("1.90% 2025 Notes"), $850 million of 2.15% senior notes due February 1, 2027
("2027 Notes") and $1.30 billion of 2.30% senior notes due February 1, 2030
("2030 Notes"). We used the proceeds to repay
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the Term Loan and 2020 Notes concurrently. See Note 15 of our notes to
condensed consolidated financial statements for information regarding our debt
refinancing.
We expect to continue our investing activities, including short-term and
long-term investments, facilities expansion and purchases of computer systems
for research and development, sales and marketing, product support and
administrative staff. 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.
Other Liquidity and Capital Resources Considerations
Our existing cash, cash equivalents and investment balances may fluctuate during
fiscal 2020 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, the effects of the pandemic and other risks
detailed in Part II, Item 1A titled "Risk Factors". While the pandemic has not
negatively impacted our liquidity and capital resources to date, it has led to
increased disruption and volatility in capital markets and credit markets which
could adversely affect our liquidity and capital resources in the future.
However, 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 and operating resource expenditure
requirements for the next twelve months.
We have a $1 billion senior unsecured revolving credit agreement ("Revolving
Credit Agreement") with a syndicate of lenders, providing for loans to us and
certain of our subsidiaries through October 17, 2023 . As of August 28, 2020 ,
there were no outstanding borrowings under this Credit Agreement and the entire
$1 billion credit line remains available for borrowing.
As of August 28, 2020 , we have $4.15 billion senior notes outstanding,
consisting of the 2023 Notes, 1.90% 2025 Notes, 2027 Notes, 2030 Notes, and the
$1 billion of 3.25% senior notes due February 1, 2025 ("3.25% 2025 Notes," and
together with the aforementioned notes, "Notes"). The Notes rank equally with
our other unsecured and unsubordinated indebtedness.
Our short-term investment portfolio is primarily invested in corporate debt
securities, asset-backed securities and municipal securities. We use
professional investment management firms to manage a large portion of our
invested cash.
Stock Repurchase Program
To facilitate our stock repurchase program, designed to return value to our
stockholders and minimize dilution from stock issuances, we may repurchase
shares in the open market or enter into structured repurchase agreements with
third parties. In May 2018 , our Board of Directors granted us an authority to
repurchase up to $8 billion in common stock through the end of fiscal 2021.
During the nine months ended August 28, 2020 and August 30, 2019 , we entered
into several structured stock repurchase agreements with large financial
institutions, whereupon we provided them with prepayments totaling $2.2 billion
and $2 billion , respectively. We enter into these agreements in order to take
advantage of repurchasing shares at a guaranteed discount to the Volume Weighted
Average Price ("VWAP") of our common stock over a specified period of time. We
only enter into such transactions when the discount that we receive is higher
than the expected foregone return on our cash prepayments to the financial
institutions. There were no explicit commissions or fees on these structured
repurchases. Under the terms of the agreements, there is no requirement for the
financial institutions to return any portion of the prepayment to us.
The financial institutions agree to deliver shares to us at monthly intervals
during the contract term. The parameters used to calculate the number of shares
deliverable are: the total notional amount of the contract, the number of
trading days in the contract, the number of trading days in the interval and the
average VWAP of our stock during the interval less the agreed upon discount.
During the nine months ended August 28, 2020 , we repurchased approximately 6.5
million shares at an average price of $350.72 through structured repurchase
agreements entered into during fiscal 2019 and the nine months ended August 28,
2020 . During the nine months ended August 30, 2019 , we repurchased approximately
7.1 million shares at an average price of $266.96 through structured repurchase
agreements entered into during fiscal 2018 and the nine months ended August 30,
2019 .
For the nine months ended August 28, 2020 , the prepayments were classified as
treasury stock on our condensed consolidated balance sheets at the payment date,
though only shares physically delivered to us by August 28, 2020 were excluded
from the computation of earnings per share. As of August 28, 2020 , $167 million
of prepayment remained under this agreement.
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Subsequent to August 28, 2020 , as part of the May 2018 stock repurchase
authority, we entered into a structured stock repurchase agreement with a large
financial institution whereupon we provided them with a prepayment of $850
million . Upon completion of the $850 million stock repurchase agreement, $2.05
billion remains under our May 2018 authority.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Our principal commitments as of August 28, 2020 consist of our Notes and
obligations under operating leases, royalty agreements and various service
agreements. Except as discussed below, there have been no other material changes
in those obligations during the nine months ended August 28, 2020. See Notes
14 , 15 and 16 of our notes to condensed consolidated financial
statements for more detailed information regarding our contractual
commitment s.
Contractual Obligations
In February 2020 , we issued the 2023 Notes, 1.90% 2025 Notes, 2027 Notes, and
2030 Notes. Concurrently, we settled our outstanding Term Loan and the 2020
Notes. The following table updates our Notes obligations as of August 28, 2020 :
(in millions) Payment Due by Period
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
Notes, including interest $ 4,763 $ 99 $ 693 $ 1,659 $ 2,312
As of August 28, 2020 , the carrying value of our Notes was $4.12 billion .
Interest is payable semi-annually, in arrears on February 1 and August 1 . At
August 28, 2020 , our maximum commitment for interest payments was $613 million
for the remaining duration of our outstanding Notes.
Covenants
Our Revolving Credit Agreement contains a financial covenant requiring us not to
exceed a maximum leverage ratio. As of August 28, 2020 , we were in compliance
with this covenant. We believe this covenant will not impact our credit or cash
in the coming fiscal year or restrict our ability to execute our business plan.
Our Notes do not contain any financial covenants.
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.
Transition Taxes Liability
Our transition tax liability which was accrued as a result of the U.S. Tax Act
was approximately $390 million as of August 28, 2020 and is payable in
installments through fiscal 2026. The U.S. Tax Act provides an exemption from
federal income taxes for distributions from foreign subsidiaries made after
December 31, 2017 , including certain earnings that were not subject to the
one-time transition or global intangible low-tax income tax. As we repatriate
the undistributed foreign earnings for use in the U.S. , the distributions will
generally not be subject to further U.S. federal tax.
Accounting for Uncertainty in Income Taxes
See Results of Operations, Provision for (Benefit from) Income Taxes above for
our discussion on accounting for uncertainty in income taxes.
Royalties
We have certain royalty commitments associated with the licensing of certain
offerings. Royalty expense is generally based on a dollar amount per unit sold
or a percentage of the underlying revenue.
Indemnifications
In the normal 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 material and we are unable to estimate the maximum
potential impact of these indemnification provisions on our future results of
operations.
To the extent permitted under Delaware law, we have agreements whereby we
indemnify our directors and officers for certain events or occurrences while the
director or officer is or was serving at our request in such capacity. The
indemnification
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period covers all pertinent events and occurrences during the director's or
officer's lifetime. The maximum potential amount of future payments we could be
required to make under these indemnification agreements is unlimited; however,
we have director and officer insurance coverage that limits our exposure and
enables us to recover a portion of any future amounts paid.
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