Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page No.
Consolidated Balance Sheets	57
Consolidated Statements of Income	58
Consolidated Statements of Comprehensive Income	59
Consolidated Statements of Stockholders' Equity	60
Consolidated Statements of Cash Flows	61
Notes to Consolidated Financial Statements	62
Report of KPMG LLP, Independent Registered Public Accounting Firm	104

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 thousands, except par value)

	November 29, 2019				November 30, 2018
ASSETS
Current assets:
Cash and cash equivalents	$	2,650,221			$	1,642,775
Short-term investments	1,526,755				1,586,187
Trade receivables, net of allowances for doubtful accounts of $9,650 and of $14,981, respectively	1,534,809				1,315,578
Prepaid expenses and other current assets	783,140				312,499
Total current assets	6,494,925				4,857,039
Property and equipment, net	1,293,015				1,075,072
Goodwill	10,691,199				10,581,048
Other intangibles, net	1,720,565				2,069,001
Other assets	562,696				186,522
Total assets	$	20,762,400			$	18,768,682
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade payables	$	209,499			$	186,258
Accrued expenses	1,398,548				1,163,185
Debt	3,149,343				—
Deferred revenue	3,377,986				2,915,974
Income taxes payable	55,562				35,709
Total current liabilities	8,190,938				4,301,126
Long-term liabilities:
Debt	988,924				4,124,800
Deferred revenue	122,727				137,630
Income taxes payable	616,102				644,101
Deferred income taxes	140,498				46,702
Other liabilities	173,056				152,209
Total liabilities	10,232,245				9,406,568
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.0001 par value; 2,000 shares authorized; none issued	—				—
Common stock, $0.0001 par value; 900,000 shares authorized; 600,834 shares issued; 482,339 and 487,663 shares outstanding, respectively	61				61
Additional paid-in-capital	6,504,800				5,685,337
Retained earnings	14,828,562				11,815,597
Accumulated other comprehensive income (loss)	(188,034		)		(148,130		)
Treasury stock, at cost (118,495 and 113,171 shares, respectively), net of re-issuances	(10,615,234		)		(7,990,751		)
Total stockholders’ equity	10,530,155				9,362,114
Total liabilities and stockholders’ equity	$	20,762,400			$	18,768,682

See accompanying Notes to Consolidated Financial Statements.

ADOBE INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

	Years Ended
	November 29, 2019				November 30, 2018				December 1, 2017
Revenue:
Subscription	$	9,994,463			$	7,922,152			$	6,133,869
Product	647,788				622,153				706,767
Services and support	529,046				485,703				460,869
Total revenue	11,171,297				9,030,008				7,301,505
Cost of revenue:
Subscription	1,222,520				807,221				623,048
Product	39,625				46,009				57,082
Services and support	410,575				341,769				330,361
Total cost of revenue	1,672,720				1,194,999				1,010,491
Gross profit	9,498,577				7,835,009				6,291,014
Operating expenses:
Research and development	1,930,228				1,537,812				1,224,059
Sales and marketing	3,244,347				2,620,829				2,197,592
General and administrative	880,637				744,898				624,706
Amortization of intangibles	175,244				91,101				76,562
Total operating expenses	6,230,456				4,994,640				4,122,919
Operating income	3,268,121				2,840,369				2,168,095
Non-operating income (expense):
Interest and other income (expense), net	42,255				39,536				36,395
Interest expense	(157,214		)		(89,242		)		(74,402		)
Investment gains (losses), net	51,579				3,213				7,553
Total non-operating income (expense), net	(63,380		)		(46,493		)		(30,454		)
Income before income taxes	3,204,741				2,793,876				2,137,641
Provision for income taxes	253,283				203,102				443,687
Net income	$	2,951,458			$	2,590,774			$	1,693,954
Basic net income per share	$	6.07			$	5.28			$	3.43
Shares used to compute basic net income per share	486,291				490,564				493,632
Diluted net income per share	$	6.00			$	5.20			$	3.38
Shares used to compute diluted net income per share	491,572				497,843				501,123

See accompanying Notes to Consolidated Financial Statements.

ADOBE INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

	Years Ended
	November 29, 2019				November 30, 2018				December 1, 2017
	Increase/(Decrease)
Net income	$	2,951,458			$	2,590,774			$	1,693,954
Other comprehensive income (loss), net of taxes:
Available-for-sale securities:
Unrealized gains / losses on available-for-sale securities	29,409				(24,464		)		(2,503		)
Reclassification adjustment for recognized gains / losses on available-for-sale securities	124				10,650				(947		)
Net increase (decrease) from available-for-sale securities	29,533				(13,814		)		(3,450		)
Derivatives designated as hedging instruments:
Unrealized gains / losses on derivative instruments	294				74,080				6,917
Reclassification adjustment for realized gains / losses on derivative instruments	(44,334		)		(48,981		)		(31,973		)
Net increase (decrease) from derivatives designated as hedging instruments	(44,040		)		25,099				(25,056		)
Foreign currency translation adjustments	(25,397		)		(47,594		)		90,287
Other comprehensive income (loss), net of taxes	(39,904		)		(36,309		)		61,781
Total comprehensive income, net of taxes	$	2,911,554			$	2,554,465			$	1,755,735

See accompanying Notes to Consolidated Financial Statements.

ADOBE INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

		Common Stock							Additional Paid-In Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock
		Shares			Amount							Shares			Amount				Total
Balances at December 2, 2016		600,834			$	61			$	4,616,331			$	8,114,517			$	(173,602	)		(106,580	)		$	(5,132,472	)		$	7,424,835
Net income		—			—				—				1,693,954				—				—			—				1,693,954
Other comprehensive income (losses), net of taxes		—			—				—				—				61,781				—			—				61,781
Re-issuance of treasury stock under stock compensation plans		—			—				1,768				(234,601		)		—				5,194			151,058				(81,775		)
Purchase of treasury stock		—			—				—				—				—				(8,186	)		(1,100,000		)		(1,100,000		)
Equity awards assumed for acquisition		—			—				10,348				—				—				—			—				10,348
Stock-based compensation		—			—				453,748				—				—				—			—				453,748
Value of shares in deferred compensation plan		—			—				—				—				—				—			(3,022		)		(3,022		)
Balances at December 1, 2017		600,834			$	61			$	5,082,195			$	9,573,870			$	(111,821	)		(109,572	)		$	(6,084,436	)		$	8,459,869
Net income		—			—				—				2,590,774				—				—			—				2,590,774
Other comprehensive income (losses), net of taxes		—			—				—				—				(36,309		)		—			—				(36,309		)
Re-issuance of treasury stock under stock compensation plans		—			—				(1,125		)		(348,729		)		—				5,087			147,651				(202,203		)
Purchase of treasury stock		—			—				—				—				—				(8,686	)		(2,050,000		)		(2,050,000		)
Equity awards assumed for acquisition		—			—				2,784				—				—				—			—				2,784
Stock-based compensation		—			—				601,483				—				—				—			—				601,483
Value of shares in deferred compensation plan		—			—				—				—				—				—			(3,966		)		(3,966		)
Impacts of the U.S. Tax Act		—			—				—				(318		)		—				—			—				(318		)
Balances at November 30, 2018		600,834			$	61			$	5,685,337			$	11,815,597			$	(148,130	)		(113,171	)		$	(7,990,751	)		$	9,362,114
Impacts of adoption of the new revenue standard		—			—				—				442,319				—				—			—				442,319
Net income		—			—				—				2,951,458				—				—			—				2,951,458
Other comprehensive income (losses), net of taxes		—			—				—				—				(39,904		)		—			—				(39,904		)
Re-issuance of treasury stock under stock compensation plans		—			—				48,686				(380,812		)		—				4,559			125,074				(207,052		)
Purchase of treasury stock		—			—				—				—				—				(9,883	)		(2,750,000		)		(2,750,000		)
Stock-based compensation		—			—				770,777				—				—				—			—				770,777
Value of shares in deferred compensation plan		—			—				—				—				—				—			443				443
Balances at November 29, 2019		600,834			$	61			$	6,504,800			$	14,828,562			$	(188,034	)		(118,495	)		$	(10,615,234	)		$	10,530,155

See accompanying Notes to Consolidated Financial Statements.

ADOBE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Years Ended
	November 29, 2019				November 30, 2018				December 1, 2017
Cash flows from operating activities:
Net income	$	2,951,458			$	2,590,774			$	1,693,954
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion	736,669				346,492				325,997
Stock-based compensation	787,705				609,562				454,472
Deferred income taxes	2,707				(468,936		)		51,605
Unrealized losses (gains) on investments, net	(47,626		)		793				(5,494		)
Other non-cash items	13,835				7,193				4,625
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Trade receivables, net	(187,826		)		(1,983		)		(187,173		)
Prepaid expenses and other assets	(531,054		)		(77,225		)		28,040
Trade payables	23,129				54,920				(45,186		)
Accrued expenses	171,705				43,837				151,104
Income taxes payable	4,152				479,184				(34,493		)
Deferred revenue	496,959				444,693				475,402
Net cash provided by operating activities	4,421,813				4,029,304				2,912,853
Cash flows from investing activities:
Purchases of short-term investments	(699,893		)		(566,084		)		(1,931,011		)
Maturities of short-term investments	699,540				765,860				759,737
Proceeds from sales of short-term investments	86,137				1,709,480				1,393,929
Acquisitions, net of cash acquired	(100,704		)		(6,314,382		)		(459,626		)
Purchases of property and equipment	(394,479		)		(266,579		)		(178,122		)
Purchases of long-term investments, intangibles and other assets	(48,735		)		(18,513		)		(29,918		)
Proceeds from sale of long-term investments and other assets	2,550				4,923				2,134
Net cash used for investing activities	(455,584		)		(4,685,295		)		(442,877		)
Cash flows from financing activities:
Purchases of treasury stock	(2,750,000		)		(2,050,000		)		(1,100,000		)
Proceeds from re-issuance of treasury stock	232,932				190,990				158,351
Taxes paid related to net share settlement of equity awards	(439,984		)		(393,193		)		(240,126		)
Proceeds from debt issuance, net of costs	—				2,248,342				—
Other financing activities, net	11,008				(1,707		)		(1,960		)
Net cash used for financing activities	(2,946,044		)		(5,568		)		(1,183,735		)
Effect of foreign currency exchange rates on cash and cash equivalents	(12,739		)		(1,738		)		8,516
Net increase (decrease) in cash and cash equivalents	1,007,446				(663,297		)		1,294,757
Cash and cash equivalents at beginning of year	1,642,775				2,306,072				1,011,315
Cash and cash equivalents at end of year	$	2,650,221			$	1,642,775			$	2,306,072
Supplemental disclosures:
Cash paid for income taxes, net of refunds	$	352,478			$	210,369			$	396,668
Cash paid for interest	$	152,075			$	81,258			$	69,430
Non-cash investing activities:
Investment in lease receivable applied to building purchase	$	—			$	—			$	80,439
Issuance of common stock and stock awards assumed in business acquisitions	$	—			$	2,784			$	10,348

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 Inc. is one of the largest and most diversified software companies in the world. We offer a line of products and services used by creative professionals, marketers, knowledge workers, students, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing, engaging and transacting with compelling content and experiences across personal computers, devices and media. We market our products and services directly to enterprise customers through our sales force and local field offices. We license our products to end users through app stores and our own website at www.adobe.com. We offer many of our products via a Software-as-a-Service (“SaaS”) model or a managed services model (both of which are referred to as hosted or cloud-based) as well as through term subscription and pay-per-use models. We also distribute certain products and services through a network of distributors, value-added resellers, systems integrators, independent software vendors, retailers, software developers and original equipment manufacturers (“OEMs”). In addition, we license our technology to hardware manufacturers, software developers and service providers for use in their products and solutions. Our products run on personal and server-based computers, as well as on smartphones, tablets and other devices, depending on the product. We have operations in the Americas, Europe, Middle East and Africa (“EMEA”), and Asia-Pacific (“APAC”).

Basis of Presentation

The accompanying Consolidated Financial Statements include those of Adobe and its subsidiaries, after elimination of all intercompany accounts and transactions. We have prepared the accompanying Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”).

Use of Estimates

In preparing Consolidated Financial Statements and related disclosures in conformity with GAAP and pursuant to the rules and regulations of the SEC, we must make estimates and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, sales allowances and programs, bad debts, stock-based compensation, determining the fair value of acquired assets and assumed liabilities, impairment of goodwill and intangible assets, litigation and income taxes. Actual results may differ materially from these estimates.

Fiscal Year

Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Fiscal years 2019, 2018 and 2017 were 52-week years.

Reclassifications

Certain immaterial prior year amounts have been reclassified to conform to current year presentation in the Notes to Consolidated Financial Statements.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Recently Adopted Accounting Guidance

On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, Topic 606, requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Topic 606 also includes Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers, which requires the capitalization of incremental costs to obtain a contract with a customer. The new revenue standard replaces most existing revenue recognition guidance in GAAP and permits the use of either the full retrospective or modified retrospective transition method.

On December 1, 2018, the beginning of our fiscal year 2019, we adopted the requirements of the new revenue standard utilizing the modified retrospective method of transition. Prior period information has not been restated and continues to be reported under the accounting standard in effect for those periods. We applied the new revenue standard to contracts that were not completed as of the adoption date, consistent with the transition guidance. Further, adoption of the new revenue standard resulted in changes to our accounting policies for revenue recognition and sales commissions as detailed below.

We recognized the following cumulative effects of initially applying the new revenue standard as of December 1, 2018:

(in thousands)	As of November 30, 2018				Topic 606 Adoption Adjustments				As of December 1, 2018
Assets
Trade receivables, net of allowances for doubtful accounts	$	1,315,578			$	43,028			$	1,358,606
Prepaid expenses and other current assets	312,499				186,220				498,719
Other assets	186,522				273,421				459,943
Liabilities and Stockholders’ Equity
Accrued expenses	1,163,185				30,358				1,193,543
Deferred revenue, current	2,915,974				(52,842		)		2,863,132
Deferred income taxes	46,702				82,834				129,536
Retained earnings	$	11,815,597			$	442,319			$	12,257,916

Below is a summary of the adoption impacts of the new revenue standard:

•	We capitalized $413.2 million of contract acquisition costs comprised of sales and partner commission costs at adoption date (included in prepaid expenses and other current assets for the current portion and other assets for the long-term portion), with a corresponding adjustment to retained earnings. We are amortizing these costs over their respective expected period of benefit.

•

Revenue for certain contracts that were previously deferred would have been recognized in periods prior to adoption under the new standard. Upon adoption, we recorded the following adjustments to our beginning balances to reflect the amount of revenue that will no longer be recognized in future periods for such contracts: an increase in unbilled receivables (included in trade receivables, net) of $24.8 million, an increase in contract assets (included in prepaid expenses and other current assets for the current portion and other assets for the long-term portion) of $46.4 million and a decrease in deferred revenue of $52.8 million, with corresponding adjustments to retained earnings.

•	We recorded an increase to our opening deferred income tax liability of $82.8 million, with a corresponding adjustment to retained earnings, to record the tax effect of the above adjustments.

•	Further, we had other impacts to various accounts which resulted to an immaterial net reduction to our retained earnings.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Adoption of the new revenue standard impacted our Consolidated Statements of Income for the year ended November 29, 2019 as follows:

(in thousands, except per share amounts)	As reported				Adjustments				Balances without Topic 606 adoption impact
Revenue
Subscription	$	9,994,463			$	1,440			$	9,995,903
Product	647,788				(101,981		)		545,807
Services and support	529,046				(7,431		)		521,615
Total revenue	11,171,297				(107,972		)		11,063,325
Operating expenses
Sales and marketing	3,244,347				11,987				3,256,334
General and administrative	880,637				(7,646		)		872,991
Provision for income taxes	253,283				(6,517		)		246,766
Net income	$	2,951,458			$	(105,953	)		$	2,845,505
Basic net income per share	$	6.07			$	(0.22	)		$	5.85
Diluted net income per share	$	6.00			$	(0.21	)		$	5.79

Adoption of the new revenue standard impacted our Consolidated Balance Sheets as of November 29, 2019 as follows:

(in thousands)	As reported				Adjustments				Balances without Topic 606 adoption impact
Assets
Trade receivables, net of allowances for doubtful accounts	$	1,534,809			$	(58,140	)		$	1,476,669
Prepaid expenses and other current assets	783,140				(198,692		)		584,448
Other assets	562,696				(340,458		)		222,238
Liabilities and Stockholders’ Equity
Accrued expenses	1,398,548				(51,918		)		1,346,630
Deferred revenue, current	3,377,986				113,432				3,491,418
Deferred revenue, long-term	122,727				(14,723		)		108,004
Income taxes payable, long-term	616,102				(7,112		)		608,990
Deferred income taxes	140,498				(88,697		)		51,801
Retained earnings	$	14,828,562			$	(548,272	)		$	14,280,290

There was no net impact to our Consolidated Statements of Comprehensive Income and Consolidated Statements of Cash Flows resulting from the adoption of the new revenue standard other than the impact to reported net income as presented above. The impact to our Consolidated Statements of Stockholders’ Equity was only to retained earnings, as presented above.

The most significant impact of the new revenue standard relates to our capitalization of certain incremental costs to acquire contracts and the requirement to amortize these amounts over the expected period of benefit. Under the previous standard, we expensed costs related to the acquisition of revenue-generating contracts as incurred. Additionally, there was impact from arrangements with our customers that include on-premise term-based software licenses bundled with maintenance and support. Under the previous standard, revenue attributable to these software licenses was recognized ratably over the term of the arrangement because vendor-specific objective evidence (“VSOE”) did not exist for the undelivered maintenance and support element as it is not sold separately. The requirement to have VSOE for undelivered elements to enable the separation of revenue recognition for delivered software licenses is eliminated under the new revenue standard. Accordingly, under the new revenue standard we recognize as revenue a portion of the arrangement fee upon delivery of the software licenses and classify that recognized revenue as product revenue instead of subscription revenue in our Consolidated Statements of Income.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Other impacts to our policies and disclosures include earlier recognition of revenue for certain contracts due to the elimination of contingent revenue limitations, the requirement to estimate variable consideration for certain arrangements, increased allocation of revenue to and from professional services and other offerings and changes to our financial statement disclosures such as new disclosures related to our remaining performance obligations. However, the timing and pattern of revenue recognition related to our professional services and cloud-enabled offerings, including Creative Cloud and Document Cloud for enterprises, individuals and teams, remain substantially unchanged. When Creative Cloud and Document Cloud are sold with cloud-enabled services, the on-premise/on-device software licenses and cloud-enabled services are so highly interrelated and interdependent that they are not each separately identifiable within the context of the contract and therefore not distinct from each other. Revenue for these offerings continues to be recognized ratably over the subscription period for which the cloud-enabled services are provided.

There have been no other new accounting pronouncements made effective during fiscal 2019 that have significance, or potential significance, to our Consolidated Financial Statements.

Significant Accounting Policies

Revenue Recognition

Our revenue is derived from the sale of cloud-enabled software subscriptions, cloud-hosted offerings, term-based, royalty, and perpetual software licenses, associated software maintenance and support plans, consulting services, training and technical support. Most of our enterprise customer arrangements involve multiple promises to our customers.

Revenue is recognized when a contract exists between us and a customer and upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which may be capable of being distinct and accounted for as separate performance obligations, or in the case of offerings such as cloud-enabled Creative Cloud and Document Cloud, accounted for as a single performance obligation. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

Product, Subscription 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.

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 or impressions per month, 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.

Licenses for on-premise software may be purchased on a perpetual basis, as a subscription for a fixed period of time or based on usage for certain of our OEM and royalty agreements. Revenue from distinct on-premise licenses is recognized at the point in time the software is available to the customer, provided all other revenue recognition criteria are met, and classified as product revenue on our Consolidated Statements of Income. Some of our enterprise license arrangements allow customers to

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

commit non-cancellable funds. These non-cancellable committed funds are nonrefundable and provide our customers options to either renew monthly on-premise term-based licenses or use some or all funds to purchase other Adobe products or services. Revenue associated with these monthly term-based licenses is classified as subscription revenue.

Our services and support revenue is composed of consulting, training, and maintenance and support, primarily related to 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 basis and recognize the related revenue as services are rendered. We typically sell our maintenance and support contracts on a flat fee or percentage of associated license fees basis and recognize the related revenue ratably over the support term as the underlying service is a stand-ready performance obligation.

We exclude from the transaction price sales and other taxes collected from customers on behalf of the relevant government authority. Most of our products are delivered electronically, however in instances where shipping and handling costs are incurred, we treat these amounts as costs to fulfill the contract and they are not considered a performance obligation and the associated fees are not included in the transaction price.

Judgments

Our contracts with customers may include multiple goods and services. For example, some of our offerings include both on-premise and/or on-device software licenses and cloud services. Determining whether the software licenses and the cloud services are distinct from each other, and therefore performance obligations to be accounted for separately, or not distinct from each other, and therefore part of a single performance obligation, may require significant judgment. We have concluded that the on-premise/on-device software licenses and cloud services provided in our Creative Cloud and Document Cloud subscription offerings are not distinct from each other such that revenue from each offering should be recognized ratably over the subscription period for which the cloud services are provided. In reaching this conclusion, we considered the nature of our promise to Creative Cloud and Document Cloud customers, which is to provide a complete end-to-end creative design or document workflow solution that operates seamlessly across multiple devices and teams. We fulfill this promise by providing access to a solution that integrates cloud-based and on-premise/on-device features that, together through their integration, provide functionalities, utility and workflow efficiencies that could not be obtained from either the on-premise/on-device software or cloud services on their own.

Cloud-based features that are integral to our Creative Cloud and Document Cloud offerings and that work together with the on-premise/on-device software include, but are not limited to: Creative Cloud Libraries, which enable customers to access their work, settings, preferences, and other assets seamlessly across desktop and mobile devices and collaborate across teams in real time; shared reviews which enable simultaneous editing and commenting of PDFs across desktop, mobile and web; automatic cloud rendering of a design which enables it to be worked on in multiple mediums; and Sensei, Adobe’s cloud-hosted artificial intelligence and machine learning framework, which enables features such as automated photo-editing, photograph content-awareness, natural language processing, optical character recognition and automated document tagging.

Standalone selling price is established by maximizing the amount of observable inputs, primarily actual historical selling prices for performance obligations where available, and includes consideration of factors such as go-to-market model and geography. Individual products may have multiple values for standalone selling price depending on factors such as where they are sold and what channel they are sold through. Where standalone selling price may not be directly observable (e.g., the performance obligation is not sold separately), we maximize the use of observable inputs by using information that may include reviewing pricing practices, performance obligations with similar customers and selling models.

Capitalized costs to obtain a contract are amortized over the expected period of benefit, which we have determined, based on analysis, to be 5 years. We evaluated qualitative and quantitative factors to determine the period of amortization, including contract length, renewals, customer life and the useful lives of our products and acquired products. When the expected period of benefit of an asset which would be capitalized is less than one year, we expense the amount as incurred, utilizing the practical expedient. We regularly evaluate whether there have been changes in the underlying assumptions and data used to determine the amortization period.

When revenue arrangements include components of third-party goods and services, for example in transactions which involve resale, fulfillment or providing advertising impressions to our end customer, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

control of the specified goods or services before they are transferred to the customer by evaluating indicators such as which party is primarily responsible for fulfilling the promise to provide the goods or services, which party has discretion in establishing price and the underlying terms and conditions between the parties to the transaction.

We offer limited rights of return, rebates and price protection of our products under various policies and programs with our distributors, resellers and/or end-user customers. We estimate and record reserves for these programs as variable consideration when estimating transaction price. Returns, rebates and other offsets to transaction price are estimated at contract inception on a portfolio basis and assessed for reasonableness each reporting period when additional information becomes available.

General Contract Provisions

We maintain revenue reserves for rebates, rights of return and other limited price adjustments.

Distributors are allowed limited rights of return of products purchased during the previous quarter. In addition, distributors are allowed to return products that have reached the end of their lives, as defined by us, and for products that are being replaced by new versions.

We offer rebates to our distributors, resellers and/or end-user customers. Transaction price is reduced for these amounts based on actual performance against objectives set forth by us for a particular reporting period, such as volume and timely reporting.

On a quarterly basis, the amount of revenue that is reserved is calculated based on our historical trends and data specific to each reporting period. The primary method of establishing these reserves is to review historical data from prior periods as a percent of revenue to determine a historical reserve rate. We then apply the historical rate to the current period revenue as a basis for estimating future returns. When necessary, we also provide a specific reserve in excess of portfolio-level estimated 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 new revenue standard.

Property and Equipment

We record property and equipment at cost less accumulated depreciation and amortization. Property and equipment are depreciated using the straight-line method over their estimated useful lives ranging from 1 to 20 years for computers and other equipment, which includes our corporate jet, 1 to 6 years for furniture and fixtures, 5 to 20 years for building improvements and up to 40 years for buildings. Leasehold improvements are amortized using the straight-line method over the lesser of the remaining respective lease term or estimated useful lives ranging from 1 to 15 years.

Goodwill, Intangibles and Other Long-Lived Assets

Goodwill is assigned to one or more reporting segments on the date of acquisition. We review our goodwill for impairment annually during our second quarter of each fiscal year and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of any one of our reporting units below its respective carrying amount. In performing our goodwill impairment test, we first perform a qualitative assessment, which requires that we consider events or circumstances including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting segment’s net assets and changes in our stock price. If, after assessing the totality of events or circumstances, we determine

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

that it is more likely than not that the fair values of our reporting segments are greater than the carrying amounts, then the quantitative goodwill impairment test is not performed.

If the qualitative assessment indicates that the quantitative analysis should be performed, we then evaluate goodwill for impairment by comparing the fair value of each of our reporting segments to its carrying value, including the associated goodwill. To determine the fair values, we use the equal weighting of the market approach based on comparable publicly traded companies in similar lines of businesses and the income approach based on estimated discounted future cash flows. Our cash flow assumptions consider historical and forecasted revenue, operating costs and other relevant factors.

We completed our annual goodwill impairment test in the second quarter of fiscal 2019. We determined, after performing a qualitative review of each reporting segment, that it is more likely than not that the fair value of each of our reporting segments substantially exceeds the respective carrying amounts. Accordingly, there was no indication of impairment and the quantitative goodwill impairment test was not performed. We did not identify any events or changes in circumstances since the performance of our annual goodwill impairment test that would require us to perform another goodwill impairment test during the fiscal year.

We amortize intangible assets with finite lives over their estimated useful lives and review them for impairment whenever an impairment indicator exists. We continually monitor events and changes in circumstances that could indicate carrying amounts of our long-lived assets, including our intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, we recognize an impairment loss based on any excess of the carrying amount over the fair value of the assets. We did not recognize any intangible asset impairment charges in fiscal 2019, 2018 or 2017.

During fiscal 2019, our intangible assets were amortized over their estimated useful lives ranging from 1 to 15 years. Amortization is based on the pattern in which the economic benefits of the intangible asset will be consumed or on a straight-line basis when the consumption pattern is not apparent. The weighted average useful lives of our intangible assets were as follows:

	Weighted Average Useful Life (years)
Customer contracts and relationships	10
Purchased technology	6
Trademarks	9
Backlog	2
Acquired rights to use technology	10
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 expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not.

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

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

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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 2019, 2018 and 2017 were $221.1 million, $173.6 million and $141.7 million, respectively.

Foreign Currency Translation

We translate assets and liabilities of foreign subsidiaries, whose functional currency is their local currency, at exchange rates in effect at the balance sheet date. We translate revenue and expenses at the monthly average exchange rates. We include accumulated net translation adjustments in stockholders’ equity as a component of accumulated other comprehensive income (loss).

Derivative Financial Instruments

In countries outside the United States, we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option and forward contracts to hedge a portion of our forecasted foreign currency denominated revenue primarily in Euros, British Pounds and Japanese Yen. We hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates.

We recognize all derivative instruments as either assets or liabilities in our Consolidated Balance Sheets and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. Contracts that do not qualify for hedge accounting are adjusted to fair value through earnings.

Gains and losses related to changes in the fair value of interest rate swaps and foreign exchange forward contracts which hedge certain balance sheet positions are recorded each period as a component of interest and other income (expense), net in our Consolidated Statements of Income. Foreign exchange option contracts hedging forecasted foreign currency revenue and Treasury lock agreements are designated as cash flow hedges with gains and losses recorded net of tax as a component of accumulated other comprehensive income (loss) in our Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction affects earnings, we reclassify the related gain or loss on the foreign currency and Treasury lock cash flow hedges to revenue and interest expense, respectively.

Concentration of Risk

Financial instruments that potentially subject us to concentrations of credit risk are short-term fixed-income investments, structured repurchase transactions, foreign currency and interest rate hedge contracts and trade receivables.

Our investment portfolio consists of investment-grade securities diversified among security types, industries and issuers. Our cash and investments are held and primarily managed by recognized financial institutions that follow our investment policy. Our policy limits the amount of credit exposure to any one security issue or issuer and we believe no significant concentration of credit risk exists with respect to these investments.

We enter into master netting arrangements to mitigate credit risk in derivative transactions by permitting net settlement of transactions with the same counterparty. We also enter into collateral security agreements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds.

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

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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.

Recent Accounting Pronouncements Not Yet Effective

On February 24, 2016, the FASB issued ASU No. 2016-02, Leases, requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases with a lease term of twelve months or less. For lessees, leases will continue to be classified as either operating or finance leases in the income statement. Lessor accounting is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. The effective date of the new leases standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new leases standard is effective for us beginning in the first quarter of fiscal 2020, and we did not early adopt.

The new leases standard must be adopted using a modified retrospective transition method and allows for the application of the new guidance at the beginning of the earliest comparative period presented or at the adoption date. In July 2018, the FASB issued ASU No. 2018-11, Leases - Targeted Improvements, providing an optional transition method that allows entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We will adopt the new leases standard using this optional transition method.

We have completed our assessment of the impacts of the standard, and note that the most significant impact will be the recognition of right-of-use assets and lease liabilities on our Consolidated Balance Sheets. The standard will not have a material impact to our Consolidated Statements of Income and Cash Flows. We are in the final stages of implementing a new lease accounting system and updating our processes for the adoption of the new leases standard.

On August 28, 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging, requiring expanded hedge accounting for both non-financial and financial risk components and refining the measurement of hedge results to better reflect an entity’s hedging strategies. For example, adoption would result in reclassification of hedge costs from foreign currency hedges from interest and other income (expense), net to revenue in our Consolidated Statements of Income. The updated standard also amends the presentation and disclosure requirements and changes how entities assess hedge effectiveness. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition with a cumulative-effect adjustment recorded to opening retained earnings as of the initial adoption date. The updated standard is effective for us beginning in the first quarter of fiscal 2020, and will not have a material impact on our Consolidated Financial Statements and related disclosures.

With the exception of the new standards discussed above, there have been no other new accounting pronouncements that have significance, or potential significance, to our Consolidated Financial Statements.

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 and intangible assets, we do not identify or allocate our assets by the reportable segments.

Our business is organized into three reportable segments: Digital Media, Digital Experience and Publishing. These segments provide our senior management with a comprehensive financial view of our key businesses. Our segments are aligned around our

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

two strategic growth opportunities as described in the “Business Overview” within Part I, Item 1, placing our Publishing business in a third segment that contains some of our mature products and solutions.

In fiscal 2019, we categorized our products into the following reportable segments:

•

Digital Media—Our Digital Media segment provides tools and solutions that enable individuals, teams and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include content creators, experience designers, app developers, enthusiasts, students, social media users and creative professionals, as well as marketing departments and agencies, companies and publishers. Our customers also include knowledge workers who create, collaborate on and distribute documents and creative content.

•

Digital Experience—Our Digital Experience segment provides products, services and solutions for creating, managing, executing, measuring, monetizing and optimizing customer experiences from advertising to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers, marketing executives, information management and technology executives, product development executives, and sales and support executives.

•	Publishing—Our Publishing segment addresses market opportunities ranging from the diverse authoring and publishing needs of technical and business publishing to our legacy type and OEM printing businesses. It also includes our web conferencing and document and forms platforms.

Revenue for fiscal 2019 presented below is in accordance with the new revenue standard that was adopted under the modified retrospective method. Prior period revenue has not been restated.

Our segment revenue and results for fiscal 2019, 2018 and 2017 were as follows:

(dollars in thousands)	Digital Media				Digital Experience				Publishing				Total
Fiscal 2019
Revenue	$	7,706,983			$	3,206,169			$	258,145			$	11,171,297
Cost of revenue	289,639				1,362,886				20,195				1,672,720
Gross profit	$	7,417,344			$	1,843,283			$	237,950			$	9,498,577
Gross profit as a percentage of revenue	96		%		57		%		92		%		85		%
Fiscal 2018
Revenue	$	6,325,315			$	2,443,745			$	260,948			$	9,030,008
Cost of revenue	249,386				922,414				23,199				1,194,999
Gross profit	$	6,075,929			$	1,521,331			$	237,749			$	7,835,009
Gross profit as a percentage of revenue	96		%		62		%		91		%		87		%
Fiscal 2017
Revenue	$	5,010,579			$	2,030,324			$	260,602			$	7,301,505
Cost of revenue	239,994				747,005				23,492				1,010,491
Gross profit	$	4,770,585			$	1,283,319			$	237,110			$	6,291,014
Gross profit as a percentage of revenue	95		%		63		%		91		%		86		%

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Revenue by geographic area for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)		2019				2018				2017
Americas:
United States		$	5,904,185			$	4,632,469			$	3,830,845
Other		601,721				484,296				385,686
Total Americas		6,505,906				5,116,765				4,216,531
EMEA		2,975,243				2,550,062				1,985,105
APAC:
Japan		751,542				609,361				524,254
Other		938,606				753,820				575,615
Total APAC		1,690,148				1,363,181				1,099,869
Revenue		$	11,171,297			$	9,030,008			$	7,301,505

Revenue by major offerings in our Digital Media reportable segment for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)		2019				2018				2017
Creative Cloud		$	6,482,345			$	5,343,498			$	4,173,964
Document Cloud		1,224,638				981,817				836,615
Total		$	7,706,983			$	6,325,315			$	5,010,579

Subscription revenue by segment for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)		2019				2018				2017
Digital Media		$	7,208,238			$	5,857,700			$	4,480,745
Digital Experience		2,670,748				1,949,185				1,552,536
Publishing		115,477				115,267				100,588
Total		$	9,994,463			$	7,922,152			$	6,133,869

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 occurring.

The opening balance of trade receivables, net of allowances for doubtful accounts, as of December 1, 2018 was $1.36 billion, inclusive of unbilled receivables of $105.8 million. As of November 29, 2019, the balance of trade receivables, net of allowances for doubtful accounts, was $1.53 billion, inclusive of unbilled receivables of $149.3 million.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts which reflects our best estimate of potentially uncollectible trade receivables. The allowance is based on both specific and general reserves. We regularly review our trade receivables allowance by considering factors such as historical experience, credit-worthiness, the age of the trade receivable balances and current economic conditions that may affect a customer’s ability to pay and we specifically reserve for those deemed uncollectible.

During fiscal 2019, 2018 and 2017, our allowance for doubtful accounts activities were as follows:

(in thousands)		2019				2018				2017
Beginning balance		$	14,981			$	9,151			$	6,214
Increase due to acquisition		10				5,602				2,391
Charged to operating expenses		5,324				5,962				4,411
Deductions(1)		(10,665		)		(5,734		)		(3,865		)
Ending balance		$	9,650			$	14,981			$	9,151

---

(1)	Deductions related to the allowance for doubtful accounts represent amounts written off against the allowance, less recoveries.

Contract Assets

A contract asset is recognized when a conditional right to consideration exists and transfer of control has occurred. Contract assets are typically related to subscription and hosted service contracts where the transaction price allocated to the satisfied performance obligations exceeds the value of billings to date. Contract assets are included in prepaid expenses and other current assets for the current portion and other assets for the long-term portion on the Consolidated Balance Sheets. We regularly review contract asset balances for impairment, considering factors such as historical experience, credit-worthiness, age of the balance and other economic or business factors. Contract asset impairments were not significant in fiscal 2019.

The opening balance of contract assets as of December 1, 2018 was $46.4 million. As of November 29, 2019, the balance of contract assets was $63.9 million.

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 deposits. Deferred revenue is recognized as revenue when transfer of control to customers has occurred. Customers are typically invoiced for these agreements in regular installments and revenue is recognized ratably over the contractual subscription period. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing, size and new business linearity within the quarter. Deferred revenue does not represent the total contract value of annual or multi-year non-cancellable subscription agreements.

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, such as invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and not to receive financing from our customers. Any potential financing fees are considered insignificant in the context of our contracts.

The adjusted opening balance of deferred revenue as of December 1, 2018 was $3.00 billion. As of November 29, 2019, the balance of deferred revenue was $3.50 billion, inclusive of $265.4 million of non-cancellable and non-refundable committed funds and $56.9 million of refundable customer deposits. Arrangements with non-cancellable and non-refundable committed funds provide our customers options to either renew monthly on-premise term-based licenses or use some or all funds to purchase other Adobe products or services. 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.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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 business combinations, which were offset by decreases due to revenue recognized in the period. During the year ended November 29, 2019, approximately $2.8 billion of revenue was recognized that was included in the adjusted opening balance of deferred revenue as of December 1, 2018.

Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes deferred revenue and unbilled amounts that will be recognized as revenue in future periods. Transaction price allocated to the remaining performance obligation is influenced by several factors, including the timing of renewals and average contract terms. 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 in accordance with the new revenue standard.

Remaining performance obligations were approximately $9.82 billion as of November 29, 2019, which includes $776.4 million of non-cancellable and non-refundable committed funds related to some of our enterprise customer agreements. Approximately 74% 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 under the new revenue standard 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 2019, we amortized $170.9 million of capitalized contract acquisition costs into sales and marketing expense. We did not incur any impairment losses.

The opening balance of capitalized contract acquisition costs as of December 1, 2018 was $413.2 million. As of November 29, 2019, the balance of capitalized contract acquisition costs was $473.7 million, of which $314.7 million was long-term and included in other assets in the Consolidated Balance Sheets. The remaining balance of the capitalized costs to obtain contracts was current and included in prepaid expenses and other current assets.

Revenue Reserve

During fiscal 2019, 2018 and 2017, our revenue reserve activities were as follows:

(in thousands)		2019				2018				2017
Beginning balance		$	25,425			$	22,006			$	23,096
Impacts of adoption of the new revenue standard		(14,733		)		—				—
Amount charged to revenue		18,276				65,241				61,031
Actual returns		(22,236		)		(61,822		)		(62,121		)
Ending balance		$	6,732			$	25,425			$	22,006

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Refund Liabilities

As part of our revenue reserves, we record refund liabilities for amounts that may be subject to future refunds, which include sales returns reserves and customer rebates and credits. Refund liabilities are included in accrued expenses on the Consolidated Balance Sheets.

The opening balance of refund liabilities as of December 1, 2018 was $75.3 million. As of November 29, 2019, the balance of refund liabilities was $126.1 million.

Significant Customers

For fiscal 2019, 2018 and 2017 there were no customers that represented at least 10% of net revenue. As of fiscal year end 2019 and 2018, no single customer was responsible for over 10% of our trade receivables.

NOTE 3. ACQUISITIONS

Allegorithmic

On January 23, 2019, we completed the acquisition of Allegorithmic, a privately held 3D editing and authoring software company for gaming and entertainment, and integrated it into our Digital Media reportable segment. Prior to the acquisition, we held an equity interest that was accounted for as an equity-method investment. We acquired the remaining equity interest for approximately $106.2 million in cash consideration. The total purchase price, inclusive of the acquisition-date fair-value of our pre-existing equity interest, was approximately $161.1 million.

In conjunction with the Allegorithmic acquisition, we separately recognized an investment gain of approximately $42.0 million, which represents the difference between the $54.8 million acquisition-date fair value of our pre-existing equity interest and our previous carrying amount.

Under the acquisition method of accounting, the total final purchase price was allocated to Allegorithmic’s net tangible and intangible assets based upon their estimated fair values as of the acquisition date. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. Of the total purchase price, $125.9 million was allocated to goodwill that was non-deductible for tax purposes, $44.8 million to identifiable intangible assets and the remainder to net liabilities assumed.

Pro forma financial information has not been presented for the Allegorithmic acquisition as the impact to our Consolidated Financial Statements was not material.

Marketo

On October 31, 2018, we completed the acquisition of Marketo, a privately held marketing cloud platform company, for approximately $4.73 billion of cash consideration. Adding Marketo’s engagement platform to Adobe Experience Cloud furthers our long-term plan for strategic growth in the Digital Experience segment and enables us to offer a comprehensive set of solutions to enable customers across industries and companies automate and orchestrate their marketing activities. Under the terms of the Share Purchase Agreement (“Purchase Agreement”), we acquired all of the issued and outstanding shares of capital stock of Milestone Topco, Inc., a Delaware corporation (“Topco”) and indirect parent company of Marketo, and other equity interests in Marketo. In connection with the acquisition, each Marketo equity award that was issued and outstanding was cancelled and extinguished in exchange for cash consideration. Also pursuant to the Purchase Agreement, upon closing of the transaction, cash was paid for the settlement of Marketo’s long-term incentive plan, the settlement of Marketo’s indebtedness and the acquisition of all remaining equity interests in Marketo K.K., a Japanese corporation and joint venture.

In connection with the acquisition, we entered into a credit agreement providing for a $2.25 billion senior unsecured term loan (“Term Loan”). The proceeds of the Term Loan were used to fund a portion of the purchase price of the acquisition and pay fees and expenses incurred in connection with the acquisition. The Term Loan funds were received on October 31, 2018 upon closing of the acquisition. See Note 17 for further details regarding our Term Loan.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

We integrated Marketo into our Digital Experience reportable segment and have included the financial results of Marketo in our Consolidated Financial Statements beginning on the acquisition date. The amounts of net revenue and net loss of Marketo included in our Consolidated Statements of Income from the acquisition date through November 30, 2018 were not material. The direct transaction costs associated with the acquisition were also not material.

Purchase Price Allocation

Under the purchase accounting method, the total final purchase price was allocated to Marketo’s net tangible and intangible assets based upon their estimated fair values as of the acquisition date. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill.

The table below represents the final purchase price allocation to the acquired net tangible and intangible assets of Marketo based on their estimated fair values as of October 31, 2018 and the associated estimated useful lives at that date. During fiscal 2019, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to total purchase price, intangible assets, deferred revenue, tax liabilities assumed and their related impact to goodwill.

(in thousands)	Amount				Weighted Average Useful Life (years)
Customer contracts and relationships	$	577,500			11
Purchased technology	444,500				7
Backlog	105,500				2
Non-competition agreements	12,100				2
Trademarks	328,500				9
Total identifiable intangible assets	1,468,100
Net liabilities assumed	(194,588		)		N/A
Goodwill (1)	3,459,256				N/A
Total purchase price	$	4,732,768

---

(1)	Non-deductible for tax-purposes.

Identifiable intangible assets — Customer relationships consist of Marketo’s contractual relationships and customer loyalty related to their enterprise and commercial customers as well as technology partner relationships. The estimated fair value of the customer contracts and relationships was determined based on projected cash flows attributable to the asset. Purchased technology acquired primarily consists of Marketo’s cloud-based engagement marketing software platform. The estimated fair value of the purchased technology was determined based on the expected future cost savings resulting from ownership of the asset. Backlog relates to subscription contracts and professional services. Non-compete agreements include agreements with key Marketo employees that preclude them from competing against Marketo for a period of two years from the acquisition date. Trademarks include the Marketo trade name, which is well known in the marketing ecosystem. We amortize the fair value of these intangible assets on a straight-line basis over their respective estimated useful lives.

Goodwill — Approximately $3.46 billion of goodwill has been allocated entirely to our Digital Experience reportable segment. Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. The factors that contributed to the recognition of goodwill included securing buyer-specific synergies that increase revenue and profits and are not otherwise available to a marketplace participant, acquiring a talented workforce and cost savings opportunities.

Net liabilities assumed — Marketo’s tangible assets and liabilities as of October 31, 2018 were reviewed and adjusted to their fair value as necessary. The net liabilities assumed included, among other items, $102.6 million in accrued expenses, $74.8 million in deferred revenue and $182.6 million in deferred tax liabilities, which were partially offset by $54.9 million in cash and cash equivalents and $71.6 million in trade receivables acquired.

Deferred revenue — Included in net liabilities assumed is Marketo’s deferred revenue which represents advance payments from customers related to subscription contracts and professional services. We estimated our obligation related to the deferred

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

revenue using the cost build-up approach. The cost build-up approach determines fair value by estimating the direct and indirect costs related to supporting the obligation plus an assumed operating margin. The sum of the costs and assumed operating profit approximates, in theory, the amount that Marketo would be required to pay a third party to assume the obligation. The estimated costs to fulfill the obligation were based on the near-term projected cost structure for subscription and professional services. As a result, we recorded an adjustment to reduce Marketo’s carrying value of deferred revenue to $74.8 million, which represents our estimate of the fair value of the contractual obligations assumed.

Taxes — As part of our accounting for the Marketo acquisition, a portion of the overall purchase price was allocated to goodwill and acquired intangible assets. Amortization expense associated with acquired intangible assets is not deductible for tax purposes. Thus, approximately $348.8 million, included in the net liabilities assumed, was established as a deferred tax liability for the future amortization of the intangible assets, and was partially offset by other tax assets of $166.2 million, which primarily consist of net operating loss carryforwards.

Any impairment charges made in the future associated with goodwill will not be tax deductible and will result in an increased effective income tax rate in the quarter the impairment is recorded.

Unaudited Pro Forma Results

The financial information in the table below summarizes the combined results of operations of Adobe and Marketo, on a pro forma basis, as though the companies had been combined as of the beginning of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place on December 3, 2016 or of results that may occur in the future.

The following unaudited pro forma financial information for fiscal 2018 and 2017 combines the historical results for Adobe for the years ended November 30, 2018 and December 1, 2017 and the historical results of Marketo for the period January 1, 2018 through October 31, 2018 and the year ended December 31, 2017, respectively:

(in thousands)	2018				2017
Net revenues	$	9,338,790			$	7,568,713
Net income	$	2,362,238			$	1,404,864

Magento

On June 18, 2018, we completed our acquisition of Magento Commerce (“Magento”), a privately held commerce platform company, and integrated it into our Digital Experience reportable segment.

The table below represents the final purchase price allocation to the acquired net assets of Magento based on their estimated fair values as of June 18, 2018 and the associated estimated useful lives at that date. During fiscal 2019, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to net liabilities assumed and their related impact to goodwill.

(in thousands)	Amount				Weighted Average Useful Life (years)
Customer contracts and relationships	$	208,000			8
Purchased technology	84,200				5
In-process research and development (1)	39,100				N/A
Trademarks	21,100				3
Other intangibles	43,400				3
Total identifiable intangible assets	395,800
Net liabilities assumed	(68,182		)		N/A
Goodwill (2)	1,316,983				N/A
Total purchase price	$	1,644,601

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

---

(1)	Capitalized as purchased technology and are considered indefinite lived until the completion or abandonment of the associated research and development efforts. Subsequent to the acquisition, the associated in-process research and development efforts for certain projects were completed and the rest were abandoned. The respective related amortization and write-off were each immaterial.

(2)	Non-deductible for tax purposes.

Pro forma financial information has not been presented for the Magento acquisition as the impact to our Consolidated Financial Statements was not material.

TubeMogul

On December 19, 2016, we completed our acquisition of TubeMogul, a publicly held video advertising platform company, and integrated it into our Digital Experience reportable segment.

Under the acquisition method of accounting, the total final purchase price was allocated to TubeMogul’s net tangible and intangible assets based upon their estimated fair values as of December 19, 2016. During fiscal 2017, we recorded immaterial purchase accounting adjustments based on changes to management’s estimates and assumptions in regards to tangible assets, liabilities assumed, and their related impact to goodwill. The total final purchase price for TubeMogul was $560.8 million of which $348.4 million was allocated to goodwill that was non-deductible for tax purposes, $113.1 million to identifiable intangible assets and $99.3 million to net assets acquired.

Pro forma financial information has not been presented for the TubeMogul acquisition as the impact to our Consolidated Financial Statements was not material.

Other

We also completed other immaterial business acquisitions during the fiscal years presented. Pro forma information has not been presented for these acquisitions as the impact to our Consolidated Financial Statements was not material.

NOTE 4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

Cash equivalents consist of all highly liquid debt investments with remaining maturities of three months or less at the date of purchase. We classify our investments in marketable debt securities as “available-for-sale.” We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Consolidated Balance Sheets. Gains and losses are determined using the specific identification method and recognized when realized in our Consolidated Statements of Income. When we have determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in income.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Cash, cash equivalents and short-term investments consisted of the following as of November 29, 2019:

(in thousands)	Amortized Cost				Unrealized Gains				Unrealized Losses				Estimated Fair Value
Current assets:
Cash	$	466,941			$	—			$	—			$	466,941
Cash equivalents:
Corporate debt securities	45,703				2				(1		)		45,704
Money market mutual funds	2,049,057				—				—				2,049,057
Time deposits	88,519				—				—				88,519
Total cash equivalents	2,183,279				2				(1		)		2,183,280
Total cash and cash equivalents	2,650,220				2				(1		)		2,650,221
Short-term fixed income securities:
Asset-backed securities	88,584				146				(9		)		88,721
Corporate debt securities	1,408,332				4,251				(252		)		1,412,331
Municipal securities	17,642				67				—				17,709
U.S. Treasury securities	7,992				2				—				7,994
Total short-term investments	1,522,550				4,466				(261		)		1,526,755
Total cash, cash equivalents and short-term investments	$	4,172,770			$	4,468			$	(262	)		$	4,176,976

Cash, cash equivalents and short-term investments consisted of the following as of November 30, 2018:

(in thousands)	Amortized Cost				Unrealized Gains				Unrealized Losses				Estimated Fair Value
Current assets:
Cash	$	368,564			$	—			$	—			$	368,564
Cash equivalents:
Money market mutual funds	1,234,188				—				—				1,234,188
Time deposits	40,023				—				—				40,023
Total cash equivalents	1,274,211				—				—				1,274,211
Total cash and cash equivalents	1,642,775				—				—				1,642,775
Short-term fixed income securities:
Asset-backed securities	41,875				—				(367		)		41,508
Corporate debt securities	1,546,860				44				(24,696		)		1,522,208
Foreign government securities	4,179				—				(24		)		4,155
Municipal securities	18,601				1				(286		)		18,316
Total short-term investments	1,611,515				45				(25,373		)		1,586,187
Total cash, cash equivalents and short-term investments	$	3,254,290			$	45			$	(25,373	)		$	3,228,962

See Note 5 for further information regarding the fair value of our financial instruments.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category, that have been in an unrealized loss position for less than twelve months, as of November 29, 2019 and November 30, 2018:

(in thousands)	2019								2018
	Fair Value				Gross Unrealized Losses				Fair Value				Gross Unrealized Losses
Corporate debt securities	$	235,155			$	(183	)		$	538,109			$	(7,966	)
Asset-backed securities	6,651				(5		)		6,696				(54		)
Municipal securities	3,305				—				6,599				(81		)
Total	$	245,111			$	(188	)		$	551,404			$	(8,101	)

There were 115 securities and 369 securities in an unrealized loss position for less than twelve months at November 29, 2019 and at November 30, 2018, respectively.

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category, that were in a continuous unrealized loss position for more than twelve months, as of November 29, 2019 and November 30, 2018:

(in thousands)	2019								2018
	Fair Value				Gross Unrealized Losses				Fair Value				Gross Unrealized Losses
Corporate debt securities	$	44,300			$	(70	)		$	969,701			$	(16,730	)
Asset-backed securities	6,754				(4		)		34,812				(313		)
Municipal securities	—				—				11,532				(205		)
Foreign government securities	—				—				4,154				(24		)
Total	$	51,054			$	(74	)		$	1,020,199			$	(17,272	)

There were 38 securities and 577 securities in an unrealized loss position for more than twelve months at November 29, 2019 and at November 30, 2018, respectively.

The following table summarizes the cost and estimated fair value of the fixed income securities classified as short-term investments based on stated effective maturities as of November 29, 2019:

(in thousands)	Amortized Cost				Estimated Fair Value
Due within one year	$	928,472			$	929,616
Due between one and two years	394,436				395,917
Due between two and three years	179,468				180,867
Due after three years	20,174				20,355
Total	$	1,522,550			$	1,526,755

We review our debt securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. The portion of the write-down related to credit loss would be recorded to interest and other income (expense), net in our Consolidated Statements of Income. Any portion not related to credit loss would be recorded to accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Consolidated Balance Sheets. During fiscal 2019, 2018 and 2017, we did not consider any of our investments to be other-than-temporarily impaired.

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

We measure certain financial assets and liabilities at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the year ended November 29, 2019.

The fair value of our financial assets and liabilities at November 29, 2019 was determined using the following inputs:

(in thousands)	Fair Value Measurements at Reporting Date Using
					Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
	Total				(Level 1)				(Level 2)				(Level 3)
Assets:
Cash equivalents:
Corporate debt securities	$	45,704			$	—			$	45,704			$	—
Money market mutual funds	2,049,057				2,049,057				—				—
Time deposits	88,519				88,519				—				—
Short-term investments:
Asset-backed securities	88,721				—				88,721				—
Corporate debt securities	1,412,331				—				1,412,331				—
Municipal securities	17,709				—				17,709				—
U.S. Treasury securities	7,994				—				7,994				—
Prepaid expenses and other current assets:
Foreign currency derivatives	28,829				—				28,829				—
Other assets:
Deferred compensation plan assets	93,776				4,348				89,428				—
Total assets	$	3,832,640			$	2,141,924			$	1,690,716			$	—

Liabilities:
Accrued expenses:
Treasury lock derivatives	$	29,652			$	—			$	29,652			$	—
Foreign currency derivatives	2,671				—				2,671				—
Interest rate swap derivatives	208				—				208				—
Total liabilities	$	32,531			$	—			$	32,531			$	—

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The fair value of our financial assets and liabilities at November 30, 2018 was determined using the following inputs:

(in thousands)	Fair Value Measurements at Reporting Date Using
					Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
	Total				(Level 1)				(Level 2)				(Level 3)
Assets:
Cash equivalents:
Money market mutual funds	$	1,234,188			$	1,234,188			$	—			$	—
Time deposits	40,023				40,023				—				—
Short-term investments:
Asset-backed securities	41,508				—				41,508				—
Corporate debt securities	1,522,208				—				1,522,208				—
Foreign government securities	4,155				—				4,155				—
Municipal securities	18,316				—				18,316				—
Prepaid expenses and other current assets:
Foreign currency derivatives	44,259				—				44,259				—
Other assets:
Deferred compensation plan assets	68,988				3,895				65,093				—
Total assets	$	2,973,645			$	1,278,106			$	1,695,539			$	—

Liabilities:
Accrued expenses:
Foreign currency derivatives	$	816			$	—			$	816			$	—
Other liabilities:
Interest rate swap derivatives	9,744				—				9,744				—
Total liabilities	$	10,560			$	—			$	10,560			$	—

See Note 4 for further information regarding the fair value of our financial instruments.

Our fixed income available-for-sale debt securities consist of high quality, investment grade securities from diverse issuers with a weighted average credit rating of A+. We value these securities based on pricing from independent pricing vendors who use matrix pricing valuation techniques including market approach methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Inputs include quoted prices in active markets for identical assets or inputs other than quoted prices that are observable either directly or indirectly in determining fair value, including benchmark yields, issuer spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. We therefore classify all of our fixed income available-for-sale securities as Level 2. We perform routine procedures such as comparing prices obtained from multiple independent sources to ensure that appropriate fair values are recorded.

The fair values of our money market mutual funds and time deposits are based on the closing price of these assets as of the reporting date. We classify our money market mutual funds and time deposits as Level 1.

Our Level 2 over-the-counter foreign currency, Treasury lock and interest rate swap 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 deferred compensation plan assets consist of money market mutual funds and other mutual funds.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The fair value of our senior notes was $1.96 billion as of November 29, 2019, based on observable market prices in less active markets and categorized as Level 2. See Note 17 for further details regarding our debt.

NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS

We may use derivatives to partially offset our business exposure to foreign currency and interest rate risk on expected future cash flows, and certain existing assets and liabilities. We do not use any of our derivative instruments for trading purposes.

We enter into master netting arrangements to mitigate credit risk in derivative transactions by permitting net settlement of transactions with the same counterparty. We do not offset fair value amounts recognized for derivative instruments under master netting arrangements. We also enter into collateral security agreements with certain of our counterparties to exchange cash collateral when the net fair value of certain derivative instruments fluctuates from contractually established thresholds. Collateral posted is included in prepaid expenses and other current assets and collateral received is included in accrued expenses on our Consolidated Balance Sheets.

Cash Flow Hedges

In countries outside the United States, we transact business in U.S. Dollars and in various other currencies. We may use foreign exchange option contracts or forward contracts to hedge a portion of our forecasted foreign currency denominated revenue. These foreign exchange contracts, carried at fair value, have maturities of up to twelve months. As of November 29, 2019, total notional amounts of outstanding cash flow hedges were $1.20 billion, hedging exposures denominated in Euros, British Pounds and Japanese Yen.

In June 2019, in anticipation of refinancing our $2.25 billion Term Loan due April 30, 2020 and $900 million notes payable due February 1, 2020, 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 hedge the impact of changes in the benchmark interest rate to future interest payments and will be terminated upon closing of our anticipated refinancing. Upon refinancing and termination of the derivative instruments, their fair value will be amortized over the term of our new debt to interest expense.

To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in fair value of these cash flow hedges in accumulated other comprehensive income (loss) in our Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction affects earnings, we reclassify the related gain or loss on the foreign currency and Treasury lock cash flow hedges to revenue and interest expense, respectively. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, we reclassify the gain or loss on the related cash flow hedge from accumulated other comprehensive income (loss) to the same income statement line item as the hedged item. 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.

We evaluate hedge effectiveness at the inception of the hedge prospectively, and on an ongoing basis both retrospectively and prospectively. We record any ineffective portion of the hedging instruments in interest and other income (expense), net on our Consolidated Statements of Income. The net gain or loss recognized in interest and other income (expense), net due to hedge ineffectiveness was insignificant for all fiscal years presented.

Effective in the third quarter of fiscal 2019, all changes in fair value of our foreign currency cash flow hedges are recorded in accumulated other comprehensive income (loss). Prior to this, we recorded the time value of purchased contracts in interest and other income (expense), net in our Consolidated Statements of Income. The impact of the de-designation of our hedges due to the change in methodology in the third quarter of fiscal 2019 was immaterial.

For fiscal 2019, 2018, and 2017, there were no net gains or losses recognized in income relating to hedges of forecasted transactions that did not occur.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Fair Value Hedges

During the third quarter of fiscal 2014, we entered into interest rate swaps designated as a fair value hedge related to our $900 million of 4.75% fixed interest rate senior notes due February 1, 2020 (the “2020 Notes”). In effect, the interest rate swaps convert the fixed interest rate on our 2020 Notes to a floating interest rate based on the London Interbank Offered Rate (“LIBOR”). Under the terms of the swaps, we pay monthly interest at the one-month LIBOR rate plus a fixed number of basis points on the $900 million notional amount through February 1, 2020. In exchange, we receive 4.75% fixed rate interest from the swap counterparties. See Note 17 for further details regarding our debt.

The interest rate swaps are accounted for as fair value hedges and substantially offset the changes in fair value of the hedged portion of the underlying debt that are attributable to the changes in interest rate. Therefore, the gains and losses related to changes in the fair value of the interest rate swaps are included in interest and other income (expense), net in our Consolidated Statements of Income. As of November 29, 2019, the fair value of the interest rate swaps is recognized in accrued expenses on our Consolidated Balance Sheets with a corresponding offset to current debt.

Non-Designated Hedges

Our derivatives not designated as hedging instruments consist of foreign currency forward contracts that we primarily use to hedge monetary assets and liabilities denominated in non-functional currencies. The changes in fair value of these contracts is recorded to interest and other income (expense), net in our Consolidated Statements of Income. Changes in the fair value of the underlying assets and liabilities associated with the hedged risk are generally offset by the changes in the fair value of the related contracts.

As of November 29, 2019, total notional amounts of outstanding foreign currency forward contracts were $702.4 million, primarily hedging exposures denominated in Euros, British Pounds, Japanese Yen and Indian Rupees. As of November 30, 2018, total notional amounts of outstanding contracts were $427.9 million, primarily hedging exposures denominated in Euros, British Pounds, Japanese Yen and Indian Rupees. At November 29, 2019 and November 30, 2018, the outstanding balance sheet hedging derivatives had maturities of 180 days or less.

The fair value of derivative instruments on our Consolidated Balance Sheets as of November 29, 2019 and November 30, 2018 were as follows:

(in thousands)	2019								2018
	Fair Value Asset Derivatives				Fair Value Liability Derivatives				Fair Value Asset Derivatives				Fair Value Liability Derivatives
Derivatives designated as hedging instruments:
Foreign exchange option contracts (1) (2)	$	25,605			$	—			$	40,191			$	—
Treasury lock (1)	—				29,652				—				—
Interest rate swap (3)	—				208				—				9,744
Derivatives not designated as hedging instruments:
Foreign exchange forward contracts (1)	3,224				2,671				4,068				816
Total derivatives	$	28,829			$	32,531			$	44,259			$	10,560

---

(1)	Fair value asset derivatives included in prepaid expenses and other current assets and fair value liability derivatives included in accrued expenses on our Consolidated Balance Sheets.

(2)	Hedging effectiveness expected to be recognized to income within the next 18 months, of which $13.2 million is expected within the next 12 months.

(3)	Included in accrued expenses and other liabilities on our Consolidated Balance Sheets as of November 29, 2019 and November 30, 2018, respectively.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The effects of foreign currency derivative instruments designated as cash flow hedges and foreign currency derivative instruments not designated as hedges in our Consolidated Statements of Income for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)	2019												2018								2017
	Foreign Exchange Option Contracts				Foreign Exchange Forward Contracts				Treasury Lock				Foreign Exchange Option Contracts				Foreign Exchange Forward Contracts				Foreign Exchange Option Contracts				Foreign Exchange Forward Contracts
Derivatives in cash flow hedging relationships:
Net gain (loss) recognized in OCI, net of tax (1)	$	16,526			$	—			$	(22,684	)		$	74,080			$	—			$	6,917			$	—
Net gain (loss) reclassified from accumulated OCI into income, net of tax (2) (4)	39,111				—				(1,228		)		48,647				—				32,852				—
Net gain (loss) recognized in income (3) (4)	(24,269		)		—				—				(41,179		)		—				(30,243		)		—
Derivatives not designated as hedging relationships:
Net gain (loss) recognized in revenue	761				—				—				—				—				—				—
Net gain (loss) recognized in interest and other income (expense), net	$	—			$	4,229			$	—			$	—			$	1,529			$	—			$	6,586

---

(1)	Net change in the fair value of the effective portion classified in other comprehensive income (“OCI”).

(2)	Effective portion of the foreign currency and Treasury lock cash flow hedges classified as revenue and interest expense, respectively.

(3)	Amount excluded from effectiveness testing and ineffective portion classified in interest and other income (expense), net.

(4)	Starting the third quarter of fiscal 2019, all changes in fair value of our foreign currency cash flow hedges are recorded in accumulated other comprehensive income.

Net gains (losses) recognized in interest and other income (expense), net relating to foreign currency derivatives not designated as hedging instruments for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)		2019				2018				2017
Gain (loss) on foreign currency assets and liabilities:
Net realized gain (loss) recognized in other income		$	(14,420	)		$	882			$	(6,142	)
Net unrealized gain (loss) recognized in other income		8,050				(3,843		)		(907		)
		(6,370		)		(2,961		)		(7,049		)
Gain (loss) on hedges of foreign currency assets and liabilities:
Net realized gain (loss) recognized in other income		6,928				(2,042		)		5,415
Net unrealized gain (loss) recognized in other income		(2,699		)		3,571				1,171
		4,229				1,529				6,586
Net gain (loss) recognized in interest and other income (expense), net		$	(2,141	)		$	(1,432	)		$	(463	)

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7. PROPERTY AND EQUIPMENT

Property and equipment, net consisted of the following as of November 29, 2019 and November 30, 2018:

(in thousands)		2019				2018
Computers and other equipment		$	1,424,368			$	1,239,033
Buildings		482,797				485,024
Building improvements		307,396				285,564
Leasehold improvements		246,244				181,990
Land		144,871				145,065
Furniture and fixtures		143,739				121,206
Capital projects in-progress		112,232				23,026
Total		2,861,647				2,480,908
Less accumulated depreciation and amortization		(1,568,632		)		(1,405,836		)
Property and equipment, net		$	1,293,015			$	1,075,072

Depreciation and amortization expense of property and equipment for fiscal 2019, 2018 and 2017 was $173.1 million, $157.1 million and $156.9 million, respectively.

Property and equipment, net, by geographic area as of November 29, 2019 and November 30, 2018 was as follows:

(in thousands)		2019				2018
Americas:
United States		$	1,126,406			$	882,145
Other		2,735				30,475
Total Americas		1,129,141				912,620
EMEA		54,394				51,033
APAC		109,480				111,419
Property and equipment, net		$	1,293,015			$	1,075,072

NOTE 8. GOODWILL AND OTHER INTANGIBLES

Goodwill by reportable segment and activity for the years ended November 29, 2019 and November 30, 2018 was as follows:

(in thousands)		2017				Acquisitions				Other**(1)**				2018				Acquisitions				Other**(1)**				2019
Digital Media		$	2,724,747			$	15,247			$	(2,481	)		$	2,737,513			$	125,899			$	(914	)		$	2,862,498
Digital Experience		2,838,390				4,775,969				(29,246		)		7,585,113				270				(15,103		)		7,570,280
Publishing		258,424				—				(2		)		258,422				—				(1		)		258,421
Goodwill		$	5,821,561			$	4,791,216			$	(31,729	)		$	10,581,048			$	126,169			$	(16,018	)		$	10,691,199

---

(1)	Amounts primarily consist of foreign currency translation adjustments.

Other intangibles, net, by reportable segment as of November 29, 2019 and November 30, 2018 were as follows:

(in thousands)		2019				2018
Digital Media		$	79,483			$	68,280
Digital Experience		1,640,925				2,000,718
Publishing		157				3
Other intangibles, net		$	1,720,565			$	2,069,001

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Certain goodwill and other intangibles were misclassified between Digital Media and Digital Experience in the prior year, which have been recast in the above tables. The impact to our prior year disclosures was immaterial and there was no impact to the Consolidated Financial Statements resulting from the change in classification.

Other intangibles, net, as of November 29, 2019 and November 30, 2018 were as follows:

(in thousands)	2019												2018
	Cost				Accumulated Amortization				Net				Cost				Accumulated Amortization				Net
Customer contracts and relationships	$	1,219,029			$	(436,545	)		$	782,484			$	1,329,432			$	(416,176	)		$	913,256
Purchased technology	759,111				(223,115		)		535,996				750,286				(118,812		)		631,474
Trademarks	384,300				(73,546		)		310,754				384,855				(25,968		)		358,887
Backlog	143,400				(75,570		)		67,830				147,300				(13,299		)		134,001
Acquired rights to use technology	59,524				(46,823		)		12,701				58,966				(48,770		)		10,196
Other	23,745				(12,945		)		10,800				51,096				(29,909		)		21,187
Other intangibles, net	$	2,589,109			$	(868,544	)		$	1,720,565			$	2,721,935			$	(652,934	)		$	2,069,001

In fiscal 2019, and 2018, certain intangibles associated with our acquisitions in prior years became fully amortized and were removed from the Consolidated Balance Sheets.

Amortization expense related to other intangibles was $402.3 million, $182.6 million and $153.6 million for fiscal 2019, 2018 and 2017 respectively. Of these amounts, $227.0 million, $91.3 million and $76.1 million were included in cost of sales for fiscal 2019, 2018 and 2017 respectively.

Other intangibles are amortized over their estimated useful lives of 1 to 15 years. As of November 29, 2019, we expect the estimated aggregate amortization expense for each of the five succeeding fiscal years to be as follows:

(in thousands)		Other Intangibles
2020		$	364,683
2021		254,921
2022		222,810
2023		214,188
2024		201,953
Thereafter		462,010
Total expected amortization expense		$	1,720,565

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. ACCRUED EXPENSES

Accrued expenses as of November 29, 2019 and November 30, 2018 consisted of the following:

(in thousands)	2019				2018
Accrued compensation and benefits	$	317,897			$	313,874
Accrued bonuses	222,333				216,007
Accrued media costs	117,591				124,849
Accrued building rent	98,570				61,544
Taxes payable	82,988				57,525
Accrued corporate marketing	79,937				66,186
Sales and marketing allowances	74,163				44,968
Royalties payable	61,938				51,529
Fair value of derivatives	32,531				816
Accrued interest expense	28,878				29,481
Other	281,722				196,406
Accrued expenses	$	1,398,548			$	1,163,185

Accrued media costs primarily relate to our advertising platform offerings. We accrue for media costs related to impressions purchased from third-party ad inventory sources. Other primarily includes general corporate accruals for local and regional expenses and sales returns reserves.

NOTE 10. INCOME TAXES

Income before income taxes for fiscal 2019, 2018 and 2017 consisted of the following:

(in thousands)		2019				2018				2017
Domestic		$	437,603			$	542,948			$	1,056,156
Foreign		2,767,138				2,250,928				1,081,485
Income before income taxes		$	3,204,741			$	2,793,876			$	2,137,641

The provision for income taxes for fiscal 2019, 2018 and 2017 consisted of the following:

(in thousands)		2019				2018				2017
Current:
United States federal		$	6,563			$	501,272			$	298,802
Foreign		211,174				140,308				60,962
State and local		30,893				28,612				33,578
Total current		248,630				670,192				393,342
Deferred:
United States federal		22,528				(466,113		)		48,905
Foreign		(11,675		)		(9,734		)		(4,242		)
State and local		(6,200		)		8,757				5,682
Total deferred		4,653				(467,090		)		50,345
Provision for income taxes		$	253,283			$	203,102			$	443,687

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

U.S. Tax Reform

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law, which significantly changed existing U.S. tax law and includes many provisions applicable to us, such as reducing the U.S. federal statutory tax rate, imposing a one-time transition tax on deemed repatriation of deferred foreign income and adopting a territorial tax system. The Tax Act reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. For fiscal 2018, our blended U.S. federal statutory tax rate was 22.2%. This was the result of using the tax rate of 35% for the first month of fiscal 2018 and the reduced tax rate of 21% for the remaining eleven months of fiscal 2018. The Tax Act also required us to incur a one-time transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income, in each case reduced by certain foreign tax credits. The Tax Act also included a provision to tax global intangible low-taxed income of foreign subsidiaries, a special tax deduction for foreign-derived intangible income and a base erosion anti-abuse tax measure that may tax certain payments between a U.S. corporation and its subsidiaries. These additional provisions of the Tax Act were effective for us beginning December 1, 2018.

During fiscal 2018, we recorded tax charges for the impact of the Tax Act using the current available information and technical guidance on the interpretations of the Tax Act. The accounting analysis was finalized based on the guidance, interpretations and data available as of November 30, 2018.

Certain international provisions introduced in the Tax Act are effective for us starting in fiscal 2019. As part of these provisions, an accounting policy election is available to either account for the tax effects of certain taxes in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We elected to account for the tax effects of these provisions in the period that it is subject to such tax.

Reconciliation of Provision for Income Taxes

Total income tax expense differs from the expected tax expense (computed by multiplying the U.S. federal statutory rate of 21% in 2019, 22.2% in 2018 and 35% in 2017 by income before income taxes) as a result of the following:

(in thousands)		2019				2018				2017
Computed “expected” tax expense		$	672,996			$	620,240			$	748,174
State tax expense, net of federal benefit		23,510				25,214				25,131
Tax credits		(99,772		)		(110,849		)		(38,000		)
Effects of non-U.S. operations		(224,214		)		(384,393		)		(215,490		)
Stock-based compensation, net of tax deduction		(85,944		)		(95,372		)		(42,512		)
Resolution of income tax examinations		(39,291		)		(42,432		)		(31,358		)
Domestic manufacturing deduction benefit		—				(13,098		)		(32,200		)
Impacts of the U.S. Tax Act		2,955				185,997				—
Tax charge for licensing acquired company technology to foreign subsidiaries		—				—				24,771
Other		3,043				17,795				5,171
Provision for income taxes		$	253,283			$	203,102			$	443,687

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Deferred Tax Assets and Liabilities

The tax effects of the temporary differences that gave rise to significant portions of the deferred tax assets and liabilities as of November 29, 2019 and November 30, 2018 are presented below:

(in thousands)		2019				2018
Deferred tax assets:
Acquired technology		$	4,568			$	9,561
Reserves and accruals		53,796				59,100
Deferred revenue		12,036				37,690
Stock-based compensation		106,911				89,240
Net operating loss carryforwards of acquired companies		137,151				209,445
Credit carryforwards		252,074				173,748
Capitalized expenses		44,912				19,074
Benefits relating to tax positions		47,458				51,965
Other		32,794				37,160
Total gross deferred tax assets		691,700				686,983
Deferred tax asset valuation allowance		(244,432		)		(174,496		)
Total deferred tax assets		447,268				512,487
Deferred tax liabilities:
Depreciation and amortization		36,458				40,425
Undistributed earnings of foreign subsidiaries		51,883				17,556
Prepaid expenses		86,279				—
Acquired intangible assets		413,146				501,208
Total deferred tax liabilities		587,766				559,189
Net deferred tax liabilities		$	140,498			$	46,702

Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Included in the deferred tax assets and liabilities for fiscal 2019 and 2018 are amounts related to various acquisitions. In assessing the realizability of deferred tax assets, management determined that it is not more likely than not that we will have sufficient taxable income in certain states and foreign jurisdictions to fully utilize available tax credits and other attributes. The deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized.

We provide U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States or are exempted from taxation as a result of the new territorial tax system. To the extent that the foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings. As of November 29, 2019, the cumulative amount of foreign earnings upon which U.S. income taxes have not been provided, and the corresponding unrecognized deferred tax liability, is not material.

As of November 29, 2019, we have net operating loss carryforwards of approximately $421.6 million for federal, $374.5 million for state and $82.6 million for foreign. We also have federal, state and foreign tax credit carryforwards of approximately $44.4 million, $243.8 million and $15.1 million, respectively. The net operating loss carryforward assets and tax credits will expire in various years from fiscal 2020 through 2038. The majority of the state tax credit carryforwards and a portion of the federal net operating loss carryforwards can be carried forward indefinitely. The net operating loss carryforward assets and certain credits are reduced by the valuation allowance and are subject to an annual limitation under Internal Revenue Code Section 382. The carrying amount of such assets and credits is expected to be fully realized.

As of November 29, 2019, a valuation allowance of $244.4 million has been established for certain deferred tax assets related to certain federal, state and foreign assets. For fiscal 2019, the total change in the valuation allowance was $69.9 million.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Accounting for Uncertainty in Income Taxes

During fiscal 2019 and 2018, our aggregate changes in our total gross amount of unrecognized tax benefits are summarized as follows:

(in thousands)		2019				2018
Beginning balance		$	196,152			$	172,945
Gross increases in unrecognized tax benefits – prior year tax positions		14,850				16,191
Gross decreases in unrecognized tax benefits – prior year tax positions		(2,282		)		(4,000		)
Gross increases in unrecognized tax benefits – current year tax positions		18,526				60,721
Gross decreases in unrecognized tax benefits – current year tax positions		(2,879		)		—
Settlements with taxing authorities		(230		)		—
Lapse of statute of limitations		(49,813		)		(45,922		)
Foreign exchange gains and losses		(987		)		(3,783		)
Ending balance		$	173,337			$	196,152

The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately $25.1 million and $24.6 million for fiscal 2019 and 2018, respectively. These amounts were included in long-term income taxes payable in their respective years.

We file income tax returns in the United States on a federal basis and in many U.S. state and foreign jurisdictions. We are subject to the continual examination of our income tax returns by the U.S. Internal Revenue Service (“IRS”) and other domestic and foreign tax authorities. Our major tax jurisdictions are Ireland, California and the United States. For Ireland, California and the United States, the earliest fiscal years open for examination are 2008, 2015 and 2016, respectively. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. We believe such estimates to be reasonable; however, there can be no assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position.

The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of our tax assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from $0 to approximately $20 million.

NOTE 11. BENEFIT PLANS

Retirement Savings Plan

In 1987, we adopted an Employee Investment Plan, qualified under Section 401(k) of the Internal Revenue Code, which is a retirement savings plan covering substantially all of our U.S. employees, now referred to as the Adobe Inc. 401(k) Retirement Savings Plan. Under the plan, eligible employees may contribute up to 65% of their pretax or after-tax salary, subject to the IRS annual contribution limits. In fiscal 2019, we matched 50% of the first 6% of the employee’s eligible compensation. We contributed $51.7 million, $41.0 million and $34.3 million in fiscal 2019, 2018 and 2017, 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

On September 21, 2006, the Board of Directors approved the Adobe Inc. Deferred Compensation Plan, effective December 2, 2006 (the “Deferred Compensation Plan”). The Deferred Compensation Plan is an unfunded, non-qualified, deferred compensation arrangement under which certain executives and members of the Board of Directors 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, performance awards, time-based restricted stock units and directors’ fees. Participants are able

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

to elect the payment of benefits to begin on a specified date at least three years after the end of the plan year in which election is made or vests. For cash benefit elections, distributions are made in cash and in the form of a lump sum, or five, ten, or fifteen-year annual installments. For stock benefit elections, distributions are settled in stock and in the form of a lump sum payment only. Beginning January 1, 2020, our updated Deferred Compensation Plan will no longer allow participants, except our Board of Directors, to make stock benefit elections.

As of November 29, 2019 and November 30, 2018, the invested amounts under the Deferred Compensation Plan total $93.8 million and $69.0 million, respectively and were recorded as other assets on our Consolidated Balance Sheets. As of November 29, 2019 and November 30, 2018, $108.8 million and $84.0 million, respectively, were recorded as long-term liabilities to recognize undistributed deferred compensation due to employees.

NOTE 12. STOCK-BASED COMPENSATION

Our stock-based compensation programs are long-term retention programs that are intended to attract, retain and provide incentives for employees, officers and directors, and to align stockholder and employee interests. We have the following stock-based compensation plans and programs:

Restricted Stock Units

Prior to April 2019, we granted restricted stock units and performance awards to eligible employees under our 2003 Equity Incentive Plan, as amended (“2003 Plan”). In April 2019, our stockholders approved the 2019 Equity Incentive Plan (“2019 Plan”) which replaced the 2003 Plan.

Beginning January 2019, restricted stock units granted as part of our annual review process or for promotions vest over four years. Restricted stock units granted as part of our annual review process or for promotions with grant dates prior to January 2019 continue to vest over three years. Restricted stock units granted to new hires generally vest over four years. Certain grants have other vesting periods approved by our Board of Directors or an authorized committee. We grant performance awards to officers and key employees which cliff-vest after three years.

As of November 29, 2019, we had reserved 46.0 million shares of common stock for issuance under our 2019 Plan and had 44.1 million shares available for grant.

Employee Stock Purchase Plan

Our 1997 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 a twenty-four-month offering period with four six-month purchase periods in each offering period. Employees purchase shares in each purchase period at 85% of the market value of our common stock at either the beginning of the offering period or the end of the purchase period, whichever price is lower. The ESPP will continue until the earlier of termination by the Board of Directors or the date on which all of the shares available for issuance under the plan have been issued.

As of November 29, 2019, we had reserved 93.0 million shares of our common stock for issuance under the ESPP and approximately 3.8 million shares remain available for future issuance.

Performance Share Programs

Our 2019, 2018 and 2017 Performance Share Programs aim to help focus key employees on building stockholder value, provide significant award potential for achieving outstanding Company performance and enhance the ability of the Company to attract and retain highly talented and competent individuals. The Executive Compensation Committee of our Board of Directors approves the terms of each of our Performance Share Programs, including the award calculation methodology, under the terms of our 2003 Plan. Shares may be earned based on the achievement of an objective relative total stockholder return measured over a three-year performance period. Performance share awards will be awarded and fully vest upon the later of the Executive Compensation Committee's certification of the level of achievement or the three-year anniversary of each grant. Program participants generally have the ability to receive up to 200% of the target number of shares originally granted.

On January 24, 2018, the Executive Compensation Committee approved the 2019 Performance Share Program, the terms of which are similar to prior year performance share programs as discussed above.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

As of November 29, 2019, the shares awarded under our 2019, 2018 and 2017 Performance Share Programs remain outstanding and are yet to be achieved.

Issuance of Shares

Upon vesting of restricted stock units and performance shares, purchases of shares under the ESPP and exercise of stock options, 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 exercises of stock options and vesting of restricted stock units and performance shares, we instituted a stock repurchase program. See Note 14 for information regarding our stock repurchase programs.

Valuation of Stock-Based Compensation

Stock-based compensation cost is measured at the grant date based on the fair value of the award.

Our performance share awards are valued using a Monte Carlo Simulation model. The fair value of the awards are fixed at grant date and amortized over the longer of the remaining performance or service period.

We use the Black-Scholes option pricing model to determine the fair value of ESPP shares. The determination of the fair value of stock-based payment awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, a risk-free interest rate and any expected dividends.

The expected term of ESPP shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights were as follows:

	2019		2018		2017
Expected life (in years)	0.5 - 2.0		0.5 - 2.0		0.5 - 2.0
Volatility	30% - 35%		26% - 29%		22% - 27%
Risk free interest rate	1.78% - 2.47%		1.54% - 2.52%		0.62% - 1.41%

Summary of Restricted Stock Units

Restricted stock unit activity for fiscal 2019, 2018 and 2017 was as follows:

(in thousands)	2019			2018			2017
Beginning outstanding balance	8,668			9,304			8,316
Awarded	4,598			4,012			5,018
Released	(3,847	)		(3,988	)		(3,859	)
Forfeited	(785	)		(660	)		(766	)
Increase due to acquisition	—			—			595
Ending outstanding balance	8,634			8,668			9,304

The weighted average grant date fair values of restricted stock units granted during fiscal 2019, 2018 and 2017 were $253.91, $208.73 and $120.33, respectively. The total fair value of restricted stock units vested during fiscal 2019, 2018 and 2017 was $969.6 million, $837.3 million and $472.0 million, respectively.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Information regarding restricted stock units outstanding at November 29, 2019, November 30, 2018 and December 1, 2017 is summarized below:

	Number of Shares (thousands)			Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value**(*)** (millions)
2019
Restricted stock units outstanding	8,634			1.12		$	2,672.6
Restricted stock units expected to vest	7,987			1.05		$	2,472.2
2018
Restricted stock units outstanding	8,668			1.06		$	2,174.7
Restricted stock units expected to vest	8,049			1.01		$	2,019.5
2017
Restricted stock units outstanding	9,304			1.11		$	1,670.2
Restricted stock units expected to vest	8,608			1.05		$	1,545.3

---

(*)	The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of November 29, 2019, November 30, 2018 and December 1, 2017 were $309.53, $250.89 and $179.52, respectively.

Summary of Performance Shares

Performance share activity for fiscal 2019, 2018 and 2017 was as follows:

(in thousands)	2019						2018						2017
	Shares Granted (1)			Maximum Shares Eligible to Receive			Shares Granted (2)			Maximum Shares Eligible to Receive			Shares Granted (3)			Maximum Shares Eligible to Receive
Beginning outstanding balance	1,148			2,296			1,534			3,068			1,630			3,261
Awarded	722			614			837			628			1,082			1,040
Achieved	(830	)		(830	)		(1,050	)		(1,053	)		(1,135	)		(1,147	)
Forfeited	(82	)		(164	)		(173	)		(347	)		(43	)		(86	)
Ending outstanding balance	958			1,916			1,148			2,296			1,534			3,068

---

(1)	Shares awarded during fiscal 2019 include 0.4 million additional shares awarded for the final achievement of the 2016 Performance Share Program which was certified in the first quarter of fiscal 2019. The remaining awarded shares were for the 2019 Performance Share Program. Shares achieved during fiscal 2019 resulted from 200% achievement of target for the 2016 Performance Share Program.

(2)	Shares awarded during fiscal 2018 include 0.5 million additional shares awarded for the final achievement of the 2015 Performance Share Program which was certified in the first quarter of fiscal 2018. The remaining awarded shares were for the 2018 Performance Share Program. Shares achieved during fiscal 2018 resulted from 200% achievement of target for the 2015 Performance Share Program.

(3)	Shares awarded during fiscal 2017 include 0.6 million additional shares awarded for the final achievement of the 2014 Performance Share Program which was certified in the first quarter of fiscal 2017. The remaining awarded shares were for the 2017 Performance Share Program. Shares achieved during fiscal 2017 resulted from 198% achievement of target for the 2014 Performance Share Program.

The total fair value of performance awards vested during fiscal 2019, 2018 and 2017 was $203.8 million, $208.2 million and $127.4 million, respectively.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Summary of Employee Stock Purchase Plan Shares

The weighted average subscription date fair value of shares under the ESPP during fiscal 2019, 2018 and 2017 were $72.98, $53.12 and $29.86, respectively. Employees purchased 1.5 million shares at an average price of $150.55, 1.8 million shares at an average price of $104.94, and 1.9 million shares at an average price of $77.63 for fiscal 2019, 2018 and 2017, respectively. The intrinsic value of shares purchased during fiscal 2019, 2018 and 2017 was $178.8 million, $198.9 million and $97.7 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.

Grants to Executive Officers

All equity awards granted to executive officers are made after a review by and with the approval of the Executive Compensation Committee of the Board of Directors.

Grants to Non-Employee Directors

Although the 2003 and 2019 Plans provide for the granting of non-qualified stock options and restricted stock units to non-employee directors, restricted stock units are the primary form of our grants to non-employee directors. The initial equity grant to new non-employee directors and annual equity grants to existing non-employee directors are restricted stock unit awards, each grant having an aggregate value of $0.3 million based on the average stock price over the 30 calendar days ending on the day before the date of grant and vest 100% on the day preceding the next annual meeting. The actual target grant value of initial equity grants will be prorated based on the number of days remaining before the next annual meeting or the date of the first anniversary of our last annual meeting if the next annual meeting is not yet scheduled.

Restricted stock units granted to directors for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)	2019			2018			2017
Annual equity grants to existing directors	10			11			18
Initial equity grants to new directors	1			1			—

Compensation Costs

We recognize the estimated compensation cost of restricted stock units, net of estimated forfeitures, on a straight-line basis over the requisite service period of the entire award, which is generally the vesting period. The estimated compensation cost is based on the fair value of our common stock on the date of grant.

We also recognize the estimated compensation cost of performance shares, net of estimated forfeitures, on a straight-line basis over the requisite performance period or service period of the entire award, whichever is longer. Our performance share awards are earned upon achievement of an objective total stockholder return measure at the end of the three-year performance period, as described above.

We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate forfeitures and record stock-based compensation expense only for those awards that are expected to vest.

As of November 29, 2019, there was $1.36 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 1.9 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Total stock-based compensation costs that have been included in our Consolidated Statements of Income for fiscal 2019, 2018 and 2017 were as follows:

(in thousands)	Income Statement Classifications
	Cost of Revenue– Subscription				Cost of Revenue– Services and Support				Research and Development				Sales and Marketing				General and Administrative				Total (1)
Restricted Stock Units and Performance Share Awards
2019	$	22,822			$	18,535			$	338,483			$	206,371			$	98,886			$	685,097
2018	$	17,515			$	12,111			$	253,078			$	178,548			$	77,462			$	538,714
2017	$	16,792			$	9,602			$	161,366			$	139,047			$	77,133			$	403,940
Stock Purchase Rights and Options
2019	$	5,823			$	7,271			$	36,663			$	42,405			$	10,446			$	102,608
2018	$	4,102			$	8,286			$	23,918			$	27,252			$	7,290			$	70,848
2017	$	180			$	6,661			$	20,126			$	18,592			$	4,973			$	50,532

---

(1)	During fiscal 2019, 2018 and 2017, we recorded tax benefits related to stock-based compensation costs of $248.4 million, $222.4 million and $153.2 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 2019 were as follows:

(in thousands)	November 30, 2018				Increase / Decrease				Reclassification Adjustments					November 29, 2019
Net unrealized gains / losses on available-for-sale securities:
Unrealized gains on available-for-sale securities	$	44			$	4,594			$	(171	)			$	4,467
Unrealized losses on available-for-sale securities	(25,374		)		24,815				295					(264		)
Total net unrealized gains / losses on available-for-sale securities	(25,330		)		29,409				124			(1	)	4,203
Net unrealized gains / losses on derivative instruments designated as hedging instruments	21,732				294				(44,334		)	(2	)	(22,308		)
Cumulative foreign currency translation adjustments	(144,532		)		(25,397		)		—					(169,929		)
Total accumulated other comprehensive income (loss), net of taxes	$	(148,130	)		$	4,306			$	(44,210	)			$	(188,034	)

---

(1)	Reclassification adjustments for gains / losses on available-for-sale securities are classified in interest and 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.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table sets forth the taxes related to each component of other comprehensive income for fiscal 2019, 2018 and 2017:

(in thousands)		2019				2018				2017
Available-for-sale securities:
Unrealized gains / losses		$	—			$	—			$	663
Reclassification adjustments		—				—				(491		)
Subtotal available-for-sale securities		—				—				172
Derivatives designated as hedging instruments:
Unrealized gains / losses		6,968				—				—
Reclassification adjustments		(383		)		(1,946		)		(732		)
Subtotal derivatives designated as hedging instruments		6,585				(1,946		)		(732		)
Foreign currency translation adjustments		—				(1,742		)		3,005
Total taxes, other comprehensive income (loss)		$	6,585			$	(3,688	)		$	2,445

NOTE 14. STOCK REPURCHASE PROGRAM

To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase shares in the open market or enter into structured repurchase agreements with third parties. In May 2018, our Board of Directors granted us an authority to repurchase up to $8 billion in common stock through the end of fiscal 2021.

During fiscal 2019, 2018 and 2017, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $2.75 billion, $2.05 billion, and $1.10 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 foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.

The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. We repurchased approximately 9.9 million shares at an average price of $270.23 per share in fiscal 2019, 8.7 million shares at an average price of $230.43 per share in fiscal 2018, and 8.2 million shares at an average price of $134.20 per share in fiscal 2017.

For fiscal 2019, 2018 and 2017, the prepayments were classified as treasury stock on our Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by November 29, 2019, November 30, 2018 and December 1, 2017 were excluded from the computation of earnings per share. As of November 29, 2019, $229.2 million of prepayments remained under the agreement.

Subsequent to November 29, 2019, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $850 million. This amount will be classified as treasury stock on our Consolidated Balance Sheets. Upon completion of the $850 million stock repurchase agreement, $4.25 billion remains under our May 2018 authority.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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, purchase rights, performance awards and stock options using the treasury stock method.

The following table sets forth the computation of basic and diluted net income per share for fiscal 2019, 2018 and 2017:

(in thousands, except per share data)		2019				2018				2017
Net income		$	2,951,458			$	2,590,774			$	1,693,954
Shares used to compute basic net income per share		486,291				490,564				493,632
Dilutive potential common shares:
Restricted stock units and performance share awards		4,875				7,142				7,161
Stock purchase rights and options		406				137				330
Shares used to compute diluted net income per share		491,572				497,843				501,123
Basic net income per share		$	6.07			$	5.28			$	3.43
Diluted net income per share		$	6.00			$	5.20			$	3.38
Anti-dilutive potential common shares (1)		175				209				141

---

(1)	Potential common stock equivalents not included in the calculation of diluted net income per share as the effect would have been anti-dilutive.

NOTE 16. COMMITMENTS AND CONTINGENCIES

Lease Commitments

We lease certain of our facilities and some of our equipment under non-cancellable operating lease arrangements that expire at various dates through 2031. We also have one land lease that expires in 2091. Rent expense includes base contractual rent and variable costs such as building expenses, utilities, taxes, insurance and equipment rental. Rent expense for these leases was approximately $170.5 million, $137.2 million and $115.4 million in fiscal 2019, 2018 and 2017, respectively. Our sublease income was immaterial for all periods presented.

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 and operating leases for each of the next five years and thereafter as of November 29, 2019:

(in thousands)						Operating Leases
Fiscal Year		Purchase Obligations				Future Minimum Lease Payments				Future Minimum Sublease Income
2020		$	545,042			$	98,200			$	9,523
2021		407,528				91,866				9,000
2022		528,266				81,493				6,362
2023		555,658				68,539				2,327
2024		—				60,691				—
Thereafter		—				337,903				—
Total		$	2,036,494			$	738,692			$	27,212

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Royalties

We have royalty commitments associated with the licensing of certain offerings and products. Royalty expense is generally based on a dollar amount per unit or a percentage of the underlying revenue. Royalty expense, which was recorded under our cost of revenue on our Consolidated Statements of Income, was approximately $153.7 million, $119.1 million and $100.9 million in fiscal 2019, 2018 and 2017, 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.

In addition to intellectual property disputes, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We consider all claims on a quarterly basis in accordance with GAAP and based on known facts assess whether potential losses are considered reasonably possible, 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 our Audit Committee and our independent registered public accounting firm.

We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in this note, we have determined that no provision for liability nor disclosure is required related to any claim against us because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial.

All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

In connection with our anti-piracy efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be negatively affected in any particular period by the resolution of one or more of these counter-claims.

NOTE 17. DEBT

Our debt as of November 29, 2019 and November 30, 2018 consisted of the following:

(in thousands)	2019				2018
Current debt:
Term loan	$	2,249,784			$	—
Notes	899,767				—
Fair value of interest rate swap	(208		)		—
Current debt	3,149,343				—
Long-term debt:
Term loan	—				2,248,427
Notes	988,924				1,886,117
Fair value of interest rate swap	—				(9,744		)
Long-term debt	988,924				4,124,800
Total carrying value of debt	$	4,138,267			$	4,124,800

Term Loan Credit Agreement

In October 2018, we entered into a credit agreement providing for an up to $2.25 billion senior unsecured term loan for the purpose of partially funding the purchase price for our acquisition of Marketo and the related fees and expenses incurred in connection with the acquisition. The Term Loan funds were received on October 31, 2018 upon closing of the acquisition and will mature 18 months following the initial funding date. In addition, we incurred issuance costs of $0.7 million which are amortized to interest expense over the term using the straight-line method. The Term Loan ranks equally with our other unsecured and unsubordinated indebtedness. There are no scheduled principal amortization payments prior to maturity and the Term Loan may be prepaid and terminated at our election at any time without penalty or premium. At our election, the Term Loan will bear interest at either (i) LIBOR plus a margin, based on our debt ratings, ranging from 0.500% to 1.000% or (ii) a base rate plus a margin, based on our debt ratings, ranging from 0.040% to 0.110%. Interest is payable periodically, in arrears, at the end of each interest period we elect. During fiscal 2019, we made interest payments on our Term Loan totaling $69.9 million. The Term Loan credit agreement contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions in favor of the lenders similar to those contained in the Revolving Credit Agreement, including the financial covenant. As of November 29, 2019, we were in compliance with all covenants. During the second quarter of fiscal 2019, we reclassified the Term Loan as current debt in our Consolidated Balance Sheets. As of November 29, 2019, the carrying value of the Term Loan was $2.25 billion which is net of debt issuance costs. We intend to refinance the Term Loan on or before the due date.

Senior Notes

In February 2010, we issued $900 million of 4.75% senior notes due February 1, 2020. Our proceeds were approximately $894.5 million which is net of an issuance discount of $5.5 million. In addition, we incurred issuance costs of $6.4 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2020 Notes using the effective interest method. The effective interest rate including the discount and issuance costs was 4.92%. Interest is payable semi-annually, in arrears, on February 1 and August 1, and commenced on August 1, 2010.

In June 2014, we entered into interest rate swaps with a total notional amount of $900 million designated as a fair value hedge related to our 2020 Notes. The interest rate swaps effectively convert the fixed interest rate on our 2020 Notes to a floating interest rate based on LIBOR. Under the terms of the swap, we will pay monthly interest at the one-month LIBOR interest rate

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

plus a fixed number of basis points on the $900 million notional amount. In exchange, we will receive 4.75% fixed rate interest from the swap counterparties. The fair value of the interest rate swaps is included in the carrying value of our debt in the Consolidated Balance Sheets. See Note 6 for further details regarding our interest rate swap derivatives.

In January 2015, we issued $1 billion of 3.25% senior notes due February 1, 2025 (the “2025 Notes”). Our proceeds were approximately $989.3 million which is net of an issuance discount of $10.7 million. In addition, we incurred issuance costs of $7.9 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2025 Notes using the effective interest method. The effective interest rate including the discount, issuance costs and interest rate agreement is 3.67%. Interest is payable semi-annually, in arrears on February 1 and August 1, and commenced on August 1, 2015.

During the first quarter of fiscal 2019, we reclassified the 2020 Notes as current debt in our Consolidated Balance Sheets. As of November 29, 2019, the carrying value of the 2020 Notes was $899.6 million which includes the fair value of the interest rate swap and is net of debt issuance costs. We intend to refinance the 2020 Notes on or before the due date.

As of November 29, 2019, our outstanding notes payable consist of the 2020 Notes and 2025 Notes (the “Notes”) with a total carrying value of $1.89 billion, which includes the fair value of the interest rate swaps and is net of debt issuance costs. Based on quoted prices in inactive markets, the fair value of the Notes was $1.96 billion as of November 29, 2019.

The 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 also include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances. As of November 29, 2019, we were in compliance with all of the covenants.

During fiscal 2019, we made semi-annual interest payments on our 2020 and 2025 Notes totaling $75.3 million.

In June 2019, in anticipation of refinancing our Term Loan and 2020 Notes, we entered into Treasury lock agreements with large financial institutions which fixed benchmark U.S. Treasury rates for an aggregate notional amount of $1 billion of our future debt issuance. These derivative instruments hedge the impact of changes in the benchmark interest rate to future interest payments and will be terminated upon debt issuance. These derivative instruments were designated as cash flow hedges. See Note 6 for further details regarding our Treasury lock agreements.

Revolving Credit Agreement

In October 2018, we entered into a credit agreement (“Revolving Credit Agreement”), providing for a five-year $1 billion senior unsecured revolving credit facility and incurred issuance costs of $0.8 million which are amortized to interest expense over the term using the straight-line method. The Revolving Credit Agreement provides for loans to Adobe and certain of its subsidiaries that may be designated from time to time as additional borrowers. Pursuant to the terms of the Revolving Credit Agreement, we may, subject to the agreement of lenders to provide additional commitments, obtain up to an additional $500 million in commitments, for a maximum aggregate commitment of $1.5 billion. At our election, loans under the Revolving Credit Agreement will bear interest at either (i) LIBOR plus a margin, based on our debt ratings, ranging from 0.585% to 1.015% or (ii) a base rate, which is defined as the highest of (a) the agent’s prime rate, (b) the federal funds effective rate plus 0.500% or (c) LIBOR plus 1.00% plus a margin, based on our debt ratings, ranging from 0.000% to 0.015%. In addition, facility fees determined according to our debt ratings are payable on the aggregate commitments, regardless of usage, quarterly in an amount ranging from 0.040% to 0.110% per annum. We are permitted to permanently reduce the aggregate commitment under the Revolving Credit Agreement at any time. Subject to certain conditions stated in the Revolving Credit Agreement, Adobe and any of its subsidiaries designated as additional borrowers may borrow, prepay and re-borrow amounts at any time during the term of the Revolving Credit Agreement.

The Revolving Credit Agreement contains customary representations, warranties, affirmative and negative covenants, including a financial covenant, events of default and indemnification provisions in favor of the lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, certain merger and acquisition transactions, dispositions and other matters, all subject to certain exceptions. The financial covenant, based on a quarterly financial test, requires us not to exceed a maximum leverage ratio.

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The facility will terminate and all amounts owing thereunder will be due and payable on the maturity date unless (a) the commitments are terminated earlier upon the occurrence of certain events, including an event of default, or (b) the maturity date is further extended upon our request, subject to the agreement of the lenders.

As of November 29, 2019, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants.

NOTE 18. NON-OPERATING INCOME (EXPENSE)

Non-operating income (expense) for fiscal 2019, 2018 and 2017 included the following:

(in thousands)	2019				2018				2017
Interest and other income (expense), net:
Interest income	$	68,321			$	92,540			$	66,069
Foreign exchange gains (losses)	(26,252		)		(42,612		)		(30,705		)
Realized gains on fixed income investments	171				655				1,673
Realized losses on fixed income investments	(295		)		(11,305		)		(725		)
Other	310				258				83
Interest and other income (expense), net	$	42,255			$	39,536			$	36,395
Interest expense	$	(157,214	)		$	(89,242	)		$	(74,402	)
Investment gains (losses), net:
Realized investment gains	$	46,141			$	6,128			$	3,279
Unrealized investment gains	5,572				—				4,274
Realized investment losses	(134		)		—				—
Unrealized investment losses	—				(2,915		)		—
Investment gains (losses), net	$	51,579			$	3,213			$	7,553
Non-operating income (expense), net	$	(63,380	)		$	(46,493	)		$	(30,454	)

ADOBE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 19. SELECTED QUARTERLY FINANCIAL DATA (unaudited)

	2019
(in thousands, except per share data)	Quarter Ended
	March 1				May 31				August 30				November 29
Revenue	$	2,600,946			$	2,744,280			$	2,834,126			$	2,991,945
Gross profit	$	2,203,660			$	2,336,792			$	2,418,163			$	2,539,962
Income before income taxes	$	702,334			$	710,772			$	834,488			$	957,147
Net income	$	674,241			$	632,593			$	792,763			$	851,861
Basic net income per share	$	1.38			$	1.30			$	1.63			$	1.76
Diluted net income per share	$	1.36			$	1.29			$	1.61			$	1.74

	2018
(in thousands, except per share data)	Quarter Ended
	March 2				June 1				August 31				November 30
Revenue	$	2,078,947			$	2,195,360			$	2,291,076			$	2,464,625
Gross profit	$	1,820,045			$	1,914,016			$	1,995,584			$	2,105,364
Income before income taxes	$	702,502			$	690,799			$	701,358			$	699,217
Net income	$	583,076			$	663,167			$	666,291			$	678,240
Basic net income per share	$	1.18			$	1.35			$	1.36			$	1.39
Diluted net income per share	$	1.17			$	1.33			$	1.34			$	1.37

Our fiscal year is a 52- or 53-week year that ends on the Friday closest to November 30. Each of the fiscal quarters presented were comprised of 13 weeks.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Adobe Inc.:

Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting

We have audited the accompanying consolidated balance sheets of Adobe Inc. and subsidiaries (the Company) as of November 29, 2019 and November 30, 2018, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended November 29, 2019, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of November 29, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of November 29, 2019 and November 30, 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended November 29, 2019, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of November 29, 2019 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for revenue from contracts with customers and sales commissions as of December 1, 2018, due to the adoption of Financial Accounting Standards Board’s Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, and Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Controls over Financial Reporting under item 9A. 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 judgment. 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.

Assessment of 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 primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s revenue recognition process, including controls related to the assessment of distinct performance obligations. We read the Creative Cloud and Document Cloud subscription offering agreements to understand the contractual terms and conditions. We participated in product demonstrations, examined marketing materials, and performed interviews with the Company’s product and engineering department to both understand and observe specific functionalities of the integrated offering and evaluate the nature of the promise made to the Company’s Creative Cloud and Document Cloud customers. We evaluated the features and functionalities of the Creative Cloud and Document Cloud subscription that can be accessed only when using the on-premise/on-device software while connected to the Adobe cloud to assess that customers receive the intended benefit from each solution only as an integrated offering.

(signed) KPMG LLP

We have served as the Company’s auditor since 1983.

Santa Clara, California

January 21, 2020