The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto. Discussion regarding our financial condition and results of operations for fiscal 2020 as compared to fiscal 2019 is included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended
November 27, 2020, filed with the SECon January 15, 2021. CRITICAL ACCOUNTING POLICIES AND ESTIMATES In preparing our Consolidated Financial Statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. We evaluate our assumptions, judgments and estimates on a regular basis. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, business combinations and income taxes have the greatest potential impact on our Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules requiring us to make judgments and estimates, and consequently, we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. Revenue Recognition Our contracts with customers may include multiple goods and services. For example, some of our offerings include both on-premise and/or on-device software licenses and cloud services. Determining whether the software licenses and the cloud services are distinct from each other, and therefore performance obligations to be accounted for separately, or not distinct from each other, and therefore part of a single performance obligation, may require significant judgment. We have concluded that the on-premise/on-device software licenses and cloud services provided in our Creative Cloud and Document Cloud subscription offerings are not distinct from each other such that revenue from each offering should be recognized ratably over the subscription period for which the cloud services are provided. In reaching this conclusion, we considered the nature of our promise to Creative Cloud and Document Cloud customers, which is to provide a complete end-to-end creative design or document workflow solution that operates seamlessly across multiple devices and teams. We fulfill this promise by providing access to a solution that integrates cloud-based and on-premise/on-device features that, together through their integration, provide functionalities, utility and workflow efficiencies that could not be obtained from either the on-premise/on-device software or cloud services on their own. Cloud-based features that are integral to our Creative Cloud and Document Cloud offerings and that work together with the on-premise/on-device software include, but are not limited to: Creative Cloud Libraries, which enable customers to access their work, settings, preferences and other assets seamlessly across desktop and mobile devices and collaborate across teams in real time; shared reviews which enable simultaneous editing and commenting of 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. Business Combinations We allocate the purchase price of acquired companies to tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets and deferred revenue obligations. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience, market conditions and information obtained from management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: •future expected cash flows from software license sales, subscriptions, support agreements, consulting contracts and acquired developed technologies and patents; •expected costs to develop acquired technologies and patents internally into commercially viable products; 38 -------------------------------------------------------------------------------- Table of Content s •historical and expected customer attrition rates and anticipated growth in revenue from acquired customers; •the acquired company's trade name and trademarks as well as assumptions about the period of time the acquired trade name and trademarks will continue to be used in the combined company's product portfolio; •the expected use of the acquired assets; and •discount rates. In connection with the purchase price allocations for our acquisitions, we estimate the fair value of the deferred revenue obligations assumed. The estimated fair value of these obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. Accounting for Income Taxes We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities. Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. In addition, we are subject to the examination of our income tax returns by the U.S. Internal Revenue Serviceand other domestic and foreign tax authorities. These tax examinations are expected to focus on our research and development tax credits, intercompany transfer pricing practices and other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. We believe such estimates to be reasonable; however, we cannot provide assurance that the final determination of any of these examinations will not have a significant impact on the amounts provided for income taxes in our Consolidated Financial Statements. Recent Accounting Pronouncements
See Note 1 of our Notes to the Consolidated Financial Statements for information on recent accounting pronouncements that are material, or potentially material, to us.
ACQUISITIONS In the fourth quarter of fiscal 2021, we completed the acquisition of Frame.io, a privately held company that provides a cloud-based video collaboration platform, for approximately
$1.18 billionand we began integrating Frame.io into our Digital Media reportable segment. In the first quarter of fiscal 2021, we completed the acquisition of Workfront, a privately held company that provides a workflow platform, for approximately $1.52 billionin cash consideration and we began integrating Workfront into our Digital Experience reportable segment.
See note 3 of our notes to the consolidated financial statements for more information on these acquisitions.
39 -------------------------------------------------------------------------------- Table of Content s RESULTS OF OPERATIONS Overview of 2021 For our fiscal 2021, we experienced strong demand across our Digital Media offerings consistent with the continued execution of our long-term plans with respect to this segment. In our Digital Experience segment, we continued to experience growth in software-based subscription revenue across our portfolio of offerings. Our financial results for fiscal 2021 benefited from an extra week in the first quarter of fiscal 2021 due to our 52/53 week financial calendar whereby fiscal 2021 is a 53-week year compared with fiscal 2020 and 2019 which were 52-week years. Digital Media In our Digital Media segment, we are a market leader with Creative Cloud, our subscription-based offering which provides desktop tools, mobile apps and cloud-based services for designing, creating and publishing rich and immersive content. Creative Cloud delivers value with deep, cross-product integration, frequent product updates and feature enhancements, cloud-enabled services including storage and syncing of files across users' machines, machine learning and artificial intelligence, access to marketplace, social and community-based features with our Adobe Stock and Behance services, app creation capabilities, tools which assist with enterprise deployments and team collaboration, and affordable pricing for cost-sensitive customers. We offer Creative Cloud for individuals, students, teams and enterprises. We expect Creative Cloud will drive sustained long-term revenue growth through a continued expansion of our customer base by attracting new users with new features and products, continuing to acquire users with our low cost of entry and delivery of additional features and value to Creative Cloud, and delivering new features and technologies to existing customers with our latest releases. We have also built out a marketplace for Creative Cloud subscribers to enable the delivery and purchase of stock content in our Adobe Stock service. Overall, our strategy with Creative Cloud is designed to enable us to increase our revenue with users, attract more new customers, and grow our recurring and predictable revenue stream that is recognized ratably. We continue to implement strategies that are designed to accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offerings. These strategies include increasing the value Creative Cloud users receive, such as offering new desktop and mobile applications, as well as targeted promotions and offers that attract past customers and potential users to experience and ultimately subscribe to Creative Cloud. Because of the shift towards Creative Cloud subscriptions and Enterprise Term License Agreements ("ETLAs"), revenue from perpetual licensing of our Creative products has been immaterial to our business. In
October 2021, we acquired Frame.io, a privately held company that provides a cloud-based video collaboration platform, and we began integrating Frame.io into our Digital Media segment. We are also a market leader with our Document Cloud offerings built around our Adobe Acrobat family of products, including Adobe Acrobat Reader DC, and a set of integrated mobile apps and cloud-based document services, including Adobe Scan and Adobe Sign. Acrobat provides reliable creation and exchange of electronic documents, regardless of platform or application source type. Document Cloud, which we believe enhances the way people manage critical documents at home, in the office and across devices, includes Adobe Acrobat DC and Adobe Sign, and a set of integrated services enabling users to create, review, approve, sign and track documents whether on a desktop or mobile device. Adobe Acrobat DC is offered both through subscription and perpetual licenses. As part of our Creative Cloud and Document Cloud strategies, we utilize a data-driven operating model ("DDOM") and our Adobe Experience Cloud solutions to raise awareness of our products, drive new customer acquisition, engagement and retention, and optimize customer journeys. As a result, we observed strong growth in Digital Media revenue during fiscal 2021. Annualized Recurring Revenue ("ARR") is currently the key performance metric our management uses to assess the health and trajectory of our overall Digital Media segment. ARR should be viewed independently of revenue, deferred revenue and remaining performance obligations as ARR is a performance metric and is not intended to be combined with any of these items. We adjust our reported ARR on an annual basis to reflect any exchange rate changes. Our reported ARR results in the 40 -------------------------------------------------------------------------------- Table of Content s
the current financial year are based on the exchange rates fixed at the beginning of the year and kept constant throughout the year. We calculate ARR as follows:
Annual Value of Creative Cloud Subscriptions and Services Creative ARR + Annual Creative ETLA Contract Value Annual Value of Document Cloud Subscriptions and Services Document Cloud ARR + Annual Document Cloud ETLA Contract Value Creative ARR Digital Media ARR + Document Cloud ARR Creative ARR exiting fiscal 2021 was
$10.30 billion, up from $8.78 billionat the end of fiscal 2020. Document Cloud ARR exiting fiscal 2021 was $1.93 billion, up from $1.47 billionat the end of fiscal 2020. Total Digital Media ARR grew to $12.24 billionat the end of fiscal 2021, up from $10.26 billionat the end of fiscal 2020. Revaluing our ending ARR for fiscal 2021 using currency rates at the beginning of fiscal 2022, our Digital Media ARR at the end of fiscal 2021 would be $12.15 billionor approximately $86 millionlower than the ARR reported above. Our success in driving growth in ARR has positively affected our revenue growth. Creative revenue in fiscal 2021 was $9.55 billion, up from $7.74 billionin fiscal 2020 and representing 23% year-over-year growth. Document Cloud revenue in fiscal 2021 was $1.97 billion, up from $1.50 billionin fiscal 2020 and representing 32% year-over-year growth which reflected an increase in demand driven by new user acquisition for our Document Cloud subscription offerings. Total Digital Media segment revenue grew to $11.52 billionin fiscal 2021, up from $9.23 billionin fiscal 2020 and representing 25% year-over-year growth. These increases were driven by strong net new user growth, including those resulting from the current work-from-home environment reflecting expanded digital engagement. Digital Experience We are a market leader in the fast-growing category addressed by our Digital Experience segment. The Adobe Experience Cloud applications, services and platform are designed to manage customer journeys, enable shoppable experiences and deliver intelligence for businesses of any size in any industry. Our differentiation and competitive advantage is strengthened by our ability to use the Adobe Experience Platform to connect our comprehensive set of solutions. In December 2020, we acquired Workfront, a privately held company that provides a workflow platform, and integrated Workfront into our Digital Experience segment. Adobe Experience Cloud delivers solutions for our customers across the following strategic growth pillars: •Data insights and audiences. Our solutions, including Adobe Analytics, Adobe Experience Platform, Customer Journey Analytics, Adobe Audience Manager and our Real-time Customer Data Platform, deliver robust customer profiles and AI-powered analytics across the customer journey to provide timely, relevant experiences across platforms. •Content and commerce. Our solutions help customers manage, deliver and optimize content delivery, through Adobe Experience Manager and to enable shopping experiences that scale from mid-market to enterprise businesses, with Adobe Commerce. •Customer journeys. Our solutions help businesses manage, test, target, personalize and orchestrate campaigns and customer journeys across B2E use cases, including through Marketo Engage, Adobe Campaign, Adobe Target and Journey Optimizer. •Marketing workflow. We offer Adobe Workfront, a work management platform directed toward marketers to orchestrate campaign workflows. In addition to chief marketing officers, chief revenue officers and digital marketers, users of our Digital Experience solutions include advertisers, campaign managers, publishers, data analysts, content managers, social marketers, marketing executives and information management and technology executives. These customers often are involved in workflows that utilize other Adobe products, such as our Digital Media offerings. By combining the creativity of our Digital Media business 41 -------------------------------------------------------------------------------- Table of Content s with the science of our Digital Experience business, we help our customers to more efficiently and effectively make, manage, measure and monetize their content across every channel with an end-to-end workflow and feedback loop. We utilize a direct sales force to market and license our Digital Experience solutions, as well as an extensive ecosystem of partners, including marketing agencies, systems integrators and independent software vendors that help license and deploy our solutions to their customers. We have made significant investments to broaden the scale and size of all of these routes to market, and our recent financial results reflect the success of these investments. Digital Experience revenue was $3.87 billionin fiscal 2021, up from $3.13 billionin fiscal 2020 which represents 24% year-over-year growth. Driving this increase was the increase in subscription revenue across our offerings which grew to $3.38 billionin fiscal 2021 from $2.66 billionin fiscal 2020, representing 27% year-over-year growth. Also contributing to the increase in Digital Experience subscription revenue was revenue associated with Workfront's workflow platform offerings. We expect that the addition of Workfront, and continued demand across our portfolio of Digital Experience solutions, will drive revenue growth in future years. COVID-19 UPDATE The COVID-19 pandemic continues to have widespread, rapidly-evolving and unpredictable impacts on global societies, economies, financial markets and business practices. As conditions fluctuate around the world, with vaccine administration rising in certain regions, governments and organizations have responded by adjusting their restrictions and guidelines accordingly. Our focus remains on promoting employee health and safety, serving our customers and ensuring business continuity. We carefully assess, and reassess, conditions on a case-by-case basis to determine when employees can safely return to our offices and resume business travel. As a result, we have reopened our offices in areas with sustained low infection rates and are allowing fully vaccinated employees to return on a voluntary basis. In addition, we are implementing our reimagined framework for the future of work at Adobe, which is rooted in a flexible and hybrid model enabled by a digital-first mindset. During the pandemic, digital has become the primary way for people to connect, work, learn and be entertained, and for businesses to engage with customers. This ongoing shift to a digital-first world has increased the importance and relevance of our solutions, which has contributed to our continued growth year over year. However, while our revenue and earnings are relatively predictable as a result of our subscription-based business model, the duration of the pandemic and the broader implications of the macro-economic recovery on our business remain uncertain. S ee the section titled " Risk Factors " in Part I, Item 1A of this report fo r further discussion of the possible impact of the pandemic on our business. Financial Performance Summary for Fiscal 2021 Our financial results for fiscal 2021 benefited from an extra week in the first quarter of fiscal 2021 due to our 52/53 week financial calendar whereby fiscal 2021 is a 53-week year compared with fiscal 2020 and 2019 which were 52-week years. •Total Digital Media ARR of approximately $12.24 billionas of December 3, 2021increased by $1.98 billion, or 19%, from $10.26 billionas of November 27, 2020. The change in our Digital Media ARR was primarily due to new user adoption of our Creative Cloud and Document Cloud offerings. •Creative revenue of $9.55 billionincreased by $1.81 billion, or 23%, during fiscal 2021, from $7.74 billionin fiscal 2020. Document Cloud revenue of $1.97 billionincreased by $477 million, or 32%, during fiscal 2021, from $1.50 billionin fiscal 2020. The increases were primarily due to subscription revenue growth associated with our Creative Cloud and Document Cloud offerings. •Digital Experience revenue of $3.87 billionincreased by $742 million, or 24%, during fiscal 2021, from $3.13 billionin fiscal 2020. The increase was primarily due to subscription revenue growth across our offerings, including from our Workfront acquisition. •Remaining performance obligations of $13.99 billionas of December 3, 2021increased by $2.65 billion, or 23%, from $11.34 billionas of November 27, 2020, primarily due to new contracts and renewals for our Digital Media and Digital Experience offerings, as well as impacts from our Workfront acquisition. •Cost of revenue of $1.87 billionincreased by $143 million, or 8%, during fiscal 2021, from $1.72 billionin fiscal 2020 primarily due to increases in hosting services and data center costs, partially offset by decreases in Advertising Cloud media costs. •Operating expenses of $8.12 billionincreased by $1.21 billion, or 17%, during fiscal 2021, from $6.91 billionin fiscal 2020 primarily due to increases in base and incentive compensation and related benefits costs, as well as increased marketing spend. 42 -------------------------------------------------------------------------------- Table of Content s •Net income of $4.82 billiondecreased by $438 million, or 8%, during fiscal 2021 from $5.26 billionin fiscal 2020 primarily due to the change in provision for income taxes, which was largely driven by the non-recurring benefit from income taxes recognized in fiscal 2020 associated with our intra-entity transfers of certain intellectual property rights. To a lesser extent, net income was also impacted by increases in operating expenses, offset by increases in revenue. •Net cash flows from operations of $7.23 billionduring fiscal 2021 increased by $1.50 billion, or 26%, from $5.73 billionin fiscal 2020 primarily due to higher net income adjusted for the net effect of non-cash items and increases in deferred revenue, partially offset by increases in trade receivables. Revenue % Change (dollars in millions) 2021 2020 2019 2021-2020 Subscription $ 14,573 $ 11,626 $ 9,63425 % Percentage of total revenue 92 % 90 % 86 % Product 555 507 648 9 % Percentage of total revenue 4 % 4 % 6 % Services and other 657 735 889 (11) % Percentage of total revenue 4 % 6 % 8 % Total revenue $ 15,785 $ 12,868 $ 11,17123 % Subscription Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings, and related support, including Creative Cloud and certain of our Adobe Experience Cloud and Document Cloud services. We primarily recognize subscription revenue ratably over the term of agreements with our customers, beginning with commencement of service. Subscription revenue related to certain offerings, where fees are based on a number of transactions and invoicing is aligned to the pattern of performance, customer benefit and consumption, are recognized on a usage basis. We have the following reportable segments: Digital Media, Digital Experience, and Publishing and Advertising. Subscription revenue by reportable segment for fiscal 2021, 2020 and 2019 is as follows: % Change (dollars in millions) 2021 2020 2019 2021-2020 Digital Media $ 11,048 $ 8,813 $ 7,20825 % Digital Experience 3,379 2,660 2,280 27 % Publishing and Advertising 146 153 146 (5) % Total subscription revenue $ 14,573 $ 11,626 $ 9,63425 % Product Our product revenue is comprised primarily of fees related to licenses for on-premise software purchased on a perpetual basis, for a fixed period of time or based on usage for certain of our OEM and royalty agreements. We primarily recognize product revenue at the point in time the software is available to the customer, provided all other revenue recognition criteria are met. Services and Other Our services and other revenue is comprised primarily of fees related to consulting, training, maintenance and support for certain on-premise licenses that are recognized at a point in time and our advertising offerings. We typically sell our consulting contracts on a time-and-materials and fixed-fee basis. These revenues are recognized as the services are performed for time and materials contracts and on a relative performance basis for fixed-fee contracts. Training revenues are recognized as the services are performed. Our maintenance and support offerings, which entitle customers, partners and developers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement. Transaction-based advertising revenue is recognized on a usage basis as we satisfy the performance obligations to our customers. 43 -------------------------------------------------------------------------------- Table of Content s
In fiscal 2021, we categorized our products into the following reportable segments: •Digital Media-Our Digital Media segment provides products, services and solutions that enable individuals, teams and enterprises to create, publish and promote their content anywhere and accelerate their productivity by modernizing how they view, share, engage with and collaborate on documents and creative content. Our customers include creative professionals, including photographers, video editors, graphic and experience designers and game developers, communicators, including content creators, students, marketers and knowledge workers, and consumers. •Digital Experience-Our Digital Experience segment provides an integrated platform and set of applications and services that enable brands and businesses to create, manage, execute, measure, monetize and optimize customer experiences that span from analytics to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers and executives across the C-suite. •Publishing and Advertising-Our Publishing and Advertising segment contains legacy products and services that address diverse market opportunities, including eLearning solutions, technical document publishing, web conferencing, document and forms platform, web application development, high-end printing and our Adobe Advertising Cloud offerings. Segment Information % Change (dollars in millions) 2021 2020 2019 2021-2020 Digital Media
$ 11,520 $ 9,233 $ 7,70725 % Percentage of total revenue 73 % 72 % 69 % Digital Experience 3,867 3,125 2,795 24 % Percentage of total revenue 24 % 24 % 25 % Publishing and Advertising 398 510 669 (22) % Percentage of total revenue 3 % 4 % 6 % Total revenue $ 15,785 $ 12,868 $ 11,17123 % Digital Media Revenue by major offerings in our Digital Media reportable segment for fiscal 2021, 2020 and 2019 were as follows: % Change (dollars in millions) 2021 2020 2019 2021-2020 Creative Cloud $ 9,546 $ 7,736 $ 6,48223 % Document Cloud 1,974 1,497 1,225 32 % Total Digital Media revenue $ 11,520 $ 9,233 $ 7,70725 % Revenue from Digital Media increased $2.29 billionduring fiscal 2021 as compared to fiscal 2020, driven by increases in revenue associated with our Creative and Document Cloud subscription offerings due to continued demand amid an increasingly digital environment and expanding subscription base. Revenue associated with our Creative offerings, which includes our Creative Cloud, increased during fiscal 2021 primarily due to increases in net new subscriptions across our Creative Cloud offerings. Document Cloud revenue, which includes our Acrobat product family and Adobe Sign service, increased during fiscal 2021 primarily due to increases in subscription revenue driven by strong new user acquisition of our Document Cloud offerings. Digital Experience Revenue from Digital Experience increased $742 millionduring fiscal 2021, as compared to fiscal 2020 primarily due to subscription revenue growth across our offerings including from our Workfront acquisition. 44 --------------------------------------------------------------------------------
Table of Content s Geographical Information % Change (dollars in millions) 2021 2020 2019 2021-2020 Americas
$ 8,996 $ 7,454 $ 6,50621 % Percentage of total revenue 57 % 58 % 58 % EMEA 4,252 3,400 2,975 25 % Percentage of total revenue 27 % 26 % 27 % APAC 2,537 2,014 1,690 26 % Percentage of total revenue 16 % 16 % 15 % Total revenue $ 15,785 $ 12,868 $ 11,17123 % Overall revenue during fiscal 2021 increased in all geographic regions as compared to fiscal 2020 primarily due to increases in Digital Media revenue and, to a lesser extent, increases in Digital Experience revenue. Within each geographic region, the fluctuations in revenue by reportable segment were attributable to the factors noted in the segment information above. Included in the overall change in revenue for fiscal 2021 as compared to fiscal 2020 were impacts associated with foreign currency which were mitigated in part by our foreign currency hedging program. During fiscal 2021, the U.S.Dollar primarily weakened against EMEA currencies and the Australian Dollar as compared to fiscal 2020, which increased revenue in U.S.Dollar equivalents by $276 million. During fiscal 2021, the foreign currency impacts to revenue were offset in part by net hedging losses from our cash flow hedging program of $18 million. See Note 2 of our Notes to Consolidated Financial Statements for additional details of revenue by geography. Cost of Revenue % Change (dollars in millions) 2021 2020 2019 2021-2020 Subscription $ 1,374 $ 1,108 $ 92624 % Percentage of total revenue 9 % 9 % 8 % Product 41 36 40 14 % Percentage of total revenue * * * Services and other 450 578 707 (22) % Percentage of total revenue 3 % 4 % 6 % Total cost of revenue $ 1,865 $ 1,722 $ 1,6738 %
(*) Percentage is less than 1% Subscription Cost of subscription revenue consists of third-party hosting services and data center costs, including expenses related to operating our network infrastructure. Cost of subscription revenue also includes compensation costs associated with network operations, implementation, account management and technical support personnel, royalty fees, software costs and amortization of certain intangible assets. Cost of subscription revenue increased due to the following: Components of % Change 2021-2020 Hosting services and data center costs
Base compensation and similar benefits linked to the workforce
Incentive compensation, cash and stock-based 4 Royalty costs 3 Total change 24 % 45
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Cost of product revenue is primarily comprised of third-party royalties, amortization of certain intangible assets, localization costs and the costs associated with the manufacturing of our products. Services and Other Cost of services and other revenue is primarily comprised of compensation and contracted costs incurred to provide consulting services, training and product support, and hosting services and data center costs. Cost of services and other also includes media costs related to impressions purchased from third-party ad inventory sources for our transaction-based Adobe Advertising Cloud offerings. Cost of services and other decreased during fiscal 2021 as compared to fiscal 2020 mainly due to lower media costs related to Advertising Cloud offerings that were discontinued beginning in the second quarter of fiscal 2020. Operating Expenses % Change (dollars in millions) 2021 2020 2019 2021-2020 Research and development
$ 2,540 $ 2,188 $ 1,93016 % Percentage of total revenue 16 % 17 % 17 % Sales and marketing 4,321 3,591 3,244 20 % Percentage of total revenue 27 % 28 % 29 % General and administrative 1,085 968 881 12 % Percentage of total revenue 7 % 8 % 8 % Amortization of intangibles 172 162 175 6 % Percentage of total revenue 1 % 1 % 2 % Total operating expenses $ 8,118 $ 6,909 $ 6,23017 % Research and Development Research and development expenses consist primarily of compensation and contracted costs associated with software development, third-party hosting services and data center costs, related facilities costs and expenses associated with computer equipment and software used in development activities. Research and development expenses increased due to the following: Components of % Change 2021-2020 Incentive compensation, cash and stock-based 8 % Base compensation and related benefits associated with headcount
Professional and consulting fees 2 Total change 16 % We believe that investments in research and development, including the recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced offerings and solutions. We will continue to focus on long-term opportunities available in our end markets and make significant investments in the development of our subscription and service offerings, applications and tools. Sales and Marketing Sales and marketing expenses consist primarily of compensation costs, amortization of contract acquisition costs, including sales commissions, travel expenses and related facilities costs for our sales, marketing, order management and global supply chain management personnel. Sales and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows and events, public relations and other market development programs. 46 -------------------------------------------------------------------------------- Table of Content s
Sales and marketing expenses increased due to:
Components of % Change 2021-2020
Marketing spend related to campaigns, events and overall marketing efforts
10 % Incentive compensation, cash and stock-based 5 Base compensation and related benefits associated with headcount 3 Transaction fees 2 Total change 20 % General and Administrative General and administrative expenses consist primarily of compensation and contracted costs, travel expenses and related facilities costs for our finance, facilities, human resources, legal, information services and executive personnel. General and administrative expenses also include outside legal and accounting fees, provision for bad debts, expenses associated with computer equipment and software used in the administration of the business, charitable contributions and various forms of insurance. General and administrative expenses increased due to the following: Components of % Change 2021-2020 Incentive compensation, cash and stock-based
Base compensation and related benefits associated with headcount 4 Bad debt expense (4) Software licenses 2 Various individually insignificant items 1 Total change 12 % Amortization of Intangibles Amortization expense increased during fiscal 2021 as compared to fiscal 2020 primarily due to amortization expense associated with intangible assets purchased through our acquisition of Workfront. The increase in amortization expense is offset in part by the impact of certain intangible assets from previous acquisitions, including Marketo and
Omniture, becoming fully amortized in fiscal 2020. Non-Operating Income (Expense), Net % Change (dollars in millions) 2021 2020 2019 2021-2020 Interest expense $ (113) $ (116) $ (157)(3) % Percentage of total revenue (1) % (1) % (1) % Investment gains (losses), net 16 13 52 23 % Percentage of total revenue * * * Other income (expense), net - 42 42 ** Percentage of total revenue * * *
Total non-operating income (expense), net
(63) 59 %
(*) Percentage is less than 1%. (**) Percentage is not meaningful. Interest Expense Interest expense represents interest associated with our debt instruments. Interest on our senior notes is payable semi-annually, in arrears, on
February 1and August 1. 47 -------------------------------------------------------------------------------- Table of Content s Interest expense decreased during fiscal 2021 as compared to fiscal 2020 primarily due to lower average interest rates on our debt instruments that were refinanced in the first quarter of fiscal 2020. See Note 17 of our Notes to Consolidated Financial Statements for further details regarding our debt instruments. Investment Gains (Losses), Net Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets, and gains and losses associated with our direct and indirect investments in privately held companies. Other Income (Expense), Net Other income (expense), net consists primarily of interest earned on cash, cash equivalents and short-term fixed income investments. Other income (expense), net also includes realized gains and losses on fixed income investments and foreign exchange gains and losses. Other income (expense), decreased during fiscal 2021 primarily due to decreases in interest income driven by lower average interest rates and increases in foreign exchange losses. Provision for (Benefit from) Income Taxes % Change (dollars in millions) 2021 2020 2019 2021-2020 Provision for (benefit from) income taxes $ 883 $ (1,084) $ 254** Percentage of total revenue 6 % (8) % 2 % Effective tax rate 15 % (26) % 8 %
(**) Percentage is not meaningful. Our effective tax rate increased by approximately 41 percentage points during fiscal 2021 as compared to fiscal 2020. The higher effective tax rate was primarily due to the non-recurring tax benefits recognized during fiscal 2020 as a result of the change in our corporate tax trading structure, and the corresponding change in geographic mix of international income in fiscal 2021. Our effective tax rate for fiscal 2021 was lower than the
U.S.federal statutory tax rate of 21% primarily due to tax benefits related to stock-based compensation. During fiscal 2020, we completed intra-entity transfers of certain IP rights to our Irish subsidiary in order to better align the ownership of these rights with how our business operates. The transfers did not result in taxable gains; however, our Irish subsidiary recognized deferred tax assets for the book and tax basis difference of the transferred IP rights. As a result of these transactions, we recorded deferred tax assets, net of valuation allowance, and related tax benefits totaling $1.35 billion, based on the fair value of the IP rights transferred. The tax-deductible amortization related to the transferred IP rights is recognized over the period of economic benefit. We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, we considered all available positive and negative evidence, including our past operating results, forecasted earnings, future taxable income and prudent and feasible tax planning strategies. On the basis of this evaluation, we continue to maintain a valuation allowance to reduce our deferred tax assets to the amount realizable. The total valuation allowance was $335 millionas of December 3, 2021, primarily attributable to certain state credits and foreign intangible assets. We are a United States-based multinational company subject to tax in multiple U.S.and foreign tax jurisdictions. The current U.S.tax law subjects the earnings of certain foreign subsidiaries to U.S.tax and generally allows an exemption from taxation for distributions from foreign subsidiaries. In the current global tax policy environment, the U.S. Treasuryand other domestic and foreign governing bodies continue to consider, and in some cases introduce, changes in regulations applicable to corporate multinationals such as Adobe. As regulations are issued, we account for finalized regulations in the period of enactment.
See note 10 of our notes to the consolidated financial statements for further information regarding our provision for (benefit from) income taxes.
48 -------------------------------------------------------------------------------- Table of Content s Accounting for Uncertainty in Income Taxes The gross liabilities for unrecognized tax benefits excluding interest and penalties were
$289 million, $201 millionand $173 millionfor fiscal 2021, 2020 and 2019, respectively. If the total unrecognized tax benefits at December 3, 2021, November 27, 2020and November 29, 2019were recognized, $199 million, $136 millionand $116 millionwould decrease the respective effective tax rates. The combined amounts of accrued interest and penalties related to tax positions taken on our tax returns were approximately $22 millionand $26 millionfor fiscal 2021 and 2020, respectively. These amounts were included in long-term income taxes payable in their respective years. The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of our tax assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from $0to approximately $5 millionover the next 12 months. In addition, in the United Statesand other countries where we conduct business and in jurisdictions in which we are subject to tax, including those covered by governing bodies that enact tax laws applicable to us, such as the European Commissionof the European Union, we are subject to potential changes in relevant tax, accounting and other laws, regulations and interpretations, including changes to tax laws applicable to corporate multinationals such as Adobe. These countries, other governmental bodies and intergovernmental economic organizations such as the Organization for Economic Cooperation and Development, have or could make unprecedented assertions about how taxation is determined in their jurisdictions that are contrary to the way in which we have interpreted and historically applied the rules and regulations described above in such jurisdictions. In the current global tax policy environment, any changes in laws, regulations and interpretations related to these assertions could adversely affect our effective tax rates, cause us to respond by making changes to our business structure, or result in other costs to us which could adversely affect our operations and financial results. Moreover, we are subject to the examination of our income tax returns by the U.S. Internal Revenue Serviceand other domestic and foreign tax authorities. These tax examinations are expected to focus on our research and development tax credits, intercompany transfer pricing practices and other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. We cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position. 49 -------------------------------------------------------------------------------- Table of Content s LIQUIDITY AND CAPITAL RESOURCES Cash Flows This data should be read in conjunction with our Consolidated Statements of Cash Flows. As of (in millions) December 3, 2021 November 27, 2020 Cash and cash equivalents $ 3,844 $ 4,478 Short-term investments $ 1,954 $ 1,514 Working capital $ 1,737 $ 2,634 Stockholders' equity $ 14,797 $ 13,264
Here is a summary of our cash flows for fiscal years 2021, 2020 and 2019: (in millions)
2021 2020 2019 Net cash provided by operating activities
$ 7,230 $ 5,727 $ 4,422Net cash used for investing activities (3,537) (414) (456) Net cash used for financing activities (4,301) (3,488) (2,946)
Effect of exchange rates on cash and cash equivalents
(26) 3 (13)
Net increase (decrease) in cash and cash equivalents
Our primary source of cash is receipts from revenue. Our primary uses of cash are our stock repurchase program as described below, payroll-related expenses, general operating expenses including marketing, travel and office rent, and cost of revenue. Other sources of cash include proceeds from participation in the employee stock purchase plan. Other uses of cash include business acquisitions, purchases of property and equipment and payments for taxes related to net share settlement of equity awards. Cash Flows from Operating Activities For fiscal 2021, net cash provided by operating activities of
$7.23 billionwas primarily comprised of net income adjusted for the net effect of non-cash items. The primary working capital sources of cash were net income together with increases in deferred revenue driven by Digital Media and Digital Experience offerings. The primary working capital use of cash were increases in prepaid expenses and other assets together with increases in trade receivables. The increases in prepaid expenses and other assets were driven by sales commissions paid and capitalized and the timing of billings and payments associated with certain vendors. The increases in trade receivables were attributable to the timing of billings. Cash Flows from Investing Activities For fiscal 2021, net cash used for investing activities of $3.54 billionwas primarily due to our acquisition of Workfront, Frame.io and ongoing capital expenditures. See Note 3 of our Notes to Consolidated Financial Statements for further information regarding these acquisitions. Cash Flows from Financing Activities For fiscal 2021, net cash used for financing activities of $4.30 billionwas primarily due to payments for our common stock repurchases and taxes paid related to the net share settlement of equity awards, which were offset by proceeds from re-issuance of common stock mainly for our employee stock purchase plan. See the section titled "Stock Repurchase Program" below. Liquidity and Capital Resources Considerations Our existing cash, cash equivalents and investment balances may fluctuate during fiscal 2022 due to changes in our planned cash outlay. Cash from operations could also be affected by various risks and uncertainties, including, but not limited to, the effects of the pandemic and other risks detailed in the section titled "Risk Factors" in Part I, Item 1A of this report. Based on our current business plan and revenue prospects, we believe that our existing cash, cash equivalents and investment balances, our anticipated cash flows from operations and our available credit facility will be sufficient to meet our working capital, operating resource expenditure and capital expenditure requirements for the next twelve months. 50 -------------------------------------------------------------------------------- Table of Content s Our cash equivalent and short-term investment portfolio as of December 3, 2021consisted of asset-backed securities, corporate debt securities, money market funds, municipal securities, time deposits and U.S. Treasurysecurities. We use professional investment management firms to manage a large portion of our invested cash. We expect to continue our investing activities, including short-term and long-term investments, purchases of computer systems for research and development, sales and marketing, product support and administrative staff, and facilities expansion. As of December 3, 2021, we expect our capital investment to be approximately $180 millionto $220 million, primarily to fund our San Jose and Bangaloreconstruction projects during fiscal 2022. Furthermore, cash reserves may be used to repurchase stock under our stock repurchase program and to strategically acquire companies, products or technologies that are complementary to our business. Revolving Credit Agreement We have a $1 billionsenior unsecured revolving credit agreement ("Revolving Credit Agreement") with a syndicate of lenders, providing for loans to us and certain of our subsidiaries through October 17, 2023. As of December 3, 2021, there were no outstanding borrowings under this credit agreement and the entire $1 billioncredit line remains available for borrowing. Our Revolving Credit Agreement contains a financial covenant requiring us not to exceed a maximum leverage ratio. As of December 3, 2021, we were in compliance with this covenant. We believe this covenant will not impact our credit or cash in the coming fiscal year or restrict our ability to execute our business plan. Under the terms of our Revolving Credit Agreement, we are not prohibited from paying cash dividends unless payment would trigger an event of default or if one currently exists. We do not anticipate paying any cash dividends in the foreseeable future. Senior Notes We have $4.15 billionsenior notes outstanding, which rank equally with our other unsecured and unsubordinated indebtedness. As of December 3, 2021, the carrying value of our senior notes was $4.12 billionand our maximum commitment for interest payments was $514 millionfor the remaining duration of our outstanding senior notes. Interest is payable semi-annually, in arrears on February 1and August 1. Our senior notes do not contain any financial covenants. See Note 17 of our Notes to Consolidated Financial Statements for further details regarding our debt. Contractual Obligations Our purchase obligations consist of agreements to purchase goods and services entered into in the ordinary course of business. As of December 3, 2021, the value of our non-cancellable unconditional purchase obligations was $1.38 billion. See N ote 16 of ou r Notes to Consolidated Financial Statements for additional information re garding our pur chase obligations. We lease certain facilities and data centers under non-cancellable operating lease arrangements that expire at various dates through 2031. As of December 3, 2021, the value of our obligations under operating leases was $604 million. See Note 1 8 of our Notes to Consolidated Financial Statements for additional information regarding ou r lease obligations. Our transition tax liability related to historical undistributed foreign earnings, which was accrued as a result of the U.S.Tax Act, was approximately $349 millionas of December 3, 2021and is payable in installments through fiscal 2026. As we repatriate foreign earnings for use in the United States, the distributions will generally be exempt from federal income taxes under current U.S.tax law. Stock Repurchase Program To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase our shares in the open market or enter into structured repurchase agreements with third parties. In May 2018, our Board of Directors granted authority to repurchase up to $8 billionin our common stock, which we fully utilized during fiscal 2021. In December 2020, our Board of Directors granted additional authority to repurchase up to $15 billionin our common stock through the end of fiscal 2024. During fiscal 2021, 2020 and 2019, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $3.95 billion, $3.05 billionand $2.75 billion, respectively. We repurchased approximately 7.2 million shares at an average price of $536.17per share in fiscal 2021, 8.0 million shares at an average price of $376.38per share in fiscal 2020, and 9.9 million shares at an average price of $270.23per share in fiscal 2019. Subsequent to December 3, 2021, as part of the December 2020stock repurchase authority, we entered into an accelerated share repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $2.4 billionand received an initial delivery of 3.2 million shares, which represents approximately 75% of our prepayment. The 51 -------------------------------------------------------------------------------- Table of Content s remaining balance will be settled during our third quarter of fiscal 2022. Upon completion of the $2.4 billionaccelerated share repurchase agreement, $10.7 billionremains under our December 2020authority. See section titled "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" in Part I, Item 5 of this report for stock repurchases during the quarter ended December 3, 2021 and Note 14 of our Notes to Consolidated Financial S tatements for fu rther details regarding our stock repurchase program . 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 Delawarelaw, 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.
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