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Basis of Presentation and Summary of Significant Accounting Policies | 6 Months Ended
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May 31, 2019
Organization, Consolidation and Presentation of Financial Statements [Abstract] |
Basis of Presentation and Significant Accounting Policies | BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES We have prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Pursuant to these rules and regulations, we have condensed or omitted certain information and footnote disclosures we normally include in our annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In management’s opinion, we have made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present our financial position, results of operations and cash flows. Our interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended November 30, 2018 on file with the SEC (our “Annual Report”). Reclassifications Certain immaterial prior year amounts have been reclassified to conform to current year presentation in the condensed consolidated statements of cash flows. 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. 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 |  | ASC 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.
Adoption of the new revenue standard impacted our condensed consolidated statement of income for three months ended May 31, 2019 as follows (in thousands, except per share amounts):
| As reported |  | Adjustments |  | Balances without ASC 606 adoption impact
Revenue |  |  |  |  |
Subscription | $ | 2,456,097 |  |  | $ | (6,444 | ) |  | $ | 2,449,653 |
Product | 152,816 |  |  | (19,148 | ) |  | 133,668 |
Services and support | 135,367 |  |  | (304 | ) |  | 135,063 |
Total revenue | 2,744,280 |  |  | (25,896 | ) |  | 2,718,384 |
Operating expenses |  |  |  |  |
Sales and marketing | 848,927 |  |  | 8,068 |  |  | 856,995 |
Provision for income taxes | 78,179 |  |  | (3,747 | ) |  | 74,432 |
Net income | $ | 632,593 |  |  | $ | (30,370 | ) |  | $ | 602,223 |
Basic net income per share | $ | 1.30 |  |  | $ | (0.06 | ) |  | $ | 1.24 |
Diluted net income per share | $ | 1.29 |  |  | $ | (0.07 | ) |  | $ | 1.22 |
Adoption of the new revenue standard impacted our condensed consolidated statement of income for six months ended May 31, 2019 as follows (in thousands, except per share amounts):
| As reported |  | Adjustments |  | Balances without ASC 606 adoption impact
Revenue |  |  |  |  |
Subscription | $ | 4,761,064 |  |  | $ | (4,237 | ) |  | $ | 4,756,827 |
Product | 323,370 |  |  | (42,028 | ) |  | 281,342 |
Services and support | 260,792 |  |  | (1,075 | ) |  | 259,717 |
Total revenue | 5,345,226 |  |  | (47,340 | ) |  | 5,297,886 |
Operating expenses |  |  |  |  |
Sales and marketing | 1,630,445 |  |  | 16,936 |  |  | 1,647,381 |
Provision for income taxes | 106,272 |  |  | (4,957 | ) |  | 101,315 |
Net income | $ | 1,306,834 |  |  | $ | (59,423 | ) |  | $ | 1,247,411 |
Basic net income per share | $ | 2.68 |  |  | $ | (0.12 | ) |  | $ | 2.56 |
Diluted net income per share | $ | 2.65 |  |  | $ | (0.12 | ) |  | $ | 2.53 |
Adoption of the new revenue standard impacted our condensed consolidated balance sheets as of May 31, 2019 as follows (in thousands):
| As reported |  | Adjustments |  | Balances without ASC 606 adoption impact
Assets |  |  |  |  |
Trade receivables, net of allowances for doubtful accounts | $ | 1,272,668 |  |  | $ | (73,370 | ) |  | $ | 1,199,298 |
Prepaid expenses and other current assets | 590,998 |  |  | (190,282 | ) |  | 400,716 |
Other assets | 503,221 |  |  | (306,265 | ) |  | 196,956 |
Liabilities and Stockholders’ Equity |  |  |  |  |
Accrued expenses | 1,314,998 |  |  | (36,444 | ) |  | 1,278,554 |
Deferred revenue, current | 3,011,552 |  |  | 58,244 |  |  | 3,069,796 |
Deferred revenue, long-term | 122,522 |  |  | (2,183 | ) |  | 120,339 |
Deferred income taxes | 133,886 |  |  | (87,792 | ) |  | 46,094 |
Retained earnings | $ | 13,183,938 |  |  | $ | (501,742 | ) |  | $ | 12,682,196 |
There was no net impact to our condensed consolidated statements of comprehensive income and cash flows from operating, financing or investing activities on the condensed consolidated 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 condensed consolidated statement 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 condensed consolidated statements of income. 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. Significant Accounting Policies Revenue Recognition For revenue recognition policies under Accounting Standards Codification Topic 605, refer to Note 1. Basis of Presentation and Significant Accounting Policies in our Annual Report. 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 (Software-as-a-Service) 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 the condensed consolidated statements of income. Some of our enterprise license arrangements allow customers to commit non-cancellable funds. These non-cancellable committed funds are nonrefundable and provide our customers options to either renew monthly on-premise term-based licenses or use some or all funds to purchase other Adobe products or services. Revenue associated with these monthly term-based licenses 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. 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, or 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 practical expedient under the new revenue standard. 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 will 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 intend to adopt the new leases standard using this optional transition method. While we are continuing to assess the potential impacts of the standard, we currently expect the most significant impact will be the recognition of right-of-use assets and lease liabilities on our balance sheet. The standard is not expected to have a material impact to our condensed consolidated statements of income and cash flows. We are implementing a new lease accounting system and are updating our processes in preparation 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 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, which is when we plan to adopt the standard. While we are continuing to assess the potential impacts of the standard, we currently do not expect it to have a material impact on our condensed consolidated financial statements and related disclosures. With the exception of the new standards discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the six months ended May 31, 2019, as compared to the recent accounting pronouncements described in our Annual Report, that are of significance or potential significance to us.

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