Adobe Systems Incorporated: Fiscal 2017 Form 10-K Summary
Business context and reporting period
Adobe provides subscription, hosted, term-license and perpetual software for digital media, digital documents and digital marketing. Its principal offerings include Creative Cloud, Document Cloud and Adobe Experience Cloud. The filing covers the 52-week fiscal year ended December 1, 2017; fiscal 2016 included an additional week.
- Fiscal 2017 reportable segments: Digital Media, Digital Marketing and Print and Publishing.
- Digital Media represented 69% of revenue, Digital Marketing 29% and Print and Publishing 2%.
- Adobe employed 17,973 people at fiscal year-end.
Financial performance and key metrics
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Revenue | $7.302 billion | $5.854 billion | +25% |
| Gross profit | $6.291 billion | $5.035 billion | +25% |
| Operating income | $2.168 billion | $1.494 billion | +45% |
| Net income | $1.694 billion | $1.169 billion | +45% |
| Diluted EPS | $3.38 | $2.32 | +46% |
| Operating cash flow | $2.913 billion | $2.200 billion | +32% |
- Margins: gross margin was approximately 86.2%, operating margin 29.7% and net margin 23.2%, versus approximately 86.0%, 25.5% and 20.0%, respectively, in fiscal 2016.
- Revenue mix: subscription revenue rose 34% to $6.134 billion and represented 84% of total revenue, while product revenue declined 12% to $706.8 million.
- Segment revenue: Digital Media increased 27% to $5.011 billion; Digital Marketing increased 22% to $2.120 billion; Print and Publishing declined 3% to $170.9 million.
- Recurring metrics: Digital Media ARR increased 31% to $5.23 billion, including Creative ARR of $4.63 billion and Document Cloud ARR of $600 million.
- Liquidity: cash, cash equivalents and short-term investments totaled $5.820 billion; working capital was $3.720 billion.
- Debt: carrying value of senior notes was $1.881 billion, consisting of $900 million due in 2020 and $1 billion due in 2025. The $1 billion revolving credit facility was undrawn and available.
- Capital allocation: Adobe repurchased approximately 8.2 million shares for $1.10 billion during fiscal 2017. No cash dividends were paid or anticipated in the foreseeable future.
Fourth-quarter results
For the quarter ended December 1, 2017, revenue was $2.007 billion, compared with $1.608 billion in the prior-year quarter. Gross profit was $1.736 billion, income before taxes was $643.0 million, net income was $501.5 million and diluted EPS was $1.00, compared with $399.6 million and $0.80, respectively, in the prior-year quarter.
Material changes versus the prior comparable period
- Adobe continued its transition from perpetual software licenses to subscription and cloud-based offerings, driving higher recurring revenue and deferred revenue.
- Total deferred revenue increased 24% to approximately $2.49 billion; unbilled deferred revenue backlog increased to approximately $3.94 billion from $3.42 billion.
- Research and development expense increased 25% to $1.224 billion, sales and marketing expense increased 15% to $2.198 billion, and total operating expenses increased 16% to $4.123 billion.
- Adobe completed the $560.8 million acquisition of TubeMogul and integrated it into Digital Marketing, including Advertising Cloud.
- Cash increased substantially to $2.306 billion from $1.011 billion, while short-term investments declined to $3.514 billion from $3.750 billion.
- Adobe early adopted employee share-based payment accounting guidance, affecting the presentation of excess tax benefits.
- Effective fiscal 2018, Adobe planned to move Adobe Connect and LiveCycle from Digital Marketing to Print and Publishing.
Guidance, outlook, commentary and risks
Management emphasized continued investment in Creative Cloud, Document Cloud and Experience Cloud, with growth expected from subscription adoption, customer expansion, product innovation, cross-selling and international markets. The filing references an attached January 22, 2018 press release updating fiscal 2018 and first-quarter financial targets, but the supplied filing text does not provide the numerical targets.
- Tax reform: the Tax Cuts and Jobs Act was enacted after year-end. Adobe expected to remeasure deferred tax balances, reclassify approximately $380 million of deferred tax liabilities related to undistributed foreign earnings, and record a preliminary fiscal 2018 tax charge of approximately $85 million, principally related to foreign earnings taxation.
- Approximately 89% of cash and investments were held by foreign subsidiaries and could be subject to repatriation tax effects.
- Key risks include intense competition, rapid technological change, customer subscription non-renewal, extended enterprise sales cycles, cybersecurity and service outages, privacy regulation, foreign currency movements, tax examinations, acquisition integration, intellectual-property litigation and dependence on third-party hosting and support providers.
- Unrecognized tax benefits were $172.9 million, with a possible reduction over the following 12 months ranging from zero to approximately $40 million.
- Contractual obligations totaled approximately $3.471 billion, including $2.251 billion for notes and interest, $525.1 million for operating leases and $695.3 million for purchase obligations.
- Management concluded that disclosure controls and internal control over financial reporting were effective. The assessment excluded TubeMogul, representing approximately 1.8% of consolidated assets and 2.5% of consolidated revenue; TubeMogul was expected to be included beginning fiscal 2018.
- The CFO and general counsel announced plans to retire during 2018, remaining in their roles until successors were appointed.
Important facts for investors to verify
- Confirm the numerical fiscal 2018 and first-quarter targets in Exhibit 99.1, which are not included in the supplied text.
- Assess whether ARR, deferred revenue and subscription renewal trends support continued growth after the substantial fiscal 2017 expansion.
- Monitor the fiscal 2018 effects of the Tax Cuts and Jobs Act, including the estimated $85 million tax charge and foreign earnings tax liability.
- Review TubeMogul integration performance, Advertising Cloud margins and the impact of increased media and hosting costs.
- Evaluate exposure to the $1.9 billion debt balance, floating-rate swaps, foreign exchange movements and the 2020 note maturity.
- Review cybersecurity, privacy, intellectual-property and subscription-renewal disclosures for changes in severity or financial impact.