Adobe Inc. Fiscal 2018 Form 10-K Summary
Business context and reporting period
Adobe reported for the fiscal year ended November 30, 2018. The company operates primarily through Digital Media, Digital Experience and Publishing. Its business is increasingly subscription- and cloud-based, led by Creative Cloud, Document Cloud and Experience Cloud.
Adobe completed the $1.64 billion Magento acquisition on June 18, 2018 and the approximately $4.74 billion Marketo acquisition on October 31, 2018. Both were integrated into Digital Experience. Adobe employed 21,357 people at fiscal year-end.
Financial performance and key metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Revenue | $9.03 billion | $7.30 billion | +24% |
| Subscription revenue | $7.92 billion | $6.13 billion | +29% |
| Gross profit | $7.84 billion | $6.29 billion | +25% |
| Gross margin | 86.8% | 86.2% | +0.6 percentage points |
| Operating income | $2.84 billion | $2.17 billion | +31% |
| Operating margin | 31.5% | 29.7% | +1.8 percentage points |
| Net income | $2.59 billion | $1.69 billion | +53% |
| Diluted EPS | $5.20 | $3.38 | +54% |
| Net margin | 28.7% | 23.2% | +5.5 percentage points |
| Cash flow from operations | $4.03 billion | $2.91 billion | +38% |
- Digital Media revenue was $6.33 billion, up 26%; Digital Experience revenue was $2.44 billion, up 20%; Publishing revenue was essentially flat at $261.0 million.
- Digital Media ARR reached $6.83 billion, up 27%. Creative ARR was $6.03 billion and Document Cloud ARR was $801 million.
- Deferred revenue was $3.05 billion, up 22%. Unbilled deferred revenue backlog was approximately $5.05 billion, although 40% to 50% was not expected to be billed during fiscal 2019.
- Research and development increased 26% to $1.54 billion, sales and marketing increased 19% to $2.62 billion, and total operating expenses increased 21% to $4.99 billion.
Liquidity, cash flow and capital structure
- Cash and cash equivalents were $1.64 billion and short-term investments were $1.59 billion, totaling $3.23 billion, versus $5.82 billion at the prior year-end.
- Working capital declined to $555.9 million from $3.72 billion, primarily reflecting acquisitions, debt financing and tax liabilities.
- Investing cash outflow was $4.69 billion, principally from the Magento and Marketo acquisitions. Financing cash flow was approximately negative $5.6 million after $2.25 billion of term-loan proceeds, $2.05 billion of stock repurchases and $393.2 million of taxes related to equity award settlements.
- Debt consisted of a $2.25 billion senior unsecured term loan due April 30, 2020 and approximately $1.9 billion of senior notes, for reported non-current debt of $4.12 billion. The $1.0 billion revolving credit facility was undrawn and fully available at year-end.
- Adobe stated that existing liquidity, expected operating cash flow and available credit were sufficient for at least the next twelve months. The company was in compliance with debt covenants.
- Adobe repurchased approximately 8.7 million shares for $2.05 billion during fiscal 2018 and had $8.0 billion of remaining repurchase authorization at November 30, 2018. It does not anticipate paying cash dividends in the foreseeable future.
Material changes versus the prior comparable period
- The subscription model continued to replace perpetual licensing: subscription revenue increased to 88% of total revenue from 84% in fiscal 2017, while product revenue declined 12%.
- Net income benefited from higher subscription revenue and a substantially lower effective tax rate of approximately 7%, versus 21% in fiscal 2017. The reduction primarily reflected the U.S. Tax Act and a change in corporate tax structure.
- Adobe recorded a $176 million transition-tax expense and approximately $504 million of long-term income-tax payable under the U.S. Tax Act. The transition tax is payable over eight years beginning in fiscal 2019.
- Debt increased materially because of the term loan used to partially fund Marketo. Goodwill increased to $10.58 billion from $5.82 billion, and purchased intangibles increased to $2.07 billion from $385.7 million, primarily due to the acquisitions.
- The company moved Adobe Connect and LiveCycle from Digital Experience to Publishing; prior-period segment information was reclassified.
Outlook, commentary, risks and unusual items
Management emphasized continued investment in cloud offerings, artificial intelligence through Adobe Sensei, mobile products, customer acquisition, enterprise adoption and integration of Magento and Marketo. The filing does not provide a specific fiscal 2019 revenue or earnings guidance range.
- Key risks include intense competition, pricing pressure, changing technology, customer renewal and subscription attrition, extended enterprise sales cycles and dependence on continued innovation.
- Cloud operations expose Adobe to cybersecurity, data privacy, service interruption, third-party hosting and data-transfer risks. The filing highlights GDPR and evolving privacy regulation.
- International operations, representing approximately 43% of revenue outside the Americas, create foreign-exchange, political, economic, regulatory and tax exposure. Adobe hedges a portion of its currency exposure.
- Goodwill and acquired intangible assets increased significantly and may generate higher future amortization expense; impairment could materially affect earnings.
- Adobe faces intellectual-property litigation, customer indemnification claims and ordinary-course legal proceedings. No material accrued loss was identified in the filing, but litigation outcomes remain unpredictable.
- Adobe adopted new goodwill impairment guidance in fiscal 2018. It expected the fiscal 2019 revenue standard adoption to have limited annual revenue impact but potentially a material opening balance-sheet effect, including capitalization of certain contract-acquisition costs.
- Subsequent to year-end, Adobe acquired the remaining interest in Allegorithmic for approximately $105 million in cash.
Investor verification checklist
- Verify the sustainability of Digital Media ARR growth, subscription growth and renewal rates after the major shift to cloud subscriptions.
- Assess the operating and financial contribution, integration progress and retention of Marketo and Magento relative to their acquisition costs.
- Review leverage, the April 2020 term-loan maturity, refinancing plans and sensitivity to floating interest rates.
- Reconcile reported earnings growth with the unusually low 7% effective tax rate and identify the recurring versus one-time effects of the U.S. Tax Act.
- Evaluate goodwill and acquired-intangible balances, forecast amortization and potential impairment exposure.
- Monitor deferred revenue, unbilled backlog and the portion not expected to be billed in fiscal 2019; these measures are not equivalent to recognized revenue.
- Review cybersecurity, privacy, service availability, foreign-exchange and intellectual-property exposures, including related contingencies not quantified in the filing.