Adobe Systems Incorporated — Fiscal 2016 Form 10-K
Business context and reporting period
Adobe reported for the fiscal year ended December 2, 2016. Fiscal 2016 contained 53 weeks, including an extra week in the first quarter, versus 52 weeks in fiscal 2015. The filing also provides unaudited fourth-quarter data for the quarter ended December 2, 2016.
Adobe operates three reportable segments: Digital Media, Digital Marketing, and Print and Publishing. Its strategy centers on cloud and subscription offerings, including Creative Cloud, Document Cloud and Adobe Marketing Cloud.
Financial performance and liquidity
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Revenue | $5.854 billion | $4.796 billion | +22% |
| Gross profit | $5.035 billion | $4.051 billion | +24% |
| Gross margin | 86.0% | 84.5% | +150 bps |
| Operating income | $1.494 billion | $903.1 million | +65% |
| Operating margin | 25.5% | 18.8% | +670 bps |
| Net income | $1.169 billion | $629.6 million | +86% |
| Diluted EPS | $2.32 | $1.24 | +87% |
| Cash flow from operations | $2.200 billion | $1.470 billion | +50% |
- Subscription revenue was $4.585 billion, or 78% of total revenue, up 42% from fiscal 2015. Product revenue declined 29% to $800.5 million, reflecting the transition away from perpetual licenses.
- Digital Media revenue was $3.941 billion, up 27%, with a 94% segment gross margin. Digital Marketing revenue was $1.737 billion, up 15%, with a 67% segment gross margin. Print and Publishing revenue declined 8% to $176.8 million.
- Digital Media annualized recurring revenue reached $4.01 billion, up 39% from $2.88 billion. Creative ARR was $3.54 billion and Document Cloud ARR was $475 million.
- Total deferred revenue was $2.015 billion, up 36%. Unbilled deferred revenue backlog was approximately $3.4 billion; approximately 40% to 50% was not expected to be billed during fiscal 2017.
- Cash, cash equivalents and short-term investments totaled $4.761 billion, including $1.011 billion of cash and cash equivalents and $3.750 billion of short-term investments. Approximately 83% of cash and investments were held by foreign subsidiaries and subject to potential repatriation tax effects.
- Net cash used in investing activities was $960.0 million, while net cash used in financing activities was $1.091 billion, principally reflecting $1.075 billion of treasury-stock purchases.
- Debt consisted of approximately $1.9 billion of senior notes: $900 million of 4.75% notes due 2020 and $1.0 billion of 3.25% notes due 2025. The $1.0 billion revolving credit facility was undrawn, and Adobe reported compliance with its covenants.
Fourth-quarter fiscal 2016 results
| Metric | Quarter ended December 2, 2016 |
|---|---|
| Revenue | $1.608 billion |
| Gross profit | $1.392 billion |
| Income before taxes | $456.7 million |
| Net income | $399.6 million |
| Diluted EPS | $0.80 |
Material changes versus the prior comparable period
- Revenue growth accelerated as the business continued shifting toward recurring subscriptions. Subscription revenue increased from $3.224 billion to $4.585 billion, while product revenue fell from $1.125 billion to $800.5 million.
- Digital Media ARR increased by $1.13 billion, driven by more paid Creative Cloud and Document Cloud subscriptions and continued enterprise term-license adoption.
- Operating expenses increased 12% to $3.541 billion, primarily from higher compensation and headcount, but grew more slowly than revenue.
- The effective tax rate declined to 19% from 28%, primarily because of benefits from completed tax examinations and the permanent extension of the U.S. research and development credit. A $60.3 million tax benefit resulted from completed examinations.
- Deferred revenue increased $529.5 million, supporting stronger operating cash flow.
- Adobe repurchased approximately 10.4 million shares for $1.013 billion during fiscal 2016, compared with approximately 8.1 million shares for $627.1 million in fiscal 2015.
Guidance, outlook, risks and unusual items
- Management expects continued growth in Digital Media and Digital Marketing, driven by Creative Cloud, Document Cloud, Adobe Marketing Cloud and expanded direct-sales and partner channels. The filing does not provide a detailed numerical fiscal 2017 revenue or earnings forecast.
- Adobe completed the acquisition of TubeMogul after fiscal year-end for approximately $549 million in cash, plus assumed employee equity awards. TubeMogul was expected to be integrated into Digital Marketing in the first quarter of fiscal 2017; purchase accounting was not complete when the filing was issued.
- Key risks include intense competition, technology and platform changes, subscription renewal rates, cybersecurity and service interruptions, privacy and cross-border data regulations, foreign-currency exposure, complex enterprise sales cycles, acquisitions and intellectual-property litigation.
- Foreign currency reduced fiscal 2016 revenue by approximately $93.1 million before hedging and by approximately $74.3 million after hedging.
- Adobe disclosed a $27 transaction involving a Paris branch representative of Bank Melli. Adobe deactivated the account, voluntarily disclosed the matter to OFAC and stated that it was reviewing compliance processes.
- Potentially material contingencies include $178.4 million of gross unrecognized tax benefits, $22.4 million of accrued tax-related interest and penalties, approximately $4.2 billion of foreign earnings without provided U.S. income tax, and $1.1 billion of associated unrecognized deferred tax liability.
- The company expects to adopt new revenue-recognition guidance in fiscal 2019, which may accelerate recognition for certain term-based software arrangements, and planned early adoption of updated share-based-payment guidance in fiscal 2017.
Investor verification checklist
- Verify the sustainability of Digital Media ARR growth and the relationship between ARR, deferred revenue, backlog and recognized revenue.
- Assess subscription renewal, churn, pricing and customer-acquisition trends as the business becomes increasingly recurring.
- Review fiscal 2017 results for the effect of the TubeMogul acquisition, integration costs and purchase-accounting adjustments.
- Monitor gross-margin trends as cloud infrastructure, data-center, royalty and support costs increase.
- Evaluate the concentration of cash and investments held overseas and the potential tax cost of repatriation.
- Review debt maturities, interest-rate swaps, foreign-currency hedges and the continued use of share repurchases.
- Track cybersecurity, privacy, regulatory, intellectual-property and tax-audit developments, including the OFAC-related disclosure.