Adobe Systems Incorporated: Fiscal 2011 Form 10-K Summary
Business context and reporting period
Adobe filed its annual report for the fiscal year ended December 2, 2011. The filing is a 10-K, not a quarterly filing, although it provides unaudited fourth-quarter data. Adobe develops software and services for digital media, digital marketing, document collaboration, enterprise workflows, publishing, analytics and online experiences.
Fiscal 2011 comprised 52 weeks, compared with 53 weeks in fiscal 2010. Fiscal 2010 revenue benefited from an extra first-quarter week, estimated by management to have added approximately $35 million of revenue and $20 million of expenses.
Financial performance and key metrics
| Metric | Fiscal 2011 | Fiscal 2010 | Change |
|---|---|---|---|
| Revenue | $4.216 billion | $3.800 billion | +11% |
| Gross profit | $3.778 billion | $3.396 billion | +11% |
| Gross margin | 89.6% | 89.4% | Up approximately 20 bps |
| Operating income | $1.099 billion | $993.1 million | +11% |
| Operating margin | 26.1% | 26.1% | Approximately flat |
| Net income | $832.8 million | $774.7 million | +8% |
| Diluted EPS | $1.65 | $1.47 | +12% |
| Operating cash flow | $1.543 billion | $1.113 billion | +39% |
Fiscal 2011 revenue consisted of $3.424 billion of product revenue, $450.6 million of subscription revenue and $341.1 million of services and support revenue. Product revenue represented 81% of total revenue, subscription revenue 11% and services and support 8%. Subscription revenue increased 17% year over year, reflecting growth in hosted and online marketing services.
Revenue by fiscal 2011 segment was: Creative and Interactive Solutions $1.713 billion, Digital Media Solutions $625.8 million, Knowledge Worker $740.2 million, Enterprise $442.7 million, Omniture $476.1 million and Print and Publishing $218.3 million. Segment growth was strongest in Enterprise, up 26%, Omniture, up 20%, and Knowledge Worker, up 13%. Print and Publishing declined 3%.
Fiscal fourth-quarter revenue was $1.152 billion, gross profit was $1.036 billion and net income was $173.7 million. Compared with the fourth quarter of fiscal 2010, revenue increased approximately 14%, while net income declined approximately 35%, principally reflecting higher restructuring charges, operating investment and other period-specific items.
Financial position, liquidity and debt
- Cash and cash equivalents were $989.5 million and short-term investments were $1.922 billion at December 2, 2011, for total cash, cash equivalents and short-term investments of $2.912 billion.
- Working capital was $2.521 billion, compared with $2.148 billion at the prior fiscal year-end.
- Total assets were $8.991 billion and stockholders’ equity was $5.783 billion.
- Total debt and capital lease obligations were $1.514 billion, including approximately $1.495 billion of senior notes and $19.7 million of capital lease obligations.
- The senior notes comprise $600 million of 3.25% notes due 2015 and $900 million of 4.75% notes due 2020. Interest expense was $67.0 million in fiscal 2011.
- Adobe had no borrowings outstanding under its $1.0 billion revolving credit facility, which remained available. Management stated that existing liquidity, operating cash flow and available credit should be sufficient for the next twelve months.
- Approximately 75% of cash and investments were held by foreign subsidiaries and could be subject to additional U.S. tax if repatriated.
- Adobe repurchased approximately 21.8 million shares for $695.0 million during fiscal 2011. The remaining authorization under its $1.6 billion repurchase program was $225 million after an additional $80 million prepayment made after year-end.
- No cash dividends were declared or paid, and management did not anticipate paying dividends in the foreseeable future.
Material changes versus the prior comparable period
- Revenue increased 11%, despite the shorter fiscal year, led by continued CS5 adoption, the CS5.5 release, Acrobat X, Day’s web experience management products and Omniture’s digital marketing offerings.
- Subscription revenue increased to $450.6 million from $386.8 million, while services and support revenue increased 34% to $341.1 million.
- Operating expenses increased 11% to $2.679 billion, primarily due to higher compensation and additional headcount.
- Restructuring and other charges rose to $97.8 million from $23.3 million. The fiscal 2011 restructuring plan included approximately 700 worldwide position reductions, facility closures and asset write-offs.
- Operating cash flow increased by $430.3 million to $1.543 billion, aided by higher net income, increased deferred revenue and accrued restructuring liabilities.
- Adobe completed six business combinations and two asset acquisitions during fiscal 2011 for aggregate purchase prices of approximately $328.3 million. Acquisitions included EchoSign, Typekit, Nitobi and Auditude.
- Adobe announced a new segment structure for fiscal 2012: Digital Media, Digital Marketing and Print and Publishing. The structure combines the prior Creative, Digital Media and Knowledge Worker businesses into Digital Media, and combines Omniture and Enterprise into Digital Marketing.
Guidance, outlook, management commentary and risks
Management did not provide quantitative fiscal 2012 guidance in the filing. Its stated strategy was to concentrate investment on Digital Media and Digital Marketing, increase recurring revenue and expand cloud-based and subscription offerings.
- Creative Cloud, including Creative Suite applications, cloud services, touch applications and community features, was expected to become available in 2012 and was intended to support recurring revenue growth and broader customer adoption.
- Management expected the transition from perpetual licenses to subscriptions to improve revenue predictability over time, but warned that it could initially defer revenue and cash receipts and reduce short-term reported revenue.
- Adobe planned to focus Digital Marketing initiatives on analytics and reporting, personalized engagement, multi-channel campaign management and media monetization.
- On January 13, 2012, after year-end, Adobe acquired Efficient Frontier for approximately $346 million in cash and assumed employee equity awards. The acquisition was expected to strengthen cross-channel digital advertising and social marketing capabilities.
- Key risks include intense competition, rapid technology changes, the transition to cloud and subscription models, uncertain renewal rates, mobile-platform changes, reliance on third-party distributors and service providers, cybersecurity and privacy exposure, foreign currency volatility, acquisition integration, intellectual property litigation and global economic conditions.
- Ingram Micro represented 14% of fiscal 2011 revenue, creating a notable distribution-channel concentration.
- The Eolas patent litigation was pending as of the filing date. Adobe had recorded no provision because management did not believe a loss was probable or estimable.
- Adobe was subject to ongoing tax examinations and reported $163.6 million of gross unrecognized tax benefits, excluding interest and penalties. Management estimated potential decreases in these benefits within the following twelve months could range from zero to approximately $40 million.
- KPMG issued an unqualified audit opinion on the consolidated financial statements and internal control over financial reporting.
Most important facts for an investor to verify
- Whether the Creative Cloud and broader subscription transition increases recurring revenue without causing sustained pressure on reported revenue, cash flow timing or gross margins.
- Fiscal 2012 revenue growth, subscription bookings, renewal rates and deferred revenue trends under the new segment structure.
- Integration progress and purchase accounting for the post-year-end Efficient Frontier acquisition.
- The financial effect of the fiscal 2011 restructuring, including approximately $88.4 million of accrued restructuring liabilities and the planned workforce reductions.
- Cash availability and repatriation constraints, including the tax consequences of foreign-held liquidity.
- Debt service requirements, covenant compliance and the maturity profile of the 2015 and 2020 notes.
- Exposure to competition from HTML5, mobile platforms, cloud-native products and large digital marketing providers.
- Resolution of the Eolas patent case, tax examinations and other ordinary-course litigation or indemnification claims.