Business Context and Reporting Period
Adobe Systems Incorporated filed this Form 10-K for the 52-week fiscal year ended November 29, 2013. The filing also reports fourth-quarter results for the 13 weeks ended November 29, 2013. Adobe operated through Digital Media, Digital Marketing, and Print and Publishing segments, with a strategic transition from perpetual software licenses toward Creative Cloud, enterprise term licenses, subscriptions, and hosted services.
Key Financial Metrics
| Metric | Fiscal 2013 | Fiscal 2012 | Change |
|---|---|---|---|
| Revenue | $4.055 billion | $4.404 billion | Down 8% |
| Gross profit | $3.469 billion | $3.920 billion | Down 12% |
| Gross margin | 85.5% | 89.0% | Down 3.5 points |
| Operating income | $422.7 million | $1.180 billion | Down 64% |
| Operating margin | 10.4% | 26.8% | Down 16.4 points |
| Net income | $290.0 million | $832.8 million | Down 65% |
| Diluted EPS | $0.56 | $1.66 | Down 66% |
| Operating cash flow | $1.152 billion | $1.500 billion | Down 23% |
Fiscal 2013 revenue consisted of $2.470 billion of product revenue, down 26%; $1.138 billion of subscription revenue, up 69%; and $447.3 million of services and support revenue, up 15%. Subscription revenue increased to 28% of total revenue from 15% in fiscal 2012.
| Segment | Fiscal 2013 Revenue | Year-over-year change | Gross Margin |
|---|---|---|---|
| Digital Media | $2.626 billion | Down 15% | 93% |
| Digital Marketing | $1.229 billion | Up 13% | 67% |
| Print and Publishing | $200.5 million | Down 8% | 95% |
At November 29, 2013, cash, cash equivalents, and short-term investments totaled $3.174 billion, including $834.6 million of cash and cash equivalents and $2.339 billion of short-term investments. Working capital was $2.520 billion. Debt and capital lease obligations totaled $1.514 billion, including approximately $1.496 billion of senior notes. The $1.0 billion revolving credit facility was undrawn, and Adobe reported compliance with its covenants.
Fiscal 2013 investing cash outflows were $1.178 billion, including $704.6 million for acquisitions and $188.4 million for property and equipment. Financing cash outflows were $559.1 million, primarily reflecting $1.1 billion of stock repurchases, partially offset by $500.8 million of proceeds from treasury stock issuance. No cash dividends were paid or anticipated.
Fourth-Quarter Results
| Metric | Q4 Fiscal 2013 | Q4 Fiscal 2012 | Change |
|---|---|---|---|
| Revenue | $1.042 billion | $1.153 billion | Down 10% |
| Gross profit | $894.2 million | $1.028 billion | Down 13% |
| Income before taxes | $88.3 million | $290.6 million | Down 70% |
| Net income | $65.3 million | $222.3 million | Down 71% |
| Diluted EPS | $0.13 | $0.44 | Down 70% |
Material Changes Versus the Prior Comparable Period
- Creative Cloud adoption accelerated, with paid subscriptions exiting fiscal 2013 at 1.4 million versus 0.3 million at fiscal 2012 year-end.
- Total Digital Media annualized recurring revenue increased to approximately $911 million from $204 million. Creative Cloud ARR reached $768 million, while Document Services ARR reached $143 million.
- Total deferred revenue increased 34% to $828.8 million, primarily from enterprise term licenses and renewals of Adobe Marketing Cloud services.
- Perpetual product revenue declined as customers migrated to subscriptions and enterprise term licenses. Management expects this transition to pressure reported revenue and earnings in the near term because revenue is recognized ratably while costs remain comparatively elevated.
- Digital Marketing revenue increased 13%, supported by 26% growth in Adobe Marketing Cloud and the Neolane acquisition. Digital Media revenue fell 15%, primarily due to the licensing-model transition.
- Cost of revenue increased 21% to $586.6 million, and operating expenses increased 11% to $3.046 billion. Higher hosting, server, compensation, acquisition, and infrastructure costs contributed to margin compression.
- Adobe acquired Neolane for $616.7 million and Behance for $111.1 million. The reported financial impact of both acquisitions was not material to consolidated results.
- Adobe recorded $26.5 million of restructuring and other charges, including a $23.8 million write-down related to the Waltham property, which was sold for net proceeds of $24.3 million.
Guidance, Outlook, Risks, and Unusual Items
Management did not provide a specific numerical fiscal 2014 guidance outlook in the supplied filing text. Management expects continued growth in Adobe Marketing Cloud and increasing recurring revenue from Creative Cloud, managed services, and enterprise term licenses, while acknowledging that the subscription transition may continue to reduce reported revenue and operating margins in the short term.
- Key risks include slower-than-expected Creative Cloud adoption, subscription renewal or pricing pressure, customer preference for perpetual licenses, and revenue-recognition timing associated with ratable subscriptions.
- Adobe faces intense competition from large software, internet, marketing, and open-source providers, including Google, IBM, Microsoft, Oracle, Salesforce, SAP, and others.
- Cloud operations and digital marketing services expose Adobe to cybersecurity, privacy, data protection, service availability, hosting, and disaster-recovery risks. Adobe disclosed network attacks discovered in September 2013 and associated professional and legal costs.
- Foreign exchange risk remains material; approximately 47% of revenue came from customers outside the Americas. Adobe used hedging instruments but does not fully offset currency exposure.
- Approximately 80% of cash and investments were held by foreign subsidiaries and could be subject to additional U.S. tax if repatriated.
- Adobe had $1.5 billion of senior notes, including $600 million due in 2015 and $900 million due in 2020, plus contractual obligations totaling $2.538 billion.
- The High-Tech Employee Antitrust Litigation class was certified in October 2013, with trial scheduled for May 2014. Adobe had accrued no loss because management considered a loss not probable or estimable.
- Adobe was subject to an IRS examination of fiscal 2010–2012 returns. Unrecognized tax benefits were $136.1 million, excluding $11.4 million of accrued interest and penalties.
Most Important Facts to Verify
- Whether Creative Cloud subscription growth, ARR, retention, pricing, and cash collection continued to offset declines in perpetual-license revenue.
- Whether reported revenue, gross margin, and operating margin recovered as the subscription model matured.
- Digital Marketing growth, including the contribution and integration of Neolane.
- Cash generation after acquisitions, capital expenditures, debt service, and stock repurchases.
- Refinancing or repayment plans for the $600 million of notes due in 2015 and the remaining $900 million due in 2020.
- Developments in the employee antitrust litigation, IRS examinations, cybersecurity matters, and other intellectual-property or privacy contingencies.