Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One) |
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x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 1, 2017
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 0-15175
ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
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Delaware (State or other jurisdiction of incorporation or organization) | 77-0019522 (I.R.S. Employer Identification No.) |
345 Park Avenue, San Jose, California 95110-2704
(Address of principal executive offices)
(408) 536-6000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class | Name of Each Exchange on Which Registered |
Common Stock, $0.0001 par value per share | The NASDAQ Stock Market LLC (NASDAQ Global Select Market) |
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer x | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o | Emerging growth company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the registrant’s common stock, $0.0001 par value per share, held by non-affiliates of the registrant on June 2, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, was $52,575,558,763 (based on the closing sales price of the registrant’s common stock on that date). Shares of the registrant’s common stock held by each officer and director and each person who owns 5% or more of the outstanding common stock of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of January 12, 2018, 491,578,529 shares of the registrant’s common stock, $0.0001 par value per share, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the registrant’s 2018 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed within 120 days of the end of the fiscal year ended December 1, 2017, are incorporated by reference in Part III hereof. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed as part hereof.
ADOBE SYSTEMS INCORPORATED
FORM 10-K
TABLE OF CONTENTS
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Forward-Looking Statements
In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements, including statements regarding product plans, future growth, market opportunities, strategic initiatives, industry positioning, customer acquisition and retention, the amount of recurring revenue and revenue growth. In addition, when used in this report, the words “will,” “expects,” “could,” “would,” “may,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “targets,” “estimates,” “looks for,” “looks to,” “continues” and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. Each of the forward-looking statements we make in this report involves risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors” in Part I, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with the U.S. Securities and Exchange Commission (the “SEC”), including our Quarterly Reports on Form 10-Q to be filed in 2018. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document, except as required by law.
PART I
ITEM 1. BUSINESS
Founded in 1982, Adobe Systems Incorporated is one of the largest and most diversified software companies in the world. We offer a line of products and services used by creative professionals, marketers, knowledge workers, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing and engaging with compelling content and experiences across personal computers, devices and media. We market our products and services directly to enterprise customers through our sales force and certain local field offices. We license our products to end users through app stores and our own website at www.adobe.com. We offer many of our products via a Software-as-a-Service (“SaaS”) model or a managed services model (both of which are referred to as hosted or cloud-based) as well as through term subscription and pay-per-use models. We also distribute certain products and services through a network of distributors, value-added resellers (“VARs”), systems integrators (“SIs”), independent software vendors (“ISVs”), retailers, software developers and original equipment manufacturers (“OEMs”). In addition, we license our technology to hardware manufacturers, software developers and service providers for use in their products and solutions. Our products run on personal and server-based computers, as well as on smartphones, tablets and other devices, depending on the product. We have operations in the Americas, Europe, Middle East and Africa (“EMEA”) and Asia-Pacific (“APAC”). See Note 17 of our Notes to Consolidated Financial Statements for further geographical information. Adobe was originally incorporated in California in October 1983 and was reincorporated in Delaware in May 1997. Our executive offices and principal facilities are located at 345 Park Avenue, San Jose, California 95110-2704. Our telephone number is 408-536-6000 and our website is www.adobe.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC website at www.sec.gov. The information posted to our website is not incorporated into this Annual Report on Form 10-K.
BUSINESS OVERVIEW
For over 35 years, Adobe’s innovations have transformed how individuals, teams, businesses and governments interact. We help our customers create and deliver the most compelling experiences in a streamlined workflow, and optimize those experiences for greater return on investment. Our solutions turn ordinary interactions into valuable digital experiences, across media and devices, anytime, anywhere.
While we continue to offer a broad portfolio of products, services, and solutions, we focus our investments in two strategic growth areas:
Digital Media—providing products, services and solutions that enable individuals, teams and enterprises to create, publish and promote their content anywhere. Our customers include content creators, web designers, app developers and digital media professionals, as well as management in marketing departments and agencies, companies and publishers. Our customers also include knowledge workers who create, collaborate and distribute documents. This is the core of what we have delivered for over 25 years, and we have evolved our business model to provide our customers with a range of flexible solutions that allow them to reach their full creative potential anytime, anywhere, on any device on projects of all types.
Digital Experience—providing solutions and services for creating, managing, executing, measuring and optimizing digital marketing and advertising campaigns across multiple channels. Our customers include marketers, advertisers, agencies, publishers,
merchandisers, web analysts, marketing executives, information management executives, product development executives, and sales and support executives. In fiscal 2017, we processed 186 trillion data transactions with our analytics products, providing our customers with a robust data platform that can be used to gain insight and optimize digital experiences delivered with our Adobe Experience Cloud solutions. By combining the creativity of our Digital Media business with the science of our Digital Experience offerings, we help our customers more efficiently and effectively make, manage, measure and monetize their content across every channel with an end-to-end workflow and feedback loop.
We believe we are uniquely positioned to be a leader in both the Digital Media and Digital Experience markets, where our mission is to change the world through digital experiences. By integrating products from each of these two areas of Adobe’s business, our customers are able to utilize a comprehensive suite of solutions and services that no other company currently offers. In addition, our ability to deliver innovation and productivity improvements across customer workflows involving the creation, management, delivery, measurement and optimization of engaging content favorably positions Adobe as our customers continue investing in engaging their constituents digitally.
SEGMENTS
Effective in fiscal 2018, our business is organized into three reportable segments: Digital Media, Digital Experience (formerly Digital Marketing), and Publishing (formerly Print and Publishing). These segments provide Adobe’s senior management with a comprehensive financial view of our key businesses. Our segments are aligned around our two strategic growth opportunities described above, placing our Publishing business in a third segment that contains some of our mature products and solutions.
MARKET OVERVIEW
Digital Media
Digital Media Opportunity
Recent technology trends in digital communications continue to provide a significant market opportunity for Adobe in digital media. In today’s world where the velocity of creation and consumption of digital content is ever increasing, customers are looking for a way to meet demand with engaging online experiences. Adobe is in a strong position to capitalize on this opportunity by driving modernization and innovation that will accelerate the creative process across all platforms and devices, deepen engagement with communities, and accelerate long-term revenue growth by focusing on cloud-based offerings, which are licensed on a subscription basis.
The flagship of our Digital Media business is Adobe Creative Cloud—a subscription service that allows members to use Adobe’s creative products integrated with cloud-delivered services across desktop, web and mobile devices. Creative Cloud members can download and access the latest versions of our creative products such as Photoshop CC, Illustrator CC, Premiere Pro CC, Lightroom CC, InDesign CC, Adobe XD CC and many more creative applications. In addition, members can access built-in templates to jumpstart designs and step-by-step tutorials to sharpen skills and get up to speed quickly. Through Creative Cloud, members can access online services to sync, store, and share files across users’ machines, access marketplace, social and community-based features within our Adobe Stock and Behance services, and create apps and websites, all at affordable subscription pricing for cost-sensitive customers.
Adobe continues to redefine the creative process with Creative Cloud so that our customers can obtain everything they need to create, collaborate and be inspired. A core part of our strategy is Adobe Sensei, a proprietary framework and set of intelligent services for dramatically improving the design and delivery of digital experiences. Adobe Sensei leverages Adobe’s massive content and data assets, as well as its deep domain expertise in the creative, marketing and document segments, within a unified artificial intelligence (“AI”) and machine learning framework to tackle today’s complex creative experience challenges.
Creative Cloud addresses the needs of creative professionals such as artists, designers, developers, students and administrators. They rely on our products for publishing, web design and development, video and animation production, mobile app and gaming development, and document creation and collaboration. End users of our creative products work in businesses ranging from large publishers, media companies and global enterprises, to smaller design agencies, and individual freelancers. Moreover, our creative products are used to create much of the printed and online information people see, read and interact with every day, including video, animation, mobile and advertising content. Knowledge workers, educators, hobbyists and consumers
also use our products to create and deliver content. We have introduced new products, features and services to address emerging categories of content creation such as 3D, augmented reality, virtual reality and user experience design. New solutions include Adobe Dimension, a tool that enables the creation of high-quality, photorealistic 3D images; Adobe XD, a solution for creating user experiences and screen designs as part of designing websites and mobile apps; and Adobe Spark, a set of capabilities that enables anyone to create impactful graphics, web pages and video stories in minutes.
Adobe’s Digital Media segment includes our Document Cloud business, built around our Acrobat family of products, the Adobe Acrobat Reader and a set of integrated, cloud-based document services. Tens of millions of knowledge workers worldwide interact with documents daily. For over 25 years, Adobe Acrobat has provided for the reliable creation and exchange of electronic documents, regardless of platform or application source type. Users can collaborate on documents with electronic comments and tailor the security of a file in order to distribute reliable Adobe PDF documents that can be viewed, printed or filled out utilizing our free Adobe Acrobat Reader. Acrobat provides essential electronic document capabilities and services to help knowledge workers accomplish a wide variety of tasks ranging from simple publications and forms to mission-critical engineering documentation and architectural plans. With our Acrobat product and its innovative cloud services, we have extended the capabilities of our solutions. Users can turn slow, manual signing processes into automated experiences and collect signatures with Adobe Scan, Adobe Sign and Adobe Send & Track.
Digital Media Strategy
Our goal is to be the leading platform for creativity where we offer a range of products and services that allow individuals, teams and enterprises to design and deliver amazing digital content.
We believe there is significant opportunity for growth across all customer segments and expect Creative Cloud will drive sustained long-term revenue growth through a continued expansion of our customer base by acquiring new users in North America and international markets. We will continue to seek to deepen our relationship with existing users through meeting their needs holistically and delivering additional features and value. As appropriate, we plan to optimize our pricing strategy and move our customers to higher priced and better value offerings and continue to employ targeted promotions that attract past customers and potential users to try out and ultimately subscribe to Creative Cloud. To target new customers and better address the needs of our existing customers, we will continue to invest in driving innovation to maintain the leadership position that we have established. We have also built a marketplace for Creative Cloud subscribers to enable the delivery and purchase of stock content in our Adobe Stock service. Overall, our strategy with Creative Cloud is designed to enable us to increase our revenue with users, attract more new customers, and grow a recurring and predictable revenue stream that is recognized ratably.
As part of our Creative Cloud strategy, we utilize our Experience Cloud solutions to drive customer awareness and licensing of our creative products and services through our website and across other channels. Adobe.com is increasingly becoming the destination site where we engage individual and small business customers to sign up for and renew Creative Cloud subscriptions. We utilize channel partners to target mid-size creative customers with our Creative Cloud for teams offering. Our direct sales force is focused on building relationships with our largest customers and driving adoption of our Creative Cloud for enterprise offering.
We offer many of the products included in Creative Cloud on a standalone basis, including subscriptions to the Creative Cloud version of certain point products. We also offer a range of other creative tools and services, including our hobbyist products such as Photoshop Elements and Premiere Elements, Typekit and mobile apps such as Photoshop Mix, Photoshop Sketch, Photoshop Fix, Adobe Capture CC, and Adobe Spark. Further descriptions of our Digital Media products are included below under “Principal Products and Services.”
In our Document Cloud business, although Acrobat has achieved strong market adoption in document-intensive industries such as government, financial services, pharmaceutical, legal, aerospace, insurance and technical publishing, we believe there are tens of millions of users who need the capabilities provided by Acrobat and the service capabilities found in Document Cloud. We plan to continue marketing the benefits of our Document Cloud solutions, combined with the low entry point of subscription-based pricing, to individuals as well as small and medium-sized businesses, large enterprises and government institutions around the world. We aim to increase our seat penetration in these markets through the utilization of our corporate and volume licensing programs. We will continue to engage in strategic partnerships to help drive the business, including the recently announced Adobe Sign partnership with Microsoft. We also intend to increase our focus on marketing and licensing Acrobat in targeted vertical markets such as education, financial services, telecommunications and government, as well as on expanding into emerging markets, while simultaneously enhancing and building out the delivery of cloud-based document services to our Acrobat and Adobe Acrobat Reader users. We intend to continue promoting the capabilities of our cloud-based document solutions to millions of Acrobat users and hundreds of millions of Adobe Acrobat Reader users. Our Adobe Sign services provide a green alternative to costly paper-based solutions, and are an easier way for customers to manage their contract workflows. The Adobe Scan app for mobile devices can be used to capture paper documents as images and transform them into full-featured PDFs via Adobe Document Cloud services that can be shared immediately, essentially putting scanning capabilities in the pocket of every person. We believe that by growing the awareness of electronic signatures in the broader contract delivery and signing market and continuing to add new capabilities
to our Adobe Scan and Sign offerings, we can help our customers migrate away from paper-based express mailing and adopt our solution, growing our revenue with this business in the process.
Digital Experience
Digital Experience Opportunity
Consumers today increasingly demand personalized content and experiences in their digital interactions, across multiple channels and devices. As a result, businesses must figure out how to best attract, engage, acquire and retain customers in a digital world where the reach and quality of experiences directly impact success. Delivering the best experience to a consumer at a given moment requires the right combination of data, insights and content. Executives are increasingly demanding solutions that optimize their consumers’ experiences and deliver the greatest return on their marketing and IT spend so they can demonstrate the success of their programs using objective metrics.
We believe there is a significant opportunity to address these challenges and help customers transform their businesses. The world’s leading brands are increasingly steering their marketing, advertising, and development budgets toward digital experiences. As enterprises make this move to digital, our opportunity is accelerating as customers look for vendors to help them navigate this transition. Enterprises need to ensure they deliver meaningful experiences to their consumers across digital channels and in areas such as sales, support, and product interactions where consumers expect experiences to be consistent and personalized.
Our Experience Cloud business targets this large and growing opportunity by providing comprehensive solutions that include analytics, targeting, advertising optimization, digital experience management, cross-channel campaign management, audience management, premium video delivery and monetization. These comprehensive solutions enable marketers to measure, personalize and optimize digital experiences across channels for optimal performance.
We believe the market for Experience Cloud is rapidly expanding, and industry analysts predict more advertising dollars will be spent in digital than in traditional media in the future.
Digital Experience Strategy
Our goal is to be the leading provider of solutions that enable our customers to provide exceptional digital experiences. Our integrated cloud-based solutions enable enterprises to build personalized campaigns, manage advertising, and gain deep intelligence about their customers. Our content and data platform provides differentiation and competitive advantage.
In March 2017, we migrated our hierarchy of solutions under what was formerly known as Adobe Marketing Cloud to our next generation offering referred to as Adobe Experience Cloud.
Adobe Experience Cloud consists of the following cloud offerings:
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• | Adobe Marketing Cloud—provides an integrated set of solutions to help marketers differentiate their brands and engage their customers, helping businesses manage, personalize, and orchestrate campaigns and customer journeys; includes Adobe Experience Manager (“AEM”), Adobe Campaign, Adobe Target and Adobe Primetime. |
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• | Adobe Analytics Cloud—enables businesses to move from insights to actions in real time by uniquely integrating audiences as the core system of intelligence for the enterprise; makes data available across all Adobe clouds through the capture, aggregation, rationalization and understanding of vast amounts of disparate data and then translating that data into singular customer profiles; includes Adobe Analytics and Adobe Audience Manager. |
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• | Adobe Advertising Cloud—delivers an end-to-end platform for managing advertising across traditional TV and digital formats, and simplifies the delivery of video, display and search advertising across channels and screens; combines capabilities from Adobe Media Optimizer (“AMO”) and Adobe’s acquisition of TubeMogul during the first quarter of fiscal 2017. |
We believe the artificial intelligence and machine learning framework enabled by our strategy with Adobe Sensei enhances the delivery of digital experiences. By building on existing features such as Enhanced Anomaly Detection, Auto-Target, and other capabilities, we believe Adobe Sensei will increase the value we provide our customers and create a competitive differentiation in the market.
To drive growth of Experience Cloud, we also intend to focus on customer engagement, partner leverage, and product differentiation. We utilize a direct sales force to market and license our Experience Cloud solutions, as well as an extensive ecosystem of partners, including marketing agencies, SIs and independent software vendors that help license and deploy our solutions to their customers. Strategic partnerships, such as the one we have formed with Microsoft, continue to increase our
market reach. We have made significant investments to broaden the scale and size of all of these routes to market, and believe these investments will result in continued growth in revenue in our Digital Experience segment in fiscal 2018 and beyond.
Publishing
Our Publishing segment contains legacy products and services that address diverse market opportunities including eLearning solutions, technical document publishing, web application development and high-end printing. Graphics professionals and professional publishers continue to require quality, reliability and efficiency in production printing, and our Adobe PostScript and Adobe PDF printing technologies provide advanced functionality to meet the sophisticated requirements of this marketplace. As high-end printing systems evolve and transition to fully digital, composite workflows, we believe we are well positioned to be a supplier of software and technology based on the PostScript and Adobe PDF standards for use by this industry.
We generate revenue by licensing our technology to OEMs that manufacture workflow software, printers and other output devices. In fiscal 2017, we maintained a relatively consistent quarterly revenue run-rate with the mature products we market and license in our Publishing business.
In December 2017, in order to more closely align our Digital Experience business with the strategic growth opportunity, we moved two legacy enterprise software offerings from our Digital Experience segment to Publishing: our Adobe Connect web conferencing platform and Adobe LiveCycle, an enterprise document and forms platform. Since fiscal 2012, the focus of marketing and licensing these products has been to financial services and government markets, driven by a subset of our enterprise sales force. We have also been focused on migrating some legacy LiveCycle customers to an updated offering with similar capabilities based on our Adobe Experience Manager solution.
COMPETITION
The markets for our products and services are characterized by intense competition, new industry standards, evolving distribution models, disruptive technology developments, frequent product introductions, short product life cycles, price cutting with resulting downward pressure on gross margins and price sensitivity on the part of consumers. Our future success will depend on our ability to enhance and better integrate our existing products, introduce new products on a timely and cost-effective basis, meet changing customer needs, provide best-in-class information security to build customer confidence and combat cyber-attacks, extend our core technology into new applications and anticipate emerging standards, business models, software delivery methods and other technological changes.
Digital Media
No single company has offerings that match the capabilities of our Creative Cloud products and services, but we face collective competition from a variety of point offerings, free products and downloadable apps. Our competition includes offerings from companies such as Apple, Autodesk, Avid, Facebook, Corel, Microsoft, Quark and others, as well as from many lower-end offerings. We believe our greatest advantage in this space is the performance and scope of our integrated solutions, which work together as part of Creative Cloud. With Creative Cloud, we compete favorably on the basis of features and functionality, ease of use, product reliability, value and performance characteristics.
Professional digital imaging, drawing and illustration products are characterized by feature-rich competition, brand awareness and price sensitivity. Competition in this space is also emerging with drawing and illustration applications on tablet and smartphone platforms. The demand for professional web page layout and professional web content creation tools is constantly evolving and highly volatile. In this area, we face direct and indirect competition from desktop software companies and various proprietary and open source web-authoring tools.
We face competition from device, hardware and camera manufacturers as they try to differentiate their offerings by bundling, for free, their own digital imaging software or those of our competitors. Similarly, we face potential competition from operating system manufacturers as they integrate or offer hobbyist-level digital imaging and image management features with their operating systems. We also face competition from smartphone and tablet manufacturers that integrate imaging and video software into their devices to work with cameras that come as part of their smartphone and tablet offerings. In addition, social networking platforms such as Facebook (including Instagram), Snapchat, Twitter and Pinterest, as well as portal sites such as Google, Bing and Yahoo! are becoming a direct means to post, edit and share images, bypassing the step of using image editing and sharing software. Online storage and synchronization are becoming free and ubiquitous. Consumers will be encouraged to use the image and video editing software offered by those storage products, thus competing with our software.
In addition, the needs of digital imaging and video editing software users are constantly evolving due to rapid technology and hardware advancements in digital cameras, digital video cameras, printers, personal computers, tablets, smartphones and other
new devices. Our imaging and video offerings, including Photoshop, Lightroom, After Effects and Premiere Pro, face competition from established and emerging companies offering similar products.
New image editing applications for mobile devices and tablets with features that compete with our professional tools are also emerging as adoption of these devices grows. Our consumer digital imaging and video editing offerings are subject to intense competition, including customer price sensitivity and competitor brand awareness. We face direct and indirect competition in the consumer digital imaging space from a number of companies whose market software competes with our offerings.
The stock content marketplace has significant competition, especially in the microstock segment, where Adobe primarily operates today with our Adobe Stock offering. Key competitors in this segment include Shutterstock, Getty Images and a number of smaller companies. Adobe Stock’s deep product integration with Creative Cloud and superior reach and relationships with creative professionals around the world differentiate our offerings.
The nature of traditional digital document creation, storage, and collaboration has been rapidly evolving as knowledge workers and consumers shift their behavior increasingly to non-desktop workflows. Competitors like Microsoft, Google, Box and Dropbox all offer competitive alternatives to our Document Cloud business for creating and managing PDFs. In addition, other PDF creation solutions can be found at a low cost or for free on the web or via mobile applications. To address these competitive threats, we are working to ensure our Adobe Document Cloud applications stay at the forefront of innovation in emerging opportunities such as PDF document generation, document collaboration and document security, and have developed mobile solutions such as Adobe Scan.
As e-signatures are quickly becoming a core element of digital documents, competitors to Adobe Sign such as DocuSign have emerged. Partnerships and integrations between these companies and third-parties create an increasingly competitive landscape in this space.
Digital Experience
The markets in which our Digital Experience business unit competes are growing rapidly and characterized by intense competition. Our Experience Cloud solutions face competition from large companies such as Google, IBM, Marketo, Oracle, salesforce.com, SAP, SAS, Verizon, Teradata and others, in addition to point product solutions and focused competitors. Additionally, new competitors are constantly entering these markets. Some of these competitors provide SaaS solutions to customers, generally through a web browser, while others provide software that is installed by customers directly on their servers. In addition, we compete at times with our customers’ or potential customers’ internally developed applications. Of the competitors listed above, no single company has products identical to our Experience Cloud offerings. Experience Cloud competes in a variety of areas, including: reporting and analytics; cross-channel marketing and optimization; online and social marketing; audience management; advertising and real-time bidding technology; video delivery and monetization; web experience management and others.
Large software, internet and database management companies have expanded their offerings in the digital experience area, either by developing competing services or by acquiring existing competitors or strategic partners of ours. We believe competitive factors in our markets include the proven performance, security, scalability, flexibility and reliability of services; the strategic relationships and integration with third-party applications; the intuitiveness and visual appeal of user interfaces; demonstrable cost-effective benefits to customers; pricing; the flexibility of services to match changing business demands; enterprise-level customer service and training; perceived market leadership; the usability of services; real-time data and reporting; independence from portals and search engines; the ability to deploy the services globally; and success in educating customers in how to utilize services effectively. We believe we compete favorably with both the enterprise and low-cost alternatives based on many of these competitive factors including our strong feature set, the breadth of our offerings, our focus on global, multi-brand companies, our superior user experience, tools for building multi-screen, cross-channel applications, standards-based architecture, scalability and performance and leadership in industry standards efforts.
Creative and digital agencies, as well as SIs, are increasingly investing in acquiring their own digital experience technology to complement their creative services offerings. Adobe may face competition from these agencies and SIs as they come to market with best-of-breed offerings in one or more digital experience capabilities, or if agencies attempt to create a more complete technology platform offering. We believe our creative tools heritage differentiates us from our competitors. We have worked closely with marketing and creative customers for over 30 years. We also believe we have leadership in this space, with current customers representing leading global brands. Our comprehensive solutions extend more broadly than any other company in serving the needs of marketers and addressing this market opportunity; we integrate content and data, analytics, personalization, digital experience management, cross-channel campaign management, audience management, video delivery and monetization and social capabilities in our Experience Cloud. Most importantly, we provide a vision for our digital experience customers as we
engage with them across the important aspects of their business, extending from their use of Creative Cloud and Document Cloud to how they manage, deliver, measure and monetize their content with our Experience Cloud.
Publishing
Our Publishing product offerings face competition from large-scale publishing systems, XML-based publishing companies, as well as lower-end desktop publishing products. Similarly, our web conferencing product faces competition from a number of established products from other companies, including Cisco, Citrix and Microsoft. Competition involves a number of factors, including: product features, ease-of-use, printer service support, the level of customization and integration with other publishing system components, the number of hardware platforms supported, service and price. We believe we can successfully compete based upon the quality and features of our products, our strong brand among users, the widespread adoption of our products among printer service bureaus, and our extensive application programming interfaces.
In printing technologies, we believe the principal competitive factors for OEMs in selecting a page description language or a printing technology are product capabilities, market leadership, reliability, price, support and engineering development assistance. We believe that our competitive advantages include our technology competency, OEM customer relationships and our intellectual property portfolio.
PRINCIPAL PRODUCTS AND SERVICES
Digital Media Offerings
Creative Cloud
Adobe Creative Cloud is a cloud-based subscription offering that enables creative professionals and enthusiasts alike to express themselves with apps and services that connect across devices, platforms and geographies. Members have access to a vibrant creative community, publishing services to deliver apps and websites, cloud storage to easily access their work, the ability to sync their files to virtually any device, collaboration capabilities with team members, and new products and exclusive updates as they are developed. Creative Cloud members can build a Creative Profile which persists wherever they are. A user’s Creative Profile moves with them via Creative Cloud services from app to app and device to device, giving them immediate access to their personal files, photos, brushes, graphics, colors, fonts, text styles, desktop setting customizations and other important assets. Creative Cloud subscriptions include all of the applications listed below and many more.
Photoshop and Lightroom
Adobe Photoshop is the world’s most advanced digital imaging solution. It is used by photographers, designers, animators, web professionals, and video professionals, and is available to Creative Cloud subscribers. Lightroom CC, our new cloud-based photo service for editing, organizing, storing and sharing photos, is also available to Creative Cloud subscribers. Customers can also subscribe to Photoshop or Lightroom CC as individual cloud-enabled subscription products, or through our Photography Plan, which is a cloud-enabled offering targeted at photographers and photo hobbyists and includes Lightroom CC, integrated cloud services, and Lightroom Classic.
We also offer Photoshop Elements, which is targeted at consumers who desire the brand and power of Photoshop through an easy-to-use interface. For tablet and smartphone users, we offer several mobile apps including Photoshop Sketch, Photoshop Mix, Photoshop Express, Lightroom for mobile and Photoshop Fix—all of which enable sophisticated photo editing and content creation using a touch-based interface on tablet and mobile devices.
Illustrator
Adobe Illustrator is our industry-standard vector graphics solution used worldwide by designers of all types who want to create digital graphics and illustrations for all kinds of media: print, web, interactive, video, and mobile. Illustrator is available to Creative Cloud subscribers, and customers can also subscribe to use it as an individual subscription product. Users can also utilize mobile apps such as Illustrator Draw to gain access to Illustrator capabilities on their tablets and mobile devices, and sync their work through CreativeSync for use with Illustrator on their desktop.
Adobe XD
Adobe XD is our all-in-one UX/UI solution for designing websites, mobile apps and more that is designed to enable users to go from concept to prototype faster. It contains intuitive tools that deliver precision and performance using timesaving features like Repeat Grid and flexible artboards to create everything from low-fidelity wireframes to fully interactive prototypes for any screen in minutes. Adobe XD also makes it easy to share prototypes with teammates via the web and show colleagues how
multiscreen experiences look, feel and work with a single click. Adobe XD is available to Creative Cloud subscribers, and customers can also subscribe to use it as an individual cloud-enabled subscription product.
InDesign
Adobe InDesign is the leading professional page layout software for print and digital publishing. Our customers use it to design, preflight, and publish a broad range of content including newspapers and magazines for print, online, and tablet app delivery. Customers can create simple or complex layouts quickly and efficiently with precise control over typography, built-in creative tools, and an intuitive design environment. Tight integration with other Adobe offerings such as Photoshop, Illustrator, and Acrobat enables customers to work productively in print and digital workflows. Customers can also access Adobe digital publishing capabilities from within InDesign to create and publish engaging apps for a broad range of devices, including iOS, Android and Amazon-based devices. InDesign is available to Creative Cloud subscribers, and customers can also subscribe to use InDesign as an individual cloud-enabled subscription product.
Adobe Premiere Pro
Adobe Premiere Pro is a leading nonlinear video editing tool used by video professionals. Customers can import and combine various types of media, from video shot on a smartphone to 8K to virtual reality, and then edit in its native format without transcoding. Premiere Pro supports a vast majority of formats, and customers can use multiple graphics cards to accelerate render and export times. As part of Creative Cloud, Premiere Pro tightly integrates with other Adobe creative applications. Customers can also subscribe to use it as an individual cloud-enabled subscription product.
Adobe Dimension
Adobe Dimension (formerly Project Felix) is our newly released product that is designed to make it easy for graphic designers to create high-quality, photorealistic 3D images. Users can composite 2D and 3D assets to build product shots, scene visualizations, and abstract art. Dimension integrates well with other Adobe apps. Users can drag and drop background images from Photoshop and 3D models from Adobe Stock - without leaving Dimension. Dimension is available to Creative Cloud subscribers, and customers can also subscribe to use it as an individual cloud-enabled subscription product.
After Effects
Adobe After Effects is our industry-leading animation and creative compositing solution used by a wide variety of motion graphics and visual effects artists. It offers superior control, a wealth of creative options, and integration with other post-production applications. After Effects works together seamlessly with other Adobe apps such as Premiere Pro, Photoshop, Illustrator, and Audition. After Effects is available to Creative Cloud subscribers, and customers can also subscribe to use it as an individual cloud-enabled subscription product.
Typekit
Adobe Typekit brings thousands of fonts from foundry partners into one library for quick browsing, easy use on the web or on the user’s desktop, and endless typographic inspiration. Our full library of commercially-licensed fonts is offered through Creative Cloud. In addition, customers may subscribe to the standalone Typekit portfolio plan, or license individual fonts in the Adobe Typekit Marketplace.
Behance
Behance is the leading social community to showcase and discover creative work online. Adobe Portfolio allows users to quickly and simply build a fully customizable and hosted website that seamlessly syncs with Behance.
Adobe Spark
Adobe Spark is our integrated web and mobile software for creating and sharing impactful visual stories. Designed for everyday communication, AdobeSpark empowers users to create stunning visual content that engages audiences across multiple channels and on any device. The Adobe Spark web app seamlessly syncs with Spark Post, Spark Page and Spark Video iOS mobile apps, allowing users to create, edit and share their story from any location regardless of their design experience. Adobe Spark with premium features allows users to apply custom branding to anything they create; the premium product is offered as part of any Creative Cloud plan or as a standalone subscription. A free version is also still available to attract new users.
Acrobat and Adobe Document Cloud
Adobe Document Cloud is a complete portfolio of secure digital document solutions that speed business transactions through streamlined digital workflows. With Adobe Document Cloud, users can create, review, approve, sign and track documents, whether on a desktop or mobile device.
At the heart of Adobe Document Cloud is Adobe Acrobat DC, the industry standard for PDF creation and conversion. Acrobat enables users to create secure, reliable and compact Adobe PDF documents from desktop authoring applications such as Microsoft Office software, graphics applications and more. Acrobat enables automated collaborative workflows with a rich set of commenting tools and review tracking features and includes everything needed to create and distribute rich, secure electronic documents that can be viewed easily within leading web browsers or on computer desktops via the free Adobe Acrobat Reader DC.
Acrobat is available to both Creative Cloud and Document Cloud subscribers. Customers can also license Acrobat Pro or Acrobat Standard (which has a subset of Acrobat Pro features) as individual point products, either as a cloud-enabled subscription or in the form of desktop software. Acrobat is also available as a free mobile app that allows users to view, annotate, and scan documents. Acrobat Reader is our free software for reliable viewing, searching, reviewing and printing of Adobe PDF documents on a variety of hardware and operating system platforms. Users of both Acrobat and Acrobat Reader can also access, edit and save changes to their PDF files stored on the Dropbox website or mobile app.
Adobe Scan can be used on mobile devices to provide scanning capabilities in the pocket of every person. It captures paper documents as images and transforms them into full-featured and versatile PDFs via Document Cloud services for instant sharing with others.
Our Adobe Sign e-signature services, which can be accessed as part of Document Cloud, allow users to securely electronically send and sign any document from any device. Adobe Sign has a mobile app companion allowing users to e-sign documents and forms, send them for signature, track responses in real-time, and obtain instant signatures with in-person signing. It integrates with users’ enterprise systems through a comprehensive set of applicable programming interfaces, and Adobe Experience Manager Forms and Advanced Workflows for Adobe Sign to create forms and provide seamless experiences to customers across web and mobile sites. Adobe Sign is Microsoft’s preferred e-sign solution and is integrated into Microsoft Office 365, Microsoft Dynamics 365, and Microsoft SharePoint.
Adobe Experience Cloud Products and Services
Adobe Experience Cloud includes our Marketing Cloud, Analytics Cloud, and Advertising Cloud offerings, which are each described below.
Adobe Marketing Cloud
Adobe Marketing Cloud provides a complete set of integrated digital marketing solutions. It contains everything necessary to deliver first-class digital experiences. Adobe Marketing Cloud enables our customers to manage their content and assets, grow audiences and increase engagement to optimize customer experiences; personalize content and deliver optimized experiences at scale that are meaningful to each of their customers; and orchestrate individual cross-channel campaigns that encourage meaningful customer experiences. Adobe Marketing Cloud also provides a solution that allows our customers to monetize video experiences. The following is a brief description of the solutions that comprise the Adobe Marketing Cloud.
Adobe Experience Manager
Adobe Experience Manager is a leading digital experience management solution that helps customers organize, create, and manage the delivery of creative assets and other content across digital marketing channels, including web, mobile, email, communities and video. It enables customers to manage content on premise or host it in the cloud, delivering agile and rapid deployment. With this ultimate control of content and campaigns, our customers can deliver real-time and personalized experiences to their consumers that help build the customers’ brand, drive demand and extend reach. Adobe Experience Manager includes digital asset management, web content management, digital publishing, integrated mobile app development, enterprise-level forms management, and social capabilities, providing customers with tools enabling users to improve their market and brand perception and provide a personalized experience to their consumers.
Adobe Campaign
Adobe Campaign enables marketers to orchestrate personalized experiences determined by each consumer’s behaviors and preferences. As part of its feature set, Adobe Campaign provides visual campaign orchestration, allowing for intuitive design and automated consumer experiences across channels, from one-off campaigns to triggered messages, with a graphically rich interface. Marketers can also integrate consumer data from across marketing channels to develop and deliver more relevant marketing experiences to their consumers. Features also include targeted segmentation, multilingual email execution, real-time interaction, in-app messaging, and operational reporting to easily see how well campaigns are performing.
Adobe Target
Adobe Target lets our customers test, target and personalize content across multiple devices. With Adobe Target, our customers have the tools they need to quickly discover what gets noticed, what increases conversion, and what keeps consumers coming back for more. It paves a path from simple testing to targeting to true segmentation and optimization through A/B and multivariate testing, content targeting and automated decision-making. Adobe Target capabilities also enable our customers to test and target adaptive or responsive mobile web experiences.
Adobe Primetime
Adobe Primetime is a multiscreen TV platform that helps broadcasters, cable networks, and service providers create and monetize engaging, personalized viewing experiences. When integrated with Adobe Experience Cloud solutions, media sellers can optimize campaign and advertisement delivery in real time.
Adobe Analytics Cloud
Adobe Analytics Cloud provides a core intelligence engine for enterprises that allow customers to put real-time insights into action. With Adobe Analytics Cloud, enterprise-level marketing analytics is made understandable and accessible to everyone in the organization; targeting is improved, as our customers can connect their analytics with real-time activation so the transition from insight to action is fast; users are provided with an objective view of their customers’ journeys across every device and channel that helps them achieve better understanding of their ROI; and segmentation is more precise as our customers can discover and create high-value audiences and understand the best way to reach them. The following is a brief description of the solutions that comprise the Adobe Analytics Cloud.
Adobe Analytics
Adobe Analytics is our industry leading solution that helps our customers create a holistic view of their business by turning consumer interactions into actionable insights. With intuitive and interactive dashboards and reports, our customers can sift, sort, and share real-time information to provide insights that can be used to identify problems and opportunities and to drive conversion and relevant consumer experiences. Adobe Analytics enables web, social, video, mobile, attribution, and predictive analytics across online and offline channels to continuously improve the performance of marketing activities. It also provides the ability to perform advanced ad-hoc segmentation and to integrate data from offline and third-party sources. Adobe Analytics is available in four plans that contain various features and add-ons to meet the needs of our customers’ businesses.
Adobe Audience Manager
Adobe Audience Manager is a data management platform that helps digital publishers build unique audience profiles to identify the most valuable segments and use them across any digital channel. Adobe Audience Manager consolidates audience information from all available sources. It then identifies, quantifies, and optimizes high-value target audiences, which can then be offered to advertisers via an integrated, secure, privacy-friendly management system that works across all advertising distribution platforms. Adobe Audience Manager provides access to multiple data sources, offering digital publishers the ability to use a wide variety of third-party data as well as Audience Manager’s private data co-op.
Adobe Advertising Cloud
Adobe Advertising Cloud is an end-to-end platform for managing advertising across traditional TV and digital formats. With Adobe Advertising Cloud, customers can identify and amplify their high-value audiences for more personal and accurate targeting; seamlessly unite creative, data, and media buying across all screens and formats; protect their brand by preventing their campaigns from mixing with content and properties that do not align with their image; and use data insights that reveal customers’ interests and past behaviors to create relevant, targeted ads. Adobe Advertising is comprised of the Adobe Media Optimizer offerings described below.
Adobe Media Optimizer Search
Adobe Media Optimizer Search allows customers to simulate and quickly act upon the best and most profitable options in their search marketing strategy. Specifically, it provides customers with sophisticated models to test and visualize the expected traffic and conversion for keywords, ad placements, and product targets. Adobe Media Optimizer Search also enables customers to run models to determine the highest performing mix of advertising at varied spend levels across portfolios and then validate assumptions with reports based on models and data.
Adobe Media Optimizer Demand Side Platform (DSP)
Adobe Media Optimizer DSP (formerly TubeMogul) is a unified cross-channel solution that allows customers to streamline global advertising from a single platform. With Adobe Media Optimizer DSP, customers can intelligently target their most valuable
audiences by optimizing display ad campaigns in real time. Adobe Media Optimizer DSP’s programmatic TV buying solution extends many of the benefits digital buying offers - like targeting and reporting insights - to television advertising. It helps advertisers plan campaigns holistically, across every screen, while providing more flexibility to shift spend and optimize reach and frequency. Adobe Media Optimizer DSP also provides users with the tools to create, manage, optimize and scale ads for Facebook and Instagram.
Adobe Media Optimizer Dynamic Creative Optimization (DCO)
Adobe Media Optimizer DCO enables advertisers to reach specific audiences with flexible creative content that’s personalized in real time based on site actions, customer and partner data, and third-party demographic data. Adobe Media Optimizer DCO provides customers with robust campaign options, from retargeting and loyalty programs to prospecting and awareness campaigns; site visitor, partner, third-party and location data to improve audience targeting; flexibility to deliver the right content across device types; and reports and algorithms to help optimize creative elements.
Other Products and Services
We also offer a broad range of other enterprise and digital media products and services. Information about other products not referenced here can be found on our corporate website, www.adobe.com.
OPERATIONS
Marketing and Sales
We market and license our products directly using our sales force and certain local offices and through our own website at www.adobe.com. We also market and distribute our products through sales channels, which include distributors, retailers, software developers, SIs, ISVs and VARs, as well as through OEM and hardware bundle customers.
Our local field offices include locations in Australia, Austria, Belgium, Brazil, Canada, Chile, China, Columbia, Czech Republic, Denmark, Finland, France, Germany, Hong Kong, India, Ireland, Israel, Italy, Japan, Mexico, Moldova, the Netherlands, New Zealand, Norway, Poland, Romania, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, United Arab Emirates, the United Kingdom and the United States.
We sell the majority of our products through a software subscription model where our customers purchase access to a product for a specific period of time during which they always have rights to use the most recent version of that product. We also license perpetual versions of our software with maintenance and support, which includes rights to upgrades, when and if available, support, updates and enhancements.
For fiscal 2017, 2016 and 2015, there were no customers that represented at least 10% of net revenue. As of fiscal year end 2017 and 2016, no single customer was responsible for over 10% of our trade receivables.
Services and Support
We provide expert consulting, customer success management, technical support, and learning services across all our customer segments, including enterprises, small and medium businesses, creative professionals, and consumers. With a focus on ensuring sustained customer success and realized value, this comprehensive portfolio of services is designed to help customers and partners maximize the return on their investments in our cloud solutions and licensed products. Our service and support revenue consists primarily of consulting fees, software maintenance, technical support fees and training fees.
Consulting Services
We have a global professional services team dedicated to designing and implementing solutions for our largest customers. Our professional services team uses a comprehensive, customer-focused methodology that has been refined over years of capturing and analyzing best practices from numerous customer engagements across a diverse mix of solutions, industries, and customer segments. Increasingly, our customers seek to integrate across Adobe’s products and cloud solutions, and engage our professional services teams to share their expertise in leading customers’ digital strategies and multi-solution integrations. Using our methodology, our professional services teams are able to accelerate customers’ time to value, and maximize the return customers earn on their investment in Adobe solutions.
A key component of Adobe’s strategy is developing a large partner ecosystem to expand the reach and breadth of Adobe solutions in the global marketplace. In order to assist partners in building their respective digital practices, Adobe Global Services provides a comprehensive set of deliverables through Adobe’s Solution Partner Program. The breadth of services described in the
program provides system integrators, agencies, and regional partners the tools required to develop core capabilities for positioning and building with Adobe technology, as well as implementing and running customer platforms. We believe that through these programmatic services and support, our joint customers benefit greatly by the combination of Adobe technology and the deep customer context that our global partners represent.
Customer Success Account Management
For our largest Digital Experience and Digital Media customers, Adobe Global Services provides post-sales Customer Success Managers, who work individually with customers on an ongoing basis to understand their current and future business needs, promote faster solution adoption, and align product capabilities to customers’ business objectives to maximize the return on their investment in Adobe’s offerings. We engage customers to share innovative best practices, relevant industry and vertical knowledge, and proven success strategies based on our extensive engagements with leading marketers and brands. The performance of these teams is directly associated with customer-focused outcomes, notably ongoing customer retention.
Technical Support
Adobe provides enterprise maintenance and support services to customers of subscription products as part of the subscription entitlement, and to perpetual license customers via annual fee-based maintenance and support programs. These offerings provide:
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• | technical support on the products they have purchased from Adobe; |
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• | “how to” help in using our products; and |
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• | product upgrades and enhancements during the term of the maintenance and support or subscription period, which is typically one to three years. |
We provide product support through a global support organization that includes several regional and global support centers, supplemented with outsourced vendors for specific services. Customers can seek help through multiple channels including phone, chat, web, social media, and email, allowing quick and easy access to the information they need. These teams are responsible for providing timely, high-quality technical expertise on all our products.
As registered owners of the current version of an Adobe desktop product, consumers are eligible to receive Getting Started support on certain matters, to support easy adoption of their products. Support for some products and in some countries may vary. For enterprise customers with greater support needs, we offer personalized service options through Premium Services options, delivered by technical account managers who can also provide proactive risk mitigation services and on-site support services for those with business critical deployments.
Lastly, we also offer delivery assurance, technical support, and enablement services to partners and developer organizations. Through the Adobe Partner Connection Program, we provide developers with high-quality tools, software development kits, information and services.
Digital Learning Services
Adobe Global Services offers a comprehensive portfolio of learning and enablement services to assist our customer and partner teams in the use of our products, including those within Digital Marketing, Digital Media and other legacy products and solutions. Our training portfolio includes a large number of free online self-service learning options on www.training.adobe.com. Adobe Digital Learning Services also has an extensive portfolio of fee-based learning programs including a wide range of traditional classroom, virtual, and on-demand training and certifications delivered by our team of training professionals and partners across the globe.
These core offerings are complemented by our custom learning services, which support our largest enterprise customers and their unique requirements. Solution-specific skills assessments help our enterprise customers objectively assess the knowledge and competencies within their marketing teams and tailor their learning priorities accordingly. Finally, aligned with our cloud strategy, we have introduced a new learning subscription service that enables customers to access both business and technical Digital Marketing training over a 12-month period, which is a scalable approach to supporting long-term learning.
Investments
From time to time we make direct investments in privately held companies. We enter into these investments with the intent of securing financial returns as well as for strategic purposes, as they often increase our knowledge of emerging markets and technologies and expand our opportunities to provide Adobe products and services.
PRODUCT DEVELOPMENT
A continuous high level of investment is required for the enhancement of existing solutions and the development of new solutions due to the speed of technological change that characterizes the software industry. We develop our software internally, as well as acquire products or technology developed by others by purchasing the stock or assets of the business entity that owns the technology. In other instances, we have licensed or purchased the intellectual property ownership rights of programs developed by others with license or technology transfer agreements that may obligate us to pay a flat license fee or royalties, typically based on a dollar amount per unit or a percentage of the revenue generated by those programs.
During fiscal 2017, 2016 and 2015, our research and development expenses were $1.22 billion, $976.0 million and $862.7 million, respectively.
PROTECTING AND LICENSING OUR PRODUCTS
We protect our intellectual property through a combination of patents, copyrights, trademarks and trade secrets, foreign intellectual property laws, confidentiality procedures and contractual provisions. We have United States and foreign patents and pending applications that relate to various aspects of our products and technology. Although our patents have value, no single patent is essential to any of our principal businesses. We have also registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights.
Our enterprise customers license our hosted offerings as On-demand Services or Managed Services, and consumers primarily use our desktop software and mobile apps. We license our desktop software to users under ‘click through’ or signed license agreements containing restrictions on duplication, disclosure, and transfer. Similarly, cloud products and services are provided to users under ‘click through’ or signed agreements containing restrictions on access and use.
Despite our efforts to protect our proprietary technology and our intellectual property rights, unauthorized parties may attempt to copy or obtain and use our technology to develop applications with the same functionality as our application. Policing unauthorized use of our technology and intellectual property rights is difficult. We believe that our transition from perpetual-use software licenses to a subscription-based business model combined with the increased focus on cloud-based computing may improve our efforts to combat the pirating of our products.
EMPLOYEES
As of December 1, 2017, we employed 17,973 people. We have not experienced work stoppages and believe our employee relations are good.
AVAILABLE INFORMATION
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our Investor Relations website at www.adobe.com/adbe as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information posted on our website is not incorporated into this report.
EXECUTIVE OFFICERS
Adobe’s executive officers as of January 12, 2018 are as follows:
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Name | | Age | | Positions |
Shantanu Narayen | | 54 | | President, Chief Executive Officer, and Chairman of the Board Mr. Narayen currently serves as our President, Chief Executive Officer, and Chairman of the Board. He joined Adobe in January 1998 as Vice President and General Manager of our engineering technology group. In January 1999, he was promoted to Senior Vice President, Worldwide Products, and in March 2001 he was promoted to Executive Vice President, Worldwide Product Marketing and Development. In January 2005, Mr. Narayen was promoted to President and Chief Operating Officer, and effective December 2007, he was appointed our Chief Executive Officer and joined our Board of Directors. In January 2017, Mr. Narayen was selected by our Board of Directors as Chairman of the Board. Mr. Narayen serves on the board of directors of Pfizer Inc., a multinational pharmaceutical corporation. He previously served as a director of Dell Inc. from September 2009 to October 2013. Mr. Narayen holds a B.S. in Electronics Engineering from Osmania University in India, a M.S. in Computer Science from Bowling Green State University and an M.B.A. from the Haas School of Business, University of California, Berkeley. |
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Name | | Age | | Positions |
Mark Garrett | | 60 | | Executive Vice President, Chief Financial Officer Mr. Garrett joined Adobe in February 2007 as Executive Vice President and Chief Financial Officer. Mr. Garrett served as Senior Vice President and Chief Financial Officer of the Software Group of EMC Corporation, a products, services and solutions provider for information management and storage, from June 2004 to January 2007, his most recent position since EMC's acquisition of Documentum, Inc., an enterprise content management company, in December 2003. Mr. Garrett first joined Documentum as Executive Vice President and Chief Financial Officer in 1997, holding that position through October 1999 and then re-joining Documentum as Executive Vice President and Chief Financial Officer in 2002. Mr. Garrett is also a director of Pure Storage, Inc., the Adobe Foundation, and the Children's Discovery Museum of San Jose. |
Matthew Thompson | | 59 | | Executive Vice President, Worldwide Field Operations Mr. Thompson currently serves as Executive Vice President, Worldwide Field Operations. Mr. Thompson joined Adobe in January 2007 as Senior Vice President, Worldwide Field Operations. In January 2013, he was promoted to Executive Vice President, Worldwide Field Operations. Prior to joining Adobe, Mr. Thompson served as Senior Vice President of Worldwide Sales at Borland Software Corporation, a software delivery optimization solutions provider, from October 2003 to December 2006. Prior to joining Borland, Mr. Thompson was Vice President of Worldwide Sales and Field Operations for Marimba, Inc., a provider of products and services for software change and configuration management, from February 2001 to January 2003. From July 2000 to January 2001, Mr. Thompson was Vice President of Worldwide Sales for Calico Commerce, Inc., a provider of eBusiness applications. Prior to joining Calico, Mr. Thompson spent six years at Cadence Design Systems, Inc., a provider of electronic design technologies. While at Cadence, from January 1998 to June 2000, Mr. Thompson served as Senior Vice President, Worldwide Sales and Field Operations and from April 1994 to January 1998 as Vice President, Worldwide Professional Services. Mr. Thompson is a board member of NCR Corporation. |
Michael Dillon
| | 59 | | Executive Vice President, General Counsel and Corporate Secretary
Mr. Dillon joined Adobe in August 2012 as Senior Vice President, General Counsel and Corporate Secretary. Prior to joining Adobe, Mr. Dillon served as General Counsel and Corporate Secretary of Silver Spring Networks, a networking solutions provider, from November 2010 to August 2012. Before joining Silver Spring Networks, Mr. Dillon served in various capacities at Sun Microsystems, a diversified computer networking company, prior to its acquisition by Oracle Corporation. While at Sun Microsystems, from April 2006 to January 2010, Mr. Dillon served as Executive Vice President, General Counsel and Secretary, from April 2004 to April 2006, as Senior Vice President, General Counsel and Corporate Secretary, and from July 2002 to March 2004 as Vice President, Products Law Group. From October 1999 until June 2002, Mr. Dillon served as Vice President, General Counsel and Corporate Secretary of ONI Systems Corp, an optical networking company. Mr. Dillon is a board member of the Adventure Cycling Association, Business Software Alliance, and the Adobe Foundation. |
Bryan Lamkin | | 57 | | Executive Vice President and General Manager, Digital Media
Mr. Lamkin currently serves as Executive Vice President and General Manager, Digital Media. He rejoined Adobe in February 2013 as Senior Vice President, Technology and Corporate Development. From June 2011 to May 2012, Mr. Lamkin served as President and Chief Executive Officer of Clover, a mobile payments platform. Prior to Clover, Mr. Lamkin co-founded and served as the Chief Executive Officer of Bagcheck, a sharing and discovery platform, from June 2010 to May 2011. From April 2009 to June 2010, Mr. Lamkin served as Senior Vice President of Consumer Products and Applications at Yahoo!, a global technology company providing online search, content and communication tools. From May 2008 to April 2009, Mr. Lamkin served as Executive in Residence at Sutter Hill Ventures. Mr. Lamkin previously was with Adobe from 1992 to 2006 and held various senior management positions including Senior Vice President, Creative Solutions Business Unit.
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Ann Lewnes
| | 56 | | Executive Vice President and Chief Marketing Officer
Ms. Lewnes joined Adobe in November 2006 and currently serves as Executive Vice President and Chief Marketing Officer. Prior to joining Adobe, Ms. Lewnes spent 20 years at Intel Corporation, where she was Vice President of Sales and Marketing. Ms. Lewnes is a board member of Mattel, The Ad Council, and the Adobe Foundation. |
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Name | | Age | | Positions |
Donna Morris
| | 50 | | Executive Vice President, Customer and Employee Experience
Ms. Morris currently serves as Executive Vice President of Adobe's Global Customer and Employee Experience organization. Ms. Morris joined Adobe as Senior Director of Global Talent Management in April 2002 through the acquisition of Accelio Corporation, a Canadian software company, where she served as Vice President of Human Resources and Learning. In December 2005, Ms. Morris was promoted to Vice President, Global Human Resources Operations and subsequently to Senior Vice President, Human Resources in March 2007. Ms. Morris is a director of the Society for Human Resource Management and the Adobe Foundation. |
Abhay Parasnis | | 43 | | Executive Vice President and Chief Technology Officer
Mr. Parasnis joined Adobe in July 2015 as Senior Vice President of Adobe's Cloud Technology & Services organization and Chief Technology Officer. Prior to joining Adobe, he served as President and Chief Operating Officer at Kony, Inc. from March 2013 to March 2015. From January 2012 to November 2013, Mr. Parasnis was a Senior Vice President and later Strategic Advisor for the Oracle Public Cloud at Oracle. Prior to joining Oracle, he was General Manager of Microsoft Azure AppFabric at Microsoft from April 2009 to December 2011. |
Bradley Rencher
| | 44 | | Executive Vice President and General Manager, Digital Experience
Mr. Rencher serves as Executive Vice President and General Manager of Adobe's Digital Experience business unit. Mr. Rencher joined Omniture, Inc. in January 2008 as Vice President of Corporate Development and was promoted to Senior Vice President of Business Operations prior to Adobe's acquisition of Omniture in 2009. Following the acquisition he joined Adobe as Vice President of Business Operations. Mr. Rencher was promoted to Vice President and General Manager, Omniture business unit in 2010 and subsequently to Senior Vice President in 2011. Prior to joining Omniture, Mr. Rencher was a member of the technology investment banking team at Morgan Stanley from 2005 to 2008 and a member of the investment banking team at RBC Capital Markets from 1998 to 2004. Mr. Rencher is a director of Pluralsight and the Utah Symphony. |
Scott Belsky | | 37 | | Chief Product Officer and Executive Vice President, Creative Cloud
Mr. Belsky joined Adobe in December 2017 as Executive Vice President and Chief Product Officer, Creative Cloud. Prior to joining Adobe in December 2017, Belsky was a venture investor at Benchmark in San Francisco from February 2016 to December 2017. Prior to Benchmark, Belsky led Adobe's mobile strategy for Creative Cloud from December 2012 to January 2016, having joined the company through the acquisition of Behance. Belsky co-founded Behance in 2006 and served as its CEO for over 6 years. He is an early advisor and investor to Pinterest, Uber, and Warby Parker among other early-stage companies, and co-founded and serves on the Board of Prefer, a referrals platform that empowers the careers of independent professionals. Mr. Belsky serves on the advisory board of Cornell University's Entrepreneurship Program and is President of the Smithsonian Cooper-Hewitt National Design Museum board of trustees. |
John Murphy | | 49 | | Senior Vice President, Chief Accounting Officer and Corporate Controller
Mr. Murphy joined Adobe in March 2017 as our Senior Vice President, Chief Accounting Officer and Corporate Controller. Prior to joining Adobe, Mr. Murphy served as Senior Vice President, Chief Accounting Officer and Corporate Controller of Qualcomm Incorporated from September 2014 to March 2017. He previously served as Senior Vice President, Controller and Chief Accounting Officer of DIRECTV Inc. from November 2007 until August 2014, and Vice President and General Auditor of DIRECTV from October 2004 to November 2007. Prior to joining DIRECTV he worked at several global companies, including Experian, Nestle, and Atlantic Richfield (ARCO), in a variety of finance and accounting roles. He served as Director of DirecTV Holdings LLC from November 2007 until August 2014. Mr. Murphy serves on the Corporate Advisory Board of the Marshall School of Business at the University of Southern California. He holds an MBA from the Marshall School of Business at the University of Southern California, a B.S. in Accounting from Fordham University and is a Certified Public Accountant. |
ITEM 1A. RISK FACTORS
As previously discussed, our actual results could differ materially from our forward-looking statements. Below we discuss some of the factors that could cause these differences. These and many other factors described in this report could adversely affect our operations, performance and financial condition.
If we cannot continue to develop, acquire, market and offer new products and services or enhancements to existing products and services that meet customer requirements, our operating results could suffer.
The process of developing and acquiring new technology products and services and enhancing existing offerings is complex, costly and uncertain. If we fail to anticipate customers’ rapidly changing needs and expectations or adapt to emerging technological trends, our market share and results of operations could suffer. We must make long-term investments, develop, acquire or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products and services. If we misjudge customer needs in the future, our new products and services may not succeed and our revenues and earnings may be harmed. Additionally, any delay in the development, acquisition, marketing or launch of a new offering or enhancement to an existing offering could result in customer attrition or impede our ability to attract new customers, causing a decline in our revenue, earnings or stock price and weakening our competitive position.
We offer our products on a variety of hardware platforms. Consumers continue to migrate from personal computers to tablet and mobile devices. If we cannot continue adapting our products to tablet and mobile devices, or if our competitors can adapt their products more quickly than us, our business could be harmed. Releases of new devices or operating systems may make it more difficult for our products to perform or may require significant costs in order for us to adapt our solutions to such devices or operating systems. These potential costs and delays could harm our business.
Our competitive position and results of operations could be harmed if we do not compete effectively.
The markets for our products and services are characterized by intense competition, new industry standards, evolving distribution models, limited barriers to entry, disruptive technology developments, short product life cycles, customer price sensitivity and frequent product introductions (including alternatives with limited functionality available at lower costs or free of charge). Any of these factors could create downward pressure on pricing and gross margins and could adversely affect our renewal and upsell and cross-sell rates, as well as our ability to attract new customers. Our future success will depend on our continued ability to enhance and integrate our existing products and services, introduce new products and services in a timely and cost-effective manner, meet changing customer expectations and needs, extend our core technology into new applications, and anticipate emerging standards, business models, software delivery methods and other technological developments. Furthermore, some of our competitors and potential competitors enjoy competitive advantages such as greater financial, technical, sales, marketing and other resources, broader brand awareness, and access to larger customer bases. As a result of these advantages, potential and current customers might select the products and services of our competitors, causing a loss of our market share. In addition, consolidation has occurred among some of our competitors. Further consolidations in these markets may subject us to increased competitive pressures and may harm our results of operations.
Introduction of new technology could harm our business and results of operations.
The expectations and needs of technology consumers are constantly evolving. Our future success depends on a variety of factors, including our continued ability to innovate, introduce new products and services efficiently, enhance and integrate our products and services in a timely and cost-effective manner, extend our core technology into new applications, and anticipate emerging standards, business models, software delivery methods and other technological developments. Integration of our products and services with one another and other companies’ offerings creates an increasingly complex ecosystem that is partly reliant on third parties. If any disruptive technology, or competing products, services or operating systems that are not compatible with our solutions, achieve widespread acceptance, our operating results could suffer and our business could be harmed.
The introduction of certain technologies may reduce the effectiveness of our products. For example, some of our products rely on third-party cookies, which are placed on individual browsers when consumers visit websites that contain advertisements. We use these cookies to help our customers more effectively advertise, gauge the performance of their advertisements, and detect and prevent fraudulent activity. Consumers can block or delete cookies through their browsers or “ad-blocking” software or applications. The most common Internet browsers allow consumers to modify their browser settings to prevent cookies from being accepted by their browsers, or are set to block third-party cookies by default. Increased use of methods, software or applications that block cookies could harm our business.
Some of our enterprise offerings have extended and complex sales cycles, which can make our sales cycles unpredictable.
Sales cycles for some of our enterprise offerings, including our Adobe Experience Cloud solutions and ETLAs in our Digital Media business, are multi-phased and complex. The complexity in these sales cycles is due to several factors, including:
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• | the need for our sales representatives to educate customers about the use and benefit of large-scale deployments of our products and services, including technical capabilities, security features, potential cost savings and return on investment; |
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• | the desire of organizations to undertake significant evaluation processes to determine their technology requirements prior to making information technology expenditures; |
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• | the need for our representatives to spend a significant amount of time assisting potential customers in their testing and evaluation of our products and services; |
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• | intensifying competition within the industry; |
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• | the negotiation of large, complex, enterprise-wide contracts; |
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• | the need for our customers to obtain requisition approvals from various decision makers within their organizations due to the complexity of our solutions touching multiple departments within customers’ organizations; and |
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• | customer budget constraints, economic conditions and unplanned administrative delays. |
We spend substantial time and expense on our sales efforts without assurance that potential customers will ultimately purchase our solutions. As we target our sales efforts at larger enterprise customers, these trends are expected to continue and could have a greater impact on our results of operations. Additionally, our enterprise sales pattern has historically been uneven, where a higher percentage of a quarter’s total sales occur during the final weeks of each quarter, which is common in our industry. Our extended sales cycle for these products and services makes it difficult to predict when a given sales cycle will close.
Subscription offerings could create risks related to the timing of revenue recognition.
We generally recognize revenue from subscription offerings ratably over the terms of their subscription agreements, which range from 1 to 36 months. As a result, most of the subscription revenue we report in each quarter is the result of subscription agreements entered into during previous quarters. Any reduction in new or renewed subscriptions in a quarter may not be reflected in our revenue results until a later quarter. Declines in new or renewed subscriptions may decrease our revenue in future quarters. Lower sales, reduced demand for our products and services, and increases in our attrition rate may not be fully reflected in our results of operations until future periods. Our subscription model could also make it difficult for us to rapidly increase our revenue from subscription-based or hosted services through additional sales in any period, as revenue from new customers will be recognized over the applicable subscription term.
Additionally, in connection with our sales efforts to enterprise customers and our use of ETLAs, a number of factors could affect our revenue, including longer-than-expected sales and implementation cycles, potential deferral of revenue due to multiple-element revenue arrangements and alternative licensing arrangements. If any of our assumptions about revenue from our subscription-based offerings prove incorrect, our actual results may vary materially from those anticipated.
If our customers fail to renew subscriptions in accordance with our expectations, our future revenue and operating results could suffer.
Our Adobe Experience Cloud, Creative Cloud, and Document Cloud offerings typically involve subscription based offerings pursuant to product and service agreements. Revenue from our subscription customers is generally recognized ratably over the term of their agreements, which typically range from 1 to 36 months. Our customers have no obligation to renew their subscriptions for our services after the expiration of their initial subscription period, and customers may not renew their subscriptions at the same or higher level of service, for the same number of seats or for the same duration of time, if at all. Moreover, under certain circumstances, some of our customers have the right to cancel their agreements prior to the expiration of the terms. Our varied customer base combined with the flexibility we offer in the length of our subscription-based agreements complicates our ability to precisely forecast renewal rates. Therefore, we cannot provide assurance that we will be able to accurately predict future customer renewal rates.
Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our services, our ability to continue enhancing features and functionality, the reliability (including uptime) of our subscription offerings, the prices of offerings and those offered by our competitors, the actual or perceived information security of our systems and services, decreases in the size of our customer base, reductions in our customers’ spending levels or declines in customer activity as a result of economic downturns or uncertainty in financial markets. If our customers do not renew their subscriptions or if they renew on terms less favorable to us, our revenue may decline.
Security breaches in data centers we manage, or third parties manage on our behalf, may compromise the confidentiality, integrity, or availability of employee and customer data, which could expose us to liability and adversely affect our reputation and business.
We process and store significant amounts of employee and customer data, most of which is hosted by third-party service providers. A security incident impacting our own data centers or those controlled by our service providers may compromise the confidentiality, integrity or availability of this data. Unauthorized access to or disclosure of data stored by Adobe or our service providers may occur through break-ins, breaches of a secure network by an unauthorized party, employee theft or misuse or other misconduct. It is also possible that unauthorized access to or disclosure of customer data may be obtained through inadequate use of security controls by customers or employees. Accounts created with weak or recycled passwords could allow cyber-attackers to gain access to customer data. Additionally, failure by customers to remove accounts of their own employees, or the granting of accounts by the customer in an uncontrolled manner, may allow for access by former or unauthorized customer representatives. If there were an inadvertent disclosure of customer information, or if a third party were to gain unauthorized access to the information we possess on behalf of our customers, our operations could be disrupted, our reputation could be damaged and we could be subject to claims or other liabilities, regulatory investigations, or fines. In addition, such perceived or actual unauthorized disclosure of the information we collect or breach of our security could damage our reputation, result in the loss of customers and harm our business.
We rely on data centers managed both by Adobe and third parties to host and deliver our services, as well as access, collect, use, transmit, and store data, and any interruptions or delays in these hosted services, or failures in data collection or transmission could expose us to liability and harm our business and reputation.
Much of our business relies on hardware and services that are hosted, managed, and controlled directly by Adobe or third-party service providers, including our online store at adobe.com, Creative Cloud, Document Cloud, and Experience Cloud solutions. We do not have redundancy for all of our systems, many of our critical applications reside in only one of our data centers, and our disaster recovery planning may not account for all eventualities. If our business relationship with a third-party provider of hosting or content delivery services is negatively affected, or if one of our content delivery suppliers were to terminate its agreement with us, we might not be able to deliver the corresponding hosted offerings to our customers, which could subject us to reputational harm, costly and time intensive notification requirements, and cause us to lose customers and future business. Occasionally, we migrate data among data centers and to third-party hosted environments. If a transition among data centers or to third-party service providers encounters unexpected interruptions, unforeseen complexity, or unplanned disruptions despite precautions undertaken during the process, this may impair our delivery of products and services to customers and result in increased costs and liabilities, which may harm our operating results and our business.
It is also possible that hardware or software failures or errors in our systems (or those of our third-party service providers) could result in data loss or corruption, cause the information that we collect or maintain to be incomplete or contain inaccuracies that our customers regard as significant, or cause us to fail to meet committed service levels or comply with regulatory notification requirements. Furthermore, our ability to collect and report data may be delayed or interrupted by a number of factors, including access to the Internet, the failure of our network or software systems, security breaches or significant variability in visitor traffic on customer websites. In addition, computer viruses, worms, or other malware may harm our systems, causing us to lose data, and the transmission of computer viruses or other malware could expose us to litigation or regulatory investigation, and costly and time intensive notification requirements.
We may also find, on occasion, that we cannot deliver data and reports to our customers in near real time because of a number of factors, including significant spikes in customer activity on their websites or failures of our network or software. If we fail to plan infrastructure capacity appropriately and expand it proportionally with the needs of our customer base, and we experience a rapid and significant demand on the capacity of our data centers or those of third parties, service outages could occur and our customers could suffer impaired performance of our services. Such a strain on our infrastructure capacity could subject us to regulatory notification requirements, violations of service level agreement commitments, financial liabilities, result in customer dissatisfaction, or harm our business. If we supply inaccurate information or experience interruptions in our ability to capture, store and supply information in near real time or at all, our reputation could be harmed and we could lose customers, or we could be found liable for damages or incur other losses.
Increasing regulatory focus on privacy issues and expanding laws could impact our business models and expose us to increased liability.
U.S. privacy and data security laws apply to our various businesses. We also do business globally in countries that have more stringent data protection laws than those in the United States that may be inconsistent across jurisdictions and are subject to evolving and differing interpretations. Governments, privacy advocates and class action attorneys are increasingly scrutinizing how companies collect, process, use, store, share and transmit personal data. Globally, new laws, such as the General Data Protection Regulation (“GDPR”) in Europe, and industry self-regulatory codes have been enacted and more are being considered that may affect our ability (and our enterprise customers’ ability) to reach current and prospective customers, to respond to both enterprise and individual customer requests under the laws (such as individual rights of access, correction, and deletion of their personal information), and to implement our business models effectively. These new laws may also impact our innovation and business drivers in developing new and emerging technologies (e.g., artificial intelligence and machine learning). These requirements, among others, may impact demand for our offerings and force us to bear the burden of more onerous obligations in our contracts. Any perception of our practices, products or services as a violation of individual privacy rights may subject us to public criticism, class action lawsuits, reputational harm, or investigations or claims by regulators, industry groups or other third parties, all of which could disrupt our business and expose us to increased liability. Additionally, we store information on behalf of our customers and if our customers fail to comply with contractual obligations or applicable laws, it could result in litigation or reputational harm to us.
Transferring personal information across international borders is becoming increasingly complex. For example, European data transfers outside the European Economic Area are highly regulated. The mechanisms that we and many other companies rely upon for European data transfers (e.g. Privacy Shield and Model Clauses) are being contested in the European court system. We are closely monitoring developments related to requirements for transferring personal data outside the EU. These requirements may result in an increase in the obligations required to provide our services in the EU or in sanctions and fines for non-compliance. Several other countries, including Australia and Japan, have also established specific legal requirements for cross-border transfers of personal information. These developments in Europe and elsewhere could harm our business, financial condition and results of operations.
Security vulnerabilities in our products and systems could lead to reduced revenue or to liability claims.
Maintaining the security of our products, computers and networks is a critical issue for us and our customers. Security researchers, criminal hackers and other third parties regularly develop new techniques to penetrate computer and network security measures and, as we have previously disclosed, certain parties have in the past managed to breach our data security systems and misused some of our systems and software in order to access our end users’ authentication and payment information. In addition, cyber-attackers also develop and deploy viruses, worms, credential stuffing attack tools, and other malicious software programs, some of which may be specifically designed to attack our products, systems, computers or networks. Sophisticated hardware and operating system applications that we develop or procure from third parties may contain defects in design or manufacture, including bugs and other problems that could unexpectedly compromise the security of the system or impair a customer’s ability to operate or use our products. The costs to prevent, eliminate, notify affected parties of, or alleviate cyber- or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities are significant, and our efforts to address these problems may not be successful or may be delayed and could result in interruptions, delays, cessation of service and loss of existing or potential customers. It is impossible to predict the extent, frequency or impact these problems may have on us.
Outside parties have in the past and may in the future attempt to fraudulently induce our employees or users of our products or services to disclose sensitive information via illegal electronic spamming, phishing or other tactics. Unauthorized parties may also attempt to gain physical access to our facilities in order to infiltrate our information systems or attempt to gain logical access to our products, services, or information systems for the purpose of exfiltrating content and data. These actual and potential breaches of our security measures and the accidental loss, inadvertent disclosure or unauthorized dissemination of proprietary information or sensitive, personal or confidential data about us, our employees, our customers or their end users, including the potential loss or disclosure of such information or data as a result of hacking, fraud, trickery or other forms of deception, could expose us, our employees, our customers or the individuals affected to a risk of loss or misuse of this information. This may result in litigation and liability or fines, our compliance with costly and time intensive notice requirements, governmental inquiry or oversight or a loss of customer confidence, any of which could harm our business or damage our brand and reputation, possibly impeding our present and future success in retaining and attracting new customers and thereby requiring time and resources to repair our brand and reputation. These risks will likely increase as we expand our hosted offerings, integrate our products and services, and store and process more data, including personal information.
These problems affect our products and services in particular because cyber-attackers tend to focus their efforts on popular offerings with a large user base, and we expect them to continue to do so. Critical vulnerabilities may be identified in some of our applications. These vulnerabilities could cause such applications to crash and could allow an attacker to take control of the affected system, which could result in liability to us or limit our ability to conduct our business and deliver our products and services to customers. We devote significant resources to address security vulnerabilities through engineering more secure products, enhancing
security and reliability features in our products and systems, code hardening, conducting rigorous penetration tests, deploying updates to address security vulnerabilities and improving our incident response time, but these security vulnerabilities cannot be totally eliminated. The cost of these steps could reduce our operating margins, and we may be unable to implement these measures quickly enough to prevent cyber-attackers from gaining unauthorized access into our systems and products. Despite our preventative efforts, actual or perceived security vulnerabilities in our products and systems may harm our reputation or lead to claims against us (and have in the past led to such claims), and could lead some customers to stop using certain products or services, to reduce or delay future purchases of products or services, or to use competing products or services. If we do not make the appropriate level of investment in our technology systems or if our systems become out-of-date or obsolete and we are not able to deliver the quality of data security customers require, our business could be adversely affected. Customers may also adopt security measures designed to protect their existing computer systems from attack, which could delay adoption of new technologies. Further, if we or our customers are subject to a future attack, or our technology is used in a third-party attack, we could be subject to costly and time intensive notice requirements, and it may be necessary for us to take additional extraordinary measures and make additional expenditures to take appropriate responsive and preventative steps. Any of these events could adversely affect our revenue or margins. Moreover, delayed sales, lower margins or lost customers resulting from disruptions caused by cyber-attacks or preventative measures could adversely affect our financial results, stock price and reputation.
We may not realize the anticipated benefits of past or future investments or acquisitions, and integration of acquisitions may disrupt our business and management.
We may not realize the anticipated benefits of an investment or acquisition of a company, division, product or technology, each of which involves numerous risks. These risks include:
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• | inability to achieve the financial and strategic goals for the acquired and combined businesses; |
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• | difficulty in, and the cost of, effectively integrating the operations, technologies, products or services, and personnel of the acquired business; |
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• | entry into markets in which we have minimal prior experience and where competitors in such markets have stronger market positions; |
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• | disruption of our ongoing business and distraction of our management and other employees from other opportunities and challenges; |
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• | inability to retain personnel of the acquired business; |
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• | inability to retain key customers, distributors, vendors and other business partners of the acquired business; |
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• | inability to take advantage of anticipated tax benefits; |
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• | incurring acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results; |
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• | elevated delinquency or bad debt write-offs related to receivables of the acquired business we assume; |
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• | increased accounts receivables collection times and working capital requirements associated with acquired business models; |
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• | additional costs of bringing acquired companies into compliance with laws and regulations applicable to a multinational corporation; |
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• | difficulty in maintaining controls, procedures and policies during the transition and integration; |
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• | impairment of our relationships with employees, customers, partners, distributors or third-party providers of our technologies, products or services; |
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• | failure of our due diligence processes to identify significant problems, liabilities or other challenges of an acquired company or technology; |
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• | exposure to litigation or other claims in connection with, or inheritance of claims or litigation risk as a result of, an acquisition, such as claims from terminated employees, customers, former stockholders or other third parties; |
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• | incurring significant exit charges if products or services acquired in business combinations are unsuccessful; |
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• | inability to conclude that our internal controls over financial reporting are effective; |
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• | inability to obtain, or obtain in a timely manner, approvals from governmental authorities, which could delay or prevent such acquisitions; |
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• | the failure of strategic investments to perform as expected or to meet financial projections; |
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• | delay in customer and distributor purchasing decisions due to uncertainty about the direction of our product and service offerings; and |
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• | incompatibility of business cultures. |
Mergers and acquisitions of technology companies are inherently risky. If we do not complete an announced acquisition transaction or integrate an acquired business successfully and in a timely manner, we may not realize the benefits of the acquisition to the extent anticipated, and in certain circumstances an acquisition could harm our financial position.
Changes in accounting principles, or interpretations thereof, could have a significant impact on our financial position and results of operations.
We prepare our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting principles. A change in these principles, how the principles are interpreted, or the adoption of new accounting principles can have a significant effect on our reported results, and could even retroactively affect previously reported transactions, and may require that we make significant changes to our systems, processes and controls.
Changes resulting from these new standards may result in materially different financial results and may require that we change how we process, analyze and report financial information and that we change financial reporting controls. For additional information regarding these updated standards, see the section titled “Recent Accounting Pronouncements Not Yet Effective” within Part II. Item 8, Note 1. Basis of Presentation and Summary of Significant Accounting Policies.
Such changes in accounting principles may have an adverse effect on our business, financial position, and income, or cause an adverse deviation from our revenue and profitability targets, which may negatively impact our financial results.
Changes in tax rules and regulations, or interpretations thereof, may adversely affect our effective tax rates.
We are a U.S.-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. A significant portion of our foreign earnings for the current fiscal year were earned by our Irish subsidiaries. In addition to providing for U.S. income taxes on earnings from the United States, we provide for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States. While, as of the balance sheet date, we do not anticipate changing our intention regarding permanently reinvested earnings, if certain foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings.
Our income tax expense has differed from the tax computed at the U.S. federal statutory income tax rate due primarily to discrete items and to earnings considered as permanently reinvested in foreign operations. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be unfavorably affected by changes in the tax rates in jurisdictions where our income is earned, by changes in or our interpretation of tax rules and regulations in the jurisdictions in which we do business, by unanticipated decreases in the amount of earnings in countries with low statutory tax rates, by unexpected negative changes in business and market conditions that could reduce certain tax benefits, or by changes in the valuation of our deferred tax assets and liabilities.
In addition, in the United States, the European Commission, countries in the European Union and other countries where we do business, we are subject to potential changes in relevant tax, accounting and other laws, regulations and interpretations, including changes to tax laws applicable to corporate multinationals such as Adobe. These countries and other governmental bodies have or could make unprecedented assertions about how earnings in their jurisdictions might be determined that are contrary to the way in which we have interpreted and historically applied the rules and regulations described above in our income tax returns filed in such jurisdictions. In the current global tax policy environment, any changes in laws, regulations and interpretations related
to these assertions could adversely affect our effective tax rates or result in other costs to us which could adversely affect our operations and financial results.
Moreover, we are subject to the continual examination of our income tax returns by the U.S. Internal Revenue Service (“IRS”) and other domestic and foreign tax authorities. These tax examinations are expected to focus on our intercompany transfer pricing practices as well as other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for adjustments that may result from these examinations. We cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position.
The success of some of our product and service offerings depends on our ability to continue to attract and retain customers of and contributors to our online marketplaces for creative content.
The success of some of our product and service offerings, such as Adobe Stock, depends on our ability to continue to attract new customers and contributors to these online marketplaces for creative content, as well as our ability to continue to retain existing customers and contributors. An increase in paying customers has generally resulted in more content from contributors, which increases the size of our collection and in turn attracts new paying customers. We rely on the functionality and features of our online marketplaces, the size and content of our collection and the effectiveness of our marketing efforts to attract new customers and contributors and retain existing ones. New technologies may render the features of our online marketplaces obsolete, our collection may fail to grow as anticipated or our marketing efforts may be unsuccessful, any of which may adversely affect our results of operations.
We face various risks associated with our operating as a multinational corporation.
As a global business that generates approximately 42% of our total revenue from sales to customers outside of the Americas, we are subject to a number of risks, including:
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• | foreign currency fluctuations and controls; |
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• | international and regional economic, political and labor conditions, including any instability or security concerns abroad; |
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• | tax laws (including U.S. taxes on foreign subsidiaries); |
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• | increased financial accounting and reporting burdens and complexities; |
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• | changes in, or impositions of, legislative or regulatory requirements; |
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• | changes in laws governing the free flow of data across international borders; |
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• | failure of laws to protect our intellectual property rights adequately; |
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• | inadequate local infrastructure and difficulties in managing and staffing international operations; |
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• | delays resulting from difficulty in obtaining export licenses for certain technology, tariffs, quotas and other trade barriers; |
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• | the imposition of governmental economic sanctions on countries in which we do business or where we plan to expand our business; |
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• | costs and delays associated with developing products in multiple languages; |
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• | operating in locations with a higher incidence of corruption and fraudulent business practices; and |
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• | other factors beyond our control, such as terrorism, war, natural disasters and pandemics. |
Some of our third-party business partners have international operations and are also subject to these risks and if our third-party business partners are unable to appropriately manage these risks, our business may be harmed. If sales to any of our customers outside of the Americas are reduced, delayed or canceled because of any of the above factors, our revenue may decline.
We are subject to risks associated with compliance with laws and regulations globally, which may harm our business.
We are a global company subject to varied and complex laws, regulations and customs, both domestically and internationally. These laws and regulations relate to a number of aspects of our business, including trade protection, import and export control, data and transaction processing security, payment card industry data security standards, records management, user-generated content hosted on websites we operate, privacy practices, data residency, corporate governance, anti-trust and competition, employee and third-party complaints, anti-corruption, gift policies, conflicts of interest, securities regulations and other regulatory requirements affecting trade and investment. The application of these laws and regulations to our business is often unclear and may at times conflict. For example, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by U.S. regulations applicable to us, including the Foreign Corrupt Practices Act. We cannot provide assurance that our employees, contractors, agents, and business partners will not take actions in violation of our internal policies or U.S. laws. Compliance with these laws and regulations may involve significant costs or require changes in our business practices that result in reduced revenue and profitability. Non-compliance could also result in fines, damages, criminal sanctions against us, our officers or our employees, prohibitions on the conduct of our business, and damage to our reputation.
In addition, approximately 52% of our employees are located outside the United States. Accordingly, we are exposed to changes in laws governing our employee relationships in various U.S. and foreign jurisdictions, including laws and regulations regarding wage and hour requirements, fair labor standards, employee data privacy, unemployment tax rates, workers’ compensation rates, citizenship requirements and payroll and other taxes, which likely would have a direct impact on our operating costs.
Uncertainty about current and future economic conditions and other adverse changes in general political conditions in any of the major countries in which we do business could adversely affect our operating results.
As our business has grown, we have become increasingly subject to the risks arising from adverse changes in economic and political conditions, both domestically and globally. Uncertainty about the effects of current and future economic and political conditions on us, our customers, suppliers and partners makes it difficult for us to forecast operating results and to make decisions about future investments. If economic growth in countries where we do business slows, customers may delay or reduce technology purchases, advertising spending or marketing spending. This could result in reductions in sales of our products and services, more extended sales cycles, slower adoption of new technologies and increased price competition. Among our customers are government entities, including the U.S. federal government, and our revenue could decline if spending cuts impact the government’s ability to purchase our products and services. Deterioration in economic conditions in any of the countries in which we do business could also cause slower or impaired collections on accounts receivable, which may adversely impact our liquidity and financial condition.
A disruption in financial markets could impair our banking partners, on which we rely for operating cash management and affect our derivative counterparties. Any of these events would likely harm our business, financial condition, and results of operations.
Political instability or adverse political developments in or around any of the major countries in which we do business would also likely harm our business, results of operations and financial condition.
Our intellectual property portfolio is a valuable asset and we may not be able to protect our intellectual property rights, including our source code, from infringement or unauthorized copying, use or disclosure.
Our intellectual property portfolio is a valuable asset. Infringement or misappropriation of our patents, trademarks, trade secrets, copyrights and other intellectual property rights could result in lost revenues and ultimately reduce their value. Preventing unauthorized use or infringement of our intellectual property rights is inherently difficult. We actively combat software piracy as we enforce our intellectual property rights, but we nonetheless lose significant revenue due to illegal use of our software. If piracy activities continue at historical levels or increase, they may further harm our business. We apply for patents in the U.S. and internationally to protect our newly created technology and if we are unable to obtain patent protection for the technology described in our pending patent, or if the patent is not obtained timely, this could result in revenue loss, adverse effects on operations, and harm to our business. We offer our products and services in foreign countries and we may seek intellectual property protection from those foreign legal systems. Some of those foreign countries may not have as robust or comprehensive of intellectual property protection laws and schemes as those offered in the U.S. In some foreign countries, the mechanisms to enforce intellectual property rights may be inadequate to protect our technology, which could harm our business.
If unauthorized disclosure of our source code occurs through security breach, cyber-attack or otherwise, we could lose future trade secret protection for that source code. The loss of future trade secret protection could make it easier for third parties to compete with our products by copying functionality, which could cause us to lose customers and could adversely affect our revenue and operating margins. We also seek to protect our confidential information and trade secrets through the use of non-disclosure
agreements with our customers, contractors, vendors and partners. However, there is a risk that our confidential information and trade secrets may be disclosed or published without our authorization, and in these situations, enforcing our rights may be difficult or costly.
We may incur substantial costs defending against third parties alleging that we infringe their proprietary rights.
We have been, are currently, and may in the future be, subject to claims, negotiations and complex, protracted litigation relating to disputes regarding the validity or alleged infringement of third-party intellectual property rights, including patent rights. Intellectual property disputes and litigation are typically costly and can be disruptive to our business operations by diverting the attention of management and key personnel. We may not prevail in every lawsuit or dispute. Third-party intellectual property disputes, including those initiated by patent assertion entities, could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers, including contractual provisions under various license arrangements and service agreements. In addition, we may incur significant costs in acquiring the necessary third-party intellectual property rights for use in our products, in some cases to fulfill contractual obligations with our customers. Any of these occurrences could significantly harm our business.
We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure.
Our operating results are subject to fluctuations in foreign currency exchange rates due to the global scope of our business. We attempt to mitigate a portion of these risks through foreign currency hedging based on our judgment of the appropriate trade-offs among risk, opportunity and expense. We regularly review our program to partially hedge our exposure to foreign currency fluctuations and make adjustments as necessary. Our hedging activities may not offset more than a portion of the adverse financial impact resulting from unfavorable movement in foreign currency exchange rates, which could adversely affect our financial condition or results of operations.
Failure of our third-party customer service and technical support providers to adequately address customers’ requests could harm our business and adversely affect our financial results.
Our customers rely on our customer service support organization to resolve issues with our products and services. We outsource a substantial portion of our customer service and technical support activities to third-party service providers. We depend heavily on these third-party customer service and technical support representatives working on our behalf, and we expect to continue to rely heavily on third parties in the future. This strategy presents risks to our business due to the fact that we may not be able to influence the quality of support as directly as we would be able to do if our own employees performed these activities. Our customers may react negatively to providing information to, and receiving support from, third-party organizations, especially if these third-party organizations are based overseas. If we encounter problems with our third-party customer service and technical support providers, our reputation may be harmed, our ability to sell our offerings could be adversely affected, and we could lose customers and associated revenue.
Failure to manage our sales and distribution channels effectively could result in a loss of revenue and harm to our business.
We contract with a number of software distributors and other strategic partners, none of which is individually responsible for a material amount of our total net revenue for any recent period. Nonetheless, if any single agreement with one of our distributors were terminated, any prolonged delay in securing a replacement distributor could have a negative impact on our results of operations.
Successfully managing our indirect distribution channel efforts to reach various customer segments for our products and services is a complex process across the broad range of geographies where we do business or plan to do business. Our distributors and other channel partners are independent businesses that we do not control. Notwithstanding the independence of our channel partners, we face legal risk and potential reputational harm from the activities of these third parties including, but not limited to, export control violations, workplace conditions, corruption and anti-competitive behavior.
We cannot be certain that our distribution channel will continue to market or sell our products and services effectively. If our distribution channel is not successful, we may lose sales opportunities, customers and revenue. Our distributors also sell our competitors’ products and services, and if they favor our competitors’ products or services for any reason, they may fail to market our products or services effectively or to devote resources necessary to provide effective sales, which would cause our results to suffer. We also distribute some products and services through our OEM channel, and if our OEMs decide not to bundle our applications on their devices, our results could suffer. In addition, the financial health of our distributors and our continuing relationships with them are important to our success. Some of these distributors may be unable to withstand adverse changes in
economic conditions, which could result in insolvency, the inability of such distributors to obtain credit to finance purchases of our products and services, or a delay in paying their obligations to us.
We also sell some of our products and services through our direct sales force. Risks associated with this sales channel include more extended sales and collection cycles associated with direct sales efforts, challenges related to hiring, retaining and motivating our direct sales force, and substantial amounts of ongoing training for sales representatives. Moreover, recent hires may not become as productive as we would like, as in most cases it takes a significant period of time before they achieve full productivity. Our business could be seriously harmed if our expansion efforts do not generate a corresponding significant increase in revenue and we are unable to achieve the efficiencies we anticipate. In addition, the loss of key sales employees could impact our customer relationships and future ability to sell to certain accounts covered by such employees.
Contracting with government entities exposes us to additional risks inherent in the government procurement process.
We provide products and services, directly and indirectly, to a variety of government entities, both domestically and internationally. Risks associated with licensing and selling products and services to government entities include more extended sales and collection cycles, varying governmental budgeting processes and adherence to complex procurement regulations and other government-specific contractual requirements. We may be subject to audits and investigations relating to our government contracts and any violations could result in various civil and criminal penalties and administrative sanctions, including termination of contracts, payment of fines, and suspension or debarment from future government business, as well as harm to our reputation and financial results.
Revenue, margin or earnings shortfalls or the volatility of the market generally may cause the market price of our stock to decline.
In the past, the market price for our common stock experienced significant fluctuations and it may do so in the future. A number of factors may affect the market price for our common stock, such as:
| |
• | shortfalls in, or changes in expectations about our revenue, margins, earnings, Annualized Recurring Revenue (“ARR”), sales of our Adobe Experience Cloud offerings, or other key performance metrics; |
| |
• | changes in estimates or recommendations by securities analysts; |
| |
• | whether our results meet analysts’ expectations; |
| |
• | compression or expansion of multiples used by investors and analysts to value high technology SaaS companies; |
| |
• | the announcement of new products or services, product enhancements, service introductions, strategic alliances or significant agreements by us or our competitors; |
| |
• | the loss of large customers or our inability to increase sales to existing customers, retain customers or attract new customers; |
| |
• | recruitment or departure of key personnel; |
| |
• | variations in our or our competitors’ results of operations, changes in the competitive landscape generally and developments in our industry; |
| |
• | general socio-economic, political or market conditions; and |
| |
• | unusual events such as significant acquisitions by us or our competitors, divestitures, litigation, regulatory actions and other factors, including factors unrelated to our operating performance. |
In addition, the market for technology stocks or the stock market in general may experience uneven investor confidence, which may cause the market price for our common stock to decline for reasons unrelated to our operating performance. Volatility in the market price of a company’s securities for a period of time may increase the company’s susceptibility to securities class action litigation. Oftentimes, this type of litigation is expensive and diverts management’s attention and resources which may adversely affect our business.
If we are unable to recruit and retain key personnel, our business may be harmed.
Much of our future success depends on the continued service, availability and performance of our senior management. These individuals have acquired specialized knowledge and skills with respect to Adobe. The loss of any of these individuals could harm our business, especially if we have not been successful in developing adequate succession plans. Our business is also dependent on our ability to retain, hire and motivate talented, highly skilled personnel across all levels of our organization. Experienced personnel in the information technology industry are in high demand and competition for their talents is intense in many areas where our employees are located. We may experience higher compensation costs to retain senior management and experienced personnel that may not be offset by improved productivity or increased sales. If we are unable to continue to successfully attract and retain key personnel, our business may be harmed.
We continue to hire personnel in countries where exceptional technical knowledge and other expertise are offered at lower costs, which increases the efficiency of our global workforce structure and reduces our personnel related expenditures. Nonetheless, as globalization continues, competition for these employees in these countries has increased, which may impact our ability to retain these employees and increase our expenses resulting from competitive compensation. We may continue to expand our international operations and international sales and marketing activities, which would require significant management attention and resources. We may be unable to scale our infrastructure effectively or as quickly as our competitors in these markets, and our revenue may not increase to offset these expected increases in costs and operating expenses, causing our results to suffer.
We believe that a critical contributor to our success to date has been our corporate culture, which we have built to foster innovation, teamwork and employee satisfaction. As we grow, including from the integration of employees and businesses acquired in connection with previous or future acquisitions, we may find it difficult to maintain important aspects of our corporate culture, which could negatively affect our ability to retain and recruit personnel who are essential to our future success.
If our goodwill or amortizable intangible assets become impaired, then we could be required to record a significant charge to earnings.
GAAP requires us to test for goodwill impairment at least annually. In addition, we review our goodwill and amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include declines in stock price, market capitalization or cash flows, and slower growth rates in our industry. Depending on the results of our review, we could be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets were determined, negatively impacting our results of operations.
We have issued $1.9 billion of notes in debt offerings and may incur other debt in the future, which may adversely affect our financial condition and future financial results.
We have $1.9 billion in senior unsecured notes outstanding. We also have a $1 billion senior unsecured revolving credit agreement, which is currently undrawn. This debt may adversely affect our financial condition and future financial results by, among other things:
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• | increasing our vulnerability to adverse changes in general economic and industry conditions; |
| |
• | requiring the dedication of a portion of our expected cash flow from operations to service our indebtedness, thereby reducing the amount of expected cash flow available for other purposes, including capital expenditures and acquisitions; and |
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• | limiting our flexibility in planning for, or reacting to, changes in our business and our industry. |
Our senior unsecured notes and senior unsecured revolving credit agreement impose restrictions on us and require us to maintain compliance with specified covenants. Our ability to comply with these covenants may be affected by events beyond our control. If we breach any of the covenants and do not obtain a waiver from the lenders or noteholders, then, subject to applicable cure periods, any outstanding indebtedness may be declared immediately due and payable.
In addition, changes by any rating agency to our credit rating may negatively impact the value and liquidity of both our debt and equity securities, as well as the potential costs associated with a refinancing of our debt. Under certain circumstances, if our credit ratings are downgraded or other negative action is taken, the interest rate payable by us under our revolving credit facility could increase. Downgrades in our credit ratings could also affect the terms of any such financing and restrict our ability to obtain additional financing in the future.
Catastrophic events may disrupt our business.
We are a highly automated business and rely on our network infrastructure and enterprise applications, internal technology systems and website for our development, marketing, operations, support, hosted services and sales activities. In addition, some of our businesses rely on third-party hosted services, and we do not control the operation of third-party data center facilities serving our customers from around the world, which increases our vulnerability. A disruption, infiltration or failure of these systems or third-party hosted services in the event of a major earthquake, fire, flood, tsunami or other weather event, power loss, telecommunications failure, software or hardware malfunctions, pandemics, cyber-attack, war, terrorist attack or other catastrophic event that our disaster recovery plans do not adequately address, could cause system interruptions, reputational harm, loss of intellectual property, delays in our product development, lengthy interruptions in our services, breaches of data security and loss of critical data. Any of these events could prevent us from fulfilling our customers’ orders or could negatively impact a country or region in which we sell our products, which could in turn decrease that country’s or region’s demand for our products. Our corporate headquarters, a significant portion of our research and development activities, certain of our data centers and certain other critical business operations are located in the San Francisco Bay Area, and additional facilities where we conduct significant operations are located in the Salt Lake Valley Area, both of which are near major earthquake faults. A catastrophic event that results in the destruction or disruption of any of our data centers or our critical business or information technology systems could severely affect our ability to conduct normal business operations and, as a result, our future operating results could be adversely affected.
Climate change may have a long-term impact on our business.
While we seek to partner with organizations that mitigate their business risks associated with climate change, we recognize that there are inherent risks wherever business is conducted. Access to clean water and reliable energy in the communities where we conduct our business, whether for our offices or for our vendors, is a priority. Our major sites in California, Utah and India are vulnerable to prolonged droughts due to climate change. In the event of a natural disaster that disrupts business due to limited access to these resources, we have the potential to experience losses to our business, and added costs to resume operations.
Our investment portfolio may become impaired by deterioration of the financial markets.
Our cash equivalent and short-term investment portfolio as of December 1, 2017 consisted of corporate bonds and commercial paper, foreign government securities and U.S. Treasury securities, money market mutual funds, municipal securities, time deposits and asset-backed securities. We follow an established investment policy and set of guidelines to monitor and help mitigate our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer, as well as our maximum exposure to various asset classes.
Should financial market conditions worsen in the future, investments in some financial instruments may pose risks arising from market liquidity and credit concerns. In addition, any deterioration of the capital markets could cause our other income and expense to vary from expectations. As of December 1, 2017, we had no material impairment charges associated with our short-term investment portfolio, and although we believe our current investment portfolio has little risk of material impairment, we cannot predict future market conditions, market liquidity or credit availability, and can provide no assurance that our investment portfolio will remain materially unimpaired.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We own and occupy three office buildings and land in San Jose, California where our corporate headquarters is located. We also own buildings and land in Lehi, Utah, and at 601 and 625 Townsend Street in San Francisco, California, and the data center in Hillsboro, Oregon. Outside of the United States, we own certain land and buildings we occupy in Bangalore, India and Noida, India. We lease or sublease the rest of the properties we occupy under operating leases. Such leases expire at various times through 2031, with the exception of our land lease in Noida, India that expires in 2091.
The following table sets forth the location, approximate square footage and use of each of the principal properties used by Adobe during fiscal 2017.
|
| | | | | |
Location | | Approximate
Square
Footage | | Use |
North America: | | | | |
West Tower, 345 Park Avenue
San Jose, CA 95110, USA | | 391,000 |
| | Research, product development, sales, marketing and administration |
East Tower, 321 Park Avenue
San Jose, CA 95110, USA | | 325,000 |
| | Research, product development, sales, marketing and administration |
Almaden Tower, 151 Almaden Boulevard
San Jose, CA 95110, USA | | 273,000 |
| | Research, product development, sales, marketing and administration |
601 and 625 Townsend Street
San Francisco, CA 94103, USA | | 346,000 |
| | Research, product development, sales, marketing and administration |
410 Townsend Street San Francisco, CA 94107, USA | | 47,000 |
| | Research, product development, sales, marketing and administration |
3900 Adobe Way
Lehi, UT 84043, USA | | 257,000 |
| | Research, product development, sales, marketing and administration |
801 N. 34th Street-Waterfront
Seattle, WA 98103, USA | | 161,000 |
| | Product development, sales, marketing and administration |
1540 Broadway
New York, NY 10036, USA | | 55,000 |
| | Sales, marketing and administration |
343 Preston Street
Ottawa, Ontario K1S 5N4, Canada | | 122,000 |
| (1) | Research, product development, sales, marketing and administration |
25100 NW Evergreen Rd Hillsboro, OR 97124, USA | | 85,000 |
| | Data center |
India: | | | | |
Adobe Towers, 1-1A, Sector 25A
Noida, U.P. | | 191,000 |
| | Product development and administration |
Plot No. 05, Block A, Sector 132 Noida, U.P. | | 363,000 |
| | Product development and administration |
Prestige Platina Technology Park Building 1, Block A Bangalore | | 250,000 |
| | Research, product development, sales and administration |
Prestige Trinity Centre Bhoganahalli Village, Varthur Hobli Bangalore | | 149,000 |
| | Research, product development, sales and administration |
Japan: | | | | |
Gate City Osaki East Tower
1-11 Osaki
Shinagawa-ku, Tokyo | | 56,000 |
| | Product development, sales, marketing and administration |
Romania: | | | | |
26 Z Timisoara Blvd, Anchor Plaza
Lujerului, Sector 6
Bucharest | | 71,000 |
| | Research and product development |
UK: | | | | |
Market House Providence Place Maidenhead, Berkshire, SL6 8AD | | 49,000 |
| | Product development, sales, marketing and administration
|
_________________________________________
| |
(1) | The total square footage is 122,000, of which we occupy 59,000 square feet, or approximately 48% of this facility; 6,000 square feet is unoccupied. The remaining square footage is subleased. |
In general, all facilities are in good condition, suitable for the conduct of our business and are operating at an average capacity of approximately 83%.
ITEM 3. LEGAL PROCEEDINGS
In connection with disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation may be very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Third-party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements and service agreements.
In addition to intellectual property disputes, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We consider all claims on a quarterly basis in accordance with GAAP and, based on known facts, assess whether potential losses are considered reasonably possible, probable and estimable. Based upon this assessment, we then evaluate disclosure requirements and whether to accrue for such claims in our financial statements. This determination is then reviewed and discussed with the Audit Committee of the Board of Directors and our independent registered public accounting firm.
We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in our Consolidated Financial Statements and notes thereto, we have determined that no provision for liability nor disclosure is required related to any claim against us because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial.
All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.
In connection with our piracy conversion efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be negatively affected in any particular period by the resolution of one or more of these counter-claims.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information for Common Stock
Our common stock is traded on the NASDAQ Global Select Market under the symbol “ADBE.” The following table sets forth the high and low sales price per share of our common stock for the periods indicated.
|
| | | | | | | | |
| | Price Range |
| | High | | Low |
Fiscal 2017: | | | | |
First Quarter | | $ | 120.35 |
| | $ | 101.55 |
|
Second Quarter | | $ | 143.48 |
| | $ | 119.60 |
|
Third Quarter | | $ | 155.16 |
| | $ | 137.25 |
|
Fourth Quarter | | $ | 185.40 |
| | $ | 144.57 |
|
Fiscal Year | | $ | 185.40 |
| | $ | 101.55 |
|
Fiscal 2016: | | |
| | |
|
First Quarter | | $ | 95.56 |
| | $ | 73.85 |
|
Second Quarter | | $ | 100.17 |
| | $ | 84.35 |
|
Third Quarter | | $ | 103.57 |
| | $ | 90.85 |
|
Fourth Quarter | | $ | 110.81 |
| | $ | 98.77 |
|
Fiscal Year | | $ | 110.81 |
| | $ | 73.85 |
|
Stockholders
According to the records of our transfer agent, there were 1,091 holders of record of our common stock on January 12, 2018. Because many of such shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
Dividends
We did not declare or pay any cash dividends on our common stock during fiscal 2017 or fiscal 2016. Under the terms of our credit agreement and lease agreements, we are not prohibited from paying cash dividends unless payment would trigger an event of default or one currently exists. We do not anticipate paying any cash dividends in the foreseeable future.
Issuer Purchases of Equity Securities
|
| | | | | | | | | | | | | | | |
Period | | Total Number of Shares Repurchased | | Average Price Per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans | | Approximate Dollar Value that May Yet be Purchased Under the Plan(1) | |
| (in thousands, except average price per share) | |
Beginning repurchase authority | | | | | | | $ | 2,298,777 |
| |
September 2 — September 29, 2017 | | | | | | | | |
Shares repurchased | 642 |
| | $ | 154.03 |
| | 642 |
| | $ | (98,777 | ) | |
September 30 — October 27, 2017 | | | | | | | | |
Shares repurchased | 662 |
| | $ | 151.04 |
| | 662 |
| | $ | (100,000 | ) | (2) |
October 28 — December 1, 2017 | |
| | |
| | |
| | |
| |
Shares repurchased | 552 |
| | $ | 178.36 |
| | 552 |
| | $ | (98,500 | ) | (2) |
Total | 1,856 |
| | |
| | 1,856 |
| | $ | 2,001,500 |
| |
_________________________________________
| |
(1) | In January 2017, the Board of Directors granted authority to repurchase up to $2.5 billion in common stock through the end of fiscal 2019. |
| |
(2) | In September 2017, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $300 million. As of December 1, 2017, approximately $101.5 million of the prepayment remained under this agreement. |
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data (presented in thousands, except per share amounts and employee data) is derived from our Consolidated Financial Statements. As our historical operating results are not necessarily indicative of future operating results, this data should be read in conjunction with the Consolidated Financial Statements and notes thereto, and with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
| | | | | | | | | | | | | | | | | | | |
| Fiscal Years |
| 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
Operations: | | | | | | | | | |
Revenue | $ | 7,301,505 |
| | $ | 5,854,430 |
| | $ | 4,795,511 |
| | $ | 4,147,065 |
| | $ | 4,055,240 |
|
Gross profit | $ | 6,291,014 |
| | $ | 5,034,522 |
| | $ | 4,051,194 |
| | $ | 3,524,985 |
| | $ | 3,468,683 |
|
Income before income taxes | $ | 2,137,641 |
| | $ | 1,435,138 |
| | $ | 873,781 |
| | $ | 361,376 |
| | $ | 356,141 |
|
Net income | $ | 1,693,954 |
| | $ | 1,168,782 |
| | $ | 629,551 |
| | $ | 268,395 |
| | $ | 289,985 |
|
Net income per share: | |
| | |
| | |
| | |
| | |
|
Basic | $ | 3.43 |
| | $ | 2.35 |
| | $ | 1.26 |
| | $ | 0.54 |
| | $ | 0.58 |
|
Diluted | $ | 3.38 |
| | $ | 2.32 |
| | $ | 1.24 |
| | $ | 0.53 |
| | $ | 0.56 |
|
Shares used to compute basic net income per share | 493,632 |
| | 498,345 |
| | 498,764 |
| | 497,867 |
| | 501,372 |
|
Shares used to compute diluted net income per share | 501,123 |
| | 504,299 |
| | 507,164 |
| | 508,480 |
| | 513,476 |
|
Cash dividends declared per common share | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
|
Financial position:(1) | |
| | |
| | |
| | |
| | |
|
Cash, cash equivalents and short-term investments | $ | 5,819,774 |
| | $ | 4,761,300 |
| | $ | 3,988,084 |
| | $ | 3,739,491 |
| | $ | 3,173,752 |
|
Working capital(2) | $ | 3,720,356 |
| | $ | 3,028,139 |
| | $ | 2,608,336 |
| | $ | 2,107,893 |
| | $ | 2,520,281 |
|
Total assets | $ | 14,535,556 |
| | $ | 12,697,246 |
| | $ | 11,714,500 |
| | $ | 10,781,991 |
| | $ | 10,374,940 |
|
Debt and capital lease obligations, non-current | $ | 1,881,421 |
| | $ | 1,892,200 |
| | $ | 1,895,259 |
| | $ | 907,248 |
| | $ | 1,493,939 |
|
Stockholders’ equity | $ | 8,459,869 |
| | $ | 7,424,835 |
| | $ | 7,001,580 |
| | $ | 6,775,905 |
| | $ | 6,724,634 |
|
Additional data: | | | |
| | |
| | |
| | |
|
Worldwide employees | 17,973 |
| | 15,706 |
| | 13,893 |
| | 12,499 |
| | 11,847 |
|
_________________________________________
| |
(1) | Information associated with our financial position is as of the Friday closest to November 30 for the five fiscal periods through 2017. |
| |
(2) | For fiscal 2014 and prior, our working capital did not include the effects of the adoption of ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which required all deferred tax assets and liabilities and any related valuation allowance to be classified as non-current on our Consolidated Balance Sheets. The new standard was adopted prospectively starting fiscal 2015. |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto.
ACQUISITIONS
During fiscal 2017, we completed our acquisition of TubeMogul, a publicly held video advertising platform company, for $560.8 million. As of the end of fiscal 2017, we are continuing to integrate TubeMogul into our Digital Marketing reportable segment.
During fiscal 2015, we completed our acquisition of privately held Fotolia, a leading marketplace for royalty-free photos, images, graphics and HD videos, for $807.5 million. During fiscal 2015, we integrated Fotolia into our Digital Media reportable segment.
We also completed other immaterial business acquisitions during the fiscal years presented. Pro forma information has not been presented for any of our fiscal 2017, 2016 and 2015 acquisitions as the impact to our Consolidated Financial Statements was not material.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our Consolidated Financial Statements in accordance with GAAP and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.
We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition and income taxes have the greatest potential impact on our Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules requiring us to make judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
Revenue Recognition
Our revenue is derived from the subscription, non-software related hosted services, perpetual and term-based licensing of software products, associated software maintenance and support plans, consulting services, training and technical support. Most of our enterprise customer arrangements are complex, involving multiple solutions and various license rights, bundled with post-contract customer support and other meaningful rights that together provide a complete end-to-end solution to the customer. Throughout the contract period, customers use our solutions to complete various phases of the creative and/or marketing processes allowing them to concurrently work on multiple projects. In response to evolving customer and market expectations, we frequently expand and improve our technology to keep up with the pace of change, to provide enhancements to our tools to meet industry needs and to provide support at each stage of the customer’s life cycle.
We recognize revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists; we have delivered the product or performed the service; the fee is fixed or determinable; and collection is probable. Determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we report.
We enter into multiple element revenue arrangements in which a customer may purchase a combination of software, upgrades, maintenance and support, hosted services and consulting.
For our software and software-related multiple element arrangements, we must: (1) determine whether and when each element has been delivered; (2) determine whether undelivered products or services are essential to the functionality of the delivered products and services; (3) determine the fair value of each undelivered element using vendor-specific objective evidence (“VSOE”); and (4) allocate the total price among the various elements. VSOE of fair value is used to allocate a portion of the price to the undelivered elements and the residual method is used to allocate the remaining portion to the delivered elements. Absent VSOE, revenue is deferred until the earlier of the point at which VSOE of fair value exists for any undelivered element or until all elements of the arrangement have been delivered. However, if the only undelivered element is maintenance and support, the entire
arrangement fee is recognized ratably over the performance period. Changes in assumptions or judgments or changes to the elements in a software arrangement could cause a material increase or decrease in the amount of revenue that we report in a particular period.
We determine VSOE for each element based on historical stand-alone sales to third parties or from the stated renewal rate for the elements contained in the initial arrangement. In determining VSOE, we require that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range.
We have established VSOE for our software maintenance and support services, custom software development services, consulting services and training, when such services are sold optionally with software licenses.
For multiple-element arrangements containing our non-software services, we must: (1) determine whether and when each element has been delivered; (2) determine the fair value of each element using the selling price hierarchy of VSOE of selling price, third-party evidence (“TPE”) of selling price or best-estimated selling price (“BESP”), as applicable; and (3) allocate the total price among the various elements based on the relative selling price method.
For multiple-element arrangements that contain both software and non-software elements, we allocate revenue to software or software-related elements as a group and any non-software elements separately based on the selling price hierarchy. We determine the selling price for each deliverable using VSOE of selling price, if it exists, or TPE of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, we use BESP. Once revenue is allocated to software or software-related elements as a group, we recognize revenue in conformance with software revenue accounting guidance. Revenue is recognized when revenue recognition criteria are met for each element.
We are generally unable to establish VSOE or TPE for non-software elements and as such, we use BESP. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly customized offerings. We determine BESP for a product or service by considering multiple factors including, but not limited to, major product groupings, geographies, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. Pricing practices taken into consideration include historic contractually stated prices, volume discounts where applicable and our price lists. We must estimate certain royalty revenue amounts due to the timing of securing information from our customers. While we believe we can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, our assumptions and judgments regarding future products and services as well as our estimates of royalty revenue could differ from actual events, thus materially impacting our financial position and results of operations.
Product revenue is recognized when the above criteria are met. We reduce the revenue recognized for estimated future returns, rebates and price protection at the time the related revenue is recorded. In determining our estimate for returns and in accordance with our internal policy regarding global channel inventory which is used to determine the level of product held by our distributors on which we have recognized revenue, we rely upon historical data, the estimated amount of product inventory in our distribution channel, the rate at which our product sells through to the end user, product plans and other factors. Our estimated provisions for returns can vary from what actually occurs. Product returns may be more or less than what was estimated. The amount of inventory in the channel could be different than what is estimated. Our estimate of the rate of sell-through for product in the channel could be different than what actually occurs. These factors and unanticipated changes in the economic and industry environment could make our return estimates differ from actual returns, thus impacting our financial position and results of operations.
In the future, actual returns and price protection may exceed our estimates as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. While we believe we can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our estimates change, our returns and price protection reserves would change, which would impact the total net revenue we report.
We recognize revenue for hosted services that are priced based on a committed number of transactions ratably beginning on the date the services associated with the committed transactions are first made available to the customer and continuing through the end of the contractual service term. Over-usage fees, and fees billed based on the actual number of transactions from which we capture data, are billed in accordance with contract terms as these fees are incurred. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
Our consulting revenue is recognized on a time and materials basis and is measured monthly based on input measures, such as on hours incurred to date compared to total estimated hours to complete, with consideration given to output measures, such as contract milestones, when applicable.
Accounting for Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. In addition, we are subject to the continual examination of our income tax returns by the U.S. Internal Revenue Service (“IRS”) and other domestic and foreign tax authorities. We expect future examinations to focus on our intercompany transfer pricing practices as well as other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from such examinations. We believe such estimates to be reasonable; however, the final determination of any of these examinations could significantly impact the amounts provided for income taxes in our Consolidated Financial Statements.
Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.
We are a United States-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. A significant portion of our foreign earnings for the current fiscal year were earned by our Irish subsidiaries. In addition to providing for U.S. income taxes on earnings from the United States, we provide for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States. While we do not anticipate changing our intention regarding permanently reinvested earnings as of the balance sheet date, if certain foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings.
Our income tax expense has differed from the tax computed at the U.S. federal statutory income tax rate due primarily to discrete items and to earnings considered as permanently reinvested in foreign operations. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be unfavorably affected by changes in the tax rates in jurisdictions where our income is earned, by changes in or our interpretation of tax rules and regulations in the jurisdictions in which we do business, by unanticipated decreases in the amount of earnings in countries with low statutory tax rates, by unexpected negative changes in business and market conditions that could reduce certain tax benefits, or by changes in the valuation of our deferred tax assets and liabilities.
In addition, in the United States, the European Commission, countries in the European Union and other countries where we do business, we are subject to potential changes in relevant tax, accounting and other laws, regulations and interpretations, including changes to tax laws applicable to corporate multinationals such as Adobe. These countries and other governmental bodies have or could make unprecedented assertions about how earnings in their jurisdictions might be determined that are contrary to the way in which we have interpreted and historically applied the rules and regulations described above in our income tax returns filed in such jurisdictions. In the current global tax policy environment, any changes in laws, regulations and interpretations related to these assertions could adversely affect our effective tax rates or result in other costs to us, which could adversely affect our operations and financial results.
Moreover, we are subject to the continual examination of our income tax returns by the IRS and other domestic and foreign tax authorities. These tax examinations are expected to focus on our intercompany transfer pricing practices as well as other matters. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for adjustments that may result from these examinations. We cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position.
Recent Accounting Pronouncements
RESULTS OF OPERATIONS
Overview of 2017
For fiscal 2017, we reported strong financial results consistent with the continued execution of our long-term plans for our two strategic growth areas, Digital Media and Digital Marketing, while continuing to market and license a broad portfolio of products and solutions.
In our Digital Media segment, we are a market leader with Creative Cloud, our subscription-based offering for creating and publishing content and applications. Creative Cloud delivers value through frequent product updates, storage and access to user files stored in the cloud with syncing of files across users’ machines, access to marketplace, social and community-based features with our Adobe Stock and Behance services, app creation capabilities and affordable pricing for cost-sensitive customers.
We offer Creative Cloud for individuals, students, teams and enterprises. We expect Creative Cloud will drive sustained long-term revenue growth through a continued expansion of our customer base by acquiring new users on account of Creative Cloud’s low cost of entry and delivery of additional features and value, as well as keeping existing customers current on our latest release. We have also built out a marketplace for Creative Cloud subscribers to enable the delivery and purchase of stock content in our Adobe Stock service. Overall, our strategy with Creative Cloud is designed to enable us to increase our revenue with users, attract more new customers, and grow a recurring and predictable revenue stream that is recognized ratably.
We continue to implement strategies that will accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offerings. These strategies include increasing the value Creative Cloud users receive, such as offering new mobile applications, as well as targeted promotions and offers that attract past customers and potential users to try out and ultimately subscribe to Creative Cloud. Because of the shift towards Creative Cloud subscriptions and Enterprise Term License Agreements (“ETLAs”), revenue from perpetual licensing of our Creative products has been immaterial to our business.
We are also a market leader with our Adobe Document Cloud offerings built around our Adobe Acrobat family of products, the Adobe Reader and a set of integrated cloud-based document services, including Adobe Sign. Acrobat provides reliable creation and exchange of electronic documents, regardless of platform or application source type. Document Cloud, which we believe enhances the way people manage critical documents at home, in the office and across devices, includes Adobe Acrobat DC and Adobe Sign, and a set of integrated services enabling users to create, review, approve, sign and track documents whether on a desktop or mobile device. Adobe Acrobat DC, with a touch-enabled user interface, is offered both through subscription and perpetual licenses.
Annualized Recurring Revenue (“ARR”) is currently the key performance metric our management uses to assess the health and trajectory of our overall Digital Media segment. ARR should be viewed independently of revenue, deferred revenue and unbilled deferred revenue as ARR is a performance metric and is not intended to be combined with any of these items. We adjust our reported ARR on an annual basis to reflect any material exchange rates changes. Our reported ARR results in fiscal 2017 are based on currency rates set at the start of fiscal 2017 and held constant throughout the year. We calculate ARR as follows:
|
| | |
Creative ARR | Annual Value of Creative Cloud Subscriptions and Services + Annual Digital Publishing Suite Contract Value + Annual Creative ETLA Contract Value |
Document Cloud ARR |
Annual Value of Document Cloud Subscriptions and Services + Annual Document Cloud ETLA Contract Value
|
Digital Media ARR | Creative ARR + Document Cloud ARR |
Creative ARR exiting fiscal 2017 was $4.63 billion, up from $3.52 billion at the end of fiscal 2016. Document Cloud ARR exiting fiscal 2017 was $600 million, up from $472 million at the end of fiscal 2016. Total Digital Media ARR grew to $5.23 billion at the end of fiscal 2017, up from $3.99 billion at the end of fiscal 2016. Revaluing our ending ARR for fiscal 2017 using currency rates at the beginning of fiscal 2018, our Digital Media ARR at the end of fiscal 2017 would be $5.39 billion or approximately $154 million higher than the ARR reported above.
Our success in driving growth in ARR has positively affected our revenue growth. Creative revenue in fiscal 2017 was $4.17 billion, up from $3.18 billion in fiscal 2016 and representing 31% year-over-year growth. Document Cloud revenue in fiscal 2017 was $836.7 million, up from $764.9 million in fiscal 2016 and representing 9% year-over-year revenue growth as we continue to transition Document Cloud to a subscription-based model. Total Digital Media segment revenue grew to $5.01 billion in fiscal 2017, up from $3.94 billion in fiscal 2016 and representing 27% year-over-year growth.
We are a market leader in the fast-growing category addressed by our Digital Marketing segment. Our Digital Marketing business provides comprehensive solutions that include analytics, social marketing, targeting, media optimization, digital experience management, cross-channel campaign management, audience management, premium video delivery and monetization. These comprehensive solutions enable marketers to measure, personalize and optimize marketing campaigns and digital experiences across channels for optimal marketing performance. In March 2017, we migrated our hierarchy of solutions under what was formerly known as Adobe Marketing Cloud to our next generation offering referred to as Adobe Experience Cloud.
Adobe Experience Cloud consists of the following cloud offerings:
| |
• | Adobe Marketing Cloud—provides an integrated set of solutions to help marketers differentiate their brands and engage their customers, helping businesses manage, personalize, and orchestrate campaigns and customer journeys; includes Adobe Experience Manager (“AEM”), Adobe Campaign, Adobe Target, Adobe Social and Adobe Primetime. |
| |
• | Adobe Analytics Cloud—enables businesses to move from insights to actions in real time by uniquely integrating audiences as the core system of intelligence for the enterprise; makes data available across all Adobe clouds through the capture, aggregation, rationalization and understanding of vast amounts of disparate data and then translating that data into singular customer profiles; includes Adobe Analytics and Adobe Audience Manager. |
| |
• | Adobe Advertising Cloud—delivers an end-to-end platform for managing advertising across traditional TV and digital formats, and simplifies the delivery of video, display and search advertising across channels and screens; combines capabilities from Adobe Media Optimizer (“AMO”) and Adobe’s acquisition of TubeMogul during the first quarter of fiscal 2017. |
In addition to chief marketing officers and digital marketers, users of our Adobe Experience Cloud solutions include advertisers, campaign managers, digital marketers, publishers, data analysts, content managers, social marketers and marketing executives. These customers often are involved in workflows that utilize other Adobe products, such as our Digital Media offerings. By combining the creativity of our Digital Media business with the science of our Digital Marketing business, we help our customers to more efficiently and effectively make, manage, measure and monetize their content across every channel with an end-to-end workflow and feedback loop.
We utilize a direct sales force to market and license our Adobe Experience Cloud solutions, as well as an extensive ecosystem of partners, including marketing agencies, systems integrators and independent software vendors that help license and deploy our solutions to their customers. We have made significant investments to broaden the scale and size of all of these routes to market, and our recent financial results reflect the success of these investments. We achieved record Adobe Experience Cloud revenue of $2.03 billion in fiscal 2017, which represents 24% year-over-year growth.
Financial Performance Summary for Fiscal 2017
| |
• | Total Digital Media ARR of approximately $5.23 billion as of December 1, 2017 increased by $1.24 billion, or 31%, from $3.99 billion as of December 2, 2016. The change in our Digital Media ARR was primarily due to strong adoption of our Creative Cloud and Adobe Document Cloud offerings. |
| |
• | Creative revenue of $4.17 billion increased by $997.8 million, or 31%, during fiscal 2017, from $3.18 billion in fiscal 2016. The increase was primarily due to the increase in subscription revenue associated with our Creative Cloud offerings. |
| |
• | Adobe Experience Cloud revenue of $2.03 billion increased by $398.9 million, or 24%, during fiscal 2017, from $1.63 billion in fiscal 2016. The increase was primarily due to increases in revenue associated with our Advertising Cloud offerings, including TubeMogul which we acquired in the first quarter of fiscal 2017, and increases in subscription revenue associated with our Adobe Marketing Cloud offerings, including AEM and Adobe Campaign. |
| |
• | Our total deferred revenue of $2.49 billion as of December 1, 2017 increased by $479.8 million, or 24%, from $2.01 billion as of December 2, 2016. The increase was primarily due to increases in Creative Cloud team and individual subscriptions, and new contracts and the timing of renewals for our Adobe Experience Cloud services. |
| |
• | Cost of revenue of $1.01 billion increased by $190.6 million, or 23%, during fiscal 2017, from $819.9 million in fiscal 2016. The increase was primarily due to increases in media costs associated with our Advertising Cloud offerings, data center and hosting costs and increased headcount. |
| |
• | Operating expenses of $4.12 billion increased by $582.0 million, or 16%, during fiscal 2017, from $3.54 billion in fiscal 2016. The increase was primarily due to increased headcount and stock based compensation expense. |
| |
• | Net income of $1.69 billion increased by $525.2 million, or 45%, during fiscal 2017 from $1.17 billion in fiscal 2016 primarily due to increases in subscription revenue. |
| |
• | Net cash flow from operations of $2.91 billion during fiscal 2017 increased by $713.1 million, or 32%, from $2.20 billion during fiscal 2016 primarily due to higher net income. |
Revenue (dollars in millions)
Revenue for fiscal 2016 benefited from an extra week in the first quarter of fiscal 2016 due to our 52/53 week financial calendar whereby fiscal 2016 was a 53-week year compared with fiscal 2017 and 2015, which were 52-week years.
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| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Subscription | | $ | 6,133.9 |
| | $ | 4,584.8 |
| | $ | 3,223.9 |
| | 34 | % | | 42 | % |
Percentage of total revenue | | 84 | % | | 78 | % | | 67 | % | | | | |
Product | | 706.7 |
| | 800.5 |
| | 1,125.1 |
| | (12 | )% | | (29 | )% |
Percentage of total revenue | | 10 | % | | 14 | % | | 24 | % | | | | |
Services and support | | 460.9 |
| | 469.1 |
| | 446.5 |
| | (2 | )% | | 5 | % |
Percentage of total revenue | | 6 | % | | 8 | % | | 9 | % | | | | |
Total revenue | | $ | 7,301.5 |
| | $ | 5,854.4 |
| | $ | 4,795.5 |
| | 25 | % | | 22 | % |
Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings including Creative Cloud and certain of our Adobe Experience Cloud and Document Cloud services. We recognize subscription revenue ratably over the term of agreements with our customers, beginning with commencement of the service.
We have the following reportable segments—Digital Media, Digital Marketing and Print and Publishing. Subscription revenue by reportable segment for fiscal 2017, 2016 and 2015 is as follows (dollars in millions):
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| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Digital Media | | $ | 4,480.8 |
| | $ | 3,370.8 |
| | $ | 2,264.7 |
| | 33 | % | | 49 | % |
Digital Marketing | | 1,609.5 |
| | 1,180.4 |
| | 937.0 |
| | 36 | % | | 26 | % |
Print and Publishing | | 43.6 |
| | 33.6 |
| | 22.2 |
| | 30 | % | | 51 | % |
Total subscription revenue | | $ | 6,133.9 |
| | $ | 4,584.8 |
| | $ | 3,223.9 |
| | 34 | % | | 42 | % |
Our services and support revenue is comprised of consulting, training and maintenance and support, primarily related to the licensing of our enterprise offerings and the sale of our hosted Adobe Experience Cloud services. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products. Our maintenance and support offerings, which entitle customers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement.
Segments
In fiscal 2017, we categorized our products into the following reportable segments:
| |
• | Digital Media—Our Digital Media segment provides tools and solutions that enable individuals, small and medium businesses and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include traditional content creators, web application developers and digital media professionals, as well as their management in marketing departments and agencies, companies and publishers. Our customers also include knowledge workers who create, collaborate and distribute documents. |
| |
• | Digital Marketing—Our Digital Marketing segment provides solutions and services for how digital advertising and marketing are created, managed, executed, measured and optimized. Our customers include digital marketers, advertisers, publishers, merchandisers, web analysts, chief marketing officers, chief information officers and chief revenue officers. |
| |
• | Print and Publishing—Our Print and Publishing segment addresses market opportunities ranging from the diverse authoring and publishing needs of technical and business publishing to our legacy type and OEM printing businesses. |
Segment Information (dollars in millions)
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| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Digital Media | | $ | 5,010.6 |
| | $ | 3,941.0 |
| | $ | 3,095.2 |
| | 27 | % | | 27 | % |
Percentage of total revenue | | 69 | % | | 67 | % | | 65 | % | | | | |
Digital Marketing | | 2,120.0 |
| | 1,736.6 |
| | 1,508.9 |
| | 22 | % | | 15 | % |
Percentage of total revenue | | 29 | % | | 30 | % | | 31 | % | | | | |
Print and Publishing | | 170.9 |
| | 176.8 |
| | 191.4 |
| | (3 | )% | | (8 | )% |
Percentage of total revenue | | 2 | % | | 3 | % | | 4 | % | | | | |
Total revenue | | $ | 7,301.5 |
| | $ | 5,854.4 |
| | $ | 4,795.5 |
| | 25 | % | | 22 | % |
Fiscal 2017 Revenue Compared to Fiscal 2016 Revenue
Digital Media
Revenue from Digital Media increased $1.07 billion during fiscal 2017 as compared to fiscal 2016, primarily driven by increases in revenue associated with our creative offerings.
Revenue associated with our creative offerings, which includes our Creative Cloud, perpetually licensed creative and stock photography offerings, increased during fiscal 2017. The increase was primarily due to an increase in subscription revenue associated with our Creative Cloud offerings driven by increases in individual, team and enterprise subscriptions. Also contributing to the increase in revenue was revenue growth associated with our Creative Cloud Photography Plan subscription offering.
Adobe Document Cloud revenue, which includes our Acrobat product family and Adobe Sign service, increased during fiscal 2017 as compared to fiscal 2016 primarily due to increases in Document Cloud subscriptions revenue, offset in part by expected declines in revenue associated with our perpetually licensed Acrobat offering. Also contributing to the increase in Document Cloud revenue was an increase in Adobe Sign revenue.
Digital Marketing
Revenue from Digital Marketing increased $383.4 million during fiscal 2017, as compared to fiscal 2016 primarily due to subscription revenue growth associated with our Adobe Experience Cloud. The increase in subscription revenue was driven by strong performance with our Adobe Marketing Cloud offerings, which include AEM and Adobe Campaign, and our Adobe Analytics Cloud offerings, which includes Audience Manager. Also contributing to the increase in Adobe Experience Cloud revenue were increases in revenue associated with our Adobe Advertising Cloud offerings, including Tubemogul which we acquired in the first quarter of fiscal 2017.
Fiscal 2016 Revenue Compared to Fiscal 2015 Revenue
Digital Media
Revenue from Digital Media increased $845.8 million during fiscal 2016 as compared to fiscal 2015, primarily driven by increases in revenue associated with our creative offerings.
Revenue associated with our creative offerings, which includes our Creative Cloud, perpetually licensed creative and stock photography offerings, increased during fiscal 2016 as compared to fiscal 2015 primarily due to the increase in subscription revenue associated with our Creative Cloud offerings driven by increases in the number of paid Creative Cloud individual and team subscriptions, and continued adoption of our ETLAs. To a lesser extent, increases in revenue associated with our Creative Cloud Photography Plan subscription offering and stock photography offerings also contributed to the increase in revenue associated with our creative offerings. Increases associated with our creative offerings were slightly offset by expected declines in revenue associated with our perpetual creative offerings and distribution of third-party software downloads.
Document Cloud revenue, which includes our Acrobat product family and Adobe Sign service, decreased slightly during fiscal 2016 as compared to fiscal 2015, primarily due to expected decreases in revenue associated with our Acrobat perpetual license offering. Decreases were partially offset by increases in revenue associated with our Document Cloud subscription offerings as we continue to migrate more customers to our Document Cloud, along with increases in Adobe Sign revenue.
Digital Marketing
Revenue from Digital Marketing increased $227.7 million during fiscal 2016, as compared to fiscal 2015 primarily due to continued revenue growth associated with our Adobe Experience Cloud, which increased 20% year over year. Increases in Adobe Experience Cloud revenue were largely driven by the continued adoption of our AEM offerings and, to a lesser extent, the increase in revenue associated with Adobe Campaign. Also contributing to the increase in Digital Marketing revenue was the increase in Adobe Analytics Cloud revenue.
Geographical Information (dollars in millions)
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| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Americas | | $ | 4,216.5 |
| | $ | 3,400.1 |
| | $ | 2,788.1 |
| | 24 | % | | 22 | % |
Percentage of total revenue | | 58 | % | | 58 | % | | 58 | % | | | | |
EMEA | | 1,985.1 |
| | 1,619.2 |
| | 1,336.4 |
| | 23 | % | | 21 | % |
Percentage of total revenue | | 27 | % | | 28 | % | | 28 | % | | | | |
APAC | | 1,099.9 |
| | 835.1 |
| | 671.0 |
| | 32 | % | | 24 | % |
Percentage of total revenue | | 15 | % | | 14 | % | | 14 | % | | | | |
Total revenue | | $ | 7,301.5 |
| | $ | 5,854.4 |
| | $ | 4,795.5 |
| | 25 | % | | 22 | % |
Fiscal 2017 Revenue by Geography Compared to Fiscal 2016 Revenue by Geography
Overall revenue during fiscal 2017 increased in all geographic regions as compared to fiscal 2016 primarily due to increases in Digital Media and Digital Marketing revenue. Within each geographic region, the fluctuations in revenue by reportable segment were attributable to the factors noted in the segment information above. Further, the overall increase in EMEA revenue was slightly offset by declines due to the relative strength of the U.S. Dollar against EMEA currencies as discussed below.
Fiscal 2016 Revenue by Geography Compared to Fiscal 2015 Revenue by Geography
Overall revenue during fiscal 2016 increased in all geographic regions as compared to fiscal 2015 primarily due to increases in Digital Media and Digital Marketing revenue, slightly offset by a decrease in Print and Publishing revenue. Within each geographic region, fluctuations in revenue by reportable segment were attributable to the factors noted in the segment information above. Further, the overall increase in EMEA revenue was partially offset by declines due to the relative strength of the U.S. Dollar against EMEA currencies as discussed below.
Included in the overall change in revenue for fiscal 2017 and fiscal 2016 were impacts associated with foreign currency as shown below. Our currency hedging program is used to mitigate a portion of the foreign currency impact to revenue.
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| | | | | | | |
(in millions) | Fiscal
2017 | | Fiscal
2016 |
Revenue impact: | Increase/(Decrease) |
Euro | $ | (2.3 | ) | | $ | (50.2 | ) |
British Pound | (46.1 | ) | | (36.2 | ) |
Japanese Yen | 4.0 |
| | 15.0 |
|
Other currencies | 6.1 |
| | (21.7 | ) |
Total revenue impact | (38.3 | ) | | (93.1 | ) |
Hedging impact: | | | |
Euro | 13.7 |
| | 4.2 |
|
British Pound | 7.1 |
| | 14.5 |
|
Japanese Yen | 12.1 |
| | 0.1 |
|
Total hedging impact | 32.9 |
| | 18.8 |
|
Total impact | $ | (5.4 | ) | | $ | (74.3 | ) |
During fiscal 2017, the U.S. Dollar strengthened against the British Pound, which negatively impacted revenue in EMEA measured in U.S. Dollar equivalents. The net foreign currency impact to revenue was offset in part by hedging gains from our EMEA and Japanese Yen currencies hedging programs during fiscal 2017.
During fiscal 2016, the U.S. Dollar strengthened against the Euro and British Pound which negatively impacted revenue in EMEA measured in U.S. Dollar equivalents. This impact was partially offset by hedging gains from our EMEA currencies hedging programs during fiscal 2016. During fiscal 2016, the U.S. Dollar weakened against the Japanese Yen, the impact of which was offset by the impact of the U.S. Dollar strengthening against other Asian currencies.
Backlog
Deferred revenue on our consolidated balance sheet consists of billings and payments received in advance of revenue recognition for our products and solutions and does not represent the total contract value of existing annual or multi-year, non-cancelable commercial subscription, SaaS and managed services agreements or government contracts with fiscal funding clauses. Unbilled deferred revenue represents expected future billings that are contractually committed under our existing subscription, SaaS and managed services agreements that have not been invoiced and are not recorded in deferred revenue within our financial statements. Our presentation of unbilled deferred revenue backlog may differ from that of other companies in the industry. As of December 1, 2017, we had unbilled deferred revenue backlog of approximately $3.94 billion of which approximately 40% to 50% is not reasonably expected to be billed during fiscal 2018. Comparatively, we had unbilled deferred revenue backlog of approximately $3.42 billion as of December 2, 2016, of which approximately 40% to 50% was not reasonably expected to be billed during fiscal 2017.
We expect that the amount of unbilled deferred revenue backlog will change from period to period due to certain factors, including the timing and duration of large customer subscriptions, SaaS and managed service agreements, varying billing cycles of these agreements, the timing of customer renewals, the timing of when unbilled deferred revenue backlog is to be billed, changes in customer financial circumstances and foreign currency fluctuations. Additionally, the unbilled deferred revenue backlog for multi-year subscription agreements that are billed annually is typically higher at the beginning of the contract period, lower prior to renewal and typically increases when the agreement is renewed. Accordingly, fluctuations in unbilled deferred revenue backlog may not be a reliable indicator of future business prospects and the related revenue associated with these contractual commitments.
Cost of Revenue (dollars in millions)
|
| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Subscription | | $ | 623.0 |
| | $ | 461.9 |
| | $ | 409.2 |
| | 35 | % | | 13 | % |
Percentage of total revenue | | 9 | % | | 8 | % | | 9 | % | | | | |
Product | | 57.1 |
| | 68.9 |
| | 90.0 |
| | (17 | )% | | (23 | )% |
Percentage of total revenue | | 1 | % | | 1 | % | | 2 | % | | | | |
Services and support | | 330.4 |
| | 289.1 |
| | 245.1 |
| | 14 | % | | 18 | % |
Percentage of total revenue | | 5 | % | | 5 | % | | 5 | % | | | | |
Total cost of revenue | | $ | 1,010.5 |
| | $ | 819.9 |
| | $ | 744.3 |
| | 23 | % | | 10 | % |
Subscription
Cost of subscription revenue consists of third-party royalties and expenses related to operating our network infrastructure, including depreciation expense and operating lease payments associated with computer equipment, data center costs, salaries and related expenses of network operations, implementation, account management and technical support personnel, amortization of certain intangible assets and allocated overhead. We enter into contracts with third parties for hosting services and use of data center facilities. Our data center costs largely consist of the amounts we pay to these third parties for rack space, power and similar items. Cost of subscription revenue also includes media costs related to impressions purchased from third-party ad inventory sources for our Adobe Advertising Cloud offerings.
Cost of subscription revenue increased due to the following:
|
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Media costs | 9 |
| | — |
|
Hosting services and data center costs | 7 |
| | 9 |
|
Royalty costs | 6 |
| | 2 |
|
Base compensation and related benefits associated with headcount | 6 |
| | 2 |
|
Incentive compensation, cash and stock based | 5 |
| | — |
|
Amortization of purchased intangibles | 2 |
| | (4 | ) |
Depreciation expense | (1 | ) | | 2 |
|
Various individually insignificant items | 1 |
| | 2 |
|
Total change | 35 | % | | 13 | % |
Media costs increased during fiscal 2017 as compared to fiscal 2016 primarily due to our TubeMogul advertising platform offerings, which are part of the Adobe Advertising Cloud and were acquired through our acquisition of TubeMogul in the first quarter of fiscal 2017. Royalty costs increased due to increases in obligations to certain key vendors for technology use.
Hosting services and data center costs increased in all periods presented primarily due to the continued increase in transaction volumes in our Adobe Experience Cloud and Creative Cloud offerings.
The increase in cost of subscription revenue during fiscal 2016 compared to fiscal 2015 were partially offset by decreases in amortization of purchased intangibles driven by the decrease in amortization expense associated with intangible assets purchased through our acquisitions of Omniture and Efficient Frontier that became fully amortized in the latter part of fiscal 2015.
Product
Cost of product revenue includes product packaging, third-party royalties, excess and obsolete inventory, amortization related to localization costs, purchased intangibles and acquired rights to use technology and the costs associated with the manufacturing of our products.
As a result of redirecting our focus and development efforts towards our Creative Cloud and Adobe Experience Cloud subscription offerings, our cost of product revenue declined in all periods presented due to the following:
|
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Amortization of purchased intangibles | (7 | )% | | (16 | )% |
Localization costs | — | % | | (10 | )% |
Royalty costs | (8 | )% | | 10 | % |
Cost of sales | (2 | )% | | (2 | )% |
Excess and obsolete inventory | — |
| | (3 | ) |
Various individually insignificant items | — |
| | (2 | ) |
Total change | (17 | )% | | (23 | )% |
The decrease in cost of product revenue during fiscal 2016 as compared to fiscal 2015 was partially offset by an increase in royalty payments related to our stock photography perpetual offering.
Services and Support
Cost of services and support revenue is primarily comprised of employee-related costs and associated costs incurred to provide consulting services, training and product support.
Cost of services and support revenue increased due to the following:
|
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Base compensation and related benefits associated with headcount | 13 | % | | 9 | % |
Incentive compensation, cash and stock based | 1 |
| | 6 |
|
Professional and consulting fees | (3 | ) | | 3 |
|
Various individually insignificant items | 3 |
| | — |
|
Total change | 14 | % | | 18 | % |
Compensation costs increased during fiscal 2017 and fiscal 2016 as compared to the corresponding year ago periods primarily due to increases in headcount resulting from decreased usage of outside consultants that were providing consulting and training services to customers.
Operating Expenses (dollars in millions)
|
| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Research and development | | $ | 1,224.1 |
| | $ | 976.0 |
| | $ | 862.7 |
| | 25 | % | | 13 | % |
Percentage of total revenue | | 17 | % | | 17 | % | | 18 | % | | | | |
Sales and marketing | | 2,197.6 |
| | 1,910.2 |
| | 1,683.2 |
| | 15 | % | | 13 | % |
Percentage of total revenue | | 30 | % | | 33 | % | | 35 | % | | | | |
General and administrative | | 624.7 |
| | 576.2 |
| | 533.5 |
| | 8 | % | | 8 | % |
Percentage of total revenue | | 9 | % | | 10 | % | | 11 | % | | | | |
Amortization of purchased intangibles | | 76.5 |
| | 78.5 |
| | 68.7 |
| | (3 | )% | | 14 | % |
Percentage of total revenue | | 1 | % | | 1 | % | | 1 | % | | | | |
Total operating expenses | | $ | 4,122.9 |
| | $ | 3,540.9 |
| | $ | 3,148.1 |
| | 16 | % | | 12 | % |
Research and Development, Sales and Marketing and General and Administrative Expenses
Research and development, sales and marketing and general and administrative expenses increased during fiscal 2017 as compared to fiscal 2016 primarily due to increases in compensation costs driven by headcount increases and stock-based compensation expense.
Research and development, sales and marketing and general and administrative expenses increased during 2016 as compared to fiscal 2015 primarily due to increases in compensation and related benefits associated with headcount increases.
Research and Development
Research and development expenses consist primarily of salary and benefit expenses for software developers, contracted development efforts, related facilities costs and expenses associated with computer equipment used in software development.
Research and development expenses increased due to the following: |
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Base compensation and related benefits associated with headcount | 11 | % | | 6 | % |
Incentive compensation, cash and stock based | 9 |
| | 4 |
|
Professional and consulting fees | 4 |
| | 4 |
|
Various individually insignificant items | 1 |
| | (1 | ) |
Total change | 25 | % | | 13 | % |
We believe that investments in research and development, including the recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced offerings and solutions. We will continue to focus on long-term opportunities available in our end markets and make significant investments in the development of our subscription and service offerings, applications and tools.
Sales and Marketing
Sales and marketing expenses consist primarily of salary and benefit expenses, sales commissions, travel expenses and related facilities costs for our sales, marketing, order management and global supply chain management personnel. Sales and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows, public relations and other market development programs.
Sales and marketing expenses increased due to the following: |
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Base compensation and related benefits associated with headcount | 5 | % | | 5 | % |
Incentive compensation, cash and stock based | 2 |
| | 2 |
|
Professional and consulting fees | 2 |
| | 1 |
|
Marketing spending related to product launches and overall marketing efforts | 4 |
| | 4 |
|
Various individually insignificant items | 2 |
| | 1 |
|
Total change | 15 | % | | 13 | % |
General and Administrative
General and administrative expenses consist primarily of compensation and benefit expenses, travel expenses and related facilities costs for our finance, facilities, human resources, legal, information services and executive personnel. General and administrative expenses also include outside legal and accounting fees, provision for bad debts, expenses associated with computer equipment and software used in the administration of the business, charitable contributions and various forms of insurance.
General and administrative expenses increased due to the following:
|
| | | | | |
| % Change
2017-2016 | | % Change
2016-2015 |
Base compensation and related benefits associated with headcount | 2 | % | | 3 | % |
Incentive compensation, cash and stock based | 3 |
| | 3 |
|
Professional and consulting fees | 1 |
| | 1 |
|
Facilities and telecom | 2 |
| | 1 |
|
Total change | 8 | % | | 8 | % |
Amortization of Purchased Intangibles
During the last several years, we have completed a number of business combinations and asset acquisitions. As a result of these acquisitions, we purchased intangible assets that are being amortized over their estimated useful lives ranging from one to fourteen years.
Amortization expense remained relatively consistent during fiscal 2017 as compared to fiscal 2016. The decreases associated with certain fully amortized acquired intangible assets from previous acquisitions were offset by increases associated with intangible assets purchased through our acquisition of TubeMogul in the first quarter of fiscal 2017.
Amortization expense increased during fiscal 2016 as compared to fiscal 2015 primarily due to the write-off of certain acquired intangible assets from a previous acquisition and the increase in amortization expense associated with intangible assets purchased in fiscal 2016.
Non-Operating Income (Expense), Net (dollars in millions)
|
| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change 2017-2016 | | % Change 2016-2015 |
Interest and other income (expense), net | | $ | 36.4 |
| | $ | 13.5 |
| | $ | 33.9 |
| | 170 | % | | (60 | )% |
Percentage of total revenue | | ** |
| | ** |
| | ** |
| | | | |
Interest expense | | (74.4 | ) | | (70.4 | ) | | (64.2 | ) | | 6 | % | | 10 | % |
Percentage of total revenue | | (1 | )% | | (1 | )% | | (1 | )% | | | | |
Investment gains (losses), net | | 7.5 |
| | (1.6 | ) | | 1.0 |
| | * |
| | * |
|
Percentage of total revenue | | ** |
| | ** |
| | ** |
| | | | |
Total non-operating income (expense), net | | $ | (30.5 | ) | | $ | (58.5 | ) | | $ | (29.3 | ) | | (48 | )% | | 100 | % |
_________________________________________
(*) Percentage is not meaningful.
(**) Percentage is less than 1%.
Interest and Other Income (Expense), Net
Interest and other income (expense), net consists primarily of interest earned on cash, cash equivalents and short-term fixed income investments. Interest and other income (expense), net also includes gains and losses on fixed income investments and foreign exchange gains and losses other than any gains recorded to revenue from our hedging programs.
Interest and other income (expense), net increased in fiscal 2017 as compared to fiscal 2016 due to higher average invested balances and interest rates and a decline in foreign exchange hedging costs.
Interest and other income (expense), net decreased in fiscal 2016 as compared to fiscal 2015 due to a gain on the sale of certain property assets that occurred in fiscal 2015 and an increase in foreign exchange hedging costs, offset in part by an increase in interest income due to higher average invested balances and interest rates.
Interest Expense
Interest expense increased during fiscal 2017 as compared to fiscal 2016 primarily due to higher short-term floating interest rates on interest rate swaps.
Interest expense increased during fiscal 2016 as compared to fiscal 2015 primarily due to higher short-term floating interest rates on interest rate swaps and higher average debt balances.
Investment Gains (Losses), Net
Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets which are classified as trading securities, and gains and losses associated with our direct and indirect investments in privately held companies.
Provision for Income Taxes (dollars in millions)
|
| | | | | | | | | | | | | | | | | | |
| | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 | | % Change
2017-2016 | | % Change
2016-2015 |
Provision | | $ | 443.7 |
| | $ | 266.4 |
| | $ | 244.2 |
| | 67 | % | | 9 | % |
Percentage of total revenue | | 6 | % | | 5 | % | | 5 | % | | | | |
Effective tax rate | | 21 | % | | 19 | % | | 28 | % | | | | |
As described in Note 1 of our Notes to Consolidated Financial Statements, we early adopted the updated accounting standard for share-based payment accounting during fiscal 2017. As a result, we recorded deferred tax attributes that we were previously tracking pursuant to the rules that preceded this standard. The deferred tax asset recorded with the adoption was offset by the establishment of a valuation allowance.
Our effective tax rate increased by approximately two percentage points during fiscal 2017 as compared to fiscal 2016. The increase was partially related to a one-time tax cost associated with licensing acquired company assets to our trading subsidiaries, offset in part by the recognition of excess tax benefits due to our adoption of new accounting guidance related to stock-based compensation and the completion of certain income tax examinations. In addition to the above noted items, the effective tax rate for fiscal 2016 included tax benefits recognized as a result of the completion of certain income tax examinations, and to a lesser extent, a one-time tax benefit related to the retroactive reinstatement of the fiscal 2015 U.S. Research and Development credit.
Our effective tax rate decreased by approximately nine percentage points during fiscal 2016 as compared to fiscal 2015. The decrease was primarily due to tax benefits recognized as a result of the completion of certain income tax examinations and the permanent extension of the U.S. Research and Development credit for 2015 and onward. The reinstatement of the credit was retroactive to January 1, 2015. A tax benefit for the credit relating to fiscal 2015 was reflected in its entirety in the first quarter of fiscal 2016. The decrease was partially offset by stronger domestic profits for fiscal 2016. In addition, the fiscal 2015 effective tax rate included one-time tax costs associated with licensing acquired company assets to Adobe’s trading companies, offset by tax benefits for the temporary reinstatement of the U.S. Research and Development credit in December 2014.
We are a United States-based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. A significant portion of our foreign earnings for the current fiscal year was earned by our Irish subsidiaries. In addition to providing for U.S. income taxes on earnings from the United States, we provide for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States. While we do not anticipate changing our intention regarding permanently reinvested earnings as of the balance sheet date, if certain foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings. Currently, there is a significant amount of foreign earnings upon which U.S. income taxes have not been provided.
Accounting for Uncertainty in Income Taxes
The gross liabilities for unrecognized tax benefits excluding interest and penalties were $172.9 million, $178.4 million and $258.7 million for fiscal 2017, 2016 and 2015, respectively, of which, $135.0 million, $144.5 million and $220.2 million if recognized, would affect our effective tax rates for fiscal 2017, 2016 and 2015, respectively, which were net of the estimated $37.9 million, $33.9 million and $38.5 million federal benefits related to deducting certain payments on future federal and state tax returns for fiscal 2017, 2016 and 2015, respectively.
The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately $23.6 million and $22.4 million for fiscal 2017 and 2016, respectively. These amounts were included in non-current income taxes payable in their respective years.
The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance of current and non-current assets, liabilities and income taxes payable. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from $0 to approximately $40 million.
LIQUIDITY AND CAPITAL RESOURCES
This data should be read in conjunction with our Consolidated Statements of Cash Flows. |
| | | | | | | |
| As of |
(in millions) | December 1, 2017 | | December 2, 2016 |
Cash and cash equivalents | $ | 2,306.1 |
| | $ | 1,011.3 |
|
Short-term investments | $ | 3,513.7 |
| | $ | 3,750.0 |
|
Working capital | $ | 3,720.4 |
| | $ | 3,028.1 |
|
Stockholders’ equity | $ | 8,459.9 |
| | $ | 7,424.8 |
|
A summary of our cash flows is as follows: |
| | | | | | | | | | | |
(in millions) | Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 |
Net cash provided by operating activities | $ | 2,912.9 |
| | $ | 2,199.7 |
| | $ | 1,469.5 |
|
Net cash used for investing activities | (442.9 | ) | | (960.0 | ) | | (1,488.4 | ) |
Net cash used for financing activities | (1,183.7 | ) | | (1,090.7 | ) | | (200.7 | ) |
Effect of foreign currency exchange rates on cash and cash equivalents | 8.5 |
| | (14.2 | ) | | (21.2 | ) |
Net increase (decrease) in cash and cash equivalents | $ | 1,294.8 |
| | $ | 134.8 |
| | $ | (240.8 | ) |
Our primary source of cash is receipts from revenue. The primary uses of cash are payroll related expenses, general operating expenses including marketing, travel and office rent, and cost of revenue. Other sources of cash are proceeds from participation in the employee stock purchase plan. Other uses of cash include our stock repurchase program, which is described below, business acquisitions and purchases of property and equipment.
Cash Flows from Operating Activities
For fiscal 2017, net cash provided by operating activities of $2.91 billion was primarily comprised of net income plus the net effect of non-cash items. The primary working capital sources of cash were net income coupled with increases in deferred revenue and accrued expenses. The increase in deferred revenue was primarily due to increased subscriptions for our Creative Cloud offerings and increases in Digital Marketing hosted services. The increase in accrued expenses is primarily due to the increase in accruals for compensation costs and employee benefits driven by headcount growth, and increased accrued media costs associated with our Advertising Cloud offerings, including TubeMogul. The primary working capital uses of cash were increases in trade receivables, payments of trade payables assumed as part of the TubeMogul acquisition, and a decrease in income taxes payable. Trade receivables increased primarily due to revenue linearity, higher revenue levels, and increased media rebill receivables attributable to TubeMogul. Income taxes payable decreased primarily due to taxes paid in excess of the tax provision increase.
For fiscal 2016, net cash provided by operating activities of $2.20 billion was primarily comprised of net income plus the net effect of non-cash items. The primary working capital sources of cash were net income coupled with increases in deferred revenue and accrued expenses. The increase in deferred revenue was primarily due to increased subscriptions for our Creative Cloud offerings and increases in Digital Marketing hosted services. The increase in accrued expenses is primarily due to the increase in accruals for compensation costs and employee benefits driven by the increase in headcount. The primary working capital uses of cash were increases in trade receivables, prepaid expenses and other current assets, and a decrease in income taxes payable. Trade receivables increased primarily due to higher revenue levels. Prepaid expenses and other current assets increased
primarily due to advanced tax payments made in the fourth quarter of fiscal 2016. Income taxes payable decreased primarily due to the completion of certain income tax audits in fiscal 2016, offset in part by increases to the tax provision in excess of taxes paid.
For fiscal 2015, net cash provided by operating activities of $1.47 billion was primarily comprised of net income plus the net effect of non-cash items. The primary working capital sources of cash were net income coupled with increases in deferred revenue, income taxes payable and trade payables. The increase in deferred revenue was primarily due to increased subscriptions for our team, individual and enterprise Creative Cloud offerings and increases in Digital Marketing hosted services. The increase in income taxes payable was primarily due to higher taxable income levels during fiscal 2015. Trade payables increased primarily due to the timing of payments to web services vendors as certain invoices were received in the final weeks of fiscal 2015. The primary working capital uses of cash were increases in trade receivables which were principally due to higher revenue levels.
Cash Flows from Investing Activities
For fiscal 2017, net cash used for investing activities of $442.9 million was primarily due to purchases of short-term investments and our acquisition of TubeMogul. Other uses of cash included purchases of property and equipment, including the Almaden Tower and long-term investments and other assets. These cash outflows were offset in part by sales and maturities of short-term investments.
For fiscal 2016, net cash used for investing activities of $960.0 million was primarily due to purchases of short-term investments. Other uses of cash represented purchases of property and equipment, purchases of long-term investments and other assets, and an immaterial acquisition. These cash outflows were offset in part by sales and maturities of short-term investments.
For fiscal 2015, net cash used for investing activities of $1.49 billion was primarily due to purchases of short-term investments and our acquisition of Fotolia. Other uses of cash during fiscal 2015 represented purchases of property and equipment and long-term investments and other assets. These cash outflows were offset in part by sales and maturities of short-term investments and proceeds received from the sale of certain property assets.
See Note 2 and Note 6 of our Consolidated Financial Statements for more detailed information regarding our acquisitions and the Almaden Tower purchase, respectively. Cash Flows from Financing Activities
For fiscal 2017, net cash used for financing activities of $1.18 billion was primarily due to payments for our treasury stock repurchases and costs associated with the issuance of treasury stock, offset in part by proceeds from the issuance of treasury stock.
For fiscal 2016, net cash used for financing activities of $1.09 billion was primarily due to payments for our treasury stock repurchases and costs associated with the issuance of treasury stock, offset in part by proceeds from the issuance of treasury stock and excess tax benefits from stock-based compensation.
In January 2015, we issued $1 billion of 3.25% senior notes due February 1, 2025 (the “2025 Notes”). Our proceeds were approximately $989.3 million which is net of an issuance discount of $10.7 million. In addition, we incurred issuance costs of $7.9 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2025 Notes using the effective interest method. The 2025 Notes rank equally with our other unsecured and unsubordinated indebtedness.
In addition to the 2025 Notes issuance and 2015 Notes repayment, other financing activities during fiscal 2015 included payments for our treasury stock repurchases and costs associated with the issuance of treasury stock, offset in part by proceeds from the issuance of treasury stock and excess tax benefits from stock-based compensation. See the section titled “Stock Repurchase Program” discussed below.
We expect to continue our investing activities, including short-term and long-term investments, venture capital, facilities expansion and purchases of computer systems for research and development, sales and marketing, product support and administrative staff. Furthermore, cash reserves may be used to repurchase stock under our stock repurchase program and to strategically acquire companies, products or technologies that are complementary to our business.
Other Liquidity and Capital Resources Considerations
Our existing cash, cash equivalents and investment balances may fluctuate during fiscal 2018 due to changes in our planned cash outlay, including changes in incremental costs such as direct and integration costs related to our acquisitions. Our cash and
investments totaled $5.82 billion as of December 1, 2017. Of this amount, approximately 89% was held by our foreign subsidiaries and subject to material repatriation tax effects. As of our balance sheet date, our intent is to permanently reinvest a significant portion of our earnings from foreign operations, and current plans do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund operations in the United States and if U.S. tax has not already been previously provided, we would provide for and pay additional U.S. taxes in connection with repatriating these funds.
Subsequent to December 1, 2017, the “Tax Cuts and Jobs Act” (the “Act”) was enacted and included broad tax reforms that are applicable to Adobe. Under the provisions of the Act, the U.S. corporate tax rate decreased from 35% to 21% effective January 1, 2018, our undistributed foreign earnings amount of approximately $4 billion are subject to taxation in fiscal 2018 and are available for repatriation, and our future foreign earnings are subject to U.S. taxation. These changes will require us to remeasure our deferred tax assets and liabilities and reclassify approximately $380 million of deferred tax liabilities related to undistributed foreign earnings to long-term income taxes payable due over eight years. In addition, based on preliminary estimates, we anticipate a tax provision charge of approximately $85 million in fiscal 2018 predominately due to the taxation of undistributed foreign earnings.
Cash from operations could also be affected by various risks and uncertainties, including, but not limited to the risks detailed in Part I, Item 1A titled “Risk Factors.” However, based on our current business plan and revenue prospects, we believe that our existing cash, cash equivalents and investment balances, our anticipated cash flows from operations and our available credit facility will be sufficient to meet our working capital and operating resource expenditure requirements for the next twelve months.
On March 2, 2012, we entered into a five-year $1 billion senior unsecured revolving credit agreement (the “Credit Agreement”), providing for loans to us and certain of our subsidiaries. On March 1, 2013, we exercised our option under the Credit Agreement to extend the maturity date of the Credit Agreement by one year to March 2, 2018. On July 27, 2015, we entered into an amendment to further extend the maturity date of the Credit Agreement to July 27, 2020 and reallocated the facility among the syndicate of lenders that are parties to the Credit Agreement. As of December 1, 2017, there were no outstanding borrowings under this Credit Agreement and the entire $1 billion credit line remains available for borrowing.
As of December 1, 2017, the amount outstanding under our senior notes was $1.9 billion, consisting of $900 million of 4.75% senior notes due February 1, 2020 (the “2020 Notes”) and $1 billion of 3.25% senior notes due February 1, 2025 (together with the 2020 Notes, the “Notes”).
Our short-term investment portfolio is primarily invested in corporate bonds and commercial paper, U.S. Treasury securities, foreign government securities, municipal securities and asset-backed securities. We use professional investment management firms to manage a large portion of our invested cash.
Stock Repurchase Program
To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we may repurchase shares in the open market or enter into structured repurchase agreements with third parties. In January 2017, our Board of Directors approved a new stock repurchase program granting us authority to repurchase up to $2.5 billion in common stock through the end of fiscal 2019.
During fiscal 2017, 2016 and 2015, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling $1.10 billion, $1.08 billion, and $625 million, respectively. We enter into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is higher than our estimate of the expected foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.
The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. During fiscal 2017, we repurchased approximately 8.2 million shares at an average price per share of $134.20 through structured repurchase agreements entered into during fiscal 2017 and fiscal 2016. During fiscal 2016, we repurchased approximately 10.4 million shares at an average price per share of $97.16 through structured repurchase agreements entered into during fiscal 2016 and fiscal 2015. During fiscal 2015, we repurchased approximately 8.1 million shares at an average price per share of $77.38 through structured repurchase agreements entered into during fiscal 2015 and fiscal 2014.
For fiscal 2017, 2016 and 2015, the prepayments were classified as treasury stock on our Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by December 1, 2017, December 2, 2016 and November 27, 2015 were excluded from the computation of earnings per share. As of December 1, 2017, $101.5 million of prepayments remained under the agreement.
Subsequent to December 1, 2017, as part of the 2017 stock repurchase authority, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $300 million. This amount will be classified as treasury stock on our Consolidated Balance Sheets. Upon completion of the $300 million stock repurchase agreement, $1.6 billion remains under our current authority.
Summary of Stock Repurchases for Fiscal 2017, 2016 and 2015
(in thousands, except average amounts)
|
| | | | | | | | | | | | | | | | | | | | | | | |
Board Approval Date | | Repurchases Under the Plan (1) | | 2017 | | 2016 | | 2015 |
| | Shares | | Average | | Shares | | Average | | Shares | | Average |
April 2012 | | Structured repurchases | | — |
| | $ | — |
| | — |
| | $ | — |
| | 3,255 |
| | $ | 73.83 |
|
January 2015 | | Structured repurchases | | 4,263 |
| | $ | 118.00 |
| | 10,428 |
| | $ | 97.16 |
| | 4,849 |
| | $ | 79.76 |
|
January 2017 | | Structured repurchases | | 3,923 |
| | $ | 151.80 |
| | — |
| | $ | — |
| | — |
| | $ | — |
|
Total shares | | 8,186 |
| | $ | 134.20 |
| | 10,428 |
| | $ | 97.16 |
| | 8,104 |
| | $ | 77.38 |
|
Total cost | | $1,098,595 | | $1,013,131 | | $627,082 |
_________________________________________
| |
(1) | Stock repurchase agreements executed with large financial institutions. See Stock Repurchase Program above. |
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Contractual Obligations
The following table summarizes our contractual obligations as of December 1, 2017 (in millions):
|
| | | | | | | | | | | | | | | | | | | | |
| | Payment Due by Period |
| | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
Notes, including interest | | $ | 2,250.6 |
| | $ | 75.3 |
| | $ | 1,061.6 |
| | $ | 65.0 |
| | $ | 1,048.7 |
|
Operating lease obligations | | 525.1 |
| | 57.5 |
| | 120.5 |
| | 95.6 |
| | 251.5 |
|
Purchase obligations | | 695.3 |
| | 449.8 |
| | 245.5 |
| | — |
| | — |
|
Total | | $ | 3,471.0 |
| | $ | 582.6 |
| | $ | 1,427.6 |
| | $ | 160.6 |
| | $ | 1,300.2 |
|
Other
Subsequent to December 1, 2017, we purchased land near our headquarters in San Jose, California for a total purchase price of $68 million.
Senior Notes
As of December 1, 2017, our outstanding notes payable consist of the 2020 Notes and 2025 Notes with a total carrying value of $1.88 billion. Interest on our senior notes is payable semi-annually, in arrears on February 1 and August 1. At December 1, 2017, our maximum commitment for interest payments under the Notes was $350.6 million for the remaining duration of our Notes. In June 2014, we entered into interest rate swaps that effectively converted the fixed interest rate on our 2020 Notes to a floating interest rate based on the London Interbank Offered Rate (“LIBOR”) plus a fixed number of basis points through February 1, 2020.
Covenants
Our credit facility contains a financial covenant requiring us not to exceed a maximum leverage ratio. As of December 1, 2017, we were in compliance with this covenant. We believe this covenant will not impact our credit or cash in the coming fiscal year or restrict our ability to execute our business plan. Our Notes do not contain any financial covenants.
Under the terms of our credit agreement, we are not prohibited from paying cash dividends unless payment would trigger an event of default or one currently exists. We do not anticipate paying any cash dividends in the foreseeable future.
Accounting for Uncertainty in Income Taxes
Royalties
We have certain royalty commitments associated with the licensing of certain offerings and products. Royalty expense is generally based on a dollar amount per unit sold, or a percentage of the underlying revenue.
Indemnifications
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products and from time to time, we are subject to claims by our customers under these indemnification provisions. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.
To the extent permitted under Delaware law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that limits our exposure and enables us to recover a portion of any future amounts paid.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All market risk sensitive instruments were entered into for non-trading purposes.
Foreign Currency Risk
Foreign Currency Exposures and Hedging Instruments
In countries outside the United States, we transact business in U.S. Dollars and various other currencies, which subject us to exposure from movements in exchange rates. We may use foreign exchange purchased options or forward contracts to hedge our foreign currency revenue. Additionally, we hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts. We hedge these exposures to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates.
Our significant foreign currency revenue exposures for fiscal 2017, 2016 and 2015 were as follows (in millions, except Japanese Yen):
|
| | | | | | | | | | | |
| Fiscal
2017 | | Fiscal
2016 | | Fiscal
2015 |
Euro | € | 1,044.7 |
| | € | 825.6 |
| | € | 589.6 |
|
Japanese Yen (in billions) | ¥ | 51.0 |
| | ¥ | 38.7 |
| | ¥ | 29.7 |
|
British Pounds | £ | 338.4 |
| | £ | 263.5 |
| | £ | 192 |
|
As of December 1, 2017, the total absolute value of all outstanding foreign exchange contracts, including options and forwards, was $1.24 billion, which included the notional equivalent of $618.4 million in Euros, $225.3 million in British Pounds, $244.5 million in Japanese Yen and $148.9 million in other foreign currencies. As of December 1, 2017, all contracts were set to expire at various dates through June 2018. The bank counterparties in these contracts could expose us to credit-related losses that would be largely mitigated with collateral security agreements that provide for collateral to be received or posted when the net fair value of these contracts fluctuates from contractually established thresholds. In addition, we enter into master netting arrangements that have the ability to further limit credit-related losses with the same counterparty by permitting net settlement transactions.
A sensitivity analysis was performed on all of our foreign exchange derivatives as of December 1, 2017. This sensitivity analysis measures the hypothetical market value resulting from a 10% shift in the value of exchange rates relative to the U.S. Dollar. For option contracts, the Black-Scholes option pricing model was used. A 10% increase in the value of the U.S. Dollar and a corresponding decrease in the value of the hedged foreign currency asset would lead to an increase in the fair value of our financial hedging instruments by $79.7 million. Conversely, a 10% decrease in the value of the U.S. Dollar would result in a decrease in the fair value of these financial instruments by $23.6 million.
As a general rule, we do not use foreign exchange contracts to hedge local currency denominated operating expenses in countries where a natural hedge exists. For example, in many countries, revenue in the local currencies substantially offsets the local currency denominated operating expenses.
We also have long-term investment exposures consisting of the capitalization and retained earnings in our non-U.S. Dollar functional currency foreign subsidiaries. As of December 1, 2017 and December 2, 2016, this long-term investment exposure totaled an absolute notional equivalent of $190.5 million and $70.2 million, respectively. At this time, we do not hedge these long-term investment exposures.
We do not use foreign exchange contracts for speculative trading purposes, nor do we hedge our foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. We regularly review our hedging program and assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
Cash Flow Hedging—Hedges of Forecasted Foreign Currency Revenue
We may use foreign exchange purchased options or forward contracts to hedge foreign currency revenue denominated in Euros, British Pounds and Japanese Yen. We hedge these cash flow exposures to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. We enter into these foreign exchange contracts to hedge forecasted revenue in the normal course of business and accordingly, they are not speculative in nature.