ADOBE INC. 
The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto. Discussion regarding our financial condition and results of operations for fiscal 2018 as compared to fiscal 2017 is included in Item 7 of our Annual Report on Form 10-K for the fiscal year endedNovember 30, 2018 , filed with theSEC onJanuary 25,2019 . ACQUISITIONS During fiscal 2019, we acquired the remaining interest in Allegorithmic SAS ("Allegorithmic"), a privately held 3D editing and authoring software company for gaming and entertainment, for approximately$106.2 million in cash consideration, and integrated it into our Digital Media reportable segment. During fiscal 2018, we completed our acquisitions of Marketo, a privately held marketing cloud platform company, for$4.73 billion and Magento, a privately held commerce platform company, for$1.64 billion , and integrated them into our Digital Experience reportable segment. During fiscal 2017, we completed our acquisition ofTubeMogul , a publicly held video advertising platform company, for$560.8 million , and integrated it into our Digital Experience reportable segment. We also completed other immaterial business acquisitions during the fiscal years presented. See Note 3 of our Notes to Consolidated Financial Statements for further information regarding these acquisitions, including pro forma financial information related to the Marketo acquisition. Pro forma information has not been presented for our other acquisitions during the fiscal years presented 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 theSEC , 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, business combinations 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, and consequently, 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 contracts with customers may include multiple goods and services. For example, some of our offerings include both on-premise and/or on-device software licenses and cloud services. Determining whether the software licenses and the cloud services are distinct from each other, and therefore performance obligations to be accounted for separately, or not distinct from each other, and therefore part of a single performance obligation, may require significant judgment. We have concluded that the on-premise/on-device software licenses and cloud services provided in our Creative Cloud and Document Cloud subscription offerings are not distinct from each other such that revenue from each offering should be recognized ratably over the subscription period for which the cloud services are provided. In reaching this conclusion, we considered the nature of our promise to Creative Cloud and Document Cloud customers, which is to provide a complete end-to-end creative design or document workflow solution that operates seamlessly across multiple devices and teams. We fulfill this promise by providing access to a solution that integrates cloud-based and on-premise/on-device features that, together through their integration, provide functionalities, utility and workflow efficiencies that could not be obtained from either the on-premise/on-device software or cloud services on their own. Cloud-based features that are integral to our Creative Cloud and Document Cloud offerings and that work together with the on-premise/on-device software include, but are not limited to:Creative Cloud Libraries , which enable customers to access their work, settings, preferences, and other assets seamlessly across desktop and mobile devices and collaborate across teams in real time; shared reviews which enable simultaneous editing and commenting of PDFs across desktop, mobile, and web; automatic cloud rendering of a design which enables it to be worked on in multiple mediums; and Sensei, Adobe's cloud-hosted artificial intelligence and machine learning framework, which enables features such as automated photo-editing, photograph content-awareness, natural language processing, optical character recognition, and automated document tagging. 38 -------------------------------------------------------------------------------- Table of Contents Business Combinations We allocate the purchase price of acquired companies to tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets and deferred revenue obligations. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience, market conditions and information obtained from management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: • future expected cash flows from software license sales, subscriptions, support agreements, consulting contracts and acquired developed technologies and patents; • historical and expected customer attrition rates and anticipated growth in revenue from acquired customers;
• the acquired company's trade name and trademarks as well as assumptions
about the period of time the acquired trade name and trademarks will
continue to be used in the combined company's product portfolio;
• the expected use of the acquired assets; and
• discount rates.
In connection with the purchase price allocations for our acquisitions, we estimate the fair value of the deferred revenue obligations assumed. The estimated fair value of these obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. 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. 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 theU.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. Recent Accounting Pronouncements
See Note 1 of our Notes to Consolidated Financial Statements for information regarding recent accounting pronouncements that are of significance, or potential significance to us.
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RESULTS OF OPERATIONS
Overview of 2019
For fiscal 2019, 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 Experience, while continuing to market and license a
broad portfolio of products and solutions.
On December 1, 2018 , the beginning of our fiscal year 2019, we adopted the
requirements of the new revenue standard utilizing the modified retrospective
method of transition, and began to report our financial results under the new
revenue standard. The impact of the adoption was not significant to our results
of operations.
In our Digital Media segment, we are a market leader with Creative Cloud, our
subscription-based offering which provides desktop tools, mobile apps and
cloud-based services for designing, creating and publishing rich and immersive
content. Creative Cloud delivers value with deep, cross-product integration,
frequent product updates and feature enhancements, cloud-enabled services
including storage and syncing of files across users' machines, machine learning
and artificial intelligence, access to marketplace, social and community-based
features with our Adobe Stock and Behance services, app creation capabilities,
tools which assist with enterprise deployments and team collaboration, 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 as a result of
low cost of entry and delivery of additional features and value to Creative
Cloud, 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 our 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 desktop and 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, including Adobe Acrobat Reader DC, 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,
unbilled backlog and remaining performance obligation 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 the current fiscal year are based on currency rates
set at the beginning of the year and held constant throughout the year. We
calculate ARR as follows:
Annual Value of Creative Cloud Subscriptions and Services
Creative ARR +
Annual Creative ETLA Contract Value
Annual Value of Document Cloud Subscriptions and Services
Document Cloud ARR +
Annual Document Cloud ETLA Contract Value
Creative ARR
Digital Media ARR +
Document Cloud ARR
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Creative ARR exiting fiscal 2019 was $7.31 billion , up from $5.92 billion at the
end of fiscal 2018. Document Cloud ARR exiting fiscal 2019 was $1.09 billion , up
from $791 million at the end of fiscal 2018. Total Digital Media ARR grew to
$8.40 billion at the end of fiscal 2019, up from $6.71 billion at the end of
fiscal 2018. Revaluing our ending ARR for fiscal 2019 using currency rates at
the beginning of fiscal 2019, our Digital Media ARR at the end of fiscal 2019
would be $8.33 billion or approximately $66 million lower than the ARR reported
above.
Our success in driving growth in ARR has positively affected our revenue growth.
Creative revenue in fiscal 2019 was $6.48 billion , up from $5.34 billion in
fiscal 2018 and representing 21% year-over-year growth. Document Cloud revenue
in fiscal 2019 was $1.22 billion , up from $981.8 million in fiscal 2018 and
representing 25% year-over-year revenue growth. Total Digital Media segment
revenue grew to $7.71 billion in fiscal 2019, up from $6.33 billion in fiscal
2018 and representing 22% year-over-year growth.
We are a market leader in the fast-growing category addressed by our Digital
Experience segment. Our Digital Experience business provides comprehensive
solutions that include analytics, targeting, media optimization, digital
experience management, cross-channel campaign management, marketing automation,
audience management, commerce, 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.
During fiscal 2019, our hierarchy of solutions in the Digital Experience segment
consisted of the following cloud offerings:
• 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.
• 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 andunderstanding of vast amounts of disparate data and then translating that
data into singular customer profiles; includes Adobe Analytics and Adobe
Audience Manager.
• Adobe Marketing Cloud-provides an integrated set of solutions to helpmarketers 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, Marketo Engage and Adobe Primetime.
• Adobe Commerce Cloud-provides digital commerce, order management andpredictive intelligence based on a unified commerce platform enabling
shopping experiences across a wide array of industries; includes Magento
Commerce.
In addition to chief marketing officers, chief revenue officers and digital marketers, users of our Digital Experience solutions include advertisers, campaign managers, publishers, data analysts, content managers, social marketers, marketing executives and information management and technology 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 Experience 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 Digital Experience 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 Digital Experience revenue of$3.21 billion in fiscal 2019, up from$2.44 billion in fiscal 2018 which represents 31% year-over-year growth. Driving this increase was the increase in subscription revenue across our offerings which grew to$2.67 billion in fiscal 2019 from$1.95 billion in fiscal 2018, representing 37% year-over-year growth. Largely contributing to the increase in Digital Experience subscription revenue was revenue associated with Marketo Engage. To a lesser extent, subscription revenue associated with Magento Commerce and Adobe Experience Manager also contributed to the overall increase. We expect that continued demand across our portfolio of Adobe Experience Cloud solutions, including new offerings and enhancements to existing solutions, will drive revenue growth in future years. 41 -------------------------------------------------------------------------------- Table of Contents Our financial results for fiscal 2019 are presented in accordance with the new revenue standard that was adopted under the modified retrospective method at the beginning of fiscal 2019. Prior period results have not been restated which limits the comparability of our results of operations for fiscal 2019 when compared to the year-ago period. See Note 2 of our Notes to Consolidated Financial Statements for information regarding adoption of the new revenue standard. Financial Performance Summary for Fiscal 2019 • Total Digital Media ARR of approximately$8.40 billion as ofNovember 29 ,
2019 increased by
to stronger new user adoption of our Creative Cloud and Adobe Document
Cloud offerings.
• Creative revenue of $6.48 billion increased by $1.14 billion , or 21%,
during fiscal 2019, from $5.34 billion in fiscal 2018. The increase wasprimarily due to the increase in subscription revenue associated with our
Creative Cloud offerings.
• Digital Experience revenue of
or 31%, during fiscal 2019, from $2.44 billion in fiscal 2018. The
increase was primarily due to the increase in subscription revenue driven
by the addition of Marketo and Magento, which we acquired in the later
part of fiscal 2018.
• Our total deferred revenue of $3.50 billion as of November 29, 2019
increased by $447.1 million , or 15%, from $3.05 billion as of
November 30, 2018 . The increase was primarily due to increases in newcontracts and the timing of renewals for offerings with cloud-enabled
services and hosted services.
• Cost of revenue of $1.67 billion increased by $477.7 million , or 40%,
during fiscal 2019, from $1.19 billion in fiscal 2018. The increase was
primarily due to increases in amortization of intangibles from ouracquisition of Magento and Marketo in the later part of fiscal 2018. To a
lesser extent, increases in hosting services and data center costs also
contributed to the overall increase in cost of revenue.
• Operating expenses of
during fiscal 2019, from
primarily due to increases in base compensation and related benefits
costs and stock-based compensation expense associated with headcount
growth, including additions from the acquisitions of Magento and Marketo
in the later part of fiscal 2018. To a lesser extent, increases in
marketing spend also contributed to the overall increase in operating
expenses.
• Net income of $2.95 billion increased by $360.7 million , or 14%, during
fiscal 2019 from
in revenue and offset in part by the increases in operating expenses and
cost of revenue.
• Net cash flow from operations of $4.42 billion during fiscal 2019
increased by
2018 primarily due to higher net income adjusted for the net effect of
non-cash items. This increase was offset in part by comparatively lower
increases in income taxes payable and higher increases in prepaid
expenses and other assets.
Revenue
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Subscription $ 9,994.5 $ 7,922.2 $ 6,133.9 26 %
Percentage of total revenue 89 % 88 % 84 %
Product 647.8 622.1 706.7 4 %
Percentage of total revenue 6 % 7 % 10 %
Services and support 529.0 485.7 460.9 9 %
Percentage of total revenue 5 % 5 % 6 %
Total revenue $ 11,171.3 $ 9,030.0 $ 7,301.5 24 %
Subscription Revenue by Segment
Our subscription revenue is comprised primarily of fees we charge for our
subscription and hosted service offerings including Creative Cloud and certain
of our Digital Experience and Document Cloud services. We recognize subscription
revenue ratably over the term of agreements with our customers, beginning with
commencement of service.
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We have the following reportable segments: Digital Media, Digital Experience and
Publishing. Subscription revenue by reportable segment for fiscal 2019, 2018 and
2017 is as follows:
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Digital Media $ 7,208.3 $ 5,857.7 $ 4,480.8 23 %
Digital Experience 2,670.7 1,949.3 1,552.5 37 %
Publishing 115.5 115.2 100.6 *
Total subscription revenue $ 9,994.5 $ 7,922.2 $ 6,133.9 26 %
_________________________________________
(*) Percentage is less than 1%. Our product revenue is primarily comprised of revenue from distinct on-premise software licenses recognized at a point in time and certain of our OEM and royalty agreements. 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 Digital Experience 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 2019, we categorized our products into the following reportable segments: • Digital Media-Our Digital Media segment provides tools and solutions that
enable individuals, teams and enterprises to create, publish, promote and
monetize their digital content anywhere. Our customers include content
creators, experience designers, app developers, enthusiasts, students,
social media users and creative professionals, as well as marketing
departments and agencies, companies and publishers. Our customers also
include knowledge workers who create, collaborate on and distribute
documents and creative content.
• Digital Experience-Our Digital Experience segment provides products,
services and solutions for creating, managing, executing, measuring,
monetizing and optimizing customer experiences from advertising to
commerce. Our customers include marketers, advertisers, agencies,
publishers, merchandisers, merchants, web analysts, data scientists,
developers, marketing executives, information management and technology
executives, product development executives, and sales and support
executives.
• Publishing-Our 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. It also
includes our web conferencing and document and forms platforms.
Segment Information
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Digital Media $ 7,707.0 $ 6,325.3 $ 5,010.6 22 %
Percentage of total revenue 69 % 70 % 69 %
Digital Experience 3,206.2 2,443.7 2,030.3 31 %
Percentage of total revenue 29 % 27 % 28 %
Publishing 258.1 261.0 260.6 (1 )%
Percentage of total revenue 2 % 3 % 3 %
Total revenue $ 11,171.3 $ 9,030.0 $ 7,301.5 24 %
Digital Media
Revenue from Digital Media increased $1.38 billion during fiscal 2019 as
compared to fiscal 2018, driven by increases in revenue associated with our
Creative and Document Cloud offerings. Revenue associated with our Creative
offerings, which includes our Creative Cloud, perpetually licensed Creative and
stock photography offerings, increased during fiscal 2019. The increase was
primarily due to an increase in subscription revenue across all of our Creative
Cloud offerings driven by increases in net new subscriptions. Adobe Document
Cloud revenue, which includes our Acrobat product family and Adobe Sign service,
increased during fiscal 2019 as compared to fiscal 2018 primarily due to
increases in subscription revenue driven by strong adoption of our Document
Cloud.
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Digital Experience
Revenue from Digital Experience increased $762.5 million during fiscal 2019, as
compared to fiscal 2018 primarily due to subscription revenue growth across our
Experience Cloud offerings. Largely contributing to the subscription revenue
increases were revenue associated with Marketo Engage, which we acquired in the
fourth quarter of fiscal 2018, and revenue associated with our Magento Commerce
offerings. Also contributing to the subscription revenue growth were increases
in our AEM and Campaign offerings.
Geographical Information
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Americas $ 6,505.9 $ 5,116.8 $ 4,216.5 27 %
Percentage of total revenue 58 % 57 % 58 %
EMEA 2,975.2 2,550.0 1,985.1 17 %
Percentage of total revenue 27 % 28 % 27 %
APAC 1,690.2 1,363.2 1,099.9 24 %
Percentage of total revenue 15 % 15 % 15 %
Total revenue $ 11,171.3 $ 9,030.0 $ 7,301.5 24 %
Overall revenue during fiscal 2019 increased in all geographic regions as
compared to fiscal 2018 primarily due to increases in Digital Media and Digital
Experience revenue. Within each geographic region, the fluctuations in revenue
by reportable segment were attributable to the factors noted in the segment
information above.
Included in the overall change in revenue for fiscal 2019 and fiscal 2018 were
impacts associated with foreign currency as shown below. Our cash flow hedging
program is used to mitigate a portion of the foreign currency impact to revenue.
(in millions) 2019 2018
Revenue impact: Increase/(Decrease)
Euro $ (73.2 ) $ 96.3
Australian Dollar (27.2 ) (0.7 )
British Pound (27.0 ) 21.6
Japanese Yen 2.3 2.8
Other currencies (12.9 ) 2.6
Total revenue impact (138.0 ) 122.6
Hedging impact:
Euro 30.3 29.1
British Pound 8.2 11.3
Japanese Yen 1.4 8.2
Total hedging impact 39.9 48.6
Total impact $ (98.1 ) $ 171.2 During fiscal 2019, the
See Note 2 of our Notes to Consolidated Financial Statements for additional details of revenue by geography. Backlog Adoption of the new revenue standard resulted in changes to our measurement of unbilled backlog starting in fiscal 2019 such that orders with a right of termination and unbilled amounts recognized as revenue under the new revenue standard are not included in our unbilled backlog, consistent with our measurement of remaining performance obligations. Our unbilled backlog represents expected future billings not yet recognized in revenue that are contractually committed under our existing subscription agreements. As ofNovember 29, 2019 , we had unbilled backlog of$6.38 billion , which excludes amounts cancellable without substantive penalty. Approximately$2.61 billion of our unbilled backlog is not reasonably expected to be recognized during fiscal 44 -------------------------------------------------------------------------------- Table of Contents 2020. As ofNovember 30, 2018 , we had unbilled backlog of approximately$5.05 billion , which was measured under the accounting standard in effect for that period. We expect that the amount of unbilled backlog will change from period to period due to certain factors, including the timing and duration of large customer subscription agreements, varying billing cycles of these agreements, timing of customer renewals, timing of revenue recognition, changes in customer financial circumstances and foreign currency fluctuations. Our presentation of unbilled backlog may differ from that of other companies in the industry. Cost of Revenue % Change (dollars in millions) 2019 2018 2017 2019-2018 Subscription$ 1,222.5 $ 807.2 $ 623.0 51 % Percentage of total revenue 11 % 9 % 9 % Product 39.6 46.0 57.1 (14 )% Percentage of total revenue * 1 % 1 % Services and support 410.6 341.8 330.4 20 % Percentage of total revenue 4 % 4 % 5 %
Total cost of revenue
_________________________________________
(*) Percentage is less than 1%
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:
Components of
% Change
2019-2018
Amortization of intangibles 17 %
Hosting services and data center costs 12
Media rebill costs 7
Royalty costs 4
Incentive compensation, cash and stock-based 4
Base compensation and related benefits associated with headcount 3 Various individually insignificant items
4
Total change 51 %
Amortization of intangibles increased during fiscal 2019 as compared to fiscal
2018 primarily due to amortization of intangible assets purchased through our
acquisitions of Magento and Marketo in fiscal 2018.
Product
Cost of product revenue includes product packaging, third-party royalties,
excess and obsolete inventory, amortization of intangibles and the costs
associated with the manufacturing of our products.
Cost of product revenue decreased during fiscal 2019 as compared to fiscal 2018
primarily due to decreases in localization costs.
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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:
Components of
% Change
2019-2018
Incentive compensation, cash and stock-based 10 %
Base compensation and related benefits associated with headcount 7 Various individually insignificant items
3
Total change 20 %
Operating Expenses
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Research and development $ 1,930.2 $ 1,537.8 $ 1,224.1 26 %
Percentage of total revenue 17 % 17 % 17 %
Sales and marketing 3,244.4 2,620.8 2,197.6 24 %
Percentage of total revenue 29 % 29 % 30 %
General and administrative 880.6 744.9 624.7 18 %
Percentage of total revenue 8 % 8 % 9 %
Amortization of intangibles 175.3 91.1 76.5 92 %
Percentage of total revenue 2 % 1 % 1 %
Total operating expenses $ 6,230.5 $ 4,994.6 $ 4,122.9 25 %
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:
Components of
% Change
2019-2018
Incentive compensation, cash and stock-based 11 %
Base compensation and related benefits associated with headcount 8 Professional and consulting fees
4
Various individually insignificant items 3
Total change 26 %
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,
amortization of contract acquisitions costs including 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.
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Table of ContentsSales and marketing expenses increased due to the following:
Components of
% Change
2019-2018Marketing spending related to campaigns, events and overall marketing efforts
8 %
Base compensation and related benefits associated with headcount 7
Incentive compensation, cash and stock-based
3
Professional and consulting fees
2
Amortization of contract acquisition costs, including sales commissions
2
Various individually insignificant items 2
Total change 24 %
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:
Components of
% Change
2019-2018
Professional and consulting fees 4 %
Facilities and telecom 4
Incentive compensation, cash and stock-based 4
Base compensation and related benefits associated with headcount 3 Software licenses
2
Various individually insignificant items 1
Total change 18 %
Amortization of 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 fifteen years.
Amortization expense increased during fiscal 2019 as compared to fiscal 2018
primarily due to amortization of intangible assets purchased through our
acquisitions of Magento and Marketo in the later part of fiscal 2018 and
partially offset by certain fully amortized acquired intangible assets from
previous acquisitions.
Non-Operating Income (Expense), Net
% Change
(dollars in millions) 2019 2018 2017 2019-2018
Interest and other income (expense), net $ 42.2 $ 39.5 $ 36.4 **
Percentage of total revenue * * *
Interest expense (157.2 ) (89.2 ) (74.4 ) 76 %
Percentage of total revenue (1 )% (1 )% (1 )%
Investment gains (losses), net 51.6 3.2 7.5 **
Percentage of total revenue * * *
Total non-operating income (expense), net
_________________________________________
(*) Percentage is less than 1%.
(**) Percentage is not meaningful.
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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.
Interest Expense
Interest expense primarily represents interest associated with our Term Loan,
senior notes and interest rate swaps. In October 2018 , we entered into a credit
agreement providing for a $2.25 billion senior unsecured term loan for the
purpose of partially funding the purchase price for our acquisition of Marketo.
Interest on our Term Loan is payable periodically at the end of each interest
period, whereas interest on our senior notes is payable semi-annually, in
arrears, on February 1 and August 1 . Floating interest payments on the interest
rate swaps are paid monthly. The fixed-rate interest receivable on the swaps is
received semi-annually concurrent with the senior notes interest payments. See
Notes 6 and 17 of our Notes to Consolidated Financial Statements for further details regarding our interest rate swaps and debt, respectively. Interest expense increased during fiscal 2019 as compared to fiscal 2018 primarily due to interest on our Term Loan which was entered into in the fourth quarter of fiscal 2018. Investment Gains (Losses), Net Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets which are classified as trading securities, and gains and losses associated with our direct and indirect investments in privately held companies. Investment gains increased during fiscal 2019 as compared to fiscal 2018 primarily due to the gain recognized upon our acquisition of the remaining interest in Allegorithmic inJanuary 2019 , which was accounted for as an equity-method investment immediately before the acquisition. See Note 3 of our Notes to Consolidated Financial Statements for further details regarding our acquisition of Allegorithmic. Provision for Income Taxes % Change % Change (dollars in millions) 2019 2018 2017 2019-2018 2018-2017 Provision$ 253.3 $ 203.1 $ 443.7 25 % (54 )% Percentage of total revenue 2 % 2 % 6 % Effective tax rate 8 % 7 % 21 % Our effective tax rate increased by approximately one percentage point during fiscal 2019 as compared to fiscal 2018. The effective tax rate for fiscal 2019 includedU.S. federal and state taxes associated with our current year international earnings resulting from the international provisions of the Tax Cuts and Jobs Act ("Tax Act") effective this year and for additional foreign taxation on our foreign operations. This increase was offset in part by the provisional accounting expense recorded in the prior year for the effects of the Tax Act adoption. Our effective tax rate decreased by approximately 14 percentage points during fiscal 2018 as compared to fiscal 2017. The lower effective tax rate was primarily due to the effects of the Tax Act enacted onDecember 22, 2017 , which included the reduction in the statutory federal corporate income tax rate from 35% to 21% effective onJanuary 1, 2018 , and a related change to our corporate tax structure from which we serve our foreign customers that provided us the ability to deduct more expenses against our earnings in theU.S. Beginning in our fiscal 2019, the annual statutory federal corporate tax rate is 21% and certain international provisions of the Tax Act, such as a tax on global intangible low-tax income, a base erosion and anti-abuse tax and a special tax deduction for foreign-derived intangible income, took effect.The U.S. Treasury Department has issued proposed regulations that could impact the calculation of taxes related to these provisions and which are anticipated to be applicable on a retroactive basis. While the Company continues to evaluate the impact, such regulations have not been finalized and are subject to change. We will account for new regulations in the period of enactment. We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, we considered all available positive and negative evidence, including our past operating results, forecasted earnings, future taxable income and prudent and feasible tax planning strategies. On the basis of this evaluation, we continue to maintain a valuation allowance related primarily to the realizability of state and foreign credits. Total valuation allowance was$244.4 million as ofNovember 29, 2019 . 48 -------------------------------------------------------------------------------- Table of Contents We are aUnited States -based multinational company subject to tax in multipleU.S. and foreign tax jurisdictions. A significant portion of our foreign earnings for the current fiscal year were earned by our Irish subsidiaries. The Tax Act provides an exemption from federal income taxes for distributions from foreign subsidiaries made afterDecember 31, 2017 , including certain earnings that were not subject to the one-time transition or global intangible low-tax income tax. As we repatriate the undistributed foreign earnings for use in theU.S. , the distributions will generally not be subject to furtherU.S. federal tax. Subsequent toNovember 29, 2019 , final and proposed tax regulations were issued that are applicable to Adobe. We are currently evaluating the impact of these enacted and issued regulations, but we do not anticipate they will have a material impact to our fiscal 2020 operating results. The Tax Act included certain international provisions effective for us starting in fiscal 2019. As discussed in Part 1. Item 1A. Risk Factors, the applicability and impact of these new tax provisions, and of other international tax law changes effective for fiscal 2020 and beyond, will likely require us to respond by making change(s) to our international trading structure. The net impact of such change(s) is uncertain but is anticipated to adversely affect our effective income tax rate and cash flows in years beyond fiscal 2020. See Note 10 of our Notes to Consolidated Financial Statements for further information on our provision for income taxes. Accounting for Uncertainty in Income Taxes The gross liabilities for unrecognized tax benefits excluding interest and penalties were$173.3 million ,$196.2 million and$172.9 million for fiscal 2019, 2018 and 2017, respectively. If the total unrecognized tax benefits atNovember 29, 2019 ,November 30, 2018 andDecember 1, 2017 were recognized,$127.0 million ,$145.2 million and$135.0 million would decrease the respective effective tax rates. The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately$25.1 million and$24.6 million for fiscal 2019 and 2018, respectively. These amounts were included in long-term 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 sheet classification of our tax assets and liabilities. 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$20 million . In addition, in countries where we conduct business and in jurisdictions in which we are subject to tax, including those covered by governing bodies that enact tax laws applicable to us, such as theEuropean Commission of theEuropean Union , 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, other governmental bodies and intergovernmental economic organizations such as theOrganization for Economic Cooperation and Development , have or could make unprecedented assertions about how taxation is determined in their jurisdictions 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 theIRS 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. 49 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES
This data should be read in conjunction with our Consolidated Statements of Cash Flows.
As of
(in millions) November 29, 2019 November 30, 2018
Cash and cash equivalents $ 2,650.2 $ 1,642.8
Short-term investments $ 1,526.8 $ 1,586.2
Working capital $ (1,696.0 ) $ 555.9
Stockholders' equity $ 10,530.2 $ 9,362.1
Working Capital
Working capital as of November 29, 2019 and November 30, 2018 was $1.70 billion
of a deficit and $555.9 million of a surplus, respectively. The decrease was
primarily due to the reclassification of $3.15 billion total carrying value of
our $2.25 billion term loan due April 30, 2020 ("Term Loan") and $900 million
4.75% senior notes due February 1, 2020 ("2020 Notes") to current liabilities.
We intend to refinance our Term Loan and 2020 Notes on or before the due dates.
A summary of our cash flows is as follows:
(in millions) 2019 2018 2017
Net cash provided by operating activities
$ 2,912.9 Net cash used for investing activities (455.6 ) (4,685.3 ) (442.9 ) Net cash used for financing activities (2,946.1 ) (5.6 ) (1,183.7 ) Effect of foreign currency exchange rates on cash and cash equivalents (12.7 ) (1.7 ) 8.5 Net increase (decrease) in cash and cash equivalents$ 1,007.4 $ (663.3 ) $ 1,294.8 Our primary source of cash is receipts from revenue and, to a lesser extent, proceeds from participation in the employee stock purchase plan. The primary uses of cash are our stock repurchase program as described below, payroll-related expenses, general operating expenses including marketing, travel and office rent, and cost of revenue. Other uses of cash include business acquisitions, purchases of property and equipment and payments for taxes related to net share settlement of equity awards. Cash Flows from Operating Activities For fiscal 2019, net cash provided by operating activities of$4.42 billion was primarily comprised of net income adjusted for the net effect of non-cash items. The primary working capital sources of cash were net income coupled with an increase in deferred revenue, which was offset in large part by cash outflows due to an increase in prepaid expenses and other assets. The increase in deferred revenue was primarily driven by increases related to Digital Media offerings with cloud-enabled services and Digital Experience hosted services. The primary working capital use of cash was due to increases in prepaid expenses with certain vendors, sales commissions paid and capitalized, advanced payments related to income taxes and increase in long-term contract assets. Cash Flows from Investing Activities For fiscal 2019, net cash used for investing activities of$455.6 million was primarily due to purchases of property and equipment and our acquisition of the remaining equity interest in Allegorithmic. These cash outflows were offset primarily by proceeds from sales and maturities of short-term investments, net of purchases. See Note 3 of our Notes to Consolidated Financial Statements for more detailed information regarding our acquisitions. Cash Flows from Financing Activities For fiscal 2019, net cash used for financing activities was$2.95 billion primarily due to payments for our treasury stock repurchases and taxes related to net share settlement of equity awards, which were offset by proceeds from re-issuance of treasury stock for our employee stock purchase plan. See the section titled "Stock Repurchase Program" discussed below. We expect to continue our investing activities, including short-term and long-term investments, 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. 50 -------------------------------------------------------------------------------- Table of Contents Other Liquidity and Capital Resources Considerations Our existing cash, cash equivalents and investment balances may fluctuate during fiscal 2020 due to changes in our planned cash outlay, including changes in incremental costs such as direct costs and integration costs related to our acquisitions. 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. We have a$1 billion senior unsecured revolving credit agreement ("Revolving Credit Agreement") with a syndicate of lenders, providing for loans to us and certain of our subsidiaries throughOctober 17, 2023 . As ofNovember 29, 2019 , there were no outstanding borrowings under this credit agreement and the entire$1 billion credit line remains available for borrowing. As ofNovember 29, 2019 , we have a$2.25 billion Term Loan outstanding and$1.9 billion senior notes outstanding, consisting of our 2020 Notes and$1 billion of 3.25% senior notes dueFebruary 1, 2025 (the "2025 Notes," and together with the 2020 Notes, the "Notes"). The Notes and Term Loan rank equally with our other unsecured and unsubordinated indebtedness. During the first quarter of fiscal 2019, we reclassified the 2020 Notes as current debt in our Consolidated Balance Sheets. During the second quarter of fiscal 2019, we reclassified the Term Loan as current debt in our Consolidated Balance Sheets. As ofNovember 29, 2019 , the carrying value of the 2020 Notes was$899.6 million which includes the fair value of the related interest rate swap and is net of debt issuance costs, and the carrying value of the Term Loan was$2.25 billion , net of unamortized original issuance discount. We intend to refinance the Term Loan and 2020 Notes on or before the due dates. During the third quarter of fiscal 2019, in anticipation of refinancing our Term Loan and 2020 Notes, we entered intoTreasury lock agreements with large financial institutions which fixed benchmarkU.S. Treasury rates for an aggregate notional amount of$1 billion of our future debt issuance. These derivative instruments hedge the impact of changes in the benchmark interest rate to future interest payments and will be terminated upon debt issuance. Our short-term investment portfolio is primarily invested in corporate debt securities, asset-backed securities, municipal securities andU.S. Treasury securities. We use professional investment management firms to manage a large portion of our investment portfolio. 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. InMay 2018 , our Board of Directors granted us an authority to repurchase up to$8 billion in common stock through the end of fiscal 2021. During fiscal 2019, 2018 and 2017, we entered into several structured stock repurchase agreements with large financial institutions, whereupon we provided them with prepayments totaling$2.75 billion ,$2.05 billion , and$1.10 billion , 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 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. 51 -------------------------------------------------------------------------------- Table of Contents The following is a summary of our structured stock repurchases executed with large financial institutions during fiscal 2019, 2018, and 2017: (shares in thousands and total cost in millions) 2019 2018 2017 Average per Average per Average per Board approval dates Shares share Shares share Shares share January 2015 - $ - - $ - 4,263$ 118.00 January 2017 - $ - 8,686$ 230.43 3,923$ 151.80 May 2018 9,883$ 270.23 - $ - - $ - Total shares 9,883$ 270.23 8,686$ 230.43 8,186$ 134.20 Total cost$2,671 $2,002 $1,099 For fiscal 2019, 2018 and 2017, the prepayments were classified as treasury stock on our Consolidated Balance Sheets at the payment date, though only shares physically delivered to us byNovember 29, 2019 ,November 30, 2018 andDecember 1, 2017 were excluded from the computation of earnings per share. As ofNovember 29, 2019 ,$229.2 million of prepayments remained under the agreement. Subsequent toNovember 29, 2019 , we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of$850 million . This amount will be classified as treasury stock on our Consolidated Balance Sheets. Upon completion of the$850 million stock repurchase agreement,$4.25 billion remains under ourMay 2018 authority. See Item 5, Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities for share repurchases during the quarter endedNovember 29, 2019 . Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Our principal commitments as ofNovember 29, 2019 consist of obligations under operating leases, royalty agreements and various service agreements. See Note 16 of our Notes to Consolidated Financial Statements for additional information regarding our contractual commitments. Contractual Obligations The following table summarizes our contractual obligations as ofNovember 29, 2019 : (in millions) Payment Due by Period Less than More than Total 1 year 1-3 years 3-5 years 5 years Term Loan and Notes, including interest$ 4,373.3 $ 3,227.0 $ 65.0 $ 65.0 $ 1,016.3 Operating lease obligations, net 711.5 88.7 158.0 126.9 337.9 Purchase obligations 2,036.5 545.0 935.8 555.7 - Total$ 7,121.3 $ 3,860.7 $ 1,158.8 $ 747.6 $ 1,354.2 As ofNovember 29, 2019 , our Term Loan's carrying value was$2.25 billion . At our election, the Term Loan will bear interest at either (i) theLondon Interbank Offered Rate ("LIBOR") plus a margin, based on our debt ratings, ranging from 0.500% to 1.000% or (ii) a base rate plus a margin, based on our debt ratings, ranging from 0.040% to 0.110%. Interest is payable periodically, in arrears, at the end of each interest period we elect. Based on the LIBOR rate atNovember 29, 2019 , our estimated maximum commitment for interest payments was$23.2 million for the remaining duration of the Term Loan. As ofNovember 29, 2019 , the carrying value of our Notes payable was$1.89 billion . Interest on our Notes is payable semi-annually, in arrears onFebruary 1 andAugust 1 . AtNovember 29, 2019 , our maximum commitment for interest payments was$200.1 million for the remaining duration of our Notes. Our Term Loan and Revolving Credit Agreement contain similar financial covenants requiring us not to exceed a maximum leverage ratio. As ofNovember 29, 2019 , 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 senior notes do not contain any financial covenants. 52 -------------------------------------------------------------------------------- Table of Contents Under the terms of our Term Loan and Revolving Credit Agreement, we are not prohibited from paying cash dividends unless payment would trigger an event of default or if one currently exists. We do not anticipate paying any cash dividends in the foreseeable future. Transition Taxes Liability As a result of the Tax Act enacted onDecember 22, 2017 , an accrued transition tax liability of approximately$427.1 million as ofNovember 29, 2019 is payable in installments through fiscal 2026. The Tax Act provides an exemption from federal income taxes for distributions from foreign subsidiaries made afterDecember 31, 2017 , including certain earnings that were not subject to the one-time transition or global intangible low-tax income tax. As we repatriate the undistributed foreign earnings for use in theU.S. , the distributions will generally not be subject to furtherU.S. federal tax. Accounting for Uncertainty in Income Taxes See Results of Operations - Provision for Income Taxes above and Note10 of our Notes to Consolidated Financial Statements for our discussion on accounting for uncertainty in income taxes. Royalties We have certain royalty commitments associated with the licensing of certain offerings. 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 and channel partners 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 underDelaware 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.
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