Item 7. Management’s Discussion and Analysis
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. Discussion regarding our financial condition and results of operations for fiscal 2022 as compared to fiscal 2021 is included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 2, 2022, filed with the SEC on January 17, 2023.
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. We evaluate our assumptions, judgments and estimates on a regular basis. 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, 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 digital assets 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.
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 loss and tax credit carryforwards. Significant judgment is required in determining our current provision for income taxes and deferred tax assets or liabilities. We record a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account our interpretation and application of current tax laws and possible outcomes of current and future examinations conducted by domestic and foreign tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and associated reserves. To the extent that the final
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determination of any of these examinations is different from the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made.
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.
RESULTS OF OPERATIONS
Overview of 2023
For our fiscal 2023, we experienced strong demand across our Digital Media and Digital Experience offerings, driven by our innovative product roadmap. As we execute on our long-term growth initiatives and deliver product innovation, we have continued to experience growth in software-based subscription revenue across our portfolio of offerings.
Digital Media
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 content and immersive 3D experiences. Creative Cloud includes Adobe Express, a web and mobile app designed to enable a broad spectrum of users, including novice content creators, communicators and creative professionals, to create, edit and customize content quickly and easily with content-first, task-based solutions. In September 2023, we released Adobe Firefly, a group of creative generative AI models designed to generate high quality images and text effects. Adobe Firefly-powered generative AI features are also available across Creative Cloud apps including Adobe Photoshop and Adobe Express. 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’ devices, 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 attracting new users with new features and products like Adobe Express and Adobe Firefly that make creative tools accessible to first-time creators and communicators, and delivering new features and technologies to existing customers with our latest releases such as share for review and generative AI capabilities. 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 existing users, continue to attract new customers, and grow our recurring and predictable revenue stream that is recognized ratably.
We continue to implement strategies that are designed to 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 and enhanced desktop, web and mobile apps, as well as targeted promotions and offers that attract past customers and potential users to experience 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 Document Cloud offerings built around our Adobe Acrobat family of products, with a set of integrated mobile apps and cloud-based document services which enable users to create, collaborate, review, approve, sign and track documents regardless of platform or application source type. Document Cloud, which enhances the way people manage critical documents at home, in the office and across devices, includes Adobe Acrobat, Adobe Acrobat Sign and Adobe Scan. Adobe Acrobat is offered both through subscription and perpetual licenses, and is also included in our Creative Cloud All Apps subscription offering.
As part of our Creative Cloud and Document Cloud strategies, we utilize a data-driven operating model (“DDOM”) and our Adobe Experience Cloud solutions to raise awareness of our products, drive new customer acquisition, engagement and retention, and optimize customer journeys, which continue to contribute strong product-led growth in the business.
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 remaining performance obligations 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 exchange rate changes. Our reported ARR results in the
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current fiscal year are based on currency rates set at the beginning of the year and held constant throughout the year for measurement purposes. We calculate ARR as follows:
Creative ARR Annual Value of Creative Cloud Subscriptions and Services
+
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 2023 was $12.37 billion, up from $10.98 billion at the end of fiscal 2022. Document Cloud ARR exiting fiscal 2023 was $2.81 billion, up from $2.28 billion at the end of fiscal 2022. Total Digital Media ARR grew to $15.17 billion at the end of fiscal 2023, up from $13.26 billion at the end of fiscal 2022. Revaluing our ending ARR for fiscal 2023 using currency rates determined at the beginning of fiscal 2024, our Digital Media ARR at the end of fiscal 2023 would be $15.33 billion or approximately $160 million higher than the ARR reported above.
Our success in driving growth in ARR has positively affected our revenue growth. Creative revenue in fiscal 2023 was $11.52 billion, up from $10.46 billion in fiscal 2022 and representing 10% year-over-year growth. Document Cloud revenue in fiscal 2023 was $2.70 billion, up from $2.38 billion in fiscal 2022 and representing 13% year-over-year growth. Total Digital Media segment revenue grew to $14.22 billion in fiscal 2023, up from $12.84 billion in fiscal 2022 and representing 11% year-over-year growth driven by strong net new user growth.
Digital Experience
We are a market leader in the fast-growing category addressed by our Digital Experience segment. The Adobe Experience Cloud apps and services are designed to manage customer journeys, enable personalized experiences at scale and deliver intelligence for businesses of any size in any industry. Our differentiation and competitive advantage are strengthened by our ability to use the Adobe Experience Platform to integrate our comprehensive set of solutions.
Adobe Experience Cloud delivers solutions for our customers across the following strategic growth pillars:
• Data insights and audiences . Our products, including Adobe Analytics, Customer Journey Analytics, Adobe Product Analytics, and our Real-time Customer Data Platform, deliver actionable data in real time to provide highly tailored and adaptive experiences across platforms.
• Content and commerce . Our products help customers manage, deliver, monetize, and optimize content delivery through Adobe Experience Manager and build multi-channel commerce experiences for B2B and B2C customers on a single platform with Adobe Commerce.
• Customer journeys . Our products help businesses manage, test, target and personalize customer journeys delivered as campaigns across B2B and B2C use cases, including through Adobe Marketo Engage, Adobe Campaign, Adobe Target and Adobe Journey Optimizer.
• Marketing planning and workflow . Our products help businesses intelligently measure, optimize, and plan marketing investments through the Adobe Mix Modeler, and allow businesses to strategically plan, manage, collaborate, and execute on workflows for marketing campaigns and other projects at speed and scale with our enterprise work management app, Adobe Workfront.
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 integrate 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, such as with our new Adobe GenStudio solution, 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.
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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 and our experience-led growth strategy.
Digital Experience revenue was $4.89 billion in fiscal 2023, up from $4.42 billion in fiscal 2022 which represents 11% year-over-year growth. Driving this growth was the increase in subscription revenue, which grew to $4.33 billion in fiscal 2023 from $3.88 billion in fiscal 2022, representing 12% year-over-year growth.
Macroeconomic Conditions
As a corporation with an extensive global footprint, we are subject to risks and exposures from the evolving macroeconomic environment, including the effects of increased global inflationary pressures and interest rates, fluctuations in foreign currency exchange rates, potential economic slowdowns or recessions and geopolitical pressures, including the unknown impacts of current and future trade regulations. We continuously monitor the direct and indirect impacts of these circumstances on our business and financial results. For example, foreign currency exchange rate fluctuations have negatively impacted our revenue and earnings during fiscal 2023, and may continue to negatively impact our financial results in fiscal 2024.
While our revenue and earnings are relatively predictable as a result of our subscription-based business model, the broader implications of these macroeconomic events on our business, results of operations and overall financial position, particularly in the long term, remain uncertain. See the section titled “Risk Factors” in Part I, Item 1A of this report for further discussion of the possible impact of these macroeconomic issues on our business.
Financial Performance Summary for Fiscal 2023
• Total Digital Media ARR of approximately $15.17 billion as of December 1, 2023 increased by $1.91 billion, or 14%, from $13.26 billion as of December 2, 2022.
• Creative revenue of $11.52 billion increased by $1.06 billion, or 10%, during fiscal 2023, from $10.46 billion in fiscal 2022. Document Cloud revenue of $2.70 billion increased by $316 million, or 13%, during fiscal 2023, from $2.38 billion in fiscal 2022.
• Digital Experience revenue of $4.89 billion increased by $471 million, or 11%, during fiscal 2023, from $4.42 billion in fiscal 2022.
• Remaining performance obligations of $17.22 billion as of December 1, 2023 increased by $2.02 billion, or 13%, from $15.19 billion as of December 2, 2022.
• Cost of revenue of $2.35 billion increased by $189 million, or 9%, during fiscal 2023, from $2.17 billion in fiscal 2022.
• Operating expenses of $10.41 billion increased by $1.06 billion, or 11%, during fiscal 2023, from $9.34 billion in fiscal 2022.
• Net income of $5.43 billion increased by $672 million, or 14%, during fiscal 2023, from $4.76 billion in fiscal 2022.
• Cash flows from operations of $7.30 billion during fiscal 2023 decreased by $536 million, or 7%, from $7.84 billion in fiscal 2022.
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Revenue
Revenue for fiscal 2021 benefited from an extra week in the first quarter of fiscal 2021 due to our 52/53 week financial calendar whereby fiscal 2021 was a 53-week year compared with fiscal 2023 and 2022 which were 52-week years.
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Subscription $ 18,284 $ 16,388 $ 14,573 12 %
Percentage of total revenue 94 % 93 % 92 %
Product 460 532 555 (14) %
Percentage of total revenue 2 % 3 % 4 %
Services and other 665 686 657 (3) %
Percentage of total revenue 4 % 4 % 4 %
Total revenue $ 19,409 $ 17,606 $ 15,785 10 %
Subscription
Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings, and related support, including Creative Cloud and certain of our Adobe Experience Cloud and Document Cloud services. We primarily recognize subscription revenue ratably over the term of agreements with our customers, beginning with commencement of service. Subscription revenue related to certain offerings, where fees are based on a number of transactions and invoicing is aligned to the pattern of performance, customer benefit and consumption, are recognized on a usage basis.
We have the following reportable segments: Digital Media, Digital Experience, and Publishing and Advertising. Subscription revenue by reportable segment for fiscal 2023, 2022 and 2021 is as follows:
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Digital Media $ 13,838 $ 12,385 $ 11,048 12 %
Digital Experience 4,331 3,880 3,379 12 %
Publishing and Advertising 115 123 146 (7) %
Total subscription revenue $ 18,284 $ 16,388 $ 14,573 12 %
Product
Our product revenue is comprised primarily of fees related to licenses for on-premise software purchased on a perpetual basis, for a fixed period of time or based on usage for certain of our original equipment manufacturer and royalty agreements. We primarily recognize product revenue at the point in time the software is available to the customer, provided all other revenue recognition criteria are met.
Services and Other
Our services and other revenue is comprised primarily of fees related to consulting, training, maintenance and support for certain on-premise licenses that are recognized at a point in time and our advertising offerings. We typically sell our consulting contracts on a time-and-materials or fixed-fee basis. These revenues are recognized as the services are performed for time-and-materials contracts and on a relative performance basis for fixed-fee contracts. Training revenues are recognized as the services are performed. Our maintenance and support offerings, which entitle customers, partners and developers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement. Transaction-based advertising revenue is recognized on a usage basis as we satisfy the performance obligations to our customers.
Segments
In fiscal 2023, we categorized our products into the following reportable segments:
• Digital Media —Our Digital Media segment provides products and services that enable individuals, teams, businesses, and enterprises to create, publish and promote their content anywhere and accelerate their productivity by transforming how they view, share, engage with and collaborate on documents and creative content. Our customers include creative professionals, including photographers, video editors, graphic and experience designers
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and game developers; communicators, including content creators, students, marketers and knowledge workers; and consumers.
• Digital Experience —Our Digital Experience segment provides an integrated platform and set of products, services and solutions that enable businesses to create, manage, execute, measure, monetize and optimize customer experiences that span from analytics to commerce. Our customers include marketers, advertisers, agencies, publishers, merchandisers, merchants, web analysts, data scientists, developers and executives across the C-suite.
• Publishing and Advertising —Our Publishing and Advertising segment contains legacy products and services that address diverse market opportunities, including eLearning solutions, technical document publishing, web conferencing, document and forms platform, web app development, high-end printing and our Adobe Advertising offerings.
Segment Information
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Digital Media $ 14,216 $ 12,842 $ 11,520 11 %
Percentage of total revenue 73 % 73 % 73 %
Digital Experience 4,893 4,422 3,867 11 %
Percentage of total revenue 25 % 25 % 24 %
Publishing and Advertising 300 342 398 (12) %
Percentage of total revenue 2 % 2 % 3 %
Total revenue $ 19,409 $ 17,606 $ 15,785 10 %
Digital Media
Revenue by major offerings in our Digital Media reportable segment for fiscal 2023, 2022 and 2021 were as follows:
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Creative Cloud $ 11,517 $ 10,459 $ 9,546 10 %
Document Cloud 2,699 2,383 1,974 13 %
Total Digital Media revenue $ 14,216 $ 12,842 $ 11,520 11 %
Revenue from Digital Media increased $1.37 billion during fiscal 2023 as compared to fiscal 2022, driven by increases in revenue associated with our Creative and Document Cloud subscription offerings due to continued demand amid an increasingly digital environment, strong engagement across customer segments and migrating our customers to higher valued subscription offerings with increased revenue per subscription, partially offset by the impact of foreign currency exchange rate fluctuations.
Digital Experience
Revenue from Digital Experience increased $471 million during fiscal 2023 as compared to fiscal 2022 primarily due to net new additions across our subscription offerings, partially offset by the impact of foreign currency exchange rate fluctuations.
Geographical Information
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Americas $ 11,654 $ 10,251 $ 8,996 14 %
Percentage of total revenue 60 % 58 % 57 %
EMEA 4,881 4,593 4,252 6 %
Percentage of total revenue 25 % 26 % 27 %
APAC 2,874 2,762 2,537 4 %
Percentage of total revenue 15 % 16 % 16 %
Total revenue $ 19,409 $ 17,606 $ 15,785 10 %
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Overall revenue during fiscal 2023 increased in all geographic regions as compared to fiscal 2022. 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 2023 as compared to fiscal 2022 were impacts associated with foreign currency which were mitigated in part by our foreign currency hedging program. During fiscal 2023, the U.S. Dollar primarily strengthened against EMEA and APAC foreign currencies as compared to fiscal 2022, which decreased revenue in U.S. Dollar equivalents by approximately $371 million. During fiscal 2023, the foreign currency impacts to revenue were offset in part by net hedging gains from our cash flow hedging program of $41 million.
See Note 2 of our Notes to Consolidated Financial Statements for additional details of revenue by geography.
Cost of Revenue
(dollars in millions) 2023 2022 2021 % Change
2023-2022
Subscription $ 1,822 $ 1,646 $ 1,374 11 %
Percentage of total revenue 9 % 9 % 9 %
Product 29 35 41 (17) %
Percentage of total revenue * * *
Services and other 503 484 450 4 %
Percentage of total revenue 3 % 3 % 3 %
Total cost of revenue $ 2,354 $ 2,165 $ 1,865 9 %
_________________________________________
(*) Percentage is less than 1%.
Subscription
Cost of subscription revenue consists of third-party hosting services and data center costs, including expenses related to operating our network infrastructure. Cost of subscription revenue also includes compensation costs associated with network operations, implementation, account management and technical support personnel, royalty fees, software costs and amortization of certain intangible assets.
Cost of subscription revenue increased due to the following:
Components of
% Change
2023-2022
Hosting services and data center costs 7 %
Loss contingency
3
Royalty costs 2
Amortization of intangibles (1)
Total change 11 %
Cost of subscription revenue during fiscal 2023 included a loss contingency associated with an IP litigation matter.
Product
Cost of product revenue is primarily comprised of third-party royalties, localization costs and costs associated with the manufacturing of our products.
Services and Other
Cost of services and other revenue is primarily comprised of compensation and contracted costs incurred to provide consulting services, training and product support, and hosting services and data center costs.
Cost of services and other revenue increased during fiscal 2023 as compared to fiscal 2022 primarily due to increases in compensation costs partially offset by decreases in professional and consulting fees.
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Operating Expenses
(dollars in millions)
2023 2022 2021 % Change
2023-2022
Research and development $ 3,473 $ 2,987 $ 2,540 16 %
Percentage of total revenue 18 % 17 % 16 %
Sales and marketing 5,351 4,968 4,321 8 %
Percentage of total revenue 28 % 28 % 27 %
General and administrative 1,413 1,219 1,085 16 %
Percentage of total revenue 7 % 7 % 7 %
Amortization of intangibles 168 169 172 (1) %
Percentage of total revenue 1 % 1 % 1 %
Total operating expenses $ 10,405 $ 9,343 $ 8,118 11 %
Research and Development
Research and development expenses consist primarily of compensation and contracted costs associated with software development, third-party hosting services and data center costs, related facilities costs and expenses associated with computer equipment and software used in development activities.
Research and development expenses increased due to the following:
Components of
% Change
2023-2022
Incentive compensation, cash and stock-based 6 %
Base compensation and related benefits 6
Hosting services and data center costs
2
Various individually insignificant items 2
Total change 16 %
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, apps and tools.
Sales and Marketing
Sales and marketing expenses consist primarily of compensation costs, amortization of contract acquisition 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 and events, public relations and other market development programs.
Sales and marketing expenses increased due to the following:
Components of
% Change
2023-2022
Base compensation and related benefits 3 %
Incentive compensation, cash and stock-based 3
Various individually insignificant items 2
Total change 8 %
General and Administrative
General and administrative expenses consist primarily of compensation and contracted costs, 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.
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General and administrative expenses increased due to the following:
Components of
% Change
2023-2022
Professional and consulting fees 9 %
Base compensation and related benefits 5
Incentive compensation, cash and stock-based 3
Various individually insignificant items (1)
Total change 16 %
Professional and consulting fees increased from fiscal 2023 as compared to fiscal 2022 primarily due to transaction costs associated with our intended acquisition of Figma.
Non-Operating Income (Expense), Net
(dollars in millions)
2023 2022 2021 % Change
2023-2022
Interest expense $ (113) $ (112) $ (113) 1 %
Percentage of total revenue (1) % (1) % (1) %
Investment gains (losses), net 16 (19) 16 **
Percentage of total revenue * * *
Other income (expense), net 246 41 — **
Percentage of total revenue 1 % * *
Total non-operating income (expense), net $ 149 $ (90) $ (97) **
_________________________________________
(*) Percentage is less than 1%.
(**) Percentage is not meaningful.
Interest Expense
Interest expense represents interest associated with our debt instruments. Interest on our senior notes is payable semi-annually, in arrears, on February 1 and August 1.
Investment Gains (Losses), Net
Investment gains (losses), net consists principally of unrealized holding gains and losses associated with our deferred compensation plan assets.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest earned on cash, cash equivalents and short-term fixed income investments. Other income (expense), net also includes realized gains and losses on fixed income investments and foreign exchange gains and losses.
Other income (expense), increased during fiscal 2023 as compared to fiscal 2022 primarily due to increases in interest income driven by higher average interest rates and cash equivalent balances.
Provision for Income Taxes
(dollars in millions)
2023 2022 2021 % Change
2023-2022
Provision for income taxes
$ 1,371 $ 1,252 $ 883 10 %
Percentage of total revenue 7 % 7 % 6 %
Effective tax rate 20 % 21 % 15 %
Our effective tax rate decreased by approximately one percentage point during fiscal 2023 as compared to fiscal 2022, primarily due to an increase in the net tax benefit from effects of non-U.S. operations in fiscal 2023.
Our effective tax rate for fiscal 2023 was lower than the U.S. federal statutory tax rate of 21% primarily due to the tax benefits from the U.S. federal research tax credit and non-U.S. operations, partially offset by state taxes.
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We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized based on evaluation of all available positive and negative evidence. On the basis of this evaluation, we continue to maintain a valuation allowance to reduce our deferred tax assets to the amount realizable. The total valuation allowance was $405 million as of December 1, 2023, primarily related to certain state credits.
We are a U.S.-based multinational company subject to tax in multiple domestic and foreign tax jurisdictions. The current U.S. tax law subjects the earnings of certain foreign subsidiaries to U.S. tax and generally allows an exemption from taxation for distributions from foreign subsidiaries.
In the current global tax policy environment, the domestic and foreign governing bodies continue to consider, and in some cases introduce, changes in regulations applicable to corporate multinationals such as Adobe. As regulations are issued, we account for finalized regulations in the period of enactment.
Beginning in 2023, under the provisions introduced by the U.S. Tax Act, we are required to capitalize and amortize research and development costs. If the rule is not modified, there will continue to be an adverse impact on our effective rates for income taxes paid, which is partially offset by a benefit to our effective tax rates from the increase in the foreign-derived intangible income deduction.
See Note 10 of our Notes to Consolidated Financial Statements for further information regarding our provision for income taxes.
Accounting for Uncertainty in Income Taxes
The gross liabilities for unrecognized tax benefits excluding interest and penalties were $501 million, $321 million and $289 million at the end of fiscal 2023, 2022 and 2021, respectively. If the total unrecognized tax benefits as of December 1, 2023, December 2, 2022 and December 3, 2021 were recognized, $356 million, $203 million and $199 million would decrease the respective effective tax rates.
As of December 1, 2023 and December 2, 2022, the combined amounts of accrued interest and penalties included in long-term income taxes payable related to tax positions taken on our tax returns were not material.
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. Although the timing of resolution, settlement and closing of audits is not certain, it is reasonably possible that the underlying unrecognized tax benefits may decrease by up to $60 million over the next 12 months.
Our future effective tax rates may be materially affected by changes in the tax rates in jurisdictions where our income is earned, changes in jurisdictions in which our profits are determined to be earned and taxed, changes in the valuation of our deferred tax assets and liabilities, changes in or interpretation of tax rules and regulations in the jurisdictions in which we do business, or unexpected changes in business and market conditions that could reduce certain tax benefits.
In addition, tax laws in the United States as well as other countries and jurisdictions in which we conduct business are subject to change as new laws are passed and/or new interpretations are made available. These countries, governmental bodies, such as the European Commission of the European Union, and intergovernmental economic organizations, such as the Organization for Economic Cooperation and Development, have made or could make unprecedented assertions about how taxation is determined and, in some cases, have proposed or enacted new laws that are contrary to the way in which rules and regulations have historically been interpreted and applied. Changes in our operating landscape, such as changes in laws and/or interpretations of tax rules, could adversely affect our effective tax rates and/or cause us to respond by making changes to our business structure which could adversely affect our operations and financial results.
Moreover, we are subject to the examination of our income tax returns by domestic and foreign tax authorities. 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 these examinations. Our policy is to record interest and penalties related to unrecognized tax benefits in income tax expense. While we believe our tax estimates are reasonable, we cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our financial position and results of operations.
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LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Our primary source of cash is receipts from revenue. Our primary uses of cash are general business expenses including payroll, income taxes, marketing and third-party hosting services, as well as our stock repurchase program as described below. Other customary sources of cash include proceeds from the maturities and sales of short-term investments. Other customary uses of cash include business acquisitions, repayment of maturing senior notes, purchases of property and equipment and payments for taxes related to net share settlement of equity awards.
This data should be read in conjunction with our Consolidated Statements of Cash Flows.
As of
(in millions) December 1, 2023 December 2, 2022
Cash and cash equivalents $ 7,141 $ 4,236
Short-term investments $ 701 $ 1,860
Working capital $ 2,833 $ 868
Stockholders’ equity $ 16,518 $ 14,051
A summary of our cash flows for fiscal 2023, 2022 and 2021 is as follows:
(in millions) 2023 2022 2021
Net cash provided by operating activities $ 7,302 $ 7,838 $ 7,230
Net cash provided by (used for) investing activities
776 (570) (3,537)
Net cash used for financing activities (5,182) (6,825) (4,301)
Effect of foreign currency exchange rates on cash and cash equivalents 9 (51) (26)
Net change in cash and cash equivalents $ 2,905 $ 392 $ (634)
Cash Flows from Operating Activities
For fiscal 2023, net cash provided by operating activities of $7.30 billion was primarily comprised of net income adjusted for the net effect of non-cash items. Beginning in 2023, under the provisions introduced by the U.S. Tax Act, we are required to capitalize and amortize research and development costs. This had an adverse impact on our effective rate for income taxes paid and, consequently, on our cash flows from operations. In addition, the primary working capital uses of cash were increases in prepaid expenses attributable to the timing of billings. These impacts were partially offset by working capital sources of cash driven by increases in deferred revenue from our Digital Media and Digital Experience offerings.
Cash Flows from Investing Activities
For fiscal 2023, net cash provided by investing activities of $776 million was primarily due to maturities and sales of short-term investments partially offset by ongoing capital expenditures.
Cash Flows from Financing Activities
For fiscal 2023, net cash used for financing activities of $5.18 billion was primarily due to payments for our common stock repurchases, taxes paid related to the net share settlement of equity awards and the repayment of our 2023 Notes. These uses of cash were offset in part by proceeds from re-issuance of treasury stock mainly for our employee stock purchase plan. See the section titled “Stock Repurchase Program” below.
Liquidity and Capital Resources Considerations
Our existing cash, cash equivalents and investment balances may fluctuate during fiscal 2024 due to changes in our planned cash outlay.
Cash from operations could also be affected by various risks and uncertainties, including, but not limited to, risks detailed in the section titled “Risk Factors” in Part I, Item 1A of this report. 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, operating resource expenditure and capital expenditure requirements for the next twelve months and for the foreseeable future.
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Our cash equivalent and short-term investment portfolio as of December 1, 2023 consisted of asset-backed securities, corporate debt securities, money market funds, time deposits, U.S. agency securities and U.S. Treasury securities. We use professional investment management firms to manage a large portion of our invested cash.
We expect to continue our investing activities, including short-term and long-term investments, purchases of computer and server hardware to operate our network infrastructure, sales and marketing, product support and administrative staff, and facilities expansion. 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.
On September 15, 2022, we entered into a definitive merger agreement under which we intended to acquire Figma, Inc. (“Figma”) for approximately $20 billion, comprised of approximately half cash and half stock. On December 17, 2023, we entered into a mutual termination agreement with Figma to terminate the proposed merger. In accordance with the terms of the termination agreement, on December 20, 2023, we paid Figma a termination fee of $1 billion using cash on hand.
Term Loan Credit Agreement
In January 2023, we entered into a delayed draw credit agreement, providing for a senior unsecured term loan (the “Term Loan”) of up to $3.5 billion for the purpose of partially funding the purchase price and related fees for our acquisition of Figma. As of December 1, 2023, there were no outstanding borrowings under the Term Loan. Subsequent to December 1, 2023, following execution of the mutual termination agreement with Figma discussed above, the delayed draw term loan agreement was terminated.
Revolving Credit Agreement
We have a $1.5 billion senior unsecured revolving credit agreement (the “Revolving Credit Agreement”) with a syndicate of lenders, providing for loans to us and certain of our subsidiaries through June 30, 2027. Subject to the agreement of lenders, we may obtain up to an additional $500 million in commitments, for a maximum aggregate commitment of $2 billion. As of December 1, 2023, there were no outstanding borrowings under the Revolving Credit Agreement and the entire $1.5 billion credit line remains available for borrowing. Under the terms of our 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.
Commercial Paper Program
In September 2023, we established a commercial paper program under which we may issue unsecured commercial paper up to a total of $3 billion outstanding at any time, with maturities of up to 397 days from the date of issue. The net proceeds from the issuance of commercial paper are expected to be used for general corporate purposes, which may include working capital, capital expenditures, acquisitions, stock repurchases, refinancing indebtedness or any other general corporate purposes. As of December 1, 2023, there were no outstanding borrowings under the commercial paper program.
Senior Notes
We have $3.65 billion senior notes outstanding, which rank equally with our other unsecured and unsubordinated indebtedness. As of December 1, 2023, the carrying value of our senior notes was $3.63 billion and our maximum commitment for interest payments was $321 million for the remaining duration of our outstanding senior notes. Interest is payable semi-annually, in arrears on February 1 and August 1. Our senior notes do not contain any financial covenants. See Note 17 of our Notes to Consolidated Financial Statements for further details regarding our debt.
Contractual Obligations
Our purchase obligations consist of agreements to purchase goods and services entered into in the ordinary course of business. As of December 1, 2023, the value of our non-cancellable unconditional purchase obligations was $4.93 billion, primarily relating to contracts with vendors for third-party hosting and data center services. Subsequent to December 1, 2023, we executed agreements associated with certain of our long-term supplier commitments that increased our minimum purchase obligations by $2.3 billion through December 2028. See Note 16 of our Notes to Consolidated Financial Statements for additional information regarding our purchase obligations.
We lease certain facilities and data centers under non-cancellable operating lease arrangements that expire at various dates through 2032. As of December 1, 2023, the value of our obligations under operating leases was $484 million. S ee Note 18 of our Notes to Consolidated Financial Statements for additional information regarding our lease obligations.
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Other
Beginning in 2023, under the provisions introduced by the U.S. Tax Act, we are required to capitalize and amortize research and development costs. If the rule is not modified, there will continue to be an adverse impact to our effective rates for income taxes paid, which is partially offset by a benefit from the increase in the foreign-derived intangible income deduction.
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 our shares in the open market or enter into structured repurchase agreements with third parties. In December 2020, our Board of Directors granted authority to repurchase up to $15 billion in our common stock through the end of fiscal 2024.
During fiscal 2023, we repurchased a total of 11.5 million shares, including approximately 7.5 million shares at an average price of $429.65 through structured repurchase agreements, as well as 4.0 million shares at an average purchase price of $348.46 through an accelerated share repurchase agreement.
During the fourth quarter of fiscal 2023, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $1 billion. As of December 1, 2023, $354 million of prepayment remained under our outstanding structured stock repurchase agreement.
Subsequent to December 1, 2023, as part of the December 2020 stock repurchase authority, we entered into an accelerated share repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $2 billion and received an initial delivery of 2.5 million shares, which represents approximately 75% of our prepayment. Upon completion of the $2 billion accelerated share repurchase agreement, $150 million remains under our December 2020 authority.
See section titled “ Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ” in Part II, Item 5 of this report for stock repurchases during the quarter ended December 1, 2023 and Note 14 of our Notes to Consolidated Financial Statements for further details regarding our stock repurchase program.
Indemnifications
In the ordinary 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 under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’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 reduces our exposure and enables us to recover a portion of any future amounts paid.
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