Adobe Inc (ADBE) — Q4 2018 Earnings Call Transcript

Good afternoon, and thank you for joining us today. Joining me on the call are Adobe's President and CEO, Shantanu Narayen; and John Murphy, Executive Vice President and CFO. In our call today, we will discuss Adobe's fourth quarter and fiscal year 2018 financial results. By now you should have a copy of our earnings press release, which crossed the wire approximately 1 hour ago. We've also posted PDFs of our earnings call prepared remarks and slides and an updated investor datasheet on adobe.com. If you'd like a copy of these documents, you can go to Adobe's Investor Relations page and find them listed under Quick Links. Before we get started, we want to emphasize that some of the information discussed in this call, particularly our revenue and operating model targets, and our forward-looking product plans, is based on information as of today, December 13, 2018, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued today as well as Adobe's SEC filings. During this call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings release and in our updated investor datasheet on Adobe's Investor Relations website. Call participants are advised that the audio of this conference call is being webcast live in Adobe Connect and is also being recorded for playback purposes. An archive of the webcast will be made available on Adobe's Investor Relations website for approximately 45 days and is the property of Adobe. The call audio and the webcast archive may not be re-recorded or otherwise reproduced or distributed without prior written permission from Adobe. I will now turn the call over to Shantanu.

Thanks, Mike, and good afternoon. Fiscal 2018 was an outstanding year for Adobe, and I'm thrilled with what we've accomplished. Our vision to empower people to create and transform how businesses compete has never been more relevant, and we welcomed millions of new customers to Adobe. From students to creative professionals to government agencies in the world's most successful brands, customers everywhere are turning to Adobe to tell their story, drive their digital businesses and change the world. This year, we delivered significant innovation across Creative Cloud, Document Cloud and Experience Cloud. We made strategic acquisitions, which have expanded our offerings in addressable markets, and we forged key partnerships that bring us increased scale. These actions have resulted in record revenue and impressive growth across all our businesses. As we enter 2019, Adobe is well positioned to build on this momentum, delight our customers and continue to deliver impressive long-term top and bottom line growth. Total Adobe revenue was $9.03 billion in FY '18, which represents 24% annual growth. GAAP earnings per share in FY '18 was $5.20, and non-GAAP earnings per share was $6.76. Total Digital Media annualized recurring revenue or ARR exiting the year grew to $6.83 billion. FY '18 Creative revenue was $5.34 billion, which represents 28% year-over-year growth. We achieved annual revenue of $982 million for Document Cloud. And in our Digital Experience business, Experience Cloud revenue for the full year was $2.44 billion, representing 20% year-over-year growth. We closed the year with another record quarter, delivering Q4 revenue of $2.46 billion, representing 23% year-over-year growth. GAAP earnings per share for the quarter was $1.37, and non-GAAP earnings per share was $1.83. These results include the acquisition of Marketo and the associated financial impacts that come with a large transaction. Excluding Marketo, we met or exceeded all of our Q4 and annual targets. Adobe believes everyone has a story to tell. Tens of millions of people around the world tell their story with Creative Cloud, whether it's in a high school magazine, a mobile app, a documentary at Sundance or an enterprise website. We achieved record Creative revenue of $1.45 billion in Q4 with 26% year-over-year growth. In Q4, our Creative business was fueled by strong performance across all segments, particularly among consumers. Black Friday and Cyber Monday were two of the largest single selling days in company history. We focused on expanding the value of Creative Cloud for existing customers while extending its capabilities to meet the needs of broad new segments of users. In October, we held our annual MAX Creativity Conference. MAX has become a movement with reach and impact well beyond the physical event. This year, hundreds of thousands of Creative customers tuned in online to watch MAX and millions more continue to view MAX content. Product announcements at MAX included major updates to our flagship Creative tools, including Photoshop, Lightroom, Illustrator, InDesign and Premiere Pro; the introduction of Premiere Rush, the first all-in-one, easy-to-use video editing app for social media creators, simplifying video creation and sharing on leading platforms such as YouTube and Instagram. Online video is one of the fastest growing Creative segments, and Rush is a cornerstone of our strategy to unlock this opportunity for millions of new customers. Exciting new innovations, powered by Adobe Sensei inside of Adobe XD, include new technology for prototyping experiences and applications for voice-enabled devices such as Amazon Echo; and new apps including Photoshop on the iPad, which will bring the power and precision of Photoshop to a touch device; and Project Gemini, a new drawing and painting application that brings unprecedented watercolor and oil painting capabilities to the digital canvas. In our Document Cloud business, we're revolutionizing how people scan, edit, collaborate, sign and share Adobe PDFs, whether they're consumers, small businesses or large enterprises. Document Cloud revenue in Q4 was $259 million, and we grew Document Cloud ARR to more than $800 million. We continue to accelerate our pace of innovation with Document Cloud, investing to modernize the PDF experience on every device and surface and building on the document intelligence available from the billions of PDFs in market to power AI-driven experiences. We recently shipped an all-new Acrobat DC with connected mobile apps like Adobe Scan and Acrobat Reader Mobile to create, share and collaborate with PDFs across smartphones and tablets. Adobe Sign, our e-signature solution, continues to gain momentum across businesses through new integrations and partnerships, including Dropbox, Microsoft Dynamics and ServiceNow. Digital transformation continues to be the mandate for CEOs across the globe. To compete and win today, both B2C and B2B businesses must provide a world-class, end-to-end customer experience across every touch point. With Experience Cloud, Adobe is reimagining customer experience management and delivering the industry's only end-to-end solution for marketing, advertising, analytics and commerce purpose built for the modern enterprise. In our Digital Experience business, we achieved Experience Cloud revenue of $690 million for the quarter, which represents 25% year-over-year growth. Key Experience Cloud customer wins in the quarter include Unilever, The Home Depot, Telegraph Media Group, Geico, Heathrow Airport and the U.S. Department of Veterans Affairs. Delivering exceptional customer experiences demands deep customer insights and a platform built for action. We continue to invest in building the industry's first open platform for customer experience management, the Adobe Experience Platform. The Adobe Experience Platform will deliver true, unified view of the customer for both CMOs and CIOs. In partnership with Microsoft and SAP, the recently announced Open Data Initiative is aimed at eliminating the data silos that exist across enterprises. It will enable enterprises to harness and take action on massive volumes of customer data to deliver personalized, real-time customer experiences. We're excited to have early support for ODI from leading brands, including Coca-Cola and Walmart. Adobe's retail reports, powered by Adobe Analytics data, have become the industry bellwether for holiday shopping forecasts and other digital media, commerce and cultural trends. Adobe analyzed over 1 trillion visits and 55 million product SKUs across U.S. retail sites this holiday season. Data showed that online sales reached $7.9 billion on Cyber Monday, making it the largest online shopping day of all time in the U.S. In October, we completed our acquisition of Marketo, the leader in B2B marketing engagement, and we're off to a great start. Marketo strengthens our offering to customers, combining Experience Cloud's analytics, personalization, commerce and content capabilities with Marketo's B2B marketing engagement platform, helping customers automate and orchestrate mission-critical marketing campaigns and activities from lead management and customer engagement to account-based marketing and revenue attribution. The addition of Marketo, along with our recently integrated commerce capabilities via our acquisition of Magento, widens Adobe's lead in customer management across both B2B and B2C in all industries. We're well positioned to continue capitalizing on this growing opportunity that we estimate to have a total addressable market of more than $71 billion by 2021. Adding Marketo to our Digital Experience business immediately accelerates overall revenue growth for Adobe, and other financial benefits will ramp during FY '19 as the accounting impact from the transaction dissipates. Adobe is the clear leader in the markets we serve: creativity, digital documents and customer experience management. Our solutions have become indispensable to millions of customers, whether they are in the design department or the IT department, the classroom or the boardroom. At Adobe, it is our 20,000 global employees that form the heart and soul of our business. In October, we achieved global gender pay parity, a critical milestone in Adobe's commitment to providing employees with a workplace that is diverse and inclusive. Last week, we were named one of Fortune's Top 100 Best Workplaces for Diversity. Adobe was once again ranked on the Dow Jones Sustainability Index, a key barometer tracking sustainability-driven companies. In 2018, we made significant investments across our product portfolio, entered new markets and made strategic acquisitions, which we believe will fuel continued top and bottom line performance. We expect 2019 to be another year of strong product innovation and financial results.

Thanks, Shantanu. We're pleased with our Q4 and full year FY '18 results. We're excited about our acquisition of Marketo, which closed on October 31, and as part of my prepared remarks, I will review our consolidated Q4 and FY '18 results and outline Marketo's impact in comparison to our targets previously provided, which excluded Marketo. In FY '18, Adobe achieved record annual revenue of $9.03 billion, which represents 24% year-over-year growth. GAAP EPS for the year was $5.20, and non-GAAP EPS was $6.76. Noteworthy achievements during the year include: Creative revenue of $5.34 billion, which represents 28% year-over-year growth; Adobe Document Cloud revenue of $982 million, which represents 17% year-over-year growth; adding a record $1.45 billion of net new Digital Media ARR during the year, and exiting FY '18 with $6.83 billion of Digital Media ARR; Adobe Experience Cloud revenue of $2.44 billion, which represents 20% year-over-year growth; generating more than $4 billion in operating cash flow during the year; returning $2 billion in cash to stockholders through our stock repurchase program; and growing deferred revenue to approximately $3 billion, and increasing our unbilled backlog to approximately $5 billion exiting the year. Together, this represents approximately $8 billion of contracted revenue. Total annual revenue growth, excluding Magento and Marketo, was approximately 22%, well ahead of the revenue target we provided entering the year. In the fourth quarter of FY '18, Adobe achieved record revenue of $2.46 billion, which represents 23% year-over-year growth. GAAP diluted earnings per share in Q4 was $1.37, and non-GAAP diluted earnings per share was $1.83. Excluding the impact of the Marketo acquisition in Q4, we estimate GAAP EPS would have been $1.48 and non-GAAP diluted EPS would have been $1.90, both of which would have exceeded the earnings targets we provided in September. Business and financial highlights in Q4 included: Digital Media revenue of $1.71 billion, including Creative revenue of $1.45 billion and Adobe Document Cloud revenue of $259 million; record net new Digital Media ARR of $430 million; Digital Experience revenue of $690 million, which represents 25% year-over-year growth; deferred revenue growth of 22% year-over-year; record cash flow from operations of $1.1 billion; returning $397 million of cash to our stockholders through stock buyback; and approximately 90% of our revenue in Q4 was from recurring sources. In Digital Media, we grew segment revenue by 23% year-over-year. The addition of $430 million net new Digital Media ARR during the quarter grew the total to $6.83 billion exiting Q4. Within Digital Media, we achieved another strong quarter with our Creative business. Creative revenue grew 26% year-over-year in Q4, and we increased Creative ARR by a record $373 million. Key growth drivers included: strong net new subscriptions across user segments and geographies, driven by robust traffic and customer acquisition on adobe.com and helped by typical year-end benefits, including enterprise seasonality, post-MAX traffic and holiday campaigns, which drove strong consumer adoption; education market success driven by our year-long effort to increase our focus on Creative Cloud use by students and schools; continued momentum with Creative Cloud in emerging markets; services adoption, including continued strength with Adobe Stock revenue, which grew by more than 25% during the year; and pricing optimizations in North America. As we outlined at our financial analyst meeting in October, we're focused on numerous initiatives to continue to fuel Creative Cloud growth in the coming years. We achieved record Document Cloud revenue of $259 million in Q4, which represents 10% year-over-year growth, and we added $57 million of net new Document Cloud ARR during the quarter. As we discussed previously, in Q4 FY '17, we achieved a significant amount of perpetual Acrobat revenue through the channel, which impacts year-over-year comparisons. Acrobat unit growth across Creative Cloud and Document Cloud was greater than 30% during the year, and Adobe Sign revenue grew by more than 25% during FY '18. With strong Acrobat subscription and Document Cloud services adoption, we exited FY '18 with more than $800 million of Document Cloud ARR and solid momentum. In our Digital Experience segment, we achieved record quarterly Experience Cloud revenue of $690 million. Magento exceeded the $30 million target we shared previously for Q4, and Marketo added $21 million during the quarter. Digital Experience year-over-year segment growth was 25% in Q4 inclusive of Marketo and 22% excluding Marketo, ahead of our Q4 target of approximately 20%. For the year, Digital Experience year-over-year segment growth was 20% inclusive of Magento and Marketo. We finished the year with strong subscription bookings in line with our target. In Q4, Experience Cloud subscription revenue grew 30% year-over-year; and for the year, we achieved 26% year-over-year Experience Cloud subscription revenue growth, both including Magento and Marketo. Experience Cloud performance in Q4 was driven by success across our offerings with particular strength in Analytics, AEM Assets and Magento Commerce. Our go-to-market relationship with Microsoft resulted in strong bookings in Q4 and during the year. From a quarter-over-quarter currency perspective, FX decreased revenue by $9.5 million. We had $30.5 million in hedge gains in Q4 FY '18 versus $16.8 million in hedge gains in Q3 FY '18. Thus, the net sequential currency increase to revenue considering hedging gains was $4.2 million. From a year-over-year currency perspective, FX increased revenue by $7.9 million. We had $30.5 million in hedge gains in Q4 FY '18 versus $1 million in hedge gains in Q4 FY '17. Thus, the net year-over-year currency increase to revenue considering hedging gains was $37.4 million. In Q4, Adobe's effective tax rate was 3% on both a GAAP and a non-GAAP basis. Both rates were lower than targeted due to a more favorable-than-expected geographic mix of earnings as well as the favorable resolutions of certain income tax matters. Our trade DSO was 49 days, which compares to 55 days in the year-ago quarter and 41 days last quarter. Deferred revenue grew to a record $3.05 billion, up 22% year-over-year. Our ending cash and short-term investment position exiting Q4 was $3.23 billion, and cash flow from operations was $1.1 billion in the quarter. The quarter-over-quarter decline in our cash position was due to the funding of the Marketo acquisition. In Q4, we repurchased approximately 1.6 million shares at a cost of $397 million. During FY '18, we repurchased 8.7 million shares at a cost of $2 billion. We currently have $7.85 billion remaining of our new $8 billion repurchase authority granted in May, which goes through 2021. Now I will discuss our financial targets for the coming year. Entering FY '19, we are excited about our business momentum, our market leadership position and the large addressable markets we presented at our recent financial analyst meeting in October. The strategic acquisitions we made in FY '18 increased FY '19 revenue growth targets with some added complexity in describing our financial outlook. I'll explain some of the details as I walk you through our targets. As we've stated previously, we will report our FY '19 results based on the new ASC 606 accounting standards beginning in March with our Q1 results. The targets we are providing today are based on ASC 605 as we are still in the process of integrating Marketo into our financial systems to report results utilizing 606. We continue to believe that moving to 606 in FY '19 reporting will not materially impact our revenue. However, we now expect there will be a slight improvement to earnings through the year as we benefit from the capitalization of sales commissions. We measure ARR in constant currency during a fiscal year, and if necessary, we revalue ARR at year-end for current currency rates. Adverse FX rate changes between December of last year and this year have resulted in a $123 million adjustment and lowers our beginning FY '19 Digital Media ARR balance to $6.71 billion. This expected revision is reflected in our updated investor datasheet and our FY '19 net new growth target, and our quarterly results will be measured against this revalued amount during FY '19. In FY '19, we are targeting total Adobe revenue of approximately $11,150,000,000; Digital Media segment revenue growth of approximately 20%; net new Digital Media ARR of approximately $1.45 billion, an increase above our preliminary target provided in October; Digital Experience segment revenue growth of approximately 34%; Digital Experience subscription bookings growth of approximately 25%; a GAAP tax rate of approximately 10% and a non-GAAP tax rate of approximately 11%; GAAP earnings per share of approximately $5.54; and non-GAAP earnings per share of approximately $7.75. Certain factors are reflected in our FY '19 annual targets specifically: approximately $35 million of adverse revenue impact due to current FX rates, which have moved against us since we provided preliminary FY '19 targets that were based on September spot rates; approximately $75 million reduction in revenue from the write-down of deferred revenue for Magento and Marketo due to purchase accounting; and the increase in tax rates between FY '18 and FY '19. In Q1 FY '19, we are targeting revenue of approximately $2,540,000,000; Digital Media segment year-over-year growth of approximately 20%; net new Digital Media ARR of approximately $330 million; Digital Experience segment year-over-year revenue growth of approximately 31%; other expense of approximately $39 million; tax rate of approximately 3% on a GAAP basis and 11% on a non-GAAP basis; share count of approximately 495 million shares; GAAP earnings per share of approximately $1.14; and non-GAAP earnings per share of approximately $1.60. For modeling purposes, after Q1, we expect total revenue in each quarter to grow by approximately the same year-over-year growth percentage implied in our targeted revenue growth rate for the year. In addition, after Q1, we expect net new Digital Media ARR in each quarter to be sequentially similar as that achieved in past fiscal years from quarter-to-quarter with typical summer seasonality, which can lead to sequentially lower net new ARR in Q3 as well as normal year-end sequential strength in Q4 net new ARR. As the impact of lost deferred revenue due to purchase accounting tapers off during FY '19 and as we grow our business, we expect quarterly operating margins to increase sequentially. We also expect quarterly year-over-year earnings growth rates to increase during the year. In summary, FY '18 was another record year for Adobe as demonstrated by our strong revenue and earnings growth and exceptional cash flow from operations. More importantly, during the year, we've invested in the business to continue our momentum over the long term. Our growth targets for the coming year reflect our confidence in our ability to execute, and we expect to exit FY '19 with a business that continues to exhibit strong top line growth, expanding profit margins and earnings growth rates that equal or exceed top line growth rates.

Thanks, John. Adobe Summit returns to Las Vegas in March. Day 1 of our Digital Experience conference is Tuesday, March 26. Invitations with registration information to Summit will be sent out in January. More details about Summit are available at summit.adobe.com. If you wish to listen to a playback of today's conference call, a web-based archive of the call will be available on our IR site later today. Alternatively, you can listen to a phone replay by calling 855-859-2056. Use conference ID #8459218. International callers should dial 404-537-3406. The phone playback service will be available beginning at 5:00 p.m. Pacific Time today and ending at 9:00 p.m. Pacific Time on December 19, 2018. We would now be happy to take your questions.

I'm wondering, for Shantanu, on the Creative side, as we look to next year, fiscal '19, and ARR that you're talking about, can you help us understand how some of the drivers that you saw this year may evolve into 2019? Which of the drivers do you expect to continue? Which do you expect to strengthen? And any that you expect to wane in terms of driving that $1.45 billion ARR?

Sure, Walter. I mean, first, as it relates to FY '18, we're certainly thrilled with the performance; and when you think about both Q4 and FY '18, we actually saw strength in ARR across all offerings as well as all geographies. Q4 was characterized, I would say, with the typical seasonal enterprise strength that we see at the end of Q4. We saw a bunch of consumer strength as we also said in our prepared remarks. But whether it was the Individual offering, the team offering or the enterprise offering, they just continue to show quite a bit of momentum. And we expect that momentum, frankly, to continue into FY '19. So I think from the Individual products, when you think about what's happening with the photography bundle, what's happening with Acrobat, what's happening with the video products, clearly, we've identified that we're working on some new categories like XD and what we showed with augmented reality and virtual reality, continued offering of services, which is adding to this. But as you remember, even during MAX, we announced numerous set of initiatives that we expect we'll all continue to drive, emerging markets, continued adoption of our services. So we're just really pleased. And I think it's important to remember, even when you look at the $1.45 billion target for next year, that FX did go adversely against us. And so when we think about both new units as well as renewal of units that happens next year, if they are internationally, that's actually going to be adverse relative to FY '18, so clearly, I think, indicating that the momentum that we saw in '18 will continue.

Shantanu, just to maybe think a little higher level, can you just talk about how the Digital Experience sales force might change this year now that it has just a lot more to sell and potentially different types of customers to sell into with both B2C and B2B? How do you think about the sales force can sort of go to market in 2019 with the addition of Magento and Marketo?

Saket, what we have done is, even in fiscal '18 as we have segmented the market and we think very strategically about what's happening in what we call the strategic accounts versus the corporate accounts versus the territory accounts, we've got a go-to-market that's optimized around what's the best way to generate pipeline, what's the best way to have what we would call named account salespeople versus the specialists. And the more comprehensive the offering, the more it actually strengthens our ability to drive pipeline and then convert existing customers. FY '18 was characterized, I think, by a return to momentum that we saw in subscription bookings. We have certainly seen good adoption, as we mentioned, of our Analytics and AEM products as well as Magento. And so what I'm excited about in FY '19 is when you think about what we had with Adobe Campaign and the B2C high-volume email and cross-channel campaign capability, when you think about what Marketo bought in B2B with a lead management and account-based marketing capability, we now have really a far more comprehensive offering for the enterprise to manage and personalize their end-to-end customer journeys across all channels. So we've already demonstrated integration. Magento is being integrated with AEM. So it just feels like there's more demand for our products. There's more refinement of our go-to-market; and there's a strengthening, frankly, of the offering, which should help.

Congrats on a strong finish to a great year. Shantanu, at MAX, you spoke a bit about Adobe's data-driven operating model, but I think it would be helpful if you could spend a moment reminding us why this is a competitive advantage and how it contributes to the visibility and predictability that you have in your business.

Sure, Brad, and thanks for the comments. I mean, going back to the data-driven operating model, I mean it's a vocabulary that's so prevalent now within Adobe; and when we talk about discover, try, buy, use and renew, I think it just enables us to have tremendous focus across each part of it. I think most companies start off with really good awareness at the top of the funnel, which is on the discovery phase, but what I think we have done is actually provided a really good mathematical underpinning to what we need to do across each of those. So I know you have and others in the past have asked us questions about how we think about promotions. We have incredible data about what is the right way to target those customers, how do they then convert into paying customers, in which countries do trials work, in which countries do trials not work. In terms of the buying, what are the right offers? How do you make recommendations? How do you convert people and upsell them into other offerings? And on the use, which is where I would say in FY '18 we spent the most time, clearly, as the base grows larger and larger and larger, it's in the utilization of the products and ensuring that they get value that the greatest upside exists for Adobe. And so the best example I could give you is once I was at a Wednesday meeting where the entire team was talking about what was happening in real-time and they were making decisions in real-time. So having this mathematical underpinning in a model and empowering people in real-time across every geography to make the right decisions based on data, I think that's really the power of this model. And I think you've seen that in our results.

This is Taylor Reiners on for Alex. I guess one of the interesting points we picked up from our conversations with partners is that it seems like AEM Forms has been picking up quite a bit. I was wondering if you could dig in a bit more on the momentum you've been seeing there. And then maybe any comments on what you've been seeing within the e-signature market?

Yes, I believe the ongoing shift from paper to digital continues to be a significant factor driving digital transformation. For most enterprises, the first step is to establish a website to engage with customers, followed by enabling digital business transactions, which is crucial. To facilitate this, we have developed solutions on both the Acrobat and AEM Forms sides to support everything from ad hoc workflows to structured ones using our products. We observe substantial usage of AEM Forms, particularly in government sectors, as governments cannot require citizens to purchase software to interact with them. This explains the underlying strength we see. AEM functions as a platform, and we've also seen growth in AEM Assets and content management. When considering documents, signing is just one of the many areas we focus on. The overall document opportunity is vast. Signing is a feature we've enabled, and our extensive client base provides us with significant reach. It's really about creating, sharing, and scanning documents. Our expertise in the PDF format, web content management, and features like signing gives us confidence that this will continue to propel our business forward.

I wanted to follow up on the positive performance from this quarter and the past year. Shantanu, I'm particularly interested in Magento, as it appears to be performing slightly better than expected. While it's still early, it seems that commerce is an area that attracts interest from nearly all enterprises. I'm curious about how Magento is enhancing your offerings, particularly for B2C clients, which has been an area where you previously relied on partnerships. Could you provide some insights on this?

Sure, Kirk. We are really excited about two key aspects of the Magento Commerce solution. First, for larger enterprises, we now have the capability to integrate content management and audience segmentation fully. At MagentoLive in Barcelona, we demonstrated how AEM can work with Magento Commerce, which is a significant milestone as many look toward next-generation commerce, especially with the increasing importance of mobile. This seamless integration allows our sales team to provide a comprehensive solution to our clients, which is a clear advantage. The second area of focus is that Magento has traditionally excelled in the mid-market and small to medium businesses. The addition of technology, content management, analytics, and personalization as a ready-to-use offering for these customers gives us a strategic edge. Furthermore, Marketo enhances our offerings for this customer segment. We are leveraging both these dimensions strategically. Supporting all this is our network of over 300,000 developers, which acts as a valuable channel for us. With Adobe's brand strength and distribution capabilities, we are positioned to take full advantage of this opportunity.

Thank you for the detail on Marketo and Magento impacts in Q4 and maybe rolling that to fiscal '19. I think there's a few breadcrumbs in there that would let us get to the revenue impact and the interest expense impacts associated with Marketo. But can you just talk a little bit about the expense line impacts from Marketo embedded in the guidance, both in terms of direct cost acquires with Marketo and also opportunities to invest in that business given that private equity's been controlling the purse strings for a while?

Well, first, Jennifer, I think there were more insights than just breadcrumbs, but we appreciate the mention regarding our transparency with that business. Let me take a step back, and then John can provide additional details. Looking at Q4 and fiscal year 2018, our financial results were clearly impressive. At MAX, as you know, we shared some preliminary targets for fiscal year 2019, including an annual recurring revenue of $1.4 billion and a 20% growth in Digital Media revenue. At that time, we also mentioned our expectation for a 20% increase in DX revenue and a 25% growth in subscription bookings. However, this did not factor in Marketo since the deal had not yet closed. We noted that our earnings would likely be affected by the inclusion of Marketo and the tax rate would also influence our earnings profile. Today, we aimed to update you on those aspects to reflect our ongoing momentum. From a currency perspective, the foreign exchange had a negative impact. However, since September, we have raised our annual recurring revenue target from $1.4 billion to $1.45 billion and maintained the 20% revenue growth target for Digital Media, despite the challenges posed by foreign exchange. Regarding Digital Experience, we have increased our revenue growth target to 34% year-over-year, showing our confidence in the continued momentum stemming from the addition of Marketo. The base is now much larger, and with that, we expect 25% growth in subscription bookings for this larger business segment. This expectation has already accounted for operating expenses related to Marketo and the entire DX business. We also wanted to illustrate that while we remain excited about the earnings potential, the accounting impact from purchase accounting, particularly around $75 million for Magento and Marketo in the first half of the year, will have an effect of about $0.15 on non-GAAP earnings. This is our perspective as we invest in growth, demonstrated by the anticipated 25% increase in total subscription bookings. We also attempted to reflect the accounting impacts on the business, which should begin to decrease around mid-year and into the third and fourth quarters. I hope this provides context on how we evolved from MAX. Operationally, Marketo is not dilutive, so we need to consider the accounting for deferred revenue and the financing implications, as well as the influence of tax rates.

On Digital Media ARR, you raised the guidance by 3.5% or $50 million going into '19. I guess, can you just outline your confidence to make that big a raise right out of the gate here?

Brent, again, I think it just reflects the momentum that we saw in Q4. I think we outlined a number of different initiatives that we just continue to drive. I mean, we're certainly going to see the benefits of pricing and how we continue to optimize that around the world. It's the new product introductions that are coming and just continued strength in Acrobat in emerging markets. We continue to do a good job combating piracy. We're seeing good strength at what we call named user deployment within the enterprises, I think continued strength in Sign and Stock and what that's doing to the particular business. So just across all of the various priorities that we outlined, we just continue to feel good about the opportunity and we have to continue to execute, Brent.

Shantanu, I would like to know your thoughts on the current situation regarding your natural intelligence and artificial intelligence from Sensei. You are among the few companies that have reported Q4 results and provided guidance for Q1. What is your perspective on emerging markets, particularly given some of the recent volatility? Meanwhile, the U.S. appears to remain strong. How do you view these uncertain economies and what are your expectations for how they will impact Adobe next year?

I mean, from our perspective, I think we're no economists. What we see is that both creativity as important initiative for everybody just continues to be really an area of emphasis and digital transformation and the digital tailwinds or headwinds that enterprises are seeing, depending on their perspective. So I think what gives us confidence is that it doesn't matter which country you're in. Digital has become an imperative for enterprises. And for individuals, the importance of creativity and design has never been more important. And so we will just continue to monitor it, we see strength across emerging markets as well. We've talked about that. I think the fact that we have a differential pricing scheme that allows us to target customers in those emerging markets might help. But overall, clearly, the exposure in that area for us is probably lower than some of the other companies that you are covering.

Shantanu, I would like to follow up on two significant statements Adobe made regarding its business, one at MAX and one at Summit. At MAX, the company mentioned that Creative Cloud is at a pivotal moment, moving from primarily a desktop focus to a more multi-service device market. At Summit, you highlighted your goal in Digital Experience to create what you refer to as the Experience System of Record. Regarding the first point, can you explain your perspective on the relationship between new Creative Cloud business and new hardware sales compared to the past with packaged software? For the second point, do you believe you have successfully established the Experience System of Record, or is that still an aspiration?

Well, Jay, our belief in multisurface usage comes from the simple idea that we want our products to be accessible wherever inspiration occurs. In response to your question, the capabilities of these new devices, whether tablets or mobile phones, are significantly more advanced than previous generations. Whenever there is a major leap in capability or the introduction of new interactions like voice or touch, it creates new opportunities for Adobe. We have led the way in this area with Lightroom, and we're pleased with its performance, especially as users want to manage their photos on any device. Another area where we have shown strong capabilities is with XD, where the number of product designers and stakeholders in the design workflow is much larger than just the designers themselves. These were the initial flagship products demonstrating our vision. At MAX, we announced not only the introduction of our flagship products like Photoshop on the iPad, but also new products like Project Gemini, which allows users to draw using a stylus on a tablet. We're excited about our progress, as we also showcased voice-enabled applications in XD that work with Echo. As we look to a future where every screen can respond to voice commands, we aim to empower users to create apps for these platforms. While we are in the early stages of this journey, we see vast potential for helping people express their stories effortlessly. On the Digital Experience front, the announcement of the ODI in collaboration with SAP and Microsoft marks a significant step forward in developing the Experience System of Record. All three companies have acknowledged the necessity of a Unified Customer Profile, which can be acted upon in real-time and integrated with various systems, including support, supply chain, financial, and marketing systems, where we are taking the lead. There's considerable interest in this initiative, especially among CIOs concerned with creating a Unified Customer Profile. This is a multi-year journey for us, aimed at delivering value. Our Experience Platform is already in use by customers, who are providing us with real-time feedback. Our applications will continue to build on our content and data platform, just as we did with the Creative Suite. We're enthusiastic about our product development and the creation of strong technological advantages. While we've made a promising start, there is much more we can do to deliver value to our customers and further enhance our competitive edge.

I have two questions, Shantanu. To follow up on something that Kash asked, I'm curious about how resilient you believe spending might be if the macro environment becomes more challenging, given that digital transformation has been a major focus for years. I also have a follow-up question regarding piracy.

Yes, Heather, I believe that customer expectations regarding business transactions with enterprises are not going to change. If the economic climate shifts, it will be even more important to focus on the key priorities that are essential. Looking at the trend of mobile devices as the primary means of interacting with enterprises, we see that digital will remain critical and central to the goals set at the executive level. This gives us confidence to keep pushing forward. We will certainly keep an eye on developments, but we want to avoid creating a scenario where everyone starts to worry about a slowdown and cuts spending preemptively. So far, we have not observed that happening. This is how I view it as a priority. Our role is to help drive revenue for our customers, and that is a key part of our mission and offerings.

Right. So for the CEOs you talk to or the CMOs, it's much more been about the fear of not spending because of their competitors' spend than they're falling further behind. Is that kind of the way to think about it?

That’s exactly how to approach it. Everyone understands that if they’re not leveraging digital as a tool, there’s likely a smaller company out there ready to disrupt their business through a mobile app and digital technology. Therefore, the significance of digital is clearly a priority for every enterprise. I believe we've observed this throughout our journey. The affordability of Creative Cloud has been a key factor in our new growth and customer acquisition, which we have emphasized every year, including at MAX. This gives us continued confidence. Our upfront pricing allows more individuals to join the platform, which helps us address piracy. Additionally, we have eliminated the issues that came with physical boxes, which once contributed to a gray market for our products. Although some people may still find ways to access Creative Cloud through unauthorized means, our brand remains strong even in the presence of malicious users. We have made significant progress and continue to focus on delivering value through our services. Given that all of our assets are now in the cloud, they are essentially useless unless one is a legitimate user of Adobe products.

Maybe one for John, so he doesn't feel completely left out on this call. If we exclude the acquired assets, especially Marketo, how are you considering operating leverage within the core Adobe businesses for fiscal year 2019? Do you believe this will be another year of the positive expansion we've seen in the underlying operating margins? Or is there a broader investment strategy taking place in the core throughout fiscal year 2019 as well?

Thank you, Keith. When considering our core business, we have operating leverage that we discussed throughout fiscal year 2018 before the acquisitions. In our prepared remarks, we highlighted that the accounting implications linked to the acquisitions, specifically through purchase accounting, result in an initial impact from deferred revenue on the operating side during the first half to the third quarter. As this effect diminishes throughout the year, we expect our model's leverage to return to growth regarding operating margins. We anticipate that as we close the year, our margins will expand back to levels that you are familiar with.

Can you give us a sense of where you are in the journey of Acrobat's subscription and how to think about the negative impact of the move of perpetual license subscriptions on the Document Cloud revenue growth?

We have used a different strategy for Acrobat compared to Creative Cloud because perpetual licenses remain significant for acquiring new customers, and we've effectively bridged both approaches. The business continues to perform well, and we are seeing growth in unit sales for Acrobat. We don’t foresee the same challenges with transitioning from perpetual to subscriptions as we experienced with Creative Cloud. Our main focus is on driving more unit growth. Additionally, there is a growing installed base that presents a significant opportunity, especially as we enhance our services and integrate AI. This potential is already considered in our targets for the upcoming year.

So trade negotiations with China are dominating the headlines. If we actually see an agreement that brings true IP protection and a real open market in China, how big could that market be for Adobe? What could that do to your revenue and revenue growth going forward?

Well, Sterling, one way you can look at it is you can say what this the number of PCs and mobile devices that are used in China and how does that compare to what's being used in the U.S. And if you look at what our revenue is in the U.S., I mean, that would, I think, at the high end show the potential of what that could be because creativity is just as important in China. And you could actually argue, we're one of the few companies, U.S. technology companies, that really doesn't have an alternative in China, so we feel good about it. But even if those trade agreements that you allude to happen, I think it would take a little while for that to completely translate into our business. So having said that, the China business for us has been doing well. As you know, we introduced CC. We focused on the team offering because we thought that would be the right beachhead for us to focus on. And the other area that we focus on is our company is doing business in China. How do we make sure that they have a site license, so to speak, or enterprise license agreement that allows us to do it? So from a purely mathematical and installed base perspective, it's massive how that translates. We have been clearly baked any of that sort of inflection point or dramatic shift into our numbers.

I wanted to follow up on the operating margin question that Keith kind of went down. And taking a little bit of a different tack here, full year operating margins have risen by more than 200 basis points, I think, for five consecutive years. You're now above 40%, phenomenal kind of progress here, highest in over 10 years. My question is going forward. I get the first half accounting impact. But as you think about the opportunity in the $70 billion Experience Cloud, do you plan to invest incremental dollars to accelerate the share in the Experience Cloud? Or do you think you can actually drive margins well above 40% on a blended basis?

Great. Thanks very much, Brent. I think when you look at the Digital Experience business, we've always long believed that, that business can actually have margins typical of a SaaS business. We continue to invest in the Digital Experience, of course, obviously recently with the two acquisitions. And so our goal there is to help them integrate to make sure that they can accelerate our growth in that space. That market's huge. So as we continue to invest in that market, certainly we want to see op earnings leverage in it, and it'll be healthy for the business overall. If we look at top line growth and we look at bottom line growth, really is what we're trying to drive. And so our long-term model has always been to grow our earnings as fast as our top line or faster. So once we kind of get past this noise of accounting through the year, more so in the first half and then it trails off in the third and fourth quarter, you'll see the operating margin for the total company kind of return to historical levels.

So the company took some pricing up here last March in Creative Cloud, I guess just in North America. But would love it if you could provide just a little bit of feedback as to how the price bumps that were put in place have been received by both new and installed customers. And can you add any color there as to whether you've seen any changes to net dollar retention stemming from the price bumps? Just overall some color on how this has gone would be great.

Sure. I think it's gone completely in line with our expectations. I mean, we have just a significant amount of experience with that. As you know, we look at FX in other countries as well to also look at pricing. So it's not the first time that we have made changes to Creative Cloud pricing since the time it was introduced. From our perspective, it was on the heels of MAX, where we introduced 5 new products, which was the sort of most significant innovation after the original introduction. We continue to be focused on a lot more innovation driving value for our customers and I think you'll continue to see it. But North America went very much in line with our expectations. And as we said, our goal is to continue to drive new customers to the platform. That remains front and center but nothing that I would say is to doubt in our experience. And I think that's just because of the diligence that we did, which is we're thoughtful about it. We want to continue to attract customers to the platform with promotional pricing and deliver them the value, which enables us to give more credence to whatever pricing changes we might do. But since the last question, I mean, I'll also start off by wishing everybody on the call happy holidays. Thank you all for joining us. We're certainly thrilled with Q4 and FY '18. I think we had a very, very strong year. And I think it's a clear indication that our strategy of empowering people to create and helping businesses transform is working. We think it represents, as we have said at our MAX financial analyst meeting, a massive addressable market opportunity, and the FY '19 financial targets reflect the momentum that we expect to continue to drive across all offerings and geographies. And we're excited about the product innovation road map that we have for all of our customers. And again, wanted to thank you all for joining us today.

And this concludes our call. Thanks, everyone.