ADOBE INC. quarterly report, Q3 FY2023

Business Context and Reporting Period

Adobe Inc. filed this unaudited Form 10-Q for the fiscal quarter and nine months ended September 1, 2023, compared with the periods ended September 2, 2022. Adobe provides cloud, subscription, term-license and other software offerings through its Digital Media, Digital Experience, and Publishing and Advertising segments. Subscription revenue represented 95% of quarterly revenue and 94% of year-to-date revenue.

Financial Performance and Key Metrics

Metric	Q3 FY2023	Q3 FY2022	Change
Total revenue	$4.890 billion	$4.433 billion	Up 10%
Subscription revenue	$4.631 billion	$4.128 billion	Up 12%
Gross profit	$4.310 billion	$3.887 billion	Up 11%
Gross margin	88.1%	87.7%	Up approximately 0.4 percentage points
Operating income	$1.697 billion	$1.484 billion	Up 14%
Operating margin	34.7%	33.5%	Up approximately 1.2 percentage points
Net income	$1.403 billion	$1.136 billion	Up 24%
Diluted EPS	$3.05	$2.42	Up 26%

For the nine months ended September 1, 2023, revenue was $14.361 billion, gross profit was $12.641 billion, operating income was $4.907 billion, and net income was $3.945 billion. Year-to-date gross margin was approximately 88.0%, operating margin was 34.2%, and net margin was 27.5%.

Digital Media revenue was $3.594 billion, up 11%; Creative Cloud revenue was $2.909 billion, up 11%, and Document Cloud revenue was $685 million, up 13%.
Digital Experience revenue was $1.229 billion, up 10%, driven primarily by subscription growth.
Publishing and Advertising revenue declined 17% to $67 million.
Digital Media annualized recurring revenue was $14.60 billion at quarter-end, up 10% from fiscal year-end 2022. Creative ARR was $11.97 billion and Document Cloud ARR was $2.63 billion.
Remaining performance obligations were approximately $15.72 billion, up 3% from December 2, 2022; approximately 71% of the applicable balance is expected to be recognized within 12 months.
Cash provided by operating activities was $5.705 billion for the first nine months, compared with $5.513 billion in the prior-year period.
Capital expenditures were $313 million. Investing activities provided $623 million, primarily from maturities and sales of short-term investments.
Cash used in financing activities was $3.965 billion, including $3.400 billion of share repurchases, $500 million of debt repayment, and $387 million of taxes paid on net share settlements.

Liquidity, Debt and Capital Allocation

At September 1, 2023, Adobe had $6.601 billion of cash and cash equivalents, $915 million of short-term investments, and working capital of $2.076 billion. Cash, cash equivalents and short-term investments totaled $7.516 billion. Senior notes outstanding at par were $3.650 billion, with a carrying value of $3.633 billion; the $500 million notes due in February 2023 were repaid during the first quarter.

The $1.5 billion revolving credit facility was undrawn and fully available.
A $3.5 billion delayed-draw term loan intended to help fund the proposed Figma acquisition was undrawn and available through March 15, 2024.
Adobe subsequently established a commercial paper program permitting up to $3 billion outstanding; the filing indicates no amounts were outstanding as of September 27, 2023.
Adobe repurchased 9.7 million shares for approximately $3.4 billion during the first nine months and had $3.483 billion remaining under its repurchase authorization at September 1, 2023. A further $1 billion structured repurchase agreement was entered into after quarter-end.
Management stated that existing liquidity, anticipated operating cash flow and available credit capacity should be sufficient for working capital, operating, and capital expenditure needs over the next 12 months.

Material Changes Versus the Prior Comparable Period

Revenue growth remained concentrated in recurring subscriptions, while product and services revenue declined.
Gross profit increased faster than revenue, supported by the subscription mix, although hosting and data-center costs increased.
Operating expenses increased 9% in the quarter and 12% year to date. Research and development increased 14% in the quarter, while general and administrative expense increased 11%, partly reflecting professional fees related to the planned Figma acquisition.
Other income increased materially, primarily because of higher interest income on cash and investments. Quarterly non-operating income was $46 million versus a $28 million expense in the prior-year quarter.
The effective tax rate was approximately 20% for the quarter versus 22% in the prior-year quarter, but 21% year to date versus 20% in the prior-year period.
Foreign exchange reduced revenue by approximately $62 million in the quarter and $367 million year to date, partially offset by hedging gains of $5 million and $36 million, respectively.
Cash increased by $2.365 billion during the first nine months, compared with a $26 million increase in the prior-year period, primarily because of stronger operating cash flow and lower investment outflows.

Outlook, Risks, Contingencies and Unusual Items

The filing does not provide a new formal quarterly or annual financial guidance range. Management described demand as strong across Digital Media and Digital Experience and highlighted product innovation, subscription growth, generative artificial intelligence, and continued customer adoption as key growth drivers.

The proposed approximately $20 billion acquisition of Figma remained subject to regulatory approvals and customary closing conditions. Adobe could owe a $1 billion reverse termination fee if regulatory clearance is not obtained or the transaction otherwise fails to close under specified conditions. Adobe expects to fund the cash portion with cash and debt.
Adobe identified macroeconomic uncertainty, inflation, interest rates, foreign currency movements, geopolitical events, and potential economic slowdowns as risks. Foreign exchange may continue to pressure fiscal 2023 results.
Key operating risks include intense competition, subscription renewal and customer spending trends, lengthy enterprise sales cycles, cybersecurity and service interruptions, privacy and data-transfer regulation, intellectual property litigation, and the evolving regulatory and reputational risks associated with generative AI.
Adobe reported no material goodwill impairment and no material impairment charges on its short-term investment portfolio during the periods presented.
Unrecognized tax benefits were $436 million, excluding interest and penalties, and the company stated that up to $30 million could decrease over the next 12 months as audits conclude or statutes of limitation expire.
Beginning in fiscal 2024, the corporate book minimum tax under the Inflation Reduction Act may affect Adobe; the company was also evaluating the impact of the 1% excise tax on net stock repurchases.
Management stated that disclosure controls and procedures were effective at the reasonable assurance level and that no material changes occurred in internal control over financial reporting during the quarter.

Important Facts for Investors to Verify

Progress toward, regulatory clearance of, and financing requirements for the Figma acquisition, including the potential $1 billion reverse termination fee.
Digital Media ARR growth, Creative Cloud and Document Cloud customer additions, and subscription renewal and retention trends.
Whether foreign exchange pressure, hosting costs, generative AI infrastructure costs, and continued research and development investment affect future margins.
Use of the delayed-draw term loan, revolving facility, commercial paper program, and cash balances if the Figma transaction closes.
The pace and pricing of share repurchases and their effect on share count, dilution, and cash resources.
Potential effects of tax-law changes, unresolved tax examinations, intellectual property proceedings, cybersecurity incidents, privacy regulation, and AI-related claims or regulation.