Adobe Inc. Form 10-Q Summary
Business Context and Reporting Period
Adobe develops and markets software and cloud-based services for creative professionals, marketers, enterprises, developers and consumers. Its reportable segments are Digital Media, Digital Experience and Publishing. This unaudited quarterly report covers the three and six months ended May 31, 2019; the comparable periods ended June 1, 2018. Adobe adopted ASC 606 using the modified retrospective method on December 1, 2018, and prior-period amounts were not restated.
Key Financial Metrics
| Metric | Three months ended May 31, 2019 | Year-over-year change | Six months ended May 31, 2019 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $2.744 billion | 25% | $5.345 billion | 25% |
| Subscription revenue | $2.456 billion | 28% | $4.761 billion | 28% |
| Gross profit | $2.337 billion | 22% | $4.540 billion | 22% |
| Operating income | $749.5 million | 7% | $1.444 billion | 3% |
| Net income | $632.6 million | (5%) | $1.307 billion | 5% |
| Diluted EPS | $1.29 | $(0.04) | $2.65 | $0.15 |
- Second-quarter gross margin was approximately 85%, operating margin 27% and net margin 23%, compared with approximately 87%, 32% and 30%, respectively, in the prior-year quarter.
- Digital Media revenue was $1.890 billion, up 22%; Digital Experience revenue was $783.5 million, up 34%; and Publishing revenue was $70.6 million, up 12%.
- Creative Cloud revenue was $1.594 billion, up 22%, and Document Cloud revenue was $296.1 million, up 22%.
- Digital Media annualized recurring revenue was $7.47 billion at quarter-end, including Creative ARR of $6.55 billion and Document Cloud ARR of $921 million.
- Operating cash flow for the six months was $2.123 billion, up from $1.966 billion. Investing cash flow used $121.8 million and financing cash flow used $1.556 billion.
- Cash and cash equivalents were $2.083 billion and short-term investments were $1.396 billion at May 31, 2019. Total cash, cash equivalents and short-term investments were approximately $3.479 billion.
- Working capital was negative $2.345 billion, primarily because $3.15 billion of debt due in 2020 was classified as current.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by subscription offerings, with subscription revenue increasing from $1.923 billion to $2.456 billion in the quarter.
- Digital Experience growth benefited substantially from the Marketo and Magento acquisitions completed in late fiscal 2018. Digital Experience subscription revenue increased 39% in the quarter.
- Cost of revenue increased 45% in the quarter, driven primarily by acquired-intangible amortization, hosting services and data-center costs. Operating expenses increased 31%, reflecting higher compensation, stock-based compensation, marketing spending and costs associated with Marketo and Magento.
- Interest expense nearly doubled year over year to $40.6 million in the quarter because of the Term Loan used to fund part of the Marketo acquisition. The effective tax rate increased to approximately 11% from 4% in the prior-year quarter.
- Adobe repurchased approximately 2.455 million shares for $659.4 million during the quarter and approximately 4.5 million shares for $1.25 billion during the first six months. Approximately $6.85 billion remained under the repurchase authorization at May 31, 2019.
- ASC 606 increased beginning retained earnings by $442.3 million and capitalized $413.2 million of contract acquisition costs. For the quarter, reported revenue was $25.9 million higher and net income was $30.4 million higher than amounts calculated without the ASC 606 adoption impact.
Debt, Liquidity, Outlook and Risks
- Debt consisted principally of a $2.25 billion Term Loan due April 30, 2020 and senior notes with a carrying value of approximately $1.89 billion, including $900 million of 4.75% notes due February 1, 2020 and $1 billion of 3.25% notes due February 1, 2025.
- Adobe had no borrowings under its $1 billion revolving credit facility, which remained fully available. Management intended to refinance the Term Loan and 2020 Notes on or before their due dates and stated that available cash, investments, operating cash flow and credit capacity were sufficient for expected needs over the next twelve months.
- After quarter-end, Adobe entered into interest-rate lock agreements covering an aggregate $1 billion of anticipated future debt issuance in connection with the planned refinancing.
- Management cited continued long-term growth opportunities in Creative Cloud, Document Cloud and Adobe Experience Cloud. No specific full-year financial guidance was provided in the supplied filing text.
- Key risks include intense competition and pricing pressure; subscription renewal and customer acquisition trends; lengthy enterprise sales cycles; foreign-currency exposure; cybersecurity, privacy and service-outage risks; integration of acquisitions; intellectual-property litigation; tax-law changes and examinations; debt refinancing and covenant risks; and potential impairment of goodwill or acquired intangible assets.
- Adobe amended two vendor agreements during the quarter, creating an aggregate incremental minimum purchase commitment of $1.74 billion through May 2024. The company also disclosed approximately $0.5 billion of transition-tax liability payable through fiscal 2026.
- Adobe reported no goodwill impairment in its annual test and stated that it remained in compliance with applicable debt covenants. Disclosure controls and procedures were effective at the reasonable-assurance level.
Investor Verification Checklist
- Reconcile reported growth and margins with the non-comparable prior period because ASC 606 was adopted prospectively for fiscal 2019 reporting.
- Monitor Creative Cloud, Document Cloud and total Digital Media ARR, subscription additions and renewal rates.
- Assess whether Marketo and Magento integration, growth and cost synergies support continued Digital Experience expansion.
- Verify the planned refinancing of the $2.25 billion Term Loan and $900 million 2020 Notes and its effect on interest expense and liquidity.
- Track operating cash flow after stock repurchases, acquisitions, capital expenditures and tax-related payments.
- Review exposure to cybersecurity, privacy, foreign exchange, intellectual-property claims, tax audits and the $1.74 billion vendor purchase commitment.