Adobe Systems Incorporated — Form 10-Q Summary
Business Context and Reporting Period
Adobe filed a quarterly report for the three months ended March 2, 2012, compared with the three months ended March 4, 2011. Adobe provides software and services for digital media, digital marketing, content creation, publishing, measurement and optimization. Fiscal 2012 reporting was reorganized into Digital Media, Digital Marketing, and Print and Publishing segments.
Financial Highlights
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Total revenue | $1,045.2 million | $1,027.7 million | 2% |
| Gross profit | $937.0 million | $920.1 million | 2% |
| Gross margin | 89.6% | 89.5% | Up slightly |
| Operating income | $289.0 million | $302.3 million | Down 4% |
| Operating margin | 27.6% | 29.4% | Down 1.8 points |
| Net income | $185.2 million | $234.6 million | Down 21% |
| Diluted EPS | $0.37 | $0.46 | Down $0.09 |
| Cash flow from operations | $314.4 million | $332.1 million | Down 5% |
- Revenue mix shifted toward recurring and service revenue: product revenue declined 4% to $808.5 million, subscription revenue increased 38% to $146.2 million, and services and support revenue increased 15% to $90.5 million.
- Segment revenue was $730.3 million for Digital Media, $259.9 million for Digital Marketing, and $55.0 million for Print and Publishing. Segment growth was negative 4%, positive 22%, and positive 2%, respectively.
- Gross profit was $937.0 million, with segment gross margins of 96% for Digital Media, 70% for Digital Marketing, and 95% for Print and Publishing.
- Operating expenses increased 5% to $648.0 million, primarily from a 9% increase in sales and marketing expense and higher amortization of acquired intangibles.
- The effective tax rate increased to 31.5% from 18.0%, primarily because of one-time tax costs associated with licensing acquired-company assets and expiration of the federal research and development credit.
- Cash, cash equivalents and short-term investments totaled $2.766 billion at March 2, 2012, including $801.3 million of cash and cash equivalents and $1.965 billion of short-term investments.
- Working capital was $2.391 billion, compared with $2.521 billion at December 2, 2011. Stockholders’ equity was $5.986 billion.
- Debt and capital lease obligations totaled approximately $1.520 billion, including $1.5 billion of senior notes and $17.4 million of capital lease obligations. The company had no borrowings under its new $1.0 billion revolving credit facility.
- Net cash used in investing was $437.7 million, primarily reflecting the Efficient Frontier acquisition. Net cash used in financing was $68.5 million, principally due to stock repurchases.
Material Changes Versus the Prior Comparable Period
- Digital Media revenue declined because customers appeared to delay Creative Suite purchases in anticipation of the CS6 launch, product mix shifted toward lower-priced offerings, and Photoshop point-product revenue declined.
- Digital Marketing revenue benefited from continued adoption of the Digital Marketing Suite, Adobe Connect, and products acquired with Efficient Frontier.
- Adobe acquired Efficient Frontier on January 13, 2012, for a preliminary purchase price of approximately $374.8 million, including $291.5 million allocated to goodwill and $122.7 million to identifiable intangible assets.
- Goodwill increased to $4.138 billion from $3.849 billion, primarily because of Efficient Frontier and foreign-currency translation.
- Restructuring expense was a net benefit of $2.8 million in the income statement, reflecting $11.3 million of current-period costs more than offset by approximately $14.1 million of favorable adjustments to prior estimates. Restructuring accruals totaled $49.2 million at quarter-end.
- Net income and operating margin declined despite modest revenue growth, reflecting higher sales and marketing costs, increased non-operating expense, and the higher effective tax rate.
- Cash and cash equivalents decreased by $188.2 million during the quarter, compared with an increase of $150.3 million in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
- Management stated that existing cash, investments, expected operating cash flow, and available credit were expected to meet working-capital and operating-resource requirements for the next twelve months. The filing does not provide a clear quantitative revenue or earnings forecast.
- Adobe expected subscription revenue to continue increasing as it expanded SaaS and subscription models, but cautioned that the transition from perpetual licenses could defer revenue and cash receipts and reduce near-term reported revenue.
- Subsequent to quarter-end, Adobe prepaid $225.0 million under a structured stock repurchase agreement. This exhausted the remaining authority under the existing $1.6 billion repurchase program, subject to possible future board authorization.
- Adobe entered into a new five-year $1.0 billion revolving credit agreement on March 2, 2012, with potential commitments of up to $1.5 billion. No amounts were outstanding at quarter-end, and the company was in compliance with its covenants.
- Restructuring obligations include termination and facility-related payments through fiscal 2021. Management estimated that approximately 75% of facility-related payments would be made through 2015.
- The company reported $156.2 million of gross unrecognized tax benefits, excluding interest and penalties, and stated that potential decreases in unrecognized tax benefits within the next twelve months could range from zero to approximately $15 million.
- Adobe was dismissed from the Eolas patent case after a jury found the asserted patents invalid. The Tarkus Imaging patent case remained pending, with trial scheduled for June 2012; no loss accrual was recorded because a loss was not considered probable or estimable.
- Key risks include product and platform transitions, competition, adoption and renewal of subscription and cloud offerings, acquisition integration, foreign-currency movements, intellectual-property litigation, privacy and data-security requirements, cybersecurity incidents, distributor concentration, tax examinations, debt obligations, and potential impairment of goodwill or intangible assets.
Most Important Facts to Verify
- Whether the anticipated CS6 launch improved Digital Media demand and reversed the quarter’s product-revenue decline.
- Subscription growth, deferred revenue trends, renewal rates, and the effect of Creative Cloud adoption on reported revenue and cash flow.
- Efficient Frontier integration progress, incremental operating costs, and whether acquisition-related goodwill and intangibles remain recoverable.
- Cash conversion and investment spending following the acquisition, repurchases, and the $225.0 million subsequent stock-repurchase prepayment.
- Changes in the effective tax rate, the status of IRS examinations, and realization of unrecognized tax benefits.
- Developments in the Tarkus Imaging litigation and other intellectual-property, privacy, cybersecurity, and indemnification exposures.
- Compliance with debt, revolving-credit, and lease covenants and the company’s remaining financing flexibility.