Adobe Systems Incorporated Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended June 1, 2012, compared with the periods ended June 3, 2011. Adobe develops and licenses software and services for digital media, digital marketing, document services, creative professionals, enterprises and consumers. Fiscal 2012 reporting segments were Digital Media, Digital Marketing, and Print and Publishing.
Adobe launched Creative Suite 6 and the subscription-based Creative Cloud in May 2012. It also completed the acquisition of Efficient Frontier on January 13, 2012, integrating its capabilities into Digital Marketing.
Financial performance and key metrics
| Metric | Q2 2012 | Q2 2011 | Change |
|---|---|---|---|
| Total revenue | $1,124.4 million | $1,023.2 million | 10% |
| Gross profit | $993.5 million | $914.0 million | 9% |
| Gross margin | 88.4% | 89.3% | Down approximately 0.9 percentage points |
| Operating income | $305.1 million | $276.7 million | 10% |
| Operating margin | 27.1% | 27.0% | Slightly higher |
| Net income | $223.9 million | $229.4 million | Down 2% |
| Diluted EPS | $0.45 | $0.45 | Flat |
| Effective tax rate | 24.0% | 11.5% | Up 12.5 percentage points |
| Metric | Six months 2012 | Six months 2011 | Change |
|---|---|---|---|
| Total revenue | $2,169.7 million | $2,050.9 million | 6% |
| Operating income | $594.1 million | $579.1 million | 3% |
| Net income | $409.1 million | $464.0 million | Down 12% |
| Diluted EPS | $0.81 | $0.91 | Down 11% |
| Operating cash flow | $762.6 million | $721.4 million | 6% |
- Q2 revenue mix was products $871.0 million, subscription $159.5 million, and services and support $93.9 million. Subscription revenue increased 46% year over year and represented 14% of revenue versus 11%.
- Digital Media revenue was $818.5 million, up 9%; Digital Marketing revenue was $250.9 million, up 17%; Print and Publishing revenue was $55.1 million, up 2%.
- Six-month gross profit was $1.930 billion, representing an approximately 89.0% gross margin. Six-month operating margin was approximately 27.4% and net margin approximately 18.9%.
- Cash, cash equivalents and short-term investments totaled approximately $2.998 billion at June 1, 2012, including $951.2 million of cash and cash equivalents and $2.0469 billion of short-term investments.
- Working capital was $2.525 billion, compared with $2.521 billion at December 2, 2011. Total assets were $9.366 billion and stockholders’ equity was $6.100 billion.
- Debt consisted principally of $1.5 billion of senior notes, comprising $600 million of 3.25% notes due 2015 and $900 million of 4.75% notes due 2020. Capital lease obligations totaled $15.1 million.
- Adobe entered into a new $1.0 billion five-year senior unsecured revolving credit facility on March 2, 2012; it was undrawn at quarter-end and the company reported compliance with its covenants.
Material changes versus the prior comparable period
- Revenue growth accelerated in Q2, primarily from the CS6 launch, Creative Cloud, continued Digital Marketing Suite adoption, and Efficient Frontier-related offerings.
- Subscription revenue grew substantially, increasing the recurring-revenue component of the business, while product revenue increased only 5% in Q2 and was essentially unchanged for the six-month period.
- Digital Marketing revenue growth was stronger than Digital Media growth, while Digital Media’s six-month growth was limited by product mix and currency effects.
- Operating expenses increased 8% in Q2 and 6% for the six months. Sales and marketing increased 11% in Q2, while general and administrative expense increased 16%; research and development declined 1%.
- Net income declined despite higher revenue and operating income, principally because the effective tax rate increased materially. Prior-year results benefited from a favorable state tax ruling and the U.S. research and development credit, which expired December 31, 2011.
- Operating cash flow increased, but investing cash use rose to $586.0 million, primarily because of the $353.2 million Efficient Frontier acquisition and higher capital expenditures. Financing cash use declined to $217.3 million, mainly because stock repurchases were lower than in the prior year.
- Adobe repurchased approximately 7.1 million shares for $305.0 million during the first six months and exhausted the prior $1.6 billion repurchase authorization. A new authorization of up to $2.0 billion through fiscal 2015 was approved in April 2012; no repurchases had yet been made under the new authorization at quarter-end.
Guidance, outlook, commentary, risks and unusual items
Management stated that existing cash, investments, operating cash flow and available credit were expected to be sufficient for working capital and operating requirements for the next twelve months. The filing does not provide a clear numerical revenue or earnings guidance range.
- Management expects subscription revenue to continue increasing as Adobe expands SaaS, Creative Cloud and other subscription models, but warned that the transition can defer revenue and cash receipts and may pressure results in the short term.
- Restructuring accruals totaled approximately $30.4 million at June 1, 2012. Approximately $7.7 million related to termination benefits and contract terminations was expected to be paid through the remainder of fiscal 2012; facility-related obligations were expected to extend through fiscal 2021.
- The annual goodwill impairment test found no impairment in Digital Media, Digital Marketing or Print and Publishing.
- Unrecognized tax benefits were $157.2 million, excluding interest and penalties. The company estimated that potential decreases in unrecognized tax benefits within the next twelve months could range from zero to approximately $15 million.
- A patent infringement trial involving Tarkus Imaging was ongoing. Adobe disputed the claims and had not recorded a material provision for the matter based on the filing’s assessment.
- Key risks include adoption and execution of the Creative Cloud and other subscription models, unpredictable renewal rates, competition and pricing pressure, product development and platform transitions, foreign currency volatility, economic weakness in Europe, acquisition integration, intellectual-property litigation, privacy and cybersecurity exposure, dependence on distribution channels, and potential goodwill or investment impairments.
- Ingram Micro represented 12% of Q2 net revenue, although no individual agreement with that distributor represented more than 10% of total revenue.
Most important facts for an investor to verify
- Whether Creative Cloud and other subscriptions continue to grow without causing excessive revenue deferral, customer churn or higher cloud-operating costs.
- Whether Digital Marketing growth and Efficient Frontier integration offset weakness in mature products, including LiveCycle and Print and Publishing.
- The sustainability of operating margins as sales and marketing investment, hosting costs, amortization and stock-based compensation remain significant.
- The effect of the higher effective tax rate, expiration of tax credits, foreign earnings policy and pending tax examinations on future earnings and cash taxes.
- Cash deployment, including the new $2.0 billion repurchase authorization, acquisitions, capital expenditures and debt service requirements.
- Potential exposure from the Tarkus Imaging litigation, intellectual-property indemnifications, restructuring obligations and lease residual-value guarantees.
- Execution of the new $1.0 billion revolving credit facility and continued compliance with debt and lease covenants.