Adobe Inc. 2020 Q2 Form 10-Q Summary
Business context and reporting period
Adobe provides software and cloud-based services for digital media, digital experiences, publishing, content creation, document management and marketing. This unaudited Form 10-Q covers the three and six months ended May 29, 2020, compared with the periods ended May 31, 2019. The quarter was materially affected by the COVID-19 pandemic and increased work-from-home demand.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Change |
|---|---|---|---|
| Total revenue | $3.128 billion | $2.744 billion | 14% |
| Subscription revenue | $2.874 billion | $2.456 billion | 17% |
| Gross profit | $2.713 billion | $2.337 billion | 16% |
| Gross margin | 86.7% | 85.2% | Up approximately 150 basis points |
| Operating income | $1.016 billion | $750 million | 35% |
| Operating margin | 32.5% | 27.3% | Up approximately 520 basis points |
| Net income | $1.100 billion | $633 million | 74% |
| Diluted EPS | $2.27 | $1.29 | 76% |
For the six months ended May 29, 2020, revenue was $6.219 billion, up 16%; gross profit was $5.352 billion; operating income was $1.953 billion; net income was $2.055 billion; and diluted EPS was $4.23, compared with $2.65 in the prior-year period. Six-month gross, operating and net margins were approximately 86.1%, 31.4% and 33.0%, respectively.
- Digital Media revenue increased 18% to $2.232 billion, including Creative revenue of $1.872 billion, up 17%, and Document Cloud revenue of $360 million, up 22%.
- Digital Experience revenue increased 5% to $826 million; subscription revenue increased 8% to $707 million.
- Publishing revenue was $70 million, unchanged from the prior-year quarter.
- Digital Media annualized recurring revenue reached $9.17 billion at quarter-end, up from $8.33 billion at fiscal 2019 year-end. Creative ARR was $7.93 billion and Document Cloud ARR was $1.24 billion.
- Remaining performance obligations were approximately $9.92 billion; approximately 74% of the applicable balance was expected to be recognized within 12 months.
- Six-month operating cash flow was $2.509 billion, up from $2.123 billion. Capital expenditures were $190 million.
- Cash and cash equivalents were $3.044 billion and short-term investments were $1.307 billion at May 29, 2020. Working capital was a $1.485 billion surplus, compared with a $1.696 billion deficit at November 29, 2019.
- Debt outstanding at par was $4.150 billion, consisting of senior notes; the carrying value of long-term debt was $4.114 billion. Adobe had no borrowings under its $1 billion revolving credit facility.
Material changes versus the prior comparable period
- Subscription revenue increased to 92% of total revenue from 89%, continuing Adobe’s shift toward recurring cloud-based offerings.
- Operating expenses increased 7% in the quarter, primarily from higher compensation, headcount and stock-based compensation, partly offset by lower travel costs.
- Adobe began discontinuing transaction-driven Advertising Cloud offerings. This reduced Digital Experience growth and is expected to continue pressuring revenue growth, while reducing related media costs and improving Digital Experience gross margin.
- Adobe completed a February 2020 debt refinancing: $3.15 billion of new notes were issued and used to repay the $2.25 billion term loan and $900 million of notes that matured in the first quarter.
- An intra-entity transfer of intellectual property rights produced a $224 million deferred tax asset and related tax benefit. The benefit drove negative effective tax rates of 10% for the quarter and 7% for the six-month period.
- Adobe repurchased approximately $1.7 billion of stock during the six months and approximately 2.6 million shares during the quarter. Approximately $3.684 billion remained under the repurchase authorization at May 29, 2020.
- Operating lease right-of-use assets and liabilities were recognized following adoption of ASC 842 at the beginning of fiscal 2020.
Guidance, outlook, commentary and risks
The filing does not provide clear quantitative fiscal-year revenue or earnings guidance. Management reported strong Digital Media demand and increased digital engagement associated with remote work, but noted that COVID-19 caused delays in enterprise transactions and consulting implementations, weakness among small and medium-sized businesses, reduced advertising spending and greater credit-related risk.
Management believes cash, investments, anticipated operating cash flow and the available credit facility will be sufficient to meet working-capital and operating requirements for the next 12 months. The pandemic had not materially affected liquidity as of the filing date, but future effects on demand, collections, sales cycles, renewals, operations and capital markets remained uncertain.
- Key risks include prolonged COVID-19 effects, delayed or reduced customer spending, subscription non-renewals, extended enterprise sales cycles and foreign-currency volatility.
- Additional risks include intense competition, cybersecurity and service outages, privacy and data-transfer regulation, intellectual-property litigation, tax-law changes, acquisition and integration risks, and potential impairment of goodwill or intangible assets.
- Adobe had no goodwill impairment as of the quarter-end and was in compliance with its debt and revolving-credit covenants.
- Legal proceedings and intellectual-property claims remain inherently unpredictable; the filing states that no material additional loss provision was required based on information available at the reporting date.
- Adobe expects an additional international trading-structure change during fiscal 2020, which could create a further discrete tax benefit in fiscal 2020 but may adversely affect effective tax rates and cash flows in later years.
Facts investors should verify
- Whether Digital Media ARR and subscription growth remain strong after temporary work-from-home demand effects moderate.
- The ongoing revenue impact, cost savings and margin effect from discontinuing transaction-driven Advertising Cloud offerings.
- Enterprise sales-cycle length, customer renewal and attrition trends, collections and bad-debt expense as pandemic effects continue.
- The sustainability of the unusually low effective tax rate after the $224 million intellectual-property transfer benefit.
- Cash deployment between stock repurchases, debt service, acquisitions and capital expenditures, including the subsequent $500 million repurchase prepayment disclosed after quarter-end.
- Future effects of COVID-19 on liquidity, deferred revenue, remaining performance obligations and the timing of recognized subscription revenue.