Adobe Systems Incorporated Form 10-Q Summary
Business Context and Reporting Period
Adobe reported results for the second quarter and six months of fiscal 2016, ended June 3, 2016. The company provides digital media, digital marketing, document, creative, hosted and subscription software services globally. Fiscal 2016 is a 53-week year, including an extra week in the first quarter versus fiscal 2015.
- Primary growth areas: Digital Media, including Creative Cloud and Document Cloud, and Digital Marketing, including Adobe Marketing Cloud.
- Subscription revenue represented 78% of total revenue in both the quarter and year-to-date period, compared with 67% and 65%, respectively, in the comparable 2015 periods.
Financial Performance and Liquidity
| Metric | Three Months Ended June 3, 2016 | Year-over-Year Change | Six Months Ended June 3, 2016 | Year-over-Year Change |
|---|---|---|---|---|
| Total revenue | $1.399 billion | 20% | $2.782 billion | 22% |
| Subscription revenue | $1.084 billion | 40% | $2.154 billion | 45% |
| Gross profit | $1.197 billion | 23% | $2.381 billion | 24% |
| Gross margin | 86% | Approximately 2 percentage points | 86% | Approximately 1 percentage point |
| Operating income | $344.2 million | 78% | $652.0 million | 78% |
| Operating margin | 25% | Approximately 8 percentage points | 23% | Approximately 7 percentage points |
| Net income | $244.1 million | 65% | $498.4 million | 114% |
| Diluted earnings per share | $0.48 | 66% | $0.99 | 115% |
- Digital Media revenue was $943.1 million in the quarter, up 26%, and $1.875 billion year to date, up 29%. Digital Marketing revenue was $412.2 million in the quarter, up 12%, and $818.4 million year to date, up 13%. Print and Publishing declined 10% in the quarter and 9% year to date.
- Digital Media annualized recurring revenue was $3.41 billion at quarter-end, up from $2.88 billion at fiscal 2015 year-end. Creative ARR was $3.00 billion and Document Cloud ARR was $415 million.
- Cash flow from operations was $986.2 million for the six months, compared with $654.5 million in the prior-year period. Capital expenditures were $100.0 million.
- Cash and cash equivalents were $886.4 million and short-term investments were $3.432 billion at June 3, 2016, for total cash and short-term investments of approximately $4.318 billion.
- Working capital was $2.853 billion, compared with $2.608 billion at November 27, 2015.
- Senior notes had a carrying value of $1.918 billion, consisting of $900 million due in 2020 and $1.0 billion due in 2025. The $1.0 billion revolving credit facility was undrawn, and Adobe reported compliance with applicable debt and lease covenants.
Material Changes Versus the Prior Comparable Period
- The business continued shifting from perpetual licenses to recurring subscriptions. Product revenue declined 28% in the quarter and 30% year to date, while subscription revenue increased 40% and 45%, respectively.
- Creative revenue increased 37% year over year to $754.9 million in the quarter. Document Cloud revenue decreased slightly to $188.2 million because of lower perpetual-license revenue, partly offset by subscription and Adobe Sign growth.
- Adobe Marketing Cloud revenue reached a quarterly record of $385.4 million, up 18%, driven primarily by Adobe Experience Manager and, to a lesser extent, Adobe Campaign and Adobe Analytics.
- Cost of revenue increased 9% in the quarter and 14% year to date, while operating expenses increased 9% and 11%, primarily due to higher compensation and headcount, data-center costs and other investments supporting subscription and hosted services.
- The effective tax rate was 26% in the quarter versus 19% in the prior-year quarter, partly due to a one-time tax cost and stronger U.S. earnings. The six-month effective tax rate was 20% versus 32%, benefiting from the permanent extension of the U.S. research and development credit.
- Adobe repurchased approximately 3.7 million shares for $375 million during the six months. Subsequent to quarter-end, it prepaid an additional $400 million under the repurchase program; $800 million remained under the current authorization after that transaction.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management characterized second-quarter results as strong and reiterated its focus on expanding Creative Cloud, Document Cloud and Adobe Marketing Cloud subscriptions and recurring revenue. The filing text does not provide clear numerical full-year or next-quarter revenue, earnings or ARR guidance.
- Management expects subscription growth to continue as Adobe invests in SaaS, cloud infrastructure, product development and customer acquisition.
- Foreign exchange reduced reported revenue by approximately $18.1 million in the quarter and $63.0 million year to date, net of hedging impacts.
- Material risks include subscription-renewal and customer-adoption rates, transition from perpetual licenses, competitive pricing and innovation, extended enterprise sales cycles, cloud reliability, cybersecurity and privacy, intellectual-property disputes, foreign currency volatility, tax examinations and regulatory changes.
- Adobe reported an immaterial impairment of certain cost-method investments and no goodwill impairment in the quarter. Restructuring charges were immaterial.
- Unrecognized tax benefits were $270.6 million, excluding interest and penalties. Management estimated that potential decreases in these benefits within the next 12 months could range from zero to approximately $10 million.
- The company stated that existing liquidity, anticipated operating cash flow and available credit capacity should be sufficient for working capital and operating requirements over the next 12 months.
Facts Investors Should Verify
- Whether ARR growth and subscription adoption continue to offset declining perpetual-license revenue.
- Creative Cloud, Document Cloud and Marketing Cloud renewal rates, seat growth, pricing and deferred-revenue trends.
- Whether operating-expense growth remains below revenue growth and supports sustained margin expansion.
- The effect of foreign exchange, cybersecurity, privacy regulation and cloud-service interruptions on reported results.
- Future cash deployment among share repurchases, acquisitions, capital expenditures and investments, including the post-quarter-end $400 million repurchase prepayment.
- Developments in tax examinations, unrecognized tax benefits, intellectual-property claims and other contingencies.