Adobe Systems Incorporated Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended February 27, 2015, compared with February 28, 2014. Adobe provides digital media, digital marketing, document, creative and publishing software and services through subscription, hosted, term-license and perpetual-license models. The filing emphasizes the continuing transition from perpetual products to recurring Creative Cloud and other subscription offerings.
Key financial metrics
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Total revenue | $1,109.2 million | $1,000.1 million | +11% |
| Subscription revenue | $713.4 million | $423.6 million | +68% |
| Product revenue | $290.8 million | $471.5 million | -38% |
| Gross profit | $942.4 million | $851.6 million | +11% |
| Gross margin | 85.0% | 85.2% | Broadly stable |
| Operating income | $173.0 million | $78.7 million | +120% |
| Operating margin | 15.6% | 7.9% | +7.7 percentage points |
| Net income | $84.9 million | $47.0 million | +80% |
| Diluted EPS | $0.17 | $0.09 | +89% |
| Net cash from operating activities | $183.0 million | $251.7 million | -27% |
Subscription revenue represented 64% of total revenue versus 42% in the prior-year quarter. Digital Media revenue was $702.8 million, up 10%; Digital Marketing revenue was $357.2 million, up 14%; and Print and Publishing revenue was $49.2 million, up 10%. Adobe Marketing Cloud revenue was $311.5 million, up 17%.
At February 27, 2015, cash and cash equivalents were $712.9 million and short-term investments were $2.464 billion, for total cash and short-term investments of approximately $3.177 billion. Working capital was $2.184 billion. Senior notes had a carrying value of $1.902 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 available.
Cash used in investing was $698.4 million, primarily reflecting the $800.3 million cash acquisition of Fotolia, partly offset by investment sales and maturities. Financing cash flow was positive $119.3 million, including approximately $989.3 million of net proceeds from the 2025 Notes and repayment of the $600 million 2015 Notes, as well as $200 million of stock repurchases.
Material changes versus the prior comparable period
- Subscription revenue increased sharply as Creative Cloud adoption expanded, while product revenue declined due to the shift away from perpetual licensing.
- Paid Creative Cloud subscriptions reached 3.971 million, up 15% from 3.454 million at fiscal 2014 year-end. Creative ARR was $1.79 billion, Document Services ARR was $297 million, and total Digital Media ARR was approximately $2.09 billion, up 11% from $1.88 billion.
- Operating income improved substantially because revenue growth and relatively stable operating expenses more than offset higher subscription-related costs.
- The effective tax rate increased to 48% from 28%, primarily due to one-time tax costs associated with licensing acquired company assets to Adobe trading companies. The reinstated U.S. research and development tax credit partly offset the increase.
- Adobe completed its acquisition of Fotolia on January 27, 2015, for a preliminary purchase price of $806.8 million. The allocation included $743.9 million of goodwill and $209.2 million of identifiable intangible assets.
- Goodwill increased to $5.396 billion from $4.722 billion, and purchased and other intangible assets increased to $629.3 million from $469.7 million, primarily because of Fotolia.
- Operating cash flow declined $68.7 million, mainly because of larger decreases in accrued expenses and a smaller increase in deferred revenue.
- Accumulated other comprehensive loss increased to $103.8 million, primarily because of an $82.6 million foreign-currency translation loss.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear numerical quarterly or full-year revenue or earnings guidance figure. Management expects subscription revenue and recurring revenue to continue increasing, supported by Creative Cloud, Adobe Marketing Cloud and other hosted services. Adobe Document Cloud and Acrobat DC were announced in March 2015 and were scheduled for availability in the second quarter of fiscal 2015.
Management stated that existing cash, investments, expected operating cash flow and the available credit facility should be sufficient for working-capital and operating requirements over the next twelve months. The company expects to continue investing in infrastructure, facilities, product development and strategic acquisitions, and does not anticipate paying cash dividends in the foreseeable future.
- Key risks include execution of the transition to subscription and cloud models, customer renewal rates, pricing and promotional pressure, and the timing effects of deferred revenue recognition.
- Other significant risks include competition, cybersecurity and data privacy, service interruptions, foreign-currency exposure, international operations, intellectual-property litigation, tax examinations, acquisitions and potential goodwill or intangible-asset impairment.
- Adobe accrued $7.1 million for restructuring obligations at quarter-end. The restructuring program was substantially complete, but certain facility obligations extend through fiscal 2021.
- The High-Tech Employee Antitrust Litigation settlement received preliminary court approval in March 2015; final approval was scheduled for July 2015. Adobe had previously accrued $10 million and expected no additional loss if approved.
- The company had $259.5 million of gross unrecognized tax benefits, excluding interest and penalties, and $23.6 million of accrued tax interest and penalties. Potential decreases in unrecognized tax benefits within twelve months were estimated at zero to approximately $10 million.
Most important facts for investors to verify
- Whether Creative Cloud subscription growth, ARR expansion and renewal rates continue to offset the decline in perpetual-license revenue.
- The cash-flow impact and operating integration progress of Fotolia and other acquisitions.
- The sustainability of the 15.6% operating margin and the effect of hosting, infrastructure, royalty, compensation and amortization costs.
- The effect of the 48% effective tax rate and the resolution of IRS and other tax examinations.
- Debt service requirements, covenant compliance and the continued availability of the undrawn $1.0 billion revolving facility.
- Progress and final approval of the employee antitrust settlement, restructuring cash payments and other legal contingencies.
- Exposure to foreign-currency movements, cybersecurity incidents, privacy regulation, intellectual-property claims and potential goodwill impairment.