Adobe Systems Incorporated: Fiscal Q1 2010 10-Q Summary
Business context and reporting period
Adobe develops and licenses creative, document, enterprise, web analytics, online business optimization and platform software and services. The report covers the three months ended March 5, 2010, compared with February 27, 2009. Fiscal Q1 2010 included an extra week because fiscal 2010 is a 53-week year.
The results include Omniture, acquired October 23, 2009 for approximately $1.8 billion. Omniture was established as a separate reportable segment and contributed $87.7 million of revenue, including approximately $77 million of subscription revenue.
Financial performance and liquidity
| Metric | Q1 FY2010 | Q1 FY2009 | Change |
|---|---|---|---|
| Total revenue | $858.7 million | $786.4 million | +9% |
| Gross profit | $769.3 million | $709.0 million | +9% |
| Gross margin | 89.6% | 90.2% | Down 0.6 percentage points |
| Operating income | $176.8 million | $207.9 million | -15% |
| Operating margin | 20.6% | 26.4% | Down 5.8 percentage points |
| Net income | $127.2 million | $156.4 million | -19% |
| Diluted EPS | $0.24 | $0.30 | Down $0.06 |
| Cash from operations | $259.8 million | $365.7 million | -29% |
- Revenue mix shifted toward recurring businesses: product revenue declined 4% to $703.9 million, while subscription revenue increased to $95.5 million from $12.3 million and services and support revenue rose to $59.3 million from $44.2 million.
- Operating expenses increased substantially: research and development rose 16% to $174.3 million, sales and marketing rose 19% to $297.3 million, and general and administrative expense rose 23% to $91.0 million. Increases were primarily associated with Omniture headcount, compensation and stock-based compensation.
- Cash, cash equivalents and short-term investments totaled $2.672 billion at March 5, 2010, up from $1.904 billion at November 27, 2009. Working capital increased to $2.276 billion from $1.629 billion.
- Net cash used in investing activities was $208.7 million, primarily reflecting purchases of short-term investments and $25.5 million of property and equipment purchases.
- Net cash provided by financing activities was $540.2 million, reflecting approximately $1.494 billion of proceeds from senior notes, repayment of the $1.0 billion revolving credit facility, debt issuance costs and employee equity issuance proceeds.
- At March 5, 2010, debt was $1.494 billion, consisting of $600 million of 3.25% notes due 2015 and $900 million of 4.75% notes due 2020. The $1.0 billion revolving credit facility had no outstanding balance and remained available.
- Adobe reported no covenant violations. The company stated that existing liquidity, expected operating cash flow and available credit were sufficient for anticipated working capital and operating requirements for the next twelve months.
Material changes versus the prior comparable period
- Revenue increased primarily because of the Omniture acquisition, improved Acrobat demand, strength in creative hobbyist products and growth in Connect solutions. These benefits were partly offset by lower Creative Solutions revenue and the absence of a comparable CS4 product launch.
- Creative Solutions revenue declined 6% to $432.0 million, while Knowledge Worker revenue increased 11% to $165.9 million and Enterprise revenue increased 4% to $79.9 million. Platform revenue declined 11% to $46.6 million.
- Americas revenue increased 25% to $408.4 million. EMEA revenue declined 1% to $275.4 million and Asia revenue declined 4% to $174.9 million, although foreign currency translation favorably affected reported international revenue.
- Operating income and net income declined despite higher revenue because of increased operating expenses, higher amortization and increased interest expense following the debt issuance.
- Non-operating expense increased to $10.6 million from $4.8 million. Interest and other income declined sharply, interest expense increased to $7.7 million from $0.8 million, and net investment losses improved to $3.5 million from $17.2 million.
- Cash flow from operations declined primarily because of lower net income, lower collections from trade receivables relative to the prior period and changes in deferred tax balances.
Guidance, outlook, risks and unusual items
- Management described worldwide demand as more stable and reported improved end-user demand in major markets. Adobe expected to ship CS5 versions of its creative professional products in the second quarter of fiscal 2010.
- Management expected Omniture to increase future revenue, cost of revenue and operating expenses, while also providing potential revenue and cost-saving synergies. Omniture revenue benefited from variable subscriptions, consulting services, cash-collection-based fees and the extra week.
- Adobe recorded $11.6 million of restructuring charges in the quarter. Total accrued restructuring obligations were approximately $25.9 million, with payments expected through fiscal 2013.
- Adobe early adopted revised multiple-deliverable revenue recognition guidance prospectively. The filing states that adoption had no material impact on Q1 revenue, but future changes in pricing and go-to-market practices could affect the timing of revenue recognition.
- Unrecognized tax benefits totaled $217.5 million, excluding interest and penalties, with approximately $16.2 million of accrued interest and penalties. Potential reductions in unrecognized tax benefits within the next twelve months were estimated at $0 to approximately $13 million.
- Pending legal matters included shareholder litigation related to the Omniture acquisition, an Eolas patent action and the ThinkVillage-Kiwi trade-secret and related claims. No loss was accrued because losses were not considered probable or estimable.
- Key risks include competition from Microsoft, Google, Apple, open-source and HTML5 alternatives; execution and integration risks from Omniture; subscription renewal and privacy risks; cybersecurity and service interruption risks; foreign currency exposure; intellectual-property litigation; distributor concentration; potential impairment of goodwill and intangible assets; and increased leverage.
- Subsequent to quarter-end, Adobe entered into a structured stock repurchase agreement requiring a $250 million prepayment.
Most important facts for an investor to verify
- Whether CS5 launched successfully and offset continued weakness in CS4-related revenue.
- Omniture retention, subscription renewal rates, organic growth, integration costs and expected synergies.
- Whether operating expense growth moderates and operating margins recover from the 20.6% reported margin.
- Debt-service requirements, use of the revolving facility and compliance with lease and credit-related covenants.
- Progress and cash costs associated with the restructuring programs and facility obligations.
- Developments in the Omniture-related shareholder litigation, patent claims and ThinkVillage-Kiwi litigation.
- Changes in revenue-recognition practices, deferred revenue and the timing of subscription and multiple-element arrangement revenue.
- Foreign currency movements, investment portfolio valuation and the effect of international economic conditions on revenue.