Adobe Inc. Form 10-Q Summary
Business context and reporting period
Adobe reported results for the third quarter and first nine months of fiscal 2020, ended August 28, 2020, compared with the corresponding periods ended August 30, 2019. Adobe provides creative, document, digital experience, publishing and related cloud-based software products. Subscription revenue represented 93% of quarterly revenue and 92% of year-to-date revenue.
Key financial metrics
| Metric | Q3 FY2020 | Q3 FY2019 | Change |
|---|---|---|---|
| Total revenue | $3.225 billion | $2.834 billion | 14% |
| Subscription revenue | $3.000 billion | $2.547 billion | 18% |
| Gross profit | $2.798 billion | $2.418 billion | 16% |
| Gross margin | 86.8% | 85.3% | Up approximately 1.5 points |
| Operating income | $1.069 billion | $854 million | 25% |
| Operating margin | 33.1% | 30.1% | Up approximately 3.0 points |
| Net income | $955 million | $793 million | 20% |
| Diluted earnings per share | $1.97 | $1.61 | 22% |
For the first nine months, revenue was $9.444 billion, up 15%; gross profit was $8.150 billion; operating income was $3.022 billion; and net income was $3.010 billion, compared with $2.100 billion in the prior-year period. Year-to-date gross margin was approximately 86.3%, operating margin approximately 32.0%, and net margin approximately 31.9%. The year-to-date effective tax rate benefited from a $224 million tax benefit related to an intra-entity transfer of intellectual property rights.
Digital Media revenue increased 19% in the quarter to $2.337 billion, including Creative revenue of $1.962 billion, up 19%, and Document Cloud revenue of $375 million, up 22%. Digital Experience revenue increased 2% to $838 million; subscription revenue increased 7% to $729 million, or 14% excluding Advertising Cloud. Publishing revenue declined 2% to $50 million.
Digital Media annualized recurring revenue was $9.63 billion at quarter-end, up 16% from $8.33 billion at fiscal year-end 2019. Creative ARR was $8.29 billion and Document Cloud ARR was $1.34 billion. Remaining performance obligations were approximately $10.34 billion, with approximately 74% expected to be recognized within the following 12 months, excluding certain enterprise committed-fund arrangements.
Cash flow, debt and liquidity
| Metric | Nine months FY2020 | Nine months FY2019 |
|---|---|---|
| Cash flow from operations | $3.945 billion | $3.045 billion |
| Cash used in investing | $283 million | $287 million |
| Cash used in financing | $2.548 billion | $2.180 billion |
| Ending cash and cash equivalents | $3.767 billion | $2.209 billion |
Cash, cash equivalents and short-term investments totaled $5.264 billion at August 28, 2020. Debt at par was $4.150 billion, with a carrying value of $4.116 billion, implying gross cash and short-term investments exceeded debt by approximately $1.114 billion before considering other obligations. Working capital was a $2.257 billion surplus, compared with a $1.696 billion deficit at November 29, 2019.
In February 2020, Adobe issued $3.15 billion of senior notes with maturities from 2023 through 2030 and used the proceeds to repay its $2.25 billion term loan and $900 million of notes that matured in the first quarter. The $1 billion revolving credit facility was undrawn, and Adobe reported compliance with applicable debt covenants.
Adobe repurchased approximately $2.2 billion of stock during the first nine months and $618 million during the quarter. Approximately $2.05 billion remained under the repurchase authorization after a subsequent $850 million structured repurchase agreement entered into after quarter-end.
Material changes versus the prior comparable period
- Revenue growth accelerated through Digital Media, while product and services revenue declined as the business continued shifting toward subscriptions.
- Operating income and margins improved despite an 11% quarterly increase in operating expenses, driven by higher compensation, stock-based compensation and marketing costs.
- Operating cash flow increased 30% year over year to $3.945 billion, primarily reflecting higher net income and non-cash adjustments.
- Debt composition changed materially following the refinancing, although total debt at par remained $4.150 billion.
- Cash and cash equivalents increased by $1.117 billion from the beginning of fiscal 2020 despite stock repurchases and debt refinancing activity.
- Adobe adopted the new lease standard at the beginning of fiscal 2020, recording operating lease right-of-use assets of approximately $519 million and lease liabilities of approximately $618 million at adoption; management reported no impact on net income or cash flows.
Guidance, outlook, commentary and risks
The filing does not provide a clear numerical quarterly or full-year guidance figure. Management described strong demand across Digital Media, particularly Creative Cloud and Document Cloud, and expects continued long-term growth from subscription adoption, new users and expanded digital engagement.
Adobe continued winding down transaction-driven Advertising Cloud offerings. Management expects the wind-down and reduced advertising spending to negatively affect Digital Experience growth, while also reducing related media costs and improving Digital Experience gross margins.
COVID-19 created significant uncertainty. Adobe shifted employees to remote work, suspended travel and converted major in-person events to digital formats through June 2021. The company reported delays in enterprise transactions and consulting implementations, weakness among small and medium-sized businesses, and potential future effects on customer demand, collections, renewals, sales cycles and service delivery.
Management stated that existing cash, investments, operating cash flows and available credit capacity should be sufficient for working capital and operating needs over the next 12 months. Key risks include prolonged pandemic effects, competition, cybersecurity and data privacy incidents, dependence on third-party hosting and support providers, foreign currency volatility, enterprise sales-cycle delays, customer renewal risk, intellectual-property litigation, tax-law changes and potential impairment of goodwill or intangible assets.
Important facts for investors to verify
- Reconcile ARR growth with recognized subscription revenue, deferred revenue and remaining performance obligations.
- Monitor the continuing Advertising Cloud wind-down and its effects on Digital Experience revenue, media costs and margins.
- Assess the sustainability of margins after increased research, marketing, compensation and stock-based compensation spending.
- Review the $4.15 billion debt portfolio, maturity schedule, interest obligations and the availability of the $1 billion revolving facility.
- Evaluate the recurring effects of COVID-19 on enterprise purchasing, small and medium-sized businesses, consulting activity, renewals and collections.
- Separate the $224 million discrete tax benefit from underlying earnings and assess future tax-rate effects from intellectual-property restructuring and California tax legislation.
- Consider the ongoing $8 billion repurchase authorization, structured repurchase commitments and resulting share-count effects.