Adobe Systems Incorporated — Fiscal Q1 2016 Form 10-Q Summary
Business context and reporting period
Adobe reported results for the 14-week first quarter ended March 4, 2016, compared with the 13-week quarter ended February 27, 2015. The extra week benefited the current-period results. The company’s principal growth areas were Digital Media, including Creative Cloud and Document Cloud, and Digital Marketing, including Adobe Marketing Cloud. Print and Publishing remained a smaller, declining segment.
Financial performance and liquidity
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Total revenue | $1,383.3 million | $1,109.2 million | +25% |
| Subscription revenue | $1,070.3 million | $713.4 million | +50% |
| Gross profit | $1,184.8 million | $942.4 million | +26% |
| Gross margin | 86% | 85% | +1 percentage point |
| Operating income | $307.8 million | $173.0 million | +78% |
| Net income | $254.3 million | $84.9 million | +200% |
| Diluted EPS | $0.50 | $0.17 | +194% |
| Cash flow from operations | $497.5 million | $183.0 million | +172% |
Subscription revenue represented 77% of total revenue, compared with 64% in the prior-year quarter. Operating expenses increased 14% to $877.0 million, primarily from higher headcount, incentive compensation and marketing spending. The effective tax rate was 13%, versus 48% in the prior-year quarter, benefiting mainly from the retroactive reinstatement of the U.S. research and development tax credit and the absence of a prior-year one-time tax cost.
- Digital Media revenue was $931.7 million, up 33%; Digital Marketing revenue was $406.2 million, up 14%; Print and Publishing revenue was $45.4 million, down 8%.
- Creative revenue was $732.9 million, up 44%, while Document Cloud revenue was $198.8 million, up 3%. Adobe Marketing Cloud revenue was $377.3 million, up 21%.
- Digital Media annualized recurring revenue increased to $3.13 billion from $2.88 billion at fiscal year-end. Creative ARR was $2.74 billion and Document Cloud ARR was $393.0 million.
- Deferred revenue was $1.61 billion at March 4, 2016, up 8% from November 27, 2015, primarily due to new and renewed Marketing Cloud contracts and higher Creative Cloud subscriptions.
- Cash and cash equivalents were $830.7 million and short-term investments were $3.27 billion, for approximately $4.10 billion of cash and short-term investments. Working capital was $2.70 billion.
- Net cash used in investing was $258.8 million, principally reflecting purchases of short-term investments, property and equipment, and long-term investments. Net cash used in financing was $284.4 million, primarily from treasury-stock repurchases and related issuance costs.
- Debt had a carrying value of $1.92 billion, consisting of $900 million of 4.75% senior notes due 2020 and $1.0 billion of 3.25% senior notes due 2025. The $1.0 billion revolving credit facility was undrawn and available.
Material changes versus the prior comparable period
- The business continued its transition from perpetual software licenses to subscription and hosted offerings. Product revenue declined 31% to $201.1 million, while subscription revenue grew 50%.
- Revenue growth was led by Creative Cloud, increased paid subscriptions, Adobe Marketing Cloud adoption, Adobe Experience Manager, Adobe Campaign and Adobe Analytics.
- Foreign currency reduced reported revenue by approximately $44.9 million after hedging impacts, although revenue increased in all geographic regions on a reported basis.
- Operating income and net income benefited from strong revenue growth, operating leverage and a substantially lower effective tax rate. The comparison also reflects the extra week in the current quarter.
- Adobe repurchased approximately 1.5 million shares at an average price of $88.67 and had approximately $1.48 billion remaining under its repurchase authority at March 4, 2016. Subsequent to quarter-end, Adobe committed an additional $225 million under a structured repurchase agreement, leaving approximately $1.2 billion available.
Guidance, outlook, commentary, risks and unusual items
Management emphasized continued investment in Digital Media and Digital Marketing, growth in recurring revenue, expansion of Creative Cloud and Document Cloud subscriptions, and continued adoption of Adobe Marketing Cloud. The filing does not provide a clear numerical quarterly or full-year revenue or earnings guidance figure.
- Management expects subscription revenue to continue increasing as SaaS and subscription models expand, but revenue recognition is spread over subscription terms and may lag changes in bookings, renewals or demand.
- Key risks include subscription renewal rates, pricing and customer adoption; competition and disruptive technologies; cloud-service reliability, cybersecurity and data privacy; foreign currency volatility; complex enterprise sales cycles; intellectual-property disputes; acquisitions and integration; tax examinations; and macroeconomic and geopolitical conditions.
- Adobe disclosed approximately $262.7 million of gross unrecognized tax benefits, excluding interest and penalties, and $29.6 million of accrued interest and penalties. Potential decreases in unrecognized tax benefits within the next 12 months were estimated at $0 to approximately $10.0 million.
- The company reported an immaterial other-than-temporary impairment of certain cost-method investments. No material impairment was identified in its short-term investment portfolio.
- Adobe disclosed a sanctions-compliance matter involving a €24.34, approximately $27, subscription purchased by a representative of Bank Melli. The account was deactivated, the matter was voluntarily disclosed to OFAC, and Adobe stated it does not intend to continue the activity.
- The company remained in compliance with its debt, revolving credit facility and Almaden Tower lease covenants. It believes existing liquidity, operating cash flow and available credit are sufficient for the next 12 months.
- New revenue-recognition and lease accounting standards were not yet effective. Adobe was evaluating their effects; the filing identifies fiscal 2019 for the revenue standard and fiscal 2020 for the lease standard.
Most important facts for investors to verify
- Separate the benefit of the 14-week quarter from underlying revenue, ARR, margin and cash-flow growth.
- Track Creative Cloud and Document Cloud ARR, paid subscriptions, renewal rates and deferred revenue as leading indicators of recurring revenue.
- Assess the sustainability of the 13% effective tax rate, including the impact of discrete tax benefits and ongoing tax examinations.
- Monitor the transition away from perpetual product revenue and the effect on reported revenue timing, margins and cash conversion.
- Review debt maturities, interest costs, share repurchase commitments and the use of cash and short-term investments.
- Evaluate exposure to foreign currency, cybersecurity, privacy, service availability, intellectual-property claims and enterprise sales-cycle volatility.