Adobe Systems Incorporated Form 10-Q Summary
Business Context and Reporting Period
The filing covers the three and six months ended June 4, 2010, compared with the periods ended May 29, 2009. Adobe provides creative, document, enterprise, web analytics, platform and publishing software and services globally. Fiscal 2010 is a 53-week year, and the first quarter and six-month results benefited from an extra week versus fiscal 2009.
The quarter included the launch of Adobe Creative Suite 5 and the first full comparable reporting period including Omniture, acquired October 23, 2009 for approximately $1.8 billion.
Financial Results and Key Metrics
| Metric | Three months ended June 4, 2010 | Three months ended May 29, 2009 | Six months ended June 4, 2010 | Six months ended May 29, 2009 |
|---|---|---|---|---|
| Revenue | $943.0 million | $704.7 million | $1.802 billion | $1.491 billion |
| Gross profit | $835.2 million | $632.7 million | $1.605 billion | $1.342 billion |
| Gross margin | 88.6% | 89.8% | 89.1% | 89.9% |
| Operating income | $227.3 million | $161.4 million | $404.1 million | $369.3 million |
| Operating margin | 24.1% | 22.9% | 22.4% | 24.8% |
| Net income | $148.6 million | $126.1 million | $275.8 million | $282.5 million |
| Diluted earnings per share | $0.28 | $0.24 | $0.52 | $0.53 |
- Quarterly revenue increased 34%; six-month revenue increased 21%.
- Product revenue increased 23% in the quarter and 9% year to date. Subscription revenue increased to $92.3 million quarterly and $187.8 million year to date, primarily due to Omniture.
- Quarterly net income increased 18%, while six-month net income declined 2% because of higher interest expense, foreign exchange losses, stock-based compensation and operating costs.
- Six-month operating cash flow was $510.9 million versus $627.3 million in the prior-year period. Capital expenditures were $75.2 million.
- Cash, cash equivalents and short-term investments totaled $2.645 billion at June 4, 2010, up from $1.904 billion at November 27, 2009. Working capital was $2.306 billion.
- Debt was $1.494 billion, consisting of $600 million of 3.25% senior notes due 2015 and $900 million of 4.75% senior notes due 2020. Adobe repaid its $1.0 billion revolving credit facility borrowing on February 1, 2010; the full $1.0 billion facility remained available.
Material Changes Versus the Prior Comparable Period
- Creative Solutions revenue increased 29% in the quarter and 11% year to date, driven by CS5 shipments, strong CS4 licensing ahead of the launch and higher Photoshop revenue.
- Knowledge Worker revenue increased 13% in the quarter and 12% year to date, primarily from continued Acrobat demand.
- Enterprise revenue increased 7% in the quarter and 5% year to date, supported by Connect and LiveCycle.
- Omniture contributed $83.5 million of quarterly revenue and $171.2 million year-to-date revenue; no comparable Omniture revenue was included in the prior-year periods.
- Cost of revenue increased 50% quarterly and 32% year to date, primarily because of Omniture subscription infrastructure, acquired-intangible amortization and CS5-related product costs.
- Research and development, sales and marketing, and general and administrative expenses increased primarily because of Omniture-related headcount and higher incentive and stock-based compensation. Sales and marketing expense increased 32% quarterly and 25% year to date.
- Non-operating expense increased materially, to $33.1 million in the quarter and $43.7 million year to date, reflecting higher interest expense, foreign exchange losses and investment losses.
- Adobe early adopted amended multiple-element revenue recognition guidance prospectively. Management stated that the adoption had no material impact on reported revenue for the periods presented, although future go-to-market changes could affect the timing of revenue recognition.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management described the quarter as a record-revenue period driven by CS5, stable demand in major markets and continued Acrobat demand. Management expected CS5 demand and revenue strength to continue through the remainder of fiscal 2010, assuming a stable economic environment.
- Omniture user transactions reached 1.26 trillion, up 12% year over year, and management reported strong bookings momentum.
- Restructuring charges were $11.5 million in the quarter and $23.2 million year to date. Accrued restructuring liabilities totaled $24.2 million at June 4, 2010, with certain facility obligations extending through fiscal 2021.
- Adobe completed its annual goodwill impairment test and recorded no goodwill impairment. Purchased and other intangible assets were $447.4 million net, with continuing amortization expected to affect future earnings.
- Adobe recorded $14.3 million of net investment losses year to date, including unrealized losses and a $0.4 million other-than-temporary impairment charge on certain direct investments.
- Unrecognized tax benefits were $210.1 million, excluding interest and penalties. Management estimated that potential decreases in unrecognized tax benefits within the next 12 months could range from zero to approximately $10 million.
- Subsequent to quarter-end, Adobe authorized up to $1.6 billion of stock repurchases through the end of fiscal 2012 and entered into structured repurchase agreements requiring $400 million of prepayments. Approximately $165.3 million remained under an earlier agreement at June 4, 2010.
- Pending matters included shareholder litigation related to the Omniture acquisition and a patent infringement action brought by Eolas Technologies. No amounts were accrued because losses were not considered probable or estimable. The filing states that unfavorable outcomes in litigation, intellectual-property disputes, tax examinations or indemnification matters could materially affect results.
- Key risks include competition from Microsoft, Google, Apple, Oracle and open-source or HTML5 technologies; dependence on successful product cycles and new business models; Omniture integration and subscription renewals; foreign currency exposure; privacy, cybersecurity and service availability; distributor concentration; global economic conditions; intellectual-property claims; goodwill impairment; and higher debt-service requirements.
Investor Verification Checklist
- Verify the sustainability of CS5-driven revenue growth after the initial launch cycle and the effect of product-transition timing on future periods.
- Separate organic Adobe performance from Omniture-acquired revenue, costs, amortization and integration effects.
- Monitor subscription growth, Omniture renewal rates, bookings, margins and the cost of hosting and supporting the services business.
- Reconcile operating cash flow with net income, particularly the effects of deferred revenue, receivables, taxes and non-cash charges.
- Review the terms, interest burden, fair value and covenant status of the $1.5 billion senior-notes offering and the availability of the revolving credit facility.
- Assess the impact of stock repurchases and structured repurchase prepayments on share count, liquidity and capital allocation.
- Evaluate restructuring cash payments, remaining facility obligations and the expected timing of related charges.
- Track tax examinations, unrecognized tax benefits, litigation and intellectual-property contingencies, none of which had a clear maximum financial exposure in the filing.