Adobe Systems Incorporated Form 10-Q Summary
Business Context and Reporting Period
Adobe Systems Incorporated develops and markets creative, digital media, enterprise, marketing, document and related software and services. This unaudited Form 10-Q covers the three and six months ended June 3, 2011, compared with June 4, 2010. Fiscal 2010 included an extra week in the first quarter, which affects six-month comparisons.
Reportable segments were Creative and Interactive Solutions, Digital Media Solutions, Knowledge Worker, Enterprise, Omniture, and Print and Publishing. Adobe completed the acquisition of Demdex in January 2011; the acquisition was not material to consolidated results. Day Software, acquired in October 2010, contributed to the Enterprise segment.
Financial Performance and Position
| Metric | Q2 FY2011 | Q2 FY2010 | Change |
|---|---|---|---|
| Revenue | $1,023.2 million | $943.0 million | 9% |
| Gross profit | $914.0 million | $835.2 million | 9% |
| Operating income | $276.7 million | $227.3 million | 22% |
| Net income | $229.4 million | $148.6 million | 54% |
| Diluted earnings per share | $0.45 | $0.28 | 61% |
Approximate Q2 margins were 89.3% gross, 27.0% operating and 22.4% net, compared with approximately 88.6%, 24.1% and 15.8%, respectively, in the prior-year quarter.
| Metric | Six months FY2011 | Six months FY2010 | Change |
|---|---|---|---|
| Revenue | $2,050.9 million | $1,801.7 million | 14% |
| Operating income | $579.1 million | $404.1 million | 43% |
| Net income | $464.0 million | $275.8 million | 68% |
| Diluted earnings per share | $0.91 | $0.52 | 75% |
| Cash flow from operations | $721.4 million | $511.0 million | 41% |
Six-month approximate margins were 89.4% gross, 28.2% operating and 22.6% net, versus approximately 89.1%, 22.4% and 15.3% in the prior-year period. The lower effective tax rate materially supported earnings: 11.5% in Q2 and 14.9% for the six months, versus 23.5% in both comparable prior-year periods, primarily due to a favorable state tax ruling and reinstatement of the federal research and development tax credit.
At June 3, 2011, cash and cash equivalents were $827.5 million and short-term investments were $1.798 billion, for total cash and investments of approximately $2.626 billion. Working capital was $2.339 billion. Total debt and capital lease obligations were $1.518 billion, including $1.494 billion of senior notes and $24.1 million of capital lease obligations. The $1.0 billion revolving credit facility was undrawn and fully available. Management stated that existing liquidity, operating cash flow and available credit were sufficient for the next twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by Enterprise, Omniture and Knowledge Worker, with Q2 segment growth of 34%, 26% and 17%, respectively.
- Creative and Interactive Solutions grew 2% in Q2 and 13% year to date, supported by Creative Suite 5 and the May 2011 launch of Creative Suite 5.5.
- Digital Media Solutions declined 2% in Q2 because of lower digital imaging revenue, including a 12% decline in Photoshop point-product revenue; it grew 7% year to date.
- Print and Publishing declined 5% in Q2 and 3% year to date, primarily due to lower Shockwave revenue and product-release timing.
- Subscription revenue increased 18% in Q2 and 15% year to date; services and support revenue increased 51% and 42%, respectively. Product revenue increased 4% in Q2 and 12% year to date.
- Operating expenses increased 5% in both Q2 and the six-month period, below revenue growth. Research and development, sales and marketing, and general and administrative expenses increased primarily because of higher headcount-related compensation.
- Restructuring charges declined sharply, from $11.5 million to a favorable $0.6 million adjustment in Q2, and from $23.2 million to a favorable $0.5 million adjustment year to date.
- Non-operating expense improved to $17.5 million in Q2 from $33.1 million, and to $33.7 million year to date from $43.7 million, largely because prior-year investment losses and foreign-exchange losses were lower or did not recur.
- Operating cash flow increased to $721.4 million. Investing cash use declined to $197.6 million from $689.6 million, while financing cash use was $452.4 million, primarily reflecting $545.0 million of treasury-stock repurchases.
- Adobe repurchased approximately 16.3 million shares for $545.0 million during the six months. A further $150.0 million structured repurchase was entered into after quarter-end, leaving $305.0 million under the authorized program.
Guidance, Outlook, Commentary and Risks
The filing does not provide a clear quantitative earnings or revenue guidance range. Management described Q2 results as strong and cited continued adoption of Content Authoring, Digital Marketing Optimization and Customer Experience Management solutions. Management expected continued investment in research and development, international operations, facilities, technology systems and potentially strategic acquisitions.
- Management noted potential near-term operating impact in Japan from the March 2011 earthquake and related events.
- Foreign-currency movements materially increased reported Q2 revenue by approximately $35.2 million, including hedging effects.
- Approximately 14% of Q2 net revenue came from Ingram Micro, creating distributor concentration risk, although no individual Ingram agreement exceeded 10% of total revenue.
- Adobe faces competition, product-transition risk, changing software-delivery models, subscription-renewal risk, platform and mobile-device shifts, and uncertainty regarding enterprise, government and cloud markets.
- Security vulnerabilities, privacy and data-protection requirements, hosted-service interruptions and third-party service-provider failures could affect revenue, costs and reputation.
- The company had $12.5 million of accrued restructuring obligations, with certain facility-related payments extending through fiscal 2021.
- An Eolas patent-infringement lawsuit was scheduled for trial in October 2011. Adobe had recorded no provision because it did not believe a loss was probable or estimable.
- Unrecognized tax benefits totaled $163.2 million, excluding interest and penalties; management estimated that potential reductions within the next twelve months could range from zero to approximately $5 million.
- Adobe completed its annual goodwill impairment test with no impairment identified and reported no material impairment of its investment portfolio.
Important Facts for Investors to Verify
- Whether revenue growth and margins remained durable after the CS5.5 launch and as the business shifted toward subscriptions and hosted services.
- The sustainability of the unusually low effective tax rate, including the impact of discrete tax benefits and foreign earnings treated as permanently reinvested.
- Enterprise and Omniture growth, customer renewal rates, bookings and the integration benefits from Day and other acquisitions.
- Liquidity after stock repurchases, future acquisition spending and the $1.5 billion senior-note obligations.
- The status and potential financial exposure of the Eolas litigation, tax examinations, restructuring commitments and lease-related residual-value guarantees.
- Exposure to foreign-exchange movements, Japan-related conditions, distributor concentration, cybersecurity, privacy regulation and hosted-service availability.
- The effect of the 53-week fiscal 2010 calendar on comparisons with the prior-year six-month period.