Adobe Systems Incorporated — Form 10-Q Summary
Business context and reporting period
Adobe reported for the quarterly period ended September 3, 2010. The company provides creative, document, enterprise, web analytics, platform, and publishing software and services globally. Fiscal 2010 is a 53-week year, so the nine-month period includes an additional week versus fiscal 2009.
The results include Omniture, acquired October 23, 2009 for approximately $1.8 billion. Adobe also commenced a tender offer for Day Software Holding AG, expected to close in the fourth quarter of fiscal 2010.
Key financial metrics
| Metric | Q3 FY2010 | Q3 FY2009 | 9M FY2010 | 9M FY2009 |
|---|---|---|---|---|
| Total revenue | $990.3 million | $697.5 million | $2.792 billion | $2.189 billion |
| Gross profit | $891.2 million | $632.5 million | $2.496 billion | $1.974 billion |
| Gross margin | 90.0% | 90.7% | 89.4% | 90.2% |
| Operating income | $302.0 million | $167.6 million | $706.1 million | $536.9 million |
| Operating margin | 30.5% | 24.0% | 25.3% | 24.5% |
| Net income | $230.1 million | $136.0 million | $505.8 million | $418.6 million |
| Diluted EPS | $0.44 | $0.26 | $0.95 | $0.79 |
| Operating cash flow | Not separately provided | Not separately provided | $802.4 million | $863.9 million |
Subscription revenue increased to $98.6 million in the quarter and $286.4 million year to date, compared with $13.3 million and $37.7 million, respectively, in the prior-year periods. Omniture contributed approximately $74.9 million of quarterly subscription revenue and $225.7 million year to date.
At September 3, 2010, cash and cash equivalents were $814.1 million, short-term investments were $1.764 billion, and total cash, cash equivalents, and short-term investments were $2.578 billion. Working capital was $2.269 billion.
Total debt and capital lease obligations were $1.524 billion, including $1.494 billion of senior notes and $30.6 million of capital lease obligations. Adobe had no outstanding borrowings under its $1.0 billion revolving credit facility, which remained available. The company stated that it was in compliance with applicable debt and lease covenants.
Material changes versus the prior comparable period
- Third-quarter revenue increased 42%; nine-month revenue increased 28%.
- Creative Solutions revenue increased 37% in the quarter, driven by adoption of Creative Suite 5 and Lightroom 3.
- Knowledge Worker revenue increased 18%, primarily from enterprise Acrobat licensing.
- Enterprise revenue increased 31%, reflecting stronger Connect and LiveCycle adoption.
- Platform revenue declined 9% in the quarter, mainly due to lower OEM and developer-tool revenue.
- Print and Publishing revenue increased 23%, aided by new products and a non-recurring revenue transaction.
- Operating margin improved primarily because revenue growth outpaced operating expense growth and product cost leverage improved.
- Operating cash flow declined to $802.4 million from $863.9 million, while investing cash usage increased to $956.3 million, principally from purchases of short-term investments.
- Adobe issued $1.5 billion of senior notes in February 2010 and used $1.0 billion of the proceeds to repay its revolving credit facility.
- The company repurchased approximately 19.0 million shares for $650.0 million during the nine-month period and authorized up to $1.6 billion of additional repurchases through fiscal 2012.
Outlook, commentary, risks, and unusual items
Management described the quarter as a record-revenue period driven by CS5 adoption and strength in Omniture, Knowledge Worker, Enterprise, and Print and Publishing. The filing does not provide a specific quantitative revenue or earnings guidance range.
Adobe expects to use existing cash and investments to fund the proposed Day acquisition, valued at approximately 254.7 million Swiss francs. A related currency forward contract had a fair value of $8.1 million at quarter-end, with the gain recorded in interest and other income.
- Restructuring liabilities totaled approximately $17.1 million at quarter-end, with facility-related payments extending through fiscal 2021.
- The company had approximately $212.7 million of gross unrecognized tax benefits, plus approximately $18.5 million of accrued interest and penalties. Potential reductions in unrecognized tax benefits over the next 12 months were estimated at $0 to approximately $100 million.
- Omniture integration, evolving subscription and SaaS models, and related revenue recognition judgments remain significant execution and accounting considerations.
- Key risks include intense competition, including HTML5 and competing SaaS offerings; product development and platform transitions; cybersecurity, privacy, and service availability; foreign currency exposure; distributor concentration; acquisition integration; intellectual-property litigation; tax examinations; and potential impairment of goodwill or intangible assets.
- Pending legal matters included shareholder litigation related to the Omniture acquisition and patent litigation brought by Eolas Technologies. No loss was accrued because the losses were not considered probable or estimable.
- Adobe early adopted revised multiple-element revenue recognition guidance prospectively. Management stated that adoption had no material impact on reported total revenue to date, although future go-to-market changes could affect the timing of revenue recognition.
Important facts for investors to verify
- Whether CS5 adoption and Creative Solutions growth remain sustainable after launch-related demand moderates.
- Omniture retention, subscription renewal rates, integration costs, and contribution to recurring revenue and cash flow.
- The closing, funding, and integration of the Day Software acquisition.
- Debt-service costs, liquidity after stock repurchases and acquisitions, and continued compliance with covenants.
- Resolution and timing of tax examinations and the potential realization of unrecognized tax benefits.
- Exposure and outcomes related to pending litigation, intellectual-property claims, privacy requirements, and cybersecurity incidents.
- Future effects of revenue-recognition estimates, restructuring obligations, stock-based compensation, and possible goodwill or intangible-asset impairment.