Adobe Systems Incorporated — Fiscal 2017 First-Quarter Form 10-Q Summary
Business context and reporting period
Adobe provides digital media, digital marketing, document, creative and publishing software and services through subscription, hosted, term-license and perpetual-license models. The filing covers the 13 weeks ended March 3, 2017; the comparable fiscal 2016 quarter covered 14 weeks, which benefited prior-year results. The condensed financial statements are unaudited.
Key financial metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Total revenue | $1.682 billion | $1.383 billion | +22% |
| Subscription revenue | $1.384 billion | $1.070 billion | +29% |
| Gross profit | $1.444 billion | $1.185 billion | +22% |
| Gross margin | 85.9% | 85.6% | +0.3 pts |
| Operating income | $469.0 million | $307.8 million | +52% |
| Operating margin | 27.9% | 22.3% | +5.6 pts |
| Net income | $398.4 million | $254.3 million | +57% |
| Diluted EPS | $0.80 | $0.50 | +60% |
| Cash flow from operations | $730.4 million | $497.5 million | +47% |
Segment revenue was $1.138 billion for Digital Media, $501.1 million for Digital Marketing and $42.4 million for Print and Publishing. Digital Media gross margin was 95%, Digital Marketing gross margin was 64% and Print and Publishing gross margin was 96%.
At March 3, 2017, cash and cash equivalents were $1.069 billion and short-term investments were $3.579 billion, for total cash, cash equivalents and short-term investments of approximately $4.648 billion. Working capital was $2.802 billion. Debt had a carrying value of $1.884 billion, consisting of senior notes due 2020 and 2025. The $1 billion revolving credit facility was undrawn, and Adobe reported compliance with all debt covenants.
Material changes versus the prior comparable period
- Subscription revenue increased to 82% of total revenue from 77%, while product revenue declined 9% to $183.4 million as the transition away from perpetual licensing continued.
- Creative revenue increased 29% to $942.2 million, primarily from higher Creative Cloud subscription revenue. Document Cloud revenue decreased slightly to $195.9 million as perpetual Acrobat declines more than offset subscription and Adobe Sign growth.
- Digital Media revenue increased 22% to $1.138 billion. Digital Media annualized recurring revenue increased to $4.25 billion from $3.99 billion at fiscal year-end, including Creative ARR of $3.76 billion and Document Cloud ARR of $493 million.
- Digital Marketing revenue increased 23% to $501.1 million. Adobe Marketing Cloud revenue reached $477.3 million, up 26%; TubeMogul, acquired in December 2016, contributed $32.1 million to the increase in Marketing Cloud revenue.
- Cost of revenue rose 19% to $237.3 million, driven by higher data-center costs, TubeMogul-related media costs and increased headcount. Operating expenses rose 11% to $975.3 million, primarily from compensation and benefits associated with increased headcount.
- Operating cash flow benefited from higher net income, strong collections and increased deferred revenue. Investing cash outflows included $459.6 million for acquisitions, primarily TubeMogul, while financing outflows included $200.0 million for treasury-stock repurchases and $183.0 million of taxes related to net share settlement of equity awards.
- Goodwill increased to $5.754 billion from $5.406 billion, and purchased and other intangible assets increased to $489.2 million from $414.4 million, primarily due to the TubeMogul acquisition.
Guidance, outlook, commentary and risks
The filing does not provide a clear quantitative quarterly or full-year revenue, earnings or cash-flow guidance. Management stated that it remains focused on long-term growth in Digital Media and Digital Marketing, continued subscription adoption, recurring revenue expansion and integration of TubeMogul. Management believes existing cash, investments, operating cash flows and available credit will be sufficient for working capital and operating requirements for at least the next twelve months.
Adobe authorized a new $2.5 billion stock-repurchase program through the end of fiscal 2019. Subsequent to quarter-end, Adobe prepaid $300 million under the prior $2 billion authority; completion of that agreement would exhaust the prior authorization. Adobe also exercised its option to purchase the Almaden Tower for $103.6 million, crediting its $80.4 million lease receivable against the purchase price.
Adobe early adopted ASU 2016-09 for share-based payment accounting. Excess tax benefits were recognized through income tax expense and operating cash flows prospectively. The company is evaluating, but has not adopted, new revenue-recognition and lease standards; the revenue standard may accelerate recognition for certain term-based software licenses bundled with maintenance and support.
Principal risks include subscription renewal and customer-retention variability, complex enterprise sales cycles, competition and pricing pressure, dependence on continued product innovation, cybersecurity and service interruptions, privacy and cross-border data regulations, foreign-currency exposure, acquisition integration, intellectual-property litigation, tax examinations, goodwill impairment and debt-servicing obligations. The gross liability for unrecognized tax benefits was $152.2 million, excluding interest and penalties; management estimated possible reductions within the next 12 months ranging from zero to approximately $25 million.
Most important facts for investors to verify
- Whether Digital Media ARR and subscription growth continue to offset declines in perpetual-license revenue.
- Creative Cloud and Document Cloud renewal, customer acquisition and upsell trends, including the effect of revenue being recognized ratably over subscription terms.
- TubeMogul integration progress, incremental media and operating costs, and whether expected Digital Marketing synergies materialize.
- Future gross and operating margins as data-center, media, compensation and amortization costs increase.
- Cash deployment across acquisitions, stock repurchases, facilities and investments, including the post-quarter-end $300 million repurchase prepayment and Almaden Tower purchase.
- Potential effects of new revenue-recognition and lease accounting standards on reported revenue, deferred revenue, assets and liabilities.
- Exposure to cybersecurity, privacy, intellectual-property, foreign-currency and tax matters, including the disclosed unrecognized tax benefits and ongoing legal contingencies.