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ADBE > SEC Filings for ADBE > Form 10-Q on 25-Jun-2014All Recent SEC Filings

Show all filings for ADOBE SYSTEMS INC

Form 10-Q for ADOBE SYSTEMS INC


25-Jun-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding product plans, future growth and market opportunities which involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Risk Factors" in Part II, Item 1A of this report. You should carefully review the risks described herein and in other documents we file from time to time with the U.S. Securities and Exchange Commission ("the SEC"), including our Annual Report on Form 10-K for fiscal 2013. When used in this report, the words "will," "expects," "could," "would," "may," "anticipates," "intends," "plans," "believes," "seeks," "targets," "estimates," "looks for," "looks to," "continues" and similar expressions, as well as statements regarding our focus for the future, are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document, except as required by law.
BUSINESS OVERVIEW Founded in 1982, Adobe Systems Incorporated is one of the largest and most diversified software companies in the world. We offer a line of products and services used by creative professionals, marketers, knowledge workers, application developers, enterprises and consumers for creating, managing, delivering, measuring, optimizing and engaging with compelling content and experiences across multiple operating systems, devices and media. We market and license our products and services directly to enterprise customers through our sales force and to end-users through app stores and our own website at www.adobe.com. We also distribute our products and services through a network of distributors, value-added resellers ("VARs"), systems integrators, independent software vendors ("ISVs"), retailers and original equipment manufacturers ("OEMs"). In addition, we license our technology to hardware manufacturers, software developers and service providers for use in their products and solutions. We offer some of our products via a Software-as-a-Service ("SaaS") model or a managed services model (both of which are referred to as a hosted or cloud-based model) as well as through term subscription and pay-per-use models. Our products run on personal and server-based computers, as well as on smartphones, tablets and other devices, depending on the product. We have operations in the Americas, Europe, Middle East and Africa ("EMEA") and Asia-Pacific ("APAC").
We maintain executive offices and principal facilities at 345 Park Avenue, San Jose, California 95110-2704. Our telephone number is 408-536-6000. We maintain a website at www.adobe.com. Investors can obtain copies of our SEC filings from this site free of charge, as well as from the SEC website at www.sec.gov.
OPERATIONS OVERVIEW For our second quarter of fiscal 2014, we reported financial results consistent with the continued execution of our long-term plans for our two strategic growth areas, Digital Media and Digital Marketing, while continuing to market and license a broad portfolio of products and solutions.

In our Digital Media segment, we are a market leader with Creative Cloud, our subscription-based offering for creating and publishing content and applications. Creative Cloud, first delivered in May 2012, is our next-generation offering that supersedes our historical model of licensing our creative products with perpetual licenses. Creative Cloud delivers value through more frequent product updates, storage and access to user files stored in the cloud with syncing of files across users' machines, community-based features and services through our acquisition of Behance in December 2012, digital publishing and app creation capabilities, and lower entry point pricing for cost-sensitive customers.

We offer Creative Cloud for individuals and for teams, and we enable larger enterprise customers to acquire Creative Cloud capabilities through Enterprise Term License Agreements ("ETLAs"). The three Creative Cloud offerings address the multiple routes to market we use to license our creative software to targeted customers. Adoption of Creative Cloud is transforming our business model and we continue to expect this to drive higher long-term revenue growth through an expansion of our customer base by acquiring new users through a lower cost of entry and delivery of additional features and value, as well as keeping existing customers current on our latest release. This model drives our revenue to be more recurring and predictable as revenue is recognized ratably.

We continue to implement strategies that will accelerate awareness, consideration and purchase of subscriptions to our Creative Cloud offering. These strategies include increasing the value Creative Cloud users receive, as well as targeted promotions


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and offers that attract past customers and potential users to try out and ultimately subscribe to Creative Cloud. Additionally, in May 2013 we announced we would exclusively deliver new creative product innovations and features to Creative Cloud subscribers, and that Adobe Creative Suite 6 ("CS6"), which was released in May 2012, would be the last major update we provide for perpetual licensees. More recently, we announced the removal of general availability of CS6 on a perpetual licensing basis from legacy shrinkwrap and volume licensing channels. We will still offer CS6 through our Adobe.com website and in certain markets.

Because of the shift towards Creative Cloud subscriptions and ETLAs, we have stated we expect perpetual revenue for CS6 to decline, and in the second half of fiscal 2014 we expect revenue from perpetual licensing of our creative professional products to be immaterial.

Total Digital Media revenue grew during the second quarter of fiscal 2014 compared to the year ago period and the first quarter of fiscal 2014 as strong adoption of our Creative Cloud subscription offering continued. Also contributing to the sequential increase in total Digital Media revenue was the increase in perpetual revenue from our channel-driven CS6 offerings. The increase in CS6 perpetual revenue was expected due to the second quarter of fiscal 2014 being the last quarter we broadly offered volume licensing of CS6 through channel resellers targeting enterprise customers. As a result, there was a final surge of CS6 perpetual product purchases during the second quarter of fiscal 2014.

To assist with an understanding of this transition and the related shift in revenue described above, we are using certain performance metrics to assess the health and trajectory of our overall Digital Media segment. These metrics include the total number of current paid subscriptions and Annualized Recurring Revenue ("ARR"). ARR should be viewed independently of revenue, deferred revenue and unbilled deferred revenue as ARR is a performance metric and is not intended to be combined with any of these items.

For our Creative business, we define Creative ARR as the sum of:

• the number of current subscriptions, multiplied by the average subscription price paid per user per month, multiplied by twelve months; plus,

•twelve months of contract value of ETLAs where the revenue is ratably recognized over the life of the contract; plus

•twelve months of Adobe Digital Publishing Suite contract value where the revenue is ratably recognized.

We exited the second quarter of fiscal 2014 with 2.308 million paid Creative Cloud subscriptions, up 60% from 1.439 million at the end of fiscal 2013. Total Creative ARR exiting the second quarter of fiscal 2014 was $1.20 billion, up from $801 million at the end of fiscal 2013.

Our Digital Media segment also includes our Document Services products and solutions, including Acrobat, Acrobat cloud services and EchoSign e-signing solution. In the second quarter of fiscal 2014 we continued to drive solid adoption of our Acrobat family of products primarily through license agreements with enterprise customers. During the second quarter of fiscal 2014, a higher percentage of these agreements were ETLAs, which like ETLAs with our creative customers, cause more revenue to be recognized over time rather than at the time of contract signing. This has caused a year-over-year decline in Acrobat revenue which was partially offset by increases associated with our Acrobat cloud services during the second quarter of fiscal 2014 compared to the year ago period.

We expect that the benefit of ETLAs will improve our growth potential over time. In addition to Acrobat, we also drove strong adoption of subscription based services including our Acrobat cloud services. Combined, adoption of Acrobat through ETLAs and our Document Services subscription offerings helped grow Document Services ARR to $183 million exiting the second quarter of fiscal 2014, up from $82 million at the end of the second quarter of fiscal 2013.

Total Digital Media ARR, which we define as the sum of Creative ARR and Document Services ARR, grew to $1.38 billion at the end of the second quarter of fiscal 2014, up from $444 million at the end of the second quarter fiscal 2013, demonstrating the progress we have made with the transformation of our business to a more recurring, ratable and predictable revenue model.

We are a market leader in the fast-growing category addressed by our Digital Marketing segment. Our Adobe Marketing Cloud includes six solutions addressing the expanding needs of marketers, the newest of which is Adobe Campaign-a cross-channel campaign management tool that we added to our portfolio with the acquisition of Neolane during the third quarter of fiscal 2013.


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Revenue from Adobe Marketing Cloud increased 23% during the three months ended May 30, 2014 compared to the year ago period. Helping to drive this performance was strong adoption of our Adobe Experience Manager ("AEM") offering and the addition of Neolane in mid-third quarter of fiscal 2013.

AEM, our fastest growing digital marketing solution, has typically been licensed by our customers as an on-premise offering where license revenue is recognized at the time of the transaction. In the past year, we introduced a managed services offering of AEM for which revenue is recognized ratably. We expect continued adoption of the newer managed services offering, which will increasingly migrate AEM revenue in this segment to be recurring. Given the comparisons involving more new license revenue being recognized over time versus past license revenue being recognized up front, we anticipate this trend may impact overall Adobe Marketing Cloud reported revenue growth in the near term.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, business combinations, goodwill impairment and income taxes have the greatest potential impact on our Condensed Consolidated Financial Statements. These areas are key components of our results of operations and are based on complex rules requiring us to make judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. There have been no significant changes in our critical accounting policies and estimates during the six months ended May 30, 2014, as compared to the critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 29, 2013. Recent Accounting Pronouncements Not Yet Effective On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for us in the first quarter of fiscal 2018. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

With the exception of the new revenue standard discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the six months ended May 30, 2014, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended November 29, 2013, that are of significance or potential significance to us.

RESULTS OF OPERATIONS
Financial Performance Summary for the Second Quarter of Fiscal 2014

• Consistent with our strategy, during the three months ended May 30, 2014, our subscription revenue as a percentage of total revenue increased to 45% compared with 25%, in the year ago period, as we transition more of our business to a subscription-based model.

• We exited the second quarter of fiscal 2014 with 2.308 million paid Creative Cloud subscriptions, up 60% from 1.439 million at the end of fiscal 2013.

• Total Digital Media ARR of approximately $1.38 billion as of May 30, 2014 increased by $434 million, or 46%, from $944 million as of November 29, 2013. The change in our Digital Media ARR is primarily due to increases in the number of paid Creative Cloud individual and team subscriptions and continued adoption of our enterprise Creative Cloud offering through our ETLAs.


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• Adobe Marketing Cloud revenue of $282.9 million during the three months ended May 30, 2014 increased by $53.4 million, or 23% compared with the year ago period. The increase was primarily due to strong adoption of our AEM offering and the addition of Neolane which we acquired in the third quarter of fiscal 2013.

• Our total deferred revenue of $928.6 million as of May 30, 2014 increased by $99.8 million, or 12% from November 29, 2013, primarily due to increases in subscriptions, ETLAs and renewals for our Adobe Marketing Cloud services.

• Cost of revenue of $154.9 million during the three months ended May 30, 2014 increased by $19.6 million, or 14% compared with the year ago period, primarily due to increased hosting and server costs associated with our subscription and SaaS offerings and costs associated with compensation and related benefits driven by additional headcount.

• Operating expenses of $778.0 million during the three months ended May 30, 2014 increased by $14.0 million, or 2% compared with the year ago period, primarily due to increased costs associated with compensation and related benefits.

• Net income of $88.5 million during the three months ended May 30, 2014 increased by $12.0 million, or 16% compared with the year ago period.

• Net cash flow from operations was $619.2 million during the six months ended May 30, 2014 and remained relatively stable compared to the six months ended May 31, 2013.

Revenue for the Three and Six Months Ended May 30, 2014 and May 31, 2013
(dollars in millions)
                                  Three Months                                 Six Months
                               2014          2013         % Change         2014          2013         % Change
Product                     $   479.2     $   644.9          (26 )%     $   950.7     $ 1,320.7          (28 )%
Percentage of total revenue        45 %          64 %                          46 %          65 %
Subscription                    476.7         254.5           87  %         900.2         478.8           88  %
Percentage of total revenue        45 %          25 %                          44 %          24 %
Services and support            112.3         111.1            1  %         217.4         218.9           (1 )%
Percentage of total revenue        10 %          11 %                          10 %          11 %
Total revenue               $ 1,068.2     $ 1,010.5            6  %     $ 2,068.3     $ 2,018.4            2  %

Our subscription revenue is comprised primarily of fees we charge for our subscription and hosted service offerings including certain of our Adobe Marketing Cloud services and Creative Cloud. We recognize subscription revenue ratably over the term of agreements with our customers, beginning on the commencement of the service. We expect our subscription revenue will continue to increase as a result of our investments in new SaaS and subscription models. We also expect this to increase the amount of recurring revenue we generate as a percent of our total revenue.
As described in Note 15 of our Notes to Condensed Consolidated Financial Statements, we have the following segments: Digital Media, Digital Marketing and Print and Publishing. Subscription revenue by reportable segment for the three and six months ended May 30, 2014 and May 31, 2013 are as follows (dollars in millions):

                              Three Months                       Six Months
                             2014       2013     % Change      2014       2013     % Change
Digital Media              $ 282.8    $  94.5       199 %    $ 520.7    $ 163.6       218 %
Digital Marketing            191.8      159.5        20 %      375.6      314.3        19 %
Print and Publishing           2.1        0.5       320 %        3.9        0.9       333 %
Total subscription revenue $ 476.7    $ 254.5        87 %    $ 900.2    $ 478.8        88 %

Our services and support revenue is comprised of consulting, training and maintenance and support, primarily related to the licensing of our enterprise, developer and platform products and the sale of our hosted Adobe Marketing Cloud services. Our support revenue also includes technical support and developer support to partners and developer organizations related to our desktop products. Our maintenance and support offerings, which entitle customers to receive desktop product upgrades and enhancements or technical support, depending on the offering, are generally recognized ratably over the term of the arrangement.


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Segment Information (dollars in millions)
                                  Three Months                                 Six Months
                               2014          2013         % Change         2014          2013         % Change
Digital Media               $   691.6     $   670.0            3  %     $ 1,332.7     $ 1,358.4           (2 )%
Percentage of total revenue        65 %          66 %                          65 %          67 %
Digital Marketing               330.3         285.4           16  %         644.7         553.1           17  %
Percentage of total revenue        31 %          28 %                          31 %          28 %
Print and Publishing             46.3          55.1          (16 )%          90.9         106.9          (15 )%
Percentage of total revenue         4 %           6 %                           4 %           5 %
Total revenue               $ 1,068.2     $ 1,010.5            6  %     $ 2,068.3     $ 2,018.4            2  %

Digital Media

Revenue from Digital Media increased during the three months ended May 30, 2014, as compared to the three months ended May 31, 2013 primarily driven by increased subscription revenue from continued strong adoption of Creative Cloud and ETLAs as we continue to transition more of our business to a subscription based model. Revenue from Digital Media decreased slightly during the six months ended May 30, 2014, as compared to the six months ended May 31, 2013 as the increases in subscription revenue were offset by declines in revenue associated with our perpetual creative offerings.

Revenue related to our creative professional products, which includes our Creative Cloud, Creative Suite editions and CS point products, increased during the three and six months ended May 30, 2014 , as compared to the three and six months ended May 31, 2013. Due to the increase in subscriptions and ETLAs, our revenue from Creative Cloud increased during the three and six months ended May 30, 2014 as compared to the year-ago periods. The increases were offset by declines in revenue from our CS point products and Creative Suite editions during the three and six months ended May 30, 2014 as compared to the year-ago periods.

Revenue associated with our other creative products decreased during the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013 primarily due to decreases associated with distribution of third-party software via Flash Player downloads and lower than expected demand for our Photoshop Elements family of products. These decreases were offset in part by increases in revenue associated with our Digital Publishing Suite.

For our creative offerings, the total number of perpetual units licensed decreased while the number of subscription units licensed increased during the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013. Unit average selling prices for our perpetual units licensed decreased during the three and six months ended May 30, 2014 as compared to the same periods in the prior year.

Document Services revenue, which includes our Acrobat product family, remained relatively stable during the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013 primarily due to increases in our Acrobat cloud service revenue offset by decreases in Acrobat desktop and EchoSign revenue as well as the continued shift to ETLAs.

Within Document Services, excluding large enterprise license agreement deals, the number of units licensed decreased while the unit average selling prices increased for the three and six months ended May 30, 2014, as compared to the three and six months ended May 31, 2013.

Digital Marketing

Revenue from Digital Marketing increased $44.9 million and $91.6 million during the three and six months ended May 30, 2014, as compared to the three and six months ended May 31, 2013. The increases were primarily due to continued revenue growth associated with our Adobe Marketing Cloud, which increased 23% and 24% during the three and six months ended May 30, 2014, respectively, as compared to the year ago period. Contributing to this increase was strong adoption of all of our Digital Marketing offerings, particularly AEM, and the addition of Neolane which we acquired in the third quarter of fiscal 2013.


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Print and Publishing

Revenue from Print and Publishing decreased during the three and six months
ended May 30, 2014 as compared to the three and six months ended May 31, 2013,
primarily due to a nonrecurring font licensing transaction in the second quarter
of fiscal 2013, decreases in legacy product revenue and, to a lesser extent,
increased ETLAs for some products in this group.
Geographical Information (dollars in millions)
                          Three Months                                Six Months Ended
                       2014           2013         % Change          2014           2013         % Change
Americas           $    579.2     $    525.4           10  %     $  1,115.8     $  1,025.7            9  %
Percentage of
total revenue              54 %           52 %                           54 %           51 %
EMEA                    296.6          262.8           13  %          596.4          560.3            6  %
Percentage of
total revenue              28 %           26 %                           29 %           28 %
APAC                    192.4          222.3          (13 )%          356.1          432.4          (18 )%
Percentage of
total revenue              18 %           22 %                           17 %           21 %
Total revenue      $  1,068.2     $  1,010.5            6  %     $  2,068.3     $  2,018.4            2  %

Overall revenue during the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013 increased in the Americas and EMEA and declined in APAC. Revenue in the Americas and EMEA increased during the three and six months ended May 30, 2014 as compared to the year-ago periods due to increases in Digital Media and Digital Marketing, partially offset by declines in Print and Publishing. The weakening of the U.S. Dollar against the Euro and the British Pound also caused revenue in EMEA to increase during the three and six months ended May 31, 2013 as compared to the year-ago periods. Revenue in APAC decreased across all reportable segments during the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013 which was due in part to the strengthening of the U.S. Dollar against the Japanese Yen. Within each geographical region, the fluctuations in revenue by reportable segment were attributable to the factors noted in the segment information above.
Included in the overall increase in revenue for the three and six months ended May 30, 2014 as compared to the three and six months ended May 31, 2013 were impacts associated with foreign currency as shown below. (in millions) Three Months Six Months Revenue impact: Increase/(Decrease) EMEA:

Euro                 $        8.1     $     12.6
British Pound                 4.1            5.1
Other currencies              0.4            0.5
Total EMEA                   12.6           18.2
Japanese Yen                 (6.1 )        (19.3 )
Other currencies             (3.4 )         (6.7 )
Total revenue impact          3.1           (7.8 )
Hedging impact:
Japanese Yen                  2.6            5.4
Total impact         $        5.7     $     (2.4 )

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