Adobe Inc.
Q1 2020 Earnings Call Transcript

Published: 12 Mar 2020

[Operator:]

Good afternoon. I would like to welcome you to the Adobe First Quarter Fiscal Year 2020 Earnings Conference Call. Today’s call is being recorded. There will be a question-and-answer session following the prepared remarks. I would like to now turn the call over to Mr. Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

[Mike Saviage:]

Good afternoon. Thank you for joining us today. Joining me on the call are Adobe’s President and CEO, Shantanu Narayen; and John Murphy, Executive Vice President and CFO.

[Shantanu Narayen:]

Thanks, Mike, and good afternoon. We delivered another record quarter in Q1, achieving $3.09 billion in revenue representing 19% year-over-year growth. GAAP earnings per share for the quarter was $1.96 and non-GAAP earnings per share was $2.27. Our strategy of unleashing creativity for all, accelerating document productivity, and powering digital businesses continues to drive strong top and bottomline performance. Adobe’s unique advantage of enabling everyone from students to creative professionals to small businesses and large enterprises, to create and deliver exceptional digital experiences is enabling our customers’ success and fueling our business momentum. With Creative Cloud, Document Cloud, and Experience Cloud, we are growing across all geographies and industries and appealing to a broader set of customers than ever before.

[John Murphy:]

Thanks, Shantanu. In the first quarter of FY’20, Adobe achieved record revenue of $3.09 billion, which represents 19% year-over-year growth. GAAP diluted earnings per share in Q1 was $1.96 and non-GAAP diluted earnings per share was $2.27. Our earnings per share results include a charge related to the cancellation of corporate events including Adobe Summit due to the COVID-19 situation, which lowered both GAAP and non-GAAP EPS by $0.07 in the quarter.

[Mike Saviage:]

Thanks, John, and thank you for those comments. As we announced last week, we have shifted Adobe Summit, our Annual Digital Experience user conference, to be an online event and virtual conference starting on Tuesday, March 31st. As the event draws closer, we will provide instructions on the summit.adobe.com website for how to access online keynote presentations and educational sessions along with the timing of them. If you wish to listen to a playback of today’s conference call, a webcast archive of the call will be available on our IR site later today. Alternatively, can you listen to a phone replay by calling 888-203-1112, use conference ID number 4347041. International callers should dial 719-457-0820. The phone playback service will be available beginning at 5 p.m. Pacific Time today and ending at 5 p.m. Pacific Time on March 19, 2020. We will now be happy to take your questions. We ask that you limit your questions to one per person. Operator?

[Operator:]

Thank you. We will take our first question from Brent Thill with Jefferies. Please go ahead.

[Brent Thill:]

Thanks. Good afternoon, Mike. Congrats on three decades. I am very happy for you. Shantanu, just on the Creative business, there are many questions around obviously no one knows how long the current situation is going to last, but many are kind of asking how insulated you believe the Creative business is. The guidance for this next quarter was encouraging and probably a little bit better than most thought. So if you could just walk through how you are thinking about that business over the next several quarters?

[Shantanu Narayen:]

Sure, Brent. Clearly, I think, let me start out by saying that, we would all acknowledge that the situation is pretty unprecedented. And so, as it relates to the Creative business, maybe I will give you color not just for Q1, but also actually for the first few days of March and I will talk about that in the context of the customers that we serve. And maybe again, as sort of a preview to what John talked about, let me just tell you a little bit about the options that we considered. I mean, clearly, given the situation we could have sort of chosen to give no forward-looking guidance, we could have provided a range given the uncertainty or what we thought was most appropriate was given we have fairly good visibility on a direct basis, to guide based on a number and then provide more color. On Creative Cloud specifically, Brent, and on Document Cloud, in the direct-to-consumer on adobe.com, we saw actually little to no impact on Q1 on adobe.com across all geographies for both Creative and Document Cloud products; and thus far, it’s early in Q2, the overall traffic and conversion pattern have actually continued. In China, where we have a little bit more of an indirect route to market for CC and DC, which is through resellers, we know that the business is small but we saw some impact in Q1, and as you saw, despite that, we had pretty awesome overall ARR for Digital Media in Q1. In South Korea, we have actually seen relatively stable business in our Digital Media business today. In Italy, what we saw was that as the situation worsened, we saw some impact in the reseller business, but we actually appear to have seen some additional strength on adobe.com, and the fact that I guess, we have multiple routes to market there sort of helps ameliorate that. So, I mean, in sort of conclusion, we are continuing to monitor. We think that clearly long-term the Creative Expression business continues to be really strong. And specifically as it relates to Q2, absent the COVID situation, we would have probably again had sequential increase to Digital Media ARR where we’re trying to factor what we have seen a little bit of the uncertainty in the reseller impact and enterprise. And even in revenue, we have a little perpetual revenue. So, I know that was a little bit of a long answer, but hopefully that gives color in terms of all of the work that’s gone in over the last 10 days. We have already done a couple of business reviews, and this is as of what we know today, while there’s uncertainty, that’s our best estimate of how we think this plays out in Q2.

[Brent Thill:]

Thanks for all the color.

[Operator:]

We will take our next question from Keith Weiss with Morgan Stanley. Please go ahead.

[Keith Weiss:]

Excellent. Thank you, guys. Thank you for taking the question. Mike, it’s been great working with you. You are way too young to be retiring, but that’s your business. Shantanu, thank you so much for kind of giving that detail on how you guys are thinking about the outlook, I think, it definitely helps investors understand how you are thinking about it and that you are imparting some conservatism into the guidance for kind of what’s going on out there. I was hoping to get some view from John on how you guys are thinking about the expense side of the equation? How aggressively that you will sort of look to match sort of the expense growth rates, is that kind of what you are seeing in the environment. Is there -- are you going to be looking to kind of protect the margins and protect the contribution margins in the business as the demand fluctuates?

[John Murphy:]

Sure. Thanks, Keith. As we think about our ability to understand our business, we have got a great ability through our DDOM model our data driven operating model to understand how we can actually drive growth, while still expanding margins and protecting the profitability of the company. And that thesis hasn’t changed. We are still a growth company and we do focus on the profitability of the company. So, we are able to shift our expenses and our spending and our investments to appropriately capture the opportunity, but at the same time be able to hit our goals of expanding operating margin as we set out at Analyst Day this year.

[Shantanu Narayen:]

And Keith, maybe I will add a couple more things, I mean, I think, we have always done a good job of balancing the topline and bottomline. I have no doubt that companies like Adobe actually will emerge stronger as a result of this. And what John has already instituted is we are looking at every expense associated with it. There’s certainly some areas where we have great online solutions to help our customers, where we will be investing more and there are other areas where we will be far more prudent as it relates to what happens. And maybe, John, you can also specifically comment on what happened in Q1 as it relates to that one-time charge just so that everybody understands that?

[John Murphy:]

Yeah. So when we decided to cancel the in-person corporate events that caused us to pull in the expenses into Q1. So we made that decision before we finished Q1. So we took that charge. Its $40 million associated with that. The -- typically much of that expense would be in Q2 and would be offset actually by revenue we would get through registration fees for participants, as well as sponsorship dollars as well. So the way we have approached it is obviously the sponsors, the participants, we will not be taking that money in, so we pulled all that expense forward. So that one-time charge that you had in Q1 associated with this, all this activity was obviously a significant impact. Our margin would have been 41.6% otherwise had we not had to take that charge.

[Keith Weiss:]

Super helpful. Thanks so much, guys.

[Operator:]

We will take our next question from Kash Rangan with Bank of America. Please go ahead.

[Kash Rangan:]

Hi. Thank you very much for all the details, Shantanu. You talked about how things finished up in the February quarter. I am more curious about your guidance for the May quarter. What are the assumptions especially as it relates to the geography that we are all most concerned about that could potentially worsen from a COVID perspective. What kind of growth rates and what kind of U-shaped or V-shaped recovery are you assuming for your two businesses in the U.S? Thank you so much and stay safe everybody.

[Shantanu Narayen:]

Well, Kash, I think, we would all agree that the situation is rapidly evolving. I was interesting just even watching after the 1 o’clock the six or seven announcements that went out. And so, clearly, we are trying to give you the best color that we have as of today and not sure that I can predict or anybody can actually predict what happens. But, I think, we gave you color in Digital Media, which is we continue to expect to see the notion of both creativity and accelerating document productivity, and where there’s a direct engagement with customers, to continue to invest in engaging with them digitally and continuing to drive our business, because there is clear value associated with that. I think maybe just similarly, I can give you a little color on the Enterprise. I mean, as you know, with Enterprise selling, the end of the quarter represents a fairly large chunk of business for most people. And while that does not have impact on revenue and you never expect to close your entire pipeline, I think, as we said in the prepared remarks as well, Kash, we saw some unanticipated slippage at the end of the quarter. And so the way we have tried to think about it for Q2, I have had a ton of conversations from CEOs across all industries, and I think, the two themes that are absolutely consistent, the first theme is everybody is first and foremost making sure that they take care of the well-being of their employees. They are all dealing with travel restrictions. They are all dealing with the outbreak. The second thing that they all tell me is that, hey, this if anything will accentuate the need to engage digitally not just internal to the corporation to keep the corporation going, but externally, in order to engage with customers. But given what’s happening with travel, we just expect that there is going to be some delays associated with it, we have tried to factor that in. And the way I would describe that is absent any COVID, we would have certainly seen Digital Experience being targeted higher than what we targeted. So I think we have tried to factor it in. And maybe just a little bit more color on that, Kash, when you look at the revenue components for our business, there are three components. There’s the revenue that comes off of bookings, bookings translating into revenue. There’s usage based Advertising Cloud revenue that goes into that. And there’s delivery based revenue when services are delivered and implemented. We suspect that the services will go out a little bit. The importance remains, but as people are concerned about people traveling that will perhaps slow down a little bit and depending on the industry or vertical, that will be different. Some of it may be more immediate in terms of the bounce back some of it may be a little bit more detailed. And so what we know is that we expect bookings will probably take a little longer. We think services delivery may go a little bit longer. We feel like the Advertising Cloud might be impacted. Those are all factored into how we thought about it. If the world falls apart, that could certainly change. But we will continue to monitor it. What I have not heard from anybody is any issue associated with keeping digital front and center, because, I think, this demonstrates more than ever before if you can’t engage with your customers digitally, you are dead in the water. So hopefully that helps.

[Kash Rangan:]

Absolutely. Thank you so much.

[Operator:]

We will take our next question from Sterling Auty with JP Morgan. Please go ahead.

[Sterling Auty:]

Yeah. Thanks. Hi, guys. So, Shantanu, I am just curious if anything with COVID-19 would actually impact any new product introductions in terms of feature functionality or any changes that maybe you would have considered in the near-term around pricing in any of the geographies?

[Shantanu Narayen:]

Sterling, not to the best, I mean, we are excited. We will be doing our first digital summit. So Anil Chakravarthy is busy. I mean all the exciting things that we were going to announce in person. The plan is to announce it actually virtually coming up, a couple of exciting things there. I mean, the Adobe Experience Manager that we just introduced, which is a cloud based approach, that’s significantly, again, I think, as we said reduces the time for people to do to through self-serve and get new websites, and campaigns up and running. So on the Experience side, it was really going to be an event where we describe everything that’s on. Now with the Creative Cloud space as well, I mean, I think, if there’s one group that works more from home and has more flexible work policy, it tends to be the product team. So, I think, overall navigating what it means for nobody to be in offices, Sterling. But I think we are actually as well placed as anybody in terms of doing it. The one other thing I will mention is, we are actually for universities, given how much universities closure that there is. We are making available our creative and other tools available for people for this online training. And so, I think, while the situation is crazy, I think, there are a whole bunch of our solutions, whether it’s all the documents that are going to be shared right now, what’s going to happen with signatures, whether what you are going to do with respect to helping people engage digitally. So nothing yet that’s changed. It all depends on how long the situation continues from my perspective, Sterling.

[Sterling Auty:]

And Mike, congratulations, it’s been one hell of a run. You have done a great job as IR. So congratulations and enjoy your retirement.

[Mike Saviage:]

Thanks, Sterling.

[Operator:]

We will take our next question from Saket Kalia with Barclays Capital. Please go ahead.

[Saket Kalia:]

Hey, guys. Thanks for taking my question here and I echo my congrats to you as well, Mike, on your retirement. Shantanu, maybe for you, just thinking a little higher level, can you just talk a little bit about bringing on Anil Chakravarthy on to the team and maybe what some of his longer term goals are in the Digital Experience business?

[Shantanu Narayen:]

Sure. Saket, I mean, I think, we are clearly the undisputed leader and have the most comprehensive offering as it relates to and we created the digital marketing category. I think as we focused on what we call as generational technology platform development. We recognized that the ability to create this unified profile and to really make sure that your first party data, you are taking more advantage of it, were two massive opportunities that every enterprise was going to have to figure out how to take advantage of, much like Adobe did with our DDOM. Anil’s background as it relates to what he had done both at Informatica and prior to that and the fact that as CEO he had the ability to look across the entire business. Both of those are going to be extremely important for us as we continue to invest in product and as we continue to focus on ensuring that the CIO and the people who engage with data, which is an area that he is completely familiar with are ones that we continue to invest in and differentiate our solution. It’s early. As I said, his presence is already being felt. But what he has been really up to is going and meeting with a number of customers. I may have to ground him for a little while right now, but he also actually had the ability to go meet with all the product people. So I think both on the product and the customer stuff, just continuing to make sure that we extend our lead and have a unified leader. Those were really the two reasons for having him on-board.

[Saket Kalia:]

Great. Thanks.

[Shantanu Narayen:]

Thank you.

[Operator:]

We will take our next question from Jay Vleeschhouwer with Griffin Securities. Please go ahead.

[Jay Vleeschhouwer:]

Thank you. Good evening. A shorter-term question, Shantanu and for you, John, as well, I noticed that you had a small sequential decrease from Q4

[Shantanu Narayen:]

… opportunity, we have tailwinds, we have growth in three areas. I think what you saw was really concerted effort again by John to rationalize as we had done these M&A’s and to make sure that we are not duplicating functions. And so, I think, as part of every annual planning process, we first prune to make sure that we are investing in the right areas, and I think, we did a really good job of looking at that. So for somebody like you who follows us and sees that sort of ebb and flow, it’s just a continuous process that we do. We have opportunities. I mean, we are going to continue I think again based on the question that I think Keith asked. We will be prudent about how we look at this stuff. But even if you look at our targets for Q2, I think, you will see that we are one of the companies that’s best positioned in the entire industry opportunities and we are going to continue to hire, but we will be prudent and we will continue to monitor this.

[Jay Vleeschhouwer:]

Thanks, Shantanu.

[Operator:]

We will take our next question from Kirk Materne with Evercore ISI. Please go ahead.

[Kirk Materne:]

Yeah. Thanks very much. And I guess at the outset, I’d say, thanks very much for the guidance with COVID and I realize things are moving quickly, but even just the color you have given today I think will help us think through this as it continues to evolve. My question, Shantanu, would be on the Experience Cloud, obviously, a year later, I think, you have integrated the acquisitions, if you weren’t talking about COVID right now. How is your feeling about just sort of the integration of the product and the setup for that business as we head into calendar 2020?

[Shantanu Narayen:]

Yeah. I think, Kirk, what we would have said absent COVID was good Q1, greater than 20% increase in the book of business, revenue growing nicely, highlighting the progress that we would have made. I think I shared a number of customers we have had the Experience Platform customers go live. I would have talked about cloud AEM. I think we touched on Adobe Commerce and that’s only because I wouldn’t have had time to talk about what we are doing with B2B and B2C. How we have integrated Marketo into that. And so, I think, that fundamental customer demand for digital and for engagement, nothing changes. And so that’s what I would have said if it weren’t for this situation with Q1. In effect, what John and I would have been here, talking about record performance in Q1, continued momentum from Q4, robust cash flows, strong EPS performance, and I think, all of you guys would have been saying why aren’t you raising targets if it weren’t for COVID and so, I think, I continue to feel good about the long-term opportunity.

[Kirk Materne:]

That’s great. Thanks. And Mike, congrats on your retirement.

[Mike Saviage:]

Thanks, Kirk.

[Operator:]

We will take our next question from Brad Zelnick with Credit Suisse. Please go ahead.

[Brad Zelnick:]

Great. Thank you so much, and Mike, I got to echo my congrats. I always thought maybe I would be able to retire before you but not with how the markets have been performing over the last few weeks, for sure. I think I am going to be working a long time. But anyway, Shantanu, thank you so much for all the color you provided on Digital Media so far, but just want to understand its resiliency. Because realistically, if we think about your end markets it includes a lot of small businesses and hobbyists, where there may be more stress or not thought of as much as top of wallet item? Are you may be able to share what that represents as the percentage of the overall ARR, even ballpark if you can? And what are the leading indicators are that you see through your DDOM to be able to see things like engagement, renewal rates, maybe even by SKU as it relates to this segment of the market? Thanks.

[Shantanu Narayen:]

You are right, Brad, in that the real blessing of that business is how broad and how diverse it is and how our tools, whether they be on the creative side or whether they be on the document side are as pervasive and market leaders as they are. We tried to give the color even during this current situation and the impact, and as we said on adobe.com, there’s been little to no impact. We have become really good at how we engage with these customers. And the thing that also gives us long-term confidence in that, Brad, is the different price points. And so you have to think about it with respect to the different price points that we have and we have got really good at understanding where the mobile offerings need to be. With all these people being at home, they will have to do some things and hopefully expressing their creativity we just have to continue to help them do that. And so, yeah, we are not saying that we are completely going to be unimpacted, but so far and just looking at what we have seen thus far, these tools and creativity and the importance of design, nothing that’s happened in the last few weeks diminishes the importance of that.

[Brad Zelnick:]

Thanks very much, Shantanu and be healthy everyone. Thanks.

[Shantanu Narayen:]

Thanks, Brad.

[Operator:]

We will take our next question from Jennifer Lowe with UBS. Please go ahead.

[Jennifer Lowe:]

Great. Thank you and I would like to echo the congrats to Mike on a well deserved retirement after a pretty impressive run. So just looking at the slipped deals that were discussed in the call, obviously, it’s sort of unprecedented times and there’s a lot of moving pieces there. But is there any sort of commonality to the deals that seemed to slip in terms of size, whether those were new versus up-sell transactions, whether they were sort of just logistical issues that cropped up? I am just trying to get a better sense of where it’s just tougher to get business done at this point? Thanks.

[Shantanu Narayen:]

There weren’t really any patterns, Jennifer. I mean, I think, there was a couple of -- if people were at home and you expect that to have people in the office to close. So just some examples of in certain countries where people were maybe not at work, I mean, you followed Enterprise Software for a long time. There are a number of stakeholders that are required. We do use Adobe Signature to close them. But I would say, it’s what little bit more of just getting the stakeholders involved. And I would actually attribute it to a large degree to the preoccupation correctly of dealing with employees and employees’ well-being. I am sure this is true of your company as well. Everybody’s just dealing with are employees safe, how do we make sure, all of that. So I would attribute it more to that, and we will just have to continue to monitor what happens. But the conversations that I am having and we are so -- one of the things we are doing is actually proactively reaching out to every single customer of what is the right way to engage with them digitally in terms of saying, here’s how we can help. I think all of you are probably seeing more communication. I should acknowledge that a number of the deals that slipped actually did close in the time that was past it, but it’s uncertain times. So hopefully that gives you some color into what we were observing.

[Jennifer Lowe:]

Okay. Thank you.

[Operator:]

We will hear next from Walter Pritchard with Citi. Please go ahead.

[Walter Pritchard:]

Hi. Thanks. Two questions, one, just on Sign, you talked pretty positively about this business for a number of quarters. I am wondering if you could update us on what is the strongest demand drivers there, are they kind of direct deals out selling as part of larger engagements or is it more transactional attached to Acrobat and especially the mid-market low end?

[Shantanu Narayen:]

I think, Walter, it’s actually all across the map. We had a good quarter as it related to Sign revenue. And make no mistake, the Reader distribution and wanting to do stuff with PDF and work flows associated with PDF, that’s a big part of that business. We have talked about how we are going to make those APIs available as well so that people can embed it. We talked a little about the integration with Google, but it’s all across. I mean, as an ingredient service or as we talk about it, Sign is certainly part of the solution across all those segments. As a complete offering with respect to what we have with PDF across Acrobat and in the enterprise and with Adobe Experience Manager. But it really is across the board. And I think you are going to see more demand for those services right now because physical signatures are going to be less easy to manage than electronic signatures.

[Walter Pritchard:]

Got it. And then just John, I am not sure if you are breaking this out but I guess we are getting this question quite a bit. On the DX business with the transactional piece where you broke out those three pieces, any way to give us, let us know if that’s the smallest of the piece or any range in terms of revenue exposure from transactional in DX would be helpful?

[John Murphy:]

Yeah. No. If you go back to the Analyst Meeting, we broke out each of those three components for you. And so you can see that it’s actually roughly 20% of the business, 20%, 25% of the total DX business in terms of Ad Cloud and Professional Services piece.

[Walter Pritchard:]

Okay. That hasn’t changed?

[John Murphy:]

No.

[Walter Pritchard:]

Okay. Thank you very much.

[Mike Saviage:]

Operator, we are coming up on the top of the hour. We will take one more question, please.

[Operator:]

Thank you. We will take our last question from Keith Bachman with BMO. Please go ahead.

[Keith Bachman:]

Hi. Thank you very much. Shantanu, I just wanted to revisit a little bit on the Experience revenue. You are guiding the current quarter, the second quarter rather to 12% year-over-year growth. Back in December, you talked about the growth potential for 2020 being plus or minus 16%. How should we think about the rest of the year in the Digital Experience segment, given macro’s really tough and the COVID virus is making it challenging, but also including any kind of competitive comments that you want to make surrounding it? Thanks.

[Shantanu Narayen:]

Yeah. I think, what we see, frankly, right now is the color associated with what’s happening in Q2. As you know, in December we provide targets based on the product roadmap. And from my perspective, Q1 execution and performance was terrific. And while we are giving you as much color as we know for Q2 as of today, given the unprecedented times, we are really not going to comment on the second half. We will continue to monitor. None of this changes long-term trends and so that’s how we think about it.

[John Murphy:]

And maybe I could just add in there, because we did give a lot of in the prepared remarks about updating tax rates for the year because of the fluctuation. And I know in terms of modeling the folks have been asking what do we think about beyond FY’20 and so as we I said at the Analyst Meeting we expected an increase in FY’21. And so based on these changes that I had highlighted in my prepared remarks on the tax rates, you can kind of expect FY’21 to be roughly a 17% non-GAAP rate, 19% on a GAAP basis.

[Shantanu Narayen:]

And since that was the last question, let me also echo, I think, all of your sentiments, which is thank Mike for his outstanding contributions to Adobe. I have certainly observed firsthand his passion for the business and his IR leadership has been invaluable to me as a partner as we have transformed the company. I told him that we have been doing this call together since 2001 and I will certainly miss him and wish him well. But with his help, we will make sure that we have a smooth transition. So thank you, Mike. As it relates to the business, Q1 was strong, we will continue to execute on our strategy and focus on the three large opportunities ahead of us, unleashing creativity, accelerating document productivity, empowering digital businesses. And I don’t think that the recent situation changes the relevance or importance of any of this for our customers and it will only magnify the need to go digital with more urgency. Given the situation is fluid we tried to give you as much insight into what’s happening in our business. The demand for Creative Document and Enterprise is strong. But the impact as we said of COVID will probably be felt a little bit more in the short-term in the enterprise business. But again, we believe that we are better positioned than most to continue to innovate, to drive both top and bottomline, and emerge stronger and more mission critical. We really hope you guys will join us for our digital summit and much like a number of you have said, stay safe and thank you for joining us today.

[Operator:]

Thank you. This concludes our call.