Adobe Inc.
Q1 2016 Earnings Call Transcript

Published: 18 Mar 2016

[Operator:]

Good afternoon, ladies and gentlemen. I’d like to welcome you to Adobe Systems First Quarter Fiscal Year 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I’d now like to turn the call over to Mr. Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

[Mike Saviage:]

Good afternoon and thank you for joining us today. Joining me on the call are Adobe’s President and CEO, Shantanu Narayen; and Mark Garrett, Executive Vice President and CFO. In the call today, we will discuss Adobe’s first quarter fiscal year 2016 financial results. By now, you should have a copy of our earnings press release which crossed the wire approximately one hour ago. We’ve also posted PDFs of our earnings call prepared remarks and slides, financial targets, and an updated investor datasheet on Adobe.com. If you would like a copy of these documents, you can go to the Investor Relations page and find them listed under Quick Links. Before we get started, we want to emphasize that some of the information discussed in this call, particularly our revenue and operating model targets, and our forward-looking product plans, is based on information as of today, March 17, 2016, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the Forward-Looking Statements Disclosure in the earnings press release we issued today, as well as Adobe’s SEC filings. During this call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings release and in our updated investor datasheet on Adobe’s Investor Relations website. Call participants are advised that the audio of this conference call is being webcast live in Adobe Connect, and is also being recorded for playback purposes. An archive of the webcast will be made available on Adobe’s Investor Relations website for approximately 45 days, and is the property of Adobe. The call audio and the webcast archive may not be re-recorded, or otherwise reproduced or distributed without prior written permission from Adobe. I will now turn the call over to Shantanu.

[Shantanu Narayen:]

Thanks Mike and good afternoon. Adobe’s year is off to a strong start, with first quarter revenue of $1.38 billion and non-GAAP earnings per share of $0.66. Adobe’s opportunity has never been greater. Every brand, government agency, and educational institution is undergoing large-scale digital transformation. Creating a compelling experience for their customers and constituents across every touch point is paramount to their success, and they are turning to Adobe for help. In Digital Media, Creative Cloud momentum continued in Q1 with strong adoption across all segments. There have never been more people creating content. Whether it’s creative professionals, photographers, students or hobbyists creating compelling images, videos, websites, or mobile applications, our opportunity is to provide them with a one-stop shop for all their creative needs. There are three primary growth drivers for Creative Cloud as we target a $17 billion addressable market

[Mark Garrett:]

Thanks, Shantanu. Before I comment on Q1 results, as a reminder, 2016 is a 53 week fiscal year with a 14 week first quarter. This was factored into all of the targets we provided in December. In the first quarter of FY16, Adobe achieved record revenue of $1.383 billion, which represents 25% year-over-year growth. We estimate the extra week added approximately $75 million of revenue to the quarter, but this was mainly offset by a net year-over-year currency decrease to revenue of approximately $69 million. GAAP diluted earnings per share in Q1 were $0.50 and non-GAAP diluted earnings per share were $0.66. These strong results reflect the continued momentum across our Cloud businesses. Highlights in our first quarter include

[Mike Saviage:]

Thanks Mark. Next week Adobe will host its annual Digital Marketing Summit in Las Vegas, with the opening day keynote on the morning of Tuesday, March 22nd. If you would like to attend Summit, please send an email to [e-mail] for registration information. If you are unable to attend in person, keynote sessions on Tuesday and Wednesday will be webcast live. For those who wish to listen to a playback of today’s conference call, a web-based archive of the call will be available on our IR site later today. Alternatively, you can listen to a phone replay by calling 855-859-2056; use conference ID number 63288010. International callers should dial 404-537-3406. The phone playback service will be available beginning at 5 PM Pacific Time today, and ending at 5 PM Pacific Time on March 23, 2016. We would now be happy to take your questions, and we ask that you limit your questions to one per person. Operator.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Brent Thill from UBS. Your line is open.

[Brent Thill:]

Thanks and Mark on operating expenditures, you were running flat to low single-digit growth, this quarter you were up 15% year-over-year. Can you just give us a sense of where these incremental investments are going and maybe talk a little bit about the build out of the direct distribution team around the Marketing Cloud and your aspirations there?

[Mark Garrett:]

Sure Brent, first off keep in mind we did have the extra week which impacts expense just like it impacts revenue. So a large chunk of that is based on just having the extra week. In addition we have merit increases that happened in the beginning of the year and you have got the full quarter effect of hires that you did in the fourth quarter. As you look out over the rest of the year, OPEX it won't be up sequentially just because of that extra week that you had in the first quarter and then you will see some growth in Q3 and Q4. And to your point that is more around driving sales and marketing capacity for the growth that we are seeing in all three clouds and the need to have that sales capacity on board as we get closer and closer to FY17.

[Brent Thill:]

Thanks.

[Operator:]

Your next question comes from the line of Ross MacMillan from RBC Capital Markets. Your line is open.

[Ross MacMillan:]

Thanks very much and congratulations on a strong start. Shantanu on Mobile, our recent survey work suggest that mobile apps are actually driving some new subscribers to the Creative Cloud and I would love if you can maybe cast some light on how mobile was influencing the business going forward and especially around maybe monetization of mobile-only users? Thanks.

[Shantanu Narayen:]

Yeah Ross, and I saw your survey as well, that was good work. I mean clearly what we are finding is that the over 20 million people who are first coming to us on Mobile. It is serving as a great top of the funnel in terms of the new creators getting interest in Adobe and they experience our mobile apps and then they both subscribe to as well as download all of our desktop applications. And part of it is because they all recognize that the content that they are creating is going to be consumed in Mobile and in terms of working in groups that’s the other thing that’s driving both tablet, mobile, as well as PC usage. The new experience design project as well initial feedback has been very positive. People have been asking about how they can get that also as well on Mobile and Touch. And so we just look at the explosion of mobile devices and where both content is created and consumed and it’s clearly being a tailwind, not just in the digital media business but also in the digital marketing business. And things like being able to take a picture and move that from camera into Photoshop, people just love the fact that they now have independence of where they can create content when inspiration strikes.

[Ross MacMillan:]

Thank you.

[Operator:]

Your next question comes from the line of Kirk Materne from Evercore ISI. Your line is open.

[Kirk Materne:]

Thanks very much. I was wondering Shantanu if you could talk a little about the educational SKUs that you guys have announced recently. If I recall correctly I think education was about with 25% of the units before you guys started this transition, can you just talk a little bit about where perhaps we are in that transition within education and some of the opportunities still see in front of us on that front? Thanks very much.

[Shantanu Narayen:]

Sure Kirk. I mean as you correctly pointed out, education has always been one of the largest verticals in terms of the Creative products and we have multiple offerings. We certainly offer site licenses for both K-through-12 institutions as well as higher Ed. I mean the student and teacher addition and then there is lab usage of our products. So, big picture what we are trying to do is make sure that in any setting that exists that we have the right Creative products. Creative in the education season tends to be Q3. We certainly believe that there is tens of millions of Creatives as they come into the market as part of the education segment, that’s a growth for us and that’s part of the reason why in Mark's prepared remarks also he talked about as we continue to offer our Creative products as a site license that we don’t talk about sub. So, it’s going well. More and more people are using our Creative products. Internationally also we are starting to have education be adopted. But big picture we look at it and say whether it’s a student teacher single edition, whether it’s an institution, or whether it’s a lab usage. We want to make sure that our offering is applicable in all of those settings.

[Kirk Materne:]

Thanks a lot.

[Operator:]

Your next question comes from the line of Kash Rangan from Bank of America Merrill Lynch. Your line is open.

[Kash Rangan:]

Hi, thank you guys. I am curious if you can give us some feel for the momentum for stock in this particular quarter, can you roughly quantify how many in terms of subscribers you added for stock? And Shantanu maybe a quick refresher on what are your longer term attached rate targets for stock perhaps netting three to four years within the Creative family? And if you have the time what was that Marketing Cloud bookings in this quarter, bookings growth rate in this quarter? Thank you.

[Shantanu Narayen:]

So multiple questions there Kash, let me try and pass them one by one. The first is as it relates to revenue for stock during the quarter it was in line with our expectations so it’s doing well. Again just to refresh folks, we offer on demand stock as a way for people to buy particular stock assets. We certainly offer a stock only subscription and we then offer a combined subscription which allows people to both access stock as well as our desktop products. And so across all of them we are continuing to see accelerated usage of the stock subscriptions. We don’t break that out Kash in terms of what it is and that’s the reason we’re focused on just continuing to make sure we gain market share in the stock and deliver value. I think big picture as we’ve always said over 80% of the people who are buying or selling stock are using our products and that’s the opportunity. From a roadmap point of view we look at integrating the stock service more directly within our applications as a way to both increase awareness for our customers and to improve their workflow. So as the year progresses we continue to expect to do better in stock moving forward. So off to a good start and it's only in the entire marketplace strategy for Adobe. And with respect to bookings I think Mark also alluded to the fact that they were strong. We did not see any seasonal slowdown from Q4 to Q1 in terms of how we look at the business. And one of the things I should probably state is when you look at the Digital Marketing revenue for Q1. It is actually being driven primarily by the bookings that we had last year, now translating into things getting live. There really wasn’t much perpetual revenue in the quarter. So, the good news is that marketing is all as a result of the strong bookings we experienced last year.

[Mark Garrett:]

In fact to add on to that when you see the Q you will see the Digital Marketing segment, the whole segment subscription revenue is up 25% year-over-year for the whole Digital Marketing segment which is great.

[Operator:]

Your next question comes from the line of Sterling Auty from JP Morgan. Your line is open.

[Sterling Auty:]

Yes, thanks. Just want to follow up on the Adobe Stock portfolio items, so specifically it sounds like you are gaining traction. Wondering what that’s going to do to the ARPU in the Creative side versus the offset that you still have because of the expanding – with photography bundle and things like that so what's that tug of war look like and what should we be thinking around ARPU trends from here?

[Mark Garrett:]

Hi Sterling, it's Mark. You know that’s why frankly this average ARPU number gets very difficult to use as a gauge for the business. If you look at just Creative, we certainly expect that Stock will raise the ARPU for the Creative Professional, the people that are going to buy Stock. It just doesn’t make sense to look at the average any more especially for all the reasons we articulated around subs with millions of people potentially buying this K-through-12 education bundle or as you said millions of people buying CCPP. But Stock will add to ARPU for the Creative Professional.

[Shantanu Narayen:]

And as it relates to the overall ARPU in the quarter again Sterling we continue to see for the core creative product an increase in ARPU very much in line as people renew at non-promotional pricing.

[Sterling Auty:]

Great, thank you.

[Operator:]

Your next question comes from the line of Heather Bellini from Goldman Sachs. Your line is open.

[Heather Bellini:]

Great, thank you. I just had a couple of questions. I was wondering now that you have a multiple years under your belt if you’ve seen with the change to subscription if you’d seen any change in the level of piracy and have you been able to combat that in any way with the new way of subscribing to the software? And then secondarily I might have missed this but did you give out the percentage of subs that were suite subscriptions versus single app?

[Shantanu Narayen:]

So Heather let me take both. The first is when you look at the number of new users that we’ve stated who are part of the Creative platform which is 30% of the people who are doing business with us, there is no question that our surveys and anecdotal evidence speak to the fact that people who may have formally pirated or used our products casually are paying for the service because its far more affordable. As you know we are seeing increased growth in international markets where there was more piracy. The reality is we still haven't offered the Creative Cloud product in China as Creative Cloud. So all of that is upside for us in terms of combating piracy, there is so much opportunity in the developed markets that’s where we focus. So, making progress and we continue to think as we roll it out in other markets around the world it's going to impact it. With respect to the single app versus the complete, as we said it's going to gravitate towards 50

[Mark Garrett:]

Right.

[Heather Bellini:]

Okay, great. Thank you so much.

[Operator:]

Your next question comes from the line of Mark Moerdler from Bernstein. Your line is open.

[Unidentified Analyst:]

Hi, this is Dan calling in for Mark, thanks for taking my question. I just wanted to ask about the opportunity for ARPU expansion outside of Stock. Obviously Stock is a homerun in terms of driving up ARPU and I know you mentioned the average ARPU in subs numbers becoming less meaningful as the mix becomes more complex but if you can just talk about what you see as opportunity for ARPU expansion outside of stock that will be really helpful? Thank you.

[Shantanu Narayen:]

Well the opportunity for ARPU expansion around Stock is as we are attracting people to the platform we’re certainly attracting them at what we would call promotional pricing. So that’s one big opportunity and we’re clearly seeing as people come onto the Creative Cloud platform they typically come from CS6 and prior versions where we give them a promotional pricing and then convert it into the full pricing. The other opportunity for ARPU expansion is moving from single app to the entire product. The third opportunity for ARPU expansion is Acrobat. We’re certainly seeing a lot of people and that’s why we’re moving them more through the Creative Cloud funnel as opposed to the Document Cloud funnel, up selling them into the entire product. And last but certainly not least while it is not called ARPU within the enterprise as well as we move from selling what used to be custom like solutions of Creative Suite into the entire Creative Cloud Complete. So, even on the core desktop products there is ARPU expansion against all of those four. Then in addition to that it’s the new services that we’ve introduced and will continue to introduce that represents ARPU expansion. And as you know in our Analyst Meeting we provided therefore the entire TAM available for us on both the Creative Cloud as well as the Document Cloud as part of Digital Media.

[Unidentified Analyst:]

Fantastic, thank you.

[Operator:]

Your next question comes from the line of Keith Weiss from Morgan Stanley. Your line is open.

[Keith Weiss:]

Excellent, thank you guys and again congratulations on a great quarter. Shantanu I want to follow on something that -- the comment that you made about the lack of seasonality in the quarter going from a Q4 to Q1 which is a lot different than what we saw last year at the time particular when it came to a subscriber add. Anything in particularly you could point to for why that happened or what was different this year than last year and the efforts you guys do to sort of sustain that level of any subscriber so much better?

[Shantanu Narayen:]

Well, I think there are a couple of things. I think at the macro level Keith firstly the solutions that we are providing I think are playing to what is a very key need in the marketplace which is everybody is dealing with digital transformation, everybody is trying to bring their businesses online. So there is no question in the marketing side as it relates to the kinds of solutions we offer. But the demand is only getting greater in organizations around the world. So I think that’s one issue. Certainly the fact that we are doing less perpetual also factors into this and so as you think about the traditional Q4 to Q1, they would be big perpetual pushes and then it would sort of fall off. The third thing I would give is our marketing group is doing a much better job of having consistent demand and growing demand so we’re looking at it not just as fiscal boundaries but as a continuous process of driving demand for our particular solution. So I think there are a number of things and then on the Creative side, I think it just continues to be opportunity to migrate customers and attract new customers. So I think for all of those four reasons we feel good about our business and we feel like they are in the sweet spot of what customers need right now.

[Keith Weiss:]

Excellent, thank you.

[Operator:]

Your next question comes from the line of Brendan Barnicle from Pacific Crest Securities. Your line is open.

[Brendan Barnicle:]

Good afternoon and Happy St. Patrick's Day. Thanks for taking my questions. Shantanu there is a lot of concerns about the macro economy particularly in the most recent quarter I was interested what you saw in the quarter in the U.S. and globally, particularly given your new Adobe Digital economy project? And just a quick one for Mark, can you remind us of the distribution breakdown between Adobe.com, the Channel, and Adobe direct sales right now? Thanks.

[Shantanu Narayen:]

Well clearly we saw a strong demand and we did not see any issues from the macro economy and that’s the reason for both the strong quarter as well as the strong outlook not just for Q2 but for the rest of the year. So if there is macro economic conditions that are impacting other peoples businesses, we haven't seen that yet. I think even should that happen as you know we are far more near to that as a result of the recurring business, but we didn’t see any demand weakness anywhere in the world.

[Mark Garrett:]

As it relates to route to market there is no doubt that we want Adobe.com to be the premier place people come to do business with us and it's becoming a much bigger piece of the business than it has overtime. As well our business from a direct sales perspective would come in right behind that. And then channel while its always going to be important to us it has just been shrinking consistently. I think at some point of levels off its not going to go away. But we really want to go direct and we want to go through adobe.com.

[Brendan Barnicle:]

Great, thanks so much.

[Operator:]

Your next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is open.

[Jay Vleeschhouwer:]

Thank you, good evening, couple questions for Mark. I noticed that in your prepared remarks you didn’t make any mention of ETLAs and could you comment on how those performed within the context of the increase in Creative ARRs sequentially. Your total subject were substantially ahead of our forecast but your Creative ARR was right in line, so I am wondering if perhaps you had somewhat flatter performance relatively in ETLAs? And then secondly you had quite substantial growth margin improvement sequentially in both businesses both Digital Media and Digital Marketing, if you could comment on what's driving the improvement in Digital Media gross margin including a sequential decline of your cost revenue there? Thanks.

[Shantanu Narayen:]

Sure Jay, you’re right. As it relates to ETLAs there is some seasonality and you’ll see that reflected in the ARR numbers for Creative and for doc services. So there is some seasonality in the ETLAs. On the gross margin side, a lot of that just has to do with the stacking effect frankly of having these subscribers build up overtime and not needing to add as much cost structure to support them because you’ve got critical mass. So, it’s a benefit of the stacking effect on the Creative side.

[Jay Vleeschhouwer:]

Thank you.

[Operator:]

Your next question comes from the line of Steve Ashley from Robert W. Baird. Your line is open.

[Steve Ashley:]

Alright, terrific, thanks so much. I'd like to talk about the Adobe Experience Design products that have been previewed now, seems have gotten a very nice response in the market and I am just wondering the users of that product, I am assuming as current customers do you foresee this as being an incremental purchase for these people or is it something that you would use in place of other Adobe products they’ve used in the past? Thanks.

[Shantanu Narayen:]

Yes, Steve I think what we’re seeing as big phenomenon in the Creative market is more people doing design and prototyping. It certainly is the traditional Creatives who’ve been doing design and prototyping and they may have used products like Photoshop or Illustrate or Fireworks from Adobe in the past. But I actually think that there is a new community of people, product managers all around the world, the way we are designing products right now is they are doing a prototyping of what that product looks like, whether that’s on mobile or on the web. And so I think this inherent need for people to have designed far more as a part of product creation I think will lead the experienced design product to be used not just by our existing customers but also by a whole new set of customers who are thinking about how do they use design to create a new generation of Experience product. So I am very excited about it, the feedback has been really good, but I do think product managers, the new breed of product managers that exist in startups they will all need to use a product such as the Experience Design product.

[Steve Ashley:]

Great, thanks.

[Operator:]

Your next question comes from the line of Brian Wieser from Pivotal Research. Your line is open.

[Brian Wieser:]

Thanks for taking the questions. I was wondering if you could talk a bit about Marketing Cloud and the competitive environment as you’re seeing it attach rate of different products and if what you think your customers are taking full suite versus individual products and maybe at the same time if you might be able to comment about how your recent issues of data, the data marketplace might be impact from the business at this point?

[Shantanu Narayen:]

Sure, with respect to the marketing cloud I think we continue to be the most both unified as well as comprehensive offering that’s out there in the market. The results are driven not just by new logos and the new logos are increasingly using multiple solutions when they start off but also with certainly up selling existing customers to new solutions. So I think we’re seeing that across the space. In terms of competition as we said even at the analyst meeting when you have a $27 billion opportunity you are going to attract other customers but I think we’re so far ahead of them, we continue to be rated and we continue to innovate. On the data market stuff, stay tuned. Next week is our Summit and we’re going to be talking a lot more about some of the exciting areas that we have on data. And so hopefully you are going to be at Summit and we’ll share more at that time.

[Brian Wieser:]

I will be there, curious so maybe to your point as new entrants and obviously I was thinking of Google but try to push harder into this space, do you see that they are -- whether it's them or others that they are really tapping into other marketers and maybe you are not and that its helping contribute to growth is totally consistent?

[Shantanu Narayen:]

Well I think with respect to what's happening we used to target the Chief Revenue Officer, the Chief Digital Officer, the Chief Marketing Officer within the enterprise and I think that has now expanded to being a C level issue all the way up to the CEO in terms of the customer journey. I think there are companies who are certainly providing the ad stack for this customer journey. There would be people who provide the experience for the customer journey and the analytics. So in that sense you are right, I mean it is -- the opportunity is dramatically expanding because this is becoming front end and center not just for the marketing function but also at the C level function.

[Brian Wieser:]

Great, thank you.

[Mike Saviage:]

Carl we’re approaching the end of the hour, why don’t we take two more questions.

[Operator:]

Your next question comes from the line of Steve Rogers from Citi. Your line is open.

[Walter Pritchard:]

Hey guys, I am Walter, just wanted to see if you can get some more color on net adds and just the strength there, is that more internationally or is that kind of the net new to the franchise ads or potentially kind of Acrobat stuffs that are coming through the Creative Cloud funnel, just some color there would be great?

[Shantanu Narayen:]

I think it’s all of the above in terms of where the net ads were. You’re right, it was strong net ads. We certainly as it relates to the document businesses or Acrobat there was a fair amount. We definitely have a clear preference for customers to adopt Acrobat DC through the Creative funnel so that shows up as net adds in the Creative funnel because that gives us permission to up sell them to the Photography plan. But team did well, team continues to do well and so we’re seeing strength. International, Japan and Germany that we’ve identified as areas for growth are growing nicely. There still is a significant opportunity there to migrate existing customers and attract new customers. So I would say those markets are a couple of years behind but we haven't seen any slowdown in the U.S. yet.

[Walter Pritchard:]

Thanks.

[Operator:]

Your last question comes from the line of Nandan Amladi from Deutsche Bank. Your line is open.

[Nandan Amladi:]

Hi, good afternoon, thanks for taking my question. So Mark question for you on metrics, since you are no longer going to be providing the Creative Cloud subscriber count historically we’ve sort of used your commentary on ARPU and the units to back into LA number or ETLA number. Going forward as you provide just the ARR number would you be providing any finer segmentation of that?

[Mark Garrett:]

Not right now. The best way to do the model from my perspective would be to take ARR which we’re now going to guide to quarterly, so we did say we will add some additional guidance by giving you ARR every quarter. And you can take that ARR and do a waterfall flowing that into revenue to get a sense of what revenue is. To be honest with you, using what you were using which was a sub number that was incomplete and an average ARPU number, it really doesn’t work anyway. We’ll periodically give you more insight into what's going on like we do at analyst days and things like that. But the best way to do it is to take that ARR number and flow it through into revenue.

[Shantanu Narayen:]

And Nandan I think as Mark said, the goal is to continue to help you model the business and provide more color on ARR so that you get a sense not just for the overall health of the business but the various components. And since that was the last question, I mean just a couple of comments, as I am travelling around the world meeting both customers and partners, it is really clear that consumer expectations and what's happening with technology is causing every business to rethink how they interact with customers. And I think that’s a digital first strategy right now for every one of them. From our point of view that great experience starts with great content. We’re clearly the company that’s helping bringing their concepts to life for Creatives and Creative Cloud is clearly the one stop shop for these customers providing everything from inspiration to monetization. I think the other thing we see is delivering that experience to the right person at the right time requires a technology platform that deals with large volumes of content and data but more importantly with the right intelligence and that’s the goal of the Adobe Marketing Cloud. All of these tailwinds we see now benefiting our businesses and I think in Q1 we saw a strength across Creative Cloud adoption and ARR growth, DC and Acrobat adoption as well as strong bookings and revenue, and implementations that are going live with the Adobe Marketing Cloud. And that’s the reason why our Q1 upside and Q2 outlook gave us confidence to raise the revenue as well as earnings target. We think we are in great shape, we remain focused on driving innovation, and strong financial results and I want to thank our customers and partners worldwide for their ongoing commitment and to our employees for continuing to drive innovation in our industry. We hope to see you folks next week at Summit and otherwise we will look forward to our next call. Thank you for joining us today.

[Mike Saviage:]

And this call concludes our call, thank you.