Adobe Inc. (ADBE) Earnings Call Transcript & Summary

Yes. And we're seeing changes -- we're seeing quick changes globally in laws work to allow electronic signature as a legal -- and we just launched an electronic solution in India a few weeks back, and that's a massive market, a massive document opportunity. So we're seeing just a cascade of change where documents are going digital across the globe.

Let's go ahead and move over to the digital experience side of the house. You've got some moving parts here that I think make it a little bit tougher for investors to wrap their head around performance. They hear your tone, which is very positive. But then the numbers are -- have a little bit of noise. Maybe walk us through specifically what's happening with advertising, cloud and the impact on this segment.

Yes. So advertising cloud, as you know, last quarter, we announced the decision to exit the transactional side of that service. We were keeping the technology on the software side of that because that's really what our customers wanted. Now when we acquired T-Mobile a few years ago, we've seen a change in the market for the transactional side. And the margins associated with it are really not margins that we frankly like. And when we think about a lot of companies in-sourcing agency talent to do more with software, that's our sweet spot. We have the software, we can provide that to them, and that's what we want to grow. So feedback has been great. We were very transparent with our customers that we were exiting that part of the business. Now at the same time, we don't want to leave them hanging, so we wanted to help fulfill the campaigns that were scheduled as we work through this transition and help them find other platforms for the transaction side. So as I said on the call, we had a little bit more ad cloud revenue in the quarter than we would have targeted, but we're still committed to that kind of $100 million run rate business going forward when it's purely just the software side of it. And that's really one of the reasons why we started talking about digital experience subscription revenue without ad cloud. The ad cloud revenue, which is primarily usage-based, was included in subscription revenue. But the core part of our subscription revenue is pure subscription, and that's in digital subscription, excluding ad cloud -- digital experience subscription revenue excluding ad cloud. That grew 14%. Our booking business was over 15% growth. So I really feel that the business itself is really doing well considering the current environment. And obviously, this is a higher touch type of business. And so our field sales force and our customers that would typically meet and collaborate and strategize on how to deploy digital transformation solutions, they had to really pivot to the virtual engagement. And I think the teams and the customers really done a great job this quarter, and we saw that with the momentum in the business that came back. And again, the over $1 million deal ASPs that we were able to do, we did the highest number ever in the quarter. So I think it just -- it shows that digital transformation is still a priority, and that companies are feeling a little bit more comfortable with their own health and when to start spending. But we're cautious there. We know that this is going to be probably a little bit of an ebb and flow and certain verticals will recover faster, and that will be great for us to be able to engage with them. But the decision cycles didn't lighten, like we talked about. But again, I think the top of mind, we're there, and so we're able to provide the solutions when they're ready to spend on it and we're ready to engage. And so -- and it looks pretty good traction so far in Q3, and it's embedded in our expectations in Q4.

And yes, I'll just add one. We really wanted it to come across in the prepared remarks that we had a strong quarter there. And we're seeing in enterprise sales cycles kind of normalize into this virtual world now. And I think on enterprise procurement teams, the sense of urgency really returned. We talked about in the Q2 call, in those first maybe 6 weeks of the pandemic, enterprises were so focused on keeping their own employees safe and their customers up and running, that the procurement cycles really slowed down. We saw that pick up a little bit in Q2. But you really see in what we -- the color we gave for Q3, a return to that momentum. For a SaaS business, it takes a few quarters before you see the business you booked in a quarter fully flow into your subscription revenues, but we're obviously optimistic there and feel like the TAM and the strategy is resonating in the world we're seeing today.

That remaining $100 million roughly ad cloud revenue, would you expect that to grow? So in other words, once you kind of transition off the transactional, all of the headwind should go away and that should grow along with the rest of Digital Experience?

I think we'll still have segments of digital experience solutions that will grow at different rates. I think I wouldn't be targeting the ad cloud software piece to grow at the same rate that I would expect our Experience platform and AEM and commerce and real-time CDP. It's definitely a service that we want to be able to provide our customers that need that. And so yes, certainly, we wanted to grow it, and we're going to invest in the software side of that to make sure that we're able to grow it. But as we go forward into FA day and we talk about our 21 targets, we'll talk more specifically on our expectations about each of the businesses.

All right. I'm going to go complete sideways tangent. Since you mentioned the Financial Analyst Day. We did get a couple of questions from investors that, "Oh, my goodness, suddenly, the Analyst Day is not part of MAX. It's correlated with your fourth quarter earnings." What's going on? Is this some sort of signal that you're saying -- giving without coming out and saying something?

No. No, not at all. Actually, it was -- MAX, of course, is moving all digital. It's going to have 56 hours of live content. And what we wanted to do is really let MAX focus on the products and the innovations that we're delivering. As Jonathan noted on our after call, we have a very important election in the United States right around at that time. And so there's obviously noise that will happen around there. We'd rather get through that so that we can talk about our strategy for the business once that's kind of settled. For me, personally, it's better for the finance team to lock down the FY '21 planning based on the exit run rate coming out of FY '20 because oftentimes, we're doing it 2 months before the end of the quarter, 1.5 months before the end of the quarter. The targets that are potentially adjusted, we always talk about those the -- our initial targets for FY '21, and then we update them on the Q4 call anyway. So in that perspective, there's no underlying reason. There's nothing going on. It's purely just logistically better to do it that way.

Yes. Makes sense.

And just to reiterate the point, when we looked at doing it a few weeks after MAX as a virtual event, we realized we don't want to be competing with all the new cycle around presidential election. And so it seems to be a no-brainer in the virtual context to do it with our Q4 call.

I agree. I agree. Now back to kind of digital experience, this is the area that investors have the toughest time understanding Adobe's position in the market. When you look at digital marketing and advertising solutions, is probably the most fragmented space that you participate in. What advice -- or how would you characterize for investors the pockets that you're focused on, where you're really strong? And what's the strategy and the vision on where you want to take it?

So I think, broadly, I'll start with saying that our strategic advantage and differentiation is our strength in content and data. And as a result of that, we've put together the most comprehensive set of solutions to provide data insights, customer journey orchestration and automation and analytics, commerce capabilities. And when we look at the newest innovations that we launched last year, being able to provide a unified profile of customer with authenticated and unauthenticated data and stitch that together for companies that have a digital and a physical presence, it's something that is unique, and nobody can do it, and we do it in real time, and we're way ahead of the competition. And to build that on Adobe Experience platform to make it a lot easier implementation for our customers, to be able to plug-and-play additional solutions as it makes sense for them to more fully engage across the entire customer journey in a digital way, that's our differentiator. Some of our competition have some features of our capabilities, but they don't have all of them. And so for us, it's a lower total cost of ownership opportunity for our customers. It's actually a competitive advantage to have real-time insights into our customers and how they can engage and transact with them. It's just -- we've just taken a very different approach to some of our competition to the static information and whether it be Customer 360 type of concepts, our Customer 360 is -- 360 is spinning all the time. We can do anything we want with that customer once you have that data and ingest it and unify it in the profile. And Jonathan, I don't know if you'd add anything there.

Yes. I mean, 1 thing I tend to underscore is we built the platform essentially productizing what we've done with our own business with the DDOM, with the data-driven operating model. I think when you see the way we transformed our creative business over a decade, quadrupling the revenues and turning it into a recurring subscription business and being able to read those insights in real-time to know where we're getting value out of our marketing spending and invest more there to target the segments we want to target, I think customers come and they talk to John and they talked to Shantanu, how can we get these insights in real-time and make them actionable the way you've done. And we really productize that, and that was a lot of the vision of building the platform the way we've built it. And so we think we have credibility in the marketplace that no one else has because we were the first to transform in that way. And we -- again, we think no one else has the product set to read signals that are coming directly from consumers in milliseconds and action on them. And so we feel like -- again, we are -- the research and development we've done were years ahead of the competition. And we're really excited about the growth and momentum of that business. Obviously, it's smaller in scale because we built it organically and launched it last year than some of our other solutions, but we think of that as, again, being a big pillar of growth for a decade-plus to come.

Well, I'll push back a little bit on the organic part of it, right? So you took core components of omniture when we think about all of the components. But I love the comment, Jonathan, that you mentioned about platform because that's exactly where it's headed with the next question is. Now that you've rolled out this unified platform, are you seeing deal sizes and customer adoption grow because they're seeing a greater value because of what you've developed now that's not really available elsewhere in the marketplace?

The answer is yes. So let me back up a little bit on Jonathan's comment on organically. We built Adobe Experience platform from scratch without any other components of the other acquisitions that we did. So that's where the uniqueness in how organic it was because, certainly, we've acquired the capabilities across digital marketing that we have now stitched and integrated together. We built a platform now that actually is expandable as other capabilities are needed. And that's something that's unique to us. We spent 2 years building that from scratch. And to your -- fit into your question on bigger deals, yes, we saw greater -- the largest number of greater than $1 million ASV deals this quarter. We continue to build significant pipeline as our enterprise customers resonate with the offering that we have. We are really incredibly excited about how customers, when they see the capabilities of Adobe Experience platform of all the other different services and intelligence services that we're adding on, analytics, insights, it's really resonating with enterprises and why they need to accelerate their digital transformation.

And one of the questions following on that coming from the audiences, they're curious about the sustainability of bookings growth within Digital Experience. It's been in the teens recently, but not too long ago, it was in the 20s. Do you think there's actually an opportunity to see that growth rate reaccelerate, if and when, knock on wood, the economy opens back up?

Yes, certainly. Our expectation is that it can accelerate. The macroeconomic headwinds right now, yes, certainly provide some uncertainty to that. However, the momentum, like I said, we're seeing the demand in the pipeline, is very solid. Will that convert as quickly as a converted before? I think that's where maybe I have a little bit of hesitation. But I'm really happy with the performance that we did demonstrate in Q3 and that the return out of the kind of, I'll say, Q2, feeling like it was a bit of a trough. But given the breadth of our offerings, the size of the TAM, assuming the economy kind of gets back, how many -- and once the vaccine is out there, I certainly believe that this business, given the size of the TAM, can accelerate into a higher growth SaaS business.

And when you talk about conversion, is that conversion of opportunities to close deals, or bookings to revenue, or all of it?

A little bit of both, right? As Jonathan pointed out and to the SaaS, the revenue comes a couple of quarters after the booking. But yes, being able to convert pipeline. Net -- we talked about it last -- in Q2, as companies focused internally on their own businesses and their employees, decision cycles definitely extended. We saw that definitely shrink. We had great linearity this quarter. That's -- from a CFO's perspective, that's something that I look for because I don't want to be waiting until the last 2 weeks of the quarter to be able to hit our number. But I feel like the teams really pivoted and developed a capability to engage virtually that I think is sustainable as long as we're working in a virtual environment. So demand is there. I think we're engaging well. I think the system integrators and our partners are also engaging better with us virtually. And so that's also driving a lot of the pipeline. So yes, I'm definitely optimistic. I mean, this is -- it's a growth area for us, period. And so we want to see this be in the realm of a healthy SaaS company at the Rule of 40.

Absolutely. Well, you're already at the Rule of 40 just with margins. So that's like an unfair headstart.

Definitely, the creative side is a different role that we enjoy.

Question from the audiences around MAX. With MAX going virtual, how is that shaping up? And what are your expectations for kind of the demand it might generate because we have heard from other companies like Okta that actually said that they did more bookings and more pipeline generation out of the virtual than they ever did in the in-person world?

Yes. Max is not so much a driver for acquisition as it is an awareness of the innovation, particularly in the professional markets. But that being said, the virtual event, and it's free versus a paid registration is attracting more that we can even imagine in registration. It's typically, we were streaming somewhere around like 100,000 during our physical conference, and we'd have somewhere around 20 -- I think we originally expecting somewhere around 23, 24 in a physical event, 24,000. And we are seeing double in terms of the streaming capability, and they're still signing up for it. So I think this is going to be the most engaged MAX we've ever seen. I think it's going to put it out to a lot of people, the capabilities that we're offering in the digital media space and the creative space. So we're pretty excited about the prospects of what that will drive longer term. It also virtually gives us an advantage to kind of be always on, where we can continue to feed content to the different features. I will tell you, the ability in a virtual environment to engage with a lot of very well-known creatives and that they can talk about how they use our products to create, to drive their art, to drive their business, to drive whatever they are great, whether it's photography. I mean the lineup we have of incredible professionals that have been in this industry for years is unprecedented than a physical event, whether they would have to travel to it or didn't work with their own schedules, but they're on now too, so we can get them for an hour to do a live presentation with us and inspire other creators.

Now is there -- I think that's fantastic, and you're right, that has such a big influence. But I think one of the challenges we're still seeing in the virtual events is how you drive that you're walking into the keynote and you're talking with 4 other users and comparing -- "Oh, I do this. Well, I never thought that." And that kind of spawns adoption as well. Is there ways that you can compensate for that?

Yes. We have a number of interactive breakouts. Similar to kind of like the Zoom breakout rooms that are allowing professionals to engage and interact with each other and share ideas. And so the program itself has got a ton of that opportunity for folks across the days that we're running MAX. So it's going to -- I think it's going to be very highly collaborative, and I think people are more comfortable working collaboratively in a virtual environment. And I think creatives always were. So I think this is going to be very helpful for them.

I teased on margins, but that is a question that comes up frequently. You're one of the most profitable software companies in the entire industry. What is the philosophy from here for balancing continued margin improvement versus growth?

Yes. I mean, first and foremost, we're a growth company, and we believe the size of our opportunities are so large that there's plenty more for us to capture. That being said, I think we've proven over the years to be a very disciplined company when it comes to earnings. And we do invest for profitable growth. That is kind of our strategy and our mantra. So there may be times, if we increase our investments, you'll see margins dip a little bit, but they always return to an expansion mode as we digest whatever those investments may be. I'll say, again, like we did not expect margins to be this high in Q3 when we provided guidance. They definitely crept up, primarily driven by the over performance in revenue. But also prolonged COVID-related benefits and savings in travel, facilities, live events. And our hiring was a little slower ramp. So many of these expenses are going to come back. But that being said, when we originally set the targets for FY '20, we had margin expansion in there over '19. So I don't want to say the 43.5% level that we achieved in Q3 is a new norm because I think there's too many opportunities for us to invest in. But I do think, longer term, we will continue to focus on expanding margin, but we want to make sure that we are capturing the growth opportunities.

I'm not going to try to pigeonhole you into '21, so I'm going to ask this at a software industry level. Obviously, the entire industry has benefited from -- on the margin front from savings on T&E because of COVID. I imagine we don't completely go back to the way that it was. You probably capture some of the opportunity. But don't you think as an industry, we have to have some sort of dip as there is just at least some increase in travel?

Yes, I think so. I don't -- interestingly, when I look at our own travel budget, we have a large field sales force and our engineers are traveling and collaborating with different facilities and some of our partners. We have pretty large travel budget. And I will tell you, I don't expect it to return to that level. I think what we're going to see is that the benefits of learning how to engage productively virtually will pan out, but there will be travel, for sure. And I don't think the level of workforce that works remotely will be as low as it was before first. I think we're open-minded to the fact that, that might expand a little bit. But there's value in people meeting physically, and we recognize that. So I think some of those costs will come back. That will provide an opportunity for us to decide where we want to invest or do -- and if you don't have the opportunity to invest with the right return that we want, we'll return that in form of EPS.

And I often talk about this as well. And we typically say, we don't know exactly what the world will look like post-COVID. That's going to be one of the words of the year next year, post-COVID. But we believe it will be different. We believe it will be different in certain ways with respect to facilities, with respect to the way we travel. And what that means is answering -- going back to the same question, how do you think about the durability of these trends towards digitization, the changed nature of the world post-COVID, whatever that will look like, which we're all still figuring out, will mean digital is more important than it was pre-COVID.

Absolutely. Totally agree. With our last quick little -- a quick one to finish, share repurchase. What's the strategy on the share repurchase program from here?

Yes. We pulled back a little bit last quarter because just a lot of uncertainty around how this is going to be. So -- and we did do a sizable purchase, as we talked about, we invested $617 million in the quarter, repurchasing 1.5 million shares. We've got $2.9 billion remaining of our authorization that runs up to May of 2021, and we are committed to that program. We have typically exhausted the program before it exhausts -- exhaust the program before it expires. And given, obviously, the performance on record operating cash flows, we certainly can afford to purchase at a higher rate. But the priority that we focus on first is what can we do to invest in our business organically? Are there opportunities inorganically that can accelerate our growth profitably? And then if not, then we'll return that excess to shareholders. So we really kind of look at it in that lens all the time. But clearly, the performance that we delivered indicate we've got capacity if we have -- don't have other opportunities to accelerate.

Makes perfect sense. With that, we're out of time. Jonathan, John, thank you so much for joining us. We really do appreciate it. Stay safe and stay healthy.

You bet. Thanks, Sterling.

Thanks, Sterling.