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Adobe Beats Q3 Earnings; Down on Weak Q4 Sales Outlook - Analyst Blog

Adobe Systems Inc. ( ADBE ) reported third-quarter 2014 earnings of 14 cents per share, beating the Zacks Consensus Estimate by a penny. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Following the earnings release, share price was down 4.6% in after-hours trading due to weaker-than-expected revenue guidance and lower sales in its digital media business, which includes the Creative Cloud software suite.

Revenues

Adobe reported revenues of $1.005 billion, down 5.9% sequentially but up 1% year over year. Reported revenues were within management's guided range of $975 million to $1.025 billion but missed the Zacks Consensus Estimate of $1.016 billion.

Products generated 34.7% of Adobe's revenues but were down 40% year over year. Subscription comprised 54.4% of total revenue, up 82.9% year over year while Services & Support brought in the balance, down 4.1% year over year.

Revenues by Segment

Digital Media Solutions , Adobe's largest segment, generated 61.8% of the revenues in the quarter. Segment revenues declined 10.3% sequentially to $621.0 million. The decrease was due to the removal of perpetual licensing from the channel in the Creative Cloud software suite.

The two major revenue earners within the segment were the Creative family of products and Document Services products. In the Creative business, Creative Cloud subscriptions continued to accelerate. The company ended the third quarter with approximately 2.81 million paid Creative Cloud subscriptions, a sequential increase of 502K.

The conversion of enterprise customers to Enterprise Term License Agreements or ETLAs which led to increased adoption of its enterprise Creative Cloud offering through ETLAs. ETLAs for enterprise customers are term-based and allow customers to access ongoing technology updates and represent the first phase of migrating enterprise customers to Creative Cloud.

The increased subscription, ETLA adoption and digital publishing suite adoption helped drive Creative annualized recurring revenues or ARR to $1.40 billion, up $209 million sequentially.

Management is quite optimistic about Creative Cloud adoption and expects to build a healthy pipeline for potential Creative Cloud paid subscribers through marketing programs, trial downloads and free memberships. The company's Photoshop Lightroom offering, which was re-branded as the Creative Cloud Photography Program in June, helps Adobe acquire new customers as well as convert those who originally licensed Photoshop Elements and Photoshop Lightroom.

In the Document Services business (includes Acrobat family and the new cloud-based services such as EchoSign), revenues were $208.0 million, up 6.1% sequentially. The segment performed well driven by continued Acrobat adoption in enterprise as well as continued momentum in EchoSign and other related Acrobat cloud services. Also, the company closed several large contracts during the quarter. ARR in Document Services business grew to $217 million, up 18.5% sequentially.

The Digital Marketing segment accounted for 33.5% of total second-quarter revenue. Within the segment, Adobe Marketing Cloud revenues were up 2.5% sequentially to $290.0 million. The growth is being driven by increase in the size of transactions, number of solutions per customer, international expansion and growth in partner-driven business. Bookings also increased year over year in this segment.

LiveCycle and Connect businesses generated revenues of $47.0 million in the reported quarter, flat sequentially.

Print and Publishing revenues were $47.0 million in the last quarter, up 2.2% sequentially.

Margins

Reported gross margin for the quarter was 84.3%, down 90 basis points from 85.2% in the comparable year-ago quarter. The gross margin is typical of a software company and variations are generally related to the mix of revenues between categories.

Adobe incurred operating expenses of $773.5 million, up 4.9% from the year-ago quarter's $737.7 million. As a percentage of sales, research & development expenses, general & administrative as well as sales & marketing expenses increased from the year-ago quarter. As a result, operating margin decreased to 7.4% from 11.1% in the year-ago quarter.

Net Income

Adobe Systems Incorporated - Quarterly EPS (BNRI) | FindTheBest

On a GAAP basis, Adobe recorded net income of $44.7 million (9 cents per share) compared with $83.0 million (16 cents) in the year-ago quarter.

On a pro-forma basis, Adobe generated net income of $707.9 million compared with $106.8 million in the year-ago quarter. Pro-forma earnings came in at 14 cents per share compared with 2 cents in the year-ago quarter.

Balance Sheet

Adobe ended the quarter with cash and investments balance of $3.52 billion versus $3.33 billion in the previous quarter. Days sales outstanding (DSO) were 48 days, flat year over year, and up from 45 days in the last quarter. Deferred revenues increased $68.5 million to $947.6 million.

In the third quarter, cash generated from operations was $268.5 million and capital expenditure was $55.0 million. Additionally, the company repurchased approximately 1.9 million shares for $133.0 million.

Guidance

For the fourth quarter, management expects revenues in the range of $1.025 to $1.075 billion. Analysts polled by Zacks expect revenues to be $1.085 billion, higher than the guided range. Additionally, management expects total Digital Media to increase sequentially. Management also expects Creative ARR and Document Services ARR to grow sequentially.

In Digital Marketing segment, management expects Adobe Marketing Cloud revenues to increase slightly year over year but LiveCycle and Connect revenues to decline sequentially. Print and Publishing revenues are expected to be relatively flat sequentially.

Accordingly, based on a share count of 508-510 million, GAAP earnings are expected in the range of 5-11 cents per share, while non-GAAP earnings are expected in the range of 26-32 cents. The Zacks Consensus Estimate is pegged at 14 cents, well below the guided range.

Also, for the third quarter, non-operating expense is expected within the $12-$14 million range and tax rate is expected to be within 28-29% on a GAAP basis and 21% on a non-GAAP basis.

Our Recommendation

Adobe reported decent third-quarter results with earnings surpassing our expectations but the top line missing the same.

Though the transition to web-based subscription for Adobe's Creative Suite 6 from traditional box licenses could impact its near-term revenues, it will attract more predictable recurring revenues, going forward. We remain positive about Adobe's market position, its compelling product lines (including CS cloud initiative and digital media products), continued innovation and strong balance sheet.

Also, we believe solid adoption of Adobe marketing cloud could serve as a potential catalyst, going forward. Adobe's acquisition of Neolane will further enhance its Adobe Marketing Cloud by integrating online and offline marketing data and accelerating its entry into social media advertising.

Currently, Adobe has a Zacks Rank #3 (Hold). Other better-ranked stocks that are performing well at current levels include ACI Worldwide, Inc. ( ACIW ), Citrix Systems, Inc. ( CTXS ) and Callidus Software ( CALD ). All these stocks sport a Zacks Rank #2 (Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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