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Adobe (ADBE) Beats Earnings and Revenue Estimates in Q2

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Adobe Systems Inc. (ADBE - Free Report) reported second-quarter fiscal 2016 earnings of 55 cents per share, which beat the Zacks Consensus Estimate by a couple of cents. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Better-than-expected earnings were backed by a strong adoption of cloud that led to record Creative and Marketing Cloud revenues and better-than-expected Digital Media ARR (Annualized Recurring Revenue) growth.

However, the share price fell more than 4% in after-hours trading session due to a weaker-than-expected fiscal third-quarter revenue guidance.

ADOBE SYSTEMS Price, Consensus and EPS Surprise

ADOBE SYSTEMS Price, Consensus and EPS Surprise | ADOBE SYSTEMS Quote

Revenues

Adobe’s revenues of $1.40 billion increased 1.1% sequentially and 20.4% year over year. Reported revenues were on the higher end of management’s guided range of $1.365–$1.415 billion and above the Zacks Consensus Estimate of $1.394 billion.

Subscription comprised 57% of Adobe’s total first-quarter revenues, up 40% from the year-ago period. Products declined 28.4% year over year and contributed 14% to revenues, while Services & Support, up 4.3%, brought in the rest.

Revenues by Segment

Revenues from Digital Media Solutions segment jumped 26% year over year to $943 million. Total Digital Media ARR grew to $3.41 billion at the end of the fiscal second quarter, reflecting an increase of $285 million, indicating strong growth in the Creative Cloud and Document Cloud businesses.

The two major revenue contributors within the segment were Creative Cloud and Document Cloud (DC).

Creative revenues were $755 million, up 37% year over year. Also, Creative ARR increased by $263 million. DC revenues were $188 million with DC ARR of $415 million at the end of the fiscal second quarter.

Management is optimistic about Creative Cloud adoption and expects to build a strong pipeline for potential Creative Cloud paid subscribers through marketing programs, trial downloads and free memberships. Management expects growth to be fueled by three initiatives, namely migrating the Creative Suite installed base; drawing new clients and driving higher ARPU through cloud services like Adobe Stock. Also, Creative Cloud mobile apps are driving new customer traffic and strong customer adoption.

Within the Digital Marketing segment, Adobe Marketing Cloud revenues were up 18% year over year to $385 million. The improvement came on the back of an increase in the size of transactions, number of solutions per customer, international expansion and growth in partner-driven business. Moreover, multi-solution adoption is increasing the size of customer engagements. Bookings in this segment also increased on a year-over-year basis.

Margins

Gross margin was 85.6%, down 9 basis points (bps) sequentially but up 149 bps year over year. Gross margin is typical of a software company and variations are generally related to the mix of revenues between categories.

Adobe incurred adjusted operating expenses of $820.3 million, down 2.5% sequentially but up 10.4% year over year. As a percentage of sales, research & development, general & administrative and sales & marketing expenses decreased from the year-ago quarter. As a result, adjusted operating margin was 26.9%, up 207 basis points (bps) sequentially and 679 bps year over year.

Net Income

On a GAAP basis, Adobe recorded net income of 244.1 million (48 cents per share) compared with 254.3 million (50 cents per share) in the previous quarter.

On a pro-forma basis, Adobe generated net income of $277.6 million compared with $263 million in the previous quarter.

Balance Sheet

Adobe ended the fiscal second quarter with cash and investments balance of $4.32 billion s against $4.10 billion in the previous quarter. Trade receivables were $666.7 million, up from $599.2 million in the prior quarter. Deferred revenues were $1.63 billion compared with $1.56 billion in fiscal first quarter.

In the reported quarter, cash generated from operations was $488.7 million and capital expenditure was $53.8 million. Additionally, the company repurchased approximately 2.2 million shares for $205.0 million.

Guidance

For the fiscal third quarter, management expects revenues in the range of $1.420–$1.470 billion. Analysts polled by Zacks expect revenues to be $1.456 billion, higher than the guided range at the mid-point.

Based on a share count of 504–506 million, GAAP earnings per share are expected in the range of 46–52 cents, and non-GAAP earnings are projected at 69–75 cents. The Zacks Consensus Estimate is pegged at 55 cents, well below the guided range. Also, non-operating expense is expected within the $11–$13 million range and the tax rate is likely to be 24% on a GAAP basis and 21% on a non-GAAP basis.

For fiscal 2016, management maintained its Digital Media ARR estimate at approximately $4 billionAlso, projections for the full fiscal were maintained at about $5.8 billion for revenues, $2 for GAAP EPS and $2.80 for non-GAAP EPS.

Our Recommendation

Adobe reported strong fiscal second-quarter results wherein both earnings and revenues beat the respective Zacks Consensus Estimate.

We remain positive about Adobe’s market position, compelling product lines (including CS cloud initiative and digital media products), continued innovation and strong balance sheet.

We believe that the company is being driven by continuous innovation in its Creative Cloud and Marketing Cloud businesses.

After the successful transition from traditional license to subscription-based services, Adobe wants to establish its presence in cloud-related software areas like documents and marketing. In this regard, the company has been introducing significant features and a number of updates to its Document Cloud.

In addition, we believe that constant adoption of the Adobe marketing could serves as a potential catalyst. Moreover, the solid adoption of Document Cloud, a new subscription package to enable users to sign documents on the cloud, will boost revenues.

Adobe carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the technology sector are CommVault Systems, Inc. (CVLT - Free Report) and OptimizeRx Corporation (OPRX - Free Report) sporting a Zacks Rank #1 (Strong Buy), and ACI Worldwide, Inc. (ACIW - Free Report) carrying a Zacks Rank #2 (Buy).

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