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Earnings Preview: Adobe Systems

ADBE MSFT

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With fiscal third quarter 2012 earnings to be reported on September 19, 2012, we see no change in analyst estimates for Adobe Systems Inc. (ADBE - Analyst Report) to date.

Prior-Quarter Synopsis

Adobe’s second quarter earnings of 49 cents surpassed the Zacks Consensus Estimate by a penny on the back of stronger revenue across segments, with particular strength in Creative Suite and Digital Marketing Suite businesses.

Adobe’s total revenue was $1.124 billion, up 7.6% sequentially and 9.9% year over year. The successful launch of Creative Cloud and Creative Suite 6 (CS6), strong Acrobat revenue and better-than-expected growth in Digital Marketing Suite business led to the strength in revenue.

Products generated 77.5% of revenue, up 7.7% sequentially while Subscription revenue comprised 14.2% of revenue, up 9.2% sequentially. Services & Support brought in the balance, increasing 3.8% sequentially.

Gross margin was 88.4%, down 90 bps from 89.3% in the comparable year-ago quarter due to unfavorable mix. However, operating margin was slightly up from 27.0% in the year-ago period due to lower-than-expected expenses in the quarter.

Management Guidance

For the third quarter, Adobe expects revenue in a range of $1.075 billion to $1.125 billion.

GAAP EPS is expected to be 38 cents to 43 cents, including stock-based compensation of 16 cents, intangibles amortization charges of 6 cents and income tax adjustment of 4 cents. Excluding all of these, non-GAAP EPS is expected to be 56–61 cents. Currently, the Zacks Consensus Estimate for the upcoming quarter is pegged at 47 cents.

For the full year, Adobe expects GAAP earnings of $1.69 to $1.76 and non-GAAP earnings of $2.40 to $2.46.

(Detailed earnings results can be viewed in the blog titled: Adobe Beats on Solid Revenue

Agreement of Analysts

None of the 9 estimates for the third quarter were revised in the last 30 days. Even for fiscal 2012, there was no revision in the last 30 days.

Most of the analysts believe that with the strong response to CS6 and Creative Cloud, earnings per share will likely come in line with the Street consensus estimate of 47 cents. However, they believe that negative foreign currency movement will act as a headwind.

The analysts believe that CS6 had a strong start, driven by an enhanced feature set, pent-up demand, newer cloud features and subscription pricing. The existing customers also upgraded to CS6 due to expanded mobile device support, photoshop enhancements, and stronger HTML5 capabilities. The analysts also believe that the inclusion of HTML5 development tools into the Creative Suite has added critical functionality, which is driving user upgrades.

However, the analysts believe that the key to CS6 success will be the ability of Subscription pricing to attract brand new customers. Also, they do not expect strong operating margin expansion due to the company’s huge growth investments and continued hiring.

Magnitude of Estimate Revisions

In the last 30 days, there was no change in the Zacks Consensus Estimates for the third quarter and fiscal year 2012.

Over the 90-day period, the Zacks Consensus Estimate decreased by 2 cents to 47 cents for the third quarter but remained unchanged for fiscal 2012.

Recommendation

We believe Adobe will come out with decent third quarter results owing to increasing revenue visibility, solid CS6 adoption, cost cutting efforts, improved execution and an expanding customer base. We believe the company’s dominance in the Creative category and the integration of Creative products with digital marketing apps will provide a competitive edge.

Additionally, Adobe’s acquisition of Efficient Frontier will enhance its Digital Marketing suite by adding optimization capabilities for search and display advertising while accelerating its entry into social advertising.

However, a weak demand environment in Europeand strong competition from Apple Inc. and Microsoft Corp. (MSFT - Analyst Report) in tablet space remain a matter of concern.

Adobe shares currently have a Zacks #3 Rank, implying a short-term Hold recommendation.

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