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Adobe Fails to Match Up

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Adobe Systems Inc. (ADBE - Free Report) reported earnings of 42 cents for the first quarter ended February 2012, missing the Zacks Consensus Estimate of 46 cents. The results reflect weaker revenue across segments, with particular weakness in Creative Suit and its significant exposure to the European region. The GAAP tax rate was higher due to a one-time charge related to the acquisition of Efficient Frontier.


Adobe’s total revenue was $1.045 billion, down 9.3% sequentially, but up 1.7% year over year. The result was within management’s expectations of $1.025 billion to 1.075 billion. The figure includes $9.6 million of revenue from the acquisition of Efficient Frontier that closed in January 2012.

Excluding currency hedge gains of $10.3 million in the last quarter, the positive impact of currency in the year-over-year comparison was $7.7 million.

Products generated 77.4% of Adobe’s revenue, down 13.7% sequentially and 4.1% year over year. Subscription revenue comprised 14% of revenue, up 18.5% sequentially and 37.7% from the year-ago quarter. Services & Support brought in the balance, decreasing 1.5% sequentially and increasing 14.7% year over year.

Revenue by Segment

Digital Media Solutionssegment, which remains Adobe’s largest, generated 69.9% of revenue in the quarter. Segment revenue was down 11.7% sequentially and 4.0% from last year to $730.3 million. The CS family performance was lower than expected in the quarter. However, management expects demand to improve with the launch of Creative Suite and Creative Cloud. Within the Digital Media segment, Document Services revenue was $183.3 million, down 0.7% from the year-ago quarter and 10% sequentially. Acrobat was in line with management expectations.

Digital Marketing segmentwas down 3.6% sequentially but up 22.1% year over year at $259.9 million. This segment accounted for 24.8% of the total first quarter revenue. Within the Digital Marketing segment, Digital Marketing Suite revenue was up 33% from the year-ago quarter, aided by the acquisition of Efficient Frontier. Excluding Efficient Frontier, Digital Marketing Suite revenue grew 26% year over year.

Print and Publishingbrought in the remaining 5.3% of revenue, down 0.2% sequentially and up 2.4% from the prior-year quarter at $55.0 million.

Revenue by Geography

Adobe’s business is fairly well diversified across geographical regions, although the Americas remains the largest contributor to its revenues, with a share of around 48%. Europe accounted for another 32% in the reported quarter, with the balance coming from Asia.


Reported gross margin for the quarter was 89.6%, up 10 bps from 89.5% 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 reported operating expenses of $648.0 million, which were 4.9% higher than the year-ago quarter’s $617.7 million. Higher expenses resulted in an operating margin of 27.7%, which was down from 29.4% in the year-ago quarter. G&A came in flattish as a percentage of sales, S&M increased slightly while R&D declined.

Net Income

On a fully diluted GAAP basis, Adobe recorded a net income of $185.2 million (37 cents per share) compared to $234.6 million (46 cents per share) in the year-ago quarter and $173.7 million (35 cents per share) in the previous quarter.

On a pro forma basis, Adobe generated a net income of $209.9 million compared to $250.8 million in the same quarter last year and 270.6 million in the previous quarter. The fully diluted pro forma earnings per share (EPS) came in at 42 cents, compared to 49 cents in the year-ago quarter and 55 cents in the previous quarter.

Our pro forma estimate excludes restructuring gains, amortization of intangibles, investments gain/loss and tax adjustments, but includes stock-based and deferred compensation. Our pro forma calculations may differ from management’s presentation due to the inclusion/exclusion of any item that was not considered by management.

Balance Sheet

Adobe ended the first quarter with a cash and investments balance of $2.77 billion versus $2.91 billion in the previous quarter. Cash and investments were around 30% of total assets at quarter-end. Cash generated from operations was $314.4 million. Principal uses of cash during the quarter included $51.1 million on capex and $353.2 million on acquisitions net of cash acquired.

At quarter-end, Adobe had $1.50 billion in long-term debt, taking the net cash balance to $1.27 billion.


Adobe provided guidance for both the second quarter and fiscal 2012 on both GAAP and non-GAAP basis.

For the second quarter, management expects revenue in the range of $1.09 billion to $1.14 billion. Additionally, management expects Digital Media revenue to grow sequentially with the launch of CS6. In the Digital Marketing segment, management expects Digital Marketing Suite revenue to grow sequentially with Efficient Frontier contributing approximately $15 million. However, management expects legacy Enterprise product revenue to decline sequentially by approximately $30 million. Print and Publishing segment is expected to be relatively flat.

Accordingly, based on a share count of 502-504 million, the GAAP EPS is expected to be 37 centsto 43 cents, including stock-based compensation of 18-16 cents, restructuring and other charges of 1 cents, intangibles amortization charges of 6 cents and income tax adjustments of 5 cents, excluding all of which, the non GAAP EPS is expected to be 57-61 cents. Currently, the Zacks Consensus Estimate for the upcoming quarter is pegged at 48 cents.

For the year, Adobe expects GAAP earnings of $1.63 to $1.73 and non GAAP earnings of $2.38 to $2.48 based on a share count of 502 million to 504 million shares.

Our Recommendation

We find Adobe’s first quarter results unimpressive, as the bottom line missed the Zacks Consensus Estimate. While we remain positive about Adobe’s market position, its compelling product lines (CS cloud initiative and digital media products included), continued innovation and strong balance sheet, the end market recovery appears slow.

Also, we believe that the expected launch of Creative Suite 6 in April and solid initial adoption of Creative Cloud could serve as potential catalysts. Adobe’s recent 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, strong competition from Apple Inc. and Microsoft Corp. (MSFT - Free Report) remains a matter of concern.

Adobe shares currently have a Zacks Rank of #2, implying a short-term Buy recommendation.

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