Adobe Systems Inc. (ADBE - Free Report) reported third quarter 2012 earnings of 45 cents per share, missing the Zacks Consensus Estimate of 47 cents. The adjusted earnings per share exclude one-time items, but include stock-based compensation expense.
Adobe’s total revenue was $1.081 billion, down 3.8% sequentially but up 6.7% year over year. Reported revenue was towards the lower end of the management’s expectation range of $1.075 billion to $1.125 billion. The sequential decline was due to increased adoption of new and lower priced subscription-based models by customers.
Products generated 75.0% of Adobe’s revenue, which was down 0.18% sequentially Subscription revenue comprised 16.0%, up 50.9% sequentially, and Services & Support brought in the balance, increasing 12.1% year over year.
Revenue by Segment
Digital Media Solutions, which remains Adobe’s largest, generated 71.2% of revenue in the quarter. Segment revenue was down 8.9% sequentially but up 3.1% year over year at $769.1 million.
Within Digital Media, Document Services (includes Acrobat family and the new cloud-based services such as EchoSign) revenue was $185.5 million. The segment had a record quarter, thanks to continued Acrobat adoption in the enterprise as well as continued momentum in EchoSign and other related Acrobat cloud services.
The company added more than 100,000 net new subscriptions, and ended the third quarter with approximately 200,000 total paid subscriptions for the Creative Cloud software suite.
Management was 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.
Digital Marketing was up 2.5% sequentially but down 18.5% year over year at $257.1 million. This segment accounted for 23.8% of total third quarter revenue. Within the segment, Digital Marketing Suite revenue was up 40% from the year-ago quarter at 192.4 million, aided by increased demand for mobile devices. Mobile transactions increased to 18%, up from 17% in the last quarter.
Revenue by Geography
In the third quarter, the Americas remained the largest contributor to Adobe’s revenues, with a share of around 52%. Europe accounted for another 27%, with the balance coming from Asia. Stable demand in the U.S.and Asia was partially offset by some softness in Europe.
Reported gross margin for the quarter was 88.9%, down 80 bps from 89.7% 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 $682.7 million, which were 7.6% higher than the year-ago quarter’s $634.4 million. Operating margin was 63.2%, which was slightly up from 62.6% in the year-ago quarter. As a percentage of sales, research and development expenses declined, while sales and marketing, and general and administrative expenses increased slightly.
On a fully diluted GAAP basis, Adobe recorded a net income of $201.4 million (40 cents per share) compared with $195.1 million (39 cents per share) in the year-ago quarter and $223.9 million (45 cents per share) in the previous quarter.
On a pro forma basis, Adobe generated net income of $224.9 million compared with $219.4 million in the year-ago comparable quarter and 245.7 million in the previous quarter. Fully diluted pro forma earnings per share came in at 45 cents, compared with 44 cents in the year-ago quarter and 49 cents in the previous quarter.
Adobe ended the third quarter with cash and investments balance of $3.25 billion versus $2.99 billion in the previous quarter. Days sales outstanding (DSO) was 48 days versus 50 days in the year-ago quarter and 43 days in the last quarter. Deferred revenue was $560.3 million, down by $32.5 million sequentially.
Cash generated from operations was $263.3 million and capital expenditure was $77.4 million. The company also repurchased approximately 2.4 million shares at a total cost of $76.1 million.
For the fourth quarter, management expects revenue in the range of $1.075 billion to $1.125 billion. Additionally, management expects Digital Media segment to be down sequentially due to continued momentum in Creative Cloud adoption. In the Digital Marketing segment, management expects Digital Marketing Suite revenue to grow sequentially, offset by a slight sequential decline in legacy Enterpriseproducts.
Accordingly, based on a share count of 500–502 million, GAAP EPS is expected at 34 cents to 39 cents, including stock-based compensation of 17 cents, intangibles amortization charges of 6 cents, restructuring charges of 1 cent, and income tax adjustment of 5 cents, excluding all of which, non GAAP EPS is expected to be 53–58 cents. Currently, the Zacks Consensus Estimate for the upcoming quarter is pegged at 56 cents.
Also for the fourth quarter, non-operating expense is expected in the range of $18–$20 million. The tax rate is expected to be approximately 23.5% on a GAAP basis and 22.5% on a non-GAAP basis.
We find Adobe’s third quarter results lackluster, as both earnings and revenues missed the Zacks Consensus Estimate. The new subscription service will hurt Adobe's financial growth, at least over the short term, as it brings in revenues on a monthly basis, instead of a lump sum at the start.
However, 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.
We believe that solid adoption of Creative Cloud could serve as a potential catalyst going forward. Adobe’s acquisition of Efficient Frontier will further enhance its Digital Marketing suite by adding optimization capabilities for search and display advertising while accelerating its entry into social advertising.
However, end-market recovery appears slow and a weak demand environment in Europe remains a matter of concern. Additionally, the company faces strong competition from Apple Inc. (AAPL - Free Report) and Microsoft Corp. (MSFT - Free Report) .
Adobe shares currently have a Zacks #3 Rank, implying a Hold rating.