Adobe's Q4 Earnings Beat Estimates

Zacks Equity Research

Adobe Systems Inc. (ADBE) reported fourth-quarter 2013 earnings of 18 cents per share, exceeding 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 rose 7.80% in after-hours trading.

Revenues

Adobe reported revenues of $1.04 billion, up 4.7% sequentially but down 9.7% year over year. Reported revenues were at the higher end of management’s guided range of $1.0 billion to $1.05 billion. The sequential revenue increase was due to the accelerated adoption of creative cloud subscription pricing model.

Products generated 54.4% of Adobe’s revenues but were down 33.5% year over year. Subscription comprised 34.5% of total revenue, up 84.9% year over year while Services & Support brought in the balance, increasing 8.2% year over year.

Revenues by Segment

Digital Media Solutions, Adobe’s largest segment, generated 60.6% of revenues in the quarter. Segment revenues were down 0.9% sequentially to $631.0 million. The two major revenue earners within the segment are the Creative family of products and Document Services products.

In the Creative business, Creative Cloud subscriptions continued to accelerate. The company ended the fourth quarter with approximately 1439,000 paid subscriptions with Creative Cloud for individuals and teams, an increase of 402K in the quarter.

As announced earlier, the company started to convert 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.

Creative Cloud ETLA momentum accelerated in the last quarter, with more than 1,000 creative ETLA contracts worth more than $100,000 and more than 80 contracts over $1 million. The increased subscription and ETLA adoption helped to drive creative annualized recurring revenues or ARR to a total of $768 million, an increase of $219 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.

In the Document Services business (includes Acrobat family and new cloud-based services such as EchoSign), revenues were $198.0 million, up 8.2% sequentially. The segment performed better than expected driven by continued Acrobat adoption in enterprise as well as continued momentum in EchoSign and other related Acrobat cloud services. ARR in Document Services business grew to $143 million, up 34.9% sequentially.

The Digital Marketing segment accounted for 35% of total fourth-quarter revenue. Within the segment, Adobe Marketing Cloud is the first component. Formerly known as Digital Marketing Suite, its revenues were up 38% from the year-ago quarter to $316.0 million, aided by increased demand for mobile devices. Mobile transactions increased to 33% from 28% in the last quarter.

The second component, LiveCycle and Connect businesses, generated revenues of $48.0 million in the last quarter.

Management expects LiveCycle revenues to decline further, while Connect revenues to remain relatively flat in the upcoming quarter.

Print and Publishing revenues were flat sequentially.

Margins

Reported gross margin for the quarter was 85.8%, down 340 basis points (bps) from 89.2% 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 $791.3 million, up 9.8% from the year-ago quarter’s $720.7 million. As a percentage of sales, research and development expenses, general and administrative expenses as well as sales and marketing expenses increased from the year-ago quarter. As a result, operating margin plummeted to 9.9% from 26.7% in the year-ago quarter.

Net Income

On a GAAP basis, Adobe recorded net income of $65.3 million (13 cents per share) compared with $222.3 million (44 cents per share) in the year-ago quarter.

On a pro-forma basis, Adobe generated net income of $90.84 million compared with $246.7 million in the year-ago comparable quarter. Pro-forma earnings came in at 18 cents per share compared with 49 cents per share in the year-ago quarter.

Balance Sheet

Adobe ended the fourth quarter with cash and investments balance of $3.17 billion versus $3.16 billion in the previous quarter. Days sales outstanding (:DSO) were 52 days versus 49 days in the year-ago quarter and 48 days in the last quarter. Deferred revenues increased $92.4 million to $775.5 million.

In the fourth quarter, cash generated from operations was $315.0 million and capital expenditure was $35.1 million. Additionally, the company repurchased approximately 7.9 million shares for a total cost of $405.0 million in the quarter.

Guidance

For the first quarter, management expects revenues in the range of $950 million to $1.0 billion, down 6.7% sequentially at the mid-point.

Additionally, management expects total Digital Media to be down sequentially in both creative and Document Services.

In Digital Marketing segment, management expects Adobe Marketing Cloud revenues to increase 25.0% 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 511 million–513 million, GAAP earnings are expected in the range of 2 cents–8 cents per share, while non-GAAP earnings are expected in the range of 22 cents–28 cents per share.

Also, for the first quarter, non-operating expense is expected in the range of $18 million–$20 million and tax rate is expected to be approximately 26% on a GAAP-basis and 21% on a non-GAAP basis.

For fiscal 2014, Adobe expects total revenue to be flat year over year. GAAP earnings are expected to be 27 cents per share and non-GAAP earnings to be $1.10 per share.

Additionally, the company outlined a three-year (2014–2016) growth plan for its business. The company expects revenues to increase at a three-year CAGR of 20%, with Digital Media business and Adobe Marketing Cloud business increasing at a CAGR of 20% and 25%, respectively. As part of these growth targets, the company expects non-GAAP earnings per share of approximately $2.00 in fiscal year 2015 and at least $3.00 in fiscal year 2016.

Our Recommendation

We find Adobe’s fourth-quarter results decent with earnings and revenues exceeding the Zacks Consensus Estimate due to strong adoption of the Creative Cloud.

Management expects revenues to decrease sequentially in the upcoming quarter due to seasonality. It also expects enterprise ETLAs to decline sequentially and slightly fewer additions to net new Creative Cloud subscriptions as compared to the fourth quarter.

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 the Creative 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 advertising.

Currently, Adobe has a Zacks Rank #3 (Hold). Some better-ranked stocks that are performing well at current levels include Microstrategy Inc. (MSTR), Interactive Intelligence Group Inc. (ININ) and Manhattan Associates, Inc. (MANH). All these stocks carry a Zacks Rank #1 (Strong Buy).

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