Adobe Systems Inc. (ADBE) reported second-quarter 2014 earnings of 23 cents per share, beating the Zacks Consensus Estimate by 7 cents. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.
Following the earnings release, share price surged 9.4% in after-hours trading driven by stronger-than-expected results. The results were aided by strong adoption of its Creative Cloud and Marketing Cloud suites.
Revenues
Adobe reported revenues of $1.7 billion, up 6.8% sequentially and 5.7% year over year. Reported revenues were above management’s guided range of $1.0 to $1.05 billion and beat the Zacks Consensus Estimate of $1.02 billion driven by higher subscription sales of creative cloud and Adobe marketing cloud suites.
Products generated 44.9% of Adobe’s revenues but were down 25.7% year over year. Subscription comprised 44.6% of total revenue, up 87.3% year over year while Services & Support brought in the balance, up 1.0% year over year.
Revenues by Segment
Digital Media Solutions, Adobe’s largest segment, generated 64.8% of the revenues in the quarter. Segment revenues were up 8.0% sequentially to $692.0 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 second quarter with approximately 2,308k paid subscriptions, an increase of 464K sequentially.
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.
The increased subscription, ETLA adoption and digital publishing suite adoption helped drive creative annualized recurring revenues or ARR to $1.2 billion, up $208 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. The company also expanded its Photoshop Lightroom offering, which enabled it to acquire new customers as well as convert those who historically licensed Photoshop Elements and Photoshop Lightroom.
In the Document Services business (includes Acrobat family and new cloud-based services such as EchoSign), revenues were $196.0 million, up 1.0% sequentially. The segment performed well 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 $183 million, up 11.6% sequentially.
The Digital Marketing segment accounted for 30.9% of total second-quarter revenue. Within the segment, Adobe Marketing Cloud revenues were up 23% from the year-ago quarter to $283.0 million, aided by increased demand for mobile devices. Mobile transactions increased to 37% from 36% in the last quarter.
LiveCycle and Connect businesses generated revenues of $47.0 million in the reported quarter, flat sequentially.
Print and Publishing revenues were $46.0 million in the last quarter.
Margins
Reported gross margin for the quarter was 85.5%, down 110 basis points from 86.6% 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 $778.0 million, up 1.8% from the year-ago quarter’s $764.0 million. As a percentage of sales, research and development expenses decreased, while general and administrative as well as sales and marketing expenses increased from the year-ago quarter. As a result, operating margin expanded to 12.7% from 11.0% in the year-ago quarter.
Net Income
On a GAAP basis, Adobe recorded net income of $88.5 million (17 cents per share) compared with $76.5 million (15 cents) in the year-ago quarter.
On a pro-forma basis, Adobe generated net income of $114.9 million compared with $123.0 million in the year-ago quarter. Pro-forma earnings came in at 23 cents per share compared with 24 cents in the year-ago quarter.
Balance Sheet
Adobe ended the quarter with cash and investments balance of $3.33 billion versus $3.13 billion in the previous quarter. Days sales outstanding (DSO) were 45 days versus 42 days in the year-ago quarter and 46 days in the last quarter. Deferred revenues increased $48.0 million to $879.1 million.
In the second quarter, cash generated from operations was $368.0 million and capital expenditure was $27.2 million. Additionally, the company repurchased approximately 2.6 million shares for $166.0 million.
Guidance
For the third quarter, management expects revenues in the range of $975 million to $1.025 billion. Analysts polled by Zacks expect revenues to be $1.021 billion, at the higher-end of the guided range. Additionally, management expects total Digital Media to decline sequentially.
In Digital Marketing segment, management expects Adobe Marketing Cloud revenues to increase 20% 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 506–508 million, GAAP earnings are expected in the range of 2–8 cents per share, while non-GAAP earnings are expected in the range of 22–28 cents. Analysts polled by Zacks expect non-GAAP earnings of 14 cents, well below the mid-point of the guided range.
Also, for the third quarter, non-operating expense is expected within the $14–$16 million range and tax rate is expected to be within 26–28% on a GAAP basis and 21% on a non-GAAP basis.
Our Recommendation
Adobe reported strong second-quarter results with both earnings and revenues exceeding the Zacks Consensus Estimate.
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.
Also, we believe solid adoption of the Creative Cloud and Adobe marketing cloud could serve as potential catalysts, 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 media advertising.
Currently, Adobe has a Zacks Rank #3 (Hold). Better-ranked stocks that are performing well at current levels include Blackbaud Inc. (BLKB), Citrix Systems, Inc. (CTXS) and Manhattan Associates, Inc. (MANH). All these stocks sport a Zacks Rank #1 (Strong Buy).
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