Adobe Systems Inc.(ADBE) has reported second quarter 2012 earnings of 49 cents per share, beating the Zacks Consensus Estimate of 48 cents. The results reflect stronger revenue across segments, with particular strength in Creative Suite and Digital Marketing Suite businesses. The adjusted earnings per share exclude one-time items, but include stock-based compensation expense.
Revenue
Adobe’s total revenue was $1.124 billion, up 7.6% sequentially and 9.9% year over year. The result was on the higher end of the management’s expectation range of $1.09 billion to 1.14 billion. The successful launch of Creative Cloud and Creative Suite 6, strong Acrobat revenue and better-than-expected growth in Digital Marketing Suite business led to the strength in revenue.
Products generated 77.5% of Adobe’s revenue, and was up 7.7% sequentially and 4.9% year over year. Subscription revenue comprised 14.2%, up 9.2% sequentially and 45.7% from the year-ago quarter. Services & Support brought in the balance, increasing 3.8% sequentially and 12.2% year over year.
Revenue by Segment
Digital Media Solutions segment, which remains Adobe’s largest, generated 72.8% of revenue in the quarter. Segment revenue was up 12.1% sequentially and 8.5% year over year from the prior-year quarter at $818.4 million. The company launched CS6 and Creative Cloud at the end of the quarter, and the performance was in line with management’s expectations despite some softness in Europe. Management was quite optimistic about the CS6 and Creative Cloud adoption. Within Digital Media, Document Services revenue was $206.7 million versus $184.3 million in the year-ago quarter and $183.3 million in the previous quarter. The segment had a record quarter, thanks to strong volume licensing of Acrobat as well as continued momentum with EchoSign and other document exchange services.
Digital Marketing segment was down 3.5% sequentially but up 16.6% year over year at $250.9 million. This segment accounted for 22.3% of the total second quarter revenue. Within the segment, Digital Marketing Suite revenue was up 35% from the year-ago quarter at 189.9 million, aided by the acquisition of Efficient Frontier. Excluding Efficient Frontier, Digital Marketing Suite revenue grew more than 20% year over year. Mobile transactions increased to 17%, up from 14% in the last quarter.
Print and Publishing brought in the remaining 4.9% of revenue, up 0.2% sequentially and 2.0% from the prior-year quarter at $55.1 million.
Revenue by Geography
In the second quarter, Americas remained the largest contributor to Adobe’s revenues, with a share of around 49%. Europe accounted for another 29%, with the balance coming from Asia. Stable demand in the U.S. and Asia was partially offset by some softness in Europe.
Margins
Reported gross margin for the quarter was 88.4%, down 90 bps from 89.3% 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 $688.4 million, which were 8.0% higher than the year-ago quarter’s $637.3 million. Operating margin was 27.1%, which was slightly up from 27.0% in the year-ago quarter. As a percentage of sales, research and development declined, while sales and marketing, and general and administrative increased slightly.
Net Income
On a fully diluted GAAP basis, Adobe recorded a net income of $223.9 million (45 cents per share) compared to $229.4 million (45 cents per share) in the year-ago quarter and $185.2 million (37 cents per share) in the previous quarter.
On a pro forma basis, Adobe generated a net income of $245.7 million compared to $240.5 million in the comparable quarter last year and 209.9 million in the previous quarter. The fully diluted pro forma earnings per share came in at 49 cents, compared to 48 cents in the year-ago quarter and 42 cents in the previous quarter.
Balance Sheet
Adobe ended the second quarter with a cash and investments balance of $2.99 billion versus $2.77 billion in the previous quarter. Cash and investments were around 31.9% of total assets at quarter-end. Deferred revenue was $592.8 million, up by $43.9 million sequentially.
Cash generated from operations was $448.2 million and capital expenditure was $60.8 million. The company also repurchased approximately 5.3 million shares at a total cost of $175.7 million.
Guidance
Adobe provided guidance for the third quarter and updated its fiscal 2012 projection on both GAAP and non-GAAP basis.
For the third quarter, management expects revenue in the range of $1.075 billion to $1.125 billion. Additionally, management expects continued softness in Europe and expects Digital Media segment to be down sequentially. In the Digital Marketing segment, management expects Digital Marketing Suite revenue to grow sequentially, offset by a slight sequential decline in legacy Enterprise products. The Print and Publishing segment is expected to be relatively flat.
Accordingly, based on a share count of 501–502 million, GAAP EPS is expected at 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 which, non GAAP EPS is expected to be 56–61 cents. Currently, the Zacks Consensus Estimate for the upcoming quarter is pegged at 49 cents.
Also for the third 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.
For the full year, Adobe narrowed its revenue growth guidance to a range of 6–7%, versus its prior range of 6–8%. GAAP earnings guidance was adjusted to $1.69–$1.76 versus its prior expectation of $1.63–$1.73 and non-GAAP earnings to $2.40–$2.46 from $2.38–$2.48.
Our Recommendation
We find Adobe’s second quarter results impressive, as the bottom line exceeded 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, the solid initial adoption of Creative Suite 6 and Creative Cloud was encouraging in the quarter and could serve as potential catalysts 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, the 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. (APPL) and Microsoft Corp. (MSFT).
Adobe shares currently have a Zacks Rank of #4, implying a Sell recommendation.
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