Adobe Systems Inc. (ADBE) reported earnings for the fourth quarter ended November 2011 that exceeded the Zacks Consensus Estimate of 50 cents. The results are a reflection of much stronger revenue across segments, with particular strength in enterprise and a resurgent Europe. Acquisitions drove the GAAP tax rate higher.
Revenue
Adobe’s total revenue was $1.152 billion, up 13.7% sequentially, up 14.3% year over year and within management’s expectations of $1.075 billion to 1.125 billion (up 6.1% to 11.0% sequentially). Excluding currency hedge gains of $3.6 million in the last quarter and $0.7 million in the year-ago quarter, the positive impact of currency in the year-over-year comparison was $12.1 million.
Products generated 81% of Adobe’s revenue, up 15.0% sequentially and 12.8% year over year. The key CS and the Acrobat product lines were very strong in the last quarter. Subscription revenue comprised 11% of revenue, up 10.2% sequentially and 22.9% from the year-ago quarter. Services & Support brought in the balance, representing sequential and year-over-year increases of 5.9% and 19.7%, respectively.
Revenue by Segment
Beginning in the first quarter, Adobe split the Creative Solutions segment into Digital Media Solutions and Creative and Interactive Solutions. Digital Media includes Adobe’s imaging and video-related products, while Creative and Interactive include the CS product lines, as well as the Platform segment, which is currently being reported as a separate segment.
The Creative and Interactive Solutions segment, which remains Adobe’s largest, generated 38% of total quarterly revenue. This was a 4.6% increase from the third quarter and an 8% increase from the year-ago quarter. The CS family had a record quarter, driven by very high volume licensing by enterprise customers, as well as Adobe.com sales. Around 40% of subscribers used CS for the first time, so CS5.5 adoption looks high.
Digital Media Solutions generated 16% of revenue in the last quarter. Segment revenue was up 23.4% sequentialy and 12.4% from last year. Adobe is building its video distribution and video ad delivery business, which was boosted by the Auditude acquisition and Production Premium solution.
Knowledge Worker revenues jumped 15.5% sequentially and 18.7% year over year to 18% of total revenue. Adobe attributed the year-over-year increase to continued strong demand for the Acrobat product line. Here too, enterprise licensing was the major driver.
The Enterprise business at more than 12% of Adobe’s quarterly revenue, had a turnaround quarter, growing 46.9% sequentially after two quarters of decline. Segment revenue was up 36.1% from last year. Management attributed the strength to its Day Web Experience management solution, as well as strength in the government vertical.
Omniture generated nearly 11% of revenue in the last quarter, representing sequential and year-over-year increases of 10.9% and 20.3%, respectively. High value contracts (more than $500,000 each) were at record levels in the last quarter, as several products within the digital marketing suite gained ground.
The conversion and multi-channel analytics tools should continue to grow, as Adobe is getting acquisitive in the area. Also encouraging was the enterprise customer retention rate, which remained at 95%. Transactions from mobile devices were particularly strong, up from 11% to 13% of total transactions in the quarter. The revenue diversification strategy is on track, with SiteCatalyst (the core product) dropping to less than 49% of total Omniture product revenue in the quarter.
Print and Publishing brought in the remaining 5% of revenue, dwon 0.9% sequentially and up 0.2% from last year.
Revenue by Geography
Adobe’s business is fairly well diversified across geographies, although the Americas region remains the largest contributor to its revenues, with a revenue share of around 48%. Europe accounted for another 33% in the last quarter, with the balance coming from Asia.
All three geographies grew in the last quarter, although the biggest increase was in Europe (up 29.4% sequentially). This was followed by the Americas with a 9.2% sequentially (the only region to grow in the last quarter), as demand remained relatively increase and Asia, which saw revenue increase 2.9%. The strength in Europe was the most unexpected, given the macro concerns that continue to plague the region.
Adobe’s pro forma gross margin for the quarter was 91.3%, up 32 bps from 91.0% in the previous quarter and 30 bps from 91.0% 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.
The product gross margin, at 96.4%, is the primary reason for Adobe’s high-margin profile, since both subscription (gross margin of 58.4% in the last quarter) and services & support (gross margin of 66.2%) generate significantly lower margins. In the last quarter, the product gross margin shrunk 42 bps sequentially although it continued to increase from the year-ago quarter.
The subscription gross margin expanded 82 bps sequentially and 739 bps year over year. The services and support gross margin managed to expand sequentially by 193 bps, although the decline from the year-ago quarter remained significant at 392 bps.
Adobe reported operating expenses of $683.3 million, which were 10.2% higher than the previous quarter’s $620.3 million. However, revenue strength resulted in an operating margin of 32.0% which was up from 29.8% in the preceding quarter. G&A came in flattish as a percentage of sales, while all other expenses (particularly S&M) declined.
Net income
On a pro forma basis, Adobe generated a net income of $270.6 million, or a 23.5% net income margin compared to $218.4 million, or 21.6% in the previous quarter and net income of $249.2 million or 24.7% net income margin in the same quarter last year. The fully diluted pro forma earnings per share (EPS) came in at 55 cents, compared to 44 cents in the previous quarter and 49 cents in the year-aggo quarter.
Our pro forma estimate excludes restructuring gains, amortization of intangibles, investments gain/loss and tax adjustments, but includes deferred stock compensation. Our pro forma calculations may differ from management’s presentation due to the inclusion/exclusion of any items that were not considered by management.
On a fully diluted GAAP basis, Adobe recorded a net income of $173.7 million ($0.35 per share) compared to $195.1 million ($0.39 per share) in the previous quarter and $268.9 million ($0.53 per share) in the year-ago quarter.
Balance Sheet
Adobe ended with a cash and investments balance of $2.91 billion, up $192.4 million during the quarter. Cash and investments were around 32% of total assets at quarter-end. Cash generated from operations was $496.7 million. Principal uses of cash during the quarter included $74.9 million on capex and $151.9 million on acquisitions net of cash acquired.
At quarter-end, Adobe had $1.51 billion in long term debt, taking the net cash balance to $1.41 billion. Including long term liabilities, the debt-cap ratio was a mere 25.3%.
Guidance
Adobe provided guidance for both the first quarter and fiscal 2012 on both GAAP and non-GAAP basis.
Accordingly, based on a share count of 500-502 million, the GAAP EPS is expected to be 37 to 43 cents, including stock based compensation of 13-14 cents, restructuring and other charges of 3 cents, intangibles amortization charges of 5 cents and income tax adjustments of 5 cents, excluding all of which, the non GAAP EPS is expected to be 54-59 cents. The Zacks Consensus Estimate for the quarter is currently just 47cents, so there will be upward revisions that could raise the Zacks Rank.
For the year, Adobe expects GAAP earnings of $1.70 to $1.83 and non GAAP earnings of $2.37 to $2.47 based on a share count of 500 to 504 million shares.
Our Recommendation
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, while the company did see some seasonal strength in the last quarter, the macro concerns in Europe are not going away just yet. Therefore, there could easily be continued macro-driven pressures on Adobe’s results given its significant exposure to the region.
Adobe shares currently have a Zacks Rank of #4, implying a short-term Sell recommendation. Our long-term recommendation is Neutral.
