Adobe Systems Keeps Climbing Into the Cloud, but Can Growth Last?

The creative-software specialist has handled its transition well but needs to keep up its momentum.

Dan Caplinger
Dan Caplinger
Jun 16, 2015 at 7:47PM
Technology and Telecom

Image: Adobe Systems.

The software industry is a cutthroat business, with plenty of competition from all corners. Adobe Systems (NASDAQ:ADBE) has made a name for itself with its creative software, which aims at professionals who need the customized features that Adobe's products provide. Coming into Tuesday afternoon's fiscal second-quarter financial report, Adobe shareholders had high expectations for the company, having sent its stock to all-time highs. Yet even though its results remained strong, Adobe's report made some investors nervous about its future prospects. Let's take a closer look at Adobe's latest quarterly report and what it says about the software developer's future.

Adobe creates growth
Adobe Systems boasted some impressive figures for the fiscal second quarter, with the company claiming record quarterly revenue of $1.16 billion, up almost 9% from the year-ago quarter and roughly in line with what most investors had expected to see from the company. After allowing for stock-based compensation and other extraordinary items, adjusted net income jumped 30% to $241.9 million, and that produced adjusted earnings of $0.48 per share, easily topping the $0.45 per share consensus figure among those following the stock.

Looking more closely at Adobe's results makes it clear how far the software-maker has come in its efforts to embrace the cloud. Subscription-based revenue soared more than 60% from the year-ago quarter to nearly $774 million, and that now represents two-thirds of Adobe's overall sales. As you'd expect, those gains came at the expense of product-based sales, which fell 45% to $274.5 million. Still, overall, Adobe has replaced a lumpy, less reliable stream of income with the recurring revenue that subscription agreements provide, and that should bode well for the company's investors going forward.

In addition, Adobe has worked hard to keep its expenses in line. Despite the big jump in sales, costs for sales and marketing and general overhead barely budged, while research and development spending actually fell slightly from year-ago levels. As a result, operating expenses rose by only a fraction of a percentage point, and that helped produce impressive gains in operating income.

Adobe's executives had positive comments about its latest results. As CEO Shantanu Narayen said, "Strong execution against our Creative Cloud, Document Cloud, and Marketing Cloud businesses drove record revenue." CFO Mark Garrett was also pleased with the company's progress, noting that "With our business model transition largely behind us, the positive financial benefits are now reflect in our [profit and loss statements]."

Why investors are nervous about Adobe's future
For its part, Adobe seems excited about its future. "We are accelerating the pace of innovation in our Cloud offerings and are thrilled to be launching our best Creative Cloud release to date, which includes Adobe Stock -- our new stock content service," said Narayen. Annualized recurring revenue from digital media reached a run rate of $2.35 billion by the end of the quarter, with creative software providing a big part of those gains.

Unfortunately, not all investors were pleased with Adobe's assessment of its financial future. The company said that sales for the fiscal third quarter would likely come in between $1.175 billion and $1.225 billion, which is less than the $1.25 billion that investors were expecting. Adobe also pushed down its sales guidance for the full fiscal year to $4.845 billion, down $80 million from its previous guidance and below consensus expectations.

Still, Adobe has put its money behind its stock, despite its recent advance. During the second quarter, Adobe spent $200 million on share repurchases, acquiring about 2.6 million shares. With such high margins, the company should continue to have the ability to buy back substantial amounts of stock, even though its outstanding share count has actually risen over the past year on a non-diluted basis.

Adobe investors seemed disappointed with the news, sending the stock down 1.5% in the first two hours of after-market trading following the announcement. In the long run, Adobe needs to demonstrate ongoing demand for its creative software, and now that it has reaped most of the gains from taking its products into the cloud, it will also have to prove that the move was a smart one. If it can do so and keep producing growth, then that will give Adobe the best chance to see its stock rise further from here.