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Adobe Systems Incorporated Creates Another Solid Quarter, "Light" Guidance

By Steve Symington - Sep 17, 2015 at 7:04PM

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The creative software specialist is down due to a soft forward outlook. But perspective is in order.

Credit: Adobe Systems Incorporated.

Adobe Systems (ADBE 1.52%) stock fell as much as 3% in Thursday's after-hours trading following the release of its fiscal third-quarter 2015 results. But don't take that to mean the quarter itself was bad.

To the contrary, quarterly revenue grew 22% year over year, to $1.22 billion, and adjusted net income nearly doubled, to $275.4 million, or $0.54 per share. Analysts, on average, were only anticipating earnings of $0.50 per share on revenue of $1.21 billion.

Digging deeper
Adobe's top line was driven both by strong adoption of Creative Cloud and record sales from Adobe Marketing Cloud. On the former, Creative Cloud subscriptions increased by 684,000, leaving Adobe with a total of 5.3 million subscriptions at quarter's end. Combined with the early success and annual value of enterprise agreements for Adobe Stock -- not the ticker, but rather a new stock content service launched in June -- annualized recurring revenue from digital sources grew sequentially by $262 million, to roughly $2.3 billion. On the latter, Adobe Marketing Cloud revenue reached a company-record $368 million, good for growth of 27% year over year.

Recurring revenue represented 73% of Adobe's total in fiscal Q3, up from around 67% last quarter and 63% in the same year-ago period. For that, Adobe can largely thank a 51.5% year-over-year increase in subscription revenue as it transitions to the cloud, and away from its installed base of perpetual licenses. Meanwhile, that growth came partly at the expense of product-based revenue, which fell just more than 21%. But you'd be hard-pressed to find Adobe management complaining, as higher cloud-based subscriptions not only result in a more predictable revenue stream, but also come with superior margins.

Adobe's operating expenses climbed less than 1% year over year, notably including a modest 3.8% increase in sales and marketing, to $422 million, a 3% increase in R&D expenses, to $218.7 million (or around 18% of revenue), and a 13.5% decline in general and administrative expenses, to $122.6 million.

Adobe also generated healthy cash flow from operations of $360 million, while deferred revenue climbed to a new company high mark of $1.31 billion. On the bottom line, Adobe bolstered investors' per-share profits by repurchasing around 1.6 million shares during the quarter for a total of $132 million.

Here's what happened
If you're wondering why the stock is falling right now, look no further than Adobe's guidance. Though Adobe CFO Mark Garrett praised the results as setting the company up for a strong end to the fiscal year, he also noted that -- similar to the trend last year in Creative -- the transition to subscriptions is now happening faster than previously anticipated for Adobe's Acrobat, Lightroom, and Photoshop Elements products.

Consequently, that means slightly lower-than-expected revenue in the fourth quarter, as revenue is recognized during the course of these subscriptions rather than in a single lump sum, as with perpetual licenses. For the reasons described above, investors should be pleased, as this signals accelerated progress in Adobe's transition.

In the meantime, however, Adobe expects revenue in the current quarter to be $1.275 billion to $1.325 billion, while adjusted earnings per share should be in the range of $0.56 to $0.62. Wall Street, for its part, was modeling fiscal fourth-quarter revenue of $1.36 billion, and adjusted earnings of $0.64 per share.

But don't get too upset by the market's misstep: Going into today's close, Adobe stock was already up more than 10% year to date. And shareholders can take solace knowing that the after-hours decline essentially brings shares back to last week's levels -- hardly a move of any consequence from a long-term investor's perspective. Over time, as Adobe's move to the cloud becomes less pronounced, so, too, should its increasingly typical post-earnings declines on what the market perceives as "weak" guidance.

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