Software maker Adobe (click ticker for report: ) announced fiscal third quarter results Tuesday afternoon. Results were a tad shy of expectations on both the top and bottom lines, as revenue declined 8% year-over-year to $995 million and earnings per share slipped 45% year-over-year to $0.32 as the firm moves to a subscription-based business model. Free cash flow remained strong during the third quarter at $169 million, equal to 17% of total revenue.
Creative Cloud Success
Image Source: ADBE Q3 FY13 Slides
The story of Adobe’s third quarter was the continued success of the Creative Cloud product suite. Paid subscriptions surpassed the 1 million mark driving Digital Media ‘Annualized Recurring Revenue’ (ARR) to $655 million. ARR is a wonderful business model for any company that can implement it, as the associated cash flow stream requires little incremental work beyond the initial investment at the firm. The switch from a licensing model to an annual recurring subscription platform has impacted reported revenue for fiscal year 2013 (explaining the negative year-over-year comparisons), but we expect the move to improve profitability over the long-haul.
Marketing Performance Wasn’t Too Shabby
In addition to the Creative Cloud product suite, Adobe’s Marketing Cloud achieved robust expansion, with revenue up 28% year-over-year, giving the product a $1 billion annualized run-rate. Adobe’s previous glaring weakness, social media, was addressed by the company in July with its acquisition of Neolane. Adobe CEO Shantanu Narayen added some color on the acquisition, saying on the conference call:
“Neolane integrates online and offline marketing data from across an enterprise, performing robust audience segmentation and delivering marketing messages across channels including web, email, social, mobile, call center, direct mail and point of sale.”
Put simply, the product runs the gauntlet of marketing dissemination mediums.
Capital Allocation
Unlike its larger tech peers such as Microsoft (click ticker for report: ) and Intel (click ticker for report: ), Adobe doesn’t pay a dividend. Still, the firm returned cash to shareholders by repurchasing 7 million shares for $326 million. Since the average price (roughly $46.57) falls within our fair value range, the purchases are value-neutral.
As we mentioned earlier, the firm generated $169 million in free cash flow. It also used $600 million to acquire Neolane, putting its current cash balance at a healthy $3.16 billion.
Guidance
Adobe provides investors with a useful guidance file (click here). For the fiscal fourth quarter, the company anticipates revenue of $1-$1.05 billion driving non-GAAP earnings per share of $0.28-$0.34. The high-end of both estimates were in-line with consensus expectations.
Valuentum’s Take
Adobe’s Creative Cloud is adding recurring revenue at a fantastic clip, setting the firm up for several profitable years to come. Nevertheless, we think shares look fairly valued at this time, and we think there are better opportunities in the technology space, including Apple (click ticker for report: ), Microsoft, Intel, Baidu (click ticker for report: ), and Google (click ticker for report: )—all members of our actively managed portfolios.
Disclosure:
RJ Towner owns shares of the following companies mentioned in this article: AAPL