Adobe (ADBE) reported weak third-quarter results Tuesday, but provided a range for its fiscal fourth-quarter results that topped consensus estimates, representing revenue growth of 10% and earnings growth of 20% at the high end of its guided range. We’re maintaining our fair value estimate of $35 per share and make available our 16-page equity research report here.
The firm’s total revenue advanced a modest 2% in the period, as expansion from subscription and services and support sales offset declines in product revenue. The company noted record educational revenue, strong growth in its digital video products, and solid performance with Acrobat. Services and support revenue grew a whopping 39% during the period, and we expect continued rapid expansion from this revenue line in coming periods. Gross profit margin on this revenue stream is in excess of 35%, significantly greater than the paltry 3% gross margins on product sales, so this represents a nice mix shift. The firm’s operating margin, however, fell below 28% from over 30% in the prior-year period, as a result of lower profitability from subscription revenue and a ramp in sales and marketing and research and development costs.
Net income fell 15% in the quarter, but cash from operations advanced over 10% — a nice showing. We view Adobe as a cash cow, with its free cash flow (free cash flow divided by sales) in excess of 25% in the period. The firm’s significant cash-flow generation prowess is one major reason why we think using a DCF valuation model is the best way to value the firm. We make our DCF valuation model template available here.
Adobe indicated that it expects sequential growth in all of its business lines (except Print and Publishing) and across all geographies. The company guided its fourth-quarter operating margin to 26.5% to 29% (on a GAAP) basis, a range we think is readily achievable, given higher-margin services/support revenue expansion and the flexibility provided by discretionary purchases in sales and marketing and research and development. The company guided its fourth-quarter earnings per share outlook to between $0.57 and $0.64 on a non-GAPP basis, a range that Adobe will hit on the high end, in our opinion. Adobe also noted that it will soon be introducing a broad set of tablet-based and cloud-connected apps and services, as well as Adobe Carousel, a new cloud-connected imaging app for Mac OS and iOS devices.
All things considered, Adobe faces a number of challenges as its industry remains in transition (software is moving to the cloud, etc.), but we think the firm’s cash flow stream and new product offerings make it an attractive consideration for long-term investors.