Earnings Preview: Adobe Systems

Adobe Systems Inc. (ADBE) is slated to release its first quarter 2011 earnings results on March 22. Analyst estimates have not moved around too much in the past few days and we think this could be because they are awaiting management commentary on the situation in Japan.


We expect downward revision to estimates for following quarters based on the crisis in Japan. Adobe has a significant portion of business coming from the country (12.6% in 2010, 13.9% in 2009 and 12.6% in 2008). So the closing down of facilities, shipping out of important personnel (both Japanese and other nationals) as a result of the earthquake and risks related to the release of radioactive materials are bound to have an impact on its results.

Despite limited response from analysts so far, investors are discounting the shares. Adobe has seen its share price dropping 8.7% in the four days following the catastrophe, although shares appear to be stabilizing now.

Separately, Adobe’s Flash platform remains shut out of Apple Inc’s (AAPL) products, which is something of a negative for growth.

Margin expansion could also be a challenge in the near term, given the step-up in sales and marketing expenses, as well as focus on growth through small acquisitions, many of which are likely to have lower margin profiles than Adobe


Adobe’s leadership in several key markets, solid business model, and the success of new products and acquisitions will determine its future.

Particularly, Adobe is seeing strong adoption of its CS5 and the CS6 suite (expected to launch later this year) is also likely to be popular. Its Acrobat platform is also seeing traction and did particularly well in the last quarter. Omniture has proved to be a good addition and the company’s online marketing suite seems to be going places.

Additionally, Google Inc’ (GOOG) Android has embraced Flash and Adobe will increase compatibility with HTML 5 with new generations of its Flash platform. So while being shut out of Apple’s business is not a good thing, the net impact may not be too negative. Especially considering the fact that the Japan crisis could see Apple facing component shortages related to its iPad2, which will no doubt impact its sales.

Adobe’s ability to generate strong cash flows and its end market diversity that protects against downside to these cash flows are other positives.

Fourth Quarter Recap

Adobe beat the Zacks Consensus in the fourth quarter, helped by the turnaround in the commercial and enterprise markets. We were particularly encouraged by the enterprise and Omniture segments, which grew strongly both with respect to the previous and year-ago quarters. Further details are available here – Adobe Beats on Enterprise Strength.

Guidance and Recommendation

On a non-GAAP basis, Adobe expects first quarter revenue of $1-1.05 billion (down 0.8% to up 4.2% sequentially), operating margin of 37-38%, non operating expense of $16-20 million, a tax rate of 22% and a share count of 508-510 million, yielding a non-GAAP EPS of 54-59 cents.

Adobe also stated that the Creative Solutions segment would be split into Digital Media Solutions and Creative and Interactive Solutions. Digital Media will include Adobe’s imaging and video-related products, while Creative and Interactive will include the CS product lines, as well as the Platform segment, which is currently being reported as a separate segment.

We do not see the company failing to meet guidance and think that a moderate beat is on the cards. However, we expect a weaker second quarter and 2011 outlook.

We have a short-term (1-3 months) Hold rating on Adobe shares, as indicated by the Zacks #3 Rank.

By: Sejuti Banerjea

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