Adobe Systems Inc. (ADBE: 32.80 +0.36 +1.11%) is slated to report second-quarter earnings on June 22, 2010.The shares have taken a tumble, falling 12.5% since the company reported last March, the main reason being Apple Inc’s (AAPL: 270.665 +3.415 +1.28%)continued opposition to Flash and the propaganda surrounding HTML 5.
Estimate Revisions
It appears that the 26 analysts covering the stock are divided on the impact of HTML 5 on Adobe’s flash platform. While some believe Adobe’s installed base is an advantage, especially given the high switching costs, a few point to Apple’s popularity, which could pull customers away from Flash. This is the main reason for the limited number of estimate revisions over the past 30 days.
During this period we see 1 analyst lowering estimates for the upcoming quarter and 1 for the following quarter, with 2 lowering estimates for fiscal 2010 and 1 for fiscal 2011. However, since these revisions did not impact the Zacks Consensus for either of the next two quarters and only lowered the fiscal year 2010 estimate by a penny and raised fiscal 2011 estimates by a penny, we cannot think of these revisions as material changes to analyst expectations.
The impact is somewhat more pronounced if we consider the past 90 days. Analysts appear to be factoring in lower earnings for the back half of the year, since May quarter estimates remain unchanged while August quarter and fiscal 2010 estimates are down by 2 cents and 5 cents, respectively. Fiscal 2011 estimates are also down by a penny.
Company Guidance
Adobe’s guidance for the second quarter was not bad, with management expecting a 2-8% sequential increase in revenue helped by the CS5 launch. Other segments were expected to come in flat, given the extra week of operation in the first quarter. Operating margin expectations were significantly higher than both the previous and year-ago quarters. As a result, the non-GAAP EPS expectations of 39 cents to 44 cents represent 34% sequential and 55% year-over-year increases at the mid-point.
Analysts expect earnings of 34 cents for the quarter, below the guided range.
First-Quarter Highlights
Adobe’s first-quarter revenue grew both sequentially and year over year, exceeding management expectations. Results were driven by seasonal strength in Asia and continued stabilization in North America and Europe. Creative Solutions revenue was soft, most likely because customers decided to wait for CS5. However, the pickup in Knowledge Worker and Enterprise Solutions was encouraging.
Management stepped up investments in R&D and SG&A, which negatively impacted the operating margin in the last quarter. As a result, the pro forma EPS of 31 cents was flat sequentially and down 7 cents from the year-ago quarter.
Reiterate NeutralWe believe Adobe is the undisputed leader and dominant player in the content creation segment. We thought the company’s first-quarter results were good, although unexciting, and we were not surprised by the softness in Creative Solutions. Additionally, we believe that Adobe’s leadership in several key markets, its solid business model, the potential success of new products, strong cash generation and end market diversity are positives.
However, we believe that investors could continue to discount the shares as a result of its tiff with Apple. We agree that Flash is an important growth avenue for Adobe, especially due to the proliferation of mobile devices in recent times. However, the business is still a relatively small percentage of sales and Adobe remains strongly entrenched. We believe this calls for a wait-and-see approach to the shares.
Consequently, we are reiterating our Neutral rating on Adobe shares.
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