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Adobe (NASDAQ:ADBE) Reports Q2 In Line With Expectations But Stock Drops


Full Report / June 28, 2022
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Creative software maker Adobe (NASDAQ:ADBE) reported results in line with analyst expectations in Q2 FY2022 quarter, with revenue up 14.3% year on year to $4.38 billion. However, guidance for the next quarter was less impressive, coming in at $4.43 billion at the midpoint, being 1.83% below analyst estimates. Adobe made a GAAP profit of $1.17 billion, improving on its profit of $1.11 billion, in the same quarter last year.

Adobe (ADBE) Q2 FY2022 Highlights:

  • Revenue: $4.38 billion vs analyst estimates of $4.34 billion (0.9% beat)
  • EPS (non-GAAP): $3.35 vs analyst estimates of $3.31 (1.31% beat)
  • Revenue guidance for Q3 2022 is $4.43 billion at the midpoint, below analyst estimates of $4.51 billion
  • Free cash flow of $1.91 billion, up 14.6% from previous quarter
  • Gross Margin (GAAP): 87.7%, in line with same quarter last year

“Adobe achieved record Q2 revenue with strong demand across Creative Cloud, Document Cloud and Experience Cloud,” said Shantanu Narayen, chairman and CEO, Adobe.

One of the most well-known Silicon Valley software companies around, Adobe (NASDAQ:ADBE) is a leading provider of software as service in the digital design and document management space.

Adobe was originally founded in 1982 and famously Steve Jobs soon after attempted to acquire it for $5 million. The founders refused and instead negotiated an investment and a five year licencing deal with Apple (AAPL), which made them the first company in the history of Silicon Value to turn profit in its first year and started their impressive journey.

The company is famous for inventing the PDF format and its photo-editing and publishing software products like Photoshop or Illustrator which have become household names and leading industry standards. Over time Adobe leveraged the key role their products played in the lives of their customers and built a cloud ecosystem of products and services around them.

Today the company has a very strong portfolio of products, through its Creative Cloud offering it provides tools for digital design and publishing, such as Adobe Premiere that is used for professional movie production. The Document Cloud enables customers to create electronic documents and manage their lifecycle, offering the ability to sign legally binding documents electronically through Adobe Sign. Lately Adobe has been expanding into offering software for hosting content online and providing customers with the ability to monetize their readers via advertising.

The demand for rich, interactive 2D, 3D, VR and AR experiences is growing, and while the ubiquitous metaverse might still be more of a buzzword than a real thing, what is real is the demand for the tools to create these experiences, whether they are games or interactive movies.

Competitors addressing the digital design and document management segments include Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Oracle (NYSE:ORCL), salesforce.com (NYSE:CRM), SAP (NYSE:SAP), and DocuSign (NASDAQ:DOCU).

Sales Growth

As you can see below, Adobe's revenue growth has been decent over the last year, growing from quarterly revenue of $3.83 billion, to $4.38 billion.

Adobe Total Revenue

This quarter, Adobe's quarterly revenue was once again up 14.3% year on year. But the growth did slow down a little compared to last quarter, as Adobe increased revenue by $124 million in Q2, compared to $152 million revenue add in Q1 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Guidance for the next quarter indicates Adobe is expecting revenue to grow 12.5% year on year to $4.43 billion, slowing down from the 22% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 14.6% over the next twelve months.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Adobe's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 87.7% in Q2.

Adobe Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.87 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a great gross margin, that allows companies like Adobe to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity. It is good to see that the gross margin is staying stable which indicates that Adobe is doing a good job controlling costs and is not under pressure from competition to lower prices.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Adobe's free cash flow came in at $1.91 billion in Q2, roughly the same as last year.

Adobe has generated $6.87 billion in free cash flow over the last twelve months, an impressive 41.1% of revenues. This robust FCF margin is a result of Adobe asset lite business model, scale advantages, and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.


Key Takeaways from Adobe's Q2 Results

With a market capitalization of $178 billion, more than $5.29 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

Adobe topped analysts’ earnings expectations, even if just narrowly. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that Adobe's revenue guidance for the full year missed analyst's expectations and the revenue guidance for the next quarter missed analysts' expectations. Overall, this quarter's results could have been better. The company currently trades at $383 per share.

Is Now The Time?

When considering Adobe, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Adobe is a solid business. Its revenue growth has been slower lately, But on a positive note, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its impressive gross margins are indicative of excellent business economics.

Adobe's price to sales ratio based on the next twelve months is 9.0x, suggesting that the market is expecting more steady growth, relative to the hottest tech stocks. There are definitely things to like about Adobe and there's no doubt it is a bit of a market darling, at least for some. But when considering the company against the backdrop of the tech stock landscape, it seems that there is a lot of optimism already priced in and we are wondering whether there might be better opportunities elsewhere right now.

The Wall St analysts covering the company had a one year price target of $643 per share right before these results, implying that they saw upside in buying Adobe even in the short term.

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