Adobe (ADBE)

Creative software maker Adobe (NASDAQ:ADBE) beat Wall Street’s revenue expectations in Q1 CY2025, with sales up 10.3% year on year to $5.71 billion. The company expects next quarter’s revenue to be around $5.80 billion, close to analysts’ estimates. Its non-GAAP profit of $5.08 per share was 2.2% above analysts’ consensus estimates.

Company Overview

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.

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, 3D tours or interactive movies.

Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last three years, Adobe grew its sales at a 10.9% annual rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the software sector, which enjoys a number of secular tailwinds. Luckily, there are other things to like about Adobe.

This quarter, Adobe reported year-on-year revenue growth of 10.3%, and its $5.71 billion of revenue exceeded Wall Street’s estimates by 1%. Company management is currently guiding for a 9.2% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 9% over the next 12 months, a slight deceleration versus the last three years. This projection is underwhelming and implies its products and services will face some demand challenges. At least the company is tracking well in other measures of financial health.

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Adobe’s billings came in at $5.95 billion in Q1, and over the last four quarters, its growth was underwhelming as it averaged 8.9% year-on-year increases. This performance mirrored its total sales and suggests that increasing competition is causing challenges in acquiring/retaining customers.

The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.

Adobe is efficient at acquiring new customers, and its CAC payback period checked in at 39.3 months this quarter. The company’s relatively fast recovery of its customer acquisition costs means it can attempt to spur growth by increasing its sales and marketing investments.

What makes the software-as-a-service model so attractive is that once the software is developed, it usually doesn’t cost much to provide it as an ongoing service. These minimal costs can include servers, licenses, and certain personnel.

Adobe’s gross margin is one of the highest in the software sector, an output of its asset-lite business model and strong pricing power. It also enables the company to fund large investments in new products and sales during periods of rapid growth to achieve higher profits in the future. As you can see below, it averaged an elite 89.2% gross margin over the last year. That means Adobe only paid its providers $10.85 for every $100 in revenue.

In Q1, Adobe produced a 89.1% gross profit margin, in line with the same quarter last year. Zooming out, Adobe’s full-year margin has been trending up over the past 12 months, increasing by 1.1 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as servers).

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.

Adobe has been a well-oiled machine over the last year. It demonstrated elite profitability for a software business, boasting an average operating margin of 36.3%. This result isn’t surprising as its high gross margin gives it a favorable starting point.

Analyzing the trend in its profitability, Adobe’s operating margin rose by 6.3 percentage points over the last year, as its sales growth gave it operating leverage.

In Q1, Adobe generated an operating profit margin of 37.9%, up 20.4 percentage points year on year. The increase was solid, and since its operating margin rose more than its gross margin, we can infer it was recently more efficient with expenses such as marketing, R&D, and administrative overhead.

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Adobe has shown terrific cash profitability, driven by its lucrative business model and cost-effective customer acquisition strategy that enable it to stay ahead of the competition through investments in new products rather than sales and marketing. The company’s free cash flow margin was among the best in the software sector, averaging an eye-popping 41.7% over the last year.

Adobe’s free cash flow clocked in at $2.46 billion in Q1, equivalent to a 43% margin. This result was good as its margin was 21 percentage points higher than in the same quarter last year. Its cash profitability was also above its one-year level, and we hope the company can build on this trend.

Over the next year, analysts predict Adobe’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 41.7% for the last 12 months will decrease to 39.4%.

One of the best ways to mitigate bankruptcy risk is to hold more cash than debt.

Adobe is a profitable, well-capitalized company with $7.44 billion of cash and $6.56 billion of debt on its balance sheet. This $872 million net cash position gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

It was good to see Adobe narrowly top analysts’ billings and revenue expectations this quarter. We were also happy its EPS and adjusted operating income outperformed. On a dimmer note, its full-year revenue and EPS guidance was in line with Wall Street’s estimates. Overall, this quarter was fine - nothing special. The stock traded down 1.3% to $433.01 immediately after reporting.

Updated: May 22, 2025 at 10:01 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in Adobe.

There are some positives when it comes to Adobe’s fundamentals. Although its revenue growth was weak over the last three years and analysts expect growth to slow over the next 12 months, its bountiful generation of free cash flow empowers it to invest in growth initiatives. And while its forecasted free cash flow margin suggests the company will ramp up its investments next year, its admirable gross margin indicates excellent unit economics.

Adobe’s price-to-sales ratio based on the next 12 months is 7.6x. Looking at the software landscape right now, Adobe trades at a pretty interesting price. If you trust the business and its direction, this is an ideal time to buy.

Wall Street analysts have a consensus one-year price target of $489.29 on the company (compared to the current share price of $413.49), implying they see 18.3% upside in buying Adobe in the short term.

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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