Adobe Systems Inc. (ADBE - Free Report) reported second-quarter fiscal 2017 earnings of 81 cents per share, beating the Zacks Consensus Estimate by 4 cents. Adjusted earnings per share exclude one-time items but include stock-based compensation expense.

Following strong fiscal second-quarter earnings, its share price was up 3.61% in the after-hours trading session. Also, in the last six months, the stock has outperformed the Zacks Computer Software industry. It has returned 39.5% compared with the industry’s gain of 21.8%.

Better-than-expected earnings were backed by strong demand for the company’s Creative Cloud software tools like Photoshop, which added more subscribers. Also, continued growth of Adobe Document Cloud subscriptions and strong bookings for Adobe Experience Cloud aided earnings growth.

Revenues

Adobe’s revenues of $1.77 billion increased 5.4% sequentially and 26.7% year over year. Reported revenues surpassed both management’s guidance and Zacks Consensus Estimate of $1.73 billion.

Subscription comprised 84% of Adobe’s total fiscal second-quarter revenues, up 36.9% from the year-ago period. Products declined 12.7% year over year and contributed 10% to revenues, while Services & Support declined 1.3% and brought in the rest.

Revenues by Segment

Revenues from Digital Media Solutions surged 29% year over year to $1.21 billion. Total Digital Media ARR (Annualized Recurring Revenue) grew to $4.56 billion at the end of the fiscal second quarter, reflecting an increaseof $312 million and indicatingstrong growth in the Creative Cloud and Document Cloud businesses.

The two major revenue contributors within the segment were Creative Cloud (CC) and Document Cloud (DC).

Creative revenues touched $1.01 billion in the quarter, up 34% year over year. Also, Creative ARR increased $285 million to $4.04 billion. DC revenues were $200 million, with DC ARR of $520 million at the end of the fiscal second quarter. Also, acrobat units across Creative Cloud and Adobe Document Cloud combined grew double-digits year-over-year, driven by a record number of new subscriptions in the quarter.

Management is optimistic about CC adoption and expects to build a strong pipeline for its potential paid subscribers through marketing programs, trial downloads and free memberships. Management expects growth to be fueled by three initiatives –– by migrating the Creative Suite installed base, drawing new clients and driving ARPU higher through cloud services like Adobe Stock. Also, CC mobile apps are continuously driving customer traffic and strengthening customer adoption.

Within the Digital Marketing segment, Adobe Experience Cloudrevenues were up 29% year over year to $495 million. The improvement came on the back of strong contribution from TubeMogul acquisition, an increase in the size of accelerated conversions and international expansion.Mobile remains a key component for this business. Mobile data transactions grew to 57% of total Adobe Analytics’ transactions in the quarter.

Margins

Pro forma gross margin was 86.5%, up 61 basis points (bps) sequentially and 94 bps year over year. Gross margin is typical of a software company and variations are generally related to the mix of revenues between categories.

Adobe incurred adjusted operating expenses of $993.2 million, reflecting an increase of 5.7% sequentially and 21.1% year over year. As a percentage of sales, research & development expenses increased, while general & administrative and sales & marketing expenses decreased from the year-ago quarter. As a result, adjusted operating margin was 30.5%, up 45 basis points (bps) sequentially and 355 bps year over year.

Net Income

On a GAAP basis, Adobe recorded net income of $374.4 million (75 cents per share) compared with $244.1 million (48 cents per share) in the year-ago quarter.

On a pro forma basis, Adobe generated net income of $405.3 million compared with $277.6 in the year-ago quarter.

Balance Sheet

Adobe ended the fiscal second quarter with cash and investments balance of $4.93 billion compared with $4.65 billion in the previous quarter. Trade receivables were $901.5 million, up from $850.8 million in the prior quarter. Deferred revenues were $2 billion, flat sequentially.

In the reported quarter, cash generated from operations was $645 million and capital expenditure was $55.3 million. Additionally, the company repurchased approximately 2 million shares for $266 million.

Guidance

For the fiscal third quarter of fiscal 2017, management expects revenues of $1.815 billion. Analysts polled by Zacks expect revenues of $1.80 billion, lower than the guided figure.

Based on a share count of 501 million, management expects GAAP earnings per share of 72 cents and non-GAAP earnings of $1 per share. The Zacks Consensus Estimate is pegged at 79 cents.

Adobe Systems Incorporated Price, Consensus and EPS Surprise

Adobe Systems Incorporated Price, Consensus and EPS Surprise | Adobe Systems Incorporated Quote

Our Recommendation

Adobe reported strong fiscal second-quarter results wherein both earnings and revenues beat the respective Zacks Consensus Estimate.

We remain positive on Adobe’s market position, compelling product lines, continued innovation and strong balance sheet.

The company is being driven by continued innovation in its Creative Cloud, Document Cloud and Marketing Cloud businesses.

After the successful transition from traditional license to subscription-based services, Adobe wants to establish its presence in cloud-related software areas such as documents and marketing. Adobe is also expanding its presence in growing markets like artificial intelligence and machine-learning framework.

Additionally, we believe that the constant adoption of Adobe Marketing Could serves as a catalyst. Moreover, the solid adoption of Document Cloud, a new subscription package that enables users to sign documents on the cloud, should boost revenues.

In December, the software giant completed its acquisition of TubeMogul, a video advertising platform for $540 million, net of cash and debt. The company achieved strong revenue contribution from TubeMogul acquisition and expects successful integration with its Adobe Media Optimizer solution.

Adobe carries a Zacks Rank #3 (Hold). Some other favorably placed stocks in the broader technology sector include KLA-Tencor (KLAC - Free Report) and Applied Materials (AMAT - Free Report) , each sporting a Zacks Rank #1 (Strong Buy), while Advanced Energy Industries, Inc. (AEIS - Free Report) , carrying a Zacks Rank #2.

KLA-Tencor delivered a positive earnings surprise of 11.55%, on average, in the last four quarters.

Applied Materials delivered a positive earnings surprise of 3.35%, on average, in the trailing four quarters.

Advanced Energy Industries, Inc. delivered a positive earnings surprise of 10.46%, on average, in the trailing four quarters.