[September.2024] Adobe's 41-quarter growth streak: what to watch in their earnings report

In the SaaS application space, two giants dominate the U.S. market: Salesforce in marketing SaaS and $Adobe (ADBE.US)$ in creative software. This article focuses on the latter.

$Adobe (ADBE.US)$ stands tall with tools like Photoshop and Premiere, capturing a dominant market share. Their shift to a subscription model has driven consistent revenue growth and a tenfold increase in stock price over the past decade.

On September 12th, $Adobe (ADBE.US)$ will release its latest earnings report. Each earnings release may signal a potential investment opportunity, but before diving in, investors need to understand how to interpret their financial statements.

For Adobe's financial reports, we may focus on three key areas: revenue growth, profitability, and cash flow along with shareholder returns.

1. Revenue growth

Adobe's business primarily revolves around two main segments: Digital Media and Digital Experience. The Digital Media segment includes flagship products like Photoshop and Premiere, which fall under Creative Cloud, and PDF-centric Document Cloud services. This segment accounts for nearly three-quarters of Adobe's total revenue, making it the company's main revenue driver. The Digital Experience segment, focusing on business processes and marketing-related cloud services, makes up about a quarter of the revenue.

Despite offering a variety of tools for creative design and business processes, Adobe's revenue model is largely subscription-based. In Q2 2024, over 95% of Adobe's revenue came from subscription services.

For subscription-based SaaS products, revenue growth hinges on maintaining a high customer retention rate and attracting new customers. Additionally, if subscription prices can be increased over time, it significantly boosts revenue growth.

$Adobe (ADBE.US)$ excels at retaining customers thanks to its robust product lineup. Flagship tools like Photoshop and Premiere have steep learning curves and high switching costs, fostering strong customer loyalty. Consequently, Adobe rarely loses existing customers, so nearly every new customer directly boosts revenue. This strength has enabled $Adobe (ADBE.US)$ to achieve 41 consecutive quarters of growth. During the SaaS industry's peak, annual revenue growth exceeded 20%. Even with the recent slowdown, Adobe's revenue growth has still topped 10%.

What's in store for Adobe's revenue growth? Let's focus on three key metrics.

First up is Annual Recurring Revenue (ARR), a measure of customer retention. Although $Adobe (ADBE.US)$ doesn't share specific user numbers or prices, ARR gives a clear picture of revenue from both existing and new customer contracts.

Adobe's ARR has consistently grown almost every quarter, suggesting strong customer loyalty. We may keep an eye on whether this trend continues.

The second key metric is Remaining Performance Obligations (RPO), which represents the value of contracts signed with customers but not yet fulfilled or recognized as revenue. Think of it as a reserve of future revenue—the larger the reserve, the more secure the revenue growth.

In Q1 of the 2024 fiscal year, Adobe's RPO stood at approximately $17.86 billion, marking a year-over-year increase of about 17.3%. We'll keep an eye on the growth of this metric moving forward.

The third key metric is revenue guidance. In each earnings report, management provides projections for the next quarter and fiscal year.

In the Q2 2024 earnings report, management guided Q3 revenue to be between $5.33 billion and $5.38 billion, aligning closely with market expectations. They also raised the full-year 2024 revenue guidance to $21.4 billion to $21.5 billion, slightly exceeding market forecasts.

2. Profitability

Beyond steady revenue growth, $Adobe (ADBE.US)$ also boasts strong profitability. Let's look at three key metrics.

1. Gross Margin: Adobe's gross margin has consistently been high, fluctuating between 85% and 88% in recent years.

2. Net Margin: Thanks to stable expenses in R&D, sales, and management, Adobe's net margin has remained around 30%.

3. Return on Equity (ROE): Since 2019, Adobe's ROE has elevated to approximately 30%, indicating strong returns on shareholder equity.

Overall, Adobe's high gross margin, net margin, and ROE may reflect its competitive advantage and market stability. Moving forward, we may monitor these profitability metrics; any significant decline may indicate a shift in its competitive position.

3. Cash flow and shareholder returns

As a mature and stable software company, $Adobe (ADBE.US)$ doesn't require significant capital investments. Its strong market position also means minimal customer debt, resulting in robust cash flow.

Since 2014, $Adobe (ADBE.US)$ has generated a cumulative free cash flow of $41.49 billion, far exceeding its net income of under $30 billion for the same period. This indicates a strong ability to generate cash well above its profit levels.

Thanks to its strong cash flow, $Adobe (ADBE.US)$ has the capacity to provide substantial returns to shareholders. In the U.S. stock market, many companies return value to shareholders through dividends and stock buybacks. While dividends offer direct returns, buybacks can enhance a company's Return on Equity (ROE) and Earnings Per Share (EPS), providing additional market liquidity—a win-win that's highly favored by shareholders.

$Adobe (ADBE.US)$ rarely pays dividends but is highly committed to stock buybacks. Since 2013, Adobe has repurchased approximately $26.15 billion worth of stock, nearly 90% of its net income for the same period, showcasing its generosity. Moving forward, we may monitor whether Adobe continues this stable performance in cash flow and shareholder returns.

Summary

To assess Adobe's performance, focus on three key areas: revenue growth, profitability stability, and cash flow/shareholder returns.

1. Revenue growth:

1. Annual Recurring Revenue (ARR): Monitor Adobe’s ability to maintain its historical growth trend.

2. Remaining Performance Obligations (RPO): Monitor this metric to gauge future revenue potential.

3. Revenue Guidance: Evaluate management’s projections for upcoming quarters and fiscal years.

2. Profitability stability:

1. Gross Margin

2. Net Margin

3. Return on Equity (ROE)

These indicators are important in assessing the sustainability of its competitive advantage.

3. Cash flow and shareholder returns:

1. Cash Flow: Adobe has historically strong cash flow; continue to monitor this.

2. Stock Buybacks: Adobe has been generous with stock buybacks. Watch for continued robust repurchase activity.