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Adobe on the Right Track

The company posted a 2% drop in GAAP gross margin, while GAAP operating income plummeted by more than 60%. It wasn't any better on non-GAAP basis -- operating income fell close to 40% and operating margin decline by roughly 12% year over year.

But here's the thing: The 12% drop in operating margin still arrive higher than Street expectations.

This tells me there's now very little Adobe's management needs to explain during the conference calls regarding the business changeover. Analysts have already plugged the new metrics into their models. It also seems that the numbers they are using in their models have created a spread between management's guidance has turned a bit too bullish.

The fact that Adobe was still able to beat the Street's non-GAAP operating margin target despite a year-over-year 12% drop is the perfect example. In the numbers that do matter, however, Adobe is blowing them out of the water. Not only was there an 11% jump in Digital Marketing revenue, but management posted almost a 20% sales jump Marketing Cloud.

Likewise, Adobe was able to secure an additional 68,000 net new subscribers for its Creative Cloud service, which followed 153,000 that were added in the previous quarter. This means that the company now has a total of 700,000 paid subscribers - an impressive accomplishment considering the service has been available for only just one year.
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Management still maintains its goal of achieving 1.25 million paid subscribers by the end of the year. This means the company must secure 550,000 more paid subscribers in the next two quarters, which averages out to 275,000 net subscribers per quarter. Considering Adobe only added 68,000 this quarter and 153,000 net paid subscriptions in the first quarter, the goal of 550,000 in the next two quarter seems a bit too ambitious.

However, I know these guys are smart and companies don't go out of their way to put undue pressure on themselves boasting about high marks they don't feel they can achieve. In that regard, let's not rule out the possibility that customers already on the company's free trial subscription have made commitments to convert to self-pay.

I'm only speculating here, but I understand enough about subscription business model projections to make an educated guess. Even so, I still maintain that this company is heading on the right track.

In that regard, management deserves plenty of credit for what they've been able to accomplish in such a short period of time. Clearly, I like this company. But regarding the stock, I don't see much more upside from here beyond $50 per share. That's to say, is not a great buy at this level, but it's an excellent hold.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site Saint's Sense. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.
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