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Adobe Is Hard to Figure

The shares are moderately lower as investors grope for the core.

Adobe Systems (ADBE) - Get Adobe Inc. Report offered a somewhat confusing earnings report and disappointing guidance. Still, the market didn't spend too much time dwelling on those things Thursday.

While the stock was off nearly 3% in recent trading, it had recovered some of its losses from Wednesday night. And analysts and investors were mostly bullish on the results and prospects of the software maker, which acquired chief rival Macromedia in December.

"This was about as good a performance coming off a big merger as seen in technology," says Tony Ursillo, a buy-side analyst at Loomis Sayles, which is long Adobe.

With the company planning to update its most important software titles over the next year, it has the potential to exceed expectations, Ursillo says, calling the stock a buy at its current price. "People are going to be willing to pay for that," he says.

In its just-completed first quarter, Adobe posted strong revenue growth thanks at least in part to the Macromedia acquisition. Although the company's pro forma results topped analysts' expectations, the company didn't make it terribly easy to understand how its core businesses were doing.

The company did not, for instance, break out how its own business and that of Macromedia performed separately, or how those results compared with those of the year-ago period. In an interview after the company's earnings call, company president Shantanu Narayen noted that Macromedia's financial quarters covered different periods than did Adobe's and that it would have been a difficult task to try to figure out how Macromedia in particular performed in Adobe's year-ago quarter.

Meanwhile, since Adobe acquired Macromedia in December, the company has begun to bundle some of Macromedia's programs with its own, making it difficult to assign sales to one or the other of the two formerly separate companies, Narayan said. Narayan did say that Adobe's separate business grew by a "double-digit" percentage rate year over year, but declined to give a specific growth rate number.

The company's bottom line was similarly confusing. It pointed analysts to a pro forma number that excluded a raft of expenses. Some of those, such as the amortization of purchased intangibles, related to the company's Macromedia purchase. But others did not, including the company's employee stock-option award and a charge for incomplete technology acquired in a separate purchase.

Analysts and investors seemed to give the company a pass, though.

"The company is providing new categories for revenue breakouts, which prevents accurate performance comparisons with prior quarters," acknowledged Pacific Crest analyst Steve Lidberg, in a research note on Thursday. But Lidberg was willing to take the company's word that things were going fine. "Management commentary indicates that segments are maintaining momentum as expected," wrote the analyst, whose firm has not done recent investment banking for Adobe.

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Looking forward, Adobe's outlook was also a bit muddled. Despite beating revenue expectations in the first quarter, it declined to ratchet up its full-year revenue forecast. In fact, the company offered revenue and earnings guidance for the current quarter that was below analysts' expectations, implying that it expects to make up the shortfall in the back half of the year.

With a new version of Adobe's Acrobat product slated for the fall, the company could well see a boost in sales. Acrobat and related products were Adobe's second-most-important product division in the first quarter in terms of revenue.

But that boost could be tempered by what happens with the company's most important software line: its suite of creative design products, including Photoshop. The company plans to release a new version of its bundle of creative software early next year, and some analysts have worried that demand for the current version will weaken in anticipation of the update.

In their revenue models for this fiscal year, sell-side analysts didn't take into account Adobe's normal seasonality, Ursillo argues. So, the company isn't really back-end weighting its year more than it normally would, he says. It just looks that way relative to the sell side's estimates.

Meanwhile, fears that sales of Adobe's creative products may fall off later this year are likely overblown, he argues. In the quarter before the last update of the company's creative software suite, the products posted record sales, he notes.

In recent trading, Adobe's stock was off $1.03, or 2.8%, to $35.59. In after-hours trading on Wednesday following its earnings report, the company's shares were off as much as 4%.

In the quarter ended March 3, Adobe earned $105.1 million, or 17 cents a share, on sales of $655.5 million. In the year-ago period, which excluded results from Macromedia as well as charges related to the acquisition, Adobe earned $151.9 million, or 30 cents a share, on $472.9 million in sales.

Excluding those merger-related expenses and charges related to employee stock options, Adobe would have earned $197.5 million, or 32 cents a share, in the just-completed quarter. On this basis, analysts polled by Thomson First Call were expecting the company to post pro forma earnings of 29 cents a share for the first quarter on $650.3 million in sales.

Looking forward, Adobe expects to post a pro forma profit of 30 cents to 32 cents a share excluding charges -- on sales of between $640 million and $670 million. The company expects to post $2.7 billion in sales this fiscal year.

Wall Street had forecast that Adobe would earn 32 cents a share sans charges in the second quarter on $675.7 million in sales. For the full year, analysts have predicted a pro forma profit of $1.29 a share on sales of $2.72 billion.