Adobe Q3 Earnings Preview: What Investors Need To Watch (NASDAQ:ADBE)

Elevator Pitch

My investment rating for Adobe Inc.’s (NASDAQ:ADBE) stock is a Hold.

In my earlier article for Adobe written on June 21, 2022, I reviewed ADBE’s financial results for the second quarter of fiscal 2022 (year ended November 30). I preview Adobe’s upcoming third quarter earnings release with the current article. Investors need to watch both Adobe’s Q3 FY 2022 financial performance, and its forward-looking guidance and commentary as well.

I don’t intend to upgrade my rating for Adobe to a Buy, even though I see a good chance of ADBE delivering an earnings beat for Q3 FY 2022. This is because the company might lower its full-year FY 2022 guidance at the same time, and Adobe’s management commentary regarding its medium-term prospects at the upcoming Q3 FY 2022 investor call might also disappoint investors. As such, I continue to assign a Hold rating to ADBE.

Third Quarter Earnings Announcement Date For Adobe

Adobe will be reporting the company’s Q3 FY 2022 earnings on Thursday, September 15, 2022 after trading hours, as disclosed in a prior press release published on September 7, 2022.

The Current Market Expectations For ADBE’s Q3 FY 2022 Performance

The Wall Street analysts have low expectations with regards to Adobe’s expected financial performance for the third quarter of fiscal 2022.

Based on the sell-side’s consensus financial projections for ADBE sourced from S&P Capital IQ, Adobe is forecasted to generate a top line of $4,440 million for Q3 FY 2022. This is to equivalent of an estimated YoY revenue expansion of +12.8% for ADBE in third quarter of the current fiscal year. In comparison, Adobe boasted vastly superior top line growth rates of +14.4% YoY and +22.0% YoY for Q2 FY 2022 and Q3 FY 2021, respectively.

Analysts also don’t see Adobe delivering very strong earnings growth as well. The market’s consensus financial forecasts taken from S&P Capital IQ imply that ADBE should report flat bottom line growth on a QoQ basis i.e. the expectations of Adobe achieving the same non-GAAP adjusted EPS of $3.35 for both Q2 FY 2022 and Q3 FY 2022. In YoY terms, Adobe’s top line expansion is projected to slow from +21.0% for Q3 FY 2021 and +10.6% for Q2 FY 2022 to +7.6% in Q3 FY 2022.

Slower revenue growth (as highlighted above) and margin compression are the key factors that are expected to contribute to ADBE’s lackluster bottom line for Q3 FY 2022.

As per consensus data obtained from S&P Capital IQ, Adobe’s EBITDA margin is estimated to contract by approximately -210 basis points YoY and -100 basis points QoQ to 48.8% in the third quarter of this fiscal year. Similarly, ADBE’s consensus normalized net profit margin of 35.4% for Q3 FY 2022, which translates into an expected net margin decline of -2.6 percentage points and -0.7 percentage points on a YoY and a QoQ basis, respectively.

It is also relevant to review the change in consensus earnings estimates for Adobe in the last couple of months, as this tends to be a good reflection of how the market’s expectations of ADBE has evolved over time.

In the past three months, more than half, or more specifically 19, of the 31 Wall Street analysts covering ADBE’s shares have chosen to lower their respective Q3 FY 2022 non-GAAP EPS projections for the stock. In contrast, only four sell-side analysts raised their third quarter adjusted bottom line forecasts for Adobe.

In a nutshell, the market’s expectations for ADBE are reasonably low based on the analysis presented in this section of the article.

An Earnings Beat Is The Most Probable Outcome For Adobe

Adobe is very likely to able to exceed expectations when it reports its Q3 FY 2022 earnings on Thursday.

One key factor is that the market’s expectations aren’t high as discussed in the preceding section, so ADBE has a low bar to clear in terms of delivering third quarter numbers that the sell-side analysts are anticipating.

Another key factor is that Adobe’s Q3 FY 2022 Net New Digital Media Annualized Recurring Revenue or ARR guidance of $430 million, which analysts have incorporated into their financial projections, appears to be fairly realistic.

The $430 million Net New Digital Media ARR guidance offered by Adobe translates into a -7.3% decrease on a QoQ basis as compared to the company’s Net New Digital Media ARR of $464 million for Q2 FY 2022. The implied -7.3% QoQ decline for Q3 FY 2022 as per management guidance seems reasonable, as this is substantially below the company’s historical three-year Net New Digital Media ARR third quarter of -4.2% which is reflective of macroeconomic weakness.

Separately, there is a positive read-through from its peer DocuSign’s (DOCU) recently announced quarterly earnings on September 8, 2022. DOCU’s actual Q2 FY 2023 (year ended January 31) EPS came in +4.3% above the consensus bottom line forecast.

Medium-Term Outlook For ADBE In The Spotlight

The current full-year fiscal 2022 guidance for Adobe appears to be too optimistic in my view, and there is a risk that ADBE’s commentary on its intermediate-term business outlook at the upcoming quarterly earnings call might be discouraging.

Adobe had previously guided for a Net New Digital Media ARR of $1.9 billion when it reported its Q2 FY 2022 financial results. This suggests that the company was expecting its Net New Digital Media ARR to rise by +36.7% QoQ from $430 million in the third quarter of fiscal 2022 to $588 million in the final quarter of the current fiscal year.

While the fourth quarter is traditionally a strong quarter for ADBE due to the timing of contract renewals, Adobe only achieved relatively more modest Net New Digital Media ARR QoQ growth rates in the 20-plus percentage range in the fourth quarter of the prior two fiscal years. In that respect, I see ADBE revising its full-year FY 2022 guidance downwards when it announces Q3 FY 2022 results.

It is also inevitable that analysts will ask Adobe questions about the company’s expectations of its financial performance in 2023 and beyond at the upcoming third quarter results briefing.

Considering that economic conditions remain challenging, the company’s management is likely to be cautious in expressing their views about ADBE’s intermediate term prospects. Any negative signals drawn from management comments will likely rattle the market, adding to investors’ worries about how Adobe will adapt to the tough operating environment that could persist for a longer-than-expected period of time.

Bottom Line

Adobe remains as a Hold-rated stock. Above-expectations earnings for the third quarter of the current fiscal year are a likely outcome as per my analysis. But the medium-term outlook for Adobe might not be as favorable, which points to a reasonably high chance of earnings misses or negative guidance revisions for ADBE in subsequent quarters (beyond the third quarter). As such, I have a Neutral (rather than Bullish) view of Adobe’s shares, which translates into a Hold investment rating.