Adobe Pre-Earnings: Transition To Cloud Subscriptions Will Weigh On Results

Adobe (NASDAQ:ADBE) is set to announce its Q3 2013 earnings on Tuesday, September 17. While the company continues to post profit, its revenues and profits have fallen significantly in the recent quarter due to its push for cloud services. In Q2, it reported 10% y-o-y decline in revenues to $1.01 billion and its net income declined by 66% y-o-y to $77 million.

However, the company witnessed good adoption of subscription licenses and increased its end-user subscriptions for enterprise term licenses (ETLA). Subscriber base for Creative Cloud (CC) services rose to 700,000 in Q2. We expect this trend to continue in Q3 as well and are closely following the growth rate for Creative Cloud’s subscriber base in this upcoming earnings. Adobe also launched its cloud services for the Acrobat family in 2012, and since then, revenue from document cloud services is on the rise. Since cloud service at the document division is central to Adobe’s growth in revenue from the Acrobat family, we will be closely monitoring the number of new Enterprise Term Licensing Agreements (ETLAs) signed in Q3.

Additionally, Adobe is aiming to increase its revenues from cloud based marketing solutions by expanding in new geographies and vertical markets where it has a strong presence. During the quarter, Adobe completed the acquisition of Neolane to bolster its digital marketing division. We will be closely watching the growth rate at Adobe’s digital marketing division as we expect this division to be an important revenue driver for Adobe going ahead.

Check out our complete analysis of Adobe

Outlook For Q3 and 2013

Adobe has guided for revenues of $0.975-$1.025 billion for Q3 2013. This would lead to Q3 GAAP EPS in the range of $0.10 to $0.16 and Q3 non-GAAP EPS of $0.29 to $0.35.

Adobe expects to have over 1.25 million paid Creative Cloud individual and team subscriptions by the end of 2013, and according to our calculations, it means it will need to add over 21.15K paid users per week for the rest of 2013, 50% more than its current weekly subscription rate of 14.4k. This would give the company total annual recurring revenue (ARR) of approximately $685 million. Additionally, we expect the company to end the year with approximately $800 million of Digital Media ARR at a revenue growth rate of 20% y-o-y. We also expect that its document services ARR will increase to $115 million by the end of 2013. However, we expects the LiveCycle and Connect business to decline further, while the Print and Publishing business is expected to remain flat this year.

Cloud Subscription To Lower Revenues and Profitability

According to our estimates, the Photoshop and Creative Software division is the biggest of Adobe’s operating segments and makes up approximately 54% of the company’s value. During Q2 2013, this segment generated approximately $670 million in revenues. Recently, Adobe abandoned its Creative Suite (CS) entirely to focus its efforts on developing Creative Cloud (CC), which will replace the CS. The company has stated that revenues from its perpetual licensing software will decline by 2015.

While we expect that the share of revenue from CC will continue to grow Q3, the adoption of CC will lower the revenues and profitability as subscription services  spread these revenues over the period of the software’s use. In this earnings announcement, we will be closely monitoring the number of CC subscribers and the conversion rate of CS subscribers to CC. Moreover, we also want to know the increase in the number of trial and free users at creative cloud as these members have a higher propensity to pay for subscription services in the future.

Revenues To Decline At Acrobat Family Division

Adobe Acrobat family is the second largest division at Adobe and makes up 13% of its value. The Acrobat family division reported a 3% y-o-y decline in revenues to $199.3 million in Q2. However, the decline in point product document services revenue was offset by higher revenue from Acrobat cloud services. We expect that this trend will continue in Q3 as well, and the company to report decline in revenues. However, we expect the company to report incremental revenues from Acrobat Cloud services, primarily due to increase in ETLAs. Going ahead, we expect document service’s ARR will drive revenue growth in the Acrobat family division.

Digital Marketing Platform In Focus

Omniture is Adobe’s third largest division and makes up 10% of its value by our estimates. Adobe acquired Omniture in 2009 and since then has included all of Omniture’s products under its digital marketing cloud division. As a result, Adobe witnessed strong growth in its marketing cloud services in previous years, and this division has emerged as an important driver for revenue growth at Adobe.

According to Ovum, Adobe’s digital marketing platform currently leads the race to become the enterprise digital marketing platform provider of choice. ^[1] We believe that this platform provides a cost effective digital marketing solution for companies that can manage marketing campaigns across different channels and devices. ^[2] We expect that as big data analytics, mobility, social media and cloud computing gain more traction across industries, this division will report incremental growth in revenues as it has a portfolio of analytical tools that deal with marketing on social media and mobile. Recently, Adobe acquired Neolane, which extended Adobe’s reach into offline campaign management. ^[3] While this division contributed 12.5% to Adobe’s total revenues in 2012, we expect it to increase to 16% by the end of our forecast period.

We currently have a $41 Trefis price estimate for Adobe, which is 15% below its market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Ovum reveals IBM and Adobe are ahead in the race to become the enterprise digital marketing platform provider of choice, August 21 2013, www.ovum.com [↩]
2. For More details on Adobe’s Digital Marketing Platform See Here [↩]
3. See Adobe’s Neolane Acquisition Will Boost Its Digital Marketing Division [↩]