Adobe (NASDAQ:ADBE) posted its Q3 earnings on September 17, and the market reacted positively to the results as the stock traded 5% higher in after market hours. The company witnessed a faster-than-expected adoption of subscription licenses for its Creative Cloud (CC) business as some of its clients chose enterprise term licenses (ETLA) instead of team offering during the period. The company now has over 1 million paid subscribers for the CC services that generated $546 million annualized recurring revenue (ARR) in Q3. Adobe also saw significant growth in its marketing cloud initiatives. In Q3, digital marketing revenues grew by 20% y-o-y to $311 million. However, its LiveCycle software and document services business declined by 11% and 2% respectively.
The company reported diluted earnings per share (EPS) of $0.16 on a GAAP-basis and $0.32 on a non-GAAP basis. While the company reported 8% y-o-y decline in revenues to $995.1 million, its net income declined by 60% y-o-y to $83 million. Due to a change in its licensing model from perpetual to subscription based, Adobe reported unearned revenue growth to $683.1 million. We examine some of Adobe’s key drivers below and its outlook for 2013. 
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- What Has Been Driving Adobe’s Revenues Growth Since 2012?
Outlook For Q4 2013 And FY 2013
Adobe has guided for revenues of $1-$1.05 billion for Q4 2013. This would lead to Q4 GAAP EPS in the range of $0.09 to $0.15, and Q3 non-GAAP EPS of $0.28 to $0.34.
Adobe expects to have over 1.35 million paid Creative Cloud individual and team subscriptions by the end of 2013. According to our calculations, it means it will need to add over 27,000 paid users per week for the rest of FY2013, 10% more than its current weekly subscription rate of 24,000. This would give the company total annual recurring revenue of approximately $685 million. Additionally, we expect the company to end the year with over $875 million of Digital Media ARR at a revenue growth rate of 25% y-o-y, and we expect that its document services ARR will increase to $115 million by the end of 2013.
The company also expects the LiveCycle and Connect business to decline further while the Print and Publishing business is expected to remain flat this year. LiveCycle and Connect business will contribute approximately $200 million to revenues in 2013. Adobe expects 2013 revenue of $4.05 billion and EPS of $0.56 on a GAAP basis and $1.34 on a non-GAAP basis.
Creative Cloud Subscriptions Gain Traction
According to our estimates, the Photoshop and Creative Software division is the biggest of Adobe’s operating segments and make up approximately 55% of the company’s value. During Q3 2013, this segment generated approximately $637 million in revenues. Recently Adobe abandoned its Creative Suite (CS) entirely to focus its efforts on developing Creative Cloud. The company has stated that the revenues from its perpetual licensing software will decrease by 2015. However, it will continue to sell CS6 to ease the transition to CC.
While we expect that the share of revenue from CC will continue to grow in Q4, the adoption of CC will lower the revenues and profitability as subscription services spread these over the period of the software’s use. With a license based model, Adobe received bursts of income every two-three years when new software was released. However, with the subscription fee structure, Adobe will have recurring stable revenue over the period of the software’s use. During the past quarter, Adobe reported an increase in adoption of enterprise CC offering through ETLAs and subscriptions. Creative Cloud added 331,000 new subscribers in Q3 2013, up from 221,000 last quarter. As a result, the revenue from CC increased by over 50% sequentially to $546 million, and subscriber base grew to 1.031 million.
Revenues Continue To Shrink At Acrobat Family Division
Adobe Acrobat family is the second largest division at Adobe and makes up 11% of its value. Acrobat family division reported 2% y-o-y decline in revenues to $182 million. The primary reason for this decline was lower sales of point product document services. However, increase in revenue from Acrobat cloud services stemmed further decline in revenues.
During the quarter, company’s online document services surpassed 1.3 million subscriptions. Revenues from Acrobat Cloud services grew 30% sequentially to $109 million, primarily due to increase in ETLAs. While we expect document services’ ARR will drive revenue growth in the Acrobat family division, the company plans to have perpetual model for Document Services for a longer period. This might negatively impact the revenue growth in the future.
Adoption Of Digital Platform Lifts Digital Marketing Revenues
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. Recently, Adobe acquired Neolane, which extended Adobe’s capabilities into offline campaign management.  During the quarter, Adobe witnessed strong growth in its marketing cloud services. Many research firms such as Gartner and Forrester rank Adobe’s web content management platform amongst the top echelons of digital marketing platform.
In Q3, this division reported a 20% y-o-y increase in revenue to $311 million, and the revenue run rate exceeded $1 billion in annual revenue. Additionally, Adobe marketing cloud achieved 28% y-o-y growth in revenues to $255 million in the quarter. 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. 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 are in the process of updating our Adobe model. At present, we have a $42 Trefis price estimate for Adobe, which is 20% below its market price.Notes:
- Adobe SEC Filings, www.sec.gov, June 18, 2013 [↩]
- See Adobe’s Neolane Acquisition Will Boost Its Digital Marketing Division [↩]