Adobe Earning Preview: Eying Growth in Cloud Services

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Adobe (NASDAQ:ADBE) is set to announce its fiscal Q3 2014 earnings on September 16. (Fiscal years end with November.) In Q2, Adobe’s core cloud business continued to deliver results as cloud adoption remained robust. As a result, the company generated $1.68 billion in revenue, with non-GAAP earnings per share of $0.37 in Q2, both exceeding the high end of its targeted ranges. For Q3, we believe the growth trend in cloud adoption continued, which likely drove revenues for Creative cloud and Acrobat family divisions. Likewise, we think Adobe’s marketing cloud division will report yet another quarter of growth, buoyed by the adoption of its marketing platform. However, we believe revenues from the LiveCycle and Connect business declined as that of the Print and Publishing business remained flat during the quarter.

Check out our complete analysis of Adobe

Outlook For Q3 FY14 And Beyond

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Adobe has guided for revenues of $975 million to $1.25 billion for the third quarter of fiscal 2014. It indicated GAAP EPS would be in the range of $0.02 to $0.8, and non-GAAP EPS between $0.22 and $0.28.

Due to excellent adoption of cloud services, Adobe now expects to have nearly 3.3 million paid CC individual and team subscriptions by the end of fiscal 2014. According to our calculations, this means it will need to add over 38,100 paid users per week in the second half of FY2014, 80% more than the 2013 weekly subscription rate of 21,000. The company has also disclosed that it expects to end the year with over $2.5 billion of digital media revenue at a growth rate of 20% year over year. Furthermore, Adobe expects revenues from its digital marketing cloud to grow by 25% in 2014. However, it expects the LiveCycle and Connect business to decline further, while the print and publishing business is expected to remain flat in 2014.

Growth In Cloud Services To Continue

According to our estimates, the Creative Cloud division is the biggest of Adobe’s operating segments and makes up approximately 57% of its value. We expect the company to report $1.35 billion in revenues for 2014, which is roughly more than double the prior year level.

Over the past year, Adobe’s cloud subscription service has witnessed robust growth as clients have increasingly adopted these services to drive collaborative development efforts across their companies. While we expect that the share of revenue from Creative Cloud (CC) will continue to grow in Q3 2014, its adoption will continue to negatively impact the revenues and profitability as use of subscription service is generally spread over the period of the software’s use.  In Q2, the company added 464,000 new subscribers, and 97% of the creative cloud subscribers have signed up for annual contracts. Additionally, the growth in licensing came from enterprise term licensing agreements (ETLA), which usually have tenure of three years. The company reported over 2.3 million paid subscribers for the CC services at the end of second quarter. To ensure that the growth in this vertical continues unabated, the company recently announced 14 new versions of CC desktop applications, including essential tools such as Adobe Photoshop CC, Adobe Illustrator CC, Adobe Dreamweaver CC and Adobe Premiere Pro CC. [1] As a result of new versions, we expect growth trend to continue in Q3 and estimate that the company is well underway to add 3.3 million subscribers in 2014. We believe that the company will continue to report traction for its cloud services in this earnings announcement.

Revenues From Marketing Cloud To Grow

Adobe’s cloud marketing division is the second biggest division and makes up 21% of its value. Over the past few years, Adobe has built a comprehensive digital marketing platform that addresses most of the needs in digital marketing. The company has scaled up the functionality and product offering of its marketing platform through organic and inorganic growth. We believe that this platform provides a cost effective digital marketing solution for companies that can manage marketing campaigns across different channels and devices.

Adobe is aiming to increase its revenues from cloud based marketing solutions by expanding in new geographies and verticals. According to the CEO of Adobe, Shantanu Narayen, the marketing cloud is easily a $10 billion opportunity. [2] Currently, we project revenues from its digital marketing division to reach $3.4 billion by the end of our forecast period. We expect that, as Adobe continues to develop its marketing solutions capabilities, this division will emerge as an important driver for revenue growth. In this earnings announcement, we expect the company to report growth in revenues from new geographies. Additionally, since many of Adobe’s digital marketing solutions cater to the growing big data analytics, mobility and social media industries, we expect the company to post incremental revenues across these industries.

Acrobat Family Revenue To Grow

Acrobat family is the third largest division and makes up 10% of Adobe’s estimated value. In the past few quarters, revenues from this division have been on a decline, primarily due to launch of document cloud services that have subscription fee spread over the period of usage. The company has amassed over 1.9 million subscribers for document cloud service. We expect this trend to continue in Q3 as well, and forecast the subscriber base to grow to 8 million by the end of our forecast period. We expect revenue to grow from $768 million to $1 billion by 2020.

We currently have a $58.14 price estimate for Adobe, which is 20% below the current market price.

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Notes:
  1. Adobe announces all new 2014 release of Creative Cloud, July 4 2014, www.adobe.com []
  2. Digital Marketing, Adobe and $10 Billion Worth of Opportunities, August 18 2014, www.mobilemarketingwatch.com []