Adobe's Results Show Its Cloud Services Gaining Traction

| About: Adobe Systems (ADBE)

Adobe (NASDAQ:ADBE) posted its Q2 earnings on June 18, and showed that its Creative Cloud offering is gaining traction among users. Additionally, the company saw significant growth in its Marketing Cloud initiatives. According to the company, it has over 700k paid subscribers for the Creative Cloud services that generated $356 million annualized recurring revenue [ARR] in Q2.

Additionally, Adobe’s Marketing Cloud division’s Q2 revenues grew 17% y-o-y to $230 million. The only significant drop in revenue was reported in LiveCycle and Connect business, which reported $56 million revenues this quarter, down from $61 million last year. The company witnessed good adoption of subscription licenses and increased its end-user subscriptions for enterprise term licenses (ETLA) during the period.

The company reported a diluted earnings per share [EPS] of $0.15 on a GAAP-basis and $0.36 on a non-GAAP basis. While the company reported 10% y-o-y decline in revenues to $1.01 billion, its net income declined by 66% y-o-y to $77 million. Due to change in licensing model from perpetual to subscription, Adobe reported an increase in unearned revenue to $691.3 million. We examine some of Adobe’s key drivers below and its outlook for 2013 [Adobe SEC Filings,, June 18, 2013].

Outlook for Q3 2013 and FY 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 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, 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 $4.1 billion and EPS of $0.62 on a GAAP basis and $1.45 on a non-GAAP basis.

Cloud Subscription Services To Bolster Revenue Of Photoshop and Creative Software Division

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 decrease by 2015 and it will continues to sell CS6 to ease the transition to CC.

During the past quarter, Adobe reported an increase in adoption of enterprise CC offering through ETLAs and 46% sequential growth in CC’s subscriber base. Creative Cloud added 221k net new subscribers in Q2 2013, up from 153k last quarter. As a result revenue from CC increased by 50% sequentially to $356 million. Additionally, CC now contributes 81% to total revenues of Creative Software division.

Acrobat Family Division

Adobe Acrobat family is the second largest division at Adobe and makes up 13% of its value. Acrobat family division reported 3% y-o-y decline in revenues to $199.3 million. However, the decline in point product document services revenue was offset by increase in revenue from Acrobat cloud services. During the quarter, revenue from Acrobat Cloud services grew 31% sequentially to $84 million primarily due to increase in ETLAs. Going ahead, we expect document services’ ARR will drive revenue growth in the Acrobat family division.

Digital Marketing Division

Omniture is Adobe’s third-largest division and makes up 10% of its value by our estimates. Adobe acquired Omniture in 2011 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.

In Q2 CY13, this division reported a 20% y-o-y increase in revenue to $230 million. Additionally, Adobe Marketing Cloud achieved 25% y-o-y bookings growth in the quarter and the company has guided $1 billion in annual revenue. 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 currently have a $37.50 Trefis price estimate for Adobe, which is 20% below its market price.

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