Adobe Systems Earnings: Subscriber Growth and Lofty Expectations

Adobe Systems (ADBE 1.53%) reported its fourth-quarter earnings on Dec. 11, handily beating analyst estimates for earnings while growing revenue amid the company's continuing transition to a subscription-based business model. The number of subscribers to its creative suite of software surged during the quarter, and subscription revenue now makes up the lion's share of Adobe's sales. Here's a look at Adobe's fourth-quarter results.

Earnings summary

Source: Adobe and Yahoo! Finance. 

Revenue grew by about 3% year over year, accelerating from growth of just 0.5% during the third quarter. Adobe has been transitioning its business model from selling perpetual software licenses to only offering subscription products, and this shift has pressured revenue for the past couple of years. It appears that the worst is over, and analysts expect rapid revenue growth going forward.

Source: Adobe.

The percentage of revenue Adobe derives from subscriptions reached 58.6% during the quarter, up from 54.4% at the end of the third quarter. This percentage will continue to rise, as Adobe will no longer offer new versions of its software in any form other than subscriptions.

Adobe's Creative Cloud subscription, which includes access to applications including Photoshop and Illustrator, added 644,000 new subscribers during the quarter. This is substantially more than the 502,000 Adobe added during the third quarter, and it brought the total number of Creative Cloud subscribers to about 3.45 million.

Adobe's Marketing Cloud, the other major part of the company's business, recorded record bookings during the fourth quarter, and posted revenue of $330 million. About two-thirds of Adobe's revenue during the quarter was derived from recurring sources, compared to 44% during the same period last year.

Adobe announced a major acquisition in its earnings release, with the company paying $800 million in cash for stock photo company Fotolia. The acquisition fits in well with Adobe's creative products, allowing subscribers to purchase assets directly from the Creative Cloud service. The use of cash instead of stock to fund the acquisition is a curious choice, though, given that Adobe shares currently trade at about 54 times 2014 non-generally accepted accounting principles earnings.

Lofty expectations
Adobe's shift to a subscription-only business model is essentially complete. Revenue has stabilized and is growing again, but the expectations placed on Adobe by both analysts and the market will be difficult to meet. Analysts on average project 19.1% revenue growth in 2015, which would put revenue at $4.93 billion for the year. That's about $500 million higher than the peak year of 2012, before the shift to subscriptions started to pressure revenue. Analysts also expect non-GAAP earnings per share to jump to $2.07 in 2015, 60% growth from 2014.

Adobe dominates the creative software market, and historically the company has managed operating margins of roughly 25%. Adobe should reach this level again once margins recover from the shift to subscriptions, but the revenue growth projected by analysts seems unrealistic. Adobe has the potential to add new customers, given the lower cost of entry of its subscription products compared to its perpetual licenses, but it could also drive away some customers who are unwilling to pay for a subscription.

The market is also extremely optimistic. Adobe was trading before the earnings report at nearly $70 per share, which put it at about 35 times the lofty analyst estimate for 2015 earnings. The company trades at nearly nine times sales, almost as high as salesforce.com, a company with revenue that is roughly equal to Adobe's and that is growing that revenue at a 30% rate.

Adobe's stock had climbed nearly 10% by 12:45 p.m. on Friday, trading just over $76.

It was a solid quarter for Adobe, and its choice to go subscription-only is starting to pay off. However, the stock is priced as if Adobe is going to post 20%-30% revenue growth for the foreseeable future, and that just doesn't seem likely.