Adobe Web Subscriptions Crimp Outlook as Designers Move to Cloud

Adobe Systems Inc. (ADBE) signed up online customers at a faster-than-projected clip, adding to evidence the largest maker of graphic-design software is reducing its dependence on the slumping personal-computer market.

The jump to 1.44 million customers for Adobe’s Creative Cloud Web-based software came as sales declined 9.7 percent to $1.04 billion in the fiscal fourth quarter that ended in November, the company said in a statement yesterday. That topped the $1.03 billion average of analysts’ projections, according to data compiled by Bloomberg.

Adobe cut its profit outlook for the next three years, as Chief Executive Officer Shantanu Narayen sacrifices income in a push to promote Internet versions of the company’s Photoshop, Illustrator and Dreamweaver applications. While Adobe’s transition to annual and monthly software subscriptions mirrors a broader shift in the way software is delivered, it still hasn’t proven whether this will enhance profitability down the road, according to Josh Olson, an analyst at Edward Jones & Co.

“Adobe’s been getting a lot of credit for their migration to the cloud,” said Olson, who is based in Des Peres, Missouri, and has a hold rating on the stock. “They have yet to really demonstrate the profitability of the model.”

The shares of San Jose, California-based Adobe jumped 7.8 percent in extended trading. The stock declined 1.2 percent to $53.99 at the close in New York, leaving it up 43 percent this year, compared with a 24 percent climb in the Standard & Poor’s 500 Index.

Cloud Transition

Adobe trimmed its sales and profit forecasts, underscoring the loss of income during the transition. Profit excluding some items will be 22 cents to 28 cents a share on sales of $950 million to $1 billion in the current fiscal first quarter that ends in February, the company said. That compares with the average projection for profit of 33 cents on revenue of $1.02 billion.

“No company has gone through a transition of this magnitude,” Narayen said. “We want to take the entire base and have them move over to the Creative Cloud.”

The move is sapping growth more than analysts had predicted. Net income for the fiscal fourth quarter slumped 71 percent to $65.3 million, or 13 cents a share, compared with analysts’ average estimate of 14 cents. Profit is suffering as Adobe sells fewer full versions of its desktop software priced as high as $2,600 as customers subscribe to Creative Cloud, which costs $50 a month per user.

Subscriber growth isn’t enough to deliver on Adobe’s 2016 earnings target, said Kevin Stadtler, president of Stadtler Capital Management LLC, a hedge fund in Fort Worth, Texas, that’s short on Adobe shares, or betting the stock will fall.

“Investors will wake up to economic gravity and recognize that Adobe is mispriced too high,” Stadtler said.

Subscriber Growth

Sales this year will be essentially unchanged, Adobe said, compared with the average estimate of 7 percent growth. Earnings excluding some items will be $2 in 2015 and at least $3 in 2016, while analysts had predicted $2.28 and $3.31.

While the move is crimping sales and profit, Adobe is signing up more subscribers and will be collecting $1.85 billion in recurring annual revenue by the end of 2014, Narayen said on a conference call with analysts yesterday.

The jump in customers for Adobe’s Creative Cloud Web-based software by 402,000 in the fourth quarter exceeded the 350,000 predicted by Brent Thill, an analyst at UBS AG, and the 345,000 estimate of Brad Zelnick, an analyst at Macquarie Capital USA. Both have the equivalent of buy ratings on the stock.

Online Software

Adobe had said it was targeting more than 1.25 million Creative Cloud customers by the end of this year. The company also said it’s on track to surpass 4 million by the end of 2015.

The software maker is promoting subscriptions to its Photoshop and Lightroom photography applications for $10 a month, helping to drive adoption of Creative Cloud, it said.

The company is using subscriptions to reduce its reliance on packaged software as PC sales decline. Consumers are migrating to smartphones and tablets, while software used on laptops and desktops can run in Web browsers. PC shipments may decline 10.1 percent this year and 3.8 percent in 2014, according to market-researcher IDC.

“Adobe’s leading the charge as it relates to the old software guard,” said Thill. “Adobe was one of the first to see this new world coming and they adapted quicker than any of the other software companies. It was painful up front, but now they’re reaping the benefits.”

To contact the reporter on this story: Aaron Ricadela in San Francisco at aricadela@bloomberg.net

To contact the editor responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net

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