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Adobe Systems Incorporated (ADBE)’s Candy Coated Earnings Report

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Until Adobe Systems Incorporated (NASDAQ:ADBE)‘s fiscal Q2 earnings were released last Tuesday, I had never before encountered a presentation so short on traditional financial metrics but long on invented metrics.  It was as if Adobe’s management wanted to distract investors from certain inconvenient truths.  Judging by the market reaction the day after the report was released, Adobe succeeded, if briefly.

Adobe Systems Incorporated (NASDAQ:ADBE)’s slide presentation contained the bare minimum of hard financial data: quarterly revenue and earnings per share (GAAP and non-GAAP). Investors interested in operating profit, gross margin or any kind of year-over-year comparison were forced to pore over a supplementary table.  I doubt that many did.  Even Microsoft Corporation (NASDAQ:MSFT), which at times I have accused of obfuscation, provides more concrete information in their earnings slides.

Adobe Systems Incorporated (NASDAQ:ADBE)It’s as if Adobe Systems Incorporated (NASDAQ:ADBE) regards investors as mere children, to be distracted or placated with colorful lolipops of data.  These lolipops took the form of estimates of annualized subscription revenue for things like Creative Cloud, Adobe’s cloud-based successor to Creative Suite. Adobe could easily have provided actual quarterly revenue for Creative Cloud, as it did for Document Services and Marketing cloud, but this was never revealed even in the supplementary data table.

These estimates of Annualized Recurring Revenue (ARR) were scattered liberally throughout the earnings slides and even the supplementary data table as if they were accomplished fact rather than forward-looking estimates.   Even if we accept these ARR’s as accurately predictive, it’s virtually impossible to know what they really mean, since Adobe Systems Incorporated (NASDAQ:ADBE) provides no basis for comparison.

For instance, how does the ARR for Creative Cloud compare with revenue in previous years for Creative Suite?  How does Creative Cloud revenue for the current quarter compare with Creative Suite revenue for the current quarter?  I guess it’s best not to ask.

Best not to ask, because the inner core of reality is just so much worse than the candy coating.  But it’s there if you really look for it in the data, which I’ve summarized in the chart below.

Quarterly revenue has fallen year over year by 10%, but what is worse, operating income and net income are down by 63% and 65%, respectively. The operating margin has collapsed from a reasonable 27% in Q2 2012 to just 11%.

Adobe Systems Incorporated (NASDAQ:ADBE) was very proud of the fact that Creative Cloud subscriptions jumped from 479,000 in Q1 to 700,000 in Q2, but it’s not clear why, since it comes on the heals of Adobe’s announcement that it is pulling the plug on future licensed versions of Creative Suite.  The announcement provoked resentment among current Creative Suite users, as documented in a recent CNET article.  More than 30,000 people have signed an on-line petition urging Adobe to change its policy on change.org.

I’m pointing out the deficiencies in Adobe Systems Incorporated (NASDAQ:ADBE)’s financial performance not to argue that Creative Cloud is a failure but that its success has not been demonstrated.  It could work, since it has the advantage of lower initial cost for users.  What hasn’t been demonstrated is whether it’s revenue neutral, let alone revenue enhancing.  Adobe is engaged in a massive experiment that other software companies, notably Apple Inc. (NASDAQ:AAPL) and Microsoft, have been unwilling to undertake.

It’s one thing to distribute software over the Internet.  This is something Apple pioneered with the App Store for iOS devices.  But here Apple has the advantage of its relatively secure and protected ecosystem of devices and can provide a seamless buying experience with one click shopping and almost instant downloads.  At WWDC in June, Apple Inc. (NASDAQ:AAPL) celebrated the App Store’s 5th year.  The App Store has over 575 million accounts, most with credit cards and simple one-click purchasing.  Customers have downloaded 50 billion apps, and Apple has paid developers $10 billion.

Clearly, this is the future of software distribution.  Apple Inc. (NASDAQ:AAPL) is currently shifting Mac OS software to Internet distribution as well with the Mac App Store, eliminating optical disc drives from its most recent computers, as well as distributing its most recent Mac OS version exclusively via download.

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