It's been over four years since CEO Shantanu Narayen stopped offering Adobe's (NASDAQ: ADBE) flagship creative cloud suite of software for sale to designers. Instead, Adobe opted to offer its solutions solely on a subscription basis for $20 to $50 a month, depending on the package. Customers were not amused, to put it mildly, with Narayen's initiative.
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Within days of announcing the transition to a subscription sales model literally thousands of creative types had signed an online petition "demanding" Adobe continue to sell its design software the traditional way. Narayen stuck to his guns however, and the result is the long-term trend that makes Adobe an awesome buy, even at its current elevated levels.
Hitting on all cylinders
Adobe stock was already flying high when it announced record-breaking second quarter results June 20. Up 43% this year, Adobe shares tagged on about 5% of that stellar growth since its last quarterly release. That kind of performance may set off alarms for some investors, particularly value-oriented folks, but it shouldn't because of why Adobe stock has climbed to near record highs in 2017.
The $1.77 billion in revenue Adobe reported in June was the best second quarter in its history, and nearly all the credit for its jaw-dropping performance harkens back to Narayen's unpopular decision -- at the time -- of shifting to a subscription sales, annualized recurring revenue (ARR) emphasis.
The 27% year-over-year jump in revenue was impressive in and of itself, yet pales in comparison to Adobe's subscription growth. Subscription revenue soared 37% last quarter to $1.48 billion, and when service and support sales of $117 million are added to the mix, an impressive 90% of total revenue -- a figure that continues to climb with each successive quarter -- was derived from ARR-related products and services.
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In fact, Adobe's shift to an ARR model has been such a success its engineering software design brethren Autodesk (NASDAQ: ADSK) followed suit. One of the reasons Autodesk shareholders are enjoying a 49% jump in share value in 2017 is because it's delivering on its new-ish ARR initiative. References to Autodesk's ARR results, including adding 233,000 new subscribers bringing its total to 1.32 million, are sprinkled throughout its earnings release, and for good reason.
"What's the big deal with ARR growth?", some investors may ask. A primary reason Adobe was able to deliver such impressive revenue and subscription-related gains, while increasing operating expenses just 20% to $1 billion last quarter, is because it simply costs less to make a one-time sale that drives revenue for years rather than rely on software package sales.
One of the largest increases in expenses in Adobe's most recent quarter was in research and development (R&D) which climbed 29%, and its development efforts and spending are beginning to bear fruit.
The future starts now
Adobe has been working on integrating artificial intelligence (AI) solutions across its multiple cloud platforms for a while and recently took a significant step forward with the release of a personalization algorithm for its marketing cloud customers. The upgraded feature allows customers to input their own data and utilize Adobe's AI capabilities to "predict what customers want and deliver it before they ask," which is quickly becoming a consumer expectation rather than a nicety.
Another high-growth initiative is Adobe's early stage voice recognition solutions, the most recent upgrade is specific to its analytics cloud and combined with AI provides detailed analytics based on consumers voice-related data.
The recent acquisition of privately held SkyBox and its 360 degree view and virtual reality (VR) technologies is yet another Adobe initiative to drive future growth.
Adobe's ARR initiative may not have been a pleasant transition for users, but it's exactly the long-term trend that makes its stock such an awesome buy.
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