Adobe Just Reported Earnings. Here's What Investors Need to Know.

The stock market's "show-me" mentality for artificial intelligence stocks -- rewarding companies with tangible results and punishing those that are heavy on expectation and promise -- claimed another victim Thursday.

Adobe (NASDAQ:ADBE) reported earnings after the close on Sept. 10, emphasizing user acquisition over its paid products. On top of that, fourth-quarter guidance fell short of analysts' expectations, sending the stock down nearly 5% in after-hours trading.

Adobe has managed to recover its losses on Friday morning and pull even. But investors are signaling their skepticism for Adobe stock even though it's showing strong growth in its AI products.

Let's see what happened.

Image source: The Motley Fool.

Adobe is in a challenging spot

Adobe is best known for its Creative Cloud suite of software, including Photoshop, Illustrator, and Premiere Pro. It's been tremendously popular with graphic artists and digital media professionals, and Adobe monetized the software through a subscription model.

But that was before the days of generative AI. Now, someone using one of the powerful AI engines such as ChatGPT, Claude, Grok, or Gemini can merely enter a prompt and, within seconds, receive an altered image or entirely new content.

Adobe's answer to this has been Adobe Firefly, its generative AI model that lets users interact with Photoshop and other products via text prompts. And it has embraced a freemium model that lets users use many of its products and AI features. That helps users new to Adobe try out its powerful software and get used to the ecosystem before they encounter paid features and higher usage limits.

Anil Chakravarthy, president of Adobe's customer experience orchestration business, who will become CEO on Dec. 1, discussed the strategy during the company's earnings call.

"One of the things we have obviously done is, for example, taken a portion of our traffic to make sure that we are sending them to the right place so we can acquire customers for, through the freemium funnel," he said. "And then we engage them and then increase the intensity of their use. And, obviously, at the right time, we will calibrate where we convert them into ARR (annualized recurring revenue). So that is the approach we have taken to make sure that we are really tapping into this large base of next-generation creators we can bring into the Adobe family."

Adobe's earnings by the numbers

The company's freemium strategy has been very successful in bringing in new users. Monthly active users of the company's creative freemium products -- Firefly, Express, and web and mobile versions of Premiere, Photoshop, and Lightroom -- topped 100 million in the third quarter, up 70% from a year ago.

Overall revenue was $6.76 billion, up 13% from a year ago, and diluted earnings per share were $4.62. Adobe said its ARR was $27.50 billion, with AI-first ARR up more than 150% year over year.

Management issued fourth-quarter guidance that included revenue in the range of $6.8 billion to $6.85 billion, but the midpoint fell below analysts' expectations. For the full year, Adobe is expecting revenue in the range of $26.576 billion to $26.626 billion.

The outlook for Adobe

I think Adobe's strategy of scaling engagement and monetizing later makes sense. It's the same strategy Mark Zuckerberg used when he launched Facebook, eventually turning the company into the social media powerhouse now known as Meta Platforms. And it's the strategy that Zuckerberg is continuing to follow now that he's investing heavily in AI -- provide a free product and get your customers hooked. Whether it's Meta's free personal AI assistants or Adobe's free access to Photoshop, the concept is the same.

But today's market is inclined to reward tangible successes from AI companies rather than potential. That's why Adobe stock will continue to tread water until the company can show more success in converting a healthy percentage of its freemium customers into paid subscribers.

Patrick Sanders has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe and Meta Platforms. The Motley Fool recommends the following options: long January 2028 $330 calls on Adobe and short January 2028 $340 calls on Adobe. The Motley Fool has a disclosure policy.