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Adobe Systems Incorporated (NASDAQ:ADBE)

F4Q08 Earnings Call

December 16, 2008 5:00 pm ET

Executives

Mike Saviage - Vice President, Investor Relations

Shantanu Narayen - President and Chief Executive Officer

Mark Garrett - Executive Vice President and Chief Financial Officer

Analysts

Michael Olson - Piper Jaffray

Brent Thill - Citigroup

Sara Friar - Goldman Sachs

Heather Bellini - UBS

Adam Holt - Morgan Stanley

Ross MacMillan - Jeffries & Company

David Hilal - Friedman, Billings, Ramsey

Steven Ashley - Robert W. Baird

Walter Pritchard - Cowen and Company

Brad Reback - Oppenheimer

Blair Abernethy - Thomas Weisel Partners

Operator

Good day, everyone. Welcome to the Adobe fourth quarter and fiscal year 2008 earnings conference call. As a reminder, today’s call is being recorded. At this time I would like to turn the call over to Mr. Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

Mike Saviage

Good afternoon and thank you for joining us today. Joining me on the call are Adobe's President and CEO, Shantanu Narayen, as well as Mark Garrett, Executive Vice President and CFO.

In the call today, we’ll discuss Adobe's fourth quarter and fiscal year 2008 financial results. By now, you should have a copy of our earnings press release, which crossed the wire approximately one hour ago. If you need a copy of the press release, you can go to adobe.com under the company and press links to find an electronic copy.

Before we get started, I want to emphasize that some of the information discussed in this call, particularly our revenue and operating mile targets and our forward-looking product plans, is based on information as of today, December 16, 2008, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued today, as well as Adobe's SEC filings.

During this call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in our earnings release and on our investor relations website.

Call participants are advised that the audio of this conference call is being broadcast live over the Internet in Acrobat Connect Pro and is also being recorded for playback purposes. An archive of the call will be made available in Acrobat Connect Pro under Adobe's investor relations website for approximately 45 days and is the property of Adobe Systems. The audio and archive may not be re-recorded or otherwise reproduced or distributed without prior written permission from Adobe Systems.

I will now turn the call over to Shantanu.

Shantanu Narayen

Thanks, Mike and good afternoon. Today we are reporting fourth quarter revenue of $915.3 million, and annual revenue of $3.58 billion. Despite a difficult economic environment in 2008, we were able to achieve record revenue and double-digit growth for the sixth consecutive year.

Looking at 2008 as a whole, and knowing now that we were in the midst of a recession that spanned our entire fiscal year, it is clear that we executed well and achieved some notable results.

First, our creative business had a solid year, as we delivered the largest and most innovative product release in Adobe's history with CS4. We grew our leadership position in the creative tools market and diversified by establishing growth businesses in the areas of dynamic media with Flash-based video and hosted services with our Scene 7 business.

In business productivity solutions, Acrobat had a good year, with double-digit revenue growth and the launch of Acrobat 9. Our LiveCycle enterprise business had a great year, achieving more than a quarter of a billion dollars in revenue with 32% annual growth.

We established the Adobe Flash platform as the standard for how the world engages with ideas and information across platforms, devices, and operating systems. Our ubiquitous client technologies, including Flash player, Air, and Reader uniquely position Adobe as a technology leader in a world in which the explosion of rich digital content is accelerating.

These accomplishments helped us to meet our goal of 13% revenue growth in fiscal 2008 and our operational focus allowed us to greatly exceed our profit targets for the year. In a few minutes, I will comment on Q4 highlights in more detail but first I will turn it over to Mark for a review of our financial results.

Mark Garrett

Thanks, Shantanu. I will first comment on our full year fiscal 2008 results. Adobe achieved record revenue of $3.580 billion in the year compared to $3.158 billion in fiscal 2007. This represents 13% year-over-year revenue growth, consistent with the target we provided at the outset of the year. GAAP operating income in fiscal 2008 was $1.028 billion, compared to $858 million in fiscal 2007. GAAP operating margin for the year was 28.7% compared to 27.2% in fiscal 2007. Non-GAAP operating income in fiscal 2008 was $1.435 billion, compared to $1.209 billion in fiscal 2007, and representing 19% year-over-year growth.

Our non-GAAP operating margin was 40.1% in fiscal 2008, compared to 38.3% in fiscal 2007, and exceeding our original target for the year.

Adobe's annual GAAP net income was $872 million in fiscal 2008 compared to $724 million in fiscal 2007. Adobe's annual non-GAAP net income was $1.136 billion in fiscal 2008 compared to $966 million in fiscal 2007. GAAP diluted earnings per share in fiscal 2008 were $1.59 compared to $1.21 in fiscal 2007. Non-GAAP diluted earnings per share were $2.07 in fiscal 2008 compared to $1.61 in fiscal 2007.

Given the economic environment throughout the year, including the year-long recession in the U.S., we are pleased that our execution and cost controls helped to deliver strong growth in profitability and an expansion in our operating margin.

Looking at our businesses in fiscal 2008, we achieved revenue growth in every segment. Our Creative Solutions business achieved revenue of $2.07 billion, which represents 9% growth when compared to fiscal 2007. Revenue for our business productivity business grew to $1.06 billion, which represents 16% year-over-year growth. Within our business productivity segment, Knowledge Worker revenue was $810.9 million, representing 11% year-over-year growth, and enterprise revenue was $253.1 million in fiscal ’08, which represents 32% year-over-year growth.

Our mobile business achieved revenue of $113.1 million, which represents 115% year-over-year growth. Other revenue was $329.8 million, which was 15% higher than last year. Within other segment revenue, our platform business achieved $118.5 million in revenue, which was growth of 46%, and print and publishing revenue was $211.3 million, with growth of 3%.

Now I would like to discuss our quarterly results. For the fourth quarter of fiscal 2008, Adobe achieved revenue of $915.3 million. This compares to $911.2 million reported for the fourth quarter of fiscal 2007 and $887.3 million reported last quarter.

GAAP operating expenses for the fourth quarter of fiscal 2008 were $555.7 million compared to $556.9 million last quarter. Non-GAAP operating expenses were $476.8 million compared to $475.1 million last quarter.

GAAP operating income for the fourth quarter of fiscal 2008 was $273.2 million, or 29.8% of revenue. This compares to GAAP operating income of $275.8 million, or 30.3% of revenue in the fourth quarter of fiscal 2007, and $219.5 million, or 24.7% of revenue last quarter.

Non-GAAP operating income in the fourth quarter of fiscal 2008 was $374.9 million, or 41% of revenue. This compares to non-GAAP operating income of $362.2 million, or 39.7% of revenue in the fourth quarter of fiscal 2007, and $351.9 million, or 39.7% of revenue last quarter.

Adobe's effective GAAP tax rate for the quarter was 11% and our non-GAAP tax rate was 16%. Our fourth quarter GAAP and non-GAAP tax rates benefited from two favorable items -- a current quarter catch-up related to the reinstatement of the United States research and development credit and a favorable tax court settlement.

GAAP net income for the fourth quarter of fiscal 2008 was $245.9 million, compared to $222.2 million reported in the fourth quarter of fiscal 2007, and $191.6 million last quarter.

Non-GAAP net income was $320.9 million, compared to $289.6 million reported in the fourth quarter of fiscal 2007 and $269.1 million last quarter.

GAAP diluted earnings per share for the fourth quarter of fiscal 2008 were $0.46 based on 534.9 million weighted average shares. This compares with GAAP diluted earnings per share of $0.38 reported in the fourth quarter of fiscal 2007 based on 587.9 million weighted average shares, and GAAP diluted earnings per share of $0.35 reported last quarter, based on 541.3 million weighted average shares.

Non-GAAP diluted earnings per share for the fourth quarter of fiscal 2008 were $0.60. This compares with non-GAAP diluted earnings per share of $0.49 in the fourth quarter of fiscal 2007, and $0.50 reported last quarter.

I will now discuss Adobe's revenue in Q4 by business segment.

Creative Solutions segment revenue was $508.7 million, compared to $570.5 million in Q4 of fiscal 2007 and $493.6 million last quarter. On a year-over-year basis, this represents a decline of 11% as demand for our new CS4 products was impacted by the global economic crisis.

Business Productivity solutions segment revenue was $278 million, compared to $246.4 million in Q4 of fiscal 2007, and $283.5 million last quarter. On a year-over-year basis, this represents 13% growth.

Within Business Productivity Solutions, our Knowledge Worker revenue was $199 million in Q4 of fiscal 2008, compared to $192.1 million in Q4 of fiscal 2007 and $218 million last quarter. On a year-over-year basis, this represents 4% growth.

The other component of our business productivity segment is our enterprise business. In Q4, enterprise revenue was a record $79 million compared to $54.3 million in Q4 of fiscal 2007 and $65.5 million last quarter. On a year-over-year basis, this represents 45% growth.

Mobile and device segment revenue was $48.2 million compared to $13.5 million in Q4 of fiscal 2007 and $27.5 million last quarter. Revenue in mobile and device was strong due to demand for Flash Lite and renewal of several agreements with major OEMs.

Finally, other segment revenue was $80.4 million, compared to $80.8 million in Q4 of fiscal 2007 and $82.7 million last quarter.

Turning to our geographic segments, results on a percent of revenue basis were as follows: the Americas, 46%; Europe, 34%; and Asia, 20%. The global economic situation affected demand for our products in all geographies, particularly North America and Europe.

Employees at the end of the fourth quarter totaled 7,544 versus 7,623 at the end of the third quarter. The reason for the decline was due to the departure of summer interns. The recently announced reduction of approximately 600 employees, or 8% of our global workforce, occurring in fiscal 2009 will begin to affect our headcount and operating expenses run-rate in Q1.

Our trade DSO in the fourth quarter of fiscal 2008 was 46 days. This compares to 32 days in Q4 of fiscal 2007 and 34 days last quarter. DSO was higher in Q4 than in recent quarters due to the shipment of CS4 in the second half of the quarter.

In regard to our global channel inventory position, we ended the quarter within company policy.

During the quarter, cash flow from operations was $338 million. Our ending cash and short-term investment position was $2 billion, the same as the end of last quarter.

In Q4, we repurchased a total of 6.2 million shares at a total cost of $206.3 million. During the fiscal year, we repurchased a total of 58.3 million shares at a total cost of $2.14 billion. We will continue to utilize this program to return excess cash to shareholders and offset dilution from employee stock programs.

This concludes my discussion of our financial results. I would now like to comment on our financial targets for the first quarter of fiscal 2009.

We are targeting a Q1 revenue range of $800 million to $850 million. Given the current economic climate and normal seasonality, we expect revenue in each of our business segments to decline sequentially. In our mobile business, we expect revenue of approximately $10 million to $12 million, due primarily to the transition to the open screen project. In addition, we are targeting a GAAP operating margin range of 26% to 28% and a non-GAAP operating margin range of 37% to 38%. These margin targets reflect the cost-savings and impact of our restructuring activities, as applicable.

We are targeting our Q1 share count to be 530 million to 534 million shares. For non-operating income, we are targeting a range of $3 million to $5 million on both a GAAP and non-GAAP basis. For our GAAP and non-GAAP effective tax rates, with the reinstatement of the R&D tax credit, we are targeting approximately 24%.

These targets lead to a GAAP earnings per share range of $0.30 to $0.35 per share and a non-GAAP earnings per share range of $0.43 to $0.47.

As a reminder, all of our targets assume a baseline of existing economic and currency conditions in our major markets. This concludes my section. I would now like to turn the call back over to Shantanu.

Shantanu Narayen

Thanks, Mark. I will spend the next few minutes reviewing highlights from Q4. During the quarter, we shipped a new Creative Suite 4 product family in English, French, and German. CS4 is a milestone release of our industry-leading design and development software for virtually every creative workflow and represents our most comprehensive software release ever.

Industry and press response to CS4 has been excellent. Design Premium and Master Collection suites both received excellent ratings from CNET and Photoshop received a perfect five out of five rating, and an Editor’s Choice award from PC Magazine.

We believe CS4 is a stellar release, with new product innovations, time-saving features, and workflow enhancements that will improve productivity. These capabilities will generate opportunities for Adobe to up-sell and cross-sell in our existing customer base and expand our reach to new customer segments and markets.

While customer feedback has been positive, given the current economic climate, we believe CS4 adoption in the short-term will be muted when compared to prior cycles. This is reflected in our early results, with CS4 revenue down more than 20% when compared to the equivalent CS3 period.

In Q1, we will be shipping the Japanese version as well as many of the other languages. We will be focusing on enhanced demand generation programs to drive awareness and adoption in 2009.

Dynamic media continues to be a key growth focus for Adobe. In November, we announced Version 3.5 of Flash Media Server. This new release, combined with the latest advancements in Flash Player and our CS4 authoring tools, are helping to deliver breakthrough interactive content, applications, and video on the web.

Recent high profile wins include Disney.com, the number one ranked kids entertainment and family community destination on the web, which is leveraging Adobe video solutions to create and deliver rich, interactive experiences. Over the past several months, Disney.com has experienced record online traffic levels, as viewers logged on to watch full-length movies delivered via the Adobe Flash platform.

Telecom Italia, which has chosen the Cisco content delivery system with Internet streaming platform, powered by Adobe Flash streaming technology to deliver live television channels and on-demand content through it’s web portal.

And MLB.com, the official website of Major League Baseball, which has selected the Flash Platform to deliver all of its live and on-demand video offerings for two years beginning in 2009. In addition, MLB.com will provide a downloadable rich Internet application built using Adobe Air, so baseball fans can access additional features outside the web browser.

In our hobbyist business, we shipped version 7 of Photoshop Elements and Premiere Elements in Q4, updates to the world’s best-selling consumer photo-editing and video-editing software products.

In our business productivity solutions segment, our year-over-year growth was driven by solid performance in both our Knowledge Worker business and our enterprise business. LiveCycle achieved record revenue with 45% year-over-year growth. Our engagement value proposition is resonating with our enterprise customers, even in this tough spending environment.

In our mobile business, we announced that OpenTV, a leading provider of advanced television services, will integrate Flash as an additional application environment, further enhancing web browsing capabilities in the living room and strengthening the development of rich applications and user interfaces.

In our platform business, we released Flash Player 10 in October. Interactive designers and developers can leverage new expressive features and visual performance improvements to deliver the most compelling web applications, interactive content and high quality video to users across multiple browsers in all major operating systems.

In November, we held our annual MAX conference in San Francisco, followed by MAX Europe in early December. MAX was an enormous success with record attendance. We made several exciting announcements related to the Adobe Flash platform. These include Adobe Flash Catalyst in a technology collaboration to optimize and enable Flash Player and Adobe Air for [inaudible] powered devices.

As the breadth of our solutions increases, we are rapidly becoming a strategic partner to larger enterprise customers. This is enabling Adobe to drive more revenue per customer across their organizations. For example, BBC in the U.K. signed a broad agreement with Adobe that includes LiveCycle for finance and production process and rights management, Flash and Air for its next generation online video content, creative tools and services for content development and production, and Acrobat Connect integration for training, support, and collaboration. Our field organization will continue to drive these strategic enterprise level agreements as part of our go-to-market strategy.

In closing, as we enter fiscal 2009, we will continue to make strategic investments that will position us well for the future while managing our business to ensure consistent profitability. Our strategic priorities are advancing the Adobe Flash platform as the preferred solution for how the world engages with ideas and information; investing in our core businesses, including Creative Suite and Acrobat, to maintain our leadership position through innovation and continue our expansion into new customer segments and geographical markets; and focusing on our growth businesses, which include LiveCycle, Connect Pro, Scene 7, and Dynamic Media as areas we believe have significant potential for future growth.

While 2009 will be a challenging year because of the macroeconomic environment, we believe the key market trends driving our business remain intact. By continuing to innovate and deliver through solid execution, we believe Adobe is well-positioned for future growth.

Thank you for joining us today. Now I will turn the call back over to Mike.

Mike Saviage

Thanks, Shantanu. Before we get to Q&A, we wanted to update you on some changes being made to our business segments as we enter fiscal year 2009. We are breaking out our former other segment into two separate segments called platform and print and publishing. We are also combining our former mobile and device solutions segment with our newly named platform segment. These segment reporting changes reflect changes we have made internally in terms of how we manage these businesses.

We will continue to report our creative solutions business as we have in the past, and we will continue to report our business productivity solutions business into two distinct segments, knowledge worker and enterprise, as we have done in the past. Our investor data sheet will reflect these changes starting with our Q1 FY2009 earnings report in March, and we’ll show adjusted segment revenue for prior reported periods.

In regard to today’s earnings report, we have posted several new documents on our investor relations webpage today. They include today’s earnings release and our updated investor data sheet, which also includes a listing of the new fiscal 2009 segment classifications by product area. To access these documents and other investor relation information, you can go to our website at www.adobe.com/adbe. For those who wish to listen to a play-back of today’s conference call, a web-based Acrobat Connect archive of the call will be available from the IR page on Adobe.com later today. Alternatively, you can listen to a phone replay by calling 888-203-1112. Use conference ID number 1394828. Again, that phone number is 888-203-1112, with ID number 1394828. International callers should dial 719-457-0820. The phone play-back service will be available beginning at 4:00 p.m. Pacific Time today and ending at 4:00 p.m. Pacific Time on Friday, December 19, 2008.

We would now be happy to take your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Michael Olson with Piper Jaffray.

Michael Olson - Piper Jaffray

Thanks a lot. Good afternoon. Could you just clarify your mobile segment guidance? Is it $10 million to $12 million overall for the quarter? And more details on what is the reason for that?

Mark Garrett

It’s $10 million to $12 million for the first quarter and the reason for the drop is, like we’ve been talking about for quite some time, the move to the open screen project will ultimately make the royalty revenue that we have for mobile go away, and you are starting to see that in 2009 as we anticipated.

Michael Olson - Piper Jaffray

Okay, and then I know you are not giving quarterly guidance but is there any reason to expect anything other than normal seasonality as we go through ’09?

Mark Garrett

You’re right, we’re not providing ’09 guidance, primarily because of the limited visibility that most companies have right now. What you can expect is for revenue to track pretty similarly to what you have seen in 2008 with Q1 and Q2 being relatively similar. We typically had a Q3 seasonal dip down -- keep in mind that we don’t have the Acrobat launch that we had in 2008, and then a spike back up in the fourth quarter. So typical pattern to 2008.

Michael Olson - Piper Jaffray

One last one -- today when you revised your guidance, you talked about weaker-than-expected demand for CS4 and do you believe that that’s really a result of kind of the macro environment, or is there any evidence to suggest that there’s just lower interest in the product from creative pros following the bigger CS3 launch? Thanks.

Shantanu Narayen

I’ll take that question, Mike. I have gone out and talked to a bunch of customers and frankly the response to CS4 in terms of the innovation that we’ve done and productivity features that we have added in addition to the workflow actually remains as strong as it’s ever been. CS4, as I said earlier, was our strongest product ever. There’s just a tremendous amount of innovation but there’s no question that the economic uncertainty is playing into the adoption rate we’ve seen and that’s why we thought it would be muted in the short-run.

It really puts more emphasis, frankly, on us as a company to continue to drive demand generation and that’s what we are going to be doing. If you parse the business a little bit more, where we are seeing the impact is primarily in the shrink side, which is where we go through distribution. What we are seeing on licensing in large deals in emerging markets where we are driving more of the revenue is where we continue to see good results, and so in the shrink side, we are going to be doing a lot more as it relates to demand generation programs to drive awareness all the way through purchase. Licensing, we have made sure that all of our partners and our resellers are trained on the product and understand what it takes to get people to move to CS4, and in the large deals, like we’ve demonstrated with Acrobat over the last couple of years, we will continue to focus on selling into both Creative agencies and organizations, as well as marketing departments. And one interesting statistic, we just saw some research that Omni had produced which stated that CS4 actually can save over 18% of the productivity versus CS3, so just another reflection and validation of the quality of the product that we’ve delivered. But we are definitely seeing some impact due to the financial situation.

Michael Olson - Piper Jaffray

Okay. Thanks very much.

Operator

We’ll go next to Brent Thill with Citi.

Brent Thill - Citigroup

I think your Q1 guidance implies negative 7% to 12% growth, and I guess just as you look at the whole fiscal year ’09, are you looking at trying to get back to break-even or do you think that we are going to see the whole fiscal ’09 as negative as is implied by your Q1 guidance?

Mark Garrett

Again, we gave the Q1 guidance, which we obviously take pretty seriously and tried to be prudent about. We’re not prepared to talk about what the rest of the year would look like right now but again, I think you can model it out as I suggested, which is Q1 and Q2 relatively similar, with a dip in Q4 and a spike -- a dip in Q3 and a spike back up in Q4.

Shantanu Narayen

And Brent, I want to also reiterate, I mean, when you think about how we are doing across each of our businesses, I think it’s been clear from our 2008 results that we’ve been executing against each one of the initiatives we outlined and so it’s really going to be how the economy progresses over 2009 rather than anything that we are doing as it relates to execution. You saw LiveCycle had a great year. Acrobat continues to do well and the adoption for our platform continues unabated.

Brent Thill - Citigroup

Okay, and Mark, the FX impact in the quarter and for what you are assuming for the guidance in Q1?

Mark Garrett

Sure. So in Q4, net of our hedging, so including the impact of our hedging, which did give us a positive benefit this quarter, we had a $7 million gain year-over-year. That was a $1 million loss from the Euro and an $8 million gain from the YEN, and then Q4, quarter over quarter, we actually had a $20 million loss, a $24 million negative impact from the Euro and a $4 million gain from the YEN. We continue to hedge and we are actually in very good shape, if you look at our hedging, for the beginning of 2009 relative to where rates are today. And the guidance that we have provided has factored in both where we think rates will be as well as the benefit of the hedging that we expect.

Brent Thill - Citigroup

Thanks.

Operator

We’ll go next to Sara Friar with Goldman Sachs.

Sara Friar - Goldman Sachs

Great. Thanks very much for taking my call. Shantanu, you mentioned that the top line will be driven a lot by just what goes on in the economy, which we all understand. Where you do though have your own ability to change the direction of Adobe is on the bottom line. You’ve made a swift move here with an 8% headcount reduction. How much through the year will you continue to look to keep costs very tight and preserve the margins, even if the demand continues to track, you know, maybe even worse than what we are seeing right now?

Shantanu Narayen

Sara, based on what we saw in the economic climate, as you point out, we took fairly quick action. We’ve already restructured and that was actually done on the day that we announced it, so I think rather than have that linger or there be uncertainty within the organization, we were able to get that all behind us. Clearly the focus right now is going to continue to be on driving revenue and focusing on the top line because we believe that that’s our really how we power through this current economic climate, and based on what we saw, we think we’ve made the changes that we need to. And we’ll just continue to monitor our business.

Sara Friar - Goldman Sachs

Right, but it sounds like -- I mean, you are at least going to keep watching it. This is not you are done with all of the cost cuts and then the macro will be what it will be. It sounds like you are thinking about the margins as well as growth.

Shantanu Narayen

No, that’s absolutely true, Sara, and it’s not just the restructuring that we’ve done. We’ve also taken a number of other internal measures to make sure that there’s a very significant scrutiny on expenses, whether it’s travel where we are not doing really any travel that’s not related to customers. We use Acrobat Connect and so that’s a good use of travel. Every single external expense as it relates to contractors is being scrutinized by Mark. We’ve also made some decisions as it relates to the salary structure for employees, so we will continue to monitor all of that and balance investing in our strategic directions versus returning to shareholders.

Sara Friar - Goldman Sachs

Sure. And then just maybe the second derivative of that, you have been quite good at buying back your own shares. You still have a fair amount of cash on the balance sheet. How are you thinking about buy-backs as you look forward, just given kind of a generally credit constrained environment?

Mark Garrett

We are very pleased with our share repurchase program. As we said, we bought back $58 million shares for over $2 billion in 2008. I continue, and Shantanu both and I continue to believe that that’s the right way to return excess cash to shareholders. We will continue buying back to offset dilution, like we did in the fourth quarter. And as it relates to a larger program, obviously we are watching the capital structure of the company with this tight credit market but when it makes sense to do it, we’ll let you know.

Sara Friar - Goldman Sachs

Terrific. Okay, thanks very much for taking my questions.

Operator

We’ll go next to Heather Bellini with UBS.

Heather Bellini - UBS

Thank you. I had a question about mobile -- I guess two questions. In regard to the mobile business, you said you renewed contracts in the quarter. I just, on the conference call last quarter you guys actually thought that the segment would decline sequentially, so I’m just wondering if these renewals happened earlier than you had thought. And then the second question, Shantanu, you talked about advanced demand generation, which to me implies a bigger marketing budget than maybe what we saw with CS3 and I was wondering one, am I thinking about it the right way and how might that factor into your margin expectations for this year?

Mark Garrett

Heather, it’s Mark. As it relates to mobile, you’re right -- we did anticipate it starting to drop a little sooner. What happened is a lot of the OEMs burned through some of their prepaids faster than we thought. Flash Lite has done extremely well and they just couldn’t wait for the OSP version of Flash to come out later in 2009, so we did some renewals with them earlier and larger than we thought we would do.

Heather Bellini - UBS

But Mark, before we leave that topic, does that -- so the new level that you talked about for Q1, is that kind of how we should think about it for the year then, since you think that revenue stream is going to burn away?

Mark Garrett

Yes, that’s right.

Heather Bellini - UBS

Okay, so for the whole year, not just for that quarter --

Mark Garrett

No, it’s --

Heather Bellini - UBS

-- spike back up?

Mark Garrett

No, it should not spike back up. It will start to tail off through the year from the $10 million to $12 million that we guided you to in Q1.

Heather Bellini - UBS

Okay, and then the demand, the advertising question and then I just had one quick follow-up.

Shantanu Narayen

Sure, and maybe I’ll just also add, Heather, that it’s really continued validation of the need for Flash on all of these devices and we have also clarified our strategic direction associated with making sure that we get great web browsing experience on smartphones, as well as building an application environment to have air applications that work across multiple streams. So the demand that we are seeing from all of our handset manufacturer partners as well as operators is something that is actually very pleasing to us.

As it relates to the marketing budget, the real focus there has to be we’ve built over the last couple of years a really great customer database and so it’s going to be far more targeted programs. I won’t look at it from a margin perspective and say we are going to be reducing any of that to invest in these marketing programs. Rather, it’s going to be a real focused effort to make sure that we are targeting the right customers to get them moved over to the right versions of the creative suite and/or the Acrobat applications. I would also say that the marketing strategy as it relates to the shrink customers versus the licensing customers, it’s a lot more refinement of what’s critical for both of those segments. And frankly, we’ve been reducing in other areas, for example, events which we feel has less limited usage right now and more investment in search.

So I would say it’s really more optimization of all of our marketing budgets but also a reflection of the fact that that’s going to be a real focus for us to continue to drive revenue in 2009.

Heather Bellini - UBS

And then can I ask one follow-up in regard to the price increases scheduled for the February 28th timeframe, I’m wondering if there’s any chance, given the macro environment we are in and given you set pricing in probably a different environment, if we could potentially see a rollback and not see those price increases go through, given what we’ve seen from other vendors, in particular Intuit last week?

Shantanu Narayen

Well, Heather, the feedback that we are getting from our customers continues to be that the value associated with what we deliver in Creative Suite, whether it’s the individual point products or the suites, is very good. So at this point, the focus really is more on demand generation and driving people to the product, explaining why the ROI more than pays for itself, rather than looking at price cutting.

Heather Bellini - UBS

Okay, so the price increase you would think would still go through on the February 28th timeframe?

Shantanu Narayen

That’s correct. And again, remember that it’s staggered, so in other words, the customers had 90 to 120 days, depending on which region the product was delivered in. So it happens only for the upgrade pricing in English at the end of February and then since the [J] version is actually shipping in Q1, that price promotional period for upgrades will stay beyond February 28th.

Heather Bellini - UBS

Okay. Thank you.

Operator

We’ll go next to Adam Holt with Morgan Stanley.

Adam Holt - Morgan Stanley

Good afternoon. I recognize you only have a few weeks of CS4 data and it may be too early to really draw any conclusions, but I thought I would ask about what the preliminary data tells you. In particular, have you seen any trends on the upgrade side, either most of the upgraders coming out of the CS3 base or some of the older customers that you were hoping to get upgraded? Any trends with respect to the suites that might be different than what you saw in CS3, and anything with respect to some of the price increases that already went through in terms of what you think they might have done potentially to demand?

Shantanu Narayen

Well Adam, as you pointed out correctly, it is pretty early in the cycle. We try to give some data as it relates to the overall macroeconomic impact and we said that we had seen a little over 20% decline cycle over cycle, and we did normalize it for the fact that, as you know, we shipped Master Collection and the video products all simultaneously this time, as opposed to CS3.

Where we are pleased is the Master Collection revenue continues to actually do fairly well, reflecting interest in the suites and the entire workflow. But as we see more data, we will certainly share more results. But it’s still a little early to draw any conclusions.

Adam Holt - Morgan Stanley

If I could just turn then to the Acrobat business, down sequentially in the quarter. Was this in line with your plans for the quarter and how sensitive do you think that business is to the broader corporate CapEx spending declines that we are seeing?

Shantanu Narayen

Adam, when we think about the Acrobat business, first we continue to be pleased by the fact that we are actually driving revenue and driving more adoption of Acrobat, and I think it just speaks to the fact that people are exchanging more information and PDF clearly is the best format to do that.

The Acrobat business is being driven primarily by exchange of information, by collaboration and more so now by the specialized use cases that we have -- you know, 3D in the manufacturing market, redaction, for example, in the legal market. And also Acrobat Professional continues to do fairly well.

If you double-click on the Acrobat business as well, again it’s really licensing that’s driving a big part of the revenue in our field organization and the shrink business, which I think has more impact from the macroeconomic environment, is getting impacted. We’ve had a couple of years of transferring from shrink to driving licensing and driving the larger deals and compliance, and that’s the kind of same focus you would expect to see us do not only in the Acrobat but also in the Creative business, Adam.

Adam Holt - Morgan Stanley

Okay, and if I could just end, and at the risk of dragging you through the business segments, the enterprise business was again one of the faster growing segments at plus 46%. Could you maybe give us a little bit of insight into why that continues to be so strong and how you expect that to fare as we head into the slower part of the first half of next year?

Shantanu Narayen

Sure. So LiveCycle was really pleasing in terms of the results that we got and I think it just reflects a couple of things, Adam. First is it’s a large available opportunity, as we’ve been stating. I think the entire category of engagement applications and the consumerization of IT that we’ve been talking about is taking stock. It demonstrates maturity, frankly, from Adobe in terms of both the product as well as the go-to-market that we’ve been perfecting over the years. And in the past, driving revenue growth was certainly the investment that we made in sales and marketing, the leverage that we have with partners in the enterprise space, and increasing the productivity of our existing resources.

So while the available opportunity we still continue to be really excited about, strategically what we are thinking about for 2009 is rather than invest way ahead of the curve, we want to make sure that we focus on both the partner leverage and increasing the productivity of our existing sales and marketing resources, rather than investing too much ahead of the curve.

And so we would expect a little bit more muted growth in 2009 but as we see the economy start to come out of its funk, we will start to again invest because we believe in the fundamental value proposition associated with that market. The last thing I would say is that the business actually did well, both in financial services, in manufacturing, as well as in government. I think moving people from inefficient, paper-based processes to automated processes is resonating with our customers.

Adam Holt - Morgan Stanley

Terrific. Thank you.

Operator

We’ll go next to Ross MacMillan with Jeffries.

Ross MacMillan - Jeffries & Company

Thanks. Three questions -- firstly on backlog, Mark, did you have a backlog number?

Mark Garrett

So again, backlog is not indicative of future performance and it is factored into our guidance. We ended Q4 with a minimal amount of shippable backlog but deferred revenue, you’ll see on the balance sheet, did go up $43 million to $275 million.

Ross MacMillan - Jeffries & Company

Great. And then on -- just on the cost cuts, just to be absolutely clear, the way these roll through the P&L, do we get partial impact on a non-GAAP basis in fiscal Q1 and then full impact in fiscal Q2? And if that’s correct, that partial impact just broadly as a percentage of the total impact, what will that be? Thanks.

Mark Garrett

The operating margin guidance that we provided you for the first quarter reflects the anticipated savings in the first quarter that we are going to get from the restructuring, and then there is some future restructuring that will happen in the first few quarters of the year. There are some people that transition over time. There are some facilities that we are going to shut down that happens over time. But again, what we are trying to just do is provide guidance for the first quarter and that 37% to 38% reflects the savings that you are going to see from the restructuring activities that we took.

Ross MacMillan - Jeffries & Company

But the headcount reductions, have they started or did they start just really post the end of the calendar year?

Mark Garrett

The great majority of them happened at the end of the fourth quarter, or the beginning of December -- beginning of the first quarter, the great majority of them happened.

Ross MacMillan - Jeffries & Company

Okay, and then the final was just on -- back to the pricing, et cetera -- are you looking at, apart from demand gen around marketing, are you looking at additional promotions or other ways to think about pricing, maybe on the CS site specifically as part of that demand generation effort?

Shantanu Narayen

Again, Ross, given our belief that the results have more to do with the economic uncertainty than anything to do with either the product, value proposition, or the fundamental premise, our focus is primarily on making sure that there’s people going through the awareness to trial to purchase cycle. So that’s really where our -- the bulk of our focus is.

Ross MacMillan - Jeffries & Company

Great. Thank you.

Operator

We’ll go next to David Hilal with FBR.

David Hilal - Friedman, Billings, Ramsey

Great. I wanted to switch focus to the Flash business. Microsoft has been making some headway with Silverlight and I wanted to understand maybe either on the MLB contract or contracts like that, when you are competing with Microsoft, because historically it seems like it’s been a monopoly and while you still have dominant share, I think Silverlight is getting some traction, does the competition come down to kind of feature functionality? And if so, can you talk about that? Or does it come down to pricing and maybe the ability to subsidize some of the streaming events that these customers end up doing?

Shantanu Narayen

Well, I think it’s a combination, frankly, of making sure that the entire ecosystem is available to enable those media partners to provide the kind of engaging experience that they want. What Adobe provides is first and foremost clearly a great ubiquitous run-time and having that run-time with the kind of market share that we have enables customers to really rely on Flash being available across multiple operating systems, as well as across multiple devices. And that’s something that we will continue to have a lead over aggressive competitors like Microsoft.

The second thing we do have is clearly the authoring tools and people want the ease of use in terms of authoring those engaging experiences and getting them delivered. The reality is when we think about online videos, Adobe actually came from behind. It was Windows Media player and Apple’s QuickTime that were the formats in the video space. But now approximately 80% of the online videos that are viewed worldwide are used using Flash technology and I think it’s the ubiquity of that, it’s the ease of deployment. We now also have Flash media servers, which allows you to stream it. And so we will be very aggressive about making sure that we continue to innovate in the entire media space to keep our lead.

David Hilal - Friedman, Billings, Ramsey

Okay, great. Thank you.

Operator

We’ll go next to Steven Ashley with Robert W. Baird.

Steven Ashley - Robert W. Baird

Thank you. My question is about the credit solutions business. In the publishing market, if we look at traditional, maybe newspaper and magazine publishers, how important of a market is that for you and what kind of performance have you seen out of that group?

Shantanu Narayen

Well Steve, I think as you think about the publishing market, increasingly the publishers who are focused primarily on print publishing have certainly been moving from print to the web, and so that’s why the print-to-web features that we have have become more important. They are also increasingly looking at video as a new means of communication and so they have been also moving towards the video production suite.

The way I would characterize that entire business, frankly, is that as you look at employment, if employment exists in those publishing markets and they are spending, the Creative Suite tends to be the top of the list. I’ve met a number of customers who say if they are going to buy a piece of software, to increase their productivity, it’s going to be Creative Suite 4. But I think the economic impact certainly weighs on them as well.

So from our perspective, we’ve been focused on making sure that as they migrate from print to web to video to wireless, that Creative Suite is ahead of where they want to be.

Steven Ashley - Robert W. Baird

Great, and just maybe a quick comment on how Flexbuilder might have performed in the platform business, within the platform business this period?

Shantanu Narayen

We are continuing to see a fairly good demand for Flexbuilder and in addition to the Flexbuilder, we are actually also pretty excited about the possibilities associated with Flash Catalyst, Steve, that as you know, we showed at our recent MAX conference. So clearly the number of people who have been downloading the Air SDK and who have been looking at Flexbuilder and our other development tools to create these engaging applications, is going up.

Steven Ashley - Robert W. Baird

Great. Thanks.

Operator

We’ll go next to Walter Pritchard with Cowen and Company.

Walter Pritchard - Cowen and Company

Just two questions, one on the mobile side -- there’s been kind of a lot of press, maybe six or nine months ago, about a lack of Flash on the iPhone when it launched and I noticed just kind of on the new category of these devices, kind of the richer mobile devices, you haven’t been able to come up with a solution or there hasn’t been a business arrangement negotiated between you and these parties. I’m just wondering, I know you are probably not willing to talk about it specifically but in general, could you just address that topic and where that overall technology and business prospects stand for that market?

Shantanu Narayen

Sure. So smartphones continues to be a category that we are focused on. We have clearly streamlined our strategic intent to make sure that we have both web browsing as well as Air support on these smartphones. We actually already deliver Flash for smartphones, such as those powered by either the series 60 from Nokia, running the [Symbian] operating system and/or running Windows Mobile, as well as in Japan we certainly have a lot of support. So I would say that already today we have a lot of smartphone category phones that are supported with Flash. That’s why we’ve shipped over 800 million and we say we expect to reach our $1 billion mark sooner than anticipated.

The other ones are ones that we are working on. At MAX recently, we also showed a prototype of Flash running on the Android operating system that’s powered by Google, and now we have also said that we are only going to focus on Flash 10 rather than Flash Lite, which is why it’s taking a little time. But we fully expect to see versions running for smartphones in the middle of next year.

Walter Pritchard - Cowen and Company

And just a second question around just the economy right now and kind of what you are seeing in this downturn -- I wonder if you could compare what you are seeing now, and I know it’s a little bit early, but it sounds like everyone agrees we’ve been in a recession for a while here, how you compare the current downturn to what you saw in 2001 and 2002, and any insight into what that holds for the next year or so as a result?

Shantanu Narayen

Well, it’s similar in that it has had an impact on our business. I would say it’s more global than we saw in the 2001/2002 timeframe. In talking to other people in other companies, most people expect that it would be in effect until the end of 2009 and hopefully we have seen the bottom. So that’s sort of how I would look at it.

As it relates to Adobe itself, one of the things that we feel fortunate in that one, we do have more of a product mix and a geographic mix than even what we had in the 2001/2002 timeframe, which should enable us to continue to drive revenue and afford better margin protection for our shareholders.

Walter Pritchard - Cowen and Company

Thanks a lot.

Mike Saviage

Operator, we’re running close to the end of time -- maybe two more questions.

Operator

We’ll go next to Brad Reback with Oppenheimer.

Brad Reback - Oppenheimer

Just looking forward and talking about profitability, Shantanu, on the other side of this cycle, without getting too specific, do you see this business as continuing to expand margins beyond where they topped out in ’08, or do they stay in the sort of current range with the upside reinvested for demand gen?

Shantanu Narayen

Well, once we get out of this economic, we continue to think that there are so many opportunities available for us as a company and at the rate at which we exited in 2008, we felt like we were at the high-end of virtually every software company in the business, and so at that point, you would continue to see us balance investing in the future versus returning to shareholders.

Brad Reback - Oppenheimer

Excellent. Thank you.

Operator

And we’ll take our last question from Blair Abernethy with Thomas Weisel Partners.

Blair Abernethy - Thomas Weisel Partners

Thank you. Just wanted to get a little further on the LiveCycle performance in the quarter -- can you give us a sense of the visibility you have in this business and how much of the business in Q4 was really coming off of backlog?

Shantanu Narayen

Well, we continue to monitor the pipeline that we have in our LiveCycle business and as you know, given last quarter was our traditional fourth quarter, that tends to be the peak for most enterprise businesses. To give you a little bit more insight, the government was a huge vertical for us in 2008 and we saw quite a bit of growth, both at the federal and national level, as well as the U.S. state and local level. Manufacturing continued to do well for us and we actually turned in better-than-expected performance, even in our financial services sector, because of our ability to help [forms], protect revenue streams, and drive cost. As Mark said in his prepared remarks, we expect to see that sequentially decline because that’s what typically happens with the enterprise business in Q1. But given the large available market opportunity and the maturity that we now have in our sales force, we would hope to see that continue to grow in the future.

Blair Abernethy - Thomas Weisel Partners

Okay, and have you seen any change in the life of the selling cycle or even deal sizes in that segment?

Shantanu Narayen

Not particularly -- not things that I would call out. Frankly I think what we are seeing is more awareness of the fact that engagement applications and providing the kinds of user experiences that our technology allows people to produce is becoming more important and so we are seeing more awareness of the category and what LiveCycle produces offset by what is happening in the economy. So I would say it is sort of been a net zero and clearly our sales force has been doing a better job, given the tough economic environment.

Blair Abernethy - Thomas Weisel Partners

Okay, great. Thanks very much.

Shantanu Narayen

So thank you all again for joining us today. I mean, in summary, when we look at 2008, we think that in a tough economic environment, we achieved both our revenue as well as our profitability goals and more important, we put the company in a very strong position as it relates to the focus on Flash platform, the Creative Suite and Acrobat business. And as we said, we think 2009 will be a tough market. We’ve already taken the actions in place to help us through this tough economic climate and we continue to be really positive about the long-term prospects for the company and we are confident that as we emerge from this economic climate, that Adobe will be in a stronger position than ever before. And we look forward to sharing more at our next earnings call.

Mike Saviage

And this concludes our call today and thanks, everybody, for joining us.

Operator

Thank you, everyone. That does conclude today’s conference. You may now disconnect.

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Source: Adobe F4Q08 (Qtr End 11/28/08) Earnings Call Transcript
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