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Adobe Systems Incorporated (ADBE)

February 26, 2013 11:00 am ET

Executives

Mark S. Garrett - Chief Financial Officer and Executive Vice President

Mike Saviage - Vice President of Investor Relations

Analysts

Adam H. Holt - Morgan Stanley, Research Division

Adam H. Holt - Morgan Stanley, Research Division

All right. We'll go ahead and get started. We've got a lot of talk about this morning. Thank you all for coming. For those of you that didn't come yesterday or I haven't met, my name is Adam Holt, and I run the enterprise software practice on the research side of Morgan Stanley, and I'm thrilled to be starting the day off today with Adobe, who is not only going through one of the more interesting business model transitions that we have seen in a while, but is also exposed to a lot of the important secular trends that I talked about yesterday as being so critical for driving demand in our group around mobility, Cloud computing, digital marketing and their leverage to all of those trends.

Today, we have Mark Garrett, the Chief Financial Officer; and Mike Saviage, who is the Director of Investor Relations. And we'll go ahead and get started with a little Q&A. When you all have question towards the end, raise your hand, I'll get you a microphone and we'll you recognized for the webcast. So thanks so much, guys, for coming.

Mark S. Garrett

Thank you.

Question-and-Answer Session

Adam H. Holt - Morgan Stanley, Research Division

Why don't we start with the general question around the model transition that I referenced, which is over the last 2 years, you've really rebuilt the company around driving subscribers moving to the Cloud. Can you talk a little bit about what you're doing and why you're doing it?

Mark S. Garrett

Yes, sure. Before I even get started, I have to say we are in our quiet period. Our quarter ends on Friday, so obviously, can't entertain any questions about the quarter, but happy to talk more on long term. So to Adam's question, we've had a really successful Creative business in the company for a very long time to help the world create content. And that business has been an upfront perpetual model for a very long time. We've been shipping about 3 million units of Creative products every year for the past several years. And while the revenue has grown, it's primarily been growing by virtue of selling people a higher-priced product, moving them up the suite ladder, if you will, and raising ASP or share of wallet. And we saw that to really drive growth in this business, on the Creative side, we needed to move to a new model. And so the big impetus for us as a company was both to drive new user growth, as well as to drive a more recurring revenue model. From the customer perspective, what we're really trying to do is allow customers access to technology updates on a much more frequent basis. So if you think about the way it used to work, we'd have a new product cycle every 18 to 20 months. We moved that in the more recent years to an annual product cycle. But in between those cycles, customers did not get new technology and with what's happening in the world on devices and different applications, people want technology updates much more frequently. So from a user perspective, they get access to technology on a regular basis as often as we want. They also, through the cloud offering, have the ability to think and share and store their content in the cloud and we ultimately create this big government user community where you've got, down the road, millions of users sharing their content and collaborating with Adobe products in the cloud. So if you net all that out, back in May, we released an individual product for the individual user to have access to all the Adobe Creative product line for a subscription fee per month. The end of last year, we announced a team product for small workgroups to have access to that same kind of technology and small workgroups buy the product. And then ultimately, we'll have that for the enterprise as well. So we end up covering all of our user community with a subscription product that allows them frequent technology updates, allows us growth in this segment and a much more predictable revenue stream. So ultimately, it's really good for the company and it's much better for the customer as well.

Adam H. Holt - Morgan Stanley, Research Division

Where are you in the journey?

Mark S. Garrett

Yes. So we came up with the strategy about 3 years ago, we walked Wall Street through it at our Analyst Conference about 18 months ago. Like I said, we shipped the individual products in May of last year, so it hasn't been all that long. But through the end of last year, we had 326,000 paid individual subscribers, well ahead of what we had anticipated in that very short period of time. We said that this year, we would end this year with 1.25 million paid subscribers and we said that by the end of 2015, we would have 4 million paid subscribers. And ultimately, as you get to that million plus subscriber number, you really start to get to critical mass where the stacking effect of subscription revenue starts to be compelling. You don't have the concept of people skipping product cycles anymore. And when you have your user community paying you a subscription fee every single month, month after month, and not skipping versions that stacking effect from a revenue point of view gets to be pretty compelling. So again, 326,000 paid end of last year, 1.25 million is what we anticipate by this year, and 4 million by the end of 2015. So it's really early, frankly. We just shipped the team product, we haven't shipped an enterprise version yet, but we're really excited about the move to this new model.

Adam H. Holt - Morgan Stanley, Research Division

If you look at the 1.25 million number, I know you've gotten asked this question a lot, it does imply an acceleration in the growth rates for subscribers. What gets you comfortable in that acceleration?

Mark S. Garrett

It really comes down to 2 things. The first thing is the product itself has to be phenomenal. We think we've got a really good product out there for individual and team users now and we just have to make that user experience better and better. We have to make the ability, as I've said, for them to think and share and store their content in the cloud that much better. The download experience to take the product from the cloud down to your desktop is a much better experience than it is to take a CD out of a box and install it on your computer or even download the product in the perpetual model off our website. So ultimately, it's about the product. It has to be a great product and a great experience. And so far, I think we've been able to do that. And you get the viral impact of the community over time as you get to some of those critical mass numbers as well. That's kind of all about the caret from my perspective. We also have the stick. We haven't used that to any large extent yet, but at some point, you could envision us making it a bit more uncomfortable for people to stay on the perpetual product, whether that's upgrade paths or pricing on the perpetual product or what's available from a perpetual perspective. Well, we didn't want to do any of that until we were 100% confident that the first part of it was right, that we had a great product with a great user experience, a great community and we're starting to get to that point on the caret side. In fact, we bought a company called Behance, which is a Creative group in New York City that has 1 million users in their community and they basically -- you can think of them almost as the LinkedIn of the creative community. People share their content, they share their resume, the even look for jobs in the creative community through Behance, and we've linked that to Creative Cloud, to create more and more of a community. And ultimately, when we have millions of people, I start to think about this as a Creative platform that has lots of opportunities around it.

Adam H. Holt - Morgan Stanley, Research Division

If I were to sort of drill down on a couple of the caret pieces, if you will. You mentioned that the team product, you also have some new capabilities in Edge and Muse that have come to market. What do those mean for you and how have those been received by your base?

Mark S. Garrett

I mean, ultimately, what we want to do, Adam, is move more and more technology through the cloud. So there are things that we will continue to put in the cloud that won't be available on the perpetual product. That may never be available on the perpetual product. And that's part of this caret concept. So you could envision us putting features in the product, in the cloud, that you can't get ever on the perpetual side. And ultimately, people will start to realize that the right way to buy our product, the best experience to use our product, the best innovation for our products is only going to come through the subscription offering.

Adam H. Holt - Morgan Stanley, Research Division

And have you seen that translate into new use cases and growth in units?

Mark S. Garrett

We have. We saw significant growth in units in 2013. We do believe, like I said upfront, that this model will drive new users to the Creative community. People that maybe didn't want to pay the upfront price, some of it will be financial, people that are doing short-term projects that didn't want to buy the product upfront because it was priced prohibitive, but in essence, subscribing to the product for a short period of time makes sense for them. Even piracy, we think, over time, this will become an interesting way for people to feel that it makes sense to be legitimate, frankly, because there's more technology in the cloud than there is in the box and why would I pirate the boxed products because it's not really the product I want. I want the most current technology offering and that will only be available in the cloud.

Adam H. Holt - Morgan Stanley, Research Division

You noted that you also have some upgrade pricing -- actually I don't know if you noted, but you do have some upgrade pricing. Has that had the impact of getting more people current and what do you expect to see from an upgrade pricing perspective going forward?

Mark S. Garrett

I mean, I think, on the upgrade, as it relates to the perpetual product, again, we've kind of made it a little bit more difficult to upgrade in that you can't upgrade from 2 and 3 version back anymore. You have to be on the last version to upgrade to the current version. So that makes it a little more difficult for people. And as I've said, on the pricing for upgrades and the pricing for the perpetual products, in the right way, at the right time, we could make that a little bit more prohibitive so people are more inclined to go over to the cloud.

Mike Saviage

In addition to that, we've been running promotions for existing customers to migrate to Creative Cloud, and that's been a very effective way of essentially upgrading our existing base to the cloud. And so for an annual commitment, they can pay $30 per month for the first year as opposed to the typical price of $50. And not only is the price attractive to them, but when they see that plus all these features and updates that we're delivering, you mentioned Edge and Muse, we just had an update to a bunch of our HTML5 tooling the last 2 weeks. So that comes off in an update we did in December, which comes off an update we did last August. So customers are getting it. They're starting to realize that with all the challenges they face and how they create all these content and all these experiences on a PC screen or tablet screen, a smartphone screen, a living room connected to Internet, connected TV screen, we're innovating quickly and delivering them value and they're starting to piece together the fact that they're getting this innovation, plus the price is very attractive, and that's really helping drive the adoption of Creative Cloud.

Adam H. Holt - Morgan Stanley, Research Division

And you've all seen pretty good adoption or very good adoption, I should say, of people actually committing to the annual contract. Can you remind us how many people are annual and what that uplift is going to look like once you start to anniversary the upgrade pricing?

Mark S. Garrett

Yes. So by far, the predominant number of people are subscribing for the full year. So we have 2 offerings, you can go month-to-month or you can go full year. And by far, most people are going to the full year offering. We expect that, that will continue. The month-to-month, like I said, is good for people that are doing short-term projects and they may want to do a 3-month project and then drop out and that's okay because we never would've gotten those people to buy the product anyway. So I think the annual package will continue to be the predominantly -- predominant choice.

Mike Saviage

And then as you lapped the release last May, you should start to get a benefit of some price improvement as the upgrade...

Mark S. Garrett

Right. So we had a promotional price, if you were an existing customer for the first year, you get a promotional price similar to the way your cable company might have offered you as a new customer a low entry price in the beginning. So existing customers got a break on the subscription for the first year. After the first year, they go back up to the full price and we fully expect that, that will go by with no big deal because people are used to that, like I said, from a cable contract or something else. But the renewals start in May and that's something that we'll clearly keep our eye on as people come up for their annual renewal.

Adam H. Holt - Morgan Stanley, Research Division

And at this time of year, in years past, people get very fixated on the next CS release and what was going to be in it, what the SKU mix was going to look like, and the good news is around the subs transition is that there's a lot less of that, at least in my world, I get asked about CS7 very infrequently, which is perfect, which is obviously one of the desired effects. But how should we think about the next product release, is that a natural time to potentially start to think about some of the stick piece and are there any features and functions that we should be paying attention to, if you will, in terms of potential drivers?

Mark S. Garrett

Yes. So it's honestly a little bit early to start talking about that. We haven't disclosed anything publicly in any big way. We have 2 big user conferences coming up that I would encourage all of you, if you're interested, to sign up for. Next week is our Digital Marketing Summit in Salt Lake and we'll talk, I'm sure, more about the Digital Marketing business in a minute. The Digital Media business, our Summit, is MAX, which is the 1st week of May. And typically, at MAX, that's where, on the Creative side, we typically roll out new technologies and what's going to be happening over the next year or more on the Creative side. So that will be the place to learn more about what's happening. Again, it's 1st week of May down in LA.

Adam H. Holt - Morgan Stanley, Research Division

Okay. Just a couple more questions on this piece of the business. So you talked about a 4 million subs target. Do you need to expand the category to get 4 million subs or do you think you can reach 4 million subs within your install base?

Mark S. Garrett

We think we can easily reach the 4 million out of our install base. I mean, if you think about the fact that we've been shipping, like I said, 3 million units of Creative products pretty much every year for quite a while now, you have to keep in mind that not everybody buys every single year. So there's an install base that's well beyond 4 million subs. And if we get to that 4 million sub number, coincidentally, what happens is at roughly $500 per user per year, which is, say, roughly the average subscription price, you get to $2 billion in revenue, which is about what we've been doing today. So you've kind of moved your entire revenue stream over to a subscription model in 2015, which would be, from our perspective, fantastic. So the 4 million is a small piece of the install base is the way to look at it.

Adam H. Holt - Morgan Stanley, Research Division

And how should be thinking about the impact of the enterprise on that subs target?

Mark S. Garrett

So the enterprise, we're not going to disclose an enterprise subs number for 2 reasons: One is, with enterprise deals, when you're licensing to the enterprise, it gets complicated. Do you talk about how many subs they're licensed for. Do you talk about how many subs they actually deploy. Plus, to be honest with you, we don't want to get into a situation where our pricing in the enterprise is public and we're competing with ourselves when we go to negotiate with customers. So enterprise subs will be over and above those kind of numbers.

Adam H. Holt - Morgan Stanley, Research Division

And just in terms of thinking about that enterprise transition, so you have a pricing transition but as you suggested, the enterprise product is not available yet.

Mark S. Garrett

Yes.

Adam H. Holt - Morgan Stanley, Research Division

Could you just walk us through how that evolution works?

Mark S. Garrett

Yes. That's a great question. So what we're doing right now, because we don't have an enterprise product yet, but we recognize that enterprises want to get ready for Creative Cloud. As we're selling ETLA, so enterprise term-based license agreements to the enterprise. So we're shifting our sales force to really focus on the enterprise in doing term-based deals. So you basically buy the Creative product for 3 years, you don't own it, at the end of the 3 years, you re-up. And what that does is it kind of gets the enterprise in the right purchasing behavior or the right financial model so that when the Creative Cloud for enterprise comes out, they're already in a subscription-like environment. So they're already -- think of it as leasing the product as opposed to owning the product. So more and more of our deals will become term-based license agreements in the enterprise. And they'll actually show up as deferred revenue because they are recognized monthly as opposed to upfront. So that's a healthy shift in our business from a modeling perspective as well.

Adam H. Holt - Morgan Stanley, Research Division

So will you be billing out quarterly for the ETLAs or will you be...

Mark S. Garrett

ETLAs are usually billed a year in advance. They'll pay the first year's worth. And then when the second year comes up, they'll pay the second year's worth. So you end up with 1 year's worth of the 3-year deal in deferred revenue and it gets burned off monthly.

Adam H. Holt - Morgan Stanley, Research Division

Okay. And -- but to be clear though, if you do an ETLA, you don't necessarily have rights to the Enterprise Edition on the cloud?

Mark S. Garrett

That's right. You don't have rights to the cloud. When the cloud comes out, we'll have some type of upgrade pass for them to go from an ETLA to the cloud.

Adam H. Holt - Morgan Stanley, Research Division

Okay. And we've been focusing principally on the Creative business, but obviously, this is a business conduction and model that can extend out to some of your other products. Can you talk about how subscriptions in ETLAs are moving into Acrobat and the other areas?

Mark S. Garrett

Yes. So we do have a subscription offering for Acrobat as part of the Creative Cloud offering. So you can buy Acrobat as a point product subscription, you can buy Acrobat as part of the Creative Cloud Suite offering, if you will. Acrobat, moving full-blown Acrobat to only a subscription offering like we're doing in Creative, that's not in the cards right now. We think people will buy the point product, we think people will use Acrobat clearly as part of the Creative Cloud offering, but the Acrobat business, we think, will stay in this perpetual model for some time. We are also doing more ETLAs in Acrobat as well. So we're shifting some of Acrobat to a recurring revenue model, but probably not all of Acrobat like we're trying to do on Creative.

Adam H. Holt - Morgan Stanley, Research Division

Just a couple of final product questions on the digital media side. So 2 years ago at the conference, there was a lot of discussion about Flash and HTML5 and that sort continued to evolve, but as you look at your current product positioning, how are you thinking about your HTML5 plays and what that is as a driver for you on the digital marketing side -- digital media side?

Mark S. Garrett

I mean, basically, we want to help people create content any way they want to do it. So while Flash is not at the, maybe, level it was before, whether people are creating digital publications for the iPad or they're creating digital publications for Android, they're using our products to do it. Whether they're using Flash or HTML5, we're somewhat indifferent to that. But we are the standard for digital publishing, as an example, on any of the devices that you see out there. So people are using both and frankly, we're letting the customers choose.

Mike Saviage

Locked in that original argument was the fact that Adobe probably makes more money than any other company in the world on HTML offering. And with the shift by customers wanting to create more engaging experiences on devices, we've really up leveled our investment in not only creating tools to help our customers create that content, but we're innovating with the standard bodies who create the standards and we're innovating in the browser community by delivering technology to the browsers, so we're advantaging ourself by really innovating across the whole spectrum in that space and that's really helped us not only drive revenue because of the shift that's happening, but also up level how Adobe is viewed in that community. And that's helping us not only with creating content for browsers, but in the app space, whether people are creating apps with Flash in the past or now they're using HTML, we're really starting to make inroads in how we're viewed in being a tool set for customers and developers creating apps in a more app-based world.

Adam H. Holt - Morgan Stanley, Research Division

Mike, you touched on the digital -- or maybe Mark, one of you touched on the Digital Publishing Suite. You've had obviously great traction there, I think it's one of the more interesting business that probably doesn't get enough attention. Could you share with us what some of the progress is there, how meaningful that business is, what the growth rates have been like, any metrics around adoption?

Mark S. Garrett

Yes. Mike can roll off some stats on adoption. But if you think about anyone that's trying to take their publishing content and put it online, whether it's a magazine, a newspaper, even catalog, we are the de facto standard to do that. I mean, every piece of content that you're viewing online as a publication or a periodical is primarily done with Adobe now. It's a very fast-growing business, it's a very interesting business for us to be in and it's done really, really well. And we have all the top publishers signed up with us for the most part.

Mike Saviage

This really goes with what I was just commenting on which is by innovating in how content is being viewed on these devices, we're adding features and capabilities to our latest Creative tools, but InDesign is our page layout tool, which is used by magazine publishers and newspaper publishers to create their printed content. They use that same tool to deploy the content to their website and also now to build an app and monetize the app. And Digital Publishing Suite is essentially a server-based capability where they can create these apps and deliver them through app stores like Amazon or through Apple or through the Google Store, and we get paid, obviously, for them buying and using our latest Creative tools. We get paid for Digital Publishing Suite, which is a server-based solution that's capacity-driven in terms of the business model, and we also get paid on per issue delivered. And we're delivering close to 150,000 digital editions a day from our content delivery network to the apps stores around world. And we've, on our last several calls, highlighted some of the key publishers more recently, Condé Nast, joined, which was one of the last big US-based publishers. And across the world, publishers are using Adobe now to really standardize across their entire workflow for how they're creating and delivering content. And they look at apps and delivering subscriptions through app stores as a brand new business model for them and we're essentially helping drive that for them and monetizing it on that situation.

Adam H. Holt - Morgan Stanley, Research Division

Shifting to digital marketing business. You all just announced a pretty meaningful shift in the way that you're positioning your product portfolio, they're moving from 30 different products to effectively 5 suites. Could you talk a little bit about what you're doing and why you're doing there?

Mark S. Garrett

Yes. So first, Digital Marketing is a really exciting business opportunity for us. If you look at the company 3 years ago, we had no digital marketing business. So we basically reorganized the company in the past couple of years or few years to digital media, which is the business we've just been talking about which is the Creative products in Acrobat, and rough numbers, call that a $3 billion business, and then Digital Marketing, which is roughly $1 billion, SaaS-oriented business. And if you put the 2 together, and you'll see this at the Digital Marketing Summit next week, we're really creating for the Chief Marketing Officer, 1 vendor, 1 place to go to create their content, publish their content out to the web, personalize that content, test what happens to it, do all the analytics around that content and then go back and kind of repurpose the content to make it even more effective. And that entire workflow, nobody else can do. So while there's a great market opportunity in digital marketing that has some competition associated with it, which we can talk about, we're the only vendor that has the digital media content creation piece to go with that. So it's a really exciting market opportunity. And as Adam said, over the years, through the acquisition of Omniture and a few other companies and some organic development, we built out a lot of products in that space. And really, what we've done now in the past 6 months or so is move to 5 major solutions in digital marketing, similar to what we did with Creative in creating the suites on the Creative platform many years ago. And these 5 solutions are sold to customers that encompass several products in each solution. It's a much easier sales cycle for our sales reps, it's a much easier kind of way for the customer to buy. So the solutions are personalization, so the ability using our day product to personalize the content. So if you come to a website and you live in Portland, you get a different experience than if you come to a website and you live in Hawaii, and you get much different products served up to you because of where you live, let's say. So all of that personalization and all of the re-architecting that's going on, on websites right now is driving that business. It's been hugely successful for us and a very high-growth business. Test and targeting, the ability to test what happens to a website, do A-B testing, really change things on a website, serve up different websites to different people and see which ones are more effective. Social media is another solution. So the ability to understand what's happening to your brand from a social media perspective. Analytics, right, analytics is a key one. So the ability to drive all the analytics off your websites so you can truly understand what's happening. And then lastly, media. So where do you effectively place your next dollar of advertising the best, is it in search, is it in display, what's the best way to drive the next dollar of ROI from a media perspective? And those 5 solutions are really going to drive for us in the digital marketing space, we said over 20% growth from a revenue perspective, over 25% growth from a bookings perspective. So a very fast-growing market, a very hot space, and again, what we're really trying to be is the key vendor to the Chief Marketing Officer, the Chief Revenue Officer, and we would argue that nobody else can say that today.

Adam H. Holt - Morgan Stanley, Research Division

And just as a reminder because I get this question all the time, those 20%, 25% targets are organic targets?

Mark S. Garrett

Yes. From where we are today, that's right.

Adam H. Holt - Morgan Stanley, Research Division

And when you went through the suite consolidation story on the CS side, you had an attached story, so people start using more products and you had been an ASP story because people were moving from the point to the suites. Do you anticipate the same kind of impact that these people move to these product groupings?

Mark S. Garrett

Yes, we do. I mean, it's early, right? So we have to see how that plays out. And it's also a little bit different at the enterprise level than it is maybe at the individual level from the Creative story, right? Because in enterprise, you've got discounting that happens that on the individual level really doesn't happen. But we do expect that we will drive more revenue by virtue of these 5 solutions than we would've by having the 30 products that you were talking about.

Mike Saviage

Just building on that, a year ago at our Digital Marketing Summit, we talked about the typical digital marketing customer of Adobe owning less than 2 of our products. And as you mentioned, we had over 20 different products that a customer could buy. And on average, the customer owned or used less than 2. By migrating to these solutions, the solutions, the 5 solutions of which typically have 4 or 5 products involved in each of them, we can really up level the footprint of revenue we can drive with these customers as they start to tackle more than just analytics. They start to tackle social, they start to tackle how they optimize their ad spend online, they start to, as Mark said, re-platform their websites. So next week, you'll see and hear a lot about our progress in driving these solutions and announcements around that, announcements with partners which are helping drive this business. So it will be the big next milestone of understanding how we are going to grow that revenue along the lines of what Mark said.

Adam H. Holt - Morgan Stanley, Research Division

As I go out and talk to the other companies that I cover, the digital marketing space, which is one that you all have been talking about for years now, it now comes up in all kinds of dialogues. Oracle is in this space, Salesforce is in this space, Google in this space. There are a lot of pure plays in this space. How have you -- do you think about the competitive landscape and where have you seen the sort of the conversations actually become a reality in terms of win-losses and that sort of thing?

Mark S. Garrett

Yes. It's really interesting. So on the digital media side, if you think about competition, it's our last version is our competition. There's not really anyone else to speak about from a competitive perspective in that $3 billion which has always been fascinating. On the digital marketing side, it is a hot market, there is a lot of competition, but I would argue that the competition is completely different than the way we're approaching that space. So if you look at IBM who's in the space, they bought Coremetrics. If you look at Oracle, they bought Eloqua. If you look at Salesforce, they bought Buddy Media. So they all touch on this space but they come at it a completely different way than we do. So they're selling to IT and they're leveraging their CRM capabilities and their CRM database and their ERP system as a way to drive marketing. We come at it completely differently. We're selling to the CMO and we come at it from the content creation space. So there's going to be plenty of room for all of us, frankly. If you think about the ERP vendors in the beginning, there's huge market opportunities for several large players in ERP. We think digital marketing will be the same way. There's going to be plenty of room for us, plenty of room for an IBM or Salesforce. But because we come at it differently, we think we've got a much more interesting sales pitch than they do.

Mike Saviage

Just to add on that. I think the fact that there are so many other big-name companies talking about this space, it's completely elevated the conversation amongst our customers. Last week, we held a CMO Summit in New York City, and I sat next to the PR team at Adobe that was organizing it. And at first, they were fearful about how many CMOs could actually get to attend for a full day of presentations and education, and attendance was through the roof. So awareness by the buyer is growing substantially. And just building off of your question, Adam, in addition to looking at the competition with a couple of key players who are primarily focused more on the social space than the rest of the marketing budget, there's probably 100 or so smaller companies that have one feature, one product, and that's obviously how you identify an early market when there's so much innovation happening. What's happening with our customers is they don't want to glue together and piece together all these individual products, it's very costly, you have to pay integrators or their IT teams a lot of money to make that happen. That's how the ERP space played out years ago and ultimately, it was a stack of capability that went out. The stack from SAP, the stack from Oracle. And we see that exact same scenario playing out. And we have a 3-year head start in this space by building out our stack. And as Mark said, nobody looks at this opportunity the same way Adobe does, through the lens of the Creative, through the lens of the fact that they're already buying and using our tools to create all this content and we're just extending the workflow across everything else they're doing in the marketing organization.

Adam H. Holt - Morgan Stanley, Research Division

All right. I've got a couple more questions, but I want to make sure that you all get yours done as well. So if there are any questions in the audience, raise your hand and I will take a couple. Well, there's a few. Why don't we start up here.

Unknown Analyst

[indiscernible] with the need for ongoing innovation whether R&D goes up as a percentage of revenue over time as well?

Mike Saviage

Yes, sure. So the question is on margins. So this has been a big transition for the company moving to a subscription model. This year is the big pivotal year, if you will, in the shift from a business model perspective and I won't go through all the details, but basically, what you've seen is reported revenue obviously comes down. But that revenue shifts over to what we're calling annualized recurring revenue because it's off balance sheet, so to speak, which is basically how many subscribers do you have times what they're paying you per month times 12, and you've got this big recurring revenue stream that starts to build up. So from this year forward, revenue grows from this year forward, margin expands, and from this year forward, earnings grows. So this was the big pivotal year, that's why our reported revenue in our margin and our earnings numbers are lower than last year because like I said, that revenue in essence comes out of reported revenue and kind of goes off balance sheet. But then it starts to come back because the subscription revenue, the stacking effect of all those subscribers more than offsets in the next several years any continued movement from perpetual to subscription. So to net your question out, margin improves from here. We haven't put a long-term margin target out there for the company. What we've said is we're really driving earnings and we will drive earnings growth at least as fast as revenue growth from here out. And I think, from our perspective, that's a better model. We don't believe that R&D needs to be higher than what you've seen from us in the past as a percent of revenue. So we think we're in good shape from an R&D point of view and the other thing from a margin perspective to keep in mind is even as the subscription revenue business margin start to ramp back, the digital marketing business is a true SaaS-based business and it's a $1 billion business for us going forward. That is always going to have inherently lower margins than the digital media side of the business because it is a true SaaS-based business. But again, overall, revenue growth from here, margin growth from here, but really, we're focused on earnings growth at least as fast as margin growth -- at least as fast as revenue growth, sorry.

Adam H. Holt - Morgan Stanley, Research Division

In the back there.

Unknown Analyst

If you look at Creative Cloud pricing, I think the $30 inflow rate looks like pretty good value to somebody who's been upgrading every 2 years on their license, whereas $50 a month looks like unreasonably substantial price increase. Can you just talk about what gives you the confidence that people are going to renew as pricing goes up. Maybe I don't know what you saw when you tried it in Australia? And then can you just talk about what options someone would have if they want to reject that price increase, I mean, they could argue with you but what can they really do?

Mark S. Garrett

Yes. So to the second point, there isn't a whole lot of options for them, right? I mean, like I said, there's not a lot of competition in the digital media space. I mean, we are pretty much the offering of choice. We do believe that the $50 will still work very well for our users. And ultimately, this can't just be about price. If this is just about price, then we did something wrong, honestly. It has to be that they, the users, see more value in the cloud offerings than they saw in the perpetual product and that's really important. This is not a price game. It feels like a price game early on, but down the road, to the point that we were talking about earlier, with all the technology that's going to be there, the shorts, the sharing, the sinking, the storing, the community, the constant technology updates, people have to see, wow, this is a much, much better offering than I ever got in the perpetual world. And frankly, a lot of these people, they've got to have this product to do their job. And we can look them in the eye and say, this is a better product for you to do your job than you had before. And yes, if you were skipping versions, this is going to be a little bit more expensive. If you were upgrading every release, every single cycle, this is not all that much more expensive for you. So some people will view it as a price increase, some people won't, but again, it's got to be about the offering. And we're confident that the offering will get people there.

Adam H. Holt - Morgan Stanley, Research Division

Unfortunately, we're out of time. But thank you, all. And that was terrific.

Mark S. Garrett

Thank you.

Mike Saviage

Thank you.

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Source: Adobe Systems' Management Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)
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