Adobe Systems, Inc. F1Q09 (Qtr End 02/27/09) Earnings Call Transcript

Mar.17.09 | About: Adobe Systems (ADBE)

Adobe Systems, Inc. (NASDAQ:ADBE)

F1Q09 Earnings Call

March 17, 2009 5:00 pm ET

Executives

Mike Saviage - Vice President, Investor Relations

Mark Garrett - Executive Vice President and Chief Financial Officer

Shantanu Narayen - President and Chief Executive Officer

Analysts

Brent Thill - Citigroup

Heather Bellini - UBS

Adam Holt - Morgan Stanley

Steven Ashley - Robert W. Baird

Sara Friar - Goldman Sachs

Tom Ernst - Deutsche Bank Securities

Philip Winslow - Credit Suisse

Walter Pritchard - Cowen and Company

Ross MacMillan - Jeffries & Company

Chad Bartley - Pacific Crest Securities

Michael Olson - Piper Jaffray

Brad Reback – Oppenheimer & Co.

Jim Kim - Broadpoint Amtech

Kash Rangan – Merrill Lynch

Dan Cummins – Lime Rock Research

Operator

Welcome to the Adobe first quarter fiscal year 2009 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.

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 will discuss Adobe's first quarter fiscal year 2009 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 www.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 model targets and our forward-looking product plans, is based on information as of today, March 17, 2009, 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 Mark.

Mark Garrett

For the first quarter of fiscal 2009 Adobe achieved revenue of $786.4 million. This compares to $890.4 million reported for the first quarter of fiscal 2008 and $915.3 million reported last quarter.

GAAP operating expenses for the first quarter of fiscal 2009 were $501.1 million compared to $532.5 million reported for the first quarter of fiscal 2008 and $555.7 million last quarter.

Non-GAAP operating expenses were $428.6 million compared to $471.8 million reported for the first quarter of fiscal 2008 and $476.8 million last quarter.

While the economy had a clear impact on overall product demand, we were able to proactively align our expenses with our revenue. This allowed Adobe to deliver earnings and profit margin results within the target ranges we provided at the outset of the quarter.

GAAP operating income in the first quarter of fiscal 2009 was $207.9 million, or 26.4% of revenue. This compares to GAAP operating income of $275.4 million, or 30.9% of revenue, in the first quarter of fiscal 2008 and $273.2 million, or 29.8% of revenue, last quarter.

Non-GAAP operating income in the first quarter of fiscal 2009 was $295.0 million, or 37.5% of revenue. This compares to non-GAAP operating income of $359.0 million, or 40.3% of revenue in the first quarter of fiscal 2008 and $374.9 million, or 41% of revenue, last quarter.

Adobe’s effective GAAP and non-GAAP tax rate for the first quarter was 23%. The tax rate in Q1 was lower than our targeted rate of 24% due to favorable settlements of several global tax audits.

GAAP net income for the first quarter of fiscal 2009 was $156.4 million compared to $219.4 million reported in the first quarter of fiscal 2008 and $245.9 million last quarter.

Non-GAAP net income was $236.8 million compared to $273.0 million reported in the first quarter of fiscal 2008 and $320.9 million last quarter.

GAAP diluted earnings per share for the first quarter of fiscal 2009 were $0.30 based on 527.8 million weighted average shares. This compares with GAAP diluted earnings per share of $0.38 reported in the first quarter of fiscal 2008 based on 571.3 million weighted average shares and GAAP diluted earnings per share of $0.46 reported last quarter based on 534.9 million weighted average shares.

Non-GAAP diluted earnings per share for the first quarter of fiscal 2009 were $0.45. This compares with non-GAAP diluted earnings per share of $0.48 in the first quarter of fiscal 2008 and $0.60 reported last quarter.

I will now discuss Adobe’s revenue in Q1 by business segment. As we discussed last quarter, we have adjusted our segment reporting for fiscal year 2009. Our 10-K for fiscal 2008, as well as our updated investor data sheet on Adobe.com, reflects the changes we have made. The data sheet also included adjusted segment information for prior reported periods.

Creative Solutions segment revenue was $460.7 million compared to $543.5 million in Q1 of fiscal 2008 and $508.7 million last quarter.

Business Productivity Solutions revenue was $227.0 million compared to $249.7 million in Q1 of fiscal 2008 and $278.0 million last quarter. Within Business Productivity Solutions, Knowledge Worker revenue was $163.1 million in Q1 of fiscal 2009 compared to $195.5 million in Q1 of fiscal 2008 and $199.0 million last quarter.

The other component of our business segment is our enterprise business. In Q1 enterprise revenue was $63.9 million compared to $54.2 million in Q1 of fiscal 2008 and $79.0 million last quarter.

Platform segment revenue was $52.3 million compared to $43.3 million in Q1 of fiscal 2008 and $76.6 million last quarter.

Revenue from our previously reported mobile and device segment, which is now included in our platform segment revenue, was $26.1 million in Q1. Mobile revenue exceeded the target range we provided in December due to the renewal of OEM contracts to provide a distribution bridge for the OEMs until the open screen project enables free distribution. In Q2 we expect mobile revenue to decline to a range of $4.0 million to $6.0 million.

Finally, print and publishing segment revenue was $46.4 million compared to $53.9 million in Q1 of fiscal 2008 and $52.0 million last quarter.

Turning to our geographic segments, results on a percent of revenue basis were as follows: the Americas, 41%; Europe, 35%; Asia, 24%. We experienced normal seasonal strength in Japan, however, the global economic situation continued to affect demand for our products in the rest of our geographies.

Employees at the end of the first quarter totaled 7,173 versus 7,544 at the end of the fourth quarter.

Our trade DSO in the first quarter of fiscal 2009 was 35 days. This compares to 30 days in Q1 of fiscal 2008 and 46 days last quarter.

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

During the quarter, cash flow from operations was $365.7 million. Our ending cash and short-term investment position was $2.4 billion compared to $2.0 billion at the end of last quarter.

In Q1 we repurchased a total of 5.0 million shares at a total cost of $115.0 million.

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

As we indicated in our preliminary results on March 4, we are targeting a Q2 revenue range of $675.0 million to $725.0 million. We continue to target a Q2 GAAP operating margin range of 21% to 26% and a non-GAAP operating margin range of 32% to 36%.

We are targeting our Q2 share count to be 528.0 million to 530.0 million shares.

For non-operating income, we are targeting a range of $1.0 million to $2.0 million on both a GAAP and non-GAAP basis.

For our GAAP and our non-GAAP effective tax rates, we are targeting approximately 24%.

These targets lead to a GAAP earnings per share range of $0.20 to $0.27 per share and a non-GAAP earnings per share range of $0.31 to $0.38.

Looking to our third quarter, we expect typical Q3 seasonality to affect our business on a sequential basis in Europe and Japan. 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 over to Shantanu.

Shantanu Narayen

I will spend the next few minutes reviewing business results from Q1. In our Creative Solutions business unit, demand for the Creative Suite 4 family of products continues to be weaker than expected, due to the global macroeconomic environment and revenue is more than 20% below that which CS3 achieved at the same point in the cycle.

We are pleased we continue to make progress moving our customers to the entire Adobe platform. Suites revenue is approximately 68% of total CS4 product family revenue.

The top three suites, in terms of revenue, are Design Premium and Standard, followed by Master Collection.

Our research suggests awareness and consideration for CS4 is high and we are focusing our marketing efforts on the ROI and cost savings capabilities of Creative Suites to upsale and cross-sell into our existing customer base as well as expanded option of CS4 by new customers.

Dynamic Media continues to be a key growth focus for Adobe. In January we shipped new versions of Flash Media Interactive Server and Flash Media Streaming Server. These new releases include additional media delivery options such as dynamic streaming, enhanced H.264 video, and high-efficiency AAC audio support, and the ability to pause and seek within a live stream.

We expect these innovations to improve the quality of video delivered over the Web and offer rich, interactive experiences for users.

Earlier this month we announced the strategic alliance with three Time Warner companies, Turner Broadcasting, Warner Brothers, and HBO. These companies intend to utilize the Adobe Flash platform and our video solutions to provide differentiated experiences for consumers of their content across multiple distribution platforms.

In January Adobe introduce the Scene 7, e-video streaming solution, a new addition to the Scene 7 hosted rich media publishing platform. The new offering leverages ubiquitous Flash platform technologies enabling e-commerce and multi-channel marketing companies to easily upload, transport, edit, manage, and stream content on the Web.

In our business productivity business unit we continue to focus on driving innovation for knowledge workers who wish to collaborate, and CIOs who wish to automate inefficient business processes using our PDF platform.

Although our Acrobat business was impacted by the macroeconomic situation during Q1, there are positives to point out when we look at the trend of adoption of Acrobat and our newer Acrobat.com offering.

Total cumulative Acrobat licenses has grown to 36.0 million, up from 30.0 million one year ago. In addition, more than 3.0 million people have signed up to use the beta version of Acrobat.com in its first nine months of availability.

Demonstrating that our engagement value proposition continues to resonate with customers, Life Cycle achieved 18% year-over-year revenue growth in Q1. Even in this challenging purchasing environment we see opportunity and are achieving success in this growing business. Life Cycle is benefitting from the maturation of our field organization as well as the build out of our systems integrator go to market partners, which now include Accenture, Cap Gemini, Cognizant, Deloitte, and TCS. Our key ISP partner, SAP, also helped contribute to the solid Q1 performance we achieved.

In our platform in mobile business, we continued to advance the adoption of the Adobe Flash platform across multiple screens, from PCs to mobile devices, to the digital living room. In January we announced Adobe AIR and Flash Player 10 software are being installed in record numbers. In less than one year there have been more than 100.0 million installations of AIR and more than 1.0 million downloads of our developer tools.

Additionally, Flash Player 10 was installed on more than 55% of computers worldwide in the first two months of its release and is expected to surpass 80% this quarter, far outpacing past installation rates.

We also expect to soon pass the 1.0 billion mark of mobile devices that are shipped with Flash Lite.

This rapid adoption advances the reach of our latest innovations, providing an incentive for customers to migrate to latest versions of our desktop tools, service software, and developer tools.

To address the digital home market, at the CES Show in January we made announcements with companies such as Broadcom and Intel. Our collaboration with them focuses on integration of Flash technologies and paves the way for rich, Flash-based entertainment experiences on televisions that offer viewers new options for accessing video and Web content on their TVs.

Although the current economic environment has had a negative impact on our revenue growth, we will continue to focus on our long-term strategic priorities while maintaining an appropriate level of profitability.

On the expense side, we will continue to focus on controlling costs, as we did in Q1, by closely managing variable marketing, discretionary spending, and headcount growth. At the same time, we will continue to make strategic investments that we believe will position us well for the future.

Our areas of focus include: advancing the Flash platform, which provides everything needed to create and deliver the most compelling applications, content, and video to the widest possible audience; investing in our core businesses, including Creative Suite and Acrobat, to increase market share and our leadership position in the markets these products target; and focusing on our newer growth opportunities, which include Life Cycle, for automating legacy document processes, Dynamic Media, where we provide an end-to-end cross platform solution that helps our customers create, distribute, and monetize their content across screens of all sizes, Acrobat Connect Pro for Web conferencing, and Scene 7, which augments our Creative product line to allow customers to deliver rich media assets for any channel of distribution.

Finally, we will continue to make Adobe a great place to work and invest in the development of our employees so they continue to have the necessary skills for Adobe to be successful.

We believe this approach will position Adobe to continue to deliver value to our customers and shareholders and enable us to take advantage of economic and recovery when it happens.

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

Mike Saviage

Before we get to Q&A we would like to announce plans for our next financial analyst meeting. We have decided to host this year’s meeting in conjunction with our annual Adobe Max Conference. This year’s Adobe Max event will be held in Los Angeles during the week of October 5 and our plan is to have the analyst meeting in L.A. on Wednesday, October 7. More information about Adobe Max and the analyst meeting will be provided later this summer.

In regard to today’s earnings report, we have posted several documents on our Investor Relations webpage today. They include today’s earnings release and our updated investor data sheet. To access these documents and other investor-related information, you can go to our website at www.adobe.com/adbe.

For those who wish to listen to a playback 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 4375992. International callers should dial 719-457-0820. The phone playback service will be available beginning at 4 p.m. Pacific time today and ending at 4 p.m. Pacific time on Friday, March 20, 2009.

We would now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brent Thill – Citigroup.

Brent Thill - Citigroup

Can you comment about the trade-off and the cost cuts to preserve operating margins versus investing for the recovery and if you could just bring us back to the 2001/2002 time frame to where you saw the margins drop about 500 basis points, how do you compare/contrast this cycle versus when you saw that last downturn?

Shantanu Narayen

As you saw in Q1 when we saw that there was going to be some impact to our revenue we very proactively managed our expenses, but we are very careful, even in this environment, to make sure that we don’t do anything that is going to impact our long-term strategic business when the recovery happens.

And the way we looked at it was really focusing on what we considered a number of discretionary expenses. In particular, as we look at what happened in Q1, we were able to look at discretionary expenses such as travel. We did look at variable marketing and we are very judicious about where we are hiring back in terms of new headcount growth that happens.

We have also realigned, actually, the company internally against the strategic priorities that I outlined, so when we looked at the Flash platform we were able to combine our mobile and platform business units to make sure that we were able to deliver one version of Flash across multiple screens.

We were able to reduce some of our consulting headcount because now we, frankly, have a very vibrant systems integrator channel that is enabling us to go ahead and implement our life cycle business.

So we don’t think we have done anything that is going to impact our long-term strategic directions for the company, but we will continue to be ruthless about looking at every expense that we have to make sure that we balance the long-term strategic direction with short-term profitability.

Operator

Your next question comes from Heather Bellini – UBS.

Heather Bellini - UBS

My question is this. Mark, you made a comment about seasonality for next quarter and I believe you commented that we should expect normal seasonality in Europe and in Asia. You didn’t comment on the U.S. I’m wondering, since we’re all trying to model out going forward, I know you don’t want to give guidance, but if we look back in the third quarter of 2008 you were flat sequentially in revenues, the third quarter of 2007 you were plus 14%. Obviously that had CS3. Third quarter of 2006 you were down 5%. So there’s a wide variety there.

But I am wondering, can you give us, is it just Europe and Japan that you are expecting normal seasonality and then what should we expect for the U.S.?

Mark Garrett

Let me back up just a little bit and then I will get to your question as well. We are fortunate that we have a really diversified business and if you look at what has been performing well for us, the enterprise side, or the high-touch side, of the business has been doing very well. Adobe.com has been doing well. Where we are feeling the economy a little bit more has been on the channel side of the business.

And since we gave targets back in December, clearly the economic conditions and the product demand, particularly on the channel side, have worsened. But since the beginning of February, we have started to see stability in the business. So for the past six weeks or so, on the channel side, we have seen more stability in the business.

And this stable February run rate for the channel side of the business is the basis for this Q2 revenue range that we provided. And that revenue range, if you look out over kind of Q3 and Q4, would basically follow the same similar patterns we have seen from a seasonal perspective in the past.

So Q1 obviously we have the Japan launch and strong seasonality there, so we would expect going into Q2 for the most part all geographies would decline and we would also expect the creative business and the platform business, because of mobile, to decline going into Q2.

But then when you get down to Q3 we would expect our normal seasonal dip a little bit and then a seasonal uptick in the fourth quarter, like we’ve seen in prior years.

So hopefully that gives you a little bit more color over the course of the year from a geographic and a product line perspective.

Heather Bellini - UBS

So just so I can be clear, you are saying wherever you come in for the second quarter, expect downward seasonality like you talked about back in the December call, and then the normal uptick in the November quarter?

Mark Garrett

Correct.

Operator

Your next question comes from Adam Holt - Morgan Stanley.

Adam Holt - Morgan Stanley

I had a couple of questions about what you’re seeing thus far on CS4. First of all, can you talk a bit about what kind of upgrade activity you are seeing? Is it primarily coming out of the CS3 base or are you seeing some of the pricing incentives drive CS1 and CS2 folks to migrate to CS4?

Shantanu Narayen

I will give you some more color as it relates to Creative Suite. First, overall the consideration that we are getting for the product continues to be fairly high. So even in this economic climate we are pleased that people are definitely putting CS4 through the consideration cycle.

The penetration that we have seen so far, I think in March we had given you a number of approximately 2.6 million of the 6.0 million or so Creative Professionals who had moved to Creative Suite. An update of that number, which we also will share, is about 2.9 million. So we are continuing to see Creative professionals definitely move to the suite. And frankly, we are seeing them move to the higher-value suite.

So as I said in the prepared remarks, we are seeing more Master Collection adoption as well as we have seen adoption of the Design Suites, which we have traditionally expected to be the best selling suites.

In terms of the upgrades versus full units, while we are not going to share a lot of the information, the pricing incentives, we have said that we will give another month to allow people. What we found when we did our survey was that people were actually not familiar with the tiered pricing schemes that we had introduced when we introduced CS4.

So awareness of that was not as high as we had expected. Awareness of the product was high, but awareness of the tiered pricing was not as high as we expected. So we want that to be an incentive for people to move to Creative Suite 4 rather than a disincentive. But we continue to believe that the tiered pricing is the right strategy and we really haven’t got much push back on the tiered pricing.

So hopefully that gives you some flavor of enterprises continue to put it through its paces. As you know, traditionally enterprises will try out Creative Suite maybe in one section of a magazine and then move it to the entire magazine. So that continues in good stead.

And when we look at revenue, the revenue fall-off has been definitely more on, as Mark pointed out, the channel business or the end-use demand, less so in the enterprise business. So in enterprises where people are employed they continue to see the value for Creative.

And in addition to the first report that we had, which said that there is approximately an 18% improvement in productivity, we just got another report from Pfeiffer Consulting, which is one of the more respected consulting groups, which also pointed to the productivity improvement that CS4 has.

Adam Holt - Morgan Stanley

The obvious question, it sounds like you see increased traction on the Creative Pro side. There has been some question, at least I’ve gotten questions, as to how the non-professionals users will act in this environment. So if maybe you could touch on that.

And then, Mark, what was the impact of currency in the quarter and what are your assumptions for next quarter?

Shantanu Narayen

Again, clearly the impact of the economy is being seen in the non-creative more than it has in the channel business, more than it has in the creative professionals, because for the creative professionals this is a mission-critical product. If you are employed gainfully, you know, the product more than pays for itself. So we have seen more of the fall-off in the channel business.

What’s interesting, though, is it’s clear that customers want more of a direct relationship with us and they want software downloads, so we are seeing more activity on Adobe.com, which we like because it means that people want a direct relationship with Adobe.

Mark Garrett

On a FX perspective, in Q1 on a year-over-year basis we had a net gain to revenue of approximately $12.4 million, most of which, again, was factored into our guidance. We had a $2.5 million loss from the Euro offset by a $15.0 million gain from the yen.

Probably the more interesting piece of that is that netted in that $2.5 million loss from the Euro was a hedging gain of $20.0 million from the Euro, which made the loss only $2.5 million versus what would have been $22.0 million.

So our hedging program has really helped us out in the first quarter. We are very well hedged through the rest of 2009 so I expect that we’re in fairly good shape from and FX perspective going forward.

Operator

Your next question comes from Steven Ashley - Robert W. Baird.

Steven Ashley - Robert W. Baird

I just had a question on the product mix within the Creative Solutions business. It looks like the Master Collection kind of moved up ahead of what the Web Premium and Web Standard. I was wondering if you could give a little color around that mix shift and what’s going on there, within the products.

Shantanu Narayen

I think what we are hearing is that the usage of rich media by our customers is clearly increasing. The movement online is something that people are clearly seeing. And if you look at the amount of video usage in particular that people are now starting to have on all websites, that’s increasing. As you know, the difference between the Web Suites and Master Collection is the availability of the video products as well, and so the fact that the video products are part of Master Collection, and frankly, as people want to adopt the entire platform, that is the best offering that we have.

We think those two factors are driving the shift that we talked about.

Steven Ashley - Robert W. Baird

Within the Acrobat business did you see any variation in demand by vertical market?

Shantanu Narayen

When we look at Acrobat, the overall mix that we have, which is Pro has the highest revenue, continues. And in terms of the vertical markets, when we look at it from our direct business, we actually continue to do well in financial services as well as government. So those remain two very interesting markets for us. Education also is an important market for both the Acrobat and Creative business.

And again, as I said, wherever we have a higher touch and we have a direct relationship with our customers, we are clearly doing better than the end-user demand generated part of the business.

Operator

Your next question comes from Sara Friar - Goldman Sachs.

Sara Friar - Goldman Sachs

I’m trying to understand the important groping for a bottom here. It’s always helpful for us to understand the progression through the quarter, and particularly any commentary you would give, even if you came into March, of how actual sales came in versus your estimates and has the pace of declines begun to slow, like has that second derivative given you any inclination of where we are in this downtick?

Mark Garrett

I will start and see if Shantanu wants to add on. Clearly, we are not giving 2009 guidance because we still feel that visibility is very difficult. But like I did say, since the time we gave the targets back in December, as we went through the quarter the economy got worse and the stability in our business got worse.

But when we got to February, so for the past six weeks, on the channel side of the business, we feel that the business has stabilized, so we have started to see more stability on sell through on a week-to-week basis since the beginning of February.

Shantanu Narayen

The only other thing that I would add is that you also have to then factor in some of the geographic performance during the quarter because clearly we did do the launch of the Creative Suite products in Japan in Q1 and so that’s why Q1 to Q2 we expect that revenue to decline.

And again, as Mark said, December was stronger clearly than February.

Sara Friar - Goldman Sachs

I feel like a lot of that CS-related. Maybe I’m mistaken. When you looked at the knowledge worker part of the business, there I think results kind of came in below what we had expected. Is there any difference between those kind of two chunks of the business?

Shantanu Narayen

Not really. When you look at the business, again, I would categorize the business as wherever it was a high-touch, enterprise-driven, greater than 50,000 deals, which we track, the Creative and Acrobat business had similar trends.

We were closer to our forecast wherever it was end-user driven it fell off, again, as I said, from December through February.

Operator

Your next question comes from Tom Ernst - Deutsche Bank Securities.

Tom Ernst - Deutsche Bank Securities

I was wondering if you noticed the difference in the CS4 cycle, here with two quarters behind you now, between upgrades and new purchases? Any shift there?

And then in follow-up to that, are you seeing any changes in customer diligence on trying to maintain and extend licenses relative to what you’ve seen in the recent years?

Shantanu Narayen

The feedback that we have, and I’ve certainly been spending a lot of time with the Creative customers, is that first, they continue to really look at Adobe even more so now as a strategic partner helping them navigate what is for them also pretty uncertain times. I mean, they’re all trying to figure out how they move from print to the Web to video, to wireless.

So the first thing, which I think is a huge positive, is they are continuing to actually work with Adobe to say how can you help us move from these silo workflows to a more integrated work flow.

In terms of looking at the business itself, it’s just hard to parse what is a result of the macroeconomic environment right now between the CS3 and CS4 cycles. So, overall business is in decline, as we said, a little over 20%. Move towards the suites is higher. But more than that it’s hard to really draw any conclusions yet. We will continue to monitor that.

Tom Ernst - Deutsche Bank Securities

No noticeable difference between upgrades or new purchases in the mix of business?

Shantanu Narayen

No, we continue to see full units, we continue to get new customers to the platform, we continue to see enterprises expand on their offering, and we continue to see upgrades which traditionally are stronger in the months after launch, you know, start to taper off.

So we haven’t seen anything very significantly different in those trends.

Operator

Your next question comes from Philip Winslow - Credit Suisse.

Philip Winslow - Credit Suisse

You obviously had strong cost control in Q1 and in your guidance for Q2. But sort of along with your revenue commentary for Q3, obviously if you look at your headcount, it’s down 371. You talked about down 600. Is there more to come when we think about Q2 and Q3, or just how should we think about headcount expenses?

Mark Garrett

We are really pleased with what we’ve done from an operating expense standpoint. It’s as low as it’s been in quite some time. If you look out the rest of the year, particularly starting with Q2, you will see a little bit more of a drop when you go to do your model and you factor revenue and the margin range that we gave you, you will see that there is a little bit more of a drop in Q2. So there is a little more to come as some of the headcount reductions are still rolling off and some of the discretionary spending cuts are still rolling off.

And then we, frankly, kind of stabilize in Q3. And then we usually get a little bit of a bump up in the fourth quarter as things like our Max Conference and year-end commissions give us a little bit of bump in the fourth quarter, but for the most part, as we roll into Q2, all of our spending reductions are now in place.

Operator

Your next question comes from Walter Pritchard - Cowen and Company.

Walter Pritchard - Cowen and Company

A question I had around the platform business being down $20.0 million or so sequentially, what was the driver of that?

Mark Garrett

That’s because we combined platform and mobile so it’s completely due to the fact that mobile declined from $48.0 million last quarter to $26.0 million this quarter, and like I said, will drop down between $4.0 million to $6.0 million for a total in the next quarter.

Walter Pritchard - Cowen and Company

As it relates to the headcount and looking out to future product development efforts, I’m just wondering where you are at the point right now with development activity and would you say right now you are at a low point with development activity and that ramps up over the next six to twelve months or does it still come down further as you’re still weighted out from a new product cycle on the Creative side?

Shantanu Narayen

In terms of the changes that we made and when we did the restructuring, we looked very hard at our priorities, but for the key priorities that we have, we have made sure that we have the appropriate headcount to be able to continue to drive innovation in those particular areas, so when you think about either our platform, the Creative Suite product line, the Acrobat product line, Life Cycle, Scene 7, Connect Pro, which is our Web conferencing product, and Dynamic Media, those R&D efforts are staffed and they are underway driving the next generation of innovation.

So when we start those cycles we continue to make sure that we have all the appropriate headcount in those particular projects.

Where we made impacts, as I said earlier, was some of the combination as a result of the platform and mobile business unit, consulting headcount, as well as in some other projects where in better economic times you might have a couple of seed projects or investigations, we clearly had a much harder lens when we looked at projects we were undertaking.

But we will not starve projects that we believe in because we want to continue to drive innovation in those products.

Operator

Your next question comes from Ross MacMillan - Jeffries & Company.

Ross MacMillan - Jeffries & Company

Shantanu, you made a comment on 68% of the CS revenues coming from Suites. I wondered if you could help us understand the units number that we’re seeing from Suites so that we can understand how far we are in that progression of point products to suite conversion as we go through these CS cycles.

Shantanu Narayen

What we like to do is share a couple of data points with you. The data point that we shared was as we look at Creative Suite penetration, we are approximately 2.9 million when you consider the 6.0 million that we believe exists as a market. And we wanted to give you some flavor of how people are moving from point products to the suites.

So we’ve got about 300,000 new users who are moving over to the Creative Suite from the March time frame to the October time frame. The individual point products continue to drive revenue but frankly, more and more of our customers are moving to the suites.

But because so much of it also goes through licensing, it goes through education, we are not going to provide unit numbers by individual point product or by suite.

Operator

Your next question comes from Chad Bartley - Pacific Crest Securities.

Chad Bartley - Pacific Crest Securities

Just a follow-up question on headcount, Mark, to the extent you can comment. What should headcount look like for Q2 and should there be some stability in Q3, an increase in Q4? Any sense would be helpful.

Mark Garrett

I would encourage you to not focus too much on the headcount number but look at the opex number because as we have shifted where our workforce is, the headcount number becomes less and less significant. But if you really want to know, headcount does slowly increase through the year because we are still hiring people and when we did the restructuring we talked about the fact that we were shifting resources from some areas into other areas and as a result of that we were going to still be hiring.

Chad Bartley - Pacific Crest Securities

And a quick question on the enterprise solutions. Clearly the strongest growth on a year-over-year basis but it did decline sequentially more than the rest of the business in aggregate. Can you talk about that from a sequential basis? Was that in line with expectations or is there some weakness there? I think your preannouncement led us to believe that maybe that business was a little bit stronger.

Shantanu Narayen

I think it was very much line with our expectations. As you know, the enterprise business has a fair amount of seasonality associated with it because what happens is in Q4 there is a big push towards trying to close all the deals, then you get the entire field organization ready with their new quotas for the year and they’re building up their pipeline, that you continue to see growth during the fiscal year.

When we look at that business, whether it was in financial services, which continued to do well, in government, I was in D.C. recently and we continue to think there is a huge opportunity with the new administration really focusing on both openness and transparency for the Life Cycle business in government. And even in manufacturing, where we are working with our partners like SAP to have Life Cycle be a product that enables people to automate business processes, we are seeing traction.

So 18% growth was very much in line with our expectations. We continue to expect to see that sequentially grow. And we are really pleased because the awareness of Life Cycle with our customers is fairly high. It clearly plays to what people have as a pinpoint, which really is the whole issue of how they can save costs, and Life Cycle plays very well to that. As does the Acrobat and Connect product offerings.

Chad Bartley - Pacific Crest Securities

And did you say there at the end you do expect that to grow sequentially from this point?

Shantanu Narayen

Very slightly in Q2 but clearly building up to Q3 and Q4 because that’s how the enterprise business typically plays out.

Operator

Your next question comes from Michael Olson - Piper Jaffray.

Michael Olson - Piper Jaffray

What are you seeing from customers for their Creative Pro headcount? And do you have any sense from a high level of just Creative Pro headcount has trended versus previous downturns?

Shantanu Narayen

We’ve been spending a lot of time with the Creative Pro customers and the kinds of questions that we get asked by them increasingly is help us make the current people more productive and start to figure out new business models and how they can move from print only to print and Web.

I mean, the appetite for digital content that they are seeing from their customers hasn’t actually diminished so all of them are looking at it and saying they want to do more with the employee base that they have. So that’s really the insight that we’re getting from those customers.

They’re also looking increasingly at AIR to be able to build online experiences that are more engaging. One of the interesting applications that we recently saw was the New York Times company is working on a new news reader built on AIR for one of their brands and they are committing to launching that by the end of the second quarter. So we clearly see more usage of video, more usage of online advertising, and they are all looking at how they deal with this current economic climate and experiment with new business models.

Michael Olson - Piper Jaffray

I realize we are a long ways away from the next launches but is there any reason to expect that your product cycle timing in the future is going to change at all from typical spacing between products?

Shantanu Narayen

Let me give you maybe a little insight as to how we look at each of our different businesses. Clearly the Life Cycle and the Acrobat business have lesser sort of launch impact because what we see there is there is more of headroom available in terms of penetration. And especially in the enterprise business it’s all about moving from a product-driven sale to a solution-driven sale, and we’re doing more and more of that, working through partners.

So in those two businesses we look at it and want to make sure that we continue to have a great value proposition for the customers.

Clearly in the hobbyist business we look at it and say we need to be ready in terms of getting the product ready for the holiday season. So that doesn’t change in terms of our strategy.

And when we look at the creative business or the Creative Suite revenue, we are not looking at this current climate and saying we should either accelerate or decelerate. We have a cadence associated with our product cycle, we have optimized that and made that very, very efficient, and so the team is hard at work on the next creative version. And the amount of innovation that we could put in there actually increases, so we have been seen some early demos of the kind of stuff people are working on and it’s very exciting.

So no change in how we look at launching the next version of the Creative Suite from a timing perspective.

Operator

Your next question comes from Brad Reback – Oppenheimer & Co.

Brad Reback – Oppenheimer & Co.

As you look forward to the recovery, how fast can you turn spending back on and how fast do you intend to turn spending back on?

Mark Garrett

We can obviously ramp up spending very quickly if we wanted to. I think we would be very judicious about doing that and making sure that it was being put in the right places and focused on the right investment categories. So we will clearly ramp up if revenue ramps back up but not irresponsibly, obviously.

Brad Reback – Oppenheimer & Co.

So just to be clear, it’s likely that spending would follow revenue ramp as opposed to anticipating revenue ramp?

Mark Garrett

Precisely.

Shantanu Narayen

And if I might add, an example of that was also what we’ve done in the enterprise business. When we look at the enterprise business and the opportunity today, we clearly think that’s a billion dollar plus opportunity for us but we made a very conscious decision of saying we want to see productivity improvements for the existing field organization and that’s how we’re going to drive Life Cycle revenue for 2009 rather than invest way ahead of the curve.

And so, as Mark said, we’re going to be judicious and as the revenue starts coming in then we will open up expense rather than the other way around.

Operator

Your next question comes from Jim Kim - Broadpoint Amtech .

Jim Kim - Broadpoint Amtech

Can you talk about the overall health of your channel partner system for CS and Acrobat and whether you may have to make some incremental investments and spending to offset some of the reduced marketing spending by your partners and also just simply invest number of sales headcount within your channel partners or are you comfortable with the overall health of your channel network given that you have some stability over the past six weeks?

Shantanu Narayen

Let me address that in two ways. First let’s talk about what we see from a customer segmentation perspective and then Mark can answer the channel partner health question.

From a customer segmentation perspective we have been doing a lot more to really understand the customer behaviors and we clearly see that individuals are increasingly looking for a direct relationship with Adobe through Adobe.com.

Where we see the channel partners add increasing value is either in the group setting where there is reduction of friction associated with procuring our products. That can happen through the channel partners.

Value added partners, who are providing more training as well as sales into either mid-level departments within enterprises or large enterprises where they are providing attach in conjunction with other software purchases.

So what we have a much better idea right now is of working from our customers back to Adobe and understanding what they are looking for as it relates to information, training, and procurement vehicles. So we feel very good about that.

Mark Garrett

And as it relates to the financial viability, if you will, of the channel partners, the treasury team here does a very good job of diligently looking at all of our channel partners on a regular basis to check their financial health and I, frankly, meet with the CFOs of many of the channel partners just to make sure that they are stable and we are not, at this point, concerned but we are clearly monitoring that situation.

Jim Kim - Broadpoint Amtech

And, Mark, capex was very light in the quarter. Is that a new level going forward or can we expect the spending to get back to the normal level?

Mark Garrett

That’s probably a new level for the time being. That’s obviously part of our spending constraints, in addition to things Shantanu had mentioned before.

Operator

Your next question comes from Kash Rangan – Merrill Lynch.

Kash Rangan – Merrill Lynch

It looks like your enterprise business has got good visibility and channel business seems to be getting better visibility in the month of February. So by default it looks like the end-user business, as you characterized it, is where are the variabilities. And I’m wondering if you have derisked the forecast, if you will, for the variability on the end-user side as you have constructed guidance for the upcoming quarter.

And also, Mark, should you need this end-user business to cycle back up for the company to regain its peak operating margins or at some point you’re actually going to be working the cost structure down, not depending upon that business to come back up, so you can hit your peak margins anyway?

Shantanu Narayen

When we talk about end-user visibility what we are really referring to is Adobe.com where given the Adobe.com store in North America continues to be a meaningful part of the retail business that we do in North America. We have weekly sell through data and so we understand what’s happening there as well as through surveys of our customers. We have some insight into buying behaviors.

But realize that a lot of the revenue, even for those individual users, does go through channel partners because they are then procuring that software either from a software retailer or from a hardware store. So when we talk about end user you have to parse that into both what happens through Adobe.com as well as a significant portion that still happens through the channel partners.

Mark Garrett

And to that point, I think we would clearly want the end-user revenue to come back before you would see margins back to where they were at the peak of 40%.

Operator

Your next question comes from Dan Cummins – Lime Rock Research.

Dan Cummins – Lime Rock Research

I wanted to go back to your statement about confidence in the stabilization you have seen in the channel business. Is that a statement you can make in equal force with respect to the U.S. versus Europe versus Asia?

Mark Garrett

If we look at the past six weeks, so February and the first couple of weeks here, we do see it stable from a channel perspective around the world, again, offset a little bit by the fact that there is some seasonality with Japan but that’s to be expected.

Dan Cummins – Lime Rock Research

But why would Europe in particular be lagging the recession that we’ve seen here in the U.S.? I’m just curious that you would have the same level of confidence around Europe as you would for the U.S.

Shantanu Narayen

Well, what we’re trying to do is provide all of you on the call with transparency relative to the business that we are seeing right now. Mark also did say that we have limited visibility and this is for six weeks. So we’re not economists, neither one of us is professing to be an economist, but what we are trying to do is give you some visibility into what we are seeing so that you can then draw conclusions as well.

So whether Europe is going to get much worse, whether or not America has seen the bottom, we are less into predicting that than to give you some color into what we’ve seen so far.

Operator

There are no further questions in the queue.

Shantanu Narayen

So what I would like to do is give you a quick assessment overall. As a management team, when we looked at Q1 while revenue was clearly a little bit below our expectations, we thought that we did a really good job managing expenses and we were pleased with the cost controls that we put in place.

We also see that the macro trends that we have talked about for our business actually continue to be in place. When you think about the explosion of content, the proliferation of devices, the consumerization of IT where people want more engaging experiences in terms of how they use the transactions systems behind the firewall, and collaboration is a key theme.

None of those have changed when we talk to our customers. And so we continue to be excited as we look to the future that when the economy turns that Adobe will certainly be in a better position to capitalize on all of those trends through the investments that we are making.

Our priorities as a company actually remain the same. They are the Flash platform and focus around making sure that we provide that as a great platform for people to deliver engaging experiences across multiple screens and for us to monetize that through the tools that we provide as well as new servers and services that we have been offering.

The Acrobat and Creative Suite business will continue to be the primary generators of revenue for us and we believe that as the economy turns we will be in a position to capitalize and earn more of that revenue. And the growth themes that we’ve outlined continue to be growth themes that we are excited about as a company, the Life Cycle business, the Connect business, Dynamic Media as an overall opportunity for us to provide everything from plan to playback as people look at video. And finally the Connect business.

So we think we have a great employee base that is motivated and we look forward to sharing with you more at our next earnings call.

Operator

This concludes today’s conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!