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Adobe Systems Incorporated (NASDAQ:ADBE)

F3Q09 Earnings Call

September 15, 2009 5:00 pm ET

Executives

Mike Saviage - Vice President, Investor Relations

Shantanu Narayen - President and Chief Executive Officer

Mark Garrett - Chief Financial Officer

Joshua G. James- Chief Executive Officer, Omniture Inc.

Analysts

Sarah Friar - Goldman Sachs

Michael Olson - Piper Jaffray

Heather Bellini – ISI Group

Sasa Zorovic - Janney Montgomery Scott

Phil Winslow - Credit Suisse

Adam Holt - Morgan Stanley

Kash Rangan - Merrill Lynch

Robert Breza - RBC Capital Markets

Philip Rueppel - Wells Fargo Securities

Ross MacMillan - Jeffries & Company

Daniel Salmon – BMO Capital Markets

Yun Kim - Broadpoint Amtech

Dan Cummings - Lime Rock Research

Walter Pritchard - Cowen & Company

Operator

Welcome to the Adobe third quarter fiscal year 2009 earnings conference call. As a reminder, today's call is being recorded. And now at this time, I would like turn the call over to Mr. Mike Saviage, Vice President of Investor Relations.

Mike Saviage

Good afternoon and thank you for joining us today to discuss Adobe's Q3 earnings report as well as our planned acquisition of Omniture. Joining me on the call from Adobe are Shantanu Narayen, our President and CEO, and Mark Garrett, Executive Vice President and CFO. Also joining us on the call from Omniture is their CEO, Josh James.

In a moment I will turn the call over to Shantanu for some opening comments. Following that, Mark will walk you through our Q3 results, as well as discuss our Q4 financial targets and financial information related to the Omniture transaction. Shantanu will then discuss the strategic rationale for Adobe's planned acquisition of Omniture. Josh will follow with his perspective on the advantages of a combination with Adobe. Later, we'll host a Q&A session, where we will answer your questions.

By now, you should have a copy of the two press releases we issued today, our Q3 earnings press release, as well as a press release which discusses the acquisition of Omniture. Both crossed the wire approximately one hour ago. If you need a copy of these press releases, you can go to adobe.com under the Company and Press links to find them.

Before we get started, I want to emphasize that some of the information discussed in this call, particularly our revenue and operating model targets, our forward-looking product plans, and a discussion on the acquisition of Omniture is based on information as of today, September 15, 2009, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in our statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the press releases we issued today. We also encourage you to review Adobe's and Omnitures's SEC filings, including our respective Form 10-Q and Form 10-K filings, as well as other documents that will be filed today in conjunction with today's announcements.

During this call, we will discuss non-GAAP financial measures in our third quarter earnings results and fourth quarter financial targets. GAAP financial measures that correspond to these non-GAAP financial measures, as well as a reconciliation between the two, are available on our Web site.

I would also like to stress that information we discuss in this conference call related to our intent to acquire Omniture is for informational purposes only. This information is not an offer to buy, or the solicitation of an offer to sell any securities. The solicitation and the offer to buy shares of Omnitures's common stock will only be made pursuant to a tender offer statement on Schedule TO, including an offer to purchase and other related materials that Snowbird Acquisition Corporation, a wholly-owned subsidiary of Adobe Systems Incorporated, intend to file with the SEC.

Once filed, Omniture stockholders will be able to obtain the tender statement on Schedule TO, the offer to purchase, and related materials with respect to the offer, free of charge at the Web site of the SEC at www.sec.gov, from the information agent, and dealer manager named in the tender offer materials, or from Snowbird Acquisition Corporation.

Omniture stockholders should read these materials carefully prior to making any decisions with respect to the offer because they contain important information, including the terms and conditions of the offer.

We have also set up a Web page for easy access to acquisition-related documents, including an FAQ document. The link for this page is in the acquisition press release we issued today.

Finally, call participants are advised that the audio of this conference call is being Web cast live over the Internet in Acrobat Connect Pro and is also being recorded for playback purposes. The Web cast will be archived on Adobe's Investor Relations Web site until the closure of the acquisition 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 would now like to turn the call over to Shantanu.

Shantanu Narayen

Good afternoon. We achieved Q3 results, which were solidly within the targets we provided at the outset of the quarter. Revenue was $697.5 million in Q3, with non-GAAP earnings of $0.35 and a non-GAAP operating margin of 34%.

More importantly, I am excited to announce we have signed a definitive agreement to acquire Omniture, the industry leader in Web analytics and online business optimization. This acquisition not only aligns two highly-innovative and successful companies, it positions Adobe to provide an end-to-end platform with the power to transform digital media and advertising.

Later in the call, I will discuss the strategic rationale for the acquisition but before that we will start with Mark walking us through our Q3 results.

Mark Garrett

For the third quarter of fiscal 2009 Adobe achieved revenue of $697.5 million. This compares to $887.3 million reported Q3 fiscal 2008 and $704.7 million reported last quarter.

Q3 GAAP operating expenses were $464.9 million compared to $556.9 million reported in Q3 fiscal 2008 and $471.3 million last quarter.

Non-GAAP operating expenses in Q3 were $409.9 million compared to $475.1 million reported for Q3 fiscal 2008 and $410.6 million last quarter.

GAAP operating income in Q3 fiscal 2009 was $167.6 million, or 24% of revenue. This compares to GAAP operating income of $219.5 million, or 24.7% of revenue in Q3 fiscal 2008 and $161.4 million, or 22.9% of revenue last quarter.

Non-GAAP operating income in Q3 fiscal 2009 was $237.1 million, or 34% of revenue. This compares to non-GAAP operating income of $351.9 million, or 39.7% of revenue in Q3 fiscal 2008, and $237.7 million, or 33.7% of revenue last quarter.

Adobe's effective GAAP tax rate in Q3 was 22% and the non-GAAP tax rate was 23.5%. Q3 GAAP net income was $136.0 million compared to $191.6 million reported in Q3 fiscal 2008 and $126.1 million last quarter.

Non-GAAP net income was $186.1 million compared to $269.1 million reported in Q3 fiscal 2008 and $185.0 million last quarter.

GAAP diluted earnings per share for Q3 fiscal 2009 were $0.26 based on 531.8 million weighted average shares. This compares with GAAP diluted earnings per share of $0.35 reported in Q3 fiscal 2008 based on 541.3 million weighted average shares and GAAP diluted earnings per share of $0.24 reported last quarter based on 528.0 million weighted average shares.

Non-GAAP diluted earnings per share for Q3 fiscal 2009 were $0.35. This compares with non-GAAP diluted earnings per share of $0.50 in Q3 fiscal 2008 and $0.35 reported last quarter.

I will now discuss Adobe's revenue in Q3 by business segment. Creative Solutions segment revenue was $400.4 million compared to $493.6 million in Q3 fiscal 2008 and $411.7 million last quarter. Our overall CS business remains stable with European weakness offset by strength in the education market.

Business Productivity Solutions revenue was $210.0 million compared to $283.5 million in Q3 fiscal 2008 and $209.7 million last quarter. Within the Business Productivity Solutions, Knowledge Worker revenue was $154.5 million, compared to $218.0 million in Q3 fiscal 2008 and $156.0 million last quarter.

Our Acrobat Business continues to be impacted by the economy while our Web Conferencing solution, Connect Pro, had a strong quarter.

The other component of our Business Productivity segment is our enterprise business. In Q3 enterprise revenue was $55.5 million compared to $65.5 million in Q3 fiscal 2008 and $53.7 million last quarter. LiveCycle revenue grew sequentially in Q3, but the business declined year-over-year due to the weaker economy.

Print and Publishing segment revenue was $42.2 million compared to $51.1 million in Q3 fiscal 2008 and $46.5 million last quarter.

Finally, Platform revenue in Q3 was $44.9 million compared to $59.1 million in Q3 fiscal 2008 and $36.8 million last quarter. The sequential increase in Platform revenue was due to increased volume of third-party tool bar distribution associated with our run time client downloads.

Mobile revenue was flat quarter-over-quarter and down year-over-year due to the impact of the open screen project.

Turning to our geographic segments, results on a percent of revenue basis were as follows: the Americas, 51%; Europe, 28%; Asia, 21%. In North America our underlying business remains stable and we achieved strong results in the education market. Asia performed better than we expected, which helped to offset some of the continuing weakness in Europe.

Employees at the end of Q3 totaled 7,564 versus 7,437 at the end of the second quarter. The majority of the new hires in the quarter were in research and development, located in lower cost geographies.

Our trade DSO in Q3 fiscal 2009 was 37 days. This compares to 34 days in Q3 fiscal 2008 and 34 days last quarter. Our global channel inventory position at the end of the quarter was within company policy.

During the quarter, cash flow from operations was $237.0 million. Our ending cash and short-term investment position was $2.6 billion compared to $2.7 billion at the end of last quarter.

In Q3 we repurchased approximately 4.0 million shares at a total cost of $116.1 million.

This concludes my discussion of our financial results. I would now like to comment on our financial targets for the fourth quarter of fiscal 2009. These targets do not include any financial impact from the proposed acquisition of Omniture.

We are targeting a Q4 revenue range of $690.0 million to $740.0 million. We expect normal seasonal trends to affect our Q4 revenue. In the Americas we expect revenue to be flat to slightly up on a sequential basis. In Europe, we expect revenue to grow sequentially, and in Asia we expect revenue to be down slightly quarter-over-quarter due to seasonality in Japan.

From a business segment standpoint, we expect our Creative, Knowledge Worker, and Enterprise businesses to grow sequentially in Q4. We also expect our Platform business to decline modestly in Q4.

For margins, we are targeting a Q4 GAAP operating margin range of 23% to 27% and non-GAAP operating margin range of 33% to 36%.

We are targeting our Q4 share count to be 530.0 million to 532.0 million shares.

For non-operating income, we are targeting a range of $1.0 million to $3.0 million on both a GAAP and non-GAAP basis.

For our Q4 GAAP effective tax rate, we are targeting approximately 23% and for our non-GAAP effective tax rate we are targeting 23.5%. These targets lead to a GAAP earnings per share range of $0.23 to $0.29 per share and a non-GAAP earnings per share range of $0.33 to $0.39.

Finally, I will cover the financial aspects of the transaction we announced today. Under the terms of the agreement, we expect to acquire all of the outstanding Omniture common stock for $21.50 per share in cash, or approximately $1.8 billion on a diluted equity value basis, including options, or approximately $1.7 billion net of cash.

This represents a 45% premium over their 30 trading-day average through yesterday's close.

We expect to finance the transaction through a combination of cash on hand and our existing line of credit. The acquisition will be structured as a tender offer for all of the outstanding shares of Omniture common stock, followed by a second step merger to acquire any remaining shares not acquired in the tender offer.

The transaction is expected to close in our fiscal fourth quarter, subject to customary regulatory approvals and other customary closing conditions.

Over time, we expect the addition of Omniture to positively impact revenue growth and earnings growth. While we expect limited expense synergies, the strategic rationale for the combination is the longer-term revenue benefits we expect from both existing products and services and new jointly developed solutions.

Omniture will further diversify Adobe's revenue given its broad-based subscription and usage-based recurring revenue model. Although Omnitures's gross and operating margins are lower than ours, given the infrastructure investments required of their SaaS delivery model, we do anticipate improvement in their margins over time as their business continues to scale.

The transaction is expected to be accretive to earnings on a non-GAAP basis in fiscal 2010 based on projected Omniture non-GAAP revenue performance. Non-GAAP excludes certain purchase accounting-related items, including a deferred revenue write-down.

We plan to integrate Omniture as a new business unit and we will report the results of this business unit within a new business reporting segment in our SEC filings.

This concludes my section. I will now turn the call back over to Shantanu.

Shantanu Narayen

Adobe's mission has been to revolutionize how the world engages with ideas and information. Increasingly, our customers have been asking us to help them deliver more effective solutions for assembling and delivering targeted Web content and applications that can be measured and optimized, effectively creating an end-to-end solution.

In addition, the inability to effectively monetize media on the Web is a pain point we hear about frequently from customers, especially in the advertising media and entertainment industries. That's why we are excited today to announce our intent to acquire Omniture. Omniture is the largest provider of Web analytics and online business optimization solutions. Their online marketing suite is a critical tool for today's online marketers and chief marketing officers.

Based in Orem, Utah, Omniture has trailing four-quarter GAAP revenue of $335.0 million with 1,200 employees in 20 locations. More than 5,000 enterprise-class customers use Omnitures's SaaS solutions worldwide. With their infrastructure, they process over a trillion user transactions quarterly.

By combining Adobe's powerful creative tools and broad client reach with Omnitures's analytics and optimization technologies, we are positioned to deliver a platform that transforms the future of engaging experiences and e-commerce across all digital content, platforms, and devices.

Together, Adobe plus Omniture will complete the loop of content creation, delivery, and optimization, enabling our customers to extract more value from their digital content and applications.

More specifically, Adobe's Creative Suite products and Flash platform help customers create and deliver engaging experiences. The addition of Omniture's online marketing suite will help customers measure, analyze, and optimize the impact and value of those experiences, creating a continuous feedback loop to maximize business results.

We see opportunities to enhance the measurement, analysis, and optimization capabilities of content and media, created with the Adobe Creative Suite, applications developed on the Adobe Flash platform, and rich media delivered by Adobe Scene 7 and the Flash media server.

This acquisition will expand Adobe's addressable market and growth potential, broadening the solutions Adobe provides to the rapidly growing Internet advertising, e-commerce, and digital media markets.

From a go-to-market standpoint, adding Omniture will expand Adobe's offering of mission critical solutions to the enterprise customer. From a business standpoint, the addition of Omnitures's SaaS model with recurring revenue, diversifies Adobe's overall business model and revenue profile. Omniture brings recognized expertise in SaaS delivery and go-to-market capabilities.

Most importantly, from an employee standpoint, we share a culture of delivering innovative solutions to solve real customer problems.

I would now like to introduce Josh James from Omniture. I am pleased to announce that upon successful closure of the deal, he will be joining Adobe as a Senior Vice President, reporting to me.

Joshua G. James

The mission of Omniture has been to enable our customers to optimize every digital interaction. By joining forces with Adobe, we will accelerate that vision by improving our ability to integrate measurement into the front end of the content creation process and optimize the user experience for Web sites, applications, advertising, mobile, video, and other emerging digital media. The bottom line, this improves content engagement, advertising effectiveness, and the overall user experience, driving the acceleration of ad dollars from offline to online.

We set out to change the market for Web analytics and online business optimization. We believe we have accomplished that. And as we've built out our solution and ecosystem of partners, we have realized there is an opportunity to be a foundational platform upon which companies build their online businesses. Through this combination with Adobe we can be involved with our customers and be their trusted partners for decades to come.

Adobe has the global operational scale and rates that will enable us to more quickly penetrate new geographies and new markets, like the government and mobile segments, to name a few.

The most critical IP in any technology company is the people. Adobe has been our partner for several years and we are excited that we share similar values, culture, and vision. As CEO and co-founder of Omniture, that was extremely important to me. Net-net, this combination is a huge win for Omnitures's customers, partners, employees, and shareholders. We are truly excited to become a part of Adobe.

Shantanu Narayen

Adobe has a history of successfully acquiring other companies, most recently with Macromedia. We set out to create a powerful set of solutions for creating, managing, and delivering compelling content and experiences, and we delivered on that vision.

Through this combination with Omniture, we will enhance that offering to enable advertisers, media companies, and E-tailers to realize the full value of their digital assets. We look forward to sharing more details about the opportunity of Omniture being a part of Adobe at our upcoming financial analyst meeting.

The meeting will coincide with Adobe MAX. It will be an exciting week for Adobe customers, Adobe partners, and certainly the financial community that follows Adobe. We hope to see you there.

Now, I will turn the call back over to Mike.

Mike Saviage

Before we get to Q&A, I would like to remind you about the details for our upcoming financial analysts meeting. As Shantanu indicated, we are hosting this year's meeting in conjunction with our annual Adobe MAX conference, which will be held in Los Angeles during the week of October 5. The Adobe analyst meeting will be in L.A. on Wednesday, October 7, and we've already sent out invitations. As part of the analyst meeting invitation, we provided a special offer for the financial community to attend MAX on Monday and Tuesday of that week.

If you have not received this invitation and would like to attend, or if you follow Omniture on the buy side or sell side and would like attend, please send an email to ir@adobe.com to receive more information. Additional details about Adobe MAX can be found on the Web at max.adobe.com.

In regard to today's earnings report and acquisition announcement, we have posted several documents on our Investor Relations Web page today. To access these documents, and other investor-related information, you can go to our Web site at www.adobe.com/adbe.

For those who wish to listen to a playback of today's conference call, a Web-based Acrobat Connect Pro 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 3412311. International callers should dial 719-457-0820. The phone playback service will be available beginning at 4:00 p.m. Pacific time today and ending at 8:00 p.m. Pacific time on Wednesday, September 23, 2009.

We will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sarah Friar - Goldman Sachs.

Sarah Friar - Goldman Sachs

Two questions for you on the Omniture side. Could you elaborate a little more on your first thoughts on the product synergies, and in particular, some of the question I'm being asked are these products really sold to the same buyer in the organization, because I would think of them as different. So how do you imagine that coming together?

And then, Mark, can you confirm, did you say the deal would be accretive in fiscal year 2010 overall?

Mark Garrett

Why don't I do that one first. Yes, I did say that the deal would be non-GAAP accretive in 2010 overall.

Sarah Friar - Goldman Sachs

But with that a whole lot of cost synergies, you're assuming that's coming more from the top line—correct?

Mark Garrett

We are not assuming a lot of cost synergies in this. Correct. It's accretive without that.

Sarah Friar - Goldman Sachs

And maybe Shantanu on the broader product synergy thought.

Shantanu Narayen

I think it will be useful for me to maybe just take a little bit of step back and talk about why Omniture and why now.

As you know, we've being sharing with you our vision of where technology is headed for quite a while now. Richer media, more video, mobile access to information, as well as rich Internet applications. And we believe that we've really delivered against that vision of creating absolutely the best tools in the world so that creative professionals and ad developers can create those engaging experiences.

What we found is that as we've been talking to our customers, in the conversation with them it's clear that they would like us to do a lot more. For example, the chief digital officers that we talk to at media companies have been telling us that they want to understand which content was performing the best so that they could feature it more prominently and increase their ad revenue.

Advertisers and agencies were using Flash to produce rich ads but they were telling us that they really wanted to understand what the click-through rates of those ads were in real time, to be able to take more advantage of it.

Web developers, who've been using Adobe technologies to create these RIAs [Rich Internet applications] have said that they want to build intelligence so the site can automatically recommend the best products to drive higher conversion rates.

And so it clearly dawned on us that all of them want us to complete the loop between the offering part, the delivery part, and consumptions, and they wanted Adobe to play this bigger role, which really for us was a natural extension of what we were trying to do to transform these experiences.

And what was interesting was that a number of these customers actually wanted us to integrate with solutions like Omniture. And we found, ironically, that we were having exactly that same experience with our own Web site in our own e-commerce site, which was adobe.com.

And so as we started to embark on this, you know we realized in conversations with Josh that they actually had the same vision, and they were equally focused on delivering greater value for their customers.

In terms of the actual buyers of these products and what we find, with the Creative Suite, we're finding that increasingly it's the mission-critical solution that the chief digital officers are deciding in terms of the entire platform. The chief marketing officers are thinking about what the experience is. And so as it relates to the go-to-market synergies as well, both companies have actually built direct enterprises that are serving these customers.

So we think that there is natural synergy between both the creative professionals who create this content and the chief marketing officers who are increasingly making the decisions on how to optimize their business.

Sarah Friar - Goldman Sachs

Was it a competitive bid or can you talk to that at all?

Shantanu Narayen

What I can say is we're excited about the prospect of what we can do together and we will file all the necessary documents.

Operator

Your next question comes from Michael Olson - Piper Jaffray.

Michael Olson - Piper Jaffray

A similar line of questioning as far as the customer overlap. I would imagine nearly all Omniture customers are Adobe customers, but not necessarily the other way around. Would you agree with that? And is the cross-sell opportunity really more bringing Omniture to existing Adobe customers?

Shantanu Narayen

I think there are both opportunities around cross-sell right now. With both customers. But even when you take LifeCycle, for example, which is an area that Josh and I have talked about, there is an opportunity even for the enterprise customers to be able to embed analytics in that. So I would say the universe of the customers that we can jointly serve actually expands for both companies with this.

Joshua G. James

I would say that as we—over the last few years especially—we've seen that the customers we talk to have increasingly become more and more the CMOs and other executives in the marketing organization. And so certainly, from our perspective, this relationship increases the opportunity because—first of all, because of the brand. And the fact that there are more relationships that we can go in and have very meaningful business opportunities because these executive officers in the marketing organization are now going to be able to look at us and say this is who they should be partnering with.

Interestingly enough, when you look at the landscape, in most industries and in most departments inside a company, there are big technology companies that are very focused on that particular department. When you look at marketers, that's not necessarily the case. There are not real large technology companies that are focused on those executives.

And so, at least over the last few years in particular, the fact that we can get in there and bring them a solution that at a high level helps them understand the analytics, the optimization, but then they go and they say okay, these folks that are creating it, they need to be able to get the tracking put in it. They need to be able to get the analytics in there.

Together, Adobe plus Omniture will complete the loop of content creation, delivery, and optimization, enabling our customers to extract more value from their digital content and applications.

More specifically, Adobe's Creative Suite products and Flash platform help customers create and deliver engaging experiences. The addition of Omniture's online marketing suite will help customers measure, analyze, and optimize the impact and value of those experiences, creating a continuous feedback loop to maximize business results.

This acquisition will expand Adobe's addressable market and growth potential, broadening the solutions Adobe provides to the rapidly growing Internet advertising, e-commerce, and digital media markets.

Offer basic tracking, basic analytics. And that's one of the additional items that it really brings to us, is just the fact that it all becomes integrated potentially with the ability to embed analytics and optimization into the creation process. And that's something that's a very big challenge for our customers today.

Michael Olson - Piper Jaffray

And a question on the core business, when you look out over the next couple of quarters, how do you think about and weight the balance between an improving environment for Creative Pro and the potential for CS4 slowdown ahead of the CS5 launch?

Shantanu Narayen

What we have seen with the CS4 business thus far is from a slope of the cycle it's actually been fairly consistent with previous cycles. So in other words, you initially see a fairly significant amount of upgrade revenue and then you have fairly steady revenue write-through, all the way to the release of the next creative product.

And it seems like CS4 has thus far experienced exactly the same pattern. So on the positive side, as Windows 7 is released, and as we see Snow Leopard adoption, we continue to think that there is potential associated with CS4.

One other fact I will throw out is that as it relates to Q3, we actually saw a fairly significant number of deals within our enterprise segment for Creative. So our assumption, it's going to play out similarly to the CS3 and CS2 cycles.

Operator

Your next question comes from Heather Bellini – ISI Group.

Heather Bellini – ISI Group

What percentage of the cost of your operating expenses have you taken out so far this year would you say have been taken out for good versus the percentage that you think you need to start slowing back in in 2010 to account for things such as salary increases and bonus accruals?

Mark Garrett

We haven't broken down the expenses at that level of granularity but there's a healthy percentage that's related to variable compensation. Things like bonuses, profit sharing, the fact that we didn't do salary increases this year. That all went away, completely. So that has to start to come back at some point, likely in 2010. And that's a fairly sizeable piece of the restructuring that we did, but we also did take a fair number of people, if you remember, out of the organization. So we did a restructuring back in December of last year of about 600 people, so I would call it a healthy mix of both.

Heather Bellini – ISI Group

Is the variable part more than 50%?

Mark Garrett

I'm not at a point to break down at that level for you.

Operator

Your next question comes from Sasa Zorovic - Janney Montgomery Scott.

Sasa Zorovic - Janney Montgomery Scott

My first question would be in terms of integrating the process you're going to be selling, so are you planning to sell Omniture to your existing Adobe channel, are you planning on keeping the sales forces separate for the time being? How do you plan to implement and augment this cross-selling that would be going on?

Shantanu Narayen

Today is announce day so the integration process starts right after this call is ending, so from the perspective of how far along we are in determining what the entire channels are, it's early.

Clearly, as part of the conversations that we've had, we recognize the both companies have a fairly healthy enterprise sales force that is targeted at the chief marketing officers and the more senior people in the creative enterprise companies that we target.

In addition to that, as you know, Adobe has a very effective two-tier distribution channel, and as we think about the products, both new and existing products that we're going to put through it, we actually have a very comprehensive offering now of routes to market from the channel, from inside sales, from the mid-market, all the out to the enterprise customers.

So we are confident that as we integrate these products and deliver value, we have the right routes to market to accelerate growth.

Sasa Zorovic - Janney Montgomery Scott

My second question would be regarding your core business at this point, so when you look at the strengths in Asia and weaknesses you mentioned in Europe, would you attribute that just to the differences in the two end markets? Are there any kind of execution issues that you would point to there? Or is it in essence just basically Asia kind of recovering or growing faster than Europe would be?

Mark Garrett

In this quarter what we saw was continued stability in the U.S. We said that in the second quarter and that continued through the third quarter. In fact, the U.S. did very well as we got our seasonal bump for education also. Europe continues to be a little slower on the recovery side. You know, we saw that in the second quarter. We also have, of course, normal Europe seasonality in the third quarter that was even more compounded by the economy over in Europe. And Asia and Japan have actually held up through this pretty well. So I think that's kind of the high level story throughout Q2 and Q3.

Operator

Your next question comes from Phil Winslow - Credit Suisse.

Phil Winslow - Credit Suisse

The cash on the balance sheet, how much of that is based in the U.S. versus international?

And also, last quarter I think you gave us what CS4 was, call it cycle-to-date, versus CS3. I wondering if you were able to update that for this quarter as well.

Shantanu Narayen

I can cover the second question, which was CS cycle to date. If we look at the data we provided in Q2, I would say Q3 experienced approximately the same trends. So whether it's version over version, the revenue decline, the mix of suites as a percentage of the entire Creative Services revenue continue to be approximately 68%. In terms of the products that we're selling, it continued to be the Design Premium, Design Standard, and Master Collection.

So when you think about the business, quarter-over-quarter, very similar to the business results that we shared in Q2.

Mark Garrett

On the cash side, as you can see, we have $2.6 billion of cash on hand. We have not disclosed how much of that is offshore, but like we've said, a good portion of our business is overseas and not as high a percentage of our expenses are overseas, so we do end up with a significant portion of cash offshore, which is why we'll also be financing the transaction through not only the cash on hand but also the credit facility.

And I think this is a great strategic use of our cash, after we evaluated a lot of different funding options, with our cash position and our strong, ongoing cash generation, and the overall interest rate environment, this was just the best financing solution for us.

Operator

Your next question comes from Adam Holt - Morgan Stanley.

Adam Holt - Morgan Stanley

Can you give us the backlog number heading into the fourth quarter?

And as we get a little closer to a potentially pretty significant corporate PC upgrade cycle, can you talk a little about on the core Adobe side what you think your exposure is there and what the implications are?

Mark Garrett

On the backlog side, again, it's not indicative of future performance and it is factored into all our guidance. That said, we were pretty pleased with the fact that we did end the quarter with 2% of revenue in backlog.

Shantanu Narayen

And on your first question, as it related to the potentially significant upgrade cycle, we have traditionally said that we do see when people upgrade their hardware that they do tend to buy new software associated with that. We are certainly going through two cycles with both Windows 7 and Snow Leopard on the MacIntosh side. If we are any indication, we have also held off on hardware purchases, like I think most companies. So one could assume that there is pent-up demand for software as well, when the hardware refresh happens.

Adam Holt - Morgan Stanley

On the Omniture side, you all talked about a lot of interesting potential product synergies down the road. As we think about CS5 upcoming, with the deal closing in the fourth quarter it would seem that we will probably miss any CS5 integration. Should we be thinking about the product road map really coming together around CS6, or am I jumping the gun on that?

Shantanu Narayen

Well, we will be pretty ruthlessly focused on who we can integrate as effectively, just like we did with Macromedia. And I think we recognized with Macromedia that this was a multi-cycled road map as it relates to the potential product synergies that we can. But once the deal closes, we will be aggressive about trying to find the low-hanging fruit that we can, much like we did with the earlier version of CS, to try and provide some functionality within the creative product, as well as within the Flash platform.

I mean, part of the benefits for us, associated with this deal, is we have a lot of our customers telling us that they really want us to take advantage of the Flash platform and find new ways to monetize it.

But make no mistake, we are also very focused on keeping our existing product road maps as they are.

Joshua G. James

I just want to add one thing to that, also. As it pertains to Flash, we already have an integration with Flash. And I think that's an important component here. We've been working with Adobe for several years. Our customers come to us and we know from our side that Flash is extremely important to them and especially as their business evolves. Not only on the Web but also in mobile. And we have a lot of customers overseas in Europe and Japan and as that mobile space evolves, it's been really fun to have our customers come to us and really demand that we figure out how to integrate and analyze and track flash in the Flash platform so that they can continue to leverage that as in investment going forward.

So that will be a continued opportunity and I think the fact that not only will we be able to have an integration, but an integration that has the stamp of approval on it, is going to be something that really motivates our customers to invest even more in that platform.

Shantanu Narayen

I will add another piece as well, which is at NAV earlier this year we announced Strobe, which was an open framework that allowed people to integrate and provide analytics support directly within the Flash player. And as we all know, Omniture has the tremendous SaaS infrastructure, the second-largest SaaS software company in the world. So one of the beauties of the potential integration is we don't have to wait just for the traditional desktop product cycle to be able to provide functionality to our joint customers.

Operator

Your next question comes from Kash Rangan - Merrill Lynch.

Kash Rangan - Merrill Lynch

Can you elaborate a little more on the strategic rationale. Are you seeing evidence that the Web analytics market and the design markets are actually starting to come together so as to converge.

And also, how you plan to address what could be more complicated sales cycles, so obviously there are rewards if you can get this thing right.

And also race through some execution hurdles and I was wondering what your thought process is on both those counts.

And Mark, maybe if you could address this—typically you have gotten a fourth quarter bump, probably 8% to 10% sequential during normal economic times. I'm sure that these are different economic times. I'm just wondering, looking at the guidance, we're not seeing that typical bump. Any thought processes behind that guide as you approach the November quarter?

Shantanu Narayen

As it relates to, again, the strategic rationale, clearly the goal is to combine the creative tools and the broad client reach with Omniture's analytic and optimization technologies, to deliver this platform that we talked about, which really can provide great and engaging experiences, and e-commerce across all content.

We didn't talk about devices yet. A number of our customers are also telling us that they want to be able to track how this content is used on mobile devices, for example. And so clearly we believe that this enables us to participate in a large, growing market opportunity and become even more mission critical to our customers. That's really the goal of being able to accelerate both revenue as well as non-GAAP earnings growth.

And also, from my perspective, it actually diversifies our portfolio for our business. We already have a number of SaaS offerings. We offer Scene 7, that we've talked about, for rich media, we offer Flash media server for video streaming. And we can integrate that as well in conjunction with the Omniture infrastructure.

Mark Garrett

As you know, we take the guidance pretty seriously and we're prudent about it. The range between $690.0 million and $740.0 million is all about two things: where CS goes and where the economy goes.

And if you look at $690.0 million, which is obviously at the lower end and would represent a relatively flat Q3 to Q4, that would suggest that the economy is just not coming back as quickly as any of us would like, and CS stays relatively flat. To the extent you're up at the higher end, towards $740.0 million, that's a stronger CS quarter as well as probably a slight uptick in the economy. And we've said the economy has been relatively stable but we certainly haven't seen it moving up yet.

Joshua G. James

I want to throw in one more thing in there about the markets coming together. Certainly from our perspective, pretty much 100% of our customers, the markets already have come together, because every single one of our customers has to deal with figuring out how to track all of their assets. And that's what they come to us for. So to the extent that we can facilitate that and improve that experience, that will greatly improve our customers' ability to manage and measure and understand the return they're getting on those investments.

And one of the most frequent questions we get form our customers during the set up and implementation process is how do I know that 100% of my assets are being tracked, so I can understand and analyze the return on that investment.

And so that's a question that our ability to answer improves dramatically and in terms of our customer base, one the things that's really limiting to us in terms of the opportunity, is just educating customers about the fact that this all can be tracked and measured and optimized.

And so I think there is an opportunity also for our business, especially once again, to be able to embedded into that creation process, that there's a lot of customers that don't understand the fact that they actually can track and measure all this stuff and we think there's an opportunity to certainly generate quite a few leads by embedding these pieces of technology together.

Operator

Your next question comes from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Mark, can you talk about the foreign currency impact in the quarter.

And then Shantanu, as you talked about combining the creative tools with Omniture, should we think about you maybe in future versions, five or ten years from now, do you see yourself actually offering extensions maybe to Creative Suite is today, do you see yourself offering features, functions, capabilities in a software-as-a-service format? How should we think about where your vision is going relative to longer term?

Mark Garrett

Q3, net of hedging, year-over-year, we had a loss to revenue of approximately $6.4 million. That was a $14.8 million loss from the Euro and an $8.4 million gain from the yen.

Shantanu Narayen

And with respect to the second question associated with extensions, first, as Josh mentioned, we already have a number of extensions that people build into the creative process to actually build into and work flow. For example, people trying to create ads are able today, with the Flash architecture, to be able to build that extension directly into the Flash professional authoring application. So certainly we expect to continue to build in terms of new extensions that add work flow capabilities.

And even as it relates to services, we have announced the acquisition of Business Catalyst that allows us to offer services, as well as we're offering other services today in beta forms on Adobe Lab. So yes, you can certainly expect us to do more with respect to services on both the creative as well as on the Acrobat side.

Operator

Your next question comes from Philip Rueppel - Wells Fargo Securities.

Philip Rueppel - Wells Fargo Securities

First, more of a general question on integration, given that most would agree that you were very successful really meshing Macromedia with Adobe. You see running the Omniture business unit more as a separate entity, at least initially? And if not, do you really see additional challenges given that the [inaudible] of an on-demand company, the sales compensation, the R&D cycles, all of that seems to be very different from most packaged software companies.

Shantanu Narayen

First, thanks for the compliment associated with our job in terms of getting Adobe and Macromedia well integrated. In many ways we think that this will actually be easier because it's additive and it actually combines the loop for us in terms of our services as well as the offerings that Omniture currently provides.

One of the very attractive parts of the conversations that we've had is the people and the culture that we've experienced in working with the folks from Omniture. They have a real passion for solving customer problems, which is something that both the companies share, a history of delivering innovative products, and really wanting to be successful in terms of solving customer problems. So it's something that Josh and I will need to continuously focus on but we are confident that we will put together a strong integration plan.

Philip Rueppel - Wells Fargo Securities

Does it shift your M&A strategy going forward at all? Do you view Omniture as a new platform and using that as something to add more capabilities, or will you continue to really focus on adding technology around the design suite?

Shantanu Narayen

Two thoughts associated with that, quickly. Firstly, we will be very, very focused on making sure that we take very seriously the integration associated with Omniture. But to your point, we think that there are multiple opportunities that then present themselves as a potential of the combination coming together, as well.

Operator

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

Ross MacMillan - Jeffries & Company

I have a high-level question on Omniture. I would have thought that it's the content itself, rather than the creation of the Web site or similar that has the biggest tie-in to the analytics. So changing content, changing offers, so on and so forth. So I'm just trying to understand that dynamic in the context of the way that you're positioning this, which is a combination of design tools and analytics rather than content and analytics. I would have just thought it was less closely tied around design than content.

Joshua G. James

That's a great question. There really are two components and that's the way that we always talk about our business. Our customers, when they wake up in the morning, they don't say, "I want to create something, I want to go analyze something." They say, "I want to improve my ad spend, the return I'm getting on my ad spend; I want to improve my conversion rates." And so the two pieces associated with that is the creation and then once you have made the offers and the content, optimizing that content. And that's really what our products do.

So if you look at, for instance, in a recent quarter of ours, the bookings that we have, more than half of our bookings are associated with optimizing that content. And the approximate other half is associated with the analytics and measuring and analyzing and collecting the data.

And in any given quarter, as Shantanu mentioned, we will have a trillion plus transactions. And each one of those transactions is a human clicking on content, a human clicking on merchandise. And each transaction represents an opportunity to create an optimized or a personalized experience for that end user.

Less than 5% of our trillion transactions are currently being optimized by our customers. And that's the real opportunity for us. And the challenge, though, is still getting it all embedded, making sure through the creation process that it's easy to get the analytics in there.

And then, in addition to that, once you have those analytics there, just being able to leverage the other products and services that we have.

And there are many more opportunities, as Shantanu was describing, down the road for us. So we're just really excited and I think this might be an appropriate time for me to say, you know, when we looked at this, we've always been laser-focused on getting this business to a billion dollars. Every employee in our company knows that's the goal. We're going to get to a billion dollars as fast as we possibly can, and we want to win.

And the way that we do that is by focusing on our customers, and our customers continue to tell us that we want to see this platform, we want to see you guys win and we want to see this platform so that we can standardize on it, that's integrated with the ability to track this stuff more effectively, to optimize our content effectively, and when we looked at this relationship with Adobe, and this combination with Adobe, what got us really excited is the fact that we could accelerate the goal that we have. We can get to a billion dollars faster. There's scale, there's opportunity in different geographies, there are opportunities in different market segments.

And when, back to the point, focusing on the customers and trying to win, when we found that this relationship, not only the great people and we feel like it's a great place for our employees, and it's a place that accelerates our ability to get to that billion dollars. That's something that excites all of us.

Operator

Your next question comes from Daniel Salmon – BMO Capital Markets.

Daniel Salmon – BMO Capital Markets

Josh, just wondering how the acquisition may or may not change some of your partnerships with some of agency resellers, and in particular if WPP had any role or advisory position in terms of your outcome here today.

Joshua G. James

I appreciate your asking that question because over the last 18 to 24 months, agencies and other partners have become a really important part of our business, and we've seen anywhere from 20% to 30% of our new bookings coming from our partners, whereas 24 months ago that number was zero.

And so as we've emerged as the leader in our space and as we've become a more credible partner, folks like WPP have been able to invest their time and resources and educating their people onto our products and our platforms. And one of the things that gets us most excited about this relationship with Adobe, this combination with Adobe, is the fact that we're not changing our strategy, we're accelerating our strategy.

And our relationships with our partners, and we need to sit down and talk with all our partners, but by all accounts it certainly seems that they are going to be very excited. And WPP specifically, I can't speak—I haven't had an opportunity to talk with them about this specific transaction, but I can tell you that they have 500 people in their organization that are trained on our products and services. I can tell you that most of the other agencies have very meaningful relationships with us.

And by the way, they also have, in almost all cases, more meaningful relationships with Adobe. So I think by bringing these companies together, it really strengthens our ability to partner with these agencies so as they try to figure out how to deal with the every-evolving digital marketplace, they've got a partner that can really help in some case lead them, in some cases learn from them, but in all cases partner with them. And that's something that we're really excited about.

Operator

Your next question comes from Yun Kim - Broadpoint Amtech.

Yun Kim - Broadpoint Amtech

Does this acquisition in any way impact your near-term product road map, especially around CS5 release that is expect first half of next year?

Mark Garrett

No.

Yun Kim - Broadpoint Amtech

Can you just update us on your latest progress on the mobile space in terms of when we can start to see meaningful revenue growth there and how does Omniture fit into what you're trying to accomplish in the market, as you continue to invest in the market?

Shantanu Narayen

That's a good question. As it relates to what we've talked about with mobile, you will see us at MAX talk a lot about the partnerships as well as actual deliverables associated with combining our Flash desktop player as well as our Flash mobile player.

As you know, with open screen project, we have changed the business model where we will not be charging royalty anymore. So what you will find is increasingly revenue associated with what we have in the Flash platform will be shown vis-à-vis the tools, as well as other services that we're offering, much like we can with a product like Omniture.

And so stay tuned and that's something that we will share a lot more with you at MAX.

Yun Kim - Broadpoint Amtech

And one product question. I just want to point out that the Omniture stock keeps trading higher than the offer price and the after [inaudible] market. Is there any way you can share with us how much line of credit you were able to line up for the deal?

Mark Garrett

I'm not quite sure how those two things relate, but from a cash perspective there are no contingencies on the deal and we have what we need to get the deal done.

Operator

Your next question comes from Dan Cummings - Lime Rock Research.

Dan Cummings - Lime Rock Research

Can you give us a comment on how Photoshop and your other products that you've typically sold, at least partially through consumer channels historically, are faring?

And Josh, a question around mobile and analytics around campaigns. I'm curious what your experience has been with customers who were trying to bridge both worlds with QR codes, for example, in Japan.

Shantanu Narayen

Well, dynamic imagining continues to be a key area of focus for us as a company, and so when you look at the revenue that we get from dynamic imaging, it's not just Photoshop as a stand-alone, but we all know that Photoshop is a key part of the work flow as it relates to Creative Suite. And we continue to focus on innovation there. The current economic climate has certainly impacted the revenue of Photoshop, much like it's done for the entire Creative Suite, but we continue to think that imaging is an area of innovation for us.

Joshua G. James

And as it relates to our business in Japan, and mobile in particular, we have many customers in Japan, actually, where we have larger relationships on the mobile side than we do on the PC side. And none of those relationships started out that way. They all started out on the Web site and then as their mobile business started to take off, they started to leverage their assets for their mobile business.

And whether it's QR codes or things like the [inaudible] for instance, or being able to—I was sitting down with the customer and they looked at a wine bottle, decided they like it, took a picture of the wine bottle, next thing you know, it shows up on his camera, the hits one button and the wine bottle gets shipped to his house. There are some really interesting opportunities from a mobile perspective and those opportunities are optimized and enhanced by us having the data of which Flash is an extremely important component, and then taking that data and integrating with Flash and with technologies, which allow that process to be optimized.

So Japan is definitely a leading market for us in helping us figure out how to address the mobile market.

Operator

Your final question comes from Walter Pritchard - Cowen & Company.

Walter Pritchard - Cowen & Company

I noticed on the G&A expense, it looked like it ticked up quite a bit sequentially. Just wondering what was behind that.

And then a clarification on your comments on the education market. It sounded like that was a source of strength in the quarter. Was that unusually strong? I know that is typically sort of a seasonally strong business this quarter. Just wanted to get a sense of relative to what you expected and what you've seen in the past on ed.

Mark Garrett

Good catch on G&A. G&A was up $10.0 million sequentially, a little over $10.0 million, and that's driven almost completely by our annual charitable contributions that we take. So that was completely a charitable contribution that is non-repeatable next quarter, so that will go away next quarter.

And education was good. We had a good, strong education quarter but it's pretty typical with what we've seen in prior Q3s.

Shantanu Narayen

Thank you again, everybody, for joining us on the call today. I also want to take the opportunity to thank Josh for joining me on the call, and I think you can clearly tell that we're both looking forward to the exciting opportunities that a combined company of Adobe and Omniture can target.

We are going to continue to focus on the key growth opportunities that we've identified for you. We will closely manage our expenses as well, in this tough economic climate. But more exciting for us are the areas that we're investing in to drive our future growth. And we look forward to sharing more with you, both our strategy at MAX and our financial analyst meeting about all the amazing things that are happening at Adobe.

Mike Saviage

This concludes today’s conference call. Thank you for joining us today.

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Source: Adobe Systems Incorporated F3Q09 (Qtr End 08/28/09) Earnings Call Transcript

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