Adobe F1Q10 (Qtr End 3/5/10) Earnings Call Transcript

 |  About: Adobe Systems Incorporated (ADBE)
by: SA Transcripts

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 2010 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 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 31, 2010 and contains forward-looking statements that risks 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 today’s earning release and on our Investor Relations website in the investor data sheet.

Call participants are advised that the audio of this conference call is being broadcast live over the internet and Adobe Connect and is also being recorded for playback purposes. An archive of the call will be made available on 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

Thanks, Mike. For the first quarter of fiscal 2010, Adobe achieved revenue of $858.7 million. This compares to $786.4 million reported in Q1 fiscal 2009 and $757.3 million reported last quarter.

Our Q1 revenue includes $87.7 million in Omniture revenue but excludes $14.9 million in deferred Omniture revenue in accordance with business combination accounting guidelines. Our Q1 revenue benefited from an extra week in the quarter due to our 52/53 week financial calendar as we discussed in our December call and which was factored into our financial targets. We estimate the net revenue benefit from the extra week to be approximately $35 million in the quarter.

We entered the first quarter with approximately 9% of reported Q4 revenue in shippable backlog and we exited the first quarter with approximately 6% of reported Q1 revenue in shippable backlog.

Q1 GAAP operating expenses were $592.5 million compared to $501.1 million reported in Q1 fiscal 2009 and $521.3 million last quarter. Non-GAAP operating expenses in Q1 were $498.7 million compared to $428.6 million reported for Q1 fiscal 2009 and $482.8 million last quarter.

GAAP operating income in Q1 fiscal 2010 was $176.8 million or 20.6% of revenue. This compares to GAAP operating income of $207.9 million or 26.4% of revenue in Q1 fiscal 2009 and $153.6 million or 20.3% of revenue last quarter.

Non-GAAP operating income in Q1 fiscal 2010 was $289.3 million or 33.7% of revenue. This compares to non-GAAP operating income of $295 million or 37.5% of revenue in Q1 fiscal 2009 and $265.2 million or 35% of revenue last quarter.

Adobe’s effective GAAP tax rate in Q1 was 23.5% and the non-GAAP tax rate was 25%. Our non-GAAP tax rate was approximately one point higher than our target of 24% due to the non-renewal of the R&D tax credit by Congress.

Q1 GAAP net income was $127.2 million compared to $156.4 million reported in Q1 fiscal 2009 a net loss of $32 million last quarter. Non-GAAP net income in Q1 was $211l7 million compared to $236.8 million reported in Q1 fiscal 2009 and $206.8 million last quarter.

GAAP diluted earnings per share for Q1 fiscal 2010 were $0.24 based on 532.6 million weighted average shares. This compares with GAAP diluted earnings per share of $0.30 reported in Q1 fiscal 2009 based on 527.8 million weighted average shares and GAAP net loss per share of $0.06 reported last quarter based on 532 million weighted average shares.

Non-GAAP diluted earnings per share for Q1 fiscal 2010 were $0.40. This compares with non-GAAP diluted earnings per share of $0.45 in Q1 fiscal 2009 and $0.39 reported last quarter. The higher non-GAAP tax rate due to the non-renewal of the R&D tax credit reduced our Q1 non-GAAP earnings per share by approximately $0.01.

I will now discuss Adobe’s revenue in Q1 by business segment. As we discussed on our December call, beginning this quarter we have adjusted our reporting segments. Specifically, we have moved our Adobe Connect product from our Knowledge Worker segment to our Enterprise segment.

Today’s update investor data sheet reflects this change with our Knowledge Worker and Enterprise segment revenue restated back to fiscal 2006 for comparison purposes.

In Q1, Creative Solutions segment revenue was $432 million compared to $467 million in Q1 fiscal 2009 and $429.3 million last quarter. This solid performance in front of the CS5 launch quarter was driven by continued stability in our CS business as well as strong Photoshop and Hobbyist product revenue.

Business Productivity Solutions revenue was $245.8 million compared to $227 million in Q1 fiscal 2009 and $211.8 million last quarter. Within Business Productivity, Knowledge Worker revenue was $165.9 million compared to $149.9 million in Q1 fiscal 2009 and $131.8 million last quarter. Acrobat revenue rebounded strongly to start the New Year, driven by an improving economy and seasonal strength in Japan and Asia.

Enterprise revenue was $79.9 million compared to $77.1 million in Q1 fiscal 2009 and $80 million last quarter. Connect had another strong quarter and our live cycle business experienced normal seasonality.

Omniture segment revenue in Q1 was $87.7 million. This did not include $14.9 million of deferred revenue, which was excluded due to purchase accounting. Omniture transactions grew to $1.23 trillion in the quarter, which represents 15% year over year growth for the similar period a year ago.

Platform revenue in Q1 was $46.6 million compared to $52.3 million in Q1 fiscal 2009 and $47 million last quarter. Print and Publishing segment revenue was $46.6 million compared to $46.4 million in Q1 fiscal 2009 and $42.9 million last quarter.

Turning to our geographic segments, results on a percent of revenue basis were as follows: the Americas 48%, Europe 32%, Asia 20%. We experienced continued stability in North American and Europe as well as seasonal strength in Asia.

Employees at the end of Q1 totaled 8,355 versus 8.660 at the end of the fourth quarter. The reduction in heads quarter over quarter was due to the impact of the restructuring we implemented last fall.

Our trade DSO was 40 days, which compares to 35 days in the year ago quarter and 49 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 $260 million. Our ending cash and short term investment position was $2.7 billion compared to $1.9 billion at the end of last quarter. The increase reflects the impact of our debt offering during the quarter less the subsequent repayment of our $1 billion credit line.

On January 25, we announced a debt offering consisting of the pricing of two series of senior unsecured notes for an aggregate principal amount of $1.5 billion. The notes consisted of two tranches; $600 million of 3 ¾% notes due on February 1, 2015 and $900 million of 4 ¾% notes due on February 1, 2020.

The cost of the debt will run at approximately $16 million per quarter and affect our earnings per share by slightly more than $0.02 per quarter. In Q1, the effect was only $0.01 due to the timing of the offering. In Q1, we repurchased approximately 1.7 million shares at a total cost of $60 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 2010.

We are targeting a Q2 revenue range of $875 million to $925 million. This target range excludes an estimated $8.6 million in Omniture revenue in accordance with business combination accounting guidelines.

Assuming achievement of our mid-point targeted revenue range, our Q2 revenue expectations by business segment are as follows: we expect our Creative business to increase sequentially because of the launch of CS5. We expect our Knowledge Worker and Omniture segments to decline slightly on a sequential basis factoring one less week of run rate in Q2 versus Q1.

We expect our Enterprise business to grow sequentially and our Platform and Print and Publishing businesses should be relatively flat in Q2 with revenue achieved in Q1. We expect all of our geographic segments to grow sequentially from Q1 to Q2 due to the CS5 launch.

For margins, we are targeting a Q2 GAAP operating margin range of 21% to 24.5% and a non-GAAP operating margin range of 33.5% to 35.5%. We are targeting our Q2 share count to be 531 million to 535 million shares. We are targeting non-GAAP operating expense to be between $16 million and $18 million on both a GAAP and non-GAAP basis due to the debt we put on our balance sheet with our bond offering in Q1.

For our Q2 GAAP and non-GAAP effective tax rates, we are targeting approximately 25%, which excludes the R&D tax credit. These targets lead to a GAAP earnings per share range of $0.23 to $0.30 per share and a non-GAAP earnings per share range of $0.39 to $0.44.

Looking towards the second half of fiscal 2010, we remain excited about our opportunities and the strong product line up we will deliver. Although we are not providing specific financial targets for the rest of the year today, assuming we achieve results within our Q2 financial target ranges, we believe our revenue and margin will grow sequentially throughout the remainder of the year.

This concludes my section. I’d now like to turn the call over to Shantanu.

Shantanu Narayen

Thanks Mark. I’m pleased with the progress we’re making against our strategic and business objectives. The Flash platform continued to show significant momentum this quarter. At Mobile World Congress, we made several announcements including news that a beta of Flash Player 10.1 was made available to content providers and mobile developers worldwide.

With general availability expected beginning in Q2, 10.1 is the first run time release of the Open Screen project enabling uncompromised web browsing of expressive content, high definition video and rich applications across multiple screens including desktops, smart phones, net books, internet connected DVD, new tablet devices and other consumer electronics.

The Open Screen project in an industry wide initiative led by Adobe that now includes 70 eco-system partners. We’ve been working closely with our OSB partners to enable the deployment of Flash Players on Google Android, the Blackberry OS, the Simbian OS, the Palm Web OS and Windows Phone Series 7 devices.

You can expect to see some of these devices starting to ship with Flash Player in the first half of this year and quickly ramping through this year and next.

We also unveiled Adobe Air 2.0 for mobile devices, consistent run time for delivery of standalone mobile device applications. Air leverages mobile specific features from Flash Player 10.1, is optimized for high performance on mobile screens, and designed to take advantage of native device capabilities for a richer and more immersive music experience. We expect to roll out Air support for mobile platforms later this year.

In our Creative Solutions business, we continue to focus on delivering an integrated offering suite for all media platforms including Flash and HTML. In Q1, our CS business remained stable and our Photoshop and hobbyist products posted strong results.

In our Video business, we continue to transition marquee media and broadcast accounts to the Flash platform for the delivery of video over the web. We’re seeing an unprecedented amount of change happening on the web in publishing and across all forms of media and advertising.

Creation and consumption of content is transforming rapidly as people engage across a growing array of devices, and this is driving significant changes in the business and distribution models of content owners and publishers.

Against the backdrop of this changing environment, we are excited about the upcoming launch of CS5. It will be a phenomenal release, rich with innovate wow features, new products and integrated workflows. It will enable an even broader set of designers and developers to more effectively create deliver and measure engaging experiences across media and devices. On April 12, we will host an online event to launch CS5, which is on track to ship in major languages late in Q2.

Our Omniture solutions will enable our customers to measure and optimize rich content including that created in our CS applications. In Q1, we achieved record quarterly revenue for the Omniture business with strong sales momentum, a 95% enterprise customer retention rate and the addition of over 150 new customers including Air Canada, REI, Korea Builder, and Terra Networks, Latin America’s largest internet company.

Integration of the two companies is going well and we are meeting all of our major milestones. We will debut product integration with CS5 and are already seeing benefits of our combined sales organization.

Earlier this month, we held the annual Omniture Summit. At that event, we announced version 2.0 of the Omniture Online Marketing Suite. We also provided details about an exciting new business relationship with Facebook which will enable marketers to buy highly targeted Facebook ads using Omniture’s Search Center Plus and then measure the performance of those ads in the context of their overall media spend.

We continue to leverage our PDF franchise in the enterprise. In our Knowledge Worker segments, Acrobat got off to a great start in 2010, driving strong year over year and sequential growth in Q1. now has over 10 million users and we’re excited about extending Acrobat functionality with the services in the next Acrobat release later this year.

In our enterprise business segment, Connect had another strong quarter as government agencies and enterprises continue to adopt our Flash based web conferencing solution. We also continue to work with customers such as Northwestern Mutual Life, T-Mobile and the California Department of Motor Vehicles to deliver life cycle solutions to extend the value of existing back office systems.

With Life Cycle ES2, we are enabling developers to build and deploy customer interaction solutions quickly and easily and empowering business users to manage application environments based on their specific needs.

Our strong Q1 combined with upcoming launches of our flagship products over the next several quarters make us bullish about the remainder of the year.

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

Mike Saviage

Thanks Shantanu. Before we begin Q&A, I’d like to cover a few housekeeping items. First, as Mark discussed, we have updated our reporting segments. Adobe Connect revenue is now included as part of our Enterprise segment starting in Q1. This means our Knowledge Worker segment will now contain Acrobat product family revenue going forward, whereas our Enterprise segment will contain Life Cycle and Connect revenue. The investor data sheet we are providing today contains a table showing this new segment classification as well as restated historical business segment revenue for comparison purposes.

Second, as Shantanu mentioned, there will be an online event on April 12 to announce CS5. Invitations and information regarding how to register for the event will be made available later today.

In regard to today’s earnings report, we have posted several documents on our investor relations web page today, including a copy of the script containing our prepared remarks for today’s call. To access these documents, and other investor related information, you can go to our website at

For those who wish to listen to a playback of today’s conference call, a web based Adobe Connect archive of the call will be available from the IR page on later today. Alternatively, you can listen to a phone replay by calling 888-203-1112. Use conference ID number 4296476. Again, the phone number is 888-203-1112 with ID number 4296476.

International callers should dial 719-457-0820. The phone play back service will be available beginning at 4:00 pm Pacific time today and ending at 4:00 pm Pacific time on Friday, March 26, 2010.



(Operator Instructions) Your first question comes from Steve Ashley – Robert W. Baird.

Steve Ashley – Robert W. Baird

Shantanu, I guess the question many people have is, what factors give you confidence that CS5 will be back to kind of a normal release product cycle?

Shantanu Narayen

First, I think you saw that the business even in Q1 2010 continued to be strong and that tells us that the demand for our offering applications continues to be similar to past product cycles. We also saw strength in Imaging as we mentioned in our Photoshop products on the extended product.

It’s clear that the trends continue to be in favor of what we’ve been doing which is to enable our customers to offer once and deliver across multiple media types and the amount of digital content that we see created continues to increase, and frankly it continues to be richer, so more video, more use of animation and interactivity.

The need is still there from our customers for us to enable them to have one workflow rather than multiple stove pipe workflows. So with that backdrop, we recognize that the creative pros and the companies are facing unprecedented challenges frankly, which is how can they deliver this engaging consistent brand experience across many devices.

We now think that our solution, the combination of Creative Suite with Omniture as well as with Flashplayer 10.1, really provides a comprehensive solution to enable them to do that. That coupled with the strengthened economy and the innovation that we’ve done in CS5, gives us a lot of confidence for the remainder of the year, but also frankly for the entire duration of the CS5 cycle.

Since it’s probably going to get asked, let me give you a few factors about what is in CS5. I think the big themes for us are first, the ability to design without boundaries, and that comes both from new products that we’re going to introduce in CS5 like Flash Catalyst. Everything we’ve done In Design where you can now us In Design content and repurpose that for electronic delivery without writing a single line of cord, what we’ve done in Photoshop including support for 3D capabilities. So the whole design without boundaries is one big theme for CS5.

The second one is really all about working faster with greater precision and this is support for new formats, HD for example, as well as what we did with the Mercury Engine and our video product which allows people to render video using hardware acceleration as well as a native 64-bit support.

And finally, services; we’ve talked about the desire to extend our desktop functionality with services. You’ll see that with CS Life. So all of that point to a solid release and we’re excited. You’ll learn a lot more about what’s in the product, pricing and the SKU’s on April 12.

Steve Ashley – Robert W. Baird

One quick question for Mark, in terms of the head count, I know that there are kind of confluence of forces going on here. You’re kind of doing a reduction but you’re simultaneously hiring. Where are we in the head count adjustment? What percentage of that was done in the first quarter? How much of that needs to continue and will we see general head count growth going forward?

Mark Garrett

There is approximately another couple hundred people that are on transition through the rest of this year. Offsetting that as you just said, we will continue to be hiring, so it’s hard to say exactly where head count will be each quarter, but there is still another couple hundred folks on transition.


Your next question comes from Walter Pritchard – Citigroup.

Walter Pritchard – Citigroup

I’m wondering if you could talk a little bit about, you mentioned all the major language. I just want to clarify. You said the major language versions in Q2. Should we expect everything including Japanese and the European languages all added in the May quarter?

Shantanu Narayen

What I said was that we would have all the major languages late in Q2, so the current plan is to get that. And again, we’ll share more on the 12th, but expect the major languages which we have traditionally said are English, French, German and Japanese to ship in Q2.

I know there’s been some confusion about what we mean by launch versus what we mean by ship. So just for everybody, again on the call, on the 12th, we will talk a lot more about the features and functionalities of the product, the various product configurations, what we’ve done with pricing. We have some new products which we will factor into the pricing moving forward.

The early feedback has been very positive. And then traditionally, four weeks later or so, you tend to ship the English version followed by the major language versions a few weeks after that. So things are on track as we’ve said. All that is factored into the targets that we provided earlier today.

Walter Pritchard – Citigroup

Relative to the upgrade pricing that you did in the last cycle around charging more for older versions and tiering it in that fashion, should we expect to see some sort of similar scheme in the CSI cycle?

Shantanu Narayen

Yes. That’s something that we’ve strategically said we will continue to have, and so expect to see the tiered pricing continue.


Your next question comes from Brent Thill – UBS.

Brent Thill – UBS

There’s obviously been a lot of confusion over HTML5 versus Flash. I was just curious if you could just provide us an update. How quickly can you introduce support for five when it comes. Is this required separate lease or is it just something that you can provide with that release? If you could just clear the air on that that would be helpful.

Shantanu Narayen

Firstly, we already support HTML in all of the different flavors that exist today. With our Creative products, so whether you’re using Dreamweaver or whether you’re using any of our other tools, if you want to output we will definitely support it.

The context that we see ourselves in as, people are using our tools to author more content. We will support any format that takes stock in the marketplace, and we’ve done that right through the existence of the company. So standards that exist, whether they be PDF, whether they be Flash, whether they be HTML, the new imaging and video standards that are emerging like H264, dynamic image resolutions, we’re going to support all of that in our Creative Tools and we want to make sure that as our publishing customers approach us and say, “Hey, these are the different formats that we want Adobe to support,” we’re not going to allow anybody to come in an create a wedge between us and our customers.

Clearly, most of our customers recognize that as there are new devices emerging, whether they be of the smart phone form factor, or whether they be of the tablet category, they’d like to leverage their assets so they don’t have these multiple stovepipe workflows.

While none of these customers want to create multiple websites, some of them will have to do it because of the different formats that are supported by each of these different vendors. So we will support HTML out of the gate. The reality is, it’s a fragmented standard, but we will continue to support it within our offering applications.

We think the benefits for our customers when they use our offering tools in conjunction with our run time which is Flash, and in conjunction now with the Omniture Suite, is a more comprehensive solution that’s out there.

Brent Thill – UBS

For Mark, if you back out Omniture, it looks like you’re targeting double-digit growth organically for Adobe. I was wondering if you could just clarify that.

Mart Garrett

You’re talking about for the year?

Brent Thill – UBS

Just in terms of its trajectory for the core business, yes, circa Omniture.

Mart Garrett

Clearly, I’m not going to parse them out. Clearly, Omniture, we’ve said in our prepared remarks is kind of slightly down based on the fact that you lose that extra week when you go into Q2. So you can take what we did in Q1 and back that out and kind of derive what you believe the rest of the company will do.


Your next question comes from Sarah Frier – Goldman Sachs.

Sarah Frier – Goldman Sachs

Mark, on the cost side, at the analyst’s day you talked about a 34% floor on margins for the year and clearly you’ve outperformed even this quarter, and now it looks like clearly you’ll get the leverage as the product cycle gets into gear. Any update on how you think about that base on margins and as you get rid of the rest of the heads and so on, wouldn’t we see even more margin expansion through the year now?

Mark Garrett

Yes, let me talk about that. We did say quite awhile ago that 34% would be our floor for margins for 2010 as we integrate Omniture into the business, and we did say that Q1 margin would be the low point for the year and if you remember we guided Q1 margins to 30% to 32% with earnings at $0.34 to $0.39.

Clearly, we outperformed all those Q1 targets with margins at 33.7% and earnings at $0.40, and we did it by absorbing as well the impact of the debt interest and the fact that the R&D tax credit has not been renewed. So with that, we clearly believe that revenue and margins should improve sequentially as we go through the year and we will as we have for years, invest prudently to both drive revenue which is our first and foremost goal, and also continue to deliver margin improvement to shareholders.

So we’re focused on both revenue and margin improvement as we go through the rest of the year and then improve sequentially from where we are today.

Sarah Frier – Goldman Sachs

If I could just ask you on the cash flow, it’s the only thing that looked a little off to us on the quarter. Is there anything in terms of timing that’s going on there and I would presume cash flow would come back to grow easily in line with net income growth if not all but ahead if the product cycle starts.

Mark Garrett

There’s nothing unusual. Cash from operations was like I said, $260 million. Capital expenditures were $25 million. We had the proceeds from the debt. We paid back the credit line. That’s really all. There’s nothing unusual. DSO’s came down so DSO’s got much better in the quarter.

Sarah Frier – Goldman Sachs

I think it was just on a year over year basis. It just looked like it was still down a lot, but tough comp I realize you’re hitting as well.

Mark Garrett

Yes, completely different environment a year ago.

Sarah Frier – Goldman Sachs

So no kind of bigger outlays coming as the product launches or anything like that for us to look out for?

Mark Garrett



Your next question comes from Adam Holt – Morgan Stanley.

Adam Holt – Morgan Stanley

It looked like a lot of the out performance in the quarter was from Acrobat, Enterprise and a substantial percentage of the raise for next quarter appears also to be in those two line items. Can you talk a little bit about what you think inflected in the quarter and what gives you confidence in that continuation into the next quarter?

Shantanu Narayen

Let me take that. First, across the business, we actually saw strength and I think Mark alluded to that so whether it was the Omniture, whether it was Connect, whether it was Acrobat, as well as in the Creative and the hobbyist products, we continue to see strength.

I would say for Acrobat, when we looked at the business, it was really driven by both stabilization and IT spend and frankly, we continue to see our run rate business which we say is dependent on the economy, continue to do well, so that was really good to see.

We also think that that’s driven a little bit by the whole move towards digital workflows for critical processes as people are moving from paper to digital. We do continue to see PDF adoption increase.

I was with the U.S. Court system and they are increasingly looking at PDF as the way in which they archive all of their court cases, and not just for what happens in terms of the judgment, but also adding audio and video so that they can have the actual depositions in there.

We think that the continued move towards online and digital work flows plays into the strengths of Acrobat which is why we’re optimistic about that business.

Adam Holt – Morgan Stanley

It sounds like we should expect some changes to the pricing around Creative Suite as we get to CS5. As you think about the relative growth drivers for CS5, how should we think about pricing as a lever? Would you expect to see the majority of the growth come from units or do you also believe that you have the ability to use pricing as a lever for growth as we get into the cycle?

Shantanu Narayen

We’ll continue to tweak our prices. We’ve clearly done a lot of research as we’ve prepared CS5. As I said, there is at least one new product that’s going to go into a number of the suites which is Flash Catalyst. So we’ll factor that in. But I think the big opportunity really is, when CS4 came out, it was an gothic economic environment and so what we find is that the number of people who migrated from prior versions of Creative Suite to CS4 were not as high as in traditional cycles.

So enabling people who are versions before CS4 to move to CS5, and frankly the innovation that we have in CS5 allowing CS4 users also to move to CS5, that’s what we believe is going to drive revenue for us for the Creative Products.

I’ve been with a number of customers over the last few weeks and all of these new devices that are coming, they are increasingly looking to Adobe to help them with their authoring workflows. It’s very gratifying to see as people think about how their content is going to be viewed on mobile devices, how their content is going to be viewed on the 12 or so slave devices that are going to come out over the next year.

People want to make sure that they can modify their existing Adobe authoring workflow to deal with that, and frankly, that’s where again, there is some great functionality in CS5 that allows people to author for multiple devices.


Your next question comes from Heather Bellini – ISI Group.

Heather Bellini – ISI Group

Shantanu, I had a question for you about CS5. There is a lot of people talking about the fact that CS5 could match the success that you had with CS3, but some of the things that you’ve been discussing, whether it’s about the tiered upgrade pricing or all the new functionality that you talked about, would suggest that CS5 could actually be a bigger cycle in terms of revenue than CS3, and I was wondering if you could share your thoughts on that.

Shantanu Narayen

Clearly, our expectations are relative to CS4. We do expect CS5 to be stronger and that’s primarily driven by the economic environment. As you pointed out, we’re very optimistic about what we’ve done in terms of helping people design without boundaries, they’re working faster in the new services, but really it’s going to take a few quarters for us to get it out in the marketplace.

We expect to see the traditional earlier adopter use in Q2 and then enterprises will put it through its paces as they transition from older versions of Creative. So I think it’s a little early to call where it’s going to finally land. We definitely expect it to be a better revenue generator for us than CS4.

Heather Bellini – ISI Group

In regards of CS4, it seemed like you had a lot of success in getting people to take advantage of design premium versus design standard when you narrowed the price gap between the two of them. Is that something now that you’ve been able to look at the CS4 cycle, would you say that the design premium, that SKU in particular performed better than the CS3 cycle in terms of what it contributed? Is there anything you can tell us in particular?

Shantanu Narayen

I think we will continue to focus on suites as the general message and especially as it relates to multiple media types and multiple devices. Pushing the suites and getting customers to adopt the suites is clearly going to be part of the marketing focus.

One of the areas that even in CS4, one of the products that grew version over version was the Master Collection, so continuing to have the Master Collection be the flagship product as people increasingly use video, is clearly going to be a priority for us.

I think the premium suites continue to resonate with our customers. As people move towards using video, Master Collection will be there. So that will all factor in and we have to keep something for the launch event to tell you about what’s here, so stay tuned.


Your next question comes from Brad Zelnick – Macquarie Research.

Brad Zelnick – Macquarie Research

As you speak about all the exciting features in CS5, I didn’t hear you speak much about the integration of Omniture capabilities into the product and what it might mean in terms of making CS5 a must have release. I was hoping you could maybe speak a little more to that.

Shantanu Narayen

We’ve talked about how despite the fact that the acquisition really closed in the October timeframe, we were expecting to see some functionality within CS, and we’re pleased because the two areas in particular that I can talk about.

In Flash Professional and Dreamweaver, we showed this at the Omniture Annual Summit. We expect to have the visitor conversion products like Desk target directly integrated into those Creative Suite products. Also with video, as people are increasingly creating video, having a library and framework that allows you to have analytics built in, is something that we will definitely deliver.

It’s early. We think there’s a lot more integration that we can do, but the combination of Creative Suite and Flash and Omniture, we think definitely meets a customer need.

Brad Zelnick – Macquarie Research

Mark, on cash flow, a follow up to Sarah’s question about the quarter, as we think about the remainder of the year, is there any insight directionally that you can speak to on cash flow as we put together our models?

Mark Garrett

If you look back over our history, we’ve generated roughly $1 billion of cash flow every year. I don’t see any reason for that to change. This $260 million is just another testament to that and as the business improves, it will only get better.

Let me just add one other thing, back to Brent’s question, if you do look at, I just jotted some numbers down here, but if you do look at a year ago Q2 revenue, and then you back out Omniture from Q2 of this year, you easily get into double digit growth for core Adobe. It’s actually in the mid teens.


Your next question comes from Phillip Rueppel – Wells Fargo.

Phillip Rueppel – Wells Fargo

Given that you’ve commented, and we’ve all seen that the adoption of CS4 was muted due to the economic environment, do you see the slope of adoption of CS5 very much different than another strong product cycle like CS3? I guess I’m getting at things like, is there a pent up demand in enterprise and larger customers that might buy earlier? Do you see more move to the Master Collection, the larger suites? Anything that you could help us in terms of just understanding how you view the slope over the product cycle would be helpful.

Shantanu Narayen

I think when the product comes out as I said, you have the earlier adopters and they tend more to be the freelancers because with respect to their own workflow, it’s much easier for them to convert.

I think the larger companies are increasingly asking us more about what we can do in newer versions such as Creative Suite to enable them to author for marketable devices. That’s a need where that demand has certainly gone up in terms of what those customers are telling us.

I still think they will have to put it through its paces. They may use CS5 to be able to output into the slave devices of the tablet devices that are going to come out because we’ve done a couple of really compelling demos.

After April 12, we’ll start to get data as we start to take orders and as the channel starts to take orders, so it’s going to take a couple of quarters frankly for us to get a better read on actual.

Phillip Rueppel – Wells Fargo

Mark, you had mentioned last quarter that you thought the extra week would add about $20 million and it turned out to be $35 million. Was that spread across the strength of all the products or was there anything in particular that drove that upside?

Mark Garrett

It was really spread across all the products, though like we said, Acrobat did do really well, so a large portion of that was Acrobat and if you look at the quarter, our sell through business was pretty consistent throughout the quarter and it kind of gives me a chance to talk a little bit here about NPD data.

I just want to make sure that you all appreciate the fact that Adobe has a very, very diversified business. I’ve talked about that for quarter after quarter. We sell to multiple routes to market. We sell direct. We have licensing business. We sell off our website, and we sell shrink-wrap of course through a two tiered distribution channel, and we also sell in multiple geographies.

NPD data as you know, only captures U.S. and it only captures shrink-wrap. So when you do the quick math, our shrink-wrap business is down to 20% of our worldwide revenue and North America is less than half of our business, and NPD captures only 85% of North America. So when you do that math, you end up with about 8% of our business.

So if you’re using just NPD data to predict our business, you’re going to get the wrong answer.


Your next question comes from Jay Vleeschhouwer – Ticonderoga Securities.

Jay Vleeschhouwer – Ticonderoga Securities

I’d like to ask about your thoughts on the possible incremental revenues from the services that you’ll be making accessible from within CS. You talked about this a bit at Max last October. Is it conceivable that those services could become roughly as large as the connect business has become? We can see from the data sheet that it’s $65 million to $75 million business now. When you consider the size of the CS base, is it feasible that you could grow CS Live as we’ll now call it into something comparable if not larger?

Shantanu Narayen

Let me reiterate. The strategy around services is first to be able to provide functionality on a quicker cadence than we can with just desktop applications. So that’s certainly one of the benefits that we see for services.

The second benefit that we clearly see is additional revenue and keeping people current on our new releases which we think helps us. And third, combating piracy. So over the long run as we introduce more functionality through services, and require an Adobe ID, we think that enables us to combat piracy.

In terms of how we might deliver services though, you can imagine that with the first purchase of the product you get maybe an annual subscription to the services. It’s similar to what we’ve done with our Photoshop elements product line. So in year one, you’re not going to see a great amount of revenue, but over the long run as you point out, it helps us both with keeping products current and it helps us with piracy and potential new revenue streams.

In year one I wouldn’t model too much into the services, but I think it starts to show directionally where we are going with that.

Jay Vleeschhouwer – Ticonderoga Securities

Mark, in light of the Omniture results reported in the quarter, particularly the transactional volumes, would it be fair to infer that they’ve seen a resumption of year over year bookings growth if the inference is correct that they had bookings declines for most if not all of last year?

Shantanu Narayen

Why don’t I take that as well? When we look at the Omniture revenue, we were pleased for multiple reasons, and the revenue itself, as you know we gave a target range that was lower than what we announced which was closer to $887 million.

I think the over accomplishment was due to increased bookings, excess of plan; also some of the higher variable revenue. As you know, some of the way in which we charge for Omniture is through over usage and actual based revenues, so that exceeded our plan.

As well as, in the past Omniture has also deferred reporting of revenue until the actual collection happens, or the receipt. So all of those contributed to the revenue being greater than what we had originally targeted.

I think the better news for us frankly was when we conducted the annual Omniture Summit, it was sold out and the number of customers excited about the joint offerings and the new customers we reported over 150 new customers with enterprise customer retention greater than 95%. That was really exciting and if you parse the businesses, the visitor acquisition business, there’s the analytics business and the visitor conversion business.

We’re certainly seeing more adoption of the entire online marketing suite. That was a strategy Omniture put in place and usage and marketable products makes it sticky as well as drives greater revenue to Adobe.

Jay Vleeschhouwer – Ticonderoga Securities

Your comments earlier about the services business and the delivery of functionality, at what point do you think that Adobe might move availability or delivery of product upgrades solely to your Adobe store and no longer have it through current distribution and perhaps use that then as a platform to move to more of a maintenance or subscriptions model.

Shantanu Narayen

It’s a good question, and frankly what we are already seeing in terms of the upgrade business is that in North America for example, the majority of the upgrade revenue is actually already coming through Adobe.

What that means to us frankly is that customers like the direct relationship with Adobe. We will still offer the upgrade through channels, but frankly it’s becoming a smaller and smaller percentage of the business because they’re all coming direct with us and as you said, that starts to allow us new possibilities in terms of offerings that we provide.

So upgrade is already moving. That would be a logical driver to drive more and more of the upgrade business to


Your next question comes from Michael Olson – Piper Jaffray.

Michael Olson – Piper Jaffray

Are there any numbers or qualitative comments that you can put around what you believe the size of the Creative Pro user base is as we go into CS5 versus what it was with the time of the CS3 launch?

Shantanu Narayen

There really is no material changes in the numbers that we’ve outlined for you both in terms of the creative professionals as well as the non-creative professionals and in terms of the mix that we see. We still continue to see both creative professionals and frankly the non creatives. These are knowledge workers, professionals in other industries as well as aficionados who buy our products.

The characteristics that we shared or the attributes at previous analysts meetings, we’re still all in line with that.

Michael Olson – Piper Jaffray

I know there’s going to be more functionality around this CS5, but can you talk about in general the pace at which from a high level the markets is embracing rich internet application development and is this phenomenon taking hold as fast as you expected?

Shantanu Narayen

We definitely see the trend more towards rich internet applications. We also announced a couple of other products earlier this week. We had an update to the Flex Framework which is the framework that people use to create these rich internet applications as well as an update to the Flash Builder as well as the core Fusion products.

There’s no question in our mind that when you see the next generation of experiences that people are creating, whether they be for enterprise applications, social applications or just websites, the distinction that we’ve consistently talked about between what’s content and what’s application continues to blur.

So the number of people who download data copies of our Flash Builder applications, that’s in the hundreds of thousands. So no question that rich internet applications are emerging and especially, I would also say on non PC devices, because on a non PC device, whether it’s an android or any other device, is that a rich internet application or is that a piece of content, and it’s really hard to distinguish so we’re excited about that.


Your next question comes from Sasa Zoravic – Janney Montgomery Scott.

Sasa Zoravic – Janney Montgomery Scott

If you could specifically address the issue with of Flash and the I-phone. Obviously I guess it was missing from the list of platform that you mentioned in your prepared remarks, and obviously as we look at it very closely as being very sort of a partnership that was sort of so critical or remains so critical to the company. So what are your plans or the strategies to address that going forward if you don’t mind giving us a comment on that.

Shantanu Narayen

I think we’ve been fairly transparent about that issue, which is we are committed to bringing Flash to any platform on which there is a screen, and it has nothing to do with technology. I think you’ve seen demonstrations of Flash running on smart phones from multiple vendors; at Mobile World Congress including Android where Eric showed it as part of his keynote.

It’s nothing to do with technology. It’s an Apple issue and I think you’ll have to check with them on that.

Sasa Zoravic – Janney Montgomery Scott

My second question is regarding the enterprise that you obviously showed a very strong come back as specifically I’m looking at the number of transactions over $50,000. Is this something really specifically that happened here in the quarter, something that kind of hold over’s from the fourth quarter or is this just really the beginning of a healthy spending on that higher end of things. You obviously mentioned things with Acrobat if you could provide us with more color there.

Shantanu Narayen

I think you are seeing IT stabilization in terms of the spend and also this move towards customer interaction solutions where people are revamping their websites to enable their customers to access that content and application for multiple devices.

We definitely see that trend, and so we think the economy has helped. We think our offering with Life Cycle ES continues to address that market need. And we’re excited about the pipe we are building. I think Mark in his prepared remarks talked about our expectation the enterprise business will continue to grow in the rest of the year.

And clearly, web conferencing with the move towards green as well as reduced travel, I think that also plays to the strength of our Connect business.


Your next question comes from David Halil – FBR.

David Halil – FBR

Mark, on the shippable backlog number, if you look at the last two quarters, it’s been a higher percent than it’s respective historical quarters and I wanted to see what’s driving these higher numbers that we saw the last two quarters?

Mark Garrett

I think the simple answer is it’s just reflective of a better business environment.

David Halil – FBR

But even if you go back from a couple of years ago when things weren’t as bad as the last year, they still seem to be even higher than that. I’m wondering if there is anything in the business or the model that suddenly may have changed that I’m not aware of.

Mark Garrett

No, no change at all.

David Halil – FBR

Shantanu, can you give us at least a rough break out of your CS installed base, what you think is on CS3 versus CS4?

Shantanu Narayen

Those are numbers that we don’t give out all of the numbers. I’ll maybe share a couple of statistics which is when we look at people who moved to CS4, they were certainly less of the install base than CS3, 2 and 1, so I would say that the transition from one, two and three to four was not as high, but we’re not going to share too many numbers as it relates to the penetration right now.


Your next question comes from Ross MacMillan – Jefferies & Company.

Ross MacMillan – Jefferies & Company

You talked a lot about CS5, but maybe I could just ask one question which relates to that addressable units. You’re introducing Flash Builder, Flash Catalyst, which are really more developer tools. You mentioned some of the life services as well. It strikes me that the addressable user units may be increasing here, especially as you push harder on developer tools as opposed to design tools. Is that fair, and if it is, should we expect to see separate suites for the developers or at least in this situation with those be wrapped up with design suites?

Shantanu Narayen

You’re right in saying that we are certainly targeting more developers and I think we’ve been careful to point out that the developers that we’re targeting are primarily web developers, people who have been using scripting languages. That will be an area of focus of us because they’re the folks who are increasingly creating rich internet applications.

So you can expect to maybe see some of what we have Flash Builder and Flash Catalyst show up in each of the suites. We’ll share all of those details with you on April 12, but we do see that as one way in which we want to address and increase the addressable universe of people for our offering applications.

Ross MacMillan – Jefferies & Company

Mark, could you just touch on the other income line again? As we think about Q2, I heard your comments around the $16 million to $18 million. I thought that was going to be the interest charge and you’d actually have some interest income against that on the cash, so I just wanted to go through that once more.

Mark Garrett

The debt is about $16 million, but you still end up with about a $16 million to $18 million charge. There’s other things in that line besides interest income on the cash and interest expense on the debt. There’s FX charges that flow through there as well. So that’s our best guess as where it’s going to end up right now when you factor all those things together.


Your last question comes from Kash Rangan – Merrill Lynch.

Kash Rangan – Merrill Lynch

If I listen to your comments carefully on the enterprise adoption side of CS5, is it a proper expectation that this could be a longer cycle, longer tailed cycle and maybe less exaggerated upfront but more uniformly distributed? And where are we with cross selling of Omniture with the Adobe install base, is you can just give us a quick update? I know it’s early, but I just wondered how that’s coming along.

Shantanu Narayen

With your first question, we think that the adoption cycle for CS5 in the enterprise will actually mirror that of CS4 and our previous versions which is, they will try it out. What I actually said was I think I sense a little bit more excitement from the enterprise because a number of those customers are dealing with this challenge of how do they repurpose their content from print to the new set of slate and tablet devices.

So I think that might prompt them actually to use CS5 hopefully in certain scenarios quicker than they might traditionally have done if they were only doing print. So that’s really how we see CS5 play out in the enterprise cycle.

With respect to Omniture, we’re definitely seeing more customers coming to us for an enterprise license with creative products, life cycle products as well as the Omniture products. So you are certainly seeing customers saying we want to standardize on the Adobe Creative Suite, and we want that integration with Omniture.

So it’s early as you point out, but we’ve been very pleased. And frankly, we’ve seen very little disruption. One of the real positives for us in the quarter was the fact that there was such little disruption in sales, which as we’ve known is one of the key drivers of the Omniture business and our revenue engine.

So the fact that that’s continuing to perform well, we’ve put the field organization and combined that with the Omniture field organization because they’re selling very, very frequently to the same customer, many times to exactly the same person in the enterprise. So early indications, very positive.

Well thanks again everybody for joining us. As I think we reported, Q1 was a strong start to the quarter and given everything that we see in terms of the product launches, we continue to remain very bullish about the remainder of the year and we look forward to sharing more with you both on April 12 as well as on our next earnings call. Thank you.

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