Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

TRANSCRIPT SPONSOR
Cornerstone OnDemand Logo

Adobe Systems Incorporated (ADBE)
F3Q07 Earnings Call
September 17, 2007 5:00 pm ET

Executives

Mike Saviage - Investor Relations
Bruce Chizen - Chief Executive Officer
Mark Garrett - Chief Financial Officer, Executive Vice President
Shantanu Narayen - President, Chief Operating Officer

Analysts

Jay Vleeschhouwer - Merrill Lynch
Adam Holt - JP Morgan
Philip Rueppel - Wachovia Securities
Robert Breza - RBC Capital Markets
Walter Pritchard - Cowen
Ross MacMillan - Jefferies & Company
Brent Thill - Citigroup
Brad Manuilow - American Technology Research
Heather Bellini - UBS
Gene Munster - Piper Jaffray
Peter Kuper - Morgan Stanley
Trip Chowdhry - Global Equities Research
Sasa Zorovic - Goldman Sachs
Steve Ashley - Robert W. Baird

Presentation

Operator

Good day, everyone and welcome to the Adobe Systems third quarter fiscal year 2007 earnings conference call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

Mike Saviage

Good afternoon, and thank you for joining us today. Joining me on the call are Bruce Chizen, our CEO; Shantanu Narayen, President and COO; and Mark Garrett, EVP and CFO.

In the call today we'll discuss Adobe's third quarter fiscal year 2007 financial results. By now you should have a copy of our earnings press release which crossed the wire approximately 45 minutes ago. If you need a copy, you can go to Adobe.com under the Company and Press links to find it.

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, are based on information as of today, September 17th, 2007, and contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued today as well as Adobe’s SEC filings, including our annual report on Form 10-K for fiscal year 2006, and our quarterly report on Form 10-Q in fiscal year 2007.

During this call, we will discuss GAAP and non-GAAP items. A reconciliation is available in our earnings release and on our investor relations website. Call participants are advised that the audio of this conference call is being broadcast live over the Internet and is also being recorded for playback purposes. An archive of the call will be made available in Acrobat Connect on Adobe's investor relations website for approximately 45 days and is the property of Adobe systems. The audio and archive may not be rerecorded or otherwise reproduced or distributed without prior written permission from Adobe Systems.

I would now like to turn the call over to Bruce.

TRANSCRIPT SPONSOR

Cornerstone OnDemand Logo

Want to understand the future of human resources software?

Cornerstone OnDemand is the leading provider of SaaS solutions for integrated talent management, covering the human capital life cycle from hire to retire.



We offer over 30,000 online training titles and performance tools for compliance and analytics to help companies maximize workforce productivity and achieve organizational excellence.



Learn about talent management and our industry leading products for learning management, corporate social networking, onboarding, compensation, compliance, employee performance management and succession planning at CornerstoneOndemand.com.



To sponsor a Seeking Alpha transcript click here.

Bruce Chizen

Thanks, Mike. I'm pleased to report that Adobe achieved outstanding growth in our third quarter of fiscal 2007. Revenue was a record $851.7 million, which far exceeded the high end of our target range and represents 41% growth over the same quarter a year ago. Non-GAAP diluted earnings per share were $0.45, which also exceeded the high end of our target range.

The record results were led by outstanding Creative Suite 3 adoption and continued momentum with Acrobat. We also drove strong revenue growth in each of our new business initiatives including enterprise, mobile and video. In a few minutes, Shantanu will provide additional business highlights for the quarter, but first I'll turn it over to Mark for a review of our financial results.

Mark Garrett

Thanks, Bruce. For the third quarter of fiscal 2007, Adobe achieved record revenue of $851.7 million. This compares to $602.2 million reported for the third quarter of fiscal 2006 and $745.6 million reported last quarter. GAAP operating expenses for the third quarter of fiscal 2007 were $504 million, compared to $474 million last quarter. Non-GAAP operating expenses were $448.4 million compared to $417 million last quarter.

GAAP operating income in the third quarter of fiscal 2007 was $255 million, or 29.9% of revenue. This compares to GAAP operating income of $110 million or 18.3% of revenue in the third quarter of fiscal 2006, and $180.4 million, or 24.2% of revenue, last quarter. Non-GAAP operating income in the third quarter of fiscal 2007 was $340.9 million, or 40% of revenue. This compares to Non-GAAP operating income of $207.2 million, or 34.4% of revenue in the third quarter of fiscal 2006 and $282.1 million, or 37.8% of revenue, last quarter.

Adobe's effective tax rate for the quarter was 25.9%. GAAP net income for the third quarter of fiscal 2007 was $205.2 million, compared to $94.4 million reported in the third quarter of fiscal 2006 and $152.5 million last quarter. Non-GAAP net income was $269.4 million compared to $171.5 million reported in the third quarter of fiscal 2006 and $223.2 million last quarter.

GAAP diluted earnings per share for the third quarter of fiscal 2007 were $0.34 based on 597.3 million weighted average shares. This compares with GAAP diluted earnings per share of $0.16 reported in the third quarter of fiscal 2006 based on 600.9 million weighted average shares and GAAP diluted earnings per share of $0.25 reported last quarter, based on 603.4 million weighted average shares.

Non-GAAP diluted earnings per share for the third quarter of fiscal 2007 were $0.45. This compares with non-GAAP diluted earnings per share of $0.29 in the third quarter of fiscal 2006 and $0.37 reported last quarter.

I will now discuss Adobe's revenue by business segment. Creative Solutions segment revenue was a record $545.5 million, compared to $331.6 million in Q3 of fiscal 2006 and $436.6 million last quarter. On a year-over-year basis, this represents 65% growth.

Knowledge workers segment revenue was $176.8 million compared to $150.6 million in Q3 of fiscal 2006 and $184.8 million last quarter. On a year-over-year basis, this represents 17% growth.

Enterprise and developer segment revenue was a record $59.3 million compared to $49.4 million in Q 3 of fiscal 2006 and $52.3 million last quarter. On a year-over-year basis, this represents 20% growth.

Mobile and device segment revenue was $13 million compared to $9.1 million in Q3 of fiscal 2006 and $12.3 million last quarter. On a year-over-year basis, this represents 43% growth.

Finally, our other segment revenue was $57.1 million compared to $61.5 million in Q3 of fiscal 2006 and $59.6 million last quarter. On a year-over-year basis, this represents a decline of 7%.

We experienced record revenue in all of our major geographic markets. Geographic results on a percent of revenue basis were as follows: the Americas, 47%; Europe, 33%; Asia, 20%.

Regular employees at end of the third quarter totaled 6,677 versus 6,427 at the end of the second quarter of fiscal 2007. The majority of the headcount increase from last quarter was in research and development.

Our trade DSO in the third quarter of fiscal 2007 was 28 days. This compares to 43 days in Q3 fiscal 2006 and 39 days last quarter. In regard to our global channel inventory position, we ended the quarter within company policy.

Deferred revenue declined sequentially in Q3 as we expected, based on the shipment of Creative Suite 3 upgrades to customers entitled to receive them.

During the quarter, cash flow from operations was $425.2 million. We repurchased 17.6 million shares at a cost of $703.5 million as part of our share repurchase program. Our ending cash and short-term investment position was $2 billion, which compares to $2.3 billion at end of last quarter.

This concludes my discussion of our financial results. I would now like to provide targets for our fourth quarter of fiscal 2007. With good momentum exiting Q3, our targets in Q4 are based on the assumption that we expect all of our businesses to grow revenue sequentially from Q3 to Q4. We are targeting a revenue range of approximately $860 million to $890 million. In addition, we are targeting a GAAP operating margin of approximately 30% to 31% and a non- GAAP operating margin of approximately 41%.

We are targeting our share count to be approximately 588 to 590 million shares.

For other income, we are targeting approximately $16 million to $19 million. For our GAAP effective tax rate, we are targeting approximately 25% to 26% and a non-GAAP effective tax rate of approximately 26% to 27%. These targets lead to a GAAP earnings per share range of $0.35 to $0.37 per share and a non-GAAP earnings per share range of $0.46 to $0.48.

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

Shantanu Narayen

Thanks, Mark. I'll spend the next few minutes reviewing highlights from our performance in Q3, starting first with the Creative Solutions business. Overall, version over version through the end of the quarter we have achieved a 36% increase in revenue with our CS3 family of products for the comparable CS2 time period. We remain excited about the long-term market dynamics that drove this performance and continue to expect CS3 to have a long tail.

In Q3, we had the following CS3 results: within the Suite offerings, Design Premium achieved the highest revenue, followed by Design Standard, Master Collection, Web Premium, Production Premium and Web Standard. We continue to see strong demand from Macintosh versions of CS3, which support the new Intel architecture. Photoshop, including Photoshop Extended, posted strong year-over-year growth with approximately 20% of revenue coming from the new extended version.

Our digital video business had a strong launch quarter, posting record revenue with over 70% year-over-year growth. More than 30% of that revenue came from Macintosh versions, reflecting high demand for our video solutions across Windows and Mac platforms.

We continue to be excited about our dynamic media opportunity. Our strategy is to provide the leading, complete, end-to-end solution from content creation tools to service solutions which provide for delivery of rich video content online to ubiquitous playback across platforms and non-PC devices.

In August, we announced the latest version of Adobe Flash Player which includes H.264 standard video support. This month, we started previewing Flash Media Server 3, our next generation's streaming media server which delivers video to PCs and mobile handsets. We have also started to see strong early adoption of Adobe Media Player by key companies involved in the creation, management and delivery of online and offline content for the entertainment industry.

Turning to our knowledge workers solutions business, we posted 17% year-over-year growth led by strong Acrobat performance with large wins that included customers such as Siemens, Rockwell Collins and Marvel. Acrobat Professional revenue continues to outpace Acrobat Standard, accounting for more than half of the overall Acrobat revenue reflecting demand for advanced collaboration and security capabilities.

In the emerging web conferencing space, the U.S. Department of Defense announced plans to adopt Acrobat Connect to enable deployed troops, support personnel and military leaders to collaborate more efficiently across locations worldwide. We continue to build momentum in our enterprise and developer solutions business in Q3, posting record revenue, up 20% year over year.

Following on the launch of Adobe LiveCycle Enterprise Suite, in June we announced new document generation solutions. With these new capabilities, LiveCycle ES integrates document generation with electronic forms, process management and document security to build business processes that extend from the initial request to the final archived document. Q3 customer wins included the Georgia Department of Transportation, which is using a LiveCycle solution to replace their manual, paper-based processes for routing documents between different state, local and federal agencies; Hang Seng Bank in Hong Kong is using Adobe's policy server and document security server to convert their paper-based statements to e-statements available to customers securely via the web; and, the Financial Services Authority, the UK financial industry's regulator, is using LiveCycle Forms, Rights Management and Reader extensions to file reports. In total, the number of enterprise transactions in the quarter with licensing revenue greater than $50,000 for our server products was 104.

In our mobile business we had another solid quarter with strong sequential and year-over-year growth that was in line with our expectations. Flash Lite adoption continues to be strong across a variety of handsets and consumer electronic devices.

In our platform business, we continue to drive awareness among developers with a beta version of Adobe Integrated Runtime, or Adobe AIR. We are pleased to see a large number of applications already being developed, including ones from mainstream companies like eBay and Salesforce.com, as well as applications from start-ups like Stride, Bounce, and Virtual Ubiquity.

This concludes my comments. I will now turn the call back over to Bruce.

Bruce Chizen

Thanks, Shantanu. Clearly Q3 was a great quarter for us. The explosion of digital information continues, and customers around the world are looking to Adobe to help them create rich, engaging content across a variety of media and devices in a constantly connected world.

As Adobe celebrates its 25th year and we are poised to break the $3 billion revenue mark, we are more confident than ever about our prospects for future growth. We are performing exceptionally well against our strategy and our position to achieve double-digit growth well into the future. We look forward to sharing more success with you in the coming months.

Mike Saviage

Thanks, Bruce. Before we start Q&A, a couple of logistical items. As we announced previously, Adobe Max 2007, our annual developer and designer event, is coming up soon. It will be held in Chicago Monday October 1st through Wednesday October 3rd. Information about Max can be found online at www.AdobeMax2007.com. For analysts and investors from the financial community, we have made available special pricing to attend the event on Monday, October 1st and Tuesday, October 2nd. On Monday, October 1st we will host a Q&A session with Adobe management to discuss news from Max. For further details on this offer and on Max, please contact Adobe investor relations or visit the Max website.

As always, we have posted several documents on the IR page of Adobe.com related to our earnings report today. They include today's earnings release, our updated investor data sheet and a table providing reconciliation for GAAP to non-GAAP financial data. To access these documents and other investor-related information, you can go to www.adobe.com/adbe.

For those who wish to listen to a playback of today's conference call, a web-based Acrobat Connect archive of the call will be available from the IR page on Adobe.com later today. Alternatively, you can listen to a phone replay by calling 888-203-1112, and use conference ID number 6464837. 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 4:00 p.m. Pacific time on Thursday September 20th, 2007.

We will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jay Vleeschhouwer - Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Thanks, good afternoon. Bruce, a broad question about the business, particularly since you are suggesting sustained double-digit growth. What would you view now with the company being more diversified, as the best macro indicators, external to the company, for sustaining that growth as you see it; versus the indicators that you may have relied upon in the past?

Secondly, a question about Acrobat before we ask about CS. I assume that a good percentage of Acrobat new unit placement are occurring through the various CS configurations that have Pro. But, in the knowledge worker business itself, what has to happen for there to be better overall momentum than we’ve seen year-to-date? Or, when do you expect the various direct selling initiatives that you have underway might begin to have a more material impact?

Bruce Chizen

Jay, let me take the first question. The three things that impact our business, one is overall marketing spend. It is a tough number to get to, because how companies and institutions are marketing and promoting their products and services is becoming more diverse than ever before. At one point in time, we could look at advertising spend; that is no longer the case. You have to factor in things like online advertising, billboard advertising and other types of marketing communications.

The other thing we look at is overall IT spend with products like Acrobat and LiveCycle, corporations and government agencies are looking to be more efficient than ever before, and they will increase their IT spend in order to do that.

The third thing we look at and continue to look at is consumer spending at the higher end. So we will pay much more attention to luxury good items, sales at the likes of Tiffany’s and Nordstrom’s versus sales of retailers like a Wal-Mart.

Besides that, we continue to look at the number of new websites that are being created, the richness of those websites, the amount of video on those websites, because that all means good things for Adobe.

Shantanu Narayen

On the second question, Jay, as it relates to Acrobat, clearly as we look at the CS3 results the customer adoption of suites is being seen, and that is being driven by Acrobat being a key component of that. But despite that, we were really pleased with the Acrobat performance this quarter. Our direct sales and licensing efforts did contribute to that, and we are seeing a number of larger enterprises adopt Acrobat, and that will continue to be our strategy, which is both with the direct sales forces getting enterprises to standardize on Acrobat, but in addition to that in the mid-market, continuing to make sure that small and medium businesses recognize the value proposition of Acrobat and adopt it as a platform, as a key part of our go-to-market initiative.

Jay Vleeschhouwer - Merrill Lynch

Finally on CS, is it fair to assume that Design Standard or Premium together are the vast majority of total CS sales? Do you have any reason to believe that there would be a material shift in the mix of the different configurations you have seen thus far?

Shantanu Narayen

Well, I would like to caution people on the call that with CS3 it is still early, we are certainly very pleased with the results, in particular Master Collection also did well this quarter. It was there for just part of the quarter. I think as we unveil CS3 for another quarter we will have better results. But, as anticipated, Design Premium is the best-selling suite, so it is clear that our segmentation is working with the customers.

Bruce Chizen

The suite is still the majority of the revenue as opposed to the independent, standalone products. With that said, when we look at the revenue from the independent, standalone products, it is holding up nicely which gives us cause for optimism as we move into later in the CS3 cycle and into CS4 and beyond. It gives us an opportunity to convert those customers to suite customers.

Operator

Your next question comes from Adam Holt - JP Morgan.

Adam Holt - JP Morgan

Good afternoon and congratulations. If I could just ask a follow-up on Master Collection, it was only in part of the quarter and you suggested obviously that it was the third-largest product, if I heard you right, in the quarter. Where are you seeing the initial demand for that product, if you could maybe go through both geographies as well as what kinds of customers are really migrating towards Master?

Shantanu Narayen

Well, the whole strategy around Master Collection was to make sure that creative professionals who wished to create content for print, web, video and wireless had a single integrated platform with best of breed products that allowed them to not only use their skills for current print or web content but in addition to that, to branch out to video as well as mobile.

The early adoption that we're seeing for the Creative Suite is primarily with a lot of individual creative professionals and they have been adopting the Master Collection because they see great value in the product and the fact that they can branch out their skills. We are starting to see larger customers also identify needs for the entire Creative Suite, but we think that will continue to happen over the next few quarters which is why we think there will be a long tail.

I think in the short run it is individual creative professionals; we certainly expect enterprises to adopt that over the next few quarters.

Bruce Chizen

Overall we did see particular strength in Europe. We were surprised, quite frankly, with how quickly the Europeans are adopting our solution. As many of you know, Q3 is typically a tough quarter for Adobe from a seasonal perspective and most of that weakness we typically find in Europe. It was surprising that all these people rushed back from their European holidays and from the beaches to go out and buy the Creative Suite.

Adam Holt - JP Morgan

And if I could just follow up, last quarter you made the comment that you were entering Q3 with pretty good backlog given the early strength in the product. Obviously this quarter was even stronger for CS. Could you talk a little bit about the kind of visibility you've got for Q4?

If I could just finish on the Acrobat business, what was licensing in terms of a percentage of aggregate revenue? Thanks.

Mark Garrett

We do have backlog going into next quarter. Like I said in my script, we do have some good momentum going into next quarter and that's factored into our guidance.

Shantanu Narayen

On the licensing and Acrobat, Adam, we used to give out that number primarily to reflect the fact that Acrobat was being adopted by larger enterprises and to reflect it. It continues to be the strength in the Acrobat business so we continue to see quite a significant amount of revenue coming from licensing.

Bruce Chizen

In fact, if you look at our overall business, the bulk of our revenue today or the majority of our revenue today across all of our businesses is not shrink wrapped. So for those of you who rely a lot on MPD data, which tends to be U.S.-based only, that number is becoming less and less relevant. I really caution you on trying to draw too many conclusions based on that data alone.

Operator

Your next question comes from Philip Rueppel - Wachovia Securities.

Philip Rueppel - Wachovia Securities

First, you mentioned the Mac a couple times and its strength. Do you sense that is really a catch-up of pent-up demand given the product was not tuned for the Intel-based Macs, or are we going through a time where the Macs as a percentage of your overall CS business is starting to creep up?

Shantanu Narayen

Clearly with CS3, when we supported the new Mac Intel architecture, the performance gains that the creative professionals get is tremendous. The Mac platform is a really important platform for us for the creative marketplace and while we are seeing growth in both the Mac and Windows -- and I want to make sure people understand it's not just on the Macintosh side that we're seeing strength in the CS3 business -- the fact is that as the Mac becomes a vibrant platform, all the creative professionals who wish to be there are adopting CS3.

The other thing we outlined was the fact our video products, we came back to the Mac this time with our non-linear editing product, Premiere Pro, as well as the entire Production Premium, and that's off to a strong start.

Finally I would say in the education segment the Mac tends to be an important platform, and again, that's where we are seeing strength.

Philip Rueppel - Wachovia Securities

Turning to the Acrobat business, I know that financial services and government are two key verticals; both of which there's been concern about spending in the near term and going forward. Did you see any of that impact at all this past quarter and has it impacted your pipeline as you head into Q4?

Shantanu Narayen

Not thus far. We had a strong quarter in both Acrobat as well as in the LiveCycle business in both those verticals.

Operator

Our next question today will come from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Bruce, a high-level question for you as we look at the breakout in the mix by geography. It looks like Europe was obviously very strong, driven by the new language releases and the Americas came in a little bit below where I thought they would as a mix percentage. Can you just comment what are you seeing by geography, in the U.S. specifically and in Europe you've already commented.

Bruce Chizen

As Mark said in his prepared remarks, the performance in each of the major geographies was great. Europe overshadowed the rest of the geographies, so the over-performance of Europe makes the Americas percentage seem smaller, but we were pleased across all of the major geographies.

Robert Breza - RBC Capital Markets

As a follow-up, as you look at the number of transactions greater than 50,000 clearly strong from a year-over-year perspective, what's really driving that from your perspective? Is it the change in licensing or just better demand? How do you nail that down?

Shantanu Narayen

Well, in terms of the transactions greater than $50,000 a lot of that is driven by both our direct sales force as well as our partners and it reflects adoption of LiveCycle ES frankly within enterprises as well as we are delivering our Connect set of web conferencing and e-learning products as well as a Flash media server for video. So all of those are included in that. We had a strong quarter, as you point out, from our direct but in addition to that we had a strong quarter with our partnership with SAP and so we're pleased to see the revenue that we're also getting from SAP and our LiveCycle business.

Bruce Chizen

Keep in mind that data point only includes deals of $50,000 or greater for our server-based products. It does not include large deals from our Creative customers or Creative Desktop, CS3 or from Acrobat; it only includes our server-based products.

Operator

Your next question comes from Walter Pritchard - Cowen.

Walter Pritchard - Cowen

Shantanu, you said several times you expect a long tail in the cycle. I'm wondering if you could give us a few pieces of evidence as you look at your business today and what you are seeing that convinces you that it's a long tail? Then I'd like to ask a follow-up on the mobile business.

Shantanu Narayen

I think the market dynamics are playing out, Walter, the way we had outlined. Namely the fact that this is the first Adobe/Macromedia release. We have supported the Mac Intel transition. As you also know, this was a long cycle between CS2 and CS3 and the new use cases that we've been talking about, which is video and mobile, what we are particularly pleased with is that the customer responds to CS3 and that the reviews have been really outstanding and the feedback is we've done a really great job both on the point products as well as delivered a comprehensive integrated solution.

So we've seen it being strong out of the gate but we know as we work with enterprises who will take a little while to evaluate the product and as we do our own customer research with other customers who have not yet moved, every indication is that it will continue to be like CS2 which is have the initial bump with a number of upgrades but then it will settle in at a higher base and continue to have a long tail.

Walter Pritchard - Cowen

Then just on the mobile business, I note that since November of '06 the business has been, you know, $12 million to $14 million in revenue a quarter and you've had great traction in terms of announcements of different partners and so forth. Going forward, how should we expect to see those announcements turn into a ramp of business? Is it the case that it will continue to be flattish here as that ramps and then start to accelerate, or do you expect it to be more gradual and sustained than that?

Bruce Chizen

Before we answer your second question, Walter, I want to make sure that I have a chance to pass my observations on why we believe the long tail of CS3 will exist and why we believe that the run rate and the revenue will consistently be above that of CS2 throughout the cycle.

The overachievement in Q3, which was greater than The Street anticipated and greater, quite frankly, than we anticipated by a large margin, for us is validation that the market dynamics of people, corporations, marketing firms, government institutions and anybody who needs to communicate needs to do so in a rich, engaging way across multiple platforms and we think that is the reason why we grew this business 41% year over year, why we believe based on the current guidance we’ll grow on an annual basis 21% to 22%. It’s why our Knowledge Worker business unit we believe grew 17% year over year. It’s why our enterprise business grew 20% year over year -- people need reliable, engaging information that works cross-platform and Adobe is the vendor that they turn to.

Shantanu Narayen

On the mobile business, specifically again, let me just quickly outline the three ways in which we make revenue on the mobile business. The first is royalty, where people who wish to use their mobile handsets to either browse the web or create compelling user experiences are licensing Flash Lite, so the royalty business, that’s the majority of our revenue today and with the attention that’s being paid on those handsets who need web browsing, we continue to think that that will be the majority of the business.

Clearly we also get revenue that’s related to the mobile business but is reflected in the authoring and this is where people are using our authoring tools to create content for these mobile devices.

The third aspect, which we said is more speculative and nascent, is the services business and that’s where, in conjunction with partners like DoCoMo in Japan and with Verizon in the U.S., we will be introducing services. So as we look to 2008, we expect the revenue to continue to be primarily the royalty-based revenue with the services being delivered to the customers but being a small percentage of the revenue.

Operator

Our next question comes from Ross MacMillan with Jefferies.

Ross MacMillan - Jefferies & Company

Thank you and congratulations. Just on the enterprise business first, do you attribute the breakout there above the historical trend as simply the LiveCycle release or is there something else going on in there that could be helping that growth? Thanks.

Shantanu Narayen

Well, on the LiveCycle business, it really isn’t like our traditional desktop business where the release of a new product leads to an inflection. I think it’s been the effort that we’ve been putting over the last few years, both in terms of getting the product right, getting more customer references, getting the partners and the entire ecosystem and the field organization primed to be able to go out and sell those solutions. So it’s something that we’ve been working on for many years. And we’ve always said we continue to expect to see sequential growth but don’t expect a sudden inflection point.

We are pleased with the results. I think it is clear that our value proposition is resonating with customers but I attribute it less to the release of LiveCycle ES than the work that we’ve actually done over the past few years.

Ross MacMillan - Jefferies & Company

And just maybe a follow-up, a general follow-up; now that Silverlight is out there formally, what is your sense as to the kind of market reaction to that, particularly with your own Flash community? I’m just curious to kind of get your first take on that.

Shantanu Narayen

Sure. I think with respect to video, we have been talking for a while now about how we think video is just a far more compelling way of communicating and we’ve been working hard. The reality is that Flash has the ubiquity across both platforms and devices and we have all the authoring tools that people are using to create it.

So we continue to be paranoid about what Microsoft does but frankly, as we look at what’s happening out there and the solutions that people are using, it’s really using the video that we have within Flash that continues to be the key standard in that marketplace.

We haven’t rested on our laurels. We’ve done H2-64 support so that we can have high definition and use the Flash Player for everything from a mobile handset all the way to our living room, and we continue to work with large media companies to make sure they adopt our end-to-end solution, from our authoring to our Flash Media Server to the player. And we are also excited about the new media player that we announced, which allows both media companies as well as people providing long tail video content to be able to monetize their video and use it in an offline mechanism.

We think we are ahead and we are continuing to innovate.

Bruce R. Chizen

The data is very revealing. More than 98.5% of people with computers have the Flash Player on it. Within the first year of release, about 90% of the people upgrade their Flash Player -- that’s more than any other desktop software, period. More than 70% of the video that is streamed on the web is currently streamed and played through the Flash Player and it’s even more telling that Microsoft itself is probably one of the biggest Flash streaming customers in the world. Even their own MSN site has a significant amount of Flash and Flash video on it, demonstrating that Silverlight is not yet there.

Operator

We’ll move on to Brent Thill as Citigroup.

Brent Thill - Citigroup

Thanks. Bruce, just back to your comment that CS exceeded your expectations by a pretty wide margin, what would you point to as the one or two things that really exceeded your view internally?

Bruce R. Chizen

It was Europe. We did well throughout all of the regions, as well as expected, but Europe was a big surprise. Most people in Europe are on vacation, business people, in the July/August timeframe. We usually get about a week or two weeks of sell-through the last couple of weeks in August. Just the amount of revenue that we saw come through was just greater than we had anticipated. People are finding a need to go out and buy the entire suite. The percentage of suites over standalone products continues to be significant, so we are getting -- we’ve invested a lot. We are getting more usage per customer than we had anticipated.

Shantanu Narayen

One of the things we also are pleased with is the fact that we were able to talk about the suites early on. We did public betas. In retrospect, we did a better job of priming the market and getting them aware of all the solutions and messaging it, so we think that’s helped as well.

Bruce R. Chizen

What’s great is, as Shantanu alluded to earlier, was that many or the majority of our corporate customers we believe haven’t yet upgraded or moved over to CS3 and that represents a nice opportunity going forward.

Mark S. Garrett

To give you a little bit more color on that, in Q4 we do expect that all the business units would be up sequentially with a slight increase in Creative and a more modest increase in Knowledge Worker, Enterprise and Mobile. We would expect that the CS3 revenue would peak in the fourth quarter due to the gradual slowdown on upgrades and that with the long tail of the CS3, similar to CS2, we believe that CS3 revenue would continue to be above CS2 levels throughout its cycle.

Brent Thill - Citigroup

Mark, just a quick follow-up; you’ve consistently talked about high 30% op margins and I think this is the first time you are going to go above 40% in operating margins into Q4 and you are target a range of 41%, so just how we think about the business. I know you are not giving guidance but certainly, should we continue to anticipate that high 30% target as the going target?

Mark S. Garrett

Sure. As you know, Brent, in the beginning of the year, our guidance was 37% to 38% operating margin for the year. We will likely end the year close to 39% when you look at what we’ve done so far, plus our guidance for the fourth quarter. And I’d anticipate margins to stay at those levels. We continue to believe there’s an incredible opportunity for the business and we want to take advantage of those opportunities by continuing to invest back in things like R&D.

Bruce R. Chizen

We really want to grow our earnings through revenue growth, not through savings.

Brent Thill - Citigroup

Thank you.

Operator

Your next question today comes from Brad Manuilow with American Technology.

Brad Manuilow - American Technology Research

Thanks for taking my question. So there is about a 24-month time lag between Creative Suite 2 and Creative Suite 3 product launches, which is a bit longer compared to what we’ve seen with some of your other product cycles. I’m just wondering going forward, how we should look at the time gap between Acrobat and Creative Suite product cycles.

Shantanu Narayen

Well, with Creative Suite 3, we are so early in the process right now, Brad, you know, I think the team is still excited about the initial reception so we’re clearly not going to be making announcements about the next release.

I think as it relates to Acrobat, you can look at historical releases to get a sense of when you might expect the next version of Acrobat but again, we’re not making any product announcements right now. Even with Acrobat, we were really pleased with how much growth we were able to get in a product that’s been in market for three quarters.

Brad Manuilow - American Technology Research

Okay, and just as a follow up, how much do you guys have left on your share buy-back authorizations?

Mark S. Garrett

With the 17 million shares that we bought in the quarter, four of those were related to the existing program that we had in place to offset dilution and roughly 13 million were related to the new program I announced last quarter to buy back 20 million shares, so shares delivered so far against the 20 million share program are about 13 million.

Brad Manuilow - American Technology Research

Great, thanks.

Operator

Our next question will go to Heather Bellini with UBS.

Heather Bellini - UBS

Great, thank you. I was just wondering, most of my questions have been answered but in particular I was wondering if you’ve seen an up-tick in this cycle versus the CS2 cycle of the amount of volume or the number of units being sold through Adobe.com’s website here in the U.S., which would make the NPD data even less relevant?

Shantanu Narayen

Heather, I think Bruce has already told you about the caution that we apply to people making conclusions, drawing conclusions based on NPD data --

Heather Bellini - UBS

Yeah, I heard that part. That’s why I’m just wondering; have you seen a bigger up-tick though with Adobe.com sales?

Shantanu Narayen

Certainly. I think as it relates to online commerce, we continue to see online commerce increase and Adobe.com is a fairly material part of our shrink-wrap sales in the U.S., so yes, we continue to see that go up.

Bruce R. Chizen

And when Shantanu says shrink-wrap, that includes people who are actually downloading the entire CS3 electronically, which is more significant than we had imagined it would be, given the size of the combined applications.

Heather Bellini - UBS

Okay, great and then just a follow-up would be, looking out to next quarter, it seems as if Asia-Pac has been the one region which really hasn’t seen the big pop like the U.S. and Europe has. I was just wondering if, given the timing of the releases there, is that something that we should expect to see in terms of an up-tick in adoption in the November quarter?

Mark S. Garrett

Heather, no. I mean, we do anticipate each region to go up next quarter but I would not anticipate anything overly significant in Asia.

Bruce R. Chizen

And keep in mind that Asia for Adobe is heavily driven by the Japanese performance because the rest of Asia, we have to deal with a lot of piracy issues, and the strongest quarters typically in Japan are Q1 and Q2, not Q3, Q4. So if anything, what you will see is sequential growth in Asia as we move into Q1 and Q2 to take advantage of the end of fiscal year for both government and businesses in that region.

Heather Bellini - UBS

Okay, great. Thank you very much and congratulations.

Operator

We’ll go now to Gene Munster with Piper Jaffray.

Gene Munster - Piper Jaffray

Congratulations. Bruce, I’m just kind of fast-forwarding to tomorrow to kind of the notes that are going to be written and it’s going to be the home run, giving you credit for the home run quarter you had and then, as has been asked a few times here, the talk about is this it, is this the -- and you very clearly addressed why you feel that this is not it. Is there -- you mentioned that CS3 is tracking 36% above CS2. Is there anything that we can look at in terms of the percent of installed base that has upgraded or that typically upgrades that might help us better get comfort with the concept that there’s going to be a long tail on CS3, there’s a lot left in the tank?

Bruce R. Chizen

No specific data, however, I think A, you want to ask yourself why did we over-achieve in Q3? And you heard our conclusion, is that it’s a validation of the market dynamics that exist in the marketplace. The other is you want to ask yourself about, or at least we certainly look at, in terms of larger customers, how long it typically takes for them to both evaluate and make the necessary changes to upgrade their infrastructure and clearly that’s not a one quarter phenomena. That’s something that happens over multiple quarters.

Gene Munster - Piper Jaffray

Okay, great. The rest of my questions have been answered.

Operator

Your next question comes from Peter Kuper with Morgan Stanley.

Peter Kuper - Morgan Stanley

Great, thanks. Real quickly, guys, when you talk about CS3 to CS2, has there been any indication that CS1, we’ve seen an upgrade of people catching up in there?

Shantanu Narayen

Well, you know, the way we have our products configured, Peter, we know what the upgrade revenue is and whether people upgrade from CS1 or CS2, it reflects as the same upgrade.

Certainly in the past we have seen generation skippers and we believe that CS3 is a good must-have release, but we are not going to be sharing any data specifically on the number of upgrades between CS3 from CS2 and CS1, but there are CS1 customers out there who are certainly part of the customer base we are targeting.

Peter Kuper - Morgan Stanley

Okay, and then very quickly, Shantanu or whomever, on the mobile, while still looking a relatively small part, do you still feel comfortable that the royalty model is the right way to go or could that be a future Acrobat kind of model, where you give away Flash Lite to help really dominate the mobile market? Or is it too soon to tell? Do you feel that you are going to dominate anyway, even with a proprietary based model right now?

Shantanu Narayen

Well, we think as long as browsing the web on those handsets continues to be a key way in which people use those handsets, the usage of Flash Lite on those devices is critical. We are not going to make any decision that jeopardizes our long-term prospects in mobile for short-term royalty revenue but in the royalty business, we actually have to do a fair amount of work with both the handset manufacturers and the carriers to make sure that Flash Lite is optimized. We’ve delivered more value recently, along with Flash Video, which allows them to monetize it in different ways.

And so while that’s a balance, we are confident that our ability to monetize it will continue in 2008 and that’s the right strategy and we’re not jeopardizing any long-term revenue prospects.

Bruce R. Chizen

We’ve been charging royalties in the Japanese market for many years now and we are on 100% of the mobile handset devices. We suspect, given the need, we will get to that kind of market share position over time in the rest of the world.

Peter Kuper - Morgan Stanley

Last quick follow-up; has there been any indications you’ve seen given your place in that mobile hierarchy where the iPhone is putting pressure on other carriers to up the ante for a user-rich environment, which could definitely help you guys, give you further penetration let’s say beyond Asia-Pac?

Bruce R. Chizen

The iPhone was a blessing for Adobe. It’s a great handset, a great device. The majority of the reviews, including the most recent one in the Wall Street Journal, clearly indicate that not having the Adobe Flash Player on that device is a deficiency.

Those handset manufacturers that are looking to replicate the success of the iPhone and enhance the success of the iPhone are certainly reading those reviews and that makes us -- leads us to believe you’ll find the Flash Player on more and more devices in the future.

Peter Kuper - Morgan Stanley

Thanks very much.

Operator

Our next question will go to Trip Chowdhry with Global Equities Research.

Trip Chowdhry - Global Equities Research

Thank you and again, very good execution. Two quick questions; first is regarding the MSRP on Creative Suite 3. Europe has about 70% more price point versus the U.S. Where do you see Asia-Pac being? And then I have a follow-up question.

Shantanu Narayen

I think, Trip, as it relates to our pricing, we do extensive research and it depends on a country-by-country basis. We certainly incur costs in each of those countries in the local currency and so it is hard to answer a question like that in absolute terms but I will say that we do a lot of research and make sure that we have the appropriate pricing by country.

Bruce R. Chizen

And clearly where the dollar is weaker is where our product is more expensive.

Trip Chowdhry - Global Equities Research

Perfect. A follow-up question is on the various tools business that I was thinking. Like, if you see historically [inaudible] haven’t done too well -- [inaudible], [inaudible] being just a few examples where you have to create more tools, sell them to certain developers or the other way around, or find new developers for the same set of tools.

I think the question I have is what is next? You are doing some server products. You did open-source something in Flex, which is having a lot of traction but how should an investor think through the tools business and maybe evolving into a server business, some open source? How should we think about what is the sustainable, other than product cycle story? Thank you and again, congratulations on a very good execution.

Bruce R. Chizen

Thank you. So first of all, the opportunities for Adobe are numerous. If you think about in addition to our ability to add value to our Creative Suites and in effect, being able to get more money where appropriate for that additional value, but at the same time we continue to diversify our product portfolio to reach new customers.

If you look at what we have done with Photoshop Extended to reach those who are in medical imaging or dental imagery or engineering, for their imaging requirements; if you look at what we’ve done with Acrobat 3D to address the manufacturing market; if you look at what we’ve done over the last couple of years in the Enterprise with LiveCycle, we now have a business that’s approaching $200 million, $250 million a year; if you look at the energy and efforts in mobile data services, in mobile licensing, a major initiative; if you look at what we are doing in the consumer markets with products like Premiere Express and Photoshop Express, major opportunity; if you look at how we are trying to leverage our position with Acrobat and real-time collaboration in e-learning and training with Acrobat Connect, major opportunity; if you look at what we are doing to address the complete workflow of video with not only our tools but our Flash Media streaming server, the Adobe Media Player, the ability to offer up analytics and advertising knowledge to our customers, big opportunity; so the list goes on and on and on.

If you look at Adobe, we are not a product cycle business. Yes, when we have a major release of our product, our upgrades go up but as we -- our revenue goes up, but as you saw with CS2, our revenue kept going up even at the last quarter of that release.

Trip Chowdhry - Global Equities Research

Perfect. Thank you.

Mike Saviage

Operator, we’ll take two more questions, please.

Operator

Okay. Our next question comes from Sasa Zorovic with Goldman Sachs.

Sasa Zorovic - Goldman Sachs

Thank you. So my question would be sort of if you kind of compare the outstanding results that Create Suite 3 has had here, you compare this to Acrobat and we are looking sort of in having to sit in a quarter with a lot stronger year-over-year growth that we’ve had for quite a few quarters but still the question kind of begs itself right here; why aren’t we seeing more growth with Acrobat? What would get the growth sort of further up, sort of even to come anywhere closer to where the Creative Suite 3 -- how are those -- what -- how different are the dynamics there to make that growth rate somewhat slower in comparison?

Bruce R. Chizen

To be clear, Sasa, we are very pleased with 17% year-over-year revenue growth in our Knowledge Worker business unit. That is a sizeable business for Adobe -- $600 million, $700 million a year -- that if we are able to sustain that kind of growth, we will continue to be very pleased.

As we have indicated in previous calls, we believe that there are about 95 million or so Knowledge Workers that could take advantage of the capabilities of Acrobat. We shipped, or at least what we said back in March, we’ve shipped about 25 million new units, which means that the market opportunity for Acrobat continues to be significant. We’ll continue to add capabilities to address new verticals, as we did with architectural engineering and construction industries, as we are doing in the legal industry, and we’ll take advantage of our ability to incorporate real-time collaboration as part of the Acrobat experience.

So the fact that we have a business in the creative business that happened to grow 65% year over year is great news. The fact that we have other businesses that are growing 17%, 20%, et cetera, is also great news. I don’t see that as a problem. I see that as very pleasing result.

Sasa Zorovic - Goldman Sachs

Okay, my second question would be regarding the currency contribution in the quarter, if you could provide the detail, please.

Mark S. Garrett

From a year-over-year basis, the benefit to revenue from currency was approximately $11 million. That’s $14 million favorable from the Euro and $3 million unfavorable from the Yen on a year-over-year basis.

Bruce R. Chizen

However, keep in mind that if you look at the time that we provided guidance, there has been zero impact as it relates to currency changes to our business. So when we provided guidance of $760 million to $800 million, the currency that we forecast at that time is exactly where it was today or was during the remainder of the quarter. So there was no impact on currency on that $851.7 million over achievement.

Sasa Zorovic - Goldman Sachs

Great. Thank you very much.

Operator

Our last question today comes from Steve Ashley with Robert W. Baird.

Steve Ashley - Robert W. Baird

Thanks for taking my question. Have you guys looked at the average transaction size within the Creative Solutions business for CS3 versus the past collections, like CS2?

Bruce R. Chizen

We do. It’s something we don’t typically disclose, other than at our annual meeting.

Steve Ashley - Robert W. Baird

Okay, and then maybe we could get an update on Acrobat Connect and what kind of demand you are seeing for that product.

Shantanu Narayen

We are pleased with what we are seeing with the Connect product. I think branding it Connect and integrating it with Acrobat was clearly the right strategy. I think one of the things I should probably clarify for everybody on the call is the real focus for Acrobat Connect is really in the e-learning segment. There’s a very broad web conferencing segment and there’s an e-learning segment that’s part of that which allows for corporate training, especially in sales departments, marketing, R&D groups around the world. That’s where we’ve been focused and we are seeing significant wins and year-over-year growth in the Connect business.

Steve Ashley - Robert W. Baird

Great. Thanks, and congratulations on the strong results.

Mike Saviage

Thank you. This concludes our call and we thank you for joining us today.

Operator

Once again, ladies and gentlemen, this does conclude our conference. We appreciate your participation. You may disconnect at this time.

TRANSCRIPT SPONSOR

Cornerstone OnDemand Logo

Want to understand the future of human resources software?

Cornerstone OnDemand is the leading provider of SaaS solutions for integrated talent management, covering the human capital life cycle from hire to retire.



We offer over 30,000 online training titles and performance tools for compliance and analytics to help companies maximize workforce productivity and achieve organizational excellence.



Learn about talent management and our industry leading products for learning management, corporate social networking, onboarding, compensation, compliance, employee performance management and succession planning at CornerstoneOndemand.com.



To sponsor a Seeking Alpha transcript click here.

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

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

Source: Adobe F3Q07 (Qtr End 8/31/07) Earnings Call Transcript
This Transcript
All Transcripts