Adobe Systems F4Q07 (Qtr End 11/30/07) Earnings Call Transcript

Adobe Systems Incorporated (ADBE)

F4Q07 Earnings Call

December 17, 2007 5:00 pm ET

Executives

Mike Saviage - Vice President, Investor Relations

Shantanu Narayen - President and Chief Executive Officer

Mark Garrett - Executive Vice President and Chief Financial Officer

Analysts

Jay Vleeschhouwer - Merrill Lynch

Heather Bellini - UBS

Adam Holt - JP Morgan

Thomas Ernst - Deutsche Bank

Philip Rueppel - Wachovia Securities

Brent Thill - Citigroup

Peter C. Kuper - Morgan Stanley

Jason Maynard - Credit Suisse

Gene Munster - Piper Jaffray

Christopher Rowen - Soleil Securities

Ross MacMillan - Jeffries & Company

Daniel T. Cummins - Bank of America Securities

Sasa Zorovic - Goldman Sachs

Walter Pritchard - Cowen and Company

Steven Ashley - Robert W. Baird

Presentation

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’ll discuss Adobe's fourth quarter and 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 of the press release, you can go to adobe.com under the company and press links to find an electronic copy.

Before we get started, I want to emphasize that some of the information discussed in this call, particularly our revenue and operating targets and our forward-looking product plans, is based on information as of today, December 17, 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 reports on Form 10-Q for fiscal year 2007.

During this call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two are 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 under Adobe's investor relations website for approximately 45 days and is the property of Adobe Systems. The audio and archive may not be re-recorded or otherwise reproduced or distributed without prior written permission from Adobe Systems.

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

Shantanu Narayen

Thanks, Mike and good afternoon. I am pleased to announce Adobe is reporting record quarterly and fiscal year revenue. Revenue in Q4 was $911.2 million, which was above the high end of our targeted range and represents 34% year-over-year growth. Driving our results in Q4 were continued adoption of our Creative Suite family of products, record Acrobat revenue and strong momentum in our enterprise business.

Revenue in fiscal year 2007 was a record $3.16 billion, an increase of 23% over fiscal year 2006. This was our fifth consecutive year of double-digit revenue growth.

2007 was a great year for Adobe, as our customers continued to look to us for solutions that enabled rich, engaging experiences across a variety of media and devices and as we continued to execute extremely well against our strategy.

In a few minutes, I will comment on 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, Shantanu. I will first comment on our full year fiscal 2007 results. Adobe achieved record revenue of $3.158 billion in the year compared to $2.575 billion in fiscal 2006. This represents 23% year-over-year revenue growth. GAAP operating profit in fiscal 2007 was $857.6 million, compared to $551.3 million in fiscal 2006. Non-GAAP operating profit in fiscal 2007 was $1.2089 billion compared to $959.1 million in fiscal 2006.

Our GAAP operating profit margin for the year was 27.2% compared to 21.4% in fiscal 2006. Our non-GAAP operating profit margin was 38.3% in fiscal 2007 compared to 37.2% in fiscal 2006.

Adobe's annual GAAP net income was $723.8 million in fiscal 2007 compared to $505.8 million in fiscal 2006. Adobe's annual non-GAAP net income was $965.8 million in fiscal 2007 compared to $757.3 million in fiscal 2006. GAAP diluted earnings per share in fiscal 2007 were $1.21 compared to $0.83 in fiscal 2006. Non-GAAP diluted earnings per share were $1.61 in fiscal 2007 compared to $1.24 in fiscal 2006.

Looking at our various businesses in fiscal 2007, we achieved strong growth in our key segments during the year. Our Creative Solutions business achieved revenue of $1.9 billion, which represents 32% growth when compared to fiscal 2006. Revenue for our Knowledge Worker business grew $728.5 million, which represents 11% year-over-year growth. Revenue in our enterprise and developer segment grew 22% year over year to $230.9 million, and our mobile business grew 40% year over year, while our other segment revenue declined 2%.

Now I would like to discuss our Q4 fiscal 2007 results. For the fourth quarter of fiscal 2007, Adobe achieved record revenue of $911.2 million. This compares to $682.2 million reported for the fourth quarter of fiscal 2006 and $851.7 million reported last quarter.

GAAP operating expenses for the fourth quarter of fiscal 2007 were $536.8 million compared to $504 million last quarter. Non-GAAP operating expenses were $480.3 million compared to $448.4 million last quarter. In the quarter, we had approximately $25 million of Q4 specific expenses that affected both our GAAP and non-GAAP results. These Q4 items included year-end variable compensation and legal settlements and were partially offset by a lower-than-anticipated tax rate.

GAAP operating income in the fourth quarter of fiscal 2007 was $275.8 million, or 30.3% of revenue. This compares to GAAP operating income of $163.4 million, or 23.9% of revenue in the fourth quarter of fiscal 2006 and $255 million, or 29.9% of revenue last quarter.

Non-GAAP operating income in the fourth quarter of fiscal 2007 was $362.2 million, or 39.7% of revenue. This compares to non-GAAP operating income of $256.4 million, or 37.6% of revenue in the fourth quarter of fiscal 2006, and $340.9 million, or 40% of revenue last quarter.

Adobe's effective tax rate for the quarter for both GAAP and non-GAAP measures was 23.6%, below our GAAP target range of 25% to 26%. The decrease in the fourth quarter tax rate can be attributed to geographic revenue mix and to the settlement of two state income tax audits.

GAAP net income for the fourth quarter of fiscal 2007 was $222.2 million compared to $183.2 million reported in the fourth quarter of fiscal 2006 and $205.2 million last quarter. Non-GAAP net income was $289.6 million compared to $198.9 million reported in the fourth quarter of fiscal 2006 and $269.4 million last quarter.

GAAP diluted earnings per share for the fourth quarter of fiscal 2007 were $0.38 based on 587.9 million weighted average shares. This compares with GAAP diluted earnings per share of $0.30 reported in the fourth quarter of fiscal 2006 based on 602.2 million weighted average shares and GAAP diluted earnings per share of $0.34 reported last quarter, based on 597.3 million weighted average shares.

Non-GAAP diluted earnings per share for the fourth quarter of fiscal 2007 were $0.49. This compares with non-GAAP diluted earnings per share of $0.33 in the fourth quarter of fiscal 2006 and $0.45 reported last quarter.

I will now discuss Adobe's revenue in Q4 by business segment.

Creative Solutions segment revenue was a record $570.5 million, compared to $364.1 million in Q4 of fiscal 2006 and $545.5 million last quarter. On a year-over-year basis, this represents 57% growth.

Knowledge Worker segment revenue was a record $192.1 million, compared to $180.9 million in Q4 of fiscal 2006 and $176.8 million last quarter. On a year-over-year basis, this represents 6% growth.

Enterprise and developer segment revenue was a record $68.4 million compared to $52 million in Q4 of fiscal 2006 and $59.3 million last quarter. On a year-over-year basis, this represents 32% growth.

Mobile and device segment revenue was $13.5 million compared to $12.1 million in Q4 of fiscal 2006 and $13 million last quarter. On a year-over-year basis, this represents 12% growth.

Finally, our other segment revenue was $66.7 million, compared to $73.1 million in Q4 of fiscal 2006 and $57.1 million last quarter. On a year-over-year basis, this represents a decline of 9%.

Turning to our geographic results, we experienced solid demand in all of our major geographic markets in Q4. Results on a percent of revenue basis were as follows: the Americas, 47%; Europe, 35%; and Asia, 18%.

Regular employees at the end of the fourth quarter totaled 6,794 versus 6,677 at the end of third quarter of fiscal 2007. The majority of the headcount increase from last quarter was in research and development.

Our trade DSO in the fourth quarter of fiscal 2007 was 32 days. This compares to 48 days in Q4 of fiscal 2006 and 28 days last quarter.

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

During the quarter, cash flow from operations was $398 million. Our ending cash and short-term investment position was $2 billion, approximately the same as it was at the end of last quarter.

Today we announced an increase to the 20 million share repurchase program we announced in April of this year. In fiscal 2007, 17.7 million shares were repurchased under this program. Our board of directors has authorized the repurchase of an additional 30 million shares, which increases the original 20 million authorization to a total of 50 million shares. This program is in addition to the ongoing stock repurchase program we initiated in 1998 to manage dilution from employee stock programs.

Under both share repurchase programs, in Q4 we repurchased 11.4 million shares at a cost of $477 million for an average cost per share of $41.97. For the year, we repurchased a total of 39.7 million shares, returning approximately $1.6 billion in cash to our stockholders as part of our share repurchase programs.

This concludes my discussion of our financial results. I would now like to comment on our financial targets.

For the first quarter of fiscal 2008, we are targeting a revenue range of $855 million to $885 million. In addition, we are targeting a GAAP operating margin of 30% to 31% and a non-GAAP operating margin of approximately 40%.

We are targeting our share count to be 586 million to 588 million shares. For other income, we are targeting $15 million to $17 million. For our GAAP and non-GAAP effective tax rate, we are targeting approximately 27%. This tax rate target does not include a potential one point benefit if there is a reinstatement of the R&D tax credit in 2008.

These targets lead to a GAAP earnings per share range of $0.34 to $0.36 and a non-GAAP earnings per share range of $0.44 to $0.46.

As we first indicated on November 12th, we are targeting annual revenue growth of approximately 13% in fiscal year 2008 and we are reaffirming that target today. Based on the results we reported for Q4, this equates to revenue of approximately $3.57 billion for the year.

We are targeting a full year GAAP operating margin in fiscal year 2008 of approximately 30% and a non-GAAP operating margin of approximately 39%.

Our full year financial targets include the following assumptions: we expect revenue in Q2 and Q3 to be approximately the same as revenue in Q1; new product releases in the second half of the year will offset normal seasonal weakness in Q3 and will also help to make Q4 the highest revenue quarter of the year, which we believe will set us up for a successful 2009. As a reminder, our targets assume a baseline of current economic conditions in our major markets. If the economy were to weaken in any of our markets, this could impact our ability to achieve these targets.

Finally, we are making some business segment modifications as we enter fiscal year 2008. The most significant change is the combining of our prior knowledge worker solution segment with our enterprise and developer solution segment into one new business segment called business productivity solutions. This segment change corresponds to changes we’ve made internally on how we run these businesses within one business unit.

Our investor relations data sheet will reflect this change starting with our Q1 fiscal year 2008 earnings report in March. Segment revenue for prior periods going back to fiscal year 2006 in our data sheet will be adjusted accordingly. In addition, we plan to continue to break out Knowledge Worker and Enterprise product revenue in the data sheet so that you are able to track our progress in these areas.

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

Shantanu Narayen

Thanks, Mark. I’ll spend the next few minutes reviewing highlights from our performance in Q4. Our Creative Solutions business continued to perform exceptionally well, driven by the ongoing success of Creative Suite 3. Based on results thus far, CS3 penetration into our creative professional customer base is mirroring the adoption of CS1 and CS2.

Version over version through the end of Q4, we have achieved a 37% increase in revenue with our CS3 family of products for the comparable CS2 time period, and approximately 65% of the revenue we’ve achieved in our creative business in fiscal 2007 is suites-based revenue. We remain excited about the long-term market dynamics that drove the CS3 performance and we remain confident about our expectations for a long tail in fiscal 2008.

With an estimated 76% of broadcasters who stream video on the web using Flash video, we continue to focus on the dynamic media market as a strategic growth opportunity. We achieved 37% year-over-year growth with our video products in Q4.

We just released an updated version of the Adobe Flash Player that includes H.264 support and we announced the new Adobe Flash Media Server Version 3 family of products, which includes significant improvements in performance, security, and mobile device support.

Finally, our digital imaging and digital video hobbyist business achieved record revenue and benefited from the release of new versions of Adobe Photoshop Elements and Adobe Premiere Elements.

Turning to our Knowledge Worker solutions business, the focus by our field organization helped to achieve record revenue with our Acrobat family of products. This is a significant achievement given the compare against the launch quarter a year ago. Acrobat Professional revenue continues to outpace Acrobat Standard, reflecting demand for advanced collaboration and security capabilities.

We achieved solid performance in the real-time collaboration and web conferencing market with our Acrobat Connect product line. Wins included the U.S. Army, the U.S. Marine Corps, and the borders group.

In our enterprise and developer solutions business, we had a record quarter with 32% year-over-year growth. Helping to drive this growth was the increase in the number of Q4 enterprise transactions with licensing revenue greater than $50,000. In total, transactions greater than $50,000 in Q4 were 154, up from 104 last quarter.

Enterprise wins during the quarter included AIR France KLM Group, which is using Lifecycle ES PDF Generator to support and administrate the flow and exchange of electronic documents; KBC, the second-largest bank in Belgium, which is standardizing on Adobe Lifecycle for all its electronic forms; and NATO, which just announced last week it will leverage Adobe Flex and Adobe Lifecycle data services ES for its new mission support system to improve NATO’s operational readiness and the delivery of information to flight crews.

In our mobile business, we had another solid quarter. In October, we launched Flash Lite 3, which supports Flash video and enables the delivery of engaging experiences and dynamic web content on mobile devices. NTT DoCoMo and Nokia have announced their commitment to deliver Flash Lite 3 enabled devices in upcoming deployments of their respective handsets.

Turning to our platform business, our focus remains on Adobe AIR. In the same way that Adobe technology contributed to the desktop publishing revolution, we believe the Adobe integrated run-time is going to revolutionize today’s web experience. AIR lets developers use their existing web development skills and standards, such as HTML, Ajax, and Flash, to build and deploy rich Internet applications to the desktop without the constraints and limitations inherent in web browsers.

Developer feedback has been positive and we’ve already showcased many applications developed on the beta version of AIR, including anthropology, AOL, business objects, eBay, the NASDAQ stock market, Nickelodeon, PayPal, Philips, QVC, Salesforce.com, SAP, and Yahoo!. These and many other companies are already building next generation user experiences based on Adobe AIR.

And finally, our print and classic publishing business celebrated a milestone this quarter with the release of the Adobe Technical Communications Suite, an integrated solution for offering, managing, and publishing technical information and training content across multiple formats and languages.

Looking forward, as Adobe celebrates its 25th anniversary, we are more focused than ever on the enormous opportunities we have to continue to revolutionize how the world engages with ideas and information.

During fiscal 2008, we will not only launch new versions of several of our leading software products, we will also deliver Adobe AIR, our platform for developing rich Internet applications that will enable rich, engaging experiences across the web, on the desktop, and on mobile devices.

We are performing exceptionally well against our strategy and the company is better positioned than ever to lead the next wave of software innovation and continue delivering solid financial performance.

Now I will turn the call back over to Mike.

Mike Saviage

Thanks, Shantanu. Before we start Q&A, I would like to go over a few items.

First, we have set the date for our next financial analyst meeting. The date is Thursday, May 1st, with the location being in the Bay area. More information will be provided in early 2008.

We have posted several new documents on our investor relations webpage today. They include today’s earnings release, our updated investor data sheet, a table providing reconciliation for GAAP to non-GAAP financial data, and information related to our new business segment classifications for fiscal 2008. To access these documents and other investor related information, you can go to our website at www.adobe.com/adbe.

For those who with to listen to a play-back of today’s conference call, a web-based Acrobat Connect archive of the call will be available from the IR page on adobe.com later today. Alternatively, you can listen to a phone replay by calling 888-203-1112. Use conference ID number 3846445. Again, that phone number is 888-203-1112, with ID number 3846445. International callers should dial 719-457-0820. The phone play-back service will be available beginning at 4:00 p.m. Pacific Time today and ending at 4:00 p.m. Pacific Time on Thursday, December 20, 2007.

We will now be happy to take your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Jay Vleeschhouwer with Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Shantanu, the first question has to do with how you think about the long tail for Creative Suite. What if any are the key leading or coincidental indicators that you look at to substantiate the view that you will have the long tail? For example, do you look at OS mix? Do you look at upgrade volume versus new units or what if anything are the variables that you take into account versus how products would have behaved in the past?

Secondly, with respect to Acrobat, can you comment at all on how the increase in the installed base compared with the previous couple of years? I believe in ’05 and ’06, based on your disclosures, you increased the base by about 5 million a year each. And the question therefore is how that base increase performed in ’07.

Shantanu Narayen

On the first question associated with CS3, first, we are really pleased with the performance that we had for CS3 in Q4 and as you know, we do a lot of research by talking to our creative customers to understand adoption cycles and the research continues to indicate that the key trends that we talked about prior to the release of CS3, namely the excitement around the fact that it was our first release of the integrated Adobe Macromedia products, that fact that we were supporting Mactel on this, the amount of video that we are seeing on the web -- those trends are absolutely continuing.

Mac performance also continues to be strong. That’s clearly one of the indicators that we do look at and our research tells us that Mac customers, while we are seeing adoption, there is still a fair amount of adoption left to go.

So fundamentally, the slope of CS3 adoption is very similar to that of CS2 and CS1, with the one exception that the revenue is significantly outpacing those other two previous cycles, which is why we continue to be optimistic about CS3 and we continue to believe that we will see a fairly long tail for CS3 this cycle.

With respect to your second question on Acrobat, we’re not updating the total number right now but when you look at Acrobat units, both as standalone, the fact that we had a record quarter a year after the release was very, very pleasing. We are starting to see some significant adoption within enterprises and when you consider the Acrobat adoption within each of the suites as well, two things come to mind: one is, it’s clear that higher value users of PDF are really what are driving the PDF usage, both within the suites as well as through Acrobat Professional and there continues to be significant unpenetrated seats with the knowledge workers that we are continuing to target against.

Jay Vleeschhouwer - Merrill Lynch

Lastly, for Mark, as part of the 13% outlook for ’08, can you comment at all on any specific geographic assumption? It’s clear that Europe was a strong performer for you throughout the year as it’s been for many technology companies. Are you seeing any indications, however, in some parts of Europe at all that the growth may be beginning to decelerate there, compounding perhaps the concerns that investors have about U.S. growth?

Mark Garrett

I’m not going to give any guidance on regional breakouts for 2008 but I will say that we have not seen any regional problems relative to performance. All our geographies continue to do well, including Europe and we would expect that to continue.

Jay Vleeschhouwer - Merrill Lynch

Thanks, Mark. Thanks, Shantanu.

Operator

We’ll take our next question from Heather Bellini with UBS.

Heather Bellini - UBS

Thank you. I was wondering if you could help out with a couple of things. First, you mentioned new product releases that you are targeting to help offset seasonality in the August quarter. Could you share with us what product segments you are referring to?

And then, I had a question regarding operating margins this quarter and I may have missed this, so I apologize, but can you walk us through? You guys fell a little bit short in the quarter versus your expectations. Can you walk us through the thought process behind that?

Shantanu Narayen

I’ll take the first one and let me start off by saying if you look at our current suite of products, whether it’s Acrobat 8, CS3, or Lifecycle ES, we believe that they are absolutely stellar releases and performing really well in the marketplace.

What we are doing is while we are not announcing any new products, we wanted to share the excitement that we had about some of the new products that are on track for delivery in the second half of the year and they should really allow us to both close 2008 strong as well as enter 2009 with momentum.

So the goal there was primarily as we talked about revenue from a quarterization perspective to give you some color. But one of the things we’ve learned is for competitive reasons, we don’t want to share product launches well before we are ready to do that.

Heather Bellini - UBS

Okay, fair enough. And then on the margin front?

Mark Garrett

I’ll take that one. I did mention we had about $25 million of Q4 specific expenses in the quarter -- $10 million of that hit our cost of sales line, so that lowered our gross margin and that was driven by some litigation settlements in intellectual property. And we had some compensation and commission charges that made up a lot as well of the $25 million. And with those $25 million worth of expenses pulled out, operating margins would have been over 42%.

Heather Bellini - UBS

Okay, great. Thank you.

Operator

We’ll take our next question from Adam Holt with JP Morgan.

Adam Holt - JP Morgan

Good afternoon. My first question is about the penetration around CS. You suggested that it’s tracking in line with the previous cycles. Presumably the installed base is much -- well, not presumably. The installed base is much larger this time around. Are you talking about penetration on a relative or an absolute basis?

And then my second question would be on the 37% cycle-on-cycle growth, could you talk a little bit in further detail about the mix between units and ASPs driving that growth?

Shantanu Narayen

Well, as it relates to your second part, I mean clearly we are seeing an uplift in ASP as people are moving from the individual point products to the suites and we are seeing adoption of the suites. When one looks at CS3 performance for the entire year, the design premium and the design standard for the entire year were primary drivers of revenue. Remember that Master Collection was not available for the entire year but Master Collection also continues to do well. So we are clearly seeing customers adopt the version of our suites.

When we talk about penetration, what we are doing is we are looking at first the number of creative professionals that exist in the community and understanding how many of them have moved to CS3 versus those who are still in the process, such as large customers of evaluating the products and have not completely moved, as well as the mix that we are seeing between creative professionals and non-creative professionals.

We have stated in the past that about 60% of the units are going to creative professionals but the rest is going to aficionados, people who like creative. So it is really mirroring prior releases quite a bit and that gives us a great degree of confidence.

Adam Holt - JP Morgan

If I could ask just one more follow-up, you left the third quarter with quite a bit of backlog heading into Q4. I believe it was over 5% of sales. Can you talk at all about the kind of backlog and visibility you have on the first quarter? Thank you.

Mark Garrett

In Q4, the end of Q4 we will exit with approximately 7% in shippable backlog. Like you said, that’s up from 6% at the end of Q3. You should know that backlog is not indicative of future performance and it is factored into our guidance.

Adam Holt - JP Morgan

Great. Thank you very much.

Operator

We’ll take our next question from Tom Ernst with Deutsche Bank.

Thomas Ernst - Deutsche Bank

Good afternoon, gentlemen. Thanks for taking my questions. With the long tail forecast here into next year and a new product cycle coming, I’m curious -- and you are forecasting a bit lower operating margin from Q2 through Q4 than in Q1. You must be investing for this product cycle or perhaps you are investing in AIR. Would you walk us through what the investments are and why you forecast a little bit lower operating margin as we get past Q1?

Mark Garrett

Let me start and then Shantanu might want to add on to this. Let me give you a little bit of color about revenue as we go through the year. We gave you a range for Q1 on revenue of 855 to 885. And we anticipate that CS3 revenue in the first quarter would be approximately the same as Q4 but overall creative business unit would decline due to hobbyist seasonality. We would expect Acrobat in Q1 to be approximately the same as Q4. We would expect enterprise would decline sequentially due to seasonality and that mobile and other would be approximately the same as Q4, so that gives you a little flavor into the first quarter.

And then, as I said in my comments, as we go through the year, Q2 is very similar to Q1, Q3 is very similar to Q2 because the launches offset some seasonality and with revenue tracking that way, obviously we are going to continue to invest in the business. So margin is a little higher in Q1. It will come down in Q2 and Q3 as we continue to invest and then it will jump back up in Q4 to hit that 39% for the year.

Shantanu Narayen

As a company we continue to be really excited about our long-term growth rates and if you think about what we have done from a margin perspective -- in ’06 they were approximately 37%. In ’07, they actually went up to approximately 38.3% and we are targeting 39% for ’08 which frankly is higher than most other companies were at this revenue rate.

So we are bullish about our organic growth rates and we continue to balance between investing for the future and returning to our shareholders.

Thomas Ernst - Deutsche Bank

Is there any particular concentration to the investment? Is it more on the AIR side or is it just general across the board?

Shantanu Narayen

Well, I think research and development continues to be the primary area, as Mark mentioned, for our investments. At the same time as the product launches are coming, we certainly want to make sure that we get the message out and get that right, much like we did for CS3 and earlier versions of Acrobat.

Thomas Ernst - Deutsche Bank

All right. Thank you again.

Operator

We’ll take our next question from Philip Rueppel with Wachovia Securities.

Philip Rueppel - Wachovia Securities

Thank you very much. On CS3, could you talk a little bit about corporate adoption? Last quarter, if I recall, you said the majority or at least a significant amount of large customers hadn’t upgraded. Are you seeing a pick-up in that now? Is it an ’07 budget item or are many of your customers waiting for ’08 budgets?

Shantanu Narayen

Well, the one thing I first want to clarify is that when you talk about CS3 adoption, there are a number of large customers who adopt right off the bat. There are other large customers, what they tend to do is either for one section of a newspaper or a magazine or a certain percentage of their workforce, they move it and then after testing it, they actually deploy it enterprise wide.

In Q4 we continued to see some significant adoptions by larger enterprises, which is why the revenue was very well, and we continue to bake that into our targets for the next year. But we do expect to continue to see adoption of CS3 by both individuals as well as larger enterprises throughout 2008.

Philip Rueppel - Wachovia Securities

Okay, thanks. And then on AIR, are there metrics we should be looking at to assess the progress that you are making there, whether it’s downloads or downloads of the SDK? And could you talk a little bit about competition in that space, whether it’s Silverlight or others? How do you see AIR positioned over the long term? Thanks.

Shantanu Narayen

What’s exciting about AIR, frankly, is the fact that the current web experience as it takes us today has some significant deficiencies and I think we have a unique opportunity to make the web experience a lot better.

What we are doing to measure the success of AIR in the early going frankly is new adoption by developers, so one of the things we try to do is give you a smattering of the applications that people have developed on AIR because it’s still frankly quite early in the process. Adobe itself will be also offering some AIR applications. We have the application called Buzzword, which we acquired, which we will be offering as well as the Adobe Media Player.

So in the short run, I would really look for new application adoption and new application delivery that highlights functionality of AIR.

With respect to competition, I think there are multiple companies that look at the opportunity to really change the web experience. What Microsoft is doing with Silverlight is really focusing more on the media aspects of it, much like we did with Flash Player. But I think you will continue to see other companies also target the entire web experience as an area for innovation.

We think we are uniquely positioned because frankly our strategy leverages the broad reach that we already have off PDF and Flash and the fact that AIR is actually built on existing standards rather than trying to reinvent web standards as some other companies are trying to do.

Philip Rueppel - Wachovia Securities

Great. Thank you very much.

Operator

We’ll take our next question from Brent Thill with Citigroup.

Brent Thill - Citigroup

Thanks. Shantanu, regarding an earlier question around units on CS3, there’s a pretty dramatic price increase in the design premium when you go off lifts, so I guess I’m just trying to reconcile the price lift versus the units sold through. If you just took the price lift, it would assume that some of the units seem to be flat at this point in the cycle. Can you just help us out in terms of trajectory of how the units are selling through?

Shantanu Narayen

The challenge with that, as we mentioned in the past, is that how do you consider a unit of a suite? I mean, do you consider a suite that has multiple products in it as multiple units or as one unit? Which is why there has been a challenge associated with looking at units when we talk about how CS3 has performed.

The other challenge frankly is that as we’ve changed versions of the suites to have different applications post the Macromedia acquisition, that also makes the comparison on a version-over-version basis really hard, which is why we look at penetration within the existing install base and we look at revenue and we’ve been trying to share that with you.

But overall the adoption and the customer reception has clearly been great.

Brent Thill - Citigroup

Okay. Despite the broader number of SKUs and the higher price points, you haven’t heard any concerns from evaluating customers that there are maybe too many selections and the price point is too high?

Shantanu Narayen

No, actually one of the things that we’ve got kudos about is after we put together the Macromedia Studio and the Adobe Creative Suite products, that the segmentation has actually been very clear, the design segmentation, the web segmentation, the video and what we are seeing with production, premium and the master collection. And remember, as more and more people use master collection, that all goes well for future releases because they will be all then using the standard as master collection rather than as the individual point products.

The one other thing that I will mention is that in the education segment, we are seeing quite a bit of adoption of the master collection, which is good because it means that the next generation of creative professional is actually familiar with all of our products.

Brent Thill - Citigroup

Real quickly, just on the business productivity solutions, the combination, can you just walk through the rational and were there any disruptions as it relates to who’s heading that business or associated sales structure behind that?

Shantanu Narayen

No, this was actually something that we had done a while ago. As you know, we are required to report external segments much in the way we run the business internally, which is why we will be reporting it as a business productivity solutions in order to maintain the transparency that we currently have for each of the individual business lines. We will continue to do that and no, there has been no disruption internally.

Brent Thill - Citigroup

Thanks.

Operator

We’ll go next to Peter Kuper with Morgan Stanley.

Peter C. Kuper - Morgan Stanley

I think this question has been danced around and not asked, but let me make sure we get to it -- looking forward to the ’08 guidance, I think you said specifically and rightly that based on current market conditions, of the product lines, the major products lines that you guys are offering the market, are any in particular would you say more subject to enterprise spending pressure? I.E., is it Knowledge Worker, et cetera, or it’s just a too broad analysis at this point?

Shantanu Narayen

You know, what we have said is that when you look at each of the individual point products in the enterprise space as it relates to the Lifecycle business, the value proposition really is about saving costs and frankly it tends to be below the capital spending thresholds for CIOs, which is why we haven’t seen any impact thus far.

When you look at the creative customer, for the creative customer as long as they are in business and there is marketing spend, frankly the product more than pays for itself in a few uses because if you are a freelancer and you have the ability to take a few more jobs, the price of the software is not an inhibiting factor.

So while I would not say that Adobe is recession proof by any means, the price points of our products tend to be lower than some of those of the much larger enterprise software companies.

Peter C. Kuper - Morgan Stanley

Great. Just following on mobile and device solutions, I mean, that line I think we’ve been looking for that to start to ratchet up. I know Flash Lite has been getting a lot of share on the handsets. Is there anything we should look forward to ’08 to see some -- either an inflection point from the ramp or just the penetration and the revenues will follow based on AIR down the road, or how should we look at that line item going forward?

Shantanu Narayen

Well, I think from a revenue perspective, we expect to see that continue to be in the range that it is right now, Peter. What’s misleading a little bit when you look at the revenue is that it does not actually reflect the penetration that we are seeing on handsets.

We’ll update the install base on handsets at the analyst meeting but the reality is that because Macromedia both had a number of prepays as well as for accounting reasons, the revenue there doesn’t fully reflect what the adoption is. The adoption of Flash Lite on handsets if anything is accelerating and we are really pleased. We’ve said that we’ve crossed 300 million and we continue to see adoption by handset manufacturers worldwide, so very excited about the adoption we are seeing on handsets.

Peter C. Kuper - Morgan Stanley

Great. That’s helpful. Thank you.

Operator

And we’ll go next to Jason Maynard with Credit Suisse.

Jason Maynard - Credit Suisse

I just wanted to touch a little bit on what you are thinking about in the Flash Media Server product and just some commentary around the recent price reduction and how you think that will affect adoption and unit growth.

Shantanu Narayen

Well, a couple of things. First with the Flash Media Server 3 product, we are excited about Flash Media Server 3 because first as we now support industry standard video up to HD quality, which was clearly one of the important things that our media customers wanted, support for things like H.264 as well as AAC. And the other key features in the product were more streams per server, significant performance improvements as well as parody between Windows and Linux, as well as support for content production, which was an important thing that our customers wanted.

What we are finding in the marketplace is that people want to use Flash streaming but frankly they are choosing less secure and less efficient methods, such as not having security but having unsecured download and really the goal for us right now in our end-to-end video workflow is to make sure that Flash video is supported by all of these media players.

So the price thing is also to make sure that as we add support for mobile devices, we have the ability to meet the needs of all our customers, so very excited about what’s happening with Flash video.

Jason Maynard - Credit Suisse

Okay, and I just have one follow-up for Mark and I apologize if I missed it; what is left than on the share repurchase authorization post the buy-back that you completed in Q4?

Mark Garrett

Of the 20 million that we announced earlier in the year, we’ve completed 17.7, so there is 2.3 million on the 20, and then we’ve raised the 20 now by an additional 30 million to a total of 50.

Jason Maynard - Credit Suisse

Okay. That’s what I needed. Thank you very much.

Operator

We’ll take our next question from Gene Munster with Piper Jaffray.

Gene Munster - Piper Jaffray

Good afternoon. You guys have talked a little bit about AIR here. Can you give us some thoughts, Shantanu, in terms of how we should be modeling AIR in 2008?

Shantanu Narayen

I think in terms of 2008, AIR is really all about getting the distribution of AIR and brand new applications. Clearly long term, we believe that AIR has some significant synergies with respect to revenue that we might see on our tools, new applications that we will develop, such as the Adobe media player which allow us to start to have new monetization mechanisms, such as advertising.

But in 2008, our expectations are more around getting broad distribution of the run-time and seeing some phenomenal new applications that take advantage of that functionality.

Gene Munster - Piper Jaffray

At some point, we will model that as a separate business like we do Acrobat? That’s kind of the idea?

Shantanu Narayen

I think it’s a little early for us to give you a final response on that but what I would say is clearly there’s a tool synergy associated with as we deliver the next version of Creative Suite people using those tools to create AIR applications. I think you will see synergy with our server products as people use streaming video servers or image servers to stream this next generation of rich Internet applications, and the new applications that we will develop from scratch.

So you’ll see some uplift in our existing segments but you’ll also see hopefully new applications that we develop on AIR.

Gene Munster - Piper Jaffray

Okay, and one final question; as you had a healthy increase in guidance for the first quarter but maintain the full year 13%, how should we read that?

Shantanu Narayen

Well, overall -- I’ll start and then I’ll let Mark add. I mean, it was clear that 2007 was a really banner year and we are very pleased with the outlook for double-digit growth that we’ve again provided for 2008. And you know, we take our targets seriously. This is over $400 million in additional revenue for 2008 and it’s clear our strategy is working and we are executing against it, so we are very pleased.

Mark Garrett

I don’t have anything to add to that. I think Shantanu said it very well.

Gene Munster - Piper Jaffray

Okay, great. Thank you.

Operator

(Operator Instructions) We’ll take our next question from Chris Rowen with Soleil Securities.

Christopher Rowen - Soleil Securities

Of the $25 million in fourth quarter specific costs, how much of a decrease would you expect to see sequentially? In the first quarter of ’07, we only saw a $1.5 million sequential decrease in pro forma operating expenses, so is there a reason why we’d see a bigger increase this year and how much?

Mark Garrett

Of the 25 that I’m talking about, that was Q4 specific and does not carry through into Q1. That was the reason I wanted to break that out for you. Also, because of the fact that it impacted the margin in Q4 but when you look at Q1, I’m not going to give you guidance on operating expenses. I’ve kind of given you top line and I’ve given you operating margins, so you can kind of figure out the math in between there but we get back to an extremely healthy 40% operating margin in Q1, which is what’s driving the EPS number.

Christopher Rowen - Soleil Securities

Okay. Thanks a lot.

Operator

We’ll take our next question from Ross MacMillan with Jeffries.

Ross MacMillan - Jeffries & Company

Thanks. Just a quick one on the quarter, just on Asia; you mentioned that obviously all regions were strong but Asia was actually down sequentially. Was that a surprise and if so, can you add any color to that? Thanks.

Shantanu Narayen

Again, as we said in the prepared remarks, we had solid performance across the board, so EMEA was a very strong quarter for us and -- but the demand for whether it’s CS3 as well as for Acrobat products continues to be worldwide.

Ross MacMillan - Jeffries & Company

Okay, and then just Mark, on the buy-back, can you just clarify -- I understand the 17.7 but I think you’ve done an incremental buy-back since then. Is that correct? So the 11.7 in 4Q or is that all included in that 17.7?

Mark Garrett

There’s two programs that we have in place. So there’s a program to offset dilution and there’s a program that’s opportunistic, which we announced earlier in the year. In Q4, we bought back a total of 11 million shares under both programs and the opportunistic program for the year, we bought back 17.7 million shares.

Ross MacMillan - Jeffries & Company

Got it. So I should just add that residual and then the 30 million and that’s the opportunistic piece still to be used?

Mark Garrett

Correct.

Ross MacMillan - Jeffries & Company

And then one final one just on -- you mentioned product releases in ’08. Are you precluding first half launches or should we not necessarily read into that, your comments that -- in other words, it is still possible we see new product releases in the first half of the year?

Shantanu Narayen

Again, we are not giving anymore color other than the color that we gave -- again, primarily to give you some idea to model from a quarterization perspective.

Ross MacMillan - Jeffries & Company

Okay. Thank you.

Operator

We’ll go next to Daniel Cummins with Bank of America.

Daniel T. Cummins - Bank of America Securities

Thank you. I wanted to ask a couple of questions about products. Could you clarify whether you believe the monetization of AIR is likely to be largely from server licenses or from some sort of royalty model on the client side over the long run? I had a question about voice-over IP and also a question about the Flash Media Server as well.

Shantanu Narayen

With respect to AIR, as people deliver this next generation of applications, first we believe that they will use our authoring applications, both our designer tools and our developer tools, to author this next generation of web applications. So much like desktop publishing drove our design tools and web publishing drove our web tools, we expect AIR to have an impact on our authoring tools.

The second thing is when you look at some of the AIR applications that are already in beta applications like the one that eBay is delivering or applications like QVC, in order to stream that rich data down to desktops, we believe that people will use our set of server products, whether it’s the Flash Media Server or whether it’s the Scene 7 imaging server in order to be able to do that. So we definitely believe there’s a revenue stream associated with AIR that accrues to our current server products.

And the third is the new applications that we will develop and we highlight the Adobe Media Player as one of the new applications that we’ve developed. And there we will actually be monetizing it with our media partners through the delivery of ads in the media.

So what AIR allows us to do is actually have multiple monetization mechanisms for the various products.

Daniel T. Cummins - Bank of America Securities

Okay, but nothing explicit around royalty on the client side yet?

Shantanu Narayen

Well again, on the client side clearly today we deliver Flash Lite for mobile devices. The client run-time is free on desktops and we continue to expect the client run-time to be free on desktops. But on mobile as Flash Lite gives way and moves to AIR, we continue to think that that’s a monetization opportunity not just for handsets but also consumer electronic devices.

Daniel T. Cummins - Bank of America Securities

Okay. Thank you. Let me just ask about Flash Media Server first; could you give us your sense of what the price change was apples-to-apples? The trade press has picked it up as a massive price cut. I know there was some simplifications in the licensing. What’s your view on the degree to which you changed pricing? And if you could comment if you feel it was in response to Microsoft’s messaging around Silverlight, that would be helpful.

Shantanu Narayen

When one looks at the overall workflow for delivering Flash video on the web, we continue to believe that we have the best offering with respect to from the authoring applications all the way out to the media player through the Flash Media Server to be able to deliver video on the web.

The pricing decrease was in response to making sure that we had a competitive offering but it really wasn’t in response to any one individual party and it is our continuing desire to make sure that Flash video, we talk about it being 76% of video streams on the Internet, we want people to use secure Flash media streaming as opposed to unsecured.

Daniel T. Cummins - Bank of America Securities

Okay, thanks. And just going back to MAX, you talked a little bit about voice-over IP. Can you give us a sense whether your product cycles over the next let’s say two years are going to have distinct offerings around a voice-over IP type client application or are these just more web services we are talking about that will be embedded in other things you are doing?

Shantanu Narayen

What I think you are referring you is at MAX we showed prototypes of some early components that we were also building on top of the Flash player, one of which was real-time collaboration, a component called Cocomo that we talked about and a component called Pacifica that we talked about that has voice capabilities.

These were really indications of some of the innovation that’s happening within our labs. At this point, we’re not announcing any products based on those technologies.

Daniel T. Cummins - Bank of America Securities

Okay. Thank you.

Operator

We’ll take our next question from Sasa Zorovic with Goldman Sachs.

Sasa Zorovic - Goldman Sachs

Thank you. My first question would be regarding your -- I’m not sure that you mentioned the currency impact in the quarter, if you could.

Mark Garrett

In the fourth quarter, we had approximately $26 million of benefit primarily driven by the Euro, when you look at Q4 this year over Q4 last year. So our 34% revenue growth for the company would still have been north of 30%, even despite the currency benefit.

Sasa Zorovic - Goldman Sachs

And on the bottom line?

Mark Garrett

On the bottom line? It flows down to margin, if you think of it as -- if you view it as incremental revenue. I don’t understand your question.

Sasa Zorovic - Goldman Sachs

What was the impact to EPS based on currencies?

Mark Garrett

The impact to EPS based on currency -- well, I guess you would just take $26 million less variable cost off the EPS number but I’m not going to do that math.

Sasa Zorovic - Goldman Sachs

-- all the way down to the bottom line? Okay, fair enough. That’s clear. That’s clear enough. And then my second question would be regarding geographies and sort of specifically regarding the outlook and the difference amongst these geographies. Obviously we should anticipate Japan to be strong going into the coming quarter and the color you could provide to us in Europe, and also specifically if you could mention a little bit maybe emerging markets to the point that it’s becoming material at this point, on one hand with strong growth there offset unfortunately by piracy there, if you could comment on that please as well.

Mark Garrett

We’ll do that. Let me just add to my comment that the currency impact was factored into our guidance so going into the quarter, we obviously knew that we had changing currency rates. And then I’ll let Shantanu talk about emerging markets.

Shantanu Narayen

Emerging markets is an area of investment for us in 2008 with what’s happening in some of the Eastern European countries, what’s happening in India and China as well as in the Latin America countries. We clearly see that as an opportunity for our particular products in those markets. We were very pleased with what we saw in Eastern Europe this year and we have plans to continue to keep that revenue momentum growing in 2008.

But as a number of you know, we also have significant piracy issues in some of those emerging markets. But as a whole, the emerging market growth rate is a good growth rate for us in 2007 and we continue to be optimistic about it in 2008 and beyond.

Sasa Zorovic - Goldman Sachs

Thank you.

Mike Saviage

Operator, we’re running close to our scheduled stop time. Why don’t we take two more questions?

Operator

Thank you, sir. We will go next to Walter Pritchard with Cowen.

Walter Pritchard - Cowen and Company

Thanks for taking my question. Mark, maybe you could talk a little bit about DSOs. If I look at it year over year are quite low versus where they were at the end of 2006. Is that just better collections? Is that linearity of business or another factor?

Mark Garrett

It’s really a combination of exactly both of those -- better collections and better linearity as we go through the quarter as the demand for the products has really picked up.

Walter Pritchard - Cowen and Company

Any way to attribute it among those two?

Mark Garrett

No, I wouldn’t want to try to do that.

Walter Pritchard - Cowen and Company

Okay, then Shantanu made a comment on the two best-selling products and alluded to master collection picking up here. Could you tell us exiting the quarter or this quarter, was master collection the number three product as you predicted it might be back at analyst day in April or May?

Shantanu Narayen

What we tried to do is give you some flavor for the entire year with respect to the suites. The way that we looked at that business, the fact that 65% of the revenue was suites, was a very encouraging indicator to us that people are using suites. And as I said for the entire year, design premium was the best selling from a revenue perspective product.

And again, remember that as it relates to master collection, a lot of the master collection we’re also seeing adoption within education. So we are overall pleased. We are trying not to give you at the end of every quarter every single SKU but from a big picture perspective, we are clearly seeing adoption of the suites.

Walter Pritchard - Cowen and Company

Thanks a lot.

Operator

We’ll take our final question from Steven Ashley with Robert W. Baird.

Steven Ashley - Robert W. Baird

Thank you. I would just like to talk about the Elements business a little. You mentioned that it was very strong. Maybe you could give us a little bit more color there. And then in addition, is there an opportunity for new SKUs or new products in the consumer business as well? Thanks.

Shantanu Narayen

As you know, traditionally in time for the holiday season, we do release a new version of our Premiere Elements and Photoshop Elements products. They did very well in the marketplace which I think is just an indication of the fact that as consumers and high end consumers are moving from analog photography to digital photography as well as buying new video camcorders that have HD, our brand certainly has a lot of say in that particular marketplace.

I think moving forward, the opportunity continues to be how can we extend those offerings through hosted services? You’ve seen that we’ve talked about Premiere Express and having Premiere Express offered in conjunction with partners but even for our desktop applications, we see an opportunity to augment the functionality that exists in those desktop products with services that we might provide through the web. So one can imagine that through partners, when you have Photoshop Elements, you might do printing services, for example. So when we have more installed base with each of those consumer applications, I think it opens up opportunities for us to offer new services.

Steven Ashley - Robert W. Baird

Thank you.

Mike Saviage

Thanks, everyone, for joining us today. This now concludes our call.

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