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Adobe Systems Inc. (NASDAQ:ADBE)

F1Q08 (02/29/2008) Earnings Call

March 18, 2008 5:00 pm ET

Executives

Mike Saviage - VP IR

Shantanu Narayen - President andCEO

Mark Garrett - EVP and CFO

Analysts

Steve Ashley - Robert W. Baird

Jay Vleeschhouwer - Merrill Lynch

Philip Rueppel - WachoviaSecurities

Heather Bellini - UBS

Robert Breza - RBC CapitalMarkets

Brent Thill - Citigroup

Yun Kim - Pacific Growth Equity

Walter Pritchard - Cowen &Company

Gene Munster - Piper Jaffray

Sasa Zorovic - Goldman Sachs

Ross MacMillan - Jefferies &Company

Operator

Welcome to the Adobe firstquarter fiscal year 2008 Earnings Call. (Operator Instructions)

At this time, I would like toturn the call over to Mr. Mike Saviage, Vice President of Investor Relations.Please go ahead, sir.

Mike Saviage

Good afternoon and thank you forjoining 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. Inthe call today we will discuss Adobe's first quarter fiscal year 2008 financialresults. By now you should have a copy of our earnings press release whichcrossed the wire approximately one hour ago. If you need a copy of the pressrelease, you can go to adobe.com under the company and press links to find anelectronic copy.

Before we get started, I want toemphasize that some of the information discussed in this call particularly ourrevenue and operating model targets, and our forward-looking product plans isbased on information as of today, March 18, 2008 and contains forward-looking statementsthat involve risks and uncertainty. Actual results may differ materially fromthose set forth in such statements. For a discussion of these risks anduncertainties, you should review the forward-looking statements disclosure inthe earnings press release we issued today, as well as Adobe's SEC filingsincluding our Annual Report on Form 10-K for fiscal year 2007.

During this call we will discussGAAP and non-GAAP financial measures. Reconciliation between the two, areavailable in our earnings release and on our Investor Relations website. Callparticipants are advised that the audio of this conference call is beingbroadcast live over theInternet in Acrobat Connect. It is also being recordedfor playback purposes.An archive of the call will be made available in Acrobat Connect at Adobe'sInvestor Relations website for approximately 45 days, and is the property ofAdobe Systems. The audio and archive may not be rerecorded or otherwisereproduced or distributed without prior written permission from Adobe Systems.

I would now like to turn the callover to Shantanu.

Shantanu Narayen

Thanks, Mike, and good afternoon.I am pleased to announce Adobe's business continues to perform exceptionallywell, with Q1 financial results exceeding the targets we provided at the outsetof the quarter. Revenue in the quarter was $890.4 million which was above thehigh end of our targeted range and represents 37% year-over-year growth.Non-GAAP earnings per share were $0.48, also above the high end of our targetedrange.

Driving our results in Q1 wascontinued strong demand for Creative Suite 3 and LiveCycle and another recordquarter for our Acrobat family of products. Another significant highlightduring Q1 was the public launch of Adobe AIR, a key element of our technologyplatform for designers and developers. Adobe AIR is enabling a whole new classof rich Internet applications that many of our customers are already using todeliver engaging experiences that we believe represent the future of the web.

In a few minutes I will commenton business highlights for the quarter. But first, I'll turn it over to Markfor a review of our financial results.

Mark Garrett

Thanks, Shantanu. For the firstquarter of fiscal 2008, Adobe achieved revenue of $890.4 million. This comparesto $649.4 million reported for the first quarter of fiscal 2007 and $911.2million reported last quarter. GAAP operating expenses for the first quarter offiscal 2008 were $532.5 million compared to $536.8 million last quarter.Non-GAAP operating expenses were $471.8 million compared to $480.3 million lastquarter.

GAAP operating income in thefirst quarter of fiscal 2008 was $275.4 million or 30.9% of revenue. Thiscompares to GAAP operating income of $146.3 million or 22.5% of revenue in thefirst quarter of fiscal 2007 and $275.8 million or 30.3% of revenue lastquarter.

Non-GAAP operating income in the firstquarter of fiscal 2008 was $359 million or 40.3% of revenue. This compares tonon-GAAP operating income of $223.8 million or 34.5% of revenue in the firstquarter of fiscal 2007 and $362.2 million or 39.7% of revenue last quarter.Adobe's effective GAAP tax rate for the quarter was 25.8% and our non-GAAP taxrate was 26.3%.

GAAP net income for the firstquarter of fiscal 2008 was $219.4 million compared to $143.9 million reportedin the first quarter of fiscal 2007 and $222.2 million last quarter. Non-GAAPnet income was $273 million compared to $183.6 million reported in the firstquarter of fiscal 2007 and $289.6 million last quarter.

GAAP diluted earnings per sharefor the first quarter of fiscal 2008 were $0.38, based on 571.3 millionweighted average shares. This compares with GAAP diluted earnings per share of$0.24 reported in the first quarter of fiscal 2007, based on 604.2 millionweighted average shares and GAAP diluted earnings per share of $0.38 reportedlast quarter, based on 587.9 million weighted average shares.

Non-GAAP diluted earnings pershare for the first quarter of fiscal 2007 were $0.48. This compares withnon-GAAP diluted earnings per share of $0.30 in the first quarter of fiscal2007 and $0.49 reported last quarter.

I will now discuss Adobe'srevenue in Q1 by business segment.

As a reminder, we have modifiedour business segments for fiscal year 2008. Our 2007 10-K provides informationabout our new segments and our updated Investor Relations data sheet providesproduct classifications and revenue results for prior period comparisonpurposes. Both the 10-K and our IR data sheet can be found on the InvestorRelations page of adobe.com.

The Creative Solutions segmentrevenue was $543.5 million compared to $346.4 million Q1 of fiscal 2007 and$570.5 million last quarter. On a year-over-year basis, this represents 57%growth. Business Productivity Solutions segment revenue was $249.7 millioncompared to $217.3 million in Q1 of fiscal 2007 and $246.4 million lastquarter. On a year-over-year basis, this represents 15% growth.

Within Business ProductivitySolutions, our Knowledge Worker revenue was a record $195.5 million in Q1 offiscal 2008 compared to a $174.8 million in Q1 of fiscal 2007 and a $192.1million in the last quarter. On a year-over-year basis, this represents 12%growth.

The other components of ourbusiness productivity segment is our Enterpriserevenue. Effective this quarter, ColdFusion revenue is reported as part of ourplatform business within our other segment. In Q1 Enterprise revenue was $54.2million compared to $42.5 million in Q1 of fiscal 2007 and $54.3 million lastquarter. On a year-over-year basis, this represents 28% growth.

Mobile and Device segment revenue was $15.2million compared to $13.7 million in Q1 of fiscal 2007 and $13.5 million lastquarter. Year-over-year this represents 11% growth. Finally, the other segmentrevenue was $82 million compared to $72 million in Q1 of fiscal 2007 and $80.8million last quarter. Year-over-year this represents an increase of 14%. Our IRdata sheet now reflects Platform and Print and Publishing as part of the othersegment.

Turning to our geographicsegments, results on a percent of revenue were as follows; the Americas 45%; Europe 36%; Asia19%. Europe had a strong quarter and Asiaperformed well driven by normal seasonality. The sequential decline in revenuein North America was in the Creative businessand was consistent with historical Q4 to Q1 trends. Regular employees at theend of the first quarter totaled 7,037 versus 6,794 at the end of the fourthquarter of fiscal 2007. The majority of the headcount increase from lastquarter was in research and development.

Our trade DSO in the firstquarter of fiscal 2008 was 30 days. This compares to 43 days in Q1 of fiscal2007 and 32 days last quarter. In regard to our global channel inventoryposition, we ended the quarter within company policy.

In Q1, we repurchased a total of33.3 million shares for a total cost of $1.25 billion. Of these sharesrepurchased in the quarter, 26.6 million shares were against our 50 millionshare stock repurchase program and 6.7 million shares were against our ongoingstock repurchase program to offset dilution from employee stock programs. Intotal, we have repurchased 44.3 million shares against the 50 million sharestock repurchase program as of the end of Q1. To facilitate the stockrepurchases in Q1, we drew down $450 million against our $1 billion creditline.

During the quarter, cash flowfrom operations was $399.3 million. Our ending cash and short-term investmentposition was $1.7 billion compared to approximately $2 billion at the end oflast quarter.

This concludes my discussion ofour financial results. I would now like to comment on our financial targets forthe second quarter of fiscal 2008.

Like everyone, we are closelymonitoring the economic environment in the US to understand the potentialimpact to our business. While we are not immune to an economic downturn in anyof our major markets, we are fortunate in that we have a global diversifiedbusiness. Based on Q1 results and the latest data we have, we are targeting aQ2 revenue range of $855 million to $885 million. In addition, we are targetinga GAAP operating margin of 29% to 30% and a non-GAAP operating margin ofapproximately 39%. These second quarter targets are consistent with thecomments we provided in December when we shared our 2008 targets.

We are targeting our Q2 sharecount to be 546 million to 550 million shares. For GAAP non-operating income,which includes an expected investment gain of approximately $9 million, we aretargeting $14 million to $16 million.

For non-GAAP non-operatingincome, we are targeting $5 million to $7 million. For our GAAP and non-GAAPeffective tax rate, we are targeting approximately 27%. This tax rate targetdoes not include a potential one point benefit, if there is a reinstatement ofthe R&D tax credit in 2008. These targets lead to a GAAP earnings per sharerange of $0.35 to $0.37 per share and a non-GAAP earnings per share range of$0.45 to $0.47.

We are reaffirming our annualrevenue growth target of approximately 13% in fiscal year 2008. We are alsoreaffirming our full year GAAP operating margin target in fiscal year 2008 ofapproximately 30% and our non-GAAP operating margin target of approximately39%. We are also providing full year earnings per share targets.

On a GAAP basis, we are targetinga range of $1.45 to $1.51, and on a non-GAAP basis, we are targeting a range ofa $1.86 to $1.92. Our financial targets are based on the same quarterlyassumptions we stated in December. We expect revenue in Q3 to be approximatelythe same as revenue in Q2. New product releases in the second half of the yearwill offset normal seasonal weakness in Q3 and will also help to make Q4 thehighest revenue quarter of the year, which we believe will set us up for asuccessful fiscal 2009.

As a reminder, all of our targetsassume a baseline of current economic conditions in our major markets. If theeconomy were to weaken in any of our markets, this could impact our ability toachieve these targets.

This concludes my section. I'dnow like to turn the call back over to Shantanu.

Shantanu Narayen

Thanks Mark. I'll spend the nextfew minutes reviewing highlights from our performance in Q1. Our CreativeSolutions business had another solid quarter of performance, led by strongresults in Europe. Based on total CreativeSuite 3 results to-date, version-over-version we have achieved a 40% increasein revenue, with our CS3 family of products for the comparable CS2 time period.CS3 penetration into our creative professional customer base continues tomirror the adoption curve we experienced with CS2. Approximately 68% of the CS3revenue is suites revenue.

Mac revenue for our CS3 productcontinues to be solid, and as expected, the Design Standard and DesignProfessional suites continue to be the leading suites in terms of mix.

We continue to be excited aboutthe long-term market dynamics that drove the CS3 performance, and we remainconfident our Creative products will continue to perform well into the secondhalf of fiscal 2008.

In our Video business, weachieved 20% year-over-year growth and continue to view the dynamic mediamarket as a key strategic growth opportunity for Adobe.

Since we announced the new FlashMedia Server 3 with revised pricing and the updated Flash player with HDsupport, we have seen an acceleration of our Flash Streaming business. Themonthly volume of video streamed and viewed in Flash through our contentdevelopment network partners using the Flash player and the Flash media serverincreased over 300% between August 2007 and January 2008.

In addition just last week,Operation MySpace marked the first music concert ever to be broadcast live overthe web in high definition. The concert held for US troops in Kuwait was broadcast using theFlash media server and Flash player with an estimated audience of 5 millionviewers.

Our Professional Digital Imagingbusiness performed well in Q1. In fact, the Professional Digital Imagingsegment, which includes Photoshop, Photoshop Extended, and Photoshop Lightroomachieved its highest revenue quarter since CS3 shipped.

Our hobbyist product revenue hasbenefited from customers increasingly purchasing the Photoshop Elements PremiereElements bundle, which has a higher average ASP. As expected, revenue for theseproducts declined in Q1, when compared to Q4.

In Q1, we achieved 15%year-over-year growth in our Business Productivity Solutions segment whichincludes our Knowledge Worker and enterprise businesses. Our Knowledge Workerbusiness, which includes Acrobat and Acrobat Connect, achieved record revenueand 12% year-over-year growth. This was driven by solid Acrobat demandthroughout the quarter.

In the enterprise business,LiveCycle achieved 28% year-over-year growth. Enterprise wins during the quarter includedthe United States Marine Corp, which is utilizing LiveCycle Reader Extensions toconvert their forms to PDF and enable digital signatures. Iberia Airlines in Spain,which is utilizing a LiveCycle Form solution to develop a maintenance ordermanagement system that is integrated with SAP and EMC applications.

In the New York State InsuranceFund, the state's largest workers' compensation and disability benefitscarrier, which is implementing an Adobe Form solution to support payrollservices and improve internal business work flows. In total, transactionsgreater than $50,000 in Q1 were [123].

In our Mobilebusiness, we achieved record OEM shipments in Q1. In fact, we had our first 100million unit quarter over a 100 million devices with Flash Lite shipped lastquarter. This is a major milestone and we have already passed a total of 500million devices shipped cumulatively with Flash Lite since inception.

At the Mobile World Congress in Barcelona, we announcedthat many major content providers are using Flash player compatible mobileproducts and solutions to extend their brands to the handheld market. Theyinclude MTV Networks, the NASDAQ Stock Market, eBay, Reuters, Dolce & Gabbanaamong others.

Yesterday we announced Microsofthas licensed Adobe Flash Lite software to enable web browsing of Flash contentwithin the Internet Explorer Mobile Browser in future versions of WindowsMobile devices. As part of the agreement, Microsoft licensed Adobe Reader LEsoftware for viewing Adobe PDF documents, including e-mail attachments and webcontent. Both Flash Lite and Reader LE will be made available to OEMs worldwidewho license Microsoft Windows Mobile software.

February 25th marked the officiallaunch of Adobe AIR which signals the next wave of rich Internet applicationinnovation. Companies demonstrating applications built on Adobe AIR includedAOL, eBay, Salesforce.com, the NASDAQ Stock Market, The New York Times Company,Nickelodeon, MTV and Sharp Corporation. Response to Adobe AIR from the presshas been extremely positive. MIT Technology review highlighted AIR as one ofthe 10 most exciting world changing technologies of the year in its emergingtechnologies of 2008 issue.

Given the strong start to theyear, a new product launches in the second half. We are reiterating our targetof approximately 13% revenue growth in fiscal 2008. Adobe is performingexceptionally well against our strategy, and the fundamental market forces drivingour long-term outlook are as strong as ever.

As the proliferation of digital contentaccelerates, customers worldwide are looking to Adobe for solutions that enablethe creation of rich, engaging experiences across a variety of media anddevices. This trend will continue to drive our diverse business. We lookforward to seeing you on May 1st, at our financial analysts meeting in San Francisco, where wewill provide more details about our long-term strategy.

Now, I will turn the call backover to Mike.

Mike Saviage

Thanks, Shantanu. Before we startQ&A, I would like to go over a few items. As Shantanu mentioned, ourfinancial analysts meeting will be held on Thursday May 1st in downtown San Francisco. Invitationsfor the all day meeting will be sent out later this week. We have postedseveral new documents on our Investor Relations webpage today. They include today'searnings release and our updated investor data sheet, which includes restateddata related to the new business segments classifications for fiscal 2008 aswell as GAAP to non-GAAP reconciliation information. To access these documentsand the other investor related information, you can go to our website at www.adobe.com/adbe

For those who wish to listen to aplayback of today's conference call, a web-based Acrobat Connect archive of thecall will be available from the IR page on adobe.com later today. Alternativelyyou can listen to a phone replay by calling 888-203-1112; use conference IDnumber 4698403. Again, the phone number is 888-203-1112 with ID number 4698403.International callers should dial 719-457-0820. The phone playback service willbe available beginning at 4:00 pm Pacific Time today and ending at 4:00 p.m.Pacific Time on Friday, March 21, 2008.

We would now be happy to takeyour questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) We willgo first with Steve Ashley with Robert W. Baird.

Steve Ashley - Robert W. Baird

Hi. In the Creative Solutionsbusiness, are you able to tell whether there is any difference in the demandbetween the enterprise customers or maybe the hobbyists customers?

Shantanu Narayen

Steve, this is Shantanu. I thinkoverall as it relates to our Creative performance, we did have a solidperformance. At this time in the cycle it tends to be that licensing is one ofthe drivers of our business and whether it's marketing departments within theenterprise or large publishing houses, as they start to test out the Creative suite,we are seeing adoptions. No, we are really seeing difference in customeradoption across those two segments.

Steve Ashley - Robert W. Baird

Great. And in respect to the AIRclient, any kind of qualitative comment? And what kind of distribution andpenetration you would hope to see after a year?

Shantanu Narayen

Well, Steve with respect to AIR,it's very, very early in the process. What's very exciting is, even a monthafter the launch of AIR, we have about 45 applications. These are shippingapplications that are already available on the Adobe website, which reflectsgreat customer developer adoption. Clearly, getting AIR run time out there isone of our key priorities, but we have the ability to piggyback off of both theReader, as well as the Flash distributions. And like the penetration that we'vegot in the past for Reader and Flash, we're confident that we will get the AIRrun time also out, not just on PCs but also on alternate devices.

Steve Ashley - Robert W. Baird

Great. Thanks so much.

Operator

We'll go next to Jay Vleeschhouwer,Merrill Lynch

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Shantanu,in the last three or four months, have there been any sort of changes behindthe scenes in terms of expense or resource commitments at the company evenperhaps just subtle ones or subtle changes of focus at all in terms of thingslike marketing programs, programs out in the field, even any changes that withrespect to any particular product commitments, products you may want to spendless time developing perhaps or anything along those lines and then afollow-up?

Shantanu Narayen

Well. Jay, I think every year aspart of our annual process, we clearly have a strategic planning process wherewe talk about the key priorities of the company. And the key priorities asrelated to this year are our continued investment in our Creative business aswell as our Acrobat and Enterprisebusiness. But in addition to that, I would say a particular focus on makingsure that we are leveraging the opportunity that we have in video and theopportunity in AIR and getting our platform out there as well as in the handsof developers.

So, from a product perspectivethose are the key initiatives. We also continue to invest in software as aservice, which is clearly one of the key trends moving forward. And I thinkwhat we've always done is look at other products, which maybe we are overinvested in and re-arrange priorities accordingly.

From a field perspective, I thinkwe continue to make sure that we are focused on providing a great experiencefor our direct customers. I think the LiveCyclesuccess is a reflection of what we've done with Matt Thompson and thefield organization and in addition, we tend to focus on the mid-market. But Ithink in conjunction with Mark, we are constantly looking at revenue andexpenses and making sure that we invest in the long-term while returning toshareholders right throughout.

Jay Vleeschhouwer - Merrill Lynch

With respect to the Creativebusiness, is it fair to assume that with CS4 you'll keep the segmentation as itis with three, that is to say you won't go any further with respect toconfigurations. This is about the right number in terms of complexity ofproducts? And secondly, would this be the right time to change your pricingmodel for upgrade in particular, the CS3, ASPs of course generally moved higherwith the configurations, but would it now also make sense to have some kind ofa stepped or tiered pricing mechanism for upgrades?

Shantanu Narayen

Well to answer your firstquestion Jay, I mean certainly every time we release a new version of theCreative suite, we do look at the segmentation and try and make sure that weare meeting our customer demands. Having said that the overall segmentationthat we put in with respect to CS3, which is having a master collection forpeople, who want to standardize on the entire platform, the design web andproduction has clearly resonated with customers. So I would imagine if anythingthere is a little tweaking rather than any significant changes because I thinkwe got it right.

With respect to your secondquestion, again, we look at that with every cycle, we do believe there is anopportunity for people who are doing version skipping, for example, to have a disincentivefor version skipping and to enable people to constantly upgrade with newversions of our products, but it's a little early to be sharing details. CS3still continues to deliver great performance. So we are focused on marketing itand getting penetration among our existing customers.

Jay Vleeschhouwer - Merrill Lynch

Okay. And then lastly, at MAX, bymy count, you had 8 new product and service initiatives like the Media Player,Astro, CoCoMo, and others, you might want to save this for the analystsmeeting, but any quick update on any of those that might convert to revenue atall this year or where you think your are furthest along in terms ofdevelopment?

Shantanu Narayen

Well, we talked about AIR a fairamount at MAX and it's good to see AIR out in the market and customer adoptionof it. The second one that I would highlight is the Media Player, we areclearly seeing a lot of customer adoption from media companies who want to havetheir video content work both online and offline. The bid has been a successfuldata. I'd encourage all of you to download it and you can see the amount ofcontent that people are already providing in Flash over the Internet isincreasing quite dramatically. So we are excited about that. Revenue from theMedia Player is probably not going to be material this year, but I think it reflectsan adoption of Flash and the Flash platform.

Jay Vleeschhouwer - Merrill Lynch

Great. Thanks, Shantanu.

Operator

We'll go next to Philip Rueppel withWachovia Securities.

Philip Rueppel - Wachovia Securities

Yes, thanks. Shantanu, andbuilding on that last comment on Flash, you've talked about the strategy tomake it to the de facto standard for video streaming on the web. How importantis it to you to get greater Apple Flash support on its mobile devices?

Shantanu Narayen

Well, you really believe thatFlash is synonymous with the Internet and frankly, anybody who wants to browsethe web and experience the web and all it's glory really needs Flash support.We are very excited about the announcement from Windows Mobile adoption ofFlash on their devices and the fact that we've shipped 0.5 billion devices now,non-PC devices. So we are also committed to bringing the Flash experience tothe iPhone and we will work with Apple. We've evaluated the SDK, we can nowstart to develop the Flash player ourselves and we think it benefits our jointcustomers. So we want to work with Apple to bring that capability to thedevice.

Philip Rueppel - Wachovia Securities

Great, thanks. And for you Mark,could you give us a little update on sort of the strategy behind stockrepurchases given the guidance for Q2. Does that assume an additional stockrepurchase ability and also do you think you will continue to fund that withdebt and sort of now the debt is part of the balance sheet, how do you viewthat from a strategic perspective?

Mark Garrett

Sure. We continue to believe thatreturning excess cash to the shareholders in the form of stock repurchases isthe right methodology. We made great progress against the 50 million shareauthorization. We only have a little over five million shares to go. Theguidance that we gave you for the next quarter in terms of share count factorsin what's already been done, it does not factor in anything over and above whatwe have already accomplished. And we will continue to look at it. Yes, I diddraw down debt off the balance sheet. I thought given where the stock was andgiven where interest rates are, that was the right capital mix and capitalstructure for us, and we'll continue to evaluate that every single quarter.

Philip Rueppel - Wachovia Securities

Great, thanks very much.

Operator

We'll go next to Heather Bellini,UBS.

Heather Bellini - UBS

Hi, good afternoon. I had twoquick questions for you. The first is, I see you were able to hit I think 68%of your sales came from suite this quarter on the Creative side. I waswondering Shantanu if you could give us a sense of what's your goal for wherethat penetration can ultimately get to? And then I was also wondering if youcould just comment a little bit as Silverlight gets ready to go in to itssecond revs of the product, if you can kind of highlight your competitivedifferentiators?

ShantanuNarayen

Sure. So Heather first on the CS penetration,we are pleased with 68 penetration of the Suites, this being the first releasebetween Adobe and Macromedia. We are pleased but we continue to see adoption ofthe Point products which also represents an opportunity for us to move thePoint product users whether they are illustrative, whether they are imagingusers or whether they are premier etcetera to the platform. And then within theSuites as well, we have an opportunity to continuously move the design suitecustomers or the production suite customers to the master collection.

So overall, I would say we are pleased. Wecertainly think there is room for improvement in getting more people tostandardize on the suites, but also within the suites to move up as they usemore products. With respect to Silverlight, its clear Microsoft also views thesame opportunity that we have been spearheading with respect to video on theweb. And among the key differentiators for Adobe is first ourAuthoring Suite. It's clear that our Authoring Suite, the video business forCreative grew over 50% CS3 over CS2, so people are adopting our video productsin order to output flash video for the web.

The adoption of the Flash client,we have virtually 98% of all PCs that are connected with Flash, the new edgedhigh-definition flash player that we have delivered is also seeing justtremendous adoption, I talked about Operation MySpace using it. We have theFlash Media streaming server, we were able to deliver a great version thatallows a lot more streams. And finally the fact that we are now delivering amedia player as well as the ability to have DRM, we're really the only companythat provides an end-to-end solution that's across platform. We delivered FlashLite to all of our mobile partners as well. So that's one key competitivedifferentiation.

The other one that I would say isthat our media partners have been using Adobe products for decades and Creativepeople who are creating this content are very, very familiar with Adobeproducts, which also I think enables us to be a differentiator. But none ofthose preclude us from continuing to innovate, which is what we are focused on.

Heather Bellini - UBS

Thank you very much.

Operator

Next to Gene Munster, PiperJaffray. Gene, your line is open. Please check your mute button. There is noresponse. We'll move on to Robert Breza, RBC Capital Markets. Robert, your lineis open. Please go ahead.

Robert Breza - RBC Capital Markets

Hi, can you hear me now?

Operator

Yes, sir.

Robert Breza - RBC Capital Markets

Great, thank you. Shantanu, I was wondering if you couldtalk a little bit about the growth in Europe.Surprisingly strong, I mean obviously the foreign currency probably helped alittle bit. But is there anything beyond kind of for almost looking at theoutside and seeing the foreign currency and the falling dollar? Anything elseyou would point to, that's really driving that really strong growth there?

Shantanu Narayen

Well, I will let Mark reflect onthe currency. I think it's clear that a number of the emerging markets as wellas the overall European market continue to be a large market opportunity forus. So we are seeing quite a bit of traction of our products in Eastern Europe as those countries enter the EuropeanUnion. And given that the release of Creative was a quarter behind typically inthose other foreign markets, it tends to continue to be strong through thecycle. So those are the two things that I would point to, which reflect ourEuropean strength.

Mark Garrett

And then on the currency benefitfrom a year-over-year perspective, we've got a $25 million favorable upliftfrom the euro and $7 million favorable uplift from the yen from ayear-over-year perspective?

Robert Breza - RBC Capital Markets

That's helpful. Maybe as afollow-up, Shantanu, do you see more newer customers in those emerging areasreally gravitating more towards the web more as it kind of more product cyclefrom your perspective?

Shantanu Narayen

No, I clearly think we areattracting new customers to the Adobe products and platform. There is noquestion that as the number of media companies or as the number of publishersare increasing, the Adobe products in many cases are the gold standard for whatthose publishers use. I think the other thing that is clearly happening in someof those markets both in Asia and in Europe isfrankly as the value of intellectual property is increasing, we are clearlyfinding that the piracy rate is also reduced somewhat in those countries.

Robert Breza - RBC Capital Markets

Great. Thank you. Nice quarter.

Shantanu Narayen

Thank you.

Operator

We'll go next to Brent Thill withCiti.

Brent Thill - Citigroup

Thanks. If you could justcharacterize your visibility in the second half of this year, there is growingconcern that this environment maybe gets worse before gets better. And just interms of your ability to preserve your margins if we do see a broader slowdownthat heads?

Mark Garrett

Hey, Brent. Sure, this is Mark.The beauty of Adobe is we get real-time data from the channel virtually everysingle week, and it allows us to react to any changes to that sell-through dataon a real-time basis. So, we do have the ability to react quickly to anysignificant changes in any region or world by virtue of this data that we getweekly.

Brent Thill - Citigroup

Okay. And Mark, so you feel thatyou're going to preserve the margins even if we saw something coming, you wouldbe able to act quick enough on the expense side?

Mark Garrett

We can act quickly on the expenseside obviously, Brent, to the extent that it was big. It's much tougher toreact to offset any full amount of revenue, but we believe that we can managethe expenses very prudently given any changes in regional economics.

Shantanu Narayen

And Brent, Ithink, this is Shantanu. I think we have reflected over the many years.We know how to balance between investing for the long-term as well as dealingwith any short-term hiccups that might happen.

As Mark said, we get all thisdata, both on a revenue and expenses perspective, but frankly in many casesthese are the times when the strong companies like Adobe actually getsstronger, and given the opportunities that we see, we want to continue toinvest in research and development, because we know we'll come out stronger asa result of that.

Mark Garrett

The other thing to keep in mind,Brent is in the second half of the year we have the product launches that wetalked about, so that gives us more confidence in the second half.

Brent Thill - Citigroup

You laid the foundation for thenext question as you alluded to these new launches, certainly I know you're not going to sayspecifics, but should we count that they will cut across all categories, ormore than narrow focus?

Shantanu Narayen

Well, as you know Brent, I thinklast year when we talked about our product launches way early, we think thatactually both gave our competitors' information as well as potentially impactedsales. What we have also said is you can look at our IR data sheet, which showssome of the historical releases and based on that I think you can see acrossboth the business productivity, business unit as well as the Creative businessunit, you can expect to see products coming out. And we're really excited aboutthe new products that are on tap for the second half of the year.

Brent Thill - Citigroup

Thanks.

Operator

We'll go next to John Jares,Boston Company.

John Jares - Boston Company

My question has been asked andanswered. Thank you.

Shantanu Narayen

Thank you.

Operator

We'll go next to Yun Kim, PacificGrowth Equity.

Yun Kim - Pacific Growth Equity

Thank you. I saw the mobile businessjump up sequentially, which as you mentioned was largely driven by the increasein the handset OEM business. Can you give any update on how Flash Cast businessis doing and where do you expect that business tracking to show and also whatis your plans for your headcount growth in the mobile group this year?

Shantanu Narayen

Well, we don't breakout headcountgrowth by each of the business units, so that one is not some information thatwe'll share. I think with respect to the mobile business, we continue as I saidto be excited about the adoption. And I think this year and next year, we'llcontinue to be just how we make sure that our client platform is available onall devices, from feature phones to smartphones. The revenue that we get rightnow is primarily the royalty business.

We get some revenue for FlashCast from the DoCoMo relationship that we've talked about. And we've alsotalked about the fact that later this year, we expect to see Verizon launchtheir Flash Cast services with us. And so, remember for mobile the revenuemodel continues to be not just a royalty but Flash Cast, but in addition tothat the fact is that people are using our authoring tools to create contentfor mobile. So, we still are pretty excited about the opportunity for us inthat space.

Yun Kim - Pacific Growth Equity

And then also, quickly with someof your recent efforts, I mean to the online advertising like dynamicplacements of advertisements in online PDF documents and maybe even similarannouncements coming up for your video products. Can we expect some ad-servingtechnology and other online advertising technology to be some of your areas youmaybe looking into in '08?

Shantanu Narayen

Well, as you mentioned, there areat least two initiatives that we have talked about PDF-based ads that we arehaving, Yahoo! provide the ads as well as the Adobe Media Player, where any ofthe media companies can actually provide their own ads that represent foraysfor us into the advertising environment. The other big opportunity for uscontinues to be to make sure that Flash for rich media advertising is theformat of choice. When you look at rich ads right now and as the CPMs of thatrich media will increase. We want to make sure that the ability to author thoseads, as well as place those ads continues to be the best format available. So,that's really our initiatives as it relates to advertising right now.

Yun Kim - Pacific Growth Equity

Thank you very much.

Operator

We'll go next to WalterPritchard, Cowen & Company.

Walter Pritchard - Cowen & Company

I actually just had one question,Mark I'm wondering if you could -- I think you guys talked about over a yearago that the Master Collection might end up being the number three sellingbundle. And you did say, the Design Standard, Design Premium or numbers werethe top two. I'm wondering if Master Collection had reached the top three interms of popular bundle?

Shantanu Narayen

Walter this is Shantanu. As itrelates, the top two selling continue to be the Design Standard and the DesignPremium. Then there are bunch of other collections that are pretty close andthat's how I'd describe what we are seeing today for the various products.Long-term, clearly we continue to believe that getting people adopting themaster collection represents upside opportunity for us.

Walter Pritchard - Cowen & Company

And could you remind us wherethat 68% of the suites right now, where was that in the last cycle at thispoint?

Shantanu Narayen

It has been going upcycle-over-cycle. At the Financial Analyst meeting we had talked aboutapproximately 60%. So, I think we are seeing it move up.

Walter Pritchard - Cowen & Company

Great, thank you very much.

Shantanu Narayen

Thanks.

Operator

We'll go back to Gene Munster,Piper Jaffray.

Gene Munster - Piper Jaffray

Hey, good afternoon. Shantanu ifyou could talk another kind of macro questions has been asked before, but whatyour expectations are for kind of the macro environment over the next sixmonths? Is it stable, are you expecting a little bit of a decline, improvement.Just some generic thoughts on that front?

Shantanu Narayen

Well, Gene we are clearlymonitoring the economic environment in the US like every other company doesand I think we've always said that while we are not immune, we are fortunateand we do have a global as well as a diversified business.

From assumption perspective, weare assuming that basically the economy stays in the current situation, so it'sstable and we've said if there is a significant change, then we will reassessthe impact, but at this point we're assuming the economy stays the same.

Gene Munster - Piper Jaffray

Excellent, then just a questionon Acrobat, the next Acrobat Cycle, should we just assume kind of a typicaltrajectory after the launch of the upgrade or is acrobat getting to a pointwhere we shouldn't expect those as dramatic spikes earlier on in the cycle?

Shantanu Narayen

Well, first, again, I'llreiterate. We just had a record quarter for that part of the business. So thebusiness continues to be very healthy. The upgrade business tends to come in alittle bit in the first quarter, but you are right. We tend not to see a hugespike again that business is primarily new unit business. We are adopting andgetting new customers to that platform. So when the next version of Acrobatcomes out, yes we would expect to see a slight uplift but not huge.

Gene Munster - Piper Jaffray

Great, thank you.

Operator

The next is Sasa Zorovic withGoldman Sachs.

Sasa Zorovic - Goldman Sachs

Thank you. My first questionwould be you've mentioned what the currency impact was on a year-over-yearbasis, 25 million versus 7 million, Euro and Yen. Could you just provide uswith the information you have it on a quarter-versus-quarter basis?

Mark Garrett

Yeah, Sasa in terms of thisquarter relative to Q4, it's about an $11 million favorable impact, $8 millionfrom the Euro, $3 million from the Yen and that has been factored in to ourguidance. It was factored in to our guidance based on what we knew at the endof last year and we factored that in to our guidance going in to Q2 as well.

Sasa Zorovic - Goldman Sachs

So, what specifically did youfactor in going due to Q2 regarding the --

Mark Garrett

Based on where rates are today.

Sasa Zorovic - Goldman Sachs

So, specifically they would kindof stay where they are.

Mark Garrett

Correct.

Sasa Zorovic - Goldman Sachs

Okay. Now my second questionwould be regarding the linearity in the quarter. Have you noticed anything sortof changes when the quarter started towards where it ended or pretty might wellsort of inline how the February quarter tends to usually be?

Mark Garrett

That's pretty much the wayquarters tend to be.

Sasa Zorovic - Goldman Sachs

Great, thank you very much.

Operator

We'll go next to Ross MacMillanwith Jefferies & Company.

Ross MacMillan - Jefferies & Company

Hey, thanks. Most of it mighthave been answered. Just one for Mark, do you have the backlog number I thinkyou've given that out historically and then your revenues?

Mark Garrett

Yeah, I do the ending backlog isapproximately 5% of revenue, keep in mind it's not indicative of futureperformance and it is factored in to our guidance.

Ross MacMillan - Jefferies & Company

Great, thank you.

Operator

(Operator Instructions) WalterPritchard, Cowen & Company.

Walter Pritchard - Cowen and Company

He actually just asked thequestion, I was going to ask. So, I'm said.

Shantanu Narayen

Okay.

Mike Saviage

So operator we'll take one morequestion then.

Operator

Okay. It looks like our lastquestion will be from Sasa Zorovic.

Sasa Zorovic - Goldman Sachs

Exactly, so my question would bea follow-up regarding to what extent -- sort of as we're looking to the nextversion of sort of the products that are going to be coming out in the secondhalf as you mentioned, so specifically if we were to look at the next versionof Acrobat and CS4, could you indicate to us sort of in what direction could wesee as sort of -- I don’t want to go -- of course you can comment specifically onthe features, but in the path the integration with Macromedia products or focuson video, what should we kind of focus on in sort of those next products. Ingenerality so you could sort of provide us with a direction.

Shantanu Narayen

Well, Sasa given we haven't talkedabout, which products I'm not sure how I can give you insight into the featuresthat are available for the new products. The reality is there is no shortage ofideas that we have. We are innovating as well as this company has ever innovatedand when you look at some of our major products, as it relates to the creativebusiness, we clearly have the ability to continue to innovate both in terms ofPoint features as well as in terms of workflow. The reality is when we puttogether Adobe and Macromedia, we only had a year to do that integration. Sothe quality and quantity of ideas for the next version of those productsgreatly outpaced that of the previous version.

When we think about Acrobat andbusiness productivity, we look at what we can do with collaboration and theirtremendous ideas available there. For LiveCycle, there is the opportunity tocontinue to provide great workflow, with mobile as I said support for devices,on video there is the ability to go high-definition, provide digital rightsmanagement. And finally with AIR, the ability to really deliver a brand newenvironment that I think can define how experiences happen on the web, which iswhat we are incredibly excited about.

So given this is the lastquestion, I mean what I would like to say is, we are really pleased with our Q1performance. I mean, it's clear that we have a global presence and we have avery diverse business. We were pleased that we reaffirmed our growth targetsfor the year and provided really strong earning targets moving forward. We areexcited about our product launches in the second half and the fact that we arereally attracting new customers to the Adobe products and platform and thefundamental trends and strategy that we talked about continue to help us moveforward and we are excited about meeting a number of few at our FinancialAnalyst meeting. So I'll look forward to that.

Mike Saviage

With that, that concludes ourcall today. Thanks for joining us.

Operator

Ladies and gentlemen, thisconcludes today's conference. We appreciate your participation. You maydisconnect your phone lines at this time.

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Source: Adobe Systems Inc. F1Q08 (02/29/2008) Earnings Call Transcript

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