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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

Brent Thill - Citigroup

Steven Ashley - Robert W. Baird

Adam Holt - Morgan Stanley

Phil Winslow - Credit Suisse

Ross MacMillan - Jeffries & Company

Michael Olson - Piper Jaffray

David Hilal - Friedman, Billings, Ramsey

Philip Rueppel - Wachovia Securities

Heather Bellini - UBS

Sasa Zorovic - Goldman Sachs

Walter Pritchard - Cowen and Company

Chad Bartley - Pacific Crest Securities

Adobe Systems Incorporated (ADBE) F3Q08 Earnings Call September 16, 2008 5:00 PM ET

Operator

Good day, everyone and welcome to the Adobe third quarter fiscal year 2008 earnings conference call. As a reminder, today’s call is being recorded. At this time for opening remarks, I will turn the call over to Mr. Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

Mike Saviage

Good afternoon and thank you for joining us today. Joining me on the call are 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 third quarter fiscal year 2008 financial results. By now, you should have a copy of our earnings press release, which crossed the wire approximately one hour ago. If you need a copy of the press release, you can go to 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 mile targets and our forward-looking product plans, is based on information as of today, September 16, 2008, 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.

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 in Acrobat Connect Pro and is also being recorded for playback purposes. An archive of the call will be made available in Acrobat Connect Pro 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 will now turn the call over to Shantanu.

Shantanu Narayen

Thanks, Mike and good afternoon. I am pleased to announce Adobe's business continues to perform exceptionally well, with Q3 financial results exceeding the targets we provided at the outset of the quarter. Revenue in the quarter was $887.3 million, above the high-end of our targeted range. Non-GAAP earnings per share were $0.50, also above the high-end of our targeted range.

Driving our Q3 results was record revenue for our Acrobat and LiveCycle products, as well as solid performance across the rest of our business. It is clear the cumulative benefit of our increasingly diversified business across product lines, customer segments, and geographies is contributing to Adobe's success.

In a few minutes, I will comment on business highlights during the quarter but first I will turn it over to Mark for a review of our financial results.

Mark Garrett

Thanks, Shantanu. For the third quarter of fiscal 2008, Adobe achieved revenue of $887.3 million. This compares to $851.7 million reported for the third quarter of fiscal 2007 and $886.9 million reported last quarter.

GAAP operating expenses for the third quarter of fiscal 2008 were $556.9 million, compared to $543.8 million last quarter. Non-GAAP operating expenses were $475.1 million, compared to $479.5 million last quarter.

GAAP operating income in the third quarter of fiscal 2008 was $219.5 million, or 24.7% of revenue. This compares to GAAP operating income of $255 million, or 29.9% of revenue in the third quarter of fiscal 2007, and $260.2 million, or 29.3% of revenue last quarter.

Non-GAAP operating income in the third quarter of fiscal 2008 was $351.9 million, or 39.7% of revenue. This compares to non-GAAP operating income of $340.9 million, or 40% of revenue in the third quarter of fiscal 2007, and $349.6 million, or 39.4% of revenue last quarter.

Adobe's effective GAAP tax rate for the quarter was 16.2% and our non-GAAP tax rate was 25%. The company’s GAAP tax rate for the quarter was approximately nine percentage points lower than projected due to the resolution of an income tax audit at an amount less than the company’s reserve.

GAAP net income for the third quarter of fiscal 2008 was $191.6 million compared to $205.2 million reported in the third quarter of fiscal 2007, and $214.9 million last quarter.

Non-GAAP net income was $269.1 million, compared to $269.4 million reported in the third quarter of fiscal 2007, and $272.7 million last quarter.

GAAP diluted earnings per share for the third quarter of fiscal 2008 were $0.35 based on 541.3 million weighted average shares. This compares with GAAP diluted earnings per share of $0.34 reported in the third quarter of fiscal 2007 based on 597.3 million weighted average shares, and GAAP diluted earnings per share of $0.40 reported last quarter based on 542.4 million weighted average shares.

Non-GAAP diluted earnings per share for the third quarter of fiscal 2008 were $0.50. This compares with non-GAAP diluted earnings per share of $0.45 in the third quarter of fiscal 2007 and $0.50 reported last quarter.

I will now discuss Adobe's revenue in Q3 by business segment. Creative Solutions segment revenue was $493.6 million, compared with $545.5 million in Q3 of fiscal 2007 and $527.2 million last quarter. On a year-over-year basis, which compares Q3 results against the year ago CS3 launch period, this represents a decline of 10%.

Business productivity solutions segment revenue was $283.5 million, compared to $227.4 million in Q3 of fiscal 2007 and $252.8 million last quarter. On a year-over-year basis, this represents 25% growth.

Within business productivity solutions, our knowledge worker revenue was a record $218 million in Q3 of fiscal 2008, compared to $176.8 million in Q3 of fiscal 2007 and $198.4 million last quarter. On a year-over-year basis, this represents 23% growth.

The other component of our business productivity segment is our enterprise business. In Q3, enterprise revenue was a record $65.5 million, compared to $50.6 million in Q3 of fiscal 2007 and $54.4 million last quarter. On a year-over-year basis, this represents 29% growth.

Mobile and device segment revenue was $27.5 million, compared to $13 million in Q3 of fiscal 2007 and $22.2 million last quarter.

Finally, other segment revenue was $82.7 million, compared to $65.8 million in Q3 of fiscal 2007 and $84.7 million last quarter.

Turning to our geographic segments, results on a percent of revenue basis were as follows: the Americas, 48%; Europe, 33%; and Asia, 19%. Our overall year-over-year performance benefited from the Acrobat 9 launch and strong Live Cycle sales, and was achieved against a tough Q307 compare that included the CS3 launch period. In the Americas and Europe, we had a strong quarter in our education business. We also experienced seasonal weakness in Europe and Asia.

Employees at the end of the third quarter totaled 7,623 versus 7,317 at the end of the second quarter.

Our trade DSO in the third quarter of fiscal 2008 was 34 days. This compares to 28 days in Q3 of fiscal 2007 and 33 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 $211.8 million. Our ending cash and short-term investment position was $2 billion, compared to approximately $1.9 billion at the end of last quarter.

In Q3, we repurchased a total of 3.7 million shares at a total cost of $147.7 million. As part of these repurchases, approximately 500,000 of the shares were against the unused balance of our 50 million share authorization that existed when we entered the quarter. The remainder of shares repurchased in Q3 were executed as part of our ongoing repurchase program to offset dilution from employee stock programs. We will continue to utilize this program to return excess cash to stockholders and offset dilution from employee stock programs. During the fiscal year, we have now repurchased a total of 52.1 million shares, returning $1.94 billion to our stockholders at an average share price of $37.19.

This concludes my discussion of our financial results. I would now like to comment on our financial targets for the fourth quarter of fiscal 2008.

We are targeting a Q4 revenue range of $925 million to $955 million. In addition, we are targeting a GAAP operating margin of approximately 30.5% and a non-GAAP operating margin of approximately 39.5%.

We are targeting our Q4 share count to be 544 million to 548 million shares. For non-operating income, we are targeting a range of $6 million to $7 million on both a GAAP and non-GAAP basis. For our GAAP and non-GAAP effective tax rates, we are targeting approximately 25%.These targets lead to a GAAP earnings per share range of $0.39 to $0.41 per share and a non-GAAP earnings per share range of $0.51 to $0.53.

As a reminder, all of our targets assume a baseline of existing economic and currency conditions in our major markets.

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

Shantanu Narayen

Thanks, Mark. I’ll spend the next few minutes reviewing highlights from Q3. Our Creative Solutions business posted another solid quarter in Q3. In anticipation of our Creative Suite 4 launch, our CS3 sell-through rates began to slow during the third quarter and our overall Creative revenue declined sequentially, as expected. As of the end of Q3, Creative Suite 3 has achieved 40% cumulative revenue growth versus the equivalent Creative Suite 2 period, with 67% of total creative professional product revenue being suites based.

In addition to success with our suites, individual point products, such as Photoshop, continued to perform well. For example, in Q3 Photoshop new user license units were up 13% year over year when factoring standalone units and units shipped within suites.

We are excited about the launch of Creative Suite 4 on September 23rd. CS4 represents the biggest software release in the company’s history. It will deliver radical workflow breakthroughs that bring down the walls between designers and developers and is packed with hundreds of feature innovations. CS4 includes deeper levels of integration of Flash technology across the product line and will advance the creative process across print, web, mobile, interactive, film, and video production.

While we are not sharing further details about CS4 pricing, product configurations, or specific features before the launch date, based on early data and press feedback we believe this is a must-have release, with innovations that will not only generate opportunities for Adobe to up-sell and cross-sell in our existing customer base but also expand our reach to new customer segments and markets.

We expect the entire CS4 product family will ship in English in Q4, with other major languages shipping in volume in Q1.

In other areas of our creative business, dynamic media remains a key growth focus for Adobe. In Q3, we continued to drive strong adoption in our Flash media streaming business. In fact, the use of Flash-based video is accelerating on the web. Comscore recently stated that 82% of online videos in the U.S. and 73% worldwide are viewed using Adobe Flash technology.

Recent high profile wins include CCTV International Networks, which used Adobe Flash and Flex technology to deliver coverage of the 2008 Beijing Olympic Games over the web in China. During the course of the games, there were more than 832 million page views for CCTVolympics.com, with more than 46 million on-demand video playbacks delivered via Flash media server technology. This made CCTV’s website one of the world’s most popular online destinations dedicated to the 2008 Summer Olympics.

And the National Football League, which has selected Adobe Flash technology to deliver live online video streaming of NBC Sunday Night Football games on NFL.com and NBCsports.com. Named Sunday Night Football Extra, the high quality streaming video, delivered with Adobe Flash technology, will enable fans to watch the games for free within a rich, immersive environment that will include interactive extras, such as alternative camera angles, picture-in-picture technology, in-game highlights, live statistics, and interactivity with network talent via a live blog.

In our hobbyist business, we launched Photoshop Elements 7 and Premiere Elements 7, updates to the world’s best-selling consumer photo editing and video editing software products. In addition to numerous enhancements, the Elements 7 products include a free one-year membership to Adobe's Photoshop.com service, extending the capabilities of the software by providing helpful templates, creative tutorials, automatic online back-up, storage of photos and videos, and improved sharing capabilities.

In our business productivity solution segment, we achieved 25% year-over-year growth, driven by record revenue with both our knowledge worker business, as well as our enterprise business. In knowledge worker, we achieved 23% year-over-year growth in Q3. This fourth consecutive quarter of record revenue was driven by the release of Acrobat 9. Reviews and commentary about the new release have been outstanding.

Driving our Acrobat results were continued success with Acrobat volume licensing by enterprise customers and product mix, where we continue to see customers migrating to higher value uses of the product family. In Q3, Acrobat Pro once again was responsible for more than 50% of total Acrobat revenue.

In our enterprise business, LiveCycle achieved record revenue with 29% year-over-year growth and strong performance across key vertical markets, including government and financial services.

In our mobile business, we achieved record revenue based on strong Flash Lite OEM shipments. Cumulatively, more than 800 million devices have now shipped with Flash Lite, which sets the stage for Adobe to increase its penetration of creative tools and data services, leveraging the ubiquitous Flash platform.

In our platform business, we achieved 69% year-over-year growth. The platform group is responsible for driving the adoption of Adobe Air, and last week we announced there have now been more than 25 million installations of applications deployed on Adobe Air since its release six months ago. Recent applications include Atlantic Records, which created an Air application called Fan Base, where music fans can receive the latest content from their favorite musicians in one single download.

Last week we also announced that DIRECTV is providing NFL Sunday Ticket Super Pass service on Air for customers to view NFL games, up-to-the minute scores, statistics, and on-demand highlights right from their desktops. Additionally, Fox News is now offering the Fox News Lifestream player to deliver live video feeds right to users’ desktops from major news events, such as the Democratic National Convention and the Republican National Convention, with exclusive up-to-the-minute content that viewers won’t see on TV.

Success stories such as these are clear evidence Adobe is the market leader in helping to define and drive the next generation user experience on the web.

In closing, the Q3 performance Mark and I outlined today reinforces two fundamental attributes of Adobe's business; first, we continue to execute exceptionally well against our strategy, and second, the demand for Adobe solutions is strong and growing. Because of this, our year-to-date fiscal 2008 performance continues to outpace the financial targets we set at the beginning of the year.

Given the uncertain global economic and currency environment, it is no longer prudent for us to comment on fiscal 2009 growth until we have completed Q4 and our 2009 planning process.

We fundamentally remain excited about the major market trends driving our business -- the explosion of digital content, the proliferation of web connected devices, and the richness of experiences that consumers now come to expect continues to fuel our growth. In addition, the diversity of our business, including major new product launches, combined with new growth initiatives such as video, LiveCycle, mobile, and air is contributing to our success today and will drive long-term growth.

We look forward to sharing more about our vision next week at the Creative Suite 4 launch event and at our MAX conferences later in Q4. Thank you for joining us today. Now, I’ll turn the call back over to Mike.

Mike Saviage

Thanks, Shantanu. In regard to the CS4 event on September 23rd, if you would like to watch the webcast, there will be several start times you can access, including 11:00 a.m. Central European Time, 9:00 a.m. Eastern Time, and 9:00 a.m. Pacific Time. Prior to the event, please go to www.adobe.com and under the news heading, select the link to see the unveiling of Creative Suite 4. This will launch a page where you can register for a preferred viewing time and will provide you further viewing instructions. An archive of the event will also be made available for subsequent viewing.

In November, Adobe will host its annual Adobe MAX conference. MAX is a week-long event that begins on November 17th in San Francisco and is an opportunity for Adobe customers to connect with thousands of designers, developers, partners, executives, and Adobe staff. We are once again providing Adobe investors and analysts a special one-day attendance offer for the opening day, and an e-mail invite was sent out in early August with details. If you are a Wall Street professional and would like to receive this offer, please e-mail IR@adobe.com with your request. We hope to see you at MAX.

In regard to today’s earnings report, we have posted several new documents on our investor relations webpage today. They include today’s earnings release and our updated investor data sheet. To access these documents and other investor related information, you can go to our website at www.adobe.com/adbe.

For those who wish to listen to a playback of today’s conference call, a web-based Acrobat Connect archive of the call will be available from the IR page on adobe.com later today. Alternatively, you can listen to a phone replay by calling 888-203-1112. Use conference ID number 9664580. Again, the phone number is 888-203-1112, with ID number 9664580. 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 Friday, September 19, 2008.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go to Jay Vleeschhouwer, Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Shantanu, I’d like to ask first about the revenue opportunity for CS4 in the following way -- it’s pretty well-established that you will do the version skipping pricing, which ought to be incremental but besides that, might there be anything else within CS that could be incremental? For example, any services offerings that would be available to customers from within the suite besides the product? And perhaps if at some point there is a sufficiently large base of laggard customers, might it make sense to have any kind of legacy programs along the lines, for instance, of what Autodesk does from time to time to bring as much of the legacy base current?

Secondly, with respect to the server number, it was a substantial growth in that business. Could you talk about that growth in the context of the investments you’ve made in enterprise and direct sales capacity?

Shantanu Narayen

Sure. So Jay, the first question was around CS4 and let me start off by saying we are incredibly excited about the CS4 launch. As I said in my prepared remarks, we think it’s an absolute must-have release. It really represents the first combined development effort after we put together Adobe and Macromedia as companies, and the early feedback from both our beta users as well as the press has been very positive.

In terms of specific pricing, what we have changed for configurations, that really is the purpose of what we are going to do at the launch event but to the point that you have raised, we have clearly stated that one of the opportunities we are evaluating is how we get everybody to standardize on the latest version of the Creative Suite rather than skipping versions, so you can expect to hear next week us talk about how we intend to do that.

In addition to that, frankly we think the large opportunity for us is to get people who haven’t even standardized on the CS3 suite to move over to CS4 when it ships, so we think there is a large opportunity associated with people who are either on point products for CS3 to move to the higher version suites or from the suites to the master collection, as well as emerging markets.

So a lot of opportunities for getting people on to the next version of CS4, which we are excited about.

The second question, as I recall, was really about LiveCycle and the enterprise business and as we’ve stated, we believe that this is a significant opportunity for Adobe because virtually every single enterprise and government really has to automate what today is fairly inefficient manual based processes. We did ship an update to the LiveCycle ES version, LiveCycle ES 1. We are seeing quite a bit of adoption of various solutions in the government and financial sector based on LiveCycle and the field organization has clearly matured in terms of the selling methodology that we are using, as well as the consulting approach that we are using. And in addition to that, our partnership with SAP, so we continue to be optimistic about the opportunity for the enterprise business.

Jay Vleeschhouwer - Merrill Lynch

Finally, as we approach ’09, can you comment on how you are thinking about expenses and investments in the business, particularly investments in the emerging and developing parts of the business outside of Acrobat and CS? You’ve got quite a full pipeline of technologies that you’ve talked about and services. Can you perhaps rank or somehow describe how you are thinking about investing in biz dev and infrastructure and support so that all of these newer areas have the requisite funding to grow into something substantial over the coming years?

Shantanu Narayen

Sure. As you point out, Jay, we really believe that we have tremendous opportunities ahead of us as a company. I think we have demonstrated that as a company, we continue to make the trade-offs between investing in the long-term future while continuing to deliver what we think are industry leading margins to our shareholders. Clearly CS4, Acrobat, LiveCycle will continue to be major areas of investment and focus in terms of revenue for ’09 but in addition to that, video on the web and continuing to get Air adopted by our customers are going to be priorities for us as a company.

Some of the hosted services that we are also in are now starting to see quite a bit of traction. Scene 7, we had a great quarter. Connect as a business continues to show strong bookings, so we have tremendous opportunities and as we finalize our ’09 plans, we will be continuing to invest in the new growth opportunities while continuing to tune existing businesses.

Jay Vleeschhouwer - Merrill Lynch

Thanks, Shantanu.

Operator

We’ll go next to Brent Thill with Citigroup.

Brent Thill - Citigroup

Thanks. Good afternoon. Just from a geographic perspective, the U.S. actually performed pretty well in light of a very difficult comp. Just curious if you could just comment in terms of what you are seeing in the spending patterns in the U.S. and Shantanu, I know you were reluctant to talk about ’09 but has anything changed in your pipeline as you see it right now?

And then Mark, if you could just address the currency impact in Q3 and how you are modeling that for Q4? Thanks.

Mark Garrett

I’ll talk about the U.S. and currency and then turn it over to Shantanu. Like you said, the U.S. did really well. We had good education results. We had good Acrobat results and like Shantanu just talked about, very good LiveCycle results, so we were really pleased with how the Americas did and it continues to show the strength of our very diversified model.

If you look at currency, from a Q3 perspective we had a net benefit to revenue of $39 million on a year-over-year basis. On a sequential quarter basis, it actually went against us and we had an actual net detriment to revenue of about $4 million. Again, from a currency perspective, it’s factored into our guidance when we provide it at that time.

Shantanu Narayen

And with respect to ’09, let me try and clarify the comments; clearly in terms of the opportunities that we see for ourselves as a company, we continue to be very excited and execute, frankly, really well against all of those opportunities. At the same time, I think every one of us will acknowledge that these are pretty interesting times as it relates to all the announcements that we see every day and like Adobe has traditionally done, we just want to make sure that we get through Q4, finish our ’09 planning before we give our targets, which as you know we take very seriously.

In terms of our own business and the trends, we remain as excited as ever about the major market trends driving the business. You know, the explosion of digital content, proliferation of web-connected devices, and frankly the diversity of our business, both from a product mix perspective and a geo mix, so nothing has changed relative to our belief and our opportunities. We just want to get through Q4 and ’09 before giving targets for ’09.

Mark Garrett

And then on your Q3/Q4 currency question, we basically assume like I said that rates would stay roughly where they are, so that’s what is factored into Q4. I don’t try to anticipate what rates are going to do.

Operator

We’ll go next to Steven Ashley with Robert W. Baird.

Steven Ashley - Robert W. Baird

Maybe I could ask about the macro economy -- are you seeing any softness in any vertical markets out there? And as you look at the fourth quarter guidance, what kind of assumptions about the macro economy have you made there?

Shantanu Narayen

Well Steve, again when you look at each of our businesses, clearly as it relates to the creative business, as expected we saw the revenue decline. That was the typical seasonal weakness. I would say there is a muted impact of the economy but more importantly, I think some anticipation of the CS4 launch against our public betas, which is good to see.

On the Acrobat business, we had record revenue within financial services, both within Acrobat as well as within LiveCycle. We actually saw good revenue there and government continues to do well for us as well.

Mark Garrett

And then from a Q4 perspective, geographically we’d expect Americas to be up sequentially due to seasonality and the CS4 launch and we’d expect Europe and Asia up slightly in the fourth quarter. And then from a BU perspective, we’d expect obviously an increase in Creative with the CS4 launch, enterprise in the LiveCycle business would be up sequentially due to normal Q4 seasonality, knowledge worker and other would be relatively flat, and then we expect a sequential decline in mobile with the OSP announcement.

Steven Ashley - Robert W. Baird

Thank you.

Operator

We’ll go next to Adam Holt with Morgan Stanley.

Adam Holt - Morgan Stanley

Good afternoon. Just a couple of questions about the strength you saw in Acrobat. I guess in particular, could you drill down a little bit on what was behind the strength, talk maybe a little bit about the importance or mix of licensing, how you are thinking about the ASP opportunity going forward, and obviously it is early but how is the cycle shaping up relative to Acrobat 8?

Shantanu Narayen

Adam, as you say, it is fairly early in the Acrobat cycle. Clearly the fact that it was our fourth quarter of record revenue for Acrobat is nice to see. From a customer perspective, I would say the feature areas that seem to be resonating the most with customers are clearly the support for Flash, where we’ve had native support for Flash now, which allows a much richer form of communication within PDF, video, animations, as well as actually entire Flash applications. The second feature is PDF portfolios, which people are increasingly using to provide more compelling information, and I would say collaborate live, where Acrobat now allows you access to capabilities for collaborating live within a PDF document. So those are really the three areas that seem to be getting a lot of traction.

In terms of the mix of the business itself, Acrobat Pro continues to be over 50% of the business, which is good because it reflects our higher value users. And in terms of where the business is heading, clearly licensing and our direct sales force, which we’ve been investing in, has been having quite a bit of impact. Like we’ve said for a couple of years right now, that business is shifting from being a traditional, shrink-only business to licensing being an increasingly important part of how customers buy that product because frankly they are standardizing on Acrobat across the enterprise.

Adam Holt - Morgan Stanley

Terrific, and if I could just ask two quick follow-ups for Mark, could you tell us where you ended the quarter in terms of backlog? And then just a follow-up on currency -- we’ve seen the filings but could you just remind us what you have in place with respect to your hedging for currency and how we should be thinking about the potential impact of a strengthening dollar? Thanks.

Mark Garrett

Sure, Adam. From a backlog perspective, again it’s not indicative of future performance and it’s always factored into our guidance. We did end Q3 with a minimal amount of shippable backlog but keep in mind we would expect it to be low in anticipation of the CS4 launch this quarter, and if you take a look at deferred revenue, which is obviously another form of backlog, it was up $16 million to $232 million this quarter.

As it relates to currency, we do two currency hedging programs, one for the balance sheet, where we execute forward transaction based hedges against net receivables and payables and in that program, we usually hedge about 100% of what’s on the balance sheet, so we lock in a rate. On the second program, it’s based around anticipated cash flow so we are hedging the net cash flow and Euro and Yen. We’ve got revenue and of course expenses in local currencies and we look at the net position of revenue minus expenses and hedge a portion of that to mitigate exposure. We hedge out up to a year and we are getting a little more aggressive around this program, obviously to try to protect ourselves as much as possible from a rising dollar.

Adam Holt - Morgan Stanley

Great. Thank you.

Operator

We’ll go next to Phil Winslow from Credit Suisse.

Phil Winslow - Credit Suisse

Hi, guys, good quarter. I just want to spend a little time on the expense side, when you start to look into this next quarter, obviously you’ve got the CS4 launch coming up but just how you see investments, R&D, sales and marketing not just next quarter but sort of trending over the cycle.

Shantanu Narayen

From an expense perspective, clearly this is going to be a big launch as it relates to CS4, so as you would expect, we will see some marketing investment both in CS4 but continuing investment as it relates to Acrobat and the LiveCycle product as well, and Connect because we continue to think that awareness of our solutions is an area that we need to focus on, and R&D continues to also be an area of investment for us as an ongoing way to make sure that we are investing in the future.

Mark Garrett

And obviously those investments are all factored into the Q4 guidance that we provided.

Phil Winslow - Credit Suisse

And then also just one quick follow-up on the OSB change, how it affects just that -- the whole business unit obviously creates maybe a change there. How should we expect that flowing on into the next quarter and the quarter after?

Shantanu Narayen

Well, the strength that you saw in the mobile business right now is really a reflection of the fact that we are seeing an acceleration of the number of devices that are shipping with Flash Lite and the fact that the initial contracts that Macromedia signed as people have moved off those contracts where all the revenue was recognized up front, we are now recognizing them as shipment of these devices occurs.

We have stated that with the next release of Flash, we are going to be reducing the royalties for Flash Lite on these particular devices and so we would expect sequentially for that revenue to decline quarter over quarter.

Phil Winslow - Credit Suisse

Great. Thanks, guys.

Operator

We’ll go next to Ross MacMillan with Jeffries.

Ross MacMillan - Jeffries & Company

Thanks. I think most of mine have been answered but just in terms of CS4, the 23rd obviously is the announcement date. Will pre-ordering be available from that date or does pre-ordering happen or start sometime after that? Thanks.

Shantanu Narayen

Well, there are two different kinds of pre-ordering, one of which is certainly on our website where we are going to be offering to customers the ability to order the product and so yes, you can expect to see people have the ability to order product directly from Adobe on that date. But in addition to that, we have the normal program with the channel, where we are informing the channel about the various products and configuration, so we make sure that when we are shipping the product, it’s available in volume, in the countries that we expect to -- one thing I will share is we are pretty excited about the number of people who have already signed up for the live launch. I think it’s getting close to 100,000 people so it’s good to see the interest in the next version of the Creative Suite.

Ross MacMillan - Jeffries & Company

Great, and then just to follow-up on Air, I saw the release obviously on the $25 million embedded. I think it’s embedded downloads. Is there any way for us to think about how you start to generate revenue or is it still too early? I mean, are we going to start to see some revenue contribution in fiscal ’09?

Shantanu Narayen

Well, the revenue contribution for Air will actually show up in two other lines -- the first line in which we expect to see revenue contribution from Air show up is in the authoring line and CS4 will continue to add capabilities in terms of offering these next generation of rich Internet applications, much like as we have Flash proliferated on mobile devices, authoring for those mobile devices is also reflected in the authoring segment.

The second are where we continue to expect to see Air drive revenue or monetization opportunities for Adobe is in the streaming servers line, so as the amount of video that you see in applications like the DIRECTV Air application show up is that they are hopefully using both the Flash Media Server from Adobe, as well as the scene server technology from Adobe.

So you won’t see a specific line which is called Air revenue but we expect to see other segments increase through the usage of air applications.

Ross MacMillan - Jeffries & Company

And any other applications like the media player, where you may embed air?

Shantanu Narayen

That’s correct, so the media player is another application where we will participate in the advertising revenue stream and again, we’ve seen over 15 million downloads of the media player as well, because that’s primarily North American content at this point, which is good to see.

Ross MacMillan - Jeffries & Company

Great. Thank you.

Operator

We’ll go next to Michael Olson, Piper Jaffray.

Michael Olson - Piper Jaffray

Good afternoon. Just a couple of quick ones here -- regarding Europe, obviously there’s been some concerns about the macro environment in Europe. Did you guys see any sign of weakness in Europe outside of just the normal seasonality, or anything just abnormal?

Mark Garrett

No, we really didn’t see anything abnormal. Like you said, it was pretty much the normal seasonality and we looked at it country to country and didn’t see any trends that concerned us.

Michael Olson - Piper Jaffray

Okay, and then one quick one on CS4 -- typically I think CS and the Photoshop products have shipped about 30 days after announcement. Is there any reason to expect at least the English shipment to be any different than that?

Shantanu Narayen

Well, Mike, what we’ve said is we expect to see the entire CS4 family ship in English in Q4. Recall last time we actually had a lag between the core design products and the video products. The production premium and master collection last time shipped a little bit later and what we are doing is we are bringing those closer together, so expect to see English in Q4 -- I am not going to give you exact dates -- and expect to see other major languages shipping in volume in Q1.

Michael Olson - Piper Jaffray

Okay. Thanks a lot.

Operator

We’ll go next to David Hilal with Friedman, Billings, Ramsey.

David Hilal - Friedman, Billings, Ramsey

Thank you. A few questions; first, after the announcement next week of CS4, will all purchases of CS3 come with the coupon to upgrade to CS4?

Shantanu Narayen

Yes, that’s typically how we have allowed customers who buy CS3 to upgrade to CS4.

David Hilal - Friedman, Billings, Ramsey

Okay, and then Shantanu, you mentioned you did not want to comment on ’09 guidance at this point, which is understandable, but I did want to revisit a specific comment you guys have made in the past when you’ve said that ’09 revenue should accelerate, should grow faster than ’08 revenue -- do you still believe that’s the case or by your comments today, are you taking that comment off the table?

Shantanu Narayen

You know, we are taking it off the table. It is not a reflection of what we see in our business. It’s just being really prudent based on everything that we see happening in the economic environment and currency. As I said, our fundamental trends -- digital content and the explosion of everything we see we continue to see but it really is -- FY08 was also stronger than what we said at the beginning of the year. Clearly we are going to beat the targets that we stated for FY08 at the beginning of the year.

So typically Adobe gives ’09 targets at our Q4 earnings call, so that’s what you can expect to see.

David Hilal - Friedman, Billings, Ramsey

Okay, and then finally, the open screen project is going to cause the mobile business to have a step function down in rev -- will that be a one-time adjustment and then it will trend back up? Or will we have a few quarters of sequential declines in that unit?

Mark Garrett

We’ll likely have a few quarters of sequential decline, up to the next Flash release, and then see it build back up in different ways.

David Hilal - Friedman, Billings, Ramsey

Okay. Thanks, guys.

Operator

We’ll go next to Philip Rueppel with Wachovia Securities.

Philip Rueppel - Wachovia Securities

Great. Thank you very much. Given that the CS4 release was on the earlier side of expectations and you do desire to get customers to stay current or stop version skipping, are you feeling any push-back from the larger customers that the release cycle is too short for them to keep up with? And kind of strategically, how do you plan to keep them current and to stop version skipping, if that is the case?

Shantanu Narayen

Well, Philip, we’ve traditionally done an 18- to 24-month cycle for CS4, so this actually is in line with what the traditional cycles have been. Clearly what we see is a number of freelancers move to the product as soon as it’s available, and as we’ve said in the past some enterprises move right off the bat, other enterprises use it to first start to test their work flows before rolling it out across the entire organization. So we would expect to continue to see that kind of adoption.

Some of the areas that we’ve invested in, however, are very important to the major publishing customers. All of them are asking us if we can help them accelerate the movement of content from print to the web. All of them are increasingly using video as a means of communication, and so they would like to see more support for Flash Video. So a lot of the features that we’ve put in CS4 I think are aligned with what major enterprises and publishers see in terms of where the demand is from their customers, so all of those give us hope.

Philip Rueppel - Wachovia Securities

Great, thanks.

Operator

We’ll go to Heather Bellini with UBS.

Heather Bellini - UBS

Thank you. Shantanu, I just had a question for you and then a follow-up question for Mark. I guess Mark, I’ll start -- the easy one first would be you detailed how FX has impacted your revenue. You’ve been doing that each quarter. I was wondering if you could give us some clarity around how the FX impact might have been impacting your operating expenses over the course of the fiscal year.

And then Shantanu, my question for you would be the macro environment is a little different right now in the launch quarter of CS4, as it was for CS3, and I guess I’m just wondering -- how would you characterize your assumptions behind adoption of CS4 versus what you actually experienced in the launch quarter of CS3?

Mark Garrett

I don’t have a number for you on the expense side. It’s obviously pretty small relative to the revenue that we have overseas and like I said, we hedge the net for that reason but I don’t have a specific dollar impact that I could give you. I’d have to look into that.

Shantanu Narayen

And Heather, as it relates to CS4 and what kind of adoption we anticipate when it comes out, clearly the visibility that we have into that business is factored into the targets that we gave for the particular quarter. What we have to go by right now is the early beta feedback, the customer feedback. That’s been universally positive, so that’s clearly on the positive side.

We’ve always stated that for people who are creative professionals and use our product eight hours or more a day, the more we can help them be efficient and productive, the product pays for itself in a very, very short order of time. So as long as these people continue to be employed, we are confident that the capabilities that we provide more than pay for themselves.

Heather Bellini - UBS

Okay and also, one last follow-up -- is this going to ship in fewer languages? I mean, English -- this one’s only shipping in English in the launch quarter. Was it three languages in the launch quarter for CS3?

Shantanu Narayen

Again, as an overall company, we are actually investing in more languages. We are going to provide CS4 in more languages this time than we provided CS3. Part of that is as we’ve folded all the Macromedia products under our brand, we certainly offer our products in more languages and as we’ve stated that we see emerging markets as a bigger opportunity.

In terms of the shipment itself, yes, English is the focus for Q4.

Heather Bellini - UBS

-- in the launch quarter, it shipped in three languages. Is my memory correct?

Shantanu Narayen

I think again, English was the primary language in CS3 and then again, there may have been a little bit of French and German, but that was primarily again in the next quarter.

Heather Bellini - UBS

Okay. Thank you.

Operator

We’ll go next to Sasa Zorovic with Goldman Sachs.

Sasa Zorovic - Goldman Sachs

Thank you. A couple of questions, one really broad one and one fairly specific one -- for the specific one, I wanted to start there first -- the Asia, the reason for the decline there, if you could provide a sequential, a little bit more of a detail there. And then secondly really when you mentioned these sort of this wide distribution use of Flash for video on the web and specifically, how are you looking to monetize that, perhaps using advertising or some of these other things that you have indicated previously, and really beyond the creation tools or the server-based tools?

Mark Garrett

As it relates to Asia, in the second quarter we had a very strong performance out of Japan and then on top of that, Q3 is usually seasonally down for Asia in total.

Shantanu Narayen

And as it relates to the video opportunity, when we looked at our video performance in Q3 of this year, we are seeing a couple of macro trends. Firstly, we are seeing increased usage of our video tools on the Macintosh as well, so as you know, we went back to the Mac with CS3. That is clearly getting us market share on the Mac.

The second thing is we are actually seeing more movement towards the suites from individual point products, so the authoring revenue we are clearly seeing.

I do want to clarify again, when you see a lot of the video on the web that’s being streamed, it is being streamed through the usage of a Flash video streaming server that Adobe providers, or a Flash Media Server, and the way we monetize it is -- think of it as megabytes served, so as the volume of Flash video increases, we have a direct correlation to driving revenue for Adobe.

The advertising revenue that you allude to, Sasa, is clearly a more nascent revenue opportunity for us, which is available through the Flash, the Adobe media player and there it’s by virtue of the fact that we are inserting ads, pre-roll, post-rolls, and interstitials, we are sharing in the revenue associated with it. That’s more nascent. The real revenue that we are seeing today in the video business is through the streaming of all the video that you see on the web and through our authoring tools.

Sasa Zorovic - Goldman Sachs

Thank you.

Operator

We’ll go next to Walter Pritchard, Cowen and Company.

Walter Pritchard - Cowen and Company

Thanks. All my questions have been answered, except for one -- just around the enterprise business, you had a sharp up-tick there in large deals and I’m just trying to get a sense of how much of that was as a result of hiring of sales reps versus increase in productivity in what you already had on board?

Shantanu Narayen

Well, Walter, as you know, for a direct sales rep from a productivity perspective, it takes a little while for them to come on board and get more productive, so I think it’s really more of a maturation of the field organization that’s already in place. But in addition to that, the solution focus that we’ve had in the field and the majority of the enterprise LiveCycle product that we have.

Walter Pritchard - Cowen and Company

And just one follow-up on that -- I know you released a new line of those products about a year ago. Was that a significant factor in terms of the up-tick or do you attribute it more to the sales productivity, which you discussed?

Shantanu Narayen

The product is certainly getting more mature and able to meet more of the automation needs. The real goal for us with LiveCycle is the confluence of people, information, and processes and if you can make that information available to knowledge workers, so I would attribute it to an ongoing maturity of both the product, the solution sale, and the field organization. But the field organization did a great job for us.

Walter Pritchard - Cowen and Company

Great. Thanks a lot.

Mike Saviage

Operator, we’re running out of time so we’ll take one more question.

Operator

Okay. Our final question is from Chad Bartley with Pacific Crest.

Chad Bartley - Pacific Crest Securities

Thank you. Just a follow-up on a previous question -- Mark, I was hoping you could talk about demand trends in July, August, and particularly the first half of September. I think in the last couple of days you’ve had companies like Ingram Micro, Dell, and others make some fairly cautious comments around September, so if there is anything incremental you can talk about that’s giving you guys confidence in that Q4 outlook and the launch of CS4, that would be helpful.

Mark Garrett

Well, we obviously get sell-through data on a weekly basis and we’ve only got what, a couple of weeks of data for the quarter but obviously we factored that into our guidance decision, so all I can say is the guidance is based on what we know so far.

Chad Bartley - Pacific Crest Securities

Can you say kind of linearly how things tracked July, August, September?

Mark Garrett

During the quarter? So you know, our business tracks pretty consistently, if you look at the channel, on a week-to-week basis, which allows us to be a lot more predictable than companies certainly I’ve been at in the past, and we didn’t see anything abnormal as we went through the quarter.

Shantanu Narayen

So in conclusion, again I want to thank you for joining us today. It’s clear from our Q3 performance that we continue to execute exceptionally well and that the overall demand for our solutions is strong and growing and we are pleased that based on the year-to-date fiscal 2008 performance, we are going to exceed the financial targets that we set at the beginning of the year. But I think more importantly, as we look to the future and the various opportunities that we have, we remain as excited about the major trends driving our business and we look forward to sharing more with you both at the CS4 launch and hope to see you at MAX later this year. Thank you.

Mike Saviage

And this concludes our call. Thank you.

Operator

Ladies and gentlemen, this concludes today’s discussion. You may disconnect your phones at this time.

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Source: Adobe F3Q08 (Qtr End 8/29/08) Earnings Call Transcript
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