Adobe Inc (ADBE) 2002 Q2 法說會逐字稿

Gentlemen, thank you for standing by.

Welcome to the Adobe Systems Q2 fiscal year 2002 earnings conference call.

During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in the question-and-answer session. At that time, if you have a question, please press the one, followed by the four on your telephone.

As a reminder, this conference is being recorded Thursday, June 13, 2002.

I would now like to turn the conference over to Mr. Mike Saviage, Senior Director of Investor Relations of Adobe Systems - please go ahead, sir.

Good afternoon, and thank you for joining us today.

Joining me on the call are Bruce Chizen, our President and CEO; Murray Demo, Senior Vice President and CFO; and Shantanu Narayen, Executive Vice President of Worldwide Products.

On the call today, we'll discuss the financial results of our second quarter of fiscal 2002. By now, you should have a copy of our Q2 earnings press release, which crossed the wire about 30 minutes ago. If you still need a copy of the press release, you can go to Adobe.com under the corporate 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 contains forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For discussion of the risks and uncertainties, you should review our

SEC filings, including the annual report on form 10-K for fiscal year 2001 and current reports on form 10-Q filed in fiscal 2002.

All participants are advised that the audio of this conference call is being broadcast live over the Internet. It is also being recorded for playback purposes. The audio of the call will be archived at Adobe's investor relations Web site for approximately 30 days and is the property of Adobe Systems. It may not be re-recorded or otherwise reproduced or distributed without prior written permission from Adobe Systems. I would now like to turn the call over to Bruce.

Thanks, Mike. I am please to announce that Adobe's revenue and earnings per share results met the target ranges we communicated at the beginning of the quarter. Revenue in Q2 was $317.4 million, which represents 18 percent sequential revenue growth over Q1. Pro forma earnings per share were 27 cents, which was at the high end of our guidance. And our pro forma operating profit margin was 30.4 percent, which was above our target range.

Driving Adobe's revenue in Q2 was the successful launch of Photoshop 7.0. Despite the ongoing soft economy, the new release is exceeding the performance of Photoshop 6.0, which was launched prior to the economic downturn. In addition to our quarterly results, we also made substantial progress positioning Adobe for future growth with our E-Paper opportunity. During Q2, we closed our acquisition of Accelio, and also announced a major agreement with SAP to integrate Adobe's Acrobat, Accelio and PDF technologies with their powerful enterprise software. Together, these two milestones served as major steps towards realizing the large market opportunity we see for our products.

IN a few minutes, Shantanu will provide product related highlights for the quarter, but first I'll turn it over to Murray for a review of our financial results. Murray?

Thanks Bruce. For the second quarter of fiscal 2002, Adobe achieved revenue of 317.4 million. This compares to 344.1 million reported for the second quarter of fiscal 2001, and 267.9 million reported last quarter. GAAP net income for the second quarter of fiscal 2002, which includes non-operating gains and losses was 54.3 million, compared to 61.3 million reported in the second quarter of fiscal 2001, and 49.8 million last quarter.

Pro forma net income, which excludes the amortization of goodwill, acquired in-process, research and development, with restructuring and other charges, and investment gains and losses from the company's venture programs, was 67.4 million, compared to 84.5 million reported in the second quarter of fiscal 2001 and 52.8 million last quarter. Pro forma diluted earnings per share for the second quarter of fiscal 2002, which excludes the amortization of goodwill, acquired in-process research and development, with restructuring and other charges, and investment loss from the company's venture programs, were 27 cents.

GAAP diluted earnings per share for the second quarter of fiscal 2002 were 22 cents, based on 247.7 million weighted average shares. This compares with diluted earnings per share of 25 cents reported in the second quarter of fiscal 2001, based on 250.1 million weighted average shares, and diluted earnings per share of 20 cents reported last quarter, based on 245.2 million weighted average shares.

Gross margin for the quarter was 92.1 percent, compared to 93.5 percent in the second quarter of fiscal 2001, and 92.2 percent last quarter. Excluding the amortization of goodwill, acquired in-process research and development, and restructuring and other charges, pro forma operating expenses for the second quarter of fiscal 2002 were 195.8 million. The planned sequential increase in operating expenses for the second quarter of fiscal 2002 for 195.8 million. The plan's sequential increase in operating expenses was primarily due to the addition of the Accelio cost space and the increase in marketing expenses to support the Photoshop launch.

Regular employees at the end of the second quarter totalled 3,510 versus 3,054 at the end of the first quarter of fiscal 2002. The acquisition of Accelio represents most of the increase in head count.

Expenses as a percent of revenue break down as follows: Research and development 19.8 percent, sales and marketing 32.7 percent, G&A 9.2 percent. Excluding the amortization of goodwill plus structuring and other charges and acquired in-process research and development, pro forma operating profit in the second quarter of fiscal quarter 2002 was 96.4 million or 34 percent of revenue. This compares to pro forma operating profit of 121.5 million or 35.3 percent of revenue in the second quarter of fiscal 2001 and 72.7 million or 27.1 percent of revenue last quarter.

Other income for the second quarter of fiscal 2002 was 2.7 million. Other income was lower than targeted due to higher foreign currency hedging costs.

Adobe's effective tax rate for the second quarter of fiscal 2002 was 32 percent compared to 33 percent in the second quarter of fiscal 2001 and 32 percent last quarter.

I will now discuss Adobe's revenue by market segment.

Graphic segment revenue was 153.6 million in Q2 fiscal 2002 compared to 148.1 million in Q2 fiscal 2001 and 108 million last quarter. Our graphics business was led by the new release of Photoshop.

Cross Media Publishing segment revenue was 67.1 million in Q2 fiscal 2002 compared to 77.3 million in Q2 fiscal 2001 and 63.4 million last quarter.

ePaper Solution segment revenue where we now include Accelio was 75.6 million in Q2 fiscal 2002 compared to 90 million in Q2 fiscal 2001 and 74 million last quarter. Year-over-year, our ePaper business was lower due to the tough compare with the launch of Acrobat 5.0. Compared to last quarter our ePaper revenue excluding Accelio was essentially flat.

OEM Postscript and other segment revenue was 21.1 million in Q2 fiscal 2002 compared to 28.7 million in Q2 fiscal 2001 and 22.5 million last quarter.

Turning to revenue by geographic segment, the results in Q2 fiscal 2002 were as follows: The Americas 50 percent, Europe 26 percent, Asia 24 percent. As of the end of Q2 fiscal 2002 Adobe's business in each of the major geographic segments continues to be stable.

Application Platform mix was 69 percent Windows and 31 percent Mac in the second quarter of fiscal 2002, which compares to 71 percent Windows and 29 percent Mac for the second quarter of fiscal 2001 and 73 percent Windows and 27 percent Mac last quarter. The increase in the Mac platform this quarter is due to the release of Photoshop.

Our trade DSO in the second quarter of fiscal 2002 was 38 days compared to 39 days in Q2 fiscal 2001 and 48 days last quarter. The trade DSO this quarter was below our target range of 40 to 45 days.

Our global inventory position at the end of the quarter continues to be within company policy.

At the end of the second quarter fiscal 2002, cash and short-term investments were 699.9 million compared to 620.8 million at the end of the first quarter of fiscal 2002.

Turning to Adobe ventures, we incurred an investment loss of 13.7 million in Q2 fiscal 2002. In the quarter, we made additional investments of $7 million. In total, Adobe has invested 204.9 million though its venture partnerships and direct investments. As of the end of the second quarter, the net returns from this program were 347.9 million including the stock dividended to stockholders and the market value investment still held by Adobe.

With respect to the Accelio acquisition, we have completed the alignment of employee resources and the rationalization of facilities. The Accelio acquisition costs that were recorded as part of the purchase price as goodwill were 19.6 million, and the restructuring expenses related to Adobe personnel were 1.6 million.

In regard to share buyback, Adobe repurchased approximately 1.4 million shares at a cost of 36.3 million during the quarter.

Adobe's board of directors declared this quarter's cash dividend of one-and-a-quarter cents per share payable on July 8, 2002 to stockholders of record as of June 25, 2002.

This concludes my discussion on second quarter fiscal 2002 results. I would now like to discuss our Q3 fiscal 2002 targets.

We are targeting revenue at 300 to 320 million. As a percent of revenue, our operating model targets for the quarter are as follows - gross margin, 92 percent; R&D, 20 to 21 percent; sales and marketing, 33 to 34 percent; and G&A, 9 to 10 percent, resulting in an operating margin target of approximately 28 to 30 percent.

For our share count, we are targeting a range of 249 to 251 million shares - million shares.

Finally, we are other income of approximately three million and a tax rate of 32 percent. These targets lead to a pro forma earnings per share target range in Q3 fiscal 2002 of 24 to 27 cents per share.

Looking to Q4 fiscal 2002, I would like to provide our preliminary targets for revenue and earnings per share. We are targeting Q4 revenue at 315 to 345 million and Q4 pro forma earnings per share between 26 and 29 cents.

This concludes my comments. I will turn the call over to Shantanu.

Thanks, Murray.

In reviewing our business from a product perspective, I would first like to comment on our graphics business segment. As Bruce stated earlier, Photoshop 7.0 is off to a strong start. On a worldwide cumulative sell-through basis, Photoshop 7.0 is running ahead of Photoshop 6.0 in both revenue and units when comparing the same number of weeks of product availability for both products.

Direct sales revenue for Photoshop 7.0 in Q2 was at an all-time high and significantly higher than Photoshop 6.0. And finally, Photoshop 7.0 Windows versus Mac unit ratios are tracking approximately the same as the ratios for Photoshop 6.0.

We also announced a relationship with

around our AlterCast

Image Serve product.

customers can now take advantage of Adobe's image creation functionality integrated with

other content management capabilities for documents, Web content, XML, audio and video.

New AlterCast customers in the quarter included

in New York,

and

worldwide. In regard to Illustrator, we saw a slight revenue increase this quarter after Photoshop shipped, but to date, it has not been significant. We did

a

sequential increase in revenue for our product suites that now include Photoshop 7.0, especially with the design collection. In Q3 we will generate revenue for the new localized Japanese collections.

Turning to our cross media segment, InDesign continues to take share against QuarkXPress.

data in the U.S. shows that between January and April of 2001, on a unit basis, InDesign had 27 percent market share when compared against QuarkXPress. For the same four-month period in 2002, which includes the release of new versions by both companies, InDesign has moved to 52 percent market share.

The key reason for the switch is that InDesign is being perceived as the superior product. "PC World" gave it its world-class award for best desktop publishing magazine. And "PC Magazine" wrote, quote, "InDesign 2.0 is the desktop publishing program of the future."

for InDesign in Q2 included Microsoft

holdings,

,

, Wells Fargo,

and

. As part of our cross media strategy, we also

FrameMaker 7.0. This new release, which received great reviews, provides businesses with an easy way to deploy XML, to facilitate reuse and speed time to market for mission-critical content.

Turning to the e-Paper segment, we continued to see new adoption at major accounts. Key

were greater than 2,500

in the quarter, included

,

,

, The University of California and

.

During the quarter, we continued to focus on Adobe's role as an e-government solutions provider. We are working with

government agencies to standardize an Adobe PDF and e-Paper solutions. Are efforts are helping broaden the potential market for Acrobat in worldwide governments and in the enterprise.

For example, during the quarter we saw formal adoption of Adobe PDF as a standard by the Taiwan government agency responsible for implementing electronic documents. Acrobat 5 continues to receive accolades. The product was recently honored with the 2002

award for best business productive

or service by the Software and Information Industry Association, the principal trade association for the software and digital content industry.

Last week, Adobe and SAP announced a global technology and global market agreement to integrate Acrobat and Adobe PDF technology with SAP's mySAP platform. This integration will provide an enhanced solution for process

enterprises and solidify PDF and PDF-based forms as the document delivery standard in SAP installations.

For Adobe, this signifies another step towards our transformation into an enterprise software company.

The short-term revenue opportunity involves SAP's endorsement of the Adobe Accelio output pack for SAP, as the preferred and recommended method of creating output from SAP systems. Long-term with Adobe PDF as a central document standard in SAP systems, we will develop and market Acrobat Silver and our stock solutions into SAPs more than 44,000 global customer installations, comprised over ten million users.

In regard to the integration of Accelio, we have finalized our product roadmap, and go to market strategy. We've integrated their sales force, and we've made the necessary reductions in force to remove redundant costs and leverage Adobe's infrastructure. On April 30th we talked about piloting a new version of Acrobat, to proliferate Adobe PDF creation within enterprises, and we have recently started this pilot program in our European market.

This concludes my Q2 business segment review. I would now like to turn the call over to Bruce.

Thanks, Shantanu. As you heard today, Q2 was a solid quarter in which we again demonstrated the ability to carefully manage our business, and deliver on the targets we committed to at the beginning of the quarter. Photoshop 7.0 is one of our strongest releases yet, as evidenced by the data we provided today. However, we have not yet seen a dramatic impact from this product on the rest of our business. Our overall performance continues to be impacted by the sluggish global economy, and reduced corporate spending.

For these reasons, we have provided you financial targets, for both Q3 and Q4, to set expectations appropriately. We are pleased that our revenue target ranges for both Q3 and Q4 show a return to year over year growth in our business. And the resulting full year pro forma EPS estimate range remains consistent with our original target we gave you last fall. As we move into the second half of fiscal 2002, we remain focused on executing against the strategy we outlined for you last October.

We continue to deliver award-winning products, and are making significant inroads within design. Most important are the strategic steps we have made to expand into the enterprise software arena, which will position us to address the large E-Paper opportunity, a market we have sized at over $4 billion by 2004. We remain bullish on Adobe's long-term growth opportunities, we will continue to invest for future revenue growth, while at the same time manage our business for profitability and achievement of our financial targets. Mike?

Thanks, Bruce. Before we start the Q&A session, I would like to provide an update on our next financial analyst's meeting. We've decided to change the date to Monday, October 28th, and move the meeting to New York City. Details, including invitations and registration information will be sent out in September. Again, that's Monday, October 28th in New York City. In Q3, Adobe management will be presenting at the Thomas Weisel conference in Santa Barbara next week, the Adams Harkness and Piper Jaffray conferences in Boston in August, and the Pacific Crest conference in Vail in August.

Our Q3 inter-quarter update will be issued on Wednesday, July 31st, after the market closes. For those who wish to listen to a playback of today's conference call an audio recording of the call will be available from Adobe's Industrial Relations Web site on Adobe.com later today.

Alternatively, you can listen to a phone replay by calling 858-812-6440. Use reservation number 20644438. Again the phone number 858-812-6440, reservation number 20644438.

Phone play back service will be available beginning at 4:30 p.m. pacific time today and ending at 4:30 p.m. pacific time on Monday, June 17th, 2002.

We would now be happy to take your questions. Out of courtesy to others on the call, we ask again that you limit your questioning to one per person.

Operator.

Thank you.

Ladies and gentlemen, if you wish to register a question for today's question-and-answer session you will need to press the one followed by the four on your telephone. You will a three-tone prompt to acknowledge your request. If your question has been answered and you wish to withdraw your polling request you may do so by pressing the one followed by the three. If you are on a speakerphone, please pick up your handset before entering your request.

One moment please for the first question.

Our first question comes James Vleeschhouwer of Merrill Lynch. Please proceed with your question, sir.

Thank you.

Bruce, I'd like to ask you first about the Photoshop results. You talked about its outperforming Photoshop 6.0, however, what you didn't say is that it in total results for the quarter exceeded the record revenues of Photoshop 6.0 back in Q4 of 2000 or even the second best quarter and the subsequent first quarter of 2001, so in absolute terms can you give us a better comparison as to how it actually did versus what were very strong first two quarters of Photoshop 6.0 and for the remainder of the year, what are you assuming about the sequential tail for Photoshop 7.0 by comparison to how it did in the second quarter? And just as follow up, where do you expect to be devoting your marketing or demand creation spending through remainder of the year? Where will you continue to drive those investments?

I was just counting questions, Jay.

All kidding aside, Photoshop - well, this is the second best quarter ever for Photoshop with the best quarter being Photoshop 6.0 quarter. Keep in the mind that the number of weeks in which we've been shipping Photoshop on a worldwide basis, Photoshop 7.0 was less than the number of weeks in which we were shipping Photoshop 6.0. So if you just compare apples-to-apples, which is the new shipment or the number of weeks in which we were shipping the product, Photoshop 7.0 is outperforming Photoshop 6.0 but because some of the foreign language products shipped a little bit later than the when the Photoshop 6.0 foreign languages shipped the Photoshop 6.0 quarter was a better quarter.

The second question in terms of the overall life cycle of the product and the tail difficult to say, clearly we're excited about the success we've already had with Photoshop 7.0. What we don't know is how is it going to proceed as we move through the quarter as well as into Q4. One of the reasons why we're providing a range in terms of revenue guidance for Q3 and Q4 is because of the uncertainty around Photoshop. If Photoshop does worse, then we'll be at the lower end of the range. If Photoshop does better we'll be at the higher end of the range. I wish I had more data to share with you.

In terms of marketing dollars as well as sales effort, it will continue to be focused heavily heavily on the Acrobat and ePaper opportunity. Certainly we'll continue to market the channel level Photoshop, and as we move into Q4, we'll take advantage of the holiday selling season around our other digital imaging offerings like Photoshop Elements as well as our video products, but a big chunk of our overall variable sales and marketing dollars as well as our people resources will be focused on the very large Acrobat opportunity and Accelio opportunity.

In theory, what, if anything, could inhibit your growth even in a better economy? What could, you know, curtail your upside even when the economy does finally start getting better?

James, what we did in the revenue guidance or targets that we provided, we factored in the sluggish economy. If the economy continues to remain sluggish, getting to the twenty-plus percent growth rate that we think that we're capable of getting to given the large size of the markets that we're addressing is going to be not as doable. Once the economy returns back to normal economic times, then we can get back to twenty-plus percent growth.

What you're seeing now is we are totally impacted by the economy. With that said, I'm not going to sit here and tell you that I'm embarrassed by 18 percent sequential growth or upset over the fact that if you look at Q3 - Q4 combined and our guidance, you're talking about year-over-year growth of 10 to 20 percent in the second half of the year.

So relative to other companies, I'm pretty proud of Adobe's performance. In terms of the possibilities, once the economy turns, I don't see any reason why we can't grow at 20 percent or higher.

Next question, operator?

The next question is from Ben Reitzes of UBS Warburg.

Hi. It's Ben Reitzes - Ben Reitzes.

I would like to ask a question about the Photoshop comments that

. Did you say that the Windows and Mac sales are equal to what they had been historically and could you clarify that? And could you - am I right in hearing that that means that the Mac OS X is having an impact - is not having an impact? If you could just clarify that ...

Yes, so let me give you a little bit of information. This is Bruce Chizen, Ben Reitzes. I apologize for the mispronounciation of your name.

That's no big deal.

So regarding OS X adoption, what is clear to us is that our Mac customers are upgrading. And one of the reasons why the movement from Windows - from Macintosh as a percentage of our sales has increased this quarter from last quarter - the driver for that was Photoshop and the adoption of Photoshop by the Macintosh customer. What we don't know yet is how many of those customers are using OS IX or using OS X? We have some data at least from our technical support group that suggests that at least the people who are calling in and they're not calling in for any specific reason related to OS X or use of Photoshop on OS X, but those who are calling in are OS - as a percentage are more OS X than they are OS IX which can suggest that people are moving to OS X. But we don't have any specific data.

In terms of the mix of Mac to Windows on Photoshop, Windows continues to be the dominant platform for the product, but it is much more Mac influenced than the rest of our product line.

But historically where is the mix versus the last launch?

The - it's exactly the way it was the last launch. So the ratio of - Shantanu, I think, has more detail.

So most specifically then, what I had said was the Photoshop 7.0 Windows versus Mac unit ratios are tracking approximately the same as the ratios for Photoshop 6.0.

Right. So what does that make you think about OS X here? No impact yet and we're going to see one, or is it not as good as anybody thought?

My guess is - and this is nothing more than a guess - that people are beginning to adopt OS clearly - it's not clear to us yet that they're adopting it as quickly as you would like based on the adoption of the existing products - you know, Illustrator and some of the collections. But again, we do not know. It's way too early.

Keep in mind we started shipping the

product in the middle of April. We didn't ship the foreign language products until May - in fact, the Japanese product didn't go out until the end of May. So for us to sit here today and know determinably whether the customers are using

or OS X, is uncertain.

Based on what customers are telling us, they've all indicated that they will be moving to OS X. It's a question of time. As they move to OS X, it suggests to us that's going to be very helpful to the rest of our OS X products, like Illustrator and InDesign.

Is it already helping InDesign?

Again, it's too early to say. We did see that the decline of illustrator was less than we anticipated or less than you would expect for Illustrator and its life cycle. But it's too early to say how much of an impact did OS X have on that, versus just the shipment of

.

Right. My question was on InDesign, though. The numbers were good. Was that - you think it had more to do with OS X?

I think in terms of the design collection with Photoshop 7.0 being there, we're certainly seeing a greater, as we mentioned, sequential increase in the design collection. And clearly, the design collection is the collection that includes both Photoshop, as well as InDesign. And we continue to see, as I said, increased market share for InDesign, versus QuarkXPress.

OK. And then just a clarification. Murray, with the DSO at 38, I'm surprised. It would seem that you'd have a back end

quarter with Photoshop. And with the DSO so low, if you could just explain what's going on there. And that's my last question, I promise.

Yeah,

, so in regard to DSO, two things. One is that, you know, our collections organization did a great job this quarter in pulling in a lot of receivables, as well as the timing of their release of Photoshop in the United States. The first wave of shipments, we didn't really get payments on those before the end of the quarter. And so those are the two things that drove the lower DSO.

OK.

Next question.

The next question is from

Rosenzweig of Salomon Smith Barney.

Hi guys.

I just wanted to clarify. Again, I think you had indicated that on the international release, that occurred in May, with some of that not occurring to the latter part of May. We know that Accelio didn't close until some time, I think it was in the middle of the quarter. So you don't have a full quarter of that yet.

Yet we're looking at revenues in the third quarter that look effectively sequentially down. I mean, you were

here, you were looking for

. So the middle of the range would be sequentially down.

So I'm trying to understand that. I would figure that given that we've got the Accelio full quarter contribution next quarter, we've got the international full quarter contribution, and even the U.S. was a half a quarter contribution. It would seem we should be going the other direction sequentially. So maybe you can just sort of clarify why we're seeing that sequential drop.

Hi

, so this is Murray. The biggest thing for the quarter is really, is the European seasonality. As you know, between Q2 and Q3 we typically see a decline because of a number of the European markets weaken during that period, then they improve in the fourth quarter. So the seasonality in Europe is having an effect of pushing down the Q3 revenue numbers. In regards to the ...

How much do you think - sorry, how much do you think that's pushed it down Murray?

It depends. There's a number of things going on here. First is, is that if you look at Photoshop, a number of the second tier languages in Europe, for Photoshop, have not shipped. They did not ship in the second quarter, so we'll get some benefit on the Photoshop tail from just the new release of some of these second tier products in the quarter.

However, we've tended to see, and you can go back and look at our results in previous years, you can see that we've had this decline from Q2 to Q3 from a seasonality perspective, so you'll just have to kind of use your own judgment on that. You know, we're giving a range of 300 to 320 for Q3, but still there's some unknown around the tail on Photoshop, and that can have an influence on where that, where that quarter finishes in terms of that range.

Is there anything else that, are you expecting any weakening maybe in the Acrobat lineup, since we're sort of now people waiting maybe for Acrobat 6.0, and, you know, some of the luster from the 5.0 release kind of, kind of fading a little bit. Is that maybe part of it?

No, we're expecting a small sequential increase in Acrobat. But it is really Photoshop, one hand we've got the second tier languages shipping, as well as the J collection, on the other hand, we're being prudent in terms of the tail on Photoshop, and the impact it has on our, on the rest of our products. Nobody is waiting for the release of the next version of Acrobat, or at least, we have not heard that from any of our customers.

Just to clarify, instead of small sequential increase, would that be including Accelio? Or in other words, would we expect a small sequential increase before the addition of Accelio?

Don't exclude Accelio.

OK.

It would just be, just be standalone Acrobat business, and related products. Does not include Accelio, that business we're looking for, you know, slight increase and then the Accelio would be, would be additive to that.

OK. Great, thanks guys.

The next question is from John McPeake of Prudential Securities.

Thank you, can you hear me guys?

Yes.

OK. Good quarter, by the way. Question here on, first off on PostScript. That was, I was at the high end of the range on my total revenues, it seemed like the PostScript came in lighter than I expected. How should we think about modeling that over the remainder of the year? And then I have a follow-up.

Hey, John, this is Murray. So in terms of PostScript, the way you should think about that is it'll continue to sort of be flattish to down. Which we've been saying now for quite a while.

OK, and that's sequentially, yeah?

Yeah.

And did that come in around your expectations in the quarter?

Yes.

OK. So the apps business was right at the high end of, right at the high end of guidance then. The Photoshop 7.0 J, did that ship into the channel at the end of May?

It shipped out toward the end of May, and started selling from resellers to end users at the very end of May. And we'll look for, you know, some carryover into the third quarter.

So did you recognize any Photoshop 7.0 J revenues in the May quarter?

Yes we did. Again the first shipments that went into the channel and were being sold to the end users before the end of the quarter, we recognized revenue on those.

OK. Was it a lot or a little, or? Couldn't have been that much with the DSO down.

An appropriate amount, John.

OK. Is that about 20 percent of Photoshop revenues in Japanese?

Well, Photoshop is strong in Japan so if you know you could assume it's at least equivalent to our typical percentages.

But, again, you know, it shipped toward the end of the quarter so it's, you know, we typically drain the channel and then we put the new product into the channel so the number of weeks in which you can ship the new version we did not have all 13 weeks, obviously, in the quarter for all the different languages. So, in the case of you know trying to look at the ratio of this quarter

difficult because it's not really apples-to-apples relative to when English shipped and French and German shipped.

Only for those different ways and more Japanese Photoshop likely in the May quarter or the August quarter, from a recognition to Adobe standpoint?

We would expect to see more in the third quarter.

OK, thank you.

Hey,

.

The next question is from Steven Jue of RBC Capital Markets.

Thanks.

Just a quick question regarding the

Adobe announcement you guys talked about. We're just kind of curious to get your thoughts on how soon you may see some ramp up with some of that joint selling and is that more joint selling versus a reseller type relationship?

Let me talk a little bit about the SAP relationship. We think the opportunity and this is the opportunity SAP also sees, is really three-fold. The first is to extend the SAP technology using Adobe PDF technology outside the extended, outside the Enterprise. The second opportunity we see together is day one to use our PDF forms technology to make sure that they can

the business processes going electronic. And the third is they value our printing and our output technology so that people can look at the data that's in these SAP systems and have good print material.

In the short-term, the win for us is that SAP will be recommending and endorsing the Adobe Accelio output pack for all their customers so that they can get the preferred print output.

There is no OEM relationship as part of this. Clearly, you know, SAP and Adobe will be together going into customer accounts and showing the benefits of what the two companies can do together.

Now, is there any up sell opportunity with existing output pack customers? I think the old jet form stuff had roughly you know 700 or 800 customers previously?

Certainly.

So I think if you look at their SAP's installed base today and if you look at how much of that was penetrated by the old jet form Accelio output pack, I think we've certainly with this relationship really changed how many customers we can get.

The last thing I'll say about the relationship is, once we have the integration that both companies have talked about, the Adobe PDF technology will be standard as part of every single

installation and so any IP within the Enterprise that uses it has the capability to build those solutions and then when they want to turn it off for production, they come to Adobe for getting a license.

Great, thanks.

The next question is from Steve Ashley of Robert W. Baird.

Hi, guys.

On the ePaper business, I guess we've mentioned that the core Acrobat business was approximately flat sequentially, which would suggest that the Accelio business contributed like $1.6 million or whatever in the period. Was that the expectation for both of those businesses or can you give us a little more color on what kind of the dynamics going on there?

Yeah, the expectation on the Accelio business was greater than what we were able to realize. While we continue to be extremely excited about the opportunity we were in retrospect a little bit overly optimistic how quickly we could resolve some of the transitional issues. Issues around things like Legacy contracts. So the Accelio revenue was significantly off from what we originally anticipated.

The Acrobat revenue while it was a little bit less than we hoped, the reality is our licensing business - so that's site licenses as well as volume licenses - was up significantly on a year-over-year basis and was up significantly on a sequential basis. So the shrink wrap business was a little bit light we think a lot due to the economic conditions around the world, but the big issue for the whole ePaper business for us was the Accelio business had come in less than we expected and that was because of our own optimism in terms of how quickly we could resolve some of the issues. Keep in mind, we didn't - we weren't able to get into Accelio and understand what needed to get done in terms of full transition until we consummated the acquisition, which wasn't until April 15.

Can you maybe just give us a little bit of context and perspective around the size of the direct sales force that is supporting the Acrobat product here and also supporting the Accelio product or the

product and what kind of growth we might look for in those sales distribution teams?

So if you take a look at our entire sales organization, we said that by the end of Q2, we wanted at least 60 percent of the sales organization focusing at the ePaper opportunity. We're there. So we accomplished our objective, which leads us to a lot of optimism going into Q3 and Q4.

In terms of numbers, we don't specifically break out numbers, we don't think for competitive reasons it's really good to let the competition know how many people we have focused on the actual opportunity. You could probably back your way into it if you look at our sales and marketing expenditures and take industry averages, et cetera.

Was that disruptive at all to the Acrobat business - that transitioning people over and into that business?

There was some minor distraction in terms of sales management. I believe that if sales management wasn't spending as much time as they needed to dealing with the organizational issues of integrating a relatively large organization that we probably could have done a little bit better on the Acrobat related products.

Perfect. Thanks, guys.

Yes, I think it's important to note that all of that - or the bulk of that's behind us, which is why we feel pretty good about Q3 - Q4.

The next question is from Gene Munster of U.S. Bancorp Piper Jaffray.

Would you guys give a little more color in terms of the enterprise Acrobat side and that beta test that's going on in Europe and maybe hint to some price? I think you guys have gone over that in the past. If you'd just refresh my memory in terms of what the kind of typical

price is and when we could see that product.

What we stated was that we were doing a

, Gene, and that's where it is at this point. It's too early to tell in terms of, you know, pricing and how that rolls out elsewhere. So what we've also stated always from a strategic perspective is we want to segment the market appropriately and insure that we continue Acrobat PDF proliferation. So - and we believe that this test will help us determine what's the optimal way to run that.

OK, so it sounds like you guys haven't price a price point yet?

No, and that's one of the reasons why we're doing the pilot is to understand the optimal pricing. We clearly learned with Photoshop and upgrades, if you pick the optimal pricing, you get the most revenue. We want to make sure we do the same thing with the

tool.

OK, excellent. And then just in terms of the overall Acrobat cycle, I know you guys don't disclose when it would start, but you guys historically have said that (X) months between cycles is a good benchmark. Would you say that the timing between Acrobat cycles is in line with historical expectations?

Yes.

Great. Thank you.

Thanks, Gene.

The next question is from Solin Cho of Morgan Stanley.

Hi. Thank you.

Way back when you had a full year revenue target of $1 to $3 billion and realize that you haven't updated it since I think the end of last fiscal year. But just using that as sort of the context, the guidance that you provided for the second half suggests a full year revenue range that's going to fall somewhat short of that. And can you just talk about - you know it sounds like Photoshop tracked relative to your expectations. It's too early to tell in terms of what the pull for timing and impact is going to be this year. So if it's too early to tell as far as sort of Illustrator and InDesign trends will be for the rest of the year, you know, where is the shortfall relative to that original

billion target?

The last quarter, when many of you asked us to comment on the fiscal year revenue targets that we communicated last October, we said it was too early. As we've gone through this quarter, it's clear to us that Photoshop 7.0 has not had the pull-through on Illustrator and the other OS X products that we had anticipated. At least it hasn't yet.

That, combined with the economic issues that are capping the short-term growth on Acrobat, led us to believe that the financial targets that we set almost a year ago are probably not achievable. It doesn't mean it's not achievable, but probably not. And we felt an obligation in terms of setting expectations to provide you with numbers that are probably more realistic, unless Photoshop

and starts to pull through the other products, or unless the economy approves that such a rate where the sequential growth at Acrobat is what it should be in normal economic times.

OK.

So I'm still not saying it's not impossible, but the probability has gone down so far or so much that it would not be - I would not feel comfortable sitting here on this call and not comment on Q4.

OK. And just to understand what happened with Acrobat in the quarter, was that a disappointment relative to your expectations, outside of what happened to Accelio? You talked about the

licensing business being up substantially, but the shrink wrap business being light. You know relative to what you'd expect today exiting the first quarter, how did Acrobat do?

If the Accelio number would have come in what we anticipated, we would have been very comfortable with the overall

number. The amount of Acrobat sequential growth we were looking for was minimal. Quite frankly, we were pleased with amount of volume licensing and

licensing for the product.

So I am not as concerned about the Acrobat growth. Disappointed in the Accelio revenue, but it's, at least from our perspective, clearly understandable.

OK. So at this point, what should we build in for Accelio, given, you know, what the performance was in the second quarter - sorry, yeah, Accelio.

So when given the fact that it was only a partial quarter, at this point we're looking at a number that we set before as a range of $30 to $35 million. But there's a possibility that it could come in lighter than that. But we like to get our way through Q3 and then we'll be able to provide an update. But at the overall level, it's really not that material.

OK, great. Thank you.

The next question is from Sasa Zorovic of Robertson Stephens.

Hi, could you provide us with an update on what the status is with your share buyback program? Thank you.

Yeah, Sasa. As I stated as to my earlier comments, we purchased 1.4 million shares in Q2, and we've been repurchasing shares for over ten years, and we'll continue to do so as we go forward to minimize dilution. So we have every interest in continuing that program.

Thank you very much.

The next question is from Keith Gay of Thomas Weisel Partners.

Hi, guys. Following up on what you had said about Accelio, does that imply that there is some delay in revenue, or that there's some revenue deferred for upcoming quarter or quarters?

Well I think it's just that we have, again a partial quarter, and because of the anti-competitive issues, it was difficult to obviously get into some detailed customer contacts, and working through some of the contract issues, et cetera, And also that some of the customers, given the pending acquisition, wanted to wait and see the acquisition close and determine, you know, where Adobe stood in terms of where we're going forward on that. And we're working through all those issues, and many of them are behind us. So we're very focused now on really driving revenue because the opportunity is quite significant for us.

I think what's important to know, what we, when we originally planned the Accelio revenue for the quarter, we made an assumption that the contract that they had in place, both for things like maintenance revenue, as well as for new bookings we be easily transferred to Adobe. And we were willing to live with the discounts that they had negotiated. As we started to review the contracts, and in some places we were unable to get our hands on the contracts as quickly as we wanted, it became clear to us that those were terms and conditions that Adobe as a large company was willing to live with.

So we now have to go back and in some cases, renegotiate or clarify the terms and conditions. In some cases it was simply an issue of finding the contract. Accelio had a very decentralized way of doing business, and as you may know, we have very strong controls in place and it's important to us that before we ship any value product that we know what the terms and conditions are of that agreement. So we continue to be very excited, remember, we didn't acquire them until April 15th, and we just chalking this off to transitional issues.

At the end of the day we don't think that the revenue for the second half on Accelio, the difference between what we anticipated and what we should deliver will be material in nature to the overall number. One of the reasons why SAP was so excited in working with Adobe was because of the Accelio products.

Keith, on the product side also, we've been working really hard since April 15th. What we have is already a comprehensive product strategy, we've got how we leverage Acrobat in place with that, and that's all on the way. The teams, you know, proceeding for the Adobe product lifecycle. So we've actually been very excited about the progress we've made on ensuring that delivering new products don't go though any hiccups.

I'd also like to point out that in terms of our strategy around realigning our expenses, the headcount reductions have happened, we've rationalized facilities. A lot of the processes have now been integrated, so we really have a lot of this behind us, and it happened very quickly, in the 45 days or so that was in our quarter. So we really feel like we're positioned, really to move forward strongly now as we've gotten this behind us. So we just again, we're very excited about the opportunity.

Now what I was getting is it might be a positive for Q3 in that there was maybe, there's some revenue that was not recognized that would be recognized?

You know, we'll just deal with that as it comes, you know, being very careful as you know with our accounting and financial controls. We're going to be very careful in terms of how we approach that. And we're going to do the right thing.

OK. On the economy, you said you're factoring in a sluggish economy into your guidance. Can you comment, and also by geography, are you seeing any signs of stabilization or improvement?

So as I said it earlier, Keith, we continue to see stabilization throughout all of our major geographic areas. It's been stable now for some time and obviously we hope that will continue but this has been, I think, the longest period now that we've seen in probably a year-and-a-half of stabilization across our major geographic areas. So that's an upbeat thing for us.

We just haven't seen an uptick in the market.

All right.

Any signs of - do you fear worse Q3 seasonality in Europe than let's say, we saw last year, which was not that great a year either?

No.

OK, thanks a lot.

Thanks, Keith.

The next question is from Chris Galvin of JP Morgan.

Thanks.

With the weak corporate spending environment, I'm wondering if you guys are being more flexible when it comes to pricing. If you could comment, maybe relating to Photoshop 7.0 versus Photoshop 6.0 and then sort of price per seed trends on the Acrobat business would be helpful. And I understand that's a no jump break this out but maybe in qualitative terms.

Our ASPs of Acrobat have not declined and the upgrade price of Photoshop we priced at $149 versus the previous release of $199 because we believe that would maximize revenue. Based on the results you've seen with Photoshop 7.0 clearly our strategy worked. So no declining ASPs in Acrobat and we made the right decisions on Photoshop in terms of maximizing the revenue opportunity.

And I would also add, Chris, that we're not doing any kind of special rebate programs or anything like that with Photoshop in the channel. We're just continuing to operate under the stated pricing and just our normal marketing activities.

Thank you.

The next question is from Gibboney Huske of CS First Boston.

Thank you.

Obviously kind of lowered expectations but based on your earnings guidance looks like you're getting to roughly the same place, implying you're continuing to balance investment and some of your emerging opportunities with the tough environment. Could you just kind of revisit what the priorities are right now? Obviously, Acrobat and developing that platform is one of them but beyond on that in terms of some of the emerging areas, is there anything you're kind of cutting back on to kind of maintain your earnings guidance? Or is there anything you're kind of maybe stepping up a little bit in anticipation of maybe against revenue growing again?

Hi, Gibboney.

The place where we've cut back the most is watching the sales and marketing expenditure against markets in which spending overall have decreased. So if anything, you've seen a decrease in some of the efforts we made in terms of reaching the creative professional with products that they have no intent of buying.

I'll use FrameMaker 7.0 as probably the best example of that. Great product. Typically appeals to people who are doing technical documentation. Typically appeals to people in the hi-tech business or telecommunications area. If you think about that, it's pretty clear that those companies or those industries are having difficult times these days so it didn't make sense for us to spend a lot of sales and marketing dollars in trying to reach that customer even though we have a great product.

In terms of product investment, if you look at R&D expenditure, we continue to increase. We continue to focus a lot of energy and effort certainly on the ePaper opportunity but we continue to move ahead aggressively in digital imaging, digital video, and professional page layout within design.

What's up with those areas, do you think you just ultimately pull back in that investment, you know? I mean, FrameMaker at this point, you know, how much does it make sense to invest in terms of marketing that product?

So we're always looking at our investment in the product and the market opportunity and again, I'll use FrameMaker as the example. We have pulled back how much we invest in that product from an R&D side as well as sales and marketing side to account for what the overall market opportunity is. We do believe that XML authoring is of interest to our customers, so we continue to invest a little bit more on the R&D side but pulled way back on the sales and marketing side. So we do that evaluation across the board.

And I guess just finally, assuming 2003 - I know you're going to kill me for asking this - assuming a normal economic environment, are you looking to be able to

percent or, given that the upgrade schedule is relatively light, more a sort of a lower level than that?

I thought you would thank us for proving Q4 guidance

...

Oh, I'm sorry

. Thank you, thank you, thank you, but beyond that, just your initial thoughts. I know it's early and I know there's not a lot of visibility, but just thinking if the economy's OK, is that performance achievable?

Please give us something to talk about at the analysts' meeting in New York.

So it doesn't make sense for us at this time. You know, hopefully by the analysts' meeting, we'll be able to provide guidance for next year. Again, long-term, it's twenty-plus percent.

OK, but that - you're still not that clear in terms of for '03?

That's correct.

OK, thank you.

The next question is from Bill Lennan of WR Hambrecht.

Hi. Could you shed a little light on the ratio of upgrade units to new units for Photoshop in the quarter?

And second part - maybe a little more color on what happened in Asia. Asia was down quite a lot year-over-year, and I know last year we had Acrobat released in the second quarter - was there some meaningful difference in the timing of the - of the Asian versions of Acrobat and Photoshop 7.0 or is it all down to weakening economy in Asia?

So, Bill, this is Murray. In regards to Asia, if you recall last year

Acrobat shipped into Japan also the - we had a very strong year-end in Japan last year. You know, the year-end in Japan is March, and government and corporate spending was very strong for us in that quarter and it was the next quarter Q3 of '01 when we saw a significant decline in Japan. And so the economy in Japan is very different for us - for our business this quarter versus where it was a year ago, and that really is what drove the difference.

In terms of the Photoshop, Bill, and the upgrade unit,

it is significantly higher for Photoshop 7.0 at this point than Photoshop 6.0.

Would you - would you be comfortable with a sort of a ratio - I mean somewhere between

and

- I mean just general ballpark?

At this point, it's early to - we don't talk about that.

It's information that we don't want to provide for competitive reasons.

OK, thank you.

Operator, we'll do a couple more calls - questions.

Certainly. The next question is from

of Goldman Sachs.

Hi. This is

for

. I think most of the questions have been answered, but just touching back on the SAP relationship, sort of wondering what's the timeline looking like for that full technical integration that you were referring to where Acrobat will be in almost all SA - all of SAP products? And I guess then, you know, from that point, what does the revenue opportunity look like?

I think it's early to talk about that - what - again, from the short-term perspective, as we said, I think getting the preferred treatment for the carton shipping product which we have which is the Accelio Adobe output back we start to see that opportunity right away. The teams are already working on what a technical integration would look like. And, as you can imagine, as we

more Acrobat products, you'll continue to see an increased level of integration with them.

OK, thanks.

The final question is from Robert Lund of Daiwa Securities.

Hi guys. Thanks for getting me on.

Nice quarter. And I have sort of a follow-up question to the SAP question previously asked.

Yeah, Robert. Go ahead.

Can you hear me - oh, OK. I was just curious, going back to

, this seems sort of like a natural fit with the enterprise vendors. Do you have any other negotiations going on with any of these guys?

It's too early to comment on anything else at this point. I think you can see with the SAP relationship, given the Accelio technology and given the Adobe technology, the whole value proposition of how structured content and unstructured content is coming together. And for people to share that across enterprises, I think they're all seeing that our technology is a natural. So that's exciting for us.

Absolutely.

And it's important to note that SAP, at least from what we could see, does not typically partner with other companies on the technology side. I was especially pleased

at SAPPHIRE in Orlando, and noticed that we were the only company that he mentioned in a positive vein. Again,

company in a positive vein.

The only logo that existed on his slide said - and clearly what

sees is that for him to continue to grow his business, he needs to reach beyond the firewall outside the individual enterprise to reach businesses, partners and customers. And the way to do that is to leverage that - do that through documents and forms. And you look at the standards for documents and forms

Acrobat, and it's

PDF.

So while SAP is the first announcement, I can understand why other vendors would want to work with us. But we have nothing to announce at this time.

Absolutely. Well, great quarter, guys.

Thanks, Robert.

Well this concludes our call today and we thank you for joining us.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.