Adobe Inc (ADBE) 2003 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the Adobe Systems Q2 fiscal year 2003 earnings conference call.

I would now like to turn the conference over to Mike Saviage (ph), VP of Investor Relations.

Joining me are Bruce Chizen, our president and CEO.

Murray Demo, SVP and CFO.

And Shantanu Narayen, EVP of worldwide products.

We'll discuss the financial results of our fiscal second quarter 2003.

If you need a copy of the press release, you can go to Adobe.com under the company info 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 model targets for the coming quarter and our forward-looking product plans, contains forward-looking statements that involve risks and uncertainties.

Actual results may differ materially from those set forth in such statements.

For a discussion of the risks and uncertainties, you should review Adobe's SEC filings including our annual report in form 10-K for fiscal year 2002 and our quarterly reports on form 10-Q for fiscal 2003.

During this call, we will discuss pro-forma financial measures.

The GAAP financial measures that correspond to such pro-forma financial measures, as well as the reconciliation between the two such measures are set forth in our press release issued today, and are also available on our website.

All participants are advised that this conference call is being broadcast live over the Internet and also be recorded for playback purposes.

The audio of the call will be archived on our web site for approximately 45 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'd now like to turn the call over to Bruce.

Thanks, Mike.

Once again, I am pleased to report that Adobe has achieved both year over year and sequential revenue growth.

Adobe's revenue in Q2 grew to $320.1 million, exceeding the target ranges we previously provided.

And earnings per share in the quarter came in at the high end of our targeted ranges.

Driving our business during the quarter was the release of our Acrobat family of products.

Initial orders had exceeded our expectations and industry comments have been overwhelmingly positive.

In addition, we are gaining momentum as an enterprise solution provider with our server-based products.

This helped drive a record ePaper quarter with 43% year over year growth.

The other major highlight in the quarter was our significant growth in the combined InDesign and Design collections revenue, demonstrating continued progress against our goal of becoming the leading provider of professional page layout solutions.

In a few minutes, Shantanu will provide more details, 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 2003, Adobe achieved revenue of $320.1 million.

This compares to $317.4 million reported for the second quarter of fiscal 2002, and $296.9 million reported last quarter.

GAAP net income for the second quarter of fiscal 2003, which includes non-operating gains and losses, was $64.2 million, compared to $54.3 million reported in the second quarter of fiscal 2002 and $54.2 million last quarter.

Pro-forma net income, which excludes the amortization of goodwill acquired in process research and development, restructuring and other charges and investment gains and losses from the company's venture program, was $66.7 million compared to $67.4 million reported in the second quarter of fiscal 2002 and $58.9 million last quarter.

GAAP diluted earnings per share for the second quarter of fiscal 2003 were 27 cents based on $239.2 million weighted average shares.

This compares with GAAP earnings per share of 22 cents reported in the second quarter of fiscal 2002 based on $247.7 million weighted average shares, and GAAP earnings per share of 23 cents reported last quarter based on $235.3 million weighted average shares.

Pro-forma diluted earnings per share for the second quarter of fiscal 2003, which excludes an investment loss from the company's venture program, were 28 cents.

Gross margin for the quarter was 92.7% compared to 92.1% in the second quarter of fiscal 2002 and 92.5% last quarter.

Our business is increasingly being driven by both new customer full unit revenue and licensing revenue, which is favorable for our gross margin.

GAAP and pro-forma operating expenses for the second quarter of fiscal 2003 were $205.3 million.

Regular employees at the end of the second quarter totaled 3,440 versus 3,377 at the end of the first quarter of fiscal 2003.

Expenses as a percent of revenue break down as follows.

Research and development 21.6%.

Sales and marketing 33%.

G&A 9.5%.

Operating expenses as a percent of revenue were within the target ranges provided at the outset of the quarter.

GAAP operating income in the second quarter of fiscal 2003 was $91.5 million, or 28.6% of revenue.

This compares to GAAP operating income of $90.8 million or 28.6% of revenue in the second quarter of fiscal 2002 and $80.5 million or 27.1% of revenue last quarter.

Excluding the amortization of goodwill, restructuring and other charges and acquired in-process research and development, pro forma operating income in the second quarter of fiscal 2003 was $91.5 million, or 28.6% of revenue.

This compares to pro forma operating income of $96.4 million or 30.4% of revenue in the second quarter of fiscal 2002, and $80.5 million or 27.1% of revenue last quarter.

Other income for the second quarter of fiscal 2003 was $3.9 million.

Adobe's effective tax rate for the second quarter of fiscal 2003 was 30%, compared to 32% in the second quarter of fiscal 2002 and 30% last quarter.

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

Creative Professional segment revenue was $93.7 million in Q2 fiscal 2003 compared to $90.1 million in Q2 fiscal 2002, and $85.8 million last quarter.

Digital Imaging And Video segment revenue was $95.3 million in Q2 fiscal 2003 compared to $130.6 million in Q2 fiscal 2002 and $96.2 million last quarter.

In regard to the year over year decline, we had a successful Photoshop 7 release in the year-ago quarter.

OEM PostScript and other segment revenue was $23 million in Q2 fiscal 2003 compared to $21.1 million in Q2 fiscal 2002 $24 million last quarter. ePaper Solution segment revenue was a record $108.1 million in Q2 fiscal 2003 compared to $75.6 million in Q2 fiscal 2002 at $90.9 million last quarter.

In Q2 with the release of Acrobat 6 English near the end of the quarter, total ePaper desktop revenue was a record $91.6 million. ePaper server revenue in Q2 was $16.5 million, a sequential increase over the previous quarter.

Turning to revenue by geographic segment, the results in Q2 fiscal 2003 were as follows: The Americas 49%.

Europe 27%.

Asia 24%.

As we stated on April 30th in our intra-quarter update, Asia was stronger in March due to better than expected fiscal year-end spending in Japan.

The Americas and Europe were essentially on track with our expectations.

Application platform mix was 73% Windows and 27% Mac in the second quarter of fiscal 2003, which compares to 69% Windows and 31% Mac for the second quarter of fiscal 2002 and 74% Windows and 26% Mac last quarter.

Our trade DSO in the second quarter of fiscal 2003 was 36 days, below our target range of 40 to 45 days.

This compares to 38 days in Q2 fiscal 2002 and 41 days last quarter.

Our global channel inventory position continues to be within company policy.

At the end of the second quarter of fiscal 2003, cash and short-term investments were $782.6 million, compared to $652.7 million at the end of the first quarter of fiscal 2003.

Turning to Adobe ventures, we incurred an investment loss of $3.6 million in Q2 fiscal 2003.

In the quarter, we made additional investments of $3.9 million.

In total, Adobe has invested $220 million through its venture partnerships and direct investments.

As of the end of the second quarter, the net returns from this program were $346.7 million, including the stock dividend to stockholders and the market value of investment still held by Adobe.

We did not repurchase any shares as part of our share buyback programs during the quarter.

Adobe's board of directors declared this quarter's cash dividend of $1.25 per share payable on July 7th, 2003 to stockholders of record as of June 23rd, 2003.

This concludes my discussion on second quarter fiscal 2003 results.

I would now like to discuss our Q3 fiscal 2003 targets.

Assuming typical Q3 seasonality, we are targeting revenue of $300 to $315 million.

As a percent of revenue, our approximate operating model targets for the quarter are as follows: Gross margin 92% to 93%.

R&D 22% to 23%.

Sales and marketing 34% to 35%.

G&A 10%.

Resulting in a GAAP and pro-forma operating margin target of approximately 24% to 27%.

On a full-year basis, we continue to target a GAAP and pro-forma operating margin of at least 28%.

For our share count, we are targeting a range of $243 to $245 million shares.

For other income, we are targeting approximately $3 million, and for our tax rate, we are targeting 30%.

These targets lead to a GAAP and pro-forma earnings per share target range in Q3 fiscal 2003 of 22 cents to 25 cents per share.

We currently believe the targeted pro-forma earnings per share and pro-forma operating margin results will not differ materially from targeted GAAP operating results.

This concludes my comments.

I will now turn the call over to Shantanu.

Thanks, Murray.

I'll review Q2 highlights in each of our major business segments starting with ePaper.

The release of the Acrobat 6.0 family, one of the most important product launches in Adobe's history, has been met with enthusiastic support from customers, industry experts and partners.

We began shipping the English versions late in Q2, which led to record ePaper desktop revenue of $91.6 million.

German and French versions began shipping the first week of Q3 and other localized versions including Japanese will begin shipping later this month.

During the quarter, we closed a significant number of Acrobat licensing deals with major corporations and government institutions that exceeded 2500 seats.

Customers included Kinko's, Shell International, (inaudible) in Sweden, the U.S.

Department of Justice, and Wake Forest university.

Revenue from ePaper desktop licensing grew sequentially in Q2.

As a percent of total ePaper desktop revenue, licensing was 31.8%, compare to 36.7% last quarter.

The licensing percentage declined sequentially due to higher shrink wrap revenue achieved for Acrobat 6.

Industry analysts have written extensively about the new Acrobat product segmentation, how our solutions complement Microsoft Office and why customers should move to Acrobat 6.

Highlights include -- (inaudible) called Acrobat, "an impressive release," and concluded, "new capabilities are effectively built into the product, offering a tighter integration with other desktop tools, specifically Microsoft Office, Outlook, Project, and Internet Explorer."

Seebold (ph) Publications stated, "Acrobat and PDF play an important role in the corporate enterprise.

We see this as a must have upgrade."

For creative professional users, Seebold added, "a variety of new functions make Acrobat 6.0 one of the most comprehensive software updates of the last few years" -- and called it the most important Acrobat release since version 1.0.

New capabilities in Acrobat 6 enable us to provide improved solutions in the areas of document control, security, and collaboration.

We're working with Entrust and (inaudible) to provide security for integrated document processes with digital signatures.

We've also made announcements with PTC and Agile to provide integration with their Product Life-cycle solutions.

Our Q2 ePaper success also extends to our server-based businesses, where we once again had sequential revenue growth.

Driving this performance were a number of significant deals across many verticals.

In the government market, they include the Social Security Administration, which has purchased the Adobe fonts client and document server for reader extension.

They will be migrating their existing administrative and claims processing electronic forms to updated Adobe technology.

The Kansas Department of Transportation, which is using Adobe document generation and processing solutions to expedite public projects and enhance application processing for tasks like highway access permits.

The commonwealth of Massachusetts Executive Office of Public Safety, which is using Adobe document server for reader extensions to move their Homeland Security grant application form processing online.

The Maritime Coast Guard in the U.K., which is utilizing form server and work flow server from Adobe to automate their form processing.

The Ministry of Education, Culture, Sport, Science and Technology in Japan, which is using Adobe document server for reader extensions to help build an online application system based on Adobe PDF and use of the ubiquitous Adobe reader.

In the enterprise market, key wins with our server solutions included -- Boeing Employees Credit Union, which is using the Adobe Form Designer and Adobe Document Server for reader extensions to deploy their employee credit union forms in PDF.

Caps Digital, which is using the Adobe Document Server as a platform to do instant document generation.

Allstate Insurance, which is using Adobe Document Server with their Legacy Documentary repository to deliver documents in PDF, utilizing metadata, security, and document fidelity features.

And Nestle Australia, which is using Adobe Work Flow form and output servers to build an end-to-end electronic work flow for managing internal product development processes.

In our overall ePaper business, the average of the top-ten transactions in the second quarter was $293,000.

We continue to focus on extending existing enterprise infrastructures with our ePaper solutions, and we recently made two key announcements.

With Documentum, we expanded our relationship to integrate Adobe form technology with Documentum's content server to deliver solutions that will automate and manage document and form intensive processes in regulated industries such as financial services, manufacturing, and government.

With IBM, we will deliver integrated document solutions based on Adobe Form Solutions and IBM Content Manager.

Initially aimed at the government market, the new solutions will integrate capabilities for intelligent web-based forms from Adobe with the robust infrastructure of IBM Content Manager, giving organizations the ability to automate their existing paper-based processes.

Often the success of our desktop and server-based ePaper products builds off important government standardizations.

In Q2, we realized another significant milestone with the U.S. government.

NARA, the National Archives and Records Administration, officially adopted PDF as a standard for electronic document archival.

Another key milestone in Q2 involved our announcement around Adobe's XML architecture to support end-to-end document processes.

And Gardner's Analyst stated, "Adobe's XML-based offering can revolutionize form-based processes" and predicted, "Adobe now offers what could be its biggest killer application since Acrobat appeared in the early 1990's.

Enterprises should understand Adobe's new XML-based offering and plan for internal and external applications to exploit it."

Turning to our Digital Imaging and Digital Video business, we made some exciting announcement in Q2 which show we have focused on growing this business in new emerging markets.

The acquisition of the cool edit pro audio production product from Centrillium (ph) provides features essential to professional digital audio production and adds a key component to Adobe's existing line of professional digital video products.

Cool edit pro's existing customers span from musicians to broadcast professionals.

Second, we formally announced Encore DVD , available later this summer, our new DVD offering product is targeted at creative professionals and will enhance Adobe's complete digital video product line.

It has already won a key industry award, even before its release.

At the recent NAB show in Las Vegas, it won Videography's best of show video award.

In addition to these two new products from Adobe, our road map in Q3 also includes new versions of our digital video products, Premiere and After Effects, in English, late in the quarter.

In regard to Q2 results in our Digital Imaging Business, as expected, we saw a year over year decline in our Photoshop business due to the top compared with last year when we shipped Photoshop 7.

However, overall Photoshop sales were marginally higher in Q2 when compared to last quarter.

We are off to a strong start with Photoshop Album and we continue to see success with Photoshop Elements, where we had 30% year over year revenue growth in the quarter.

Turning to our Creative Professional business, InDesign and Design collection continue to perform well.

Combined revenue for these products was up 47% year over year, and PC World named InDesign best desktop publishing software in 2003, an award it has won three years in a row.

During the quarter, we closed additional licensing business with key customers such as Harper Collins, Coakley Press (ph), and Bloomberg's magazine division, which is replacing a Quark QPS system.

Industry experts, such as David Blackner (ph), have been comparing Express and InDesign for the graphic design user community.

Blackner recently stated, "InDesign is so much a better product than Express in most ways that it's hard to see our Quark will every catch up."

And while Quark is now playing catch-up to InDesign 2.0, we are hard at work on the next major up-grade of InDesign to set the feature and innovation bar even higher.

This concludes my Q2 business segment review.

Before I turn the call back over to Bruce, I would like to review our product road map for Q3.

As I stated earlier, we plan to deliver new versions of our video products by the end of the quarter.

In addition, several foreign language versions of Acrobat 6 have already shipped in Q3 with more to come through the rest of the quarter.

Looking ahead to better serve our customers, we have decided to align several of our creative professional applications for release in the fourth quarter.

Bruce?

Thanks, Shantanu.

Our results in Q2 show that we continue to execute exceptionally well.

We delivered the most comprehensive product family in Adobe's history with the release of Acrobat.

We continue to make progress against our vision of delivering document-based solutions for the enterprise customer.

Required Cool Edit Pro, which combined with Encore DVD and the new versions of our video products will enable us to provide a high performance, integrated product line for video professionals.

And looking to Q4 and into fiscal 2004, we remain excited about several upcoming major product releases that will serve the needs of our creative professional customers.

I'll now turn the call back over to Mike.

Thanks, Bruce.

Before we start Q&A, I would like to provide some important calendar dates.

We plan to release our regular intra-quarter updates for the third quarter of fiscal 2003 on Thursday, July 31st, after the market closes.

As in past quarters, there are no plans to have a conference call in conjunction with the intra-quarter release.

We have changed our Q3 earnings date to Wednesday, September 10th, after the market closes.

We have set our date for our 2003 financial analyst meeting.

It will be held in New York City on Monday, October 26th.

Details for the meeting will be sent out later this summer.

To summarize, Q3 intra-quarter update on July 31st, Q3 earnings date on September 10th and analyst meeting on October 26th in New York.

In Q3, Adobe management will present at several investment conferences including the Thomas Weisel conference in Santa Barbara next week, and three conferences in August.

We will make all the conference presentations available via webcast from Adobe.com.

All these dates are kept current on the investor relation section of our website as well.

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 investor relations website on Adobe.com later today.

Alternatively, you can listen to a phone replay by calling 402-977-9140.

Use reservation number 21145973.

The phone playback service will be available begins at 4:00 p.m.

Pacific time today and ending at 4:00 p.m.

Pacific time on Monday, June 16th, 2003.

We'd now be happy to take your questions.

Operator?

Thank you.

Our first question comes from the line of Gibboney Huske with Credit Suisse First Boston.

Please go ahead with your question.

Thank you very much.

Just a question talking about the linearity of the quarter.

Obviously start off the quarter in March where you had the war and did that have an impact, and I was just curious given your DSO's were so low at the end of the quarter, particularly when you were shipping a new version of Acrobat, presumably that was billed but not paid, so can you just give me a sense of the strength of the quarter and the linearity of the quarter?

And I have one follow-up question.

Gibboney, this is Murray.

In terms of the quarter, it was actually quite linear.

March, we did have a strong month.

As you know, in Japan, March is the strongest month of the year.

We also had good strength in Europe and in the United States, and so the quarter was very linear, even though we had the Acrobat 6 launch that occurred towards the end of the quarter.

So it's a linearity of the quarter that really drove the DSO of 36 days.

Ok.

And then based on that, you said really the Q2 guidance is based on normal seasonality.

Could you give us a little more color around sort of specific geographic performance?

There's been some broad commentary of Europe maybe getting a little bit softer and giving us a sense kind of what you're seeing there?

Yes, so in terms of seasonality in Q3, as many of you know, the last two years during the summer we've had some challenges because of Japan and Europe, and we're going into this quarter with the recognition of what we've experienced in the previous two years with July being weak in Japan and also in Europe.

Now, the other seasonal factors is that in the United States, we tend to see the strongest education season in the month of August, so we'd be looking for education revenue strength in the month of August.

So I think really to step back and look at the who quarter, the key factors are what does the Acrobat launch, how does that look for us in the ensuing weeks around the world, it's what kind of weakness we have in Japan and Europe during the is summer season in the July time frame, and then what do we see with the education season in the United States.

And those are the things that went into us determining the range of $300 million to $315 million of revenue in the quarter.

Ok.

Just one final thing.

In terms of the initial orders for Acrobat, could you give us a sense of just the relative demand for the three different versions that you have now?

Sure, Gibboney.

This is Shantanu.

In terms of the initial demand, as we said earlier, demand for the Acrobat family of products did exceed our expectations.

And really, it's too early to comment on product mix, but what we can say is that the initial demand for the Acrobat professional product exceeded our internal expectations.

And we believe that the targeted nature of that product and the increased functionality that it has contributes to that.

Ok.

Thank you very much.

Our next question comes from the line of Jay Vleeschhouwer from Merrill Lynch.

Couple of questions.

What did you mean, Shantanu, by "aligning the products" within Creative Pro with that target in mind, and by inference or by omission, did you suggest that there would not be a Photoshop release or Photoshop Elements release until after Q4?

Well, Jay, as we stated, you know, what we did specify with the Q3 product road map, with respect to the creative professional products, what we are hearing from our customers is that they really would like to see us make sure that the work flow is consistent, and I think the success of the Design Collection really points to people saying that having these products come out with them working really well together enables them to create an entire work flow for media across multiple data types.

So we're not at this point commenting on specific product delivery for Q4.

As you know, both for competitive reasons as well as we want to make sure that we don't stall sales of the existing version.

So at this point, what we wanted to do was just give you a little guidance relative to what's there in Q3.

All right.

And no comment on Photoshop then at this point?

That's correct.

Ok.

So presumably Design Collection gets upgraded in Q4 along with Illustrator and InDesign.

Can you talk about what your plans are for any particular emphasis on any other bundles with Premiere and After Effects coming out, would you expect that there might be a resurgence in the digital video collection, for example?

Well, I think, you know, with Premiere and After Effects being certainly the flagship products of the digital video collection, we are excited about the prospects for the digital video collection.

In addition to that, you know, we've clearly announced that we have two new products in that space aimed at the professional creative pro customer as well as the specialist video customer in the video space with both the DVD product as well as the audio product.

So I think that all goes well for us as it relates to targeting them.

The one other question that you did talk about was Photoshop Elements, and let me talk a little bit about our Digital Imaging business as it relates specially to the consumer.

We see the market trends for that really being driven more by digital camera sales, and I think the initial success of Photoshop Album as well as the success of Photoshop Elements is driven more by camera sales, and traditionally the holiday season, as you know, is a time where people take more pictures, there's more software purchases, so we think those are more the macro trends that will drive our digital imaging business in those customer segments.

So I think that's important to remember.

As it relates specifically, Jay, to some of your assumptions, some of your assumptions were certainly -- we're certainly not going to comment on one way or the other.

Your assumption on video collection, it would be pretty logical for if all four products are shipping late in the quarter, that we would probably do something with video collection around the same time.

Right.

Just one last one for Murray just to go back to the point about seasonality.

I understand what you're saying about July last couple of years.

On the other hand, if you just look at the Acrobat volume licensing business third quarter of last year, it was quite strong.

Up 50% or so sequentially.

Are you still assuming that there might be a similar kind of large sequential increase in Acrobat desktop licensing business this quarter again but more than offset by weakness elsewhere in the product line?

Well, in terms of licensing, we will tend to see strong licensing in our third quarter because of the education market.

Obviously (inaudible) drive as much the overall revenue, but licensing can be strong in the third quarter driven by education.

What we're really focused on is just going back to what I said before which is, you know, the Acrobat launch, we're just getting into this thing, we're off to a good start, we want to see how that goes.

We've got the Japan and Europe that we'll just have to see how that works out, we expect to see good education sales in North America, both on a shrink wrap and a licensing basis, and we'll see how those key variables work themselves through for the quarter.

Our next question comes from the line of Ben Reitzes with UBS Warburg.

Wanted to ask a couple things, first with regard to backlog.

How did the quarter end?

And did you say that earlier?

So Ben, in terms of backlog, we stated at the end of Q1 that we did enter Q2 with a higher level of backlog.

When you look at this quarter now and you exclude the backlog associated with Acrobat French, German and the related collections, that the backlog is now more sort of at normal levels as we exit Q2.

So kind of normal levels, obviously we had some backlog for Acrobat French, German and the collections that we shipped in the first week of this quarter.

But how is the backlog for the U.S.?

Acrobat?

We're not providing any kind of specifics on that.

Clearly in the last week of the second quarter, we did ship the first -- the first shipments of our English product, and we'll just continue to monitor how that performs in the channel and we will order accordingly based on sell-through.

All we can say is that we're off to a good start at this point.

Ok.

Let me get to what I think everybody wants to hear on this call explaining the guidance for the third quarter in some different kind of terms.

The way I'm hearing it is, you know, with the $320 million in revenue with the DSO looking to be in pretty good shape that, you know, revenues being down sequentially really -- there's seasonality and what not, but it's really a function of these creative pro products being pushed into the fourth quarter, and it sounds to me, perhaps, that that is why and how Shantanu went through his presentation.

And also maybe that's the reason why it's coming in a little lighter than I would have thought for the third quarter, given the strength you had in the quarter.

And I just wanted to know if you could just confirm that in real simple terms rather than going into the seasonality in Europe -- unless there's something there in Europe, some kind of weakness that may be behind it as well.

I mean, Europe was a little lighter than I expected in the quarter, but it does seem to be a creative pro push-out accounting for the guidance.

Thanks.

Your assumption is not correct, Ben.

If you take a look at Q3, as Murray said previously, there are a couple of dynamics at play.

First of all, on the positive side, we have the French version of Acrobat, we have the German version of Acrobat, we have the Japanese version of Acrobat, and some of the other foreign languages.

We have hopefully what we will continue to see as a strong demand for the English version of Acrobat, as we stated, the initial demand was better than we had expected.

We also have the video products, the video products, as we said, will be coming in late in the quarter and will be at least right now we're targeting English only for the end of the quarter.

Ok.

Let me go on.

We also have education.

We typically get a strong education business in the U.S. that typically shows up in the August time frame, which should help the quarter.

The two negatives or potential negatives in the quarter, first of all in terms of education, we all understand what the state and local governments are going through with their overall budget, and that could potentially have an impact on our education business.

But we won't know that until we come closer to the August time frame.

The second and the biggest factor that is somewhat constraining us from moving the guidance higher is the seasonality.

Remember, Q3 for us is right in the heart of summer.

It's June, July and August.

And at the same time, if you'll look at last year Q3 and the year before Q3, we experience weakness.

And we have factored that into our guidance.

Regarding pushing-out a creative pro product to the Q4 period, what we have stated, and we stated it back in October, that we want to make sure we are providing more value to our Creative Pro customers than ever before.

We are right on track with that strategy, and our product plans and our strategy are going along exactly as we have planned.

All right.

Your assumptions are not accurate.

Well, the point is, really, I thought maybe you threw that in there because some people might have thought that they would have come in the third quarter, and that perhaps that's why you made the point to talk about how it's going into the fourth.

Is there just a comment on what Acrobat should do sequentially in the third?

No, we're not providing any specifics on various segments in terms of what it should do or should not do.

Obviously we're excited about the launch of Acrobat 6 across the different languages, and we'll just need to see how it goes over the next few weeks.

Thanks.

There's one point I do want to reinforce, and that's an issue around why we're not more transparent with what products are coming in what quarter.

For both competitive reasons, as well as stalling revenue from exist products, it would be unwise for us to provide you with product information beyond the a quarter at a time.

And I think that our investors would not want to see us do that.

So I apologize that we can't be more open with you.

We're being as open as we can be without hurting our business.

All right.

Well, thanks.

Maybe we can talk about my question offline.

I think there's some misinterpretation on both sides.

Thanks.

Our next question comes from the line of Steve Jue with RBC Capital Markets.

Thanks.

Congratulations on the quarter, guys.

I'm wondering if you could talk a little bit about the go-to-market strategy and maybe changes in your sales strategy with regards to some of the volume licensing with the Acrobat Elements opportunity -- how you're approaching that differently from traditional sales.

This is Shantanu.

I think we've talked about the increased focus that we've been putting both on our direct sales force and our ability to target enterprises with that.

Our partnership with our licensing centers which also enable us to fulfill that, as well as partnerships with other enterprise software infrastructure vendors who are, as part of their offerings are bundling Acrobat.

So a couple of things as it relates to Acrobat Elements.

The strategy behind Elements is to allow corporations to standardize PDF creation for all communication.

What we saw in our pilot in Europe is that as Acrobat extends into multiple work groups within an enterprise, then the IT group specifically is looking to standardize Elements across their entire company.

So it tends to be a little bit of a longer sales cycle for Elements than it is for the shrink wrap, but our direct sales force is in there demonstrating the value of it.

As our solutions are delivered, also, people are looking at the Adobe Solutions and also saying in addition to the solutions, they want to standardize on Elements as part of the entire enterprise.

So a lot of focus on direct, but a lot of focus equally on partners who will help get Elements into the enterprise.

Great.

And then Murray, just looking at the launch of the expert support programs, just wondering infrastructure wise how you guys are handling that, if you're leveraging existing resources and any potential market impacts on this business?

At this point, we're just leveraging existing resources.

As you know, the entire effort we've put in over the last year and a half -- also through the acquisition of Exelio, the capability is building up to do those sorts of things.

So we'll continue to use the existing resources that we already have in place.

Great.

Thank you.

Our next question comes from the line of Gene Munster with U.S.

Bancorp Piper Jaffray.

Good afternoon, everybody.

In terms of just to kind of step back and look at the overall guidance on the revenue side, you mentioned two or three times about difficulty in the summer season over the past couple years.

Are you guys -- is the current guidance reflecting continued difficulty?

Is this basically a conservative estimate going into the quarter so you don't miss this summer?

Is that one way to look at this?

I don't want to use the word conservative -- I'd rather use the word "prudent."

We take our guidance seriously, and we want to be prudent with it, and we're assuming that the economy, especially in Asia, and that for us means mostly Japan, as well as Europe remains soft through the summer.

As we experienced similar declines in Q3 of last year and Q3 of the year before.

So it does assume a relatively weak economy.

If you can think back towards last year, you feel you're being more prudent going into this summer season versus last year?

We certainly learned from our experiences.

I don't know if I could classify it as being more prudent or less prudent.

All I can tell you is we are absolutely being prudent.

Ok.

And just in terms of the operating margin, obviously the revenues are getting kind of tweaked around here, but any general thoughts on absolute dollar spending, is it pretty consistent with what you had originally looked at?

Second, you talked about the 28% operating margin.

Is that for the full I year exiting or for the final quarter of this year?

Gene, in terms of the operating margin, the guidance we provided for the targets we provided for Q3, the 24% to 27% operating margin, obviously you can multiply that against the revenue range and come up with some numbers.

So it's going to yield something slightly -- a modest sort of increase from where we are in Q2 as we continue to push the launch of Acrobat 6.

We also said that for the full year, that we are targeting at least a 28% operating margin on a full year basis, so we've been at 27.9% in the first half of this year, 24% to 27% is the target for the third quarter, so clearly the fourth quarter is going to have to be higher than 28% to bring the overall average up to at least 28%.

That's kind of how we see the year finishing out.

Ok.

So the incremental spending is on sales and marketing for the Acrobat launch?

Is that accurate, for this quarter?

It's primarily the focus, again we've got the French, German and Japanese product launching, we just started the English.

There's obviously other cost involved.

We'll continue to look to hire some key individuals to invest in our future, but there's a clear focus on continuing to spend the dollars that we need to really invest in the growth of Acrobat

If you think about what we're doing in addition to the current Acrobat product, we need to begin to spend money against the launch of the video products as well as the new Creative Pro product into Q4.

So the market opportunities for us are so great as we move through the end of this year and into 2004, we want to make sure what we're spending now so we can take advantage of those opportunities of the future.

Is it accurate -- it's more on the sales and marketing side versus maybe the R&D or the G&A?

That's accurate

That's correct.

That's what the primary focus would be.

As we go through in order to hit that operating margin of basically greater than 30% exiting the year, we need to have those expenses be more variable in coming down, but if we have a pretty consistent strong product release scheduled for the rest of this year, does that make sense that you'd be scaling down some of those sales and marketing costs even though you have a pretty consistent product release schedule?

Well, again, we've got a lot of plans for the fourth quarter as well.

We want to make sure we do a good job with our launches there, so we'll need to spend some money on sales and marketing.

Clearly the revenue side of the operating margin equation will also have to be looked at in terms of how we would get to the higher margin.

So there's great opportunities for us out there.

We've got a lot of products coming.

It's very important for us to make sure that we're making investments in sales and marketing that are consistent with the R&D investments we've made over the last couple years building up to this.

That's kind of how we're looking at this point.

We're obviously continuing to manage expenses very tightly where we need to -- so we can save the money to invest in growth that we need to do over the next few quarters.

Let me ask it this way.

In terms of the sales and marketing expense on an absolute bases, do you see that declining going forward in the August/November quarter?

Again, I think if you take the percentages that we've provided for the quarter, you can multiply it out yourself and see what that gives you, but we have a lot of products coming, and it's very important that we market those products effectively to get the revenue that we think we can achieve even in this challenging economic times, there's a lot of opportunity out there, and we want to make sure we're investing appropriately, and that will involve the spending of marketing dollars.

Ok.

And just lastly, what was the total number of days you're recognizing revenue for Acrobat?

In the May quarter?

Well, we don't specifically measure it from that perspective, but we are very careful, as you know, at managing our entire channel, and we look at previous versions and how they shipped on a sell-through basis in the weeks following the launch, both of Acrobat 4, Acrobat 5.

We've got a very scientific model basically in terms of measuring all of that, and as we see the progress to date, we feel very good about how we've approached all of that.

I know the actual shipment date was May 27th, but you guys are probably actually shipping previous to that.

Can you give me a ballpark?

Was it seven days you were effectively recognizing revenue for the quarter?

I see.

In terms of the total number of days, it's about a week

Great.

Thanks.

The next question comes from the line of Steve Ashley with Robert W. Baird.

Please go ahead with your question.

Hi, guys.

I'm assuming that of the three new Acrobat products, that the professional and the standard would be sold more through the channel and that the Elements product by its nature would be more of a direct sale, and as a result, it may take longer to ramp-up, and we may see that mix take more time to come online.

Can you maybe comment on that?

Is that a correct way to think about that?

Yeah, I think that's exactly the way to look at it.

The Acrobat element sale again is more of a company-wide deployment that's going to involve potentially the CIO being involved in terms of being a standard on the desktop so the sales cycle on that will be longer than it would be on the professional or standard, which can be more departmentally focused.

It still will be sourced through the channel, but it's definitely a little bit longer sales cycle than it would be on the professional or the standard product.

Great.

And you've talked about the preorders for the foreign language versions of Acrobat.

Can you just mention whether those preorders are consistent with your expectations?

Yes, they definitely -- we had very good orders and it will be probably be on the side of being a little bit higher than our expectations.

great.

You've mentioned being cautious in Asia and haven't mentioned the word SARS.

Is that any at all of the conservatism on your guidance?

No we have seen no impact on SARS.

We did take measures to be very careful in terms of that.

If we did run any issues in terms of our supply chain, we've seen no impact at all on our business, and we're not factoring any negative impact for SARS in our Q3 guidance.

And just, I think Gibboney asked this question in the beginning, which was -- we also did not see any material impact from the war in Iraq, none that we could even determine.

Maybe somebody out there didn't buy the product, but there was nothing that we could see in any kind of material I way that would suggest that we saw any impact from the war or from SARS on our business.

Perfect.

Thanks, guys.

Our next question comes from the line of Keith Gay with Thomas Weisel Partners.

Please go ahead with your question.

Good afternoon.

I noticed when you were talking about the server portion of the business that most of the deals you talked about were government-related.

Is that based on what your current focus is or is that just where you're seeing most of the demand on that business?

Hi, Keith this is Shantanu.

I think in terms of our ePaper solutions, we believe that there's relevance across multiple industries.

I think we've always stated that regulated industries have been in the area of focus for us, which is financial services, process manufacturing and government.

And we're seeing success across all of them.

I think some of the examples that we gave in the enterprise space also demonstrated with Boeing and Gaps (ph) are continued penetration there, and the acceptance of our value proposition within the enterprise.

So certainly regulated industries is an area that we're focused on, but we're seeing success in multiple industries beyond government.

It's also easier for us to comment on government wins because the government wins tend to be public in nature because the procurement process is public.

The private sector, we have to ask for permission, and there are many customers who don't want us to use their name publicly for competitive reasons.

So what we can disclose ends up being biased towards government.

That's not necessarily a reflection of what the overall deal flow is.

Ok.

Ok.

And on the segmenting strategy, you commented that it's a little too early to tell, but can you give us -- what's the reaction from the channel?

Any thoughts yet on any price adjustments required, any sort of feedback on what you may have learned?

No, I think overall, we have seen very enthusiastic response to our segmentation strategy.

I think the initial reviews that we've seen have been very positive, particularly in the engineering and the community that we're targeting new with the product, the engineering reviews have been really good.

And from the channel also, I think the feedback has been pretty positive.

But again, as I said, it's early to comment on the product mix.

We are optimistic.

Ok.

Thanks.

Our next question comes from the line of Craig Ellis with Solomon Smith Barney.

Please go ahead with your question.

Thanks.

Really two clarifications here.

One, staffing is up by about 120 folks since the end of the fourth quarter.

Can you just update us on what the plan is as we look forward over the next few?

Craig, we had said actually back at our analyst meeting back in October that we would have certainly a focus on hiring in 2003 to continue to build up our expertise and especially focusing on the enterprise, and you've seen that clearly in the first two quarters.

We'll continue to focus on hiring.

The rate may not be quite at the same pace as what we've seen in the first two quarters, but we will continue to definitely hire because it's a great opportunity right now to hire some great employees to really complement what we're trying to do in terms of really focusing on the enterprise.

That's understandable.

And I didn't catch the year over year growth numbers in the InDesign and Design Collection, but I think they were in the 30% to 40% range and the segment overall was up 4%, so can you help us with the offsets on what was slower-growing there?

Well, the overall growth between those two was -- I believe we said 47% on a year-over-year basis, just showing the strength of InDesign.

In terms of -- from an overall basis, the key here really is in the PageMaker area as we continue to focus on really driving InDesign, we've seen some weakness on the PageMaker side, not that it's not expected, it's our strategy right now to move our customers from PageMaker over to InDesign.

Ok.

Thanks, Murray.

Our next question comes from the line of Bill Lennan with WR Hambrecht.

Thanks.

Back to Acrobat for a second.

Could you comment on -- I know upgrades are not the driver here, but could you comment on the upgrade rate so far in Acrobat 6, what it is vis-a-vis where we were last time with Acrobat 5?

And within the community or the population of people who have upgraded, could you talk about the mix of people going pro verses standard and vice versa?

And I have one follow up.

Bill, this is Bruce.

It's so early, and I know many of you are trying to get at the same question.

It's so early that whatever information we would give you in terms of more detail would end up -- or you would end up making conclusions on on the information that would not necessarily be the right conclusions.

So we've had a couple weeks of sell-through data.

It's early.

We have seen, as we've said again and again, the results on the Acrobat professional side was greater than we anticipated.

The overall demands for the product, at least based on the initial experience is better than we had expected, but it's still early.

We'll provide you with a lot more color.

Hopefully we can give you some color in our release on July 31st, but certainly at the end of the quarter, when we give you our Q3 guidance, we'll give you the specifics.

It's great that at places like Amazon.com, the Acrobat professional upgrade continues to be a top seller.

Does that mean it's going to go on for another two or three months?

I don't think that we can conclude that, can make that conclusion.

So I encourage you to just be patient.

We've given you guidance for the quarter, factoring in what we think could be a good Acrobat quarter, balancing that with potentially the typical weak seasonality that we experienced especially in places like Japan.

Ok.

Thanks.

And the other question is on a completely new topic, I guess.

I mean, I have an expectation for Encore but I wonder how you guys arrive at it.

What do you think the addressable market is for that prosumer DVD offering segment, and how do you measure it?

Penetration of Premiere's install base, is it the number of videographers in North America?

So I guess addressable market for that product and the bases for arriving at that market is the question.

Sure.

I think if you look at the opportunity, the significant revenue opportunity we see is really in capturing the video professional desktop.

And it's really aimed at the creative professional who's using video production as well as the specialist video customer.

So within that, our strategy is to make sure that we have the entire portfolio of products that that particular professional is going to use, whether that's Premiere, whether it's After Effects, whether it's Audio Now or whether it's DVD.

So I'm not sure that there's a significant opportunity for audio, for example, but I think if you take the entire product into account, every desktop that's using a creative professional product for now for print, we believe that's the opportunity for us moving forward to video.

We believe there's going to be a video publishing revolution the same way there was a desktop revolution in the 1980s.

There is now two ways to get video communicated.

One is broadband, the other is through DVD's, and with DVD proliferation being what it is just about everywhere, every corporation in the world, any government agency in the world can now communicate using video as a data type in which to communicate.

And we think that will drive our overall video business, and that's why we're so excited about the category.

Thanks a lot, guys.

Our next question comes from the line of Scott Kessler with Standard & Poors.

Please go ahead with your question.

Hi.

Thanks very much.

My first question involves why you didn't repurchase any shares in the quarter.

That struck me as interesting.

And if you could comment on maybe what your plans are with respect to your repurchase plan going forward, that would be great.

And I have a follow up.

Thanks.

Right now our board is currently reviewing our cash use and our overall capital structure, and as such, we did not repurchase any stock in Q2, so we have no other update to provide at this time other than that we're undergoing a review with our board right now on our overall structure.

Ok.

My second question involves something a little bit different.

I'm not sure if I remember the exact numbers that you gave about the expected growth in your addressable markets over the next, say, three years or so.

But it struck me as curious that looking at vendors that provide data, your expected annual EPS estimate increases over the next, say, three to five years are around, say, 12% to 14%.

And I'm just wondering if you could comment on that, just give you an opportunity to talk about that maybe vis-a-vis what you expect the growth to be in your addressable markets, and if you expect to gain share.

We always expect to gain share.

However, -- we're not giving any kind of long-term guidance certainly in this environment, that would be somewhat -- probably challenging is the best word, bordering on foolish.

I think it's safer to say when you look at the categories and the markets in which Adobe is able to participate in, the opportunity for us is significant.

If you look at just the ePaper space, we had Microsoft that just entered the form space, and one of the industry analysts said it's a $12 billion market opportunity, and yet it's a market where we have a unique value proposition.

That's one big opportunity.

If you look at the major transformation from film to digital photography, it's a category in which Adobe leads on the desktop with products like Adobe Photoshop and Photoshop Album and Photoshop Elements.

And we believe we'll be able to benefit from that major paradigm shift in consumer behavior.

And of course in the Creative pro space, we have a strong market share position, but in the area of page layout, we still have a lot of market share to be gained, and we also believe because of the loyalties that the customers have for Adobe, that we'll be able to continue to sell them more products and services, bringing in more revenue for Adobe.

So I can't give you a specific number, but we are absolutely convinced of the opportunities ahead of us are significant.

Ok, Bruce, let me ask it in a different way then.

Looking at, say, independent firms that are sizing these markets that you address at this point or intend to -- my impression is that 12% is almost ridiculously low.

And I guess what I'm getting at is that there seems to be a disconnect between a portion of the analyst community in their assessment of your growth prospects verses even what the industry analysts are saying your addressable markets are going to grow at, not withstanding the fact that you intend to gain share.

That's what I'm trying to get at.

There's two things I'll ask you to look at.

Go back and look at their forecast of a year ago or two years ago, and now look at their forecast and see how much it's changed.

I suspect that their ability to forecast category growth is probably no better than anybody else's ability when it comes to actual data.

The other is -- I would go ahead and ask them what are they projecting for GDP growth, because at the end of the day, if you can figure out what GDP growth is going to be, that will have a bigger impact on the overall market we play in than anything else.

And at this point in time, I'm certainly not willing to predict what the GDP growth is going to be.

Sure.

Fair enough.

Thank you.

Our next question comes from the line of Gibbony Huske with CSFB.

Please go ahead with your question.

Thanks.

You did announce a number of E forms deals.

If you could give us a sense of the competitive dynamics there, who are the competitors in that market, are you seeing any anticipation as Microsoft moves to the market with an E forms product?

Maybe it's on the low end of the E forms side, any anticipation of Adobe being more of a competitor going forward and how these kind of deals play out?

Sure, Gibboney.

This is Shantanu.

I think in terms of the competitors that we're seeing in the marketplace now, they're really the smaller players at this point as well as maybe people trying to build some of their own solutions.

I think when we go in with our value proposition about the document server for reader extensions and how they can take all their existing PDF forms and suddenly make those PDF forms intelligent documents like we talked about and tied them back into their back end infrastructure.

So it leverages as well as it moves from a paper-based to an electronic.

We're seeing traction.

So certainly the competition that we're seeing today, we aren't seeing Microsoft in many of the deals at this point.

And I think it's again based on what our target is, which is the financial industries, regulated industries where the fidelity of the documents needs to be important, and where it's really important that those forms extend beyond the firewall, and that's where the Adobe reader is really the only -- is the only game in town.

So we continue to be -- we think our strategy is right on, and that's why you see the number of wins that we outlined.

Can you say who you see specifically as competitors then?

Again, as I said, you know, they're really the smaller companies.

If I were seeing a consistent background, I'd give it there, but the reality is we're not seeing that in the marketplace.

If there's one, I would say it's some of the IS shops who not knowing that there's an external solution want to build it themselves.

Ok.

Fair enough.

Thank you very much.

Our next question comes from the line of Jay Vleeschhouwer from Merrill Lynch.

Technology questions first.

For many years the company was quite adept at shipping new releases, more in the middle part of a quarter, recognizing the the inherent risks of having products ship late in a quarter.

Yet, Acrobat shipped late this quarter, understandably, perhaps because of the complexity of the product line, but now Premiere and After Effects go late in the August quarter.

I guess remains to see what happens with Creative Pro in the fourth quarter.

So the question is, has there been some change in your product development and/or QA process such that you're tending towards later quarter releases?

Second technology question for Shantanu, you're apparently working on a new comment or integrated server architecture bringing together, or so we understand, DOC server, Work Flow and E forms.

Can you talk about perhaps the timing or addressable market of that new server architecture?

Sure.

So let me address the first one first, which is sort of the product development in QA process.

Even though I'm biased, I will say I think Adobe of all the companies I've ever been part of, it's absolutely the most predictable and in terms of product development cycle, we have pretty phenomenal track record of making and meeting our product schedules.

Which is why I think, you know, there's a lot more confidence that we have as a company when we announce a product schedule internally of meeting it.

As Bruce said, we have not made any changes to our internal product road maps based on our strategy.

So, as it relates to where the products fall, I think with some of the major products, we've looked at it, but again, it really is one of when we define a product and we look at the tradeoff between features and schedule, where it falls.

I just think there's a lot more confidence in the management team of meeting those dates.

With respect to the common server architecture that you talked about to integrate all our solutions, I think we have stated that as part of the acquisition of Excelio, certainly one of the key goals for us was to take the technology that they had and the technology that we are working on and make sure that we provide an integrated version of those, and that's well underway.

It's going well.

And the second thing is, you know, it's important only as it relates to making sure that as Dark Net and as the Java J2EE environment evolve, that our server architecture fits on top of both of that.

So you'll see those roll out.

I'm not going to comment on any specific timings for those.

But it's going well.

Ok.

What about the addressed market for that new combined server, cost does that change your addressed market, does it move you up in terms of ASP's in the server area?

No.

The common server architecture is really more about enabling the us for the solutions that we identified --document generation, document process management and document collaboration -- of having an architecture that allows us to mix and match that functionality to provide customer with the benefit that they want.

That's really the focus.

Ok.

Couple last ones.

Bruce, you've often talked in the last year or so about implementing pricing and packaging optimization.

Perhaps the segmentation of Acrobat is in itself an example of that, but how else might you undertake that kind of optimization over the course of the rest of the year?

And then last, I think the last time anybody on a conference call asked anything about PostScript QA's was maybe 1997, but it's interesting that the PostScript number seems to be holding up a little bit better, was a little bit better than we thought.

Is there something finally on the margin going on in terms of your OEM customer base that is on the margin improving that number?

In terms of the price optimization, that continues to be a strategy, especially in those categories in which we have a way of better integrating our products and providing more value to our customers who use more than one of our products.

So you can imagine that as we introduce new collections of products, and I don't mean collections -- the product itself, but as we release potentially some of the video products, as we release some of the Creative Pro products, you could imagine us beginning to optimize the pricing.

How we're going to do that specifically, we haven't communicated yet, but there's been some best practices, certainly Microsoft with Microsoft Office has been at this now for about 10 years, and we could certainly learn a lot from what they've done, and there's also been some other smaller players like Macro Media (ph) that has done, we think, a fine job.

So there are some things that we could do where we could get more value for the products that we're offering to our customers.

Regarding PostScript, I'll ask Shantanu to answer that.

Sure.

So I think if you look at the OEM PostScript business, I think some of the larger accounts that we have turned in a good performance, which is why I think you've seen a good performance on a year-over-year basis.

I think sequentially there was a slight decline, and we continue to model that business as a slight decline moving forward.

Some of the new (inaudible) -- high end, color, which plays into Adobe PostScript's strength, but I wouldn't let one quarter's performance change anything we're doing.

We continue to believe that will be a business that will decline.

Thanks, Jay.

Operator, we'll do one more question, please.

Your last question comes from the line of Bill Lennan with where WR Hambrecht.

Please go ahead with your question.

Thanks a lot.

One question about the next Illustrator, which I think is actually applicable to all products that are getting up around the seventh and eighth version.

When you get up around 10, 7, 8, 9, 10 in a version and the upgrade rate is what it is, do you go back and say let's add some really wow features, let's get the upgrade rate going in the right direction, or do you scale back your investment and sort of harvest a product and let the upgrade rate feed naturally?

I think the way to look at some of the applications that we deliver to the creative professionals is for these people, these applications are truly mission-critical applications, and in terms of what they're looking to Adobe for, they're looking for productivity and flexibility because they use these applications five, six hours a day or more than that.

And I think in terms of our strategies for all of these applications, I think it's the integrated work flow that's allowing them to deal with all the different media and devices that are coming up that's key.

But for every one of these products, there are lists that are long lists of our really important things that our customers are asking for that are on the drawing board both in terms of the next release and multiple releases after that.

So we think there's a significant amount of things that we could do for each of these products.

Thanks, and thanks for taking all of the questions today.

This concludes our call today, and we thank everybody for joining us.

Ladies and gentlemen, that does conclude your conference call for today.

We thank you for your participation and ask that you please disconnect your lines.