Adobe Inc (ADBE) 2003 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Adobe Systems Q4 fiscal year 2003 earnings conference call.

During the presentation, all participants will be in a listen-only mode.

Afterwards we will conduct a question-and-answer session.

At that time if you have a question, press the 1 followed by the 4 on your telephone.

As a reminder, this conference is being recorded Thursday December 11, 2003.

I would now like to turn the conference over to Mr. Mike Saviage, VP of investor relations.

Please go ahead sir.

Thank you.

Good afternoon and thank you for joining us today.

Joining on the call is our Bruce Chizen, and president and CEO, Murray Demo, senior vice president and CFO, and Shantanu Narayen, executive vice president of worldwide products.

On the call today we will discuss Adobe's fourth quarter and fiscal 2003 financial results.

By now you should have a copy of our earnings press release which crossed the wire about 45 minutes ago.

If you need copy of the press release, you can go to adobe.com under the company and press links to find an electronic copy.

Before we get started I want to emphasize that some the information discussed in this call, particularly our revenue and our operating targets for the coming quarter and our forward-looking product plan, contains forward-looking statements that involve risk and uncertainty.

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

For a discussion of these risks and uncertainties, you should review Adobe's SEC filings including our annual report on Form10K for fiscal 2002 and our quarterly reports on Form 10-Q in 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 reconciliation between the two such measures are set forth in our press release issued today and are available on our website.

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

The audio of the call will be archived of Adobe's investor relations website for approximately 30 days and is the property of Adobe Systems.

It may not be rerecorded 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.

I'm pleased to announce that Adobe is reporting outstanding fourth quarter fiscal year end results.

Q4 revenue was a record $358.6 million, which exceeded our target range and represents 22% year-over-year growth.

Earnings per share were 34 cents in the quarter, also above our target range.

Our results were driven by the launch of the new Creative Suite and new CS versions of Photoshop, Illustrator, InDesign and GoLive as well as continued success with Acrobat.

For the year, revenue in fiscal 2003 grew to an all-time high for Adobe, achieving 11% year-over-year growth over fiscal 2002.

Our profit and cash generations during the year were excellent with GAAP and pro forma operating margins exceeding 29% above our original annual target of 28% for the year.

I will turn it over to Murray for review of our financial results, then Shantanu will provide business highlights for the quarter.

Murray?

Thanks, Bruce.

Before I discuss Q4 results, I would like to comment on our full year 2003 results.

Adobe achieved revenue of $1,295 million compared to $1,165 million in fiscal 2002.

This represents 11% year-over-year revenue growth.

GAAP operating profit in fiscal 2003 was $379.4 million compared to $287 million in fiscal 2002.

This represents 32% year-over-year growth in GAAP operating profit.

GAAP operating profit margin was 29.3% compared to 24.6% in fiscal 2002.

And GAAP diluted earnings per share in fiscal 2003 were $1.10 compared to 79 cents in fiscal year 2002.

Pro forma operating profit, which as applicable excludes the amortization and impairment of goodwill restructuring of other charges and acquired in process research and development, was $378.9 million in fiscal 2003 compared to $325.9 million in fiscal 2002.

This represents 16% growth in pro forma operating profit.

For fiscal 2003, we achieved pro forma operating margin of 29.3% compared to 28% last year.

Pro forma diluted earnings per share, which excludes as applicable the amortization impairment of goodwill, restructuring and other charges acquired in process research and development and investment gains and losses, were $1.14 in fiscal 2003 compared to 95 cents in fiscal 2002.

Now I would like to discuss our Q4 fiscal 2003 results.

For the fourth quarter of fiscal 2003, Adobe achieved revenue of $358.6 million.

This compares to $294.7 million reported for the fourth quarter of fiscal 2002 and $319.1 million reported last quarter.

GAAP net income for the fourth quarter of fiscal 2003 was $83.3 million compared to $40.1 million reported in the fourth quarter of fiscal 2002 and $64.5 million last quarter.

Pro forma net income, which excludes as applicable the amortization of goodwill, restructuring and other charges and investment gains and losses from the company's venture program, was $83 million, compared to $59.1 million reported in the fourth quarter of fiscal 2002 and $66.3 million last quarter.

GAAP diluted earnings per share for the fourth quarter of fiscal 2003 were 34 cents based on 245.5 million weighted average shares.

This compare with GAAP diluted earnings per share of 17 cents reported in the fourth quarter of fiscal 2002 based on 238.4 million weighted average shares and GAAP diluted earnings per share of 27 cents reported last quarter based on 240.5 million weighted average shares.

Pro forma diluted earnings per share for the fourth quarter of fiscal 2003 which excludes a minor reversal of a previous restructuring charge and an investment gain from the company's venture program also were 34 cents.

Gross margin for the quarter was 93% compared to 91% in the fourth quarter of fiscal 2002 and 93.1% last quarter.

GAAP operating expenses for the fourth quarter of fiscal 2003 were $218.1 million.

Pro forma operating expenses for the fourth quarter of fiscal 2003 which does not include the $105,000 reversal of a prior restructuring charge were $218.2 million.

Regular employees at the end of the fourth quarter totalled 3,515 versus 3,486 at the end of the third quarter of fiscal 2003.

Expenses as a percent of revenue breaks downs as follows: research and development, 20.4%; sales and marketing, 31.7%;

G&A, 8.8%.

GAAP operating income in the fourth quarter of fiscal 2003 was $115.3 million or 32.1% of revenue.

This compares to GAAP operating income of $62.9 million or 21.4% of revenue in the fourth quarter of fiscal 2002 and $92.2 million or 28.9% of revenue last quarter.

Excluding the amortization and impairment of goodwill, restructuring charges pro forma operating income in the fourth quarter of fiscal 2003 was $115.1 million or 32.1% of revenue.

This compares to pro forma operating income of $83.8 million or 28.4% of revenue in the fourth quarter of fiscal 2002 and $91.8 million or 28.8% of revenue last quarter.

Other income for the fourth quarter of fiscal 2003 was $3.4 million.

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

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

Creative professional segment revenue was $107 million in Q4 fiscal 2003 compared to $86.9 million in Q4 fiscal 2002 and $82 million last quarter.

Digital imaging and video segment revenue was $112.6 million in Q4 fiscal 2003 compared to $101.6 million in Q4 fiscal 2002 and $88.3 million last quarter.

As we communicated at our analyst meeting in October, we expected some customers to purchase the Creative Suite rather than stand alone CS products.

Our Q4 results reflect this shift.

Some Photoshop revenue which previously would have been reported in the digital imaging and video segment is reflected in Creative Suite revenue in the creative professional segment.

OEM postscript and other segment revenue was $20.8 million in Q4 fiscal 2003 compared to $21.8 million in Q4 in fiscal 2002 and $21.8 million last quarter.

EPaper solutions segment revenue was $118.1 million in Q4 fiscal 2003 compared to $84.4 million in Q4 fiscal 2002 and $127 million last quarter.

In Q4, total ePaper desktop revenue was $98.6 million representing year over year growth of 44%.

New unit Adobe Acrobat desktop revenue grew sequentially from Q3.

As anticipated, due to product cycle, Acrobat upgrade revenue was lower than last quarter.

EPaper server revenue grew sequentially from $17.5 million in Q3 to $19.5 million in Q4 demonstrating continued momentum in the enterprise.

Turning to revenue by geographic segment, the results in Q4 fiscal 2003 were as follows: the Americas. 50%;

Europe, 31%;

Asia, 19%.

And in reviewing our geographic performance for Q4, we continue to experience stable demand across our major geographic segments.

Application platform mix was 73% Windows and 27% Mac in the fourth quarter of fiscal 2003 which compares to 73% Windows and 27% Mac for the fourth quarter of fiscal 2002 and 77% Windows and 23% Mac last quarter.

Our trade DSO in the fourth quarter of fiscal 2003 was 37 days.

This compares to 36 days in Q4 fiscal 2002 and 31 days last quarter.

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

At the end of the fourth quarter of fiscal 2003, cash and short term investments were $1,097 million compared to $852 million [AUDIO DIFFICULTIES] at the end of the third quarter for fiscal 2003.

Turning to Adobe ventures, we realized an investment gain of $379,000 in Q4 fiscal 2003.

In the quarter we made additional investments of $1.4 million.

In total, Adobe has invested $222 million through its venture partnerships and direct investments.

As of the end of the fourth quarter, the net returns from this program were $346.1 million including the stock dividend to stock holders and market value of investments still held by Adobe.

In regard to share buyback, Adobe did not repurchase shares during the fourth quarter as part of its share repurchase programs.

Adobe's Board of Directors declared this quarter's cash dividend of $1.25 cents per share payable on January 23, 2004, to stock holders of record as of January 9, 2004.

This concludes my discussion on fourth quarter fiscal 2003 results.

Now I will discuss our Q1 fiscal 2004 targets.

We are targeting revenue of $360 to $380 million.

As of a percent of revenue, our approximate operating model targets for the quarter are as follows: gross margin, 93%;

R&D, 21%;

Sales and marketing, 31-32%;

G&A, 9%.

Resulting in a GAAP and pro forma operating margin target of approximately 31 to 32%.

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

For other income, we were targeting approximately $3 to $4 million, and for our tax rate we were targeting 28%.

The lower tax rate in fiscal 2004 is due to the ongoing benefits from our international restructuring completed in 1999.

These targets lead to a GAAP and pro forma earnings per share target range in Q1 fiscal 2004 of 33 to 36 cents per share.

We currently believe that targeted pro forma results will not differ materially from targeted GAAP results.

Finally as noted in our 10K filings, our fiscal year is a 52, 53 week year ending on the Friday closest to November 30th.

Accordingly in Q1 fiscal 2004, we will have an extra week of revenue and expenses.

In regard to fiscal 2004, we were reaffirming our full year targets of $1.425 billion in revenue and an operating margin of approximately 30%.

This concludes my comments.

I will turn the call over to Shantanu.

Thanks, Murray.

I will take the next few minutes reviewing highlights in each of our major businesses starting with the creative professional and digital imaging and video segments.

With the launch of the Adobe Creative Suite, we delivered the industry's first complete design and publishing platform.

In addition, we also shipped major new stand alone versions of Photoshop, Illustrator, InDesign and GoLive.

Combined this was most the comprehensive product introduction for creative professionals since the desktop publishing revolution.

We are pleased with the overwhelmingly positive response from the press and industry analysts thus far for the Creative Suite and the new CS products.

The Creative Suite has received Maxwell's prestigious Eddie award for 2003.

PC Magazine has given it a five out of five star rating.

The new stand alone CS products have received similar accolades.

Creative Mac stated, "Illustrator CS has undergone a major transformation in its latest incarnation.

The new features bring dramatic improvements to this application."

InDesign CS received a five out of five rating and an editor's choice award from PC Magazine and continues to compare favorably against Quark Express.

PC Magazine stated, "In the long run, designers may choose InDesign for the ways in which it surpasses Quark including its cutting edge typography and integration with other Adobe apps."

Electronic Publishing Magazine stated, "It has becoming easier for professionals to justify a switch to InDesign."

We continue to see customers making that switch.

In Q4, TV Guide, BBC Worldwide, the magazine publisher for all BBC titles, and Future Publishing, the U.K.'s fifth largest publisher, stated that they are moving to InDesign.

Finally, Photoshop, one of the most significant tools used by creative professionals, has again raised the digital imaging standard with the new CS version and is receiving some of the best reviews ever for a Photoshop upgrade.

Creative Pro.com said, "It is without a doubt the biggest, baddest, absolute best version of Photoshop there ever been.

There's something for everyone."

While it is far too early in the CS product cycle to draw conclusions on overall performance, initial revenue for the Creative Suite and the new individual CS products has been strong.

Foreign language versions have just begun shipping this quarter.

We continue to expect upgrade and full unit revenue for these products to extend longer into the product cycle than past releases.

Beyond creative professionals, we continue to be excited about our growth opportunities in digital imaging.

The new version of Photoshop addresses the needs of professional photographers and serious photo hobbiests.

As Photo Focus Magazine stated, it's the single most significant Photoshop upgrade ever especially for photographers.

We also ship Photoshop Album 2.0 which has received strong reviews from a variety of publications in the last few months.

For example, a Miami Herald columnist stated, "For photo cataloging and editing my favorites are all Adobe's.

Photoshop, Photoshop Elements and Photoshop Album."

This new release of Album combined with Photoshop Elements has enabled Adobe to remain the market leader in retail digital imaging software revenue.

Video also continues to be a strategic growth opportunity.

Q4 revenue for our digital video platform including Premier Pro After Effects, edition, Encore DVD and the video collection grew 24% year over year.

Turning to our largest and fastest growing business, we continue to see excellent performance with our ePaper desktop products.

Strong revenue for Acrobat 6 was driven by new unit adoption of the professional and standard versions and continued momentum in our licensing business.

EPaper desktop licensing as a percent of the total desktop business was 40% in Q4.

We continue to focus on driving adoption for Acrobat in government, financial services, manufacturing and the AEC, architecture, engineering and construction markets.

We believe this contributed to the strong results in Q4.

Our Q4 ePaper success also extends to our server base business where we had sequential revenue growth.

EPaper server revenue grew to $19.5 million representing 24% year over year growth.

Driving this performance were a number of significant wins.

In the government market they include the State of Illinois which has expanded their adoption of Adobe intelligent document products to include the Adobe document server [INAUDIBLE] extensions.

PDF has become the standard for electronic documents within the state.

The Federal Reserve Bank of Richmond which has adopted the Adobe form server to support their e-phones implementation of the [INAUDIBLE].gov website.

[INAUDIBLE] the IT consortium of the Italian Chambers of Commerce will use the Adobe document server to manage and process 6 million PDF files annually.

Using the Adobe document server to read extensions they will provide Adobe PDF forms to approximately 2.5 million Italian companies for the secure submission of financial statements.

The Norwegian Public Roads Administration which is using the Adobe document server to produce electronic brochures, manuals, user guides and other types of documents.

In the commercial market, [INAUDIBLE] with our server solutions included, the consumer retail banking division of JP Morgan Chase which is implementing Adobe eForm technology to provide intelligent fillable ML/PDF form services to their users.

The Texas Medicare health care partnership, a project under the Texas Health and Human Services Commission, is deploying Adobe document server reader extensions to manage comprehensive health care provider enrollment applications.

Applicants will be able to electronically download the application and working offline collaborate with multiple contributors to complete the application.

PBVA, one of the largest banks in Spain, is using Adobe document generation server solution to automate the internal business processes. [INAUDIBLE], one of the largest banks in Scandinavia, is using Adobe form solutions to implement a web based employee form and data capture solution.

And Whirlpool Europe which has chosen Adobe document generations solutions to manage the out put of critical documents from their SAP system.

In Q4 we also announced and released Adobe Acrobat Element Server, a new network based version of Acrobat Elements.

With both we now provide enterprises the capability of deploying low cost PDF creation on every desktop.

As we discussed at our analyst meeting in October we are providing two metrics on our enterprise business.

The first is the number of enterprise server transactions greater than $50,000.

And the second is the average size of these transactions.

In the fourth quarter, the number of enterprise server transactions greater than $50,000 totaled 35, compared to 29 in the third quarter.

The average size of these transactions was $114,000 compared to $120,000 in Q4.

Finally, during the quarter we acquired the technology assets of a small private company called Yellow Dragon Software, a leading developer of XML messaging and metadata management software.

The acquisition further strengthens our XML architecture which enables businesses and governments to combine the powerful data and business logic capabilities of XML with the rich presentation and enhanced security capabilities of Adobe PDF.

This concludes my Q4 business segment review.

Bruce.

Thanks, Shantanu.

Our results throughout 2003 demonstrate great execution.

We met or exceeded our financial targets every quarter.

We introduced a complete platform for design and publishing.

We extended our digital imaging and digital video platforms.

And we built on our ePaper desktop success with the delivery of mission critical server base solutions for the enterprise.

In fiscal 2003, we said what we were going to do and we did it.

In the process, we transformed Adobe from a point product provider to a platform company.

As a platform company, we're more relevant to our customers and partners than ever before.

Going forward, our focus remains on growth.

We will expand our commitment to the creative professional, extend our offerings to the digital imaging and digital video markets, and execute on our vision of providing intelligent document solutions for our enterprise customers.

Given the positive momentum established during 2003, along with our plans for the future, we were optimistic about continued growth in fiscal 2004 and beyond.

Mike?

Thanks, Bruce.

Before we start Q&A, I will announce the date for our regular quarter update for the first quarter of fiscal 2004.

It will be Thursday January 29, 2004, after the market closes.

Also, our quarterly earnings dates for fiscal 2004 have been scheduled and are available on our investor relations website in the financial calendar page.

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 at adobe.com later today.

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

Use reservation number 21167910.

Again the phone number is 402-977-9140.

Reservation number 21167910.

The phone playback service will be available at 4:00 P.M.

Pacific time today and ending at 4:00 P.M.

Pacific time on Monday December 15, 2003.

We will be happy to take your questions.

Operator?

Ladies and gentlemen, if you would like to register a question, please press the 1 followed by the 4 on your telephone.

You will hear a three tone prompt to acknowledge your request.

If you question has been answered and you would like to withdraw from the queue, please press the 1 followed by the 3.

If you are using a speaker phone, please lift your handset before asking your question.

Our first question is from Ben Reitzes with UBS.

Please proceed with your question.

Nice quarter, guys.

Thanks.

Couple things with regard to your -- actually if I'm running the numbers right, it looks like your revenue with Apple was up 34% sequentially and 24% year over year.

Can you comment on how their product cycle coinciding with your product cycle is benefiting your business.

Also, can you comment on Asia?

Obviously it looks like Japan took a breather, but you are saying things are stable.

How do you think things play out in that area?

Also, I guess I will add one more and Murray, so we were supposed to believe that your operating margin will go down after the first quarter with this kind of revenue performance?

That's kind of my rhetorical question for you.

I want you to talk me through that if you can.

Let me take the question on Apple and what it means to our business.

We continue to be very excited and enthused by the G-5 as well as all the functionality in the OS-10 operating system.

Our customers have told us that they intend to begin to upgrade their platforms, especially those that are loyal to Macintosh over this coming year.

We do not expect it to happen in one quarter.

We believe that our -- the gain in our Macintosh business on a sequential basis has a lot more to do with our Creative Suite than it does anything specific to apple's business.

However, we do believe that the movement or the migration to the G-5 by our customers will allow us to continue to be successful with the suite throughout fiscal 2004.

Thanks.

In terms of Japan, what we saw Q3 clearly we mentioned that was we saw an improvement in business in Q3.

And that business continued in Q4 we did not see an exhilaration in that growth that we saw in Q3.

You have to remember that we announced all the CS products on September 29.

We have not shipped the Japanese versions of the CS products.

So customers obviously are aware of the new products going out there.

They are coming out in Q1.

It will have an impact on Q4.

The overall results for Japan were definitely on where we expected them to be in Q4.

Great.

And the up margins, Murray?

We were targeting a 31 to 32% in Q1 and continue to hire across our organizations in our company.

We will continue to focus on the CS launch outside of the U.S. and continuing to do so in the U.S.

And then also we have our new building in San Jose coming on board as we continue to put the infrastructure in place required to meet our future growth needs.

I believe having the extra week in Q1 will give us an extra week of expenses which could potentially impact our margins.

Your 31 -- your estimate for Q1 is higher than the rest of the year.

We are model it and it goes down after Q1 to your target of 30 and it just seems like you are being very conservative.

We were targeting 31 to 32%.

With a full year target of approximately 30%, there would have to be some quarters that would have to be lower to hit that overall target of 30%.

So we are seeing margin expansion in 2004 but are continuing to invest in the growth opportunities we have as a company.

Thanks, guys.

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

Please proceed with your question.

Bruce, in terms of your growth outlook, we have seen some strong growth figures being published and the fed seems to expect continued strong growth through next year in the U.S. economy.

How have you factored that in to your thinking of consumer and professional demand, particularly since those forecasts and results have come into the 6 or so weeks since you originally set your '04 guidance.

Then more on the product side, with respect to the Creative Suite itself, you pretty much did what you said you would which is to say you delivered more value to creative pro customers with that suite.

But by the same token by discontinuing the predecessor bundles, are you running the risk of becoming overly dependent on a single product or suite in this case?

Let me address the question on where we see the economy going.

For guidance purposes, we are assuming a relatively stable economy.

We are not factoring in any significant improvement in the environment.

Clearly if that does happen, that could represent the potential upside for us.

Customers are telling us they continue to be relatively cautious in their overall spending.

They will spend for products that increase productivity or allow for additional efficiencies, but they are not opening up the spigots to any greater degree than we saw a month ago.

And I think with respect to the question around the creative suite, Jay, what we have been talking about consistently is our strategy to insure for the creative professional we make sure that we have a complete platform that allows them to create content for different kinds of media.

And in terms of offering, we have four major new products as part of that offering and specifically we do have the CS premium and the standard edition, but in addition to that we also have a video collection that demonstrates value for the customer that really wants to create content for video.

In addition, each of the individual products will also appeal to creative professionals and Photoshop in particular will continue to appeal to a much broader set of customers including customers at work and professional photographers.

So we have a fair diversity of people who will buy our products.

The point you made about Photoshop, you said at the last meeting that more than one-half of Photoshop is now coming from nonprofessional customers.

It seems to have been growing.

What's the risk in that case of a product that is relatively high end becoming increasingly dependent on nonprofessional customers for its revenues?

The creative professionals will continue to want to get the Creative Suite which will have Photoshop CS as part of the products.

So I think it will continue to appeal to a very broad set of creative professionals, whether it be print professional, video professionals as well as professionals that wanted to create for the web.

And we continue to think that it will appeal to a set of both set of professional photographers as well as consumers who are exposed to digital photography our imaging strategy is about making sure question get people hooked to a using the computers and then moving them upwards.

And we are not worried about Photoshop CS.

Our research continues to indicate that those noncreative professionals that are buying Photoshop are buying the product because of its capabilities and its brand and willing to pay the premium for that product even though in many cases a different offering from Adobe might meet their requirements, they want the best and are willing to spend the money for the best even in the tough economic environment given that, we are coming in to what we believe are a better environment that suggests that those serious hobbiests would be more likely buy Photoshop in the future than the last couple of years.

I think the other thing, Jay, that's important to note when you talk about our dependency on the creative or even the stand-alone products, when we take a step back and look the holistic business, it's more diverse now than ever before.

It's not just the creative professional and includes many, many serious hobbiest and more casual workers in the business community and now 34%, at least this quarter, is dependent on our intelligent document solutions which is predominantly a business product and enterprise product.

So given our diversity, our dependence is even less and therefore the risk is much less than it ever was before.

And if we find that creative professional customers are not buying the stand alone Photoshop product and buying the suite, we would have achieved exactly the aims we have which is to write a broader solutions to them and drive the higher revenue per customer and that's what we are exactly trying to do.

Thanks.

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

Please proceed with your question.

Thank you, good afternoon, guys.

Just to get started.

A question for Bruce or Shantanu, when I -- in the past when we had the calls, you typically given us a glimpse into the new product outlook.

Can you give us color what we might expect in the first quarter and second quarter.

Specifically for the first quarter, Craig, what we have talked about is that we will have the international versions of the Creative Suite as well as the individual point products that are coming out.

A new version of Photoshop, Illustrator, GoLive and InDesign for French, German and Japanese for example.

We announced FrameMaker and the new version of FrameMaker.

At this point we aren't announcing any new products for the next couple of quarters.

So a continuation of what we saw in the U.S. in the fourth quarter.

Secondly, and going back to Ben's initial question, it seems like with no change in the full year guidance, what the guidance suggests is that revenue growth will be around 2 do 3% versus the back half of '03.

Is that what you are saying with the guidance?

If not, can you clarify that?

Excuse me, could you repeat that question?

Given the first quarter's guidance in your full year guidance, it seems that what's implied is that there is 2 to 3% year over year revenue growth in the back half of the year.

And am I missing something?

If so, can you help me with that?

Well, in terms of the math, we targeted 14, 25 for next year.

Targeting 306 to 380.

Mathematically you back that out and compare it to the same period of time you will get the percentage.

I don't have the exact number in front of me from a calculation standpoint.

That's what you have done and that's what you are saying.

Let's clarify on the product side is clearly we have our product road map and what we aren't saying is we were not shipping other products.

At this point we won't comment on it and it's reflected in our overall targets.

And then lastly, Murray, why not share buyback in the quarter and can you give us some color on where you think that could be compelling going forward given the activity we are seeing with the share count right now?

We mentioned at our analyst meeting in October that we will target a higher level of cash and you have seen that this quarter.

More flexibility for us to invest in our business in the future.

We have been repurchasing stock for the last ten years.

We said that is what we intend to do going forward and we believe it's the most efficient way to return excess cash to share holders.

What you saw this quarter was us trying to target a higher level of cash.

Okay, thanks.

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

Please proceed with your question.

First of all, good quarter.

At least won't be accused of being mean spirited in my next question.

Doing the basic math, it implies roughly averaging out the revenue and about 26 million incremental for the quarter and I know there is some back end loading and front end loading that makes that not a perfect calculation.

Does that mean if we looked at unadjusted your normalized guidance would be 334 to 354?

Is my math wrong or maybe I'm not taking something into account?

I don't think it's that simple.

You have a bunch of new products coming out toward the front of the quarter.

Different seasonal trends that occur during the quarter.

Some parts of our business aren't really dependent on the 14th week.

It's more about sales execution.

Like around our server business et cetera.

So you can do a mathematical look at that.

It's not that linear given the things that are going on.

I don't have a further comment on terms of what it would have been.

Well, obviously adjusted to some degree.

I guess you are saying the magnitude of 26 million for the week is on the high side?

I mean, we are a lot of the international versions of the CS products will be launching earlier in the quarter.

It will be different if they were shipping on the 14th week but they aren't.

It does have a lot to do with the cycle throughout the quarter, clearly we are getting some benefit by having the 14th week and will increase our operating expenses as well.

It's not as linear as it might be mathematically.

Okay.

That's fair.

And just my second question in talking about sort of your investment around ePaper and your other businesses, just looking at the average transaction size that you are reporting in that business, certainly relative to a lot of your base business very high, you look at relative to other enterprise software companies, maybe a little bit lower than you would typically see.

Can you talk about the sales and expense model?

You have a direct sales model.

Just sort of the level of business, sort of sales cycles and the things that go into that where just with sort of if you hire someone, when do you get the payback on that sales personnel?

Try to understand the impact as you ramp that business that it has on your expense ratios relative to investments in your other businesses.

So first of all, those numbers that we gave on average sizes, that's licensing revenue only.

That does not include maintenance and professional services.

That needs to be understood.

Secondly is that we are making investment in our enterprise business in the last two years getting ourselves in a position to take advantage of this large market opportunity that we have.

It does take time for a sales rep that comes on board to become productive.

If it might take them a few months to understand our products and solutions and time to develop the pipeline and close the first deal, you don't get the productivity in the first year that you would if they were obviously fully up to speed.

As we go forward, we have more sales -- more of the sales force that's in a position to be more productive and drive our revenue on the server side going forward and we are optimistic what that can be over the 2004 and beyond time frame.

We do quite a bit of work around portfolio analysis in the company to figure out what we believe is the right allocation of resources against our market growth opportunities.

We have been doing a lot of work around that over the last few you as -- years and continue to do so.

We tend to look at what is going to drive the resource allocation is about size of market and market growth opportunities that we have and the timing of that could be very much that you are in a position that you are not having great margins or in a negative position as you get yourself built up and take advantage of the long term opportunity where others are later in their cycle.

With the number of products that we have it's complicated all of the different margin structures.

It's fair to say that we have put in a investment in the last two years and looking for an increasing return as we go forward in '04 and beyond.

I guess it looks like you are stepping up again given sort of overall annual margin targets relative to where you have come from this past year and looking at your revenue growth as you do your guidance there is obviously -- it implies meaningful stuff in investment again which is fair given the growth that you are seeing in that business.

Try to understand the timing and I guess sort of ultimately when you start to normalize that out.

If you hire 100 sales people, do you get back to a normalized margin.

Is that 6 months or a full year?

Gibboney, this is Bruce.

For us, it's much more about whether we see the growth opportunities, how much do we want to invest in those growth opportunities, and what's a reasonable amount of money to return back to our shareholders.

We believe that for a company of our size with the market opportunities that are available to us that delivering operating margin profits, at least on an annualized basis of 30% is a reasonable amount given the size of the opportunity that exists, especially in the enterprise around the intelligent documents.

Be much different scenario if we didn't believe we didn't have these growth opportunities.

I would ask you to look back at the investment that we made a number of years ago in Acrobat and PDF, one could have argued back then that we were sacrificing some of the short-term profits to invest in the future.

Clearly that investment paid off and we believe that the investments that we were making today will yield results similar to what we have experienced with products like Acrobat.

Okay.

Let's leave it at that.

Thanks.

Our next question comes from Jaime Friedman with Fulcrum Global Partners.

Hi, thank you.

I think that you shared some color about Japan, can you give us more granularity observations of sales elsewhere, especially Europe.

And if we could ask when we might expect the foreign language launches for CS?

In terms of the demand as you look around the world and the U.S. we continue to see stability, but we have not seen marked up turn in terms of our business.

There has been an up turn in terms of the new products but have not seen an improvement in overall demand.

And the same can be said for Europe.

We did see the seasonal improvement this quarter from the summer quarter in Europe like we expected.

Again, we have not seen any that would indicate increasing demand from an economic perspective.

In terms of Japan, we saw an improvement in the third quarter.

We saw the improvement in the fourth quarter.

It continued but we have not seen an acceleration in that improvement.

That's what we have seen from a global perspective.

With respect to the international languages for CS products both the individual and Creative Suite, the first two months we will see the shipment of the major French, German and Japanese and then we will continue to ship the other foreign language versions.

As a follow-up to that, I thought that you mention that you expect the versions to extend longer into the product cycle.

Could you elaborate what that means?

I think for the Creative Suite, what we said was that the initial revenue has been strong.

But we expect the tale tail for this cycle to extends beyond than what it has been given the brand-new publishing platform than we have done.

We have seen more adoption with respect to operating systems.

And it was really referring more to the tail of the entire product cycle rather than any shipment being delayed.

Understood.

Thank you much.

Next question comes from the line of Gene Munster with Piper Jaffray.

Proceed with your question.

Congratulations.

Can you talk about Bruce, just the tail on the ePaper side.

It seems to be stronger than we were expecting.

Is there a fundamental difference with how it's showing off its cycle?

With the ePaper, I think, Gene, we talked about the opportunity being the large opportunity.

I think what you are starting to see is execute on more is a focus on each of the different markets and making sure we have the marketing programs available to target financial sector, the government as well as the AEC market.

In addition to the creative pro and the broader market.

I think we are starting to see is more awareness of the benefits of PDF.

I think as people continue to do more electronic mail and sharing, certainly new units continue to be up.

And that's been re-enforced by the amount PDF that you are getting.

We are seeing the network effect associated with that.

The other thing we were seeing is the payoff with increased focus on licensing with an enterprises and we talked about our desire to make sure that it's penetrating enterprises.

And I think 40% in the last quarter was reflection of those results.

Should we think the ePaper side of down again this quarter I would assume and stabilizes?

We haven't fired a specific target in the first quarter but we expect to see the upgrade revenue for Acrobat desktop to decline from Q4 to Q1 just like we saw from Q3 to Q4 as part of the normal product cycle.

It will put downward pressure on the Acrobat desktop revenue.

We expect to see our server business to improve.

Let me look at that from this perspective.

The big picture is putting more emphasize on intelligent document side.

How far away are we through the cycle where you get an offsetting from the CS.

Well, if I understand the question correctly, if you look at Acrobat desktop, it operates on a different cycle than the professional, the creative professional products we have.

We think the CS cycle will be different and more extended tail.

You look at Acrobat 5, we had the second best quarter ever on Acrobat 5 which was the last quarter of the cycle before the launch of 6.

So we see a lot of opportunity in both going forward to next year.

And they will be on their own cycles to some degree.

And just lastly in terms of product activation, it seems like it's going smoothly.

Any thoughts on that front?

I think as we clearly focused the product activation on making sure it's seamless experience and the response we have gotten so far from our customers is twofold.

One is it has been seamless and we have very few negative responses to that.

And B, people who have copies, the activation is going smoothly.

Any idea how many people tried to false the activation?

Any thoughts on that?

Any idea how many people tried to false the activation?

Any thoughts on that?

The software is working as advertised when somebody doesn't have the right to use the software.

It's still too early to understand the benefit from a revenue perspective.

Great.

Thanks guys.

Our next question comes from the line of Steven Jue with RBC Capital markets.

Please proceed with your question.

Congratulations on the quarter.

Two questions, one, can you talk a little bit about what you are hearing from the design houses?

We had positive comments coming from the print advertising market about growth next year.

I'm wondering your thoughts on what they are saying in terms of staffing levels and having to ramp up personnel to meet increased demand.

And my second question is on the Acrobat Element sales cycle.

You recently released that.

Have you had any marquee sales in that area and how the sales cycle is working.

The design houses and the publishing houses, what I'm hearing from the executives are that they are cautiously optimistic.

They remind me that the published advertising revenues don't necessarily reflect what is being paid for which is their way of saying the revenue might not be as great as what it seems to be, especially those who are either private or division of larger corporations.

However, they cautiously optimistic about the overall environment.

We have not seen them hiring additional people yet.

But they are looking at enhancing their overall environment in terms of platforms.

In terms of the Acrobat Elements, that product just was released.

Really, it was in a response to some enterprise customers wanting the ability to have the PDF creation be on the server side.

We think it continues to reflect a comprehensive product offering for PDF creation from server base to elements to the standard and professional products.

Do you think the sales cycle is a six month type of deployment and testing and so forth?

No.

I think the Acrobat Element server itself, the amount of testing that's required for that is minimal.

What we tend to find is that they their department adopt enterprises and as dems adopt enterprises it tends to get more adoption across the entire extended enterprise.

And the server is one other way to make sure that deployment happens rather than having that happen on the desktop.

With the new tower or building going online, how does that impact the average expense line for the lease commitment?

Is that something that's a spike up toward the back half of the year?

We will have in the first quarter.

It's not going to be a big material number but another factor in our expenses going up.

We have done a good job in terms of making it cost effective for Adobe.

It will be something that will impact on a pretty linear basis or consistent basis all year long, each quarter will be pretty much the same.

Thank you.

It's already factored into all of our targets that we provided for Q1 and for the full year.

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

E-shipments -- going into the downturn you indicated that you didn't feel revenue were that correlated to PC shipments.

Now that we see the numbers improving and a couple of years count the road, can you comment on what improving PC shipments might mean to your business in '04 and then I have a couple of other questions.

We have not seen any additional data to suggest there is a direct coring will between PC shipments and Adobe's revenue.

PC shipments can imply in improving economy which has shown at least historically a greater correlation to Adobe's business.

Clearly, a change in the operating system or customer that's choosing to move up to a new operating system or a new computer in some cases is more likely buy software in some cases has to buy new software.

When a customer moves from a current McIntosh to a G-5 system they have to using OS 10 it's difficult to use anything other than OS 10 and the current applications won't use effectively and that means they have to buy new software.

This typically we don't see correlation will this time around and might be more of a direct correlation, especially with the higher end customer.

Shifting over to ePaper, on the larger deals, greater than $50,000 deal, how much of those are channel or partner influenced versus just your own direct sales?

Trying to get a better sense of your go to market effectiveness or strategy particularly on the larger enterprise deals.

At this point, the majority of the deals are really direct and that was in line with our expectations and our plan.

Clearly, overtime in the go to market strategy, we expect more and more of that to go through the channel partners and in conjunction with the partners.

And the partners we are seeing increased momentum quarter over quarter.

And finally, can you just give us comment on the consumer side with Album and Elements particularly with the last week of the quarter after Thanksgiving what kind of performance did you see in terms of sell through with those products?

Sure about on the consumer and imaging we saw growth quarter over quarter.

We are heading into the holiday season.

So our focus with respect to both Album and Elements are a couple fold.

One is to offer a bundle to consumers who want both a copy of Album and Elements for the holiday season.

Second to make sure we have all the marketing programs in place.

We also introduced a new Photoshop Album free edition to enable people to start to experience digital photography and hope that they move up to it.

I think we are entering it.

Overall, in that particular market, the digital imaging market, we continue to gain market share against our competitors.

And we have not provided any information on what's happening post Thanksgiving.

That would be into our first week of the new quarter we will provide information on our interquarter update on January 29 in terms of how December and January are going.

Thanks.

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

Thank you.

Can you provide color around your decision to essentially discontinue live motion and how you're kind of supporting your client base until March, I guess that is.

What your plans around that particular category are from perhaps an ancillary product basis.

Thanks a lot.

I think as part of our product portfolio we look at the individual products and strategies moving forward.

I think with light motion as we look at the particular animation market associated with us offering for that animation market we thought that was a limited opportunity for us.

And really our focus is primarily on digital video.

So moving that customers as broadband materializes to using both DVD as an output medium and video in particular as the particular media type.

Our next question comes from Sterling Auty with J.P. Morgan.

Hi, when you talk about the longer tail for Creative Suite, how much of that is getting further penetration into existing customers and how much is gaining new customers?

Well, I think with the Creative Suite, firstly as you get existing customers, we think that given the benefits of the integration of the products as well as version two which is new, we anticipate that more and more people will standardize on the publishing platform on Creative Suite rather than the individual product.

That's more penetration with existing customers.

In addition to that as new customers come in and want to create content with any print web or video, we think the Creative Suite represents the best opportunity for them to get into this particular market.

Okay.

Murray, want to take another stab at the operating margin this way.

If I look at the research development spending, it seems like a design step up here in the first quarter.

Would you expect at any point over 2004 to see the absolute dollar spent on R&D go down quarter over quarter?

Well, again, it makes it tricky with this 14th week.

If you run the math, with the targets you provided and look at the absolute dollars of expense in Q1, clearly R&D is primarily those expenses are compensation to people and when you have an extra week you have an extra week of salaries and benefits that you have to accrue for so that has the ability to drive the absolute dollar expenses higher in Q1.

It is possible for the R&D expenses to be lower in absolute dollars in other quarters but we aren't playing a specific guidance on that at this time.

Based on that, it is logical to see it up in the first quarter and down a little bit in the second quarter and from there no guidance for the rest?

Not providing any guidance for any of the quarters other than Q1.

It's clearly possible for the R&D spending to go down after Q1 given the fact that there will be only 13 weeks in the subsequent quarters.

But when you talk about investing in the business, is part of that going to be R&D as well as kind of the increased sales and marketing to go after the enterprise market?

I think we have demonstrated over the years that R&D investment R&D is one of the key differentiators for Adobe and will continue to be a key differentiator for Adobe going forward including with our enterprise business.

Okay.

And last question, can you -- sorry if you talked about it, but can you give us an update on kind of the penetration in the digital video going after the videographers and penetrating the market and how things are progressing?

The new DV platforms and the products have been received very well.

So we did talk about year over year I think we saw 24% growth in that particular business.

And again, we continue to think that with faster CPUs and people moving to digital camcorders and DVDs exploding, we are witnessing what we think will be people using video more to communicate for sales training, for brochures, et cetera.

Thank you.

Our next question comes from Amy Feng with JMP Securities.

Proceed with your question.

When you look at your ePaper server deals, the deals that don't close, are you typically seeing that they are slipping through the next quarter?

Or are you competing with in-house solutions, Microsoft perhaps?

Or if someone is perhaps tweaking a content management solution and trying to mimic what you are doing with your server products?

I want to get feel for your ePaper server.

In general with the ePaper solution that we provide, firstly, the value proposition of automating the manual processing -- it tends to be more of they are looking at how they are looking to do that internally not knowing they are packaged applications such as those provided by us which is the largest competitor out there.

So it's letting them know of our solutions.

We have not really seen any one competitor in a significant number of deals.

Okay.

And then can you give me a sense of what were your most popular products across your geographical lines, do certain regions show stronger demand for different products?

I think the three categories that we talk about tends to be the form server tends to be something that's popular when people have PDF forms that are already out there and they want to electronically enable them.

So that's typically the value proposition around the form server.

The document server is actually being received very well and that's all about enabling these processes to extend beyond the fire wall leveraging the Adobe reader and the third category that we see and these are consistent across all geos.

Tends to be document generation and preparation with our Adobe document server or the output server that we have.

In terms of growing out, the ePaper sales force, if your head count is "X" at the end of the year, what would you expect your head count to be next year?

Would it be 1.1 "X" perhaps?

Well, we are targeting head count growth across our organization in 2004 as we continue to invest in our future opportunities as well as we will expect to see additional head count in the sales organization to continue to complete the team that we need to have to take advantage of our opportunities.

So there will be an increase in sales head count in 2004.

Okay, thank you.

Ladies and gentlemen, as a reminder to register for a question, press the 1-4.

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

A couple questions.

One, again on the consumer, can you tell us how Encore DVD is doing.

Is it meeting your expectation and is there category creep on that.

For example, pros stepping down to buy a lower priced product or consumers stepping up to spend a little extra money on Encore?

Secondly in the consumer environment, how do you feel your position vis-a-vis the competition with Elements and Album and what's going on with pricing?

Do you think price points will hold over the next year or do you see that category getting more price competitive?

Thanks.

On the first question, Bill, our focus in the video segment has been with the DV collection and we continue to see adoption of the DV collection and that's where the customer has a complete offerings from nonlinear all the way out to video and audio.

With respect to the consumer side, from a competitive perspective market share-wise, Elements and Albums continue to gain market share against all the other competitors and we continue to see on an annual basis the ASP holding.

One other thing, you guys have pulled off two great quarters of revamped pricing recently with Acrobat and now with the CS and the individual point products.

Given that you have done so much right on this new pricing, what have you heard from customers?

Where is there room for improvement going forward in terms of how you segment the market and change pricing?

Is there anything you would have done differently?

The lesson we learned is that customers are willing to pay for great products.

As long as we continue to provide and enhance functionality and help our customers become more efficient and productive, they will pay the right price for that functionality.

Certainly the Adobe brand also provides them with a level of insurance and comfort and they are willing to pay a premium for that brand comfort.

So I don't think there is anything specific beyond that other than we know as long as we innovate, we can continue to capture the appropriate revenue for our efforts.

I think the numbers reflect that you did a great job on the back half of the year on this pricing.

It was easy to be skeptical about people absorbing and you pulled it off and it was a great job.

That's it for my questions.

Thanks.

Our next question comes from the line of Mark Schappel with McDonald Investments.

Please proceed with your question.

Your line is open.

Please go ahead with your question.

We will continue with the next question from the line of Brian Foote with Ryan Beck and Company.

Please proceed.

The explanation of why there was no share buyback this quarter, you said you were targeting a certain level of cash for reinvestment in the business.

What is your target level of cash on the balance sheet?

What should we be looking at going forward in terms of attractive opportunities for repurchase?

In terms of cash target we have not provided a specific target on that.

I can just say that we are closer to our target at the end of this quarter than we were at the end of last quarter.

In terms of what we will do on repurchase, we don't have a comment at this time.

We will make decisions that we have gone through the last ten years quarter to quarter and will continue doing that.

No specific guidance on that at this time.

I mean it would seem to me that the current cash on the balance sheet is generating much lower returns for you than outright repurchase of the equity.

Are we to assume that you would be using that cash potentially for acquisitions?

Or is this to be redeployed toward the sales and marketing goals you talked about?

It could be for acquisitions.

Obviously in the last few years we are focusing on smaller acquisitions.

We want to make sure we have the flexibility to continue to do that and invest in our company.

We also look at all of the benchmarks of other software companies that we believe is the appropriate level we should hold for cash to give us flexibility in many different ways.

So we are on path to do that.

I would like to point out we generated $132 million in cash in the quarter on stock option exercises and had quite a bit of cash coming into the company from that and that had a big part to drive the cash to the levels that they are at this time.

One more question, in terms of how we should view the international revenue growth, can you quantify year over year what the currency -- currency translation effect was?

Yes.

We obviously sell in Euro and Yen and had a benefit.

It was primarily on the Euro that was some on the Yen.

Together it was approximately about $59 million between 2003 and -- excuse me, 2002 and 2003.

Obviously we had higher operating expenses and higher direct cost associated with that because we have Euro and Yen denominated expenses.

Can you quantify what those were?

No, we won't provide specifics on that at this time.

We don't want to provide specific expense levels in Europe and Japan.

Fair enough.

Thanks very much.

As a final reminder to register for a question, press the 1-4.

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

On the verdict third quarter, Acrobat seems to account for a third of sales and Acrobat pro upgrade out sold the standard upgrades.

What was the in the fourth quarter in terms of the pro mix and did you continue to see relatively stronger performance in the pro upgrade versus standard upgrades?

Lastly, in prior calls you have given other segment growth rates you gave the DV growth rate this quarter.

Do you have data you can show?

At this point we aren't providing other specific growth information.

We will give you some information on terms of the mix with the Acrobat desktop products.

Overall standard revenue is about twice what the professional revenue is on the desktop.

About a two to one ratio there.

Regarding the Creative Suite revenue, Jay, the challenge is early in the cycle and we don't want anybody to provide any conclusions that would mislead them.

So initially strong and then as we move through the cycle we will provide more color as we do that with Acrobat.

That's on the Creative Suite.

What about the stand alone products?

When you talk about the momentum individually for instance for InDesign or Illustrator.

Same thing with the individual products.

This is way too early.

What we are encouraged by is the outstanding reviews to have Photoshop version number 8 in effect have reviewers talking about it being the best upgrade ever is certainly encouraging for us.

But it's way to early to draw a conclusion again initial revenue is strong and we will provide more color as we go forward.

Okay.

Anything new to say on your services strategy that you talked about at the analyst meeting it's a longer term objective but anything more you can say in terms of the pieces you are beginning to put in place there.

What the business model might look like?

We were working hard away on new businesses but nothing to announce at this time.

I'm assuming you are talking about services as relates to the Creative Suite platform services as potentially relate to consumer imaging?

Correct.

What you talked about at the analyst meeting.

Working hard away but nothing to announce at this time.

It's only been one month since we last chatted.

Thanks.

We will take one more question.

There are no further questions at this time.

This concludes our call today and we thank everybody 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 line.