Adobe Inc (ADBE) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Adobe Q2 fiscal year 2004 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, please press the 1 followed by the 4 on your telephone.

As a reminder, this conference is being recorded Thursday, June 17, 2004.

I'd now like to turn the call over to Mr. Mike Saviage, VP of Investor Relations.

Please go ahead sir.

Good afternoon and thank you for joining us today.

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

In the call today we'll discuss Adobe's second quarter fiscal 2004 financial results.

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

If you need a copy of this press release you can go to adobe.com under the "Company" and "Press" links to find an electronic copy.

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

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

For a discussion for these risks an uncertainties you should review Adobe's SEC filings including our annual report on Form 10-K for fiscal in fiscal 2003, and our quarterly reports on Form 10-Q in fiscal 2004.

During this call we'll discuss non-GAAP financial measures.

The GAAP financial measures that correspond to non-GAAP financial measures as well as the reconciliation between the two are set forth in our press release issued today.

And are also available on our website.

Call participants are advised that the audio of this conference call is being broadcast live over the Internet.

And it is also being recorded for playback purposes.

The audio of the call will be archived in a Adobe's "Investor Relations" website for approximately 45 days.

And it is the property of Adobe Systems.

It may not re-recorded or otherwise reproduced or distributed without prior written permission from Adobe Systems.

I'd like now to turn the call over to Bruce.

Thanks, Mike.

I am pleased to report that our financial performance in the second quarter of fiscal 2004 was exceptional.

And as a continuation of the success we experienced in Q1.

Highlights included: strong demand for our Creative Suite platform, record revenue for our Acrobat products family and continued momentum with our Enterprise Server business.

Total revenue for the quarter was $410.1 million representing 28% year-over-year growth.

And earnings-per-share were 44 cents.

Both revenue an EPS results were at the top of our revised target ranges.

Our strategy of delivering comprehensive platforms to our customers is driving greater revenue than originally anticipated.

I'll now turn the call over to Murray for a review of our financial results and then Shantanu who will provide business units highlights.

Murray.

Thanks Bruce.

For the second quarter of fiscal 2004 Adobe achieved revenue of 410.1 million.

This compares of to $320.1 million reported for the second quarter of fiscal 2003 and 423.3 million reported last quarter.

When comparing Q2 fiscal 2004 results to last quarter, please remember that we experienced a 14 week quarter in Q1 due to our 52, 53 week accounting year.

Therefore, when making comparisons between the two quarters the extra week in Q1 must be considered in any analysis.

GAAP net income for the second quarter of fiscal 2004 was 109.4 million compared to 64.2 million reported in the second quarter of fiscal 2003, and 123 million last quarter.

Non-GAAP net income which excludes investment gains and losses from the company's Venture program was 108.8 million compared to 66.7 million reported in the second quarter of fiscal 2003 and 123.8 million last quarter.

GAAP diluted earnings per share for the second quarter of 2004 were 44 cents based on 247 million weighted average shares.

This compares with GAAP diluted earnings per share of 27 cents reported in the second quarter of fiscal 2003, based on 239.2 weighted average shares.

And GAAP diluted earnings per share of 50 cents reported last quarter based on 246.1 million weighted average shares.

Non-GAAP diluted earnings per share for the second quarter of fiscal 2004 which excludes investment gains and losses also were 44 cents.

Gross margin for the quarter was 93.4% compared to 92.7% in the second quarter of fiscal 2003 and 94.3% last quarter.

Operating expenses for the second quarter of fiscal 2004 were 241 million.

Regular employees at the end of the second quarter totaled 3,646 versus 3,518 at the end of the first quarter of fiscal 2004.

The primary increase in headcount was in R&D.

Expenses as a percent of revenue breakdown as follows: Research & Development 18.5%, sales and marking, 31.8%, G&A 8.4%.

GAAP and non-GAAP operating income in the second quarter of fiscal 2004 were 141.8 million or 34.6% of revenue.

This compares to GAAP and non-GAAP operating income of 91.5 million or 28.6% of revenue in the second quarter of fiscal 2003 and 163.3 million or 38.6% of revenue last quarter.

Other income for the second quarter of fiscal 2004 was 5.1 million.

Adobe's effective tax rate for the second quarter of fiscal 2004 was 26%, compared to 30% in the second quarter of fiscal 2003, and 26% last quarter.

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

Creative Professional Segment revenue was 153.4 million in Q2 fiscal 2004 compared to 93.7 million in Q2 fiscal 2003 and 158.1 million last quarter.

Creative Suite's revenue in Q2 fiscal 2004 was higher than last quarter.

Digital Imaging and Video segment revenue was 103.3 million in Q2 fiscal 2004 compared to 95.3 million in Q2 fiscal 2003 and 113.5 million last quarter.

As we've been communicating we expected some customers to purchase the Creative Suites rather than stands alone CS products.

Our Q2 results again reflect this shift.

Some historic Photoshop revenue which previously would have been reported in the Digital Imaging and Video segments is reflected as Creative Suites revenue in the Creative Professional Segment.

OEM Postscript and Other segment revenue was 20.3 million in Q2 fiscal 2004 compared to 23 million in Q2 fiscal 2003 and 21.4 million last quarter.

Intelligent Document segment revenue was a record 136.1 million in Q2 fiscal 2004 compared to 108.1 million in Q2 fiscal 2003, and 130.3 million last quarter.

In Q2 total Intelligent Document to Desktop revenue was a record 112.8 million representing year-over-year growth of 23%.

As a reminder Acrobat 6 was launched in the year-ago quarter.

Intelligent Document Server revenue grew sequentially from 21.3 million in Q1 fiscal 2004 to 23.3 million in Q2 fiscal 2004 demonstrating continued momentum in the enterprise.

Turning to revenue by geographic segment the results in Q2 fiscal 2004 were as follows: The Americas 44%, Europe 33%, Asia 23%.

In reviewing our performance for Q2, we experienced solid demand across all of our major geographic markets.

Application platform mix was 72% Windows and 28% Mac in the second quarter of fiscal 2004.

Which compares to 73% Windows and 27% Mac for the second quarter of fiscal 2003 and 71% Windows and 29% Mac last quarter.

Our trade DSO in the second quarter of fiscal 2004 was 23 days.

This compares to 36 days in Q2 fiscal 2003 and 28 days last quarter.

In regard to our global channel inventory position, we ended the quarter below company policy given the lack of historical Creative Suite's product cycle data combined with the fact we were entering our seasonally weak third quarter.

Our backlog of channel orders at the end of Q2 was higher than usual.

At the end of the second quarter of fiscal 2004 cash and short-term investments were $1,281 million compared to $1,249 million at the end of the first quarter of fiscal 2004.

Turning to Adobe Ventures, we realized an investment gain of 873,000 in Q2 fiscal 2004.

In the quarter we made additional investments of 3.6 million, in total Adobe has invested 227.3 million through its Venture partnerships and direct investments.

As of the end of the second quarter the net return to this program from its inception in 1994 were 350.1 million including the stock dividended to stockholders and the market value of investments still held by Adobe.

In regard to share buyback, Adobe repurchased approximately 2.5 million shares in Q2 at a cost of 104.2 million as part of its share repurchase programs.

Adobe's Board of Directors declared this quarter's cash dividends of 1.25 cents per share payable on July 13, 2004 to stockholders of record as of June 29, 2004.

This concludes my discussion on second quarter fiscal 2004 results.

Now we will discuss our Q3 fiscal 2004 targets.

We are targeting revenue of 360 to 380 million, as a percent of revenue our approximate operating model targets for the quarter are as follows: Gross margin 93% to 94%.

R&D 21% to 22%.

Sales and marketing 32% to 34%.

G&A 9% to 10% resulting in a GAAP and non-GAAP operating margin target of approximately 28% to 31%.

For our share count, we are targeting a range of 247 to 249 million shares.

For other income, we are targeting approximately 4 million and for our tax rate we were targeting 26%.

These targets lead to a GAAP and non-GAAP earnings per share target range in Q3 fiscal 2004 of 31 to 36 cents per share.

We currently believe that targeted non-GAAP results will not differ materially from targeted GAAP results.

For fiscal year 2004 we expect to exceed the financial targets we provided on March 18.

However, we are not providing specific revised full year targets today as we prefer to complete our third quarter before providing guidance for Q4.

This concludes my comments.

I will now turn the call over to Shantanu.

Thanks, Murray.

I'll take the next few minutes reviewing highlights in each of our major businesses starting with the Intelligent Documents Business Unit.

In Q2 we achieved Acrobat Desktop revenue of 112.8 million, an all-time high led by record revenue for Acrobat Professional.

This represents the fifth consecutive quarter of outstanding performance for Acrobat 6.

Overall Intelligent Documents, Desktop Licensing as a percentage of the total Desktop Business was 43.1% demonstrating continued penetration of Acrobat in the enterprise.

Our Q2 success with our Intelligent Documents Business also extends to our Server Based Businesses.

Intelligent Document Server revenue grew to 23.2 million in Q2 representing 41% year-over-year growth.

Driving this performance were a number of significant wins.

In the government market they include: Hawaii Real Choices which has adopted the Adobe Intelligent Document Platform as part of the Hawaii Department of Human Services Access Portal which will enable constituents to complete online forms.

The New York Department of Transportation which is using Adobe Acrobat Professional and Adobe Form Server to implement internal online forms.

The State of New Jersey which is using Adobe Reader Extension Server to make all court forms available online so citizens and attorneys can fill them out and submit them electronically.

The Dutch Tax office which intends to use Adobe Reader Extension Server and PDF forms to enable users to fill in tax forms online an offline.

Electronic submittal of the Dutch Tax Forms will be mandatory for all companies in the Netherlands and paper tax forms will not be accepted after January 1, 2005.

In the Berlin police department which is using Adobe Form Server as part of a project to modernize their administrative paper processes.

In the Commercial market our Enterprise Server solutions are being adopted across a variety of vertical industries.

In Q2 key wins included Farmers Home Mutual which has adopted Adobe's Intelligent Document Platform for policy enrollment and administration. [Phoning] Credit Union and its subsidiaries which have adopted the Adobe Solution to improve customer service and employee productivity.

[Phoning] has created a series of interactive intelligent forms that employees can complete online to instantly generate loan packets 60% faster.

Abington Memorial Hospital in Pennsylvania which is using the Adobe Form Server and Adobe Work Flow Server to automate the routing and electronic approval of documents which are critical to the operation of the hospital.

Transunion Settlement Solutions which is using Adobe Form Server and Adobe Reader Extension Server to allow their business partners to work online and offline with Adobe PDF e-forms for data capture.

And Vought Aircraft Industries, a large supplier of air frame structures which is using Adobe servers and PDF to implement the electronic routing and tracking of engineering change orders.

In regard to the key quarterly performance indicators that we report, in the second quarter the number of Enterprise Server transactions greater than 50,000 totalled 34, up from 29 last quarter.

The average size of these transactions was $236,000.

Our Intelligent Document strategy is about helping enterprises increase their operational efficiencies by automating their end-to-end document based processes.

The benefits include: building a closer relationship with their customers, meeting regulatory and compliance mandates and saving costs.

Last week we made several important announcements related to this strategy.

We formally announced the Adobe Intelligent Document Platform and Adobe Lifecycle, the Umbrella brand, for our server products.

Our new Adobe Lifecycle Server products are built on a common server architecture based on J2EE and XML, allowing for easy integration into enterprise infrastructures by providing java APIs and support for standard web services protocols.

We also announced two new document services as part of our Adobe Lifecycle offering.

Document Is Process Management and Document Control and Security.

The Document Process Management service enables organizations to extend the reach of transactions and effectively capture, manage and track information from disparate sources inside or outside the firewall.

The Document Control and Security Service provides enterprises the power to control access to information, create order trails of record usage and certify document authenticity with digital signatures.

Earlier in the quarter we announced the acquisition of Q-Link which provides Adobe with a more scalable and robust work flow business process management foundation.

The Q-Link technology strengthens our offerings and competitive position in the enterprise.

Our Intelligent Document strategy is also dependent on broadening our relationships with key enterprise server, software providers, systems integrators and standards bodies.

At SAP Sapphire Conference we announced the availability of Adobe interactive forms as part of SAP solutions.

Our technology is embedded in the SAP NetWeaver platform an as SAP customers migrate to the new My SAP Business Suite Adobe and SAP will sell, support and provide implementation services.

On the standards front we announced that Adobe an Accord, the Association for Cooperative Operations, Research & Development are working to bring intelligent documents to the insurance industry by adding additional capabilities to the Accord insurance forms built in Adobe PDF.

By adding support for the Accord XML data standard to these forms currently available in PDF users can leverage the ubiquity of the Adobe leader to extend the reach of their applications.

In addition, we announced a strategic relationship with Identrus a global provider of trusted identity.

Identrus' membership consists of more than 55 of the world's leading financial institutions spanning 160 countries.

Together, we will offer a digital signature solution that creates legally binding electronic documents.

And finally, we continue to expand the reach of Adobe Reader and PDF across a variety of devices and platforms.

Most recently we announced support for a consumer electronics version on the Linux platform.

Sony will be the first to embed this product with its recently announced car navigation system.

Turning to our Creative Professional and Digital Imaging Video Business segments we had an outstanding quarter driven by record revenue for the Adobe Creative Suites.

In Q2 the Creative Suite won the prestigious Software an Information Industry Association Codie Award for "Best Business Productivity Product Or Service".

We can highlight the following points as it relates to the Creative Suite and standalone CS product cycles.

The number of customers choosing to choosing to purchase the Creative Suites verse standalone products continues exceed our expectations.

Total Creative Suite revenue was higher in Q2 than in Q1 demonstrating an extended adoption cycle by our customers for the new platform.

We also continue see a revenue split of approximately three to one in favor of the Premium Creative Suite versus the Standard Version, clearly strategy of moving customers to the complete Creative Suite platform is working.

InDesign continues to perform well and won PC Magazine Editor's Choice Award for the "Desktop Publishing Category" this past month.

In addition Creativepro.com announced a new publication called InDesign Magazine which they tut as an independent bimonthly magazine for the growing population of InDesign users.

This is significant and demonstrates the growing user base and ecosystem build around the InDesign product family.

In Digital Imaging Adobe's products continue lead their respective markets and win honors from industry experts.

For example, Photoshop CS won PC Magazine Editor's Choice Award in the "Professional Image Editing Category."

With respect to Photoshop, Q2 full unit results of stands alone Photoshop combined with Photoshop as part of the Creative Suites and Collections grew sequentially and year-over-year.

Overall upgrade units of Photoshop CS at this point in the cycle trail prior versions which we believe represents future opportunity.

Our Digital Imaging strategy also includes exposing consumers to our introductory imaging products an up-selling them as they gain expertise.

The free Photoshop Album Starter Edition surpassed the five million active user mark this week.

Q2 was also an important quarter for our Digital Video Business as we shipped new versions of all of our video products and a new video collection with enhanced HD support and a combines list of more than 200 innovative products in Premier Pro, After Affects, Audition and Encore DVD we're leading this emerging market.

The industry is starting to take notice.

Premier Pro recently won the PC Magazine Editor's Choice Award in the "Professional Video Editor Category."

This concludes my Q2 business segment review.

Bruce.

Thanks, Shantanu.

As we enter the second half of our fiscal year we continue to be excited by the growth prospects in front of us.

Now more than ever, we believe we are uniquely positioned to take advantage of those opportunities.

delivering more value to the creative professional customer, through our Creative Suite and family of digital video products, providing imaging products and services to the growing community of digital photography users, solving the digital document needs of the millions of knowledge workers with our Acrobat family of products, and our largest growth opportunity, delivering mission critical solutions to enterprise customers.

Last week we presented our vision and value proposition to several hundred customers, prospects and partners from the financial services industry and the government sector.

Based on customer feedback, it is clear to us our Intelligent Document Platform offers unique ability to extends and enhance core business applications.

To take advantage of these opportunities we will continue to invest in technology to extend our platforms as well as the marketing and sales capabilities required to create demand and close business.

In addition to developing our own capabilities, we will continue to focus on building key partnerships with organizations like IBM, SAP and EMC.

This gives us additional credibility and access to markets and customers.

We're optimistic and excited about our future prospects, we look forward to sharing our progress with you next quarter.

Mike.

Thanks, Bruce.

Before we start Q&A I'd like to announce the date for our regular intra-quarter update for the third quarter of fiscal 2004.

It will be Monday, August 2, 2004.

After the market closes.

I'd also like to remind everyone that Adobe's Fall Financial Analyst Meeting will be held on the afternoon of Tuesday, October 26 in San Jose so please mark your calendars.

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

Use reservation number 21197015.

Again the phone number is 402-977-9140.

With reservation number 21197015.

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

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

Pacific time on Monday June 21, 2004.

We'd now be happy to take your questions.

Operator.

Thank you. [Caller instructions] Our first question comes from the line of Jay Vleeschhouwer from Merrill Lynch.

Please proceed with your question.

Thanks.

Good afternoon.

I'd like to ask first about your volume licensing revenues, specifically for Acrobat, the revenues there in absolute terms were flat sequentially though up strongly year-over-year as you pointed out.

Is it your expectation that in the third quarter that volume business will be up seasonally as it typically is in third quarters?

And could you also talk about the splits that you're seeing in the volume business for Standard Pro and if any for Elements.

The second question perhaps to Shantanu , is do your Acrobat Server portfolio now with LifeCycles and later in the bar coder server to be now reasonably complete or is there more you need to build out in the server business?

And what kind of expectations do you have for your partner influenced business such as YourIBM and SAP?

So Jay, with regards to a volume licensing as we look at the third quarter, I think when you look at the guidance we provided for the third quarter of 360 to 380 million we're obviously factoring the seasonally weak third quarter and that would apply to all of our products so that would include in the area of Acrobat Desktop both from a shrink wrap and licensing perspective that we would expect to see some seasonal weakness because of the summer quarter in Europe and Japan.

Jay, with respect to the server business, firstly I think the announcement of Adobe LifeCycle was a pretty compelling one for us.

We've been talking about having an integrated server architecture that enables businesses to completely automate their manual processes.

And now we have that from designing the process electronically automating it with the work flow, integrating the data back into the back end systems.

We continue to believe, however, that if you look at document services as a category there is a lot more innovation that we can continue to provide.

So as it relates to either the bar coded serve that we announced or the document security server we will continue to deliver new services based on documents within an enterprise.

So very excited about what we have but we continue to believe that the entire category has more depth in terms of services that we can offer.

And as it relates to the partner business, clearly the milestone of now being embedded in NetWeaver is major milestone for us an as we are now exposed to the tens of thousands of SAP customers, as they move to the My SAP Business Suite that represents an opportunity for them to get exposed to Adobe Interactive Form and for us to then upsell our other document services.

One last followup with respect to Photoshop.

Notwithstanding the comments you've made about the growth in the quarter when you combined all versions or types of Photoshop, do you think that at least a standalone version is nevertheless in secular decline given the shift to CS.

And if Photoshop by our calculations have been averaging about a $.25 billion a year or more for the past few years why would it not trend over to perhaps 200's over the next few years even taking into account the effect over time the new releases?

With respect to Photoshop, as we said, Jay, firstly on the units side we were seeing growth of units as it relates to both units as a standalone an units as part of the Creative Suite.

In the product features we're getting tremendous customer satisfaction from people who move to Photoshop.

Our strategy has been for the creative Professional Segment to move increasingly to the platform and that strategy is working.

But in addition to that, we do see opportunities for Photoshop in more specialized customer segments such as digital photography and as more and more people move to digital photography we think that there's an opportunity for us to grow Photoshop with that category.

Thank you.

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

Please proceed with your question.

Thanks, congratulations on the quarter.

I'm wondering, Shantanu you talked a little bit about the upgrade units for Photoshop kind of trailing prior upgrades and with the shift towards the Creative Suite, I'm just wondering at a high level do you feel like the overall units and the number of people you're touching is kind of in line with prior cycles or do you have still have some room to catch up there?

Well, I think the introduction of the Suite model certainly caused many customers to consider their purchase more carefully.

And that's one of the reasons why we have stated in the past the that we believe that there's going to be a longer cycle than in the past.

The second thing is as people move to the suites, especially on the Mac platform they do need to also make the decision to Mac or extend and hardware upgrades before they move over into the Suite.

So one of the things that we have been focusing on is our primary messaging was around the Mac, was around the Creative Suite platform and we've been changing that marketing message to be a lot more also about the benefits of people moving from one individual point product.

Either to the new Photoshop product or in particular case the Suite.

But in terms of obviously value that we've provided in the new version of Photoshop we think that has value for every single customer who has used Photoshop in the past.

Okay great.

And then Bruce as you talk to a lot of design firms and just the overall advertising market seems to be picking, are you sensing a lot of new people, new professionals being hired or any sense on hiring trends?

So, what we're seeing as couple of things.

First of all, most organizations, corporations are beginning to add to their marketing efforts as they see an economy that's either stable or improving.

So they're increasing their marketing expenditures which is driving more marketing materials which does drive more use of either employees within that organization or more contracts with some of the smaller graphic shops.

So we are seeing more hiring.

Additionally, we are seeing an interest in the part of the large publishing customers, magazine publishers, newspaper publishers in the like in enhancing or upgrading their overall infrastructure which includes the purchases of new computers which means additionally most cases the purchases of new software.

Okay.

Great. and just lastly, Murray, gross margins were down a little bit this quarter.

Is that just kind of a catch up with some of the obsolete products from maybe a quarter back with the CS launch?

Actually the primary reason for the lower gross margin this quarter relative to last quarter is we did have a one time litigation settlement that was charged to direct cost in the second quarter.

Okay.

Thanks.

Our next question comes from the line of Keith Gay from Thomas Weisel Partners, please proceed with your question.

Can you quantify you stand if you look at Creative Suite units that have been sold thus far versus what you would say have had in terms of your units in terms of the last Photoshop upgrade?

Where do you stand on a unit basis relative to the penetration of Creative Suite relative to what you would normally expect on a Photoshop upgrade?

Without going into a lot of specifics, Keith, we're very pleased with the results from the Creative Suite.

Where we see opportunity is with upgrading the Photoshop customer.

If you look at the overall strategy, the first thing we wanted to do was convince the serious creative professional that instead of upgrading to Photoshop or upgrading to InDesign or upgrading to Illustrator, they should buy one of the Creative Suites.

Where it not only have they been doing so at a greater degree than we anticipated but they are choosing the Premium Version at a higher rate than we thought they would.

With that said, we haven't focused as much as we would like to and will be doing on getting the standalone customer, especially that very important Photoshop customer, who only cares about digital photography, to upgrade to either the Creative Suite, but in many cases more likely just to the standalone version of Photoshop.

They're still some confusion out there with the whole CS naming schemer.

As well as just a lot of confusion around the difference between the Creative Suite, the Creative Suite Premium.

And we haven't done as much as we would have liked to or need to in marketing to that customer on why they should just buy that standalone version.

And that's where in addition to continuing to promote the Creative Suite a lot more of our energy and resources are going towards getting that standalone Photoshop customer to move up.

Which is where we've seen not as much is success as we would have liked but not surprising given the strategy we've taken.

Are you seeing a longer valuation cycle by some of your larger graphics design firms who happen to be contemplating a larger change over versus smaller firms in terms of lengthening that cycle?

The bigger issue for the Logic customers has more to do with upgrading their overall environment.

Many of them are very loyal to the MacIntosh they're still sitting with a lot of old machines, a lot of old G3's, early G4's.

So it's a move to the Creative Suite.

It's not about moving to the software.

It means upgrading to OS-10, it means moving over to a G5 and then it means moving over to the Creative Suite.

The good news is it's been so long since they've actually upgraded their equipment that their tendency, is go ahead and make the move.

They have told us that they do plan on, or many of them, have told us that they do plan on moving this year.

We think which is good news, certainly not for only people like Apple but certainly excellent news for us.

Okay.

And one more question.

Murray, we started off the quarter, you were guiding the 30% to 33% up margin targets and you came in at 34.6%.

Now you're guiding 28% to 31% for Q3.

If I just look at R&D, for example, the mid point of your guidance would be around 79.5 million up from 76 million.

Are you really adding that much headcount that fast to be able to come within that margin range, it seems like you've been above on the margin targets over of the last several quarters?

Well a couple things.

One, I think we've done a great job over the past years of managing our expenses very effectively and now with the economy improving we're very focused in making sure that we position ourselves for the multitude of future opportunities which include hiring in R&D.

And so we'll continue to hire there as well as across the organization.

We also have our annual salary increase that takes effect this quarters and that would also contribute to some of the higher R&D expenses.

Okay.

Thank you.

Our next question comes from the line of Benjamin Reitzes from UBS.

Please proceed with your question.

Hey, gentlemen it's actually Russ [Hammerstein] sitting in for Ben.

Just one question on the channel inventory.

It looks like last quarter you guys made the same comment that channel inventories right now are trending below company policy.

And I just wanted to get a sense of comparing right now to the last quarter, are channel inventories below or above on a relative basis going into the next quarter given that your DSOs are looking sequentially pretty solid down to 23?

In terms of the inventory levels, as we stated last quarter we don't have some sort of historical data to look at for the Creative Suite so we've been very careful with our level of inventory there.

We've also are entering our seasonally weak third quarter so we've been careful to take that into consideration.

From an overall inventory standpoint, the levels are very similar between the two quarters.

Okay.

And if I look at the fourth quarter I know you guys don't give guidance going that far forward.

But the last couple of years you've been up 3% to 4% and 12% sequentially in the November quarter.

Is there any reason for us to believe that we are not going to see sequential improvement in the November quarter given the length of the current product cycles?

We're not providing any specific guidance for the fourth quarter today.

We've had some seasonal improvement in Europe from the Q3 to Q4 time frame and so unless some economic situations change, we would expect there to be some seasonal improvement from Q3 to Q4 in Europe.

Okay.

Great, thanks.

Our next question comes from the line of Amy Feng from JMP Securities.

Please proceed with your question.

Hi, good afternoon, it's actually Ingrid Evelyn for Amy.

My first question relates to the total addressable market for the creative professional market.

I think you said earlier that you believed there were about 6 million creative professionals that you're targeting.

Now that you're bundling all of the modules in with the Creative Suite, Are you reaching new customers out of $6 million market?

And if yes, who and how big do you think it is?

Just for clarification purposes, Amy P.

it's been a quite number of years since we've -- I'm sorry, Ingrid, it's been quite a number of years since we were able to provide some sort of guestimate as to the number of creative professionals and given the volatility of that overall community it's a number that's hard to get at.

That's decided it's not wise to upgrade.

When we look at the creative professional, in total there's two opportunities there.

One is regardless of what that number is, we do know that they spend thousands upon thousands of dollars a year individually on products and services.

And that we don't historically we've only been able to obtain hundreds of dollars a year from them.

Through strategies like the Creative Suite as well as other things we're doing we're able to capture in effect more share of their spending by providing them more and more value.

In addition, there are quite a few people who are not creative professionals that just want the best.

And we've shown historically that they want to buy the Adobe brand and the Adobe product because that is the solution of choice for the professional.

Trying to size that opportunity is a very difficult task and something that we haven't been able to do so in reliable way.

But we do think combined both the more casual user who's serious combined with the creative professional who we know is in the millions and they spend thousands upon thousands of dollars, we believe that to be a big opportunity for Adobe in terms of dollar opportunity going forward.

Okay.

Great.

Thanks.

And with respect to the digital video products, can you give us a idea of what kind of revenue contribution you're getting from that family?

From specifically digital video?

So we don't provide specific information on our total digital video revenue.

We do continue to believe that this an important segment or opportunity for us going forward.

We are pleased with the launch of our new products here in the past weeks an as an overall growing category that we expect to see grow at more rapid rates as we proceed over the next quarters and years.

There's a dynamic at play.

The adoption of broadband combined with the proliferation of DVD players, that is going to drive more and more demand of video communications for corporations.

Any corporation that is trying to sell a product or service or communicate to their employee base or partner base is going for start using video at a much greater degree than they do today, and that will mean a great opportunity for a company like Adobe.

And we expect to take advantage of that opportunity.

Great.

Thank you.

Our next question comes from the line of Jamie [Friedman] from Fulcrum Global Partners.

Please proceed with your question.

Thank you.

Two questions primarily on the enterprise side of the document business.

First, with regard to the NetWeaver relationship with SAP, NetWeaver's a rather technical integration protocol.

I was wondering Shantanu, can you give us an example that might help us to understand who essentially the documents run on top the MySAP stack?

And the a second question is with regard to Q-Link so in a similar category.

Shantanu can you give us some perspective as to what you're thinking now that you got some business process management functionality what are some of the attributes you would think would have some market demand as you build a future path in the intelligent document world?

Thank you.

Jamie, NetWeaver as you know as application in an server much like what IBM does with WebSphere.

And SAP stated strategy is that NetWeaver is the application server on which they build their comprehensive set of applications such as ERP, or HR, or PLM et cetera, et cetera.

What the its integration of Adobe Interactive forms allows a customer to do is: first if they're using NetWeaver as just an application server and building a customized application that accesses data from from the SAP business warehouse, for example, they can now have all that data be represented in a PDF.

And allow the customer to interact with that data both inside an outside the firewall.

So more specifically the design of these forms is integrated into the development environment that a SAP developer would use when they're customizing their SAP installation.

That's step one.

Step two however is also the applications that are build on this NetWeaver.

Instead of they also leverage the Adobe interactive forms.

So when you are, for example, in the HR and you're doing as a manager of self-service instead of seeing forms that may not extend outside the firewall or be Adobe Interactive forms, now all those will be built though the Adobe technology.

And any customer who wants to then extend that has to come to either SAP or to IBM to get a license to enable that functionality.

So that's really the extent of the integration with SAP On the Q-Link part what we've done is as we look at documents the routing of these documents are also becoming important.

The sort of evolution has been first people created these forms.

Then they made these forms interactive.

Now what they want is for the data that comes back to be automatically routed and integrated with their back end systems.

And what Q-Link allows is to do is do the process orchestration in the back end of where that data should go, who needs to be able to route it.

So it's truly automatable.

Our focus really is around documents and work flow associated with those documents rather than the more generic business process management where we continue to work with close partners like IBM to make sure our documents are integrated within their work process.

Thank you.

Our next question comes from the line of Gene Munster from Piper Jaffray.

Please proceed with your question.

Hey everybody.

Just in terms of the backlog you mentioned it's higher this quarter versus the previous quarter.

And just from a high level are there any key levels that are driving the backlog in that front?

So, Gene, what we stated was that we were below company policy in inventory now for Q1 and Q2.

And that the backlog that we had at the of the second quarter was higher than usual.

And again we are managing the inventory levels carefully in that the Creative Suites we have no previous history to monitor you know what they'll sell through, what the sell through was for those suites to be able to predict the right amount to have the in the channel in the clarity that we would like.

So we're just being very careful with the overall levels there.

In addition to the fact that we're entering our seasonally weak third quarter.

So in both cases we had higher levels of backlog when we exited the quarter as well as low levels of inventory below our company policy.

And the Intelligent Document side can you talk a little bit about the possibility in terms of the server side of that?

It sounds like this is becoming a bigger focus in terms of the business growth?

So in terms of our server revenue, yes, again, we were up again this quarter over last quarter about $2 million from 23.3 versus 21.3 million.

We continue to see great opportunities in the server business going forward.

We would expect to see it up sequentially as we go into the third quarter, but as a reminder, it is a seasonally weak quarter so there's some risk.

Yeah.

Regarding profitability per se, Gene, we do not break out profitability by business units.

What I can tell you is we continue to invest aggressively against the mission critical document server opportunity.

It's clear by the 34 customers who bought more than $50,000 worth of service from us this quarter, from the many customers who are buying more than $1 million worth of server products from us, that the opportunity is tremendous.

We believe that in the outer years this could potentially be the largest business for Adobe, and we're going to invest accordingly as long as we continue to see that kind of return opportunity.

And clearly the validation that we're getting from partners like SAP and IBM, the validation of the sequential revenue growth on the product licensing side, along with the other successes we're having suggests that we should continue to invest at this aggressive rate.

So it sounds like just continue to invest at the aggressive rate but that would probably amount to margin expansion down the road as this becomes greatly adopted.

Is that fair to say?

I think the way you want to look at is as for Adobe as a whole, what's going to happen in terms of margins and we haven't given any kind of guidance for 05 or beyond for that matter.

This year we talked about having operating margins of somewhere between 31% and 32%.

When we first upped our revenue guidance, clearly given where we are today we'll probably he end up exceeding that which we think is, you know, quite healthy.

We'll invest accordingly.

We're in a great position whether you look at our Creative Professional Business, you look at the opportunities in digital imaging and digital video or you look at the opportunities with Acrobat penetration or this big opportunities we're talking about in the enterprise side.

Adobe is well-positioned and we want to make sure that we invest in the future.

As it relates to enterprise specifically, sure, over time, we'll see margin expansion in that business as the tens of thousands of SAP customers migrate over the next few years, as we take more and more advantage of IBM's MiddleWare and as we work more closely with folks like EMC on their information lifecycle management work flow.

We believe this business will not only grow but will obviously be more profitable as it grows.

I would also add that as we see that expansion in the future in that business there will be other businesses that we will be new that we'll want to invest in.

And so it can be somewhat of an offsetting in terms of the relative margin.

There always something that we need to invest in that's new on on the horizon as part of just developing and growing a healthy business.

One final question.

On the consumer product side any thoughts related to potential new products in consumer meaning this fall time frame?

Well, I think one of the things we've talked about in the past is looking at video and premier elements.

And I'm not denouncing product, but that's something that we've talked about in the past that we are working on.

I think on the consumer imaging side what we're really pleased about is the adoption of the Photoshop Albums Starter Edition.

This is something that people have to explicitly register and surpassing the five million mark I think bodes well for us because we know that those people then outgrow that software, an upgrade to our other imaging products.

Thanks.

Our next question.

One thing, one thing, of course, we will, you know, over time be upgrading our products like Photoshop Elements.

We just haven't announced a specific time.

Our next question is coming from the line of Gibboney Huske from Credit Suisse First Boston.

Please proceed with your question.

Thank you.

I was just looking at it and I think you'd have to go back to 1997 when you had the last share where your diluted share count didn't go down and annual basis.

And just based on your guidance for Q3 pretty clearly you're going to be higher.

I know a couple quarters ago you mentioned part of the goal is to increase the cash balance to give yourself some potential to do an acquisition maybe.

And I just wanted to get an update of kind of where you are from an acquisition perspective.

Are there things out there beyond some of the smaller ones you've been doing that look interesting?

And if not sort of directional expectations in terms of what you want to do with the cash?

Our strategy regarding strategy, Gibboney, hasn't changed.

We enjoy doing acquisitions of smaller companies with great technology, Q-Link being a great example.

We have not shown a desire to do large acquisitions.

It doesn't mean we would never do them but as I've said many, many times before, not only does it have to be strategic in nature, not only does it have to be a good value to our shareholders but probably even more important we have to believe that we can execute with some kind of acquisition of a significant size.

So unless we can meet all three requirements the strategic value, the value to the shareholder from a pricing perspective, and our confidence against integration an execution, we would not move ahead with a large acquisition.

In terms of our cash, nothing new to really report at this time.

We continue to believe that there's a number of ways for us to use cash.

The one that's been the most prominent over the past years, and again you saw this quarter, is stock repurchase.

We did use about $104 million, we returned to shareholders through a share repurchase program this quarter.

And continue to believe on a go-forward basis that share repurchase is an excellent way to return excess cash to shareholders.

The share count in terms of where that goes has been primarily in driven by the fact that the stock price has gone up over the past year and that's been a primary driver of the increase in share count.

And just one quick followup.

So getting back to sort of from a strategic perspective it would seem now as you focus on the enterprise that the scope of your business is broader and there are some potential areas where, you know, a broader array of opportunities relative to the past.

And I guess just from a strategic perspective or maybe just a size perspective, if you saw an acquisition that was say a billion acquisition made sense strategically, you felt you could execute and the price was right, at that magnitude would you be willing to go ahead with it?

The answer is yes, but I wouldn't limit that to an enterprise .

I would say that's across all of our businesses.

If we see an exciting opportunity that is executable, that's priced appropriately, we would move ahead with that type of acquisition.

In the enterprise our focus is really around documents, and mission critical document work flows so that would be the area of interest.

We wouldn't want to go beyond that especially given that we prefer to partner with some of the larger infrastructure players like IBM someone SAP.

We don't need the reality is if you look at growth opportunities ahead of us across all of our businesses, we don't need M&A to grow as a company.

Great, thank you very much.

Our next question comes from the line of Steven Ashley from Robert Baird.

Please proceed with your question.

Hi, guys.

I'm just wondering, the success of the Creative Suite and the adoption, do you think, are there any specific aspects or elements of the value proposition that the customers are finding most or more enticing that's really compelling them to adopt that?

Steve, this is Shantanu, I think if terms of the Creative Suite adoption I think there are many, many reasons that we've heard why people are adopting them.

First, from an individual point perspective, each of the individual products that we delivered Photoshop, Illustrator, InDesign and GoLive had just significant new both creativity and productivity features in them this particular time.

But in addition to that, I think what they really find compelling are three things.

One is the fact that from an usability perspective we've really done a phenomenal job of integrating all these products so that the work flow that they have to accomplish is done far more seamlessly than they ever have in the past.

I think the second thing they see a lot of value in is as we move toward asset management an allowing them to do work flow.

That's something that they see exciting because a lot of these creative professionals are really present in work groups rather than individual freelancers.

And it's sort of peace of mind.

They understand that if they just get a Creative Suite platform any kind of media that they're trying to do creation for it's covered through the platform that we deliver.

What's extremely exciting to us, Steve, not only the current success we're having but in our initial research we're finding that the active usage of the applications is relatively high which means that as not only are they buying it for peace of mind, not only are they buying it for a specific one or two products but once they have all of their products we're finding they're using them at a greater rate than we thought they might.

Which means that as we look to upgrade either the individual products and more importantly the Suite, that the likelihood we believe the likelihood for them to upgrade will be greater.

Great.

And you guys have had, you know, increasing success with volume license of sales with Acrobat an I'm wondering obviously one of your goals is to have become more involved in the process of the document, the whole lifecycle getting in and being involved earlier in the birth of a document.

It appears that's happening.

I'm just wondering if Sarbanes-Oxley may be benefiting that?

And if you thought there was any benefit from that?

Well, we think there are a myriad of document work flows where making sure that the document is secure.

And in terms of sharing that document ensuring that the fidelity is exactly as intended.

That's the real megatrend that's driving Acrobat adoption both through e-mail as well as on the web.

I think the other thing that is driving adoption of Acrobat is long term archival.

And I think Sarbanes is one of the cases where they want to make sure that the documents that's being archived has long term fidelity.

So we just see so many uses off that, case management, compliance reporting, Sarbanes-Oxley, financial reporting are just some examples of how people are using Acrobat today in addition to collaboration.

And just lastly, you talked about the Netherlands and the income tax opportunities there for your interactive form capability.

That seems like that would be a sizable opportunity.

Just qualitatively is the revenue, the preponderance of the revenue opportunity there for that still ahead of you guys?

What the example opportunities that we gave with the Dutch Tax Office was to really demonstrate how people are taking the PDF forms that exist and first step of that is to really make those forms more interactive.

Certainly we continue to believe that as people make those forms interactive there's a lot more products that we can sell them, upsell them to work flow, upsell them to integrating that data.

So I think it's representative of all of our customers.

Earlier they get the forms they make them interactive and then there's a lot more products we can sell to them.

So the opportunity is significant.

If you think about the Dutch Tax Authority, there are runs hundreds of other tax authorities around the world at the federal level.

And then when you start looking at the state and local levels, there are thousands and thousands of tax authorities that we have an opportunity to sell that same solution to.

In fact, if you were to go back and listen to all of the examples that we gave today or go back and look at our website over the now what are close to more than a hundred examples that are posted up there, you could take each of those examples and realize that there's hundreds or thousands of solutions or there are solutions that will have 100 or more or thousands of repeatability to it.

So, you know, whether it's a Dutch Tax Authority, the Inland Revenue Service in the UK the IRS in the U.S. or on and on.

The opportunity is so enormous which is why we're so excited about the success that we're having.

Great, thanks a lot.

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

Please proceed with your question.

Thanks very much.

Getting back to a question that was asked earlier, I'm kind of curious if you could provide some more information regarding the operating margin.

Clearly it looks like on a sequential basis for this fiscal year that we're going down 400 basis points this quarter and around that amount next quarter.

It seems like some of that is being taken up by increased R&D expenditures and I was just wondering if you could provide a little bit more in the way of detail as to how we should be thinking about the margin?

And I have a follow-up.

Thanks.

Scott, regarding the margin, I mean what you've seen this year is that the revenue has obviously a lot to do with the margin, the level of revenues.

So we had the 423 million in Q1, 410 in Q2 and now we are a targeting 360 to 380 in Q3.

And with the leverage model that we had that obviously compresses the margin in a sense.

And that is contributing to it.

As well as the fact is that we are continuing to invest in our future through hiring and R&D, sales and marketing and G&A.

And also with a series of marketing programs that we have, continuing to increase our awareness around our Intelligent Document solutions and products as well as the Creative Suite.

And so you kind have two forces at play here that are going on.

We continue to believe that we're a high profit margin company and continue believe so going forward.

But we need to continue to make sure we do the proper trade off between short term profitability and long term investments in our future.

To comments further on that though, just taking say FY03 as an example, your R&D expenditure ranged from roughly 24 -- 20.4% to 22.2%.

I'm talking about a quarterly basis.

Here we have a sequential increase of what I expect is going to be roughly about 300 basis points, that's more variation than you had all of last year among all four quarters.

So I guess I don't know if I'm necessarily speaking for other people but it seems to me like that's a pretty substantial uptick.

I think as someone asked before if you could provide any increased information regarding what I think is pretty significant increase in the percentage committed to R&D that would be really helpful.

Well I think there's two things.

One is that from Q2 we had revenue of 410 now we're targeting 360 to 380 so you've got that change between Q2 and Q3.

Latch year we were in the Acrobat launch and the revenue between Q2 and AQ3 was essentially flat.

So that's contributing to some of the change as a percentage of revenue.

We continue to hire in R&D, clearly the number of hires we had in Q2 didn't all start on the first day of the second quarter.

They were hired throughout the quarter and now in in Q3 we'll have a full quarter of expenses for those that were hired in Q2 plus the hiring in Q3 plus the fact that we have our annual salary increase that impacts the third quarter.

So that's what's kind of contributing here in terms of what you see in terms of the increase as a percentage of revenue.

I think it's important, Scott, that you look at Adobe as a company that has a lot of growth opportunities ahead of itself.

But if you look at this year, this is a year back in October where we provided guidance of 10% to 14% and there were a lot of people who certainly in the Wall Street community who were concerned about our ability to deliver on that 10% to 14% growth without a lot of new products.

Here we sit here today without giving revised guidance for the year.

But it's pretty clear that we will in all probability, in fact, with a lot of degree of confidence I could say that, we will exceed that growth without a lot of new products as we enter 2005.

It will be a rich product year especially relative to 2004.

Which means that that will be another year we believe of significant growth to the company.

And given the opportunities that I discussed earlier, we could believe that as we move through '06, '07 and beyond those growth opportunities don't go away.

We want to make sure that we invest against those opportunities so we can sustain double-digit growth, 20 plus percent growth or whatever as we move through '06, '07, '08 and beyond.

And we think that's the right thing to do for the shareholders.

I also believe that delivering this year greater than 32% operating margin profit is very respectable for a company that's growing as quickly as we are.

So while I understand the concerns around sequential increase in R&D spending, I encourage our investors to think about our performance and the opportunities going forward the same we look at it.

Okay.

Point taken.

The other question I have is a little bit more arcane and that is related to your investment gain.

If you look I guess over the last, oh, I don't know, 10 quarters or so, even more than that, 20 quarters, the company hasn't really shown gains in the investment portfolio.

Is that something that's based upon the economy and based upon the increasing hasn't of venture-backed companies that we should kind of see on a consistent basis going forward at this point from your vantage point?

Well, the losses that we've had in the past years obviously equity markets have declined significantly from where they were and we had impairments that we needed to take each quarter in our investments.

What we saw this quarter was we did see one particular company was acquired at a level above our cost so we recognized a gain.

It's really going to depend upon what the equity markets do from here in terms of what that would look like from a portfolio perspective.

We continue to believe that we're investing in companies that are related to our business, that make sense for us, and with the hope of driving, you know, good financial returns over the long-term.

But it is a more speculative business than our current operating software business.

And so it's very difficult to predict what the performance could be from quarter for quarter.

So I guess is it fair to say that the light at end of the tunnel has been reached because obviously, you know, this has been an area that's contributed to net losses in this particular line item for the last several fiscal years and now you've had, you know, positive numbers over the last, you know, 2 out of 3 quarters.

So I guess in terms of thinking about this from a modeling perspective, you know, is that something that these looking at it on a binary narrow positive versus negative fashion that we should probably be thinking about it more in terms of positive at this point?

Well, again I think it's very difficult to be able to determine what the future gains are going to be.

This is obviously a more speculative business and not knowing where the equity markets are going to go.

If the equity markets are going to improve over the next year or two then obviously there's going to be a positive bias to it.

So that's what makes it challenging.

From an exposure in the balance sheet we've obviously written down our investment significantly over the last couple of years as we were required to take impairments as they occurred in each quarter and so the overall exposure from a loss standpoint going forward is significantly lower than it was a number of years ago.

Great.

Thanks a lot

Our next question comes from the line of Tom Berquist from Smith Barney Citigroup.

Please proceed with your question.

Thank you.

The first question is looking at your comments earlier, Bruce, about some of the confusion about trying to understand which products the best or most appropriate for people to purchase I struggle with just trying to figure out within your creative professional category what you include from a product perspective in there.

Obviously the Premium and Standard Suites are in there.

Do you put the Photoshop 8.0 Creative Suite product in that bucket as well?

The standalone Photoshop?

When we think about the customer, a significant percentage of the Photoshop customer falls into the creative professional market.

However, for reporting purposes, the standalone Photoshop revenue falls in Digital Imaging, Digital Video Business unit.

But from a customer perspective there is still a significant number of people who buy Photoshop who are a creative professional and they are people who will also use products like Illustrator, InDesign, GoLive an others so, therefore, it is a Creative Suite opportunity.

I think if we were to do this all over again we'd probably report out one business unit.

But the reality is I want to give more visibility, not less, to those who are shareholders of our company.

Got it.

Can you give me any metrics than your view of those relative success of Creative Suite Standard versus Creative Suite Premium?

I think what we've said there Tom, is that certainly Creative Suite Premium has been out selling Creative Standard three to one.

And so that's success for us relative to the fact that they're adopting the entire platform.

We also said that entire Creative Suites revenue Standard plus Premium has exceeded our expectations.

And that trends that Shantanu Narayen talked about three to one we saw continue through Q2.

Okay.

Then on the discussion about the server product, I think I followed what you said a couple different questions.

But I just wanted to follow up on two points of it.

One is would you consider your SAP relationship with to compete with IXOS or are you complimentary to IXOS?

I couldn't tell from how far you were broadening the document managing concept as to whether or not you were going to do raw Word Excel files or things of that nature?

I think the relationship that we have with SAP is actually complimentary to the one that they have with IXOS.

What we are working with SAP is all around the area of print and interactive forms.

And so for anything that we do to produce interactive forms, that's where the forms will be in PDF as opposed to being either in HTML or a proprietary SAP format.

So that SAP can leverage the ubiquity of the Adobe Reader.

That's the value that SAP saw with us.

Okay.

So the relationships that they have with these other providers like IXOS don't change as a result of this.

Somehow customers will have to decide I guess whether or not they're trying to do more general purpose document management as a sort of traditionally defined versus whether they're trying to do PDF form entry.

Is that how the lines are drawn?

As it relates to SAP's relationship with IXOS that's really a question for SAP.

In terms of what the customer has to think about, any form that they want as opposed to it being a static form to make it interactive, to make it dynamic, to make it routable with business logic associated with that.

That's where both the companies, SAP an Adobe believe that they will look to PDF forms to accomplish that.

Okay.

And then as a follow-up to that question you made before about the revenue authorities, tax authorities as they're rolling this out, is there like a deployment element to this that could be substantial?

So, for example, if I go down the process from the Dutch government of using your products to basically data entry enable my tax forms I suppose they could do that without buying a lot of the server technology but at some point if all those taxpayers are starting to fill those forms out and send them they would obviously want the extraction technology on the server side.

Where does that part of the sale happen?

Does that happen at deployment or has that already happened?

That's a great question.

As it relates to the tax authorities, even at the front end when they're serving up these forms, as the number of forms that are being served up increases certainly they could be using more Adobe forms servers to serve up these forms.

Because with an Excel based template we serve it up in a variety of different formats.

So as the number of people who are downloading those forms increases that's a revenue opportunity for us.

As the data that's being filled in gets submitted into the tax authority website, that again as you mentioned is another revenue opportunity for us because now we have to be able to extract the data from the PDF form with our workflow server integrated into the back end.

In many cases the customer might decide to do a pilot of both of those at the same time.

In other cases what they do is get they get the downloadable forms out there first.

And then once they're getting the data back then they start to deploy our servers to do the workflow as well as the integration.

I think what's even more exciting is over time for the next year now the Tax Authority has the ability to even prefill these forms so you're actually delivering personalized forms on an user by user basis.

And so we think that that again represents future opportunity for us.

I would add one more which is very exciting which is around our 2D bar code implementation.

So if you use the IRS as an example, the K1 form in this past year for their commercial providers actually included a 2D bar code.

And as they typed in the information on the form, that 2D bar code captured that information.

So if somebody kos not to submit electronically when that paper form was mailed in, the IRS was able to scan just the 2D bar codes and seamlessly capture XML data back into their infrastructure.

An incredible savings on just those few forms.

And they have announced their intent to incorporate that capability into more of their forms next year.

And so that little 2D bar code has enough information content to be able to handle all the information on the form?

That's correct. and, In fact, in the XML schema that the customer defines and the business models for these can go from server based to transaction based to forms based.

So in all those particular cases there's more potential product revenue for Adobe.

And that's just an example for a tax authority.

But if one was to use their imagination, think about all those insurance applications, claim forms, mortgage applications, other types of banking forms.

Just about any form today where somebody doesn't feel comfortable submitting electronically we make it easy for those corporations to allow their constituents to mail, print and mail and submit.

U.S. corporations alone are spending approximately $16 billion a year re-key punching information that was once electronic.

We now eliminate or help reduce that cost.

I got it.

That's very slick.

One final very quick question.

I know you guys hedge currency.

What was the currency impact this quarter and did you hedge some more?

Well, the overall benefit that we received on the currency Euro Yen on a year-over-year basis was about $16 million in revenue.

Obviously there was -- it worked against us in directs cost an operating expenses.

And I'd also add that we have factored that into the guidance we provided so the overall performance in the quarter is not related to currency.

That currency benefit was already factored into the initial and revised targets.

Okay.

Thank you very much.

Our next question comes from the line of Sterling Auty with JP Morgan.

Please go ahead, sir.

Hi, guys.

If Creative Suite was actually up sequentially what other items in Creative, the Creative Pro category are seeing declines?

Well, I think, Sterling, in terms, if you look at the overall segment the Creative Suites was up Q2 versus Q1 as more and more customers are choosing to go with the Suite.

In some of the other products we've got they're longer in the cycle or some of the standalone products as we move through some of the upgrades to the specific stands alone CS product we're moving through the cycle on that.

So if you look at some specifics we continue to see relative strength with InDesign and Illustrators but some of the older products like PageMaker, FrameMaker those products that we haven't been focusing a lot of resources on are declining as we expected and as I would expect others would.

Do you think that they reach a point where they stabilize so that you don't see too much further decline in those?

Well, I think a lot of it is time dependent and it varies product by product.

If you take a look at a product like PageMaker what we are actually doing is encouraging our PageMaker loyal customers to InDesign taking advantage of some of the plug-ins that we developed that make it PageMaker like.

If you look at a product like FrameMaker, we do believe there is a loyal constituent that will continue to stay with FrameMaker because of its unique capability.

So it really varies product by product.

When I think about the creative professional business it's around the Creative Suite, the growth in Illustrator the growth in InDesign that represent the big growth opportunities.

The declines in the other area probably won't be significant enough to have a material impact on us.

Okay.

And then looking at the lack of full-year guidance, can you just give us a little bit of color as to what the thought process was behind?

Is there basically, are you thinking about product timing, are you thinking about where you're hiring plans will be in the back half of the year?

What was the rationale to wait until after the third quarter to give us fourth quarter guidance?

Sterling, as you know in past years the third quarter being seasonally weak and at times unpredictable.

We'd like to just complete the third quarter and then at that point we'd like to then give the fourth quarter guidance.

And so it has to do more with the seasonality of the third quarter than anything.

Sterling, I also want to remind you, we do take our guidance seriously and two times in a row we underestimated our revenue on a fiscal year basis.

So I think we realized that let's get through Q3 and we'd rather just give you the final number when we have more confidence that that number is more likely to be accurate.

Because clearly we underestimated twice this year already, we don't want to do that again.

Okay.

And then last question, back to the channel inventory, would it be your expectation to exit the August quarter in more normal corporate policy for channel inventory?

An I know what the answer has been for this question in the past but can you give us any type of quantitative number in terms of how far below corporate policy you are?

So in terms of the guidance for the third quarter, it does factor in that we would see our inventory levels move back within the company policy range.

That is factored into the guidance now that we would have a few more months of sell through information around the Creative Suites and we would have an idea around what kind of demand we face during the seasonally weak third quarter.

In terms of specifics we're not providing any specifics today in terms of on an absolute basis of where we stand in terms of inventory.

Okay.

Thank you.

Operator, we'll take one or two more calls.

There are no further audio questions at this time.

Well 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 an ask that you please disconnect your lines.