Adobe Inc (ADBE) 2004 Q3 法說會逐字稿

Good afternoon ladies and gentlemen, thank you for standing by and welcome to the Q3 fiscal year 2004 earning's call for Adobe Systems.

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, Monday, September 20, 2004.

I would now like to turn the conference over to Mr. Mike Savage, Vice President 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 third quarter fiscal 2004 financial results.

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

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

Before we get started I want to emphasize that some of the information discussed in this call, particularly our revenue and operating model targets for the coming quarter and our forward-looking product plans is based on information as of today, September 20, 2004, and contains forward-looking statements that involve risk and uncertainty.

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

For a discussion of these risks and uncertainties you should review Adobe's SEC filings including our annual report on form 10-K for fiscal 2003.

And our quarterly reports on 10-Q in fiscal 2004.

During this call we will 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 available on our Web site.

All 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 on Adobe's Investor Relations Web site for approximately 45 days and is the property of Adobe Systems.

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

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

Thanks, Mike.

I continue to be pleased with our performance and with the execution we are demonstrating against the strategy that we outlined last fall.

Our market relevance continues to grow as we evolve from a point product Company to a platform provider.

In Q3 we continued to see strong adoption of the Creative Suite platform and enterprise licensing of the Acrobat family of products.

In addition our Intelligent Document platform is being adopted by governments and enterprises worldwide to automate business processes.

These successes led to revenue for our third-quarter of $403.7 million representing 27% year-over-year growth and earnings-per-share that exceeded expectations.

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

Murray.

Thanks, Bruce.

For the third quarter of fiscal 2004, Adobe achieved revenue of 403.7 million this compares to 319.1 million reported for the third quarter of fiscal 2003 and 410.1 million reported last quarter.

GAAP net income for the third quarter of fiscal 2004 was 104.5 million compared to 64.5 million reported in the third quarter of fiscal 2003 and 109.4 million last quarter.

Non-GAAP net income which excludes as applicable investment gains and losses in the Company's Venture program and minor reversal of a prior restructuring charge was 105.6 million compared to 66.3 million reported in the third quarter of fiscal 2003 and 108.8 million last quarter.

GAAP diluted earnings-per-share for the third quarter of fiscal 2004 were 42 cents based on 247.1 million weighted average shares.

This compares with GAAP diluted earnings-per-share of 27 cents reported in the third quarter of fiscal 2003 based on 240.5 million weighted average shares and GAAP diluted earnings-per-share of 44 cents reported last quarter based on 247 million weighted average shares.

Non-GAAP diluted earnings-per-share for the third quarter of fiscal 2004 which excludes investment gains and losses were 43 cents.

Gross margin for the quarter was 94.2%, compared to 93.1% in the third quarter of fiscal 2003 and 93.4% last quarter.

Operating expenses for the third quarter of fiscal 2004 were 239.8 million, regular employees at the end of the third quarter totaled 3,749 versus 3,646 at the end of the second quarter of fiscal 2004 the majority of the headcount increase was in R&D.

Expenses as a percent of revenue breakdown as follows.

Research & development 19.8%, sales and marketing 30.5%, G&A 9.1%.

GAAP operating income in the third quarter of fiscal 2004 was 140.3 million or 34.8% of revenue.

This compares to GAAP operating income of 92.2 million or 28.9% of revenue in the third quarter of fiscal 2003 and 141.8 million or 34.6% of revenue last quarter.

Non-GAAP operating income which excludes as applicable a minor reversal of a prior restructuring charge also was 140.3 million in the third quarter of 2004 or 34.8% of revenue.

This compares to non-GAAP operating income of 91.8 million or 28.8% of revenue in the third quarter of fiscal 2003 and 141.8 million or 34.6% of revenue last quarter.

Other income for the third quarter of fiscal 2004 was 2.3 million, other income was lower this quarter due to higher cost related to our foreign currency hedging activity.

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

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

Creative Professional segment revenue was 150.4 million in Q3 fiscal 2004 compared to 82 million in Q3 fiscal 2003 and 153.4 million last quarter.

Revenue for the Creative Suites, Illustrator, and InDesign continue to be strong despite the seasonally weak third quarter.

Digital Imaging and Video segment revenue was 98.4 million in Q3 fiscal 2004 compared 88.3 million in Q3 fiscal 2003, and 100.3 million last quarter.

Photoshop revenue continues to be strong consistent with the other major CS products reported in the Creative Professional segment.

OEM PostScript and other segment revenue was 19.4 million in Q3 fiscal 2004 compared to $21.8 million in Q3 fiscal 2003 and $20.3 million last quarter.

Intelligent Document segment revenue was 135.5 million in Q3 fiscal 2004 compared to 127 million in Q3 fiscal 2003 and 136.1 million last quarter.

In Q3 total Intelligent Document's Desktop revenue was 105.8 million and Intelligent Document Server revenue was 29.7 million.

Server revenue in Q3 included a large payment from a software partner.

Excluding this payment Server revenue grew sequentially from Q2 demonstrating continued momentum in the enterprise.

Turning to revenue by geographic segment the results in Q3 fiscal 2004 were as follows.

The Americas, 48%.

Europe 31%.

Asia 21%.

In reviewing our performance for Q3 we experienced solid demand in typical seasonal patterns in the U.S. and Europe.

Japan met expectations for the quarter although August was slightly softer than typical.

Application platform mix was 73% Windows and 27% Mac in the third quarter of fiscal 2004 which compared to 77% Windows and 23% Mac for the third quarter of fiscal 2003 and 72% Windows and 28% Mac last quarter.

Our trade DSO in the third quarter of fiscal 2004 was 25 days, this compares to 31 days in Q3 fiscal 2003 and 23 days last quarter.

In regard to our global channel inventory position, we ended the quarter below Company policy.

Channel inventory levels and order backlog were consistent with our position at the end of Q2.

In Q3 the Company launched a revised licensing program, the program changes included reporting some electronic orders on a daily rather than a monthly basis.

We estimate the impact of the program change in implementation was a net increase of approximately $10 million in revenue in Q3.

Our Q4 targets assume normal quarterly licensing activity.

At the end of the third quarter of fiscal 2004 cash and short-term investments were 1 billion 140 million dollars compared to 1 billion 281 million dollars at the end of the second quarter of fiscal 2004.

Cash and short-term investments were lower this quarter due to higher uses of cash for stock repurchase and for the lease financing on two of our corporate headquarter buildings.

The cash used for the financing is reflected on the balance sheet as investment and lease receivable.

Turning to Adobe Ventures we realized an investment loss of 1.5 million in Q3 fiscal 2004, in the quarter we made additional investments of 3.5 million.

In total Adobe has invested 230.8 million through its venture partnerships and direct investments.

As of the end of the third quarter the net returns from this program from its inception in 1994 were 351.8 million including the stock dividended to stockholders and the market value investments still held by Adobe.

In regard to share buy-back Adobe repurchased approximately 4.5 million shares in Q3 at a cost of 195.7 million as part of its share repurchase program.

Adobe's Board of Directors declared this quarter's cash dividends of 1 1/4 cents per share payable on October 12, 2004 to stockholders of record as of September 28, 2004.

This concludes my discussion on third quarter fiscal 2004 results.

Now I will discuss our Q4 fiscal 2004 targets.

We are targeting revenue of 400 to 415 million, as a percent of revenue our approximate operating model targets for the quarter are as follows.

Gross margin 94%.

R&D 20%.

Sales and marketing 32 to 34%.

G&A 9% resulting in a GAAP and non-GAAP operating margin target approximately 31 to 33%.

For our share count we are targeting a range of 249 to 250 million shares.

For other income we are targeting approximately 3 million and for our tax rate we are targeting 26%.

These targets lead to a GAAP and non-GAAP earnings-per-share target range in Q4 fiscal 2004 of 38 to 41 cents per share.

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

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.

We achieved Acrobat Desktop revenue of $105.8 million demonstrating continued adoption of the Acrobat product family more than five quarters after we shipped Acrobat Version 6.

Overall, Intelligent Documents Desktop licensing as a percentage of the total Desktop business was 45.9%.

Our success with the Intelligent Documents business also extends to our Server based business.

Intelligent Documents Server revenue grew to 29.7 million in Q3.

Driving this performance were a number of significant wins.

In the government market, they include the IRS which is using Adobe Reader Extension Server and our new 2-D barcode technology to provide fillable and scannable tax forms to its constituents.

The Canadian government which is developing and deploying a government wide form solution based on Adobe Form server and Reader Extension Server with their systems integrator CDI Information Systems.

The European parliament which is using an Adobe Document Generation solution based on Adobe Document Server to generate documents in PDF in all 20 official languages of the European union.

The U.N.

Department of Veteran Affairs which ha-s licensed Adobe E-form and WorkFlow solutions to improve service for veterans and decrease operating costs through the automation of form processing and information sharing.

And the University of California at San Diego which is using Adobe E-form and WorkFlow solutions as part of a pilot program for paperless automation of administrative processes on campus.

In the commercial market, our enterprise server solutions are being adopted across a variety of vertical industries.

In Q3, key wins included CNA, a leading provider of property and casualty insurance which has selected Adobe's Intelligent Document Platform to automatically generate and distribute all business forms and letters required for initiating and processing insurance claims.

The American Bureau of Shipping responsible for certifying the seaworthiness of ships is implementing a paperless process where certification documents will be sent in Adobe PDF to be completed either on or offline using Adobe LiveCycle software.

Sofinko (ph) a subsidiary of Credit Agricol (ph) which is using an Adobe Document Generation solution to streamline the creation and delivery of loan documents.

Anturo Ethical Razioni (ph) a leading insurance company in Italy which is using Adobe Document Generation and E-form solutions to distribute and manage insurance policies.

In regard to the key quarterly performance indicators that we report, in the third quarter the number of enterprise server transactions greater than 50,000 totaled 39 up from 34 last quarter.

The average size of these transactions was $184,000.

Turning to our Creative Professional business segment we had an outstanding quarter.

Once again driven by strong revenue for the Adobe Creative suites.

In regard to results to date with the Creative Suite platform we continue to see a revenue split of 3-1 premium to standard which is consistent with recent quarters.

As evidenced by our Q3 results we continue to see an extended adoption cycle by our customers for the new suite platform, especially on the Mac where OS-10 adoption continues.

We also see ongoing Creative Suite and InDesign adoption at major global accounts, for example, Post (ph) magazine's one of the world's largest magazine publishers with 18 U.S. titles and more than a hundred international additions announced that it has adopted the Adobe Creative suite as its standard publishing solution.

Meredith Corporation publisher of 17 popular magazine brands and approximately 450 special interest magazines and books announced that it is standardizing on the Adobe Creative Suite platform.

PBC magazines the UK publisher of popular titles like Eve, (INAUDIBLE), Good Food, and Good Homes announced that it has adopted Adobe and Design CS to produce its portfolio of consumer magazines.

And Sony Communications has selected the Adobe Creative Suite as the key platform for their digital publishing WorkFlow and back up system.

Turning to our Digital Imaging and digital video business.

Photoshop had a strong quarter with year-over-year growth.

We continue to believe there are a number of customers who have not yet upgraded to the Creative Suite or Photoshop CS representing an ongoing opportunity.

In our Digital Video business our new video product line continues to receive positive commentary and awards from the industry.

A reflection on the state of art features available in our new products.

At NAV, Videography magazine gave Premier Pro a highly coveted video award.

In addition PC Magazine awarded the new video collection an editors choice award stating, quote, Adobe Video Collection Professional simply can't be beat.

Last week we announced two exciting new products for Photo and Video hobbyists.

Photoshop Elements 3.0 adds new organization and sharing functionality as well as a new generation of image editing tools.

Premier Elements delivers professional level capabilities in an all new hobbyist video product that combines simple video capture, sophisticated editing, and quick output to DVD.

Available at separate products Photoshop Elements and Premier Elements can also be purchased in a single retail package.

This concludes my Q3 business segment review.

Bruce.

Thanks, Shantanu.

As you have heard during today's call we are executing well against our platform strategy and continue to see the results of our efforts.

Creative Professional customers are adopting the Creative Suite at a rapid rate.

And are expressing interest in our video offerings as video becomes more important for mainstream communications.

Digital photographers and creative professionals continue to look to the Adobe Photoshop product line as the gold standard for enhancing and sharing their photographs.

Knowledge workers are embracing our Acrobat product family to reliably distribute and collaborate on important documents.

Finally, enterprises around the world are adopting our service solutions to automate mission critical document workflows improving efficiency and increasing business productivity.

Factoring in our Q4 targets, this will be one of Adobe's best years ever with annual revenue growth exceeding 25%.

As we look to fiscal year 2005 it will be a rich product year with major new releases beginning in Q1.

We're excited by our prospects for continued growth next year and beyond.

Mike.

Thanks, Bruce.

Before we start Q&A, I would like to remind everyone about our upcoming annual financial analysts meeting.

It will be held on the afternoon of Tuesday, October 26, in San Jose so please mark your calendars.

Invitations for the meetings will be sent out in a few weeks.

Our regular interquarter update for Q4 will also be issued that day prior to the meeting's start.

For those who wish to listen to a playback of today's conference call, an auto recording of the call will be available from Adobe's Investor Relation's Web site on Adobe.com later today.

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

Use reservation number 21207462.

Again the phone number is 402-977-9140, with reservation number 21207462.

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

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

Pacific time on Friday, September 24, 2004.

We would now be happy to take your questions.

Operator.

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

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

If you're using a speaker phone we ask that you please lift your handset before entering your request.

Our first question will come from the line of Jay Vleeschhouwer from Merrill Lynch and Company.

Please proceed with your question.

Thanks.

Good afternoon.

A question first about Creative Suite.

It appears that it continues to account for just over a fourth of your revenue.

One of the things you've been saying earlier in the year about CS is that as new as it is it's been somewhat difficult for you to predict or forecast the products since there hadn't been much or prior history to it.

Question now is with its being now nearly a year old do you feel you have a better handle on being able to predict demand for CS than you might have had earlier in the year when it was, of course, much newer.

The second one regarding Acrobat, you said that one of the marketing targets for Acrobat is to go after vertical markets such as financial services, government, manufacturing and the like.

With respect to Version 7 coming up, is there going to be any particular change in functionality or packaging or even pricing relative to those targeted verticals for Acrobat?

That is different from what you've done to date with Acrobat?

Jay, in regard to the Creative Suite demand, according to Al, we're coming up on a year as you noted, we do believe that we're in a position to be able to be more predictable in terms of guesstimating where that CS is going from a revenue perspective but obviously it's not the same as having been through one.

So yes we've improved in terms of predictability but it's still the first time we've had one.

Jay, with respect to your question on Acrobat we still continue to be focused on the opportunity around 6.

I think as we've talked about, you know, we believe there's over 60 million available seats for us to penetrate and so there's still significant head room with 6.

As we did with 6, you know, we continue to make sure that we segment the product appropriately and the Pro product which is targeted at the Creative Professional as well as the engineering and education communities continues to do well and I think the opportunity for Acrobat continues to be in both extending horizontal capability such as reliably sharing information the collaboration capabilities, digital signatures, but clearly continuing to add value, understanding workflows in vertical industries is something we will continue to focus on.

One final question.

To the point you just made Shantanu on the Pro or Premium versions that's been a very high percentage of both the design applications like CS and Acrobat as a percentage of revenue, what percentage of the base do you think has adopted Premium or Pro versions.

So can you -- near term how much headroom is there to further penetrate the base with premium new units or upgrades?

Well, I think, as it relates to this particular quarter, Q3 first the proportion of Acrobat's Pro revenue was actually greater than normal so the Standard to Pro premium mix was 3-2 as compared to 2 to 1 in previous quarters such as Q2.

But as we continue to segment the product it clearly enables us to better market the higher value features that we have in the Pro product and so even the customers who have Standard today we would like to continue to target them as customers who can move to Pro in the future.

The opportunity, Jay, is enormous.

If you look at 200 million knowledge workers who have paid for and own Microsoft Office.

If you look at a subset of them with 60 million who we believe have the need to reliably collaborate with rich documents and you look at the number of units that we shipped somewhere 14, 15, 16 million units, it means that there's approximately 45 million potential out there users out there that we could sell Acrobat into.

We'll continue to segment the product, we'll continue to develop functionality that meets specific customer requirements but at the end of the day we think the opportunity ahead of us continues to be significant.

Thank you.

Next question comes from the line of Sasa Zorovic.

Please proceed with your question.

Indeed.

Could you please tell us a little bit more about how linear your quarter was as it progressed?

Well, Sasa in terms of the linearity it was a relatively linear quarter through the June, July, August timeframe.

Probably a little bit of softness in the July which we typically do see.

As we see the slowdown in Europe sort of taking place and then we tend to see a pick up toward the end of August in Europe.

So generally pretty linear but a little bit of a dip toward the middle of the quarter as we would again expect from a seasonal pattern.

At this time you're starting to have a significant amount of cash.

Any plans to do something more aggressive with it cash beyond the dividends and the share buy-back?

Well, we've always pointed that we thought that share repurchase was one of the best ways to return excess cash to shareholders and we did 4.5 million shares in the quarter which is a higher number than we've done in past quarters so it's close to 200 million in cash was returned to shareholders.

On a go-forward basis we'll continue to look at different means of returning cash.

We believe that share repurchase is the most effective way on a go-forward basis.

If -- there continues to be talk about a potential sort of IT spending weakness towards the remainder of the year particular for enterprise like software do you believe that in any way this could be affecting Acrobat sales?

If not, why?

Sasa, it's hard for us to comment on the global IT market or the global economic conditions around the world.

From a macro perspective, what we can comment on is what it means to Adobe and its customers.

When we look at our customers the first segment that seems to be benefiting from the environment is the Creative Professional.

Corporations are, indeed, we believe spending more money in marketing their products and services, it's been a long time since our customers have either bought new or upgraded equipment and software and we believe they are doing that today and we believe they will continue to do that over the next year and into the future as long as the economy continues to be as stable as we see it today.

The second set of customers and that's the business customer and/or the enterprise, they're looking for a quick return on investment.

Fortunately our products both Acrobat on the Desktop and the LiveCycle server products are products that do provide for a quick return on investment and they're also relatively inexpensive.

It doesn't require 10, 15, $20 million to deploy one of our systems.

You could buy a piece of our software for $249 or implement a new business process for typically less than a quarter of a million dollars.

So we think we're in a great position, but, again, I'm not sure that speaks to the rest of the IT market.

Thank you very much.

Thanks, Sasa.

Our next question comes from the line of Steve Ashley from R.W. Baird.

Please proceed with your question.

Hi.

In terms of the $10 million of step-up revenue that was brought in this period because of the change in accounting, were certain products affected more by that than other product groups?

No.

The change in licensing programs and system in the quarter really, it impacted all the products.

It wasn't specific to one particular product.

Great.

And you mentioned that there was a one-time payment in the Intelligent Document Server business from software company.

Are you able to quantify that at all?

No, due to confidentiality purposes or reasons we're not in a position to be able to communicate what that specific number is or was and who the partner is.

And in terms of Creative Suite and the success you're having there, have you any feel, either through surveys or customer focus groups able to determine if Version Q is being used and is one of the reasons that we're seeing strong adoption of that product?

So Steve, I think what we're hearing first from our customers is the fact that we've delivered an integrated platform is clearly resonating with them and so the number one thing that they tell us is having all these products integrated is what they're using.

With respect to Version Q we're starting to look at asset management and rudimentary work flow in these small work groups.

Yes, they are starting to play with Version Q. It does require them to think about how they want to manage their assets as well as collaborate with others.

And the Universal feedback that we're getting from our customers is that's a very promising area for us to continue to innovate to help them be more productive as they share this content with their clients so we think that it's a very exciting area.

Great thank you.

Steve, one thing I wanted to point out as it relates to your previous question on the partner revenue related to the server business, even without that server revenue from that large partner, you would have seen a sequential growth quarter-over-quarter which is great news considering that Q3 tends to be a tough quarter.

Great.

Thanks a lot, guys.

Thanks, Steve.

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

Please proceed with your question.

Thanks.

Let me echo my congratulations on a nice quarter.

Two questions.

One can you just maybe update us on the build-out of your direct sales force and professional services organization and maybe give us a sense of the kind of productivity levels you're seeing and is that an area you guys are still adding on to.

And then secondly, curious as you're seeing more I guess Creative Suite integrated platform sales are you starting to see more volume licensing direct to customers.

I'm just curious as to how those trends are evolving.

I think with respect to your question on sales, Steve, I think one of the things we've talked about is investing and making sure that we have that direct sales force.

We're certainly seeing the direct sales force become a lot more productive.

I think the number deals that were getting greater than 50,000 is increasing.

We see repeat business from existing customers but fundamentally we believe that there is a large opportunity ahead of us in the Intelligent Document business and you will continue to see us invest in that particular area to make sure that we capitalize on that opportunity.

On the professional services side, our strategy is less one of driving revenue and more of making sure that we have our eyes and ears with some of the large key customers who want Adobe to be in there helping them develop their solutions so that we can use them as reference accounts and case studies to make sure we have repeatable solutions as well as to train our other SI partners and so our focus will be more on the direct sales side than it will be on the professional services side.

So Steve, in terms of licensing, what we're seeing and I think you're probably seeing it in other software -- package software companies is more and more of a movement from shrink wrap software to licensing and we've seen this trend now for a number of years and so as we've brought out of the Creative Suite we're also seeing an increase in licensing of volume licensing of the Creative Suite like we are with other products as part of an overall trend.

Have you noticed, I guess a number of seats going up as people are doing more volume licensing, just, you know, on a typical customer?

Well, it depends on the implementation, I believe, and Shantanu described a number of customers where they're making larger and larger deployments of the suite or InDesign.

In those particular cases you're going to see larger amounts from a volume purchase standpoint but there's still a full range of smaller licensing deals that can be a few seats up to those that, you know, can be over a thousand.

Okay.

Great, thank you.

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

Please proceed with your question.

Hi, thanks very much.

My first question is about the fact that it was referenced that August was slightly softer than usual.

I think Murray, you used that phrase.

If you could provide a little bit more detail on exactly why you think it was softer than usual, what particular products maybe were softer than usual.

That would be helpful.

The other question I have is in looking at the mid point of the guidance you gave regarding the share count, I'd say it's fair to conclude that it's a pretty significant increase relative to say the last four quarters on a sequential basis and I'm wondering if there's anything we should read into that?

And the last question I have, it's more of an observation.

We have seen the Intelligent Documents business essentially showing I'd say range-bound revenues over the last several quarters and I'm wondering if you have any thoughts about that generally?

Thanks a lot.

Scott, in terms of August, first of all, what we were commenting there was on Japan only, not on the rest of the business.

So in Japan, August is typically one of the weakest months of the year in terms of revenue and we would expect and did expect going into August that it would be a weak month.

What we'd noted was, it was just a little softer than what we had expected.

You know, I just a few weeks of data, we don't have a lot of points to make about why that could be the case.

Again it's their summer season.

A lot of vacations and what we typically see in September is that there's semi annual peer down, and you see a rebound seasonally from August into September and that's something that we are factoring into our targets we've set for Q4 is that sort of seasonal increase in demand.

So again, we were just referring to Japan only.

In terms of the share count, there's really four things that we look at in terms of the share count, it's what we believe the average stock price will be during the period what we're going to do from a share repurchase standpoint, how many stock options are exercised, and what kind of stock option grants there might be in the quarter and all four of those go into factoring the targets that we set for each quarter, and we're not in a position today to go through each of those details but that's the four components that go into that decision.

Okay.

Scott, regarding server revenue, I think it's important to take a step back and think about what we're accomplished there.

In the last two years we've gone from a relatively no position in that space to this year having a business that will probably exceed $100 million in revenue, the bulk of that being licensing revenue.

We've been able to establish ourselves as a component, as a significant component of SAPs brand new platform.

We have been able to partner with both IBM and EMC/Documentum to become their infrastructure for rich document or document work flow components.

Also when you look at, you know, there's a number of customers that we talk about that have bought at least $50,000 worth of server product over the last 5, 6, 7 quarters as well as those customers that we can talk about an indication of what they're doing with our technology, it's been a significant achievement for this Company.

In fact, if you look at Adobe's success that we're having in the enterprise with mission critical software vis-a-vis the rest of the enterprise software business, we are doing significantly better than just about everybody.

With that said, we are being prudent with our expectations.

We're still new at this, growing quarter-over-quarter is a great achievement, but we do think that this is a multiple-year effort.

And while we're not providing any kind of '05 guidance today I would continue to suggest that expect us to continue to grow the business at a rate at which we've been growing it, and it will take a number of years until we see the explosion that we think we could have, given the market opportunity ahead of us.

Thanks a lot for those answers.

And if I could one follow-up.

Bruce, you mentioned EMC Document and I'm kind of wondering if you could provide any increased detail regarding what you're seeing in terms for lack of a better characterization the ECM opportunity or ECM belated opportunity particularly as it relates to the forms business which I know is of increasing importance to Adobe?

Thanks.

Yeah, Shantanu probably has a little bit more of the details but what I will share with you is the excitement of Documentum being part of EMC allows us to take the opportunity or the relationship that we've had with Documentum and expand it into new areas around storage and our discussions with their management team, they see that same level of opportunity both in our forms business but also with storing assets from our Creative Professional business.

If you think about what we are doing around the Creative Suite, working on small work groups as those customers look to expand into more global solutions that are more enterprise-based you can see us partnering with folks like EMC and IBM and others.

So Scott, I think, more specifically in terms of the solutions, firstly I think all these content management providers, they are going up to archival and compliance as one of the key solution areas that they are targeting and making sure that they have an archival format such as PDF, is really important and strategic to them.

I think in addition to that building all these solutions for vertical industries such as a drop submission process does require a forms front end to all the data that's present in the content management system.

So I think, whether it's forms as a front end or the whole work flow it's rapidly becoming a necessity for them to be able to automate their business processes.

And finally as Bruce mentioned, we have a lot of the applications that people are using to create, you know, content for the Creative Professional and they want these content management repositories to be the place where people store those assets so I think just tremendous energy between us and the content management players.

Gentlemen, thanks very much for indulging me.

Thanks, Scott, next question please.

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

Please proceed with your question.

Thank you.

Shantanu, you mentioned that a new (INAUDIBLE) last week which are more designed for the consumer and hobbyist.

One of the things we've heard from -- consumers are interested in your products but they're very complicated to learn and often require training courses.

Is there going to be, is there any element to these new products that are going to significantly improve the time to productivity for consumers and hobbyists?

Yeah, let me just maybe talk a little bit about the customer segment that we're targeting with our products because if you look at the mainstream market beyond the Creative Professional, there's really sort of an entry-level consumer and there's a more advanced hobbyist and if you look at what we've done in imaging very successfully at the entry level consumer it's more about getting our brand out to them and getting the product.

The revenue opportunity is lower there.

Truly in the hobby (AUDIO DIFFICULTIES) hobbyist market that we are focused with our products and with the hobbyist certainly making it much easier to use than our professional products has been a priority for us both with Photoshop Elements as well as with Premier Elements I think the reviews reflect the job that we've done in making it easy for these hobbyists who do want to take a little time, who do care about the quality of their output, and so, you know, it's people who want to add that great professional looking effects to home video or home imaging that's our target customer.

The mainstream consumer, they want something that's much easier to use and that's available either through album or products that are directly within the OS, but yeah, we will continue to focus on these reviews.

The other thing that we'll do Tom, is we do know that many of our customers who are advanced hobbyists, not only do they want an Adobe product but they want the same exact product that the Creative Professional is using.

For example, Photoshop we know that the majority of the people who buy Photoshop are not creative professionals but they tend to be either advanced hobbyists or people at work who's trying to enhance their images for things like presentations and other activities.

Because of that we will continue to make our Creative Professional applications, products like Photoshop and InDesign, and Illustrator easier to use, certainly not cutting back on features.

But we do want to make the accessibility into the product a much quicker path, and, of course, we'll work with training companies as well as book publishers and many of you have caught on to that on making sure that there's lots of materials available for all of our products.

Got it.

You also mentioned I think that the InDesign product is doing well as part of the obviously the Creative Suite sale and licensing programs.

Can you talk a little bit about the publishing side.

I know that historically Quark (ph) has been pretty strong at the publishing side, have you gained traction there relative to Quark?

Do you feel that there's mor opportunity there?

Or are you pretty well penetrated on the publishing side as well?

No, I think InDesign continues to grow steadily in the publishing market.

I think that's the reason why customers like Meredith or BBC or Hurst that we talk about is to reflect the adoption that we're seeing of InDesign and frankly the entire Creative Suite platform within those customer segments, it continues to be an area of focus for us.

Is it displacement generally or is it more just an augmentation (INAUDIBLE) both of your products to satisfy sort of the broad population of users?

I think a number of them today use Quark but as they think about what they want the publishing platform for the future to be they're standardizing on Creative Suite as they move to OS-10 and the new hardware from Apple, I think they find that our solutions clearly a superior one.

It's no different than if you go back 10 years and you look at Microsoft Word, displacing WordPerfect.

It took Microsoft a number of years to displace WordPerfect and for many years Novell and then Corel had a nice size business because there are people who do want to stay with their current product.

But as we all seen over time, the laggards will follow the leaders with a switch and we believe the same will happen with InDesign vis-a-vis Quark.

Got it.

Hey, Bruce in terms of the server (AUDIO DIFFICULTIES) Intelligent Document for this quarter given that you have the one time contract in there, would it be a surprise if this was actually down sequentially this quarter given the potential large size of that OEM contract?

Yes.

I think, what you want to -- what we'd like to see and what we anticipate seeing is at a minimum a sequential increase factoring out that one large partner revenue payment that we had.

Whether it goes beyond that combined a little bit too early for us to tell.

But at a minimum we expect sequential growth factoring out that one large deal.

Fair enough.

Then finally, you had actually a little bit more momentum last quarter on the Apple side as a sort of percentage of the business it only changed by 1% but I'm just curious there was a component shortage over the summer in Apple's new machines that seems to have been resolved.

You also mentioned obviously softness in Europe during the summer.

Can you talk now about the -- specifically about the Apple.

Did you guys have a noticeable pause in the Apple business over the summer and has that rebounded?

No, the Mac I think continues to be a strong platform within the Creative Professional market and with the Creative suite.

Our customers continue to indicate that they plan on moving to new G-5 computers.

Okay.

And then as the time that they buy the G-5 is that the same time that they buy your product or does that come at a later -- later time periods?

I think traditionally when they get new hardware they do look for new software about the same time.

Okay.

Great, thanks a lot guys.

I appreciate it.

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

Please proceed with your question.

Hey, congratulations and Bruce if you could talk a little about the volume licensing.

You said there's a switch, more of an emphasis on that.

Is this rough numbers as far as a percent of business that's coming from the volume licensed channel?

Gene, this Murray.

So in terms of volume licensing, we mentioned that we have seen a overall trend more and more of our revenue is coming from license software sales as opposed to shrink wrap software sales so we're definitely seeing that trend on the Acrobat Desktop side this quarter.

We had 45.9% so a very strong quarter there.

That is the trend that we have seen.

Okay.

And then just in terms of Acrobat, you mentioned it's going to be in the first quarter, any color in terms of maybe earlier in the quarter versus later in the quarter.

Gene, we have not commented on the next release of Acrobat, no other timing of it.

I can assure you we're hard at work on upgrading the majority of our critical applications with Acrobat being one of them.

And as we've demonstrated with all of our major releases, the list of functionality and new markets that we could address is always significant and I would say the same would be true of the next version of Acrobat.

So please stay tuned.

I can assure you that fiscal year '05 will be a rich product year for this Company.

And that certainly is exciting to us.

And just in terms of Acrobat going into the next upgrade, historically it's been relatively strong last Acrobat upgrade, your second highest Acrobat quarter ever was the quarter previous to the upgrade.

Is there any reason why that trend would be different this time around or maybe better question is what are your thoughts kind of looking at historically versus this trend going into it?

We expect demand for Acrobat to continue to be extremely strong given the opportunity that the product has.

Okay.

Just one final question in terms of CS.

I know this question has been asked in probably a couple different ways.

But, is there just rough numbers as far as percent of the installed base or a percent of your registered users that have in some form upgraded to CS whether it be Professional or the normal version.

I think we've seen a large number of the customers who've upgraded make the switch from upgrading to an individual point product to upgrading to the entire suite and that's very pleasing.

We continue to believe there's a large untapped opportunity that we're still focusing on for more creative professionals to upgrade and so as they move to OS 10 as they continue to decide between upgrading to the point platform -- point products or the platform.

That's an area we'll continue to market the benefits of the solution to them.

When you look at the number of units that were shipped compared to the overall number of Creative Professionals, it's easy to see why we're excited about the future opportunities for that product.

Would you say that it's less than 50% has upgraded?

Yeah, absolutely.

Okay.

Great.

Congratulations.

Our next question comes from the line of Chris Roland from SunTrust Robinson Humphrey.

Please proceed with your question.

Yes.

Could you give us a little more detail on the license change that led to the $10 million one-time issue and then also can you explain the lease transaction on the two corporate buildings I think showed up with over a $100 million impact on the balance sheet?

Yes, so in regarding the licensing -- in July we launched Adobe Options 4.0 our new licensing program and that impacted a number of our different licensing programs, CLP, TLP, et cetera.

What happened was we moved to a daily receipt of orders from our license centers as opposed to on a monthly basis receiving orders and what we've done basically is we just caught up now so we're operating on a more daily basis receiving everything electronically where as in the past it was sorts of like a month delay.

And that's really what drove this increase.

It's not a pulling of revenue from Q4 into Q3.

Q4 will be a normal quarter of revenue.

I'd also like to add that some of the products did have a price increase as part of this new program and we look at the data.

We don't see anything that suggest to us that revenue from Q4 has moved into Q3 as customers were trying to take advantage of in some cases lower pricing so nothing material there suggests any of have happened.

So we've made the transition over in terms of the channel, with our customers, with systems, and we're into Q4 and expect to see a normal licensing quarter.

If it didn't pull from 4Q into 3Q why was there an impact?

Because what we've done in the past is is that on some of our programs we receive revenue from our license centers when they are reporting the previous month's revenue for licensing and we would just receive a report on a monthly basis.

What this is doing now is that instead of getting revenue one month in arrears it's bringing it right up-to-date to the current day so it was really just more of a catch-up than it was anything coming from Q4 back into Q3 so again no impact on Q4.

Great thanks, and then on the lease transactions.

Yeah.

So we refinanced two of our three towers here in San Jose as part of the lease transaction and as part of that we as a Company have purchased some of that rent receivable as any other bank would in the marketplace and in doing so we have an asset in our balance sheet of this lease receivable of about 127 million.

Great, thanks a lot.

Question comes from the line of Sterling Auty from JP Morgan.

Please proceed with your question.

Hi, guys.

Thanks.

Bruce, you mentioned the rich product year next year.

I'm just wondering outside of the top line growth that you expect to continue what that might mean to profitability.

We see the aggressive hiring in research & development.

How much investment do you feel is necessary to keep the Company growing at this pace?

Sterling, we're not prepared at this time to comment on fiscal year '05 business model.

We do plan on providing more color on the year a the analyst meeting next month.

We'll continue to do the right thing by both our customers, our employees, and our shareholders.

Certainly providing the right level of profitability along with that will allow for the right level of growth.

I think we've demonstrated the investments that we made in 2000, 2001, 2002, 3, have yielded a respectable growth.

Last year 11%.

This year we'll exceed it looks like we expect to exceed 25% so we'll continue to invest to ensure long-term growth.

Okay.

And then looking at the geographies, was the payment from the software partner accounted for in the Americas.

The Americas seem to have a very strong August quarter more than I might have expected.

Is there any other color that you can give to the geography?

Not material.

We're not in a position to be able to comment.

Okay.

And then last question would be in terms of -- if I remember correctly going back to last year, I don't know if government actually had budgeted for Acrobat 6 accordingly.

Is there maybe some opportunity here -- further opportunity with the U.S. government in the November quarter given their fiscal year end?

Yeah, certainly there's always opportunity.

We believe we've got some great products that provide solutions into that particular vertical, and we'll continue to look for opportunities in that space.

Yeah, and our guidance, that's certainly factored into our guidance for Q4.

Okay.

Thank you.

Thanks, Sterling.

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

Please proceed with your question.

Behind the Q4 guidance being sequentially up, are you assuming that Creative Suite will tail sequentially down a little bit and if so what are some of the other positive seasonal factors?

Would it be a pickup in consumer products.

Also are there end of fiscal year incentives for your enterprise sales force and I would also assume channel inventories must also factor into that.

But could you just review maybe some of the factors behind the sequential up guidance?

Yeah.

Keith, so in terms of the guidance for Q4 number one is that we always have seen in the past a pickup seasonally in Europe from Q3 to Q4 and we would expect that to happen.

We'd also expect to see a seasonal pickup in Japan from Q3 and we expect that to happen.

We'd also expect to see continued momentum with our CS products that we've seen all year to continue as well as continued solid demand for Acrobat and then, of course, we've got the launch of both Photoshop Elements and Premier Elements happening in the quarter so there's a number of factors that gives us a reason to set the targets we have for the fourth quarter slightly up from where we are in the third quarter.

Okay.

And if you look at the your enterprise business, licensed business, and server, it looks like 75 to $80 million, what percentage of that is now being influenced by partners such as IBM, SAP, Documentum, can you give a rough number there.

Yeah.

I think, Keith, the number that's being influenced by the partners is certainly increasing.

I would say the majority of the revenue that we're seeing today is still being driven by our direct sales force.

Where we're going out there and creating the solutions and the repeatability now is something that we will leverage to our partners to make sure we get the fan-out effect.

Okay.

And then finally on the software payment, it looks like that would be at least several million given the sequential pattern and server, does that imply a licensed partnership which seems like it might be something significant and might there be any follow-on revenues expected and when might we get more detail on this?

Yeah, Keith, you know, we're really sorry because of contractual requirements we really can't comment on the details of that relationship.

You know, that certainly factored in to our long-term planning having partners like IBM like SAP and Documentum/EMC are a critical component but we can't really talk about this one specific arrangement out of confidentiality clauses.

Well, will that be -- will something be forthcoming or is that just something you're not going to be able to talk about?

We're not going to be able to talk about it.

Okay.

Thank you.

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

Please proceed with your question.

Just one quick question.

Could you give us an update on where you are in Sarbanes-Oxley 404?

Gibboney, in terms of SOX 404, we are -- we've accomplished a great deal on SOX 404.

We continue to work it through, we're working with our external auditors as part of their work.

We have a year-end of November which makes us one of the first Companies in the U.S. to go through this process.

At this point we feel good about the progress that we've made.

No comments in terms of since like some of the early ones going to be sort of more common than not to have sort of at least some comments, material weaknesses or, you know, identifiable matters, any color there?

I sure hope not.

I mean, at this point we've worked hard.

I mean you got to remember, we really centralized the Company and did a lot of work starting really in 1999 and we've been working hard on this with our processes and controls that we've demonstrated for a number of years.

It's obviously been a lot of work over the past months on the Documentation to put it in the format from which SOX 404 calls for it.

We've had a very focused program.

We haven't had any issues internally in terms of restatements and those kind of things over the past years and we feel like, you know, we've done the things that we needed to do to put ourselves in a good position but obviously it's not he the end of the year yet and we need to complete the work to be in a position where we wouldn't -- we would have a unqualified opinion.

At this point in time we do not believe we have any material weaknesses.

Okay.

Thanks and great quarter.

Thank you.

Thank you.

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

Please proceed with your question.

Thanks.

No matter what you do in the four quarter which end of the guidance you hit you'll have a great year up north of 25%.

So part of that is Creative Suite.

Part of that is the point products, the sale, part of that is licensing, expanding the market.

So I'm just trying to get a handle on through all the moving parts and the way you've been expanding the market, first of all, do you think there's any organic improvement in the budgets and the attitude, and optimism of your customer base and if so -- in other words, organic growth and if so how do you determine that these days with so many new moving parts.

That's part one and I have a follow-up.

So, Bill, in terms of organic growth we do believe obviously that corporate marketing spin has increased over the last year.

And you can see that in many different ways including advertising spin and we've certainly benefited from that.

You know, one of the great successes of the Company is the diversification that we have across many different product lines and different market opportunities, a diversified customer base and so, yes, it's maybe more to manage, but it's more opportunity and we believe that it's been a great year for us this year and that again we have many opportunities in 2005 and beyond.

Okay,.

On that note I think I want to make sure I got this right.

I think Bruce said expect us to continue to grow the business at the rate we've been growing it.

I don't think anybody want to go out and write that you're going to do 27% revenue growth next year.

So just trying to get a handle on that.

The way you've been growing it this year's a great year, 27%.

Last year was 11%.

Maybe if you can just provide a little more color on what the rate we've been growing it actually means?

Thanks.

Yeah.

So Bill, let me clarify a little bit.

I did not mean to say I don't believe I actually said that we expect to grow at the same rate next year as we grew this year.

What I did hope to communicate was that given the investments that we've been making, given the opportunities that exist for the markets in which we participate in that Adobe will continue to invest for growth.

What that growth rate is for '05 or beyond is something that we're not prepared to talk about today.

We hope to provide more color about our beliefs around fiscal year '05 at the analysts's meeting, but I'm not prepared today to talk about anything beyond that.

We just are optimistic about our future both long term and also in the short term based on the results that you've seen this year, the results you saw last year and the many markets in which we serve and the products, technologies that we have, and the people in this organization.

Okay.

And then I actually have one more.

Murray, somebody asked before about Japan.

Clarification.

Did you say you expect sequential improvement in Japan in Q4?

What I said was that in August we had -- we saw some softness that was a little more than what we would typically expect to see in a typically seasonally weak month of August.

However, September is the semi annual period in Japan and we've seen in the past a improvement from August into September and that's what we've commented.

We have not provided any specific targets for any of our geographies for the fourth quarter relative to the third quarter.

Okay.

And I'd also like to say congratulations.

You guys are really knocking the cover off the ball.

Thank you.

Operator we'll take one more question please.

Our next question comes from the line of Harry Shernavassan from Banc of America Securities.

Please proceed with your question.

Hi, Bruce.

Can you comment on how the spend on regulatory compliance is affecting software purchases?

It would strictly be a guesstimate on my part.

I do believe that because of regulatory requirements having a document format like PDF as part of an organization's document work flow, both at the ad hoc level and at the more structured mission critical enterprise level is benefiting the Company.

Specifically it's really hard to quantify.

Okay.

Harry, I think just to add a little.

In terms of what the customers are using, our Intelligent Document solutions as far as we talked about, customers, there are a couple of drivers that I think are common across all of the customers.

The first is their desire to communicate electronically with their own customers and get closer to them.

Second is reduce cost of ownership, the third is compliance and trying to get a handle on all the documents and make sure it's in an archiveable format and finally to make sure that all the three things that I talked about, namely communication, reduced cost of ownership and compliance is happening in a secure fashion.

But as Bruce said, it's hard for us to look at the overall compliance and figure out what that has.

It's certainly one of the drivers of why people are looking at our Intelligent Document solutions.

Okay.

And Murray, one question on the margin outlook.

Historically the fourth quarter has been pretty strong from a sequential perspective.

And what you have guided to is roughly down sequentially in terms of operating margin.

Could you kind of give us some color on that?

Yeah.

So if you look at the fourth quarter we are planning on continuing to invest in our future so we look to continue to hire.

In the third quarter because of the seasonal, the number of customers that are on vacation we tend to spend less in marketing.

And you can see that on the sales and marketing line from Q2 to Q3 and also in the third quarter a lot of our employees are on vacation and we get some benefit of that and then the fourth quarter we don't get that so those are all really contributing to, you know, an increase in spending in the fourth quarter and a little bit lower margin.

Okay.

Thank you.

Thanks, everybody, for joining us today.

This now concludes our call and we do look forward to seeing you at our analysts meeting again, on October 26.

Have a great day.

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

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