Adobe Inc (ADBE) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Adobe Systems Q4 fiscal year 2004 earnings conference call.

During the presentation all lines will be in a listen only mode.

Afterwards, you will have the opportunity to ask questions. (OPERATOR INSTRUCTIONS)As a reminder, this conference is being recorded Thursday, December 16, 2004.

I would now like to turn the conference over to Mike Saviage (technical difficulty).

Vice President, investor relations Adobe Systems.

Please go ahead, sir.

Good afternoon.

Thank you for joining us today.

Joining in the call are Bruce Chizen, our President and CEO;

Murray Demo, Senior Vice President and CFO; and Shantanu Narayen, Executive Vice President of Worldwide Products.

On the call today we will discuss Adobe's fourth quarter and fiscal 2004 year-end financial results.

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

If you need a copy of the press release you can go to Adobe.com under the Companyand Press Links to find an electronic copy.Before we get started I want to emphasize that some of the information discussed on 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 December 16, 2004, and contains forward looking statements that involve risks and uncertainties.

The actual results may differ materially from those set forth in our statements.

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

During this call we will discuss non GAAP financialmeasures.

The GAAP financial measures that correspond to non GAAP financial measures as well as a reconciliation between the two are set forth in our press release issued today and are available on our website.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 at Adobe's investor website for approximately 45 days and 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 like to turn the callover to Bruce.

Thanks Mike.

For the second consecutive year, I'm pleased to report record revenue and outstanding profits for Adobe's fourth quarter and full fiscal year.

Q4 revenue is $429.5 million, representing 20 percent year over year growth.

For the year, revenue was $1.67 billion, an increase of 29 percent over fiscal year 2003.

Operating margin for the year was 35.5 percent which was significantly higher than our original target of 30 percent and helped generate year-over-yearnet income growth of 69 percent.At the beginning of the year, we said we would focus on growth, leveraging the investments we made to become more of a software platform company.

We delivered on that promise by expanding our commitment to the Creative Professional, extending our offerings for the digital photography and video markets, and executing on our vision of providing Intelligent Document solutions for our enterprise customers.

As a result, we exceeded our expectations in all four quarters, demonstrating the performance of a well diversified execution-oriented company.

I will now to the call over to Murray for a view of our financial results and then Shantanu will provide more detail about our performance in each of our business units.

Murray.

Thanks, Bruce.

Before I discuss Q4, I would like to comment on our full year 2004 results.

Adobe achieved revenue of $1,667,000,000 compared to $1,295,000,000 in fiscal 2003.

This represents 29 percent year-over-year revenue growth.

GAAP operating profit in fiscal 2004 was 591.8 million compared to 379.4 million in fiscal 2003.

This represents 56 percent year-over-yeargrowth in GAAP operating profit.

GAAP operating profit margin was 35.5 percent, compared to 29.3 percent in fiscal 2003, and GAAP earnings per share in fiscal 2004 were $1.82 compared to $1.10 in fiscal 2003.(technical difficulty) applicable excludes the partial reversal of prior restructuring charges was 591.8 million, the same as GAAP operating profit in fiscal 2004, compared to 378.9 million in fiscal 2003.

This represents 56 percent growth in non GAAP operating profit.For fiscal 2004 we achieved a non GAAP operating margin of 35.5 percent compared to 29.3 percent last year.

Non GAAP diluted earnings per share, which excludes as applicable, the partial reversal of the prior restructuring charges and investment gains and losses were $1.81 in fiscal 2004 compared to $1.14 in fiscal 2003.Now I would like to discuss our Q4 fiscal 2004 results.

For the fourth quarter of fiscal 2004, Adobe achieved revenue of 429.5 million.

This compares to 358.6 million reported for the fourth quarter of fiscal 2003 and 403.7 million reported last quarter.

GAAP net income for the fourth quarter of fiscal 2004 was 113.5 million compared to 83.3 million, reported in the fourth quarter of fiscal 2003, and 104.5 million last quarter.

Non GAAP net income which excludes as applicable investment gains and losses from the Company'sventure program and a minor reversal of a prior restructuring charge was 110.4 million compared to 83 million reported in the fourth quarter of fiscal 2003 and 105.6 million last quarter.

GAAP diluted earnings per share for the fourth quarter of fiscal 2004 were 45 cents based on 253.3 million weighted average shares.

This compares with GAAP diluted earnings per share of 34 cents reported in the fourth quarter of fiscal 2003, based on 245.5 million weighted average shares and GAAP diluted earnings per share of 42 cents reported last quarter based on 247.1 million in weighted average shares.Non GAAP diluted earnings per share for the fourth quarter of fiscal 2004, which excludes investment gains and losses, were 44 cents.

Gross margin for the quarter was 93.2 percent, compared to 93 percent in the fourth quarter of fiscal 2003, and 94.2 percent last quarter.

Operating expenses for the fourth quarter of fiscal 2004 were 253.8 million.

The increase from last quarter was due to higher sales and marketing expenses.

Regular employees at the end of the fourth quarter totaled 3,848 vs. 3,749 at the end of the third quarter of fiscal 2004.

The majority of the head count increase was in R&D.

Expenses as a percent of revenue breakdown as follow.

Research and development 18.6 percent, sales and marketing 32.7 percent, G&A7.8 percent.

GAAP operating income in the fourth quarter of fiscal 2004 was 146.4 million, or 34.1 percent of revenue.

This compares to GAAP operating income of 115.3 million or 32.1 percent of revenue in the fourth quarter of fiscal 2003 and 140.3 million or 34.8 percent of revenue last quarter.Non GAAP operating income which excludes as applicable a minor reversal of prior restructuring charge also was 146.4 million in the fourth quarter of fiscal 2004 or 34.1 percent of revenue.

This compares to non GAAP operating income of 115.2 million or 32.1 percent of revenue in the fourth quarter of fiscal 2003 and 140.3 million or 34.8 percent of revenue last quarter.

Other income for the fourth quarter of fiscal 2004 was 2.8 million.Adobe's effective tax rate for the fourth quarter of fiscal 2004 was 26 percent compared to 30 percent in the fourth quarter of fiscal 2003 and 26 percent last quarter.

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

Creative Professional segment revenue was 151.2 million in Q4 fiscal 2004, compared to 107 million in Q4 fiscal 2003, and 150.4 million last quarter.

Momentum has continued for our Creative Suites and CS products.Digital Imaging and Video segment revenue was 118 million in Q4 fiscal 2004 compared to 112.6 million in Q4 fiscal 2003, and 98.4 million last quarter.

The growth in the quarter was driven by the new releases of our hobbyist products.

OEM PostScript and other segment revenue was 20.4 million in Q4 fiscal 2004, compared to 20.9 million in Q4 fiscal 2003 and 19.4 million last quarter.Intelligent Document segment revenue was a record 139.9 million and Q4 fiscal 2004 compared to 118.1 million in Q4 fiscal 2003 and 135.5 million last quarter.

In Q4 total Intelligent Documents desktop revenue was 110.6 million, the second highest quarter ever.

Intelligent Document server revenue was 29.3 million and represents 50 percent year-over-yeargrowth.

Factoring out the significant software partner payment we received in Q3, our server revenue recorded its best full quarter to quarter sequential growth since the acquisition of XLeo (ph) in April 2002.Turning to our geographic segments the result in Q4 fiscal 2004 on a percentage of revenue bases were as follows.

The Americas, 49 percent, Europe, 32 percent, Asia, 19 percent.

The strength in the quarter was driven by better-than-expected results in the U.S. and Europe.

Application platform mix was 75 percent Windows and 25 percent Mac in the fourth quarter of fiscal 2004 which compares to 73 percent Windows and 27 percent Mac for the fourth quarter of fiscal 2003 and 73 percent Windows and 27 percent Mac last quarter.Our trade DSO in the fourth quarter of fiscal 2004 was 30 days.

This compares to 37 days in Q4 fiscal 2003 and 25 days last quarter.

In regard to our global channel inventory position, we into the quarter within company policy.

At the end of the fourth quarter of fiscal 2004, cash and short-term investments were $1,313,000,000 compared to $1,140,000,000 at the end of the third quarter of fiscal 2004.Turning to Adobe ventures, we realized an investment gain of 4.2 million in Q4 fiscal 2004.

In the quarter, we made additional investments of 4.9 million.

In total Adobe has invested 235.7 million through its venture partnerships and direct investments.

As of the end of the fourth quarter, the net returns in this program from a conception in 1994 were 360.3 million, including the stock dividend to stockholders and the market value investments still held by Adobe.

In regard to share buyback, we repurchased approximately 2.5 million shares in Q4 at a cost of 125.5 million as part of our share repurchase program.Adobe's Board of Directors declared this quarter's cash dividend of 1 1/4 cents per share payable on January11, 2005, stockholders of record as of December 28 2004.

This concludes my discussion on fourth quarter fiscal 2004 results.

Before I discuss our Q1 fiscal 2005 targets, I'd like to provide a brief update on management's pending report on internal controls of our financial reporting, also known as SOX 404.

As you know the SOX 404 process for fiscal year 2004 continues up to the point the Company filed its 10-K.

It will be at that time management will provide certification on internal control of the financial recording and our auditors will express their opinion on the effectiveness of our internal controls over financial reporting and management certifications.While I work on the SOX 404 processor fiscal year 2004 will continue until the 10-K is filed.

I'm pleased to report that as of December 16, 2004 no material weaknesses in our internal controls of our financial reporting have been identified.

Now I will discuss our Q1 fiscal 2005 targets.

We are targeting revenue of 435 to 455 million.

As a percent of revenue, our approximate operating model targets for the fourth quarter are as follows.

Gross margin, 94 percent;

R&D, 19 percent, sales and marketing, 31 to 32 percent;

G&A, 9 percent.

Resulting in a GAAP and non GAAP operating margin target of approximately 34 to 35 percent.

For our share count, we are targeting a range of 254 to 255 million shares.

For other income we are targeting approximately 3.5 million and for our tax rate we are targeting 25 percent.These targets lead to a GAAP and non GAAP earnings per share target range in Q1 fiscal 2005 of 45 to 48 cents per share.

We currently believe that targeted non GAAP GAAP results will not differ materiallyfrom targeted GAAP results.

We are also reaffirming today our full year fiscal 2005 targets we provided on Oct. 26.

We expect to achieve revenue of between 1.85 and 1.9 billion, with an operating margin target range of 34 to 35 percent.This concludes my comments.

I will now turn the call over to Shantanu.

Thanks Murray.

I will take the next few minutes reviewing highlights in each of our major businesses starting with the Intelligence Documents business unit.

In Q4 we achieved Acrobat Desktop revenue of 110.6 million.

Over all Intelligent Documents desktop licensing, as a (indiscernible) total desktop business was 47.2 percent in the quarter.

For the year we achieved Acrobat Desktop revenue of 438.2 million demonstrating continued adoption of PDF in enterprises and governments worldwide.Later this month we will begin shipping Acrobat Version 7.0.

As we discussed at our analyst meeting in October, a major focus of the new release will be to drive higher value uses of the product families beyond just PDF creation.

We are pleased to see many positive reviews and comments about the upcoming release.The Associated Press stated Acrobat 7 "gives powerful new features to not only others of electronic documents but also their recipients." (indiscernible) stated (indiscernible) because Adobe plans to change the way businesses share comments on documents.

And the Washington Times added "Acrobat 7 professional revolutionized the way an organization transacts business."

Thus far we have seemed strong distribution orders for the new product, building a healthy backlog as we enter Q1.

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

Intelligent Documents server revenue was 29.3 million in Q4, representing 50 percent year-over-year growth.

Driving this performance were a number of significant wins.

In the government market they include the Department of the Environment in Belgium which is using an Adobe lifecycle firm solution to generate personalized customer PDF forms for online and off-line usage.

And Visa, the national health surveillance agency in Brazil which will use Adobe workflow and Adobe lifecycle reader extension service, along with Adobe's (indiscernible) barcode solution to automate and streamline the internal processes and to automate external data and document capture.

Osaka and the Hiroshima Prefecture (ph), two government agencies in Japan. which have purchased Adobe lifecycle server products to implement electronic application except in systems.In the commercial market our enterprise service solutions are being adopted across a variety of vertical industries.

In Q4, key wins included Cingular Wireless which has chosen in Adobe document generation solution to create customized collateral for customers buying cell phones and cell plans at their approximately 12,000 locations.

Phillips in Europe, which is utilizing a document generation service from Adobe to generate output from their SAP system.

Toshiba Finance Corporation, which has chosen an Adobe e-form solution for their settlement workflow system.

And Helvetia Insurance in Switzerland which has implemented Adobe form server along with the IBM content manager as a platform to manage the formatting, delivery, and retrieval of the insurance policies across their agents' network.

In regard to the key quarterly performance indicators that we report.

In the fourth quarter the number of enterprise server transactions greater than $50,000 totaled 44 up from 39 last quarter.

The average size of these transactions was $219,000.

Turning to our Creative Professional business segment, we had another strong quarter.

Once again, driven by solid revenue for the Adobe creator suites.

We continue to see a revenue split of 3-to-1, premium to standard which has been consistent throughout fiscal 2004.

As evidenced by our Q4 results we also continue to see an extended adoption cycle by our customers for the New Suite platform we shipped more than a year ago.For the year we have achieved 66 percent growth in our Creative Professional business segment when compared to fiscal 2003.

In addition to the Creative Suite performance, standalone in design revenue has also helped drive growth in the segment.

In fact, Q4 was our strongest in design revenue quarter of the year.

At our analysts' meeting in October we discussed some of rkey in design customer wins this year.

We are pleased to add Macan (ph) worldwide and advance magazine group the parent company of Conde Nast to that list in Q4.Turning to our digital imaging business, Photoshop's standalone revenue has been steady throughout fiscal 2004 despite many imaging customers choosing the Creative Suite.

In addition we had a strong launchfor Photoshop Elements 3.0, our updated image hobbyist product which shipped during the quarter.

The new version adds new organization and sharing functionality as well as a new generation of image editing tools.Photoshop Element's 3.0 has already earned strong accolades.

PC Magazine gave it the Editor's Choice Award and stated, "Photoshop Elements 3 is the best single solution for fixing, organizing, and sharing your digital photos."

The Houston Chronicle added if you are in the market fa or graphics program for less than $100 nothing else comes close.

In our digital video business we shipped Premiere Elements 1.0, a new video hobbyist product.

Premierd Elements provides professional capabilities with an easy-to-use interface, including simple video capture and video editing tools and quick output to DVD.

Premiere Elements is off to a good start and is receiving rave reviews.

PC Photo Magazine gives it the Editor's Choice award and video systems magazine stated quote with Christmas around the corner I recommend Adobe Premiere Elements for the consumer crowd.Available as separate products Photoshop Elements and Premiere Elements can also be purchased in a single retail package.

This concludes my Q4 business segment review.

Bruce.

Thanks, Shantanu.

As you heard in our comments today Adobe is executing exceptionally well on its strategy.

As we move into fiscal 2005, we are well positioned for continued growth and to further leverage our strengths as a platform company.

As always, we will focus on the needs of our diverse and ever-expanding set of customers.

For Creative Professionals we will continue to enhance the value of the Creative Suite as well as deliver our promising new service on the next generation platform.

We also remain excited about offering our video solutions to these same customers.

And for the hobbyists and professional photographers who are migrating to digital workflows we will continue to innovate on our Photoshop platform to offer enhanced digital photography solutions.

For knowledge workers who need to reliably share and collaborate on important documents, we will deliver enhanced functionality with our new Acrobat 7 family of products.

And finally for enterprise customers we will continue to build out our lifecycle service solutions to help them automate business processes and increased efficiency and productivity.

Based on these significant opportunities, we are reaffirming our double-digit revenue growth target for fiscal 2005.

We look forward to reporting our progress to you throughout the coming year.

Mike.

Thanks Bruce.

Before we start Q&A I'd lot to announce the date of our Q1 regular intra quarter update.

We plan to issue the press release on Tuesday, February 1st after the market closes.

Those who wish to listen to a playback of today's conference call an audio recording of the call will be available from Adobe's investor relations website on Adobe.com later today.

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

Use Reservation No. 21215317. (Repeats instructions.) The phone playback service will be available beginning at 4 PM Pacific time today and ending at 4 PM Pacific time on Monday December 20, 2004.We will now be happy to take your questions which we trust will be limited to one question per person.

Operator.

(OPERATOR INSTRUCTIONS).

Jay Vleeschouwer.

Merrill Lynch.

Bruce, when you look back at 2004 and now you are planning to 2005 -- there is no question you had a successful year on the whole, but the question is, is there any product or strategy or intent you had that might have been in some way below plan?

For instance with version 7 of Acrobat, you've changed your pricing model for elements from the original model, you had to reconsider that.

Are there any other examples of anything that you've had to reconsider or rethink in terms of pricing or product strategy or anything along those lines as you did with elements, for instance?

Also now looking into '05, could you talk about the kind of incremental investments you are going to be making in services, support, direct sales, server R&D and the like?

First Jay, regarding your question on adjustments that we are making for '05, based on what we learned in '04.

First of all, let me just say, it is something we do on an ongoing basis.

We are constantly analyzing how our business which, this past year ended up being quite successful.

But at the same time we continue to look for ways to improve it or tune it without getting anything specific.

I think we shared with everyone the highlights at the recent analyst meeting.

There is nothing major that I could talk about at this point in time.

Of course as we release new products, product features, pricing of those products, we will take what we learned the prior year and make the necessary changes.

I think if you look at what we have done over the last three, four, five years it is an ongoing process.

Regarding additional costs associated with anything we might do, relative to services and support, nothing that hasn't been factored into our '05 guidance.

All right.

One follow up.

With respect to the design products are you seeing anything to suggest that you could have a large or as large a contribution from volume licensing for the design aps for CS in particular as you've clearly seen for Acrobat on the desktop besides the move to suites and the pro versions, you think volume licensing for the design application become a similarly large phenomenon?

In terms of the licensing, at our analyst meeting we also explained that over the past couple of years we have seen a migration of our revenue to more and more toward licensing.

And we would expect that trend to continue.

Our design products today also -- we see a fair amount of licensing with those products as well.

So we would continue to expect to say that happen over time.

As more and more large organizations adopt these products we can expect them to do that to licensing as opposed to shrinkwrap boxes.

Keep in mind with that said many of our Creative Professionals work in small graphic shops or they're individual contractors and we suspect that until they are able to do things like electronic software downloads through fast broadband lines that they will probably continue to buy shrinkwrap plus for many organizations even though their corporate purchasing people would prefer for them to buy through the proper corporate channels, many of them find it more convenient and easier just to buy the shrinkwrap products from their local reseller.

Ben Reitzes with UBS.

With regard -- how did the quarter end with regard to backlog and, Bruce, how would you say the economy is right now especially with regard to the creative pro and then maybe if you could just discuss the timing of Acrobat.

Again are you on track for everything this month?

And then how we see that ramp throughout the first half of the year and any thoughts on the Creative Suite in the second quarter?

Those are all my questions.

In terms of backlog we announced, obviously, the next version of Acrobat in November and with that announcement we received strong orders for our Acrobat desktop products and also for the Creative Suite Premium which includes Acrobat Professional.

So we ended the quarter with a quite high level of backlog but of course what is important about that is we need to see the sell-through in Q1 after we release the products to determine to what degree how strong that backlog really is.

So the end of the quarter in great shape with backlog entering Q1.

Regarding the market or the environment for Creative Professionals, we continue to see what we saw as we moved through 2004 which was a very stable environment.

We are finding that most corporations around the world have increased over the last 12, 14, 15 months or so their expenditures on marketing and they are marketing at promoting their products and services which helps fuel the demand for Creative Professionals and their services which helps fuel the demand for Adobe's creative Creative Professional products.

And with respect to your question on Acrobat we are intending to share Acrobat 7 prior to the end of this year.

However bulk shipments in English will release our shipment in early January; and the intent is to ship the other major languages -- French, German, and Japanese -- later in Q1.

And with respect to CS2 we are not announcing anything at this point.

However as we did say we will be shipping a new version a new platform sometime during the fiscal year.

Operator:Tom Berquist with Citigroup.

Tom Berquist: I'll try to make it a two-part one question.

First you mentioned a reversal on the Mac platform.

We had heard that there would be component shortages on the Mac last quarter and thought that might reverse a bit this quarter, but the waiting went down.

Like to hear a little bit more about why that was the case abd also whether or not that was tied to specifically (indiscernible)sales of products like for example Creative Suite?

Tom, with respect to the application platform mix between Mac and Windows.

The difference was really driven more by the hobbyist products which were more heavily skewed towards the Windows platform.

On the Creative Suite we continue to see strong adoption on the Macintosh platform but the difference between Q3 and Q4, again, was driven primarily by the hobbyist problems.

When you say hobbyists, do you mean hobbyist in stand-alone Photoshop or stand-alone Premier or Premier Pro or how do you look at that?

The hobbyist products include Photoshop elements and Premier elements and the bundle that has Photoshop elements and Premiere elements.

Tom Berquist:Would that hobbyist category also include consumers' purchasing Photo Album and some of the other products?

Again, I think the primary driver of the difference was Photoshop elements and Premiere elements.

In terms of expectation on that business this quarter would you expect to see this platform stay relatively constant or do you think it shifted in any one direction?

We're not really providing any targets for a Mac split 1 for Q1 at this time.

So we do not that with the launch of Acrobat it tends to be on the Windows platform so that could skew it towards Window.

But we need to see the whole mix of our product shipped throughout the quarter and we will report on that at our Q1 call.

Gene Munster with Piper Jaffray.

Gene Munster: Bruce, I thought you mentioned in there promising new service on next-generation platform of Creative Suite.

Is there anything unique or is there anything more to talk about on that front?

Is this a new revenue item where potentially you could be talking about?

Yes.

One of the things we have been talking about for a number of years now was the opportunity to sell both more product and services to the Creative Professional.

They are very loyal to Adobe.

We continue to try to innovate to serve their needs and as we -- I think we have done with the Creative Suite, we continue to do a really good job.

The -- regarding a new service we will have a new service.

It will be a multiple year opportunity in terms of revenue.

We do think it will be exciting.

We did at the Anallyst meeting somewhat used stock photography as an example of a potential new service and we hope to be able to offer something like that for our customers, along with the next release of the Creative Suite.

(technical difficulty) something that is measurable or or is this just going to be incremental?

In fiscal 2005 it is probably not material.

We hope that in the outer years that it could be material.

Gene Munster: The second, I guess, just relative some of the street was looking for you guys basically front end loaded the year in a sense.

Is there anything that is making you more optimistic about the first quarter and less optimistic about the back half?

What should we read if anything into that?

We are talking 1.85 to 1.9 billion for fiscal year '05 and at our analyst meeting, we stated that we believe that Q1 would be the lowest quarter of the year in revenue.

So, obviously, we are targeting record levels of revenue again in Q1.

We are off to a great start in 2005 but our expectation is that it will be the lowest quarter of the year in revenue.

Sasha Zorovic with Oppenheimer & Co..

The DSLs are slightly up sequentially and the server revenue is slightly down.

Could you comment on that?

The first question was on DSLs?

Yes.

So the DSO was up slightly from last quarter.

First of all (technical difficulty) 30 days terrific performance but it is up a few days from last quarter and that is primarily driven by the fact that our hobbyist product shipped in the second half of the quarter.

And we saw strong performance with those products and so we will get to collect on those shipments in the first quarter and that is what really drove our DSO up five days from Q3.

With respect to the server revenue, Sasha, we were actually pleased with the performance in Q4.

If you factored out that significant software partner payment actually the largest full quarter to quarter sequential growth; and we continue to see adoption of our lifecycle server platform in government and financial institutions worldwide.

Steve Ashley, Robert Baird.

If we look at the server business, which of your partners are most active today, committing resources and building out the ecosystem to support that?

So Steve on the server side, if you look at the ISV partners, we are spending more time with SAP and IBM than with the other partners and EMC Documentum.

So those are the three software partners with whom we are seeing quite a bit of effort.

On the SI side there are a number of them all around the world, including the ones that you might expect such as IBM global services but there are a number of them in the government.

The tend to be partners that are closer to government in each of the different countries.

And in terms of their resources contributing to our joint efforts, IBM EMC/Document and SAP, all three of them are depending on our platform for different components of their business.

For example, SAP continues to look at using our interactive forms as an integral component to their Net Weaver platform which means over time all of their applications will be dependent upon it.

And that does require effort on their part to make it happen.

In the case of somebody like IBM many of their go to market solutions, the solutions that they are selling and marketing to their customers rely on the Adobe Lifecycle components to make them successful.

In the case of somebody like Documentum, they OEM a number of our solutions to complete their solutions to their customers.

So when we talk about the three partners being strategic it is not only strategic from an Adobe perspective, we believe they are very important partnerships for those three organizations.

Great and, Murray, the G&A expense declined sequentially $3.4 million last year, in the same period it rose slightly.

Is there anything related to that decline or color you could provide on that?

Really probably the primary one is we had lower legal expenses in the quarter and that is what primarily drove it.

As we look into Q1 of '05, we expect to see the expenses higher and we are going to continue to invest in all the functional areas to support the infrastructure and the growth of the Company.

Stephen Jue, RBC Capital Markets.

Stephen Jue: I just had a question around the next Acrobat cycle.

Obviously the percentage of licensing, the percentage of desktop revenue is now close to 47 percent versus, I think, the low 40s last year.

As people upgrade in the cycle how does the volumelicensing impact sales cycles or are people entitled to the upgrade?

I'm just wondering how that processing works this time around?

Steve, really, it's not going to be much different than in past cycles.

You could either buck maintenanceand get the upgrade when it comes out or you could choose to upgrade your licensing or shrinkwrap once we launch the new products.

We have seen an upward trend in the licensing as a percentage of revenue as larger organizations are adopting our platform and choosing licensing as the way to purchase the product.

We would expect over time that trend to continue.

The licensing as a percentage of revenue can note change from quarter to quarter, based on seasonal factors or we are draining the channel, and we are shipping more, less shrinkwrap products in advance of a new launch.

That can also have an effect on the overall percentage.

So the trend has been up.

We expect it to be up.

It can still bounce around from quarter to quarter; and we are excited about the launch of Acrobat 7.

Are most people on a maintenance stream with that licensing -- net volume licensing program typically?

Typically they are not.

With Adobe and our products, they tend to buy it when the upgrade comes out and we don't go through the maintenance approach.

Sume do, but far majority don't.

Brent Thill with Prudential Equity Group.

(indiscernible) professional as a percent of revenue showed a really nice uptick this year and Intelligent Docs fell a little bit.

Would we expect Intelligent Docs to pick up the pace in terms of overall percent of revenue this year?

In terms of the revenue mix.

Yes, Brent, so given the fact that we are shipping Acrobat 7 early in the year and we continue to be very excited about the significant opportunity that we have in our server business, we would certainly expect to see great strength of those products, those businesses in 2005 and that could lead to a higher percentage of revenue in 2005.

Murray, if you could just touch on the currency impact and should we be using 25 percent for the tax rate for the full year model?

As far as the currency we did have some benefit in the fourth quarter.

It was about $12.5 millionboth for the euro and the yen.

In terms of the tax rate we are targeting 25 percent right now.

In past years, what we targeted in Q1 has tended to hold throughout the year.

Clearly this year with the Jobs Creation Act out there and the potential for coming back to Adobe to take advantage of the lower tax rate on the repatriation of our offshore cash and earnings, we will have to see how that plays out.

But for right now we are targeting 25 percent.

Operator:Sterling Auty with J.P. Morgan.

Sterling Auty: The schedule that you talked about in terms of the shipping of Acrobat 7 has that been the schedule that you have been holding to?

In other words, has there been a movement in the and Murray or Shantanu I think you mentioned the international versions are actually going to ship in the later part of the first quarter.

Is that actually shipment for revenue from the international versions in the first quarter?

Yes so first the schedule has stayed consistent with our expectations and the shipments for international versions -- French, German, and Japanese -- will be for revenue in Q1 of 2005.

One follow-up question which is, the hobbyist -- the Photoshop Elements did very well in the quarter.

Can you talk to us a little bit about the adoption cycle or the product cycle on those items?

Should we see that also being a little bit longer than what we have seen historically, given the continued good uptake of digital photography?

For the Creative Suite? (MULTIPLE SPEAKERS)

Photoshop Elements.

Yes, for Photoshop Elements we continue to believe that digital photography is one of the key drivers of adoption.

And I think with the new product we continue to believe that organizing, sharing of these images as well as the image editing functions will continue to be drivers.

I think the other thing that is happening is you are seeing a lot more people also use imaging in conjunction with video, which is why we are excited about the fact that we have Premier and Photoshop Elements.

I will also add that these products are focused on retail; and retails tend to be very strong around the holiday season.

So there are seasonal factors in this particular business because the customers tend to purchase quite a bit around the holiday season and they can do that less so in the summer months.

Keith Gay with Thomas Weisel partners.

Keith Gay: A few financial questions.

Gross margin you were targeting 94 percent drop-down and 93.2 and now you are targeting 94 percent in Q1 so could you just give some color there?

Secondly, preferred revenue had a nice sequential jump by about 12 million which is the largest amount in a number of quarters looking back and just some further color there.

Finally you are showing a share count increase in your Q1 guidanceby about 4-5 million shares so can you just comment on possible buyback plans or the possibility of offsetting that sharecount increase?

In terms of the gross margin we came in at 93.2 percent in the fourth quarter.

The variance from the 94 percent was due to a technology license payment in the quarter and for Q1 we expect to be back up at the 94 percent range.

Primarily driven by this technology license payment.

In terms of deferred revenue it was up quite a bit from last quarter and due to three factors.

One is that we saw the number of customers choose to buy maintenance of our Acrobat products in advance of the launch of Acrobat 7.

Two is that as part of offering a free upgrade to those who buy Acrobat 6 during the channel transition, we have to divert revenue around that free upgrade so we have that; and that will tend to reverse itself back in subsequent periods.

And then, lastly, our server business continues to grow and we continue to see increases in deferred revenue associated with that business.

Really three factors driving the increase in deferred revenue.As far as the share count?

The share count is up basically because the stock price has come up quite a bit. (indiscernible) obviouslyexecuted and stock price is a reflection of that and that has been driving a higher share count.

We continue to look at our cash.

We believe we have excess cash.

We have used repurchase as the most efficient way to return it to shareholders and we'd expect to continue to repurchase stock on a go forward basis.

(OPERATOR INSTRUCTIONS) Chris Rowen with Robinson Humphrey.

Can you recap the key drivers fourth the sequential increase in marketing and the key drivers for the guided sequential increase in G&A for Q1?

In terms of the operating expenses we, from Q3 to Q4, we saw an increase in sales and marketing associated with a major effort around advertising.

As we go into the first quarter with the launch of Acrobat 7, we will continue to have a number of marketing programs to support that launch and drive revenue growth.

I will continue to invest in our go to market capabilities across our sales organization given the opportunities that we have.

In G&A we would expect to see our legal expenses be higher as well as across all our functional organizations.

The Company has grown quite a bit now in the last two years; and we need to continue to invest in our infrastructure to support the growth that we've had and the growth that we expect in subsequent periods.

Chris Rowen:So the marketing was mostly consumer advertising?

Sequential difference?

No the number of areas that clearly we've done quite a bit in terms of advertising around our lifecycle platform, we've had a number of ads you might have seen out in The Wall Street Journal.

We have had a major effort around that as well as obviouslywe have watched our hobbyist products and continue to sustain all our other products.

So big effort that occurs typically in the fourth quarter and the third quarter we tend to spend less in marketing because many of our customers are on vacation.

So the transition from Q3 to Q4, you would expect to see this increase in sales and marketing.

I think what you are seeing, Chris, is that we are committed to investing in our business, long-term opportunities for this Company are significant.

Yet at the same time, we continue to deliver what we believe to be outstanding operating margin profits.

We targeted in fiscal year '05 somewhere between 34 and 35 percent operating margin profits which is our highest ever in terms of targets on a going forward basis.So despite the investment, we believe we are delivering the appropriate level of profitability back to our shareholders.

Great.

I wasn't passing judgment, just trying to get the components.

Thanks a lot.

George Godfrey, with Columbia Management Group.

Just a question to follow-up on one of the prior questions.

That was the option issuance program.

I heard the comment that the reason why the share count is up because of the price and the stock is up but also the option program seems quite generous.

Can you go over what your plans are for the current fiscal year?

Again what we do in terms of granting options, because we are looking at the competitive marketplace and where we believe we need to recruit and retain the best.

We want to make sure we have appropriate option plans.

But at the end of the day, our shareholders are the ones that are approving our option plans.

So the option grant levels are down considerably from where they were a few years ago because of the supply and demand for labor has changed materially the last two years.

With the fact that the Company has performed exceptionally well in 2004 our stock price has gone up.

It had an impact in raising the share count.

In total for 2004 it was up only 1.9 percent.

No, I asked for fiscal '05 -- what the option plans are going forward?

We haven't communicated any as of this time but that will be up to our shareholders as part of what we do in 2005.

Murray Demo: Our intent is to be competitive in the marketplace and we will certainly when we issue our proxy we will put in our request.

And we hope that you will view as investors will do the right thing for us.

We have demonstrated over the last 5, 6, 7 years that we are a company that performs and that our employees only benefit if we perform and shareholders also benefit at the same time.

Operator, we will do one or two more questions, please.

Barbara Coffey with Brean Murray.

I have a question about the adoption into the different verticals.

You have spoken about the financial vertical and the government vertical.

Are there plans to take these other verticals into your go to market strategy in that way?

With respect to the Intelligent Document business, Acrobat and Lifecycle, we have plans to make it far more appropriate in different verticals.

The Acrobat product on the desktop certainly is being adopted by all verticals but in addition to that we have identified manufacturing as one of the verticals with increased and enhanced 3-D support that we will target.

On the Lifecycle set of products, clearly, financial services and government has been the initial focus for us.

Regulated industries is where we intend to continue to deepen our presence with our Lifecycle server of products.

Verticals including pharmaceutical and manufacturing where the requirement really is for high fidelity documents which really play well to the strength of the solution that we deliver.

Will you be going in a more direct way as to your partnership to these newer verticals?

At this point the primary revenue that we get on the Lifecycle server business is to our direct, but clearly the strategic partnerships that we have.

With SAP's presence in the manufacturing market, we believe that that will represent opportunity for us to also work with SAP to further penetrate that vertical.

And similarly document them as very powerful as we know in the pharmaceutical market.

We will do one more person, Operator.

(indiscernible) Bank of America.

Bruce did you see any -- given the imminent release of Acrobat in December has that affected any purchasing decisions from customers in this quarter?

It is hard to say whether people held off or not.

However it is exciting to see that, despite the fact that we announced the product in the middle of November, it was still our second best quarter ever.

Clearly the channel once we announced started placing orders for Acrobat 7.

And we no longer for the most part provided them with the current version Acrobat 6.

Which is why we had a healthy backlog for both Acrobat 7 as well as those products that contain Acrobat 7 which predominantly means the Creative Suite Premium edition.

I am also trying to understand the strength of In Design.

What are the factors that can push customers to buy In Design vs. the Creative Suite?

I think you know first Creative Suite is really where the primary focus of our marketing efforts are, and that is because we believe that the integrated package is where everybody derives the most value.

The reality is that In Design adoption has steadily increased against Quark.

And we have said that Quark certainly has had huge penetration but quarter after quarter, more and more enterprises are adopting In Design.

So page layout market tends to be a market where, whether you're using it for brochures or newspapers or magazines, we want to see continued adoption by these enterprises and given how broad the usage of page layout is, we expect to continue to see In Design gain marketshare from Quark.

In addition to its adoption within the Creative Suite.

There's two major reasons why customers choose In Design over the competition.

One is it makes them that much more productive and efficient because it works extremely well with the other tools in the toolbox, many of which are provided by Adobe.

The second is, they get a better design and typically a better design means more people will read their publications.

And that is the reason why organizations like Conde Nast, Merit of Communications, Heast magazines and other large magazines and newspapers published around the world have chosen to move to In Design despite the fact they already had an entrenched product.

Well this concludes our call today.

We thank everybody for joining us.

Thank you.

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

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