Adobe Inc (ADBE) 2005 Q2 法說會逐字稿

Good afternoon.

At this time, I would like to welcome everyone to the Adobe Systems Q2 fiscal year 2005 earnings conference call. [OPERATOR INSTRUCTIONS] After the speakers' remarks there will be a question and answer period.

Thank you.

I would now like to pass the call over to Mr. Mike Saviage, Vice President of Investor Relations at Adobe Systems.

Please go ahead, sir.

Good afternoon.

Thank you for joining us today.

Joining me on the call are Bruce Chizen, our CEO, Murray Demo, Executive Vice President and CFO, and Shantanu Narayan, President and COO.

In the call today, we'll discuss Adobe's second-quarter fiscal 2005 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 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 product plans is based on information as of today, June 16, 2005, and contains forward-looking statements that involve risks and uncertainties.

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

For discussions of these risks and uncertainties, you should review Adobe's SEC's filings including our Annual Report on forms 10-K for fiscal year 2004 and our quarterly reports on form 10-Q in fiscal 2005.

Some of the subject matter in today's call will cover Adobe's acquisition of Macromedia .

Information about the acquisition will be available in a forthcoming registration statement on form S-4 and in a joint proxy statement and prospectus to be filed with the SEC.

After its filing, it may be obtained at no charge from the SEC Website or from Adobe's or Macromedia 's Website.

We urge to you review these documents as they will contain important information about the planned acquisition.

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 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 purpose.

The audio of the call will be archived on Adobe's Investor Relations Website for approximately 45 days and is the property of Adobe Systems.

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

I would now like to turn the call over to Bruce.

Thanks, Mike.

I am pleased to report that our strong business momentum continued in the second quarter as we achieved record revenue of $496 million, representing 21% year-over-year growth.

This was our eighth consecutive quarter of double-digit revenue growth on a year-over-year basis.

The quarter was driven by record demand for the Creative Suite and ongoing adoption of our Acrobat Solutions.

In addition our enterprise server business continues to show momentum as the number of transactions over $50,000 grew to 60, up from 39 last quarter.

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

And give an update on our acquisition of Macromedia .

Murray?

Thanks, Bruce.

For the second quarter of fiscal 2005, Adobe achieved record revenue of 496 million.

This compares to 410.1 million reported for the second quarter of fiscal 2004 and 472.9 million reported last quarter.

On a year-over-year basis, this represents 21% revenue growth.

GAAP net income for the second quarter of fiscal 2005 was 149.8 million, compared to 109.4 million reported in the second quarter of fiscal 2004 and 151.9 million last quarter.

Non-GAAP net income, which excludes as applicable; investment gains and losses from the Company's venture program and the net tax impact of the planned repatriation of certain foreign earnings was 142.9 million compared to 108.8 million reported in the second quarter of fiscal 2004 and 133.8 million last quarter.

GAAP diluted earnings per share for the second quarter of fiscal 2005 were $0.29, based on 508.2 million weighted average shares.

This compares with GAAP diluted per earning per share of $0.22 reported in the second quarter of fiscal 2004 based on 493.9 million weighted average shares and GAAP diluted earnings per share of $0.30 reported last quarter based on 506.2 million weighted average shares.

Non-GAAP diluted earnings per share for the second quarter of fiscal 2005, which excludes investment losses and the net tax impact of the planned repatriation of certain foreign earnings were $0.28.

Gross margin for the quarter was 94.5%, compared to 93.4% in the second quarter of fiscal 2004 and 94.3% last quarter.

Operating expenses for the second quarter of fiscal 2005 were 286.4 million.

Regular employees at the end of the second quarter totaled 4,207 versus 4,016 at the end of the first quarter of fiscal 2005.

The majority of the headcount increase was in R&D and sales & marketing.

Expenses as a percent of revenue break down as follows: research & development 18%; sales & marketing 31.2%;

G&A 8.5%.

GAAP operating income in the second quarter of fiscal 2005 was 182.2 million or 36.7% of revenue.

This compares to GAAP operating income of 141.8 million or 34.6% of revenue in the second quarter of fiscal 2004 and 170.7 million or 36.1% of revenue last quarter.

In each of these quarters, GAAP and non-GAAP operating income and operating income as a percentage of revenue were the same.

Other income for the second quarter of fiscal 2005 was 8.3 million.

Adobe's effective tax rate for the second quarter of fiscal 2005 was 20.2%, compared to 26% in the second quarter of fiscal 2004 and 14.1% last quarter.

Our tax rate last quarter and this quarter included a net tax impact of the planned repatriation of certain foreign earnings, excluding this benefit, our non-GAAP effective tax rate last quarter and this quarter was 25%.

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

Creative professional segment revenue was a record 184.4 million in Q2 of fiscal 2005, compared to 153.4 million in Q2 fiscal 2004 and 160.7 million last quarter.

The strong initial launch of our Creative Suite 2 releases drove the record revenue performance.

Digital imaging and video segment revenue was 115.9 million in Q2 fiscal 2005, compared to 100.3 million in 2Q fiscal 2004 and 106.6 million last quarter.

The increase in revenue from last quarter was primarily due to the shipment of Photoshop CS2.

OEM, postscript and other segment revenue was 19.5 million in Q2 fiscal 2005, compared to 20.3 million in Q2 fiscal 2004 and 20.7 million last quarter.

Intelligent document segment revenue was 176.2 million in Q2 fiscal 2005, compared to 136.1 million in Q2 fiscal 2004 and 184.9 million last quarter.

In Q2, total intelligent document to desktop revenue was 149.8 million, representing 33% year-over-year growth.

As expected, intelligent document to desktop revenue declined from last quarter due to the launch of all major languages of Acrobat 7 in Q1.

Intelligent document server revenue was 26.4 million.

Turning to our geographic segments, the results in Q2 fiscal 2005 on a percentage of revenue basis were as follows: The Americas, 49%;

Europe, 29%;

Asia, 22%.

Adobe experienced solid demand across all major geographic segments.

Application platform mix was 74% at Windows and 26% Mac in the second quarter of fiscal 2005, which compared to 72% Windows and 28% Mac for the second quarter of fiscal 2004 and 76% Windows and 24% Mac last quarter.

Our trade DSO in the second quarter of fiscal 2005 was 32 days.

This compares to 23 days in Q2 fiscal 2004 and 27 days last quarter.

DSO on trade receivables was higher this quarter due to the timing of the CS2 shipments in the last month of the quarter.

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

At the end of the second quarter of fiscal 2005, cash and short-term investments were $1.691 billion, compared to $1.467 billion at the end of the first quarter of fiscal 2005.

In regard to share buyback, we repurchased approximately 1.4 million shares in Q2 at a cost of 47.2 million as part of our share repurchase program.

This concludes my discussion on second-quarter fiscal 2005 results.

Now we will discuss our Q3 fiscal 2005 targets.

Our Q3 target assumptions include the initial major shipments of French, German and Japanese CS2 products.

The major French and German shipments begin in the first week of Q3, and the Japanese products are expected to begin shipping in a few weeks.

In addition, our Q3 targets reflect the normal summer weakness that we experience every year in Europe and Japan.

Based on these assumptions, we are targeting a Q3 revenue range of 470 million to 490 million.

As a percent of revenue, our approximate operating model targets for the quarter are as follows: gross margin, 94%;

R&D, 20%; sales & marketing 29% to 31%, G&A 9%.

Resulting in a GAAP and non-GAAP operating margin target of approximately 34% to 36%.

For our share count, we are targeting a range of 511 to 513 million shares.

For other income, we are targeting approximately 9 million to 10 million.

And for our effective tax rate, we are targeting 25%.

These targets lead to a GAAP and non-GAAP earnings per share target range in Q3 fiscal 2005 of $0.25 to $0.27 per share.

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 creative professional business unit.

We achieved record revenue in Q2 with the launch of our Creative Suite 2 products.

This performance was driven by adoption of the Premium version of the Suite, which on a revenue basis, is outselling the Standard version by a 3-to-1 ratio.

In addition, we are experiencing the expected shift towards customers adopting the Suite platform.

Creative Suite 2 is designed to accelerate design and publishing work flows for print, the Web, and the latest generation of handheld devices.

It integrates new full versions of Adobe's design software along with version Q CS2 and a new visual file browser called Adobe Bridge.

The press reaction to CS2 has been positive. "PC Magazine" said, "with version 2, Adobe has made sweeping improvements to the functionality and integration of all the included programs and even topped the whole package off with a more attractive price".

CNET added, "if you have used any of the individual products in the past, we think CS2 Premium is a worthy upgrade".

In addition the new additions of the CS2 products, Photoshop, Illustrator and InDesign have received strong reviews. "PC magazine" gave InDesign CS2 a perfect 5 out of 5 rating and CNET called Illustrator CS2 "the best tool of its kind" and gave it an Editor's Choice Award.

Turning to the intelligent documents business unit.

In Q2, we achieved Acrobat desktop revenue of $149.8 million representing 33% year-over-year growth.

Licensing, as a percentage of Acrobat revenue was 47.2% higher than last quarter due to the typical one quarter lag in licensing following a major product introduction.

The adoption of Acrobat 7 was also strong in newly targeted verticals such as manufacturing and AEC, architecture, engineering, and construction.

For example, Airbus, a leading aircraft manufacturer, will deploy 32,000 seats of Acrobat 7 throughout the Company over the course of this year for PDF document generation, collaboration, security, and archival.

In our life cycle server business we continue to see broad customer adoption of our solutions.

Intelligent documents server revenue grew sequentially and year-over-year to $26.4 million in Q2.

The number of transactions with software licensing revenue greater than $50,000 in the quarter grew to 60, up from 39 last quarter.

The average of these transactions was $119,000.

Helping drive this performance were key wins in the government market, which included, the Citizenship and Immigration Services Agency of the U.S.

Department of Homeland Security, which is utilizing our form solution to collect information to administer benefits and services to its constituents, such as work authorization permits and naturalization of qualified applicants for U.S. citizenship.

The Australian Department of Industry Tourism and Resources, which is building an online resource for small businesses using an Adobe forms and security solution to ease the burden of compliance reporting and improve the quality of service delivery.

The Swedish police force, which is using an Adobe electronics form solution to streamline their reporting processes and decrease the amount of time their police force spends at their desks.

And the State of Oregon, which is using Adobe Reader Extension Server and Adobe Form Server to streamline online application completion and processing.

In the Commercial market, key wins in Q2 included Beth Israel Deaconess Medical Center, a Harvard affiliated hospital, which will utilized Adobe's Form Server and Adobe's Reader Extension Server to take its records to 80% electronic in the next two years.

They will automate over 400 forms, resulting in greater cost savings, quality improvement, and increased patient satisfaction.

Gjensidige, one of Norway's largest insurance companies, which will use Adobe form's technology in its new IBM Websphere extranet for corporate insurance customers.

AMP, one of Australia's leading financial services companies, which will use Adobe Reader Extension Server and 2-D barcode technology to streamline key business processes related to forms filled in by their financial planners and end-customers.

Approximately 50 key forms have been targeted for development into interactive forms, including both offline business logic and 2-D barcode capabilities. [Atoffs Origin] One of Europe's leading systems integrators and consulting firms, which will use Adobe's document security server to apply digital signatures to financial documents to comply with electronic document archiving regulations.

And Euronext, the largest Pan-American exchange, which will deploy Adobe's LifeCycle Policy Server to preserve the confidentiality of information, manage access rights and control user actions on documents it sends outside of its organization.

Adobe's Life Cycle server products picked up several industry reviews and awards during the quarter.

PC World said LifeCycle Designer 7 "may change the way you run your business".

LifeCycle was also named winner in the Software and Information Industry Association's 20th Annual Codie Awards for Best Business Process Automation Solutions.

And LifeCycle Policy Server received Government Computer News Best of 4C Award.

In addition, we have continued to make significant progress in industry standards, partnerships and product delivery.

Several weeks ago, PDF-A, with the "A" standing for Archive was approved unanimously by the International Organization for Standardization, ISO, the leader developer of international standards.

In just two and a half years, the PDF-A working group has managed to develop a standard that will be now adopted by governments and industries throughout the world for long-term archiving and preservation of documents.

The new standard will help proliferate the use of PDF and broaden awareness of Adobe's committment and support for the development of International standards.

It also acknowledges PDF as an open, public specification.

Yesterday we announced that we are working with global consulting and technology services company, Covansys, to develop a solution for delivering unemployment benefits and services to government constituents.

In May, Adobe joined other major software, hardware, and networking companies in SAP's new initiative for advancing the enterprise services architecture, SAP's blueprint for services oriented architecture.

We will work with SAP to deliver additional document services that help companies further extend information in their enterprise systems.

Finally, extending the reach of the Adobe Reader as the universal client, we released Adobe Reader 7.0 for Linux in April.

Adobe supports the ability to reliably, view, print and interact with content across all the major operating systems in the enterprise.

Turning to our professional digital imaging business, our momentum continued with the launch of Photoshop CS2, which has received numerous accolades in the press.

CNET gave it an Editor's Choice Award saying, "when it comes to professional digital imaging, editing, Adobe CS2 stands head and shoulders above the competition." "PC Magazine" also gave Photoshop CS2 an Editor's Choice Award with a 5 out of 5 rating.

In the digital imaging market, we remain the category leader.

Photoshop Elements 3.0 continues to perform well with revenue growing sequentially in Q2 when compared to last quarter.

In the professional video market, we announced at the National Association of Broadcasters Convention that we are collaborating with industry leading companies, including Dell, HP, Intel, and Microsoft to deliver a line of open and scalable high-definition solutions, which are optimized to meet the needs of video, film, and broadcast professionals.

The Adobe video collection is the cornerstone for four new open HD certified solutions providing the software needed to capture, edit, and output professional HD productions.

Adobe Premiere Pro and AfterEffects were also showcased as the centerpiece of Discovery HD Theatres professional work flow for their new network advertising campaign.

Our solutions enables creative directors to work will uncompressed, full-resolution HD footage from start to finish.

Finally, in regard to the status of our merger with Macromedia, here is an update.

On June 8, we voluntarily withdraw and re-filed our premerger notification and report form under the Hart-Scott-Rodino Act.

This was a procedural step we took to provide the Department of Justice additional time to review the information we submitted.

The next major step will be the filing of the form S-4 registration statement which we expect in the coming weeks.

We have put together a comprehensive integration plan and are actively working on the many planning tasks that are required to put these two companies together.

Each of the cross functional teams is working aggressively to accomplish day one objectives that have been agreed to.

Their progress is being reviewed by an integration steering committee from both companies on a weekly basis.

We are pleased with the progress we are making and we continue to anticipate the transaction will close this fall.

This concludes my comments.

Bruce?

Thanks, Shantanu.

Adobe's strong performance reflects solid execution against our strategy.

And the alignment of our business with major market trends, including the accelerating growth of digital content and the increasing migration to online business processes.

This is an exciting time for Adobe, our business is stronger than ever, and our planned acquisition of Macromedia will further enhance our ability to deliver an industry defining technology platform and a wider range of solutions to customers and industries around the world.

We look forward to sharing our progress with you in the coming months.

Mike?

Thanks, Bruce.

Before we start Q&A, I would like to announce the date of our Q3 regular interquarter update.

We plan to issue the press release on Monday, August 1, after the market closes.

Again, that is Monday, August 1, after the market closes.

I would also like to give you an early heads-up that our annual financial analysts' meeting is tentatively scheduled for Tuesday, October 25, in New York City.

So please save that date on the calendar.

Again, October 25 in New York.

For those who wish to listen to a playback of today's conference call, an audio recording of 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 800-642-1687.

Use conference ID, 6636888.

Again, the phone number is 800-642-1687 with conference ID number 6636888.

International callers should dial 706-645-9291.

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 Monday, June 20, 2005.

We'll now be happy to take your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Ben Reitzes with UBS.

Good afternoon, thanks.

I will try to keep to your request, Mike.

I wanted to ask about Europe.

Your usual seasonal pattern is a little bit of decline sequentially, that's what you had.

That was a little worse than I had forecast - - though maybe I should have done it better.

But I was wondering if you noticed any slowdown in Europe or perhaps any pause for the release of the new Creative Suite?

And if you could talk about how you expect that geography to play out with the launch of French and German and maybe even touch on Japan in the next quarter?

And then Murray, if you can touch on currency as well, , if that was a hit in the quarter and how much and what we are looking at for currency in the next?

Thanks.

Yes, Ben, thanks.

In terms of Europe and Japan, we have not seen any change in sort of the economic conditions at this point.

So we haven't seen any of that.

It continues to be the way it has been, but we are, again, as you mentioned, and as we stated earlier, are going to factor in summer seasonal weakness in both of those geographies as we have experienced in past years.

We have seen obviously strong initial starts to CS and English.

And we expect to see a strong performance as well around the world as we bring these products to market.

But, again, that summer seasonality as we've talked ad nauseum has to be factored in.

In terms of currency, we had benefit in Q2 of about $10 million.

And as we look into the third quarter, the guidance that we have provided of 470 to 490 factors in the current currency exchange rates.

We do have some of this hedged in the third quarter.

As you know we have a rolling hedging program.

And so we are able to mitigate some of the the weakening of the Euro and the Yen with our hedging program.

But again that hedging program is really hedging a percentage of the net cash flow.

It is not hedging all of the revenue.

Sorry to break the rule here, Mike.

But Bruce, with regard to the year, could you just update us on, at your current run rate, it seems pretty conservative to be at 1.925 billion for the year.

Just where are you again for the year for 2005?

And is 20% a good growth rate per quarter or per year that you are thinking about?

Or is there anything we should think about with regard to the year?

That would be great.

Yes, Ben.

We are not prepared today to comment on our fiscal year guidance.

Clearly today we are providing Q3 guidance as we did last year.

We will provide Q4 guidance, and, therefore, the final fiscal year guidance during our Q3 earnings call.

We are excited about the growth that we are experiencing in our business.

If you think about it, this quarter we are growing 21% - - or we grew 21%.

If you factor in our guidance of Q3, so that means we will grow somewhere between 16% and 21%.

This is our eighth consecutive quarter of double-digit growth.

This is the third quarter of record revenue.

So we're optimistic about Q3.

Clearly we have factored in seasonality.

We like what we are seeing with the adoption of Acrobat.

As part of our upside this quarter was due to the fact that Acrobat did not decline as much as we thought it would.

Was very excited about the initial take-up of the Creative Suite 2, and that was without releasing the bulk of the foreign language versions.

So we are optimistic.

Unfortunately, we are not prepared to comment on Q4 guidance at this point in time.

Thanks, guys.

Your next question comes from Steve Ashley with Robert Baird.

Hi, guys.

Do you have any idea - - if we looked back at the CS1 release, what percentage of professional graphic artists of your professional customers may have upgraded to CS1 during the last product cycle?

Steve, what we had talked about at the analyst meeting was giving some data in terms of how many creative professionals we have, how many had upgraded.

And of that point as of October we said that it was a small percentage.

We are not updating that number right now.

With CS2, the initial take so far though, we are seeing very good uptick in our new units.

We are also seeing people upgrade from both the individual point products as well as from the previous versions of the Suites.

Great.

And with respect to NTT DoCoMo, You entered into a relationship with them a few months back.

Maybe you can update us on what is going on there with respect to the PDF Reader?

Well I - - with NTT DoCoMo and with a number of the other partners, it is to make sure that we can distribute copies of the Adobe Reader.

So people in Japan using subway maps, other documents have the ability to do that with the Adobe Reader.

In Japan, we are working with a partner called ACCESS.

ACCESS distributes, as you know, the NetFront browser as well.

And so through ACCESs we expect to have significant distribution not just across cell phones, but in addition to that, a number of electronic - - other electronic consumer devices.

I believe that the third generation FOMA phones are about to hit the streets.

Those phones do have Adobe Reader embedded into their devices.

Clearly with the 50 plus market share position that NTT DoCoMo has in Japan, that is a big win for not only the Adobe Reader but all of the applications that we, other third parties, our customers create around the PDF in their systems.

Great, thank you.

Your next question comes from Tom Ernst with Deutsche Bank.

Good afternoon, thank you.

Digging back in on the penetration question that was just asked.

As you look back at the types of customers that tended to buy CS1, how has it changed here with CS2?

Is the mix more in terms of number of customers that can only have one point product or no products that are buying CS2 relative to CS1?

Tom, the first thing I would say is we've been - - it's been a month since we started shipping CS2.

It was a record quarter and it is clear us to that our strategy of getting people to adopt the platform is working.

All our marketing messages are all about the benefits of moving to the entire platform.

But to get a better feeling of CS2, it will take a little while.

What I can say is that the new units are the primary driver of this revenue.

We are seeing good upgrades from the point products, as well as the earlier version of the Suite, which reflects the new value that we have created in the CS2 product.

And the run rate is higher than what the comparable period was in the last cycle.

But it is very early to draw any long-term conclusions.

Perhaps I was guiding you toward the way I was thinking about it.

What are you looking forward to to give you comfort that you're going to be able to achieve a much deeper rate of penetration with CS2 rather than CS1?

What kind of metrics?

It may be early but what should we think about over time to measure that?

We'll continue to - - Tom, this is Bruce.

We'll continue to look at same types of things we looked at last time.

Who is buying it.

Is it one of the potentially 3 million - - approximately 3 million Creative professionals around the world?

Is it one of the potentially 18 million creative professionals or aspiring Creative professionals at home?

Or is it one of the 20 million people at work that just want the best solution?

So we will look at the type of customers that are buying it.

We will look at whether they are buying them as new units or whether they are buying them as an upgrade to the current Creative Suite or whether they are moving up from the point products.

We'll also continue to look at active usage.

Are they using the application?

Our belief is if they are using the application on a regular basis, they're more likely to upgrade next cycle.

Keep in mind as Shantanu has said, when you look at - - when we shipped, we shipped the last month of the quarter, so we are talking about four weeks of information.

The fact that we had record revenue is very exciting to us.

Also the fact that we are finding that when we look at the upside of that creative professionals business, that it is due to the Creative Suite.

Meaning that even though our point products are doing well, many of them are choosing to go to Creative Suite 2 instead of the individual point products.

And that's something else that we do measure and it's something that we do find exciting.

So, just one follow-up if you will permit.

Anything stand out in terms of the mix of customers that may point to you to the optimism that you will achieve a much deeper penetration on this version?

Keep in mind, Tom, we do not have separate SKU's or separate products for each of those customers.

So our ability to know in this short period of time of; which product is going to which customer is not doable.

Which is why it will take us a couple of quarters for us to be able to communicate to you what the status is.

Okay.

Thank you.

Your next question comes from Jay Vleeschhouwer with Merrill Lynch.

Thanks, good afternoon.

A question regarding Acrobat.

You pointed out that the business is down sequentially as planned.

But for the half year to date, would it be accurate to say you have grown the Acrobat installed base both through desktop volume and through CS premium sales by a larger amount than the annual increases in each of 2003 or 2004?

In other words, so far you have grown the base by more than the annual increases in each of the last two fiscal years?

So, Jay, we don't have the data in front of us in particular.

And that's not typically information or detail that we would go into on the call or in our communications.

But clearly when you look at the revenue performance for last quarter of 160 million.

You look at the 150 million this quarter, those two quarters are just unbelievable relative to past performance.

And it's certainly a great indicator for what the future will look like.

We continue to believe - - I think last fall we said something like we sold 15 million new units of Acrobat.

And we believe that the possibility was around 70 million, which left us with 55 million remaining potential customers.

We certainly haven't fully penetrated those 55 million.

We are making great progress and we are excited with the progress we are making.

Shantanu, you are obviously aware of what has been published so far as far as Microsoft's plan with respect to Metro and Acrylic.

And I realize neither is commercial and won't be for some time.

But do you have enough information to make at least some assessment or give us some of your reading thus far on either one of those?

Sure Jay.

So, I think Metro and Acrylic are different.

With respect to Metro.

The value proposition of Acrobat just continues to be differentiated from Metro by our desire to provide a high quality sharing environment across heterogenous environments.

If you look at key elements of our strategy and why we believe our ability to win will continue to be the case is: The distribution of Reader, over 0.5 billion Readers have been distributed.

We've actually moved beyond where Microsoft is currently targeting with Metro, which is just the creation of it and really adding significant value-added features like security, like collaboration.

You look at what we've done in terms of partnering with ISP's.

I talked about the standardization of PDF-A, in terms of archival of PDF/X.

The vertical approach that we've taken with architecture and engineering construction and just large Company adoption.

The reality is we are shipping.

It is here today.

It's been in the market for a decade.

And we are going to continue to add value to our customers.

But I do have to add given Microsoft's monopoly, power and reach, we will continue to pay close attention to any of the developments in that area.

But we are confident that we are continuing to really push the envelope of what we can do with PDF, with Acrobat, with Reader and our server solutions against what Metro will provide.

On Acrylic, again, we've had a great track record of competing with them in areas of imaging and illustration.

Photodraw is a good area where they tried to compete with us.

Our belief continues to be that for creative professionals who want complete precision and a range of creative tools.

We're confident of our ability to continue to innovate with both Photoshop and Illustrator to keep our lead.

And as you know a large number of those customers use the Mac OS.

Which is not - - at least so far has not announced support for the Acrylic product.

But you can be sure that they monitor everything they do with Acrylic and Metro and continue to focus on innovation and delivering value to our customers.

Shantanu touched on the Microsoft [opposer] to our products.

For those of how may not remember that product was released in the '90s.

It was actually included free with Microsoft Office.

There was a lot of concern at that time that that would have an impact on Adobe Photoshop and Adobe Illustrator.

Clearly it did not have the impact that Microsoft had intended.

In fact that product no longer exists.

So, again, given Microsoft's $40 billion in revenue and virtually unlimited resources, we can't ignore them, but we are feeling pretty good about where we are vis-a-vis where they are.

Operator, next question, please

Your next question comes from James Friedman with Fulcrum Global Partners.

Thank you, Shantanu, I was just hoping for clarification, not to beat a dead horse, but with regard to CS2.

I realize it's early days.

I think you said - - I had written run rate is higher for CS2 than in the prior cycle.

Does that mean in the month that it was available relative to these numbers, it is outperforming CS1 which launched in Q4 of '03?

If you take the comparable four weeks that were in the quarter that we just ended that we talked about, the run rate of CS2 from a revenue perspective was greater than that for CS1.

Great.

Then just one housekeeping detail.

Did you do any seven-figure deals on the enterprise side, on the intelligent document enterprise side?

We don't break out the individual price of the deals, Jamie, but what we did talk about was that we had the largest number of greater than 50,000 deals that we had since we've started reporting server transactions.

And it's obvious from the average ASP of those deals that the number of large deals was down from where they were in other quarters.

Okay.

The last thing, you did say - - I apologize if I missed this, that you are going back to the mid-quarter updates again?

Yes.

So we always have a regularly scheduled interquarter update I think as you know, Jamie.

The only thing that was maybe a little different here in Q2 was we decided to do the interquarter update in Q2 at the same time we announced the acquisition of Macromedia as opposed to announcing the acquisition and then just waiting two weeks to do the interquarter update.

We thought it made more sense to give everybody all the information at once.

Thank you.

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

Thanks.

You kind of touched on it, but I just wanted to see if I could dig a little bit further in terms of; in the CS2 in terms of the new units and the point products moving into the Suite, in the first four weeks, I know it is early, but any sense - - is it still just kind of the Photoshop users being the primary source of the move?

Or are you starting to see the InDesign users being a source of the move into the suite?

And just on the Acrobat front, you mentioned the falloff was as expected or less than expected.

What should we be thinking from here?

Thanks, guys.

With respect to CS2 selling, I will take that question.

And it is clear us to that the active usage of all the products in the Creative Suite is increasing in addition to Photoshop, certainly Illustrator and InDesign.

InDesign continues to be one of of the key products in the Suite in terms of adaptation and usage.

Even the point in design product, we had the best quarter in many years with the InDesign product.

So we are seeing people use all the products in the Suite.

In terms of Acrobat, again, in the first quarter, we launched all the major languages in one quarter, which is different than the past few releases of Acrobat.

So we were able to have, a very strong quarter in Q1 from a revenue perspective.

As we mentioned in Q2, it's performed better than we expected.

While it was down it didn't drop off sequentially as much as we had expected.

We look at Q3, we had summer seasonal weakness in Europe and Japan and therefore we would expect Acrobat Desktop to be sequentially down in Q3 from Q2 because of the summer seasonal aspect.

Thank you.

Your next question comes from Tom Berquist with Citigroup.

Thank you.

I think subsequent to the end of your quarter Apple made the decision to switch to the Intel architecture over the next year or two.

And there's been a lot of controversy about what will happen to Mac shipments over that time period.

It looked like your Mac platform shipments were pretty good this quarter.

It's still a pretty big chunk of revenue.

How are you thinking about the next, call it 12 to 18 months as Mac going through that transition process?

So, Tom, I think it's a little early to tell frankly what this impact is going to have on hardware sales.

From my perspective, it is clear that creative professionals are anxious to get more performance and so we believe that Apple's strategy to move to the Intel architecture will allow them to deliver better performance which increases - - it delivers better value.

The reality is that Adobe - - Apple has had a good history of managing both hardware and software transitions, the move to power PC, the move to OS10.

And so we think their strategy of allowing ISP's to get the machines early so that we can get our products delivered on the new Intel architecture, delivering a good development environment.

And for customers providing technology that allows current software applications to run emulated on the Intel architecture is a good strategy.

So it seems that Apple is doing all the right things.

It is just a little too early to tell what impact this will have on hardware sales.

There was some press that suggested, Shantanu, that your products, Photoshop in particular don't run - - won't run on the emulator because of the way they were built in the past and you will have to rewrite them, is that correct?

It is again too early to tell; however, having said that, there was a demonstration at the keynote where Apple introduced this new architecture which actually showed Photoshop running under their emulator which is called Rosetta.

With acceptable performance from your perspective?

Well, again, it was a demo.

The launch time I would say was a little slower, but once the application had launched, it looked pretty good.

Okay.

The reality is, Tom, if you look at what Apple is doing, it is very similar what they do moving from 86-K chips to power PC.

Moving most recently from OS9 to OS10.

It will require work on their part.

It will require work on our part.

And we will definitely be working closely with them.

I suspect that be as smooth those two transitions.

It will be a little bit of additional labor, but in the end, our customers will benefit.

The reality is, we believe and certainly based on the initial sales or the initial revenue of Creative Suite 2 that our solutions are so compelling to the creative professional customer, that even though they know that in one or possibly two years, Apple might have yet another faster machine, they are going to want to take advantage of the benefits or the features and the product that provide the huge benefits as soon as possible.

And I think the revenue that we experience, at least initially is validation of that.

The other thing that Apple said was there is still more faster-powered PC machines coming, which we think will be a benefit to our joint customers.

Got it.

So the CS3 Suite when it should arrive, would we assume you build that for the new Intel platform on the Mac side as opposed to building it for the Mac platform?

Yes.

When I was stage with Steve Jobs I wasn't specific about which products and when.

But I did commit that Adobe would be as serious with the new Intel architecture as we were with OS10.

And as most of you may recall, we were the first out there with a full suite of products that ran on OS10.

So we will be as aggressive.

And I certainly hope to expect us to support their offerings as appropriate.

Okay.

Thanks.

Thanks, Tom.

Your next question comes from Sasa Zorovic with Oppenheimer.

Thank you.

My question would be like this regarding your average server transaction size.

It seems to be somewhat down.

And actually if I it to where they have been for the first two quarters this year compared to last year, they seem to be down.

Are we seeing a trend here?

Or do you think this is just somewhat of an anomaly going on here?

Well, Sasa, I think what we are seeing in our server business, certainly it did grow sequentially in year-over-year.

We are seeing a number of new accounts that we won during the quarter.

And so the deals greater than $50,000 was the largest that it has been.

What we see is that customers typically adopt a couple of pilots.

They convert a single business process.

And once they have success in that and demonstrate the ROI within the company, they then go ahead and make repeat purchases.

And so our business was also characterized by both new business, as well as repeat business.

In terms of the average price, that is going to fluctuate.

It is influenced by the larger deals that we have in the quarter.

But overall, we are pleased with the amount of adoption we are seeing of our customers solutions.

Sasa, I really think it is important to think of this as a multiple-year opportunity.

The fact that last quarter, 39 customers spent at least $50,000 on the license software and probably somewhere around an additional 250,000 or more to deploy the solution; and that this quarter, that number went up to 60, gives us cause for a great deal of encouragement.

It says that we are solving real critical mission document work flow problems.

And that the fact that approximately half of these customers are coming back for more and we continue to find new customers at that time kind of rate, we find very encouraging.

We do not - - and we've been saying this all along.

This a multiple-year initiative, and when we begin to see the - - a hockey-stick like revenue performance, it is still too early to say.

Great.

And also can you tell us a little bit - - you did say that in terms of currency going forward, you are going to be - - you are basically putting into your guidance and you are going to be hedging a little bit based on the cash flow there.

Could you tell us what you are assuming for the Euro rate to be?

Sasa, we are not providing any specifics on that.

Again, we look at the net cash flow position for Euro and Yen and we hedge a portion of that.

We tend to do it on sort of a multi-quarter rolling basis.

So we hedged the rates for Q3 a few months ago.

So it's obviously at a rate that's much higher than where it is trading at today.

And again, when we provide guidance, all of this will be factored into the guidance.

When we say 470 to 490, it is assuming the hedge position as well as the unhedged position from a revenue perspective in that guidance.

Thank you.

Your next question comes from Barbara Coffey with Brean Murray.

Thank you.

On the intelligent documents area, were you seeing certain verticals being the majority of sales for the server business?

And if there are certain strong verticals, what are they?

Barbara, in the server business it is the government and the financial services businesses which we've targeted which represent the bulk of the revenue.

But in addition to that, we are seeing some customer wins, for example, in health care, as well as in the manufacturing sector.

Our focus primarily was government and financial services.

That continues to be the bulk of the revenues.

And are these sales more direct than indirect?

Or is there a percentage or how do you approach them?

I would say the business today is primarily direct, so it is our sales force who are making the server deals.

Thank you.

Your next question comes from Drew Brosseau with SG Cowen.

Thank you.

Similar question to the ones on the Creative Suite about Acrobat Desktop.

Can you just give us a sense for how much of the activity you have seen in the last couple of quarters around 7 have come from new customers versus going back to the existing customer base?

For Acrobat, the primary driver of the business is new customers.

It is new units that are driving the Acrobat business.

I didn't catch the other question, Drew.

Was that the question?

Yes, that was the question.

So most of of the sales of 7 are not - - there's not upgrade activity as part of that?

Well, there is certainly upgrade activity but it's primarily new units that is driving.

So we are, as Bruce talked about, penetrating the 55 million that we had talked about as being potential for people who would use Acrobat and Document work flows.

Unlike the creative professional business or creative professional revenue, which was historically more dependent on upgrade revenue, our Acrobat revenue has historically been always dependent on new unit penetration.

So the upgrade rate tends to be much less for that customer set than for the customers who buy the creative professional products.

What we find is as we add more functionality in each release, the number of customers that we're able to target with the product becomes larger.

For instance, when we added 2-D capabilities, we are able to go more aggressively into the AEC community.

Now that we have added 3-D capabilities, we are able to reach those people who have manufacturing base, supply chain base work flows.

So just as a quick follow-up.

Could you give us a sense of how fast you think the installed base of Acrobat Desktop is growing at this point?

Again, we are not providing numbers.

We provided a number at an analyst meeting and we are not providing an update at this time.

Drew, it's one of those numbers you can probably - - we don't have the calculation in front of us, but you could probably get to relatively easily.

Just look at what you think the average ASP should be.

We break out revenue.

We've said that -- I think we've said - - if we haven't I will say it now, about half of the revenue is - - in terms of mix of Acrobat Professional to Acrobat Standard, it is about a 1-to-1 basis.

So about half of it is Premium or Professional, about half is Standard.

A small amount of revenue associated with Elements.

And hopefully, giving you that information, you can work through the actual numbers.

We will - - we typically update all of the quantitative numbers in terms of penetration against the overall tam at our analyst meeting that we have in the fall.

Great, thank you.

Your next question comes from Gene Munster with Piper Jaffray.

Good afternoon, everybody.

Over the last CS cycle, you guys have talked a lot about revenue per customer increasing as you moved to the Suites approach and Shantanu, you talked about I guess moving to some of the Pro.

In terms of when you look at Macromedia and the impact of Flash and Dreamweaver on the Suite, would it be safe to say that you'd want to probably get those integrated within the CS Suite as soon as possible?

Or would a more conservative approach mean going to maybe CS3 be the way we should be thinking about that?

We see many, many, many opportunities with Macromedia as part of the AW family.

Unfortunately we are not at liberty to discuss any those.

And quite frankly, in many cases, those discussions are happening in clean-room environments.

So I wish I could answer specifics, Gene.

We are not able to according to the legal requirements.

Okay.

Let me just ask this.

Would you be supportive of putting out a CS release that didn't have integrated interfaces initially between the Macromedia and Adobe products?

Again, we are going down a path I really can't go down, Gene.

We are going to look at - - we are looking at in the clean-room environment the different combinations that would make sense for specific customers, how to package them, how to price them, how to deliver them, channels, how to market them.

So we are undergoing that opportunity.

Clearly there is an opportunity to take advantage of their assets as it relates to the creative professional, the Web developer, and combine them with our assets the same way that we will be looking at the opportunities between what we are doing with LifeCycle and what they do with Flex and so on and so on.

Okay.

I guess one more attempt here.

As you look at putting these together, would you say you would rather - - are you going to move at a slow pace in terms of integrating some of the parts?

You said initially your response that there are many, many opportunities.

Would it be a relatively slow pace, or do you see yourselves kind of quickly moving to capitalize on the parts synergy?

We are going to move as rapidly as we possibly can within the law.

Great.

Thank you.

Your next question comes from Brent Thill with Prudential.

Thanks.

Being the International versions of CS2 in Q3, how should we think about the product cycle for the second half of the fiscal year?

We haven't provided specifics updates on which of the products we will be shipping.

Clearly, we choose not to do that because we don't want to stall current sales of existing products.

So I don't want to announce unannounced products at this time.

We continue to be very optimistic about the adoption of Acrobat, achieving a greater revenue number this quarter than we originally expected.

It certainly gives us comfort.

And the initial uptake of the Creative Suite 2 in English gives us a lot of cause of optimism.

But other than that I don't want to comment on any specific - - any other product upgrade that might occur later this year or next year.

Murray, just on your R&D guidance of 20%, the last two quarters you have been running well below that at 18%.

Even last year at 19%.

Just give us a sense of what you are seeing there?

Yes.

We've been - - we've stated over time that our target is 20% and we have plans to achieve that 20%.

It is also dependent on our ability to hire at the pace we would like to.

And it also dependent on the revenue.

The revenue obviously this quarter in Q2 came in slightly above the high end of the range.

And we've seen over-performance in revenue like we have for many quarters now.

Our R&D as a percentage of revenue comes in below 20%.

So, it's as much a function of the revenue as it is just the hiring pattern that we have in R&D.

But we are going to continue to invest in our long-term opportunities.

Innovation is critical.

We need to continue to hire and our plan is to continue to do so.

Thanks.

Operator, we will take one more question please.

Your final question is a follow-up question from Jay Vleeschhouwer with Merrill Lynch.

Thanks.

Murray, can you comment on your non-Acrobat volume licensing business in terms of any trend or proportions there on the Creative Pro or the IND side?

And then CS, you said, had a record quarter, but is it fair to say that it was still smaller than the 150 you did for Acrobat Desktop?

Kind of something more in the 130 to 135 range?

In terms of the licensing, Jay.

When you just look at our overall licensing and the coming to volume licensing, it's been very similar patterns that we have seen across I think the entire industry.

There has been an upward trend in licensing over the last few years and the recent quarters, the levels of licensing overall have been very similar.

We tend to see more licensing in our third quarter because a lot of the education purchases tend to come through licensing.

In terms of the Creative Suites, in terms of the overall run, we are just providing any specifics amounts of revenue for the products that we don't normally provide that information on.

But, again, the Creative Suites were truly a record in a quarter.

Thank you.

Thanks Jay.

Well this concludes our call and we thank everybody for joining us today.

That concludes today's Q2, fiscal year 2005 earnings conference call.

You may now disconnect.