Adobe Inc (ADBE) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Adobe Systems Q3 fiscal year 2005 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to pass the call to Mr. Mike Saviage, Vice President, Investor Relations at Adobe Systems.

Good afternoon.

Thank you for joining us.

Operator, there's a voice on the line.

Good afternoon.

Thank you for joining us.

Joining on the call are Bruce Chizen, our CEO;

Murray Demo, Executive Vice President, CFO; and Shantanu Narayen, President and COO.

In the call today we'll discuss Adobe's third 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, our forward-looking product plans and our pending acquisition of Macromedia is based on information as of today, September 15, 2005, and contains forward-looking statements that involve risk and uncertainty.

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

For a discussion of these risks and uncertainties you should review Adobe's SEC filings including our annual report on Form 10-K for fiscal 2004 and our quarterly reports on Form 10-Q filed in fiscal 2005.

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 is being broadcast live over the Internet and is also being recorded for playback purposes.

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

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

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

Thanks, Mike, and good afternoon.

Solid execution in Q3 resulted in another outstanding quarter of double-digit growth.

Third quarter revenue was $487 million, an increase of 21% year-over-year, and at the high end of our targeted range.

Our operating profit was also outstanding with year-over-year growth of 31%.

Driving our strong performance was the continued adoption of Acrobat 7 and another record quarter for Creative Suites.

We also achieved record quarterly revenue with our enterprise focused LiveCycle server business.

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

Murray.

For the third quarter fiscal 2005 Adobe achieved revenue of 487 million this compares to 403.7 million reported for the third quarter of fiscal 2004 and 496 million reported last quarter.

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

GAAP net income for the third quarter of fiscal 2005 was 144.9 million compared to 104.5 million reported in the third quarter of fiscal 2004 and 149.8 million last quarter.

Non-GAAP net income, which excludes as applicable, investment losses and the net tax impact of the planned repatriation of certain foreign earnings was 146.4 million compared to 105.6 million reported in the third quarter of fiscal 2004 and 142.9 million last quarter.

GAAP diluted earnings per share for the third quarter of fiscal 2005 were $0.29 based on 507.8 million weighted average shares.

This compares with GAAP diluted earnings per share of $0.21 reported in the third quarter of fiscal 2004 based on 494.2 million weighted average shares and GAAP diluted earnings per share of $0.29 reported last quarter based on 508.2 million weighted average shares.

Non-GAAP diluted earnings per share for the third quarter of fiscal 2005 which excludes investment losses were $0.29.

Gross margin for the quarter was 94.4% compared to 94.2% in the third quarter of fiscal 2004 and 94.5% last quarter.

Operating expenses for the third quarter of fiscal 2005 were 276 million.

Regular employees at the end of the third quarter totaled 4,286 versus is 4,207 at the end of the second quarter of fiscal 2005.

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

Expenses as a percent of revenue break down as follows.

Research and development 19.4%.

Sales and marketing 29.5%.

G&A, 7.7%.

GAAP operating income in the third quarter of fiscal 2005 was 183.6 million or 37.7% of revenue.

This compares to GAAP operating income of 140.3 million or 34.8% of revenue in the third quarter of fiscal 2004, and 182.2 million or 36.7% of revenue last quarter.

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

Other income for the third quarter of fiscal 2005 was 12.4 million.

Adobe's effective tax rate for the third quarter of fiscal 2005 was 25.3% compared to 26% in the third quarter of fiscal 2004 and 20.2% last quarter.

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

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

Creative Professional segment revenue was a record 206.3 million in Q3 fiscal 2005 compared to 150.4 million in Q3 fiscal 2004 and 184.4 million last quarter.

Strong demand with our Creative Suite 2 releases drove the record revenue performance.

Digital imaging and video segment revenue was 95.6 million in Q3 fiscal 2005, compared to 98.4 million in Q3 fiscal 2004 and 115.9 million last quarter.

As we have stated, many imaging customers are choosing the Creative Suite causing some Photoshop revenue which previously would have been reported in the digital imaging and video segment to be reflected as Creative Suite's revenue in the Creative Professional segment.

OEM, PostScript, and other segment revenue was 19.3 million in Q3 fiscal 2005 compared to 19.4 million in Q3 fiscal 2004 and 19.5 million last quarter.

Intelligent Document segment revenue was 165.8 million in Q3 fiscal 2005 compared to 135.5 million in Q3 fiscal 2004 and 176.2 million last quarter.

In Q3 total Intelligent Documents desktop revenue was 135.5 million representing 28% year-over-year growth.

As expected Intelligent Document's desktop revenue declined from last quarter due to typical Q3 seasonality.

Intelligent Document server revenue was a record 30.3 million.

Factoring out the large OEM payment in the year-ago period server revenue grew approximately 23% on a year-over-year basis.

Turning to our geographic segments, the results in Q3 fiscal 2005 on a percentage of revenue basis were as follows.

The Americas, 47%.

Europe, 31%.

Asia, 22%.

Adobe experienced typical Q3 seasonality in Europe and Japan and solid demand across all major geographic segments.

Our trade DSO in the third quarter of fiscal 2005 was 29 days, this compares to 25 days in Q3 fiscal 2004 and 32 days last quarter.

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

At the end of the third quarter of fiscal 2005, cash and short-term investments were $1.893 billion compared to $1.691 billion at the end of the second quarter of fiscal 2005.

In regard to share buyback, we did not repurchase any shares during the quarter as part of our share repurchase programs.

Due to restrictions related to our pending acquisition of Macromedia.

This concludes my discussion on third quarter fiscal 2005 results.

Now, I will discuss our Q4 fiscal 2005 targets, which do not factor in our pending acquisition of Macromedia.

We are targeting a Q4 revenue range of 490 to 510 million which represents 14 to 19% year-over-year revenue growth in the quarter.

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

Gross margin 94%.

R&D, 20%.

Sales and marketing, 29 to 30%, G&A 9%.

Resulting in a GAAP and non-GAAP operating margin target of approximately 35 to 36%.

For our share count, we are targeting a range of 509 to 511 million shares.

For other income, we are targeting approximately 11 to 12 million, and for our effective tax rate we are targeting 25%.

These targets lead to a GAAP and nonGAAP earnings per share target range in Q4 fiscal 2005 of $0.27 to $0.29 per share.

This concludes my comments.

I will now turn the call over to Shantanu.

Thanks, Murray.

I'll take the next few minutes reviewing highlights in each of our major businesses starting with the Creative Professional business unit.

For the second consecutive quarter our Creative Suite products achieved record revenue.

Driving this performance in Q3 was the launch of our localized versions especially French, German, and Japanese.

While only a relatively short period of time has passed since we started shipping Version 2 of the Creative Suites we can provide these initial observation.

First, the premium version of the suite continues to outsell the standard version on a revenue basis by a more than 3 to 1 ratio.

Second, revenue and units for Version 2 of the Creative Suites is outpacing that of Version 1 at this point in the cycle by a double-digit percentage margin.

And third, while Creative Suite 2 revenue has primarily been driven by new full unit licenses we are also seeing a healthy mix of upgrades from Creative Suite 1 as well as from Photoshop.

Adobe InDesign achieved another quarter of sequential revenue growth and maintained positive momentum with customers.

In Q3 we announced that top retailers Macy's West, Plow & Hearth, and Staples have adopted InDesign as their standard for catalog production.

In the press MacWorld called InDesign "the best layout program available", MacAddict gave InDesign CS2 an editor's choice award and called it "the world's most feature-rich layout program".

Creative Suite 2's, new Visual 5 browser, called Adobe Bridge, has drawn particular praise.

The Chicago Sun Times called Bridge, "the best thing about CS2."

And EV called it "the biggest and most useful feature in the suite."

Turning to our Professional Digital Imaging business stand-alone new full Photoshop units combined with units included in the suites achieved double-digit growth on a year-over-year basis.

In addition, Photoshop CS2 continued to receive positive comments in the press.

MacWorld said, "Photoshop CS2 is a tour de force backed with innovations that will make your images better."

They added, "this is the most significant Photoshop upgrade in quite a while, and if you're serious about digital imaging you need it."

Digital Photographer commented, "if you've been waiting for the right time to upgrade this is it".

And PC Photo stated that Photoshop CS2 "will quickly pay for itself in functionality and time saved."

In the digital imaging market we achieved more than 60% growth on a year-over-year basis for Photoshop elements.

We also ramped up our marketing focus towards the K through 12 education market, including a marketing partnership with Olympus than combines Photoshop elements with a choice of Olympus digital camera and accessory kits.

Turning to the Intelligent Documents business unit, in Q3 we achieved Acrobat desktop revenue of $135.5 million which represents 28% year-over-year growth.

Licensing as a percentage of Acrobat revenue, was 52%.

The professional to standard mix was approximately 1 as to 1 demonstrating the success of our strategy to target verticals such as manufacturing and AEC, architecture, engineering, and construction, where we believe higher value capabilities beyond PDF creation are being adopted.

Positive reviews for Acrobat 7 Professional included those published by Catalyst magazine, a CAD user publication, and Federal Computer Week magazine which awarded it a perfect five out of five stars.

Intelligent Documents server revenue grew sequentially and year-over-year to a record $30.3 million.

Factoring out a large OEM partner payment in the year ago quarter server revenue grew 23% year-over-year.

The number of transactions with software licensing revenue greater than $50,000 in the quarter was 56, and the average of these transactions was $191,000.

Last week, we announced significant enhancements to the LiveCycle server platform.

Livecycle now delivers visual assembly of process automation applications without the need for programming.

In addition, LiveCycle now includes business activity monitoring for visibility into business processes, better integration of document security and control capabilities, and the ability to integrate data from 2-D bar coded forms for paper to electronic automation.

We are pleased with our success in the commercial market.

Ameriprise Financial, formerly American Express Financial Advisors, one of the nations largest asset management and insurance companies is using the new LiveCycle software to provide its client advisors with desktop access to an easy to use system of business and services forms. [Bank Smart] National Bank, a southeast-based banking institution with approximately 140 branches which will utilize an Adobe document generation solution to provide retail banking documents electronically in PDF format.

FIA, an Italian provider of IT solutions for the international banking and financial community is using Reader Extension server and Form server to automate and validate banks' communication with their customers.

The solution provides an on-line and off-line electronic form capability, and helps organizations avoid data reeking costs.

H&R Block, the nations largest tax preparer is using LiveCycle software to automate forms processing related to hiring up to 120,000 part-time employees during tax season.

Improving accuracy, increasing internal efficiency, and improving the experience of job applicants.

In the government market, key wins in Q3 included, the United States Small Business Administration, which will utilize Adobe Reader Extension serve to provide PDF-based electronic forms and documents.

The solution will utilize PDF and XML data to share information within the agency as well as with other government agencies.

The state of California's Controller's Office which has initiated a project called Local Government E-claims to supplement the mandated cost claiming forms and instructions that are currently found on their website.

The project will leverage a variety of LiveCycle forms and workflow products to enable the secure delivery of forms over the Internet and integrate form data into their database.

The New Jersey Department of Treasury which is using a LiveCycle solution to automate its procurements processes with electronic phones.

Sonacotra, in France, a government welfare agency which is using an Adobe output solution to automate their printing and billing processes and Dafolo A/S a Danish systems integration partner that is helping all Danish municipals standardize on PDF for their internal forms administration utilizing Adobe form solutions.

Adobe's LiveCycle Policy server received several positive industrial reviews during the quarter.

E-week praised Policy server for its, "powerful and flexible rights management capabilities for controlling access to PDF documents" adding "we loved how easy it was to integrate external workers into the right management system."

AEC magazine in the United Kingdom also endorsed Policy server commenting that it, "works like magic" to protect valuable content.

The SAP and Adobe relationship continues to be a key focus, interactive forms based on Adobe software is now commercially available in SAP applications and we have begun to see initial customer pilots.

Yesterday we announced we are working with Canon to develop paper to digital scanning, security, and print solutions based on Adobe PDF.

The combination of Adobe LiveCycle and Adobe PDF technologies with Canon's imageRUNNER multifunction product line and imageWARE software products will make it easier for information workers to integrate paper processes into more secure digital workflows.

Lastly, the U.S.

Patent and Trademark office announced a new Internet-based electronic filing system for creating and submitting patent applications and associated documents based on PDF.

The new system will be secure and easy to use and will eliminate the need for using the patent and trademark offices proprietary software.

Under this new system which is beginning beta testing users will utilize PDF fillable forms and will also have the capability to submit the accompanying documents in PDF.

This concludes my comments.

Bruce.

Thanks, Shantanu.

As we enter the final quarter of fiscal 2005, we are on track for our third consecutive year of record revenue and profits.

In addition we are making great progress with our integration planning efforts in connection with our pending acquisition of Macromedia which we continue to expect to close in the fall.

The overwhelming support of both Adobe and Macromedia stockholders last month was an important milestone in finalizing the transaction.

And we are working with the DOJ and several other government agencies in Europe as we seek final regulatory approval.

The combined company will position Adobe for even greater success as we deliver solutions that enable people to engage with information more powerfully than ever before.

We look forward to providing additional updates on the progress of the acquisition in the weeks ahead.

Mike.

Thanks, Bruce.

Before we start Q&A, I would like to comment on our interquarter update and analyst meeting.

As we have indicated today we continue to expect the Macromedia transaction to close sometime in the fall.

Accordingly we've made the decision to postpone our fall analyst meeting until a later date.

We are also not providing a specific date for our Q4 interquarter update today which normally coincides with our analyst meeting date.

However, shortly after the close of the acquisition we plan to provide you with that information as well as financial targets for fiscal 2006.

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

Alternatively, you can listen to a phone replay by calling 800-642-1687, use conference ID number 9167268.

Again, that phone number is 800-642-1687, with conference ID number 9167268.

International callers should dial 706-645-9291.

The phone playback service will be available at 4:00 p.m.

Pacific time today and ending at 4:00 p.m.

Pacific time on Monday, September 19, 2005.

We would now be happy to take your questions.

Operator.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Jay Vleeschhouwer with Merrill Lynch.

Bruce, I'd like to ask you about the macroeconomic environment first.

We've scene recent signs of improvement in the German economy in particular that's undoubtedly one of your largest country markets and Japan as well.

Is that in fact, translating into improvement in the run rate of your business in those markets such that you could see ongoing growth in those markets elsewhere in Europe beyond just the immediate effect of the CS2 local language launches?

Second question regards CS as your pointed out, had a record quarter, looks to us like it did it about 160 million or so.

The question there is what's your sense of the mix of pro versus consumer demand for CS?

Is there any meaningful change in the mix of market or buyer?

On the macroeconomics, Jay, I'm probably the wrong person to comment on the overall macroeconomics.

I can only comment on it as it relates to Adobe's business.

We are seeing solid demand throughout Europe as well as Japan.

One of the reasons for the successful quarter that we just experienced, or just had, was because of the up-take of the Creative Suite in Germany, France, as well as some of the other countries.

Same is true in terms of Japan.

We did see a significant growth year-over-year and are feeling good about the overall economy and continue to expect no changes as we move through this quarter.

Jay, with respect to the Creative Suite question we still continue to believe that we have opportunity to penetrate in the Creative Pro market.

Certainly we are seeing uptick, people like the integration but we continue to also see the Creative Suite being adopted in both the at-home as well as in the at-work market.

So continues to be opportunity in both those segments, and we will continue to target the at-home and at-work market as well.

With respect to the timing of the close, you've consistently said fall, of course, you may not want to be any more specific than that on any of the issues involved but are there, in fact, any product related or market related issues that you can describe that are on the minds of either DOJ or the European regulators?

I wish I could be more specific, Jay, in terms of an actual date.

Clearly, that's not under our control.

It is dependent on the regulatory bodies around the world, especially the DOJ here.

As I think many people know the DOJ did have a second request around the areas of vector graphics as well as web layout.

We believe if anything that the combination of Adobe and Macromedia is more pro competitive than ever before, especially given the recent announcements from Microsoft and their aggressive movement into both web design, interactivity and vector illustration.

Thank you.

Your next question -- sorry.

Your next question comes from the line of Steve Ashley with Robert Baird.

I'd like to ask about the digital imaging business.

Were the results consistent with your expectations, and how should we think about that business going forward in terms of mix of business?

Steve, we don't comment on our expectations, per se, but I can tell you that it's quite exciting to see for Photoshop business double-digit growth on a year-over-year basis in terms of the percentage of units when you factor in the units from the studio.

It's also very encouraging to see 60% growth year-over-year with Photoshop elements.

So I can't specifically talk about our internal targets, but I can tell you that we are quite pleased with the growth that we are seeing in digital photography, and our digital imaging solutions.

We're also pleased to see that many of the people that would have typically bought either a Photoshop Elements or a Photoshop are stepping up to the Creative Suite, either the standard version or the premium version.

Great.

Then on your new stock photo service business, there's a press release that I think a million photos have been looked at in the first 90 days.

I guess my first question is, on accounting, how do you plan to report the revenue that comes from that?

Will you report 100% of the photo price or will you report just the royalty that you're retaining as your revenue?

In terms of the accounting side, Steve, we're going to look at just the royalty that we generate.

So just our share of the revenue is how we'll report that.

In terms of the business, Steve, the first step was to make these pictures available.

Clearly we want to try and provide value-add to our customers through Adobe Bridge, but it's very early in that business.

I want to add that this is not a material number at this point in time, nor do we expect it to be, as least in the short term.

Lastly, just a housekeeping question, Murray, with G&A $38 million, a little lower than I was looking for, can you provide any color on that?

Yes, we had some lower litigation expenses and bad debt expenses in the quarter that gave us a little bit lower expenses.

Obviously we also have the vacation that goes on during the third quarter and so we have an expense benefit there as well.

Great.

Thanks.

Your next question comes from the line of Brent Thill with Prudential.

Operating margins hit a record 37.7%.

What do you think that intermediate term targets for margin, where do you think they can end up over the next six months to a year on an organic basis for Adobe?

Well, for the fourth quarter we're targeting 35 to 36% for operating margin targets.

And we're going to continue to focus to invest in our future and to spend money in marketing to drive demand, and so right now we're targeting 35 to 36%.

We've been a little bit higher through the first three-quarters, but we think 35 to 36 is the right mix of short-term profitability as well as investing in our future.

If you could talk just a little bit about the distribution buildout to build the Document Server business, what you're seeing in terms of the characteristics there, of that buildout, and what type of resources you're adding to build that out.

At this point, we're not adding significant resources to that.

I think the LiveCycle announcement that we just made was a significant accomplishment for us.

It just enhances our offerings in that particular marketplace.

We have a sales force that's now been trained and is making traction in financial services and government.

It is primarily a direct revenue at this point, and as the SAP relationship comes along we expect that to enable us to further extend into the manufacturing segment.

The SIs also we have worked with the SIs to train them and have them be part of the leveraged model that we hope to expect but we were pleased to see the results that we had in the quarter in terms of both number of customers who are using our solutions as well as overall revenue.

It's great to see when we look at the number of deals coming from new customers versus existing customers, it's a very healthy mix which suggests to us that current customers appreciate what they've bought and they want more, and then our value proposition continues to extend to many more customers.

Thanks.

Your next question comes from the line of Martin Aconin with Hofer and Arnett.

Question on Photoshop, it seems fairly obvious that it was up double digit considering the total topline, I'm just curious if you can comment as to whether Photoshop stand-alone was also up double digit as opposed to just combined with CS2.

And then any comparable comment on Illustrator?

Was that up double digit stand-alone and/or as part of CS2 as well.

And a third part, if you don't ming, when you say double-digit, any flow to scale, I mean low double-digits well into the double digit teens range?

Anything you could say on that would be great?

Thanks.

Martin, we don't comment specifically on any of the line items on a product basis, and it really doesn't make any sense for it to call out Photoshop as a stand-alone product because whether the customer buys it as a stand-alone product or whether they buy it through the suite it is immaterial.

The fact that -- if you look at it combined because that's what we're trying to measure is how many new customers are we gaining.

Clearly we prefer to see the customer buy the suites instead of the stand-alone, and that, at least on the surface, appears to be happening at a greater rate than we anticipated.

Anything on Illustrator?

And actually just a quick follow-up.

Within Photoshop is elements becoming any -- obviously the price point is considerably lower than full Photoshop is that becoming a meaningful percentage of Photoshop units or is that still relatively small?

In terms of Photoshop Elements the revenue is becoming meaningful.

We've been quite successful at gaining share in this particular space.

This is an important category.

We'd certainly expect in the fourth quarter given it's the retail season, the holiday season that we'll see continued strength in the Hobbyist space so we're seeing very strong results in that particular area.

Then Illustrator was that up double digits inclusive of CS2 as well as stand-alone?

Kind of a comparable comment to Photoshop, if you will.

Again, the focus there really is is on we want to drive sales towards the Creative Suite.

And so in the case of Illustrator and Photoshop it's less about how they perform on a stand-alone basis and it's much more about how successful we are in driving Creative Suites revenue.

InDesign is a little bit of a different situation where many customers are choosing to move to InDesign first and then to the suites as we've commented over the last few years but in the case of Photoshop and Illustrator we want to see customers buy Creative Suite and we're spending marketing dollars to try to drive revenue in that direction.

Thanks.

Your next question comes from the line of Ben Reitzes with UBS.

Wanted to ask about two things.

One is in Acrobat did you see any weakness in your federal side of the business, maybe in licensing, and could you comment on that and how the momentum is going there?

Also on Acrobat on the shrink-wrap side we're calculating about 65 million in sales of the stand-alone product through retail and distributors.

I'm wondering if you think the shrink-wrap side kind of plateaus around that level here after the big upgrade where it was a much higher number?

Then, Bruce, I just wanted to ask you about overall guidance and how you're taking it with -- in light of a major merger that you're doing.

Do you feel you're being conservative in case there's any merger distractions?

Or how are you kind of work in the Macromedia integration issues into how you thought about giving guidance for that fourth quarter?

Ben, in regards to Acrobat, the Q3 seasonality that we have in Europe and Japan will impact the shrink-wrap portion of our products.

Especially in the case of Acrobat where we saw that we were up to 52% of our total Acrobat desktop revenue was coming from licensing.

So in sort of the larger organizations we continue to see strong demand but with the summer seasonality has an impact on the shrink wrap portion of the business and therefore you see the mix move more towards licensing in the quarter.

As it relates to guidance, we continue to take our guidance very seriously.

We're very prudent.

We have factored in any potential distraction from the Macromedia integration efforts into the Q4 guidance.

With regard to Acrobat again in the federal side, Murray, did you see any weakness there?

Your licensing was pretty much in line with our expectations.

Did you see anything there that may be with that environment?

Nothing really to comment object.

We just saw very strong licensing and we just saw softer shrink-wrap because of the seasonality.

As we look to the fourth quarter though, we do expect to see Acrobat desktop to be up sequentially in the fourth quarter versus the third quarter.

Keep in mind, Ben, that Q3 we did see, even though down from Q2, it was up 28% on a year-over-year basis.

Which we think is quite good performance.

Okay.

Great.

And one other thing, Bruce.

Just with regard to outlook what did you -- maybe Shantanu can answer this too, but what are you qualitatively saying Creative Suite will do in the fourth quarter versus the prior cycle?

Or do you expect the momentum to continue this strong?

Or is there anything qualitative that you can say about what you expect Creative Suite sales to do into year end?

Ben, in terms of the Creative Suite in the fourth quarter we would expect to see it slightly down from the third quarter.

We've had the launch with French, German, and Japanese in the third quarter.

We would expect to see the Creative Suites, the combination of the two to be down in the fourth quarter.

We would expect to see, again, as I had mentioned earlier that Acrobat will be up in the fourth quarter versus the third quarter.

We'd expect to see our server business to be higher in the fourth quarter versus the third quarter.

We'd also expect to see our hobbyist products to be up in the fourth quarter because of the strong holiday retail season.

All right.

Appreciate that color.

Thanks a lot, guys.

Your next question comes from the line of James Friedman with Fulcrum.

Hi, it's Jamie Friedman at Fulcrum.

Most of my questions have been answered but maybe about the Intelligent Document data, the server transactions, both the ASPs and the units were up -- the units up nicely year-over-year, the ASPs up pretty sharply year-over-year and sequentially.

Is that -- maybe if you can give us a sense of, is that a reflection of the channel partners specifically SAP, starting to resell the product more aggressively?

Some color around that would be helpful.

Yes, I think the business, Jamie, at this point is primarily direct.

What we are seeing, as our product offering has really strengthened, the entire ability to automate a business process, and our ability to take that more specifically into the vertical markets that we are focused on, and, for example, in the financial services talk about how we help with new account enrollment or how in government we deal with case management has just enabled us to better position our solutions in terms of the overall business problems that those enterprises are facing.

A number of these are also customer stock within an initial pilot.

As Bruce earlier mentioned we are seeing a nice healthy mix between both existing customers who are coming back and buying new software as well as new customers.

The awareness of what we are doing in this marketplace is certainly growing, and the relationships with the partners is strengthening.

So one of the things that's gratifying for us is we had talked about this being a multi-year effort for us, but it's clear that we're providing value to our customers and they're seeing demonstrable ROI.

And so as Murray said we expect this to sequentially continue in the next quarter.

As our customers experience success with our offerings they tend to share those successes with both their colleagues and the industry analysts.

For example, the IRS here in the United States has had a great deal of success with our solutions with reader extensions to save out information in tax forms as well as the 2-D bar code technology and now we're seeing tax authorities like the Dutch tax authority imitating those solutions for their own workloads.

The same is true of somebody like the spin-off from American Express, they're doing new account applications.

They're beginning to have success, you could suspect that many of their competitors are looking at that, and we're certainly sharing their success with them, and we suspect over time they'll also move in our direction.

Sorry to hear the IRS is doing so well. [ LAUGHTER ] One follow-up.

With regard to the geographic mix, you've had about a month of results in the quarter from Japan, but historically you've had quite a following there and the economy is said to be recovering.

If you could give us some additional color as to what we could expect out of Japan in the fiscal fourth quarter that would be helpful.

Thank you.

Jamie, typically in Japan the strong quarters are Q1 and Q2 for us all built around their March year end where there's the budget flush activity that goes on in corporations, government, and education.

The Q3 we just finished and Q4 tend to be the seasonally weaker quarters.

Typically in Japan we have seen in the past, is you don't see an increase in the demand environment in the fourth quarter versus the third quarter.

Clearly in the third quarter we had the launch of the CS products, but that's what you'd have to try to look at.

So Japan is really for us more seasonally strong in Q1 and Q2.

Different than in Europe where Europe is weaker in the third quarter typically and you see strength in the fourth quarter.

Again, you'd have to factor in that the launch of French and German was early in the third quarter when you try to balance that off against a seasonally stronger fourth quarter.

Thank you.

Your next question comes from the line of Tom Berquist with Smith Barney.

I heard your comments about the fourth quarter for Creative Professional, what I'm curious about is after the last credit cycle, after that initial first quarter where a lot of products were shipped it did come off a bit sequentially but then it kind of held into those levels for three or four quarters.

I'm just wondering do you expect a similar thing to to happen with Creative Professional 2 after this quarter?

We commented earlier that after the fourth quarter we would expect the Creative Suites to be down from the third quarter because French and German launched right at the beginning of the third quarter, Japanese followed shortly thereafter, and we're still on the heels of the initial move on English.

So we are expecting to be down from the third quarter into the fourth quarter but still seeing strong adoption of the Creative Suite.

As far as 2006, at this point we're not providing any kind of specifics.

Obviously we believe it's a large opportunity for us, and one we'll continue to focus on over the short to long term.

If you look at overall penetration we have only just touched the surface of the opportunity, and we believe that the solution unto itself is compelling where you also have the driver around the movement from corp to end design which also helps a lot with our Creative Suite pickup.

Got it.

Then just on kind of a mix question, as I look at -- as Creative Professionals come on line as a product category over time it's gotten to be larger for a lot of reasons, in the Intelligent Documents category, it's pretty obvious as to why, but I guess the question is, is that are you finding an increasing percentage of your customers are picking up their Intelligent Document products, at least the desktop products, through the Creative Suites side as opposed to buying it on a stand-alone basis.

Certainly I think as you look at the features that exist within Acrobat Pro that cater to the Creative Pro market, namely. doing digital workflow, a number of those customers are also standardizing on the suite because they do want to use InDesign for their professional page layout and Photoshop and Illustrator and move completely towards Digital Workflow so there is a segment of the larger intelligent document customer segment, namely the Creative Pro, that would be using the creative suite rather than going with the Acrobat Pro products.

Got it.

Then finally, Shantanu, maybe just a follow-up on the Microsoft Expressions launch, I thought it was interesting that they launched it through their developers conference as opposed to some sort of a creative conference which appears to me to mean that they're targeting maybe more the web development side as opposed to the more traditional creative professionals side.

Did you get that read or do you have any insight on that?

I wish that was the case.

In looking at their website it's clear to us they are targeting the creative professional, the creative designer, the names of the product, Web Designer, Interactive Designer, and so on, and how they talk about it, they are looking at both the design professional and the developer professional and they have stated such.

The reality is we take Microsoft very, very seriously.

We've always taken Microsoft seriously.

And we're taking them even more seriously today because of the aggressiveness in which they're moving into the creative professional market.

They are a $40 billion monopoly.

They have virtually unlimited resources.

However, with that said, we have demonstrated over the last 20 years that we can compete against them effectively.

We ended up competing against them with PostScript, with their True Image printing language, we ended up competing with them successfully against Microsoft Photo Draw with Photoshop and Illustrator in the mid '90s.

We continue to compete very effectively with them with Digital Imaging Pro against Photoshop.

Adobe has lots of experience in this market.

In fact, we have 22 years of experience.

We have complete ecosystems that live and breathe around our solutions.

We have service providers, plug-in developers, a whole bunch of just about every design school in the world who train their students on our products.

We have a bunch of curriculum.

The reality is our customers have their mission critical work flows based on our solutions as evidenced by the success of the Creative Suite.

We have a great brand, it represents high quality and innovation, and that will be enhanced with the combination of Macromedia.

With that said, Microsoft is a monopolist, and if they abuse their monopolistic position then it could be an issue.

Other than that, we think we can compete successfully.

I hear you completely on that, Bruce.

I was just curious as to, I thought it was surprising that they actually chose the Professional Developers Conference as the forum to launch it as opposed to a creative professionals forum.

My take on that is, what they're trying to do is encourage designers and developers to switch over to their tools so they can optimize for Windows Vista.

Fortunately, I believe that the creative professionals are very loyal to both Adobe and the great innovative products that we have.

Got it.

And I believe the same is true of Macromedia.

Thanks.

I appreciate that.

Your next question comes from the line of Sasa Zorovic with Oppenheimer.

Thank you.

This is Sasa Zorovic from Oppenheimer.

My question would be as follows -- in the dilligent document segment here we've had here now a couple sequential declines here ever since the launch basically back in the first quarter.

Last time that happened was basically in '01 at the time that the fifth version of Acrobat was launched.

We didn't see it, though, when the 6th version came out.

I was wondering why would we see that at this point?

Sasa, this cycle is a little bit different.

A couple of things to take note of is, in the first quarter we did about 161 million on Acrobat desktop but we launched all four major language versions in that quarter where as in the previous version Acrobat 6, we did not launch all the major versions in one quarter.

So, in effect, you had a very strong revenue quarter since all these major languages shipped at once.

Then we saw it come down a little bit, about 10 million to 150 million the second quarter, because we had just moved past the initial launch quarter.

The third quarter is our seasonally weak quarter in Europe and Japan, and so we expected to see a decline as well in the third quarter, and now as we move out of the sequentially, the softer third quarter, into the fourth quarter, we expect to see Acrobat desktop revenue increase.

As a reminder, despite that seasonality, despite the fact that it was off from the initial shipping quarters, we saw a 28% year-over-year growth.

That, I believe, is stellar performance, and that doesn't include the Acrobat Pro that's part of the Career Suite shipments.

Great.

Also, could you tell us what your benefit was from currency on a -- in the quarter here?

Our benefit was $3 million.

So obviously it's much lower than what we've seen in past quarters.

So you look at the 21% growth that we had year-over-year, and it was driven just by operational performance and not any benefit from currency.

Then basically as you're providing guidance for the coming quarter how is that current as part of that hedging, how are we going to think about that?

Well, the currency is factored into our guidance, and the assumption is that the dollar trades relative to the euro and the yen fairly consistently where we've been here over the last few weeks.

Great.

Thank you.

Your next question comes from the line of Philip Rueppel with Wachovia Securities.

Thank you very much.

You did mention that there was some difference in the last upgrade cycle of Intelligent Documents.

Could you refresh us on -- your comments very interesting about the CS2 product cycle being up in both revenues and units compared to the last product cycle.

Are we comparing apples to apples, or did you have a smoother transition in CS2 to the Japan and European countries, and kind of along those lines, could you comment a little bit about the U.S.?

Was that kind of in line with what we thought we'd get now that you had -- in the second quarter of the upgrade cycle?

I'll comment on the first question, Philip, which is around Creative Suite and are we comparing apples to apples.

Yes.

What we were looking at was in a similar number of weeks since the launch of the version.

What are we seeing with respect to units, and what we think we're seeing is one, we continue to see the drive from the customers to a standardizing on the Creative Suite platform.

The reviews that we've got for all the products are pretty incredible.

The new versions as well as Adobe Bridge.

And frankly the increased adoption of Adobe InDesign which also causes customers to standardize on the Creative Suite rather than the individual product.

So both in terms of units as well as in terms of revenue we are seeing greater adoption for Creative Suite 2 as opposed to Creative Suite 1 when it first came out.

We had also talked a little bit about, in Creative Suite 1 initially it was a new product and the awareness was probably not as high as it has been in this version.

To be more specific, Philip, we do look at -- we do compare apples to apples by major language.

Okay.

By geography.

Okay.

Correct.

Okay.

Then just one other question.

Even though we all know that the merger hasn't closed has there been any qualitative benefits to your dealings with customers or, I'm thinking in particular partnerships with some of the mobile providers that you could elaborate on, or any issues, do you notice any delays, let's take out Vector or Web Layout, but, on the intelligent desktop side were there any delays that customers wanted to wait and see how this plays out or is it pretty much business as usual?

We haven't seen any significant impact on our business because of the announcement of the Macromedia deal.

However, we have gotten lots and lots of positive feedback from our customers and partners alike who are thrilled about the combination.

I had a financial services provider who does 401(k) programs who's been working with Adobe on new customer acquisitions on LiveCycle and what he shared with me was that he was also working with Macromedia on a rich Internet application to allow for asset management of those bars and of the graphics within the application, and the fact that he can now or in the future he'll be able to come to one partner for a complete solution was very exciting to him.

I also had one of our major partners, SAP, come to us and say, this is great, because I've chosen to go with your Interactive Form technology that's based on LiveCycle as part of NetWeaver, and they've also publicly stated that they've gone with Flex, which is the rich Internet application for Macromedia based on flash, and again, he is looking forward -- they are looking forward to working with us on a post-close basis.

Obviously, until we close the deal, we can't get into any business details with any of our partners or customers as we have to act as two independent companies.

Great.

Thanks very much.

Your next question comes from the line of Drew Brosseau from SG Cowen.

I just wanted to follow up on the question on Microsoft.

It appeared to me that a lot of the announcements this week were particularly focused on the Macromedia side of design and development.

I'm curious, Bruce, from your perspective what you see the pros and cons of that fight being, Photoshop obviously has this enormous ecosystem as you described it, and particularly as it relates to the print world.

But as you look to try moving into web design, does Microsoft present more of a risk to the Macromedia business?

We've known about their entree with Animation with Sparkle for a long time now.

That's been publicly available information.

At least on many of the sites.

We learned about Acrylic, and we suspect that they were going to get more aggressive in web design.

Obviously they are.

We are absolutely convinced that the position that Macromedia has with Dreamweaver and flash is equal to the position that we have with our customers with products like Illustrator and Photoshop.

There's a great deal of loyalty, there's an incredible ecosystem that's built up, the swift file format that's associated with flash is used by many, many designers and developers around the world.

I have a tough time seeing anybody, including Microsoft, coming in with an entirely brand-new set of tools as well as a brand-new presentation layer and expect for them to take over the world, unless we stopped innovating and clearly over the last 20 years we've demonstrated an ability to innovate and our customers expect that of us.

So yes, on the surface, I certainly see the concern.

Again, unless they do things that is abusive in terms of their position, or potentially illegal, I think that Adobe is going to do quite well.

I think back to the Microsoft photo draw experience when they bundle a product that competed with Photoshop and Illustrator for free in Microsoft Office.

That product no longer exists today, and that's because we innovated against Photoshop and Illustrator.

The our thing is, we are cross-platform.

Many designers, many developers don't want to do their work solely on a Windows machine.

They also want to do it on platforms like Macintosh, and because we innovate on both platforms we think we have a competitive advantage.

Thank you.

Your next question comes from the line of Chris Rowen with Robinson Humphrey.

I just wanted to ask in the digital imaging and video space, now that we've had Creative Suite for more than a year wouldn't that have anniversaried the impact of the drain on Photoshop?

Then beyond that is there anything to get the video side of that business really energized and a growth engine for the Company?

Chris, can you repeat your first question?

We didn't quite understand it.

You've had a Creative Suite now for over a year, so I would have thought that maybe the drain on the stand-alone Photoshop would have kind of anniversaried itself.

Well, in terms of Photoshop, the focus obviously has been and continues to be to move customers -- to get them interested in buying the Creative Suite.

That's been our focus.

Again, as we stated, if a customer chooses to buy Photoshop stand-alone or Photoshop through the Creative Suite we're focusing on those new customers and they can come either way.

Obviously though the marketing efforts are focused on the getting them to buy the Creative Suite and not the stand-alone Photoshop product.

Chris, as we've said, the number of people who have standardized on the Creative Suite platform, there's still a significant opportunity for us to continue to grow.

A number of them are customers who were buying Photoshop in the past, and as they move to the Creative Suite you will continue to see that switch off the revenue that was previously reported in the DI segment now being reported as Creative Suite revenue in the Creative Pro segment.

I would encourage you to go back and look at what happened over time with Microsoft Office, vis-a-vis Word and Excel.

It used to be that many of us used to go out and buy Microsoft or/and Excel and then over time we started to buy Office and today I would suspect that more than 80% of the purchases of Word and Excel buy it via the Office.

I can envision a scenario happening like that with Photoshop versus the Creative Suite over time.

We'd be thrilled if Photoshop stand-alone was not needed any longer and everybody ended up buying the full suite of products, specially the premium suite.

As it relates to video there's lots of opportunities for us to provide video solutions to those customers that are using our Creative Suite.

We believe that there will be a video explosion over the next couple of years or a video revolution because of the pervasiveness of broadband and the easy distribution of things like DVD.

And we think it's our customers that are looking to Adobe to provide them with a compelling integrated solution with their suite.

No announcements today but that certainly is an opportunity for us.

Okay.

Great.

Thanks a lot.

Your next question comes from the line of Steve Lidberg with Pacific Crest Securities.

Steve, your line is open.

Next we go to the line of Barbara Coffee with Brean Murray.

Yes, good afternoon.

On the Intelligent Documents area, you said it was a nice mix of, obviously the ASPs went up as did the number of transactions.

But was there -- and this is interesting, over a rather weak summer month set, did you see it more through the partners gaining traction, or was it through your own direct and were any verticals in particular showing strength?

Barbara, it was primarily through our direct business.

Certainly we are seeing an increase in partner source deals as well.

In terms of the verticals, financial services and government represent the majority of our deals.

Other regulated industries like manufacturing, pharma, we are starting to see some deals in those but we are focused primarily on financial services and government.

Through the SAP relationship we hope to extend that into manufacturing.

And on the licenses piece, the desktop, are you seeing larger companies standardize on you or are you still seeing it more in the pilot phases at this moment?

With respect to the desktop and Acrobat we do see larger companies as they have information that they want to share with fidelity and richness outside the firewall that they are standardizing on Acrobat, but in addition to that we are actually seeing increased usage of the value added features, features like the forms fill-in capabilities, features like review and comment and the collaborative capabilities.

We're starting to see digital signature usage go up.

In the AEC market a number of the enhanced features that we've added in Acrobat Pro.

So PDF is now being taken as a given.

They recognize the value proposition.

We're seeing the value-added features now being used increasingly in enterprises.

It's one of the reasons why last quarter we talked about Airbus buying approximately 32,000 licenses for their complex collaborations, and if you think about collaborating around building airplanes and procurement around the parts and technical publications and 3-D drawings, et cetera, Acrobat and PDF becomes an ideal tool in which to accomplish those tasks.

Thank you.

Your next question comes from Richard Keiser with Bernstein.

Hi.

I just wanted to go back to a question that another caller touched on with respect to the Federal Government.

Have you perceived -- I know that you have business in several areas of the Federal Government.

Have you perceived any shift or attitude toward kind of spending or spending outlook given the massive amount of spending that has come up for reconstruction of other projects related to recent political events or just everything in the southeast?

We haven't seen a major impact.

I suspect part of it is we typically aren't selling them a 10, 20, $30 million solution.

Our solutions are typically less than $1 million, as you saw the average deal was $192,000.

We do do some large procurements with Acrobat desktop but that's a tool that they need and in the scheme of things it's not a large expense.

When you look at some of the expenditures today and the deficits we're running as a country, the return on investment with an Adobe product or solution is very high and the expense is in the scheme of things very, very low.

So do you think the companies with a higher ticket item are more generally kind of -- your replacement or general upgrade spending may be more impact if something like that does come down the pike?

I suspect so, but it's probably a better question for them.

Thanks for your help.

Operator, we'll take one more question.

Very well, your final question comes from the line of Jay Vleeschhouwer with Merrill Lynch.

Thanks.

A product or technology question for Shantanu.

Could you be a bit more specific on how much of the Acrobat business is being driven by the verticals?

You seem to have grown your total new unit base of Acrobat by far more than you did all of last year.

So when you look at AEC, manufacturing, relative to the two to three million seats of design software there, technical software there, how penetrated do you think you really are?

And then finally, a development question.

Typically in the past, how long after Microsoft came out with a new version of an OS did you come out with new compliant versions of Photoshop and other products, and would you expect to come out as quickly in the past when Vista comes out?

With respect to the first question, Jay, and adoption of Acrobat in the vertical market, especially AEC and manufacturing, we think there's some significant head room that still exists.

We are starting to see the product being used in some very interesting ways, requests for proposals and information, design collaboration in that particular space, bidding. as bidding contracts are going outside the firewall, as well as engineering, change orders and archiving.

It was actually particularly gratifying, some Adobe customers were using Adobe Acrobat received a Vision award by one of those magazines in construction for using technology to foster innovation in the construction industry.

But, while it's growing, certainly both in AEC and manufacturing we think there's significant more opportunity for us in that particular marketplace.

With respect to Microsoft we're not going to be announcing any product here.

Traditionally what we have done is we have not altered our road map for either what happens either on the Microsoft side as well as on the Apple side.

And so we continue to expect to drive towards our product road map providing innovation to our customers and we look to Microsoft in this particular place to make sure that they have compatibility with our older versions.

We'll also listen to our customers and get a sense for how quickly they expect to migrate.

We've heard that migrating to new operating systems, especially for Microsoft, seems to be taking longer today than it had in the past.

Certainly the migration to XP was a much slower path than Windows 2000 was.

So we'll keep an eye on the market.

Microsoft certainly continues to work closely with us because they do want our applications to work on their new operating system, as I think most people realize we are one of, if not the largest commercial provider of desktop applications for Microsoft Windows, so there's a co-dependency there that exists.

Thanks, Bruce.

Well, thanks, everybody and this concludes our call today.

Ladies and gentlemen, we do appreciate your joining us today.

This does conclude our Adobe Systems fiscal year 2005 earnings conference call.

You may now disconnect.