Adobe Inc (ADBE) 2006 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Adobe Systems Q1 and fiscal year 2006 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you.

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

Please go ahead, sir.

Good afternoon.

And thank you for joining us today.

Joining me on the call are Bruce Chizen our CEO;

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

On the call today we will discuss Adobe's first quarter fiscal 2006 financial results.

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

In addition, we will be issuing a revised press release in the next few hours in order to change the presentation of amortization of deferred compensation on our income statement.

There is no change to operating income, net income, or earnings per share.

It is only a change in the presentation of the income statement.

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

Before we get started, I want to emphasize that some of the information discussed in this call, particularly our revenue, and operating mile targets and our forward-looking product plans is based on information as of today, March 22, 2006 and contains forward-looking statements that involve risk and uncertainties.

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 2005, and our quarterly reports on Form 10-Q, in fiscal 2006.

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 the press release issued today, and are available on our website.

All participants are advised that the audio of this conference call is being broadcast live over the Internet, and is also being recorded for playback purposes.

An archive of the call will be made available in Breeze on Adobe's Investor Relations website for approximately 45 days and is the property of Adobe Systems.

The audio and archive may not be re-recorded, or otherwise reproduced or distributed without prior written permission from Adobe Systems.

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

Thanks, Mike.

And good afternoon.

I am pleased to announce that our business continues to perform well.

Today, we reported record revenue near the high end of the range we provided in December.

And earnings per share, which exceeded our target ranges.

In Q1, revenue was $655.5 million, representing 39% year-over-year growth, and reflects the addition of the Macromedia business.

Even without the addition of the Macromedia business, we estimate Adobe's business would have delivered double digit year-over-year growth.

Driving our business performance this quarter was strong demand for our Creative solutions, and our Acrobat product line.

In addition to our strong financial results, the integration of Macromedia is going well.

It is also exciting to see that our engagement platform strategy is resonating with customers, partners, and developers, who are beginning to deliver the most engaging experiences across media and devices.

I will now turn the call over to Murray to provide a review of the financials, later Shantanu will provide more detail about our performance in each of our key businesses.

Murray?

Thanks, Bruce.

Before I review our Q1 financial results, I would like to point out that we are not providing combined prior period Adobe and Macromedia results.

As we have previously stated, Adobe and Macromedia reported their results on different fiscal quarters which limits our ability to provide accurate comparisons.

Therefore today, we will compare our Q1 fiscal 2006 combined company financial results, to pre-acquisition Adobe only results.

In addition, we also have the challenge of meaningfully comparing our fiscal 2006 results versus our fiscal 2005 results due to acquisition accounting and the implementation of stock-based compensation under FAS 123-R.

I will comment on these 2006 charges later in my prepared remarks.

For the first quarter of fiscal 2006, Adobe achieved revenue of 655.5 million.

This compares to 472.9 million, reported for the first quarter of fiscal 2005, and 510.4 million reported last quarter.

GAAP net income for the first quarter of fiscal 2006 was 105.1 million, compared to 151.9 million reported in the first quarter of fiscal 2005, and 156.3 million last quarter.

Non-GAAP net income was 197.5 million, compared to 133.8 million reported in the first quarter of fiscal 2005, and 151.5 million last quarter.

Non-GAAP excludes as applicable Macromedia acquisition costs, restructuring charges related to the Macromedia acquisition, a charge for incomplete technology related to a small acquisition, stock-based compensation, the net tax impact of the repatriation of certain foreign earnings, and tax differences through the timing and deductibility of the Macromedia acquisition costs and related charges and stock-based compensation.

And investment gains and losses.

GAAP diluted earnings per share for the first quarter of fiscal 2006 were $0.17, based on 621.8 million weighted average shares.

This compares with GAAP diluted earnings per share of $0.30 reported in the first quarter of fiscal 2005, based on 506.2 million weighted average shares and GAAP diluted earnings per share of $0.31 reported last quarter, based on 508.6 million weighted average shares.

Non-GAAP diluted earnings per share for the first quarter of fiscal 2006 were $0.32.

GAAP gross margin for the quarter was 88.1%, compared to 94.3% in the first quarter of fiscal 2005, and 94% last quarter.

Non-GAAP gross margin, which excludes the amortization of Macromedia acquisition-related costs, was 93.8%.

GAAP operating expenses for the first quarter of fiscal 2006 were 447.8 million.

Non-GAAP operating expenses which exclude Macromedia acquisition costs, restructuring charges related to the Macromedia acquisition, a charge for incomplete technology related to a small acquisition, and stock-based compensation, were 362.4 million.

Regular employees at the end of the first quarter totaled 5,480, versus 4,285 at the end of the fourth quarter of fiscal 2005.

GAAP and non-GAAP expenses as a percent of revenue break down as follows.

Research and development, GAAP, 21%.

Non-GAAP, 17.3%.

Sales and marketing, GAAP 32.6%, non-GAAP 30%.

G&A, GAAP 9.2%, non-GAAP 8%.

GAAP operating income in the first quarter of fiscal 2006 was 130 million, or 19.8% of revenue.

This compares to GAAP operating income of 170.7 million, or 36.1% of revenue in the first quarter of fiscal 2005, and 191.9 million or 37.6% of revenue last quarter.

Non-GAAP operating income in the first quarter of fiscal 2006 was 252.4 million, or 38.5% of revenue.

This compares to non-GAAP operating income of 170.7 million, or 36.1% of revenue in the first quarter of fiscal 2005, and 191.9 million or 37.6% of revenue last quarter.

Non-GAAP operating income in the first quarter of fiscal 2006 was 252.4 million, or 38.5% of revenue.

This compares to non-GAAP operating income of 170.7 million, or 36.1% of revenue in the first quarter of fiscal 2005 and 191.9 million or 37.6% of revenue last quarter.

Other income for the first quarter of fiscal 2006 was 15.5 million.

Adobe's GAAP effective tax rate for the first quarter of fiscal 2006 was 27.2%, and Adobe's non-GAAP effective tax rate was 26.3%.

The difference between the two rates is related to the timing and deductibility of the Macromedia acquisition costs and related charges, and stock-based compensation.

Our original tax rate target for the quarter was 25%, which assumed the R&D tax credit would be retroactively extended by Congress.

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

As we communicated previously, we are reporting our results in five new business segments in fiscal 2006.

Creative solutions segment revenue was 379.6 million.

We experienced solid demand for our Creative Suites and new bundles.

Also, the video product launch is off to a good start.

Knowledge worker segment revenue was168.8 million, quarterly Acrobat results were the second best in company history and we experienced solid demand with Breeze.

Enterprise and developer segment revenue was 45 million.

It was a record quarter for LiveCycle, up 45% from the year-ago quarter.

Mobile and device segment revenue was 8.6 million.

While we continue to experience strong demand for our technologies overall revenue is down from pre-acquisition levels due to lost revenue from acquisition accounting, consistent with our previous comments.

Other segment revenue was 53.5 million.

PostScript revenue was essentially flat year-over-year consistent with our expectations.

Turning to our geographic segment, the results in Q1 fiscal 2006 on a percent of revenue basis were as follows.

The Americas, 48%.

Europe, 32%.

Asia, 20%.

Overall, we experienced solid demand in all of our major geographies.

Our trade DSO in the first quarter of fiscal 2006 was 39 days.

This compares to 27 days in Q1 fiscal 2005, and 31 days last quarter.

In regard to our global channel inventory possession, we ended the quarter within company policy but at a level higher than the previous quarter.

The change in inventory level was due to high distribution sell-through in November in advance of some distributor margin decreases, and higher sell-in to distribution in February, to meet strong seasonal demand.

At the end of the first quarter of fiscal 2006, cash and short-term investments were 2.1 billion, compared to 1.7 billion at the end of the fourth quarter of fiscal 2005.

In regard to share buyback, during the quarter, we repurchased 9.6 million shares at a cost of $355 million, as part of our share repurchase programs.

Now that we have essentially completed our purchase accounting activities related to the acquisition of Macromedia, I would like to update our various purchase accounting targets.

We now expect a loss of approximately 60 million, in fiscal 2006 revenue, due to purchase accounting, an increase of 10 million over our previous estimate of 50 million.

The increase in lost revenue is due to our inability to recognize as much revenue from Macromedia's deferred revenue balance as we had previously estimated.

For fiscal 2006, we also are refining other approximate purchase accounting targets as follows.

Amortization of purchase technology for fiscal year 2006 is estimated to be 136 million.

Our prior target range was 140 to 150 million.

In Q1, fiscal 2006, the amortization of purchase technology was 34 million.

Amortization of purchased intangibles for fiscal year 2006 is estimated to be 68 million, our prior target range was 50 to 55 million.

In Q1 fiscal 2006, the amortization of purchased intangibles was 17.1 million.

Amortization of deferred compensation for fiscal year 2006 is estimated to be 64 million.

Our prior target range was 55 to 60 million.

In Q1, fiscal 2006, the deferred compensation expense was 23.5 million.

In Q1, we also incurred a restructuring charge related to the Macromedia acquisition of 19 million, and a charge of approximately 5.8 million for incomplete technology related to a small acquisition.

In addition to the acquisition-related charges, we reported our first quarter of stock-based compensation under FAS 123-R.

Due to changes in forfeitures related to the reduction in force, and other estimates, we are reducing our target range for fiscal year 2006 from $0.15 to $0.17 per share, to $0.12 to $0.14 per share.

Line item details for our Q1 fiscal 2006 FAS 123-R expense charge of 23 million, can be found in our GAAP to non-GAAP reconciliation in our press release.

This concludes my discussion on first quarter fiscal 2006 results.

Now we would like to discuss our Q2 fiscal 2006 targets.

We are targeting a Q2 revenue range of approximately 640 to $670 million.

In addition, we are targeting our Q2 GAAP operating margin of 22 to 24%.

On a non-GAAP basis, which excludes acquisition-related costs and stock-based compensation, we are targeting an operating margin range of 37 to 38%.

We are targeting our second quarter share count to be approximately 620 to 622 million shares.

For other income, we are targeting 15 to 16 million.

And for our GAAP effective tax rate, we are targeting 27%, and for our non-GAAP, effective tax rate, we are targeting 26%.

These targets lead to a GAAP earnings per share target range in Q2 fiscal 2006 of $0.18 to $0.21 per share.

And then our non-GAAP earnings per share target range of $0.30 to $0.32.

For the full year, we are also -- we also are reaffirming today our fiscal 2006 revenue target of approximately 2.7 billion.

In addition, we continue to expect the third quarter of fiscal 2006 to be the lowest revenue quarter of the year due to typical summer weakness in Europe and Japan.

Also, we are targeting the fourth quarter to be the highest revenue quarter of the year, primarily due to the launch of the next major version of the Acrobat family of products.

This concludes my comments.

I will now turn the call over to Shantanu.

Thanks, Murray.

Q1 was a productive quarter.

We started executing as a combined company with Macromedia, and launched our vision for the future around the Adobe engagement platform.

As we highlighted at our analyst meeting in January, our strategy is to establish the Adobe engagement platform as the cross media, cross device standard for delivering engaging digital experiences.

Based on our new reporting segments, I will take the next few minutes reviewing highlights in each of our major businesses starting first with Creative solutions.

The charter of our Creative solutions business unit is to deliver a complete professional line of integrated tools for a full range of Creative and development tasks to an extended set of customers.

In Q1, factoring in the new bundles, we achieved record revenue for our suites as the product line continues the momentum we achieved in 2005.

In addition, our design, web, and video bundles which combine Creative Suite 2 or the new Production Studio, along with Studio 8 or Flash professional 8 have been well received by customers with the web bundle showing particular strength.

The premium version of the Creative Suite continues to be the largest revenue generator in this segment.

In addition, our momentum within InDesign continued.

It was the best revenue quarter since we launched the product more than six years ago.

Creative Suite 2, and Studio 8, also continued to receive positive accolades in the press.

Macworld gave CS2 an editor's choice award, Electronic Publishing named CS2 in its listing of 2005 hot products and PC Magazine recognized both CS2 and Studio 8 as break-through products of 2005.

Key customer adoption of both the creative suite and Studio 8 helped drive our success.

Lonely Planet Publications among the world's most successful travel media companies with more than 500 book titles has adopted the creative suite including InDesign to publish guide books, activity guides, phrase books, and other travel materials that are distributed globally.

In addition, Harris Publications, Oracle, and Psion have utilized Studio 8 to create new web based educational tools, design high response online marketing programs, and increase brand adoption.

We continue to grow our partner Ecosystem around our creative platform.

Recently, Logitech announced the NuLOOQ Professional Series, a hardware device, and software interface, designed for use with Creative Suite 2, as well as the CS2 versions of Illustrator, InDesign and Photoshop.

Turning to our digital video solutions, we continue to believe we are in a unique position to drive video usage on the web through a combination of our video products and the Flash Player.

In Q1, we announced and shipped Adobe Production Studio which combines new versions of our world class video and graphics applications.

Auto Effects, Premiere Pro, Audition, Encore and the latest versions of Photoshop and Illustrator, with time-saving innovations, such as Adobe Dynamic Link, that deliver a highly efficient work flow experience.

Production Studio also integrates Flash video export capabilities, to provide video professionals with a new fluid method of delivering content to the web.

Based on the strength of this upgrade, we achieved record quarterly revenue in Q1, in our digital video business, spanning our professional and hobbyist product lines.

In addition Flash Media Server our solution for streaming content over the web via the Flash file format continues to see strong adoption.

Press reaction to Production Studio has been outstanding.

PC World said "every component of Production Studio is extremely useful and highly complementary ."

Adding that it makes "working with multimedia far more efficient than it used to be ."

And PC Magazine gave it a PC Magazine's editor's choice award.

In our professional digital imaging business, full units of Photoshop grew 33% year-over-year, when factoring units shipped with the Creative Suites, the new bundles, and Production Studio.

We also introduced the public data of Adobe Lightroom an all new digital imaging solution for professional photographers that delivers a complete photography work flow.

More than 100,000 copies of Lightroom data have already been downloaded to date and more than 2800 photographers are actively participating in online discussions about the product.

Lightroom received the best of show award at Apple's Macworld conference in January.

In summary, our the Creative business continues to have momentum.

Looking forward, we are excited to have John Loiacono join us next month as the new Creative Solutions business leader.

He and the team will be working hard on the next release of the Creative Suite 3 family of products which we continue to target for a spring 2007 release.

Turning to our knowledge worker business, our strategy is to provide essential applications, and services, to help knowledge workers collaborate with confidence, with particular focus on building out vertical solutions, for specific targeted markets, such as engineering.

In Q1, we continue to see strength with our Acrobat business.

Revenue for the Acrobat family of products in the quarter was second only to Q1 '05, when we launched Acrobat in all major languages.

In addition, the ratio of Acrobat professional and Acrobat 3D combined to Acrobat standard remained at approximately one as to one.

Demonstrating demand for features beyond PDF creation.

Acrobat 3D began shipping in late January, helping to extend document-based 3D design collaboration capabilities to virtually anyone in the design supply chain.

AEP Bytes, a publication serving the architecture engineering and construction industry said of Acrobat 3D "the ability to capture 3D model information from an open application right from the screen and convert it to PDF on the fly is a very powerful one and constitutes a critical break through for Acrobat and PDF.

It will continue to maintain PDF's current stature as one of the most ubiquitous and compelling options for electronic publishing in the AEC industry ."

Breeze,, our rich web communication and conferencing solution that leverages the ubiquitous Flash Player continues to be an exciting opportunity.

Breeze is being used to enable online meetings, provide self-based training material on the web and to create on demand presentations.

While still a nascent business, Breeze achieved record revenue in Q1.

In our enterprise and developer solutions business, our strategy is to create market leading enterprise interaction solutions that automate people centric business processes and provides great user experiences.

In Q1, our success in this business continued, with LiveCycle, we achieved approximately 45% year-over-year growth, resulting in a record quarter.

The number of transactions with software licensing revenue, greater than $50,000, for all of our server products, including LiveCycle, Flex, Cold Fusion, Breeze, and flash com media server was 113.

LiveCycle highlights in Q1 included customer wins such as the Dutch Chamber of Commerce which will implement an Adobe document solution for the complex process of confirming notary data and registering new companies.

INPS, the Italian Social Security Agency which is using an Adobe LiveCycle solution to reduce paperwork, increase the accuracy of information, and improve customer satisfaction by providing electronic forms via the web.

And the Belgian Social Security Organization which is utilizing an Adobe eCom solution comprised of Reader Extensions Server, form server, and 2D bar coded forms to create an improved user experience with improved data quality.

We continue to also build out our ecosystem around the LiveCycle business.

For example, in Italy, the National Center for Information Technologies and Public Administration recognized Adobe PDF as a valid digital signature format giving Adobe an opportunity to deliver solutions that will help Italian citizens, businesses, and governments, to improve constitute interactions.

In Germany, IBM announced it is working with Adobe to develop an enterprise rights management solution, utilizing our technologies to help companies protect their digital data from product tests.

And we continue to work closely with SAP which is resulting in increased adoption of the Adobe NSAP interactive form solution based on NetWeaver.

While still early, customer wins in Q1 were greater than all the previous quarters combined.

Finally, with LiveCycle, we broadened our security solution, with the acquisition of the Fine Line Digital Rights management division of Navisware.

The acquisition enables us to provide new capabilities for LiveCycle policy server to persistently protect business critical documents in PDF, Microsoft Office, and CAT application formats independent of how they are stored or delivered inside and outside the fire wall.

Also in our enterprise and developer business, we announced the public data of the Adobe Flex 2.0 product line, and Flash player 8.5.

Combined, they create the leading development solution for delivering rich Internet applications and we expect the final versions to ship in June.

We often get asked about the relationship between Flex and Flash and Ajax.

These are complementary technologies that can be used to enhance the user experience of the next generation of rich interactive application.

Flex plays an important role in helping to augment Ajax applications and overcome its limitations, especially as it relates to addressing router -- browser issues and offline data access, audio enriched video use, high performance data exchange, and message based published subscribed models.

We recently released an open source Flex Ajax bridge which makes it easy to integrate the two technologies and to bring Flex data services and offline data access to Ajax style applications.

In addition to developers, industry analysts are starting to take notice.

Gartner recently wrote, "Adobe is positioning itself for the time when web developers run out of steam with Ajax ."

The net result of our efforts is that conversations with the developer community and customers are not Ajax versus Flash, but rather, how Ajax and Flash work together.

Let's turn to our mobile and device solutions business.

Our key opportunity here is to provide solutions that create compelling experiences through rich content and applications on mobile and nonPC devices, leveraging a universal client that is available on each of these devices.

At the beginning of the calendar year, we announced the availability of Macromedia Flashlight 2 software.

Flashlight 2 is a major new release of the Flash Player for nonPC devices bringing rich user interfaces to mobile phones and consumer electronic devices worldwide.

We also announced that leading consumer electronic device manufacturers including Kodak, Sony, iRiver, and Magic Box are adopting Flash technology to deliver customizable user interfaces, enhanced content and superior browsing experiences to end users.

We also announced licensing agreements for Flash technology with LG Electronics and BenQ Mobile.

In addition, NTT DoCoMo, the major carrier in Japan, stated that over a million subscribers are now paying for a FlashCast based service.

FlashCast is our server solution for providing specialized content to mobile devices.

And finally, last week, Sony announced Flash will be available on the next generation of PlayStation devices including PSP and PS3, further advancing the reach of Adobe technology to a whole new ecosystem of developers and consumers.

This concludes my comments.

Bruce?

Thanks, Shantanu.

As we look at fiscal year '06 and beyond, we have the business strategy and talent in place to take advantage of the global market trends that will drive our growth.

We are focused on our strategy to deliver an engagement platform and a variety of solutions that enable our customers to differentiate themselves in a world where the proliferation of content, media, and devices continues to accelerate.

The future opportunities for Adobe are tremendous.

And we look forward to sharing our progress with you.

Mike?

Thanks, Bruce.

Before we start Q&A, I would like to go over a few logistical items.

We will provide our regular Q2 inter-quarter business update press release on Tuesday, May 2, after the market closes.

Again, that is Tuesday, May 2.

We will post several documents on our Investor Relations web page related to our earnings report later today.

This includes today's earnings release, our updated investor data sheet, and the spread sheet providing reconciliation for GAAP to non-GAAP financial data.

To access this and other investor related data you can go to our website at www.Adobe.com/ADBE.

Our annual meeting of stockholders will be held next week on March 28.

Our annual report, proxy statement, and letter to stockholders were mailed several weeks ago to stockholders of record.

These documents are also available on the Investor Relations page of Adobe.com.

For those who wish to listen to a play back of today's conference call, our web based Breeze archive of the call will be available from the IR page on Adobe.com later today.

Alternatively you can listen to a phone replay by calling 800-642-1687.

Use conference I.D. number 6146834.

Again, the phone number is 800-642-1687 with conference I.D. number 6146834.

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, March 27, 2006.

We would now be happy to take your questions.

Operator.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of Steve Ashley with Robert Baird.

Hi, guys.

Murray, would it be possible for you to perhaps give us the year-over-year growth rates for the five business segments of which you had given us the dollar revenue break down?

Steve, yes, we wanted to provide that information, but when we got to looking at it and realizing that with Macromedia reporting on different fiscal quarters than Adobe, it wasn't really possibly for us to be able to provide accurate information on a year-over-year basis so we will be providing on a go forward basis what the combined company is but only providing a compare to Adobe stand-alone or sort of pre-acquisition, in the compare year.

What is encouraging, Steve, is that even when we factor out the Macromedia revenue, and we look at just the Adobe core revenue, that business grew double digits year-over-year.

So even without Macromedia, we saw healthy growth.

Murray, what kind of impact did FX have on the top line?

And maybe on the other income line or bottom line?

Well, in terms of revenue, it is a -- it is a touch tricky in the sense that we don't necessarily have the exact numbers for Macromedia for the base year a year ago but if you think of it this way, if we could have had the same exchange rate euro to dollar and yen to dollar this year that we had last year, our revenue would have been about $25 million higher this quarter.

Right.

Okay.

And just lastly, Shantanu, can you comment on how maybe CS2 continues to perform versus how CS1 had performed, at maybe a similar stage in its life?

Thank you.

Sure, so Steve, clearly CS2, if you take the same duration that CS2 has been out relative to CS1, we are very pleased with the performance of CS2, it continues to outpace what we saw with CS1, and if you look at this particular quarter, when you take the new bundles that we talked about and given the focus that we had on integration during the period before the close, we were able to actually again have a record revenue quarter for the Creative Suites standard and premium and the two new bundles that we introduced.

So continue to be really pleased with the performance.

Great.

Thanks, guys.

And your next question comes from the line of Thomas Ernst with Deutsche Bank.

Good afternoon.

Thanks, guys.

Question on where are you in the integration of the two companies in terms of overlapping functions and pulling costs out of the business.

Have you completed actions you expect at this point?

And when in the quarter did those actions take place?

Tom, we're quite pleased where we're at at this point.

We moved very swiftly throughout the quarter and we believe we realized the cost savings at this point.

The work is essentially done.

And our focus right now is on hiring more people to help drive the great opportunities that we have going forward, we have on a go-forward basis, so it is behind us, and we're moving forward.

Thomas, I would comment overall the integration is going well, and not only from an expense perspective.

In fact, if you look at the operating margin profits on a non-GAAP basis this quarter, probably a little bit higher than we originally anticipated because things are going so well.

But not just about the finances and the systems, the strategy is set, and complete, and as you probably know, it has been communicated to both the financial community, and to many, many of our customers who are executing against the product road map that is in place, and you saw the result of some of that even this quarter, with the bundle, as well as the integration of Flash with new video products our go to market plans are in place, and we're executing against our vertical solution strategy, and most of the transition employees that were helping us through this period are no longer with Adobe.

So just overall, I think things are going well for an acquisition of this size.

Good to hear.

How much cost was pulled out of the business?

And how much of that did we feel this quarter?

So in other words did it come in the middle, on average?

Or what is the full cost run rate as we look forward that was pulled out?

Well, Tom, we're not providing any specific numbers on the savings because a lot of it was that -- we made certain cuts, but with the same idea that we were going to take some of those savings and reinvest them in the business.

Clearly, we're quite satisfied with the results we had this quarter, as Bruce mentioned at 38.5% operating margin, we provided a target for the second quarter of 37 to 38%, so we continue to see excellent profitability but very focused on increasing our resources to focus on the opportunities that we have going forward.

One thing we made sure of, as we went through the planning process, prior to integration, was to set our priorities appropriately, and that meant a reduction in force in many areas across the Company, on projects that no longer made sense for us, or projects that we wanted to spend resources on to make sure that we could fully resource those projects that we were most excited about.

We are in the process of continuing to ramp headcount against those projects, which is why our expenses will go up throughout the year.

One more follow-up to that, if you'll permit, and then I will let others jump on.

Certainly the margin you delivered this quarter was impressive, I think it was better than anybody was looking for.

I'm just a little surprised to see that the margin guidance down next quarter, given that I only expected you to get a partial benefit from the rest and some cost to take out.

Is there anything looking forward here into the next quarter that is a new expense or a one-time expense that is included in your pro forma number?

No, it is just a continued focus on hiring and bringing on more resources, obviously we have a little benefit during the holiday period and the Christmas time that we get some savings from employees going on vacation, that we don't get in the second quarter.

So it is primarily focused on really the ramping resources, focused on the future opportunities that we have.

And of course as we get closer to the new product cycle around Acrobat 4 and as we start thinking about Q2 '07, we are going to want to ramp up marketing expenses.

Okay.

Thanks again.

And your next question comes from the line of Heather Bellini with UBS.

Hi, thank you.

And good afternoon.

I was just wondering if you could share with us some color on two topics.

First, there was a lot of concern in the quarter about what type of impact the Mactell transition would have on your revenues and I was just wondering if you could give us your thoughts there, Bruce.

And then secondly I guess for Murray, if you could give us an idea, since these are new segments for you guys, how we should think about seasonality of the biggest segments for the May quarter?

Thank you.

I will take the one on the Mactell and what we've seen so far.

We continue to see real strength in the Macintosh business.

If you really look at the percentage of revenue that we've had in Mac, it actually grew a little bit quarter over quarter, so with the Creative Suites clearly driving the significant amount of revenue on the Mac platform, we're working on the transition for Mactell with our next generation of products, but so far, we continue to see customers want to buy the Creative Suites, the studio and the bundles because of the features that we have in the product.

We've always found that when the features are present in our products, people will buy the products.

We have heard from some of our larger customers that their transition to new CPU's that are Mactell-based will be a similar transition that they experienced going from OS9 to OS10, they will get there but they won't get there en masse for a while and we think by the time they get there we will be there with our Creative Suite 3 products.

Great.

And then Murray, the question about the seasonality of the business segments in the May quarter?

Yes, Heather, in terms of looking at Q2, I think the way to look at it is basically more of the same relative to Q1 and that the business should be relatively consistent across all of our business lines in the second quarter relative to the first quarter.

And if some of these products do better then we will come in toward the high end of the range and if some of them do a little bit weaker then we come in toward the low end of the range.

In terms of some of the seasonal factors, clearly we have the March year-end budget flush in Japan, as a seasonal factor in Q2, as well as we tend to have -- that benefits the quarter and then we tend to have a slowdown around the Easter holiday in Europe and the U.S.

Great.

Thank you.

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

It is Jamie Friedman at Soleil.

Murray, you seemed to increase the write down in the acquired deferred revenue by 10 million.

Can you help us understand the linearity?

Like what quarter does that write-down occur in?

Yes, Jamie, we did see a -- we lost 10 more million in revenue this year relative to purchase accounting and the way to look at that is, obviously it's not a large number, and when you look across all the quarters, it is going to be essentially similar on each of the quarters, and it could be slightly skewed toward the first quarter versus the fourth quarter the way these maintenance programs roll off, but I will probably look at it more sort of kind of a pretty standard amount quarter to quarter.

So in other words, your guidance relative to Street expectations may be haircut by a couple 3 million related to that increase in the write-down?

You're referring to Q1 or Q2 here?

I'm referring to -- I get disoriented, fiscal Q2.

Well, essentially we've lost 10 million, so it is going to come out of each of the quarters so when you start sort of dividing that by four you start getting some pretty small numbers so I guess in the absolute sense it has a slight impact but it wouldn't be a major driver in changing any kind of targets we'd set for any of the quarters.

In fact the fact that we reaffirmed $2.7 billion, that includes the additional $10 million of revenue that we will lose.

So we are sticking with our guidance regardless of the additional $10 million of revenue loss from purchased accounting.

Helpful.

Thanks.

And then historically, and I guess you're getting it up on the website, you had this Investor Relations data sheet, and Shantanu, I think you alluded to this, but what was the platform mix if you still have it between Windows and Macintosh in the quarter the way that you used to report it?

We don't have that data in front of us.

It was a slight shift, I believe, to the Macintosh quarter over quarter.

But in the scheme of things, it was immaterial.

I think it was just the fact that it was relatively the same, or slightly up, was a great indication to us that our Macintosh customer continues to buy the Creative Suite.

One of the challenges we have going forward is that many of our products are now delivered on cross platforms in a cross platform way, so it becomes harder and harder for us to differentiate a Mac SKU from a Windows SKU and it's one of the reasons why we're not at least proactively providing the percentages.

Obviously, if things change in a material way, we will share that with you.

If it is something that is a major, major difference from what we have experienced historically.

And Jamie, and for everybody else, we will have that data sheet out there here, after a bit.

Because of sort of inadvertently putting the amortization of deferred comp as a line item on the income statement, we need to fold that back into each of the line items for R&D sales and marketing, G&A, once we get that tweaked we will put the Investor Relations data sheet up there and again it will be a revised proselyte just fixing that presentation on the income statement, there will be no change again to operating income, net income, or EPS.

Okay.

Great.

All right.

That's it for me.

Thank you.

And your next question comes from the line of Jay Vleeschhouwer.

Thanks, good afternoon.

First a couple of product and technology questions.

As you pointed out, you've introduced the new bundles, the production bundle and design bundle.

The question is, how much further do you think you can or should take that segmentation or vertical approach to the business?

Is that about as far as you can go in terms of fine tuning the bundles mix or might there be more that you could do, particularly given some of the references you've made to having more of a vertical approach for a Photoshop, and similarly, could you further segment Acrobat as you've done with 3D?

Then some follow-ups.

Jay, with respect to the bundles, again, as I said, you know, the fact that we have -- we were able to provide bundles on day one, we thought was a really positive indication of how we've been able to integrate it.

And we are seeing good strength in the web bundles.

Specifically with respect to Photoshop, clearly we continue to talk to our customers, and we are hearing that Photoshop is being used for very specialized imaging applications.

And functionality such as being able to deal with medical imaging, being able to do measurement of images, et cetera, that the value add that we can provide is significant.

At this point, we're not talking about any new products, but directionally, we are hearing that there is value-added functionality, specific to certain verticals where they believe that they would want that product over the generic Photo shop product.

With Acrobat, Acrobat 3D it's early -- we've been very pleased with the response that we've got from the press, and the early customer adoption is also encouraging.

Clearly, we continue to believe that Acrobat has more vertical uses and we will continue to explore other vertical SKUs for Acrobat.

But at this point, our focus is really on continuing to make sure that our AEC strategy evolves successfully.

The next technical question is the presumption is that the true, let's call it Adobification of the products post merger will occur with CS3 and the other stand-alone apps next year, however in the meantime is there something more that you can do?

Some interim integration that you can accomplish to bring the products a bit more together, short of the full releases next year?

Clearly, I think we were able to demonstrate that with the Production Studio, we were able to provide Flash export which has been received very well.

The other thing that we've been able to do pretty quickly, Jay, is to provide an emulator for mobile to make sure that as people are creating more content for mobile devices that you can actually emulate this within Flash, for example, which prevents people from having to test it, explicitly on hundreds of phone devices.

So I think we've demonstrated already that we can provide really quick integration.

Our focus right now really is on providing great new CS3 applications for best of breed applications, and truly integrating the products and as you know, we also have to deal with both Vista as well as the Mactell transition.

So that really is our focus right now as a company.

For Murray, setting aside the deferred revenue issue for the Flashlight business, can you update us on what the number of shipping Flash products and units to date have been, Macromedia used to disclose those kinds of numbers each quarter?

Jay, at this point, we're not planning on providing that information so we have nothing to report at this time.

All right.

And then finally, since you called out Japan seasonality, are you seeing strength in both the corporate and consumer side to the business in Japan?

Well, I can just speak to what we saw in February, when we saw strong demand as you would expect in February, it's the second strongest month of the year in Japan, as we moved toward March being the strongest, and through February, we saw strength across the board.

Thanks very much.

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

Thanks.

Volume licensing has been trending up over the last couple of years.

I think at analyst day you mentioned it is closer to 40%.

Does Macromedia now change any dynamic of that trend line?

It really doesn't.

I mean essentially, we fell through the same channels, and our customers tend to buy in very similar ways, and so the overall mix between shrink and license -- shrink wrap and licensing was very similar between the two companies and doesn't have a material impact on the joint company going forward.

Very similar.

Okay.

Murray, there was an article today in the Mercury about the potential for a fourth tower in San Jose.

If that happens, is that imbedded in the cost structure that you've given the Street?

Well, we can't really comment on rumors that are out there, but when we do provide targets, we do include everything that we know at the time into those targets to make sure that we're providing what we believe is the appropriate and to the best of our knowledge accurate targets at that time.

Okay.

And just two quick metrics, the DSO and inventory trended up this quarter.

What should we expect for both of those going into Q2?

Well, a couple of things on first of all, on the DSO this quarter, as you know, when the companies came together, we assumed some receivables that were on the Macromedia balance sheet, where they had already recognized revenue and so we probably, you can look at the DSO as 39 days this quarter.

If you factor out some of that, we probably were closer to 36 days this quarter.

So it tended to inflate the DSO from what the underlying businesses running again because of the acquired receivables.

In terms of the inventory, the Q1, 2006 levels are really back in line where we were in 2005, other than the fourth quarter.

In the fourth quarter, we implemented some distributor margin decreases based on some efforts we put in place to try to standardize the margins across the number of our products and geographies, so distribution, seeing that coming, they ended up wanting to buy more product and ship more product and so what we did was because we knew this was happening and wasn't really a major change in underlying demand from an end user standpoint is that we held the inventory levels down some in the fourth quarter because of this sort of unique situation, and so all we've done now in Q1, is just bring it back to sort of the appropriate healthy levels that we saw throughout much of 2005.

Thanks.

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

Thanks.

Murray, just following up on that in terms of the inventory, is there any kind of a geographic trend to that, meaning was that pattern seen more in North America or Europe?

No, not really.

It was pretty much consistent across the board, because we were looking to make some margin changes in -- like I said, across products and market areas so what we've done now is, we're still within company policy, we're right where we want to be in terms of a healthy level of inventory to be able to run our business efficiently as we enter the second quarter.

So nothing really from a geographic perspective.

And then can you comment a little bit on the share repurchase, you mentioned the 9.6 million shares bought in the quarter, what your thought on kind of completing the $1 billion buyback that you talked about with the Macromedia acquisition over kind of what time frame?

Sterling, in terms of the repurchase, we had said that we were going to go after $1 billion worth of stock repurchased in the 12 months following the close of the acquisition.

We've now through the first quarter done 200 million of that 1 billion.

And we also did 155 million under our normal stock repurchase program.

So that's what sort of makes up the 355.

So 800 million to go, Q2 and beyond, over that sort of next nine months.

And how does some of the financial transactions that you entered in for share repurchase, how does that kind of play itself out?

Well, we've tended to go into some structured repurchase agreements where we're looking at something relative to VWAP, and kind of looking at it that way, we're buying over the course of time, we can set different schedules on those, and we also have the availability of just doing open market purchases, so we will use a mix where we think it makes most sense over the remaining period of time here.

I think just to help clarify, the $200 million that Murray is talking about were actual shares purchased.

It does not include any potential commitment that we might have going forward.

Okay.

And then last question, you updated the full-year guidance on the revenue, but didn't make any mention to EPS.

So kind of a share repurchase leads into it, I didn't know if there was -- given the pace of share repurchase, if that has any impact on full-year guidance, or is there any way that you would update us for full-year EPS guidance?

Well, the main reason why we provided the revenue, reaffirmed the revenue today is we really want to talk about the third and fourth quarter.

We've now said for some time that the third quarter is our seasonally weak quarter and it is going to be the lowest revenue quarter of the year and looking at a number of estimates out there, that does not seem to be the case for many out there, and we wanted to speak to that again, but the third quarter is going to be the lowest revenue quarter of the year, because of seasonal weakness that we see in the summer time, in Europe and Japan, and the fourth quarter now, we're going to see a seasonal pickup in Europe, like we would typically expect and we have the launch of Acrobat in the fourth quarter.

So it is going to be the highest revenue quarter of the year.

We felt that since we wanted to communicate that again about Q3 and Q4, it was appropriate to also talk about the full-year revenue target, which we're doing today, and at this point, we're not going to talk about earnings per share or margins at this point, we provided Q2 guidance, and we will probably continue to look at it doing it on a quarterly basis.

We also believe that given the great results that we had in Q1, and the guidance on the margin, and EPS side for Q2, that I believe most people probably feel comfortable with us, and where we are, regarding annual EPS.

Okay.

Thanks, guys.

Your next question comes from the line of Larry Solomon with Capital Guardian.

Just a couple of clarifications.

When you reported the non-GAAP number this quarter, does that include any benefit from the deferred revenues that Macromedia had?

Or are those -- do those just go away and then next year, you pick them back up?

That's a clarification.

And then I have another question.

Yes, Larry, we're not trying to guesstimate how much revenue we lost add that back to the non-GAAP performance.

I mean the revenue is the revenue that we booked and the revenue will come back in 2007.

Okay.

Because some companies do estimate that and add it back.

Secondly, the guidance, if you look at the midpoint of revenue, and operating margin, is for flat revenue sequentially, but a 1% lower operating margin.

You talked about how you're going to spend more, but going back to Tom Ernst's question, it seems like you probably would not have gotten a full quarter of expense savings last quarter.

So what are you spending on in this quarter we're in right now, and to what extent might that be offset by a full quarter benefit from expense savings?

That's the second question.

Again, a couple of things there.

One is that we will continue to hire, and obviously we've hired during the current first quarter as well and we have not had the full impact of that expense on a quarterly basis, so that will obviously increase some of the expenses in the second quarter, we will look to add more employees in the second quarter, and we will not have the savings that we get from the vacation savings that occurred during the year end holiday period.

And so those things will be driving the expenses higher in the second quarter.

Also, we've gotten through the integration period and we're very focused on our go to market activities throughout the quarter from a marketing standpoint, et cetera.

So it is very important for us to continue to increase our resources, given the opportunities we have, and the big year that we've got coming in front of us in '07.

And then finally, it sounds like you did not reiterate the $1.26 to $1.30 non-GAAP guidance that you provided earlier, but Bruce, are you basically saying that you're still comfortable with that, that that is still the guidance, you're just not putting it in writing each time?

So, Larry, we don't want to -- today, we don't want it to reaffirm anything else other than the revenue.

We don't typically every quarter comment on the fiscal number on the annual number for the year, we typically do a quarter at a time.

This quarter, it was important for us to comment on the revenue because we wanted to get clarification in particular on Q3, and then subsequently Q4.

And we looked at some of the estimates out there, as related to Q3 and Q4, and it was concerning, especially given the fact that at the analyst meeting, we did communicate that Q3 was going to be the weakest quarter of the year, yet many chose not to listen to us, so we thought it was important to restate it again.

In doing so, we wanted to make sure everybody understood we were not restating or changing the original revenue number.

We didn't want to go through all the details regarding the rest of the P&L.

Clearly, the EPS that we delivered this quarter and what we're guiding towards in Q2 should give everybody comfort in what we can deliver for the fiscal year.

Okay.

Thank you.

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

Thank you.

The first question would be Murray, as you're now looking for basically a person to come as a team and sort of replace you at the moment.

Could you provide us with an update there as to how that is progressing?

Yes, since Murray will be leaving and I will be the one working with Shantanu hiring, I will take that one.

So we are continuing searching for the position.

It is a critical position for us.

We want to make sure we have the right candidate in place.

A number of candidates that we're speaking with don't have the specific date, but I am thrilled and thankful that Murray has agreed to stay with Adobe through the close and the earnings call of Q2.

So for those of you who have thought that you've gotten rid of Murray, he will be here at least that one more time, and hopefully by the time Murray leaves, we will have somebody that will be able to replace him.

Great.

And my second question here, is sort of on a segment basis, any sort of a geographical trend that would be notable, you did mention a few things about -- I guess you mentioned how across product lines, you are somewhat sort of similar geographically.

Is there any particular differences in Europe versus Japan versus domestic and one versus another?

On a go-forward basis, again, the key seasonal highlights are Japan in March, and we've got Easter slowdown in Europe and U.S., and then of course, as we get into the summer time, we're going to -- we fully expect to see a big slowdown in Europe and Japan, that whole point about the third quarter being the lowest of the year, and then we get to the fourth quarter, Europe, we expect like it has every year, will rebound in the fourth quarter, Japan tends to stay relatively flat Q3 to Q4 but we would expect to see that pick up in Q4 in Europe and we also tend to see stronger retail performance in the United States in the fourth quarter.

So those would be the key seasonal aspects, and it wouldn't necessarily change it for one set of products versus another.

Okay.

Thanks.

Operator, we will take one more question, please.

And your next question comes from Mark MacKegny with Twin Peaks Capital.

And Mr. MacKegny, your line is open.

And there seems to be no response from Mr. Mackegny's line.

All right.

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