Adobe Inc (ADBE) 2012 Q4 法說會逐字稿

Good afternoon.

My name is Jay, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Adobe fourth-quarter fiscal year 2012 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you, I'd now like to hand the call over to Mr. Mike Saviage, Vice President of Investor Relations.

Please go ahead.

Good afternoon and thank you for joining us today.

Joining me on the call are Adobe's President and CEO, Shantanu Narayen, as well as Mark Garrett, Executive Vice President and CFO.

In the call today, we will discuss Adobe's fourth-quarter and fiscal year 2012 financial results.

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

If you need a copy of the press release, you can go to Adobe.com, under the Company and Newsroom 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, subscription, and operating model targets, and our forward-looking product plans, is based on information as of today, December 13, 2012, 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 the forward-looking statements disclosure in the earnings press release we issued today, as well as Adobe's SEC filings.

During this call, we will discuss GAAP and non-GAAP financial measures.

A reconciliation between the two is available in today's earnings release, and on our investor relations website, in the investor data sheet.

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

An archive of the call will be made available on Adobe's investor relations website for approximately 45 days and is the property of Adobe.

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

I will now turn the call over to Shantanu.

Thanks, Mike, and good afternoon.

I'm pleased to report, we delivered record revenue of $1.153 billion in Q4.

This performance helped us achieve record revenue of $4.4 billion in fiscal year 2012.

At Adobe, we are focused on two large market opportunities, digital media and digital marketing.

2012 was a milestone year in terms of innovation, with our Creative Cloud and Adobe Marketing Cloud.

We achieved great success in both these areas.

In the digital media business, we are redefining the Creative process with Creative Cloud.

Through frequent product and feature enhancements, new Cloud services, and attractive pricing, Adobe is changing how we provide value to a broader set of customers.

We will deliver customized offerings for individuals, workgroups, and large enterprises.

As with all successful subscription services, we are offering a free trial program.

This enables an easy on-ramp and a funnel of prospects that we intend to convert to paying subscribers.

Since we launched the individual Creative Cloud offering in May, we have already delivered three updates to the service.

Earlier this year, we added Lightroom to the current Creative Cloud as well as new features for Dreamweaver and Illustrator.

Since then, we have provided new HTML products including Edge and Muse, and this week, we delivered major feature enhancements to Photoshop and Digital Publishing Suite.

We also introduced a Sync & Store capability, which will enable our Creative customers to share and collaborate.

We are now shipping Creative Cloud for teams, which includes central administration of licenses, expert support, online training, and collaboration features.

Creative Cloud for enterprises, which we will deliver in 2013, integrates with Digital Publishing Suite and the Adobe Marketing Cloud, with digital asset management being an obvious area of integration.

We have begun transitioning enterprise customers to enterprise term license agreements, which provide them Cloud services and updates to our desktop tools.

Pricing for each segment is designed to reward loyal customers, and aggressively transition them to the Cloud.

Response to the Creative Cloud exceeded our expectations, the helping us growth total Creative units by over 13%.

As of the end of the year, we had 326,000 paid memberships, and over 1 million free Creative Cloud members.

As a result, in our Creative business, we exited fiscal year 2012 with $153 million in annualized recurring revenue.

Based on overwhelmingly positive customer feedback, our results to date, and the roadmap of new innovation planned for the coming year, we intend to accelerate customer transition to the Creative Cloud in 2013.

In Document Services, we launched Acrobat 11 with newly-integrated Cloud services, including Web contracting with Adobe EchoSign in forms creation, data collection, and analysis with Forms Central.

Acrobat and these Document Services has record revenue in 2012.

Three years ago, we embarked on a strategy to create a new business for Adobe.

Through organic innovation and acquisitions, we have become a market leader in the explosive digital marketing category.

Our Adobe Marketing Cloud enables marketers to deliver personalized web experiences across multiple devices, manage multi-channel campaigns, and optimize media monetization.

We target Chief Marketing Officers, Chief Revenue Officers, advertising agencies, publishing executives, and digital marketers with our solutions.

Our five Adobe Marketing Cloud solutions are architected to provide best-of-breed capabilities across analytics, online targeting, media optimization, social media, and web experience management.

By consolidating our 30 distinct offerings, we have simplified our messaging, and made it easier for customers to license and implement our solutions.

In addition to innovating on the product side, we intend to aggressively evangelize the benefits of digital in the evolution of marketing.

We believe digital marketing will be a multi-billion dollar category, and 2012 was a great year for Adobe, as we established ourselves as the leader in analytics, online targeting, and media optimization.

In web experience management, we have the fastest-growing solution in the space, doubling our market share over the past two years.

As a result, we drove over $220 million of revenue in Q4, and achieved 35% annual revenue growth for the year.

In summary, 2012 was an outstanding year of accomplishments against our strategic priorities.

We entered 2013 in a strong position.

Now, I'll turn it over to Mark.

Thanks, Shantanu.

Our earnings report today covers both Q4 and fiscal year 2012 results.

Adobe achieved record revenue of $4.404 billion in the year, compared to $4.216 billion in fiscal 2011.

Our success in fiscal 2012 demonstrates significant progress towards our goal of transforming our business, and building a predictable revenue stream.

In 2012, 25% of our revenue was recurring, up from approximately 19% in fiscal year 2011.

In fiscal 2012, we added approximately 293,000 net new paid subscriptions.

Using an ASP of $750, this achievement in subscriptions effectively transitions approximately $220 million of perpetual revenue to Creative Cloud during the year.

Backing out recognized subscription revenue of $39 million, we would have achieved approximately $181 million more of revenue in fiscal year 2012.

Additionally, moving to term-based enterprise license agreements transitions approximately $19 million of fiscal year 2012 perpetual revenue.

After these adjustments, we believe fiscal year 2012 revenue would have been approximately $4.6 billion, representing 9% year-over-year growth.

In the fourth quarter of fiscal 2012, Adobe achieved record revenue of $1.153 billion, exceeding our targeted range of $1.075 billion to $1.125 billion.

We continue to accelerate adoption of Creative Cloud subscriptions.

In Q4, we added approximately 132,000 net new paid subscriptions.

Using an ASP of $750, this achievement in subscriptions effectively transitioned approximately $99 million of perpetual revenue to Creative Cloud in Q4.

After backing out recognized Q4 subscription revenue of $20 million, we would have achieved approximately $79 million more of revenue in Q4.

We also began to ratably recognize some enterprise agreements, which additionally transitioned approximately $19 million of Q4 perpetual revenue.

With these adjustments, we believe Q4 revenue would have been approximately $1.251 billion.

We experienced stable demand across our major geographies.

From a currency perspective, quarter-over-quarter FX rate changes had a $6.7 million positive impact on reported revenue.

Hedging gains contributed $2 million to revenue in Q4 fiscal year 2012 versus $7.7 million in Q3 fiscal year 2012, thus the net sequential quarterly currency increase to revenue, considering hedging gains, was $1 million.

Year-over-year, FX rate changes had a $13.7 million negative impact on reported revenue.

Comparing the $2 million in Q4 fiscal year 2012 hedging gains, to the $3.6 million of hedging gains in Q4 fiscal year 2011, the net year-over-year currency decrease to revenue, considering hedging gains, was $15.3 million.

Employees at the end of Q4 totaled 11,144, versus 10,811 at the end of last quarter.

The sequential increase was driven primarily by hiring in our field organization.

Our ending deferred revenue balance increased by $59.3 million, to a record $619.6 million.

As a reminder, Creative Cloud subscriptions are billed monthly, and are not reflected in deferred revenue on the balance sheet.

Our trade DSO was 49 days, which compares to 50 days in the year-ago quarter and 48 days last quarter.

During the quarter, cash flow from operations was $473.7 million.

Our ending cash and short-term investment position was $3.54 billion, compared to $3.25 billion at the end of Q3.

More than 80% of our cash is off-shore.

In Q4, we repurchased approximately 2 million shares at a total cost of $67 million.

For the year, we repurchased approximately 11.5 million shares, at a total cost of $372 million.

I will now discuss business segment results.

Our Digital Marketing segment is made up of two components.

The first is revenue from our Adobe Marketing Cloud, which we previously referred to as Digital Marketing Suite.

During the quarter, we achieved record Adobe Marketing Cloud revenue of $220.4 million.

This represents Q4 year-over-year growth of 32%.

Adobe Marketing Cloud analytics transactions in the quarter were 1.74 trillion, up 17% year-over-year.

Mobile device use continues to be a driver in our analytics business.

Mobile transactions increased to 22%, up from 18% last quarter.

On Cyber Monday, we achieved a single-day traffic record with 19 billion server transactions, up from the previous record of 17.5 billion last year.

The second component of our digital marketing segment is revenue from the LiveCycle and Connect businesses.

LiveCycle and Connect contributed $70 million in Q4 revenue, down as expected from the $102.7 million we achieved in Q4 of fiscal year 2011.

In our digital media segment, we achieved revenue of $810.7 million.

The two major components of revenue are our Creative family of products and our Document Services products.

In Document Services, the new Acrobat release achieved strong enterprise adoption.

That, plus continued growth in EchoSign, our electronic contract solution, and Acrobat Cloud Services, drove record revenue in Q4 of $210.2 million.

Similar to the Creative business, we are driving subscriptions growth and a shift to enterprise term-based licenses.

As a result, we exited the year with approximately $50 million in annualized recurring revenue in Document Services.

I'd now like to discuss our Creative Cloud business.

Our strategy is to provide differentiated offerings for our Creative Cloud customers.

During fiscal 2012, our subscription results were primarily driven by adoption of Creative Cloud for individuals.

Towards the end of Q4, we had a limited release of Creative Cloud for teams, which became widely available this week.

In 2013, we will be offering Creative Cloud to enterprise customers.

In anticipation of transitioning enterprise customers to Creative Cloud, during Q4, we began moving them to enterprise term license agreements or ETLAs.

Like Creative Cloud subscriptions, ETLAs are term-based, give customer access to ongoing technology updates, and will enable a smoother migration to the enterprise offering when it becomes available.

Earlier this year, we introduced several metrics to help you understand our progress with Creative Cloud adoption.

They included total number of subscriptions, and annualized recurring revenue, or ARR.

ARR is calculated by multiplying the number of current paid subscriptions by the average monthly revenue per user per month, multiplied by 12.

We also provided a methodology to correlate the value of our new subscribers to revenue we would have recognized, if those customers had licensed perpetual software, assuming a transaction value based on product mix.

As our enterprise customers migrate to ETLAs, some of these contracts involve estimated numbers of licenses, rather than precise registered user information.

As such, we have decided we should exclude enterprise-based subscriptions from our Creative Cloud subscription count.

However, because revenue from ETLAs is recognized ratably, we will include the annual contract value of ETLAs in our Creative ARR calculations.

Now, I would like to review our recent Creative Cloud results.

During the fourth quarter, we continued to accelerate the adoption of Creative Cloud subscriptions.

We added approximately 132,000 net new individual and team subscriptions during the quarter.

To reiterate, these do not include enterprise users, who are covered under ETLA agreements.

In Q4, we averaged 10,000 new subscriptions per week, up from 8,000 per week in Q3.

Exiting Q4, 90% of subscribers are on an annual subscription, versus month-to-month, and 81% of subscribers are subscribed to the full Creative Cloud, versus point product subscriptions.

We exited Q4 with Creative ARR of $153 million, up from $90 million of ARR, exiting Q3.

$146 million of ARR was from Creative Cloud individual and team subscriptions.

The remaining $7 million was from the annual contract value of Creative ETLAs, signed in Q4.

Adobe.com is increasingly becoming the preferred way for our customers to engage with us.

28% of all Creative subscriptions and perpetual units were licensed via Adobe.com in fiscal year 2012, up from 18% last year.

With Creative Cloud for individuals and teams now available and with our sales team migrating enterprise customers to ETLAs, we are in a position to utilize all our routes to market, to help accelerate customer migration to Creative Cloud.

At our last analyst meeting, we reported that total Creative product units have been at approximately 3 million units per year, for each of the past four years.

We disclosed our goal to increase total perpetual and subscription units by 10% this year.

I'm pleased to report that we grew Creative units 13% in fiscal year 2012.

Now let's look at Q1 and fiscal year 2013.

For the first quarter of fiscal 2013, we are targeting a revenue range of $950 million to $1 billion.

In Digital Media, we expect to exit Q1 with approximately $215 million of Creative ARR, up from $153 million in Q4.

The estimated Q1 Creative ARR is based on adding slightly fewer new Creative Cloud paid subscriptions than what we achieved in Q4, due to normal Q4 to Q1 seasonality.

In Document Services, we expect to exit Q1 with approximately $60 million of Document Services' ARR, up from $50 million in Q4.

Adding Creative ARR to Document Services ARR yields a total Digital Media ARR exiting Q1 of approximately $275 million.

Assuming the midpoint of our targeted revenue range, we expect Digital Media reported revenue to be down sequentially due to continued migration to Creative Cloud subscription and ETLAs, as well as normal Q1 seasonality.

In our Digital Marketing segment, we expect Adobe Marketing Cloud Q1 revenue to be relatively flat with Q4 revenue, coupled with a sequential decline in our LiveCycle and Connect businesses.

We expect Print and Publishing to also be flat quarter over quarter.

In addition, we are targeting Q1 share count to be 503 million to 505 million shares.

We are targeting non-operating expense to be between $19 million and $21 million, on both a GAAP and non-GAAP basis.

We are targeting a Q1 GAAP tax rate of 28%, and a non-GAAP tax rate of 22.5%.

These targets yield a Q1 GAAP earnings per share range of $0.08 to $0.14 per share, and a Q1 non-GAAP earnings-per-share range of $0.26 to $0.32.

Now, I would like to discuss fiscal 2013.

We expect to exit fiscal year 2013 with over 1.25 million paid Creative Cloud individual and team subscriptions.

We expect the impact of these subscriptions and continued adoption of ETLAs to effectively transition approximately $690 million of reported perpetual revenue to subscriptions next year, and to exit the year with a total ARR of approximately $685 million.

In Document Services, in order to drive consistency in how we sell the enterprise customers, we have begun to migrate many of our large Acrobat customers to ETLAs.

As a result, we expect Document Services' reported revenue to be approximately $750 million in fiscal year 2013, with an additional $80 million of perpetual revenue transition to ETLAs, that will be ratably recognized.

Together, this results in a targeted growth rate in Document Services of 5% to 7%.

Combining Acrobat ETLAs and Cloud-based services, we expect to exit fiscal year 2013 with $115 million of Document Services ARR.

Fiscal year 2013 will be the pivotal year in our transition to a subscription model, and we expect to exit the year with approximately $800 million of Digital Media ARR.

As the leader in the digital marketing segment, we will continue to invest in this explosive growth category.

By focusing on the five solution areas of the Adobe Marketing Cloud, we expect to grow bookings by over 25%, yielding reported revenue growth of over 20%.

In just a few years, we will have built a brand-new $1 billion business for Adobe.

We expect LiveCycle and Connect to continue to decline, but to contribute an estimated $200 million of revenue during fiscal year 2013.

We expect Print and Publishing to be flat year-over-year.

We expect total Adobe reported revenue in fiscal year 2013 to be approximately $4.1 billion.

We will closely manage expenses during this upcoming transition year, and expect earnings-per-share to be approximately $0.62 on a GAAP basis, and $1.40 on a non-GAAP basis.

Keep in mind, the $770 million of revenue effectively transitioned from perpetual to subscription and ETLAs equates to approximately $1.20 of non-GAAP EPS.

At our analyst meeting last November, we said we would redefine the Creative process, and deliver an amazing set of products and services for our customers, available via a new subscription model.

In fiscal year 2012, we over-achieved our goals by growing total Creative units by 13%.

We exited the year with 326,000 paid subscriptions and over 1 million free members.

At the analyst meeting, we said the transition to a Cloud model would be complete within four years.

Based on our success in fiscal year 2012, and our plans for fiscal year 2013, we anticipate we will complete the bulk of the transition sooner than that, with approximately four million individual and team Creative Cloud paid subscriptions by the end of 2015.

After fiscal year 2013, we believe reported revenue from our Creative Cloud and CS product family will achieve a CAGR of over 15% from fiscal year 2014 through fiscal year 2016.

We said by the end of 2014, we would build $1 billion business in digital marketing.

With the success we have achieved in fiscal year 2012, we are on pace to achieve a $1 billion run rate by the end of 2013, growing 25% in bookings and 20% in revenue.

We said by the end of 2014, 40% of Adobe's overall revenue would be recurring.

We are on a track to achieve this goal, exiting the end of 2013.

While fiscal year 2013 is a transition year, we are confident that our strategy and our execution show that the Company is better positioned than it has ever been.

We are committed to providing continued transparency to demonstrate progress, as we reinvent the Company.

I'd now like to turn the call back over to Shantanu.

Thanks, Mark.

These are exciting times at Adobe.

Last year, we outlined the strategy to reinvent the Company and accelerate growth by focusing on the Digital Media and Digital Marketing categories.

I am pleased to report we are ahead of schedule in our transformation.

We continue to be the undisputed leader in Digital Media, and in just seven months since the launch of Creative Cloud, we have over 326,000 paid subscriptions, and $153 million of annualized recurring revenue.

We are a leader in Digital Marketing, with the most comprehensive offering and the inside track with the marketing community.

This business, which didn't exist at Adobe three years ago, is on pace to reach $1 billion in annual revenue.

As we close the year, we see huge opportunity for Adobe ahead.

The dramatic shift we are making in our business is really not different than what we have done for the past 30 years.

Innovation is in our blood.

It defines us and galvanizes our employees.

We look forward to 2013.

Thank you for joining us today.

Now, I'll turn the call back over to Mike.

Thanks, Shantanu.

Before we begin Q&A, I have a few logistics items to go over.

First, for those investors and financial analysts who want to stay current on the latest Adobe news, we encourage you to follow Adobe on Twitter, Facebook, and YouTube, and to frequently check Adobe's corporate blogs on Blogs.

Adobe.com.

We are increasingly using blogs and social channels as a primary means to communicate important information.

In addition, TV.

Adobe.com is a great resource to learn more about Adobe's products and solutions, and check out new customer case studies.

We have updated Adobe's investor relations website to provide easier access to these resources.

During fiscal 2013, Adobe Investor Relations will begin to use Twitter to highlight news and interesting stories or articles, which will help the investment community stay on top of what is happening.

Follow Adobe_IR on Twitter to track what we have to say.

Second, I'd like to highlight the invitation we sent out last week to attend our upcoming Digital Marketing Summit in March.

There is no better way to immerse yourself into the opportunities we see in this explosive category and how Adobe is best positioned to win in this market.

Contact Adobe Investor Relations to get more information on how to attend.

Third, I'd like to highlight that we have slightly modified our segment reporting for fiscal 2013.

We have moved our video server solutions products from Digital Media to Digital Marketing, to better align the role how Adobe can help with customers monetize their video assets with their digital marketing solutions.

The updated IR data sheet we have published today contains a page with the new segments by product name, and updated IR data sheet with restated revenue by segments will be made available at the end of January, around the time our 10-K is filed.

For reference, the amount of Q4 revenue that will be moving from Digital Media to Digital Marketing is less than $10 million.

In regards to today's earnings report, we have posted several documents on our IR website, including a copy of the script containing our prepared remarks for today's call.

Given the new detailed information we've provided today, the script should be a useful resource to assist with modeling our business.

To access these documents, and the other investor-related information, go to www.Adobe.com/ADBE.

For those who wish to listen to a playback of today's conference call, a web-based Adobe Connect 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 855-859-2056, use conference ID number 73230376.

Again, the number is 855-859-2056 with ID number 73230376.

International callers should dial 404-537-3406.

The phone playback service will be available beginning at 4.00 PM Pacific time today and ending at 4.00 PM Pacific time on Monday, December 17, 2012.

We would now be happy to take your questions.

Operator?

(Operator Instructions)

Our first question comes from Walter Pritchard with Citigroup.

Your line is open.

Shantanu and Mark, great disclosure, and I think everybody appreciates all the transparency there, so just wanted to highlight that.

But a question I had around the Creative Cloud move.

It does seem like customers are enduring somewhat of a price increase as they move to these new offerings, and I'm wondering if you could talk about where customers are seeing the additional value, that is driving them to move?

How much of it is a carrot that you are offering in terms of value, versus the stick in terms of practices you may be using, especially around enterprise licensing to encourage the change?

Let me start off with that and with respect to the transparency, as I think both Mark and I have said right through, we want to make sure that we provide you with the information, why we go through this transition.

As it relates to the Cloud, I think people are really seeing the benefit of always having access to the applications and the latest applications.

As I mentioned, we've actually given three updates already.

We have introduced new services like Sync & Share, and we have really just started, in terms of the innovations.

So come I think it is just a better way to stay current.

I think people see the promise of having their assets in a place, which they can get location independent.

And so there really are no sticks so to speak right now, it is all about seeing that the future of creation is being delivered through the Creative Cloud.

Okay, great.

And then Mark I didn't hear you talk about, you give a lot of detail on fiscal 2013, I didn't hear you talk about cash flow.

I know there is probably also some cash flow impact here, based on the fact that most of these are monthly billed, but maybe you could help us understand where we should be thinking about cash flow for fiscal 2013?

Yes, so, the great news is we have a terrific cash balance.

I talked about that.

From a cash flow perspective, Walter, it is going to model, as it has, somewhat closely with non-GAAP net income.

So you should expect the cash flow will be less as we go through this pivotal year in 2013, than it has been in, say, 2012.

Okay, great, thanks for taking my questions.

Next, we have the line of Peter Goldmacher, with Cowen.

Your line is open.

I went to ask you a quick question, it was interesting to hear your reconciliation from a shrink wrap to subscriptions, and the revenue you think you gave up.

How do you think about drawing in new users that maybe have been priced out of the products because of the up-front costs were so high and new users you are getting because of a more affordable price point?

Peter, we certainly are seeing new customer adoption.

I think we referred to that statistic last time, in terms of the number of new users, because it is more affordable.

And I think we've heard that over 30% at times would not have subscribed, or would not have gone to the perpetual version, but are finding that Creative Cloud is the best option to go.

I think actually, there is again a lot of headroom ahead of us as we start to combat piracy as well, and start to get those customers as part of the Creative Cloud.

So, at this point, we're clearly attracting new customers.

I think Mark referred to the fact that for the first time in many years, we've actually grown units for the Creative business, which is exciting to see, and just again speaks to the innovation that the teams are providing.

Maybe to add to Walter's question as well, we do have information on all of the apps that are being downloaded, and the new HTML applications that we gave created have seen quite a bit of downloads.

We're certainly seeing the flagship products of Flash Pro, Photoshop, and Illustrator and InDesign.

But the new products that we are delivering as part of the Creative Cloud, whether it is Lightroom or whether it's Edge and Muse, are also seeing fairly significant adoption, which I think bodes well for us.

Following up on that, so when you selling these new products and some of these are products are integrated with the Digital Marketing Cloud, I know it's early days, but how helpful is it to you to leverage that Creative brand when you're selling the Digital Marketing products?

Are we early in that part of the sales cycle, or do your Digital Marketing customers already have a positive view of Adobe, and that is a catalyst to sell that Digital Marketing stuff?

I think it is a great question, Peter, and there is no question that we're seeing quite a bit of synergy between the Creative Cloud and the Marketing Cloud.

And the two places where we see that a lot is in the web experience part of Digital Marketing, that business continues to be on fire as people re-platform their online businesses.

And the second area where we see that is, if you have a Chief Revenue Officer who is thinking about Digital Publishing Suite, traditionally, it was just magazines that were buying Digital Publishing Suite, now you're seeing insurance companies, financial services, retail and travel, all seeing it.

So I think Matt and his organization are really able to go in and paint a picture of the entire content lifecycle, and it is clearly working.

It is also working for us the reverse way, which is, if you have our content management solution you want to make sure that you have the latest version of the Creative product, so that it can automatically put data, and as I said, we will be also releasing Digital Asset Management that ties them together.

Great, thanks a lot.

Next, we have the line of Adam Holt with Morgan Stanley.

Your line is open.

Thanks very much.

I had a couple of questions.

First, it looks like you all had nice unit growth for the year.

I was hoping maybe you could break down -- was that all on the Creative Cloud side and maybe if you can, add any color about what you think you added in terms of net new users in the quarter and/or year?

Net new to the Adobe family.

So, Adam, overall units, we do know that we added approximately 13% new units in 2012.

And I think it has actually been across the board.

Commercial units did really quite well.

We continued to see adoption of both what you would call the perpetual version, as well as clearly the subscribers, were materially ahead of where we thought we would be in the first six or seven months.

And we will continuously update what we're seeing in terms of new users, but we are certainly attracting new users to the platform.

If I could just ask a follow-up on the subs guidance for next year, it looks like it implies a little bit of an acceleration in your subs adds.

You have new products in the market, maybe walk us through the different variables you're thinking about thinking about, that get you comfortable with an acceleration on that sub side.

Thank you.

Sure, Adam, and I think it comes, from the initial success that we have seen on subscriptions has been predominantly on the individual side.

The team, we had product released to our partners that has come out, that is now shipping.

So that significantly enhances the number of people we can target.

Similarly, geographic expansion, I think as we go through 2013, you're going to see geographic expansion in terms of the subscriptions.

And frankly, I think we expect that as the innovation is increasingly Cloud-based, that more and more customers are going to be doing it.

We are going to have community, we're going to have training, and the viral impact of people looking at it and understanding that the latest version is on the Cloud, we do believe will drive it.

Last, we also have a funnel.

I think we talked about the fact that we have over 1 million free members, and it is certainly our goal to convert them.

Trials have always been the number-one way in which we have converted customers, and we believe that is a good opportunity to go be a world-class consumer marketing company and convert them.

Thanks very much.

Next, we have the line of Steven Ashley with Robert W. Baird.

Your line is open.

I would like to ask about the enterprise term license agreements you've begun to introduce, and why they are a necessary or required interim step to moving people to the Cloud?

Or is it just simply because the enterprise version isn't out now, it will be out in a little while, and you simply wanted to start the transition now?

So a little bit of color on that.

And then my second question has to do with the education market.

Have you started to tap that?

Do we see any activity in the fourth quarter?

And is there a game plan, if we didn't, to tap into next year?

Sure, Steve, so on the first question as it relates to the enterprise, it clearly is in line with our strategy to have the Creative offerings be, rather than perpetual offerings, be term offerings.

So, as we are signing these enterprise-wide agreements, I think it makes a lot more sense for us to have those be term license agreements.

It is very aligned with the subscription model.

And so, in Q4, we started to move to that.

I think it is in our best interest, I think it is also in customers' best interest, because by definition, then they have access to all of the latest upgrades as they become available.

We will deliver enhanced functionality to enterprises as well in 2013, and that will be much better integration between our desktop products and what our marketing Cloud provides.

So certainly, there will be more functionality, but moving to ETLAs was very much in line with strategically where we want to go.

In terms of education, we did see a fair number of education subscribers.

I think people are starting to adopt the Creative Cloud in education, and we saw a very healthy number of subscribers in Q4.

The other thing I would add, Steven, this is maybe inherent in what Shantanu said is that, ETLAs from a customer's perspective, they are buying and paying for the software in a similar way to the way they will under a subscription model.

So it gets them more adapted to paying us on a regular basis instead of all up-front.

Thank you.

Next, we have the line of Mark Moerdler with Sanford Bernstein.

Your line is open.

Two questions, just a quick clarification.

You said that there were 3 million Creative units over the last couple of years, and you have seen growth.

Is that 3 million that were sold, or a total of 3 million in there?

The second part of it is, we see the EPS guide is below, obviously, and a good chunk of that is due to the move to subscription.

Is there some other part of that from line items we should be considering that might be additional costs or expenses we should be modeling at?

Mark, this is Mark.

So the 3 million is 3 million units per year that we were shipping of Creative product and it has been relatively stable at 3 million for the past many years, and this year we saw a 13% uplift to that unit count.

Perfect.

That's what I thought.

On the financial model, and we can go into this in detail, but at a very high level, yes, the primary move in earnings was driven by the transition of revenue from perpetual to subscription and to ETLAs, both together.

That was worth $1.20, as I said in the script, in 2013 earnings.

And if you believe that there is more there that we could have driven from an earnings perspective, yes, there is a portion of that, that is cost.

It is not too terribly different than where our run rate is from a cost perspective, however.

So, if you look at expenses, they ramped during the year, and then you've got obviously the full effect of that cost going into the next year.

And the other thing I would say is that, we do think it is very important to continue to invest in the business, particularly around the Digital Marketing space, where it is a very hot market.

We are the leader in the space, and we want to keep that 25% bookings growth and 20% revenue growth going.

Perfect, thank you very much.

Next we have Ross MacMillan with Jefferies.

Your line is open.

Thanks a lot.

The first question I had was to do with the fact that this year, I think you had offered folks that really were on versions older, the opportunity to still get upgrade pricing through the end of the calendar year.

And I'm just curious as to whether there is any way you can look at the units that you sold this year and get a sense for whether you have had a better success in converting, if you will, older version users to the new products either on Creative Cloud or just on the perpetual?

Thanks.

Ross, I think I would say that across the board, that Creative Cloud, we have seen interest from new users, from users of the latest version, and clearly, allowing people on prior versions to upgrade through the Cloud.

We have also seen uplift on that.

As I said earlier, the number of subscribers that we saw in the first few months was significantly higher than the one we expected.

Moving forward, the good news about having them all in our customer database is that we will be in a position to get a lot more information on what they are using to improve their customer sat, which by the way, I should say, we track customer satisfaction quite a bit, and we have seen that satisfaction of people online as part of the Creative Cloud is quite a bit higher than perpetual.

So I think that bodes well for us as well.

That's helpful, and then maybe just one quick one on ASP.

I know, Mark, you didn't call out ASP.

I think you got a blend ARR now, but it there is any color you can provide around the ASP on the Creative Cloud subscriptions?

And also what is your current thinking with regard to how you deal with the promotional pricing as we start to come up against the anniversary?

Thanks.

Yes, so we are, Ross, more focused on the ARR number, but the average revenue per user on the individual side has been very stable, it is very consistent with what it was last quarter.

On the promotional pricing, it's our expectation that those people will stay with us and start paying the higher price.

That has been tested in many other businesses, and we expect that it is a very sticky product, and that those people will continue to subscribe at the higher price.

That is great, thank you.

Our next question is from Brent Thill with UBS.

Your line is open.

Mark, just on the margins, I think you are assuming somewhere in the mid-20%s if we did the math rate on your operating margins for this next year.

From your perspective, over the long haul, do you believe this transition will yield a more profitable Adobe, relative to where you saw the margins, or do you expect a similar operating margin target as we go through this, when we exit?

So, yes, Brent, you are right.

This is the pivotal year, as we said, and it is very consistent with what we would expect from a transitional perspective.

From here onward, from 2013 onward, revenue, margin, and EPS are all going to grow.

And we have tried to give you some transparency around longer-term growth rates for some of the revenue streams.

We talked about 4 million Creative Cloud subscribers in 2015.

We talked about Creative Cloud and the CS product group growing 15% on a CAGR from 2014 to 2016.

We talked about the Marketing Cloud growth continuing at 20%.

And I would expect that EPS through all that starts to grow, again at least as fast as revenue.

So, we get through this year, and all those metrics get better and better from 2013 onward.

Okay, do you believe over time, then, it can be as profitable as the old model?

Well to be honest with you, as the digital marketing business grows, that's an inherently lower-margin business, right, that is a complete SaaS-oriented business.

It is just not ever going to be at Digital Media-type margins.

So as that gets bigger and bigger, it does weigh on margins.

I think we can do some things to pull more margin out of some of the businesses that we have, and we are very good at that, but again, we are going to be very focused on driving EPS growth and driving that EPS growth with revenue growth, even if it means doing so at a lower margin than where we've been.

Okay, just one last point.

At the analyst day, you did say, and through the transition, you thought operating markets you could hold the margins up, and obviously you're crossing a point where you can go after this given the success that you have seen.

I would assume that this success now has fueled increase in spending beyond what you had initially mentioned at the analyst day.

It is not the spending, Brent, it is that we are moving faster on the transition.

Right?

We are so happy with the way this is going that we want to get through this in 2013.

We want to be completely transitioned when we get through 2013 from a financial model perspective, and that is clearly more optimistic than what we thought at analyst day.

Great, thanks, Mark

Next, we have the line of Brad Zelnick with Macquarie.

Your line open.

Securities.

Great to see, you finished the year on a high note, especially the overachievement on unit growth, which brings me to my question.

Mark, what is your assumption for Creative unit growth embedded in your guidance, with subscribers and revenue in 2013, and what growth will you have achieved in 2014 and 2015, if you exit with 4 million Creative Cloud subs?

And just ask another way because I get this question gets asked all the time, what does the decay rate look like on the perpetual side?

What is your assumption there?

The what rate, you mean the churn rate?

No, on the perpetual side.

Okay, I see.

So, Brad, we have said for a while, and we still believe this, that we think we can drive 10% more unit growth.

If you look at the 4 million, the 4 million is significantly above the 3 million that we said we've been shipping per year for the past several years.

So, when you get out to 2015 with 4 million units, that's quite a jump up from the 3 million that we have seen in the past.

I think that, at a high-level, that's the best way to look at it.

The other thing I would say, Brad, is that relative to what we had talked about it at the analyst meeting, we certainly believe that subscriptions are going to grow faster.

It's going to come with unit growth, but also, what you consider perpetual, we do believe that's going to transition as well, faster.

Thanks, Shantanu.

And to follow up on something else you said earlier.

You said almost 30% of new Creative units have been due to franchise.

How you define that and determine that?

What is the trend been from Q3 to Q4 and what assumptions do you make from your guidance for next year and beyond?

Yes, so Brad I was reiterating some of that statistics that we had said at the end of Q3.

We do periodic surveys.

We certainly understand that we are attracting new customers, and we will give you more insight, but net-net, it is clear to us that we are driving new users.

We are driving faster subscription than we had originally expected, and we will, certainly as we have been with other numbers, continue to update that as we do our surveys.

Great, thanks for taking my questions.

Our next question is from Jay Vleeschhouwer with Griffin Securities.

Your line is open.

Couple of operational questions first.

Shantanu, how do you anticipate investing in external sales and distribution capacity this year, and through the rest of the transition?

And internally, would it be fair to say that by the time you get to 2015 and complete the transition, that the Adobe.com could be roughly a $1 billion business for you, well up from the $0.5 billion or so that it's been typically doing.

A couple of follow-ups, thanks.

Sure, so Jay, if the question was around sales and distribution capacity only for the Digital Media business, we are certainly seeing more on Adobe.com.

You are right, if we have the subscriber growth that we've talked about, Adobe.com will be in the $1 billion range.

I just want to reiterate that we will continue to invest in sales capacity for the Digital Marketing business.

The other thing I will highlight is that, even as it relates to Digital Media and subscriptions, we do expect to continue to sign a lot of online partners who will be able to drive traffic, and hence subscribers, to Adobe.

And we continue to think that is a great way to attract customers.

There is no reason why retail stores as well as other online services will not be a source of customers to Adobe moving forward.

Okay.

And, Mark, with respect to the revenue shift, so far the majority of the customers signing up, I think, have been from existing customers, within the installed base, who therefore might otherwise have been eligible to upgrade.

So, somewhat similar to an earlier question, how do you think about the decay of your upgrades business, which has also been roughly, typically, I think over $0.5 billion a year, do you think that decays significantly as well as the eligible existing customers move to Cloud?

Yes, I think the short answer is, I do.

I think as the Cloud gets more and more adoption, and as people have that viral aspect towards the Cloud, both sides of perpetual, full and upgrade are going to come down.

And that is baked into these assumptions on subscribers, on long-term adoption, and units, as well.

Okay, and then lastly, a product question for Shantanu.

You mentioned in your remarks, Digital Asset Management, I assume you are referring to the Day CQ product line.

So with respect to that, are you going to be quickly transitioning that to a ratable model, which historically hasn't been, and could you talk about how Day might become more integrated with other Adobe products and technologies to make it a broader or more functional platform in its own right?

Sure, so, at first as it relates to the Day business, which is now part of the Adobe Marketing Cloud as part of the web experience management solution, that business has been doubling.

It has been really a phenomenal success for us, Jay.

We both offer Day on an on-premise so that people can have their websites behind the firewall, we've also started to offer it as managed services, where we will one that website for them and we offer that as a hosted.

And so I think we are the most comprehensive offering right now for online web asset management.

In terms of the digital asset management, that is a component that we will deliver over and above the core web experience management solutions.

So we think that is actually additive to revenue and helps tie the Creative Cloud and the Marketing Cloud together and that is going to be -- we are already testing it out with some customers and it's going to be out imminently.

Thank you.

Next, we have Heather Bellini with Goldman Sachs.

Your line is open.

I just had a couple of questions, and I think there has been some talk about this, but I was wondering if you could get maybe a little bit more granular.

You gave us your view about the fiscal 2014 to fiscal 2016 15% revenue CAGR in your prepared remarks.

I'm wondering if you can walk us through the one or two key drivers behind those.

And then also, I think a lot of people are trying to figure out how should we be thinking about the fiscal 2014 impact of subscription on the top line?

I know you said, things are going to grow from there in terms of revenue, margins, and EPS, but will there still be this transition period going on, and how should we make about the high-level impact on 2014?

And then I have a follow-up.

Sure, Heather, it is Mark.

I will start out.

So, the big impact when you get out to 2014, 2015, and 2016 from a revenue point of view and the reason you get that 15%-plus CAGR is primarily two things.

One is, we are driving new units.

You are shipping, in essence, 4 million units a year instead of 3 million units a year.

And the other is you get this very nice stacking effect of the subscription model.

It is the beauty of the subscription model.

Obviously, people are paying you every month, month after month, nobody is skipping releases, and that stacking effect plus the new units drives a very healthy growth rate in that business.

On the--

Fiscal 2014.

On the path from here forward, revenue grows.

So we will not see a dip in revenue after fiscal 2013.

You do get--

Right, but to get to that CAGR, I'm just wondering what is the slope of the line look like?

I can't do that for you, frankly, Heather, but you can do the modeling at a high level, based on some of the metrics we gave you.

And that is why we wanted to make sure you had the 4 million subscribers in 2015, but everything does grow from here.

So, you won't see a revenue dip in Creative or in total Adobe from here on out.

Right, and then Mark, I guess the follow-up would be, could you walk us through what type of churn rates we should be thinking about in our models from the subscription business?

So, it hasn't been --

Or what you using in your assumptions?

Right now we've been at 80% retention rates in terms of modeling, which we think is conservative.

We haven't seen churn yet for the annual people.

So, the big--

Right.

The big data point will come when the annual people have to renew.

But we've assumed in the modeling, 80% retention.

Okay, great.

Thank you very much.

Next, we have Blair Abernethy with Stifel.

Your line is open.

Just wondering, Mark, if you could drill in a little bit more into the Acrobat business and give us a sense there, in terms of the historically, when it was really just a shrinkwrap business, how much of that business would be under enterprise site licenses?

I'm just looking for a shape of the magnitude of that, that's going to transition to term.

Blair, let me take that question.

I mean the Acrobat business has been pretty broad-based.

The enterprise license agreements are actually a smaller part of the entire business, but the important thing for us in that was to make sure that we offer both the Creative products as well as the Acrobat products in one enterprise term license.

As I think about modeling that business, I think for 2013, we have said you can model that at about a 5% to 7% growth.

And that revenue, I think we broke up how much would be in perpetual and how much would be going to ARR.

And I would model that as growing in revenue after 2013 at that 5% to 7% and growing in ARR higher than that.

Okay, great.

Thank you.

And then on the subscriptions on the Creative side, what's been the experience in the last six months here, from a geographic or regional strength?

I think as it relates to subscriptions, it is primarily at this point US and some countries in Europe.

It is sort of actually mirrors what you would think of as our traditional strength, that is one of the reasons why I said, as we roll out the offering in other geographies, there are certainly opportunity, but you can assume that at this point it's primarily the big markets for Adobe, which tends to be the US, UK, Germany, Japan.

Okay, great.

Thank you.

Operator we have gone past our normal hour.

Why don't we take two more questions?

Certainly.

Our next question comes from Robert Breza with RBC Capital Markets.

Your line is open.

Mark, as I look at the 3 million units going to 4 million units in 2015, and think about what you said from a term perspective, but the new renewal rates being high, not a lot of alternatives for people to switch after they get on that Creative Cloud.

And historically, you have been a 40% margin kind of business, or at least it peaked out over 40% margins.

What prohibits you from getting back to that level given this transition going forward?

Thanks.

It really comes down to Digital Marketing, it really comes down to how big Digital Marketing becomes as a percent of the total Company.

And I think you could look at any SaaS company in the world and see that you're just not going to get to 40% operating margins in those businesses.

So, it becomes a mix question.

Believe me, I think you seen over the past 5-plus, 10-plus years that we are very focused on the cost side of the business.

We pay very close attention to it.

We will manage it very effectively.

But I am leery to say that we are going to go back to 40% operating margins, primarily due to the mix.

Again, we're going to be very focused on driving earnings per share, at least as fast as revenue.

Great, thank you.

Next, we have the line of Jason Maynard with Wells Fargo.

Your line is open.

Thanks for taking my question.

Mark, the one thing, and maybe I missed it earlier on, was on the cash flow question.

When you think about the amount of revenue that is getting deferred, what would be helpful is, what's the rate, if you will, of cash flow capture, if you will?

Are you thinking about on that revenue?

So if it is a $700 million deferral, should we think about roughly the Creative Cloud Suite annual ARR, ARR versus the perpetual license, and maybe look at that and say, okay, that will get captured over X type of timeframe.

What is your best guess, if you will, for us to think about that type of modeling?

Again, the challenge is that, it's not a challenge, the way the business model works is that, we are billing people monthly, so we are collecting that cash monthly, even the annual people are getting charged on their credit card monthly.

So that revenue that used to come in upfront is getting spread out over say two years, if you think about they are paying roughly $480 per year, that now gets spread out over a couple of years, to get back to that $780-plus that we used to get up front.

So, I don't know if that helps answer your question, I think going forward, I'll look at cash flow and provide more details about go-forward cash flow.

I'm just frankly not prepared to do that today.

All right, that is fair.

Thank you.

I just want to again reiterate.

Thank you for joining us on the call today.

And there is no question in our mind that as a Company, we are in significantly better shape entering 2013 then we were entering 2012.

I think we had a very successful introduction of Creative Cloud.

We are attracting new customers.

We are creating a strong funnel for conversion, and I think we've transitioned the company to a more rapid development methodology that helps us innovate faster for our customers.

I think we are broadening the customer base that we can target with Creative Cloud, with the introduction of the team product, and we will extend that even further with Creative Cloud for Enterprises in 2013.

We are starting to transition our enterprise customers to the ETLAs, and there is no question that we are seeing synergy with the Adobe Marketing Cloud, both in their web experience management area, as well as in the Digital Publishing Suite.

And I think you've also seen that in Document Services, with mobile driving more PDF usage, we're actually building a really nice annuity with our document services.

And I think you will see that the ARR shows the health of the business that we expect to exit in 2013.

Digital Marketing, the business is doing well, both revenue and bookings, and it is clear that it is an explosive market category where Adobe is very well-positioned.

I'm actually quite pleased with the introduction of the Adobe Marketing Cloud, and the solution focus that we are going to take with content management, analytics, targeting, media optimization and social had a really good quarter as well in Q4.

And so, as we think about entering 2013, it is with driving innovation, serving customers, and having a really energized employee base.

We are building a recurring revenue stream, as well.

Thank you for joining us today.

And this concludes our call, thanks everyone.

This concludes today's conference call.

You may now disconnect.