Adobe Inc (ADBE) 2014 Q3 法說會逐字稿

Welcome to the Adobe Systems Q3 FY14 earnings call.

I'd like to turn the call over to Mr. Mike Saviage, VP of Investor Relations.

Please go ahead, sir.

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.

On the call today, we will discuss Adobe's third quarter FY14 financial results.

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

We have also posted PDFs of our earnings call prepared remarks and slides, our financial targets, and an updated Investor Data Sheet on www.Adobe.com.

If you'd like a copy of these documents, you can go to the Investor Relations page and find them listed under Quick Links.

Before we get started, we want to emphasize that some of the information discussed on this call, particularly our revenue, subscription, and operating model targets, are forward-looking product plans, is based on information as of today, September 16, 2014, 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 statement 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 our Financial Targets document and in our updated Investor Data Sheet on Adobe's Investor Relations website.

Call participants are advised that the audio of this conference call is being webcast live on Adobe Connect and is also being recorded for playback purposes.

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

The call audio and the webcast archive may not be rerecorded 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.

Adobe's strong performance continued in Q3.

We achieved $1.005 billion in revenue, with non-GAAP earnings per share of $0.28.

Adoption of Creative Cloud, Adobe Marketing Cloud and Document Services was robust, demonstrating continued momentum across our businesses.

In Digital Media, we continue to deliver new innovation and enhance value for our customers, spanning our Creative and Document Services businesses.

In June, we unveiled a major update to Creative Cloud, with 14 new versions of our desktop applications and 4 new mobile apps, and we announced the Creative SDK for mobile devices.

We added new offerings for enterprises, educational institutions, and photographers.

With the pace of innovation accelerating with Creative Cloud, adoption from existing, as well as new customers has been outstanding.

We exited Q3 with $1.4 billion of Creative annualized recurring revenue, or ARR, which now includes more than 2.8 million Creative Cloud subscriptions and reflects a record increase of more than 500,000 from the prior quarter.

To capitalize on the large opportunity with Creative Cloud, we remain focused on three growth initiatives.

First, we are aggressively converting the large install base of CS customers to Creative Cloud.

This transition is going well, as CS customers realize the significant value they obtain when they migrate.

We are driving this conversion with individuals through trials and promotional pricing on Adobe.com, and moving enterprises and teams to Creative Cloud through direct sales and the channel.

Second, we are expanding the market opportunity through acquiring new customers with tailored offerings such as Creative Cloud for Photographers.

The potential market for creative expression has never been greater, with the desire to use creative tools at work, at home and at school.

While Adobe remains dedicated to meeting the needs of the creative professional, we see big opportunities ahead with a broader array of workers, students and consumers, and you will continue to see new targeted offerings for these audiences.

And third, we will significantly expand the definition of Creative Cloud with mission-critical and valuable services such as mobile apps built on our SDK, training, a marketplace for content, and talent search and acquisition.

This focus will expand the Creative Cloud market opportunity and revenue potential beyond our current subscription offerings.

MAX has become the community showcase for creative inspiration and innovation, and we're excited about what we will be able to announce and deliver in October, particularly in the area of mobile, which represents a big opportunity for our customers and for Adobe.

In Document Services, we achieved strong revenue of $208 million in Q3.

Our Document Services business spans Acrobat ETLAs, cloud-based Acrobat services and EchoSign.

Document Services ARR grew to $217 million exiting Q3.

PDF and Acrobat are de facto standards for document collaboration and workflows, and mobile represents huge potential to increase usage of our document creation, sharing, and signing services.

We have permission to expand our footprint and brand in these areas, and are excited about the product road map which will position our document solutions as must-haves now and in the future.

Across our Creative and Document Services businesses, total Digital Media ARR grew to $1.62 billion at the end of Q3.

Digital Marketing is an explosive category that is fundamentally transforming every business.

In order to enable the personalized experience that every consumer expects, companies need to invest significantly in a modern technology platform.

This revolution is beginning in marketing, but is extending to include the entire realtime enterprise.

We are the leader in this category.

We achieved strong Adobe Marketing Cloud bookings in Q3 and have a healthy pipeline heading into Q4.

The volume and size of engagements with our customers is growing.

In Q3, the number of customers with annual contract value of greater than $500,000 grew by more than 40% year-over-year.

Examples of Marketing Cloud customer wins in the quarter included Adidas, Biogen, British Sky, Ford Motor, H&M, Lloyds Bank, Nestle, the State of Illinois, the State of Utah, Tiffany, Travelocity, the US Department of Treasury, the US Marine Corps, DSV in Germany, and Motorola in the UK.

Our value proposition is clearly resonating with marketers, driven by the market share and thought leadership that we have built in this category.

Interest in our solutions is high, as evidenced by sold-out conferences across the globe.

In addition, we are earning strong industry analyst recognition for our Adobe Marketing Cloud solutions.

Forrester recognized Adobe as a strong performer and best positioned in their Digital Experience Delivery Platforms Report.

Gartner named Adobe a leader in their 2014 Magic Quadrant for Mobile App Development Platforms, highlighting the capabilities of Adobe Experience Manager, PhoneGap and Digital Publishing Suite.

And Forrester named Adobe Campaign a leader in their Cross Channel Campaign Management 2014 Wave Report.

This recognition in our leadership in the Digital Marketing industry is helping to build an even stronger partner ecosystem with software companies, agencies, and systems integrators.

Recent partnerships include a global reseller, where SAP will resell Adobe Marketing Cloud with their HANA platform and Hybris commerce suite.

The relationship has progressed well since the announcement in March.

A strategic partnership with the Publicis Groupe to deliver the first end-to-end marketing management platform automating all components of a client's marketing efforts.

All Publicis agencies will standardize on Adobe Marketing Cloud, making this our most comprehensive agency partnership to date.

And a partnership with Web Pro, a leader in global IT consulting and business process services, which is creating a new business unit to deliver integrated marketing, commerce, analytics and customer experience solutions.

In summary, Adobe demonstrated strong execution across our business in Q3.

Our Creative Cloud user base continues to grow, as we offer an ever-expanding stream of new Creative solutions and tailored customer offerings.

Adobe Marketing Cloud had another strong quarter and is outpacing the market from a solution, partner and customer perspective.

Content and data have never been more important, and Adobe is the leader in both.

We have become the trusted content and data partner for the world's biggest brands, media companies, governments, and educational institutions.

We have a strong tailwind moving into Q4 and are excited about the opportunities ahead.

We hope to see many of you at our MAX conference.

Mark?

In the third quarter of FY14, Adobe achieved revenue of $1.005 billion, within our targeted range.

GAAP diluted earnings per share in Q3 were $0.09 and non-GAAP diluted earnings per share were $0.28.

Looking at highlights in our third quarter, those that stand out include driving strong adoption of Creative Cloud, growing Adobe Marketing Cloud bookings well ahead of our target, managing expenses to deliver upside on earnings-per-share, achieving record deferred revenue, and generating a substantial increase in recurring revenue.

We exited Q3 with 63% of our revenue as recurring.

In Digital Media, we achieved revenue of $621 million.

This segment has two major components of revenue, our Creative family of products and our Document Services products.

In our Creative business, adoption of Creative Cloud accelerated quarter-over-quarter, while reported revenue declined sequentially, as expected, due to Q2 being the last quarter of any meaningful perpetual CS6 revenue.

We exited Q3 with 2,810,000 Creative Cloud individual and team subscriptions.

Retention of Creative Cloud subscriptions, including renewals after promotional pricing expiration, continues to track ahead of our initial projections.

Across all active subscriptions, Average Revenue Per User, or ARPU, in each Creative Cloud offering was consistent with Q2.

Given continued adoption of the Photography offering and seasonal educational strength, which are adding new customers, total Creative Cloud ARPU exiting Q3 decreased slightly.

Our success with subscriptions, enterprise term license agreements, or ETLAs, and Digital Publishing Suite adoption helped to drive Creative ARR to a total of $1.4 billion exiting Q3; at constant currency from December of 2013, an increase of $209 million quarter-over-quarter.

Our strategy with segmented Creative Cloud offerings is to target existing customers across all user categories, as well as attract new customers to the platform.

Overall, we are seeing strength in migrating the installed base, as well as expanding our market with new user adoption.

Adobe's direct sales force continues to migrate enterprise customers with new ETLAs and we have a strong pipeline going into the end of the year.

Creative Cloud for team units grew sequentially on both Adobe.com and through the channel.

Subscriptions through the channel were below our expectations in Q3, as resellers came off a strong final push with CS6 in Q2.

We expect subscriptions and the associated ARR will gain momentum, as the channel now focuses exclusively on Creative Cloud.

Q3 adoption of the full Creative Cloud offering in the Creative Professional segment was consistent with our performance in Q2.

Our Photoshop Lightroom offering, which was rebranded as the Creative Cloud Photography program in June, continues to drive new customer adoption, as well as migrate those who historically licensed Photoshop Elements and Photoshop Lightroom.

In Document Services, we achieved revenue of $208 million in Q3.

Our momentum in this category is being driven by continued adoption of Acrobat, including several large contracts which closed during the quarter.

Adoption of Acrobat ETLAs, Acrobat Cloud Services, and EchoSign grew Document Services ARR to $217 million exiting Q3.

In our Digital Marketing segment, there are two components.

The first is revenue from our Adobe Marketing Cloud offering, and our momentum as the leader in this market continued.

We achieved revenue of $290 million in Q3.

More importantly, we continue to drive strong year-over-year bookings growth that puts us ahead of our goal for the year.

Our success is being driven by an increase in size of transactions, number of solutions per customer, International expansion, and growth in partner-driven business.

The second component of our Digital Marketing segment is revenue from the LiveCycle and Connect businesses, which contributed $47 million in Q3 revenue and was consistent with our expectations.

Print and Publishing segment revenue was $47 million in Q3.

Geographically, we experienced stable demand across our major geographies.

Asia as a percent of total revenue was low, given Creative Cloud adoption in Japan has been slower than other geographies.

With the removal of perpetual licensing from the channel in Japan, we are confident the transition towards Creative Cloud will begin to accelerate.

From a quarter-over-quarter currency perspective, FX had no meaningful impact on revenue.

We had $1.1 million in hedge gains in Q3 FY14 versus $2.6 million in hedge gains in Q2 FY14; thus, the net sequential currency decrease to revenue was $1.5 million.

From a year-over-year currency perspective, FX increased revenue by $7.1 million.

Comparing the $1.1 million in hedge gains in Q3 FY14 to the $10.5 million in hedge gains in Q3 FY13, the net year-over-year currency decrease to revenue, considering hedging gains, was $2.3 million.

In Q3, Adobe's effective tax rate was 29% on a GAAP basis and 21% on a non-GAAP basis.

The GAAP rate was higher than targeted, primarily due to stronger than forecasted profits in the US.

Employees at the end of Q3 totaled 12,368 versus 12,026 at the end of last quarter.

Our trade DSO was 48 days, which compares to 48 days in the year-ago quarter and 45 days last quarter.

Cash flow from operations was $269 million in the quarter, and our ending cash and short-term investment position was $3.52 billion, compared to $3.33 billion at the end of Q2.

In Q3 2014, we repurchased approximately 1.9 million shares at a cost of $133 million.

Now I would like to go over our financial outlook.

We are targeting a revenue range of $1.025 billion to $1.075 billion in our fourth quarter of FY14.

In Q4, we expect Digital Media segment revenue to grow sequentially, with Document Services revenue relatively consistent with the strong revenue we have achieved in Q3.

We expect Creative ARR and Document Services ARR to grow sequentially.

We expect net new Creative Cloud subscriptions to grow on a sequential basis and slightly exceed the approximately one million net new subscriptions we targeted in the second half of FY14.

We continue to expect we will achieve total Digital Media ARR of approximately $1.925 billion exiting the year.

We are targeting Q4 Adobe Marketing Cloud revenue to grow slightly on a year-over-year basis.

As you think about Adobe Marketing Cloud revenue, it is important to understand we are seeing increased customer adoption of our term-based Adobe Experience Manager and Adobe Campaign Solutions.

This is resulting in larger customer engagements, more predictable revenue, as well as higher long-term revenue growth.

In FY13, approximately 45% of these Marketing Cloud bookings were term-based.

Entering FY14, we anticipated a move toward a mix of approximately 60% term-based bookings in FY14 for AEM and campaign.

With the acceleration of term-based adoption in FY14, we anticipate achieving approximately 75% term-based bookings this year.

As a result of the faster transition, we estimate approximately $60 million of revenue that would have been recognized in FY14 will have shifted from perpetual AEM and campaign licensing to term-based contracts during the year.

Adding the Q3 portion back to our results this quarter would have driven total Adobe revenue to the high-end of our targeted revenue range and Adobe Marketing Cloud would have achieved greater than 20% year-over-year revenue growth in Q3.

Adding back the estimated Q4 impact, the high-end of our targeted Q4 revenue range would have been $1.1 billion.

And adding back the $60 million full-year impact, Adobe Marketing Cloud FY14 year-over-year revenue growth would have been greater than our annual target of 20%.

We highlighted at the outset of the year our goal of driving at least 25% revenue CAGR for Adobe Marketing Cloud revenue between FY14 and FY16, and we're on pace to achieve this.

We expect combined revenue with LiveCycle and Connect to decline sequentially, and we are targeting Print and Publishing segment revenue to be relatively flat.

We are targeting our Q4 share count to be 508 million to 510 million shares.

We are targeting net nonoperating expense to be between $12 million and $14 million on both a GAAP and non-GAAP basis.

We are targeting a Q4 tax rate of 28% to 29% on a GAAP and 21% on a non-GAAP basis.

These targets yield a Q4 GAAP earnings per share range of $0.05 to $0.11 per share and a Q4 non-GAAP earnings per share range of $0.26 to $0.32.

Mike?

Adobe MAX is coming up in a few weeks, with the opening day keynote on the morning of Monday, October 6. As we've previously announced, we will host a financial analyst briefing that afternoon beginning at 3:00 PM Pacific time.

The MAX keynote, as well as our meeting with the financial community, will be webcast, with the financial analyst briefing ending by approximately 5:00 PM Pacific time.

If you still want to sign up to attend MAX, please contact Adobe Investor Relations.

For those who wish to listen to a playback of today's conference call, a web-based archive of the call will be available on our IR site later today.

Alternatively, you can listen to a phone replay by calling 855-859-2056.

Use conference ID number 95884752.

Again, the number is 855-859-2056, with ID number 95884752.

International callers should dial 404-537-3406.

The phone playback service will be available beginning at 5:00 PM Pacific time today and ending at 4:00 PM Pacific time on Friday, September 19, 2014.

We would now be happy to take your questions.

Operator?

(Operator Instructions)

Ross MacMillan, RBC Capital Markets.

Thanks very much.

Mark, the question on the mix between the full Creative Cloud and the Point products this quarter.

I think maybe some of us thought we might see that return to a higher mix of full Creative Cloud, because of the rundown of inventory of the Creative Suite from the channel.

Obviously, there was some mix, a difference there, perhaps it was explained by education strength and so forth.

What is your expectation for that mix going forward?

And also for the blended ARPU, as we think about Q4 and beyond?

Thanks.

Hello, Ross.

Like we said on the prepared remarks, we feel really good about the quarter.

We drove 500,000 units.

This is a Q3 for us which is a seasonally more difficult quarter and we felt very good about how we did.

We do believe there's tremendous upside in the channel in the second quarter.

You saw the channel was primarily focused on the last hurrah of perpetual revenue with CS6, if you will.

This is the first quarter they had to sell exclusively the subscription product, and we think there's a tremendous ramp that we're going to see from them contributing to that mix moving forward.

Education, as you know, is strong in Q3, as well.

We had a good education quarter.

And the bundle continues to attract new customers.

So we're really happy with how it's progressing.

We do think that the channel will be able to contribute more moving forward, and that's going to help that mix and it's also going to add to ARPU over time.

And Ross, maybe if I were to add two other quick things.

When we think about excluding the PSLR bundle, as well as education units, ARPU across the individual team single application, as well as the complete CC in all markets, was relatively consistent.

In fact, it increased slightly.

And so we feel good about how that performance is happening.

And in general, you have to also go back to the Creative Suite mix that we had.

Single application was, even in that particular business, about 40%.

We realize that's an on-ramp that's accretive to overall ARR, as Mark also mentioned with the Photography bundle.

So pleased with how the quarter performed.

That's great.

And maybe just one quick follow-up.

I know that you're seeing better retention rates than your initial 80% assumption.

Will we get to a point in the near future where we might actually talk about what sort of percentage retention you're seeing?

Thank you.

Well, Ross, we told you approximately 80%.

We're ahead of that, as we talk about, in our retention rate.

So we think that that gives you the right color to understand that the business is very healthy.

Other way we look at it is when you think about the number of units that we've transacted, with 2.8 million subscriptions, as well as what we are doing with the enterprise ETLA, that's already ahead of what we were doing steady-state with Creative Suite.

And we continue to think there's headroom, both in terms of migrating existing customers, as well as attracting new customers.

So that should also give you a good sense of how healthy the business is.

That's helpful.

Thank you very much for taking my question.

Let's take the next question.

And let's try to limit to one, just so we can fit everybody in.

Thanks.

Brent Thill, UBS.

Mark, just on the Q4 guidance, you're guiding below the Street.

I just want to be clear that that's largely a transition to term versus perpetual?

Yes, Brent.

So as I pointed out up front, in the Adobe Marketing Cloud, we are seeing a much faster move to term-based managed services solutions for AEM and Campaign.

We went into the year assuming about a 60% term-based mix, and we're going to end more around 75%; and that delta, that $60 million delta for the year, is what's really driving the difference.

If you look at the fourth quarter, as I said, we would have been closer to $1.1 billion, at the high end of our range, had we not gone through a faster shift of this AEM and Campaign from perpetual to term-based.

Okay.

Just a quick follow-on then.

As you mentioned, the Marketing Cloud bookings were well ahead of target.

I know you don't give out a booking number, but can you perhaps just give us some color as it relates to what you've seen the last couple quarters relative to your booking target?

Did you significantly exceed?

Or any other color that you could help to frame that, that would be helpful.

Thanks.

Brent, maybe I can jump in there.

We had talked about getting 30% bookings, which would drive 25% CAGR over three years.

And as Mark mentioned in his prepared remarks, we're seeing significant strength above that particular target.

And maybe big picture, it's better to explain that it's really in our best interest to manage and deliver the entire customer marketing platform.

And what that is resulting in is we're seeing multi-year deployments.

It's increasing the revenue per customer.

We gave you some color on what we are seeing of deals greater than $500,000.

That grew over 40%.

What we're also seeing is more solutions within existing customers, which is driving stickiness.

And so I think this transition to the platform, the multi-solution, multi-year sale has really gone faster than expected, which hopefully is good news, if you want better and more predictable revenue.

And that's why we also provided you with some way to model it with what happened with AEM and Campaign for 2014.

And then just to add onto that one more time, what that does, Brent, as you know, is it helps drive deferred revenue.

We had a record deferred revenue quarter.

It also helps drive the unbilled backlog, which we disclosed at the end of the year.

And between the two of them now, we've got roughly $2 billion of contracted business waiting to be recognized in the form of revenue.

So it just makes for a much healthier business overall.

Great.

Thanks.

Brendan Barnicle, Pacific Crest Securities.

Shantanu, I was interested in where you might be seeing some of the cross-sell around both the Creative Cloud and the Marketing Cloud.

I know you've highlighted that at some of the conferences.

Can you give us any more color on where we are in that migration and maybe a sense of what percent of the installed base is even looking at using both of those and leveraging them both off each other?

Thank you.

Sure.

I think when we look at what's happening with our enterprise sales force and the sales force that is selling both the Creative Cloud as well as the Marketing Cloud into enterprises through the ETLAs, the Document Services ETLAs, as well as Marketing Cloud bookings, that's where Matt and his team are driving multiple billions of dollars in terms of what we are being able to sell.

Some customer examples there include publishing.

They want a single asset repository and workflow to create content once and repurpose that across web and mobile applications and video, which is fast becoming one of the key things for every publisher to do online.

So publishing is a good industry.

In retail, you're seeing more and more of the innovative customers want to completely accelerate their time to market by having the design for these goods directly delivered through this workflow all the way out to manufacturing, as well as for the consumer to have the ability to actually create personalized goods directly on a retail website.

And video, I think when you talk about creation, delivery and ad insertion.

So hopefully that gives you some examples, but it's driving more strategic relationships with customers across all of these industries.

Great.

Thank you.

Walter Pritchard, Citibank.

Just one question, Mark, around pricing.

You've been in the market now for quite a while with the individual edition.

And you haven't talked about what percentage of your customers have gone past the one-year anniversary and have had pricing go up.

But can you talk maybe about an ARPU on that segment or something that would give us an idea of how many of those customers or what progress you're seeing in terms of the expiration of the promo and the uplift in ARPU that that would drive?

Generally speaking, like Shantanu mentioned, and I think I mentioned, across each of the offerings, the ARPU has either remained constant or actually increased.

And from a retention perspective, we're seeing very good retention with people renewing even after the promo expires.

So as that happens, of course, it does drive ARPU up.

And Walter, if you go to the website and you look at the pricing for the various offerings, I think you would recognize that the individual complete is about $49.99 and you can look at the promotional pricing at about $29.00 And for Team, the complete pricing is $69.99, and the promotional pricing could be $39.00 or $49.00.

So I think that gives you some sense of what you're seeing in terms of as people migrate off the promotional pricing, what kind of ARPU we're getting from those customers.

Okay.

Thank you.

Kirk Materne, Evercore.

Mark, you mentioned that the channel had a little bit of a slower start to the third quarter, given that they've shifted away from the license-based product.

In your guidance for the fourth quarter, how much are you counting on that to bounce back to meet your subscription, as well as your ARR targets for the quarter?

Or do you expect it to maintain itself the way it was in 2Q, and that's upside if you get a lift from there?

We're expecting it to move up.

We're not expecting a huge ramp, but we are expecting it to move up from here, given that they are done with perpetual, and frankly, they're solely focused on selling subscription now.

The other thing I might add is if you look at the traditional Q3 to Q4 transition, and you go back and look at what happened last year, there are two things that drive it.

First is seasonal strength.

The second thing is enterprise ETLAs.

Q4 tends to be the strong quarter for that.

And so you should factor that in also as you think about how we go from Q3 ARR to adding Q4 ARR.

Thanks.

If I could just ask a really quick follow-up to Mark's comment on the deferred being so strong this quarter.

Obviously, I'm sure the transition to term deals in Marketing Cloud played a part in that.

Was there anything else in terms of billing, how you're billing some of your customers, that played a part that you expect to continue to go forward?

Thanks.

It's two big pieces, really.

It's Digital Marketing Cloud and then it's the Creative Cloud, as well.

It's the ETLAs around Creative Cloud, as well.

ETLAs are billed in advance for the first year and that goes into deferred, and then years two and three would show up in that unbilled backlog number that I referenced.

So it's really both businesses that are driving the deferred revenue, as well as the unbilled backlog.

Thanks.

Kash Rangan, Merrill Lynch.

I'm just wondering if you could talk about the percentage of business from term-based bookings in Marketing Cloud that has obviously caught you by surprise.

Why would you not just take the step of making all that business completely ratable?

And if you were to do it, I'm wondering what might be a rough way to think about impact to your revenue?

Maybe talk about a 10 percentage point shift in term-based bookings might mean X millions of dollars in revenue, so we will not be at all absolutely surprised by any development in the future.

And also curious if you can comment on the TAM.

I think Shantanu likes to mention, reiterate that the goal of the Company is to draft the entire installed base.

At this pace at which you're adding stuff, it looks like you could transition the entire installed base in about 4 to 5 years.

So the question is, do you anticipate adding more capacity so you could even add more units than what you're doing now to enable this transition happening quicker?

Thank you.

So Kash, there were multiple questions in that.

Let me address the question associated with the term-based, as well as the perpetual, from an offering point of view.

There's certainly still a number of customers, and we think it's a competitive advantage for us, that want to have the AEM solution, the Experience Manager, as well as the Campaign Solution on premise.

You can think about government agencies and other agencies who want to actually manage it themselves.

Which is why we can't completely transition from the perpetual offering to the managed services, which we definitely think is the right long-term solution.

If you look at the trend, as Mark pointed out, it's moved from 45% to close to 75%.

So I think it's now becoming less and less.

And as Digital Marketing revenue grows, the impact of this is certainly going to be muted.

So I think that should give you comfort as it relates to the Marketing Cloud bookings and revenue and that transition.

Shantanu said exactly what I was going to say.

The 75% -- this is the reason we wanted to tell you the 75%, because it shows that we're pretty much through this.

This was a very quick transition.

The good news is it really happened much faster in the back half of the year than we thought.

And with only 25% left to go, and the business in total growing, as Shantanu said, it's not going to have a material impact next year.

With respect to your second question, Kash, Q3 was the first 500,000 subscription quarter for Creative Cloud.

It was half a million, Q3.

It was a strong quarter.

And so as we look at what's happening in the business, we are both migrating existing customers, but we continue to add a healthy dose of new customers to the platform.

And so the strategy that we outlined, namely getting new customers to the platform as well as migrating, continues.

With CS6 perpetual being strong in the last couple of quarters, all of them represent available opportunity or headroom for us to move over to the cloud, as do some of the countries where we outlined that the adoption has been slightly slower.

So we're going to be focused on driving that.

MAX is going to be another catalyst in terms of how far the Creative Cloud offering distances itself from the Creative Suite offering.

So we have to continue to innovate.

We're focused only on the Creative Cloud as an offering, and there's still significant headroom opportunity.

Jennifer Lowe, Morgan Stanley.

Shantanu, in your remarks you mentioned that there was a thought of having more targeted offerings akin to the Photography SKU, especially given the success you've seen there.

So I guess two questions related to that.

One, as you think about how those targeted SKUs fit into the traditional point versus suite strategy, what are the right breakpoints around packaging and pricing to go after specific use cases versus maintaining the premium ASP traditionally associated with suites?

Is it a situation where we could see a whole spectrum of offerings, or are you still working along the lines of point versus suite, with a relatively big gap in between?

And then related to that, in terms of the time horizon that we should think about for these types of targeted offerings, is that something that we'll hear more about next month at MAX, or is that something that's going to be more of a multi-year strategy for you?

Jennifer, when I think of overall the Creative Cloud offerings and the fact that the complete offering is still, we think, the best solution for a creative professional who wants to create content for multiple kinds of media, we still believe that that's really the right offering.

Photography has always been, even with the traditional Creative Suite, such a large opportunity that having the Photography bundle was the right way to go target that.

Part of what we are alluding to is new ARPU enhancing services that we will start to introduce.

And that could be to the entire Creative Cloud customer base.

And you will start to see some of that starting at MAX.

And some of them might be even more market expansion opportunities, as it relates to what consumers are trying to do.

And you've seen us introduce mobile offerings.

So I think for the core creative professional, I think we have it right.

And I think we have to continue to innovate and migrate existing customers.

But I think you're going to start to see us implement against the things we've talked about, the mobile SDK leading to new ARPU enhancing services for the entire base.

Thank you.

Heather Bellini, Goldman Sachs.

I was wondering just if you could walk us through -- we've heard a lot about how agencies are evolving their digital marketing strategies and trying to figure out how to build or whether to buy some of the ad tech that they think they need to serve their clients better.

I'm just wondering how you see the landscape evolving on that front and how you feel Adobe -- how you position Adobe in that context.

Sure, Heather.

First, I think it's a good opportunity to reiterate that global agreement that we announced with the Publicis Groupe.

From my point of view, Digital Marketing agencies have always been working with their key clients, chief marketing officers, chief revenue officers, chief digital officers, to demonstrate a digital strategy for media buying, as well as a creative strategy.

I think the creative strategy need continues unabated.

And I think all digital agencies have to continue to provide that creative strategy and now augment it with what they are doing on the technology side to enable people to truly understand the return of investment, and move the marketing spend from just being analog to more digital.

And I think again, if you saw the announcement around what Publicis announced today, digital certainly becomes a more important part of any agency's strategy.

I think what they are also seeing, honestly, is that systems integrators are seeing the marketing automation as a huge untapped market.

And so I think they're going to see competition as it relates to the traditional systems integrators, companies like Deloitte or PwC, also enter that market.

And from our point of view as a technology provider, none of these relationships are competitive.

They're all using our technology to go implement and automate marketing flows within all traditional industries.

To give you some color, our relationship with Publicis allows them to use our technology to do automated search spin or social spin or display using our technology.

It allows a company like Razorfish, that's part of the Publicis Groupe, to go ahead and implement re-platforming associated with websites.

It also allows them, honestly, to now, with our Audience Manager solution, have a way to segment both the online and off-line customers, which is a big part of how they want to target their offerings.

So we're excited about that and, whether it's agencies or SIs, expect to see more people want to partner with Adobe.

Great.

Thank you.

Mark Moerdler, Sanford Bernstein.

I'd like to have Mark fill in a little more on the $60 million.

Should we be thinking of this move to 75% being term agreements, does it simply mean that we get the license revenue is ratably recognized over the contract term, or is there a revenue lift during the first contract term?

Obviously, there's a lift after the first contract term.

And then a quick follow-up on that.

Mark, it's $60 million, just to make sure everybody heard that right.

6-0.

And it's recognized ratably over the contract term, for the most part.

So it is spread out.

Typically, they're multi-year deals and it's spread out over that multi-year period.

But it's not in the first contract term, it's not more revenue, it's just ratably recognized and then potentially it's more revenue in the second contract term?

Correct.

Okay.

And then the quick follow-up to that, to keep you on the line.

Do you -- are you now selling -- still selling the same mix of term versus perpetual in this space, or are you now basically predominantly selling the term agreements?

By far, we're now predominantly selling the term agreements.

So the 75% that we'll end the year at, like I said, only leaves 25% of perpetual.

So it's not going to be a material shift in any given quarter moving forward now.

Okay.

Thank you.

Derrick Wood, Susquehanna.

So you guys talked about Japan being a little weaker than expected.

How do you weigh the impact potentially coming from the macro versus the impact coming from the shifting channel focus around Creative Cloud?

And then how does that bake into your expectations for Japan next quarter and looking at your pipeline and sub/add contribution?

From my point of view, I think Japan continues to be a large untapped opportunity for Creative Cloud.

It's been a traditional strength for us with the Creative products when we had the Creative Suite offering.

I think what's a little bit different about that geography is the large dependency on our retail in that.

And we had the retail product until Q2.

We see early adopters and we think there's untapped opportunity associated with the Japanese market.

So nothing changes our long-term view.

And it's not a demand issue.

Thank you.

Robert Breza, Sterne Agee.

Just wanted to touch back onto the $60 million, Mark.

So as you think about the remaining 25%, do you think that's a -- how should we think about that transition?

I know you're saying it shouldn't be a big part, but do you think that moves to 80% by the end of FY15, or how do you think that trends longer term?

I think the 75% continues to creep up a little bit.

I think we will get to a point where it stops, frankly, and we're getting close to that.

It's a little hard to say exactly where.

But yes, I could see it going up to 80-20 or something like that over the course of next year.

It's going to depend in any given quarter on how the bookings come in and who the customers are.

As Shantanu said, certain customers want the perpetual version.

But I don't think it's going to get to the point where it move the needle in terms of our total company revenue, like it has the back half of this year.

Okay.

Maybe as a quick follow-up, given the strong deferred revenue numbers that you guys did put up -- and I'm sure it's hard to quantify exactly what drove that -- but was part of that moving more of this $60 million through the term-based piece or overall strength of the demand?

Just qualitative commentary would be helpful.

Thanks.

The $60 million represents multi-year contracts.

So a big chunk of the -- the $60 million is the impact to this year.

But the bookings that that drove would get recognized over time under a term-based model, and that would show up in next year's revenue on a ratable basis.

The first year's worth would be in deferred.

And years two and three of those bookings would be in the unbilled.

Great.

Thank you very much.

Jay Vleeschhouwer, Griffin Securities.

Shantanu, Mark, other than highlighting the momentum you're seeing for EM and for Campaign, could you talk otherwise in terms of what you're seeing for the other components of Marketing Cloud?

Specifically for example, Media Optimizer, which you highlighted in the past as a particularly strong new product for you, and perhaps, update us as well on the number of solutions that customers are taking, on average?

I believe the last time you updated that was six months ago at Salt Lake, where it was 1.4 solutions per customer.

Is there an update in that respect?

And a quick follow-up.

Sure, Jay.

In terms of the solutions, what we were trying to do is highlight the key differentiation that we had.

And the differentiation is still very much the combination of Experience Manager plus analytics.

Campaign has been doing really well.

After the acquisition of Campaign, it's got really good analyst reviews, as well as customer adoption.

So Campaign's off to a solid start.

Media Optimizer, the amount of marketing spend under management continues to grow.

I would say Target has been doing really well.

We've seen significant growth year-over-year, as the ability to offer personalized solutions really increases.

And so when I look at it, the way we look at that business is both new sales, which are largely multi-solution sales, as well as existing installed customer base and how we can continue to sell existing customers on more and more of our solutions.

And when you think about the number of large deals, again as we said, that grew 40% year-over-year.

So overall, I think people are standardizing on our platform.

The usage starts always pretty much with AEM plus analytics and now Campaign as a third leg of that stool.

Okay.

And lastly for Mark, just a clarification from the earlier questions on retention or renewal rates.

Now that we've had 10 quarters of Creative Cloud behind us, could you talk a little bit more about the cohort churn of the original class from 2012, let's say, or early 2013 in terms of their retention rates?

If you go back 8, 9, 10 quarters, how does that retention look?

Yes.

So Jay, we can't get into that level of detail here.

But the bottom line is, like I said, from a retention perspective, people are renewing after the promotion along the lines of what we had expected, if not even better than we had expected.

While I'm chatting here, one thing.

I tried to be very clear about the impact of the Digital Marketing shift from perpetual to term.

I think we laid it out at the end of my prepared remarks pretty well.

So if you have any questions, please refer back to that paragraph and then we can do some more follow-up phone calls, because we tried to lay it out exactly as we had in the past under the Creative transition.

Samad Samana, FBR Capital Markets.

I wanted to ask about Neolane.

You've had that for a little bit over a year now.

What has success been in upselling that into the installed base and how is the integration with the rest of the Marketing Cloud going for that set of products?

Really well.

That's the solution that we now call Adobe Campaign.

Adobe Campaign had another strong quarter in Q3, pipeline looks great for Q4.

And the ability to orchestrate these multiple campaigns across the web, e-mail, SMS, outside the US, which is pretty strong, we're very pleased with the performance of Campaign so far.

And have you seen any change in the competitive environment?

I know that ExactTarget has been with Salesforce for a while now, and their customers are coming up for renewals.

Has there been any change in the competitive environment in the marketing space for you guys?

I think from a competitive point of view, as this market continues to explode, you're certainly seeing everybody participate in it.

We still think we are the leader in the category and our solutions are most differentiated.

And we continue to grow that by both expanding our footprint.

So specifically as it relates to ExactTarget versus Campaign, a lot of the Campaign solutions for us right now are greenfield opportunities, as people are continuing to implement and automate their marketing processes.

So we've been focused a lot of that.

Okay.

Thanks.

Operator, we're coming up on the hour, so maybe we'll take one more question.

Steve Ashley, Robert Baird.

I just wanted to swing back to the Digital Marketing business again.

You talked about the nice increase in the number of larger deals that's happening there since you've introduced the platform.

And I was hoping to just get more color around how you're driving that.

Is that coming from you going back into the installed base and cross selling more solutions into existing customers, or is that also coming from new customers buying more solutions when they initially buy, and where you're getting traction among those solutions?

Thanks.

Steve, the short answer is actually it's both.

It's both, and it's happening both through our direct sales force -- and honestly, it's happening through partners who are increasingly recommending us as the solution of choice as they go into all of these digital transformation products.

Again, I would say until 2 quarters ago, it was largely driven by the combination of AEM and analytics, and then the cross-sell was Media Optimizer and social and target.

Today, I would say the initial sale is much more AEM plus analytics plus Campaign, because that's been very well received.

And then the upsells continue to be those other solutions.

In terms of industries, retail continues to be really strong.

Automotive is strong.

Financial Services is doing well.

Government, as government does digital, government, we've had a really strong presence with AEM and analytics in government, as well as Document Security there.

So we're seeing trend -- good positive trend across every industry.

There isn't a CMO in the world that I go to who isn't talking about digital transformation and trying to understand how technology helps them.

So I think it's that tremendous tailwind, Steve.

That's really helpful.

Thank you, Shantanu.

Thanks for joining us.

I think, as I think about all of the questions, I do want to reiterate in what's traditionally been a weak quarter for Adobe, Q3, we really had strong performance, both with subscriber additions over 500,000, Digital Marketing bookings that were strong, as well as Document Services revenue in Q3.

And as a result, we are on track to deliver the key financial commitments that we outlined for the second half of the year.

On the Creative Cloud, it still is how do we drive customer adoption and migration to Creative Cloud?

Adobe.com has been focused on this for a couple of years and now the entire channel ecosystem, as well as ETLAs through the enterprise, we're focused on this.

In Digital Marketing, I would say awareness has been growing.

We continue to drive leadership with successful product launches of our marketing products.

The fact that we're seeing this shift from perpetual to term, we view that as a real positive, because people are signing these large multi-year agreements with us.

On the internal side, the innovation engine is humming.

We're delivering new value with the Creative Cloud, Marketing Cloud, as well as Document Services.

And I think the earnings upside continues to demonstrate the leverage of our financial model.

We're excited about MAX and we look forward to seeing you there.

Thank you for joining us.

This concludes our call.

Thanks for joining us.