Live: Adobe Systems Q3 earnings call by Jon Fortt @FortuneMagazine September 17, 2007, 5:08 PM EST E-mail Tweet Facebook Google Plus Linkedin Share icons Adobe Systems (ADBE) has reported Q3 earnings that blew past analyst expectations and the company’s own projections, based on unexpectedly strong sales of its Creative Suite and Acrobat products. Because Adobe is the first major technology company to report earnings during this cycle, executives sometimes offer insights into the technology buying patterns that affect larger players such as Apple (AAPL) and Intel (INTC). The call has begun. Bruce Chizen, CEO; and Shantanu Narayen, COO, are among those on the call. Bruce says the growth in Q3 was outstanding. Revenue was $851.7 million, up 41 percent from a year ago. CS3 adoption and Acrobat momentum are the main reason, but Chizen cites growth across all businesses. Mark, the CFO, is giving all the GAAP and non-GAAP numbers; I’ll catch up with those in a bit. The effective tax rate: 25.9 percent GAAP net income: $205.2 million, up from $94.4 million a year ago, and $152.5 million last quarter. GAAP diluted earnings per share: 34 cents, comp to 16 cents a year ago, and 25 cents last quarter. Non-GAAP: 45 cents, up from 29 cents from a year ago, and 37 cents last quarter. Revenue by segment: Creative: $504.5 million, up from $331.6 a year ago, $436.6 million last quarter, up 65 percent y/y Knowledge worker: $176.8 million, compared to $156 million a year ago, $184.8 million last quarter. Enterprise: $59.3 million, compared to $49.4 million a year ago, $52.3 million last quarter, up 20 percent y-y Mobile: $13 million compared to $9.1 million a year ago, and $12.3 last quarter, up 43 percent y-y Other: was down 7 percent (this is PostScript, and has been declining for a long time) Record revenue in all markets. Percentage breakdown: Americas: 47 percent Europe: 33 percent Asia: 20 percent Adobe closed the quarter with 6,677 employees, up from 6,427 last quarter. Global channel inventory was within company policy. The quarter saw $425.2 million cash flow. 17.6 million shares were repurchased. Adobe had $2 billion in cash at the end of the quarter, down from $2.3 billion (due to repurchases et al). Q4 targets. Adobe expects: $860 – $890 million revenue target GAAP operating margins 30-31 pct non-GAAP of 41 percent effective tax rate 25-26 percent non-GAAP 26-27 percent GAAP earnings: 35-37 cents per share 46-48 cents non-GAAP Shantanu: 36 percent increase in CS revenue. Adobe expects a long tail. Most popular versions: Design Premium , Design Standard, Master Collection, then others Strong demand for Mac versions 27 percent of revenue came from Photoshop Extended There was high demand for Mac video software — about 37 percent of the mix was Mac. Knowledge worker up 17 percent. Acrobat Professional continues to be more popular than standard. The Department of Defense plans to begin using Acrobat Connect. Server: The segment that includes LiveCycle was up 20 percent. Mobile: Flash Lite adoption is strong. AIR development is going well. Bruce: “Clearly Q3 was a great quarter for us.” He says the company is poised to break the $3 billion revenue mark, and they’re positioned to achieve double-digit growth well into the future. Bruce is asked what’s driving Adobe revenues now. He says overall marketing spend is now one of the biggest drivers of Adobe revenues. Overall IT spend is a factor for Acrobat. High-end consumer spend is something else Adobe looks at – luxury spend at retailers like Tiffany. Shantanu says it’s very early in CS3 sales still. Chizen: The suites are still the majority of the revenue, but the individual products are still going OK too, which tells them they might be able to convert some more customers to suites later. On Master Collection: Shantanu says Master Collection was built so that creative professionals could have everything in one place that works well together. Individual creative professionals are the main customers. Larger customers don’t tend to be the ones getting it, though they might come along later. Chizen: Overall, there was particular strength in Europe, which was surprising. Q3 is typically tough for Adobe, and that weakness is typically in Europe. Bruce said people rushed back from holiday to buy Creative Suite. Bruce says the majority of Adobe revenue today is not shrink-wrapped, and cautions analysts against drawing too many conclusions based on non-licensing revenue data. On Mac strength: Shantanu says CS3 performance gains on the Mac are impressive, and the Mac is a vibrant platform. Adobe came back to the Mac with video products, and Adobe is off to a strong start with those. On geographic performance, Bruce says Europe really outperformed expectations, and that made the Americas look a little stronger than usual, but Adobe is happy with the overall mix. Shantanu says he expects a long tail on the CS3 cycle because there was a long cycle between CS2 and CS3, and the reviews have been outstanding for CS3. Adobe knows that enterprises take longer to buy, and Adobe is doing customer research on big customers who have not yet moved. Considering this information the company is gathering, and the fact that CS2 had a long tail, it seems CS3 will have one, too. Bruce weighs in on the long tail: The overachievement in Q3, which was greater than the Street and Adobe anticipated, serves as validation that any business that needs to communicate is a potential customer for CS3. People need reliable, engaging information that works cross-platform. (In other words, there are a lot more potential CS3 customers out there than some people thought, and demand is higher among those potential customers.) Shantanu on the mobile business: Royalties on Flash Lite make up the bulk of revenue. People are also using tools to create the content. Adobe is also looking at carrier services. In 2008, Adobe expects licensing to continue to be the bulk of mobile revenue. Shantanu says Adobe believes video is a more compelling way of communicating in general. Adobe continues to be paranoid about what Microsoft does, but the video playing capabilities Adobe has in Flash continue to be the way people want to communicate in video. Adobe isn’t resting on its laurels, and the company continues to innovate with HD and with the Flash video player. Bruce says more than 98.5 percent of people with computers have Flash player, and more than 90 percent of people with computers upgrade their player within a year of a new release. Even Microsoft’s own MSN site has a lot of Flash on it, demonstrating that Silverlight (Microsoft’s new competitor to Flash) is not yet there. Back to CS3, Europe was a big surprise, Bruce says. (I wonder how much of this has to do with the Web design boom in Europe.) The percentage of suites over standalone products was strong. Shantanu says Adobe did a better job of priming the market this time with public betas and whatnot, and that probably helped create the revenue surprise. Bruce says that a majority of corporate customers still haven’t upgraded, which is a good sign for future revenue from CS3. Mark says Adobe expects CS3 to continue to be above CS2 in revenue levels throughout its cycle. Adobe will probably end the year with 39 percent operating margins, and won’t try too hard to increase those margins because Adobe wants to invest in R&D. Bruce says Adobe wants to grow earnings through revenue growth, not cost-cutting. Bruce says Asia is heavily driven by Japan because the rest of Europe is heavily affected by piracy. Japan is strongest in Q1 and Q2. Analyst Gene Munster says the analyst notes tomorrow will say Adobe’s quarter was a home run, but was this it? (Key question. The Street has been underestimating Adobe lately.) Bruce repeats that this revenue surprise was a validation of the market dynamics, and that enterprises still haven’t weighed in, so their CS3 revenues are still to come. Shantanu says that Adobe has to do a significant amount of work with handset makers and carriers to make sure that Flash Lite works. Bruce says that he expects Flash will eventually be on all mobile phones and carriers. Bruce says the iPhone was a blessing for Adobe — a great device. The manufacturers who are looking to follow the iPhone are reading the reviews that say a deficiency of the iPhone is that it doesn’t have Flash — Chizen says that leads Adobe to believe that Flash will be on a lot of high-end handsets in the near future. In response to a question about Acrobat growth: Bruce says Adobe is very pleased with 17 percent y-y growth in the Knowledge Worker segment. Adobe believes there are 97 million workers who could take advantage of the software. Bruce says you don’t need to compare Creative Suite growth rates to Acrobat. Adobe’s pleased with both. The call has ended.