By Jan Stoddard of Raine Consulting While Adobe continues to march through 2003 with strong financial performance, there are continuing implications for anyone in the (physical) printing world. To quote, Adobe CEO Bruce Chizen, "We believe that there is going to be a video publishing revolution in the same way that there was a desktop revolution in the 80's. There are now two ways to get video communicated. One, through broadband and the other is through DVD's. With the DVD proliferation, any company worldwide can use DVD to communicate." The conclusion offered by Shantanu Narayan, Executive VP, Worldwide Products, "If you take the entire product into account, every creative desktop that is using a professional product for print is the market opportunity." June 12th , 2003 -Adobe (NASDAQ: ADBE) is one of the world's largest PC software companies, with annual revenues exceeding US$1.2 billion and ranking #487 in the Global FT 500. The company employs approximately 3,400 people worldwide and has its headquarters in San Jose, California. In the second quarter of fiscal 2003, Adobe achieved revenue of $320.1 million, compared to $317.4 million reported for the second quarter of fiscal 2002 and $296.9 million reported in the first quarter of fiscal 2003. Adobe's revised second quarter revenue target range was $305 to $320 million, up from its prior target range of $300to $315 million. GAAP diluted earnings per share for the second quarter of fiscal 2003 were $0.27. (Adobe's GAAP and pro forma second quarter earnings target range was $0.24 to $0.28 per share, up from its prior target range of $0.24 to $0.27.) Call Topics: * President Comments * Financial Comments * Major Business Segments * Q&A President Comments Mr. Bruce Chizen, President and CEO, reviewed the highlights for this quarter including: * The achievement of year-over-year and sequential revenue growth at $320.1 million, exceeding the previously provided target ranges. * Earnings per share came in at the high end of targeted ranges. * Driving the business was the release of the Acrobat family of products where initial orders have exceeded expectations and industry comments have been overwhelmingly positive. * Adobe is gaining momentum as an enterprise solutions provider which also helped drive a record ePaper quarter with 43% year-over-year growth * Significant growth in combined InDesign and Design Collection revenue demonstrating continued progress against the goal of becoming the leading provider of professional page layout solutions. Financial Reporting Mr. Murray Demo, Senior VP and CFO reviewed key financial metrics for the quarter. GAAP net income was $64.2 million for the second quarter of fiscal 2003, compared to $54.3 million reported in the second quarter of fiscal 2002, and $54.2 million in the first quarter of fiscal 2003. Adobe's GAAP operating income was $91.5 million in the second quarter of fiscal 2003, compared to $90.8 million in the second quarter of fiscal 2002 and $80.5 million in the first quarter of fiscal 2003. As a percent of revenue, GAAP operating income for the second quarter was 28.6 percent, compared to 28.6 percent in the second quarter of fiscal 2002 and 27.1 percent in the first quarter of fiscal 2003. Demo also noted these additional highlights: 1. Revenue by Market Segment: * Greater Professional Segment: $93.7 million (versus $90.1 Q2 2002 and $85.8 last quarter) * Digital Imaging and Video Segment: $95.3 million (versus $130.6 Q2 2002 and $96.2. last quarter) noting the year-over-year decline was due to a successful PhotoShop7 release in the year ago quarter * OEM Postscript and Other Revenue Segment: $23.0 million (versus $21.1 Q2 2002 and $24.0 last quarter) * ePaper Solutions Segment: A record $108.1 million (versus $75.6 Q2 2002 and $90.9 last quarter) including a sequential revenue increase from e-Paper server revenue of $16.5 million 2. Results by Geographic Segment: * America's - 49% * Europe - 27% * Asia - 24% noting that the strength in Asia came from stronger than expected revenues in Japan, while the America's and Europe are on track. 3. Applications mix: * 73% Windows (versus 69% 2Q 2002) * 27% Macintosh (versus 31% 2Q 2002) Third Quarter Guidance: For the third quarter of fiscal 2003, the Company announced that it is targeting revenue at $300 to $315 million, a gross margin of 92 to 93 percent, and GAAP and pro forma operating margin ranges of 24 to 27 percent. These targets lead to GAAP and pro forma target ranges of $0.22 to $0.25 earnings per share in the coming quarter. Major Business Segments Q2 Review: Shantanu Narayan, Executive VP, Worldwide Products, noted that the highlight was the release of Adobe Acrobat 6 - English version late in Q2, followed by the German & French versions which began shipping the first week of Q3 and other localized versions (including Japanese) which will begin shipping later in June. Citing numerous industry endorsements, the new Acrobat 6 release is proclaimed as a "must-have" due to new capabilities in areas such as document control, security (integrated document processes with digital signatures) and collaboration. A significant number of licensing deals exceeding 2500 seats were closed in the quarter including Kinko's, Shell International, U.S. Department of Justice, and Wake Forest University. Quarterly revenue from ePaper desktop licensing was 31.8% of revenue versus 36.7% last quarter attributing the decline to higher shrink-wrap revenue for Acrobat 6. Server-based business growth came from new deals including: The Social Security Administration (migrating administrative and claims processing electronic forms), The Commonwealth of Massachusetts Executive Office of Public Safety (to move homeland security documents processing online); The U.K. Maritime Coast Guard (automate forms processing). New Enterprise customers include: Boeing Employee's Credit Union, All-State Insurance, and Nestle Australia. Several announcements were made during the quarter: * Expanding relationship with Documentum: Adobe form technology will be integrated with Documentum's content server for regulated industries such as financial services, manufacturing, and government. * With IBM, Adobe will deliver integrated document solutions initially into government markets. * Adobe's XML architecture announced to support end-to-end document processes. Two new products aimed at professional customers, as well as existing product upgrades to deliver by the end of the coming quarter, drove increased sales for the Digital Imaging and Video segment. Question and Answer Session 1. The quarter was linear with March as a strong month. (In Japan, March is the strongest month.) In terms of seasonality, Adobe historically has had a weak summer particularly in Europe and Japan. However, in the U.S. the strongest educational season is in August. They anticipate strong licensing in Q3 driven by education and a soft economy in Asia (particularly Japan). These factors were included in the projections for the revenue range in the upcoming guidance. "We are absolutely being prudent." 2. When asked about the Adobe Acrobat product mix, Narayan noted the initial demand for Acrobat Professional exceeded expectations. Too early to comment on what is happening with the mix. 3. No comments on product releases for Q4 relative to Creative Pro and Photoshop. Adobe sees the macro marketing trends for digital imaging for consumers being driven by digital camera sales and as very seasonal. Most likely there will be Q4 releases and a Digital Collection. 4. Backlog for the quarter has normalized versus Q1 that ended with a higher level of backlog into Q2. Some backlog for Design Collection and German and French Acrobat versions. 5. When questioned why Q3 projected revenues appear lighter than anticipated due to strong Q2 quarter, Chizen emphasized that they hope a strong demand for English will continue as well as other language versions shipping, as well as the strong education business in U.S. The two potential negatives are the current financial struggles of state and local governments that will be an unknown impact until August timeframe, and the biggest constraint due to the historical summer seasonality noted previously. 6. The go-to-market strategy in licensing Acrobat Elements (which allows corporations, especially IT groups, to standardize PDF for all creations) is built on a longer sales cycle with a focus on direct sales, but also on partners to get it into the enterprise. No sales ramp-up planned. 7. Market opportunities are great for Q4 and into 2004, including Q4 launches with new products, making it critical to manage expenses and balance R&D against Sales & Marketing expense. 8. Acrobat 6 sales reflect one week, from May 24th. Sell-through comparisons from previous versions demonstrate a very strong release. 9. SARS has had no impact on sales. No impact on supply chain or business and not factoring any future negative impact. Also, did not see any material impact from the war in Iraq. 10. One analyst observed that most of the cited deals were from government and asked if that due to focus or demand. In response, it was noted that there has been significant foray into regulated industries and that government wins are easier to announce because of already being in the public disclosure realm. 11. Staffing up by 120 employees since Q4 2002 to support buildup of enterprise support and will continue to hire due to great hiring opportunities. 12. In terms of overall Design Collection PageMaker side has seen some weakness and there is an emphasis to move PageMaker customers over to InDesign. 13. In answering what is the addressable market for Encore pro-consumer market, Narayan said it is aimed at the professional desktop with professional video maker and their customers whether audio, DVD, etc. If you take entire product line into account, every creative desktop that is using a professional product for print is the market opportunity. Chizen stated, "We believe that there is going to be a video publishing revolution in the same way that there was a desktop revolution in the 80's. There are now two ways to get video communicated. One, through broadband and the other is through DVD's. With the DVD proliferation, any company worldwide can use DVD to communicate. We think that will drive our overall video business and that is why we are so excited about the category." 14. The Board reviewing cash use and overall capital structure and that is why there was no share re-purposing in the quarter. 15. When asked to project any gain in market share, Chizen advised that it was "challenging if not foolish" to make market share gain projections. However, he noted that by looking at Adobe's categories and markets, there are significant opportunities ahead. For example, Microsoft just announced that they are entering the forms market (noted by one analyst as a $ 1.2 billion market) or the major transformation from film to digital photography (a major paradigm shift in consumer behavior). 16. While not seeing Microsoft in any of the deals so far, Narayan stressed that Adobe is focused on financial markets with special demands. There are several smaller competitors (IS shops) but no one competitor consistently. 17. Pricing packaging optimization continues to be a strategy especially in categories where products can be integrated (such as Video and Creative products). 18. When asked about upgrades that reach higher version levels (version 9 or 10), do you continue to develop or harvest the market; Narayan noted that these are "mission critical products" with critical customer demands for new features and capabilities that will need to be incorporated into future releases. ------------------------------------------------------------------------