By Jan Stoddard of Raine Consulting March 19, 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. Offering Network Publishing software solutions, Adobe has three areas of focus - Acrobat-based solutions for the enterprise, digital solutions, and creative professional solutions. Products include Acrobat Reader (distributed free of charge) a tool that displays portable document format (PDF) files on the Internet. The company's Web and print publishing products include Photoshop, Illustrator, and PageMaker. Adobe's offerings also include print technology geared toward manufacturers, as well as Web design (GoLive) and electronic book publishing software. Its InDesign publishing package provides professional layout and design applications. For most of 2002, Adobe had been rated as a "hold " meaning that a stock should perform relatively the same as the overall market. Earlier this year, based on revenue projections and anticipated product upgrades, some analysts upgraded Adobe to a "buy" position, boosting investor confidence in the company for 2003. The market responded favorably to this latest quarter report with the same day announcement performance per share price closing up 1.03 -- a 3.75% gain. Topics: - Financial Summary - CEO Comments - CFO Comments - Product Results - Q&A - Summary Comments Financial Summary For first quarter of fiscal 2003, Adobe achieved revenue of $296.9 million, compared to $267.9 million reported for the first quarter of fiscal 2002 and $294.7 million reported in the fourth quarter of fiscal 2002. Adobe's first quarter revenue target range was $275 to $290 million. Pro forma diluted earnings per share for the first quarter of fiscal 2003, which does not include an investment loss from the Company's venture program, were $0.25. Adobe's first quarter pro forma earnings target range was $0.21 to $0.23 per share. CEO Comments: Bruce Chizen, President and CEO "Our second consecutive quarter of double-digit revenue growth is an excellent start to 2003. We exceeded the targeted revenue forecasted at the beginning of this quarter. It is the second quarter of double sequential growth. It is particularly impressive as no material revenue can be attributed to a major product launch for this quarter. [The results] highlight e-paper's best quarter ever, driven by 2nd highest quarterly for desktop Acrobat. These results are particularly encouraging given our strong product line up for the remainder of the year, beginning with a new version of Acrobat targeted to launch in Q2." "Our strategy for growth opportunities has had three elements: 1-Adobe Acrobat and ePaper, 2-Extend the digital business, and 3-Enhanced solutions for professional customers. We are executing against this strategy. We are entering one of the strongest new product introduction cycles in the company's history." CFO Comments: Murray Demo, Sr VP and CFO GAAP net income was $54.2 million for the first quarter of fiscal 2003, compared to 49.8 million reported in the first quarter of fiscal 2002, and $40.1 million in the fourth quarter of fiscal 2002. This represents 9 percent year-over-year growth in GAAP net income. Pro forma net income, which does not include restructuring and other charges, acquired in-process research and development, and investment gains and losses, was $58.9 million for the first quarter of fiscal 2003, compared to $52.8 million in the first quarter of fiscal 2002, and $59.1 million in the fourth quarter of fiscal 2002. This represents 12 percent year-over-year growth in pro forma net income. GAAP diluted earnings per share for the first quarter of fiscal 2003 were $0.23, based on 235.3 million weighted average shares. This compares with diluted earnings per share of $0.20 reported in the first quarter of fiscal 2002, based on 245.2 million weighted average shares, and diluted earnings per share of $0.17 reported in the fourth quarter of fiscal 2002, based on 238.4 million weighted average shares. Adobe's pro forma operating profit, which does not include the amortization of goodwill, restructuring and other charges, and acquired in-process research and development, was $80.5 million in the first quarter of fiscal 2003, compared to $72.7 million in the first quarter of fiscal 2002 and $83.8 million in the fourth quarter of fiscal 2002. As a percent of revenue, pro forma operating profit for the first quarter was 27.1 percent, compared to 27.1 percent in the first quarter of fiscal 2002 and 28.4 percent in the fourth quarter of fiscal 2002. Other comments included: • The 92.5% gross margin was higher than targeted due to product mix. Generated both higher new versus upgrade revenue and higher licensing versus shrink-wrap than expected. • New reporting for the ePaper Solutions group with desktop as 75% of group revenue and server as 15.4%. • Geographic revenue split with 49% from America's, 30% from Europe and 21% from Asia. This mimics overall past seasonal patterns across all geographies. The quarter reflects a typical holiday slowdown followed by seasonal strength in February. • Forecasts for Second Quarter 2003 performance assume a late quarter shipment of Adobe Acrobat with revenues in the $300-315 million range, a 26-28% pro forma operating margin ranges resulting in 24-27 cents earnings per share. Product Results by Shantanu Narayan, Exec VP, Worldwide Product highlights: ePaper successful results in large vertical such as hi fidelity printing, and multi-platform multi system support for industries such as pharma, insurance, legal, financial, manufacturing, government, aerospace. EPaper is gaining momentum with: • Significant licensing opportunities more than 2500 seats including new clients:Bayer, Qwest, The U.S. Navy, and Renault. • Server deals including the Australian tax office, INPS (Italian insurance office), the State of Hawaii statewide portal disability services and online child support system for counties in Northern California. • Other examples: United Health Services (management of forms and output as part of CRM initiative), Polaris (repository of dealers and marketing materials), Grey Global Group (.pdf and xml to digitize invoices and bill processes) New Photoshop Album consumer product for digital camera users has received market recognition with a 5-star rating from PC Magazine and editor’s choice, as well as being the current best selling software product on Amazon. New clients for the Adobe Design Collection include: Leo Burnett, Omincom Interbrand, WPP JWT, Federated Department Stores, IPG Footcone Belding, and the largest newspaper in Argentina. Q&A Session 1. When asked if the guidance for Second Quarter 2003 is conservative because it includes a geopolitical disruption, it was stated that the revenue targets for the next quarter do no assume any change (only a relatively stable but depressed economy), such as consumers pulling back if things take a turn for the worse. If that happened, would have to go back and reassess targets. Guidance assumes late ship of new Acrobat release in the quarter and not draining the channel in advance. 2. Several analysts noted the channel inventory backlog being up at end of the quarter. Backlog was higher than experienced historically. This was due to a heightened level of orders at end of quarter (February). Adobe continues to focus on not being put in a position of having too much inventory out there by taking a conservative position. February was a stronger month than anticipated, but there is no guarantee that it will continue, so the strategy is not to put too much inventory into the channel. 3. Regarding (newly segmented) server revenue: The percentage of server sales reflects the strategy to measure the server business. Server revenue relatively flat. This is the year upon which the foundation is built, anticipating significant growth in 2004 and beyond. 4. With the Acrobat release will come information on specific segmentation of products and pricing, as well as name for new light version of Acrobat. No details available on minimum order quantities. Note that the at-home at-work classification versus just creative and professional for products end up crossing different categories. For example, the majority of Photoshop users are not creative professionals but desktop or brand followers. 5. Regarding Acrobat performance: Surprised with Acrobat desktop growing at a sequential quarter over quarter increase. We expected good results, but were surprised by overall strength globally; especially as it is fairly well known a new version is coming. It shows Adobe continues penetration into enterprise. "With no major upgrade in two years, it was the second best quarter since we shipped the product. The percentage that was licensing was a clear indication of our penetration into the enterprise. It suggests great things to come." 6. On competitive Quark OS 10 version release: Gives customers an opportunity to review products and switch to Adobe from Quark Based on new unit sales, we have been winning transition battle. 7. In meeting the key challenge of moving into the enterprise: A year ago, moved 60% of the Sales force to ePaper opportunities and with training, this has made a difference. Will announce additional system integrator relationships when announce Acrobat launch as well as additional partnering with key ISV's that provide a full solution. Relationship with SAP, Documentum and Open Tech, and will announce more partnering. 8. Big solid software companies, like Adobe are getting attention from CIO's who understand who we are, our brand, and our Unique Value Proposition around free Adobe viewer and Acrobat Reader, as well as .pdf as a file format. Also see analysts talk about documentation problems in enterprises and governments. Additionally, Adobe is continuing basic marketing programs, including a seminar series with Accenture. Using a combination of newly trained sales force with partners (like Accenture) and independent research firms to understand value and share success examples. 9. Status of the targeted hiring and reorganization of sales force: hired 100 employees in first quarter with some attrition due to Fourth Quarter restructuring. Currently, there is a great hiring environment with the biggest challenge choosing between great candidates. There will still be some fixed expense for remainder of hiring and variable spending for marketing spend in relation to Acrobat launch. 10. Overall licensing is up from the previous quarter. Also, there is good strength in shrink-wrap sell-thru. Early adopters within the licensing pipeline include the highly regulated financial industry and government verticals. The top ten ePaper opportunities also present opportunities to sell within. For example, deploy one application such as with a bank on mortgage applications (a $250,000.00 revenue) and then go to another process such as loan applications. 11. The Acrobat Light proliferation strategy is based on the offering document control to the base of (from Microsoft) 175 million paid owners of MS Office. The ePaper strategy is to also go into vertical informs area. Once a vertical accepts .pdf generation, there are opportunities for either multiple, individual users or the entire enterprise. The value proposition for content management providers is based on: 1-all content management companies want to standardize on a format for archival of assets (.pdf is valuable), 2- Adobe forms in the front end to run content mgmt workflows, and 3- Want Acrobat as front end to integrate to back end for deep collaboration. There is additional synergy, particularly with Documentum, getting into creative professional space with their media serving and allowing licensing of Adobe graphics server for content production of graphic media assets. 12. On timing of the new Acrobat release versus historical: Last time, Acrobat shipped mid-April with localized versions shipping at the end of May. Historic releases cycles are a good guide for when new versions are coming out. Adobe Photopshop and Ilustrator are typically 15-18 month cycles with two years for Acrobat. 13. Performance for specific geographies: America's remain strong (versus one year ago) and Europe. Asia is down due to Japan being much weaker than it was a year ago. European update: More color despite macroeconomic conditions. Good performance in Germany economy. Movement to digital camera & digital camera growth is a worldwide phenomenon. Major European agencies are switching from Quark to Acrobat. 14. There is a mix of enterprises who buy upgrades through maintenance agreements and those who buy upgrades through contractual licensing. Currently, the bulk of the base is not through licensing, as only recently has it become a bigger part of the business. ePaper is about seats, but there is an opportunity to go back and up sell. Upgrades are not a significant expense (defer revenue in anticipation of programs). Consequently, there are no barriers to keep clients from buying products up until release date. 15. New market development in relation to CAD software market (such as AutoDesk), Acrobat is a great target for engineering and AutoDesk for document sharing and procurement. Could be announcement of small partnerships in that area with new Acrobat release.