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Edited Transcript of ADBE earnings conference call or presentation 17-Sep-19 9:00pm GMT

Q3 2019 Adobe Systems Inc Earnings Call

SAN JOSE Sep 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Adobe Inc earnings conference call or presentation Tuesday, September 17, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John F. Murphy

Adobe Inc. - Executive VP & CFO

* Mike Saviage

Adobe Inc. - VP of IR

* Shantanu Narayen

Adobe Inc. - Chairman, President & CEO

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Conference Call Participants

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* Aleksandr J. Zukin

RBC Capital Markets, LLC, Research Division - Analyst

* Brent John Thill

Jefferies LLC, Research Division - Equity Analyst

* Christopher George Eberle

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* Jay Vleeschhouwer

Griffin Securities, Inc., Research Division - MD of Software Research

* Jennifer Alexandra Swanson Lowe

UBS Investment Bank, Research Division - Analyst

* Kasthuri Gopalan Rangan

BofA Merrill Lynch, Research Division - MD and Head of Software

* Keith Weiss

Morgan Stanley, Research Division - Equity Analyst

* Mark L. Moerdler

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Saket Kalia

Barclays Bank PLC, Research Division - Senior Analyst

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Stewart Kirk Materne

Evercore ISI Institutional Equities, Research Division - Senior MD

* Walter H Pritchard

Citigroup Inc, Research Division - MD and U.S. Software Analyst

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Presentation

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Operator [1]

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Good afternoon. I'd like to welcome you to the Adobe Third Quarter Fiscal Year 2019 Earnings Conference Call. (Operator Instructions) At this time, I would like to turn the call over to Mike Saviage, Vice President of Investor Relations. Please go ahead, sir.

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Mike Saviage, Adobe Inc. - VP of IR [2]

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Good afternoon, and thank you for joining us today. Joining me on the call are Adobe's President and CEO, Shantanu Narayen; and John Murphy, Executive Vice President and CFO.

In our call today, we will discuss Adobe's third quarter fiscal year 2019 financial results. By now, you should have a copy of our earnings press release, which crossed the wire approximately 1 hour ago. We've also posted PDFs of our earnings call prepared remarks and slides and an updated investor datasheet on adobe.com. If you like a copy of these documents, you can go to Adobe's Investor Relations page and find them listed under Quick Links.

Before we get started, we want to emphasize that some of the information discussed in this call, particularly our revenue and operating model targets and our forward-looking product plans, is based on information as of today, September 17, 2019, and contains forward-looking statements that involve risks and uncertainties. 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.

On this call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the 2 is available in our earnings release and on Adobe's Investor Relations website. Call participants are advised that the audio of this conference call is being webcast live 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'll now turn the call over to Shantanu.

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [3]

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Thanks, Mike, and good afternoon.

Q3 was a record quarter for Adobe with strong revenue and continued growth across our entire business. We delivered $2.83 billion in revenue in Q3, representing 24% year-over-year growth. GAAP earnings per share for the quarter was $1.61, and non-GAAP earnings per share was $2.05.

Adobe's strategy to empower people to create and transform how businesses compete is fueling our continued success. The ability to deliver a personalized relationship with every customer using digital technology is a mandate for every business. Internal efficiency, including a paper-to-digital revolution, is critical to achieving that imperative. In addition, design and creativity has never been more relevant. Everyone has a story to tell from professional photographers, to immersive content and experienced designers, to students and small business owners, and they need to tell it on an ever-increasing number of canvases. Adobe is innovating to expand these market opportunities, and customers around the globe continue to count on Adobe Creative Cloud, Document Cloud and Experience Cloud to run their businesses, transform how they work and bring their creative ideas to life.

In our Digital Media business, we drove strong revenue growth in both Creative Cloud and Document Cloud in Q3. Net new Digital Media annualized recurring revenue, or ARR, was $386 million, and total Digital Media ARR exiting Q3 grew to $7.86 billion. Q3 Creative revenue was $1.65 billion, which represents 22% year-over-year growth.

Creative Cloud is the creativity platform for all. Through a relentless focus on innovation across different media types, devices and segments, Creative Cloud has become the one-stop shop for creative applications and services as well as the leading source for creative inspiration, learning, training and community.

Our goal is to ensure that Creative Cloud applications and services make every creative possibility a reality for every one of our customers. Adobe's vision is that mobile devices and tablets should be used for creation in addition to consumption. Adobe Lightroom, our complete system for photo editing, achieved significant growth on mobile devices with Q3 monthly active users growing 130% year-over-year. In Q3, new Adobe IDs created from Adobe mobile apps rose more than 40% year-over-year, showing that mobile continues to be a healthy on-ramp for subscriptions.

In Q3, we announced Adobe Fresco, a groundbreaking drawing and painting app, which will be available first on iPad later this fall. Fresco digitally reimagines the process that artists have traditionally used, whether it's chalk, pastels, oil or watercolor paint. Like Photoshop transformed and democratized photography, we believe Fresco will change how artists use digital to draw and illustrate. Apple will feature Fresco in hundreds of its retail stores as part of its iPad Pro Big Draw campaign.

At Adobe, we believe that creative skills should be a core part of school curricula and that STEAM, not just STEM, should be a focus in education. We've expanded our Adobe Ambassador Network to target more than 100 colleges across the country where students evangelize creativity and lead on-campus workshops to help fellow students learn to use Adobe Creative products. Last week, we launched a new program with Reddit to encourage young creators to contribute their personal designs to a giant global canvas on the Reddit front page. This was the biggest community event on Reddit based on total contributions and participation. These types of partnerships give us an opportunity to introduce Creative Cloud to millions of next-generation creators.

Adobe MAX is the world's largest creativity conference. In November, we'll welcome our global creative community and partners, more than 15,000 live attendees and nearly 1 million virtual attendees and unveil significant new Adobe Creative Cloud innovation.

With Document Cloud, we are accelerating the transformation of paper-to-digital processes and reinventing how people scan, edit, collaborate, sign and share digital documents. Q3 Document Cloud revenue and net new ARR were records for a quarter, and we grew total Document Cloud ARR to $993 million. Key Document Cloud customer wins in Q3 included Deutsche Bank, Saudi Aramco, Dell and the U.S. Department of Veterans Affairs. As with our Creative products, our Document Cloud customers increasingly expect business processes to be seamless across desktop and mobile devices.

In Q3, more than 2.5 billion PDFs were opened in Adobe Reader on mobile devices. Adobe Scan, which has become the top document scanning app for both iOS and Android, has close to 35 million installs with downloads increasing more than 30% year-over-year in Q3. Strong uptake of our Document Cloud mobile applications as well as continued strength in Acrobat subscription adoption is driving momentum in the business. In addition, we launched new web-based services that offer instant access to Adobe PDF creation and compression capabilities from any browser. We believe these services are not only relevant to individuals looking to quickly get work done but also developers who need to build best-in-class PDF document support into their web applications. We are investing in creative marketing campaigns to drive awareness of these capabilities and target new users.

Adobe Sign, our leading cloud-based electronic signature solution, continues to gain traction among businesses and organizations. This quarter, we introduced Adobe Sign for small business, providing small and mid-market businesses enterprise-level e-signature capabilities.

In our Digital Experience business, we achieved Experience Cloud revenue of $821 million for the quarter, which represents 34% year-over-year growth. Our vision is to help every business become an experienced business. This means enabling them to deliver engaging experiences that anticipate and meet the needs of their customers at every stage of their journey from acquisition to purchase and renewal. We believe customer experience management is a significant growth opportunity for Adobe. Experience Cloud is the industry's most comprehensive offering, providing content and commerce, customer journey management and customer data and insights to power experience-driven businesses across all industries. In Q3, Experience Cloud was named a Leader in 7 Gartner Magic Quadrant and Forrester Wave reports. Key Experience Cloud wins in Q3 included Delta Airlines, T-Mobile, Capital One and Best Western.

We are the undisputed leader in this large and growing market, and we continue to expand the opportunity in front of us, extending our footprint from B2C to B2B, from enterprise to mid-market and from the CMO to the CIO, CTO and CEO. Content and commerce are the foundation for every digital business. We continue to drive strong performance with Adobe Experience Manager for multichannel experience delivery. Through integration with Magento Commerce, we are making every experience shoppable. This has led to strong performance of our integrated content and commerce offering and Magento Commerce bookings growth of more than 40% year-over-year in Q3.

Multichannel campaign management is another differentiated pillar of the Adobe Experience Cloud. The integration of Marketo with Adobe Campaign gives Adobe the industry's strongest offering in the customer journey management and orchestration space across both B2B and B2C.

Earlier this year, we introduced Adobe Experience platform, the industry's first real-time platform for customer experience management. Adobe Experience platform will solve a critical challenge every enterprise is facing: how to harness massive amounts of valuable customer data that is siloed and not easily accessible or actionable. Adobe Experience platform stitches together data from across the enterprise, creating real time unified customer profiles, enabling the activation and delivery of hyper-personalized experiences.

By combining Adobe Experience platform with Adobe Analytics, Adobe Audience Manager and our new real-time customer data platform or CDP, we are creating a new comprehensive customer data and insights offering for the digital enterprise that is unmatched. Adobe Experience platform has been several years in the making, and we've seen tremendous enthusiasm from customers for this solution with multiple pilot deployments already in market. We continue to be the leader in customer experience management, which has a TAM of more than $70 billion by 2021. While we experienced some bookings delays in Q3, our robust product road map and customer pipeline positions us for multiple years of strong growth.

At Adobe, we continue to invest in our employees, who are the heart and soul of our company. Last week at our annual Adobe For All Summit, we reaffirmed global gender pay parity for our workforce and shared new details and data on our opportunity parity initiative, which examines fairness in promotion rates and access to new opportunities for our employees. Adobe is the leader in several large and growing categories: creativity, digital documents and customer experience management. We remain excited about the opportunities in front of us and confident in our ability to drive strong top line and bottom line growth.

John?

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John F. Murphy, Adobe Inc. - Executive VP & CFO [4]

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Thanks, Shantanu.

In Q3 FY '19, Adobe achieved record revenue of $2.83 billion, which represents 24% year-over-year growth. GAAP diluted earnings per share in Q3 was $1.61, and non-GAAP diluted earnings per share was $2.05.

Business and financial highlights in Q3 included: record Digital Media revenue of $1.96 billion, including record Creative revenue of $1.65 billion and record Adobe Document Cloud revenue of $307 million; strong net new Digital Media ARR of $386 million; record Digital Experience revenue of $821 million; remaining performance obligation, or RPO, grew to $8.77 billion; cash flow from operations of $922 million; repurchasing 2.6 million shares of our stock; and approximately 92% of our revenue in Q3 was from recurring sources.

In our Digital Media segment, we achieved record revenue with 22% year-over-year growth. The addition of $386 million net new Digital Media ARR during the quarter grew the total to $7.86 billion.

Within Digital Media, we achieved another strong quarter with our Creative business. Creative revenue grew 22% year-over-year in Q3, and we increased Creative ARR by $314 million. Strong acquisition, upsell and retention of Creative Cloud subscriptions continued during Q3 and were driven by: new user growth, helped by many global initiatives to generate demand, including targeted campaigns and promotions, a large funnel of users coming from desktop and mobile and leveraging Adobe's brand and new products to expand into adjacent creative categories; increasing adoption of single app offerings, including Adobe Premiere Pro for video and Adobe Illustrator for artwork; continued growth in international markets, including greater than 40% year-over-year unit growth in key emerging markets; ongoing success in the enterprise, including new logos, seat expansion and services adoption, which drives higher contract value; and adoption of creative services including Adobe Stock where revenue grew greater than 30% year-over-year.

Our momentum with Document Cloud accelerated in Q3. We achieved Document Cloud revenue of $307 million, which represents 24% year-over-year growth, and we added a record $72 million of net new Document Cloud ARR during the quarter. Strong Document Cloud performance during Q3 was driven by subscription demand across key routes to market with individuals, small and mid-market businesses and large enterprises; the continued migration of Acrobat perpetual customers to subscriptions; enterprise services adoption; and the conversion of free mobile reader users to paid subscriptions. Adobe Sign revenue grew greater than 25% year-over-year.

In our Digital Experience segment, we achieved quarterly Experience Cloud revenue of $821 million, which represents 34% year-over-year growth. Experience Cloud subscription revenue was a record $679 million, growing 37% year-over-year. While we had strong overall revenue in Q3, our subscription bookings growth from Marketo in the mid-market did not meet our expectations, which is being addressed by increasing our focus and investment on demand generation and inside sales. In addition, there were Analytics Cloud subscription bookings delays with related shortfalls in consulting services bookings and revenue associated with the launch of our new Adobe Experience Platform. We are confident the enhanced innovation in Analytics Cloud, the introduction of our real-time CDP product and the ongoing global rollout of the Adobe Experience platform will convert strong customer demand and the current pipeline into bookings starting in Q4. We now expect to grow our total Digital Experience subscription bookings in fiscal 2019 by greater than 20% year-over-year.

From a quarter-over-quarter currency perspective, FX decreased revenue by $8.5 million. We had $10.8 million in hedge gains in Q3 FY '19 versus $9 million in hedge gains in Q2 FY '19, thus the net sequential currency decrease to revenue considering hedging gains was $6.7 million.

From a year-over-year currency perspective, FX decreased revenue by $38.3 million. The $10.8 million in hedge gains in Q3 FY '19 versus $16.8 million in hedge gains in Q3 FY '18 resulted in a net year-over-year currency decrease to revenue considering hedging gains of $44.3 million.

In Q3, Adobe's effective tax rate was 5% on a GAAP basis and 11% on a non-GAAP basis. Our trade DSO was 44 days, which compares to 41 days in the year ago quarter and 42 days last quarter. Remaining performance obligation, or RPO, was approximately $8.77 billion exiting Q3, which compares to $8.37 billion exiting Q2. Deferred revenue exiting Q3 was $3.26 billion. Our ending cash and short-term investment position exiting Q3 was $3.65 billion, and cash flow from operations was $922 million in the quarter.

In Q3, we repurchased approximately 2.6 million shares at a cost of $750 million. We currently have $5.85 billion remaining of our $8 billion repurchase authority granted in May 2018, which goes through 2021.

Turning to our targets considering second half Digital Experience bookings and consulting revenue. In Q4 FY '19, we are targeting revenue of approximately $2.970 billion; Digital Media segment year-over-year revenue growth of approximately 20%; net new Digital Media ARR of approximately $450 million; Digital Experience segment year-over-year revenue growth of approximately 23%; net nonoperating expense of approximately $20 million; tax rate of approximately 11% on a GAAP and non-GAAP basis; share count of approximately 490 million shares; GAAP earnings per share of approximately $1.68; and non-GAAP earnings per share of approximately $2.25. We look forward to a strong finish for the early and sharing insights with you about our strategy and opportunities at our financial analyst meeting at MAX.

I'll now turn the call back over to Mike.

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Mike Saviage, Adobe Inc. - VP of IR [5]

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Thanks, John.

Adobe MAX is less than 2 months away. On Day 1 at our user conference in Los Angeles on Monday, November 4, we will host a financial analyst meeting in the afternoon. Invitations, including discounted MAX registration information, were sent to our analyst and investor e-mail list over the summer. Please contact Adobe Investor Relations via e-mail at ir@adobe.com if you have not registered and wish to attend. More information about the event can be found online at max.adobe.com.

If you wish to listen to a playback of today's conference call, a webcast archive of the call will be available on our IR site later today. Alternatively, you can listen to a phone replay by calling (888) 203-1112. Use conference ID number 7673180. International callers should dial (719) 457-0820. The phone playback service will be available beginning at 5:00 p.m. Pacific Time today and ending at 5:00 p.m. Pacific Time on September 24, 2019.

We would now be happy to take your questions (Operator Instructions) Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question today from Keith Weiss with Morgan Stanley.

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Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [2]

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Very nice quarter, particularly on Digital Media side of the equation. It does sound like you guys are having some sort of go-to-market and disruption impacts on the digital streaming side of the equation. I was hoping you could dig in a little bit further to help us explain exactly what's going on, on that side of the business. What does it take to fix that? Because it definitely sounds like you are much more optimistic about that business a quarter ago. And then maybe one for John, is there any margin impact in terms of the increased investments in inside sales and some of the go-to-market stuff that, that is going to take to get Experience Cloud back up to growth rates you guys are expecting?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [3]

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Great. Keith, as you pointed out, it was a strong quarter. We were pleased with the growth across the businesses. Since I suspect that there'll be a couple of people asking about Digital Experience, let me go into a little bit more color on that particular opportunity. And let me clarify that, that wasn't any impact associated with macro. The interest from enterprises, all sizes, different verticals in our comprehensive solutions remains incredibly strong. And even if you look at the targets that we've provided, it's clear that we are delivering strong revenue growth while actually accelerating the subscription bookings year-over-year on what is a much larger book of business because we do an apples-to-apples comparison.

I think as you think about Q3, it's clear we have leading solutions in the first mile and the last mile. So Adobe Experience Manager, Campaign and Magento had strong growth. The Magento acquisition has been viewed extremely well by customers. It's clearly very strategic, and we grew the book of business greater than 40% in Q3 and actually have done a really good job of taking Magento into the enterprise. The other part that we're absolutely clear about is that there's a new generation of enterprise software that's going to emerge, which will be required to digitally engage with customers across all these multiple channels. What it has to do is deliver first-mile content experiences, that's the content and commerce piece. It has to segment audiences now in real time across multiple channels. You have to do customer journey management and orchestration, and you have to provide data and insights to enable these AI services.

We've been focused on this opportunity just like we created the Digital Marketing category, we believe this is absolutely crucial for the experience business. And so we build the Adobe Experience Platform from scratch to deliver what we call DDOM in terms of how we run our own digital business. Customers are really excited. It's the first software actually that exist that's designed to specifically integrate the needs of the CMO, the Chief Revenue Officer and the CIO. So our strategy with the Adobe Experience Platform is that we want to actually augment the Analytics capability, the Audience Manager capability with what we are doing with these new services as well as the real-time CDP in the market. We're really excited about the multiple installations that we have as well as the interest globally. You can argue we were maybe a tad aggressive, Keith, about the timing adoption. But this pace shift that we've seen in no way diminishes the magnitude of the opportunity or my belief in the lead that we have.

And so as I think about the business, as we think about the targets, we're leading in this particular category. We saw, as I said, some delays in the bookings, but that has in no way changed our excitement and optimism about the business. So hopefully, that gives you some color associated with each of the businesses. The last thing I would say is that we talked about Marketo specifically. And there, I would say our natural inclination was to perhaps focus our aspirations on the enterprise business, serve our existing customers. That's going well. Mid-market continues to be a huge growth opportunity. We have the leading product in that space. And much like we drove growth in the Magento business, our focus will now be the same on Magento as well as Marketo. And so we've created a unified organization. It's going to drive aligned demand generation, customer support. We have the right individuals in the field that's organized the right way, so I'm excited about that as well. I know I was a little long, but I thought I'd just give you color associated with all of those businesses. And again, the Adobe Experience Platform, that is really our platform that deals with the future of what we are doing around analytics services, what we are doing around campaign services. And so when bookings are light, you'll certainly see some impact on consulting as well.

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John F. Murphy, Adobe Inc. - Executive VP & CFO [4]

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And Keith, just to answer your question on investments, yes, they've been factored into the targets that we issued for Q4. And as you've seen those targets, we continue to expand our operating margin as we had expected through the year as we have said the second half would accelerate expansion. So the investments are embedded in those targets. And as Shantanu said, we're focused on really driving that mid-market motion like we did with Magento.

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Operator [5]

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Next, we hear from Kirk Materne with Evercore ISI.

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Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD [6]

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Maybe I'll flip over to the Digital Media side of the business, which obviously had a really strong quarter. Shantanu, maybe the stat that stood out to me is actually some of the subs growth in the emerging markets. Can you just provide a little bit more detail on that, sort of how you feel like you're monetizing those opportunities, how that's coming along? And maybe just talk a little bit about the opportunity maybe internationally because I know that's sort of just taking off right now.

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [7]

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Sure, Kirk. And yes, when we look at Digital Media ARR both across the creative as well as the document business, we just continue to see strength. If you look at our targets for the combined year, I mean, it's clear that driving approximately $1.6 billion of net new Digital Media ARR, creativity and design have never been important. A couple of points. The first is mobile. What we've been doing with the mobile applications and having mobile be in on-ramp, especially in international as well as key emerging markets, what we've seen with the Lightroom system that we've developed, photography is such a universal phenomenon, and Lightroom is a great product. So we're driving adoption across a couple of dimensions. The first is the number of people who come in from mobile and only buy a mobile subscription through an app store, the people who come in through mobile but then realized that there's more to Adobe's Creative offerings and then come in and download a desktop application as well as then adopt it. We're seeing significant growth for Document Cloud also in these international markets as they are migrating from the perpetual version of the product as well as engaging on the web. This is something that we started to talk about, which is people just coming from the web, they want to create a PDF, they want export PDF, that same traction.

So -- and frankly, Stock, we actually did some really interesting work with Stock. Stock was a primarily U.S. product. But as you have more international content, as you have the search capabilities available, so the services revenue is also increasing. So just across the board as we talk about new customer acquisition, as we talk about focus on engagement, mobile certainly has momentum and services like Adobe Stock, both in the U.S. as well as international. And the last thing I'll say is that the DDOM that we have really gives us insight into what's effective in those markets. So rather than have a one-size-fits-all where we spend our money digitally, how we engage with our customers, how do we price the products appropriately. China is again seeing really good growth as it relates to our team offering in Creative Cloud. And so across the board, it just reflects creativity is important, and we're the leader.

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Operator [8]

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Our next question comes from Brent Thill with Jefferies.

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Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [9]

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Shantanu, just back on the Digital Experience business, if you plug in your fourth quarter guide, you're going to come in a few points below your full year guide. And I'm just curious, I think the Marketo mid-market and some of the other explanations makes sense, but this has been something historically that's been fairly inconsistent. I guess the question is how do you back to more consistency in making numbers in this business? And if you could just comment as it relates to your linear, why it's taking so long to get someone in that seat for the new role.

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [10]

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Well, a couple of questions in there, Brent. And the first one is I would say, as I pointed out at the beginning, we're growing our subscription book of business, which is a much larger subscription book of business, greater in 2019 than we did in 2018. So I think putting that in perspective, I would say clearly, with the mid-market, our motion was perhaps a lot more in the enterprise. We saw tremendous success with Magento in the enterprise and creating a demand generation machine, I think having that aligned organization. Part of what I've done as I've been running this business is to align all of them quicker. I wish I've done it even earlier in terms of having a combined Magento and Marketo mid-market offering because that demand generation is a machine. So I'm confident that we'll see improvements as a result of those organizational changes.

And the Adobe Experience Platform, when you look at it, Brent, nobody's delivered something like this. It is so innovative. We talked about it being groundbreaking. And much like we did with Digital Marketing, which is when we first came out, we were decades ahead of the competition, we feel excited about that. Customer interest is high. There's an ongoing on-ramp. And maybe we were a tad aggressive, but when you're the leader and you're driving such innovation, we have to be optimistic about what we are doing for customers. And we experienced firsthand what it takes. So we're confident that he will continue to grow that business the way we have.

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John F. Murphy, Adobe Inc. - Executive VP & CFO [11]

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Organization.

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [12]

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And as it relates to the organization, I think I mentioned this last time as well. I intentionally put that on hold because I needed to get all of those organization aligned. The product road map, the innovation road map that exist right now, Brent, is stronger than it's ever been as a result, I think, of Abhay's help over the last 6 months. What we are doing with delivering new services, the AI and intelligence services that are available, the delivery of the Adobe Experience Platform, what we've done with content and commerce, aligning that and getting that unified, that is clearly the sweet spot of where Abhay is helping and where I focus. And I think that would not have happened without somebody doing that directly. And so I'm actually pleased that I did it and aligned the organization first. So it's in great shape for somebody when they come in.

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Operator [13]

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Our next question comes from Jennifer Lowe with UBS.

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Jennifer Alexandra Swanson Lowe, UBS Investment Bank, Research Division - Analyst [14]

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And maybe just to follow up on Brent's question a little bit because there was a number of different items that came up there, both in terms of getting greater product alignment, in terms of Marketo and Magento and also organizational alignment. So is it possible to just sort of at a high level give us a sense of how much of this is a product-related issue of just trying to get the products working together versus just organizational. And as you think about how long this will take to kind of get back to where you'd like to be, is that something that could happen in a quarter or 2? Or could this be a more extended time line to get all the things working the way you want them to?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [15]

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Listen, Jennifer, again, multiple questions there. First, let me end with that, which is in Q4, we expect substantial increase in quarter-over-quarter bookings in that particular business. So let me start off by that. I think when you introduce an upgrade to the Analytics, which is now available through the Adobe Experience Platform, the customer adoption has been good. It doesn't have to do with a product issue. The product is years ahead of the competition, as I said. It's a new motion. I mean what we went through as we went through our digital transformation, people have to get ready for that adoption. And we are seeing that right now. We're seeing the on-ramp. So I would put that less as any product issue, definitely not a customer demand issue. And it's just one of those things that you work through and you work through aggressively to ensure that customers get the value that they want. And again, in Q4, we expect a substantial increase in quarter-over-quarter bookings based on the pipeline and based on what we would do.

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Operator [16]

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Next, we'll hear from Mark Moerdler with Bernstein Research.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [17]

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Congrats on the quarter also. This quarter, even with the integration work and sales expansion driven by Marketo and Magento acquisitions, you delivered a really good operating margin. Given what you're looking -- it sounds like you're going to do in terms of the increased mid-market focus, in other areas, is there any reason why we shouldn't continue to see that margin continue to move up?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [18]

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Well, Mark, if you look at our sort of guidance for Q4 and look at what the operating margin guidance would be on the revenue that we outlined and the GAAP and non-GAAP EPS, it's clear that we are continuing to focus on the margin as well. And I think at the beginning of the year, we had said you would start to see margins back in the 40%, that's certainly there. However, big picture, I would say, we're really focused on the long-term opportunity and continuing to drive top line growth. But the margins and the leverage in the model, you saw that in Q3 as well across the business. And you are right in that the mid-market motions are more marketing and generated by demand through the website and less through direct sales. So that would be better margins than perhaps an enterprise business.

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Operator [19]

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Jay Vleeschhouwer with Griffin Securities has our next question.

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Jay Vleeschhouwer, Griffin Securities, Inc., Research Division - MD of Software Research [20]

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Shantanu, I'd like to ask a sequel to the technology question I asked a quarter ago, although without the plethora of 3-letter acronyms that we talked about at the time and still however with an intent to understand how you're thinking about your technology or platform as a driver to content velocity usage and ultimately retention. So the question tonight is about AEM. Next year is the 10th anniversary of the Day acquisition, and as best we can tell, you've quintupled or more the revenue from that product. So perhaps you could just talk about how you're thinking about the ongoing momentum in AEM -- any fundamental investments or rearchitecture work you need to do or are doing in AEM to continue to drive that as the focal point of DX.

And then just a quick clarification, in terms of the fixes that you talked about, at least for mid-market in DX, are you planning to accelerate or implement any more of the self-service capabilities that we've talked about there besides the inside sales and other things you talked about tonight?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [21]

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So let me answer the second question first, Jay, which is certainly both the Magento and Marketo, we have both self-serve capabilities as well as ecosystem of partners. As you know with Magento, having the open source community helped us not just with bringing us leads but also helping integrate with any point-of-sale or inventory or supply chain systems. It's a huge advantage, and I think we're leveraging that. And also as it relates to Magento, we've already integrated that with AEM. On AEM, content just continues to be a significant, significant differentiator, and I referred to it earlier as the first mile experience that every customer has with a digital enterprise. So really exciting things underway there. As you know, when we acquired Day Software, that was a perpetual business. I think we effectively transitioned it to be a managed services business. We have some really exciting plans underway that we're starting to deliver to customers as it relates to fully SaaS-ifying that and making that even more self-serve in terms of people using that technology.

When you think about what's happening with what's called headless content management, that's an area of significant investment for us so that people can automate their content production. AEM assets, which is the assets product, there's a lot of excitement for that for content velocity as you pointed out. We talked a little bit less about AEM forms, but AEM forms also is a way in which people want to use AEM technology. So AEM has really become a platform. It's your web infrastructure. What's really exciting for us is there isn't a digital event that happens, whether it's debates, companies introducing product launches, sports events that aren't completely run sort of on Adobe technology. And that's really exciting to see. When we see these spikes in our traffic, we know what's happening on -- in virtually every online event. And AEM is at the core of that. AEM had a strong quarter. It continues to be a way in which people are replatforming their web. And so stay tuned for more. But hopefully, that gives you a glimpse of some of the things that we're doing. The move to SaaS, the move towards headless content and asset management are maybe 3 of the ones I'd identify.

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Operator [22]

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Our next question will come from Heather Bellini with Goldman Sachs.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [23]

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I just wanted to go back to a couple questions that were asked previously. One, just thinking through the digital experience and some of the comments you made. Can you give us a sense, is there anything to do from a competitive standpoint here? Is it really all go-to-market? And I'm just wondering kind of who you're seeing most frequently and if that's changed. And then I think to Jen's question kind of talking about margins, I was wondering if you could speak a little bit about OpEx growth. And based on your comments and your guide for the -- for Q4 and as such, the full year, when we think about parsing your comments about investing for growth and margin, how should we be thinking about the pace of OpEx growth going forward? I mean you guys have been 20% or higher for the last few years. Obviously, there's M&A included in that. But should we be expecting, just given the opportunities that are ahead of you, kind of similar type growth rates as we start to think about the periods ahead?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [24]

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Sure. So let me answer the first question. While there may be some point solutions that have point competitors or products that are there in the market that do similar technology for the vast majority of what we offer in Digital Experience, we're the undisputed leaders. And really, as we talk about innovation for new things like Adobe Experience Platform, the real time CDP, what we are doing with intelligent services, Heather, where there really isn't anybody else who's offering capabilities similar to what we have in the market. I think as it relates to M&A, if that was a question, there is nothing major that we look at and feel like is a gap currently in our portfolio. I think the combination of Magento and Marketo and what we've done with the Adobe Experience Platform, that gives us, without a doubt, the leading platform and significant portfolio to continue to drive growth. I think what we are doing on the document side with the verbs and having the ability for people to embed PDFs, so think of it as a PDF service, we're pretty excited about the opportunity associated with that. And we talk about Creative. So hopefully, that gives you a flavor as we talk about the $100 billion addressable market. That's really driving our growth at this point.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [25]

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And then the second question, on OpEx, right, OpEx growth.

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John F. Murphy, Adobe Inc. - Executive VP & CFO [26]

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Yes. Yes, well, Jen, on all expense, really. I mean I think when we look at margins in general, where our goal is to continue to invest in top line growth but then obviously drive efficiencies both in how we look at our COGS and how we're looking at the rest of the P&L. And so you see that here in Q3, where we're able to vary through a lot of like relentless fiscal discipline contribute to the lower OpEx in Q3 than probably was modeled and that came through obviously in the EPS performance. And you'll see it again in Q4 as we model it out. You'll see the operating margin expand again in Q4 based upon our targets. So diligently focused on that. From time to time like we did with the acquisitions, we found opportunities to invest in growth, and we'll do that. But the idea is to really always focus on growing our earnings as fast if not faster than revenue.

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Operator [27]

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Our next question will come from Saket Kalia with Barclays Capital.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [28]

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John, maybe for you -- and I apologize for the background noise by the way. Adobe continues to do a good job on generating new Creative ARR. And so as you think about next year, understanding that we aren't giving guidance yet, can you just talk about some of the puts and takes to how ARR may look next year, particularly with some of the benefit of pricing that we got in fiscal '19?

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John F. Murphy, Adobe Inc. - Executive VP & CFO [29]

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When I look at ARR more philosophically because obviously, we have Analyst Day coming up where we'll actually talk a lot about next year, we've laid out many, many times the different drivers that we have. And Shantanu covered a number of them when he talked about that earlier to the earlier question. So we have international markets, we've got new products, we've got single apps and mobile on-ramp that are really driving new users to the platform. And that's one of our biggest growth areas, that's still a focus for us. We have -- I think other folks have asked about promotions before as well, and we used those, and we've seen through our DDOM model that they're very effective in driving new users and then converting those to paid users. So overall, we've got a number of vectors that we believe we can continue to grow ARR in the future and beyond.

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Operator [30]

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Alex Zukin with RBC Capital Markets has our next question.

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Aleksandr J. Zukin, RBC Capital Markets, LLC, Research Division - Analyst [31]

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So maybe just the first one about the -- if it's possible to unpack kind of the -- where the greater magnitude of the bookings kind of headwinds came from, whether it was more the mid-market Marketo side or whether it was the Analytics side. And then just maybe one for John about the cash flow, Outperformance in the quarter was a bit below our numbers. Was there -- were there any onetime issues there that should self-correct?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [32]

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Yes. Alex, as it relates to the bookings, I would, in order of sort of priority, first talk about the Analytics as its moving to the Adobe Experience Manager. So the combination of Analytics and Audience Manager sort of moving to Experience Platform with the real-time CDP and then, to a lesser extent, the Marketo mid-market. So that's sort of how I would look at it as people are transitioning and upgrading to the Adobe Experience Platform.

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John F. Murphy, Adobe Inc. - Executive VP & CFO [33]

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And on cash flow, we're actually pretty happy with the performance, but we did have some onetimes in the quarter. We ended up taking advantage of some favorable vendor pricing by doing a couple large prepayments. And then also, we had some timing of some tax payments in the quarter as well. So those impacted that but had -- excluding those items, would have been well above $1 billion in the quarter.

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Operator [34]

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Next, we'll hear from Sterling Auty with JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [35]

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You mentioned the softness in the Marketo bookings, specifically mid-market. Can you give us a sense of what percentage of that business is usually targeted towards mid-market? And is there a different kind of product set or requirement than what you're currently offering that you think you need to deliver to get it back on track?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [36]

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No, Sterling. I think first, to put it in perspective, we saw growth. We're talking about the acceleration in mid-market the way we did it for Magento in terms of sort of growing it across the enterprise. And so I think it's really all about having the demand generation machine, which is easier to fix in terms of getting that sort of motion going again in the company. And in terms of it being self-serve, I mean, the product is actually applicable already across of the mid-market and enterprise. So there are no product issues there. It really has been, as I said, the national inclination was to go in the enterprise. And so continuing to accelerate the mid-market in addition to enterprise like we are focusing on Magento and having that as an aligned organization so we can leverage our marketing is the 2 changes we've made.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [37]

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And the general split, enterprise versus mid-market in that business?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [38]

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We have such good market share across both of those segments as the leading B2B segment. It really is well penetrated across both, if there's any -- there's probably more penetration in the mid-market and the smaller size of the large enterprises than the large enterprise, Sterling, if I were to give you some color on their current penetration within the enterprise.

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Operator [39]

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Our next question will come from Kash Rangan with Bank of America Merrill Lynch.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [40]

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Shantanu, I just want to clarify. Generally, when you put out a new -- newly integrated platform, the enterprise market is the one that's a little bit more demanding, and they are the ones that are likely to delay purchasing. But here, it appears that it's more on the mid-market side. So I'm just curious to get a little bit more color. What else do you need to see in the product by which the customer base can move forward with confidence? And I've got to believe that just based on the new guidance for Q4 that we're not expecting a snap back in Marketing -- or what used to be called Marketing Cloud bookings. So therefore, should we expect -- what are we expecting for this year to actually happen next year while not being specific about growth rate?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [41]

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So Kash, first, with respect to the bookings, let me again reiterate what we said in the prepared remarks, which is we would expect the overall subscription book of business for all of the experience cloud across mid-market, across enterprise and across all solutions to be greater than 20%. So I wanted to make sure that, that was understood despite what we saw in Q3. I think as it relates to your first question, the integrated platform, that is really aimed more at the enterprise. And that's the natural migration of Analytics and Audience Manager customers. I think the mid-market is specifically as it relates to Marketo. So I just wanted to clarify that. And so there are no issues with respect to adoption in the enterprise. If anything, as I said, we were maybe a tad aggressive with how quickly they would adopt it, but we do expect to see substantial bookings in Q4 quarter-over-quarter.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [42]

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Got it. And the outlook for this combined newly integrated platform going into next year, what are the things that you could do or customers can do that they could not do with the previous product? Just trying to understand qualitatively how this changes things for Adobe. That's it. Congrats.

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [43]

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Well, I think what we've been through, Kash, with our own move to digital, the ability to have a real-time platform where you can actually activate what happens to customers across multiple channels, it doesn't exist. I mean the first generation of dealing with these customers is a record in our database. That is completely inadequate in terms of how people can engage with customers. So this is absolutely groundbreaking in terms of what can be done. So think of it as how many times have you gone to a website, you bought a product and then the ad for that product continues to dog you for weeks. And maybe sometimes to add insult to injury, it actually says there's a discount now available for that product. That's sort of the thing that we're addressing. Or when you call in to a customer support and you've done something in a retail store or you've done something online, and it has no idea about who you are and what you did. So I think this real-time CDP, the other massive movement that you know is happening is between known and unknown and a movement towards that with browsers. So we're the first to convert what was our leading position with DMP or data management into real-time CDP or a customer data platform.

So this is the ability to have one single unified view of a customer across multiple channels, understand how you acquire them, understand how you engage with them. So that's really what I think is an imperative for every company doing digital transformation. So that's our opportunity and our lead.

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Operator [44]

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Our next question will come from Walter Pritchard with Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [45]

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Sorry for the background noise here. John, just a question for you on pricing as a driver. I've noticed in the past, you've outlined and this quarter, you've outlined the different -- some of the different drivers in the script, and I didn't see pricing there. I'm wondering sort of how pricing, both the expiration of the promotional pricing as well as some of the pricing actions you've taken over the last 18 months, are faring as drivers of the Creative business compared to what you see in recent quarters.

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John F. Murphy, Adobe Inc. - Executive VP & CFO [46]

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Sure, Walter. Yes, pricing is certainly a lever. It's not one that we've ever used really as a driver for an annual price increase to increase ARR, for instance. One of the things that we look at is with the value that we're providing to the customers and when we provide the value and we see that value resonate with customers, then we price it accordingly. What we saw this year, of course, is the price increase that we did, I should say, last year for North America and then this year internationally in Australia and Japan, we've seen those price increases be well accepted. We have customers who stay on the platform, and their value is resonating. So it's something that we'll look at. It's not a core driver, but something that is one of the many levers that we can use to grow.

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Operator [47]

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Our final question will come from Chris Eberle with Nomura Instinet.

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Christopher George Eberle, Nomura Securities Co. Ltd., Research Division - Research Analyst [48]

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Just wanted to touch on advertising really quickly. We noticed that in -- back in August, Google had shut out Adobe DSP from their ad exchange. Can you talk about if that had any effect at all or maybe just kind of remind us of the size of that business now and if it's material at all?

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Shantanu Narayen, Adobe Inc. - Chairman, President & CEO [49]

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So the easy answer to that is it really had no impact. That was a 1 day in one part of Europe as a result of a customer who used it inappropriately. And we were back up and running. So that really had no issue. I mean the advertising business for us is important part of the Experience Cloud business. It allows the CMOs to have real attribution associated with their marketing spend. It helps with customer acquisition as the on-ramp to a digital business. So it plays a strategic role, and we have good offering in that it cuts across all of the different channels that people are looking to acquire customers on, namely TV, search, display and video. So I think in particular, where we are strongest right now is certainly in helping people with the new media types such as video and TV. So that's it as it relates to the ad business.

I mean given that was the last question, I continue to believe that Adobe is not just driving, but we are creating large market opportunities. We were pleased with our fiscal performance in Q3, and I'm particularly pleased with the product road map and innovation that we're delivering across all 3 clouds to what is increasingly an incredibly diverse set of customers. Our strategy, empowering people to create and helping businesses transform, is certainly working, and we're executing against that strategy. Design and creativity have never been more important. You've seen the strength in both the creative as well as the document business. And digital transformation and digitization continues to be an incredible opportunity.

Clearly, FY '19 will be another record year with strong cash flow and margin expansion. And as a plug, I am particularly excited about the innovation that we're going to showcase at MAX. It's going to be our largest Creative event, and I hope to see you join us in L.A. for both MAX as well as our FA meeting.

Thank you for joining us today.

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Mike Saviage, Adobe Inc. - VP of IR [50]

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This concludes our call. Thanks, everyone.