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Autodesk, Inc. (NASDAQ:ADSK)

February 27, 2013 4:20 pm ET

Executives

Mark Hawkins - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Keith Weiss - Morgan Stanley, Research Division

Keith Weiss - Morgan Stanley, Research Division

Thank you for joining us. My name is Keith Weiss. I'm part of the software research team here at Morgan Stanley. And we're very pleased to have with us from Autodesk, Mark Hawkins, CFO.

Question-and-Answer Session

Mark Hawkins

You guys just reported on Monday -- I wasn't too pleased about the timing of that interrupting our conference.

Mark Hawkins

Yes. I understand.

Keith Weiss - Morgan Stanley, Research Division

You reported -- your most recent quarterly results came in above the high end of the guidance range, in both PPS and revenues. I thought maybe to start out, if you could talk to us a little bit about where you did better than expected in the most recent quarter from an Autodesk perspective.

Mark Hawkins

Sure. It's a pleasure, Keith, to be back. And in terms of where we did better, you can look at it at a couple of spots. Our Asia-Pac business was really strong, and it was really great to see that. I think we had some strength there that helps us from that standpoint, but I think that's more geographically. I think from a product base, we're very pleased to see the AEC business post 18% growth for the quarter. I think during a period when I think most people would acknowledge that there's been commercial construction headwinds, we just finished the third year in a row of double-digit growth in the AEC space. And we like what we're seeing at the atomic level there, down at the deal level in that business. That was -- those would be a couple of headlines.

Keith Weiss - Morgan Stanley, Research Division

Got it. There's some puts and takes in the quarter in terms of various impacts on revenues. It was an upgrade -- a pricing change that you put into place. You talk about pulling forward some revenues. I think the number you put there was $24 million. You also had some currency impact on a year-on-year basis that impacted that number, as well as a build up in backlog. So 2 questions, if I normalize all those out, I come to a low single-digit type -- let's call organic or core constant currency revenue growth. A, do you agree with that kind of assessment of sort of what that core growth was? And, B, in particular, I was wondering if we can dig into that backlog build? So that's something I think was a little bit unanticipated in the quarter?

Mark Hawkins

So a couple of things. Yes, let me just make sure the whole audience is level set, I think, made several key points. One is that like any company, we'll run promotions at times. And in this particular case, what we did is we announced a price increase for cost grades and upgrades. And basically, we announced they'll be effective February 1. And the effect of that was it accelerated some people upgrading and cross grading, which we quantify to be about $24 million. And this is a playbook item. We did this, also, I think it was Q1 of '11. We did this before. We call it out. We put it in our guidance. We call out -- call it out when it happens after we do the analytical measurement, and you can see that in our -- even in our press releases back in Q1 of '11. So it's a playbook promotional kind of an item. But I think your analysis of the $24 million is correct.

I think the takeaway from that is that -- so you'd say, "Okay, that accelerated some revenue from the first half." The other side of that is we backlogged almost all of it, if you think about that, because our backlog sequentially went up $18 million, which was substantial. And part of that was the fact that we got a lot of deals that came in late in the quarter. Our linearity was quite different. Q4 is always a big deal quarter for us, just in the nature of ways some of our direct business works. But in this particular case, we are pleased, the number of big deals went from 36 to 45 year-on-year. But we supersized and they went up the size of the deal, on average, went up 36%. So the activity that we saw at the end of the quarter caused very much a different linearity. We're glad to see it. Some of it came in so much so that it went to backlog. So, Keith, the first way to think about it is if you look at the benefit of the pricing change and the backlog kind of offsetting that, that kind of neutralizes off to a degree.

What I would have you think about is -- if you want to think about the Q1 or Q4 rather, I'd throw out a couple commentaries for you. Nominally, we grew at 2%. Nominally, our constant currency, we grew at 5%. If you looked at it on a net new basis, you would add 3 more points to that, and that would be closer to 8% if you took all the actual gone from nominal to what actually happened. Our billings grew at 9% versus the 2%. And one of the things that I think most of the investors notice right away is that our deferred revenue jumped from about $713 million, $714 million to $835 million. So we -- and that pushed it up on a year-on-year basis, up 16%. So if you want to look at the economic activity, that would maybe get you -- and I think that's what you're going at is, is a look beyond phenomenal. The last point that I would make, I think, Keith, made a good point. In Q4, even though we do a 4 quarter rolling hedge, we took an FX, we had a headwind in Q4. And you can see we announced and we communicate that, that had an effect and the growth rates that we can describe. It also had an effect on a downward pressure on our operating margin. Despite that, we are able to post 140 basis points of operating margin improvement despite the fact that the FX headwind and the slower growth rate and the fact that we put a lot of our economic activity either in backlog or in deferred revenue. So that's a view for how Q4 landed. So hopefully that talks around the spirit of what you're looking for.

Keith Weiss - Morgan Stanley, Research Division

Yes, excellent. Perfect. In terms of thinking about what was a pick-up in growth [indiscernible] on a normalized basis, to what extent are you guys seeing a better macro environment helping you? And maybe we're talking about it a little bit regionally. In the Americas, we all [indiscernible] look to ABI data, which is then turning much more positively. Maybe you can talk about how you see stuff in Americas then maybe turning to Europe and Asia-Pac, where you had some very strong results.

Mark Hawkins

Yes. So a couple of things I'll try to address -- how about if I do it both in terms of Q4 and then [indiscernible] forward-looking. So certainly, I would say on a macro basis, globally, we see it as slightly improved, nothing dramatic but slightly improved. I would say -- and I'll talk about Q4 and then go into '14. I would say on a country-by-country basis, we saw a real strength in Japan. We saw a real strength in China. We saw a real strength in the Asian countries. We saw a real strength in Canada. We saw a real strength in Northern Europe, performing very nicely for us. Central Europe was solid performance. Those would be a few examples of some areas. The BRIC countries were uneven and weaker, I would say, with the exception of China, which I called out. The other ones, we know they're lumpy. We've seen that they're lumpy. China, we're very pleased with. As we've called out in the past, in India and Brazil, we had leadership changes, and those teams are building their plans and making the changes that we're glad to see for more of a long term, but I think BRIC, in general, is a bit lumpier.

So that's more kind of what we saw from a Q4 standpoint. I think if you look at it in terms of how we view '14, I think -- and one of the things Carl called out on the call was we see the economic and political uncertainty is something that everybody kind of pays attention to. We also see beyond that, that we think we have really interesting opportunities that'll be generated by, I think, APAC geographically would lead. I think AEC and manufacturing would lead on the more product-based basis. And I would say even in '14 I think Carl called off for the first time that I've heard in 4 years, that even though we've navigated through this commercial construction headwind effectively in AEC, largely because of our BIM offering, that we're beginning to see kind of some green shoots at the atomic level. And when I say atomic level, I mean more like deals and projects and that type of thing. And those are all comprehended in our approximately 6% revenue growth. I think if it wasn't for the kind of macro political uncertainty, I think that could -- that view might be even different.

Keith Weiss - Morgan Stanley, Research Division

Okay. Got it. So just to put a fine point on it, is there any significant macro improvement implied or sort of assumed in that 6% growth target for FY '14?

Mark Hawkins

I would say not. I'd say pretty much what we see today is what we're counting on. That being said, we do find it encouraging to see more activity going around on the AEC base.

Keith Weiss - Morgan Stanley, Research Division

Right. Maybe turning a little bit to product strategy, if you will. One of the rationales around the upgrade pricing change, basically making upgrades a little bit more expensive is to help sort of foster that shift towards subscription revenues. Maybe just give us an update of how that shift has been going, where you guys think you are in terms of being able to transition the majority of your base to subscriptions?

Mark Hawkins

Okay. So I think you're absolutely right. The fact that when somebody gets out of being current with their license and they have to pay more quickly closer to a full license price, it really incents people more and more to be in subscription. Our customers give us very positive feedback on subscription. We have, 10 years ago, unlike -- I mean, there's a lot of people that are trying to replicate this model today, but 10 years ago, we began to plant the seeds for a subscription business, which we started out with 1 pot of money in our company, which was desktop software. We got the idea to provide maintenance and subscription to help -- have them have a better experience, protect their license, so on and so forth. And that was another part of -- pot of money, which is now 40% of our revenue base.

So when some people talk about trying to create a reoccurring revenue base with subscription, think about where we're at 10 years forward. We got 40% of our revenue there. That being said, I think 1 of the things, Keith, that you're touching on is this notion of we have good attach and renewal rates. These type of changes with cross-grade upgrade tend to incent people even more. So we think that, that core subscription business will continue to grow in a natural way with the model that we have today.

Keith Weiss - Morgan Stanley, Research Division

Got it. And if you could do just that in terms of core subscription, I think 1 of the questions I get a lot from investors, and 1 of the ideas that investors are grappling with, is the idea of more of your core product revenue being sold on a recurring revenue model. There's -- some products that you have out today like a PLM 360, they're already on a subscription model, if you will, that's not your core subscription. Can you talk about where you are today in terms of how many of your products you're actually selling today based on subscription and where you guys expect it to go on a go-forward basis.

Mark Hawkins

So just so I'm precise on the language, today, a lot of people use the words interchangeably between companies. Today, I'll talk about desktop software and then let's call it maintenance for the portion -- for this discussion. We've talked about it interchangeably with subscription. And then let's talk about new reoccurring revenue streams. I think that's the spirt of what you're trying to get at.

Keith Weiss - Morgan Stanley, Research Division

Yes, exactly. I'm trying to parse out that right there.

Mark Hawkins

Yes, exactly. And so 1 of the things that we spent -- we were very busy this year. In addition to creating the financial results that we created, we were very busy in terms of cloud offerings. PLM 360 has been launched. We're very pleased with the activity that's going on there. It's financially not significant as all new businesses are not when they initially start. So that's out there. That will add to reoccurring revenue over time. Every dollar that we get will be a new dollar for the company. So no -- nothing different there.

We have other services that are incremental. We have rendering services; we have BIM 360; we have Fusion 360, the 3D mechanical industrial design offering that's relatively recent; Simulation 360, to allow our simulation capabilities that are out there as well will be all Web services that are really additive on this progression of desktop, call it, maintenance and new Web services.

In terms of the core products, someday, we can get -- we can talk about that over time. What we find is that these Web services are largely what we have today and largely the way our business will look in '14. Over time, to your point, could there be more core products that could be delivered by the cloud? Certainly that's possible. If that were to happen, certainly, we would make announcements and talk about that. The other thing that I would just call out from a reoccurring revenue basis is we also talked about rentals. And we have -- there's some activity there that's tailored really to the absolute smallest part of the small and medium business and to the prosumer and largely about getting new revenue for people that are now like enterprises that don't want to do something on a short-term basis. They can't because it's in the workflow, it's in the smallest part of the business but can help us actually monetize piracy, for example. And so that'll be additive to us, but that would be a reoccurring revenue thing that we're -- that we'll tackle in a very focused manner down at the very kind of bottom part of the SMB space and at the top part of the kind of the prosumer space.

Keith Weiss - Morgan Stanley, Research Division

I mean, if I could sum up, is it correct to -- it sounds like the majority of the new recurring revenue streams are additive to existing core products versus anything that would be -- would counteralize or would be a shift in, in

revenue streams.

Mark Hawkins

Yes, and I think that's right, Keith. And I think a lot of folks know engineering software. It's really interesting. Some people have software where you put it on a desktop and say, "Hey, I think I'll dabble with something different." And they can make sharp turns in terms of the way the end market uses it. Think about our products. They go into people that are building cars, building airplanes, building buildings, really serious work where people don't tend to shift quickly. And what you can see is that you make the technology available or even the delivery mechanism available and it takes time for that to happen, Keith. For example, subscription took us 10 years to really build that business. You look at 2D to 3D -- you and I talked about that for years. That's been a long, winding road to get to where we got. If you look at Suites, for example, we're now at 30% of our revenue. That's been a long and winding road, it's because the end markets, what they work on, it takes a while to go into, different than a lot of markets. Does that make sense?

Keith Weiss - Morgan Stanley, Research Division

Yes, definitely. It's essentially a great segue. And maybe we can talk about an update in some of those core revenue, core growth drivers that Autodesk have in place, maybe starting with Suite. Suite has been a very good growth driver for years. Suite revenues has been outgrowing the overall business. What are the Suite initiatives on a go-forward basis from here? You put a lot in place over the past couple of years, a lot of products, that it is only now sold on a 3D basis. I don't want to say forcing your customers but really pushing your customers in that direction. How do you take the next step? What do you have to do to get that next leg of Suite adoption amongst your customer base?

Mark Hawkins

Sure. So 1 of the things that we try to do, we really hugely focus on making our end customers, the designers, successful. And so every time that we get a chance, we try to amplify the value proposition of what they're getting. So to your point, the first thing we try to do with Suites is have good interoperability, good functionality, tailored to their industries and continue to make improvements in that respect. The other thing that I think is interesting is our functionality, each year gets better and better, including -- a lot of you know, that we do small tuck-in M&A. And that tuck-in M&A is, largely, if you think about what happens, we can take that technology, much of it, and pop it immediately into Suites. So somebody has a great product that's world class, and they come and they look at the next version of it, and they've got even more functionality that's going to help them stay current in a changing world. So I think continuing to amplify that technology, the ability to solve problems for our end designers is the key thing that kind of keeps taking that up a notch, Keith, would be my take.

Keith Weiss - Morgan Stanley, Research Division

Okay. Got it. And then in terms of the 2D to 3D migration. It has been going on for quite some time. If we think about maybe the 2 core segments, the AEC and the Manufacturing, how much headroom do we have there? Because obviously, the platform business, AutoCAD LT, the 2D businesses, continues to be big businesses for you. Is there -- maybe from a baseball analysis, what inning are we in, in terms of AEC and Manufacturing?

Mark Hawkins

In terms of the migration to -- from 2D to 3D. I think about it, on the analogy of baseball, maybe the third inning. I mean, I feel like there's a lot of opportunity for us to continue to take this functionality to the marketplace for people to fully adopt and look for the points and projects that they're working on and to get into that. So I think there's a lot of headroom on that. And frankly, just with Suites in general, to continue to migrate people from point solutions to Suites. We really like what we're doing today, Keith. But if you think about a company with such an install base as ours, the opportunity for that upgrade just continues, and it'll benefit us from years to come.

Keith Weiss - Morgan Stanley, Research Division

Got it. So in terms of the -- you mentioned some of the tuck-in acquisitions that you've made. I think some of the acquisitions that have less investor discretion have a little bit, as in some stuff on consumer side, maybe some stuff like the Socialcam or whatnot. Can you talk to us a little bit about the strategies yet -- the strategy there? Why get into these consumer technologies? And is it at all relevant to the broader sort of set of products in Autodesk?

Mark Hawkins

Yes. So first of all, let me just talk about Socialcam with a video capability. And I think the true measure of success for that, although that goes into our nascent consumer business, I think the true measure of success for that long term is that we believe that there'll be more video and B2B. And so that's -- I think when people take that jump, they begin to understand what we're really trying to do with Socialcam. And I totally acknowledge your point and your question, Keith, from that standpoint.

The second thing that's interesting about our consumer activity is if you think about what it's done -- besides create approximately 100 million new customers. We went for 30-plus years to get 10 million to 12 million core engineering customers. We have about 100 million in the consumer space. It's been a direct -- and there's been a very favorable effect. The products have been good. There's been great PR forum. You can Google and see and try, and we just celebrated the 50th -- the 50 million download on the App Store. Think about that. I mean, we're a significant player in that App Store. And so we're getting good, a lot of good interesting experiences there. But the thing I would call to you in a broader sense is think about doing things that gets you to understand mobility better, social better and the cloud better, which is what consumer does. And when I think about some of the challenges up and down the valley are people that didn't really understand and do the innovator's exploration in areas of mobility and also the world turned to mobility and creates incredible problems for people.

We are deeply embracing mobility in the cloud. We're deeply learning on this on the consumer space. We've created 100 million new customers. We've had a modest investment. And in the case of the M&A, the only thing I would say -- and I really appreciate the question -- is look for the endgame: Socialcam is B2B. And in our engineering core systems, when that video is pervasive there, that's when we really score. And if we get more out of it in the consumer space, that's wonderful.

Keith Weiss - Morgan Stanley, Research Division

Got it.

Mark Hawkins

Hope that helps.

Keith Weiss - Morgan Stanley, Research Division

Yes, definitely. I have a bunch more questions, but I wanted to take the opportunity to open it up to the audience. If there's any questions from the audience? There's one upfront, if you could just wait for the microphone.

Unknown Analyst

Yes. If I recall, your market cap is $8 billion, yet the solid printing business has gone from 5 years to 0. Some companies have over $6 billion market cap. How did you miss that and what are you doing about that?

Mark Hawkins

Okay. So 3D printing, from that standpoint?

Unknown Analyst

3D printing.

Mark Hawkins

First of all, 1 of the things I would say is that we're excited about the 3D printing. If you come to our galleries, 1 Market Street, you'll see us -- we 3D printed a Harley-Davidson. So it's a pretty interesting aspect. We work with the thought leaders in 3D printing. And from a software standpoint, when you think about how people are 3D printing, I would say, "Just go" -- I'd go back and say, "Whose software are they using and what's the opportunity from that standpoint." So your assertion is your assertion, but I would say, I think, we have a great partnership in 3D printing. I think that's a long play in terms of the opportunity, much like Clean Tech, where we have strategic relationships in Clean Tech, and we have been very active in that particular industry in terms of our relationships and the activities and economic activity that's going on, even though there's not big commerce there yet. So we think that 3D opportunity is in all front of us.

Unknown Analyst

Well, what's your revenue in that area?

Mark Hawkins

Well, again, I think the revenue in that area is nascent. It's not material from that standpoint. So, yes, I would leave it at that. I think my interpretation of 3D in general is it's the beginning of a beginning. So, I mean, that's my view there. But we're not a 3D printing company, if that's -- those are the kind of companies that you're referring to. So, okay?

Keith Weiss - Morgan Stanley, Research Division

Additional questions from the audience? A couple of last questions that I want to make sure that we got to. You recently filed for a debt offering. You guys have a relatively good cash balance. Why take on the debt? And how are you thinking about your capital strategy on a go-forward basis?

Mark Hawkins

Sure. So a couple of things here. One is that about, I guess, last summer we talked about just the whole notion of going beyond a change in the policy of the company and going -- to formally acknowledge -- and we've always reserved the right, but actually to acknowledge it we're going to take shares out over time in a thoughtful way, in a non-spreadsheet way, but as the facts and circumstance merited. And that's in fact what we've done. We announced an increase in the share buyback authorization as approved by the board, and then we went to the debt market. And 1 of the reasons we did that is we had over $100 million of line of credit to ensure we had sufficient U.S. cash, because even though we have a substantial cash balance, most of that is offshore like most of the tax sector, that's certainly in the Silicon Valley area. So we did that IPO. We did it at a very attractive pricing and with the understanding that first we would pay off the U.S. line of credit. We would now have more U.S.-based cash to give us the flexibility for small tuck-in M&A and the appropriate M&A that we might do and also for -- to support our share buyback intentions and other corporate general purposes. So from a capital allocation standpoint, I would say our #1 preferred choice is the appropriate M&A that will help us build the business. And you've seen our profile of small tuck-in, repeatedly, over the years. We always reserve the right, but you've seen a strong pattern there, like share buyback as the facts and circumstances merit and then just funding the business to grow for the long play.

Keith Weiss - Morgan Stanley, Research Division

Got it. And then last question on guidance on FY '14. Rightly or wrongly, I think investors had a presumed or presumption around Autodesk of a cadence of 200 basis points of margin expansion a year. Your initial target for FY '14, a little less than that, 125 to 150 basis points of margin expansion. To what degree does that speak to sort of the low-hanging fruit has been -- already been gotten in terms of these introductions within the company? And to what degree do you need to rely more on revenues reaccelerating, getting that revenue growth back into the model to garner further margin expansion?

Mark Hawkins

Yes, sure. Well, one of the things that I would say, as you know, Keith, we've talked -- I think we've made some real progress since we laid out that improvement plan. We think 25.4%, I guess, in FY '10. When we kicked it off, it was 16.7% for the year. So there's progress and yet there's more work to do to your point. The one thing I would maybe clarify just a little bit, I obviously look at we've put our guidance on in terms of what we believe, approximately 125 to 150. My look at the consensus at the time was 150 as opposed to 200, but I understand your point, the different people in the market have different views. In terms of going forward, I hope I never -- there's never a day that I don't tell you we see opportunity. We've shown you the ability to expand operating margin. Let's just take Q4 in a lower growth environment, with an FX headwind that you saw was almost 200 basis points with taking on new services like cloud costs that we have to include as we fulfill our services plus continue to deliver expansion of 140 basis points. That would be an example.

So I think we certainly, with 91.5% gross margin, revenue growth gives us an incredible ability to expand operating margins, and we've shown that. And hopefully, we have shown that we can expand when there's less revenue growth during the slowdown a bit that we had in the prior fiscal year. So clearly, it's easier with more revenue growth. Clearly, the commitment to get up and over 30% is -- we're there, and you've heard that from Carl and from me. And hopefully, more than hearing from us, you've seen this continued expansion that we've been driving on. So...

Keith Weiss - Morgan Stanley, Research Division

Does the target remain FY '15 or is that...

Mark Hawkins

Yes, I'm glad you asked that. The -- we talked about the target being -- exiting FY '15 at 30% plus. What Carl called out on the call is that's what we're driving toward. He also, in the spirit of we trying to be incredibly transparent, is to say, "Hey, if we -- we need some help on the revenue growth to get there in '15. And in the absence of that, then we're going to get there as soon as we can in '16." But I think Carl was talking out loud about we're driving to the -- exiting this 30%, we're going to hit this 30%. This is our plan. But I think he's also trying to share the color around, "This is the stuff that's on our mind as we get closer and closer to the goal."

But clearly, you can see the commitment, you can see through lots of different dynamics that we've been posting improvement. And I -- a lot of investors talk to me that we didn't make a big deal out of it, but Monday, we announced the most profitable operating margin dollars the company has ever experienced. And I remember you and I talking about when would we get back, we're back. We even set an all-time record. And when would we hit the -- a record for EPS, and we hit that. And people asked us, "Will you be as profitable when you come back?" And, of course, we're slightly more. So that's a good back pattern, but it's all about the future. We got more work to do.

Keith Weiss - Morgan Stanley, Research Division

Got it. And unfortunately, this takes us right to the end of our time slot here, but thank you very much for joining us.

Mark Hawkins

Yes, thank you. It's a pleasure, guys. Thanks.

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