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Autodesk, Inc. (NASDAQ:ADSK)

Q3 2006 Earnings Call

November 16, 2006 5:00 pm ET

Executives

Sue Pirri - Vice President of Investor Relations

Carl Bass - President, Chief Operating Officer and Chief Executive Officer

Al Castino - Senior Vice President and Chief Financial Officer

Analysts

Heather Bellini - UBS

Phil Winslow - Credit Suisse First Boston

Sasha Zorovich - Oppenheimer and Company

Jay Vleeschhouwer - Merrill Lynch

Brendan Barnicle - Pacific Crest Securities

Brent Thill - Citigroup

Chris Sailer - Goldman Sachs

Gene Munster - Piper Jaffray

Richard Davis - Needham and Company

Brian Essex - Morgan Stanley

Tim Fox - Deutsche Bank

Ross Macmillan - Jefferies

Michael Huang - ThinkEquity

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Autodesk financial results conference call. My name is Sam, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions].

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Ms. Sue Pirri, Vice President of Investor Relations. Please proceed.

Sue Pirri

Thanks, operator. Good afternoon everyone. Thank you for joining us today, as we report results for our third quarter of fiscal 2007. With me today are Carl Bass and Al Castino.

Today's conference call is being broadcast live through an audio webcast. In addition, a replay of the call will be available via webcast on our website, "www.autodesk.com/investor."

During the course of this conference call, we will make forward-looking statements regarding future events and the future performance of the Company, including our guidance for the fourth fiscal quarter and the fiscal years 2007 and 2008, the factors we use to estimate our guidance for those periods, our competitive position, our future business prospects and revenue growth, our market opportunities, and trends for our products in various geographies. We caution you that such statements reflect our best judgment based on factors currently known to us and that actual events or results could differ materially.

Please refer to the documents we file from time to time with the SEC, and specifically our 10-K for fiscal 2002, our 10-Q for the quarter ended April 30th 2006, and our periodic 8-K filings, including the 8-K filed with today's press release. These documents contain and identify important risks and other factors that may cause the actual results to differ from those contained in our forward-looking statements.

In adherence to regulation Fair Disclosure, Autodesk will provide quarterly information and forward-looking guidance in its quarterly financial results press release and this publicly announced financial results conference call. We will not provide any further guidance or updates on our performance during the quarter, unless we do so in a public forum.

Autodesk does not assume any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were made.

Now, I'd like to turn the call over to Carl Bass.

Carl Bass

Good afternoon and thank you for joining us. Today, Autodesk reported another quarter of very good financial performance. Quarterly revenue was a record $457 million, a 21% increase over last year.

Spending on total costs and expenses was in line with our projections in the quarter, increasing $10 million sequentially, before taking into account expenses resulting from the voluntary stock option review. And once again, we achieved record quarterly results on many of our most important business metrics, including 3D revenue, subscription revenue, and revenue from emerging economies.

Before we get started, I would like to remind you that like many companies, Autodesk has undertaken a voluntary review of our past stock option granting practices. We will not provide the interim results of the review. Similarly, we will provide final earnings results, once the review is complete.

Now, let's talk about the quarter. Customer demand for Autodesk products was robust this quarter. Compared to last year, revenue from new seats increased 20%. Revenue from new seats of Revit and Civil 3D continued to be exceptional, increasing 94% and 44%, respectively, compared to last year.

Revenue from new seats of AutoCAD Mechanical and AutoCAD were also robust, increasing 57% and 24%, respectively, compared to last year. In addition, one of our emerging businesses showed particular strength this quarter. Revenue from Buzzsaw, our hosted collaboration service for the Building industry, increased 79% over last year.

Once again, sales from new seats and emerging businesses were approximately two-thirds of total revenue in the quarter. This continues to be an indicator of the underlying strength of our business.

Our 3D solutions, Inventor, Revit and Civil 3D, continued to gain market share, as customers across all industries recognize the benefits of adopting model-based design. Total 3D revenue increased 36% over the third quarter of last year to $98 million. We shipped more than 38,000 commercial seats of our 3D products.

Our Revit family of products had outstanding performance, again. Quarterly revenues increased 98% over last year, and we shipped 18,200 commercial seats. Civil 3D had terrific performance in the quarter, growing 57% over last year, and we shipped 6,900 commercial seats. Inventor revenue increased 12% compared to last year and 7% sequentially.

Japan continues to be a source of weakness for Inventor, where revenues again declined compared to last year. Inventor revenue increased 15% in EMEA and 26% in the Americas. In total, we shipped 13,000 commercial seats of Inventor in the quarter. We continue to win market share, as the boundaries erode between mainstream solutions, such as Inventor, and overpriced legacy offerings.

Our model-based 3D products already represent 22% of total revenue, and we are still in the early stages of penetrating our large installed base of 2D users as well as increasing our market share by converting users of competitive legacy systems. We estimate that approximately 10% of our growing 2D base has added 3D, leaving significant opportunity for future growth.

Emerging economies continue to be an area of very strong performance for us. Quarterly revenue in emerging economies increased 38% over last year and now represents 15% of total quarterly revenues.

Subscriptions showed terrific performance in the third quarter. Driven by strong attach and renewal rates, subscription revenue reached $111 million, an increase of 50% compared to the third quarter of last year. Subscriptions now represent 24% of total revenues. Deferred subscription revenue increased $12 million sequentially to $275 million.

Consistent with the large increase in subscriptions, upgrade revenue decreased in the quarter, as expected. Combined revenues from subscription and upgrades in the third quarter increased 17% over last year to $162 million, representing approximately one-third of total quarterly revenue.

Quarterly revenue from our Media and Entertainment segment grew 50% over last year. Our animation business grew 14% sequentially and nearly 160% over last year to $33 million. New versions of Max and Maya were launched at the end of the second quarter, and customer feedback on both products is terrific.

Revenues from 3ds Max increased 28% over last year. And Maya had its best quarter ever, increasing revenue 33% sequentially. As our results show, the integration of Alias is complete, and the animation business is soundly on track. We are looking forward to strong results in the future.

Advanced Systems revenue increased 5%, both sequentially and over last year. Our customers continue to transition away from proprietary high-end SGI workstations to Linux-based solutions running on standard PCs. Revenue from our Linux-based solutions was strong in the quarter. In fact, once again, more than 80% of systems product revenue was Linux-based this quarter.

While we don't believe this transition is complete, we are very encouraged by these results. Overall, I'm very pleased with our financial performance this quarter. Now, I'd like to turn the call over to Al for a review of our financials.

Al Castino

And thanks, Carl. Once again, Autodesk delivered great performance. As Carl said, net revenues in the quarter were $457 million, 21% higher than last year. Each of our geographies grew substantially compared to the third quarter of last year.

Revenue in the Americas was $194 million, an increase of 21%. EMEA revenues were $160 million, an increase of 20% as reported and 14% constant currency. And Asia Pacific increased 22% to $103 million. Revenues in Japan increased 3% compared to last year. Excluding Japan, revenues in Asia Pacific increased 36% compared to last year.

Looking at the divisions. Platform Technology revenue decreased 9% over the third quarter of last year to $197 million. Growth in PTDs was led by a 24% increase in AutoCAD new seat revenue and a 29% increase in AutoCAD subscription revenue.

As planned, upgrades of AutoCAD decreased 40% compared to last year. Revenue from AutoCAD LT was approximately flat with last year, due to weakness in Japan and the timing and type of promotional activity.

Manufacturing Solutions revenue was $85 million, an increase of 34% over last year. As Carl mentioned, AutoCAD Mechanical had a terrific quarter, increasing revenues 33% over last year. In total, we shipped more than 93,000 seats to our users in the manufacturing market.

Revenue for Building Solutions increased 28% over last year to $58 million. Revenues from Revit increased 98% compared to last year. Revenues from Architectural Desktop, our vertical solution for architects, were approximately flat compared to last year, as customers are increasingly moving to our Revit platform.

Infrastructure Solutions revenue increased 14% over last year to $50 million. As in the Building industry, strong adoption of our 3D products is impacting growth rates for our vertical 2D products. While revenues from Land Desktop decreased compared to last year, revenue from Civil 3D increased by 57%.

And as Carl mentioned, Media and Entertainment had a very strong quarter with revenue of $64 million, an increase of 50% over last year and 10% sequentially, driven by growth in our animation products, 3ds Max and Maya.

As we have said, because we're in the process of completing the stock option review, we will not provide EPS. However, we can tell you that our spending for total costs and expenses, which include cost of license and other revenue, cost of maintenance revenue, marketing and sales, research and development, and general and administrative, increased by $10 million sequentially as expected.

This increase does not take into account expenses resulting from the voluntary stock option review. This increase does include a $3-million write-down of Advanced Systems' inventory. As a result of this write-off, gross margins decreased 1 percentage point, both sequentially and compared to the third quarter of fiscal 2006.

In addition to the $10 million increase I just mentioned, we spent approximately $3.6 million on legal, tax and accounting fees related to the voluntary review of our stock option grant practices and paid a onetime bonus of $8.8 million to the non-executive employees who were enrolled in the employee stock purchase plan.

This bonus was approved by the Board to compensate for the benefits lost by non-executive employees, because Autodesk was legally precluded from issuing shares to the employee stock purchase plan due to the ongoing review.

Interest and other income increased by $3 million sequentially to $6 million, partially due to higher interest rates and increasing cash balances as well as reimbursement of an escrow amounts related to a prior acquisition.

Compared to last year, foreign currency impact was $6 million favorable on revenues and immaterial on expenses. Compared to the second quarter, foreign currency impact was $2 million favorable on revenue and $2 million unfavorable on expenses.

Total deferred revenues were $333 million, including $49 million classified as long-term. Deferred subscription revenues were $275 million, an increase of $12 million sequentially and $90 million over the third quarter of last year.

Total backlog, including deferred revenue, increased to $352 million. This included product backlog of $19 million. Channel inventory was slightly below our normal range of three to four weeks. DSO decreased 1 day from last quarter to 51 days.

Capital expenditures were $7 million in the quarter. Cash and investments increased $129 million sequentially to $597 million, because we were not able to repurchase shares during the quarter pending the resolution of the stock option review.

During the quarter, we received $10 million from employee stock plans. There were approximately 231 million total shares outstanding and 242 million fully diluted shares. We had a very strong third quarter. Now, I'll turn to guidance.

As usual, our guidance takes into account today's foreign exchange rates, including some level of buffer against future strengthening of the dollar. Because of our ongoing voluntary stock option review, I'm not going to provide EPS guidance.

Net revenues for the fourth quarter of fiscal 2007 are expected to be between $490 million and $500 million. We expect spending for total costs and expenses in the fourth quarter to be approximately flat with the third quarter.

Estimates of fourth quarter spending for total costs and expenses include approximately $5 million in legal, tax and accounting fees related to the voluntary stock option review and do not take into account other charges, if any, resulting from the voluntary stock option review.

For fiscal 2007, we are now expecting revenue in the range of $1.832 billion to $1.842 billion. Now, looking at fiscal 2008, based upon the best information that we have today, we are first providing preliminary guidance for the first quarter and full year.

For fiscal year 2008, net revenues are expected to be between $2.075 billion and $2.125 billion. Operating margins for the year are expected to increase 3 to 4 percentage points excluding expenses, if any, resulting from the voluntary stock option review.

Operating margins from fiscal 2008 are expected to increase 1 to 1.5 percentage points, not taking into account estimated FAS 123(NYSE:R) stock-based compensation expenses, amortization of acquisition-related intangibles, litigation accruals, legal tax and accounting fees, if any, and charges, if any, resulting from the voluntary stock option review.

Net revenues for the first quarter of 2008 are expected to be approximately flat with the fourth quarter of fiscal 2007. Consistent with normal seasonal trends, we expect spending for total costs and expenses for the first quarter of fiscal 2008 to increase approximately $10 million sequentially.

Estimates of spending do not take into account legal, tax and accounting fees, if any, or any other charges, if any, resulting from the voluntary stock option review. Now, let me turn it back to Carl

Carl Bass

Thanks, Al. Before we take questions, I'd like to summarize a few key thoughts. Once again, Autodesk had very strong financial results. We continue to win share in all of our key markets. We achieved record results from many of our key metrics including 3D revenue and revenues from our subscription program.

The Americas and the emerging economies reported their best quarters ever, but the modest growth we saw in Japan was not up to our expectations and we continue to focus on improving our performance in this key economy. Adoption of our model based 3D solutions is increasing worldwide and growth in our 2D solutions remains robust. Remember that our strong 2D growth fuels our 3D opportunity.

Excluding the cost of the voluntary stock option review, our profitability continues to exceed our expectations. We remain committed to optimizing revenue growth and profitability.

And finally, we remain very confident of our growth opportunities. While there are currently a number of mixed signals about the overall health of the economy, customer demand for our products remains very strong. The innovation and productivity enabled by Autodesk solution provide our customers with a real competitive advantage they need in every economy.

Operator, we're ready for questions.

Question-and-Answer-Session

Operator

[Operator Instructions].

Your first question comes from the line of Heather Bellini from UBS. Please proceed.

Heather Bellini - UBS

Right. Thank you. Carl, I was wondering if you could share with us. You had a great uptick in 3D revenue growth this quarter. I was wondering if you could talk a little bit about what you think is driving that in particular, and also where do you think we are in the inflection point in terms of an inflection point on that growth curve? Thank you.

Carl Bass

Sure, Heather. Well, I think one of the things that we see is that our 3D products, you know, requires some change as people add that to their tool set. And so we do see some on and even this on a product line business. And so what we see is sometimes they come together in a nice way like they did this quarter where they all move ahead.

But as we've said, the trends around 3D will continue. They will be strong. There's a big base, but they may not necessarily monotonically increasing quarter-over-quarter. So we expect some in this but it just continues really to be the productivity, the return on investment that people get, I mean, I think as I've said before, from most of our customers, there's really a question of when, not if, they add 3D tools to their 2D tool set.

Heather Bellini - UBS

Could you comment then how much you think of the activity was the uptick in 3D was related to the promotions in the quarter or do you think even excluding those you would have had similar-type of results? So as we look to the next couple quarters, as the promotions start to end?

Carl Bass

Yeah. I mean, right now, we don't think much of the activity was driven around promotional activity. One of the things I always try to distinguish is there's some promotional activity that we do as a Company and there's certainly some that are resellers and distributors do but certainly very little is driven by our promotional activity. And I know that so there for I don't think it's going to be in the future quarters.

Heather Bellini - UBS

Okay. Great. Thank you.

Carl Bass

You are welcome. You're welcome.

Operator

Your next question comes from the line of Phil Winslow from Credit Suisse. Please proceed.

Phil Winslow - Credit Suisse First Boston

Hi, guys. Great quarter. You seem to be experiencing continued strength in just the manufacturing vertical. Wonder if you could just categorize the competitive environment that you see there, you know, vis-à-vis the [Deskos] and PTC's of the world.

Carl Bass

Sure. I mean, I think, when you look at it broadly speaking, the trend that we've talked about for years and years continues to be true. This idea of people moving to mainstream solutions, you know, readily learn about, readily available, readily approachable products is happening like it happens in every technology market.

And so I think we've continued to be a beneficiary of that. Then, I'm really the wind is in our sales in terms of people adopting these mainstream solutions. I think what you see in the competitive environment is many of our competitors are either choosing to focus on other parts of serving the manufacturing industry, you know, part of their PLM solutions or other parts of their business, technical documentation.

But most of them are not really focused on the design and engineering business. And that tends to be a place where we continue to win share. I think this is going to continue all of the factors that have contributed to the growth of this mainstream market, stay in place and I think they will continue into the future.

Phil Winslow - Credit Suisse First Boston

Great. Thanks. And then, Al just one quick question. Just on the tax rate for the next fiscal year, just what are your expectations?

Al Castino

Yes. I would say the tax rate we've been talking about for the past year is what you'll see going forward. The different factors and impact that, first of all, the R&D tax credit has not yet been passed by Congress for the current fiscal year and we don't know about next year.

I'm hearing reports that when Congress expects business that it is on the agenda on the new democratic leader so that might be promising. But the other thing that impacts the rates are in the mix of international versus domestic earnings. And then, our assumption about the amount of overseas cash that needs to be repatriated back to the US.

So there's a number of things impacting the rate, rather than giving you a good firm guidance yet for next year. But I'd say the rates you've been seeing this past year is roughly 24% is a good starting point.

Phil Winslow - Credit Suisse First Boston

Great. Thanks, guys.

Operator

Your next question comes from the line of Sasha Zorovich from Oppenheimer and Company. Please proceed.

Sasha Zorovich - Oppenheimer and Company

Yes. Could you please tell us if you mentioned that you were gaining some share against some of your competitors? Could you say specifically maybe whom you would be gaining that share from in particular?

Carl Bass

Yes I think you see in most markets almost every competitor. You know, if you look at the growth rates, particularly if you factor out the parts of the business that are not parts that we complete against.

So if you were to take some of our manufacturing competitors, for example, if you were to look at them and take out some parts of their business in which we don't complete and instead look at their core CAD offerings, you're seeing growth in anywhere from low single digits to low double digits. And so that would be an instance of where we're gaining share.

If you look at the building industry or the infrastructure industry, we're gaining share there. And clearly, the growth rates we're seeing in the media and entertainment business, particularly on the animation side indicate that we're gaining share there.

So I think you could -- you would be hard pressed whether looking on a regional basis or on a global basis to find many companies that are growing at the same rates that are competing really for the same available market.

Sasha Zorovich - Oppenheimer and Company

Great. And my second question was regarding Japan, I guess, so overall Japan did grow a little bit, however I guess there were still issues with Inventor. I remember you mentioned that earlier on the call, and I was wondering if you could comment on that a little bit, sort of, why do you -- what -- sort of why does it continue to be weak in Japan and what you're doing about it?

Carl Bass

Yes. Sure, Sasha. I mean, first of all, I think it did grow slightly but it's not at a level that we think is, you know, appropriate. If you look at our growth around the world, almost on a much more consistently basis, we've done well in all of the places both developed economies and more emerging economies.

So the 3% kind of growth is nothing that we're satisfied with. I think we've spoken about this a little before. We talked about it being a multiple quarter issue in order to rectify, but I think it revolves around a number of things. One is certainly continuing to increase the capacity and capability of our channel.

Second, I think there were things that we need to do in our own organization to promote the adoption of 3D. As well as I think there are some factors about culturally how the Japanese have been adopting 3D technology that we've seen similar issues with some of our competitors. But despite, the very modest growth, that's not a level that we're comfortable at going forward.

Sasha Zorovich - Oppenheimer and Company

Thank you very much.

Operator

Your next question comes from the line of Jay Vleeschhouwer from Merrill Lynch. Please proceed.

Jay Vleeschhouwer - Merrill Lynch

Thanks. First question for Al. Regarding your fiscal '08 margin expansion outlook, the 3 to 4 points increases -- how much of that do you think would be driven by mix either on the license or subscription side or other structural changes? For example, the recapture of margins by changing distribution economics, as you did with the fulfillment change, for example, this quarter.

Al Castino

Okay. Jay, the 3 to 4 points versus 1 and 1.5, I want to make sure people understand that. It's been a difficult thing to explain because normally we talk about GAAP and non-GAAP and we're not able to do that at the moment because there could be stock option review related things that had GAAP, and so we can't say for sure GAAP versus non-GAAP.

So the 3 to 4 percentage points is typically in other circumstances we refer to GAAP earnings. And that tends to expand more quickly because some of the charges that hit GAAP versus non-GAAP don't grow in relation to revenue. And I'll include things like the stock based comp expense, the amortization of some of the acquisition intangibles, things like that.

And then when you get into the non-GAAP, you get into more of the real operational base of what's going on in the business. And there we're talking about 1 to 1.5%. So that expansion is really driven by the things I've talked about in the past. So we definitely benefit from scale. So as revenue goes up, we don't have to expand our operations at the same proportion as revenue rises. So it benefits the scale.

In addition to that, we have constant productivity initiatives in the company and that's been going on now for about four years. We start every budget cycle with productivity factors in every area of the company and we continue to execute it and over execute on gross so that allows us to get more bang for the buck, we can expand the revenue and not have to increase some of the back office operations in proportion to the revenues.

And then the last thing I'll mention is we really control the spigot somewhat on our operating margin because we want to make investments for future growth. And so basically what happens is our productivity gains, our scale gains, we split them between operating margin improvement and the investment in the growth initiative. So the sum of all of that in our budget process in terms of the base operations is the expansion of 1 to 1.5% of operating margin -- and in other circumstances, we call it GAAP.

Jay Vleeschhouwer - Merrill Lynch

Well, let me rephrase the question then. How much of the profitability improvement in the most recent quarter came from the change in distribution fulfillment for AutoCAD and LT? Some of your channel partners have quantified it in terms of their own business, so you must have recouped some of that that they, in effect, lost on the margin side.

And so the question is how much further can you push that change in distribution economics in terms of continuing to move the discount structure, the mix structure, as far as channel economics are concerned? And for Carl, when you look at your geographies, is there any geography that is disproportionately high or low in terms of a vertical? Is Japan disproportionately high or low, for example, in terms of BSD or MSD versus the corporate average?

Al Castino

Okay. So starting with the distribution changes, that had very little impact on the quarter. As a matter of fact that happened at the very end of the quarter last month. That's not driving our margin improvement. We are doing that because we want our resellers focused on selling the vertical products, the high end rating products rather than taking orders for AutoCAD.

So that's not a margin expansion program and our margins are expanding for the reasons I mentioned and that's why for three years and they will keep on that path for the same reasons they've been expanding the last three years.

Carl Bass

So Jay, as a matter of fact, sometimes what you're seeing -- just to answer a little bit or add some color to Al's commentary, what you see is because our quarters are offset with some of the distributors and resellers that report publicly. Some of those incentives that we put in place are back end loaded. And so they may not have seen them. And so they may have reported on them.

But if you take it and average it over any reasonable period of time, we are distributing the same amount of money to our distribution partners and we can get over and we remain committed to making sure that the channel is strong and healthy, but that they are doing the things that we want in terms of being out there, promoting our 3D products.

I think if you look on a geographic basis, when you look at the adoption of 3D, I think there's been a slightly disproportionate adoption of 3D and the adding of 3D in the emerging economies, just slightly that way. I mean, there is a little bit of a phenomena that I equate kind of to land lines and wireless, or cell phones in which sometimes there's a skipping of a generation of technology.

And so we see that in some of the emerging economies. When you look across the developed countries, I would say there's really pretty good equivalent metrics in all of the countries with the exception of Japan which has been a laggard in terms of the adoption of 3D.

Jay Vleeschhouwer - Merrill Lynch

All right. And finally, just a quick question on LT -- not the cross grade question, but LT generally. It's your second biggest product, typically does around $300 million a year, but lately hasn't been growing meaningfully. The question there is what do you think the long-term growth can or should be for your second largest product as part of your total mid-teens corporate growth objectives?

Carl Bass

Yes. So as we've talked about I've said that there are products like AutoCAD that I think are in the 10 to 12% kind of growth range, maybe, say 10. And you think about our 3D products as being double that rate, just as a bogey we think about that as being 2X. And just something similar around our emerging economies versus developed economies, developed economies growing in that low double-digits and the emerging economies growing at about 3X is a way to frame the whole business.

And then, specifically about LT, I would plunk it in the middle to the high end of double-digits of teens, 15 to 17% kind of growth rate so just above what the corporate growth targets are, should be something that's sustainable over a reasonable period of time.

Jay Vleeschhouwer - Merrill Lynch

Thanks, Carl.

Carl Bass

Sure, Jay.

Operator

Your next question comes from the line of Brendan Barnicle from Pacific Crest Securities. Please proceed.

Brendan Barnicle - Pacific Crest Securities

Thank you. Carl do you have any sense on what percent of the installed base is now over on 3D?

Carl Bass

Yes, I think we think it's about 10%.

Brendan Barnicle - Pacific Crest Securities

It's still around the 10% level?

Carl Bass

Yes. You know the problem with this is, the denominator is the problem with this equation. There's 2D revenue and 2D installed base just keeps growing. And so it makes it hard to make a meaningful impact on it. And so our 3D is for the most part been living up to or exceeding our expectations. I think in many cases, though, 2D revenue and 2D seats has exceeded our expectations.

Brendan Barnicle - Pacific Crest Securities

Now, in the past sometimes you said to get to the inflection point, you see a need to be somewhere around 20% because then it becomes a competitive disadvantage for people not to have it. Given that we've had both the numerator and denominator increasing does that change that at all, do you think you can get that inflection point some time sooner or do we still need to get something out of that 20% range?

Carl Bass

You know, I believe that in these markets there will be an acceleration. I've always been a little bit loaded to talk about inflection points, particularly as you guys like to draw hockey stick-like inflection points, and so I've never really gotten to see that picture in my mind and I thought about an acceleration that does take place in the market.

But I do think people need to remember in these markets that the switching costs or the adding costs of additional products to peoples processes is difficult, and so there's a natural kind of frictional co-efficient, there's a difficulty in adding it too quickly and so it's not something where this is not like a consumer product where the market is just going to rush out tomorrow and we'll get to 70% or something. So I can imagine seeing an acceleration, but I still don't envision that kind of inflection point.

Brendan Barnicle - Pacific Crest Securities

Great. And then obviously manufacturing was good but there's been some concern from the macro level about manufacturing slowing down results at Caterpillar and others. How do you deal with that as a possibility? Is it just the digitization is so early in these products that it doesn't really matter what happens on that macro level?

Carl Bass

I always say, we are not exempt from macroeconomic trends. To the extent that the economies do really well or really poorly, we are absolutely not exempt from them. However, I think people often try to read too much into weekly, monthly, quarterly results. Many of these decisions companies are making for the long-term health and profitability of their business.

And so for example, the decision to add 3D technology, start eliminating physical prototypes with digital prototypes, doing more analysis and simulation that's a long term commitment you make and I don't think people make those decisions lightly nor are they influenced necessarily by more volatile economic data.

Brendan Barnicle - Pacific Crest Securities

Great. And then just lastly, any idea on timing on when the stock option inquiry may be completely wrapped up?

Carl Bass

No. We can't say with any certainly.

Brendan Barnicle - Pacific Crest Securities

Okay. Great. Thanks so much.

Operator

Your next question comes from the line of Brent Thill from Citigroup. Please proceed.

Brent Thill - Citigroup

Thanks, good afternoon. Just a question on the guidance for next year. I think it's assuming mid teen growth and Al maybe if you can just walk us through some of the assumptions in how you're driving to that number. And I think as a response to Jay's question, maybe Carl had framed it up. But just wondering if there's any other details you can give us in terms of some of the assumptions.

Al Castino

Well, in terms of revenue growth, you know, Carl, already talked about the factors that we think keep driving us into that range for the foreseeable future. But we again expect that 2D stays healthy for a long time. You know, it's going to be double digit growth for a long time. It doesn't go away.

There's many, many design cases where 2D makes a lot of sense, very productive, very quick. You know, it automates the draft team drawing process. And it doesn't always make sense to sit there and do a model. But there's many projects where you need both kind of where there's portions of the project where the 2D product makes a lot of sense and then the overall project and models absolutely works and more productive for the long term.

So 2D will stay strong. 3D will grow more quickly though, and we're going to continue to get customers to convert to 3D and probably double the rate of 2D. And then the emerging market continues to be a pleasant area of execution for us. It gets better and better. And again, it's not just China and India. You know, Eastern Europe is a great market for us. The Latin America is a great market for us.

The emerging markets is 15% of revenue, and that percent is going to keep rising. So I look for that to keep happening for several years. That's really what drives us. And in terms of the currency rates and the economy, we assume what we have now is we have in the future. We always put a small buffer in place for the currency in case the dollar were to strengthen, but we don't try to predict the economy.

We look at what we have today. And first of all, we think it's a reasonably good economy and has been for quite a while. And our expectation built in the guidance is that what we see right now is what we get next year.

Carl Bass

Yes. And Brent, the only thing I would add to that is we had very -- you know, we continue to have very good performance in our subscription business, and we've talked about how that allows both us and our channel partners to focus on new business in the more valuable parts of the business. And that's turned out to be true, and we continue to see good growth in that. And we expect that to continue, which really just allows for a more efficient deployment of resources.

Brent Thill - Citigroup

And Carl, maybe if you can just talk about PLM. Does that start to come into effect in '08 or is that more of '09 event?

Carl Bass

Well, I kind of choke on that acronym. I have a difficult time, you know, with the PLM acronym. You know, if I was to believe anybody's estimates, it should be about a $20 billion or $30 billion market by now. And by any estimate, you know, it's probably no more than $1 billion.

So we continue to be focused on processes that are much closer to the design and engineers who are our core customers. You know, and while I think there is a long-term market for PLM, I think many people are chasing this gold ring that may never show up.

Remember, you know, the reports of 2000 already had this market painted huge by this time. And we haven't invested nor believed in that vision of where the market is going. We do, however, believe there are ancillary processes. There's other jobs that are involved in the design and engineering. And we're sticking pretty close to that core customer.

Brent Thill - Citigroup

Thanks.

Operator

Your next question comes from the line of Chris Sailer from Goldman Sachs. Please proceed.

Chris Sailer - Goldman Sachs

Great. Thanks, guys. I wonder if you could maybe talk a little bit about sort of the upgrade revenue going forward and how we should think about modeling it, because on the one hand, you know, you are getting I guess the cross grades and that should continue to do well. So we think about especially into 2008, how should we think about those two dynamics and what offset there might be?

Al Castino

Well, the way I look at the upgrade revenue, so first of all, you know, we had something of a headwind this year, because the upgrades were planned to be smaller from last year. And we've planned that for a couple of years. We still had some of that in the first quarter. But if you look over the telecom part of the year, that's finally gone.

But on the other hand, I'll tell you, subscriptions are going to continue to improve. We're going to have higher attach rates, strong renewal rates. Our goal is to move customers off the upgrade path. We want them on subscriptions and, you know, upgrades are now part of the smaller subscriptions. That's going to continue too. I think in the year, you're going to ask us about upgrades.

Cross grades will continue to be important, because we want to move our 2D base to higher-end products, but upgrades are becoming less and less important in our business. And again, it's still -- the way I look at it is you take the combination of prescription and upgrades, think of it as about a third of revenues and what's happening over time is more of that service going subscriptions and increasing percent is going to be upgrades. That's how I look at it.

Chris Sailer - Goldman Sachs

Great. And one just sort of housekeeping question. It looked like the total AutoCAD installed base in the press release for last quarter was a little bit different than the previous press release. Am I looking at the right number? And the same thing for Inventor.

Sue Pirri

Chris, I can get back to you on that. I don't have last quarter's release in front of me. I've only got the release from this quarter.

Chris Sailer - Goldman Sachs

Okay.

Sue Pirri

I'll get back and confirm that.

Chris Sailer - Goldman Sachs

Thanks.

Operator

Your next question comes from the line of Gene Munster from Piper Jaffray. Please proceed.

Gene Munster - Piper Jaffray

Hey, congratulations and good afternoon.

Carl Bass

Gene, it's really hard to hear you.

Gene Munster - Piper Jaffray

Okay, is that a little bit better?

Carl Bass

Yes. That's like 10 times better.

Gene Munster - Piper Jaffray

Okay. I guess the previous question kind of touched on this, but if you look back over the last three quarters, the street has been nervous about your business, because essentially the smaller upgrade pool -- and I know you don't want to talk about that -- but the smaller upgrade pool puts more pressure on some of the results.

Obviously, if you look at how the story is going to shift over the next two or three quarters, as Al just mentioned is that the upgrade pool should start to improve in April of next year. Is that correct? Is that -- it should be flat to start to improve, because just -- [maybe it should] start to improve. I just want to confirm that directionally, we're seeing a positive inflection point versus the negative inflexion point we've had to deal with over the last three quarters.

Carl Bass

Gene, first of all, and I'd have to say I'm a little less optimistic than Al, that you guys won't be asking us no doubt this next year. So might as well provide as much guidance as we can about this topic. Gene, you're absolutely right that it does go in the direction.

And so while it will continue to diminish as subscription increases, it will be less of a headwind going forward than it was during this period of heightened concern.

Gene Munster - Piper Jaffray

Okay. Is it safe to say that the size of the OBIT pool will actually be up next year? I know -- I mean our conserved estimates are that it's flat, but could it actually be -- the OBIT pool be up next year?

Carl Bass

Well, first of all, remember, the first thing to remember for everybody is as we look at the upgrades is the OBIT part of it, as you call it, is not the only part of it. There's several other components that go into the overall upgrade opportunity. And -- I mean I would think of it as more as a flat opportunity, but I really think, you know, just to back up a little bit, the best way to model it as Al suggested, think of the combo and the rate lead change and it may vary quarter-by-quarter.

But overall, we expect to see an increase in the combination of subscription and upgrades rather than pull out the specific component and try to model it too closely.

Sue Pirri

Gene, I think that -- I mean if you really want to think about it, we've been so successful on our attach rates on upgrades that base is going to continue to diminish over time. That's why subscription continues to grow.

Gene Munster - Piper Jaffray

Yes. What was you said subscription was 24%. Can you remind me what it was last quarter?

Sue Pirri

It was 22 last quarter.

Gene Munster - Piper Jaffray

Okay. Great. Thank you.

Carl Bass

Welcome.

Operator

Your next question comes from the line of Richard Davis from Needham and Company. Please proceed.

Richard Davis - Needham and Company

Hi. Thanks very much. With regard to the kind of the media and entertainment side of the business, you had animation grow a lot this quarter. And if you smooth it out over a period of time that side of your business grows nicely.

But is there a way that you guys could think about it, in terms of connections with regard to launches of either new game platforms or the launch of Blu-Ray and HDTV that drives this business or from an outsider standpoint, how do you think about how this thing grows over time and I'm just curious why it seems to be kind of growth in spurts.

Carl Bass

I think that that's a good question, Richard. I mean, I think one of the things is for many of the things let's say like game platforms or films, we are far -- the purchase of our tools happens far in advance of the release of those platforms. So it's a little bit hard to tie those things together.

It also continues to be a business that was not as much subscription based as the other businesses and so you saw a little bit more clustering around the releases. So we're still more on the annual releases and along with those product releases, people tend to follow that more.

Now, I think as you look at overall trends, you do things -- you do see things like HD contributing, the two forms of DVD, the new DVD are going to drive demand for Hi-Definition, high quality content. And I think that there's a number of things in the past we've gone and we've talked about when we've failed to execute on this business.

And I think some of the changes in management have driven a better strategy and better execution. And so I think the division is overall performing better and it's aided by some of these factors out there in the market.

I mean, when you think about it, you look at this new generation of entertainment, media and entertainment that's happening in developed countries. And then, you think about this emerging consumer class that you see in the emerging economies.

And you recognize that there's going to be a big drive for production of content and much of it's regional. I mean, when you see the populations of billions of people in China, most of the content produced for that market will be local. And so that just drives the need for these kind of tools, but it really is a combination of a new strategy, better execution and those macroeconomic factors.

Al Casino: What I would add to that is, Maya had it's best quarter ever and I don't mean here, I mean in the history of that product and its benefiting from being part of our best seller and that's a great acquisition and the fact that we have more feet on the street, a great sales team and things like the infrastructure to go after pirated versions around the world, that's something we can do level they coming to when they were a smaller company, so Maya is going to have some very good traction in Autodesk and that's part of what's going on here too.

Richard Davis - Needham and Company

Got it. I know that's very helpful. I appreciate it. Thanks a lot.

Operator

Your next question comes from the line of Brian Essex from Morgan Stanley. Please proceed.

Brian Essex - Morgan Stanley

Hi. Good afternoon. Just a couple really quick ones. One, you noted the Alias results placed integration was now fully integrated. Any indication in terms of progress in the channel for authorization of sales of that product?

Carl Bass

Alias would have drawed a lot of, first of all, Alias had some great technology and it has some great people there, so, I mean, we're happy to welcome that into the portfolio. On a channel side, we have been able to add it to in the appropriate places to our channel and in other places we've maintained an independent channel.

So, it's been a mix but certainly, Al kind of hinted at. When you get to the places, smaller economies, smaller countries, Alias didn't have the scale to really reach those places, and so I think it's really benefiting with this additional infrastructure and really the scale of Autodesk.

It's helping it reach places where it was, and particularly as you know with most of our business, the first indicators of a successful new market for the reason which it gets pirated. And Maya was very popular in many places in the world at which we, Alias as a stand alone Company really didn't have the resources to turn those into legal copies.

And so we have been able to do a lot more license compliance with that, but it's really a combination of just driving new business and I think the combination with Max of being able to use these two products and some of the technical directions we're taking in order to be able to use the best of Max and the best of Maya, you know, has removed some uncertainty and doubt in the market.

Brian Essex - Morgan Stanley

Okay. And then on the Buzzsaw results, anything you can point to in particular that drove those results?

Carl Bass

I mean, I think its continued execution and one of the things the Buzzsaw team has done really well. It has concentrated on a number of segments that it's done really well and so it continues to work with the home builders.

We reported on that in the past couple years. We've talked about specific deals. And I think the acquisition of Constructware is really letting us address the construction segment at a large sale construction segment in a way that we didn't have the product offering to go at before.

So I think there's a nice synergy between Buzzsaw and Constructware. And I think it continues just to have really a heads down focused approach on going segment by segment as opposed to broad based.

Brian Essex - Morgan Stanley

Okay and then one last housekeeping item. Do you guys have an estimate for cash from operations in the quarter?

Carl Bass

You know, we don't, but I'll tell you, as I have in the past is we typically don't have a lot of capital view. You know, sometimes there's timing of working capital things that make it deviate a little bit from the change in net income, but not a lot.

And the other thing I'll tell you is we gave you -- if you look carefully at what we gave you in our script, there's information there to help you come pretty close to cash from operations in the third quarter and that will give you a good idea of the trend.

Brian Essex - Morgan Stanley

Okay. Great. Thank you.

Operator

Your next question comes from the line of Tim Fox from Deutsche Bank. Please proceed.

Tim Fox - Deutsche Bank

Thank you, good afternoon. Carl, quick question for you on Revit. This has been another outstanding quarter, nearly 100% growth year-over-year. Can you comment there around any particular geography that's driving that?

And it seems like in some of these 3D products where there's a little less competition, the growth in the 3D segment is out pacing others. Is this a lack of competition or is it really just driven by overall adoption of Revit?

Carl Bass

So I think it's driven by a number of things. I mean first of all, Revit is not without competition. It certainly has strong competition in lots of parts of the world. But it is kind of game shifting technology. It's unique in what technological advantage it has, so in other Markets, you know, some of the technology we have where very good. There are others who have good technology as well.

The Revit technology is head and shoulders above what any of the competitors can offer. So I think that's what we're seeing. That's what we're seeing in the Revit market. Other than that, I think you're actually right. Certainly the amount of competition in any particular market affects the uptake and you know the volume of adoption that you'll see in any one of these 3D products.

Tim Fox - Deutsche Bank

Okay. And secondly, again, merging geos are performing well. Just if you could comment on how the development of the channel is going in those emerging geographies. Do you feel like you're sort of at capacity there as far as a channel development perspective and is growth really just going to be driven by an increasing investment in overall infrastructure in those areas?

Carl Bass

I think, in all of the geographies, including the developed economies, we still don't have the channel capacity, channel capability that we believe we need. And particularly when you look back and you can say you know over the -- and we're talking about $450 million in revenue going to $500 million. It's nearly a doubling over four years, I mean it's hard to have the channel keep pace with that.

And so we continue to need and to invest in both the channel in developing and emerging economies. And you know when you look at it on a little bit more fine-grained basis, clearly there's a greater need in some of the emerging economies where we have very little coverage.

So if you looked in certain places, we're really early in the market development and we may be in a handful of industrial centers, but there's still a lot more to do in terms of channel development, and it requires some amount of investment for us going forward.

If you layer in the kind of growth we expect at a minimum, you would expect almost proportional growth in the size of the channel with that. You know with only minor increases in productivity that really comes from the scale of our partners operations.

Tim Fox - Deutsche Bank

Okay that's helpful and Al just one quick question for you. You had spoken earlier in the year about Alias and Constructware, your acquisitions contributing about 5% to 6% points of growth in the year. Is that still on track, do you expect that for the full year still?

Al Castino

I didn't hear part of your question, but I think you're asking whether Alias and Constructware are on track for the year. They are, and both of them have turned out to be great acquisitions and are meeting all of our expectations.

Tim Fox - Deutsche Bank

Yes, I was asking if you still expect it to be about 5% to 6% points of growth.

Al Castino

That's roughly it.

Tim Fox - Deutsche Bank

Okay. Thank you.

Operator

Your next question comes from the line of Ross Macmillan from Jefferies. Please proceed.

Ross Macmillan - Jefferies

Yes. Thank you. Two questions. Firstly, just Carl, maybe you can take this one, on Inventor units. They were kind of down in the 10,000 per quarter for the last two quarters and they've obviously jumped up this quarter. What's changed because I guess that like manufacturing and you commented last quarter manufacturing in the US was softer, so, what are you seeing that's changed to maybe help that growth first of all?

Carl Bass

The first thing I'd say about it and I kind of hinted at this before, I think in each of our 3D products, particularly but you know, generally across our products, there is some variability quarter-to-quarter and that's what I said you know this idea that each product line is going to be monotonically increasing is probably not a reasonable assumption that in some ways you do need to look at it over a little bit longer timeframe.

So there are a number of things that happen. It's kind of things like the product releases make a big difference along with those product releases, remember we have people as they move through the subscription renewal process, new seats sometimes go along with that, so there are a number of factors that contribute to it.

We also have you know, what I talked about is that we've talked about where we sell in product during a particular quarter and during that next quarter, we often see that our channel partners have a greater need to service and train and customize those products, so you often almost see an alternating between big leap forward and then a little gradual slowing down as there's some adoption and customization and training of the customer base.

And so I think that will continue. I think the way to look at it is, you know it's certainly interesting to understand the dynamics quarter-by-quarter. But if you look over a little bit longer time horizon, I think some of the trends emerge more clearly.

Ross Macmillan - Jefferies

And then that's great. Then one on Asia-Pac. Last year, you know, it kind of hovered around about $90 million every quarter and this year it's really broken out, and it's happening this year despite the fact that Japan is decelerating. So is there anything that you're seeing non-Japan Asia that's really helping you drive that growth?

Is it anything to do with piracy control, is it anything to do with, you know, just the channel growth, you suddenly got that to a critical mass, anything at all that's really helping that breakout here? Thanks.

Carl Bass

Yes. So most everything I'm seeing in non-Japan Asia is very positive. I mean, imagine if Japan was performing at the levels of the other developed economies. It's a number of factors, it's there we have adopted and added 3D to their toolsets, more so than other places. We see a fair amount of license compliance as we go around.

I think it continues to be expansion of the channel and we talked about this -- maybe haven't returned to this for awhile, but there are a bunch of products that we've introduced in other parts of the world first and then brought to Asia. And so what we're seeing is a maturing of those products in the Asian markets and it requires not only the introduction of those products.

But the education of the channel and then often kind of the customization and countrification of those products to meet local needs, so we brought products to those markets that they are, you know, we talked a little bit about things like some of the Alias products now being able to put more sales and marketing effort in those regions to it. So it's a combination of factors but most all the trends we're seeing are very positive in Asia.

Ross Macmillan - Jefferies

Great. Thank you.

Carl Bass

You're welcome.

Sue Pirri

Operator, we have time for one more question.

Operator

All right, your next question comes from the line of Michael Huang from ThinkEquity. Please proceed.

Michael Huang - ThinkEquity

Thank you. A couple of quick questions. So first, historically have you seen resellers hold back in Q3 in order to aggressively take advantage of Autodesk promotions in Q4? And then a follow-up to that, do you actually believe that this is any less or more pronounced this year than previous years?

Carl Bass

You know here I think on a one-off basis people may do it. I think we monitor pretty closely the channel inventory out there and so there's very little flexibility out there in terms of what individual resellers may do.

So no, I don't think there's much of that going on and think there are compensation systems are not designed in a way that would really encourage that kind of behavior. So therefore the comparison to other years, I think most of those practices have been true for a number of years.

Michael Huang - ThinkEquity

Great. And last question for you, so how much of the strong animation business performance stems from cross-selling into the core verticals including manufacturing? And I'm wondering if you could comment how Alias, is helping drive sales of the core design products especially in automotive?

Carl Bass

Yes. So let me take that as, you know, from two different places. First one is probably a quarter to a third of our so-called animation business is in some ways tied to design visualization. And that's true with both our Max product and our Maya product. I mean, we often talk about gains in film but there's a huge amount of it's usage that's tied to visualizing designs.

And so it's an important part and one that we've been emphasizing and we've been doing a number of things on the product fronts about product interoperability. We continue to promote that, particularly as you look forward with things like Vista, which will be running on more powerful hardware, better graphics hardware, this visual component is an important part of the design process. And so we think that's important.

Second thing is you hit upon the auto and while there's a little bit of use of Max and Maya in the auto and industrial design. The primary tool there is the Alias product called studio tools and our studio tools had a very, very good quarter.

And we continue to be pleasantly surprised and see a big opportunity, to go into the automotive design segment, particularly the up-front design, conceptual design process, as a place where Alias, has a strong hold and I still think there's future opportunity.

Michael Huang - ThinkEquity

Thank you.

Operator

Ladies and gentlemen, we have exhausted the time set aside for questions. At this time, I would now like to turn the call back over to Ms. Sue Pirri, for closing remarks.

Sue Pirri

Thank you everyone for joining us. Thank you, Operator. We will be around for questions later this afternoon, if you have any questions. Please feel free to give me a call at 415-507-6467. And we look forward to talking to you later. Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Good day.

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Source: Autodesk Q3 2006 Earnings Call Transcript

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