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AutoDesk, Inc. (ADSK)

F2Q08 Earnings Call

August 16, 2007 5:00 pm ET

Executives

Sue Pirri - Vice President, Investor Relations

Carl Bass - President, Chief Executive Officer, Director

Alfred J. Castino - Chief Financial Officer, Senior Vice President

Analysts

Gene A. Munster - Piper Jaffray

Jay Vleeschhouwer - Merrill Lynch

Heather Bellini - UBS

A. Sasa Zorovic - Goldman Sachs

Philip Alling - Bear Stearns

Brendan Barnicle - Pacific Crest Securities

Steven Ashley - Robert W. Baird

Brent Thill - Citigroup

Peter Kuper - Morgan Stanley

Daniel Cummings - Bank of America Securities

Victor Churamani - Lehman Brothers

Presentation

Operator

Good day, ladies and gentlemen. Thank you very much for your patience and welcome to the second quarter 2008 AutoDesk Incorporated earnings conference call. My name is Bill and I’ll be your conference coordinator for today. (Operator Instructions) I would now like to turn the call over to your host for today’s conference, Ms. Sue Pirri, Vice President of Investor Relations. Please proceed.

Sue Pirri

Thank you, Operator. Good afternoon, everyone and thank you for joining us today as we report results for our second quarter of fiscal 2008. 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 by 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, our guidance for the third and fourth fiscal quarters and for fiscal year 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 year 2007, our 10-Q for the quarter ended April 30, 2007, 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 day in which they were made.

During the call, we will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures will be provided either on this conference call or can be found in today’s press release, made available on our website at www.autodesk.com/investor.

Now I would like to turn the call over to Carl Bass.

Carl Bass

Good afternoon, everyone. Thank you for joining us. Today AutoDesk reported another quarter of strong financial performance. Quarterly revenue was a record $526 million, a 17% increase over last year. Diluted earnings per share were $0.38 on a GAAP basis and $0.44 non-GAAP.

As you know, our customers work and compete in a different world today than even a few years ago. Globalization, worldwide building expansion, development and rejuvenation of infrastructure, the rising cost of energy, and the increasing drive to keep data digital. These are important macro economic trends driving our customers to search for tools to increase innovation and work more efficiently in order to improve their competitive position.

These global changes are creating significant growth opportunities for AutoDesk. At investor day, we updated you on our strategy to capitalize on the opportunities these challenges create. Our results this quarter demonstrate we are executing soundly against that strategy.

Adoption of our 3D model design products and our 2D vertical products continue to increase. With 3D, customers set the foundation for digital prototyping. Our 2D vertical products provide customers the best of 2D AutoCAD design and documentation, and enhanced by industry-specific functionality.

As you know, at the beginning of 2008, we implemented changes to our partner incentive programs to continue to shift reseller focus to selling vertical and 3D products. These changes are having the desired effect.

As I said, revenues from both 3D and 2D vertical were at record levels in the second quarter as resellers increased their focus on these important products.

Revenues from new seats of our products were also at record levels this quarter. New seat sales are an important indicator of the health of our business. This was the first full quarter of sales for the 2008 family of products and market acceptance has been terrific. Our products provide customers the ability to be more innovative, productive, and ultimately more competitive.

We continue to win market share and increase revenues faster than our competition. Strong execution, coupled with increasing power and improving price performance ratios for processing power, memory and bandwidth are enabling our mission to deliver 3D to he broadest possible markets.

Our competitors are finding it increasingly difficult to sell legacy products -- hard to use, expensive to implement, and unable to keep up with the needs of today’s customers.

As we continue to increase our competitive separation, we have increased our investment in R&D over the past 12 months to bring new products to market and create exciting new versions of existing products. Both AutoDesk and our resellers have increased our investment in sales and marketing by increasing our marketing program spend and adding sales staff.

For example, during the first half of the year, AutoDesk resellers added more than 200 people in the Americas alone. That is a significant investment in our future success.

We also used M&A activity to enhance our strategic position. During the quarter, we completed the acquisition of NavisWorks, a provider of software for 3D coordination, collaboration and sequencing in the AEC, shipbuilding and plant design industries. We have also announced two other acquisitions, Opticore and Skymatter.

Opticore technology leverages CAD information to reduce the need for physical prototypes, shorten development cycles, and increase communication by producing believable, highly interactive and realistic 3D product visualizations and presentations.

Skymatter’s 3D brush-based modeling tool, Mudbox, allows users to sculpt organic shapes in 3D space with brush-like tools --

Operator

Okay, sir, you may resume.

Carl Bass

Okay. Sorry for that. We continue to win market share and increase revenues faster than our competition. Strong execution coupled with increasing power and improving price pro forma ratios for processing power, memory and bandwidth are enabling our mission to deliver 3D to the broadest possible markets.

Our competitors are finding it increasingly difficult to sell legacy products -- hard to use, expensive to implement, and unable to keep up with the needs of today’s customers.

And we continue to increase our competitive separation. We have increased our investment in R&D over the past 12 months to bring new products to market and create exciting new versions of existing products. Both AutoDesk and our resellers have increased our investment in sales and marketing by increasing our marketing program spend and adding sales staff.

For example, during the first half of the year, AutoDesk resellers added more than 200 people in the Americas alone. That is a significant investment in our future success.

We also used M&A activity to enhance our strategic position. During the quarter, we completed the acquisition of NavisWorks, a provider of software for 3D coordination, collaboration and sequencing in the AEC, shipbuilding and plant design industries.

We have also announced two other acquisitions, Opticore and Skymatter.

Opticore technology leverages CAD information to reduce the need for physical prototypes, shorten development cycles, and increase communication by producing believable, highly interactive and realistic 3D product visualizations and presentations.

Skymatter’s 3D brush-based modeling tool, Mudbox, allows users to sculpt organic shapes in 3D space with brush-like tools which allow a simple and intuitive method for creative modeling, prototyping and detailing. These acquisitions will further enhance our leadership in our core markets.

I am very pleased with our results and the continued momentum in our business. Now I would like to turn the call over to Al for a detailed discussion of the financial results.

Alfred J. Castino

Thanks, Carl. Once again, AutoDesk delivered great performance this quarter. As Carl said, net revenues grew 17% compared to the second quarter of last year to $526 million. GAAP diluted earnings per share were $0.38, which is higher than expected, primarily due to lower-than-anticipated tax and other costs associated with the recently completed voluntary stock option review. Non-GAAP fully diluted EPS was $0.44.

Customer demand for AutoDesk products was very strong again this quarter. The partner incentive program changes we implemented at the beginning of fiscal 2008 are having the desired effect. Revenues from vertical and 3D products showed strong growth in the second quarter, as dealers increased their focus on these important products.

Revenues from our model-based 3D solutions, Inventor, Revit and Civil 3D, were $122 million, an increase of 34% over the second quarter of last year. Without the change in the unit price for 3D, the growth rates would have been several points higher.

During the quarter, we shipped more than 39,000 commercial seats of our 3D products. In addition to our robust 3D growth, revenues from 2D vertical products increased 22% compared to the second quarter of last year.

Revenue growth in emerging economies continues to significantly outpace growth in developed economies. Quarterly revenue in emerging economies increased 37% over last year and represents 15% of total quarterly revenues.

Compared to the second quarter of last year, revenues from new seats increased 17%.

Upgrade revenue and maintenance revenue from subscriptions combined increased 16% over the second quarter of last year. As expected, total upgrade revenue decreased slightly. Crossgrade revenue, which is included in total upgrade revenue, increased 29% over the second quarter of last year.

Maintenance revenue from subscriptions was $132 million, an increase of 27% compared to a particularly strong second quarter of last year. As well, the increase in the number of users on subscription was smaller than the past as we removed the subscription offering associated with a few products.

While we are confident that our subscription program will remain strong, we do expect future subscription growth to be more moderate than in prior years.

Each of our geographies grew substantially compared with the second quarter of last year. Revenue in the Americas was $195 million, an increase of 16%. EMEA revenues were $204 million, an increase of 17% as reported, and 10% constant currency. While growth in EMEA was not as robust as we have seen in recent quarters, we are very confident that EMEA will show strong results in the second half of the year.

Asia-Pacific revenues increased 18% to $127 million. Revenues in Japan increased 5% over last year. As I said last quarter, we believe that our business in Japan has stabilized and we remain optimistic about continued improvement going forward.

Now let’s look at divisional performance. Revenue from Platform Solutions increased 8% over the second quarter of last year to $241 million. AutoCAD LT had a strong quarter, growing 13% over last year. As we mentioned earlier, the changes in our incentive programs have shifted dealer focus to selling 2D vertical and 3D products and away from AutoCAD. As well, AutoCAD upgrade revenue decreased as planned.

AutoCAD revenue increased 4% compared to last year. However, the more relevant measure given our strategy is the growth of all AutoCAD-based products in total, which grew 12%.

Total revenue for our Manufacturing Solutions division increased 31% over the second quarter of last year to $99 million. This far exceeds the growth of our competitors, such as SolidWorks, the American subsidiary of Dassault, which grew just 4% in their latest quarter.

Inventor revenue increased 60% compared to last year. We shipped more than 11,000 commercial seats of Inventor in the quarter. Revenue from new seats of Inventor increased 23% compared to last year.

AutoCAD Mechanical had another great quarter, increasing revenue 53% over last year. In total, we shipped more than 68,000 seats to our users in the manufacturing market.

AEC Solutions revenue increased 33% over last year to $119 million. The building industry is rapidly adopting the concept of building information modeling, both in the U.S. and abroad, driving strong Revit results.

Revenues from our Revit family of products increased 68% over the second quarter of last year. We shipped more than 21,000 commercial seats of Revit. Civil 3D also had a great quarter, growing 36% over last year on 7,200 commercial seats.

Media and Entertainment revenue increased 6% over last year to $62 million. Animation revenue increased 16% over last year while revenue from advanced systems declined 3%.

The success of our Linux-based offerings continues to drive increases in average selling prices for advanced systems as we transition away from proprietary SGI hardware. While this decline has a negative impact on revenue, it has improved the systems gross margin substantially.

Revenues from Luster, our color grading solution, declined in the quarter due to some past product quality issues which we have now resolved.

Moving to the rest of the income statement, gross margins were 90% on a GAAP basis and 91% non-GAAP. Our gross margins improved two percentage points on a G&A basis and three percentage points non-GAAP. The improvement was primarily due to increased gross margins on our advanced systems Linux solutions, as I just mentioned, as well as continuing to benefit from strong software license sales and productivity improvements in our operations.

Operating expenses were $411 million GAAP and $385 million non-GAAP. Operating expenses were lower than expected due to lower spending as well as a technology investment that was recorded in other income and expense instead of operating expense.

Excluding the items I mentioned above, operating income was $150 million GAAP and $141 million non-GAAP. Our operating margin was 22% GAAP and 27% non-GAAP.

Our tax rate in the quarter was 22% GAAP and 25% non-GAAP. The GAAP tax rate was lower than expected, due primarily to timing of tax benefits related to stock option exercises recorded under FAS-123R.

Net income was $92 million GAAP and $108 million non-GAAP.

Total shares outstanding decreased by almost 2 million shares to 229 million. There were 244 million shares used in calculating non-GAAP diluted earnings per share.

Compared to rates we use when we set our guidance for the second quarter, foreign currency rates impacted our results by an insignificant amount. Compared to the second quarter of last year, foreign currency impacts was $12 million favorable on revenues and $5 million unfavorable on expenses. Compared to last quarter, the foreign currency impact was $4 million favorable on revenues and $2 million unfavorable on expenses.

Turning to the balance sheet, cash and investments decreased as expected to $827 million. During the quarter, we received $84 million from employee stock plan exercises of 5.2 million shares. We used $325 million to buy back 7.1 million shares. We will continue to repurchase shares under our previously authorized share repurchase program to offset dilution from stock options and we expect over time that our cash balance will trend down.

Cash from operating activities was $137 million, which is down from the second quarter of last year due to the timing of balance sheet movements in the prior year. We used net cash of $21 million for acquisitions.

Total deferred revenues increased $12 million sequentially to $412 million. Deferred maintenance revenues from subscription increased $12 million sequentially and $100 million over the second quarter of last year.

Unshipped product orders, or shippable backlog, were $21 million, an increase of $2 million sequentially and were flat compared to the second quarter of last year. Total backlog, including deferred revenues and unshipped product orders, increased $15 million sequentially to $433 million.

Channel inventory was flat with the first quarter and remains below three weeks.

Days sales outstanding was 48 days this quarter as we continue to see good business linearity.

We are very pleased with our second quarter results. Now I would like to turn to guidance.

We are feeling very good about our business around the world heading into the third quarter and as a result are raising our guidance for the third quarter and the year. We currently expect third quarter revenue in the range of $530 million to $540 million. GAAP earnings per diluted share are expected to be in the range of $0.34 and $0.36. Non-GAAP EPS is expected to be in the range of $0.47 and $0.49.

Net revenues for the fourth quarter are expected to be between $575 million and $585 million. GAAP earnings per diluted share are expected to be in the range of $0.42 and $0.44. Non-GAAP EPS is expected to be in the range of $0.52 and $0.54.

For fiscal year 2008, net revenues are expected to be between $2.14 billion and $2.16 billion, a growth rate of 16% to 17% over the last fiscal year. Full year GAAP earnings per diluted share are expected to be in the range of $1.48 and $1.52. Non-GAAP EPS is expected to be in the range of $1.87 and $1.91, a growth rate of 22% to 25%.

We continue to expect our tax rate for all of fiscal 2008 to be between 25% and 26%.

Now I will turn it back over to Carl.

Carl Bass

Thanks, Al. Before we begin taking your questions, I would like to share a few final thoughts. AutoDesk had a terrific second quarter. Despite considerable noise in the market about the residential housing market, the credit crunch, our competitors’ poor performance, and the impact of changes to our resellers incentive programs, once again we concentrated on execution and once again we delivered strong results. And we are confident about the future.

We are confident because we have the right strategy and our growth drivers remain firmly in place. Our mainstream 3D solutions are increasing in market awareness and adoption. Emerging markets remain a source of outstanding growth and we continue to win market share, as evidenced by record revenue from new seats in emerging businesses, which continue to represent approximately two-thirds of total revenue.

We continue to improve our strategic position through investment in R&D and sales and marketing, as well as through acquisitions. AutoDesk solutions provide the competitive advantage our customers need. Our product innovation and quality, coupled with quick orientation and ease of use, produce fast return on investment for our customers. We are raising our revenue and EPS guidance for the third quarter and the year to reflect our optimism.

Operator, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Gene Munster of Piper Jaffray. Please proceed.

Gene A. Munster - Piper Jaffray

Good afternoon and congratulations. Carl, the 3D growth was really sprung back, up 34% year over year, it was 19% last quarter. Obviously that’s a key metric that we are all focusing in on and I know that you’ve made some changes to the channel to really accelerate that and it seems that that’s working.

How should we be thinking about -- just kind of manage our expectations for 3D growth going forward. Is it kind of in this range? I know before last quarter it was kind of in the 30% to 35% range. Is that what we should think about for 3D growth rates going forward?

Carl Bass

Gene, by the way, I’m glad you’re still with us. I thought we lost everyone for a while.

The rule of thumb we’ve given out on this is that our 3D growth rate should be probably twice our 2D growth rate is a good way to think about it over the long-term. Clearly as our 3D base grows, the rate of growth is going to slow but I generally think if you look at our long-term financial targets of 15% growth, easy to accomplish that with our 3D growth being twice the 2D growth.

The other thing I would just add is while I think the channel program changes we made are having the desired effect, it is still a little bit lumpy in terms of results and so I wouldn’t get too wound up about a quarter. We ask you always to look over a several-quarter period as the moving average is probably a better reflection of what’s really going on. There’s still some lumpiness around when we release product and the adoption of those products.

Gene A. Munster - Piper Jaffray

Should we think about it as kind of a 25% to 35% growth for next quarter for 3D? Is that kind of a fair range?

Carl Bass

I would put it in the mid-20s, mid- to high-20s.

Gene A. Munster - Piper Jaffray

Okay, and then second is the LT crossgrade promo. Obviously that was going this quarter. You’ve kind of brought that back. I know you had gone to that a few quarters ago. Maybe talk a little bit about why you brought it back and is this something that has a material impact on the October quarter? Or is this more or less just part of everyday business?

Carl Bass

Just to start back with -- it’s not going to have a material impact. You know, we continue to think that there’s a segment of the LT base and it really is only a small segment, that given the opportunity, when we create awareness around our 3D products and our vertical products, those really are the right choices. There’s a large part of the LT population where LT is really the best product for them. So we will continue to offer that periodically and I would characterize it as you did, as just part of our normal business.

Gene A. Munster - Piper Jaffray

Great. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Jay Vleeschhouwer of Merrill Lynch. Please proceed.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Carl, I would like to ask you about what you think is, for the intermediate term, correlated to the business? That is to say, you don’t think the housing index correlates, you’ve talked about some positive longer term trends, such as infrastructure building. You don’t think that the recent credit concerns correlate. So what if anything would you look at as some sort of intermediate corollary to the business? And I have some follow-ups.

Carl Bass

Jay, I sense and share your frustration. We have looked for one single metric that would even be a lagging indicator, let alone a leading indicator of our business. We’ve employed economists, kind of metrics experts to look at it and just -- probably the best thing is to return to this idea that our business is fairly diversified across industry segments and very diversified across geographies, and for that reason alone it becomes really hard to correlate it with any single metric.

I would say along with that, our business no doubt rises and falls with the economy, you know, generally speaking. I can’t be a lot more specific. We’ve not been able to target it but as the economy does well, we do better.

I’ve also at times talked about I think at the extremes in the bell curve of economic activity are actually where we perform worse and in the middle is where we perform best. In really bad times of economic, and not financial, of economic activity, people are worried about other issues and when growth gets too robust, people start focusing on just getting their job done. In that big fat middle section is where we do well, so I don’t have a crisp answer for how you tie our business to anything specifically.

The only other thing I’d repeat in some ways, the best indication that we’ve found of our business is kind of like the weather. The best predictor of the weather tomorrow is the weather today, and so we do better by extrapolating the trends in our business than we’ve been able to tie it to any external measures.

Jay Vleeschhouwer - Merrill Lynch

Let’s talk about the channel for a second. Notwithstanding the revenues in quarter and your comments about the incentives beginning to have an effect, you are undoubtedly aware that there’s been some pretty visible examples of resellers having to experience some compressed margin, the publicly held ones, the privately held ones talk about that. That may be temporary but talk about the light at the end of the tunnel, so to say, as to when the margin pressures, pursuant to the incentive changes for 3D, can come to an end and ultimately the channel comes out better than before by virtue of the changes you’ve made towards 3D.

Carl Bass

Sure. Well, first of all, you took away my two best arguments in your question by not letting me talk about the health of the business. But when you focus really on the channel, the first thing to think about with the channel is what we’ve really done is we’ve taken the incentives and we’ve moved it around. There’s no more money coming to us as a result of this. This is really reallocating incentives in order to drive behavior. And so for every negative comment you hear out there, there is somebody else who is benefiting as a result of their changed behavior.

What I think you got an extra dose of this time is that the public companies tend to be the larger ones and the ones that may move slower. There are many out there that are doing really well and the ones who saw the signals coming for two or three years were really well-positioned to take advantage of this.

I think the other thing is, only being slightly sarcastic, is that somehow some of our resellers believe the most effective way to communicate their grumblings is to talk to you guys. And with all due respect, I would say that the resellers who have enough time to talk to you guys are missing out on opportunities to sell more 3D product.

Jay Vleeschhouwer - Merrill Lynch

All right, but the answer to the question as far as when the margins get back to where they were --

Carl Bass

No, no, let me be clear -- the margins are already higher for many of our resellers. So it’s not a question of time. About any individual reseller, it all depends on their behavior but in this quarter, in quarter two, there are resellers who have much higher gross margins as a result of the changes in the incentive program. This is not something that gets feathered in over time. People’s behavior may make it that way but there are people who are already benefiting and any of the ones that you spoke to had the opportunity this quarter as well as they have the opportunity next quarter.

Jay Vleeschhouwer - Merrill Lynch

All right, a couple of last things; at the analyst day, you introduced the notion of your doing more large transactions, or large for you, over $100,000 and over $1 million. Any update on how you are doing in that respect? And then finally, your business was up in Japan. Was that just an extraordinarily easy compare or are you in fact fixing the problem that seems to be so widespread in your industry in that market.

Carl Bass

Let’s start with the large deals. Let me just qualitatively say I think all the trends we talked about with large deals continue. We continue to see large deals but we also said at the analyst day that we weren’t going to provide updates through the year. Sure we’ll talk about it again in the spring but all the things we said, no changes that we are seeing there. If anything, there’s probably more of that because of all the reasons you know in the market in terms of our products being sold to larger corporations and more strategic position of our 3D products and some of our 2D products. So large deals continue.

It’s sad to say in some ways, but we did make an easy compare for ourselves in Japan. It wasn’t intentional but I think the real answer is we think we’ve stabilized the business. We think we may have gone beyond stabilizing the business. I don’t want to be too quick to predict that but we talked about for the last couple of quarters a number of changes we made in terms of programmatic stuff, some channel changes, some management changes. We think all of that is contributing. We are really bullish about the efforts that sit there on the ground but I don’t want to declare victory too early.

Operator

Thank you very much, sir. (Operator Instructions) Your next question comes from the line of Heather Bellini of UBS. Please proceed.

Heather Bellini - UBS

Hi, everybody. I just had a question, I guess as a comment, we’re obviously very happy that you guys raised guidance. You’ve got some people out there though that are now concerned how much visibility does the company really have to feel comfortable raising revenue guidance in a market like this where there’s obviously all the concerns about housing and all the concerns about non-residential construction.

I was just wondering if you could just share with us the confidence in the pipeline that you are seeing in terms of being able to raise your guidance level for the next quarter and for the fiscal year. Thank you.

Carl Bass

In some ways, Heather, our actions kind of speak for themselves. We carefully considered it. There’s no doubt that the financial markets are volatile now. The equity markets are volatile. There’s a lot of movement going on out there. There’s no doubt about it. There’s a lot of anxiety.

The interesting thing is that from our point of view, it continues to remain financial rather than economic and it hasn’t really translated into anything we’ve seen in our business. I would go back to also remember the diversification of the business and so while -- just to pick on a couple of issues, one, we’ve gone out of our way to try to say that even in the best of times, residential construction has nothing to do with our business. The non-residential obviously does.

I think the place at which these external concerns might manifest themselves in terms of our business are things like if the credit crunch, if they are raising interest rates to the point where they start effecting project starts, new product development. At that point, I would suggest we are in a much more difficult economic environment than even people, even than some of the bears are suggesting today.

I think we have a long way to go to that point but right now, our customers have a full pipeline of work. We double-checked and triple-checked our internal pipelines with our sales guys. We tried pushing them off the pedestal. We were unsuccessful. They remain very confident. We checked with our reseller community. They remain confident. We did this with our eyes fully open.

Heather Bellini - UBS

And then just one follow-up, the ADI index for people who look at that in terms a look at non-residential construction, is that something that you monitor at all in terms of looking at the point where projects start and product might get impacted?

Carl Bass

No, you know what, we don’t look at it at all. I think our best indication is certainly through our clients, which in many ways, design projects, the design part of the project starts much earlier and so we see these design projects and in some ways, we’ve always imagined we should be a leading indicator because some of the design projects are in the works for two to three years before they actually turn into a construction start. What we have seen from architects and engineers is that the pipeline continues to be full.

The other thing that’s interesting is, I mean, as we’ve dissected this a little more, there are sectors of the non-commercial market that are affected by things like credit rates, so interest rates do matter. There are others, like some of the institutional stuff, some of the government stuff, universities, that are going to continue to build not willy nilly but are not very much affected by the day-to-day economics.

Heather Bellini - UBS

Great. Thank you very much.

Operator

Thank you very much, Madam. Ladies and gentlemen, your next question comes from the line of Sasa Zorovic of Goldman Sachs. Please proceed.

A. Sasa Zorovic - Goldman Sachs

Thank you. My question would be regarding Europe. You mentioned that it was I guess overall sort of a strong performance across geographies. That was one that was potentially sort of the weakest and I guess 10% growth in terms of constant currency. So what’s really going on there? What is driving that?

Carl Bass

I think one of the things when we look at Europe is that we think Europe is going to be really strong in the second half of the year. We pointed that out. I think it will have a growth rate that is comparable to what is going on in the rest of the world. Not the emerging countries, of course, but we think it will be comparable I think in some of the artifacts of it being Q2, summer, new product introduction, crosses the boundary into Q2 for our localized language products. But we are confident about the second half of the year in Europe.

A. Sasa Zorovic - Goldman Sachs

Okay, then my follow-up would be regarding competition. You mentioned SolidWorks. How about Solid Edge in particular, after they have been bought by Siemens? Or Parametric, for that matter? Could you tell us a little bit more sort of how your winning market share really kind of differs across these competitors?

Carl Bass

Generally speaking, the company out there, there’s Dassault, there’s USG, now part of Siemens, and Parametric. I mean, the simplest thing to look at is just look at the growth rates to see that we are gaining market share. Over the last couple of years, the product that has been the most competitive has been SolidWorks. That clearly slowed down this quarter.

As we’ve talked about, when you look at the other vendors and their CAD products, that tends to be one of the weaker parts of their portfolio, both in terms of investment and development and certainly from growth rates. If you were to take most of the other CAD products out in the market, it would probably be in low single digit rates. And we have growth rates for comparable products or mechanical design products, 20%, 30% kind of growth rates.

I think it really is this -- our product is in the sweet spot of its life. It’s a mature product. It’s very capable. It’s very compatible with our other products, as well as we are one of the companies out there that offers a complete solution for manufacturers.

I think we have the right product offering, the right product, the right time, it’s on the right platform and then it comes down to execution. I think a number of other companies have a number of challenges across the board.

A. Sasa Zorovic - Goldman Sachs

Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Philip Alling of Bear Stearns. Please proceed.

Philip Alling - Bear Stearns

Thanks very much. Last quarter you gave a little visibility with respect to the penetration of subscription into the AutoCAD base. Could you bring us up to speed in terms of where you think the penetration is now and just maybe speak to your comments as far as a slight deceleration in growth of your maintenance revenues going forward? Thanks.

Carl Bass

Again, we won’t update you specifically on penetration, and again that’s something we’ll do on an annual basis, we’ll talk about the rates. Really just an extrapolation of what’s going on.

I think the only thing we were trying to get at with the subscription growth rates, because subscription obviously is continuing to be larger, it’s just that we think as the base gets larger and larger, you are going to see deceleration in the rate of growth. And so it’s really kind of the law of large numbers that we are seeing going on there.

Alfred J. Castino

The other thing I would add to that is growth of 27% is very consistent with growing the business 15% to 17% for the year. So the prior year numbers, we were growing in the low to mid 20s for a couple of years and a number of these ratios just don’t look the same when we talk about things like 15% to 17%.

Philip Alling - Bear Stearns

I understand. Okay, Al, if you could also do me just a -- you had in your comments given some visibility into what the growth rates may have been for 3D had you not made the change in incentives and last quarter, you actually talked about the impact on the 2D side as well. What was the impact on your reported 2D revenues from the change in incentive, with the lower incentive payments on those particular products?

Alfred J. Castino

That’s not anything for us to estimate six months into it. In general, we think there are several points of growth that would have been in 3D if we hadn’t lowered, in fact lowered the unit price but as we get further into it, there are offsets from volume too and from incentive, so we are not really able to estimate that precisely anymore.

All I can say about the incentive plans is they are clearly working. We are getting 3D and the vertical 2D doing really, really well and the focus is moving. And even though it can be lumpy across particular resellers or regions, it is clearly working. I expect it is going to do even better in the second half.

Philip Alling - Bear Stearns

Okay, and just a final question for me then, with respect to cash balances. At the analyst day, you had talked about maybe $500 million in cash as the level that you would like to have for the business going forward. You did make some comments about share repurchase, primarily to offset option dilution for grants to employees. Any likelihood of share repurchases in excess of offsetting option grants and what could you share with us on that point?

Alfred J. Castino

Well, that actually happened in the second quarter. So we bought back 2 million more shares than options were exercised.

In terms of the optimal cash balance, you’re in the ballpark. Basically I was referring to prior cash balances for the stock option review, and of course we’re larger now than we were then but somewhere in that range is just what we need. Over the next several quarters, I expect to trend down to that level. We are not going to do a big splash and do it all at once but over the course of several quarters, we’ll get back to where we belong on the cash balance.

Philip Alling - Bear Stearns

All right. That’s all I had. Thanks so much.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Brendan Barnicle of Pacific Crest Securities. Please proceed.

Brendan Barnicle - Pacific Crest Securities

Thank you so much. Al, I was wondering if you could give us a sense on any of the revenue contribution side from NavisWorks, Opticore and Skymatter?

Alfred J. Castino

Well, if you are talking about the second quarter, next to nothing. If you look at the full year, it’s not very large. We are buying these companies not for revenue. This is very typical for us. We’re buying technology, we’re buying some great people. This helps us get to market more quickly with important functionality but we are not buying much in the way of revenue.

Carl Bass

Just to be clear, the Opticore and Skymatter have not closed.

Brendan Barnicle - Pacific Crest Securities

Right, but as we look out, I’m trying to figure out if it has any impact on the guidance, or is the guidance reflective of organic growth, so anything from those acquisitions would be additional to that guidance.

Carl Bass

Yes, but as standalone companies, they have very, very small revenue streams.

Brendan Barnicle - Pacific Crest Securities

Okay, and then Carl, as we see 3D reaccelerate this way, do you think you are at a point or will get to a point where we see an inflection point in 3D? I know you’ve talked about it in the past in terms of getting a certain amount of the installed base over to the 3D and then seeing more rapid acceleration.

Carl Bass

You know, I find it hard to see the catalyst for a real inflection point. I think this is just something that continues over time. Where I’ve been willing to stick my neck out is that I think the move to 3D for almost all of our customers is inevitable. I’ve been less willing to say that there’s some inflection point, some tipping point at which it goes faster.

I continue to see steady growth here. I do think an emphasis by our channel partners on it will certainly accelerate the rate but I’m not sure you will see a dramatic change in the penetration curve.

Brendan Barnicle - Pacific Crest Securities

Great and the just lastly, Al, on your comments about subscriber growth, is that 27% that you are talking about, is that what we should normalize for the remainder of the year, somewhere around that range?

Alfred J. Castino

We’re not doing a specific forecast for subscription growth but our point is more modest, more moderate growth than we’ve seen in prior years. You’re in the ballpark with that number but we are not going to do a precise forecast for subscription.

Brendan Barnicle - Pacific Crest Securities

Great. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Steve Ashley of Robert W. Baird. Please proceed.

Steven Ashley - Robert W. Baird

I think, Al, you mentioned that you had removed a couple of products from the subscription offering and via subscription. If that’s correct, could you tell us what those products are and maybe some color around the reasoning around that?

Alfred J. Castino

They’re really small products, like Designer Views, Civil Services, and the reason they were removed is they weren’t any traction and it was clear that given the product lifecycle of those products, this is not the time to start a subscription offering, or even try to build a subscription offering, so that’s why.

Steven Ashley - Robert W. Baird

Okay, great. And the deal registration program, have you started to expand that and where are we with that, and what kind of status? Thank you.

Carl Bass

The deal registration program has been expanding. We think it is a good program and it was a necessary component that really complemented some of the incentive program changes. Basically what it enables a reseller to do is to make sure that no other reseller comes and undercuts them based on price alone after investing in a longer sales cycle, which typically these 3D sales can take longer and it requires more investment on that part and we didn’t want to encourage people coming in and kind of bottom fishing at the last minute.

Steven Ashley - Robert W. Baird

Great. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Brent Thill with Citigroup. Please proceed.

Brent Thill - Citigroup

Thanks. Carl, you mentioned you are seeing the desired impact from the partner channel on some of the incentive changes. I think every one of us on the line that has done some of those checks have heard some of the push-back at least in the channel and I’m just curious to get your take in terms of do you just feel this is temporary push-back and that they need to change? And regarding the lumpiness of some of the changes, what do you think is required to help them through this? What’s the next step for you guys to give them to make their way through this so that we’re not getting that type of feedback from the reseller channel?

Carl Bass

I can’t in the years I’ve been associated with the company, I can’t think of a single channel change that got a warm reception. It is one of those difficult things in which a business model change goes into effect.

I think what you guys tend to here from other people who have time to grumble, some of the others are outselling -- you know, in many ways, Brent, if you look back on this, this is a change that we signaled to our channel partners starting about three years ago.

Many in the calls to me said finally, you know, we’ve been waiting for this. Many of them, the ones you didn’t talk to, would’ve been grumbling the other way. I’ve made these changes, where’s my reward for making these changes?

And so I think what you are hearing from is the ones who move slower. If you look at it in terms of the amount of money our channel partners are making, it is pretty close to a zero sum gain. So for every one who is grumbling, there’s somebody else who is celebrating.

I think also when you look out there and you see the investment that our channel partners have made in the future of their businesses, they recognize that there’s a good opportunity out there as well.

So I think for many, it’s just a question of continuing their move over. It will take place over a period of time but there is no less money being given to channel partners, which is the important thing to remember, as a result of this.

Alfred J. Castino

The other thing to keep in mind is it is very difficult for you to get a good sample when you do these reseller checks. We have thousands of resellers and all of the reports we see from analysts are based on talking to a very small number. I think there is a bias on who you get to. As Carl indicated, the ones who want to grumble are more likely to want to talk to you than the ones who are doing well. That’s a problem --

Carl Bass

I mean, I think the other thing out there is the people who send thank you gifts with a bottle of wine is one thing. Once you are starting to offer thousands of dollars to resellers to talk, you are starting to really bias the sample in a bad way.

For what it’s worth, you should recognize the two problems we’ve seen is a real bias sample that you get as a result of paying. The second thing we’ve seen as a problem is in terms of the questions and trying to correlate their quotas to our guidance, in which there is not enough information to really make that connection. So the combination of the two has caused a number of people I think to be misdirected.

Brent Thill - Citigroup

Okay, just as a follow-up, on last year’s number, you grew 20% on total revenue growth. I think your new guidance implies 16% to 17% and it almost feels like last year you were aided by Alias. This year it feels like -- is it fair to say you feel your core is stronger than maybe even last year?

Carl Bass

It appears like it. If you do the math and about five percentage points came from Alias, it really was an organic growth rate last year, 14, just over 14%. This year, there’s almost -- I mean, there’s almost none -- there’s no inorganic growth in there, and so yes, it is a stronger year.

I mean, generally speaking, we think the core business is stronger and we think some of the other investments we made in R&D, some of those small technology acquisitions from previous years are starting to contribute.

Alfred J. Castino

And our competitive position is improving year by year. I think we are seeing that too.

Brent Thill - Citigroup

Thanks.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Peter Kuper of Morgan Stanley. Please proceed.

Peter Kuper - Morgan Stanley

Thanks. I think we’ve beaten the channel question to death, so I’ll just scratch it off the list here. Just turning to the model and a very simplistic question now; it looks like expenses are fairly moderating here. We’re seeing kind of a lift, easy gains that we could have from G&A, given the conclusion of option investigation, things of that nature is one thing in the model I was wondering could pick up a couple of basis points. But as you guys are really starting to dominate here, given 3D showing some good strength, what other leverage points might we see as the mix shift continues to evolve here with the product lines?

Alfred J. Castino

We are going to continue to raise our margins modestly year by year and we are doing that while we are investing for growth, so keep that in mind.

We see more productivity gains than you see because what you are seeing on the income statement is the productivity gain less the investment we make when we go after growth. But with that said, what I look at as a base for activity before we make investments, there’s room to grow every area on our income statement, so that includes gross margins, which are continuing to get better every year. Part of that is mix, part of it is productivity, the people in media and entertainment have done a great job on advanced systems. Scale in general is helping us across all of the different expenses, including gross margin.

When I look at sales and marketing, more of the same. We’re getting more productive every year. That’s certainly the area where as we grow the revenue, we always need more feet on the street to sell. But even at that, we get more productive as we do the channel plans, the incentive plans to help us to get more productive.

And then as I look at G&A, we definitely benefit from scale. We benefit from a number of productivity initiatives we are still driving in the company. And then R&D continues to benefit from just doing a great job in managing distributed R&D across the world. That allows them to get great engineers at reasonable prices and that’s helping us get more productive there too.

And of course, R&D and marketing always benefit tremendously from scale. As products like Inventor and Revit get larger, we don’t have to increase the R&D and the marketing investment in proportion to that.

So I look at the income statement, there’s room for productivity in all the areas. What you will see though is a modest improvement because you see it after we make our growth investments.

Peter Kuper - Morgan Stanley

Okay, and the Carl, in line with that, 3D seems to be getting to be I would say dominating. It might be a little early to say that but as you are taking on the visualization world as the leading brand, et cetera, is the ASP lift there? Are you guys seeing less pricing competition now as people are saying look, this pretty much is now the new standard again and your competition has a harder time competing on price?

Carl Bass

What we’ve seen in this market is generally speaking is stable ASPs. I think broadly speaking and across geographies, across products, you see stable ASPs. There are certainly parts of the world where it is more competitive. Some of our competitors are discounting heavily in order to get deals in parts of the world, so it’s a little bit more singular, as you look at individual things. But generally speaking, we see stable pricing.

Peter Kuper - Morgan Stanley

Great. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Daniel Cummings of Bank of America. Please proceed.

Daniel Cummings - Bank of America Securities

Thanks. Looking at the high 20s percent growth fiscal year-to-date in manufacturing for revenue, despite some I guess mild Inventor seat shipments, can you talk about that a little bit in terms of that gap? Or alternatively, just describe for us what’s going so well in manufacturing away from the 3D technology. We’re just curious if any competitive dynamics for Inventor, are they markedly different by global region? Thanks.

Carl Bass

I think when you look at manufacturing, all of our products are doing well. Inventor is doing particularly well. I think you can also look at a shift within Inventor. There’s more Inventor Professional being sold, which includes higher functionality that’s a different price point, both on the new unit price as well as on the subscription price. So there’s a little bit of mix shift built into the Inventor, but Inventor is doing really well.

On a competitive basis, we continue to believe we have the best, most comprehensive product on the market and we are doing well there.

Clearly it is one of our most competitive markets. When you look out there on a regional basis, or by segmentation of the manufacturing industry, you see different kinds of competitors. You know, whether you look at consumer products in a certain part of the world, you would see a different competitor than if you looked at heavy industrial machinery in another part of the world. But we think we are well-positioned to compete in that market.

In addition, remember we have a complete portfolio of products that go all the way from conceptual design to mechanical drafting and detailing, as well as our electrical products, and so we have a nice portfolio and those are all growing. So it’s probably a more robust portfolio than many of our competitors offer, but the flagship Inventor continues to be producing great results.

Daniel Cummings - Bank of America Securities

Can I ask a follow-up? I noticed it seems as if the compares could get a little tough here in the second half of the year, specifically for the Inventor seat shipments. So if they are negative, it could well be due to mix?

Carl Bass

Again, there’s some mix and for whatever reason, the linearity, certainly on a seat basis in our Inventor product line, has always been more weighted. It’s not as linear as our other products. It’s more heavily weighted to the back end of the year. If you look back over any number of years, you’ll see that trend. I would expect the same one but I feel confident about our ability in the Inventor market.

Daniel Cummings - Bank of America Securities

Thank you.

Sue Pirri

Operator, we’re running over time so we will take one more question.

Operator

Okay. Our last question will come from the line of Victor [Churamani] of Lehman Brothers. Please proceed.

Victor Churamani - Lehman Brothers

Just two questions; one, Al, are we still comfortable with the 15% long-term growth rate that you guys gave out at the analyst day? And then also, when you look at it from a -- when you look at the margins, you guys are exiting this year with about a 200 basis point improvement, and you’ve commented in the past that is the sort of improvement that we should look for going forward. Is that something also -- you are still maintaining that or is there any change in that plan? And I have one follow-up.

Alfred J. Castino

We are comfortable with the 15% company annual growth rate long term. We have a lot of runway ahead of us and you are continuing to see that this year.

In terms of margins, we have been talking about 1%, 1.5% a year. That’s still our target, so we will gradually raise our margins. We feel we have a -- again, we have a lot of runway and we want to make the growth investments to take advantage of that. That’s why we are modestly improving our margins.

Victor Churamani - Lehman Brothers

Okay, and then just on the 3D side of the equation, you mentioned you raised prices in the middle of the quarter, I believe. Why was that the case and how much was the price increase and when was a similar sort of increase done in the past? And then just to follow-up with that thought, you also had some sort of a headwind this quarter because of that. What gives you the confidence that going forward you won’t see that, since you are raising your numbers for the forward quarters? Thanks.

Alfred J. Castino

We actually didn’t raise prices. What we were referring to is the channel incentive plans that we changed at the very beginning of the year, and in effect what we did is we lowered the unit price to us for 3D, which means we left the dealers with more margin, and we do the opposite on 2D, so they wind up with -- the resellers wind up with less margin selling AutoCAD and they get more margin selling the vertical 2D and 3D. That’s what we are referring to. It happened at the beginning of the year and whenever you make a channel change like that, it gradually works it way through the resellers, so they take time to react to it. Those are the dynamics we’ve been referring to. We actually haven’t changed prices in terms of the suggested retail price this year.

Victor Churamani - Lehman Brothers

Sounds good. I might have misheard. Thank you very much.

Sue Pirri

All right, everyone, we are going to wrap up here, as we’ve run over in time. Al and Katie and I will be available for calls later this afternoon, so feel free to give us a call in the office and we’ll be happy to take your questions. Thank you for joining us.

Operator

Thank you very much, Madam. Thank you, ladies and gentlemen, for your participation in today’s conference call. This concludes your presentation and you may now disconnect. Have a good day.

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Source: AutoDesk F2Q08 (Qtr End 7/31/07) Earnings Call Transcript
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