Autodesk Inc (ADSK) — Q4 2016 Earnings Call Transcript

Thanks, operator. Good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter and full year fiscal 2016. Also on the line is Carl Bass, our CEO; and Scott Herren, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of this call will be available at autodesk.com/investor. As noted in our press release, we have published our prepared remarks on our website in advance of this call. Those remarks are intended to serve in place of extended formal comments, and we will not repeat them on this call. During the course of this conference call, we will make forward-looking statements regarding future events and the anticipated future performance of the company, such as our guidance for the first quarter and full year fiscal 2017, our long-term financial model guidance, the factors we use to estimate our guidance, including currency headwinds, expectations regarding our restructuring, our transition to new business models, our market opportunities and strategies, and trends for various products, geographies, and industries. 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, specifically our Form 10-K for the fiscal year 2015, our Form 10-Q for the periods ended April 30, July 31, and October 31, 2015, and our current reports on Form 8-K, including the Form 8-K furnished with today's press release and prepared remarks. Those documents contain and identify important risks and other factors that may cause our actual results to differ from those contained in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will provide guidance on today's call, but we'll not provide any further guidance or updates on our performance during the quarter unless we do so in a public forum. During the call, we will also discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of our GAAP and non-GAAP results is provided in today's press release, prepared remarks, and on the Investor Relations section of our website. We will quote a number of numeric or growth changes as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-on-year comparison. And now, I'd like to turn the call over to Carl.

Thanks, Dave, and good afternoon, everyone. Let's start by wrapping up Q4, then I want to take a few minutes to talk about long-term value creation for our shareholders and then we'll end with guidance. As you saw in the press release, we had a terrific fourth quarter and our results demonstrate that our business model transition is working. The end of the fourth quarter marked a key milestone in Autodesk's transition to our software as a service business as we hit the end of sale for perpetual licenses for individual products. While the end of sale went well, what makes our Q4 results particularly good is that they were not driven by a dramatic surge in last opportunity buying of perpetual licenses. In fact, our analysis suggests that only a small portion, around 10% of our Q4 unit volume is related to end of sale activity. More importantly, strong subscription growth, both new model and maintenance subscriptions, and a record number of large transactions drove these results. Our total unit volume for the fourth quarter was flat compared to the fourth quarter last year, which was a major accomplishment. Recall that in Q4 last year, we had a significant uptick in demand related to the end of our upgrade program; in other words, we were able to cover last year's Q4 uptick in unit volume with our new model subscription offering. When we look at total unit volume for the year, we were pleased to see volume of approximately 650,000 licenses. The total number of subscription additions for the quarter was better than expected at 109,000. As we've seen all year, the additions were led by new model subscriptions with strong growth in all three types: desktop, enterprise, and cloud subscriptions. Desktop subscription remains our fastest-growing new model subscription offering and grew nearly 300% year-over-year. More specifically, desktop subscription is thriving with our channel partners. In just the past four quarters, the channel volume with desktop subscription has increased by more than 400%. In Q4, approximately 65% of our desktop subscription volume came through our channel partner, which is up from less than 50% in Q4 last year. What's also notable is that we achieved our highest quarter for new model subscriptions for the year, and it was the highest ever in terms of organic new model subscription adds in the same quarter that we hit the end of sale for perpetual licenses for individual products, a remarkable achievement. For the year, we added 50% more new model subscriptions than maintenance subscriptions, even as maintenance attach and renewal rates moved to record highs. The growth in new model subscriptions fueled 74% constant currency growth in new model ARR. Total recurring revenue grew to 53% of revenue compared to 47% in the fourth quarter last year. We're also pleased to see the unit volume through our eStore grow stronger. We believe that our online business will continue to grow meaningfully. When you add in the business we do directly with enterprise customers, our overall direct business reached 21% of our revenue volume compared to just 17% and 16% for the past two years. We set a record for the number of large deals in the quarter overall, a 19% increase in total deal value. The majority of these large deals were flexible enterprise licenses or EBAs, which are helping drive subscription growth. Specifically, existing enterprise customers that moved from one of our older license agreements to the new Token Flex EBAs have resulted in subscriber growth three times higher than before, that's pretty meaningful. Just as a reminder for those of you keeping score at home, the new Token Flex EBAs that we signed up this quarter, over 20,000, won't start to show up in accounts until next quarter. Large enterprise deals signal that we are becoming a more strategic and essential partner to our largest customers. Our long-term vision and position as the thought leader in the industry is an essential part of their commitment to us. To summarize, Q4 provides a nice proof point that the business model transition is working for our customers, our partners, and us. I couldn't be happier with the results. Now, that we've covered the past quarter, let me turn to long-term value creation. Given the short-term impact that the model transition is having on our traditional financial metrics, the recent turmoil in the stock market, growing fears about a global macroeconomic slowdown, and the noise created by investors focused on the short-term, I think it's worth stepping back and taking a few minutes to outline how we are creating long-term value for our shareholders. First, we are dramatically increasing the lifetime value of our customers with our new business model. While this creates short-term downward pressure on our traditional financial metrics, we have repeatedly called out how it creates significant financial returns over the next three to five years. Second, we're simplifying our entire go-to-market strategy to align with the concept of being an all-subscription company. This involves a significant increase in our direct customer sales and marketing efforts, both at the enterprise level and through e-commerce. Not only will it change the cost structure, but it will greatly increase how effectively we serve our customers. And third and most importantly, we are exploiting the cloud to deliver more compelling products to our current customers and dramatically expand the size of our market opportunities. Our early investment in cloud-based design and engineering tools has given us a once-in-a-generation opportunity to lead both the construction and manufacturing software market. Mainstream mobile and cloud technologies have opened up a market with more than 100 million potential subscribers. We have made substantial investments to achieve our leadership position, and let me be as clear as possible: the technology platform for the future, for all design and engineering software, is now really all software in the cloud. The company that wins will have substantial and sustainable long-term advantage. To summarize, our framework for building long-term shareholder value is to increase the lifetime value of every customer, change our cost structure, the means by which we reach customers, and finally, build the best cloud-based products and services in the industry. So while generalities are important, let me specifically highlight recent activity in terms of these long-term objectives. Most importantly, our business model transition is underway and exceeding expectations. By the second half of this year, we will fully be in a subscription-only mode. Customer and partner reaction to our new business model has been very positive, which gives me great confidence about our approach to the transition. Next, we continue to diligently control our costs. In Q4, we kept savings flat year-over-year. We recently did a sizable restructuring that balances the need for financial discipline with an ability to invest in critical initiatives that drive the long-term health of the company. In September, we discussed annual operating expense growth to be around 5% to 6%. The restructuring combined with other cost-cutting measures has allowed us to put a significant cap on spending for the next two years. We're committed to keeping spend growth roughly flat to slightly down through FY 2017 and FY 2018. Finally, our cloud-based products are the undisputed leaders in their respective category. While many people are focused on the business model shift, winning the leadership position in the cloud leads to a long-term sustainable competitive advantage. Building a great company over the long term aligns the interests of shareholders, employees, and customers. Done well, these are not mutually exclusive. Though it's easy to talk about, it's harder to do, and I am very proud of the many awards we received that recognize our success in doing just that. A few in particular worth mentioning are we were selected for Fortune's World's 25 Best Multinational Workplaces, Fortune's 100 Best Companies To Work For, and we are in the top five of Fortune's Most Admired Software Companies. We were also given countless awards for innovation and product leadership. Now bringing it all together, we are updating our long-term cash flow mark. As we look to FY 2020, assuming that the number of outstanding shares remains constant, we will be able to produce about $6 of free cash flow per share. In the following years, free cash flow continues to dramatically increase, and we see a path to free cash flow that exceeds $2.5 billion or more than $11 per share of free cash flow by FY 2023. As you are aware, our cash flow generation this year and next year will be impacted by the transition from perpetual to term-based licenses. The silver lining is that we now have an opportunity to switch to a new operating structure to support our business needs. This change will result in an increase in our U.S.-based cash while lowering our long-term tax rate. This will greatly help with the long-term structural imbalance of ongoing revenues and cash flows as we move through the business model transition. We will give you more details during this year as our plans materialize. As we turn to fiscal 2017, we couldn't be more excited about entering this next phase of our business. This year will be the most unique in the company's history as we complete the transition from perpetual licenses to cloud-based subscriptions at the end of Q2. It'll be an interesting and unique quarterly pattern. None of the traditional seasonality patterns for sales metrics will be applicable, nor will year-over-year growth rates of traditional financial metrics be helpful in understanding how we're performing through the transition. Q1 will be our first quarter with only subscription offerings for individual products. We have a number of sales promotions in place to accelerate our customers' move to cloud subscriptions. As you think about Q1, the best result for us would be to be higher on subscriptions and lower on revenue. Now, this may seem counterintuitive, but in fact, it would result from an accelerated transition to desktop subscriptions. The end of Q2 will be the next major milestone of our business model transition as we stop selling perpetual licenses for suites. We expect the dynamics will most closely resemble what we saw in Q4 with the end of sales for individual products. Q3 will be our first quarter of subscription-only sales across the board and we'll likely experience a sequential slowdown. Q4 should begin to show more normal sales trends in our new subscription-only model. In our view, the better metrics for tracking our progress over the next few quarters will be subscription additions and ARR growth. The entire company has been realigned and is hyper-focused on subscription additions and growth in recurring revenue. We have put in place both the processes and incentives, such as new sales compensation and bonus plans, to align with our goal of growing our subscription base by a 20% CAGR over the next four years, which will drive a 24% CAGR in ARR. Many of you have asked about the impact of the macroeconomic environment on our business. We've said for the past several quarters that the global conditions have been uneven. Most of the emerging markets have been a mess, but most of the mature markets have been decent. As we evaluated our strong Q4 results, we didn't see any further degradation in the demand environment. However, there's no denying there is clear divergence in sentiment with regards to global macroeconomic conditions. Coupled with the uniqueness of this year, our forecasting process has never been more challenging. As such, we believe it's prudent to take an appropriately conservative approach to our outlook for the year, while remaining confident in our ability to achieve our long-term targets. For the year, we're projecting to add approximately 500,000 subscriptions, with new model subscriptions contributing the vast majority of the growth. As expected, this will be the year where the transition causes the biggest revenue impact as we move more fully into the subscription model. On the earnings call last quarter, I talked about 1% to 2% spend growth for FY 2017. Given that our typical annual spend increase starts at about 4% just from American healthcare costs, et cetera, some cost actions were already factored into our guidance. I've spoken repeatedly about reducing our spend growth, while staying the course with the investments required to make both the business model and platform transition. Examples of the investments include building out a low-cost high-touch inside sales team or in building out our cloud platform products. We are conscious of the impact that cutting spending too much or not reducing it enough could have on the rate and ultimate success of the transition. We believe our current course of managing spend growth flat to modestly down for FY 2017 strikes the right balance, and as I previously mentioned, we will maintain flat growth throughout FY 2018 as well. We aren't updating the entire framework we laid out at the Investor Day last September, but there are a couple of data points that should help you with longer-term modeling. As I said earlier, with the updates to the model overall, we see FCF per share of roughly $6 in FY 2020, given our current view of top-line growth and our spend trajectory. Our revenue projection for FY 2017 is slightly lower than the framework we provided in September for a few reasons: continued FX headwinds are pushing revenue down, we're assuming a higher mix of new model subscriptions based on our recent performance, and as I mentioned earlier, we're taking a more conservative stance given all the moving parts this year. Similar to our view on Q1, hitting the low end of our revenue range while exceeding our subscription guidance is a desirable outcome for the year. If we experience greater than expected demand for the last perpetual licenses for suites, it will likely drive the revenue to the high end of guidance or beyond. To wrap things up, we're really excited to be one step further along in the transition; our long-term strategy will provide our customers with greater flexibility, more compelling products, and a better user experience. In doing so, we're driving higher life-time customer value, simplifying our go-to market, and significantly increasing the size of the available market. Simultaneously, we are reducing our cost structure to accelerate our transition and increase our profitability, as well as evolving our operating and tax structure to better meet our future business needs. In short, we are creating a more predictable, recurring, and profitable business for Autodesk in the years to come. Finally, I'd like to thank all of our employees and our partners who worked so hard to make last year a success.

Hi, yeah, thanks, guys. I mean, congrats on a great, great quarter, and Carl, I really appreciate that update on the outlook; it certainly is impressive on the cash flow metric. So it's clearly above your old guidance and above where we were. When you look at those cash flow long-term targets you gave up there; I know you're not updating the whole framework, but it certainly implies and feels like margin solidly ahead of what you talked about at the Analyst Day and obviously you talked about in fiscal 2017 and fiscal 2018 on the cost side, I wondered if you'd give us just sort of how you're thinking about the framework of margins kind of in that long-term guidance, and then from a top-line perspective, sort of how you're building up there, obviously not giving the full detail that you guys talked about? Then just one quick follow-up to that.

Yeah. So, let me just quickly touch on it, and Scott can jump in. Most of the update to the guidance was not a change in the overall demand, so let's just put that out there. Assuming the same level of demand, we were pleased in Q4 to see greater demand, but no difference in demand from when we talked about the model. A lot of the upside is driven by greater cost control, which relates to the stuff we outlined for FY 2017 and 2018. It is advantageous to start from a lower cost base. Many of our investors said that they understood the transition and loved the outcome, but they wanted us to control costs better through this transition. So that's where we focused. The other slight shift is that we're more optimistic about the move to the new model; we've seen more positive signs of acceptance by both customers and partners. Remember, some of our reluctance to move more quickly was to ensure acceptance from both groups and their ability to navigate the transition successfully.

Yeah. And Phil, this is Scott. The only other thing I would add is that the framework we laid out is not intended to be updated every quarter. As you roll through the changes we've talked about in spend growth, it does not step function up after fiscal 2018. It takes a while for the spend engine to accelerate again. We do see margins expanding. I think what we showed in the 29th was in that mid-to-high 20% range in fiscal 2020 and it's probably a good 4 points to 5 points higher than that given what we just talked about in spending.

Great. Well, I was at $8 to $9 on free cash flow, so I'm a big fan of your $11. So, one last, just follow-up on the quarter itself. You guys talked about the quarter's strength was not driven by the end of sale of licenses for some of the products. Carl and Scott, I wonder if you'd talk through just the verticals and geographies, sort of what areas were standing out as particular areas of strength, and then how are you thinking about that in terms of your guidance?

Yeah. I mean we – so a couple of things about geographies. Let's start with the geographies, because it's really clear. Every emerging economy, developing country, has struggled. The exception for us was China. Despite what you may have read, China continues to perform well, but there are places where our business in emerging markets has tanked. The Middle East, Russia, which are largely driven by oil, and Brazil are not performing well. So when you compare geographically, our EMEA results look weak compared to others. EMEA had a fabulous fourth quarter last year, but the MEA part really struggled, mainly due to oil and commodities. So the geographic part is pretty straightforward; I think it reflects trends others have noted. On the flip side, China's fared better than anticipated. The only weak part of the developed world is Japan, which has been struggling for a while with currency issues but didn’t see any notable demand changes. Overall, markets in construction and manufacturing, as well as media and entertainment, all performed well and there wasn't much difference to highlight.

Yeah. I agree with that. And by the way, what we mentioned earlier about emerging markets is consistent with what we've seen all year. We saw China actually being a bright spot for us in the emerging markets, while Russia and Brazil have really struggled year-on-year. I would also say there was strength across the board in Q4 with large transactions, driven heavily by our EBAs, with a very strong quarter, including several eight-figure deals.

Hi, guys. Thanks for taking my questions here. Carl, you talked last quarter about selling anywhere from 500,000 units to 800,000 units in a given year, and I think you said that it was about 650,000 units this year, correct me if I'm wrong. You've given us the subscription component of that with the subs guidance for fiscal 2017, but just normalizing for all the noise in 2017 how do you think about unit volume for fiscal 2017?

I think, unit volume will be up, not a huge amount, but up. One of the tricks we have in forecasting relates to Q1 and Q2 in particular; even extending into Q3, it’s hard to know which way people will go. We’re trying to triangulate from what we're hearing from our partners, from sales teams, using top-down models, and extrapolating trends, but it's difficult to predict, and that’s why we have a slightly broader range in guidance. Our bias is to transition our customers to the new model as quickly as possible. We may seem counterintuitive, but I wouldn’t mind seeing revenue down; it would mean we are accelerating the transition to desktop subscriptions.

That makes sense. And for my follow-up. I'm not sure if this is for Carl or Scott, but one of the difficult things to model externally is the ARPS number particularly around new model ARR. Any steady-state basis, in Q3, Q4 and beyond, based on the historical mix that you've seen of historical volume and subscription pricing, what's a fair range to think about new model ARPS in kind of a steady state, if that makes sense?

Yeah. I understand that metric can be difficult, Saket. The key is what Carl said earlier, we're geared to drive subs and ARR. The focus is on those numbers, because the more we drive subs and specifically new model subs, the stronger our model becomes in the long term. As for ARPS, considering that the fastest growing segment is the desktop business, which drives new model subs, the lower-end products will obviously put downward pressure on ARPS. The nature of our ARR calculation, which is a multiplication of quarterly recurring revenue, can also throw off ARPS.

Just in general, I would expect ARPS to increase slightly this year due to more robust offerings. However, our lower-cost products like LT will put pressure downward on that, just as many of the cloud subscriptions, which are individual design and engineering products, will likely also exert downward pressure on the average cost per subscriber.

Yeah, thanks. Scott, the comment you made in the desktop segment about the lower end really driving the subscriptions at the moment, do you think that's just a matter of who is interested in adopting first, and will we see that mix change over time, or is there something about the subscription format that's going to drive users more towards a lower-end product versus some of the higher-end products?

It's just that we introduced it first.

Exactly right. There's nothing inherently advantageous about a subscription for LT over one of our flagship products. It’s simply that it’s our highest-volume product and the nature of our sales cycle reflects that.

We focused on LT first because we were concerned that flagship product customers would be comfortable with new models, but LT users might be reluctant. We've invested to ensure that it goes smoothly.

Got it. And then as a follow-up, you mentioned a couple of times the good results in terms of large deals. Was there anything in particular that drove some of those deals in terms of the timing, whether it was year-end budget flush or particular problems those customers were trying to solve?

I think a couple of things happened: some short term, some long term. One is there has always been seasonality to our large enterprise deals, influenced by end-of-year budgets. Our fiscal year aligns with many of our customers, so Q4 has a stronger influence by virtue of this. Over several years, we have built out a focused salesforce to cater to this market segment, and our changing licensing model has better served the needs of these customers, paving the way for larger transactions. As we shift our strategy towards enterprise offerings, I believe the results showcase our growth potential in that sector.

Got it. Thank you.

Great. Thanks, Carl, for taking the question. I just wanted to ask you about your maintenance ARR, which declined in the quarter, and I guess after you canceled suite licenses at the end of the second quarter, should we expect declines in the maintenance ARR to accelerate?

Yes, you absolutely should count on maintenance ARR going down after the end of Q2.

I wouldn't say accelerate is the right term, but as we sell our last perpetual license, we will be seeing a decline in maintenance subscriptions consistent with our churn rate. A lot of maintenance is in deferred revenue. It won't come off quickly from reported revenues, but will decline over time and be a headwind in the second half of the year.

Okay. And then the follow-up question, I guess there's actually two quick ones. Your new model ARR increased by about $35 million in the quarter, how do we think about that ramping throughout fiscal 2017, is there a target you should be thinking of?

We're not providing ARR guidance for the year at that level of granularity. Again, we've set the company up to focus on driving subscriptions, so total subscriptions and new model subscriptions are the best barometers for measuring our business growth moving forward.

And then the other question we're getting asked a lot about – you gave us some of the pieces, but how are you thinking about your cash flow for fiscal 2017?

Cash flow for Q4 was artificially low. We had interesting linearity in the quarter where the third month of the quarter saw more than half of our total sales. Given the linearity, that impacted our reported free cash flow for Q4, but will be resolved when those sales from month three get reflected in Q1 cash inflow. The bottom line is, we'd previously guided cash flow for FY 2017 to breakeven or slightly negative, but we now anticipate it being positive in the range of $50 million to $100 million.

Yeah. Thanks. Good evening. Carl, in the second half of this year, after you terminate the perpetuals for suites, you will be introducing your so-called collections. Could you talk about how you've anticipated the cost savings and the selling process from introducing these new collections?

The way – so let me just break this apart into two halves, Jay. I don't think our financial guidance depends exclusively on collections, but simplifying our product portfolio is important for operational reasons. It allows us to provide clearer options for our maintenance customers transitioning to subscriptions, which helps facilitate the move.

All right. At the analyst meeting, you mentioned that about a tenth of your named accounts had already adopted EBAs. Could you provide us with an updated adoption rate and how are you thinking about the pipeline for fiscal 2017?

We do have a lot of large manufacturers and construction companies interested, and currently we're around the 10% to 20% mark in adoption. There’s still significant room for growth. What stands out is not only the new accounts but the growth within existing accounts and their consumption. Our existing EBAs continue to grow at a rate that reflects their needs, and with over 80% of our largest clients not yet on these flexible licensing plans, we see ample opportunity ahead.

Hey, guys. Good afternoon. It's actually Stan Zlotsky sitting in for Keith. I wanted to come back to the restructuring that you guys announced. 10% headcount reduction. Where are the costs being cut and where are they being reinvested as you head towards fiscal 2017?

There are probably three main areas for reinvestment. One area is increasingly moving toward inside sales. Second is the need to build out our back office to support the transition to consumption-based models. Finally, we are consistently investing in cloud and mobile, trying to redefine market dynamics. On a deeper level, you could see continued investment towards the enterprise sales force and ongoing adjustments within the structure.

We built our spend target for next year based on what we have planned, it's fully under our control. Any upswing from variable compensation will trigger from subscriber growth, but in general, we monitor spend carefully; it’s something we can manage effectively.

Hey, guys, maybe a question first for Scott. In terms of your spend target for next year being flat to down 1%, any conservatism baked into that particular number? I know you control most of that, but still wondering.

No, there is no conservatism baked into it; it’s entirely manageable on our end. The only variable could be in relation to comp based on performance. But overall, this spend number is firmly within our control.

Moreover, our ARPS expectation is largely a derived number. Our focus remains fundamentally on growing subs and ensuring we meet customer needs; sustaining that will allow the metrics like ARPS to work themselves out based on our overall performance.

Thanks so much. Something if you might be willing to disclose, what kind of unit volume you had in the year just ended FY 2016?

Yes, unit volume was about 650,000 licenses.

Perfect. And then at the Analyst Day, you outlined a potential revenue path to FY 2022. You commented earlier that you're tweaking it somewhat. If we look to out years of FY 2021 and 2022, is your revenue expectation still similar to what it was at the Analyst Day?

Yes. Our revenue outlook in the out years aligns with what we outlined, and although we are adjusting expenses lower, rest assured that our revenue projections will hold true.

I’d reiterate that this year represents a paradoxical scenario. If we focus on the new models and have a rapid move towards them, it could produce revenue swings that may appear less favorable but ultimately lead to stronger fundamentals in the future.

Okay. Thank you very much and good afternoon, guys. Carl, I was wondering if you could give us a bit more insight into recent customer behavior when it comes to the termination of perpetual standalone subscriptions for customers that opted not to buy one last license. Can you provide more color on this?

Most customers are moving to desktop subscriptions, and anecdotal information from partners has confirmed this. The 10% we're expecting reflects the smaller last-minute buys. We can't fully predict the timing of these trends until Q3, but the overall move towards desktop subscriptions seems promising.

Thanks so much. Just as a follow-up to that question on new model subs. At the Analyst Day, you shared that about 40% of the desktop subs were new to Autodesk. Do you have any update on that statistic now?

We don't have an updated number today. However, keep in mind that most cloud products are primarily attracting net new customers which is an encouraging trend for our overall market expansion. The potential for growth in these areas outweighs others, particularly as we introduce new cloud offerings.

All right. That concludes this afternoon's call. As many of you know, we'll be at the Morgan Stanley conference on March 3. You can contact me directly at 415-507-6033. Thanks.