Autodesk Inc (ADSK) — Q3 2018 Earnings Call Transcript

Thanks, operator and good afternoon. Thank you for joining our conference call to discuss the results of our third quarter of fiscal year 2018. On the line today is Andrew Anagnost, our CEO and Scott Herren, our CFO. Today’s conference call is being broadcast live via webcast. In addition, a replay of the 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 fourth quarter and full year of fiscal 2018, our long-term financial model guidance, the factors we use to estimate our guidance including expectations regarding our restructuring, our maintenance to subscription transition, our customer value, cost structure, 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 2017, our Form 10-Q for the periods ending April 30, July 31, and our current reports on Form 8-K, including the Form 8-K filed 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 this 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 will 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 the financial performance, and unless otherwise noted, each such reference represents a year-on-year comparison. And now, I would like to turn the call over to Andrew.

Thanks, Dave. I just got back two weeks ago from the largest Autodesk University in our history. There were over 10,000 design, engineering, construction, manufacturing, and film production professionals in attendance. And as usual, their enthusiasm for and dedication to our products is absolutely inspiring. Now, I know several of you were able to attend the event and I'm sure you felt some of the same level of excitement I did. And before we get started with the details, I want to point out that after we review our Q3 results, I'll discuss the restructuring that we announced in today’s earnings release, which now brings me to our Q3 results. I'm pleased to announce that Q3 marks our return to revenue growth and we continue to make excellent progress on our two major initiatives, completing the subscription transition and expanding beyond design with cloud-based solutions for construction and manufacturing. The consistent performance we've delivered over the last several quarters increases our confidence in our ability to achieve the goals of the subscription transition. Now, here are some key outcomes of Q3 that I want to highlight. Total annualized recurring revenue or ARR grew 25% at constant currency. Recurring revenue had increased to 92% of total revenue. Approximately a third of the eligible customers are choosing to migrate to subscription with the maintenance to subscription program or M2S. We added 146,000 total subscriptions driven by 307,000 subscription plan additions, making the base of subscription plan subs larger than the base of maintenance plan subs. That is a great milestone. Now, let's take a closer look at our Q3 performance. I think it's important to first note that Q3 represents our return to revenue growth. It's the first quarter where the year-over-year revenue is comparing back to our first subscription-only quarter. The growth was even better than it looked if you remember that our Q3 results last year also included $38 million of licensed backlog that rolled over from the end of sale of Suites perpetual licenses in Q2 of fiscal year ’17. Normalizing for that, Q3 revenue would have grown 14% year-over-year. The trends we're seeing in ARR are clear signals that the transition is working. Total ARR continued to accelerate powered by double-digit growth in all three major geographies. Subscription plan ARR more than doubled, driven by growth in all subscription plan types, led by product subscription. We continue to experience tremendous growth in product subscription ARR on both a year-over-year and sequential basis. Subscription plan ARR was just shy of becoming the major component of total ARR, and there is no doubt it will become the major component in Q4 as we anticipated. We achieved the growth in subscription plan ARR by adding a record number of subscription plan subs in Q3, led by continued strong adoption of product subscription. Even when we normalized for M2S, total product subscriptions more than doubled year-over-year. Another consistent attribute of the transition is that new customers continue to make up a meaningful portion of product subscription additions and represent 30% of the mix for the quarter. These new customers come from a mix of market expansion, growth in emerging markets, converting unlicensed users and people who have been using an alternate design tool. We continue to make meaningful progress in converting legacy non-subscribers into subscribers. In Q3, we added another 26,000 product subscriptions through another successful promo targeted at legacy users, which is on par with the promo related subs we added in Q1 despite an even lower discount structure. Interestingly, we're still finding that more than half of those participating in the promo are turning in licenses seven years back or older. This reinforces our view that there is a meaningful number of active users who are interested in moving to the latest software and have licenses that are more than five years old. There are over 2 million of these legacy users that are actively using an old perpetual license. Over time, we will convert a large portion of these users either through a promotion or compelling new product releases as their product becomes increasingly outdated. One more positive development with the Q3 promo is that we experienced a meaningful uptick in the percentage that purchased an industry collection. Now, Q3 is not typically a big quarter for EBA subscription additions and we experienced normal seasonal trends this quarter. However, we did experience a sizable increase in large deals valued at over 1 million in Q3 and most of them were EBAs. We’ll see the benefits of the new EBAs in both subscription additions and ARR in future quarters. We also signed the two largest contracts in Autodesk history in Q3. Both were EBA renewals with large engineering companies and both increased their annual contract value by more than 50%. These cases illustrate how Autodesk is moving beyond being a software vendor to becoming a strategic partner with our customers. That doesn't happen by wishful thinking. It's been very intentional on Autodesk's part to become a thought and technology leader in the industry and work with our customers to solve the biggest design challenges they're facing today. Now, total cloud subscriptions continue to be a fast-growing subscription component. There are three areas of our cloud-based products that I want to highlight briefly; the acceleration of new technology integration into Fusion 360, the growth of the Forge partner ecosystem, and the evolution of the BIM 360 product and business. Let's start with Fusion 360. We recently announced the integration of two key capabilities into Fusion 360, Inventor and SolidWorks interoperability in the basic version and general design workflows in the $1500 per year ultimate version. This will allow users to associatively move data back and forth between Fusion, Inventor, and SolidWorks so they can access advanced manufacturing capabilities like 5-axis CAM and the automated creation of manufacturing-ready geometry delivered by Generative. This will bring these users one step closer to true push-button manufacturing. Next, I want to talk about our Forge platform. We're working with dozens of partners integrating with Forge and BIM 360. These third-party developers share the same vision as we do on supporting the needs of construction workflows today as well as anticipating their future needs in pre-construction and site execution. There are nearly 50 Forge applications for BIM 360 available today. We also have customers successfully integrating BIM 360 with their existing systems using Forge. One example is a company that is designing and constructing large infrastructure projects, including hydropower stations, tunnels, and more. Another large U.S.-based construction company is using BIM 360 and Forge to extend their workflows and services to facilities management. Forge is well on its way to becoming the extensibility platform for the world of design and making. And you can expect us to talk a lot more about it in the future. In addition, we just announced the next generation BIM 360 platform is now available as a public technology preview. This new platform is built on Forge and integrates the capabilities of the BIM 360 family in a single environment that easily allows customers to pilot, test and implement their next project. We've also had several key BIM 360 wins with construction companies. And in Japan, we signed a $5 million BIM 360 deal with one of the country's largest general contractors. In EMEA, we had a seven-figure deal with another contractor. These are just a few examples of the BIM 360 deal activity. Now, I’ll turn it over to Scott for a few more details on the M2S program, ARPS, and other financials. Scott?

Thanks, Andrew. I’ll start with subscriptions and our maintenance to subscription, or M2S program. Partially offsetting the strong growth in subscription plan subs was the expected decline in maintenance plan subs. It’s worth repeating that we expect to see ongoing declines in maintenance plan subscriptions and the rate of decline will vary based on the number of maintenance plan subscriptions that come up for renewal, the renewal rate, and the pace of the M2S program. 110,000 of the decline in maintenance subs was a result of the fast start to the M2S program. It was the first full quarter of availability for the program and we again experienced better-than-expected results. Approximately one-third of all maintenance renewal opportunities during Q3 migrated to product subscription, which is even better than the early data we got from Q2 results. And of those that migrated, over 25% of eligible subscriptions upgraded from an individual product to an industry collection. Once again some customers are doing a partial conversion of their maintenance seats, but we’re especially pleased that overall participating accounts are growing their total subscriptions and growing their spend with Autodesk. In other words, accounts that participate in M2S are purchasing net new product and cloud subscriptions and we're seeing this behavior across all geographies. It's still early days for the M2S program, but as we've said, we'd like these maintenance customers to move sooner rather than later, as product subscription provides them the greatest value with increased flexibility, support, and access to our cloud products. Moving to a single model makes the most sense and will immensely simplify our business and how our customers interact with Autodesk. Now, let’s talk a little about annualized revenue per subscription or ARPS. We spent a lot of time on ARPS on last quarter's call and reiterated the influence on short-term performance of ARPS, including product mix, geographic mix, timing, and the M2S program, which is having an impact on ARPS. That's a positive impact on maintenance ARPS and a negative impact on subscription plan ARPS through the discount offered for conversion. I know it's easy to get distracted by the near-term noise in ARPS, but here is the metric to focus on. Product subscription ARPS grew nearly 20% year-over-year and if we exclude the effects of M2S, it would have grown nearly 25% and had its fourth consecutive quarter of sequential growth. That’s meaningful growth in ARPS for our core business. We remain confident that overall ARPS will increase in Q4, driven by less discounting and promotions, the price increase for maintenance and M2S customers and the migration to higher value products. Moving to spend management, we continue to be able to execute and drive results while keeping spend growth nearly flat. Non-GAAP spend increased by 1% at constant currency in Q3 and it's flat year-to-date. We're achieving this through targeted divestments and reallocation of those dollars to initiatives that drive our transition. Andrew will talk more about how we’re accelerating this with the restructuring and that we remain committed to keeping spend approximately flat this year and next year. Looking at the balance sheet, reported deferred revenue grew 15%. At the same time, unbilled deferred revenue increased by 85 million sequentially. So total unbilled deferred revenue now stands at 148 million, which would have added another 10 percentage points of growth to deferred revenue and we expect it to continue to grow meaningfully in Q4 and going forward as we move more of our enterprise customers to annual billing terms. Our view of the global economic conditions remains consistent with our view over the past several quarters, with most of the mature markets performing relatively well and little change in emerging markets. Turning to our outlook, we continue to see strength in our core business around product subscriptions, EBAs and our ongoing maintenance and are seeing the trends we expected for total ARR, which is the key driver for our long-term model. We’re holding steady or slightly increasing most of our guidance metrics, however, we slightly reduced our Q4 subs outlook related to our cloud assumptions. With cloud subs, we continue to see good traction with our core products, namely BIM 360 and Fusion. As the capability of these products have matured, more and more customers are purchasing the higher-value offerings that include the features of the lower-value products they were purchasing last year. As such, we expect to see continued increases in cloud subs, but at higher ARPS and lower volume. Now, I’ll turn the call back over to Andrew.

Thanks, Scott. I’ll reiterate what Scott just said and assure you that we remain fully committed to the FY20 goals around ARR, subs, and cash flow, which brings me to the restructuring. Some of you may recall that last quarter I outlined the three strategic priorities that I believe will drive long-term success at Autodesk; completing the subscription transition, digitizing the company, and reimagining manufacturing, construction, and production. The next era of Autodesk will not be defined by simply product or business innovation, but in their combination. We must excel at both and we must do that all in the service of our customers. Restructuring actions like we are announcing today are usually taken when the company is under external pressure, such as a prolonged economic downturn or when there is a need to significantly cut expenses. In contrast, this action is being taken to support our evolving company strategy by rebalancing our investments, divesting in some areas and investing in others. By realigning our investments, we are positioning the company to meet our long-term goals. We will be investing in building and expanding the digital infrastructure of the company, increasing go-to-market and development spend for the construction opportunity and maintaining development on our core products. To fund these growth areas, we must rebalance resources and divest where it makes sense. We will therefore divest in some research and development activities that are not well aligned with reimagining construction, manufacturing, and production. We will also close some Autodesk sites that are no longer aligned with our global location and talent acquisition strategy. I want to reaffirm what Scott said earlier, our flat spend goals for this year and next are not changing. To wrap things up, we're excited to be another step further along in our transition. We've been able to consistently execute on our long-term plan while providing our customers with greater flexibility, more compelling products and a better user experience. Operator, we’d now like to open the call up for questions.

Let's hit the 625 to 650 net adds for the year, down from the 625 to 675. Scott, you gave us some color, but some of the discussions I had with investors look like the maintenance conversion program is working really well, getting more subs from that component would seem to indicate that you're getting lower organic net adds since that subscription program. Is it just cloud or is there anything else that you're not getting quite the traction that you thought at the beginning of the year?

It really is cloud, our cloud assumptions and what we see in cloud in Q3. So the core business is still strong; in fact, our core business subs are up sequentially Q2 to Q3 and they'll grow again from Q3 to Q4. That's what delivered the strong quarter that we just announced with ARR up 25%. That's what underpins the guidance that we gave, a slight uptick in our guidance on the financial metrics at least for Q4. So the core business is strong, but as we look at cloud, the slight guide down that we've got there at the midpoint is really a function of continuing to see good traction. We're pleased with the growth. We're seeing our overall cloud subscription base just to give you a sense of it is up 150% year-on-year. So, the cloud base continues to be strong, but it's still a relatively new business and it's still fairly choppy. We also have a really big renewal opportunity on cloud in Q4. Remember cloud Q4 a year ago, we talked about how big a quarter we had on cloud sub adds; many of those come up for renewal this quarter. So we're trying to be conservative on our expectations on that cloud business but it’s in effect moving from a little bit of what I talked about during the script-a seeding strategy with promotional activity that drove a high volume at a low price to a more mature market that we see now that is likely to have slightly lower volume in cloud, but at a higher price.

This is Andrew. I want to jump in too just before you do your follow-up questions. So first, one of the things that I want to reiterate that Scott said is the core business is doing well. The net adds for product subscription are up quarter over quarter, year over year; they are robustly heading in the right direction and let's remember that's the key driver to the financial metric. That's why you see us with a slight uptick in the guide around some of the core financial metrics. When you look at cloud, the construction business is doing well right now and one of the reasons why I highlighted those large deals we were talking about in both EMEA and APAC is I am trying to give you a sense for where that business is trending right now. Last year, we were doing a lot of work seeding the business, injecting things like BIM 360 Team into various accounts through promos and other types of activities to try to get people exposed to the offering. Now, what we're seeing is people are stepping up and making large investments in the BIM 360 offering. So I think what you're going to see, and we kind of started to feel it in Q3, is you’re going to see lower volume in things like BIM 360 but at higher prices, because we're actually making bigger deals and going deeper into accounts. So the cloud is on fire. Construction is on fire. It's just in a different mix than we were expecting earlier in the year. We expected a mix like this further down in the maturation cycle.

And then glad to hear the reiteration of the fiscal long-term goal, especially on cash flow, which brings up the point; cash flow I think was negative again in the quarter, getting questions from investors, when do we start to see that inflection in cash flow to get positive and start to trend towards those long-term goals?

I believe this aligns with the cash flow information I presented during our Investor Day last December, which indicated that fiscal '18 would be the low point. We anticipate positive cash flows for the entire fiscal '19. Additionally, we expect to see revenue growth in fiscal '19, similar to what we observed in Q3 when comparing to a full subscription quarter. This revenue growth should continue, and we expect earnings per share to be positive next year. While we don't specifically forecast cash flow as a metric, it's not surprising that cash flows were negative this quarter, and I wouldn't be surprised to see negative cash flows again next quarter.

This is Mark Grant on for Heather. Just wanted to dig into some of those large deals a little bit. You mentioned most of those are EBA, cited the two largest contracts in history, but in the prepared remarks I look and I see that you called out a decline in EBA ARPS. Can you give us a sense of kind of what that sales cycle is looking like in those EBAs? Is there any kind of incremental promotion that you might be doing that’s having a negative near-term impact on the ARPS there?

That decline in the EBA ARPS is what we typically see actually every Q2 and every Q3. So if you think about the way our enterprise business agreements work, they are three-year commitments with an annual payment. That's what we see in the cash flows now. But that revenue is fully ratable over the three-year time frame. So we lay it out and the revenue then is unchanged, but the denominator in ARPS and subs and for EBAs, it’s a token base, right? It's a consumption-based offering. So what we use for subscriptions is monthly active users and what we see in all of our EBAs is from the time they sign, the monthly active usage continues to increase, right? They access more and more of our products, so the numerator of the EBA equation stays flat on an account-by-account basis, but the denominator grows. We typically will see that aggregated result in enterprise ARPS for both Q2 and Q3 every year, and then they’ll begin to tick up a little bit in Q4 and then of course it gets much bigger in Q1 when we get the full quarter, the full benefit from the Q4 EBAs that we’ll sign. That's just the normal seasonality trend. It's not about any additional promos or discounting into those accounts.

This is actually Michael Barrett sitting in for Phil. Wanted to touch on the two-thirds of maintenance customers who are up for renewal who decide not to migrate. Do you have a sense of their thinking about the timing of migration? Are they just waiting until next year? Are they going to ride out the price increase as long as they can? Any sense of that that you could give would be great?

Yeah. Look, I think what's really kind of straightforward here is that the small price increase this year. So, when you're looking at a 5% price increase, you say okay, look, I'm going to ride this out probably to the 10% price increase and reevaluate my option at my next renewal cycle. And if you're really concerned about holding on to your perpetual rights as long as possible and locking into release at some point, you're going to do that. That's really what's happening. What’s interesting is we actually didn't expect to see as much front loading as we're seeing right now. So we're way ahead of our expectations. We expected the surge to start next year as we got close to the 10%. So this gives us a lot more confidence in terms of how this program is going to play out over the next two years, but really, a 5% price increase, if you wanted to hedge your bet, you just wait until the next renewal cycle.

Michael, another noteworthy point is that we analyze the migration rate based on customer size. What we observe is that smaller customers are more hesitant to abandon their perpetual licenses, while larger customers are more inclined towards subscriptions and are often already purchasing various products through those subscriptions, so they are transitioning more rapidly. They are also shifting to EBAs.

And then just one quick follow-up, what impact on subs did the migration to industry collection among those M2S customers have on sub adds, if any? I imagine there was some consolidation of numbers?

So whenever you have the customers moving to an aggregate offering, there is always some consolidation associated with that, but remember that the price of the industry collections is significantly higher, but what we did see in these M2S accounts is all of these accounts when the renewal cycle was over, they were actually higher value accounts than when they started. So in some cases, they may have consolidated some of their offerings around industry collections, but at the same time, they actually bought additional cloud subs and additional other types of subs that actually made the value of the account actually increase over time, which is what we were expecting. So it's no surprise if you see some, we saw the exact same thing when we rolled out Suites.

I just have a question about the impact of the EBAs in the Q4 new subs. You said that you’re expecting some tailwind; can you quantify how much compared to last year you’re expecting if you have any visibility on that?

Yeah. Gal, what we typically see in EBAs is a one-quarter lag from when we see a significant amount of sales. So we did have a good quarter for EBA, a surprisingly good quarter or I guess it wasn’t surprising, a good quarter for EBA sales in Q3, bigger than what we normally would see in Q3. We expect another big quarter of sales for EBAs in Q4. Most of those Q4 EBA sales will accrete to subscribers to monthly active users, beginning in Q1 of next year. So the impact we'll see in the coming quarter will be the impact from the sales we had in Q3, and that is already baked into the guidance that we gave. It's not something that I want to break out, but it's baked into the guidance that we gave you.

Okay. And then just as a follow-up, you said that the guidance implies lowering yields and the cloud on the other side. Does that imply considering cloud consistently lower ARPS, does that imply a significant improvement in ARPS you expect in Q4?

We do expect that. We said all along, I mean, that's only one effect that I think will cause ARPS to tick up in Q4. We do expect to see ARPS pick up in aggregate between maintenance and subscription plans.

Yeah. The obvious behavior we're seeing right now is exactly the kind of behavior we expected. We fully expect to see the ARPS tick up in Q4 just as we said it was going to tick up in the second half. We're well on our way to getting there.

Scott, maybe for you. Just kind of thinking about subs a little bit higher level, can you just talk about any commonalities that you're seeing from the first couple of slugs of M2S conversions? And I guess what I mean by that, are the first slug of M2S conversions maybe coming in focused on any particular product family or any particular vertical, any commonalities that you're seeing in the first couple of quarters of M2S?

So, it's going to be Andrew speaking first and then we'll probably switch to Scott. One thing to note is that the Suites customers are a significant factor here. They are transitioning the quickest because they have a direct path to collections and are looking to secure the lowest possible prices for these collections. You can definitely notice a slight bias towards Suites in some of the migrations, and that's clear. An important statistic to highlight is that among those eligible to transition, 25% are choosing to switch to a collection. Thus, while you may observe a budget move with people opting for collections, a substantial portion of non-Suites customers are also transitioning to collections, which is positive and exceeds our initial expectations.

Actually Andrew, maybe just to stay with you, again kind of even going higher level than kind of the M2S, which of course is the focus here, but even more strategically, is it kind of getting to your first couple of quarters as CEO, just maybe longer term around the business, how do you think about M&A strategically?

Well, so I’m going to pass that one to Scott. No. I’m just kidding. No, look, I think when you look at yourself entering new markets like when we talk about reimagining construction, manufacturing production, you're going to be looking at M&A as a major part of that re-imagination. We're going to be bringing in not only technology but whole businesses that increase our effectiveness, not only from a technology and product side but also from a go-to-market side and market knowledge side. So I think M&A is an important part of the strategy moving forward, especially in these reimagining exercises we have in the new markets in construction and manufacturing. So I see it as a super-critical element.

Andrew, let me start with you with a longer-term question stemming from a couple of things you said at AU. You made the pretty interesting comment or observation that you think that eventually, if I'm quoting you correctly, that all subscription companies will eventually be consumption model companies. With respect to you specifically, how do you see effectuating that? What do you see as the intersection of your business model with your technology platform, enabling a broad consumption model, not just for the EBAs as today, but more broadly? Secondly, the near term question for Scott vis-à-vis the restructuring for you. You mentioned some product rationales or R&D rationalization there. I assume it has to do largely with what you call your horizon three designations, but anything on the sales and distribution cost side, anything baked into the restructuring from channel management or any cost of that kind, not specifically related to products?

Sure. So I’ll go first. So Jay, thank you for asking that question. First, let me explain it for the other people who weren't there for my comments. What I said exclusively, I said, look, the cloud is turning every software company into a subscription company, and I said machine learning and artificial intelligence is going to turn every subscription company into a consumption company. And what I mean there is the value of the automations that are being created on top of cloud platforms is so large that people are going to pay for an outcome. We're talking out in the future, and I'll give you some examples of some of the outcomes that we might deliver in the future. So one of the things we've been talking a lot about is push-button manufacturing and this idea that I come up with an idea, I come up with the design of my design is instantaneously informed by the type of manufacturing methods I'm going to be using, and when I'm done with my design, I push a button, not today, but in the future, and that the design is immediately turned into a stream of bits that go to a configurable micro factory that makes it. Pushing that button, Jay, is incredibly valuable. When you go from having a design to instantaneously turning into a stream of bits that you can then manufacture without any intervention by a human being, that's worth a lot. People are going to push that button. Now, we've already been experimenting in consumption in numerous ways. The EBAs are a consumption model, so that allows people to consume all of our portfolio, and by the way, it’s how a lot of our largest customers are getting access to BIM 360. But we've also experimented with pure consumption models in the push-button sense. One of the most successful offerings we have right now is a rendering service for consumption. That’s one of our most successful consumption offers. People push a button, and they get an outcome. They either get an incredibly large pixel that high resolution or they get a lower number of pixels at lower resolution, and they pay for that outcome. You're going to see us deliver numerous types of outcomes in the future. Some of the outcomes may be, I want to know what the energy consumption of this building design is, push a button, you know what the energy consumption of the business is. I want to know what it's going to cost me to manufacture this particular, push a button, you get the answer. That's where we're going to be going over the future, and as we mature and develop these machine learning-based algorithms and these artificial intelligence-based algorithms, you're going to see more and more of their things show up as consumption offerings, and that's where the future is going. No, it’s not tomorrow; it’s the five to ten year horizon, but that's where we're heading.

Jay, regarding your second question about restructuring, this will indeed affect our sales organization as we advance our sales model. This aligns with our discussions about transitioning to a subscription model, which naturally enables us to have closer interactions with our customers. The subscription model is designed for that direct engagement, whether via e-commerce, customer success, or inside sales. We will continue to invest in this direct interaction, so I want to clarify that this isn’t indicative of diminishing our channel; it’s not the case. We have been transparent with the channel about our ongoing efforts, and based on our projections, we believe the channel business will grow in absolute dollar terms. While its share of the overall revenue may be smaller, it represents more money overall. Thus, the restructuring will clearly affect sales. There will be some pullback and reinvestment in that area. Consistent with the plans we've shared, I just want to ensure it's clear that this does not signal the demise of the channel; that interpretation wouldn’t be accurate.

No. And as I've said previously when I talked about investing and digitizing the company, a large chunk of the investment is going to go into that; that is all about providing self-service to the set of customers that work with us directly either EBAs or digitally direct through e-stores or hub sales. That’s absolutely going to be valuable to the customer, but at the same time, we're going to be able to provide more account insight to our internal sales force and our partners as well so that they can better serve those customers, do better cross-sell, upsell, and engage with those customers. So it's going to work both ways. We're going to have a healthy 50-50 mix of channel indirect, as I’ve said before, and yes, a big part of this investment is going into that digital infrastructure to enable that.

I just want to dig into the 30% metric of the subscribers being at; 30% being net new customers, pretty impressive considering Adobe at this point of their transition I think was only adding 20% net new customers. Can you just talk a little bit about the composition of that 30% net new customers, how much is coming from the new emerging products such as cloud and BIM 360, et cetera, versus how much is coming from customers buying the product offerings?

The majority of our gains are from our existing offerings, and it's a combination of factors. Many customers are encountering our competitive pricing for the first time and are now able to purchase sophisticated software, like Revit, which previously seemed unattainable due to their budget constraints. They may have used free software or alternatives that weren't professional-grade, and now they have chosen to invest in Autodesk. We are seeing a significant number of new customers. It is difficult to determine how many of these new customers were previous users who never paid for the software, often referred to as pirates. These individuals don't identify themselves, but we know some have transitioned from piracy to purchasing, which is a positive development. Furthermore, we are also attracting individuals who are starting new businesses, essentially fresh customers. We are pleased that the consistency of this trend has persisted throughout our experience, and particularly in our cloud business, especially with our fusion offerings, the percentage of new customers is even higher.

Just a quick follow-up, how do you think about when you could if or when revise upward your cost guidance? It seems like the opportunity construction ends in the collaboration tools and the cloud; the massive potential tam which was pretty underpenetrated. How do you think about when you might want to actually revise upward your cost guidance to just capture that land grab or drive greater growth in some of these emerging products?

Yes. And we’ve talked about that. We’ve committed to flat spend this year, which is almost at the end of, and flat spend again next year, but after that, we do see total spend, and when I say total spend, by the way, it's not just OpEx, it's COGS plus OpEx. But we expect to see it begin to trend up in fiscal ‘20 in a single-digit kind of way, but I think you can expect to see spend trend up in fiscal ’20 and then beyond.

Starting out on the restructuring side of the equation, how should we think about the timing? There are actually a lot of heads coming out of the organization; how should we think about the timing in terms of when those guys are coming out of the equation sort of coming out of our models and then vice versa what’s the expense ramp on the other side? And then maybe you can give us a little bit of color in terms of what types of stuff that investment will come in to, so where and when does the expense ramp on the other side of that restructuring?

This is Andrew. I'll start and then hand it over to Scott for any additional insights. Most of that is very front-end loaded. We're going to see those expenses and that operating lease come out of the system fairly quickly. If I could accelerate everything in two months, I would, because I’m eager to increase that investment in construction, especially since we're seeing so much success there. I want to keep that momentum going. I'm also very focused on digitization, so the timing of hiring back that many people will take time, likely causing a lag as we move into Q1 and Q2 of next year. Our overall goal is to reinvest that money back into the business as quickly as we can. Scott, do you want to add anything?

No. You said it exactly right. The only other comment I would add, Keith, is if you do the math on our EPS guide, you can see there's a couple of pennies of benefit that we're expecting to accrue to Q4. That's built into our guide.

And then one follow-up on going back to the subscriptions number; can you remind us, is there any sort of impacts that we should be aware of in terms of like a year-over-year compare, in terms of promotions you're doing where you attached cloud subscriptions to collections?

Yeah. As we discussed regarding the subscription guidance change we made in Q4, that was part of the cloud impact we experienced. We had two factors that contributed to a significant increase in cloud subscription additions in Q4 last year. First, we introduced user packs for the first time, and there was considerable pent-up demand for them. Second, we conducted promotional activities, particularly for a low-end member of the BIM 360 family called Team, with many of those subscriptions coming up for renewal in Q4. This is a key consideration in our perspective on cloud. You’re accurately highlighting what we mentioned earlier.

And so we shouldn’t expect a similar type of promotion this year to attach Team subs to collections?

No. We don't, one, we don't need it. All right. Those promotions were seeding efforts, they were brand-building efforts, they were trying to get the message out there. Here's BIM 360, welcome to me. We don't need those right now. The brand is carrying itself. You're not going to see that kind of promotional activity.

Scott, you mentioned that a lot of the timing on the conversions is going to depend upon just when maintenance subs are up for renewals. Is there anything just to keep our eyes open for there in terms of seasonality? Just wondering on seasonal trends there and when we might, how we might think about that? And I had one quick follow-up; you did talk about some customers doing partial conversions, and I was wondering if you could just add a little bit more color on that?

Sure. The customers can participate in the maintenance to subscription program only when their maintenance subscriptions expire, and we see the highest volume of renewals in the fourth quarter. This aligns with historical patterns where Q4 was our strongest quarter for perpetual license sales, so it follows that it would also be the peak for subscriptions renewals. Aside from that, there's not much other seasonal variation. Surprisingly, the first quarter also sees a fair number of maintenance subscriptions up for renewal, but the most significant impact is in Q4. And Rob, could you remind me of your second question?

It was just on the, you mentioned I think it was in reference to larger or EBA customers doing some partial conversions, and I just...

Sure. One of the questions that has come up, and it has been confirmed through channel checks, is that some customers are doing partial renewals or partial conversions as they transition from maintenance to subscription. Partial renewals are not a new occurrence; we've had them for quite some time, even before we announced the product subscription. Customers have moved from standalone products to Suites using partial renewals. We are observing this trend currently and are monitoring it closely. Interestingly, we see that customers moving from maintenance to subscription and opting for partial moves are also adding more new subscriptions, whether that's cloud subscriptions or other product subscriptions. Therefore, the net total of subscriptions and revenue in those accounts is increasing. So even though there is only a partial renewal, the assumption that subscriptions or revenues are declining is incorrect; we are actually witnessing the opposite behavior.

Hi. It’s Dan Bergstrom for Matt Hedberg. So you mentioned piracy in an answer to a question, a couple of questions ago. That was something you talked about at last year's Analyst Day and since then and the strategy is to communicate more with customers pirating the software next year. As we approach that point, could you talk a little bit more about that strategy and then maybe how we should think about that unfolding through next year?

We are focusing on providing higher quality leads and insights to our existing capacity targeting piracy this year. We are using analytics and dashboards to help identify where piracy is occurring. Moving into next year, we will roll out more in-product communication and pilot initiatives in various locations to improve lead quality and increase capacity through automated fulfillment for piracy activities, engaging directly with customers. We anticipate this will enhance our piracy conversion rates and are looking at it as an ongoing effort for years to come, given the large number of unpaid users. Next year will see us shift towards more automation and direct customer communication, with these initiatives expected to be fully operational by the second half of the year, yielding ongoing impacts beyond that point.

I wanted to ask you, Scott, for more details on cash flow. It seems the cash flow results were affected by two main factors. First, the transition to annual billings appears to be impacting your billings negatively, and second, the collections, or days sales outstanding, were also quite weak. Can you provide further information on these issues, and were there any other reasons for the poor cash flow this quarter? Also, while I understand you're not providing guidance on cash flow, how should we approach modeling that in the future? Is there a way to conceptualize it?

It's evident that you're examining the figures closely. I would note that our Days Sales Outstanding (DSOs) increased slightly during the quarter, reaching the mid-50s, which indicates some back-end loading. This means that the revenue recognized was more concentrated towards the end of the quarter. The quality of receivables remains consistent, with a very high percentage being collected on time. Therefore, while the timing of when these receivables were collected shifted towards the end of the quarter, it resulted in them being recorded as receivables rather than cash as the quarter concluded. This change in timing contributed to the situation. Additionally, there has been a transition to annual billings for Enterprise Business Agreements (EBAs), and as a part of our maintenance to subscription initiative, we have stopped multi-year sales for maintenance to prevent customers from anticipating our upcoming price increases. Consequently, you're observing two main factors affecting long-term deferred revenue: the reduction in multi-year maintenance and the shift to annual billings for EBAs.

So Scott, how do we think about how long the anniversary stays in Q1 before it subsides? More generally, how should we consider the cash flow?

The unbilled deferred amount I mentioned is driven by our results, with 148 million in unbilled deferred recorded during the quarter. If you want to assess how deferred revenue has changed year-over-year, you can add that amount to the deferred revenue. We expect that number to continue to grow in Q4, primarily due to EBAs with three-year commitments and annual billings. This trend will persist as we build more unbilled deferred throughout fiscal 2019, although we will also see some unbilled deferred from previous years gradually decrease due to ongoing annual billings. We believe the overall system will reach a more stable condition by late fiscal 2020. You can analyze the growth in unbilled deferred each quarter to determine when it will begin reverting.

Just getting back to the restructuring, you're planning to reduce staffing levels by 13%, so obviously a material number, given what will be some degree of transition in go-to-market. Can you just expand on why you have confidence this will not impair your ability to execute your fiscal 2020 plan?

Yeah. First off, we were very selective in where we divest. We actually looked at project areas and functional areas that were not contributing to either our long-term strategic goals around reimagining construction, manufacturing, and production. So that’s where we're actually seeing permanent removals in cost. So those areas are not aligned with any of the goals or with the subscription transition and they're not going to affect any of our ability to achieve those goals. In fact, the money we’ve taken out of those areas, we’re reinvesting in areas that are absolutely going to allow us to achieve our goals. Now, on the sales side, what we're doing is we're moving away from some of the things that we were using to focus on the territories and other parts of the organization to move more into the inside sales structure. We've already been doing this for a while, so we have nice machinery in place to actually manage these moves. So this is actually in line with actions we've already been taking. So it has absolutely no material impact on our ability to hit our goals. In fact, what it’s doing is it's reinforcing our ability to hit these goals, especially when you look at the digital infrastructure side.

And then Scott, so the unbilled deferred obviously grew very nicely this quarter. We assume you’re still on track to be over 300 million by year end.

So it continues to grow; rather than make that a metric that I try to forecast each quarter and update guidance because there's a lot of variables in that number. It's driven by EBAs and both the size and the timing of the EBAs have an impact on that number, but we continue to expect that to grow strongly, not just in Q4, but throughout fiscal ’19 as well.

I wanted to hop back and talk about this net subscription adds. I was wondering if you could give us a sense for which elements within that mix you have the least amount of visibility and if you could give us a sense for, if there's a baseline of net subscription adds that we can think about as sort of being your floor on a quarterly basis or even an annual basis if that's easier to predict.

Unfortunately, there isn't a straightforward rule of thumb for this, even within a category like maintenance. Within maintenance, renewal and migration rates to subscription vary by major product family, such as AutoCAD, LT, Suites, and other standalone products. So, I can't provide a simple guideline on that. However, I would connect it to the strength of the core business, which includes maintenance, product subscription, and enterprise business agreements. Combining those three constitutes the core business. We continue to see solid growth in the core business and subscriptions, which are driving our results. That’s reflected in the ARR we reported for Q3, which is 24% as reported and 25% at constant currency. It's essential to focus on these three elements.

Okay. And just as a point of clarification on an earlier comment, I think you said that linearity was a bit different this quarter. I wanted to confirm, one, is it different from what you've seen in the past and was there a substantial impact on ARR in the quarter because of that?

No. I mean obviously a later linearity in a subscription model does have an impact on ARR. I don’t think it was significant. I think the change in DSOs was from the mid-40s to the low to mid-50s. So I'm trying to find it on my sheet here. Yeah. It went from 48 days to 54 days. So it wasn’t a big swing, but it was a little bit later. It doesn't make a big difference in ARR, but the question that was asked in relation to was what’s happening to cash flow; it does make a difference on cash flows, right? Those six additional days sitting, not collected and sitting in cash, but sitting in receivables make a difference when you're talking about a cash flow number that’s as small as our cash flow number is right now.

My question tends to do with the restructuring. Andrew, you said that typically these things are done when there's an adverse business condition; clearly, business is going really well for you guys. I'm thinking through your goals to keep the spend flat next year and the year after, and if you're cutting 13% of your headcount, it's going to take some time to rehire back. So how realistic is your plan going to be to reabsorb that 13% back, the workforce? And also to an earlier question, these kinds of moves can be somewhat disruptive. How much of a buffer have you provided to Wall Street with respect to your financial plans as you go through this restructuring?

So first off, let me make sure we're all clear on what our stated goals are. So we're flat next year. We are not flat the year after that and we do not intend to be, all right? We intend in fiscal ’22 to ramp up our investment especially in some of the areas that we think are important in expanding our business. So, that goal is all that flat on OpEx next year. With regards to your other question, yes, there's always a ramp in terms of rehiring some of these people. So you're not going to immediately rehire them. But remember, we’ve divested from areas that are not right now aligned to some of our critical key goals like for instance completing the subscription transition, digitizing the company, and reimagining construction in particular right now. So we've been very deliberate in how we've actually executed this restructure to create a pool of money that we're going to be able to execute on, but we're reaffirming the goals for next year in terms of the total spend for the years. Scott, do you want to add anything?

Kash, in response to your last comment about the buffer, I want to emphasize that these situations are challenging, and we expect a difficult few days ahead. However, I want to clarify that this was not a broad, indiscriminate restructuring. Instead, we made very targeted divestments in specific areas. Therefore, I don't anticipate it will disrupt our core business to the same extent as a more widespread approach would have. I recognize today is tough, and the coming days will be challenging, but I believe the overall impact won't be as severe as it could have been with a more drastic cut across the board.

Yeah. And frankly, peanut butter cuts are actually, as Scott said, more disruptive to the execution and actually more demoralizing to the teams because everybody feels like we're all getting squeezed but we're being asked to do the same thing. When you actually stop doing something, although it's hard for the team that was on the projects or initiatives that are being shut down, it’s more motivating for the other people because they say, wow, okay, we're getting investment over here and we're not being asked to do two things with less money again and I think that's something you have to pay attention to.

Wonderful. And is it fair to say that you're reiterating your long-term fiscal ‘20, what we laid out at the Analyst Day, the ARR, the revenue, the earnings, and free cash flow; is it fair to say that you still are reiterating that, and that's it for me. Thank you so much.

Absolutely, Kash. We are reiterating our FY ‘20 goals. The 24% CAGR in ARR, the free cash flow targets, all of that is completely reiterated. As a matter of fact, the restructuring is aligned to increase our confidence and our ability to execute on those goals and actually deliver results beyond FY ‘20, especially when we look at what's going to happen with construction as we move forward.

Thanks, operator. That concludes our call today. Just by reference, we will be at Credit Suisse Conference tomorrow in Scottsdale. After that, we’ll be at the Wells Fargo Conference in Deer Valley on December 5 and at the Barclays Conference in San Francisco on December 6th. If you have any questions in the meantime, you can reach me, Dave Gennarelli at 415-507-6033. Thanks.