Autodesk’s FQ3 shows the upsides –and downsides– of change

Nov 30, 2016 | Hot Topics

Autodesk surprised investors yesterday when it reported positive movement on any number of fronts during its fiscal third quarter. But weaker than expected guidance for Q4 will dampen investor enthusiasm. The highlights:

  • Total revenue was $490 million, down 18% as reported and down 16% in constant currencies (cc) — but the total was well ahead of expectations, which seemed to hover around $478 million
  • The number of subscribers grew 134,000 from the Q2 to 2.95 million by the end of Q3, including 13,000 maintenance customers of Solid Angle’s Arnold renderer (acquired earlier this year)
  • “New model” subscriptions, which Autodesk defines as “product, enterprise flexible license, and cloud subscriptions”, increased 168,000 from the second quarter of fiscal 2017 to 861,000. If Autodesk annualizes that ‘New model” subscription revenue, it would total $414 million, up 88% year/year as reported and up 91% cc
  • Maintenance subscriptions were 2.09 million, a decrease of 34,000 from Q2 even with the inclusion of the13,000 added with the Solid Angle acquisition. Here’s why: As of July 31, Autodesk customers can no longer buy maintenance for perpetual contracts, so none were bought in FQ3 and total maintenance subscriptions declined
  • By line of business, Architecture, Engineering and Construction revenue was $212 million, down 6%
  • Revenue from the Manufacturing product family was $147 million, down 16%
  • Revenue from the Media and Entertainment business was $34 million, down 13%
  • AutoCAD and AutoCAD LT revenue was $80 million, down 44%
  • Finally, revenue from the Media and Entertainment line was $34 million, down 13%
  • There’s no real color on the verticals –the usual “pockets of strength”, key customer wins, etc. were missing from this earnings report and call. (Except AEC; see the very bottom of the post –Mexican walls come into the discussion.) BIM 360 and Fusion 360 were highlighted as successes but with few details. CEO Carl Bass did refer to a 7-figure deal (though it’s unclear how many periods or what math was used to come up with the 7-figure total) for a global deployment of BIM 360.
  • By geo, revenue from the Americas was $213 million, down 10% as reported and down 9%cc.
  • Revenue from EMEA was $191 million, down 15% (down 9% cc)
  • Revenue from Asia Pacific was $85 million, down 39% (down 38% cc)
  • And, finally, revenue from emerging economies was $57 million, down 36% (down 35% cc).
  • Here are the reasons for all of Autodesk’s turmoil: Total recurring revenue in Q3 was 76% of total revenue, up from 56% a year ago and deferred revenue was up 26% to $1.53 billion
  • Autodesk has always sold indirect, through channel partners and distributors, with direct revenue hovering at around 20% of total. In Q3, direct revenue was 29% of total sales, reflecting Autodesk’s growing importance to large enterprise customers as well as the progress of its e-store. During the earnings call, the company said that by fiscal 2020 “there will be more dollars of sales going through the channel than there were in fiscal 2016. But in terms of a percent of pie, the percent of the total sales that get done, it’ll be a smaller percent.” CFO Scott Herren added that he thinks there will, by 2020, be “fewer channel partners than we have today, so it’s a more profitable business for the channel partners that remain”.

So what’s the upside? Mr. Bass reminded investors that “this was the first quarter of selling only subscriptions, a significant milestone in our business model transition. We also had a record-breaking quarter for cloud subscription additions, driven by continued momentum of BIM 360 and Fusion 360”. The other big upside, for investors, is that the company reported a much smaller net loss than expected, of 18 cents per share, versus an expectation of a 24 cent loss per share. [Remember that the net loss is based on revenue reported in the quarter and can’t realistically be turned into a net profit until the license transition is complete — Autodesk needs to continue to pay its people, keep the lights on and do all of the other running-a-business and creating-products-people-want stuff so that subscribers stick with them. –Ed.]

Mr. Bass said that in Q3 the company “made progress on our two major initiatives: growing lifetime customer value by moving customers to the subscription model, and increasing adoption of our cloud based solutions. Given that this quarter was the most uncertain when we started the year, these are fantastic results.” He noted that “product subscriptions drove the vast majority of the new model additions. The launch of industry collections, the next generation of suites that include many of our cloud services, contributed to our strong growth this quarter. Collections are a great example of how we’re simplifying our offerings while increasing lifetime customer value.”

Autodesk continues to wield its mighty promotions stick to move customers to subscriptions. Mr. Bass said that Q3 promotions added 43,000 product subscriptions, “significantly more than in Q1”. But here’s the interesting bit: he said that the average selling price in Q3 was “twice as high as the Q1 promotion due to a lower discount and the fact that customers favored higher price products”. AND, “more than 50% of the subscribers turned in licenses that were seven years back or older”. Two lessons: if you’re an Autodesk customer not yet on subscription and are considering it, grab the next promotion that you can, since the price is likely to keep going up.

But perhaps more important is this: Autodesk has worked to create content for its industry collections that add value, enough for someone who has a product that’s 7 years old, that they’re fast and comfortable using, to switch to something that may initially slow them down — and that certainly costs them more than what they paid last quarter. That’s significant for two reasons: it ratchets up customer expectations for value from all suppliers and it means that potentially more of the customers Autodesk had written off as “lost” could come back.

It’s not all about moving existing users forward, however. Mr. Bass said that “new customers” were responsible for about 1/3 of the new subs in Q3. “New” because Mr. Bass believes that a some had been using illegal, pirated versions; others are true new users, who are choosing Autodesk over competitive offerings. He said that “for every legitimate user out there, there is slightly more than one user who’s not paying for the software, so my guess would be, as we made some of these offerings more affordable from an upfront perspective we’re attracting a fair number of the pirates. The piracy base is probably bigger than we originally anticipated,”

During the earnings call, Mr. Bass told investors that the platform concept introduced at AU a few weeks ago (see my AU writeup for my impressions) has been a long time coming. “We have firm belief that design and engineering software will be in the cloud … we started investing in this area three or four years ago. While everybody is rightfully focused on the business model transition of our existing business and how we are using it to attract new customers, I think people will be surprise about the size of the cloud business that we build, and how this really expand our TAM [Total Addressable Market — Ed.] The cloud is a place for collaboration as well as giving access to virtually unlimited amounts of compute power — something our uses demand — so it’s a natural fit. It’s unusual that engineering has been one of the slowest to move to the cloud, but we see lots of evidence of hitting the tipping point, not just in the U.S. but in other places as customers are willing to adopt it.”

The downsides? Two things:

  1. Autodesk’s Q4 forecast has revenue between $460 million and $480 million, which means FY17 revenue of $2,012 million to $2,032 million. Before the earnings release, the consensus for Q4 was revenue closer to $490 million. Mr. Bass and Mr. Herren said that Q4 doesn’t have the “end of perpetuals” backlog that boosted Q3 revenue, meaning that there’s only the sale of subscriptions in the revenue line. And if there is going to be a bump from increased infrastructure spend in the US, it won’t be soon and it won’t have a huge impact on Autodesk’s revenue. Mr. Bass told investors that AEC is “around 50% [of total revenue] and then you can take the fraction that’s the U.S. part of that and go from there. And of course Mexico’s going to be building the wall, so I guess we can extend to the rest of North America …. I’d put it in the 10% to 15% range.”
  2. Autodesk uses several metrics to try to describe to investors how the transition is going (and, to be honest, distract from the topline performance). One of these is annualized recurring revenue (ARR), the “annualized value of the average monthly recurring revenue for the preceding three months”. I get a nosebleed just typing that, but Autodesk sees ARR as a “key performance metric to assess the health and trajectory of our business.” In Q3, total ARR was $1.5 billion, up 11% as reported and up 15% cc; that’s lower than the 24% average the company had guided to for the 5 years from fiscal 2016 to fiscal 2020. But an average is … and average and there’s still lots of time to bump it up as we get closer to fiscal 2020.

Next week’s investor day will offer more details on the forecasts (and perhaps new acronyms to learn) but I think the key takeaway is this: more people are subscribing –true new customers, illegal copies being made right and perpetual buyers switching to Autodesk products rather than choosing competitors — leading Autodesk to up its forecast of total subscribers at the end of fiscal 2017 (in January) from 500,000 – 525,000 to 515,000 – 525,000. That’s 15,000 expected new additions. Are these customers paying more? Perhaps — it’s hard to tell given the mix of old/new, promotion pricing/not, but it does seem from Autodesk’s statements that many buyers are leveling-up to get at the value Autodesk has built into the newer offerings. That’s all good, even if the math is opaque right now.