Autodesk, Inc. (ADSK) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fiscal Q2 2019 Autodesk Inc., Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] And as a reminder, this conference call is being recorded. And I would now like to introduce your host for today’s call, Mr. Abhey Lamba. Sir, you may begin.

Thanks, operator, and good afternoon. Thank you for joining our call to discuss the results of our second quarter of fiscal 2019. On the line 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 third quarter and full-year fiscal 2019, our long-term financial model guidance, our cash flow expectations, the factors we use to estimate our guidance, including assumptions regarding ASC 606, our maintenance to subscription transition, ARPS, 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 fiscal year 2018, our Form 10-Q for the period ending April 30, 2018, 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 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 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 in our financial performance, and unless otherwise noted, each such reference represents a year-on-year comparison under ASC 606. And now, I would like to turn the call over to Andrew.

Thanks, Abhey. Our strong Q2 results led by 28% growth in total annualized recurring revenue not only reflect a healthy demand environment, but also continued execution as we move further through our transition to subscription. We also achieved strong growth in ARPS, billings, revenue and earnings. There are several key areas that I want to highlight. We had record growth in total ARR and total ARPS on both a year-over-year and sequential basis. The same goes for core ARR, which grew 29% in core ARPS. Recurring revenue advanced to 96%. We continue to see steady migration of maintenance customers in subscription with the maintenance-to-subscription program or M2S. And we’ve bolstered our presence in the construction market with the acquisition of Assemble Systems. First, let’s dive into ARR. I’ll repeat that we view ARR is the best proxy for measuring our progress in the overall health of our business. I noted last quarter that we expected ARR growth to build as we move through the year and we are absolutely seeing that in the second quarter. The strength in total ARR was once again broad-based with all three major geographies showing growth with APAC showing the strongest growth. Subscription plan ARR more than doubled for the sixth time in the past seven quarters, driven by growth in all subscription plan types led by product subscription. We continue to drive impressive growth in product subscription ARR on both a year-over-year and sequential basis. Looking at our core business, which represents the combination of maintenance, product subscription, and EBA subscriptions. It’s not surprising that core ARR grew in line with total ARR, as our core business drives the overwhelming majority of our revenue, ARR and billings growth. Simultaneously, customers continue to engage with our solutions for reimagining construction and manufacturing. That progress is reflected in cloud ARR, which grew more than 20% year-over-year and 10% sequentially. You've heard me say many times the construction is our key initial focus for becoming a designer made company. The market is ready and we have compelling technology and products. The biggest contributor to our cloud ARR is our BIM 360 family of products, our project delivery and construction management software that connects design and construction. A great example of how BIM 360 is being utilized in the field comes from WebCore, a large U.S. based general contractor. They are utilizing a range of advanced technology to support an innovative and efficient approach to construction. The Company is using Autodesk BIM 360 on the UC Merced 2020 project, which will expand the University of California as Merced campus by over 1.2 million square feet across 14 structures. BIM 360 is enabling WebCore to gain greater efficiency in delivering documentation and coordinated models to the field. They are also using the Forge platform to integrate and connect project data with BIM data, resulting in a single source of information and enhanced project delivery and performance. We continue to aggressively pursue that $10 billion construction opportunity. And last month, we expanded our product offerings with the acquisition of Assemble Systems, a cloud-based solution offering combined 2D and 3D quantity take off for the construction market. Assemble is doing something very unique and was one of the first companies to recognize the power of BIM for preconstruction planning and developed ways to efficiently get information out of the model and into the planning process. They extract the information and make it useful and accessible for contractors to help them with bid management, estimating, project management, scheduling, site management and finance. They were also an early adopter of our Forge platform. Assemble is a team of about 50 people, fairly evenly split between sales and engineering. Their products are used by over 200 companies, including a quarter of the ENR 400 and have been used on more than 7,000 construction projects. Assemble will enhance our market positioning and contribute to making BIM 360 a more comprehensive solution, spanning across the design and construction phase. We believe this will be a great fit both from a product and people perspective. We know them all well as Autodesk through our Forge Fund was a lead investor in their Series A realm last year. We are also seeing nice progress with the adoption of Fusion in the manufacturing market, an exciting Fusion customers Fabric, makers of award-winning cycling products. Fabric’s mission is to bring innovation to its industry by leveraging unique manufacturing methods. The Fabric team was initially introduced to Fusion by another customer and started using it for the complex industrial design requirements of bicycle saddles and affords ability to link the designs directly to manufacturing and 3D printing. Then they expanded their uses of Fusion into design, simulation and validation. Recently they have begun using generative design in Fusion to explore hundreds of practical design alternatives that delivers superior performance and can be manufactured efficiently. They are a great company and they illustrate how manufacturers are innovating with the use of advanced tools like Fusion. Now I’ll turn it over to Scott for more details on subscriptions, ARPS and other financial metrics.

Thanks Andrew. Before getting into the Q2 numbers, I want to comment on the terrific progress we've made since we started down this path to transform our model to subscription and cloud back in calendar 2014. We’ve added over 1.7 million net subscriptions over that time period and it’s now been two years since we sold our last perpetual license. The mix of our business is also dramatically shifted, as maintenance now makes up less than 30% of the subs and ARR basis, and the new model has allowed us to add a significant number of new customers to Autodesk. We’ve also migrated over 600,000 maintenance customers to subscription. From a financial standpoint, we are now firmly back in the growth stage. We’re back to non-GAAP profitability, positive cash flow, and we’ve transformed our business from less than 40% recurring revenue, prior to the start of the transition, to a highly predictable 96% recurring revenue in Q2. We still have some ways to go to achieve the fiscal 2020 targets we’ve laid out and believe the best is yet to come, but it's worth noting the meaningful progress we’ve made today. Looking at Q2, now I'll start with a closer look at subscriptions. Subscription plan subs grew by 290,000 in Q2 with growth coming in all three categories; cloud, enterprise and product subscriptions. Core subscription additions were 88,000 and increased 6% sequentially. We added 31,000 net cloud subscriptions, which is a nice step up from the 18,000 we added in Q1. It's important to note that net subscription additions continued to be impacted by product consolidation from the adoption of Industry Collections. Again, the good news is that many of these customers are increasing their total spend with Autodesk, contributing to solid increases in ARR and ARPS. The adoption of Industry Collections is happening through the regular run rate of new business, the renewal process, the legacy promo and the M2S program. New subscriptions for Industry Collections increased 60% year-over-year and represented 40% of the net product subscription additions in Q2. Industry Collections now make up 27% of the total base of product subscriptions, up from 14% in Q2 last year, that’s great progress. This is important because Industry Collections generate higher ARPS and have a much higher renewal rate compared to standalone products and it also signals a deeper relationship with the customers they were able to utilize more of our solutions. Speaking of the M2S program, we continue to make solid progress in migrating our maintenance customers to do subscription. In Q2, customers migrated 117,000 maintenance subs to product subs. While at less than what we have converted over the past two quarters. Remember that the pool of maintenance subscription gets smaller each passing quarter. The conversion rate remains strong with over one-third of all maintenance renewal opportunities during Q2 migrating the product subscription. But those that migrate once again about 30% of eligible subscriptions upgraded from an individual product to an Industry Collection. The renewal rate for maintenance declined slightly sequentially as expected. This is consistent with our long-term model, where we’ve projected a decrease in maintenance renewal rates as we progressed further into the M2S program. The renewal rate for product subscription experienced another sequential increase and we expected to continue to rise as the product mix shifts towards higher value products. Helping bolster that renewal rate are the M2S related subscriptions which have a very high renewal rate as expected because the program was designed to be very sticky. Let’s go to deeper on this topic, when we first announced the M2S offer, we provided a three-year price outlook to our maintenance customers who converted. As time went on, we heard customer feedback on extending this pricing outlook, so they can plan for their long-term business needs and investment in Autodesk solutions. So in June, we announced that we are extending our price commitment to 2028 for customers to continue to renew after they switch to subscription. For these converted customers to renewal SRP will increase by no more than 5% every other year starting in calendar 2021 subject to currency movements of course. It’s has nothing to do with the adoption of M2S, but rather putting customers at ease regarding their number one concern that our investment will significantly increase pricing once they move to subscription. This action simply puts into writing, but we've been verbalizing since we lost the program. The cost of living type adjustments would be implemented after the initial three-year price freeze and is consistent with our long-term financial goals. In each, quarter the vast majority of the new subscription plan subs are added through traditional means. However, we continue to make progress in converting legacy users into subscribers. In Q2, the legacy promo added 17,000 product subscriptions and 35% of those where Industry Collections, which is the highest percentage we ever achieved for the legacy promotion. Once again the average age of the licenses that are turned in with the promo is about seven years behind the current release indicating there is still a very long tail of legacy customers to convert. There continues to be about 2 million of these legacy users that are actively using an old perpetual license without maintenance plan. We believe that over time we will convert a large number of them utilizing our insides sales team to concentrate on converting this important cohort. The consistent attribute of the transition is the new customers continue to make up a meaningful proportion of the product subscription additions and represented over 25% 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 have been using an alternative design tool. Not let’s talk a little bit more about annualized revenue per subscription or ARPS. ARPS continue to inflect up in Q2. Various pricing changes we made in the past two quarters have the greatest influence on Q2 ARPS. These are been relatively small adjustments such as the price increase associated with the M2S program, lower channel discount on AutoCAD LT and an increase from multi-user subscriptions. Long-term ARPS drivers will continue to be the growing renewal base which comes at higher net price to Autodesk, the increase in digital direct sales also at higher net price to Autodesk. The product mix shift to Industry Collections, the maintenance price increase for those customers who don’t take advantage of the M2S program and less discounting and promotional activity. We expect ARPS to continue to inflect up for all the reasons I have just discussed as we progressed through the transition. Our e-store which is like a bigger part of our digital sales grew over 75% in Q2. For the past four quarters, our e-store has generated over 20% of the product subscriptions and Q2 also marked the seventh consecutive quarter of greater than 30% growth in our direct-to-enterprise business. What’s interesting is that while the growth of our total direct business accelerated to its highest range in over two years, growth indirect business grew even faster, leading the mix of indirect business to tick up a point to 72% of total revenue. We continue to believe that over time the mix of direct business will outpace the growth of indirect, leading to a more even spilt between direct and indirect revenue. Moving to spend management, our total non-GAAP spend came in at $556 million for the quarter, which is slightly higher than expected. However, if we normalize for ASC 340 and foreign exchange rates, the year-over-year growth in total spend would have been less than 2%. The sequential increase in spend was related to the continued hiring ramp that we’ve been calling up for the past few quarters as we near the completion of the resource rebalancing we announced in Q4 of last year. Our intent for fiscal 2019 remains to keep non-GAAP spend roughly flat at constant currency relative to our fiscal 2018 budget at about $2.2 billion. Looking at the balance sheet, total deferred revenue grew 20% as reported and 24% under ASC 605. Unbilled deferred revenue decreased by $6 million sequentially to $406 million. It’s important to note the impact of ASC 606 here because 606 require early renewals to be captured in unbilled deferred revenue. Early renewals in Q2 were $20 million lower than Q1 when some maintenance customers renewed early ahead of the M2S price increase. So while traditional unbilled deferred revenue related to moving our large EBA customers to annual billings increased by $14 million sequentially, it was more than offset by fewer early renewals. Looking at cash flow, we return to positive cash flow as expected in Q2. Operating cash flow was $43 million which benefited from growth and billings and better than expected billings linearity and cash collections. We used $147 million in the quarter to buyback roughly 1.1 million shares at an average price of $131.52. We continue to be committed the managing dilution and reducing shares outstanding over time. Now I’ll turn the discussion to our outlook and I’ll start by saying that our view of the global economic conditions remains mostly unchanged from the last few quarters for monitoring the potential macroeconomic impact from various trade and tariffs disputes. There have been some FX volatility but our hedging program is succeed and smoothing of the bigger swings. Overall, we really proud the results we achieved in Q2 in the first half of the year. As we look at our outlook for Q3 in the second half, we expect to see continuing sequential increases in most metrics, including ARR, ARPS, billings, revenue, spend, earnings, and subscription additions. We expect our hiring ramp to continue in the second half as we finished the rebalancing of resources to the most strategic projects and as such we expect our spend to increase sequentially and would likely be at the high end of our guidance range for the full-year. Keep in mind the adoption of ASC 340 capitalizes commissions. So we won’t have as big of step up and spend in Q4 compared to historical trends. Also point out the remodeling cash flow to decrease moderately sequentially in Q3 related to the shipping billings linearity that I mentioned earlier, which resulted in more of our Q2 billings being collected in quarter. We continue to expect a sizable uptick in cash flow in Q4 and then will be cash flow positive for the year and the acquisition of Assemble will not have the material impact on our overall results this year. We have confident and achieving our fiscal 2020 goals that said subscription additions for this year likely will be at the low end of our guidance range, primarily related to the success we are having with the adoption of industry collections and the consolidation we are experiencing with the M2S program. And one side note with regards to subscriptions, we will continue to report out on subs and ARPS for the remainder of this year, but are not planning on reporting those metrics on a quarterly basis starting in Q1 of fiscal 2020. Of course we use events like our annual Investor Day to report at an important metrics that will help you build out your long-term models. Now I’ll turn the call back over to Andrew for a quick closing comment.

Thanks Scott. I wanted to note that I’ve recently completed my first year as Autodesk’s CEO. It's been an exciting four quarters and we've made a tremendous amount of progress. The three primary focus areas that I outlined at this time last year have not changed and all are on track. So allow me to remind you what new organization is focused on for driving success. The first is completing the subscription transition. We remain focused not only in the financial results, but on enhancing the subscriber experience and delivering more value to our customers and customers are acknowledging that we absolutely providing greater value with subscription. Second, is digitizing the Company. By that I mean that we are investing in our own digital infrastructure to create opportunities for our customers to transact and engage directly with us, increase their level of self-service for a wide range of customer needs, and increase our ability to instantly and reliably understand how successful our customers are being with our products. We've made progress in this area and we have expanded the self-service capabilities in Autodesk account, allowing customers to easily manage users, add seats, align billings, and take advantage of the flexibility inherent in our subscription model. We've also rolled out a broad set of capabilities that help our inside sales and support teams understand the status of the customers they interact with every day. The third is reimagining construction, manufacturing and production. You should have no doubt that we are absolutely committed to winning the construction space and winning in the new world of digital manufacturing. We've done well to establish early leadership position in construction and we're not going to slow down. Operator, we'd now like to open the call up for questions.

[Operator Instructions] And our first question comes from the line of Jay Vleeschhouwer with Griffin Securities. Your line is now open.

Thank you. Good evening. Andrew, let me start with you and ask a question regarding the alignment with your sales and distribution model to your product and market strategy in two respects. With respect to the growing intersection of manufacturing that you see through your strategy, can you talk about how you're aligning, particularly the indirect channels to do that? You've typically separated the AEC from the manufacturing specialties in indirect. Would it make sense for you to increasingly combine or converge the channel specialties in that way to be more directly aligned with your product market strategy that is the focus areas you just spoke off? And then secondly with regard to the self-service model, when would you expect that the e-store could be at least half of the direct business? And then lastly for Scott, your AEC Manufacturing segment revenues were largely in line with our model, so the upside was as it turned out in AutoCAD for the repackaged AutoCAD. Would you expect for the remainder of the year that the relatively better growth or upside might occur in the repackaged AutoCAD as compared with the AEC Manufacturing segment?

Okay. So Jay, let me start answering your question by just kind of summarizing how we structured the sales force, because I think it actually talks directly to what you're talking about. So at the beginning of this year, we realigned the sales force along with a series of new models. First, what we did is, we of course maintained and invested a little bit more on our major account team. And as you know, the major account team is basically account-based. So account-based is kind of an industry type model, but it focuses on what's most important to the account, which by the way is the most valuable way to go-to-market with anything, because accounts blend many different things. Some of our biggest accounts are both AEC customers and Manufacturing customers that they have buildings, and maybe they design products. The other thing we did is we built out what we call a mid-market team, which is one level below our major account team. This is still a team that fulfills indirectly, but it's structured like a named accounts team, in that the reps have a series of accounts assigned to them that they then work with designated channel partners to satisfy. Again, this is the best way to try to scale a business when you see customers of our business is coming together because the accounts are already identified either as manufacturing or construction or architecture accounts or engineering accounts or as holistic – accounts. So that model actually allowed us to expand the account paradigm deeper into our channel network, and actually sort of align the channel on an account-based methodology and thinking. The next tier down below from that is what we call territory sales. And the territory sales has essentially split into two pieces, this kind of the more generic horizontal part of our business where it's more picked up by ambient demand. There's not specific accounts called out, but we do market along the specific segments. And what we've done in that area is we've got the business completely driven by channels. The channels are in the lead there and then we've got the digital piece. The piece that encompasses our inside sales teams and our e-store, which can be highly somewhat verticalized just like what we’ve done with named account sales where a particular inside sales rep might call and just have an e-accounts or just manufacturing accounts, just ADC accounts. We believe that structure combined with some intermediate steps around accelerating opportunities saying construction manufacturing is the right structure going forward and aligns with some of the concepts you're saying, well a lot of things that our customers do are getting closer and closer together. So that answers to your first question. The second question, I'll answer this way. Our long-term target for our business is half direct, half indirect. We anticipate that direct piece is going to be half e-store, half major account direct. Our e-store grew over 70% this quarter year-over-year. We are posting impressive growth numbers down there. More and more of the LT business is being captured in that channel. And I can give you a specific number on when that mix becomes 50/50 and see what the investment is doing. It’s driving a lot more growth in that channel and we expect that growth to continue to be robust especially as it starts to get more and more robust and say Europe and then APAC first to pick up. There are still lots of room to grow down that channel. And Scott I’ll turn the last question over to you.

Sure. Your question on AutoCAD upside, we repackaged all the AutoCAD verticals and AutoCAD together into one AutoCAD. We launched that earlier this year. And the whole goal of that was to make it easier to sell, easier to buy, easier to consume AutoCAD. And so some of the benefits we are seeing is from that for sure and I think we will see some of that benefit continue through the year. I think the second is I think most of you know, we made changes in our channel marketing structure for AutoCAD LT which also rolls into AutoCAD family. When we reduced the channel margins on AutoCAD LT with the goal of having the channels, but more then are focused on selling collections which we see is actually having a quite nice outcome. But when you layer in both the acceleration from one AutoCAD and the change in the channel margin on LT, those are the two things that are fueling the growth in the AutoCAD family.

Okay. Thanks very much.

Thanks Jay.

Thank you.

Thank you. And our next question comes from the line of Phil Winslow with Wells Fargo. Your line is now open.

Thanks guys for taking my question and congrats on a great quarter. Just one question for Scott and then a follow-up for Andrew. Scott, obviously another strong quarter in ARPS and you laid out a lot of the drivers that we should see over the next multiple years to continue to move that higher. I was hoping you gave some color as you think sort of the next few quarters here, how we think about sort of the incremental drivers and ARPS versus what we've seen here in the first half of this year. Then to your comment about sort of collections being strong, obviously a positive to ARPS, could you also maybe provide some color on just the impact to the subscription unit number? And then like I said, just one quick follow-up for Andrew.

Sure, Phil. On the drivers of ARPS – the long-term drivers of ARPS are going to be the same one that we've talked about an Investor Day and that I highlighted in the opening commentary. The growing renewal base which is higher net to us, the digital sales continues to grow, that's a higher net to us. M2S – and M2S both as a long-term driver of growth and also had a significant impact on Q2. As you know, the beginning of Q2, we got a year or two of maintenance subscription, which met the maintenance price index up another 10% and the conversion price index up 5%. So that's a long-term driver that's also a specific Q2 driver for us on ARPS. And then greater or less discounting and promotional activity, so greater net yield to us across the Board. The LT channel discount change that we made earlier in the year, we're seeing that now flow through, obviously goes first into deferred revenue from deferred revenue into the P&L and ARPS. That was a benefit to ARPS in Q2. Industry Collections continues to – we continue to have great success. And 40% of the net product subscriptions added in the quarter were Industry Collections, which is a high water mark for us. That's driving ARPS. It is having an offset. To the second part of your question Phil, that does have an offset to subs obviously, but I think that's a – in most cases, the customers end up spending more money with us when they make that change from standalone products to Industry Collections. So we drive more ARR and of course higher ARPS and trade-off faster subscriptions growth. I think that's a good trade-off. And then finally, we made a slight price adjustment on our multi-user products. We also saw the benefit of that for the first time really flowing through deferred revenue and into reported results during Q2. So it's a lot of things that all move right direction on ARPS in Q2 – probably get ahead of your next year follow-up on this. When you look at our guidance for the full-year, you can see – we do expect to see continued ARPS growth in both Q3 and Q4 throughout the year.

Got it. Thanks Scott. And then Andrew, obviously you highlighted the acquisition of Assemble and if I think about just your construction management, portfolio is broad, and obviously start on the design side, but then BIM, and then the Assemble being able to connect that BIM data into planning systems, then you've got your planning construction management team. You think about sort of lifecycle of CMS. So how do you think about how sort of deep Autodesk wants to go onto the CMS side, because it seems to be you're inching further along kind of that lifecycle, but still being grounded in the design side, kind of like CAD and PLM?

Yes. So long-term our goal is to capture every aspect of that cycle. From all the way from designs, you’re preconstruction to site execution into operation. We're very interested in that whole process. And the reason I said this multiple times is because it's moving in a direction of the manufacturing cycle moved in the past. The model is going to become the currency that moves from one aspect of the design process to the next aspect of the main process to ultimately once you do retire or manage the asset and make the next asset. So we think the model is going to be a critical piece of this process moving forward and we intend to manage the flow that information across the entire process. You're correct and what you said around Assemble Systems that was a classic move for us to double down on the area of pre-construction where we're trying to help people take driven data and turn it into actionable information in the creek pre-construction planning cycle. That's exactly what Assemble it does and it helps us basically drive opened the opportunity in an area that we feel we're highly competitively advantaged in the space.

Got it, so CLM not just PLM, all right. Thanks guys.

Thanks, Phil.

Thank you. And our next question comes from the line of Saket Kalia with Barclays Capital. Your line is now open.

Hi guys, thanks for taking my questions here. First, may be for you Scott. Nice job on the billings this quarter. I think clearly the acceleration in ARR is the main driver, but you touched on some other items as well. So just wondering if you could talk about some other factors there are like duration and linearity and how you think about – how you thought about some of the drivers of ARR – a billing strength in the quarter?

Yes. Thanks Saket. Duration really doesn't have an effect during the quarter on billings. If you look at our weighted-average term links of our deferred revenue effect you see on the balance sheet. You see our long-term deferred actually declined again sequentially. So we're not seeing a change in duration this driving billings. It does get back to a lot of the things I just talked about in response to Phil's question about the drivers of ARPS. ARPS, the layering on of greater growth of industry collections, some of the changes that we made on channel margins, that the growth through the channel, frankly we had a really strong quarter indirect as you heard in the opening commentary and we actually take down a one percentage point in the percent of direct because the channel grew really strong during in the quarter. So that – if it was a combination of those things, much more so than any kind of one-time benefit that hit billings during the quarter.

Got it. That's very helpful. Andrew, for may be my follow-up for you. I know we've talked about renewal rates a little bit, but I'd like to zoom in a little bit on subscription renewal rates in particular. Now that we've gone through a couple price increases. I guess the question is how those trended? I think we've touched on a little bit, but can you recap for us how those have trended and more importantly, how have you thought about those renewal rates for subscription in the long-term model?

All right, Saket, let me answer that question from a couple of things. First, one of the things that we watch very, very closely here as we watch transition is the maintenance renewal rates in particular. All right, we know that the prices were going to be going up. We modeled in certain changes in maintenance renewal rates over time. So we've got a long-term model and what we expect to happen to maintenance renewal rates as the price is ratchet up on maintenance and as the M2S program progresses. What I can tell you right now is those renewal rates are smack dab in line with what we've been modeling and what our goals were with regards to that. Now, do the models numbers create the outcome or are we just brilliant modelers in predicting customer behavior? We can debate that. But what we're seeing is behavior that's right in line with what we’re modeling. The same goes from what we're seeing in the product subscription area, the pure product subscription area. We’re seeing nice increases in renewal rates, what we expected, what we have built into our model. So I think the important headline here is we're seeing things that are consistent with our expectations. And one of the things that was also very gratifying, and Scott mentioned it earlier in the opening commentary is the M2S program was designed to be very sticky. It's designed to incent our maintenance customers to come over and feel great coming over. And what we're seeing is really high or highest renewal rates for customers that took on the M2S program, which by the way is an important fact that in terms of taking care of our best customers, but also making sure to retain that basis in the future.

Very helpful. Thanks guys.

Thanks, Saket.

Thank you. And our next question comes from the line of Richard Davis with Canaccord. Your line is now open.

Thanks. BIM is been around for – I mean I've been hearing people talk about it for at least a decade, but it's doing well. And so the question I have is, so when I talked to some of your customers, some bought it because it was like – a very few have bought it – some bought it because of the digital transformation. Others were more kind of I guess cold blooded and saw hard dollar ROI. So when I kind of think about how markets evolve. Is this a market and you guys have much more visibility in this thank I will. So is this a market that kind of starts with like a hard dollar ROI sale? And then as you kind of get momentum and people say, this is like really important, you'll start to get these kind of bigger deals because you'll hear this digital transformation discussion. And this is exactly what we saw with sales force is what we're seeing with service now and other industries and sectors. I wonder if that's – how this market is going to play out, so thanks.

Yes. Look here is how these markets generally play out. There's always a first mover and when you’re talking about BIM, I want to distinguish whether or not you’re talking about. BIM is in the whole – discipline in building information modeling or BIM 360 in terms of the construction [indiscernible]. What you’re saying is actually – but let's just talk specifically about BIM 360. What you're seeing right now in the space is that there is a pressing problem to digitize the site. So the mainstream problem, that's the problem that just about every construction company sees is this idea – well I get digitized my site. I need to get model information to the construction site, I need to get up-to-date drawing information to the construction site. There's a lot of – that segment of the market right now because the technology is ready, the customer is ready. They want it and they need it. That's getting that kind of classic adoption curve that we typically see in any kind of technology, more and more people are buying. And now they're starting to ask the question about, okay, so what's the next step? So if I go and I look at some of our more forward looking customers, especially some of our largest construction and general contractors, they're already looking at, okay. I'm able to digitize my site. But I want to digitize my entire construction process just like those guys do over in Boeing or Airbus and make the same processes that they have for how I build the building, a road or a bridge. They're experimenting early with this pushing the building information model further and further down into the process. And what's you're going to see is this battle for competitive advantage. It's now becoming who can be more digital first, so that they can increase their fidelity on project bids, cut a few hundred million off their bid for a project because they have much more precise information about what the margin is. So it’s going to become a digital arms race. And that's exactly what starts to happen in classic technology adoption. There is all sorts of words for it, the tornado and you've heard of many different kinds of words. It's been called different things over the ages. But we're starting to see the early signs of basically a digitalization arms race between various people in the construction space and it's going to play out there.

Yes. That's super helpful. Thank you very much.

Okay. Thanks Richard.

Thank you. And our next question comes from the line of Heather Bellini with Goldman Sachs. Your line is now open.

Great. Thank you. So I just wanted to talk a little bit. You guys are obviously well on your way to $6, which was the first target you guys laid out years ago. But as people start to shift the focus to $11, and I know you've touched on this a little bit here, but can you share with us how you're thinking about the contribution from cloud subs, how important are they to getting to that number and how do we think about broader adoption in the construction market given they've typically been really slow to embrace technology? So I guess I'm wondering what do you think the industry needs to see to be more open to leveraging technology. Thank you.

Yes. So let me approach this from a couple of directions. So first off, we're definitely committed to our long-term capital targets that we put out there in various forms, especially at Investor Day. I want to remind you something we said at Investor Day because it's very important for how we look at the company moving forward. And we look less at the ratios that we've been classically talking about and much more at the sum of revenue growth and free cash flow margin and trying to optimize that number to provide the right long-term outcome for the company and the right kind of value creation. So just remember, as we look forward out beyond FY 2020, we're really looking at the sum of those two numbers, revenue growth and free cash flow margin growth is kind of the ways to look at where we're going moving forward, that we remain completely committed to the free cash flow targets we put out there. Now, when you look at the construction market, so I want to challenge something you said, there already is a large increase in technology spending going on in the construction space. It's not just because of all the VC money that's been invested in this space. There's actually hundreds of millions of dollars in revenue being generated right now on the site execution product. So what's changed fundamentally is it’s getting harder and harder for these construction companies, especially on large projects to win without having some kind of digitization in their process. They're simply not able to get the margins and hit the scheduling requirements they have without having tighter control over the data flow. So they've been historically reluctant because the industry as a whole has been historically sloppy. And because the industry as a whole is sloppy, there was no competitive pressure to actually drive technology adoption. But what you're starting to see is types of excellence inside the construction industry where people are adopting, some of our best customers are becoming very digital and they're highly visionary in terms of how they see the construction industry evolving that vision and that move towards being highly digital is changing the way people have to compete in this space. So it's been slow in the past because sloppy has been tolerated and everybody was sloppy and they were all equally sloppy. People are getting a lot tighter and that's what it's going to change things Heather as you move forward, it's basically back to this fundamental thing about as the secular margin gets more digital the rest of the segments right back into the digital by necessity.

Thank you very much.

You’re welcome.

Thanks Heather.

Thank you. And our next question comes from the line of Sterling Auty with JPMorgan. Your line is now open.

Hi guys. Thanks. So a lot of discussion around BIM, not only on this call, but a lot of investor questions leading up to the call. I just want to ask is simply, has the financial results out of your BIM initiatives lived up to your expectations?

Sterling, we just had 21% growth in cloud ARR this quarter which is a mostly made up of BIM 360. We added 31,000 subs in the BIM 360 space. We are absolutely seeing results that we want to see in this space. You also saw it moved to make an acquisition around Assemble to try to double down. And frankly what we believe is a highly differentiated part of the process for us around preconstruction. It's an area where our customers are actually saying, well, we're glad you're doing this site digitization stuff, but can you do more on preconstruction for us? So we're actually seeing a lot of the things we expected to see and we're getting increased demand from some of our best customers around the area they want to see us spend more effort on. So I do feel pretty good about where we're going and I feel very good about our prospects. And one of the things I want to iterate here too, is because I've said it many times, our goal to be number one in this construction space right, looking for number two, we are not. We would never be satisfied with number three, we're going to be looking to be number one and we're heavily focused on doing everything it takes to become number one in the space. And I think you just want to make sure that you hear kind of our commitment to that and frankly our passion for that.

And one follow-up again on the space, if you look at the big customers, like ENC 300, et cetera. How are they adopting? Are they going with a single vendor and trying to build? Or are they kind of using a couple of different vendors and a couple of different projects to kind of test the waters and then making their decisions and developing from there.

Yes. So I mean [indiscernible] what you see is the biggest in the ENR 100 and top of GC chain. What they do is, they have a combination of vendors they bring in and also they bring custom developed solutions on top of what they're doing to fill the gaps between what they see that no vendor is providing. Now the great news about the fact that they’re engaged in some of these custom solution executions, they’re becoming big adopters of Forge, because Forge, let them stitch together some of our data into some of their flows in ways that we haven't done the work in some of our off the shelf products to do that. So everything you just described is exactly what's happening. I will tell you that there's more and more pressure on us to consolidate more and more of the process around the building information model and we're trying to respond to all of those requests, but the way you described it as multiple vendors involved and custom software coming together at the [indiscernible] that's exactly what happens.

Got it. Thank you.

You’re welcome.

Thank you. And our next question comes from the line of Keith Weiss with Morgan Stanley. Your line is now open.

Hi, this is Hamza Fodderwala and for Keith Weiss. So it seems like the overall ARR growth was strong, but the cloud ARR did come in a bit below that of the core business? Is that largely just a result of a tougher year-on-year compares and do you see any indication of a reacceleration in the second half from the revamped BIM 360 product?

Yes, Hamza, the cloud business actually accelerated sequentially, right? So we talked about the ARR being at 21% and the number of subs going from $18,000 net adds, right? So it grew in aggregate $18,000 net adds in Q1, the $31,000 net adds in Q2. So this is actually performing quite well. You remember this is the last quarter where our year-on-year comparison cloud compared back to a quarter where we were using a lot of kind of seeding strategy, pushing out a lot of high volume, low price, BIM 360 team subs out into the marketplace. So on a year-on-year basis maybe is where you're drawing your conclusion. You look at sequentially how it's moving – it's actually moving quite nicely. And fueled by the Andrew just said that fueled mostly by the growth of BIM 360.

Got it. And then on the direct business, so I understood the dynamic between the indirect business growing a bit faster, but when could we see a more material pickup there given the sales restructuring that you talked about, are there any sort of exclusive discounts that you're offering through the e-store that to incentivize customers through that channel?

No, we are not. Hamza, I don't think it makes sense to do a lot of that. It's a high class problem to have when you've got the fastest growth rate in our e-store and in our enterprise sales we've had in the last two years and yet the indirect channel is growing faster. So it's not a case that the direct channel is not growing. It's growing really quickly. The indirect channel is just keeping pace at this point. Longer-term, we still believe that settles in closer to a 50-50 blend, but frankly as long as we continue to grow that direct touch space, indirect business keeps pace that that's a good problem to have.

Okay. Thank you.

Thank you. And our next question comes from the line of Gal Munda with Berenberg Capital Markets. Your line is now open.

Hi, thanks. This is Alex on for Gal. I just wanted to dig a little deeper in the collection upselling. I was wondering which collections do you see, selling the best and I was wondering if you could give a quick breakdown on roughly how they're split? And then secondly, just on the $2 million user base that are not currently subscribers. What is the aging profile of that pool and are you thinking about any more promos to get them to move over, how are you trying to attract them to become paying subscribers? Thanks.

So Alex, on your first question we don’t actually provide that level of granularity as you'd expect AEC, which is the biggest piece of our overall business that you would expect the AEC collection to be the bigger piece of our total collection business as well. But we don't provide that that level of granularity down to the vintage of the collections. The overall good news is collections rapidly.

Okay.

Your second question on legacy, the 2 million legacy customers, we're making good strides on that, right. We the statistic that we gave earlier is 17,000 took advantage of the legacy promotion that we ran during Q2. Andrew also touched on this in his opening commentary. We will continue to go after advance space, continue to migrate the legacy customers. We continue to see the average of this scattergram of the licenses that they turn in, the legacy customers turn in to take advantage of the promo. We continue to see the midpoint of that bell curve to be seven years old, seven years behind the current version, which means there's a – there continues to be a pretty long tail of legacy customers out there. I think what you'll see is through is price is one reason they move. And Andrew, you can jump that on a little bit more on this as well. The older their licenses, their perpetual licenses, I remember we sold the last perpetual licenses for standalone products more than two years ago. The older it is, the more it ages out, the harder announce for them to work effectively within their ecosystem. So price is only one lever to get those guys, just with those licenses age, they will come back and need to update the licenses. So we'll continue to farm that base probably more so with an inside sales types through our direct sales to hubs as opposed to trying to just get their price discounts.

Perfect. Thank you.

Thank you. And our next question comes from the line of Gregg Moskowitz with Cowen & Company. Your line is now. Okay.

Okay. Thank you very much. The core ARR was strong and it was good to see some improvement in cloud subscriptions as well. But Scott, you did mention that you expect net new subs to come in at the lower end of the range for the year. Is that solely because of the headwind on net adds from the M2S consolidation in the back half of the year? And if so, when do you expect that that dynamic will significantly subside.

Yes, it is mostly related to success with collections is what I would say. Obviously, when maintenance customers consolidate that that turns into a gain in ARR, as we've talked about, but a decline in the total number of active subs. We will continue to fuel that headwind through the second half of the year. The other things that will fuel though that the other part of your question, which is what's going to fuel the subs growth in the second half of the year, there's a couple of things inside there. One is we'll continue to see increased productivity from the mid-market channel that Andrew talked about. So this is a field sales team that we've put out there that's driving, direct touch with customers and that tier of customer is below named accounts and selling side by side with a partner. We just started that process the beginning of this fiscal year. So they got their accounts assigned in February 1, first ever of fiscal year. They’ve been meeting those accounts. They've been driving opportunities. They've been filling the pipeline. That business will uptick through the second half of the year. The productivity of that channel, now that’s it’s taking a longer decision will drive that. And the second is just historically new product subs are higher in the second half of the year than they are in the first half of the year. So it will drive that growth in the second half.

Perfect.

Yes, Gregg, with respect to the consolidation on the M2S side, I said last earnings call that we expect that to work its way out of the system through the second half of this year and the reason for that is very simple. The accounts that are most likely to consolidate our largest accounts. They're the ones that actually make the move from M2S earlier in the cycle. So for instance, in the U.S., the conversion rates for M2S is much higher than the average. I mean they came out of the gate fast and strong, and the largest accounts are already really moved in terms of M2S. You're starting to see that phenomenon work itself. It's way through. The European market. So you're seeing the large accounts start to take the M2S offering and move. And just like with any pattern of anything we rollout the Company, I don't care what program it is. APAC comes up to speed third in that process and it will start to see, which has we move towards the end of the year. It’s largest account start to move. So what you will see as these large accounts that moves that are most likely to consolidate will start to flush out as we move to the second half of the year or so. So watch that to happen as we move that mobile. See the headwind starts to slow down.

Very helpful. Thanks guys.

Thanks Gregg.

Thank you. And our next question comes from the line of Rob Oliver with R.W. Baird. Your line is now open.

Hey guys, thanks for taking my question, just one for Andrew to start. Andrew, I know you won't be held to a number on piracy in terms of conversions there, but you did float last quarter a little bit about some of the initiatives you guys had and I know Scott, you just touched on them as well with the mid market channel, but new sales motions, I mean product messaging, things like that. I was just wondering if you could talk about the progress of some of those conditions.

Yes, it’s good. I'm glad you're allowing me to refresh what I said last quarter. There will never be this announcement of some massive non-paying user event that fundamentally changes our trajectory. But you are right, we did roll out in English speaking countries, a new program that allows us to get more information and more direct engagement with people basically using invalid license of the software. That program has been integrated with our license compliance teams and with our inside sales teams. So we're actually getting leads through that program and getting into discussions with customers. It's beginning to have an impact on the run rates and it will continue to grow. I mean, with all these programs it roll out, we start to get traction with them. We start to understand them more and they start to add more and more contribution. I think the great thing about the whole non-paying user paradigm here is that it's going to be the gift that keeps giving over multiple years. These users aren't going away. They continued to use the software. They continue to procure more valid licenses as time goes on and we're going to be continuing to reach out with them more and more as we move forward. So look forward just to continue to support the ramp ups in volume that we have built into our models over the next few years.

Great. Thanks Andrew. And Scott, I just wanted to make sure. I think you touched on it pretty clearly. But just on that – but the change to kind of the subscription contracts, if you could just repeat that, I think what you said was, people get the price freeze for three-years and then it subject to sort of a cost of living adjustment under that, just wanted to make sure I had it right? Thank you guys very much.

Yes, you got it right, Rob. When we first rolled out maintenance subscription, if you remember we gave three-years worth of visibility to what the prices would be for maintenance and what the increases would look like and then what it would be to convert. And for those that converted, we offered a three-year – they didn't have to pay upfront, but they got grandfathered with that conversion price for up to three years. What we've added to that now, one of the feedbacks that we got from the channel is, okay. I want to know what's going to happen after that, right. I guess that you're going to grandfather me for three years, but I'm giving up a perpetual license that I'd spend a lot of money on and I did exactly what you asked me to do. I kept the current on maintenance for the entire time that I had it. I'm giving that up, so I want to understand some sense of what pricing is going to be longer term. And you’ve heard us say several times that there would be kind of cost of living price adjustments that go into that. What we've done is just formalized that, but after the channel that there will be kind of an every other year, 5% price increase subject to currency changes obviously, but 5% price increase, which averages out to kind of a 2.5% annual cost of living price increase every year for up to 10 years. So that's what we've done on M2S. Just to put it in writing, but we've been saying verbally and of course what's been built into our modeling for the entire time.

We have time for one more question.

Thank you. And our next question comes from the line of Brad Zelnick with Credit Suisse. Your line is now open.

Hi [indiscernible] on for Brad. Thanks for taking the question. I just want to ask, unpack the 10-year pricing plan a little bit more, I mean has that extra assurance helps with incremental and tax conversions are all and how does that pricing compared to non-promo subscriptions beyond 2021?

Yes. So we didn't provide this clarity because of any issues we're having with M2S program. As you can see, we have very, very robust conversion rates. They're actually ahead of our original model. So we're feeling good about this. We did this communication more to ensure that our sales resources didn't have to have protractive long back and forth conversations about the implications of moving to M2S. It's an efficiency move for us and it's a visibility movement and trust movements regards to our customer base. So it's purely something that we're trying to do to look ahead to the last year and a half of the M2S program, makes sure it's highly efficient and make sure our customers basically have no questions, all right. And remember, as we look at the three-year period or it was a published price – increased true up at the end of that three-year period. All we did was given visibility to how the cost of living will play out in years after that.

Beyond that.

Yes, beyond that. Now your question about promos, are you referring to the legacy promos or…

Are you asking what's the relative price of this cohort versus the people that come in to a net new sub, because if you recall, when we laid that out, it starts at about a 50% discount for this converted group versus what the price of a new product subs is. And so with these kinds of cost of living price increases, that probably takes place on both lines. They'll continue to have an advantage price for some period of time.

Yes. And just remember as time goes on this cohort, this M2S cohort that moved from maintenance subscription. It starts to become a fairly small percentage of our total subscriber base.

So with an extremely high renewal rate.

With an extremely high renewal rate.

Got it. That makes sense. Thank you.

Thanks. End of Q&A

Thank you. And that does conclude today's Q&A session. And I'd like to return the call to Mr. Abhey Lamba, for any closing remarks.

Thanks everybody for joining us. This concludes our call. Please feel free to call us at 415-547-8502 if you have any questions. Thank you.