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AUTODESK INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The discussion in our MD&A and elsewhere in this Form 10-Q contains trend analyses and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are any statements that look to future events and consist of, among other things, our business strategies, including those discussed in "Strategy" and "Overview of the Three and Six Months Ended July 31, 2014 and 2013 - Business Outlook" below, anticipated future net revenue, future GAAP and non-GAAP earnings per share, operating margin and other future financial results (by product type and geography) and operating expenses, the effectiveness of our efforts to successfully manage transitions to new business models and markets, expected market trends, including the growth of cloud, mobile and social computing, the effect of unemployment and availability of credit, the effects of weak global economic conditions, the effects of revenue recognition, our backlog, expected trends in certain financial metrics, including expenses, the impact of acquisitions and investment activities, expectations regarding our cash needs, the effects of fluctuations in exchange rates and our hedging activities on our financial results, our abilities to successfully expand adoption of our products, our ability to gain market acceptance of new businesses and sales initiatives, our ability to successfully increase sales of product suites as part of our overall sales strategy, and the impact of economic volatility and geopolitical activities in certain countries, particularly emerging economy countries, and the resulting effect on our financial results. In addition, forward-looking statements also consist of statements involving expectations regarding product acceptance, continuation of our stock repurchase program, statements regarding our liquidity and short-term and long-term cash requirements, as well as statements involving trend analyses and statements including such words as "may," "believe," "could," "anticipate," "would," "might," "plan," "expect," and similar expressions or the negative of these terms or other comparable terminology. These forward-looking statements speak only as of the date of this Form 10-Q and are subject to business and economic risks. As such, our actual results could differ materially from those set forth in the forward-looking statements as a result of the factors set forth below in Part II, Item 1A, "Risk Factors," and in our other reports filed with the U.S. Securities and Exchange Commission. We assume no obligation to update the forward-looking statements to reflect events that occur or circumstances that exist after the date on which they were made, except as required by law. Note: A glossary of terms used in this Form 10-Q appears at the end of this Item 2. Strategy Autodesk's vision is to help people imagine, design and create a better world. We do this by developing software and services for the world's designers, architects, engineers, and digital artists, professionals and non-professionals alike-the people who create the world's products, buildings, infrastructure, films, and games. Autodesk serves professional customers in three primary markets: architecture, engineering and construction; manufacturing; and digital media and entertainment. Our goal is to provide our customers with the world's most innovative, and engaging design software and services. Our product and services portfolio allows our customers to digitally visualize, simulate, and analyze their projects, helping them to better understand the consequences of their design decisions; save time, money, and resources; and become more innovative. Autodesk was founded during the platform transition from mainframes and engineering workstations to personal computers. We developed and sustained a compelling value proposition based upon desktop software for the personal computer. Just as the transition from mainframes to personal computers transformed the industry thirty years ago, we believe our industry is undergoing a similar transition from the personal computer to cloud, social, and mobile computing. To address this transition we have accelerated our move to the cloud and are offering more flexible licenses. For example, in fiscal 2014, we began offering Autodesk BIM 360, PLM 360, Sim 360 and Fusion 360, a few of our cloud based offerings, which provide tools, including social and mobile capabilities, to help streamline design, collaboration, and data management processes. We believe that customer adoption of these new offerings will continue to grow as customers across a range of industries begin to take advantage of the scalable computing power and flexibility provided through these new services. Our strategy is to lead our customers and the industries they serve to the new cloud and mobile platforms. This entails both a technological shift and a business model shift. During fiscal 2014, we announced more flexible term-based license offerings, including term-based desktop subscriptions, for certain products. These offerings are designed to give our customers even more flexibility with how they use our products and service offerings and address new types of customers such as project-based users and small businesses. Over the next four years, we expect to increase our subscription base and customer value, which we believe will help drive billings growth. During the transition, revenue, deferred revenue, operating margin, and earnings per share will be impacted as more revenue is recognized ratably rather than up front and as new offerings bring a wider variety of price points. 28 -------------------------------------------------------------------------------- For the three months ended July 31, 2014, our billings increased 27%, as compared to the same period in the prior fiscal year. The 14 percentage point change from our 13% year over year growth in revenue and our 27% year over year growth in billings represents 12 percentage points from the increase in deferred revenue and 2 percentage points related to the change in acquisition-related deferred revenue and other. For the six months ended July 31, 2014, our billings increased 18%, as compared to the same period in the prior fiscal year. The 9 percentage point change from our 9% year over year growth in revenue and our 18% year over year growth in billings represents 10 percentage points from the increase in deferred revenue offset by 1 percentage point related to the change in acquisition-related deferred revenue and other. At July 31, 2014 and January 31, 2014, our total subscriptions were 2.01 million and 1.85 million, respectively. For the past three years, suites have been an important growth area to our overall strategy. As our customers in all industries adopt our design suites, we believe they will experience an increase in their productivity and the value of their design data. For both the three and six months ended July 31, 2014, revenue from suites increased 20%, as compared to the same periods in the prior fiscal year. As a percentage of revenue, suites consisted of 36% of our net revenue in both the three and six months ended July 31, 2014, as compared to 34% and 33% of our net revenue in the three and six months ended July 31, 2013, respectively. Expanding our geographic coverage is another key element of our growth strategy. Much of the growth in the world's construction and manufacturing is happening in emerging economies. Further, emerging economies face many of the challenges that our design technology can help address, including infrastructure build-out and innovative design and manufacturing. Revenue from emerging countries increased 14% and 10% during the three and six months ended July 31, 2014, respectively, as compared to the same periods of the prior fiscal year. We believe that emerging economies continue to present long-term growth opportunities for us. Revenue from emerging countries represented 15% and 14% for the three and six months ended July 31, 2014, respectively, and represented 15% and 14% for the three and six months ended July 31, 2013, respectively. While we believe there are long-term growth opportunities in emerging economies, conducting business in these countries presents significant challenges, including economic volatility, geopolitical risk, local competition, limited intellectual property protection, poorly developed business infrastructure, scarcity of talent, software piracy and different purchase patterns as compared to the developed world. Today, complex challenges such as globalization, urbanization, and sustainable design are driving our customers to new levels of performance and competitiveness, and we are committed to helping them address those challenges and take advantage of new opportunities. To achieve these goals, we are capitalizing on two of our strongest competitive advantages: our ability to bring advanced technology to mainstream markets, and the breadth and depth of our product portfolio. By innovating within existing technology categories, we bring powerful new design capabilities to volume markets. Our products are designed to be easy-to-learn and use, and to provide customers with a low cost of deployment, a low total cost of access to our software offerings, and a rapid return on investment. In addition, our software architecture allows for extensibility and integration with other products. The breadth of our technology and product line gives us a unique competitive advantage, because it allows our customers to address a wide variety of problems in ways that transcend industry and disciplinary boundaries. This is particularly important in helping our customers address the complex challenges mentioned above. We also believe that our technological leadership and global brand recognition have positioned us well for long-term growth and industry leadership. In addition to the competitive advantages afforded by our technology, our large global network of distributors, resellers, third-party developers, customers, educational institutions, faculty and students is a key competitive advantage. This network of relationships provides us with a broad and deep reach into volume markets around the world. Our distributor and reseller network is extensive and provides our customers with the resources to purchase, deploy, learn, and support our products quickly and easily. We have a significant number of registered third-party developers who create products that work well with our products and extend them for a variety of specialized applications. We are committed to helping fuel a lifelong passion for design in students of all ages, and inspiring and supporting educators. As such, we offer extensive educational programs supporting our software and services including a new program, initiated in fiscal 2014, under which we offer software licenses to students, educators and institutions for little or no fees. Through these programs we intend to further Science, Technology, Engineering, Digital Arts, and Math (STEAM) education initiatives. With an extensive global community of students who are experienced with our software and poised to become the next generation of professional users, our goal is to reduce the cost of training and education of new talent for our customers. 29 -------------------------------------------------------------------------------- Our strategy includes improving our product functionality and expanding our product offerings through internal development as well as through the acquisition of products, technology and businesses. Acquisitions often increase the speed at which we can deliver product functionality to our customers; however, they entail cost and integration challenges and may, in certain instances, negatively impact our operating margins. We continually review these trade-offs in making decisions regarding acquisitions. We currently anticipate that we will continue to acquire products, technology and businesses as compelling opportunities become available. Our strategy depends upon a number of assumptions, including that we will be able to continue making our technology available to mainstream markets; leverage our large global network of distributors, resellers, third-party developers, customers, educational institutions, and students; improve the performance and functionality of our products; and adequately protect our intellectual property. If the outcome of any of these assumptions differs from our expectations, we may not be able to implement our strategy, which could potentially adversely affect our business. For further discussion regarding these and related risks, see Part II, Item 1A, "Risk Factors." Critical Accounting Policies and Estimates Our Condensed Consolidated Financial Statements are prepared in conformity with U.S. generally accepted accounting principles. In preparing our Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our Condensed Consolidated Financial Statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. We regularly reevaluate our assumptions, judgments and estimates. Our significant accounting policies are described in Note 1, "Business and Summary of Significant Accounting Policies," in the Notes to Consolidated Financial Statements in our Form 10-K for the fiscal year ended January 31, 2014. In addition, we highlighted those policies that involve a higher degree of judgment and complexity with further discussion in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in such Form 10-K. We believe these policies are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. Overview of the Three and Six Months Ended July 31, 2014 and 2013 Three Months Three Months Ended July 31, As a % of Net Ended July 31, As a % of Net (in millions) 2014 Revenue 2013 Revenue Net Revenue $ 637.1 100 % $ 561.7 100 % Cost of revenue 87.9 14 % 67.8 12 % Gross Profit 549.2 86 % 493.9 88 % Operating expenses 499.3 78 % 410.3 73 % Income from Operations $ 49.9 8 % $ 83.6 15 % Six Months Ended As a % of Net Six Months Ended As a % of Net (in millions) July 31, 2014 Revenue July 31, 2013 Revenue Net Revenue $ 1,229.6 100 % $ 1,132.1 100 % Cost of revenue 166.6 14 % 135.3 12 % Gross Profit 1,063.0 86 % 996.8 88 % Operating expenses 970.9 79 % 831.8 73 % Income from Operations $ 92.1 7 % $ 165.0 15 % During the three months ended July 31, 2014, as compared to the same period in the prior fiscal year, net revenue increased 13%, and gross profit increased 11%, while income from operations decreased 40%. During the six months ended July 31, 2014, as compared to the same period in the prior fiscal year, net revenue increased 9%, and gross profit increased 7%, while income from operations decreased 44%. Our business experienced year over year growth in our Architecture, Engineering and Construction ("AEC") and Manufacturing ("MFG") segments, many of our major products, particularly our AEC suites, and all of our geographic areas, particularly Europe and Middle East and Africa ("EMEA"). This growth contributed to the year over year increase in both subscription and license and other revenue during the three and six months ended July 31, 2014. 30 -------------------------------------------------------------------------------- We continue to make progress on our business model transition announced during the latter half of fiscal year 2014 with more flexible licenses and service offerings that have ratable revenue streams. We also experienced growth in our total subscriptions and billings during the three and six months ended July 31, 2014. Income from operations during the three and six months ended July 31, 2014 was negatively impacted by increased spend as a result of the business model transition, investments in our move to the cloud, the dilutive impact of the Delcam acquisition, as well as incremental spending on other key initiatives. Additionally, cost of revenue, commissions and our employee incentive program are volume-related and increased based on our better-than expected billings and subscriptions performance. The reasons for these changes are discussed below under the heading "Results from Operations." Revenue Analysis Revenue from flagship products was 48% and 49% of total net revenue during the three and six months ended July 31, 2014, respectively. Revenue from flagship products increased 6% and 1% during the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year. Revenue from suites was 36% of total net revenue for both the three and six months ended July 31, 2014, and increased 20% in both periods as compared to the same periods in the prior fiscal year. Revenue from new and adjacent products was 16% and 15% of total net revenue for the three and six months ended July 31, 2014, respectively and increased 24% and 13% as compared to the same periods in the prior fiscal year. We anticipate that, as our new and existing customers migrate from our stand-alone products to suites, our revenue from suites will increase as a percentage of revenue and our revenue from our flagship and new and adjacent products will decrease over time. We rely significantly upon major distributors and resellers in both the U.S. and international regions, including Tech Data Corporation and its global affiliates (collectively, "Tech Data"). Tech Data accounted for 26% of Autodesk's total net revenue for both the three and six months ended July 31, 2014, as compared to 24% and 25% in the three and six months ended July 31, 2013, respectively. We believe our business is not substantially dependent on Tech Data. Our customers through Tech Data are the resellers and end users who purchase our software licenses and services. Should any of the agreements between Tech Data and us be terminated for any reason, we believe the resellers and end users who currently purchase our products through Tech Data would be able to continue to do so under substantially the same terms from one of our many other distributors without substantial disruption to our revenue. Operating Margin Analysis Income from operations decreased 40% in the three months ended July 31, 2014 due to an $89.0 million or 22% increase in our operating expenses and a $20.1 million or 30% increase in cost of revenue, as compared to the same period in the prior fiscal year. Partially offsetting the increase in our spend was a $75.4 million or 13% increase in net revenue, as compared to the same period in the prior fiscal year. Our operating margin decreased to 8% for the three months ended July 31, 2014 from 15% for the three months ended July 31, 2013. The increase in operating expenses and the corresponding decrease in operating margin was primarily related to higher employee-related costs and professional fees during the three months ended July 31, 2014. The increase in employee-related costs was primarily due to an increase in salaries, coupled with an increase in bonuses, both of which were primarily driven by an increase in employee headcount from acquisitions, such as Delcam, compared to the corresponding period in the previous fiscal year. Income from operations decreased 44% in the six months ended July 31, 2014 due to a $139.1 million or 17% increase in our operating expenses and a $31.3 million or 23% increase in cost of revenue, as compared to the same period in the prior fiscal year. Partially offsetting the increase in our spend was a $97.5 million or 9% increase in net revenue, as compared to the same period in the prior fiscal year. Our operating margin decreased to 7% for the six months ended July 31, 2014 from 15% for the six months ended July 31, 2013. The increase in operating expenses and the corresponding decrease in operating margin was primarily related to higher employee-related costs and professional fees during the six months ended July 31, 2014. The increase in employee-related costs was primarily due to an increase in salaries, coupled with an increase in bonuses, both of which were primarily driven by an increase in employee headcount from acquisitions, such as Delcam, compared to the corresponding period in the previous fiscal year. Further discussion regarding the cost of goods sold and operating expense activities are discussed below under the heading "Results of Operations." 31 --------------------------------------------------------------------------------Foreign Currency Analysis We generate a significant amount of our revenue in the U.S., Japan, Germany, France, and the United Kingdom. Our revenue was minimally impacted by foreign exchange rate changes during the three months ended July 31, 2014, as compared to the same period in the prior fiscal year. Our revenue was negatively impacted by foreign exchange rate changes during the six months ended July 31, 2014, as compared to the same period in the prior fiscal year. Had applicable exchange rates from the three and six months ended July 31, 2013 been in effect during the three and six months ended July 31, 2014 and had we excluded foreign exchange hedge gains and losses from the three and six months ended July 31, 2014 ("on a constant currency basis"), net revenue would have increased 13% and 9% during the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year. Our total spend, defined as cost of revenue plus operating expenses, during the three and six months ended July 31, 2014 increased 23% and 18%, respectively, on an as reported basis as compared to the same periods in the prior fiscal year. Had applicable exchange rates from the three months ended July 31, 2013 been in effect during the three months ended July 31, 2014 and had we excluded foreign exchange hedge gains and losses from the three months ended July 31, 2014, total spend would have been negatively impacted by foreign exchange rate changes and would have increased 22% on a constant currency basis compared to the same period in the prior fiscal year. Had applicable exchange rates from the six months ended July 31, 2013 been in effect during the three months ended July 31, 2014 and had we excluded foreign exchange hedge gains and losses from the six months ended July 31, 2014, total spend would have been minimally impacted by foreign exchange rate changes and would have increased 18% on a constant currency basis compared to the same period in the prior fiscal year. Changes in the value of the U.S. dollar may have a significant effect on net revenue, total spend and income from operations in future periods. We use foreign currency contracts to reduce the exchange rate effect on a portion of the net revenue and operating expenses of certain anticipated transactions but do not attempt to completely mitigate the impact of fluctuations of such foreign currency against the U.S. dollar. Balance Sheet and Cash Flow Items At July 31, 2014, we had $2,168.5 million in cash and marketable securities. We completed the six months ended July 31, 2014 with higher deferred revenue and lower accounts receivable balances as compared to the end of the fiscal year ended January 31, 2014. Our deferred revenue balance at July 31, 2014 included $839.1 million of deferred subscription revenue primarily related to customer maintenance contracts, which will be recognized as revenue ratably over the life of the contracts. The term of our maintenance contracts is typically between one and three years. Our cash flow from operations increased 9% to $314.9 million as of July 31, 2014 from $289.4 million at July 31, 2013. We repurchased 1.9 million shares of our common stock for $101.8 million during the three months ended July 31, 2014. Comparatively, we repurchased 3.1 million shares of our common stock for $110.6 million during the three months ended July 31, 2013. We repurchased 3.9 million shares of our common stock for $204.3 million during the six months ended July 31, 2014. Comparatively, we repurchased 6.3 million shares of our common stock for $239.8 million during the six months ended July 31, 2013. Further discussion regarding the balance sheet and cash flow activities are discussed below under the heading "Liquidity and Capital Resources." Business Outlook Autodesk's business model is evolving. We continue to assess current business offerings including introducing more flexible license and service offerings that have ratable revenue streams. The accounting impact of these offerings and other business decisions are expected to result in an increase in the percentage of our ratable revenue, making for a more predictable business over time, while correspondingly reducing our upfront revenue stream. Over time, we expect our business model transition to expand our customer base by eliminating higher up-front licensing costs and providing more flexibility in how our customers gain access to and pay for our products. However, we expect the business model transition to cause our traditional perpetual license revenue to decline without a corresponding decrease in expenses. In the future, we expect this business model transition will increase our long-term revenue growth rate by increasing total subscriptions and customer value over time. We expect net revenue for the third quarter of fiscal 2015 will range from $590 million to $605 million, and GAAP diluted earnings per share will range from a loss of $0.05 to a profit of $0.01 while non-GAAP diluted earnings per share will range from $0.17 to $0.23. Non-GAAP earnings per diluted share exclude $0.15 related to stock-based compensation expense and $0.07 related to the amortization of acquisition related intangibles, net of tax. Given our strong Q2 performance and our optimistic view of the macroeconomic environment, we've raised our full year fiscal 2015 guidance ranges for revenue, billings, and subscriptions. We expect net revenue for fiscal 2015 to increase by approximately 7% to 9% compared to fiscal 2014. We expect billings for fiscal 2015 to increase by approximately 10% to 12% 32 -------------------------------------------------------------------------------- compared to fiscal 2014. Autodesk anticipates fiscal 2015 GAAP operating margin to be approximately 4% to 5% and non-GAAP operating margin to be approximately 15% to 16%. The 15% to 16% non-GAAP operating margin excludes 7 percentage points related to stock-based compensation expense, and 4 percentage points related to the amortization of acquisition related intangibles. Autodesk expects to add 200,000-250,000 subscriptions during fiscal 2015. We remain diligent about managing our spend to make essential investments to drive growth. If we are unable to successfully achieve our major business initiatives we may not achieve our financial goals. Results of Operations Net Revenue Increase (Decrease) Three Months Increase compared to Three Months Six Months compared to Six Months Ended prior fiscal year Ended Ended prior fiscal year Ended July 31, July 31, (in millions) July 31, 2014 $ % July 31, 2013 2014 $ % 2013 Net Revenue: License and other $ 350.4 $ 37.2 12 % $ 313.2 $ 666.6 $ 29.9 5 % $ 636.7 Subscription 286.7 38.2 15 % 248.5 563.0 67.6 14 % 495.4 $ 637.1 $ 75.4 13 % $ 561.7 $ 1,229.6 $ 97.5 9 % $ 1,132.1 Net Revenue by Geographic Area: Americas $ 223.3 $ 21.7 11 % $ 201.6 $ 429.0 $ 25.2 6 % $ 403.8 Europe, Middle East and Africa 243.5 41.7 21 % 201.8 469.0 51.0 12 % 418.0 Asia Pacific 170.3 12.0 8 % 158.3 331.6 21.3 7 % 310.3 $ 637.1 $ 75.4 13 % $ 561.7 $ 1,229.6 $ 97.5 9 % $ 1,132.1 Net Revenue by Operating Segment: Platform Solutions $ 207.5 $ 10.2 5 % $ 197.3 $ 419.4 $ 9.4 2 % $ 410.0 and Emerging Business Architecture, 217.9 40.8 23 % 177.1 413.4 64.2 18 % 349.2 Engineering and Construction Manufacturing 168.2 24.2 17 % 144.0 315.5 32.4 11 % 283.1 Media and Entertainment 43.5 0.2 - % 43.3 81.3 (8.5 ) (9 )% 89.8 $ 637.1 $ 75.4 13 % $ 561.7 $ 1,229.6 $ 97.5 9 % $ 1,132.1 License and Other Revenue License and other revenue consists of two components: (1) all forms of product license revenue and (2) other revenue. Product license revenue includes software license revenue from the sale of seat licenses, software license revenue from the sale of seat term-based licenses from our desktop subscription and enterprise offerings, and upgrades and product revenue for Creative Finishing. Other revenue includes revenue from consulting, training, Autodesk Developers Network and Creative Finishing customer support, and is recognized as the services are performed. Total License and other revenue increased 12% during the three months ended July 31, 2014, as compared to the three months ended July 31, 2013. This increase was primarily due to a 12% increase in product license revenue as compared to the same period in the prior fiscal year. The increase in product license revenue was primarily due to an increase of 11% in revenue from our flagship products and an increase of 9% in our suites products. During the three months ended July 31, 2014, the 12% increase in product license revenue was due to a 17% increase in the average net revenue per seat partially offset by a 5% decrease in the number of seats sold. Product license revenue, as a percentage of License and other revenue, was 90% for both the three months ended July 31, 2014 and 2013. During the three months ended July 31, 2014, total other revenue represented 10% of License and other revenue. Other revenue increased by 14% during the three months ended July 31, 2014, as compared to the three months ended July 31, 2013 33 -------------------------------------------------------------------------------- primarily due to a 19% increase in revenue from our new and adjacent products within the other category, partially offset by a 64% decrease in our education products as a result of our strategic transition to offer software licenses to students, educators and institutions for little or no fees. Total License and other revenue increased 5% during the six months ended July 31, 2014, as compared to the six months ended July 31, 2013. This increase was primarily due to a 5% increase in product license revenue as compared to the same period in the prior fiscal year. The increase in product license revenue was primarily due to an increase of 7% in our suites products and an increase of 3% in revenue from our flagship products. During the six months ended July 31, 2014, the 5% increase in product license revenue was due to a 9% increase in the average net revenue per seat partially offset by a 5% decrease in the number of seats sold. Product license revenue, as a percentage of License and other revenue, was 90% for both the six months ended July 31, 2014 and 2013. During the six months ended July 31, 2014, total other revenue represented 10% of License and other revenue. Other revenue increased by 5% during the six months ended July 31, 2014, as compared to the six months ended July 31, 2013 primarily due to an 8% increase in revenue from our new and adjacent products within the other category, partially offset by a 52% decrease in revenue from our education products as a result of our strategic transition to offer software licenses to students, educators and institutions for little or no fees. Backlog related to current software license product orders that had not shipped at the end of the quarter increased by $6.6 million during the six months ended July 31, 2014 from $19.7 million at January 31, 2014 to $26.3 million at July 31, 2014. Backlog from current software license product orders that we have not yet shipped consists of orders for currently available licensed software products from customers with approved credit status. Subscription Revenue Autodesk subscription revenue consists of three components: (1) maintenance revenue from our software products; (2) maintenance revenue from our term-based desktop subscription and enterprise offerings; and (3) revenue from our cloud service offerings. Our maintenance program provides our commercial and educational customers of perpetual products with a cost effective and predictable budgetary option to obtain the productivity benefits of our new releases and enhancements when and if released during the term of their contracts. Under our maintenance program, customers are eligible to receive unspecified upgrades when and if available, downloadable training courses and online support. We recognize maintenance revenue ratably over the term of the maintenance agreement, which is generally between one and three years but can occasionally be as long as five years. Revenue for our cloud service offerings is recognized ratably over the contract term commencing with the date our service is made available to customers and all other revenue recognition criteria have been satisfied. Subscription revenue increased 15% during the three months ended July 31, 2014, as compared to the three months ended July 31, 2013, primarily due to a 16% increase in commercial maintenance revenue. The 16% increase in commercial maintenance revenue was due to a 5% increase from commercial enrollment during the corresponding maintenance contract term and an 11% increase from net revenue per maintenance seat. Commercial maintenance revenue represented 96% and 95% of Subscription revenue for the three months ended July 31, 2014 and 2013, respectively. Subscription revenue increased 14% during the six months ended July 31, 2014, as compared to the six months ended July 31, 2013, primarily due to a 14% increase in commercial maintenance revenue. The 14% increase in commercial maintenance revenue was due to a 5% increase from commercial enrollment during the corresponding maintenance contract term and a 9% increase from net revenue per maintenance seat. Commercial maintenance revenue represented 95% of Subscription revenue for both the six months ended July 31, 2014 and 2013. Changes in Subscription revenue lag changes in subscription billings. Subscription billings increased 31% and 24% during the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year primarily due to an increase in maintenance subscription billings. Our deferred subscription revenue balance at July 31, 2014 and January 31, 2014 was $839.1 million and $789.3 million, respectively, and primarily related to customer maintenance agreements, which will be recognized as revenue ratably over the term of the maintenance agreement. 34 --------------------------------------------------------------------------------Net Revenue by Geographic Area Net revenue in the Americas geography increased by 11% on an as reported basis and a constant currency basis, during the three months ended July 31, 2014, as compared to the same period in the prior fiscal year. This increase was primarily due to a 19% increase in our suites revenue and an 18% increase in our new and adjacent product revenue in this geography during the three months ended July 31, 2014 as compared to the three months ended July 31, 2013. The increase in our revenue in this geography was led by the U.S. Net revenue in the Americas geography increased by 6% on an as reported basis and on a constant currency basis, during the six months ended July 31, 2014, as compared to the same period in the prior fiscal year. This increase was primarily due to a 19% increase in our suites revenue partially offset by a 4% decrease in our flagship product revenue in this geography during the six months ended July 31, 2014 as compared to the six months ended July 31, 2013. The increase in our revenue in this geography was led by the U.S. Net revenue in the EMEA geography increased by 21% on an as reported basis and 16% on a constant currency basis, during the three months ended July 31, 2014 as compared to the same period in the prior fiscal year. This increase was primarily due to a 28% increase in our suites revenue and a 10% increase in our flagship product revenue in this geography during the three months ended July 31, 2014 as compared to the three months ended July 31, 2013. The increase in our revenue in this geography was led by France and Germany. Net revenue in the EMEA geography increased by 12% on an as reported basis and 9% on a constant currency basis, during the six months ended July 31, 2014 as compared to the same period in the prior fiscal year. This increase was primarily due to a 26% increase in our suites revenue and a 29% increase in our new and adjacent product revenue in this geography during the six months ended July 31, 2014 as compared to the six months ended July 31, 2013. The increase in our revenue in this geography was led by France and Germany. Net revenue in the APAC geography increased 8% on an as reported basis and 14% on a constant currency basis, during the three months ended July 31, 2014, as compared to the same period in the prior fiscal year. The increase was primarily due to a 6% increase in our flagship products and an 8% increase in our suites revenue in this geography during the three months ended July 31, 2014 as compared to the same period in the previous year. The increase in our revenue in this geography during the three months ended July 31, 2014 was led by South Korea and India. Net revenue in the APAC geography increased 7% on an as reported basis and 14% on a constant currency basis, during the six months ended July 31, 2014, as compared to the same period in the prior fiscal year. The increase was primarily due to a 7% increase in our flagship products and a 9% increase in our suites revenue in this geography during the six months ended July 31, 2014 as compared to the same period in the previous year. The increase in our revenue in this geography during the six months ended July 31, 2014 was led by Japan and South Korea. Net revenue in emerging economies increased by 14% during the three months ended July 31, 2014 as compared to the same period in the prior fiscal year, primarily due to increases in revenue from India and Brazil. Revenue from emerging economies represented 15% of total net revenue for both the three months ended July 31, 2014 and 2013. Net revenue in emerging economies increased by 10% during the six months ended July 31, 2014 as compared to the same period in the prior fiscal year, primarily due to increases in revenue from India, Taiwan, and Brazil partially offset by a decrease in revenue from China. Revenue from emerging economies represented 14% of total net revenue for both the six months ended July 31, 2014 and 2013. International net revenue represented 71% of our total net revenue for both the three and six months ended July 31, 2014 and 2013. We believe that international revenue will continue to comprise a majority of our total net revenue. Unfavorable economic conditions in the countries that contribute a significant portion of our net revenue, including in emerging economies, may have an adverse effect on our business in those countries and our overall financial performance. Changes in the value of the U.S. dollar relative to other currencies have significantly affected, and could continue to significantly affect, our financial results for a given period even though we hedge a portion of our current and projected revenue. Additionally, weak global economic conditions that have been characterized by restructuring of sovereign debt, high unemployment, and volatility in the financial markets may impact our future financial results. 35 --------------------------------------------------------------------------------Net Revenue by Operating Segment We have four reportable segments: Platform Solutions and Emerging Business ("PSEB"), AEC, MFG and Media and Entertainment ("M&E"). We have no material inter-segment revenue. During the three months ended July 31, 2014, net revenue for PSEB increased by 5% as compared to the same period in the prior fiscal year primarily due to a 9% increase in AutoCAD LT and a 7% increase in AutoCAD. During the six months ended July 31, 2014, net revenue for PSEB increased by 2% as compared to the same period in the prior fiscal year primarily due to a 6% increase in AutoCAD LT. During the three months ended July 31, 2014, net revenue for AEC increased by 23% as compared to the same period in the prior fiscal year primarily due to a 40% increase in revenue from our AEC suites, which was primarily driven by Autodesk Building Design Suite and Autodesk Infrastructure Design Suite. During the six months ended July 31, 2014, net revenue for AEC increased by 18% as compared to the same period in the prior fiscal year primarily due to a 38% increase in revenue from our AEC suites, which was primarily driven by Autodesk Building Design Suite and Autodesk Infrastructure Design Suite. During the three months ended July 31, 2014, net revenue for MFG increased by 17% as compared to the same period of the prior fiscal year primarily due to a 9% increase in revenue from our MFG suites, which was primarily driven by the Autodesk Product Design Suite. During the six months ended July 31, 2014, net revenue for MFG increased by 11% as compared to the same period of the prior fiscal year primarily due to an 8% increase in revenue from our MFG suites, which was primarily driven by the Autodesk Product Design Suite. During the three months ended July 31, 2014, net revenue for M&E was flat as compared to the same period in the prior fiscal year, due to a 7% increase in revenue from Creative Finishing partially offset by a 2% decrease in revenue from Animation. The increase in Creative Finishing was primarily due to a 71% increase in sales of our Creative Finishing hardware products. The decrease in Animation revenue was primarily due to a 20% decrease from our M&E suites, in particular our Autodesk Entertainment Creation Suite. During the six months ended July 31, 2014, net revenue for M&E decreased by 9% as compared to the same period in the prior fiscal year, due to a 7% decrease in revenue from Animation and a 17% decrease in revenue from Creative Finishing. The decrease in Animation revenue was primarily due to a 23% decrease from our M&E suites, in particular our Autodesk Entertainment Creation Suite. The decline in Creative Finishing was impacted by a general decrease in M&E industry end-market demand. M&E revenue is impacted by a general decrease in the M&E industry end-market demand, the planned inclusion of our M&E products in other Autodesk industry suites, and our business model transition as customers are opting for desktop subscription. Cost of Revenue and Operating Expenses Cost of Revenue Increase compared to Increase compared to Three Months Ended prior fiscal year Three Months Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 Cost of revenue: License and other $ 53.4 $ 10.6 25 % $ 42.8 $ 102.7 $ 15.5 18 % $ 87.2 Subscription 34.5 9.5 38 % 25.0 63.9 15.8 33 % 48.1 $ 87.9 $ 20.1 30 % $ 67.8 $ 166.6 $ 31.3 23 % $ 135.3 As a percentage of net revenue 14 % 12 % 14 % 12 % Cost of license and other revenue includes labor costs associated with product setup and fulfillment and costs of consulting and training services contracts and collaborative project management services contracts. Cost of license and other 36 -------------------------------------------------------------------------------- revenue also includes stock-based compensation expense, direct material and overhead charges, amortization of purchased technology, professional services fees and royalties. Direct material and overhead charges include the cost of hardware sold (mainly PC-based workstations for Creative Finishing in the M&E segment), costs associated with transferring our software to electronic media, physical media, packaging materials and shipping and handling costs. Cost of license and other revenue increased 25% and 18% for the three and six months ended July 31, 2014, as compared to the same periods in the prior fiscal year, primarily due to higher employee-related costs related to salaries associated with an increased headcount, primarily from acquisitions such as Delcam. Cost of subscription revenue includes the labor costs of providing product support to our maintenance and cloud subscription customers, including rent and occupancy, shipping and handling costs, professional services fees related to operating our network and cloud infrastructure, including depreciation expense and operating lease payments associated with computer equipment, data center costs, salaries and related expenses of network operations. Cost of subscription revenue increased 38% during the three months ended July 31, 2014, as compared to the same period in the prior fiscal year, primarily due to higher cloud service-related expenses and increased product support expenses. Cost of subscription revenue increased 33% during the six months ended July 31, 2014, as compared to the same period in the prior fiscal year, primarily due to higher cloud services-related expenses. Cost of revenue, at least over the near term, is affected by the volume and mix of product sales, mix of physical versus electronic fulfillment, fluctuations in consulting costs, amortization of purchased technology, new customer support offerings, royalty rates for licensed technology embedded in our products and employee stock-based compensation expense. We expect cost of revenue to increase in absolute dollars and slightly increase as a percentage of net revenue during the third quarter of fiscal 2015, as compared to the third quarter of fiscal 2014. Marketing and Sales Three Months Increase compared to Three Months Increase compared to Ended prior fiscal year Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 Marketing and sales $ 237.6 $ 39.5 20 % $ 198.1 $ 463.0 $ 56.1 14 % $ 406.9 As a percentage of net revenue 37 % 35 % 38 % 36 % Marketing and sales expenses include salaries, bonuses, benefits and stock-based compensation expense for our marketing and sales employees, the expense of travel, entertainment and training for such personnel, the costs of programs aimed at increasing revenue, such as advertising, trade shows and expositions, and various sales and promotional programs. Marketing and sales expenses also include labor costs of sales and order processing, sales and dealer commissions, rent and occupancy, and the cost of supplies and equipment. Marketing and sales expenses increased 20% and 14% for the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year primarily due to an increase in employee-related costs related to salaries, bonus, commissions and fringe benefits primarily associated with increased headcount, primarily from acquisitions such as Delcam and merit increases and professional fees. For the third quarter of fiscal 2015, as compared to the third quarter of fiscal 2014, we expect marketing and sales expense to increase in absolute dollars and slightly increase as a percentage of net revenue. 37 -------------------------------------------------------------------------------- Research and Development Increase compared to Increase compared to Three Months Ended prior fiscal year Three Months Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 Research and development $ 179.3 $ 30.4 20 % $ 148.9 $ 349.8 $ 50.1 17 % $ 299.7 As a percentage of net revenue 28 % 27 % 28 % 26 % Research and development expenses, which are expensed as incurred, consist primarily of salaries, bonuses, benefits and stock-based compensation expense for research and development employees, and the expense of travel, entertainment and training for such personnel, rent and occupancy, and professional services such as fees paid to software development firms and independent contractors. Research and development expenses increased 20% and 17% during the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year, primarily due to an increase in employee-related costs related to salaries, bonus and fringe benefits primarily associated with increased headcount, primarily from acquisitions such as Delcam and merit increases and professional fees. For the third quarter of fiscal 2015, as compared to the third quarter of fiscal 2014, we expect research and development expense to increase in absolute dollars and slightly increase as a percentage of net revenue. General and Administrative Increase compared to Increase compared to Three Months Ended prior fiscal year Three Months Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 General and administrative $ 71.5 $ 19.2 37 % $ 52.3 $ 134.0 $ 31.0 30 % $ 103.0 As a percentage of net revenue 11 % 9 % 11 % 9 % General and administrative expenses include salaries, bonuses, benefits and stock-based compensation expense for our finance, human resources and legal employees, as well as professional fees for legal and accounting services, gains and losses on our operating expense cash flow hedges, expense of travel, entertainment and training, expense of communication and the cost of supplies and equipment. General and administrative expenses increased 37% during the three months ended July 31, 2014 as compared to the same period in the prior fiscal year, primarily due to an increase in professional fees and employee-related costs related to salaries, bonus and fringe benefits primarily associated with increased headcount and merit increases. General and administrative expenses increased 30% during the six months ended July 31, 2014 as compared to the same period in the prior fiscal year, primarily due to an increase in employee-related costs related to salaries, bonus and fringe benefits primarily associated with increased headcount, primarily from acquisitions such as Delcam and merit increases and professional fees. For the third quarter of fiscal 2015, as compared to the third quarter of fiscal 2014, we expect general and administrative expenses to increase in absolute dollars and slightly increase as a percentage of net revenue. 38 --------------------------------------------------------------------------------Amortization of Purchased Intangibles Increase compared to Increase compared to Three Months Ended prior fiscal year Three Months Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 Amortization of purchased intangibles $ 10.1 $ 0.8 9 % $ 9.3 $ 21.0 $ 0.9 4 % $ 20.1 As a percentage of net revenue 2 % 2 % 2 % 2 % Amortization of purchased intangibles increased 9% and 4% during the three and six months ended July 31, 2014 as compared to the same periods in the prior fiscal year, primarily related to the accumulated effects associated with amortization expense of intangible assets purchased over time, including $81.9 million in assets purchased in the current year. For the third quarter of fiscal 2015, as compared to the third quarter of fiscal 2014, we expect amortization of purchased intangibles to remain relatively flat in absolute dollars and as a percentage of net revenue. Restructuring Charges, Net Decrease compared to Increase compared to Three Months Ended prior fiscal year Three Months Ended Six Months Ended prior fiscal year Six Months Ended (in millions) July 31, 2014 $ % July 31, 2013 July 31, 2014 $ % July 31, 2013 Restructuring charges, net $ 0.8 $ (0.9 ) (53 )% $ 1.7 $ 3.1 $ 1.0 48 % $ 2.1 As a percentage of net revenue - % - % - % - % During the third quarter of fiscal 2014, the Board of Directors approved a world-wide restructuring plan in order to re-balance staffing levels to better align them with the evolving needs of the business. The authorized plan included a reduction of approximately 85 positions and the consolidation of four leased facilities, with a total cost of approximately $15.0 million. We have substantially completed the actions authorized under this plan. During the three months ended July 31, 2014, we recorded an incremental restructuring charge associated with the Fiscal 2014 Plan of $0.8 million. During the six months ended July 31, 2014, we recorded an incremental restructuring charge associated with the Fiscal 2014 Plan of $3.1 million. See Note 13, "Restructuring," in the Notes to the Condensed Consolidated Financial Statements for further discussion. Interest and Other (Expense) Income, Net The following table sets forth the components of interest and other (expense) income, net: Three Months Ended July 31, Six Months Ended July 31, (in millions) 2014 2013 2014 2013 Interest and investment (expense) income, net $ (3.3 ) $ (1.9 ) $ (5.7 ) $ (5.0 ) (Loss) gain on foreign currency (0.3 ) 0.1 (3.6 ) (4.3 ) Loss on strategic investments (3.3 ) (0.2 ) (6.8 ) (1.3 ) Other (loss) income (0.1 ) 0.2 2.5 - Interest and other (expense) income, net $ (7.0 ) $ (1.8 ) $ (13.6 ) $ (10.6 ) Interest and other (expense) income, net, decreased $5.2 million and $3.0 million during the three and six months ended July 31, 2014, respectively, as compared to the same periods in the prior fiscal year, primarily due to an other-than-temporary impairment on one of our privately held strategic investments and losses on the derivative portion on certain of our strategic investments that are marked-to-market each period. Interest and investment income fluctuates based on average cash, marketable securities and debt balances, average maturities and interest rates. 39 -------------------------------------------------------------------------------- Gains and losses on foreign currency are primarily due to the impact of re-measuring foreign currency transactions and net monetary assets into the functional currency of the corresponding entity. The amount of the gain or loss on foreign currency is driven by the volume of foreign currency transactions and the foreign currency exchange rates for the period. Provision for Income Taxes We account for income taxes and the related accounts under the liability method. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted rates expected to be in effect during the year in which the basis differences reverse. Our effective tax rate was 27% and 24% during the three and six months ended July 31, 2014, respectively, compared to 25% and 24% during the three and six months ended July 31, 2013, respectively. Our effective tax rate increased 2% during the three months ended July 31, 2014 as compared to the same period in the prior fiscal year primarily due to stock-based compensation expense, accrual for uncertain tax positions, the tax impact of an increase in the forecasted annual rate from the previous quarter, and expiration of the federal research and development tax credit provision, partially offset by greater tax rate benefits from foreign earnings. Our effective tax rate remained flat during the six months ended July 31, 2014 as compared to the same period in the prior fiscal year primarily due to greater tax rate benefits from foreign earnings offset by tax rate detriments from stock-based compensation expense, accrual for uncertain tax positions and expiration of the federal research and development tax credit provision. Excluding the impact of discrete tax items, the effective tax rate for each of the three and six month periods ended July 31, 2014 was 29%, and was lower than the Federal statutory tax rate of 35%, primarily due to foreign income taxed at lower rates partially offset by the impact of non-deductible stock based compensation expense and accrual for uncertain tax positions. Our future effective tax rate may be materially impacted by the amount of benefits and charges from tax amounts associated with our foreign earnings that are taxed at rates different from the federal statutory rate, research credits, state income taxes, the tax impact of stock-based compensation, accounting for uncertain tax positions, business combinations, U.S. Manufacturer's deduction, closure of statute of limitations or settlement of tax audits, changes in valuation allowances and changes in tax laws including possible U.S. tax law changes that, if enacted, could significantly impact how U.S. multinational companies are taxed on foreign subsidiary earnings. A significant amount of our earnings is generated by our Europe and Asia Pacific subsidiaries. Our future effective tax rates may be adversely affected to the extent earnings are lower than anticipated in countries where we have lower statutory tax rates or we repatriate certain foreign earnings on which U.S. taxes have not previously been provided. At July 31, 2014, we had net deferred tax assets of $163.1 million. Pursuant to the adoption of ASU 2013-11, $41.4 million of unrecognized tax benefits have been presented as a reduction of deferred tax assets at July 31, 2014. We believe that we will generate sufficient future taxable income in appropriate tax jurisdictions to realize these assets. 40 --------------------------------------------------------------------------------Other Financial Information In addition to our results determined under U.S. generally accepted accounting principles ("GAAP") discussed above, we believe the following non-GAAP measures are useful to investors in evaluating our operating performance. For the three and six months ended July 31, 2014, and 2013, our gross profit, gross margin, income from operations, operating margin, net income and diluted earnings per share on a GAAP and non-GAAP basis were as follows (in millions except for gross margin, operating margin and per share data): Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (Unaudited) (Unaudited) Gross profit $ 549.2 $ 493.9 $ 1,063.0 $ 996.8 Non-GAAP gross profit $ 565.8 $ 506.3 $ 1,094.3 $ 1,021.5 Gross margin 86 % 88 % 86 % 88 % Non-GAAP gross margin 89 % 90 % 89 % 90 % Income from operations $ 49.9 $ 83.6 $ 92.1 $ 165.0 Non-GAAP income from operations $ 115.1 $ 136.6 $ 217.1 $ 273.5 Operating margin 8 % 15 % 7 % 15 % Non-GAAP operating margin 18 % 24 % 18 % 24 % Net income $ 31.3 $ 61.7 $ 59.6 $ 117.3 Non-GAAP net income $ 82.0 $ 101.8 $ 155.8 $ 198.1 Diluted earnings per share (1) $ 0.13 $ 0.27 $ 0.26 $ 0.51 Non-GAAP diluted earnings per share (1) $ 0.35 $ 0.45 $ 0.67 $ 0.86 _______________ (1) Earnings per share were computed independently for each of the periods presented; therefore the sum of the earnings per share amount for the quarters may not equal the total for the year. For our internal budgeting and resource allocation process and as a means to evaluate period-to-period comparisons, we use non-GAAP measures to supplement our condensed consolidated financial statements presented on a GAAP basis. These non-GAAP measures do not include certain items that may have a material impact upon our reported financial results. We use non-GAAP measures in making operating decisions because we believe those measures provide meaningful supplemental information regarding our earning potential and performance for management by excluding certain expenses and charges that may not be indicative of our core business operating results. For the reasons set forth below, we believe these non-GAAP financial measures are useful to investors both because (1) they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making and (2) they are used by our institutional investors and the analyst community to help them analyze the health of our business. This allows investors and others to better understand and evaluate our operating results and future prospects in the same manner as management, compare financial results across accounting periods and to those of peer companies and to better understand the long-term performance of our core business. We also use some of these measures for purposes of determining company-wide incentive compensation. There are limitations in using non-GAAP financial measures because non-GAAP financial measures are not prepared in accordance with GAAP and may be different from non-GAAP financial measures used by other companies. The non-GAAP financial measures included above are limited in value because they exclude certain items that may have a material impact upon our reported financial results. In addition, they are subject to inherent limitations as they reflect the exercise of judgments by management about which charges are excluded from the non-GAAP financial measures. We compensate for these limitations by analyzing current and future results on a GAAP basis as well as a non-GAAP basis and also by providing GAAP measures in our public disclosures. The presentation of non-GAAP financial information is meant to be considered in addition to, not as a substitute for or in isolation from, the directly comparable financial measures prepared in accordance with GAAP. We urge investors to review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not to rely on any single financial measure to evaluate our business. 41--------------------------------------------------------------------------------Reconciliation of GAAP Financial Measures to Non-GAAP Financial Measures (In millions except for gross margin, operating margin and per share data): Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (Unaudited) (Unaudited) Gross profit $ 549.2 $ 493.9 $ 1,063.0 $ 996.8 Stock-based compensation expense 2.1 1.4 3.8 2.9 Amortization of developed technologies 14.5 11.0 27.5 21.8 Non-GAAP gross profit $ 565.8 $ 506.3 $ 1,094.3 $ 1,021.5 Gross margin 86 % 88 % 86 % 88 % Stock-based compensation expense - % - % - % - % Amortization of developed technologies 3 % 2 % 3 % 2 % Non-GAAP gross margin 89 % 90 % 89 % 90 % Income from operations $ 49.9 $ 83.6 $ 92.1 $ 165.0 Stock-based compensation expense 39.8 31.0 73.4 64.5 Amortization of developed technologies 14.5 11.0 27.5 21.8 Amortization of purchased intangibles 10.1 9.3 21.0 20.1 Restructuring charges 0.8 1.7 3.1 2.1 Non-GAAP income from operations $ 115.1 $ 136.6 $ 217.1 $ 273.5 Operating margin 8 % 15 % 7 % 15 % Stock-based compensation expense 6 % 6 % 6 % 6 % Amortization of developed technologies 2 % 2 % 2 % 2 % Amortization of purchased intangibles 2 % 1 % 2 % 1 % Restructuring charges - % - % 1 % - % Non-GAAP operating margin 18 % 24 % 18 % 24 % Net income $ 31.3 $ 61.7 $ 59.6 $ 117.3 Stock-based compensation expense 39.8 31.0 73.4 64.5 Amortization of developed technologies 14.5 11.0 27.5 21.8 Amortization of purchased intangibles 10.1 9.3 21.0 20.1 Restructuring charges 0.8 1.7 3.1 2.1 Loss on strategic investments 3.3 0.2 6.9 1.3 Discrete tax provision items (2.6 ) 1.2 (4.7 ) 0.7 Income tax effect of non-GAAP adjustments (15.2 ) (14.3 ) (31.0 ) (29.7 ) Non-GAAP net income $ 82.0 $ 101.8 $ 155.8 $ 198.1 Diluted net income per share (1) $ 0.13 $ 0.27 $ 0.26 $ 0.51 Stock-based compensation expense 0.18 0.14 0.32 0.28 Amortization of developed technologies 0.06 0.05 0.12 0.10 Amortization of purchased intangibles 0.04 0.04 0.09 0.09 Restructuring charges - 0.01 0.01 0.01 Loss on strategic investments 0.01 - 0.03 - Discrete tax provision items (0.01 ) - (0.03 ) - Income tax effect of non-GAAP adjustments (0.06 ) (0.06 ) (0.13 ) (0.13 ) Non-GAAP diluted net income per share (1) $ 0.35 $ 0.45 $ 0.67 $ 0.86 ____________________ (1) Earnings per share were computed independently for each of the periods presented; therefore the sum of the earnings per share amount for the quarters may not equal the total for the year. 42--------------------------------------------------------------------------------Our non-GAAP financial measures may exclude the following: Stock-based compensation expenses. We exclude stock-based compensation expenses from non-GAAP measures primarily because they are non-cash expenses and management finds it useful to exclude certain non-cash charges to assess the appropriate level of various operating expenses to assist in budgeting, planning and forecasting future periods. Moreover, because of varying available valuation methodologies, subjective assumptions and the variety of award types that companies can use under FASB ASC Topic 718, we believe excluding stock-based compensation expenses allows investors to make meaningful comparisons between our recurring core business operating results and those of other companies. Amortization of developed technologies and purchased intangibles. We incur amortization of acquisition-related developed technology and purchased intangibles in connection with acquisitions of certain businesses and technologies. Amortization of developed technologies and purchased intangibles is inconsistent in amount and frequency and is significantly affected by the timing and size of our acquisitions. Management finds it useful to exclude these variable charges from our cost of revenues to assist in budgeting, planning and forecasting future periods. Investors should note that the use of intangible assets contributed to our revenues earned during the periods presented and will contribute to our future period revenues as well. Amortization of developed technologies and purchased intangible assets will recur in future periods. Goodwill impairment. This is a non-cash charge to write-down goodwill to fair value when there was an indication that the asset was impaired. As explained above, management finds it useful to exclude certain non-cash charges to assess the appropriate level of various operating expenses to assist in budgeting, planning and forecasting future periods. Restructuring charges (benefits), net. These expenses are associated with realigning our business strategies based on current economic conditions. In connection with these restructuring actions, we recognize costs related to termination benefits for former employees whose positions were eliminated, the closure of facilities and cancellation of certain contracts. We exclude these charges because these expenses are not reflective of ongoing business and operating results. We believe it is useful for investors to understand the effects of these items on our total operating expenses. Loss (gain) on strategic investments. We exclude gains and losses related to our strategic investments from our non-GAAP measures primarily because management finds it useful to exclude these variable gains and losses on these investments in assessing our financial results. Included in these amounts are non-cash unrealized gains and losses on the derivative components, realized gains and losses on the sales or losses on the impairment of these investments. We believe excluding these items is useful to investors because these excluded items do not correlate to the underlying performance of our business and these losses or gains were incurred in connection with strategic investments which do not occur regularly. Establishment of a valuation allowance on certain net deferred tax assets. This is a non-cash charge to record a valuation allowance on certain deferred tax assets. As explained above, management finds it useful to exclude certain non-cash charges to assess the appropriate level of various cash expenses to assist in budgeting, planning and forecasting future periods. Discrete tax items. We exclude the GAAP tax provision, including discrete items, from the non-GAAP measure of income, and include a non-GAAP tax provision based upon the projected annual non-GAAP effective tax rate. Discrete tax items include income tax expenses or benefits that do not relate to ordinary income from continuing operations in the current fiscal year, unusual or infrequently occurring items, or the tax impact of certain stock-based compensation. Examples of discrete tax items include, but are not limited to, certain changes in judgment and changes in estimates of tax matters related to prior fiscal years, certain costs related to business combinations, certain changes in the realizability of deferred tax assets or changes in tax law. Management believes this approach assists investors in understanding the tax provision and the effective tax rate related to ongoing operations. We believe the exclusion of these discrete tax items provides investors with useful supplemental information about the Company's operational performance. Income tax effects on the difference between GAAP and non-GAAP costs and expenses. The income tax effects that are excluded from the non-GAAP measures relate to the tax impact on the difference between GAAP and non-GAAP expenses, primarily due to stock-based compensation, amortization of purchased intangibles and restructuring charges (benefits) for GAAP and non-GAAP measures. Liquidity and Capital Resources Our primary source of cash is from the sale of licenses to our products. Our primary use of cash is payment of our operating costs which consist primarily of employee-related expenses, such as compensation and benefits, as well as general operating expenses for marketing, facilities and overhead costs. In addition to operating expenses, we also use cash to fund our 43 -------------------------------------------------------------------------------- stock repurchase program and invest in our growth initiatives, which include acquisitions of products, technology and businesses. See further discussion of these items below. At July 31, 2014, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $2,168.5 million and net accounts receivable of $365.3 million. In fiscal 2013, we issued $400.0 million aggregate principal amount of 1.95% senior notes due December 15, 2017 and $350.0 million aggregate principal amount of 3.6% senior notes due December 15, 2022, (collectively, the "Senior Notes"). As of September 2, 2014, we have $750.0 million aggregate principal amount of Senior Notes outstanding. In addition, we have a line of credit facility that permits unsecured short-term borrowings of up to $400.0 million. As of September 2, 2014, we have no amounts outstanding under the credit facility. The credit facility expires in May 2018. Borrowings under the credit facility and the net proceeds from the offering of the Senior Notes are available for general corporate purposes. Our cash and cash equivalents are held by diversified financial institutions globally. Our primary commercial banking relationship is with Citigroup and its global affiliates. In addition, Citibank N.A., an affiliate of Citigroup, is one of the lead lenders and agent in the syndicate of our $400.0 million line of credit. The decrease in our cash, cash equivalents and marketable securities from $2,544.4 million at January 31, 2014 to $2,168.5 million at July 31, 2014 is primarily due to cash used for acquisitions, including business combination and technology purchases, repurchases of common stock, and capital expenditures partially offset by cash generated by operating activities, and proceeds from the issuance of common stock following stock option exercises and employee stock plan purchases. The cash proceeds from issuance of common stock varies based on our stock price, stock option exercise activity and the volume of employee purchases under the Employee Stock Purchase Plan. The primary sources for net cash provided by operating activities of $314.9 million for the six months ended July 31, 2014 were the cash effect of expenses totaling $146.7 million associated with depreciation, amortization and accretion and stock-based compensation, changes in operating assets and liabilities of $100.0 million and net income of $59.6 million. The primary source of working capital was a decrease in accounts receivable and increase in deferred revenue. Our days sales outstanding in trade receivables was 52 at July 31, 2014 compared to 66 days at January 31, 2014. The days sales outstanding decrease relates primarily to a seasonal billings linearity shift and lower maintenance renewal billings. The primary working capital uses of cash was a decrease in accrued compensation. At July 31, 2014, our short-term investment portfolio had an estimated fair value of $583.3 million and a cost basis of $578.0 million. The portfolio fair value consisted of $382.1 million invested in commercial paper and corporate securities, $116.6 million invested in certificates of deposit and time deposits with remaining maturities at the date of purchase greater than 90 days and less than one year, $42.9 million invested in mutual funds, $13.8 million invested in municipal securities, $9.7 million invested in other short-term securities, $6.2 million invested in U.S. treasury securities, $6.0 million invested in U.S. treasury bills and $6.0 million invested in U.S. government agency securities. At July 31, 2014, $42.9 million of trading securities were invested in a defined set of mutual funds as directed by the participants in our Deferred Compensation Plan (see Note 10, "Deferred Compensation," in the Notes to Condensed Consolidated Financial Statements for further discussion). Long-term cash requirements for items other than normal operating expenses are anticipated for the following: common stock repurchases; the acquisition of businesses, software products, or technologies complementary to our business; and capital expenditures, including the purchase and implementation of internal-use software applications. Our strategy includes improving our product functionality and expanding our product offerings through internal development as well as through the acquisition of products, technology and businesses. Acquisitions often increase the speed at which we can deliver product functionality to our customers; however, they entail cost and integration challenges and, in certain instances, negatively impact our operating margins. We continually review these trade-offs in making decisions regarding acquisitions. We currently anticipate that we will continue to acquire products, technology and businesses as compelling opportunities become available. Our decision to acquire businesses or technology is dependent on our business needs, the availability of suitable sellers and technology, and our own financial condition. As of July 31, 2014, there have been no material changes in our contractual obligations or commercial commitments compared to those we disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2014. 44 -------------------------------------------------------------------------------- Our cash, cash equivalent and marketable securities balances are concentrated in a few locations around the world, with substantial amounts held outside of the U.S. As of July 31, 2014, approximately 78% of our total cash, cash equivalents and marketable securities are located offshore and will fluctuate subject to business needs. Certain amounts held outside the U.S. could be repatriated to the U.S. (subject to local law restrictions), but under current U.S. tax law, could be subject to U.S. income taxes less applicable foreign tax credits. We have provided for the U.S. income tax liability on foreign earnings, except for foreign earnings that are considered permanently reinvested outside the U.S. Our intent is that amounts related to foreign earnings permanently reinvested outside the U.S. will remain outside the U.S. and we will meet our U.S. liquidity needs through ongoing cash flows, external borrowings, or both. We regularly review our capital structure and consider a variety of potential financing alternatives and planning strategies to ensure we have the proper liquidity available in the locations in which it is needed and to fund our existing stock buy-back program with cash that has not been permanently reinvested outside the U.S. Cash from operations could also be affected by various risks and uncertainties, including, but not limited to the risks detailed in Part II, Item 1A titled "Risk Factors." However, based on our current business plan and revenue prospects, we believe that our existing balances, our anticipated cash flows from operations and our available credit facility will be sufficient to meet our working capital and operating resource expenditure requirements for at least the next 12 months. Our revenue, earnings, cash flows, receivables and payables are subject to fluctuations due to changes in foreign currency exchange rates, for which we have put in place foreign currency contracts as part of our risk management strategy. See Part I, Item 3, "Quantitative and Qualitative Disclosures about Market Risk" for further discussion. Issuer Purchases of Equity Securities Autodesk's stock repurchase program is largely to help offset the dilution from the issuance of stock under our employee stock plans and for such other purposes as may be in the interests of Autodesk and its stockholders, and has the effect of returning excess cash generated from our business to stockholders. The number of shares acquired and the timing of the purchases are based on several factors, including general market conditions, the volume of employee stock option exercises, stock issuance, the trading price of our common stock, cash on hand and available in the U.S., and company defined trading windows. During the three and six months ended July 31, 2014, we repurchased 1.9 million and 3.9 million, respectively, of our common stock. At July 31, 2014, 17.9 million shares remained available for repurchase under the repurchase program approved by the Board of Directors. This program does not have a fixed expiration date. See Note 15, "Common Stock Repurchase Program," in the Notes to Condensed Consolidated Financial Statements for further discussion. The following table provides information about the repurchase of common stock in open-market transactions during the quarter ended July 31, 2014: Total Number of Maximum Number of Shares Purchased as Shares that May Yet Total Number of Part of Publicly Be Purchased Under Shares Average Price Announced Plans or the Plans or Programs (Shares in millions) Purchased Paid per Share Programs (1) (2) May 1 - May 31 0.7 $ 49.52 0.7 19.1 June 1 - June 30 0.7 54.81 0.7 18.4 July 1 - July 31 0.5 56.13 0.5 17.9 Total 1.9 $ 53.15 1.9 ________________(1) Represents shares purchased in open-market transactions under the stock repurchase plan approved by the Board of Directors. (2) These amounts correspond to the plan approved by the Board of Directors in June 2012 that authorized the repurchase of 30.0 million. This plan does not have a fixed expiration date. There were no sales of unregistered securities during the six months ended July 31, 2014. Off-Balance Sheet Arrangements As of July 31, 2014, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K. 45 --------------------------------------------------------------------------------Glossary of terms BIM (Building Information Modeling)-BIM describes a model-based technology linked with a database of project information, and is the process of generating and managing information throughout the life cycle of a building. BIM is used as a digital representation of the building process to facilitate exchange and interoperability of information in digital formats. Constant currency growth rates-We attempt to represent the changes in the underlying business operations by eliminating fluctuations caused by changes in foreign currency exchange rates as well as eliminating hedge gains or losses recorded within the current and comparative periods. Our constant currency methodology removes all hedging gains and losses from the calculation. Digital prototyping-Digital prototyping allows designers, architects and engineers to analyze, simulate and visualize a design using a digital or virtual model rather than a physical model. Flagship-Autodesk flagship products are our core design products. Flagship includes the following products: 3ds Max, AutoCAD, AutoCAD LT, AutoCAD vertical products (such as AutoCAD Architecture and AutoCAD Mechanical), Civil 3D, Inventor products (standalone), Maya, Plant 3D, and Revit products (standalone). License and Other revenue-License and other revenue consists of two components: (1) all forms of product license revenue and (2) other revenue. Product license revenue includes software license revenue from the sale of seat licenses, software license revenue from the sale of seat term-based licenses from our desktop subscription and enterprise offerings, and product revenue for Creative Finishing. Other revenue includes revenue from consulting, training, Autodesk Developers Network and Creative Finishing customer support, and is recognized over time, as the services are performed. Maintenance-Our maintenance program provides our commercial and educational customers with a cost effective and predictable budgetary option to obtain the productivity benefits of our new releases and enhancements when and if released during the term of their contracts. Under our maintenance program, customers are eligible to receive unspecified upgrades when and if available, downloadable training courses and online support. We recognize maintenance revenue over the term of the agreements, generally between one and three years. New and Adjacent-Autodesk new and adjacent products include Autodesk's new product offerings as well as products that are not included in flagship or suites. New and adjacent includes the following services and products: Autodesk Alias Design products, Autodesk 360 products, Autodesk Consulting, Autodesk Simulation, Autodesk Simulation Multiphysics, Autodesk Buzzsaw, Autodesk CF Design, Autodesk Constructware, Autodesk consumer products, Autodesk Creative Finishing products, Autodesk Moldflow products, Autodesk Navisworks, Autodesk Scaleform, Autodesk Vault products and all other products. Suites-Autodesk design suites are a combination of products that target a specific user objective (product design, building design, etc.) and support a set of workflows for that objective. Our current design and creation suites include: AutoCAD Design Suite, Autodesk Building Design Suite, Autodesk Entertainment Creation Suite, Autodesk Factory Design Suite, Autodesk Infrastructure Design Suite, Autodesk Plant Design Suite, and Autodesk Product Design Suite. Subscription revenue-Autodesk subscription revenue consists of three components: (1) maintenance revenue from our software products; (2) maintenance revenue from our term-based desktop subscription and enterprise offerings; and (3) revenue from our cloud service offerings. Total Subscriptions-Consists of subscriptions from our maintenance, desktop, cloud service and enterprise license offerings that are active as of the quarter end date. For certain cloud based and enterprise license offerings, subscriptions represent the monthly average activity within the last three months of the quarter end date. Total subscriptions do not include data from education offerings, consumer product offerings, certain Creative Finishing product offerings, Autodesk Buzzsaw, Autodesk Constructware, third party products and Delcam products. Subscriptions acquired with the acquisition of a business are captured once the data conforms to our subscription count methodology and when added, may cause variability in the quarterly comparisons of this calculation. Billings-Amounts billed to customers during the current fiscal period net of any partner incentives or other discounts. 46-------------------------------------------------------------------------------- |