Autodesk, Inc. (NASDAQ:ADSK) Citi 2022 Global Technology Conference September 8, 2022 3:15 PM ET
Company Participants
Simon Mays-Smith – VP, IR
Sidharth Haksar – SD, Head of Construction Strategy
Conference Call Participants
Tyler Radke – Citi
Tyler Radke
Good afternoon, everybody. Welcome. We’re in the home stretch of day two of Citi’s Technology Conference. I’m Tyler Radke. I co-Head the software sector here at Citi. And we got the Autodesk team here. We got Sid Haksar, who runs the Construction Strategy for Autodesk; and we got Simon Mays-Smith, Investor Relations. Gentleman, thanks for making the trip. And I should say welcome back, Sid. One of your first jobs was at Citigroup. Is that right?
Sidharth Haksar
Yes, started in finance. [indiscernible] where I spent a lot of time there.
Tyler Radke
That’s awesome. So maybe you could just, before we get into the discussion here, just give us a description of what you’ve done since your first job at Citigroup and how you got to be in the role you are today.
Sidharth Haksar
Sure. So I’ve spent — I’ve had a pretty traditional path around investment banking, private equity and then a very short stint at a start-up hedge fund, which was timed really poorly right in the financial crisis, — the financial crisis. But post that, I got my MBA. Did 3 years of software M&A at Evercore and then found Autodesk to lead up corporate development for them for their AEC business, which is over 2/3 of their revenue and joined them in 2014 when construction was still something that we were thinking about but hadn’t really made any sort of movement and any sort of real seriousness.
And effectively, when Andrew took over as CEO in 2017, one of the things he did say to Wall Street was construction was going to be the next billion-dollar business line for us. And behind that, we obviously had the acquisitions that we did from [indiscernible] with BuildingConnected. We’ve acquired 5 companies since. And in 2021, I moved out of corporate development to really lead strategy for our construction business unit.
Question-and-Answer Session
Q -Tyler Radke
Got it, got it. Well, it’s a great intro. I think investors are always asking about the demand environment out there. But I think we could start off the conversation. I mean, certainly, it’s been an interesting 12 months, I think. A little over a year ago, you were one of the first software companies to really call out any type of macro headwinds. You talked about higher material costs. Some of these contractors were bidding for projects, but that kind of impacted when those projects actually happened and had an impact on when you could close deals.
But then you fast forward to today, you reported pretty strong results. You didn’t lower guidance. And it’s at a time when actually a lot of other software companies are taking guidance down. So maybe just walk us through the puts and takes of the demand environment now and how it contrasts versus a year ago.
Simon Mays-Smith
So I think the way you phrased it was exactly right, Tyler, which is we were sort of cursed and blessed to go first, is that we were first to call it in terms of supply chain, ebb and flow of COVID, labor shortages. And then, of course, we got punched in the face by currency as well. And when we first started talking about it in the fall last year, everyone was running around with their hair on fire because they thought it was just us. But since then, pretty much every other company has talked about all of those things.
So we were unlucky to go first, but we were lucky because then we were able to build that into the way that we gave guidance. And so essentially, the way we have given guidance since then is to say we assume that the macroeconomic conditions that we saw starting in the third quarter continued and pretty much they continued give or take since then. Obviously, there have been a few exceptions. We weren’t expecting Russia to invade Ukraine overnight and that’s before we reported our Q4 earnings, which was a bit inconvenient.
But generally, it’s been pretty much as we’d expected. Directionally, Europe because of Russia-Ukraine, a little bit probably worse, U.S. a little bit better but in the round has been pretty much exactly as we expected. And we also sort of looked at it on a sort of multidimensional basis because a number of companies are talking about SMBs and contract lengths and lots of stuff. And all of it is performing normally or consistent with recent quarters. And you can also see that reflected in what we’ve been saying about multiyear. So that’s how it’s been, and our guidance for the year assumes that, that continues.
Tyler Radke
Yes. And Sid, you’ve obviously been at the company for a number of years, including during COVID, when there was a big fall-off in new business. I guess as you are looking at some of the leading indicators that probably start to inflect before you see it in the revenue, how are — I guess, what are you kind of looking to in terms of the first signs of recovery? And I don’t know if you have a view on where we are just in the cycle and kind of what’s different now versus other downturns.
Sidharth Haksar
Sure. I mean, I think for us, business has been basically normal. And when we are looking to see how any sort of impact that’s happening, when we talk to customers, they say backlogs remain robust. And then we try to triangulate that with what we’re seeing within our own bid management platform, BuildingConnected, which has probably the biggest depth of subcontractors in North America in bid activity.
And what we’re seeing over there is that as Andrew called out in his Q2 earnings remarks, we’ve seen record activities in terms of bid activity. So that just shows that while the backlog is already there, we are starting to see our customers and contractors bidding on more work. So we haven’t seen anything as of now and our customers are continuing to report healthy backlogs. I think what they’re seeing, though, is having to turn away more work because of the biggest problem that they face is labor shortages. And that’s the big thing that they’re trying to get around.
Simon Mays-Smith
With apologies for stable host, I’m just being reminded by my team, I’ve got to read our forward-looking statement as well so I’m just going to read that and get out of the way. I should have said it’s fun. Sorry, and bless you, just sneezed by the way. Well, we may make forward-looking statements during the course of this presentation. Please refer to our SEC filings for information on risk and other factors that may cause our actual results to differ.
Tyler Radke
Okay. So now we can talk about where we’re going to land in your guidance range for the quarter. So that’s helpful context. I mean, so in a lot of ways, you’re kind of seeing — like customers are trying to grow faster in some ways and they’re just capacity constrained around labor shortages or supply chains.
Sidharth Haksar
That’s one, yes. The other thing is that your — the need for technology is becoming all that more important because of these external pressures that companies are facing that if they continue with the status quo, they risk being irrelevant. They may not be here when the turn happens for the better, when supply chain pressures ease up, input prices come down.
So you can sat here and asked me in 2019, why do you think this time is going to be different. And honestly, I would have struggled to say because I’ve been saying this for the last 10 years, yes, construction is the least digitized industry and we’re hating that McKinsey graphic where it shows compared to hunting and agriculture, that was basically the laggard, and we are second to that.
But we do believe this time it really is going to be different. And a lot of that is very these external externalities that are forcing construction companies to reinvent themselves. And they’re having to do it at a pretty robust pace that went from zero to 100 That, obviously, brings with it its own set of challenges around change management because this is an industry that is not prone to adopt technology at an accelerated pace.
Tyler Radke
Right, right. So like obviously, we’ve all seen that graphic you’re referring to in McKinsey. How do you think this plays out in terms of this opportunity? I mean, do you think we’re at an inflection point now, given the labor dynamics? Or is this a — is this still kind of a 10-year phenomenon? I mean, you’re saying this time is different but I’m just curious how you’re seeing the time frame of this playing out.
Sidharth Haksar
Look, I think there’s a lot of acceleration that is happening and some basic digitization, right, getting people off of pen and paper. But in construction, there are so many workflows. There are so many processes all the way from design to actually handing over the keys to the owner. And the more you dig into a construction company’s workflows, you may think they’re very mature digitally, and then you’ll find something that you’d be like, “Wow, you are still using a whiteboard and Excel to manage this.”
So we think of it as a couple of ways. I think getting people off of pen and paper, like the basics, digitizing your growings as an example. That is starting to happen a lot faster. Collaborating with third parties, that is happening. I think that when you get into specific workflows, there’s a lot of opportunity there as well. So we think it’s going to be, I hate putting a time line on this, but they’re just going to — we’re still very early in the innings.
Simon Mays-Smith
The long-term opportunity is there and, as we said, has been there for some time. The efficiency you get from connected workflows, the increased sustainability you get from connected workflows. But the — what’s changed is the lived experience, whether it be the pandemic and the need — you can’t work in an in-person connected way and you have to be able to work connected. You need to have workflows in the cloud to do that.
Inflation, 30% of the cost of a project is waste, and that becomes more — in the context of an industry, that has 3%, 4%, 5% margins. And so in a world where inflation is becoming more important, managing that waste just becomes much more important as well. So it’s just a succession of lived experience is making the need to realize the long-term opportunity more acute in the near term.
Sidharth Haksar
Yes. And I’ll just add the other part, which is historically, construction has — the purchasing of construction software has been extremely decentralized. It’s been actually at the project level. And you’ve had a lot of point solutions manifest themselves, right? And there’s a stat that says within a construction company, I think 25% of construction companies have probably 5 or more software applications for the same process, but it’s across different offices.
And what’s happening now is the rationalization of technology spend on effectively on platforms. And so for us as a company with Autodesk Construction Cloud, we have built out a platform, a unified platform, which goes all the way from design review to handover or close-out. And are we going to do every single part in that workflow because there are still best-of-breed solutions out there? No, but we are building a robust set of third-party ecosystem partners and having APIs to ensure that direct data goes bidirectionally into and out of those solutions.
Tyler Radke
Yes, yes. And I’d love to talk about that a little bit, especially given your background in kind of building construction portfolio. So obviously, Autodesk is well known in the design space, architecture using — but now that you have a more complete construction portfolio, maybe it’s not fully complete, how do you think about the — how big that business could be over time? And what’s the TAM we’re talking about? And maybe within that, where are you highest penetrated and where is the biggest share gain opportunities?
Sidharth Haksar
So I think we’re really early in our journey. I think the TAM, you’ve probably seen us put numbers. Competitors have put numbers, I mean, anywhere between $9 billion to $13 billion opportunity in growing. Historically, as you correctly pointed out, we have a large installed base of construction companies that are using our design tools, whether it’s AutoCAD or Revit 3D. So we already have them there.
Historically, they would use that. They would use another hero product which doesn’t get enough airtime, but it is used and you’ll have to pull it out screaming out of the hand of a construction, VDC professional, which is Navisworks. That is used for clash detection and that’s used predominantly by the majority of construction companies that are doing anything related to model-based design.
So that was kind of what we had. And then we had BIM 360 Field, which was an acquisition we made back in 2012 of a company called Bella System, which we rebranded. That was our construction portfolio back then, right? When we started acquiring, we got scale with our acquisition of Climate in the field. We acquired BuildingConnected, which gave us the #1 bid management platform in North America for the preconstruction phase.
And then over time, we have added incrementally other solutions like pipe, which gave us a position in project management, really around automating certain very processes. And we acquired on the preconstruction side, again, assembled systems, which gave us model-based take-off capabilities. And the most recent acquisition, which was a company called Pros, which gave us cloud-based estimating.
So if you think about the entire life cycle of a project from design to precon to actually site execution or build and ultimately hand over, we have now bookended the process of the stages with solutions, including in the middle as well. So if you think historically, where have we been very strong? Yes, it wasn’t construction, right?
But we have — with the acquisition, we have really established really good critical mass on the site execution side. And we’re also pushing more into the — ultimately over into the handover phase as well. So it’s still very early days in terms of the opportunity that there is for us. Historically, our customer base was really enterprise customers. We think of enterprise customers a $1 billion-plus in revenue. Mid-market is $100 million to $1 billion and then territory is, call it, $5 million to $99 million. We had really good penetration in the enterprise, and we’ve been going increasingly into the mid-market and the territory accounts.
Tyler Radke
Okay, that’s helpful. So maybe within those phases you talked about, design, preconstruction, site execution, handoff, like where are customers look behind the curve in terms of digitizing the workflows? I mean, is this — you talked a little bit about pen and paper conversions. But what are like the big obvious pain points that you see out there and — that are ripe for this technology?
Sidharth Haksar
I mean, I think it’s really more automation, doing more with less at the end of the day, I mean, with labor shortages there. A great example I’ll give you is a company we acquired called Pype. Effectively, what Pype does is it takes a specification manual, which has everything that in order to — because everything is very directive. In order to buy something a subcontractor needs to look to a specification manual and say, all right, these are the things that I need to use. If I have to go outside of this box, I need to submit an RFI.
And so basically, that job of actually creating that submittal register is done manually using Excel. And it’s some project engineer who’s new to construction will spend hours doing it. And any time scope changes on a project that specification mail gets updated. Imagine having to do change analysis on that. Pype basically takes what would take hours and days and sometimes even months on mega-projects into minutes to hours to days. And so it’s a massive time savings that you can get.
So I think there are areas around really unlocking productivity. That is something that we’re seeing customers gravitating towards. The other part, which I think is tends sometimes to be lost upon is preconstruction. And the way we think about preconstruction is, and especially in today’s environment, I don’t care which project management solution you have. But if you scope a project incorrectly and price it wrong, you won’t be chasing our tail on the job site.
And so connecting preconstruction into design so that you can actually also look at potential RFIs before shovel hits the ground versus actually RFIs coming out in the field or change orders happening in the field. That is something that we’re really pushing and trying to advance the industry. Because having RFIs is not a vanity metric. I mean, you want to make sure you take those RFIs down to effectively 0.
And that’s why for us, it’s really the connection between precon and design. And we have the design tools already that our customers are using. We’ve built out a robust preconstruction portfolio so that interconnection is going to be critical and help our customers in this environment.
Tyler Radke
Yes. So I’d love to talk kind of a little bigger picture, but specifically about your products and platform strategy, because I think during the last earnings call, there was a lot of discussion around kind of modernizing all these kind of various products, some of which are already cloud-based but some of them are on-premise into more of like a connected and a common data environment because a lot of these things have been acquired and maybe on different code bases. Where are we in that journey? And I guess, what is the end goal for Autodesk in kind of this next phase of modernizing?
Simon Mays-Smith
Yes, so I’ll sort of talk to that. So probably the sort of furthest along we are on that is within our manufacturing business with Fusion. And so let me sort of talk a bit about that, about what we’ve done and why. What we’ve done with Fusion is essentially disaggregate the platform, which is Fusion, from the vertical functionality, which we call extensions. And what Fusion is, is a set of 12 connected workflows which provide you with — if you think of a sort of Excel spreadsheet, most people only use 20% of the value. I’m sure you use of the functionality of a spreadsheet.
And so what Fusion does is provide you, across those 12 different workflows, the 20% of functionality that most people use most of the time and provide it at a very attractive subscription price point of about $500. So it means that any user and any one of those workflows and make sense for them to subscribe. But then very quickly and very easily, adjacent users can switch on the workflows across all the different workflows. So we can populate the new opportunity of connected workflows.
In ECON 101 terms is we’re pushing out the demand curve. And then what we can do with the vertical functionality, which we call extensions, which is essentially the other 80% of the XL functionality is for specific users, provide them with a higher price point, typically between $1,500 and $3,000. The other 80% of the functionality, which that specific user needs to do their job. And that’s sort of splitting — the disaggregating of the platform at a low price point with the vertical functionality allows us to push out the demand curve and then with the vertical functionality to capture much more efficiently the value under that demand curve. So it allows us to capture the new market opportunity.
Secondly, it allows us, to your question, to migrate our on-prem business to the cloud and retain value because essentially, in this world, slowly migrates to becoming essentially at an extension on Fusion and the value of the inventory extension plus the Fusion base is the same or more as the inventor customer in the on-prem world, so it allows you to retain value. And in the meantime, it’s competitively very disruptive because most of our peers still haven’t made the subscription tradition that we have. And we are adding an additional pricing moat because they have vertically integrated technology stacks.
So the only way they can compete against the disaggregated platform vertical functionality is by discounting the value of the entire stack, which is financially not good for them. So it allows us to be very competitive with our peers in the industry as well. So that’s really what we’re doing from a sort of competitive standpoint. But at the same time, what we’re doing is we’re moving file-based data to data in the cloud. And what that does over time is allow us to — for data to be shared by our customer much more efficiently and for them to generate efficiencies but also, over time, will allow us to apply more AI and machine learning to that data so that we can develop more higher-value products across more efficiency for our customers.
So for example, what it means is that if we have a design process that we then are using machine learning and figure out is causing problems at the machining phase at the end of the phase, we can then feed that information back using machine learning back into the design phase. So that problem isn’t made. So you’re not having to then rework the machine and rework the design in a very time consuming — which is financially inefficient way as well.
Tyler Radke
Right. So I guess maybe on the construction side, though, as you think about Construction Cloud. I mean, where are we in that kind of modernization process? Or I guess another way to ask it is 3 to 5 years from now, will there be kind of newer use cases as you have more of these data sets in the cloud that you’ll be able to take advantage of?
Sidharth Haksar
Absolutely. I think if you think of what we did with the acquisitions. The biggest lift for us was integrating PlanGrid and BIM 360, the merging of the code base, right? That to us was the heaviest lift. There was duplication. We knew it intentionally when we made the acquisition, but we’re behind that. And what you see with Autodesk build, it’s a unified code base.
And as part of that, we’ve also got our preconstruction solutions from takeoff and BillCollaborate Pro there. Autodesk Bill is obviously the flagship product. It includes both project management, cost management, as well as quality and safety. And we don’t charge separately for each of those specific modules as part of Autodesk Build.
So that’s — the heavy lift has been done. I think if you think of the other acquisitions we’ve made, you’re going to, over time, see more of that goodness being infused in the Unified platform. Our approach is to — right now, you have 2 integrations with the Unified platform. Those will go away and will all become first-class citizens within Construction Cloud, within that platform.
Tyler Radke
Okay. Okay, great. And one of the things that we’ve seen over the last few months at Autodesk and even some of your peers has been price increases in various international markets. There’s always a bit of movement on the pricing front at Autodesk, whether that’s kind of the move from multiuser to named user, and obviously, you’re still in a number of years post the subscription transition. Could you just frame for us like how much you’re seeing pricing as a tailwind to growth? Or how we should just think about the pricing environment as it relates to the overall business?
Simon Mays-Smith
Yes. I mean, really so 2 things. One is on average and over time, volume and price will be roughly equal contributors to our growth. In some years, volume will be doing more of the heavy lifting. In some years, price will do. But on average and over time, they will be roughly equal contributors. And then the sort of second thing is that pricing is not a single flavor popsicle. And what I mean by that is that most people assume that you have a pen and you increase the price and that sort of thing. And that is indeed 1 way to get pricing.
But you can also invest in R&D and create a better penance for more. So that’s another way of getting pricing. You’ve already talked about another sort of initiative we’re doing similar to what Adobe and Microsoft have done in the past, which is rather having an incredibly complex pricing for every different — different pricing in every different market of the world, having sort of different 3 pillars of pricing around euro, dollars and yen and then unifying upwards markets to those sort of 3 pillars.
You can also do work around the number of promotion days and the discounts you’re offering those promotion days as well, the multiyear discounts as well moving to annual billing, et cetera. So there’s always stuff that we’re working on in the background, have consistently done so, and you can expect us to continue to do so.
Tyler Radke
Got it. I’d love to talk about some bigger picture topics. So one being the infrastructure bill finally saw us a little bit more clarity and what that looks like here. How are you seeing that as it relates to Autodesk and what type of impact would you expect that to happen the business?
Simon Mays-Smith
I mean, the first important thing is that there are billions and billions and billions of dollars spent every year across the globe with or without an infrastructure bill. So infrastructure is a fantastic business to be in with or without an infrastructure bill. And we are very well placed within infrastructure because of all the competitive strengths that we have, namely the fact that we can connect workflows together and make our customers more efficient and more sustainable and that’s becoming more important.
And also the fact that we combine both vertical and horizontal infrastructure. So what I mean by that is if you’re building railway tracks, you need train stations. If you’re building roads, you need bridges, airports, you need roads into the airport. So there’s vertical and horizontal and our ability to combine both of those things together in 1 ecosystem makes us very efficient of being able to deliver that. So we have a competitive advantage.
So what the Infrastructure Bill in the U.S., and by the way, there’s other infrastructure bills in Europe and various other places as well are doing is essentially putting money behind a vast infrastructure spend deficit. There’s been underinvestment in infrastructure for decades, and that’s become an acute problem because, firstly, it’s beginning to fall down. And secondly, it’s beginning to fall down at a faster rate because of climate change because the infrastructure is not designed for the precipitation trends for heat, for wind. It’s just not designed for it. So it has to change.
So that’s driving demand. And so the infrastructure bill is really just a sort of symptom of that need for change. So in terms of the U.S. build specifically, which is what you’re probably asking about, I’m sorry, that’s a rather long-winded answer, but that’s not that specifically. It always takes time from when the money is set aside for it to reach the market. It’s beginning to trickle into the market. It’s slow and it will come out over the coming sort of months, quarters and years. As I said, it’s unlikely to be transformational but does it provide a tailwind to the infrastructure market? Yes.
Sidharth Haksar
One thing that is, I think, not as much appreciated, so as the construction business, I think Andrew called out Indiana Department of Transportation. So on the roads and highway side, we’re continuing to see good momentum there for our business. But with this money coming in, you’re already going to take a very stressed environment on the commercial contracting side where you have labor shortages and material price increases and now, you’re going to tax it even more.
And I think that’s something we need to see how that plays out because it hasn’t really hit it right now. The money hasn’t really flowed through, because now you’re going to have subcontractors, general contractors having options. All right, do I work on this particular project or do I go do something separate, right? And so we think it’s going to be a very interesting time. Whether there will be consolidation within the ENR 400 general contractor base, I think I would expect that to happen. People are going to try to diversify their revenue streams based on where the money is coming.
Simon Mays-Smith
And also because there’s — particularly in the U.S., a change going on in the way that construction is done from design, bid, build to design builds, so integrated design and construction shops. And that will actually drive some consolidation, too.
Sidharth Haksar
Yes. And that, for us, is another nice tailwind when I was talking about preconstruction and the reason why we want the design to be preconstruction. The project delivery models historically have been designed with Build, so it’s very sequential. And I think that doesn’t set up a project for success because the designers will create something and then the general contractors come in and then they bid off of those 100% construction documents.
And from there on in, then the work starts. What we’re seeing is more collaboration between contractors, designers, engineers, subcontractors, they have a better say at the table, which can obviously derisk a project. So some of our tools, which enable that collaboration, become important.
Tyler Radke
Right, right. Okay. And one of the themes that had a lot of discussion, I assume, in your customers has been the topic of sustainability, reducing waste, obviously carbon footprint. I guess are you seeing this in certain industries or verticals in more ways than others? And how are you kind of — I know there’s a lot of different ways to be kind of by definition, using a digital-based design, you’re optimizing. Means you’re going to use less materials. But specifically, how do you kind of play into that theme? And what are the regions and the verticals that are kind of pursuing that in the strongest way.
Sidharth Haksar
So I’ll say a couple of ways, right? We’ve got embodied carbon calculators within RAPID, right? So if you’re an architect now, you can decide when you’re specifying the materials, what that impact can be from a carbon standpoint, print standpoint, right? So that’s at the highest level. More importantly, I mean, construction generates the most amount of waste on the planet of any industry, right? A lot of that is due to also rework and throwing away ways to work, right?
So the more you digitize the job site or your processes and the more you simulate the job before at least hits the road, you are derisking issues, which will lead to reworking waste. So we do believe that there — and especially on the fact that now when you have long lead times for certain items on the job, it’s becoming even more important to get it right, right? You don’t have that luxury. So I think all of this is a little bit — efficiencies lead to increased sustainability and I’ll borrow a word from Simon there.
Simon Mays-Smith
Yes. I mean, it’s 2 additional things. One is if you look at our impact report, what’s interesting is that the number of our customers who have some sort of external projection, I have a target or talk about it, has gone up on a big company, from a big number to a bigger number percentage. What’s interesting is it’s now beginning to permanent down into the small and medium customers as well. So that’s — if you look at our impact report, it’s trickling down into the market. So that’s interesting.
And the sort of second thing is that, to Sid’s point, is that sustainability and efficiency are connected at the hip. They’re not in separate things, is that the reason stuff is done unsustainably is because it’s cheap and it’s cheap because it doesn’t reflect the externalities of producing that way. So doing stuff more sustainably may margin be more expensive because then you have to reflect the externalities of whatever you’re producing with. And therefore, you need the efficiencies to be able to offset that cost and manufacturer sustainably or construct sustainable. So efficiency and sustainability go hand in hand with each other. They’re not separate items.
Tyler Radke
Right. And as we think about kind of government initiatives that might be accelerating that, right, I remember years past, we talked about BIM mandates for digitizing your information models for buildings. How are you seeing government initiatives, particularly outside the U.S., kind of contribute to some of the demand or strength that you’re seeing?
Sidharth Haksar
I mean, I think 1 thing that we’re watching very closely is the Building Safety Act coming out of the U.K. I don’t know if you are familiar with the Grenfell Tower fire, that resulted in, unfortunately, folks just not knowing where the information was, there was cladding, which was put in there, which was highly combustible, which led to it. But a lot of that information was with, I believe, a general contractor that went out of business.
And so what’s happening is when you high-rise buildings within a certain number of floors they are looking to actually digitize the entire work process, workflows, all the way from actually prequalifying your subcontractor base. You know exactly whether they adhere to certain requirements and compliance from a compliance standpoint, to really understanding where are things. Everything needs to be done via a model-based workflow. So we see some of these initiatives will inherently drive greater adoption of technology.
Simon Mays-Smith
And it’s not always around BIM mandates as well. So often, what you see is companies that are sort of forced to use BIM in 1 country, then realize it’s efficient and then they take it back to — so the Japanese builders are actually a very good example of this. If you look at our Investor Day, you’ll see Japan picking up in terms of bid penetration from a low base begin to pick up. And that’s because a lot of the large international Japanese construction companies that have been using BIM outside of Japan. And then have decided to unify on it internally within the company and then have been lobbying Japanese government to then unify that in Japan as a sort of regulation. So it kind of — it goes both ways. It’s not just top down, it’s also bottom-up.
Tyler Radke
Got it, okay. And kind of the final bigger picture topic I wanted to hit on was water infrastructure. So you recently acquired Innovyze an interesting acquisition, I think we all know, particularly those from the West Coast, how important water is. But what was — what’s kind of your view on the opportunity here? And how has that business been performing since —
Simon Mays-Smith
I mean it’s been performing great and you can — we call it out most quarters. So you can see you can track some of the stuff that we’ve been doing it. But fundamentally, this goes to what I was talking about earlier, is that the vast majority of water infrastructure is not fit for purpose because there’s too much water turning up in some places, too little water turning up in other places.
The hole in California — sorry to be parochial as I’m now a native of California, the whole water infrastructure is designed to bring snow down from the hilt of the mountains to the coast and that’s a problem if it doesn’t snow. So you got some huge and then you’ve got flooding — terrible flooding across the country. So it’s a big issue that needs to be fixed. And so it’s really solving that problem in a way that is, again, most efficient and sustainable is what an adviser is trying to do.
And our position now with Innovyze, we already have the sort of construction bit to the chain. We had the design bid with our existing design bids. And what Innovyze does is gives us the planning phase, the sort of predesign phase. And then it also, through their digital twin, gives us the operations and maintenance space. So we’re the only operator now that has end-to-end workflows in water and infrastructure. So we’re pretty excited about that.
Tyler Radke
So this would be your traditional water infrastructure, pipes, dams and aquaducts?
Simon Mays-Smith
Yes and stuff. And we have — and what we’ve done over the last few years is build up strength in road, rail airports and water infrastructure have been our sort of key verticals in the infrastructure market.
Sidharth Haksar
And a key growth opportunity, tying it back to construction is, since we have Innovyze, a lot of these are water utilities that are using this. Now they need to do the upgrades to their water infrastructure. Guess what we could work with them to use areas build on that construction process? So that’s an area of opportunity, a synergy that we have clearly meaningly unlocking.
Simon Mays-Smith
Yes. Because the owners, they have a lot of owners.
Sidharth Haksar
Exactly, right.
Tyler Radke
Yes. So would the buyer of Innovyze be utility managers or would it be contractors working on these repair or new projects?
Sidharth Haksar
So on Innovyze, because I work on the acquisition side, a little bit now about that. The opportunity there is you’re selling to really to utility owners and you’re also selling to design firms, engineering firms. And the reason why we like the opportunity about it was when we acquired it was you had the same customer using Innovyze and Civil 3D. And it was like — and then there were those that were not using Civil 3D but were using Innovyze. I thought there was this opportunity to harmonize the existing base of Civil 3D and Innovyze. And then obviously, for those that were not using Civil 3D, it was a great opportunity to upsell them, cross-sell them a Civil 3D product.
Tyler Radke
Right. Maybe as we — obviously, you spent a lot of time in the M&A role. Where do you kind of see M&A going from here? I know to your point, Andrew talked about construction being the next billion-dollar business. I think beyond that, he’s talked a lot about manufacturing. So where is kind of the M&A focus at this point?
Simon Mays-Smith
So I’ll take that one. So it’s really — logically, what we’re trying to do is we’re trying to connect adjacent workflows. And simplistically, when we do that, we add new customers, not just — and typically, we’re doing it, we’ll acquire something in 1 country, and then we’ll be able to take that model across the globe. And then what we can also do by connecting that customer base to our existing customer base is bring additional value to our existing customers to the workflows of both customers. So there’s a real synergy for us when we’re making the acquisitions, which is why it makes sense for us to continue to put capital to work in this sort of channel.
As you said, we’ve had — for starting in our world of design, we’ve moved downstream into preconstruction and construction. And what we’ve been doing more recently is moving upstream from design into the planning phase, which is then getting us into the owner’s market and also downstream from construction through the digital twin into the operations and maintenance side of the market. We’ve barely begun to scratch the surface of that. It’s important because roughly 70% of the cost of the building is post-construction. And the digital twin is essentially the operating system to help you realize the efficiency savings in that part of the market. So there’s a long opportunity there.
Similarly, in manufacturing, we’re doing the same thing from CAD/CAM, product data management, product life cycle management. And then more recently, we’ve been moving from sort of head office down onto the actual shop floor in terms of managing data on the actual manufacturing line. So lots of opportunity there to extend.
And then in Media and Entertainment, we’ve been actually going in the opposite direction. So from a strong position in what is the equivalent of construction post-production, we’ve been moving upstream into the design phase with things like and Loop. Again, same thing, connecting the workflows end-to-end to enable what is a remarkably 20th century manufacturing technique. They’re cutting around all these physical files with terabytes of data on them in the media industry in a world where the unit cost of content is becoming much more important in a subscription world than feeding the subscription engine. So we’re optimistic about that as well. So really, those are the sort of 3 — the areas, putting them into adding adjacent versus.
Tyler Radke
And a common theme for us.
Simon Mays-Smith
Correct, correct. [indiscernible] and then what’s going on underneath that, going back to where we started, is a lot of organic investment in our platform to enable us to sort of build once and use many times across each of different verticals to enable us to connect workflows in the cloud, to move data from file-based data to data in the cloud and then add a machine learning to it; and thirdly, to enable us to build a much bigger, broader and deeper third-party ecosystem on our platform.
Tyler Radke
Great. I know we have just under a minute left. Maybe just some closing thoughts from both of you on how investors think about the rest of the year and what your biggest focus areas are.
Simon Mays-Smith
Yes. So really sort of 2 things. One is that we are — our end markets are cyclical, construction and manufacturing. I’m not going to trying to pretend that they’re not. But we have, as a company, an enormously resilient sort of engine within the business, which is our subscription business, which has good renewal rates, high net revenue retention and a customer base that are typically using our product regularly during — they’re working, they’re using our product all of the time.
And that is a very resilient, as you saw during the pandemic. It’s not immune from the cycle but it’s very resilient to the cycle. Where we have cyclical exposure is in the rate of new sub growth, in the — in terms of people buying or not buying premium products. And in terms of the duration, whether they buy 1 year or 3 year. But as a percentage of the total business, that’s relatively small relative to the size of the subscription renewal business. So that’s the first point is resilience of the business.
And then secondly, fiscal ’24 cash flow, as we go through the sort of business transition from upfront to annual billing, we will have a sort of trough of cash flow in ’24. And then you get a mechanical rebuilding of the cash flow as the impact of the annual billing flows through and you get a rebuilding of the subscription stack and the cash flow in ’25 and ’26.
Tyler Radke
Great. Ended on free cash flow. I like it. We like free cash flow. Thank you very much for joining us. Thank you.
Simon Mays-Smith
Thank you very much.
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