Evan on Engineering Software

Autodesk filed its 10K (annual report) with the SEC today.

It's enlightening for reasons that you might not expect - not just because of what's in it, but also because of what's not.

Here are some salient sections. (If you want to see the complete document, you can find it on Autodesk's web site):

COMPETITION

Our Design Solutions Segment primarily competes with vendors that specialize primarily in one of the three industry segments in which we compete. Our competitors range from large, global, publicly traded software companies to small, geographically focused firms. Our primary global competitors in this segment include Dassault Systemes and its subsidiary SolidWorks Corporation, Parametric Technology Corporation, UGS Corporation, Bentley Systems Inc. Environmental Systems Research Institute, Inc. (ESRI), and Intergraph Corporation. In addition, in each of our markets, there are numerous regional and specialized software and services companies, with which we compete.

The software industry has limited barriers to entry. . The design software market is characterized by vigorous competition in each of the vertical markets in which we compete, both by entry of competitors with innovative technologies and by consolidation of companies with complementary products and technologies.

INTELLECTUAL PROPERTY AND LICENSES

We protect our intellectual property through a combination of patents, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions. Nonetheless, our intellectual property rights may not be successfully asserted in the future or may be invalidated, circumvented or challenged.

We retain ownership of software we develop. All software is licensed to users and provided in object code pursuant to either shrink-wrap, embedded or on-line licenses, or signed license agreements. These agreements contain restrictions on duplication, disclosure and transfer.

RISK FACTORS

Because we derive a substantial portion of our net revenues from AutoCAD-based software products, if these products are not successful, our net revenues will be adversely affected.

We derive a substantial portion of our net revenues from sales of AutoCAD software, including products based on AutoCAD that serve specific vertical markets, upgrades to those products and products that are interoperable with AutoCAD. As such, any factor adversely affecting sales of these products, including the product release cycle, market acceptance, product competition, performance and reliability, reputation, price competition, economic and market conditions and the availability of third-party applications, would likely harm our operating results.

Our efforts to develop and introduce new products and service offerings expose us to risks such as limited customer acceptance, costs related to product defects and large expenditures that may not result in additional net revenues.

... competitors may introduce new products and services that achieve acceptance among our current customers, adversely affecting our competitive position. In particular, a critical component of our growth strategy is to convert our 2D customer base, including customers of AutoCAD, AutoCAD LT, and related vertical industry products, to our 3D products such as Autodesk Inventor Series or Autodesk Revit. Should sales of AutoCAD, AutoCAD upgrades and AutoCAD LT products decrease without a corresponding conversion of customer seats to 3D products, our results of operations will be adversely affected.

If we are not able to adequately protect our proprietary rights, our business could be harmed.

We rely on a combination of patents, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Despite such efforts to protect our proprietary rights, unauthorized parties from time to time have copied aspects of our software products or have obtained and used information that we regard as proprietary... Furthermore, our means of protecting our proprietary rights may not be adequate, and our competitors may independently develop similar technology.

There is, of course, a lot more to this 10K – but consider some of the things that Autodesk is saying:

• Autodesk derives a substantial portion of its net revenues from sales of AutoCAD-based software.

• A critical component of Autodesk's growth strategy is the migration of its customers from AutoCAD-based (2D) products to 3D products.

• There is significant risk that competitors may introduce new products that achieve acceptance among its current customers—in particular, customers of AutoCAD-based software.

• Autodesk's primary global competitors include Dassault, SolidWorks, PTC, UGS, Bentley, ESRI, and Intergraph.

• The software industry has limited barriers to entry.

• Autodesk protects its intellectual property through a combination of patents, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions.

• Despite efforts to protect its proprietary rights, unauthorized parties from time to time have obtained and used information that Autodesk regards as proprietary.

This all sounds pretty reasonable, on its face. But there are a few glaring omissions and potentially misleading statements:

• A statement about the "software industry" having limited barriers to entry is completely irrelevant to Autodesk's situation. The CAD industry has significant barriers to entry.

• Autodesk enjoys a massive network effect because the DWG file format, native to its AutoCAD-based products, is the most popular design data format in the world.
  

• The most critical risk that Autodesk faces is if its competitors introduce new products that achieve acceptance among customers of its AutoCAD-based products. The only thing that keeps competitors from achieving this acceptance is a lack of total compatibility with DWG files created by AutoCAD-based products.

• To create a barrier to entry to its existing customer base, and leverage its 2D market power into the 3D market, Autodesk takes overt actions to prevent competitors from achieving DWG compatibility. (See, among other things, Autodesk's "Trusted DWG" initiative.)

• Nowhere – not in this annual report, nor in its EULAs, nor in any legal filing or formal document - does Autodesk actually assert any intellectual property rights whatsoever in the DWG file format.

• The only reference in this annual report that might be about the DWG file format is a statement about information that Autodesk "regards" as "proprietary." (The word "proprietary" in this case implies something that is not protected by intellectual property laws, such as US copyright, patent, and trademark codes, or state trade secret statutes.)

• Autodesk lists as its competitors in this annual report companies that compete primarily in vertical markets. It lists no companies that compete directly, in any substantial way, for its installed base of AutoCAD and AutoCAD LT users.

• In this 10K, Autodesk conspicuously fails to mention the most significant threat to both its control over its existing customer base, and its ability to convert that base to newer 3D products: The Open Design Alliance - the only significant independent developer of DWG compatibility tools.
  

It may seem odd that I, as president of the Open Design Alliance, would say "hey, Autodesk forgot about us!"  In the past, I've carefully tried to point out that the Alliance is a non-profit consortium, with members including not only all the companies that Autodesk lists as its competitors, but thousands of companies, organizations, schools, governments, and individuals - many of which are Autodesk's most important customers.

Yet, in the last year, Autodesk has taken a number of aggressive actions, and made statements to the CAD industry, that show it considers the Open Design Alliance to be a serious danger to it. 

Carl Bass calls the Open Design Alliance the "arms supplier to Autodesk's enemies."  And it appears that Autodesk has declared war on the Alliance, without regard to the collateral damage to its own customers, millions of which use software tools developed by the Alliance.

It's troubling that Autodesk has chosen not to disclose these issues to its shareholders.  Particularly as a failure to disclose material risks is, as I understand it, a violation of both the Securities Act, and the Sarbanes-Oxley Act.