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Executives

Sue Pirri - VP, IR

Carol Bartz - Executive Chairman

Al Castino - CFO

Carl Bass - President and CEO

Analysts

Sterling Auty- JP Morgan

Daniel Cummins - Banc of America Securities

Gene Munster- Piper Jaffray

Jay Vleeschhouwer - Merrill Lynch

Brendan Barnicle - Pacific Crest Securities

Brent Thill - Prudential

Michael Huang - ThinkEquity

Sasa Zorovic - Oppenheimer

Tim Fox - Deutsche Bank

Israel Hernandez - Lehman Brothers

Presentation

Operator

Good day, ladies and gentlemen. Welcome to the Autodesk fourth quarter 2006 earnings conference call. (Operator instructions) I would now like to turn the call over to Sue Pirri, Vice President of Investor Relations. Please proceed, ma'am.

Sue Pirri

Good afternoon, everyone. Thank you for joining us today as we report results for our fourth quarter and fiscal 2006. With me are Carol Bartz, Carl Bass and Al Castino. Today's conference call is being broadcast live through an audio webcast. In addition, a replay of the call will be available by webcast on our website, www.autodesk.com/investor.

During the course of this conference call, we will make forward-looking statements regarding future events and the future performance of the Company. We caution you that such statements reflect our best judgment based on factors currently known to us, and that actual events or results could differ materially. Please refer to our documents we file from time to time with the SEC and specifically our 10-K for fiscal year 2005 and our 10-Q for the quarter ended October 31st, 2005 as well as our periodic 8-K filing. These documents contain and identify important factors that may cause the actual results to differ from those contained in our forward-looking statements.

In adherence to regulation Fair Disclosure, Autodesk will provide quarterly information and forward-looking guidance in its quarterly financial results press release and in publicly announced financial results conference calls. We will not provide any further guidance or updates on our performance during the quarter unless we do so in a public forum.

During the call, we will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with General Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is set forth in our press release issued today, February 28th, and is made available on our website. Now I’d like to turn the call over to Carol Bartz.

Carol Bartz

Good afternoon. Thank you for joining us. Before Al provides a detailed review of our financial results, I would like to discuss our Q4 2006 performance. Autodesk had another outstanding quarter and year. We grew revenues 17% to $417 million. I would remind you, this would be a 23% growth rate on a constant currency basis. Full year revenues were $1.523 billion, an increase of 23%.

We continued to show strong profitability in the quarter, increasing non-GAAP net income 21% to $91 million. Our non-GAAP operating margin was 25% in the quarter, and we achieved our targeted 25% non-GAAP operating margin for the entire year.

Demand for our products continues to be very strong. Compared to last year, revenue from new commercial seats increased 16%, or 23% constant currency. Once again, sales from new seats and emerging businesses were approximately two-thirds of our revenue. This confirms the underlying strength of the business, and the robust demand for our solutions.

Autodesk's is gaining share in all markets and all geographies. We are especially pleased with the growth in our emerging economies, which grew 35% this quarter and more than 60% for the year. Market penetration of our 3D products is increasing. Revenue from new, commercial 3D seats grew 73% in the quarter and 88% for the year. In fact, 3D has become the single biggest driver of new commercial seat revenue growth, and will lead to increasing downstream growth in maintenance revenue.

The value of our subscription program continues to resonate with customers, driving higher subscription attach and renewal rates. Subscription revenue increased 56% over last year, and exceeded upgrade revenue for both the quarter and the full year. As expected, upgrade revenue declined compared to last year, due to higher subscription and the movement of the retired Autodesk 2002 base products to the first quarter of fiscal 2007. Combined revenues from subscription and upgrades in Q4 represented 38% of revenue.

Finally, we completed the Alias acquisition in January. We are now in execution phase, driving synergies across the businesses. Alias extends our opportunity across both the media and manufacturing markets, and our customers will benefit from more complete and integrated solutions. Overall, we are extremely pleased with our fourth quarter and our fiscal year. Now I would like to turn the call over to Al.

Al Castino

Thanks, Carol. Once again, Autodesk delivered great performance. As Carol said, net revenues in the quarter were $417 million, 17% higher than last year, and 23% higher on a constant currency basis. This includes revenues from Alias of $3 million, after the write-down of deferred revenues required by GAAP.

GAAP earnings were $0.33, a 27% increase. Non-GAAP earnings were $0.37, a 23% increase. Non-GAAP EPS excludes the impact of Alias and pre-tax in-process R&D and the amortization of purchased intangibles.

Each of our geographies grew substantially in the quarter. The Americas had a great quarter, growing 29% to $177 million. AMEA grew 7% to $150 million, or 19% constant currency. Asia Pacific grew 14% to $90 million, or 21% constant currency.

Gross margins increased 2 percentage points from last year to 90%, benefiting from continued strong software license sales, and productivity measures in our operations. GAAP operating expenses were $279 million. Excluding acquisition-related charges, non-GAAP operating expenses were $271 million.

Operating income was $97 million GAAP, up 24% over last year. Non-GAAP operating income was $106 million, up 18%. Our operating margin was 25% on a non-GAAP basis. Without Alias, our non-GAAP margin would have been 26%. Our operating margin continues to demonstrate the leverage in our model, as well as our commitment to improvements in efficiency and business execution.

Our full year non-GAAP tax rate was 19%, lower than our 20% estimate, primarily due to the geographic mix of earnings. The full year true-up drove our non-GAAP tax rate to 17% in the fourth quarter. Our full year GAAP tax rate of 14% includes benefits related to prior years. Our 18% Q4 GAAP tax rate was impacted by the non-deductibility of in-process R&D.

Net income was $83 million GAAP, and $91 million non-GAAP. There were 249 million shares used in calculating diluted net income per share, and 230 million total shares outstanding. You should note that over the past three years, outstanding shares have increased just 2%, while non-GAAP EPS gained 640% and the GAAP increase is even higher.

The changes in foreign exchange rates cost us 6 percentage points of growth, and $0.06 per share compared to last year. Once again, the underlying strength of our business allowed us to exceed our guidance, despite the negative currency movements.

Turning to the balance sheet, cash in investments were $378 million, down from last quarter due to the $197 million used to purchase Alias. With continued strong cash generating capability of our business, we are very comfortable with this reduced level of cash entering the new year.

Cash from operating activities was $114 million, compared to $144 million last year. The decline was due to working capital transaction timing, such as timing of tax payments related to the repatriation which will reverse itself in the first quarter. We received $17 million from employee stock plans, and used $107 million to buy back 2.5 million shares of stock.

Total deferred revenues were $286 million at quarter end, including $36 million classified as long term. Deferred subscription revenues increased $28 million, reaching $213 million. For the first time, we are heading into the new year with 14% of revenue already booked.

Total backlog increased to $303 million. This includes product backlog of $17 million, down slightly from the prior quarter, but within our normal range. Year end backlog growth was not a factor this year, due to the movement of our product retirement program from Q4 to Q1.

Turning to channel inventory. Channel inventory was slightly below our normal range of three to four weeks. Weeks supply of inventory in the channel decreased sequentially. DSO was 56 days. Strong subscription bookings, and the Alias acquisition each added four days to our DSO, and accounts for the entire sequential change. The Alias acquisition added to our DSO because the calculation picks up their entire accounts receivable balance in the numerator, while we have only 20 days of revenue in the denominator. This impact will reverse itself in Q1.

Now to quickly recap our great year. Revenues increased by 23% to $1.523 billion, including the $3 million from Alias. Earnings per share increased more than 45%, both GAAP and non-GAAP. Now we hit our non-GAAP operating margin of 25%. That summarizes our third excellent year in a row.

Now, let's talk about fiscal 2007, a year we expect will be our fourth excellent year in a row. Our guidance for fiscal 2007 considers the following events and trends:

  • The launch of our newest family of products in March. This is the fourth consecutive March release of new products.
  • The end of the retirement of the AutoCAD 2002 base product in March, and the beginning of the retirement of the AutoCAD 2004 base family of products.
  • Continued growth of our subscription program. In fact, we expect subscription revenue to continue to exceed upgrade revenue in fiscal 2007.
  • Increased penetration of vertical and 3D products. As you know, these products have higher ASPs and margins.
  • The unfavorable impact of foreign exchange rates. The spot rates for the euro and the yen are approximately 5% below the average rates in fiscal 2006. As a result, our fiscal 2007 revenue growth target would be 3 percentage points higher on a constant currency basis.
  • The effect of expensing stock-based compensation as required by GAAP. Our 2007 GAAP EPS guidance includes $0.28 for stock-based compensation expense, which is less than 20% of GAAP EPS before stock compensation expense.
  • The end of the tax benefit associated with the repatriation of foreign earnings. In fiscal 2007, we expected 23% effective tax rates.
  • Finally, I would remind you that all of our guidance includes the anticipated financial results of Alias and Constructware.

After considering all of these factors, we expect revenue growth of 18% to 20% in fiscal 2007, including approximately 6% growth from these acquisitions. Remember the dollar strengthened considerably at the beginning of our fourth quarter. On our last earnings call, we estimated that the strengthening dollar would cost us 3 percentage points of growth in fiscal 2007, and that still remains true. Therefore, using fiscal year 2006 average foreign exchange rates, our 2007 revenue growth would have been 3 percentage points higher, or 21% to 24%.

We expect GAAP EPS to be in the range of $1.12 to $1.17 per share. Non-GAAP EPS is expected to be in the range of $1.45 to $1.50, excluding the impact of amortization of intangibles and equity-based compensation expenses.

For the first quarter, we expect revenue in the range of $425 million to $435 million, or 20% to 23% above last year. On a constant currency basis, this revenue growth would be approximately 26% to 29% above last year. We expect GAAP EPS to be in the range of $0.22 to $0.24. Non-GAAP EPS is expected to be in the range of $0.30 to $0.32.

For the second quarter, we expect revenue in the range of $440 million to $450 million, or 18% to 21% above last year. On a constant currency basis, this revenue growth would be approximately 21% to 24%. We expect GAAP EPS to be in the range of $0.26 to $0.28. Non-GAAP EPS is expected to be in the range of $0.34 to $0.36.

As we mentioned previously, the acquisitions of Alias and Constructware will be dilutive to EPS in the first six months of the year. Our guidance includes expected dilution of $0.03 to $0.04 on a non-GAAP basis in the first half. These acquisitions are expected to be slightly accretive for the full year. Now let me turn it over to Carol.

Carol Bartz

Thanks, Al. Let's review our product division results. Platform technology had a great quarter, increasing revenue 13% over last year and 19% constant currency. AutoCAD LP was especially strong, increasing revenues from new commercial seats 19%, or 27% constant currency.

As expected, with the growth of subscriptions and the move of the retirement out of Q4, AutoCAD upgrade revenue decreased compared to last year. The great news is that revenue from new commercial seats of AutoCAD increased 11% and 16% constant currency. We continue to be very successful migrating AutoCAD customers to subscriptions. The majority of new seats and upgrades attach to subscriptions again this quarter, and renewal rates remain very strong. AutoCAD subscription revenues increased 58%.

Looking forward, during the quarter we will retire the AutoCAD 2002 family of products, and then launch the AutoCAD 2007 family. AutoCAD 2007 continues our tradition of innovation, performance and out-of-box productivity, and allows users to explore their design ideas with updated solid modeling and surfacing tools; and then, visualize and present these designs with built-in rendering. Once users have created their shapes and models in AutoCAD 2007, they can easily bring these designs into our model-based, 3D applications to transform these shapes into intelligent building or manufacturing models. In simple terms, this means that we can get our 2D users more familiar and excited about 3D, making the move to our 3D solutions much easier.

We continue to see adoption of our grid-based solutions for design to downstream workflow. Total seats from our Autodesk DWF Composer grew 144% year-over-year. Downloads of our free DWF Viewer doubled over the same timeframe, crossing 10 million.

Our manufacturing division had another record quarter. Revenues were $74 million, a 23% increase over last year, and 31% constant currency. Our 2D manufacturing product, AutoCAD Mechanical and AutoCAD Electrical, showed strong growth in the quarter, increasing 21%. Customer uptake of our 3D manufacturing product, Inventor and Inventor Pro continues to be very strong. Revenue from new commercial seats of our Inventor products increased 45% over last year.

We again increased the competitive gap, selling nearly 13,500 commercial seats. In total, we shipped over 51,000 commercial seats to our manufacturing customers in the quarter, more than twice as many as our closest competitor.

Our manufacturing results demonstrate once again that our strategy is working. There is a sea change occurring in the manufacturing segment. Customers are increasingly choosing high value, mainstream solutions as the capabilities and economics surpass high-cost legacy systems. The breadth and productivity of our solutions and the ease of migrating from 2D has allowed us to grow substantially faster than the market, and continue to gain market share. For the year, MSD revenue grew 29% to $257 million.

Building solutions had another outstanding quarter. Revenues were $52 million, an increase of 34% over last year, and 39% in constant currency. Our strategy in migrating customers to building information modeling continues to show success. We shipped more than 13,700 commercial seats of Revit. Revenue from new Revit seats increased nearly 130% over last year. Autodesk Building Systems increased revenues 64% over last year. For the full year, BSC revenues increased 43% to $178 million.

Buzzsaw collaborative solution for the building and infrastructure industries grew revenues 72% over last year, and ended the quarter with 137,000 subscribers. Buzzsaw continues to show particular resonance with home builders, securing another win for NAR Homes this quarter.

We are now seeing growth adoption in engineering and construction sectors as well, with wins such as Santec, a leading provider of professional design and consulting services; Noble Drilling, one of the world's largest offshore drilling contractors; and the Pennsylvania Turnpike, which is using Buzzsaw to manage a major retrofit of the entire statewide turnpike system.

Increasingly, we are seeing demands from our customers to offer a complete, integrated solution to manage the entire building life cycle. Earlier this month, we announced an agreement to acquire Constructware. The acquisition will enable us to enhance our offering with both Constructware's cost estimating and bid management capabilities. We expect to close this acquisition some time next month.

Our infrastructure division also had a very strong quarter. Revenues were $53 million, an increase of 22% over last year, and 27% constant currency. Adoption of Civil 3D, our first model-based civil engineering design solution, continues to surpass our expectations. During the quarter, we shipped over 8,700 commercial seats of Civil 3D. Revenue from Civil 3D increased 160% over last year.

Autodesk Map 3D continued to increase market penetration also, growing revenues by 15% over last year. It is the only product on the market that increases customer productivity by connecting CAD and GIS data with unique geospatial tools. For the full year, revenues from ISD increased 21% to $178 million.

Our media and entertainment division had a mixed quarter, resulting in revenues that increase slightly over last year. Animation continues to be strong worldwide. Film studios are rushing to incorporate more feature-length animation projects into their pipelines to meet box office demand. Games are becoming increasingly complex. Game studios are using both animation and design tools in their work, creating more realistic and exciting games with more dynamic environments.

Our acquisition of Alias expands our opportunity across the media industry, enabling us to better deliver solutions that address our customers' end to end requirements. Animation revenues increased 34% over last year, including Alias. New commercial seat revenue for 3ds Max grew 26%.

Systems revenues, however, decreased 15% in the quarter. The systems business is in a planned transition away from proprietary, high-end SGI work stations to Linux-based solutions running on standard PCs. In fact, we had 26% growth in our Linux products in the quarter, offset by an obvious decline in SGI-based product revenue. This transition is important, as it will not only reduce our dependency on questionable suppliers, it will also improve the division operating margin as it moves towards more favorable software life operating margins.

Late in the quarter, we began the launch of Linux-based versions of Inferno and Flame. These are our last two system products to be ported from SGI to Linux. Customers' reactions to these new offerings has been very positive. While customers have been eagerly awaiting the new platform choice, the decision to move is made only after extensive demonstration and testing. Over time, as customers evaluate these new platforms, we believe the lower price point and open systems approach will appeal to more users, and ultimately stay in the market. However, systems revenue in the first half will be impacted by this transition.

On a positive note, our sales force is back on track in the Americas where systems revenue increased 15% for the quarter. Overall, the M&E division is poised for increased profitability, strong animation growth and a much needed platform transition in the systems business.

Before we take your questions, I would like to summarize a few key points. Growth in our 2D business continues to be very robust. Revenues from new commercial seats of 2D grew 18% in fiscal 2006. This is important, because 2D growth fuels our future opportunity for 3D migration and life cycle management.

Market penetration of our 3D solutions is increasing. Revenue from new commercial seats grew 88% in fiscal 2006, and 3D is now the single biggest driver of new seat commercial revenue growth. Yet, despite all of our success with 3D, penetration of our installed base remains very low. This presents a tremendous growth opportunity for the future.

Subscription is one of our strategic goals, and remains firmly on target. Subscription revenue exceeded upgrade revenue for the first time in fiscal 2006, and we expect this trend to continue in the future. As you know, subscription reduces volatility and provides a consistent, stable revenue stream in place of the annual focus on the size of the upgrade base and upgrade revenue. As Al already told you, we have nearly 15% of fiscal 2007 revenue already booked.

Customer demand for Autodesk solutions is very strong. Once again, revenues from new seats and emerging businesses was approximately two-thirds of total revenues for the year. As we near the launch of our new products in March, we continue to enjoy strong, underlying market demand.

Finally and most importantly, our real opportunity is what is happening in the marketplace. The world of our customers is changing profoundly. They are no longer interested in just features and speed; instead they are looking for a partner to help them navigate the increasing competitive pressure of our global economic environment. This affects every business segment and division. All customers need a partner to help increase innovation, drive productivity, reduce cycle time and compete for business around the globe. Autodesk is meeting those needs. I have never been more confident of our future opportunities. Operator, we are ready for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Sterling Auty with JP Morgan. Please proceed.

Sterling Auty - JP Morgan

Thanks. I have two questions. First on the subscription business, given the strong deferred revenue, can you just talk a little bit to the linearity of what you saw in the quarter, especially around subscriptions?

Carol Bartz

Well, we had good linearity in the quarter. Subscription linearity -- first of all, if you're talking about the bookings, there tend to be more bookings in the January timeframe just because that's when a lot of people did their upgrade and movement to subscription. The linearity of subscription is dead linear from a revenue standpoint because of how we do it, one-twelfth.

Sterling Auty - JP Morgan

Well, I should have said on the bookings or the new purchases -- or maybe I should have just said talk to the linearity. You mentioned the increase in DSOs from Alias and such. As you pushed out the end of life of AutoCAD 2002, can you just talk to the linearity that you saw, in terms of the demand, relative to what you saw last year?

Al Castino

You're talking about subscription again, right? The subscription revenue is heavier late in the quarter, because a lot of renewals come up then. That was the impact on the DSO.

Sterling Auty - JP Morgan

Okay. In terms of the Alias contribution for fiscal 2007, can you give us an idea of what the deferred revenue that you would have lost? Because I thought you said when you purchased them that they did about $80 million or so for the 12 months ending June '05. Looking at the contribution for fiscal '07, it looks like there must have been a pretty substantial deferred revenue loss.

Al Castino

We're not going to tell you the exact amounts. We told you that about 6% of the growth next year comes from the two acquisitions. I can tell you Constructware is relatively small. It is less than $10 million. That gives you a good idea of how much the revenues are. They are growing the revenues organically. But yes, we have to take a deferred revenue write-down.

Sterling Auty - JP Morgan

Okay, thank you.

Operator

Your next question comes from Daniel Cummins of Banc of America Securities.

Daniel Cummins - Banc of America Securities

Thank you. I wanted to ask about the European results. Can you give us the growth there at constant currency? Can you tell us, just behaviorally, is there more delay to the last minute, let's say, in terms of upgrade? I'm wondering about the QoverQ growth going into fiscal 1Q with respect to Europe.

Carol Bartz

Constant currency was 19%, Daniel so they are really on track with pretty much everybody else. The Americas came back really roaring strong, but I don't think there was anything unusual relative to Europe and upgrades and so forth. They just, of course, got the big hit with the euro.

Daniel Cummins - Banc of America Securities

I'm sorry. Europe was plus 19% constant currency year-over-year?

Carol Bartz

It wasn't plus. It was 7% that we recorded, but it would have been 19% constant currency, so plus 12%.

Daniel Cummins - Banc of America Securities

QoverQ.

Carol Bartz

Yes, QoverQ.

Daniel Cummins - Banc of America Securities

Okay, great. How about into the 1Q? Do you think seasonally, Europe will be flat, down, up?

Carol Bartz

We don't actually give you forecasts by geos. But there's nothing unusual happening in Europe.

Daniel Cummins - Banc of America Securities

Okay, thank you.

Operator

Your next question comes from the line of Gene Munster with Piper Jaffray. Gene, your line is open. Please proceed with your question.

Gene Munster - Piper Jaffray

Good afternoon and congratulations. Carol, you mentioned that one of the biggest growth drivers is the move from 2D to 3D, which you guys have talked about for a long time. I think there's been controversy on the story about the smaller pool for next year, and the balancing of that. The offsetting factor, obviously, is this whole move to 2D to 3D and the new seat opportunity with that.

How do you think about that balancing act -- if it is a balancing act, first of all -- of the smaller renewal pool offset by, obviously, the larger ASPs with the 3D seats, and just the overall market opportunity with the seats in fiscal '07?

Carol Bartz

Well first of all, there are a lot of moving parts on that. We have a larger base of subscription coming in there for renewal. I would remind you of the maintenance business, which is both subscription and upgrades. We have half in the door already. I think what all of you should focus on more is how well we're doing in those new businesses.

The good news in the new businesses is as you speak, it's starting to move more towards the higher ASP 3D, because you saw the growth of plus 80% in 3D. This concentrating on smaller upgrades bases is all factored into our guidance. There are no big surprises one way or the other coming here, Gene. This is kind of a dead issue as far as we are concerned. Do you want to add anything to that, Carl?

Carl Bass

I would just say that it's not a balancing act in that our migration of customers from 2D to 3D is largely independent of the size of the upgrade base. So while there is certainly some when that is a defining moment for them to make a choice; for the most part, the customers' choice to move to 3D is independent of their choice to upgrade. So, we don't really see these two things as being much in conflict with each other.

Gene Munster - Piper Jaffray

No, that makes perfect sense. I guess in the sense of that ASP difference between 2D versus a 3D and new seat, what is the price differential between those two?

Carol Bartz

Well, in manufacturing it can be -- depending if they do Inventor, Inventor Pro -- 3X to 4X. In the other businesses, it's anywhere from 80% to 2X.

Carl Bass

I think Gene's question was on new units. It tends to be about 25% to 35% premium on new seats. Carol's numbers are for an ongoing basis with subscription or upgrades.

Gene Munster - Piper Jaffray

Okay. Obviously, the market opportunity to 3D -- I know, Carol, you've always talked about that the good news is that it is multiple years. This isn't something that you guys are all going to get in one specific quarter. Is there anyway to try to outline how many potential seats that could be? I know you talked about it being relatively lightly penetrated right now.

Carol Bartz

Yes, Gene, we're going to talk a lot more about that on Analyst Day. If you included LT in the base, we are significantly lower than 10% in penetration. If you pull LT out, we are around 10%, 11% penetration of all the businesses. So I mean, what are a few points here when you've got about 90 to play with? There's an enormous potential of moving folks to 3D.

By the way, maybe it was lost in the whole script, but AutoCAD 2007 is a fantastic product in getting people excited and comfortable with 3D. First, you might look at it and say, well, if that's 3D, why do they need these other 3D? It's the tantalizer that says, this is really what it's all about. Now move to the big boy products.

Carl Bass

I'd also add one thing, Gene. We've slightly masked the growth in 3D, because so many new 2D users have been added to each release. So what's been going on is while people are choosing to move to 3D, I think surprisingly, you see numbers of AutoCAD and LT growth that are somewhere between 10% to 25%, so we are continuously growing that pool. While many people are moving to 3D, the overall penetration is only growing slightly.

Gene Munster - Piper Jaffray

Okay, great. Thank you.

Operator

Your next question comes from Jay Vleeschhouwer of Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Carol, could you elaborate on your subscriptions comments? Maybe you'll want to do this at Analyst Day. What was the total number of subscribers as of year end? Can you talk about the kind of attach rates that you're seeing in the verticals besides base AutoCAD and Inventor itself?

Carol Bartz

Well, Jay, we are about 800,000 at year end. We will go more into some specifics, as we always do for you, at Analyst Day. I think again, the fact that we were 19% of revenue and the fact that we are almost 15% going forward -- which, by the way, again, is almost half of our entire maintenance revenue expected for the year. It might be 15% of all the business, but it's 50% of the maintenance business.

We are finally achieving what we set out to do four years ago, and that is to get that business as a rolling business, and really concentrate on 3D, life cycle management, emerging markets, and so forth and have the channel buy in. We never want to declare victory, because you don't always get 100% of 100% of 100%. We are really doing nicely here now.

Jay Vleeschhouwer - Merrill Lynch

Carl, could you talk about the ongoing program to redirect the channel in terms of how they sell the products? That is, toward more specialty or vertical orientation? You discontinued the earnbacks for AutoCAD. You rolled out VIR. What are some of the main objectives for fiscal '07 in terms of getting that mix of guiding the channel right in terms of having them invest the right amount at the right time towards the way you want their mix to be?

Carl Bass

Yes, and you said it, Jay. As you are aware, we introduced the VIR program last year. We made some modifications to the program -- the two axis that we measure our partners on is the vertical mix as well as their customer satisfaction.

Customer satisfaction continues to be an important part. What we've changed in this year going forward is the vertical mix component in which people are not compensated for selling. No you know, no additional points for selling AutoCAD.

We've also rolled out the program in EMEA. We will get to a worldwide, consistent program. What we're really trying to do is totally consistent with our strategy, which is moving our customers to 3D as appropriate, but recognizing that there's extra selling effort involved in that, and compensating our partners for that extra effort.

Jay Vleeschhouwer - Merrill Lynch

All right. I assume that your margin structure encompasses how you will compensate the channel, or new changes in programs over fiscal '07?

Carl Bass, Autodesk

There's no real difference. Just like when we introduced VIR, we said there's no overall effect. This is really moving the grains of sand around in the pile in terms of how we distribute it. It doesn't change the overall size of the pile.

Carol Bartz

Yes, it's more to the people that actually put the effort in and staff up and do the work to make sure that they get the reward.

Jay Vleeschhouwer - Merrill Lynch

Lastly, you pointed out that your 2D business is growing anywhere from 10% to 25%, which would exceed all but a handful of competitors' 3D products. Obviously, SolidWorks is at the upper end of that range. Most other competitive products are below that range. Do you think that is a sustainable out-performance for 2D, notwithstanding the growth in 3D?

Carl Bass

Jay, I think mostly what you referred to in that while we compete in a large number of industries, obviously, most of the public information is for those that we compete with in the manufacturing segment. I think both our growth in 2D, which does by 2X, 3X, 4X exceed the growth of those other MCAD players. As well as our 3D growth which way exceeds it, is just a testament to the strength of the strategy.

We are just in the right place at the right time. We have the right products. I think a lot of people are really executing on decades-old strategy. The market has changed fundamentally. I even look at some of the things the other companies are doing by trying to change the focus to small and medium manufacturers. Basically, what they're masking is the fact that they no longer have appropriate products for the majority of that market.

Carol Bartz

Jay, I would also say that while you have the preponderance of the install base 2D -- 90%, as I said a few minutes ago -- you're going to continue to see growth there. I mean, might there ever be a time when you get -- and, of course, there will be -- when it's a preponderance of 3D? Then 2D might change. But I think we've got a big run here on both sides for a long time.

Al Castino

Keep in mind that we have the geographic in those emerging countries, that has definitely helped us with 2D. There's a legacy base of customers that's falling further and further behind every time we do a new release. We are doing great new releases every year, that helps us. We have activation code, anti-piracy efforts in general around the world. Those all help us grow 2D. I think that goes on for a long time.

Jay Vleeschhouwer - Merrill Lynch

Thank you.

Operator

Your next question comes from Brendan Barnicle with Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Great. Getting back to the 3D, do you guys have any expectations about what the 3D workstation market is going to grow like this year?

Carol Bartz

I don't know what the 3D workstation market is anymore, Brendan, to be honest. I don't think there is such a thing anymore. Most 3D is now general-purpose PCs. Even the PC manufacturers don't split out that as a concept much anymore. We don't actually look at it that way.

Brendan Barnicle - Pacific Crest Securities

Okay, perfect. What percentage of revenue is coming from 3D now?

Al Castino

In the fourth quarter, it was approximately 21%.

Brendan Barnicle - Pacific Crest Securities

Perfect, thank you.

Carol Bartz

That is the fastest growing part. For the year, it grew north of 80. That's the beauty. That's when you start seeing -- even moving small amounts of the base, not even a percentage point of the big installed base -- what that does for the revenue growth. That's really the message we have been trying to give you guys, is not only the change in ASP or cross grade, but the annual subscription that you get. You know, you start getting a nice additive business going here.

Brendan Barnicle - Pacific Crest Securities

Right. Lastly, as you look at 2007, I know you guys have talked some about the shading and the curves may be helping some with the CPG market. What should we look for to be able to measure some of that? What are some of the things you're measuring for to look at how well you've penetrated into that market?

Carol Bartz

There are actually different segments of that market. The market of course that is sort of the easiest for us right now -- if any market is easy -- is what's happening in gaming, animation and computer graphics in general.

The other side of computer graphics, which is effects editing and compositing is, as I said on the call, in a very important transition to Linux. So there isn't anything new over what I said, except that it's kind of interesting. If you look back three years ago, the animation part seemed kind of stalled out. That's on fire now. Do you have anything to add to that, Carl?

Carl Bass

I think you might have been talking about the consumer products in the manufacturing?

Brendan Barnicle - Pacific Crest Securities

Yes, that's right.

Carol Bartz

I thought you said computer graphics.

Carl Bass

Yes, and the things going on there . We have added the capability and the new release of Inventor will have some advanced shaping features. That will help. StudioTools definitely help us with consumer products. That's a great conceptual design tool for the manufacturing industry, including consumer products.

Carol Bartz

And Asia has been really waiting on this.

Carl Bass

I think the unique thing we're going to be able to do is not only having the leading product in manufacturing with Inventor, but having StudioTools, having Maya and Max, which are alternately used in the conceptual design part in the early stages of design, as well as the visualization and presentation. Anything we can do to make that workflow more seamless between those products is a big advantage for our customers.

As you've heard us talk about the challenges our customers face, getting rid of those discontinuities in the process is really what we're aiming to do. So this is a nice way, both on the front end and then as it has to go downstream, to get rid of some of those speed bumps, if not real hurdles.

Brendan Barnicle - Pacific Crest Securities

Perfect. Thank you very much.

Operator

Your next question comes from Brent Thill of Prudential.

Brent Thill - Prudential

Thanks, good afternoon. Al, I don't think we got explicit operating margin guidance. In the past, I think the Company has mentioned the way to think about it is a 200 to 300 basis point improvement every year. I guess the question is, because subscription is gaining more traction, should we think of a higher build out beyond that in terms of the margin expansion? Is it unrealistic to think of 35% to 40% longer-term op margins at Autodesk?

Al Castino

Well, in terms of fiscal year '07, we already have that guidance of about 27% for the full year. We also mentioned that the acquisitions would be dilutive in the first six months and drag that down, but accretive for the whole year. That takes it down somewhat. When you look at the EPS guidance, you can back into it. It winds up being a bit under that original target because of the cost of getting the acquisitions into the Company.

In terms of the long-term margin guidance, I continue to believe our model looks a lot like other high-volume box software companies. It belongs in the 30s long-term. In terms of when we'll get there, we're going to do that at a moderate pace. We're not going to have an explicit year by year kind of jump factor that we are assuming.

The reason for that is we have a lot of growth opportunities in this business. As long as those growth opportunities are there, we will constrain our margins and make investments back in 3D, product lifecycle management and geographic growth. We continue doing these adjacent products -- things like structural engineering, di-folding systems engineering. Those are all important investments that help us grow the Company over time.

Now there are a couple of other things going on that impact margins. So we're going to constrain our margins to make investments. As we get bigger, though, volume helps us raise those margins up. There's no doubt about that. There are definitely economies of scale in this business. At the same time though, we keep driving productivity gains in this business, and that is going to help us do many of the investments.

But what I would expect is there will be some gradual increases in margin over time. We'll constrain the margins to make investments. Long term, I do believe we belong in the 30s. But in terms of timing for getting there, it depends on how the growth does, and as long as we see great investments to make or help us grow, we'll keep doing that.

Brent Thill - Prudential

A quick follow-up for Carol or Carl -- you mentioned PLM as a longer-term opportunity. Can you give us a sense of where you think the market is now for starting to adopt to some of your solutions here?

Carl Bass

I think we're still early in the adoption. I think we've had very good adoption of our Vault products and product stream, and we'll spend a little bit more time in April going through what's going on in product lifecycle management.

One of the things to know about product lifecycle management, it generally involves a change of process. We have spent the past year or two seeding the market, getting customers' data ready, working with them in terms of changing their process. If we think the migration from 2D to 3D is going to take place over five to ten years, it's certainly similarly true for lifecycle management.

We think we're well positioned. We think we have a unique solution for bringing it to market. Once again, we're looking at the mainstream part of the market. We're now looking at the high cost, high implementation -- implementation of 20-year-old systems. We're looking at a new approach, a fresh web service approach to PLM that I think is much more appropriate for most of our customers. We're really confident about where we're headed, but we are also moving this along slowly and appropriately.

Carol Bartz

The other thing that I would add to Carl is that it's very clear to us now that our sort of incremental approach -- so customers can start with Vault, can start with a workgroup, can go to Product Stream, can go to Streamline, is being very well-received by the customer because they feel as though they can try and buy, try and buy, try and buy as opposed to just choke down a huge hairball. That is just becoming clear.

We'll give you some examples when we are there in April. One of my favorite ones is one of our customers installed Vault and they had 75,000 product files for parts and design parts. Once they put it in Vault, they got it down to 5,000 which took their design time for a new product to spec to a customer from 30 days to three days. That's just Vault. These people are over the moon with this stuff.

It's just very clear to us that when you consider 3D, when you consider emerging countries as fantastic revenue growth for the next long period of time, this is the real kicker I'm talking about. This stuff is really hot. It's just as Carl said. You go customer to a customer. They are learning, we are learning. But it's very clear -- hitting small and medium businesses as well as large and doing it incrementally is the answer.

Brent Thill - Prudential

Thank you.

Operator

Your next question comes from the line of Michael Huang with ThinkEquity.

Michael Huang - ThinkEquity

A few questions -- they are real quick. Just a quick follow-up to the prior question on the collaboration products, Product Stream and Buzzsaw. I was wondering if you could provide an estimate of the percentage of resellers that actually have dedicated head count to push these products? Given the fact that it is early, but you actually have seen some uptick in activity. I was wondering how you expect that to trend over the next couple of years?

Carl Bass

So what I would say is one of the ways we roll out products is we really start early in the lifecycle of our products by taking them direct with our own sales force as well as our own consulting. Over time, as we get it right, as we understand the value we're bringing to customers, we move it to the channel.

Buzzsaw, which has been around longer, is moving to that stage where resellers are engaged. Right now it's only a handful of resellers. I would put it at several dozen people dedicated to that. Primarily our efforts on the Buzzsaw side are through direct selling and consulting, ours. Over the next couple of years, we will continue to spread this to channel.

I'd say similarly, when you look at our Vault and Product Stream businesses on the manufacturing side of the house -- same thing today. We are out there working with lots of customers. We have a handful of dedicated resellers who are investing ahead of the curve.

One of the things about our business is we think it's really important not to get our resellers too far out ahead of us. What we need to do is really go out and evangelize new products, better understand them, keep that feedback loop with our product development teams. So we are holding on to them. You'll always see the investment from us in that. Over a period of time, you'll see it move to the channel.

Michael Huang - ThinkEquity

Great. Another question on the 3D products. I was wondering if you could share your thoughts on shelfware of the 3D products. Do you believe that Autodesk has the opportunity to drive higher adoption and higher usage of these products? How do you believe this actually impacts spending trends going forward?

Carl Bass

I think there's a myth being perpetrated about the shelfware. I think some of our competitors are frustrated by our success and, as I think Jay alluded to, their own lack of success in actually being able to sell design software. The rumor is it's not being used. I'll tell you by virtue of what people are spending for the difference -- you know, when you talk about the difference from 2D to 3D, people don't buy 3D subscriptions for the fun of it. They don't buy 3D subscriptions for shelfware.

We also know by the registrations, as well as error reports and other online mechanisms we have about the usage of our products. I would say the vast majority, in the high 90s, of our products are deployed. At the early stages, you certainly see pilots. But over time, the vast majority of these things are in use and in production.

Michael Huang - ThinkEquity

Great, thanks very much.

Operator

Your next question comes from Sasa Zorovic with Oppenheimer. Please proceed.

Sasa Zorovic - Oppenheimer

Thank you. My first question would be regarding your growth in programs -- if you were going to call it amnesty or basically getting people -- legitimate users in the emerging markets. China and India, India in particular. You just started this fairly recently.

Carol Bartz

Well, we have anti-piracy or antitheft programs, frankly, in every country. But clearly, we're getting a lot more efficient with sharing best practices in the emerging geos. In fact, probably the country that has done the best job of it is China, as far as how they have handled it. And Korea, by the way. Korea does a fantastic job, and we don't mention it enough.

So we actually have an emerging task force that is run by our China Vice President to make sure we take those same practices to Latin America, to Eastern Europe. It really is working with local governments, informing customers when we think they are not legal, education, all of that sort of thing. There isn't any sort of new magic bullet here. It's just that I think we are getting a lot more efficient in how we share successes and see if we can duplicate them.

Sasa Zorovic - Oppenheimer

You mentioned that there was about 10 million in China and roughly about 7 million licenses in India. Do you have any sort of estimates as to where you are in terms of bringing those to be the legitimate ones?

Carol Bartz

Sasa, I don't actually know where that data comes from, because I don't recall ever saying that. What we do say is that if you look at DSA stats, those countries are somewhere in the low to high 90s as far as piracy. If that's the case, there are nine stolen for every one bought. It's much, much greater than the numbers you just said.

Sasa Zorovic - Oppenheimer

Finally, regarding your acquisition strategy, I guess you've been speeding it up here recently. What should we look for regarding your acquisitions coming up?

Carl Bass

I think you should expect to see a continuation of the acquisition strategy in place. We continue to like the small, tuck-in acquisitions that are complementary to our business. I think you'll continue to see us do relatively small and adjacent -- ones that fit our business model, that complement what we have. You won't see us, generally speaking, with far-reaching acquisitions. I think you'll see a continuation. As you are well aware, the timing of these things is not totally under our control. Sometimes, they seem to cluster together. But I wouldn't read anything too much into the last few months.

Sasa Zorovic - Oppenheimer

Thank you.

Operator

Your next question comes from the line of Tim Fox with Deutsche Bank.

Tim Fox - Deutsche Bank

Thank you, good afternoon. Could you discuss a little bit the new design seat license revenue? Last year at the Analyst Day, you broke out a chart showing how quickly that had grown. Again, this year, it sounds like it's about two-thirds of license revenue.

Could you talk about where the strength in the new seat license revenue is coming from? Do you think the mix in fiscal '06 turned out to be somewhat similar, in that 2D and 2D LT were the key drivers? Going forward, are you going to be able to continue this north of 30% growth in new seats? Or, are we going to start to see that slow down a bit?

Carol Bartz

You know, really Tim, it pretty much mirrored the growth of divisions. If you look at the various division growths, B&C grew the fastest. They have the most new seats. I mean, it really is pretty much even steven throughout the divisions as far as new seat penetration.

There doesn't seem to be an indication to have us change our concept that two-thirds of the revenue will be new from new seats. It's been very stable, I think the fourth year in a row -- and I would repeat that, fourth year in a row -- of putting fantastic new products out in the second month of the fiscal year, of course, really enables the excitement so I don't see this changing at all. There's nothing on the horizon that tells us that's going to change. There's so much happening in building information modeling, as Al said, in the structural world. The building solutions. Then you move to we are at the beginning of 3D in the infrastructure world. So there isn't any reason to believe that's going to change at all.

Tim Fox - Deutsche Bank

Okay. A question for Al. You have hit 90% gross margins here in the quarter. I was wondering if you could characterize where you are in the set of productivity initiatives that you had laid out a few years ago? What and sort of what inning are we in at this point?

Al Castino

We've made very good progress in the past few years. The gross margins were in the low 80s a few years ago, and now we hit 90% in current quarter.

In terms of the productivity initiatives looking forward and where are we in them, I would say we're in the fourth or fifth inning. We still have a lot of stuff we can do. Some of these are things that can't be done overnight, but they will continue to generate productivity gains for us in the next several years. We will use that to help us make the investments while we keep the operating margins moving at a healthy clip too. So there's still a lot more we can do, and we have some very good things in progress that will bear fruit over the next couple of years.

Tim Fox - Deutsche Bank

Lastly, could you characterize what it was that prompted you to raise your revenue outlook for the year? I know obviously it was five quarters out when you gave the last guidance. Was there any particular thing i.e. a subscription attach rate, or the strength in 3D, that prompted you to take your guidance up?

Carol Bartz

I'd say one of the things -- and my colleagues can answer here -- if you recall in November when we gave guidance, the dollar still looked like it was in an uphill surge. It had come on so fast and it wasn't clear to us where it was going to stop. At the time, we had talked about 3 points and that happened really over 60 days, not even. If that had moved another 2, 3 points on us -- it wasn't clear to us what was happening.

So if you take that; if you take the fact that, yes, we are a quarter closer, we did see exactly how strong new seats were in Q4, so there's room for upgrades, more in Q1. We are just feeling better.

Tim Fox - Deutsche Bank

Very good. Thank you.

Sue Pirri

Operator, we have time for one more.

Operator

Your last question is from Israel Hernandez with Lehman Brothers.

Israel Hernandez - Lehman Brothers

Good afternoon and congratulations on a solid quarter, everyone. My question was just asked, with respect to the gross margin opportunity. Perhaps you could talk a little bit about the media and entertainment division, and with The Street, the last couple of quarters not necessarily up to par. How quickly do you think you can get that to ramp in fiscal '07, and what needs to happen there for you to get the performance that you want out of that business?

Carol Bartz

The biggest issue is we really -- I mean, we actually feel very good about being able to pull this transition off, because you literally are moving price points down, which is important to do for the customer; putting them on an open systems platform; but you're doing all that, and having to absorb a revenue loss from the lower ASPs. This is clearly a year of transition. In fact next year, we were talking -- we will have great comps.

It's just an issue of not how good the products are, because the customers like the product. It's just changing from an SGI workstation to a PC Linux base is desirable, but you don't do it in a month. Every customer has to have their own plans of how they are putting their Linux farms together, and how people are going to collaborate differently. I mean, it's very clear that's what they're after. That's why we're doing it, but you just don't throw a switch.

Israel Hernandez - Lehman Brothers

Great. I think last quarter, there was a little bit of a sales execution issue there. Has that been resolved to your satisfaction at this point?

Carol Bartz

Yes. As I mentioned in the remarks, the interesting bright spot was that the U.S. was up 15% in systems revenue. We got the people hired early enough, and got that back on track. That really was a one-spot deal.

Al Castino

The other thing I want to point out though is that you refer to the M&E division and there's really two different stories here. Carol has been talking about the systems part of the business, but the animation business is on a roll. It grew in the high teens, and we picked up some great salespeople from Alias. We feel really good about that business. Animation is a very different picture within that division than that Linux systems business.

Israel Hernandez - Lehman Brothers

Great. Thank you.

Operator

I would now like to turn the call back over to management for closing statements.

Sue Pirri

Well, we'd like to thank you all for joining us. If you have questions, please feel free to give us a call this afternoon. We'll be available to answer questions and talk to you about the quarter. Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Autodesk F4Q06 (Qtr Ending Jan 31, 2006) Earnings Conference Call Transcript (ADSK)
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