PTC Inc (PTC) 2002 Q4 法說會逐字稿

Good morning. Welcome to the PTC fourth quarter 2002 earnings call. All participants will be able to listen only until we open up for questions and answers. Also, at the request of paramed trick technologies this call is being recorded. I would like to introduce your speaker for today's call miss Meredith Mendola, director of Investor Relations. Ma'am, you may begin.

Thank you. Good morning, everyone. Thank you for joining us today. Participating on the call will be Dick Harrison, our President and Cheif Executive Officer, Ed Gillis, our Chief Financial Officer, and Jim Heppelman, our Chief Technology Officer and EVP on software products in addition, Barry Cohen, EVP of Strategies Services and Partners is here to participate in the Q&A.

Before we get started, I would like to remind everyone during the course of the conference call we will make projections and other forward-looking statements regarding future financial performance, business trends, and other future events. We caution you that such statements are only predictions and that actual results might differ materially from the results projected in their statements. We refer you to the risks detailed in the company's 2001 annual report and form 10-K, our fiscal third quarter 10 temperature Q and the other fiscal reports filed with the SEC from time to time.

A replay will be available until 5:00 p.m. eastern Friday October 18th at 4:02402-988-1452. Additionally, this conference call is being webcast and the replay will be available through our website at ptc.com until this Friday at 5:00 p.m. As always, after our prepared remarks, we will hold a Q&A session. In order to keep this moving, please limit yourselves to one question and one follow-up. If you have an additional question, you'll need to get back in the queue. Dick, would you like to begin?

Meredith, thank you. Good morning.

You know, we had an okay quarter during what continues to be a difficult time in the manufacturing industry. Revenues were about $185 million for the third consecutive quarter. You know, at a time when other high-tech companies continue to see yearly as well as sequential declines. As a company, we continue to work on six key corporate initiatives, superior products, optimized sales coverage model, customer satisfaction and retention, marketing and branding, growth and profit, and our own internal people development. Rather than describing each initiative today, I'd like to group them together and describe our progress generally. During the past two years, we have been focused exclusively on improving the operational execution of the company. There has been a great deal of work done with an eye toward building sustainable relationships with our customers and improving overall levels of customer satisfaction and retention. To that end, we have completed the redeployment of our direct sales reps to large vertical industrial accounts. This. In addition, we make very good progress in the recruiting of alternate channels to address media and small-sized companies. Excellent overall progress has also been made in our partner program as we provide a more complete and total solution with the involvement of these key partners in customer accounts.

As measured by surveys, customer satisfaction is increasing, which is also a manifestation of the improvement in retention of our employees. As Jim Heppelman will describe, our products continue to get better stronger and to work more easily together as well as with those from other software companies. I believe that you will continue to see improvement this year against these corporate goals and initiatives. At the same time, we have been almost unrelenting in our belief in what we call Product First. We ask our customers, what matters most, and the overwhelming response is products first. This has helped us develop a strong point of view about product development. We want to be the trusted guide for our customers in the area of transforming the way products are developed. Including the innovation, the quality, and the engagement with the extended enterprise of customers and suppliers.

The point of view is elevated far beyond the old cad cam paradigm. Yes, overall additional productivity tools for design are very important and we have the best. But the ability to connect, collaborate, notify, and control are far more important in this new world. This has led to our view that a new category is emerging where a product development system is needed to create products. The underpinnings of this system are the ability to create product innovation, collaborate with others while doing so, and control all changes that are made, create, collaborate, and control. Pro/Engineer, Project Link and PDM Link. I think we are well on our way in terms of executing on our initiatives while gaining consent from our customers that our vision is meaningful and exciting. Let me turn it over to Ed for a little review.

Okay, thanks, Dick. We issued a press release this morning outlining the results for the quarter. They included revenues at $186.5 million and pro-forma earnings per share before amortization, non-recurring charges and one-time gains of a penny. This was slightly above analysts' expectations of 180.6 and break-even EPS. If I look at the revenue components, license revenue represented 65.3 million, and services were 121.2 million. From a geography perspective, North America represented 43% of revenues or 79.9 million dollars. Europe was 33% of revenues, or $60.9 million, and Asia Pacific was 24%, or $45.7 million.

From a revenue metric and a revenue product breakdown perspective on the product side, windshield represented $41 million in the quarter. Licenses were 13.5 and windshield services were at 27.5. On the CAD side of the business, total CAD revenue was $145.5 million. License was $51.8 million, and MCAD services were $93.7 million. From an operating metric perspective, we added 4,300 CAD seats in the quarter with an average asp of about $12,000. We added 619 new customers, 82% of the installations in the quarter were on the mt platform, and recurring avenue on the CAD side of the business represented 90% of our CAD revenue.

On the windshield side, we added 11,100 new seats in the quarter, 42 new customers. We now have slightly over 302 production accounts or accounts in production, and asps on the windshield side for the quarter were $1,217.

If I turn to the spending side of the equation, spending in the quarter was down quarter over quarter by $3.8 million. This reflected a significant decrease in head count. Head count was at 3,780 people at the end of the fourth quarter, down 210 people from the end of the third quarter, which stood at 3,990. And down substantially from a year ago when we were at 4,432 people.

On the balance sheet, we closed the quarter with $210 million in cash. That's up from 204 in the third quarter. Day sales outstanding are at 76 days. That's down from 78 in the third quarter.

Preferred revenue is at 176 million. That's down from 190 million in the third quarter. The change in deferred revenue is primarily due to the seasonality of renewals on the annual maintenance contracts, the continued lack of large deals, particularly in previous quarters which don't result in kind of off-calendar new year new maintenance contracts and the sale of our ISON business, which occurred during the quarter. Share accounts at the end of the quarter was 262 million shares. On reported results, it included a number a number of non-recurring charges. So, let me review those with you briefly, and they're outlined clearly in the press release. In the fourth quarter, we took a $6.7 million charge related to accruals associated with excess facilities. Primarily in North America reflecting the weakness in the commercial real estate market.

We wrote down a million dollars related to an equity investment. This is a non-cash charge. We also took a $36.9 million non-cash income tax charge in connection with the establishment of a valuation allowance against previously-recorded deferred tax assets. These deferred tax assets relate primarily to net operating loss carry forwards. We believe that providing this valuation there's a conservative, prudent action to take at this time and was based primarily on our recent historical performance. We should be able to recover these deferred tax assets to lower tax rates in the future if we begin to generate taxable income. About $24 million of these benefits expire in '05, and the balance expire between '06 and '13.

Finally, as previously announced, we closed the sale of our ISOM servicing business after quarter. This resulted in an after-tax gain of $15.6 million, 8.7 in pre-tax and a tax benefit of 6.9.

Let's turn to our outlook, and as we do, let me remind you that our comments regarding outlook and guidance constitute forward-looking statements which involve assumptions about the future, which may be wrong. The risks and uncertainties associated with these assumptions are outlined in our public filings with the SEC and should be referred to in order to evaluate the reasonableness of our perspective in the future.

As Dick indicated, we've been focused over the past year on improving our operational effectiveness and building a solid foundation upon which -- on which to drive growth when the economy improves. He outlined those operational initiatives to you, distribution especially around our systems integrators and value-added resellers, product, customer care, and driving our Product First message around the importance of product life cycle management into the marketplace. We continue to make good progress with the systems integrators. We now have more than 700 partners trained on windshield implementations, windshield related partner revenues billed directly to their customers with approximately $17 million in the quarter and partner influence business to PTC continues to be well above 50%.

We continue to see commitment from our community of systems integrators and increases in their product development practices. For the year, the partners booked $69 million in windshield related service revenue, which was an increase from last year. Regarding our wire channel, indirect sales were 22% of total mCAD license sales. This represents about $11.5 million in license revenue. We're making good progress at diversifying our re-selling network. We achieved our license targets this quarter despite receiving no license revenue from Rand. We're now recognizing revenue from Rand on a cash basis. We expect some continued revenue from Rand in the future, but their current cash flow situation is uncertain.

Finally, our previously announced cost structure deductions have been successful. We removed about $120 million on an annual basis. This model can be leveraged at revenue levels above 720 annually. Despite the work we're doing around these initiatives, spending in our sector of the economy is weak, and in our view is likely to continue at disappointing levels for the next several quarters. It continues to impact big deal spending, new category spending, and spending in the technology vertical disproportionately. Until the economy improves, we're unlikely to see significant revenue or profit growth or for that matter, significantly improved predictability. Although activity levels represented in terms of sales leads and sales opportunities in the pipeline continue to improve, at this point, these are not resulting in significant revenue growth.

Given the economic uncertainty, we're not going to provide targets for the full fiscal year. However, as we look at the first half of next year, we typically incur some seasonal decline in revenues at least in our first quarter. Also, the uncertainty from the Rand cash flow situation probably introduces about $5 million of further uncertainty. Our target is to achieve at least break-even results for the next two quarters, which requires quarterly revenue levels of $180 million or above.

Our mix of revenues between the windshield business and the CAD business is equally difficult to predict. As our products become more integrated and more interoperable, distinctions begin to blur. But in the near term, we would expect windshield to contribute somewhere between 40 and $50 million of quarterly revenues.

To wrap up, we continue to be convinced that the product development category is an underpenetrated and underinvested opportunity. As a result, we strongly believe that if we continue to work hard at improving our execution around our major initiatives and distribution in product and marketing and in operations, we'll be strongly positioned to capitalize on the opportunity when customers begin to spend money again.

These operational initiatives are necessary, but not sufficient basis for growth. Our vision of the PLM opportunity and the road forward is captured in our Product First roadmap, which Jim Heppelman, our chief technology officer, will review with you now. Jim?

Thanks, Ed. Many of you pay remember when we first launched the Product First campaign in February of this year. Well, Product First is first and foremost, a rallying cry for manufacturers to really remember what matters most. We feel that a company's most important assets are its products and in terms of creating sustainable competitive advantage and business success, there is no substitute for product superiorty. Product First companies are those companies that understand this and prioritize their activities accordingly, so since February, the Product First concept has really begin to resonate with customers. While the importance of having superior products is clear to everybody at a gut level, many executives and manufacturing companies, especially those that came up with through finance or sales ranks don't have a strong grounding in product development and didn't include with them what they needed to do to excel in product development.

Since February, a number of customers said to us, hey, we agree with the concept of Product First, but what do I need to do to become a Product First company? So in our attempt to answer those questions, we began to realize that there's not one simple answer. In fact, if we look at some of our customers who are really truly exemplars for Product First, we see there's a number of different ways that they're winning with product development. So, for example, companies like Samsung and Segue, both of whom are PTC customers use break through innovation as a way to develop and to design entirely new markets.

Companies like harley Davidson and Bose, again, good PTC customers focus on creating higher levels of quality, engineering and branding all in an effort to design and realize a price premium. Hewlett Packard, especially the printer division, who employed windshield in a significant way, produces printers and cartridges. They sell the printers with aggressive pricing, but the printers, in turn, generate follow-on demand for the printer cartridges, which turns out to be an extremely high-margin business, so we characterize that strategy as design for ongoing revenue streams. Royal Appliance who makes the Dirt Devil products that you probably all heard of really focuses during their design on lowering internal manufacturing costs and purchasing costs as a mean to lower overall product costs. John deer who is one of our longest standing customers has a strategy they refer to as design anywhere, build anywhere. This strategy is designed to allow John Deer to improve their ability to fulfill worldwide demand. Steel Case, a great Pro/Engineer customer designs what they call a total workplace environment, which can be customized and configured to each customer's exacting specifications. We would call this strategy gross share with customer products.

Just to recap, Samsung and segue are developing and defining new markets. Harley Davidson and Bose are designing to realize a price premium. Hp's printer division is pricing for revenue streams. Royal alliance is lowering product cost. John deer is improving ability to improve demand and steel case is growing share with customer focus products. These are great examples and it proves there are many different valid strategies, but it also begs the question, how many more strategies are there? What else could I do? What are the tradeoffs?

Unfortunately, unlike manufacturing or supply chain management or other areas of operations of a manufacturing company, there really is no body of knowledge regarding product development strategy and what it takes to win. We at PTC have realized that this lack of knowledge is an impediment to the growth of the PLM marketplace, and we committed ourselves to developing a PTC point of view regarding what it takes to win with product development.

So about six months ago, we formed a large cross-functional team that involves more than 30 people from our sales, services, product development and marketing organizations. We spent six months collecting, analyzing, and organizing our experiences that we've gained from working with thousands of customers over the years. We've developed a strategic framework for understanding how companies can use product development to generate real value. In turn, then, we took and interviewed more than 100 customers to test and certify the findings in that framework. So this point of view has now been published into what we call a Product First roadmap that we will announce and elaborate on in a press release tomorrow.

The Product First road map boils down these findings to a summary level that gives us a convenient means to engage in strategic conversations with our customers and partners regarding product development. The roadmap, itself, I have here in front of me, and if you can envision, it looks like an automotive type roadmap and highway map that you would use for driving purposes. It's a laminated piece of paper. It folds out and is printed on both sides, and it represents visually the connections between value, which companies want to generate and typically is expressed in terms of revenue growth and profitability. We connect revenue growth and profitability to nine value opportunities, nine opportunities to generate revenue and profitability. Those value opportunities, in turn, are decomposed into 22 what we call executing strategies. Executing strategies are strategies that you go execute in order to capitalize on that value opportunity. And then we further decompose that into 103 business initiatives. So business initiatives are bite-sized chunks of strategy that can be implemented and every customer we talk to always have a number things that they are trying to pursue. In turn, we take those business initiatives and connect them to four key process key competencies that companies need to develop to realize those business initiatives and three areas of technical infrastructure that they need to have in place in order to be successful, and that technical infrastructure, as you might guess, is ultimately expressed in terms of create, collaborate, and control infrastructure that needs to be in place.

So much like a road map that you would use for driving purposes, our Product First road map exposes to customers that there are multiple paths that a company can take in terms of its product development strategy, and there are numerous compromises and tradeoffs that they need to make along the way. During our research, we noted that many of the companies that are struggling right now are, in fact, trying to do it all, but as Michael Porter from Harvard business school and PTC's board of directors frequently points out, a real strategy requires tradeoffs. The problems that companies face today is that they don't have a framework to understand the possibilities and to make intelligent decisions regarding which tradeoffs are appropriate.

So the Product First road map is designed to allow us to engage with C-level executives to help them understand the strategic value of product development and what they need to do to excel. It ultimately serves to demystify product development and to connect product development practitioners with the executives in the corner suite to help drive a common understanding of various initiatives, process changes, and technical infrastructure improvements that are being deployed and how all of this ties back to corporate strategy and the creation of value in terms of growth and profitability. So the Product First roadmap is very flexible. We can start from a top down perspective and help companies chart corporate strategy and then ultimately identify process changes and technical infrastructure that they need to put in place and product development to realize those strategies. Or, alternatively, we can follow a bottom-up perspective that starts with technical infrastructure and connects back to corporate strategies that are used to generate growth and profitability. Together, this allows us to elevate our engagement with customers and helps drive the optimization of product development process as a strategic imperative within manufacturing companies worldwide.

So it's evidenced by the recent AMR report, and you are probably familiar with AMR, advanced marketing research. AMR is a leading firm in the PLM space. They released a deep dive report. They did a deep dive into PTC technology ands the technologies and PLM businesses of many competitors. This report concludes that PTC is in the leadership position both in terms of product capabilities and overall. So we feel like the AMR report validates that we have the best product line of PLM space. However, selling pier technology without a link to strategy of value is a bit like pushing a rope. So we've seen circumstances where customers may conduct a benchmark and then make a technology selection. Yet be unable to convince their company executives to fund the initiative. So we think that this Product First roadmap will really help in this area.

We intend to use the roadmap prod broadly throughout PTC. It will affect our selling process starting immediately. It will affect our services practices. It will affect our messaging and our advertising campaigns, and it will affect our own product development strategy.

Going forward, at all levels within PTC, we now have one common point of view regarding product development, the need for collaborating control and the strategic value of PLM to our customers. As of the end of this week, nearly all of our sales and services representatives worldwide will have been through an initial education regarding the use of the Product First roadmap, and we're also in the process of educating our consulting partners so we can have a shared point of view when we engage together with customers.

We think that this work, both the body of knowledge we have created and the summary roadmap that we published, will ultimately help to drive growth to the PLM marketplace and continue to position PTC as the thought leader who is setting the agenda for the industry.

With that, I'll turn it back over to Meredith for the Q&A session.

Thanks, Jim. So I think we're ready for Q&A. I just want to remind everybody, please, please limit your questions. Just one question and one follow-up, and that way, we will be able to get to everybody in the queue. Thanks.

Thank you. If you would like to ask a question, press star one on your touch tone phone. Star one to ask a question. Ebony Husky, you may ask your question and state your company name.

Thank you. Ebony Husky, Credit Suites First Boston. You can give us a little bit more color behind the performance on the mCAD side and the pretty significant substantial job in licensing, and were there big deals in that, or are you just starting to see that business stabilize? What sort of outlook with Wild Fire coming up calendar year next year, are you concerned that some of our customers may defer some spending to wait and see the full production version?

Yes. I'll take a crack at it. Ebony, so we had a pretty good mCAD quarter. I think we had nine deals over a million dollars in the mCAD business, and one large deal, large deal defined as over 3.5. It's clear to us that the Wild Fire story is resonating in terms of giving customers a vision of where we're headed, a vision of what a product development system can look like and a vision for the role that the create process can play in the overall product and process, and that is we think not only reenergizing our own sales force in terms of going out and actively engage in the customer, but I think it's resonating very strongly with the customer.

So I think we began to see that this quarter. We would hope that that would continue as the Wild Fire release comes into the marketplace, and you know, we're optimistic about the prospects there.

The other thing that I think is going on is we really are seeing better diversification on the bar channel, which I think will help particularly at the lower end.

This is a follow-up on that. You said you did not recognize revenue from Rand in this quarter. Could you just give us sense whether the last couple of quarters what that revenue level has been and also just sort of your internal process where you decided not to recognize anything?

Yeah. You know, Rand's been a good partner, but their importance relative to the overall reseller base has been -- has declined significantly over the last probably 18 months. The delta this quarter is probably about $5 million, and what really precipitated it is that they were overdue in their payments to us, so we have given their uncertain cash flow situation. Putting them on a cash basis from a revenue recognition perspective and seems to be the only logical way to go forward.

And any visibility on some of those payments possibly being received in time for this quarter, Q1.

For Q1? At this point, no. Not a lot of visibility.

We shouldn't count on it.

The issue, in terms of sizing the issue, the issue is at a $5 million level, and obviously, their intent is to pay us.

Great. Thank you very much.

Thank you. William Brown, you may ask your question and please state your company name.

Thanks. Good morning. A.G. Edwards. Two questions, and I'll just kind of bundle them together and let you guys go from there. Could you talk about what you're seeing from a geographic standpoint, a little more color? We hear about weakness in Europe. Just curious if you guys are going that, as well? And then a quick numbers question. Sales head count, where did you end up for the quarter? And can you talk about what you're seeing from a turnover standpoint?

Ed, do you have the exact numbers? I'll take it here. Let's see, in terms of turnover, I think the company turnover is at 10% or so, which is, you know, pretty low. It might be below that, 9%, and sales turnover is in the same general area. Very low turnover right now, which is good, and we did a couple of things, I think to help out with that. One of the things we did was actually give the sales force a fifth quarter this year so that could well help this quarter. This quarter, the first quarter of '03 is the fifth quarter in a sales plan that we gave them last year to try to smooth out the revenue between our Q4 and Q1. So there's an incentive for them to stay because the revenue that they generate this quarter counts both toward this year as well as last year.

I think the salespeople also, we just completed the kickoffs worldwide, I think there's a pretty big bounce in their step. There's a lot of anticipation and excitement around Wild Fire. There's a lot of excitement about the Link Solutions in terms of being able to deploy them quickly and easily, and there's excitement about the story where the three of them play together, and I think Ed has the exact numbers.

So we have 475 reps and about 1,200 people in the sales organization at the end of the quarter.

By geography, the revenue mix was --

So the revenue mix by geography was 43% direct America, 43 Europe, and 24 Asia Pacific.

So we did see a little bit of softness in Europe, which I think we generally do see during the September quarter just given the summertime over there and the fact that nobody works. But in general, I think Europe is a little bit softer than our other geographies right now.

Okay, so did you see some incremental weakness beyond just the seasonality, you think, there?

I think a little bit. I think it's a little bit soft in Europe.

Okay. One last follow-up. You mentioned the link solutions. Do you have any update on or are there any new link solutions you have planned in the next 6, 12 months?

I'll let Jim do that one.

Yeah. So the one that we're releasing toward the end of this quarter beginning of next is supply link, which we're already starting to demonstrate to customers and begin some lighthouse deployments with, you know, I think we had told you previously at the previous call that we charted the strategy that delivers six of these linked solutions.

Yep.

We have delivered four. We will deliver five. We have put number six on the back burner will it will remain for some time, but we also really come with this concept of the starting line-up, and the starting line-up of our collaborate and control story is pro-engineer, it's pdm limpk and project link. There are many products, design dynamic link and CADs and so forth, which are, in the sense, on the bench. We can sell them any time the situation sort of warrants, but we feel like these three products that epitomize collaborate, create, and control are truly special products, and that we'll be most productive, most effective if we focus the bulk of our selling effort around those three products. I think you will continue to see that going forward, that we'll treat project link, PDM link and project Wild Fire a little more special than the rest of the products.

Thanks. I'll get back in the queue.

Thank you. Jay Flieshauer, you may ask your question.

Merrill Lynch. Dick, a follow-up for you and then one for Jim. You mentioned there are 475 or so sales reps now, which by our count brings you back to your same sales capacity or head count as as you had seven years ago, and so the question is do you feel that you have adequate market coverage? Can you talk about the general capabilities or productivity of your sales force and what perhaps the composition of the sales force is now? Secondly, for Jim, the point you made about the Product First road map and the messaging sound very much like an elaboration of what you said six months ago, the meeting at Half Moon Bay. The question is, where do you think the bulk of the motivation for customer implementation is occurring? In other words, is it cost reduction? Is it product development and revenue growth? Where do you think the main activity is occurring and can you talk about how you conceive of the Wild Fire deployment in terms of perhaps stabilizing the pro-E-Bay and then doing complimentary windshield sales. Believe it or not that was two questions.

Do you want to go first, or do you want me to?

Either way.

I'll start on the rep thing, and that will give you a chance to see if you can remember his second question.

See if I can boil it down to a question.

Jay, you know, with respect to the number of sales reps at 475, I think that as you know, it's a totally different coverage model today than would have existed seven years ago. For example, the sales force 75% of those sales reps are now deployed in large accounts, you know, with revenues over a billion dollars in annual sales, which simply wasn't the case, you know, seven years ago or even two years ago. So there's a focus on large accounts. There's a vertical orientation for those sales reps so they're teamed by industries, such as automotive and aerospace. They have business development managers that are part of the sales teams. We have located our technical people in sort of common gee graph Cal areas or i-centers so we can do webcasts and demos and technical reviews with the customers from a common place.

The whole sort of way we address the customer, the interaction with the big 5 sort of systems integration partner as well as others in the sales process really is much more of a model like a traditional enterprise software company than we were sort of organized before. At the same time, Ed alluded to, and I think you will see more progress here. While we haven't really counted on any production from Rand, and I think Jim was on the point a little bit. We did 186 million, and there was more than Rand submitted that we didn't take, so a quarter where I think the consensus was about 180 million and where most of you thought we were going to miss given that all of our competitors missed, the 186 plus the Rand stuff that's in reserve represented not a bad quarter all in all. So I think the sales force, you know, I'm comfortable with the way they're deployed and I think, you know, with where the quotas have gone, they're in the range of $2 million each. I think we have more than enough sort of investment in the head count around sales to hit our objectives. You know, if anything, you might say that we have too much so I'm comfortable with it.

I think you're going to see some real interesting developments particularly in the channel, in Europe, in the far east, and continuing to get more re-sellers, you know, for the low end and medium-size accounts. One of the reasons is we've taken the direct guys out of there so there's no more competition for them. You know, we have 32,000 customers worldwide, 31,000 are in the small and medium-size account range which we really have our re-sellers focused on. So there's a huge opportunity for re-sellers.

I met with a re-seller recently in Europe that saw Wild Fire and basically described for me, said that Wild Fire is a reinvention of Pro/Engineer. It has the power of Pro/Engineer for large assemblies and surfaces and complex geometric Cal problems. It has the look and feel of the solid x low m systems. It has inside of it an internet browser for connectivity, and we've embedded the groove software for peer-to-peer collaboration. It will be the biggest single CAD cam release ever, and I think it will have a huge impact beginning in 60 days and the other thing I would say, vis-a-vis some of other offerings that have come out from competitors over the last several years is this product is an extension of Pro/Engineer, completely compatible, and will work, so I'm excited about the opportunity to sort of stabilize the mCAD revenue while we develop the Product First category.

So on the second half of that question to go back to the Product First roadmap for a minute. Back when I talked about this at half moon bay, this is when we were developing much of that material. Since that time, we developed it much further and really got it to this point where we could summarize it, condense it, show all the strategic connections and educate the whole company. So six months ago, some of the thought leaders in PTC understood this. Today, the entire company understands it, and I think that this Product First road map is a real breakthrough, and to get back to the core of your question, which is why do people buy a PLM system.

And the honest answer to that today is they buy it to drive revenue growth, but they justify it based on its impact to profitability. And the reason they do that is they don't have a good model for quantifying the revenue growth side of the equation. It's a qualitative discussion and they don't have a framework to lead somebody through that discussion. So instead, they revert to the profitability discussion which is much more of a quantitative discussion so that they can actually sell on to benefits. But you're in this weird situation, if you're a typical customer that you're doing it for one reason and justifying it for another, but you're doing that simply because you lack the means to justify the real reason. I think the Product First roadmap connects everything we're doing on a product side, whether it's Pro/Engineer 2001 or Wild Fire, whether it's windshield foundation or any of the linked solutions, we can knit that right back to the expectations that you ought to have, you know, in terms of your growth in revenue and your profitability because of these initiatives, which enable these strategies, which allow you to harvest this value which impacts your bottom line and creates this value for you. So I think we're going to start having a different discussion. And I think that the Product First road map is a necessary prerequisite to having this discussion. I think it's a necessary prerequisite to the PLM industry. We have to demystify the connection between PLM technologies and growth and profitability in terms of creating value for a company. I think the Product First roadmap is a real break through. It's the first time that we ever have seen anything that does something of this nature.

By the way, just one last point. What was curious about the AMR report is that the rankings with you first and Matrix second seem to be inversely related to the financial performance of the companies. Do you have any response to that? In other words, they selected you on product and implementation, I suppose, but there seems to be no connection to the actual financial performance of the vendors.

Well, I will take a stab at it and then you can. Well, you know, in terms of financial performance, I'm sure you have a lot more metrics at your disposal than I do. In the past quarter, we were number one on the report, and we're really the only one of the key competitors that didn't pre-announce. I think there's some consistency in terms of the final reports and the financials of the companies reporting in this space. You can interpret that as you will.

Thanks.

Thank you. Gene Munster, state your question and state your company name.

Piper Jaffray, and if you can talk about the pricing at the maintenance level, how that has been tracking in the last few quarters? Second, any thought on Inventor Six?

The pricing at the matrix level, gene, has actually been reasonably constant. The obvious concern you have from a long-term perspective and the concern we would have from a long-term perspective is that historically in the marketplace, customers have tended to think of maintenance as a percentage of list price, and as list price comes down, or a percentage of street price. As street price comes down, you worry about maintenance prices coming down. In fact, the maintenance prices have been pretty stable, in part because there's been a greater effort to offer tiered maintenance, to try to discriminate between the types of support and charge accordingly. And in part, because of packaging that's been introduced on the product side. I think as I look forward to the maintenance business, there's very strong opportunities to do more with customer support and there's very strong opportunities to do more with training. So the tighter we can make those connections, I think the longer we can sustain a good, healthy growing maintenance business.

As you look at your overall maintenance business, it's been relatively stable, but with the annual customers, just as the math works out is the maintenance contract per customer declined slightly for the reason you added is that the asps are declining slightly.

Yeah. That would be, you know, that's the negative, and as I say, the positives would be the tiered pricing, the introduction of tiered pricing and the introduction of more fully configured packages.

Okay.

The other issue we have going on in maintenance, which obviously over time should be a positive, is the introduction of Wild Fire. So renewal rates on maintenance have been steady. I would think that there's probably an opportunity to increase them a little bit with the Wild Fire introduction.

Okay. So I can elaborate a little bit on the --

I can elaborate a little bit on the inventor 6 product. I think inventor 6 is a good product, but to go back to I acomment Dick said, Pro/Engineer wildfire is a great breakthrough. We characterize it as being simple, powerful and connected.

It always was powerful. We all know that. It didn't used to be simple, and it didn't used to be connected, and so, you know, a lot of our competitors characterize their solutions as design centric or process centric, and design centric really means if I'm working all by myself, how productive am I in coming up with a great design? I think because Pro/Engineer Wild Fire is both simple and powerful Pro/Engineer wildfire is a more effective design centric tool than is the solid x suite, and we have a number of bench marks that show not so much against inventor six and the solid suite of products that Pro/Engineer Wild Fire is a more productive activity tool than are those low end products that used to be the benchmark for ease of use and design centric personal productivity.

From a sales and marketing perspective, do you tweak anything when the market shifts or is it business as usual?

We've been tweaking. We're in the midst of the biggest tweak we ever made, and it is, on one hand, the position better against these low-end tools.

On the other hand, people characterize products like Catia or unigraphics as process centric, they're designed for a big, complex process involving a lot of people. Well, we think the Pro/Engineer being powerful and connected is actually a more compelling process and it's the only CAD system out there where you're working driven by work flow and working on business problems and change orders and everything else as opposed to working independently. What we think is an interesting message to customers is this discussion of personal productivity versus process productivity or design centric versus process centric. We would ask "why compromise?" Why does deshown need two tools to some that problem? Why does eds need two or three tools to solve that process. Why does auto desk think they can get away with half of it?

We think this discrimination between simple low end and sophisticated high end is artificial and it's more a question of how people got to this point rather than is this the right point to be at. We feel having one tool which is as simple as inventor 6, far more powerful, can model far more complex geometries and analyze them and you know perform the whole CAD cam cae suite of capabilities and also keep you connected to your enterprise. The smallest mom and pop tool shop has customers that it needs to collaboratively design with everyday so we feel that this discrimination between design centric and process centric doesn't make any sense and we are the only vendor in today's kad cam cae marketplace that has one offering that positions itself really as a leader on either dimension, and you don't have to compromise.

Excellent, thanks.

Mr. Richard Davis. Ask your question, please state your company name.

Richard Davis, Needham and Company. Maybe to drill down a little bit more on what Jay was saying, I was going back and looking. In '97, you guys did $800 million in revenues a year, 90% off gross margins and let's just say that all of that gross margin now is diminished because of the mixed change, et cetera and the maturity of the business and you do 70% margins and this coming fiscal year. But if you actually look at your operating expenses, sales and marketing is about 320 or so by my guess for this coming year. R&D will be 120 and g & a will be 60 million if you make no changes.

Sales and marketing is exactly in line, so I think you're right on talking about the fact that you got your sales and marketing organization in step and then organized properly. But why in the world R&D twice what it was back then, and why is g & a $20 million more than it was back then. The real question is, why isn't this business a business that should generate operating margins in the low to mid-teens, if not even 20%, you know, half of what you did in the late '90s? Because inherently this shouldn't be a bad business.

I'll take a crack at it. I guess the first observation on it is sales does tend to be more variable, right? You're selling what is largely license oriented. The business or the function is very measured based on sales productivity per rep, and you've got something that is reasonably variable over a period of months. The R&D and the g & a functions tend to be more fixed and those functions, I think, were basically scaled for an operation that was a billion dollars or more. There's a lot of - [inaudible].

The second obvious issue is we have transformed not only the product offering but the product strategy in the last four years from a single tool that was terrific tool and a very successful tool, but that from a segment perspective really did mature to one that is a much broader category and so if you look at the numbers of projects in R&D today and contrast them with the numbers of projects in R&D in the '97- '98 timeframe, it's dramatically different.

Then I think the other major issue with operating profit is the revenue mix. So we've got something in the order of 65s and of the business now that comes out of services, a big piece of which are training and consulting services, which are completely people-dependent and where the margins in that business, the gross margins in that business tend to be very low. So I think probably in rank order, the single biggest margin shift has been the kind of services mix.

That would show up in the gross margin because it goes from 90% to 76.

Then below the line and in the operating margin areas, I think what you are really talking about is this whole fixed cost versus leverage issue as opposed to a variable cost kind of issue. So you know, the issue or the dilemma or the tradeoff that we have made is, you know, let's get the spending side at a break-even level and put the foundation in place for growth, and let's be in a position where as we drive revenue above $720 million we start to generate leverage.

Part of that, I think, is having great products. You know, the point about R&D, this is a major release, this Wild Fire release, and at the same time, we're building the linked solutions.

We can -- age-old question, we can cut our way to self-fulfilling spiral in terms of decline, and I know investors are impatient for profits and so are we, or, you know, we can continue to invest at an appropriate level and hope that and spending comes in and as it does, we're better positioned than anybody else to capitalize on it, and that's sort of what we have chosen. It would be, I think, a mistake for us to reduce the commitment in R&D because we're only going to be as good ourselves as our products because if you look at the product roadmap coming up in Wild Fire with January, release 7.0 with PDM Link and Project Link coming in the March timeframe, we have an extraordinary release schedule for the next six months. I don't see a need for reconciling higher operating margins right now. I'm hoping that we get upside on the revenue rather than cut our way to that.

One other comment I would like to add, Richard, you can never go home again, but if we could go back to '96 or '97, knowing what we now know, I bet you we would spend a little more on R&D than we were then. At that point in time, we were levering the heck out of a strong position and I think a little bit oblivious to the fact that the run was going to come to an end. Come '97, '98, '99, we were naked and exposed by being a one-product company in a market that suddenly turned and was starting to decline headed in that direction. So you know, we needed to make this second product suite. We are now making it. The dream's coming true right now. I think the it would be a mistake to give up on that and as Dick said, I think we can cut our way to prosperity. We're making this market. We should have started making this market about four years earlier and then we did start making it. That's okay. It's not too late. We're making up for lost ground now.

Is it fair to say that spending on R&D is it crest or do you keep it the same or hope that revenue grows and that's what I'm trying to figure out. You can't cut your cost to zero because usually your revenues get there first.

I think our R&D spending right now is not an all-time high, by any means. We're at a lower level than we were a year ago. We put a floor on it and said as long as we believe in this marketplace, as long as we believe the tide will turn and we will be best positioned then we're not going to go beneath this floor absent some other data that that says we have to, so I think what you see here is confidence in the business, you know, next year, the year after, whatever that suggests that there's a minimum amount of expenditures we ought to keep spending in R&D, so that we're positioned for better times.

I think practically speaking, Richard, to tell you the truth, I don't think we could cut to a 15 to 20% operating margin level, you know, without really, you know, hurting the company pretty dramatically. I do agree, and I will talk to Ed a little bit more about his expense side of the g & a side. He's a little more disciplined over there. You know, we talked about it. You know, if we can show 10% operating margins, you know, what's the stock price really going to do at the end of the day to talk directly about it. We don't know where it's going, but I don't think it's going that far north. Vis-à-vis the potential that the investments represent, you know, with the longer term perspective, if we look a year or two out. We continue to make good, solid investments, we do come out with this very, very exciting set of products that work interoperablely, that change the paradigm around products are built, and I know we're making progress there. If we execute on that strategy, the upside, I think is much greater than 10% operating margins or 12% operating margins in the short term. That's the path we're on.

Got it. One quick question with, Ed, you struck me with a comment that I have been thinking about, but does windshield eventually -- this is probably too strong of a word -- a feature of overall product, a feature of pro--e, it's just one really nice addition to a feature set of a whole platform? Is that the way we want to think about it?

Yeah. Dick said a comment earlier which is worth highlighting, which is we are selling a product development system. It has components for creating digital products, for collaborating cross-functionally and with supply chain members and partners and customers, and for controlling the product development process so that you get a good, timely result with cross-functional alignment. We think that the days of stand-alone CAD are probably fading, which is one of the reasons I'm not that concerned about inventor 6 because stand-alone create versus an integrate create, collaborate, and control story is not a lot different than trying to sell a financial package or mrp-2 package against an erp competitor. People just say, hey, I need all of that stuff, and I would like to have it integrated tightly together and I would like to have one vendor accountability. I would like to have a product development solution, not a CAD cam solution, and I think that's where you are starting to see more of a focus on the system than on the components of the system.

Richard, I also wouldn't say windshield is a module or ek tension of Pro/Engineer. I wouldn't extension of Pro/Engineer. I wouldn't characterize it that way. I just believe that side of the business, the link solutions from a revenue standpoint at some point really will go past the MCAD. Not only for ourselves and I think there's general consensus by the so-called experts that this category is going to be larger than CAD cam. I mean, you strip out sort of all the simulation stuff and you take the real revenues from auto depth for mCAD, 300 million at most, and 500 million if you take out all the novia and dellimy and get solid works and Catia. You look at EDS, CAD business, 500 million; Pro/Engineer, 500 to 600 million. It's a $2 billion market and it's shrinking.

Right.

Unknown Speaker*: At the end of the day, I think this new space is really going to be a larger category. And as Jim described, I think it's part of an overall system that works together that enables companies to get their arms around a very difficult task. As more and more of these assemblies are outsourced around the globe to suppliers and customers, it's a difficult task to manage the process and it's one that customers are going to have to do.

So I think that sort of wraps things up. We appreciate your time. We're working hard, and hopefully, we can continue to execute this quarter again on these same initiatives, and we'll talk to you early next year. Thanks.