PTC Inc (PTC) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to PTC's fourth-quarter fiscal year 2003 results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this conference is being recorded. I would like to introduce Meredith Mendola, PTC's Director of Investor Relations. Ma'am, you may begin.

Thank you. Good morning everyone and thank you for joining us today. Participating on the call will be Dick Harrison, our President and Chief Executive Officer, and Neil Moses, our EVP and Chief Financial Officer. In addition, Jim Heppelmann, our EVP of Software Products and Chief Product Officer, and Barry Cohen, EVP of Strategic Services and Partners, are here to participate in the Q&A.

Before we get started, I would like to remind everyone that 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 may differ materially from the results projected in these statements. We refer you to the risks detailed in the company's 2002 annual report and Form 10-K, our fiscal third quarter 10-Q, and in the company's other reports filed with the SEC from time to time. A replay will be available until 5 PM Eastern Monday, October 27, at 402-220-3138. Additionally, this conference call is being webcast and a replay will be available through our website at PTC.com until Monday, October 27, at 5 PM.

I would also like to direct everyone's attention to our investor relations website at PTC.com where we have posted a PDF document with financial and operating metrics that we will discuss on this call. As always, after our prepared remarks, we will hold a Q&A session. In order to keep this moving, please limit yourself 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?

Okay, Meredith. Thank you. Thanks for joining us today. You've all seen our press release this morning. Revenue and loss per share were in line with our guidance on last quarter's call. I'm pleased with this performance, given continued weakness in spending as well as the short-term implications of executing an aggressive cost-reduction program. As we have said in the past, we've made significant investments in transforming our business from a one product technical software vendor to an enterprise software vendor with a full suite of product lifecycle management solutions.

We have been investing in new products, product integrations, and an improved distribution strategy. We have also been validating the value of product lifecycle management and improving our customer relationships. At the same time, (technical difficulty) declined and put a damper on our revenue. We recognized the need to reduce costs, but made a strategic decision to continue to invest in our products because we are in the middle of our business transformation.

In 2003, we marked the completion of a large portion of the investment necessary for this transformation. We have delivered Pro/ENGINEER Wildfire, our Windchill Link Solutions, our product development system, a strong value proposition for our customers, and an improved infrastructure that makes it easier for our customers to do business with us. And, we were finally able to announce an aggressive plan designed to reduce costs and return to profitability.

Many of you have asked us how we expect to reduce our resources and remain competitive. We think that solid execution of our strategy will allow us to become more competitive even while reducing costs. The antidote to cost-cutting is focus. PTC's expense reductions are allowing us to get back to basics in many regards, choose our priorities carefully, and focus relentlessly on what is important for the success of PTC, our customers, and our shareholders.

Simplifying our messages and solutions leads to standardizing our offerings and our customer approach. The results will be higher quality revenue, more profitable customer engagements, and stronger overall execution from PTC. Our entire organization is aligned behind our strategy. I would characterize this strategy as the why, what, how, and to whom of PLM. Why is PLM valuable to manufacturing companies? What are we offerings to our customers? How is this more easily adopted? And who is our target market?

The why correlates to our product first messaging and our commitment to help our customers create value. Manufacturing companies that put products at the core of their business will gain a competitive advantage. Though we have yet to see the PLM market take off, we know that manufacturing companies are faced with complex challenges every day. Many of these challenges can be solved by optimizing the product development environment. These messages resonate with customers. Let me give you an example. Last quarter, I told you about a new agreement with Toyota. We issued a press release regarding this agreement this morning. As you know, Toyota has been a longtime user of Pro/ENGINEER in its engine and drivetrain unit. Our relationship has grown stronger as PTC has introduced the concept of a product development system that aligns with Toyota's view of product development in its engine and drivetrain unit. Toyota leads the automotive industry in time to market, quality, and profitability.

This success comes from a relentless commitment to optimizing processes and operations. Toyota can foster technical innovation while further reducing time to market and continuing its quality leadership by optimizing around its product development processes. They have chosen to standardize on PTC software to create an engine and drivetrain development system. We have worked closely with Toyota to ensure that our software fits Toyota's product development processes. This important partnership is a clear testament not only to PTC's superior products, but also our unique approach to solving customers' product development problems. Toyota was PTC's largest customer in fiscal 2003.

The what in our strategy correlates to our product offering. Our 18 products are ProView Wildfire, Windchill ProjectLink and Windchill PDMLink. They are offered together in a packaged bundle to make it easier for existing Pro/ENGINEER customers to start on the path toward implementing a product development system. We are certifying the integrations of these products across standard business processes for our customers to help remove customer risk. Increasingly, customers see the value in our bundled product offering.

Let me give you an example. Ingersoll-Rand is a long-standing customer of PTC's in the industrial products sector. It employs about 45,000 people throughout the world and operates more than 100 manufacturing facilities, over half of which are outside the United States. Ingersoll-Rand's strategy is to enable its divisions to, quote, design anywhere, build anywhere. This will help the company grow revenue to increase flexibility while reducing the cost of bringing products to market. This type of strategy requires a flexible design solution, the ability to collaborate with others, the sharing of product information across multiple geographies, and strong change management capabilities. This quarter, Ingersoll-Rand purchased upgrades to Flex 3C, enabling its engineers to take advantage of Pro/ENGINEER Wildfire, the Windchill Link Solutions, and the tight integration of the products in a cohesive system.

The how in our strategy correlates to our ability to evolve a Pro/ENGINEER customer for a non-PTC customer into a PTC product development system customer. We have outlined a process to help customers optimize their design environment with Pro/ENGINEER Wildfire, then move to Windchill PDMLink for engineering data management, and finally move into enterprise level collaboration and control activities like change management, supplier collaboration, and ERP integration.

Let me give you an example. Swift Group is based in the UK and is the country's largest manufacturer of recreational vehicles. Its current 2D CAD software and limited data management capabilities are restrictive in an increasingly competitive and complex manufacturing environment. Swift needed to move swiftly to adopt new capabilities in its product development environment. Swift determined that the right solution was PTC's product development system, including Pro/ENGINEER Wildfire and the link solutions. PTC's adoption roadmap aligns with Swift's implementation plans. First, adoption of Pro/ENGINEER Wildfire, then data management configuration and change management, and finally ERP integration.

Finally, the who portion of our strategy is key to our success. PTC has a tremendous asset in our customer base. As a leader in the PLM market, we will continue to win new customers. However, we have a very large opportunity before us if we can leverage our why, what, and how across a core group of our existing customers. Making our existing customers successful will drive revenue and profitability because of our domain expertise and repeatable approach.

Let me give you an example from the quarter. The U.S. Department of Energy's Nuclear Weapons Complex is responsible for certifying the safety and predictable performance of the existing U.S. stockpile of nuclear weapons. The NWC employs about 50,000 people at multiple U.S. sites. The three largest sites are Los Alamos National Laboratory, Lawrence Livermore National Laboratory, and Sandia National Laboratory. This quarter, the NWC extended its relationship with PTC by signing a $10 million multiyear contract for new software and software upgrades. This exciting new contract is the result of our strong relationship with the NWC and NWC's excitement regarding Pro/ENGINEER Wildfire release.

The NWC purchased new seats of our foundation advantage package as a replacement for SolidWorks seats already in use. Additionally, the NWC will upgrade existing Pro/ENGINEER seats to our Flex 3C package, which includes both Pro/ENGINEER Wildfire and Windchill Link Solutions. The NWC anticipates migration to Wildfire in January of 2004.

The first step in applying our strategy to our customer base is driving Pro/ENGINEER Wildfire adoption. I am pleased to say that we have moved about 25 percent of the base to Wildfire to date. We are generating this response due to the software's ease of use and power, our focus on driving adoption in large accounts, and strong adoption programs that our VARs are running. These VAR programs called hands-on workshops have brought 1600 users up to speed on the advantages of migrating to Wildfire quickly.

Before I turn the call over to Neil to walk you through the financial details of our guidance, I will sum up by saying that we feel optimistic about the future. Near-term, I expect we will continue to face revenue challenges. We are realistic about our expectations for 2004, which will be about significant earnings growth. Longer-term, we are excited about the opportunities our strategy will bring us. We have never had a stronger product lineup, clearer value proposition, sharper focus on our target market, or more consistent methodology to help our customers succeed. Our entire organization is aligned behind our strategic goals to improve both customer and shareholder value. Neil, I will turn things over to you.

Thanks, Dick. I would like to start with an overview of our fourth quarter and fiscal 2003 results, and then I will walk you through our guidance and the efforts we are making to achieve our profitability goals for fiscal 2004. At a high level, the results from our fourth quarter were in line with our guidance. The fourth quarter was our strongest Windchill quarter in over a year. However, our revenue from large deals declined, impacting both sequential and year-over-year results. Our expenses were flat sequentially, but our cost-reduction program is on track, and I will spend more time discussing this later. Finally, we close fiscal 2003 with a very strong balance sheet, including cash and investments of 205 million.

Total revenues for the fourth quarter were 164 million, a 1 percent sequential decline and a 13 percent decline year-over-year. Our license revenue improved 3 percent sequentially, but year-over-year license revenue declined 24 percent. A big factor in this decline was the difference in deal size. In the fourth quarter of this year, we had 10 deals greater than $1 million for a total of 18 million in license and service revenue, compared with 12 deals in the fourth quarter of 2002 that totaled $30 million in license and service revenues.

Service revenue for the fourth quarter was 114 million, down 2 percent sequentially and 8 percent year-over-year, mainly as the result of lower consulting and training service revenue. Although service revenue is ultimately driven by license trends, the fourth quarter tends to be a soft quarter for consulting and training, especially in Europe, due to summer schedules. By geography, North American revenue was 59 million or 36 percent of total revenue, up 8 percent sequentially but down 27 percent year-over-year. In North America, we had stronger revenue from large deals sequentially, but revenue from large deals was $9 million lower than in the fourth quarter of 2002.

European revenue was 62 million or 38 percent of total revenue, and was up 2 percent sequentially and flat year-over-year. On a constant currency basis, revenue from Europe grew 1 percent sequentially and was down 11 percent year-over-year. Our Asia-Pacific revenue was 43 million or 26 percent of revenue, and was down 15 percent sequentially and 7 percent year-over-year. As was true in North America, we had fewer large deals in the Pacific Rim, both sequentially and year-over-year.

Total Windchill revenue was 45.7 million, up 10 percent sequentially and 11 percent year-over-year. Windchill license revenue of 16.2 million grew 53 percent sequentially and 20 percent year-over-year, with higher revenue from both our Windchill Link Solutions and our foundation software. Windchill Link Solutions license revenue grew 50 percent sequentially and 153 percent year-over-year.

Windchill consulting service revenue was 19.9 million; that was down 8 percent sequentially but up 3 percent year-over-year. Windchill maintenance revenue was 9.6 million, up 3 percent sequentially and 16 percent year-over-year. This is attributable to stronger customer acceptance of the Windchill Link Solutions over the past year, as well as the sales of Pro/ENGINEER Wildfire Flex 3C packages, which include Windchill software.

We had 80 new Windchill customers in the quarter, which brings our total Windchill customer number to 1,092. In fiscal 2003, an additional 1,000 companies purchased Windchill (technical difficulty) time to our Flex 3C package. This is exciting for two reasons. First, it underscores the leverage that we have in our Pro/ENGINEER installed base, now that we're building a tighter integration between our products. Second, our customers are validating our product development system strategy.

During the fourth quarter of 2003, we had 189 Windchill transactions, versus 173 transactions last quarter. Our transaction size also improved sequentially; and this contributed to the stronger Windchill revenue this quarter. Windchill cumulative seats were 262,350, with 8,000 additions in the quarter. Windchill ASPs were $2035, about flat with last quarter's ASP. License revenue from existing Windchill customers was 90 percent of Windchill license revenue compared to 67 percent last quarter.

Total design solutions revenue was 118 million, and the license revenue component was 33.7 million, a decline of 11 percent sequentially and 35 percent year-over-year. This quarter we saw stronger demand for low-end seats and high-end Flex 3C upgrades. However, we sold fewer new high-end seats, which contributed to the overall license revenue decline. Year-over-year comparisons of design solutions license revenue are impacted by lower revenue from large deals, particularly in North America and the Pacific Rim.

Design solutions consulting services revenue was 17.9 million, down 3 percent sequentially and 24 percent year-over-year. Design solutions maintenance revenue was 66.4 million, down 1 percent sequentially and 8 percent year-over-year, due primarily to the lag effect of license revenue declines in prior periods.

Our new customer number for the design solutions business was 540, bringing the cumulative designs solutions customer base to 36,479. Cumulative design solutions seats were 299,200, with 3,300 seats added during the quarter. License revenue from existing design solutions customers was 88 percent of total design solutions license revenue, in line with past results. ASPs this quarter were down sequentially, from 10,700 to 10,100, due to a higher mix of low-end seats in the quarter.

Regarding our VAR channel, indirect license sales were 27 percent of total design solution license sales, or 9.2 million. This is down slightly from last quarter and down 20 percent year-over-year. We're working on improving our channel infrastructure, so that we ensure that we grow VAR revenue profitably for both PTC and our VARs. In fiscal 2003, our license revenue from VARS grew 5 percent when compared to fiscal 2002.

Let's talk about spending for a minute. Although overall operating expense was flat sequentially, headcount decreased by 5 percent to 3,500. Headcount declined in all functional areas, particularly in sales and marketing, where we took steps to flatten the organization and consolidate regionally. As a result, sales and marketing expense declined by 7 percent sequentially.

This decline was offset by higher royalty expense incurred on our license and service offerings, which drove up cost of revenue. In addition, we incurred higher sequential G&A expense, due to a write-off of certain accounts receivable. PTC recorded restructuring and other charges in the fourth quarter of 15.8 million for severance and facilities-related charges associated with our current cost reduction program.

Our tax expense was in line with our guidance of 5 million; and you should expect for the foreseeable future that we will continue to book a quarterly provision of approximately 5 million to cover mostly foreign entity tax liabilities, and indirect taxes in some Asian entities.

Turning to the balance sheet, our cash was 205 million, down slightly from 208 million in the third quarter. We had stronger collections this quarter, which helped to offset the cash impact of our net loss. Receivables DSO improved significantly to 77 days in the fourth quarter, from 88 days in the third quarter. Four days of this improvement came from collection activity; and seven days in the improvement was driven by receivables financing that is a lower-cost alternative to prompt-pay discounts. Deferred revenue was down to 173 million from 190 million in the third quarter. This is attributable to normal seasonality of revenue amortization from annual maintenance contracts.

Let's talk about our outlook for next year, more specifically the first quarter. As we reiterated in our press release this morning, our goal is to deliver an operating profit in fiscal 2004. We are aggressively reducing costs, and are on track to deliver operating expense of 160 million in the first quarter, excluding restructuring charges. Our plan also calls for additional reductions in 2004, such that we expect our operating expense to be 150 million by the fourth quarter of next year. In connection with these reductions, we expect to incur restructuring charges of 35 to 40 million throughout fiscal 2004.

None of that is new news; we talked about it last quarter. But, we also told you we would give you some additional details on our current cost reduction program during this call. I would like to take some time to discuss this now.

First of all, we intend to complete the reductions as soon as possible. However, due to the nature of headcount and facility reductions in various geographies, and our intent to minimize the impact on revenue, we cannot make all of the reductions at once.

Regarding headcount we began the reductions when our headcount was about 3,800. At the end of the fourth quarter it was 3,500. As of today, our headcount is 3,392. By the end of fiscal 2004, we expect headcount to be about 3,000. By function the majority of dollar savings will come from sales and marketing and cost of service. We are achieving the sales expense savings by rationalizing our sales management structure; substantially reducing our direct sales presence in unprofitable or non-strategic geographies; and by migrating to a lower-cost distribution model with the elimination of direct sales presence in the VAR-designated space.

Marketing expense is being reduced through more targeted program spending. Cost of service will be reduced through out partnership with an offshore services company for subcontracting engagements, by building a multishore technical support organization, and through a greater reliance on our sales force to drive service revenue.

Research and development capacity will remain stable because competitive advantage through product superiority is key to our success. However, we can and are reducing overall R&D spending, by continuing to shift some of our resources to low-cost geographies like India and Israel, for maintenance-related development work. New product innovation will remain in the United States.

General and administrative costs are being reduced through across the board headcount reductions, as well as targeted reductions in insurance programs and outside services contracts. These reductions will represent a smaller dollar but higher percentage savings in the cost of service, sales and marketing, and research and development areas.

Let's talk about our guidance for the first quarter of fiscal 2004, which ends, by the way, on January 3, 2004. Our guidance is revenue of 150 to 160 million and a net loss per share of 9 to 13 cents, including 20 to $25 million in restructuring charges. Due to the projected net loss in the first quarter, as well as the cash impact of our current restructuring program, cash and investments is expected to decline to approximately 175 million in the first quarter.

Let me close by just saying that we are very confident we can achieve our cost reduction targets in fiscal 2004. Execution of this plan is going to drive the efficiencies needed to provide strong earnings leverage and positive cash flow for PTC. Our plan for 2004 also helps us to focus on the more profitable and productive revenue opportunities before us. We look forward to reporting back to you on our progress in January. Thank you very much. At this point, I would like to turn the call back over to Meredith.

Thanks Neil. Operator, I think we're ready for the Q&A session.

(OPERATOR INSTRUCTIONS) Jay Vleeschhouwer of Merrill Lynch.

For Jim first, at the user conference in June, you gave a fairly detailed product development roadmap of PTC releases through '04 and beyond. Can you say whether that schedule that you talked about then, four months ago, is still intact with a Q1 release, for instance, of Windchill 7, and expectation of the X-10 (ph) and other releases over the course of '04 and beyond?

For Dick, on the revenue generation or sales capacity side, you have handily raised the revenue line for the direct to 500 from 250. Can you talk about the implications of that, in terms of overall sales capacity? Or whether you think the channel can, in fact, sufficiently backfill in those territories or with those accounts that you're now taking direct out of? Thanks.

We're largely on track for the product roadmap discussion I had with the user group. But keep in mind that we now have a product roadmap discussion at both the individual product level as well as at the integrated product development system level. But if I go back to the individual product level, where you brought up, we are still tracking for a 7.0 release in Q1 of this year. So this quarter.

The one commitment I made to the customer then, and I will reiterate now to any that might be listening, is we are very committed to quality and we're executing to a quality set of quality metrics and criteria; and we will ship the product when we achieve that criteria. Current course and speed would indicate we will hit that criteria this quarter. Obviously there is some risk, if we don't hit the criteria, that release could slide into January. But right now we're sticking with a Q1 date based on the data that we have.

That will be followed up by a Wildfire 2 release in Q2. That is looking pretty good. We're tracking well for that date. Then, the X-10 release we talked about, we're still playing a little bit with the content and date on that. I think we might actually surprise you with a date that is earlier then I might have earlier indicated. But then the flipside would be potentially less content in it. We will still ship the X-10 release in the fiscal year, but again the content and date is still a little bit in flux.

Jay, on sort of the trade-off between direct sales reps and resellers, I think that one of the things we did see this year was an increase in the productivity by the direct reps, as we continue to move them up into larger accounts. So I think productivity there was up about 10 percent.

I think we can do more of that in a couple of ways. The first is continue to move them up into these large accounts, such as Toyota, and the Nuclear Weapons Complex, and those kinds of accounts that can generate not necessarily the big big deals, because as Neil was describing, those really are not there as much anymore. But just more consistent revenue from these accounts. The Boeings and the Airbuses.

We're building a nicer set of recurring revenue from these large accounts. So, to the extent that we continue to move the direct guys up there, that is helpful. As you know, the only way for us to do that, and to pull them out of the installed base in the lower and medium-size accounts, was to have a product that was better for the resellers; and that is Wildfire.

I was just at a reseller -- we had a worldwide VAR meeting out in Las Vegas. First time I was ever in Las Vegas; earlier this week. There is a lot of momentum and excitement in the channel. I think that we are going to have a few hiccups here and there inside the channel, because it is growing and there are some changes in there. They are actually beginning to sell the whole product development system concept as well.

But, I do think the channel is going to fill in nicely during the course of the year as the direct guys continue to move upstream.

As a follow-up, your maintenance revenue for Pro/E declined again sequentially and year-over-year, though the rate of decline seems to be moderating. Do you think we have hit bottom now in that maintenance number? Would you still see that as perhaps a leading indicator of some stability or improvement in the business?

Lastly, on the Windchill side, your new deal size on average was about 20,000 or so; the lowest we have seen it to date. Certainly well down year-over-year. Is that just a function of link (ph) adoption and so a lot of preproduction testing? Or do you think that is more of the norm even when the market gets better?

Jay, how are you calculating that new deal size?

It is the new customer transaction divided by the number of -- new revenue divided by new customer transactions.

I see what you're doing; you are taking out the 90 percent of the transactions that came from existing Windchill customers?

Pretty much, yes.

Why don't we take that question offline, and will reconcile that for you. With respect to the question on maintenance revenue, the answer is that I don't think that we have hit bottom yet. The reason we have not hit bottom is there is a lag effect obviously associated with the license revenue performance revenue.

Having said that, one of the encouraging signs in fiscal year 2003 was that our license revenue was relatively stable across all four quarters. However, I don't think we are going to see the benefit of that (technical difficulty) that we hope is going to continue, probably until fiscal 2005 in terms of its impact on maintenance revenues.

Thanks, Neil.

Gene Munster of Piper Jaffray.

If we look back over the last year and a half, I think at the analysts day about a year and a half or two years ago, you guys talked about kind of a stratified productline; and free offerings; and just from a competitive nature to kind of block people like SolidWorks out.

I see the revenue still dipping. Has there been any traction on those fronts, looking back the past year and a half? And any thoughts on any tweaks to that strategy?

We outlined, two years ago I believe it was, a strategy of Pro/ENGINEER positioned at the high-end; and this Pro/DESKTOP product positioned at the very low-end; in kind of a box strategy. We executed that strategy for a while, until we got the Wildfire release out. With Wildfire were able to more appropriately position Pro/ENGINEER kind of across the line.

So we still have the Pro/DESKTOP product out there. We still use it as sort of an introduction to 3-D modeling. And we use in our education program and so forth. But Pro/ENGINEER Wildfire has become the product of choice in our VAR channel.

That is obviously not a free product. But it gives us a product that is simple for the low end; it is powerful for the high end; and constant across the board. So that the entire value chain has a solution that is completely interoperable, from the smallest supplier to the biggest OEM. That is a little bit of kind of an update where we are with respect to the positioning of the products within that strategy.

How about from a competitive perspective? Looking back at my notes, I know you guys have not given current quarter guidance previous. But it looks like it is going to be down sequential quarter. Can you talked about your guidance last quarter assuming a stable environment; or no change, I think, was the words that you used in terms of the overall environment. Is it safe to say that the environment has softened a little bit, and that is the reason? Or is it more competitive related? Or just some bigger picture thoughts behind the down sequential quarter.

I will take the first part of that question, which is really around the sequential decline for next quarter. Then maybe either Dick or Jim can comment on the competitive side things. There's two reasons for the decline in the first quarter. One is historically we have had a decline in a first quarter. So we're reflecting that in our guidance.

The second reason that we're in a midst of a pretty aggressive cost reduction program. We took a restructuring charge in the fourth quarter of 15 million; that number is going to be 20 to $25 million in the first quarter. We would like to tell you that we are going to pull that off without any hiccups; but the fact of the matter is that there may be a couple of hiccups along the away. So we have tried to kind of conservatize what we're looking at for revenue in Q1.

So it would be more just internally, as the company gets realigned, the natural challenges, or natural function of getting things realigned; that is impacting revenue? And then the seasonality versus anything competitive? Is that safe to say?

I think that is safe to say.

If I could cover the competitive part of the question. I think if you looked at Pro/ENGINEER prior to Wildfire, because the product was viewed as too complex, we were not competitive in the small accounts. We were being forced kind of back into just the big accounts. Of course in the big accounts there's not a lot of growth in the marketplace, and there is a fair degree of saturation and so forth. So, a little bit we were suffering from a lack of new oxygen flowing into the business.

With Pro/ENGINEER Wildfire having been released earlier in 2003, I think we have become much more competitive. We are more actively participating in the new business in the low-end accounts, some of which ultimately grows into bigger accounts and bigger business for us. But I think some of the metrics we actually showed indicated that the business in the low end is actually doing pretty well. We continue to suffer from some of the market in saturation effects, I think, in the high end.

Just a final question, in terms of -- you guys might have already hit this too; but the higher royalty expense. Any thoughts in terms of where that might go, going forward? Was that kind of a onetime blip? Just your thoughts on that.

I can tell you that generally speaking, the sale of our Windchill products brings with it higher royalty bearing expense than do our sales of Pro/E products. So the good news is that we had a better Windchill quarter in Q4. We would hope to continue on that growth going forward. And that could result in some higher royalty expense that comes along with it.

Is there any sort sensitivity, Neil, in terms of what that would be?

You mean in terms of how to model that?

Yes; too fractional to even model?

It is too fractional to model.

Good. Thank you.

Richard Davis of Needham.

This is maybe putting the cart before the horse; but after you stabilize the business and things are presumably looking up next year, the two questions I had is, one, do you have a point of view on the disposition of the cash? What you might be doing with it? Because we have had some questions on that.

The second kind of detailed question is, implicit in your thought process as to what you are doing guidance; what is the economic outlook? Is it flat, do you assume an improvement in IT spending? Just trying to calibrate that vis-a-vis our expectations.

Let me take the second question first, and then come back to the cash question. Our expectation on IT spending is relatively flat for next year. I think the way we're thinking about things, Richard, is that while there are some signs from a macroeconomic standpoint that the economy is starting to improve, that that really has not manifested itself to a great deal in IT spending.

So, IT budgets for 2004 are by and large going to be set here, right in the next 90 to 120 days. But I think we're still skeptical that, even if those budgets might reflect higher dollars, that people are going to immediately open their wallets.

So we're approaching next year as if for the first half of the year there's really no change. We're hoping to see some change in the second half; but we're not counting on it.

More of a back-end loaded?

Absolutely. But certainly not hockey stick. Modest improvement in the back end, if at all. So, that is the answer to your second question.

On the first question in terms of what we're planning to do with our cash, the answer is, we've got 205 million of cash. So I think we've got a reasonably healthy balance sheet. As I mentioned, our cash is going to go down in the first quarter. So, we would really like to maintain the cash cushion that we have today.

If the implicit question you're asking is, are we out there looking at M&A opportunities? The answer is kind of I guess we always are. And we will continue to do so. But I don't think we're looking at cash going out the door in support of any initiatives we might take there.

I would not think you would do it, until you kind of get all the ducks in a row first.

You've got it.

Good. Thank you.

Gibboney Huske of CSFB.

I just wanted to drill down a little bit on the performance of the MCAD license sales in the fourth quarter. I guess if you could just walk me through. I understand that you did not have quite the same number of big deals in the quarter. It just seemed to me you have been making some transitions in terms of sales. That those are more of an impact last quarter relative to this, so that you would not have seen more of an impact this quarter.

Secondly, in terms of your VAR revenue, that was down even a little bit sequentially, in the quarter. Just maybe you can remind me in terms of -- I know the dish (ph) account that you have with Mencha (ph), I think that is still on, and maybe that improves next quarter.

But, I guess given that it is your fourth quarter, I don't understand why you would have such a sequential drop, in an environment where a lot of your competitors are actually talking about things getting better. And is this maybe just a reflection of that line item is going to continue to decline; and you're starting to see some real secular pressures there.

The first question was around MCAD license sales, for the fourth quarter.

They are all about MCAD license. I just don't understand that performance.

(multiple speakers) second question was around our VAR channel.

Obviously, how that contributed to that. In terms of the VAR license that you reported was down a little bit sequentially. I do know there's some discounts and some transitions there. So maybe clarify what impact that may have had. But I am really struggling to understand the performance there. It just seems like you would extrapolate that maybe that business is just going to continue to decline.

Here is how I look at it, Gibboney. I think that MCAD license sales have declined fairly significantly year-over-year. Right? Most notably in North America. The largest component of that decline is the impact of large deals. Whether that is a going-forward phenomena or just a phenomenon of where we are economically, no one really knows that for sure. Right?

The other thing we know about MCAD license sales from a geographic standpoint is that the North American market is fairly saturated. The European market is probably not far behind it. So, when we look forward in our MCAD license business, I think we see, with a better economy and growth perhaps in Asia-Pacific, an opportunity to stabilize that business. But really not a real significant growth trajectory to it. The growth trajectory is going to have to come from the Windchill business.

It seems like maybe stable is being overly optimistic. And what realistically you should be looking for is more of a decline, to the extent you do have saturations in the two primary markets. In addition to that. You kind of indicated, and I think generally speaking, large deals are going to tend to decline, since you have saturation. And things like companies are buying software in smaller and smaller pieces anyway throughout the industry. So.

I don't think I said that we were planning in fiscal 2004 for stable Windchill license revenues. Excuse me, MCAD license revenues. I don't really want to get into the full 2004 year, because we're going out one quarter. I think that is a reasonable long-term goal for the MCAD license business.

With respect to the VAR channel, yes, VAR revenues were down slightly in the fourth quarter compared to the third quarter. Overall VAR revenues, as I mentioned earlier, were up year-over-year. I think in fairness, we have experienced some growing pains with our VAR channel. We have been working on, as I said earlier on the call, making sure that what we're doing with the VARS is a profitable revenue opportunity for both them and us. And I would say that those growing pains impacted us a little in both the third and fourth quarters of this year.

Having said that, we are very confident about the VARS in the under $250 million space going forward; their ability, if you will, to step in for the direct sales force. We're very optimistic about the overall channel business as a component of PTC's business going forward.

But I think in retrospect over the past 18 months, maybe we tried to grow that business a little bit too aggressively. So I think we have recognized that, and we're making some structural changes to improve that program going forward.

Just would you confirm, the discounts that you been doing through Mencha, does that go away next quarter? Or when do we expect that? How much of an impact will that have?

I don't think we have spoken specifically about that information. So I don't think we would comment on that at this point.

Okay. Thanks.

Philip Alling of Bear Steins.

Obviously a lot of focus on cost control here. I did notice that in the quarter your gross cost in core expenses actually bumped up about $1 million. I was wondering whether that was intended? And was there something in particular that happened in the quarter that led to a slight increase there? Given longer-term plans for a significant reduction in costs.

Two answers to that question. One is, I think we gave -- on our guidance for the fourth quarter in our third-quarter call, we did say that we did not expect operating expense, the needle to move on operating expense significantly in the fourth quarter. And in fact it did not.

Secondly, from a purely selfish standpoint, I have been here four months. And obviously I would like to start the slate as clean as possible for fiscal year 2004. That involves doing whatever we can to get any issues we have in 2003 behind us, to position us for profitability in 2004.

Okay. Different question. Regarding planned spinoff of the PLM unit at EDS; any changes in your go-to-market strategy? Given plans there for those guys to be more focused on this particular space. And do you see those guys competitively? And what can you comment there?

I am not really sure what is going to happen with the spinoff. If you look at their history over the last ten years, they had it inside, they spun it outside, they brought it inside, now they are going to spin it outside. I don't thanks that we're really paying too much attention to that, and I don't really think it will change very much how we are going to market.

As we talked about, the productline has really -- if you look at where we are today versus a year ago, with Wildfire and the links and the way they all work together, and this goes all the way to our direct sales force, to channel, to services people, even our maintenance people. Everybody is tuned up about talking to our customers and our new account opportunities, about this product development system, and the impact that it can have on their business.

We actually see the EDS accounts as being vulnerable. While we are focused and hunkered down around the base, opportunistically we are going after some of their accounts.

If I might add a little more color. Dick mentioned our strategy in terms of who, what, why, and how. That really does not involve EDS. So that is the strategy we're executing. Obviously from time to time, we find ourselves in competition with EDS. And I think that the EDS sort of gyrations on, are we in the business, not in the business, is starting to call into question their credibility. And I think that helps us.

Clearly, PLM was big important part of EDS's business maybe a year, year and a half ago. People were questioning it. Now they're really questioning it. Is seems to be a lot of waffling on the issue, which is probably helping us in some competitive situations.

Okay. One final question. Just give a little more color on the deterioration in services margin? Is that something we should expect to see going forward?

That was really around the issue that we talked about. We talked about cost of revenue being impacted by higher royalty expense, which actually affects both cost of revenue and cost of service.

Good enough. Thanks.

We have got time for one more question.

Brian Foote of Ryan Beck Co.

In terms of the headcount reductions, in particular terms of the sales force, what is the size in terms of headcount for your sales force, that you would target for next year? Say the end of fiscal '04?

The number of sales reps is about 350, 360 sales reps. Then, the sales organization is larger than that, given that you have presales people and managers and so forth. But the actual number of sales reps that are targeted on the larger accounts is 360.

What percentage of revenues in 2004 or going forward would you attribute to the channel, to the VARs?

Order of magnitude around 10 percent.

So, by the end of 2004 you will be at 10 percent; and that is how you want to manage it going forward? Or will that be increasing?

I think you should expect to see kind of steady controlled growth around that number.

Okay. In terms of -- you say you took a write-off of Accounts Receivable. You might have answered this, but how broad was that? How many accounts were there? Are there any other accounts receivable in jeopardy?

I think that we have taken care of the problem we had. I would say that it is a handful of accounts.

Okay. One final one. In terms of the 35 to 40 million that you're targeting, in terms of restructuring next year. How much of that is cash? And how much of that is non-cash?

Well, most of that will be cash for next year. The reason I say that is because the bulk of it is happening in Q1 and Q2; so there is really not much of a delayed reaction from a cash payment standpoint. Most of that cash will be paid out by the end of the year. So you should expect 90 percent of that number to be cash in next year's numbers.

Okay. Great. Thanks very much, guys.

Thanks again for your time, and we will look forward to getting together in early next year. Thank you.