PTC Inc (PTC) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the PTC second quarter fiscal 2005 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] I would like to now introduce, Meredith Mendola, PTC's Vice President and Corporate Communications. Please go ahead.

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 Heppelman, our EVP of Software Products and Chief Technology Officer; and Barry Cohen EVP of Strategic Services and Partners are here to participate in the Q&A.

Before we get started, I'd 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 might differ materially from the results projected in these statements. We refer you to the risks detailed in the Company's 2004 annual report and Form 10-K and in the Company's other reports filed with the SEC from time to time. A replay of this call will be available until 5:00 p.m. eastern Monday, May 2 at (402)280-1615. Additionally, this conference call is being webcast and a replay will be available through our website at www.ptc.com until Monday May 2 at 5:00 p.m. Also on our investor website, is a PDF with financial and operating metrics that we will discuss on this call.

I have one housekeeping item today. I'd like to let everyone know about our media and analyst day that will be held in conjunction with our user conference in sunny Orlando, Florida, on Monday, June 6, 2005. We'll be sending more information on this shortly to our investor e-mail list. If you want come and don't think you're on the list, please contact me and we'll add you. And the event will also be webcast live for those who can't make the trip in person.

As always on this earnings call, 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, let's get started.

Okay, Meredith. Thank you. Good morning, everyone, and thanks for joining us today. 2005 is shaping up nicely. We're ahead of our revenue and earnings plan in the first half of the year. Our second quarter results were strong. We delivered significant growth in Windchill across license, service and maintenance as both new and existing customers realize the advantage of adopting our solutions. Our Services Business benefited from increased delivery capacity and delivered strong growth in consulting revenue along with double-digit margins. By geography, we saw strong growth in North America and Asia-Pacific. Our sales productivity continues to grow as we benefit from improved customer relationships, and the investments we've made to grow our sales force in recent quarters. Our cash position grew another 50 million during the quarter to 384 million. Neil will walk you through the financial details in a few minutes. But first, I'd like to describe what we believe is driving our business and positive results.

PTC has always been at the forefront of improving product development productivity. Over the past 20 years, trends in the market and customer adoption of existing technologies have required constant evolution of our products and our customer approach. Our customers' challenges have evolved as well. They were once focused solely on individual engineering productivity, and then on engineering work group productivity. Our customers now ask us for help in finding data that can be digitized, processes that can be automatic, and too ls and systems that can be rationalized. In order to increase product innovation, quality, and time to market, without increasing overall costs, companies have begun to use globally disbursed contract manufacturers, supply chains and service partners. This makes the process of developing products increasingly complex. We call this trend, global product development.

Customers understand that by globalizing their product development efforts, they can more efficiently execute initiatives such as 24 by 7 engineering, custom development for unique local markets, and the integration of mechanical, electrical and embedded software development. In addition, they can balance the cost and value of various development activities to increase capacity in a constant cost structure, or lower cost with constant capacity. The value of global product development is too compelling for our customers to ignore. And so it has become a major focus for them. But in order to really unlock the value inherent in global product development, companies must tackle difficult issues, such as process change, and upgrading IT infrastructures to next-generation solutions like Windchill. PTC's ability to help customers solve this challenge is unparalleled. We believe it is now influencing our sales, and we expect global product development to become a major driver of our business in the years to come. All of our strategic initiatives including R&D, distribution, services, and corporate development have supported our focus on driving customer value in an increasingly complex world.

In the past we've told you about the success we've had reengineering, re-energizing our proengineer base with prowildfire. This same product opened up the entry level 3-D Design Solutions market to PTC, a market we had not participated in previously. We overhauled our distribution model so that we could profitably serve customers of all sizes. We delivered our Windchill Link Solutions, which helped customers adopt our Windchill technology incrementally and with a quicker time to value. We worked with IBM to deliver a hosted version of Windchill for small and medium businesses. We are delivering solutions with specific functionality for our key vertical markets. We have transformed our services business from an installation in training business to one that customers trust for process consulting services. And we delivered our product development system that provides a broad fingerprint on a simple architecture, which keeps the long-term ownership costs of PLM affordable, the power of our strategies and the combination of our offerings and delivery model. Customers choose PTC to help solve their global product development problems, because we provide an integrated solution that includes process consulting, our product development technology infrastructure, and implementation adoption services. This is important to our growth story and our business model. And this is becoming a strong differentiator for PTC in the market. The powerful combination of our offerings helps us improve our competitive win rate and makes our customers repeat buyers. I'd like to give you a customer example.

Hipro Electronics is a supplier of power supplies for desktop and enterprise computers to leading technology companies like Dell, IBM, and HP. Hipro is based in Taiwan and has 3,000 employees worldwide. Hipro not only needs to work with globally distributed customers but also has distributed manufacturing facilities. Hipro also needs to manage its mechanical and electrical design processes. Hipro's goal was to coordinate this distributed environment while improving product quality, customization and time to market. The solution for Hipro was PTC's Product Development System, with Pro/ENGINEER, Windchill PDMLink and Windchill ProjectLink. PTC's services team helped then helped Hipro deploy and operate key steps in its product development process, product data management, change management, configuration management, product management and execution and release to manufacturing. Our software and services solutions have helped Hipro manage revisions and versions of product integrations with detailed change histories, created a single point of data entry through the implementation of an ERP integration and shortened engineering change cycle time through adoption of standard change management processes. This example highlights the power of our product development system and adoption road map story.

We're excited about our business and about our future. Our customer satisfaction is high, our solutions are well suited to solving customer challenges, and our consulting expertise is becoming a clear differentiator for us in the market. We believe that we have just started to benefit financially from the strategy we've executed over the past several years. To drive continued growth in the future, we will continue to innovate and invest in our business and provide software and services that help solve our customers' evolving challenges. We look forward to sharing our progress with you during the rest of the year.

Now I'll turn the call over to Neil to discuss the financials and then take some questions.

Thanks, Dick. Good morning. Halfway through the year, we're ahead of our plan for fiscal 2005, with 7% year-over-year revenue growth, and a $63 million improvement in net income, and 384 million of cash on the balance sheet. Despite some of the weakness we saw from other software companies we saw this quarter, we have increased confidence in our business prospects. In fact, given the improved visibility we have in our business, we have decided to provide guidance for the rest of our fiscal year. Our financial and operating metrics are available on our website. So I'll take a few minutes to add some color to our financial performance and then follow-up with our guidance before we open up the call to questions.

Total revenue for the second quarter was 176.1 million, our highest quarterly revenue since the fourth quarter of 2002. Licensed revenue grew 3% year-over-year and 12% sequentially to 52.7 million. And this represented our strongest license revenue quarter in two years. Consulting and training services revenues grew 14% year-over-year and 4% sequentially to 39 million. This improvement follows the trend in our license business and also reflects our success in providing process consulting services to our customers. Additionally, we have added delivery capacity in this business to drive our growth, and our services margins continue to improve.

Maintenance revenue grew 6% year-over-year at 84.4 million and was flat sequentially. The strength of our maintenance revenue during the past year reflects improving relationships between PTC and our customers. By geography, our revenue was as follows. North American revenue was up 15% year-over-year and 8% sequentially to 63.2 million, reflecting strong performance against - - across product lines and in both our direct and indirect businesses. Four of our top ten deals were in North America this quarter. European revenue was down 4% year-over-year and 13% sequentially to 59.2 million. At constant currency, European revenue declined 7% year-over-year and 15% sequentially. The sequential decline was expected as we closed a significant number of large deals in Europe in the first quarter. In the second quarter, two of our top ten deals were in Europe, versus five last quarter. Asia-Pacific revenue was up 11% year-over-year and 24% sequentially to 53.7 million. At constant currency, Asia-Pacific revenue grew 9% year-over-year and 23% sequentially. Within the region, the Pac Rim showed particular strength with 43% growth year-over-year. And both Japan and the Pac Rim grew more than 20% sequentially. Four of our top ten deals were in Asia-Pacific this quarter. Our reseller channel continues to grow, and for the quarter the channel grew 8% year-over-year and 5% sequentially to 34.7 million. This represented 20% of total PTC revenue.

Moving on to our operating metrics by product line, Total Design Solutions' revenue was up 2% year-over-year and 1% sequentially to $124.8 million. For the first half of the year, Design Solutions' revenue is up 5%, which is at the high end of growth in the overall MCAD market. Design Solutions' license revenue declined 9% year-over-year but grew 7% sequentially to $34.8 million. The year-over-year decline was expected due to a difficult comparison in the year ago period with several large MCAD orders for high-end seats. However, our seat volume was up versus the year ago period and above 4,000 for the second quarter in a row. Design Solutions' services revenue grew 16% year-over-year and 3% sequentially to 18.9 million. This increase is due to higher sales of training and consulting packages that help our customers improve user proficiency and engineering productivity. And Design Solutions' maintenance revenue grew 4% year-over-year to 71.2 million but was down 1% sequentially. Overall, our maintenance performance continues to be very strong.

For Windchill, the metrics are as follows: Total Windchill revenue grew 23% year-over-year and 11% sequentially to $51.3 million. This was the strongest Windchill quarter since the fourth quarter of fiscal 2001. For the first half of fiscal 2005, Windchill revenue grew 15%, which is at the high end of the growth in the market for collaboration and data management solutions and also at the high end of our expectations. Windchill license revenue was $17.9 million, up 38% year-over-year and 24% sequentially. This growth was reflected across all Windchill solutions and modules. Windchill Services revenue grew 13% year-over-year and 6% sequentially to 20.1 million. This growth is attributable to increased services delivery capacity and the growing license revenue trend in previous quarters. And Windchill maintenance revenue grew 20% year-over-year, and 4% sequentially to 13.2 million, driven by our ability to move customers more quickly from the pilot environment to production environment. And I might just add in the third quarter our expectation is that the number of Windchill seats that we've sold on a cumulative basis will, for the first time, exceed the number of Pro/E seats we've sold.

Now I'll move onto our spending. Operating expenses were 151.6 million. This is in line with our plan to make modest investments to help fuel growth throughout the year. We have invested in our services organization, and have driven both revenue and margin growth in this business as a result. In addition, we have made investments in sales capacity, and now have 330 direct reps around the world. In R&D we have increased our development staff and have begun to deliver vertical functionality for Windchill. And finally we are investing in corporate development initiatives and are continuing our Sarbanes-Oxley compliance initiative in G&A.

Moving onto the balance sheet, cash was 384 million, up 50 million from 334 million in the first quarter. We continue to execute well on receivables collection, and our receivables DSO was 71 days this quarter, down 14 days from the year-ago period. Deferred revenue was 221 million, up from 200 million last quarter as a result of typical seasonality of deferred revenue from annual maintenance contracts. Deferred revenue is up year-over-year as well, primarily reflecting an increase in maintenance bookings. As you know, the first and second quarters are usually our strongest quarters for maintenance contract renewals.

Our guidance for the third quarter of fiscal 2005, which ends on July 2, is as follows: Revenue of 175 to 180 million, and operating expenses of 150 million to 155 million. We expect earnings per share on a GAAP basis to be between $0.06 and $0.08. For the full year, which ends on September 30, we expect revenue to be between 700 and 710 million, which represents 6% to 8% revenue growth. Operating expenses for the full year should be between 600 and 610 million, and we expect earnings per share on a GAAP basis to be between $0.26 and $030. This excludes any impact from potential expensing and/or granting of equity-based awards to employees As many of you know, PTC had planned to adopt stock option expensing during our fourth quarter of fiscal 2005. We also expected to undertake a restricted stock grant and a buyback program of certain employees' stock options in the fourth quarter, as approved by our shareholders at our 2005 annual meeting last March. Given the SEC's postponement of the requirements for stock option expensing, we're currently assessing our alternatives. We will inform you of our decision once we have determines the best course of action.

As many of you know, our longer-term financial goals are to achieve 1 billion in revenue and 20% operating margins by fiscal 2008. For the first half of fiscal 2005, our organic growth has exceeded our expectations. The strength of our balance sheet is enabling us to pursue corporate development opportunities that will supplement this organic growth. Our operating margins have also improved significantly in the first half of the year. We're committed to growing our operating margins for the full year by approximately 200 basis points. Thank you for your time today. We look forward to your questions.

At this point, I'll turn the call back over to Meredith.

Great. Thanks Neil. So, I think we're ready to take some questions.

Thank you. At this time, we will begin our Q&A session. [OPERATOR INSTRUCTIONS] One moment while questions register. [inaudible]

Hi, James.

Good morning. Thanks. First question is a larger market question for Dick and for Jim. You're comments about the market and about integration were very similar to what Deso talked about yesterday. So the question is first, with the improvement that they saw in their results and now the momentum you're referring to in your results, what's made the difference here after a couple of years of pretty curtailed growth? What do you think has changed in the end markets to spur this improvements now? And your results and Deso and we'll have to see what Eugene talks about, but what's making the difference here in the market? And then on the integration thing, they too talked about that a great deal as far as architecture and product integration, and they seem to have a further project in mind or goal in mind of how having a much more highly integrated products by perhaps 2007. So the question is there if everyone at the - - in your market has very highly integrated products, what is the differentiator on the architectural or product side?

Okay, James. This is Jim. I'll take a stab at it, and then Dick can follow up. So, first on what's changed in the market. You know, I think there are two trends that have been helping PTC. Number one, by bringing all of our products together in a tightly integrated way on a single architecture and simplifying all of those products, we've made our products total cost of ownership much lower. So, I think people see our investment as a more contained investment, a less risky investment. So that's on the investment side.

On the value side, I think that this concept of global product development is an executive. It's a boardroom issue. And I think people are starting to see that this is an imperative to be competitive and reach the kind of earnings goals they want to reach in their own company environment. And so I think they're seeing a greater level of importance on deploying solutions like our product development systems. So I think people are seeing the value more clearly on one hand, and we're containing the cost and the risk and they're seeing this as a more simplified, lower risk proposition in terms of putting the technology in place. So I think both of those things are working to our advantage.

Now, vendors can say what they want, but personally I don't buy that Deso has a highly integrated solution. You know, there's VPM, there's ANOVIA, and there's Smart Team. Those have three different products with three different databases on three different architectures. Smart Team is a dot net architecture, ANOVIA and VPM are not. So, maybe they have a plan to start over and create yet another new one in a few years. I'm not sure. But I certainly wouldn't give them credit for having a highly integrated solution. If you look at UGS with Teamcenter, we sometimes joke there's no team in Teamcenter, because there's no center in Teamcenter. In fact, this system in its broadest configuration could have up to a dozen different databases and different IT architectures. Again, there's a lot of capability there, but I think people are concerned about the cost to deploy it, the cost to get it integrated, the total cost of ownership over time, and so forth. And our solution compared to that looks lean and mean and clean, and on a pure single internet architecture. And I think that helps us competitively.

All right. The second question, I'll count that last one as just one. A very near-term question. You seemed to have run a promo for Pro/E in the last quarter. Seemed to have another one on for this quarter through the end of June. some special pricing for Pro/E packages. Is this something that you think will be an ongoing practice to heavily discount certain configurations of Pro/E at the entry level?

This is Meredith. Jay, actually one of the things that we're doing in terms of competing in that entry-level market, is thinking more like a retail business. And things like time-limited offers and interesting bundles and things like that, it's exactly up the alley of thinking in the small customer's mindset. So, you know, in conjunction with everything we've done in the channel, everything we've done to make that product easier to use than anything out there in the marketplace and more powerful, we also want to think like a retail business. So that's what the debt that is. I would expect to see more of that in the future.

Thank you.

And our next question comes from Tim Fox with Banc.

Good morning.

Good morning.

One question on - - in your press release you mentioned that there had been a decline in large transactions, particularly in the Design Solutions Group. But on your stats there, it looks like you did nine, which is not necessarily that far below the norm. Can you talk a little bit about whether more of those nine big deals came from Windchill, or what was driving the difficulty in closing those larger Design Solutions deals.

Tim, it's Neil. First of all, the nine transactions was pretty - - in the dollar value associated with it was pretty comparable to the previous quarter. And it was pretty comparable to last year. The reference that I think that I made in - - when I spoke a few minutes ago was that we had two very significant transactions in the year ago period that were in the Far East. And so there was a decline, if you will, in overall value of large transactions due to that - - due to those two significant transactions that took place a year ago.

I would also add, Tim, that just from an MCAD - - from an MCAD perspective, in terms of the number of deals, it was, there were a smaller number of large deals and a smaller number of revenue from those larger deals that were MCAD only deals. One thing that's really interesting that we've seen over the past three quarters, is that the vast majority of our big deals are combined MCAD and Windchill deals. This is, I think, a great reflection of the strength of that PDF story that we have, and so this quarter eight of our top 10 deals were a combination of MCAD and Windchill, which is nice to see. Which is really nice to see. I - - which is really nice to see.

Okay. So, in fact, you didn't have any trouble closing larger deals. It was the compared to last year?

Yeah.

Got it. Okay.

We wouldn't characterize the MCAD performance this quarter as bad performance at all. We thought it was great performance. We knew we were going to have a difficult time getting to the same level of license as we did in the year ago period because of those two bigger deals. When you have a significant number of seats that are [flexorisi] packages in a deal, it's going to skew those results. It's hard to beat.

I'm going to stick with MCAD for my second one, then move on. The other question was in the midrange and low-end Wildfire offerings. You reported continued growth here for a number of quarters. We've heard the same out of Deso, the same out of Auto Desk. I guess the question is where is all of this growth coming from, if it's not necessarily competitive, if everybody seems to be growing. Where would you think that these new seats are coming from?

I can take a stab at that. I think the biggest contributor of new seat opportunities for all of us are companies who have been using 2-D drawing and drafting tools and are now for the first time dry trying to upgrade and come online with the real 3-D, CAD Cam CIE-type systems. So I think it's still mostly this 2-D to 3-D. A lot of those 2-D seats, not all of them but many, are Auto Desk, Auto CAD seats, and as they upgrade, we manage to poach a lot of them, in particular, because we're the only vendor who can provide a scalable growth path. A system that's simple and can be packaged in a low-end price point. But it's also powerful and can scale all the way up to our Flex 3C configuration. And it's part of a product development system. So I think some set of those companies say, as I upgrade, I want to upgrade to something with legs. If I grade to a - - Solid Works I can never get to [Katia]. And if I did the same thing with UG, I'd start at one product and then maybe later wish I was with another one with a difficult time switching. Only Pro/E would offer that level of scalability.

All right, thank you. Nice quarter, I'll move on.

Thanks, Tim.

And our next question comes from Richard Davis, Needham & Company.

Hi, thanks. Jay kind of touched on this one. Maybe I'll just circle back to make sure that I got the answer right. So do you think that customers, when you talk to them regarding Windchill, do they view that as part of a broader solutions, because you were talking about solution sales. Or do companies still kind of want a stand-alone collaborative design product. And I - - you don't necessarily say that the independent guys are dead, but it seems to me that it's more, look, I need to solve a problem as opposed to having a piece-part solution. Is that a fair assessment as to what you're seeing customerwise?

That is absolutely a fair assessment. I think our customers want a problem solved. They don't want to launch a system integration product by acquiring lots of little component technologies - - you could, in theory acquire a PDM system, a collaboration system, a visualization system - - try to hook that all up to your CAD system. But you might have a solution, and you might just have headache. They see us with really a broad integrated turnkey kind of solution that steps right in and solves that problem they have, and takes it off the table. And I definitely think it's making life difficult for those vendors who are only providing a tiny piece of what would be a complete product development environment.

If I were - - if I were a niche guy and I had architected my product in either pure JAVA or pure dot net, would that make it easier to integrate or is it still - - there's still real headaches that customers just say, look I don't want to deal with.

Well, the most fundamental issue in integration occurs at the level of the data model. Two data bases, and they both have tables for part numbers. Now I don't care if they're sequel-server databases with dot net architectures Oracle databases with J2E architectures on top of them. The problem of solving two different databases with conflicting overlapping data models, they have more or less the same data, but they both think they can own it and change it without consulting with the other guy. It's the Gordia Knot of computer science problems, and customers can't solve that problem. So they look to us and they see that we actually, under that entire product development system, we have that broad footprint, sits on one single architecture, one single data base, one single data model, and they say that's the much better alternative.

Got it. Last quick question would be - - talk about how you're approaching, because it sounds like to get to your longer-term goals, you might have some - - you would have mostly organic, but some inorganic growth. Talk about how you're approaching looking at acquiring firms, and then how prepared do you feel you are to integrate any possible future acquisitions, whether they happen in the next three months or nine months or fifteen months.

Okay. Richard, it's Neil. I think we feel pretty prepared. I think we've been working hard on it. I - - from an integration standpoint, we've been working hard on that as well. In terms of what we've been looking at, not specifically, but more generically, we've talked a lot about global product development. So acquisitions have kind of expand our footprint with respect to global product development are interesting to us.

We've also talked about possible - - potential acquisitions that would expand our overall PLM footprint, provided that we can continue to have a clean, integrated architecture when we're done. So, you know, we might be a little pickier than some of our peers in that respect. That's very, very important to us. But - - I think those are the two principal areas that, that we've been exploring. And as I said we've been working hard on it. And so hopefully some of those efforts will pay off.

Got it. Okay, thank you very much.

I think just one little comment there, Richard too. We want it to be accretive. I mean, we're all about, right now in the last couple years here, earnings. That's going to be very important to us through the back half of '05 and '06 and in the future. So, we want solutions that fit in our vision, that have legs, i.e. can grow, because they're fresh and clean, and that are accretive.

Got it.

And we've actually done some interesting stuff in terms of on the integration side, which I think we'll tell you more about later. It's a longer answer. But, it has to do with making sure we've got some integration at the service level, at the sales level, at the finance level, and so forth. And just thinking that out ahead of time.

Got it. Okay. That's good. Thanks.

Our next question comes from Yun Kim A.G. Edwards. Thank you. Looks like you had a strong PLM quarter so far for the first half. Your PLM business grew 21%. If this strength in your PLM business continues, than we could see your PLM business grow well above your 10 to 15% growth target for the year. Would that be a fair assumption, especially considering that you have not officially released a new version that is supposed to replace the old Pro/INTRALINK?

Yun, I think, are you looking at the license growth for the first half of the year?

Yes.

Okay. The total revenue was up 15%. Which was at the high end of our expectations for Windchill for the year. So, our expectations are around the total business. You know, license should be a big component of that, obviously.

I think, you know, another way - - you're asking sort of a tough question. We don't really know the answer.

Mm-hm.

Because certainly we have really good momentum right now. I think we gave you guidance here for the first time in a long time that goes beyond a quarter. So we feel stronger about the predictability of the business. The maintenance, the service, and the license business and also by product line. Could we, as we release the next version of Windchill see some uptick? I mean it's possible. There's some really nice things in the next version that enable our customers to basically sort of move away from the old INTRALINK database that manages Pro/ENGINEER and move to a common Windchill database in the engineering department as well as the enterprise? And could we see some uptick? It's possible, but I would say that's over time and we probably have a little bit more insight into that at the end of this year. That's going to ship in June. I don't really think we're going to see the impact of that in this fiscal year. But over time there's a huge number of INTRALINK users, that actually have to do with what Jim was describing earlier. They have to synchronize this older client server architecture with the Windchill Enterprise Solution. And the new version of Windchill enables them to have the Windchill database, one common data model in the engineering department as well as the enterprise, so we've got a lot of interest from the customers. A lot of them will move to upgrade to that new environment, because of its power around flexibility. And it's an enabler for this global engineering or distributed engineering that we've been describing. but I think it's a little early to sort of predict that for you.

Okay. Great. Neil, CapEx spending went up a lot in the quarter. What was driving that and where do you see the CapEx number coming in for the year?

We're going to spend about 15 million for the year. I think we're up - - we spent about 9 million through the first half of the year. 15 million was our original plan. We spent about 12 million last year.

okay.

You know, I expect that we, that we'll spend, as I said, about 6 million in the second half of the year and land right about on plan. Land right about on plan.

Okay, great. Thank you very much.

You're welcome.

And our next question comes from Gene Munster, Piper.

Good afternoon, and congratulations.

Thanks.

Thank you.

In terms of the - - I just want to make sure I got the math right here. The ASPs again were, was it 8400 per seat?

You took the license revenue and divided it by the number of seats that we put out there?

Yep.

Yep.

And then it's - - that's up from basically 7,000 last quarter?

Yeah. You'll notice we didn't put it on the spreadsheet quarter. Because I've been piping up that I don't think it's a very useful measure of what's really going on in end user markets, because there is so much in there. There's the mix of the low-end and the midrange and the high-end packages. And there's upgrade and modules. So it's - - there's a lot going on in there, but you did the math the way we used to the math, so - -

Okay, so - -

[inaudible] are up, and they're up, notwithstanding Jay's comment earlier about some discounting in the low-end.

Okay, so it's a positive trend, but don't put a lot of data in it, because it could be negative next quarter. Or, just don't put a lot into that is all you're telling me.

Right.

Okay. And then second, in terms of the head count changes for direct Windchill?

Head count changes for?

Direct sales on Windchill.

It's on - - everybody sells everything.

Well, I guess more - - I mean Windchill is going to be I guess the key going forward, so as it has. But any idea what the actual number change is? How fast you add in head count, direct head count to Windchill sales.

We're at 330 sales reps, but the sales reps all sell Pro-ENGINEER as well as Windchill. And what we've described earlier is sort of this product development system.

Yep.

We don't really have a separate Windchill only sales force. Do we have - - do we talk about the head count going [inaudible]

We've added about 10% to that head count in the past six months or so. Up from 300. We'll probably, you know, kind of level out more or less where we are now for the balance of this year.

Okay.

And then, you know, address the issue again as part of our planning process for '06.

Yes, I wouldn't be surprised if hired a few three was good. Looking at the forecast and the pipeline in Q4, if we started to hire a few more Q4 for next year, but right now we're at 330.

Okay. Great. Thank you.

Thanks.

And our next question comes from Philip Alling with Bear Stearns.

Yeah, thanks much. Question on the service gross margins in the quarter. Trended down a little bit. Could you maybe give us a little bit of color there? Presumably that has something to do with the head count additions and what should we be looking for going forward with respect to the service gross margins?

We look - - maybe not as visible to you. We look at kind of the operating margins for our services businesses in total. And those were in the double-digit range for the second quarter in a row.

Just to interrupt. That's excluding the maintenance organization.

Right. Internally we look at services and maintenance separately, if you will. There were some royalties this quarter that fell into cost of service as opposed to cost of license, which probably impacted the gross margins that you're referring to. The overall health of our services business is tremendous. You know, Philip, last year, our services business dropped from $160 million of revenue the year before to 137 million. And we did mid single - - mid single-digit operating margins for our services business, again exclusive of the maintenance business. And the way our services business is performing this year, we're going to end up significantly exceeding our plan and we're going to report double digit operating margins for the business. So we're pretty pleased with the performance we're seeing there.

And it's just much healthier service business. It's less customizations and that kind of work, training and sort of low-level consulting and more with larger and medium-sized companies. Process oriented consulting. And deployment. It's just a - - it's a healthier, cleaner services business.

Question also on G&A. Given the comment you made about Sarbanes-Oxley compliance as well the head count additions and all. That was down in the quarter sequentially. Could you just maybe give us a better sense of what was really driving the reductions in the G&A that you reported on the income statement?

Yes, That's more a function of in that the first quarter we kind of a one-time expense in the first quarter in G&A, transaction expense oriented, that did not recur in the second quarter.

Okay. Just a final question for me. Regarding certainly, relative weakness in Europe. We've heard that from a number of other software firms. Thus far this quarter, can you give us a sense really of what demand the environment is changing at all, in particular in Europe, and what are you doing to sort of improve the sales effort there?

Yes, the first thing I would say, European business for the first half of the year is actually pretty good. What we saw is incredibly strong Q1, followed by a difficult to repeat Q2. So, overall I think we're up for the first half of the year. 5% in Europe. We feel pretty good about that. The vagaries of the quarter-to-quarter performance is a little bit more difficult to predict.

It think it will be up in Q3 based on the preliminary forecast. Q1 is always sort of funny. Our Q1, which is December quarter, Europe is generally pretty stong for us. There seems to be end-of-year money there that we get. Then the March quarter is a little slower. I think the June quarter will be stronger.

Great. Thanks much.

A little bit more on the question that had to do with sort of Windchill sales and so forth. One thing I didn't say with respect to that question, that might be helpful is that we have started to give Windchill to some of our resellers. Some of the more successful resellers, and we're starting to see them contribute to the Windchill numbers by selling links into their install base, as well as we launched, announced and then launched pretty recently, this Windchill on demand with IBM. Where they host a version of Windchill for the small and medium-sized customers, predominantly for our resellers. So that the resellers don't have to go through the process of configuring and installing and training, necessarily, the customers with an onsite implementation. And I think both of those things are going to contribute to the Windchill Link sales for a long time here in the future. Next question, please. Are we done?

Our next question comes from Jim Mendelson, Lazard.

I was wondering if you could comment a little bit on the linearity of the quarter, versus prior quarters. Also a little bit of color on contribution by major verticals?

Linearity. I'm sorry, I missed first part of your question. Could you repeat it?

I was just asking about the linearity of the quarter, how it compares to other quarters in terms of the contribution of the business from license revenues through the course of the quarter.

Through the month. By month, by month?

Yes. And then if you could comment a little bit on contribution by verticals.

In terms of linearity, I would say that our business performs pretty comparably to how it has in the past, which is that our maintenance business and is relatively ratable. Our services business is certainly more ratable than our license business, but we get some backend loading there in the third month. Our license business continues to have a significant portion of it flowing through in the last two weeks of the quarter. So - -

Although, Neil, I would to some degree the linearity has improved in the last year, vis a vis prior years, like the channel seems to be able to - - we sort of get a smoother line on the channel license revenue. What we call our done number. It's marginally sort of more predictable I'd say in the last year than it was in prior years. By vertical, I don't know if we've done the analysis by vertical.

By vertical, we don't actually have the numbers for you. We don't report that information. But just looking at the major deals that came in from the quarter, by far the strongest vertical for us was the aerospace and defense vertical. That continues to be a major contributor. Automotive has been doing well for us. High tech and electronics we saw some nice deals from some of the larger customers, and our industrial products sector, which has always been one of our largest revenue contributors continues to plug away. The one other thing that I would add is that very recently, in the past nine months or so, we have started to see more deals in emerging verticals, like consumer products and medical products. Verticals, so that traction has continued as well. Though, they're not - - they're not nearly the same type of revenue contribution as the other four.

Less than 10%?

Yes. Less than 10%. Round figures, and I'm not talking about this quarter, but I'm just talking generically. Industrial products is roughly 30%. Aerospace and defense has been between 25% and 30%. High tech electronics has been between 20 and 25%. And automotive has been between 10% and 15%. And, you know, roughly - - a little bit less than 10% makes up the remainder.

Got it. Thank you.

Welcome.

Our next question comes from [inaudible].

Hi. Thanks. Just a couple more follow-ups. Back to Jim on some product questions. Just update us on where you are relative to the product release schedule you last gave at the user conference and at the last analyst meeting. I think Dick mentioned that Windchill 8 goes in June, or at least the new Pro/I module But I think the last stated target was for this month for Windchill 8. If you would comment on that and on Wildfire 3.

Yes, I can. We delayed the Windchill 8 release by about six weeks. That was based on a beta program we did with customers. Got some feedback and decided to do a round of iteration to incorporate some of that feedback so that we could have an even better product. That pushes the announced date from right about now to June 6th, where we're going to launch it on an opening morning of our User Group Conference. Product looks pretty good. We're pleased about it. Customers are pleased about it. With respect to the Wildfire 3, we continue to track to the same dates, which are sort of late summer, early fall, that I think we've given you in the past.

Okay. Now you once had a plan in the past to have a set of multiple links. Now you have the two. And you've been putting more functionality in those two. Do you think you'll ever go back to having more than just ProjectLink and PDM Link, or is there plan to basically stuff more and more into just those two.

Actually I have a pleasant surprise you for. The product formally known as PartsLink, which we didn't promote that much, because at the time it was a separate database, and then we kind of realized that that strategy was somewhat of a nonstarter. In our Windchill 8 solution, we have reimplemented that into our single consistent architecture, so we're relaunching PartsLink coincident with Windchill. So in Windchill 8, PDMLink, ProjectLink, Pro/INTRALINK and PartsLink all share the same common database.

There's a number of other modules, and so forth, including some new ones that we'll be releasing with Windchill 8. Some new functionality for EML AVL, which is an approved manufacturer list, approved vendor list, which is very important in high tech environments. We're launching some new derivative products based on our Ohio acquisition of approximately a year ago. That helped companies achieve a deeper level of ECAD, MCAD, and ECAD PLM integration. Let's see what else?

We're launching a new interface to software source code management tools. Such as Clear Case. We'll be announcing all of this at our User Group Conference. And some of you who are at the analyst conference might get to hear those announcements as well. But anyway, this Windchill 8 release is a great release. Performance looks good. Functionality looks good. Customers who have looked at it are excited. It's got a lot of new capabilities in there. It consolidates all of our product line on this single one - - this one single architecture. And we're pretty excited about.

How much of the base is now on Version 7, Jim?

I couldn't give you that statistic. Just don't have it.

Okay. Lastly, for Dick on the sales and distribution side. Ultimately how big do you think the reseller channel can be for you? You said it's 20% now. You do - - still seems somewhat less business in the channel than your direct peers in that market. But given - - we think a fairly finite business of reseller, how much more business do you think you can add in that part of the channel?

Gee, I think it can actually continue to grow pretty nicely. I mean 25 to 30% of our revenue as we move towards this billion dollar number in '08? I don't think is unreasonable at all. We have to see how they do with the links and so forth. You know the channel for us, maybe vis-a-vis our peers, is a newer business in that we were predominantly direct there. And then you migrated from a single-channel partner to a more - - to the one we have today, let's say. So there's a lot of enthusiasm there. I know you check with them. I think as you do you'll get good feedback from them. We listen pretty closely to what they want. And I think we're going to continue to see our own direct sales force focused on the largest accounts. And more and more space will be opened up for the channel. If you really factor in the maintenance and the fact that our channel only sells to companies, let's say less than or equal to 250, 300 million in annual revenue? We compete pretty well, vis-a-vis our competitors in the same space. At least as well as they do. So, you know, our - - the competitors that you're talking about are selling their products everywhere, to large accounts, as well as small accounts. If you take the revenue, including maintenance, just in that sub-250 million line, we're competing pretty effectively today. I think it's going to grow.

Dick, thanks. See you in Orlando.

We have time for one more question.

Our last question comes from Tim Fox, Deutsche Banc.

Hi, Tim.

You may ask your question, Tim Fox.

Sorry. Just a quick follow-up on the Windchill data. Dick, you may have addressed this a little bit early . But your - - the percentage of revenue from existing customers ticked down seats when, went up significantly. ASPs actually seem to be fairly flat. I'm just wondering if you could talk a little bit about some of the dynamics there. Is it because of the reseller channel already starting to contribute or some of the OnDemand products? Where's this strength coming from in the Windchill seats?

I think the percentage of Winchill from existing customers was 81% this quarter, versus 88% or 89%, a run rate for the past three quarters.

Yes.

Tim, I do think that we're having a little bit of strength in terms of the selling the Links product into the channel. I think that's helpful. I think also, you know, in terms of new customers, we've talked about the fact that our focus has been primarily on our existing customer base, because we've got a large untapped opportunity there. But we're also selling into some different verticals today, which are basically new customers for us, and I think Meredith touched on that a little bit earlier. I think that's also helping to drive that number down.

A testament to the new sales capacity that you're putting online?

Yes. Plus the success we've had quite frankly in the medical products area and also in the footwear and apparel area, which we've talked to you about. We're picking up new customers in those areas and that's helping drive that number down.

I think we also had some pretty good Windchill performance in Asia pack, particularly in Japan.

Very good performance in Asia-Pacific. After the MCAD business was down and the Windchill business was up significantly.

So, which is a huge market for us. We'll talk more in the coming quarters about this whole distributed engineering, global product development environment. If you saw software jobs move offshore in the last 3-4 years, you're going to see mechanical engineering, drafting, tech pubs, simulation, those things are going offshore. At an even faster rate, because there are more of them. It's going to drive infrastructure that's going to support collaboration and this whole offshoring. We saw a pretty good response in the whole Asia pack market.

Thank you. That's helpful.

Thanks a lot for your time today. We'll look forward to talking with you again in early July. Thank you.

Thank you.

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