PTC Inc (PTC) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to PTC's third quarter fiscal 2006 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 now like to introduce Meredith Mendola, PTC's Vice President of Corporate Communications. Please go ahead.

Thanks. 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, EVP 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 might differ materially from the results projected in these statements. We refer you to the risks detailed in the Company's 2005 Annual Report and Form 10-K, our Q2 2006 10-Q and in the Company's other reports filed with the SEC from time to time. A replay will be available until 5:00 p.m. Eastern, Monday, July 31st at 203-369-1034. Additionally, this conference call is being Webcast and a replay will be available through our website at www.ptc.com until Monday, July 31st at 5:00 p.m. Also on our investor website, you will find a document with Q3 financial and operating metrics, which we will discuss on this call. After our prepared remarks, we will hold a Q&A session. In order to keep this moving, please limit yourselves to one question and one follow-up. If you have an additional question, you will need to get back in the queue. I will now turn things over to Dick.

Okay, Meredith, thank you. Good morning, everyone. Thank you for joining us today on our third quarter 2006 earnings call. As you can see from our announcement this morning, we exceeded our expectations for both revenue and EPS for the quarter. We grew 20% year-over-year in the third quarter and 16% for the first nine months of the year. We continue to grow across our product categories and lines of business. I'd like to highlight some of the important results from the quarter. Q3 was the highest total revenue and license revenue quarter for PTC in five years. Our organic business has accelerated beyond 10% year-over-year growth and our acquisitions are becoming increasingly important as competitive differentiators. License revenue during the quarter grew 33% year-over-year and has grown 20% through the first nine months of 2006 versus the same period last year. This is outstanding performance. It was the result of an increased number of large deals as well as growth in our base business. Our competitive win rate has improved, which has led to an acceleration of our new customer count. And our performance in existing accounts has also improved as we move more and more customers down the path from stand-alone Pro/ENGINEER to the full product development system.

In Q3, we delivered a record Enterprise Solutions quarter for the third quarter in a row. Organic Windchill revenue growth is outpacing the overall market growth for Data Management and Collaboration Solutions. We believe this is the result of several factors. First, overall customer PLM spending has improved. Second, we are executing well in our existing customer base and seeing strong benefit from our decision to tightly integrate Windchill with Pro/ENGINEER. Third, in addition to our tight integration to Pro/ENGINEER, Windchill continues to benefit from its openness and integrations to competitive CAD offerings. It has helped us win many accounts and programs where a competitive CAD tool is used or there is a multiCAD environment.

We also had an outstanding Desktop Solutions quarter. Desktop Solutions grew 14% year-over-year and we continue to capture market share from our competitors. We saw strong Pro/ENGINEER revenue from large accounts and continue to see good results from the small and medium business market segment. This underscores the success of Pro/ENGINEER Wildfire as a vehicle for invigorating our existing base and capturing new accounts. Our sales productivity continues to improve. The transformation of our distribution model continues as we grow our channel around the world. This allows our direct sales reps to focus on large accounts and we have successfully added new offerings without increasing our direct rep headcount significantly. Our services organization also continues to improve its profitability. We have improved utilization and revenue mix from higher margin service offerings. Together, our sales productivity and services profitability improvements helped drive our 16% operating margin in Q3. These are a few of the key factors to achieving our longer-term operating margin goals of 20%.

Additionally, we closed another deal under our new agreement with IBM. This one was with the largest aerospace manufacturer in China, AVIC1 Commercial Aircraft Company. In a highly competitive selection process against our largest competitors, AVIC has chosen Windchill for its ARJ21 program, a series of regional aircraft for the Chinese market. PTC was selected based on Windchill's capability footprint and web-based architecture, our local technical support and implementation teams, and strong references from other large aerospace customers; particularly Airbus. This Windchill implementation will be the first configuration management system to be deployed in the history of the Chinese aviation industry.

To recap the highlights, we had an excellent quarter by almost every measure. It is clear to us that our strategic efforts of the past several years in R&D, sales and services are benefiting us. I'd like to share a customer story from the quarter which illustrates the power of our differentiated solutions. Festo is a leading maker of industrial automation and controls with over 11,000 employees, an annual revenue of EUR1.4 billion. Festo began a vendor selection process about a year ago for CAD standardization. Festo has engineering teams and suppliers around the world that contribute to the development of 23,000 products and several hundred thousand product variance. Each of these products and variance add complexity to the product development process, as well as the process for delivering technical documentation. In the middle of its selection process, Festo determined that CAD standardization would help improve engineering productivity but wouldn't solve all of the challenges it faces as a growing business. As a result, Festo expanded its requirements to select a system that would help fuel innovation and global collaboration while at the same time controlling key content and processes. In the end, Festo chose to work with PTC because of the strength of our solutions and our differentiated vision for the development of integrated products and technical documents. This is a customer that we may not have won without an integral product development system, including Pro/ENGINEER, Windchill and our Arbortext Solutions.

Our performance during the quarter and first nine months of the year gives us increased confidence that we have the right strategy and are executing well. Though investors seem to have questions about the economy and software spending, our own experience in pipeline indicate a healthy environment. Our customers have increased their PLM spending both in absolute dollars and relative to overall IT spending. Our market is growing and PTC is growing even faster. Whether we include acquisitions or not. We are enthusiastic about our opportunities in the fourth quarter and on the road to achieving our 2008 goals of 1 billion in revenue and 200 million in non-GAAP operating margin. With good execution, we should continue to deliver strong results for both our customers and shareholders. I will now turn the call over to Neil for details on the quarter and our guidance and I look forward to taking your questions in a few minutes.

Thanks, Dick. And good morning, everyone. First I'd like to spend some time providing some color on the third quarter and our year-to-date financial performance. And then next I will follow-up on our outlook for the remainder of the year and then we will open up the call to questions. As Dick mentioned, we achieved 20% year-over-year revenue growth and 28% year-over-year non-GAAP operating income growth during the quarter. Our organic revenue growth accelerated to double-digit growth, as well, with strong performance from both Pro/ENGINEER and Windchill. Our non-GAAP operating margin increased to 16%, which means with good execution in the fourth quarter we'll achieve our goal for the year of 15-plus percent operating margins. Our non-GAAP EPS was $0.26 in the third quarter, a 30% improvement over the third quarter of last year and was $0.62 for the first nine months of 2006. Currency had a negative year-over-year impact on EPS of $0.01 for the third quarter and $0.07 for the first nine months of the year.

Total revenue for the third quarter was 217 million with a year-over-year growth of 20%. For the first nine months of 2006, revenue grew 16%. Holding currency constant versus the same periods last year, our revenue grew 22% for the quarter and 20% for the first nine months. Our line of business, our revenue breaks down as follows: License revenue grew 33% year-over-year to 66 million in the third quarter and for the first nine months of 2006, license revenue increased 20% over the same period last year. The accelerated growth we experienced in license revenue was across both Desktop and Enterprise Solutions and was attributable to an increased number of large deals, an increase in base business, and the addition of Arbortext and Mathsoft. Third quarter consulting and training services revenue grew 26% year-over-year to 56 million. And for the first nine months of 2006, services revenue grew 30%. This growth is attributable to improvements we have made in the business to grow training revenue and increase consulting bookings, as well as to the addition of Arbortext.

Our third quarter maintenance revenue grew 9% year-over-year to 95 million. Maintenance revenue grew 7% in the first nine months compared to the same period last year. This continued growth reflects improvements in coverage rates which inturn relate to the increased value we are providing our customers for their maintenance dollars. By geography, our revenue was as follows: North America delivered 37% year-over-year growth to 91 million and six of our top-10 deals were in North America this quarter. We grew across all lines of business with contribution from our organic business as well as acquired companies. And for the first nine months, North America revenue was up 30%. European revenue grew 8% year-over-year or 12% at constant currency to 72 million. Two of our top-10 deals came from Europe this quarter. European revenue growth was attributable to strong services performance, solid channel revenue growth and the sales of our newly-acquired solutions. And for the first nine months, European revenue grew 11% or 17% at constant currency versus the same period last year. Asia-Pacific revenue grew 13% year-over-year or 16% at constant currency to 54 million in the third quarter. Two of our top-10 deals were in Asia-Pacific and growth in this region came primarily from outstanding performance in the Pacific Rim, which grew 40% year-over-year. And this performance more than offset a 9% year-over-year revenue decline in Japan and the revenue decline in Japan was 3% at constant currency and represents an improving trend over the past two quarters. For the first nine months of the year, revenue in Japan is down 13% year-over-year or 5% at constant currency and the Pac Rim is up 27% year-over-year for the first nine months of 2006.

Our third quarter retailer revenue was 46 million, up 28% year-over-year, reflecting continued success in selling our products to small and medium businesses. The channel grew across all geographies including Japan. The retailer channel represented 21% of total PTC revenue during the quarter and for the first nine months of 2006, the channel delivered 20% growth versus the same period in 2005 and represented 20% of our total revenue. During the quarter, we had 16 large license and service revenue transactions over 1 million each for a total of 36 million. This was up significantly from the year-ago period in which we had eight large revenue transactions for a total of 17 million. For the first nine months of the year, our large revenue transactions have contributed 89 million in revenue. Which is up from 60 million for the first nine months of 2005. The average size of these transactions has increased just slightly, which indicates to us that our competitive win rate and customer adoption are driving this number as opposed to a heavy reliance on a few large customers. As further evidence of this trend, our top-10 customers represent only 13% of total year-to-date revenue. Okay, let's move on to our product categories.

Third quarter Desktop Solutions revenue was up 14% year-over-year to 144 million. And for the first nine months of the year, Desktop Solutions grew 8%. It is clear to us that this line of business is not only healthy and sustainable but that our organic Pro/ENGINEER business is growing faster than what we expected. The highest growth in Desktop Solutions for the quarter came from license revenue, which grew 30% compared to the same period last year to 44 million. License revenue growth for Desktop Solutions came from closing large deals and from success in the channel. A key contributor to desktop license revenue this quarter came from sales of new high-end seats and upgrades to global licenses in our installed base. For the first nine months of this year, Desktop Solutions license revenue grew 14%. Desktop Solutions consulting and training services revenue for the quarter was up 15% year-over-year to 23 million. And for the first nine months of the year, Desktop Solutions revenue was up 12%. Both Q3 and year-to-date Desktop Solutions revenue growth for services is due mainly to increased training revenue. And finally, Q2 desktop maintenance revenue was up 6% year-over-year to 77 million. For the first nine months, desktop maintenance revenue was up 4%. This revenue stream continues to grow at a healthy pace and we are particularly pleased that we have recently begun to improve renewal and coverage rates in the Pacific Rim, the geography with the lowest historical maintenance contribution.

Okay, moving to Enterprise Solutions revenue, our third quarter Enterprise Solutions revenue grew 34% year-over-year to 73 million. As Dick mentioned earlier, this was the third quarter in a row in which we achieved record Enterprise Solutions revenue. For the first nine months, Enterprise Solutions revenue was up 37% and both the Q3 and year-to-date numbers reflect significant organic Windchill revenue growth. The revenue contribution from the Enterprise Solutions product category was 34% of total revenue for both the third quarter and the year-to-date. Up from about 30% last year. Enterprise Solutions license revenue was 22 million, up 41% year-over-year. Large deals contributed to this growth as did the Arbortext Solutions. For the first nine months of the year, Enterprise license revenue was up 34%. Third quarter Enterprise Solutions consulting and training services revenue grew 35% year-over-year to 33 million and for the first nine months, our Enterprise Solutions consulting and training services revenue grew 46%. This growth is due to increased services bookings as well as the addition of Arbortext. And for the third quarter, Enterprise Solutions maintenance revenue grew 25% year-over-year to 18 million and also grew 25% for the first nine months, as well. These numbers reflect implementation success and subsequent strong customer adoption of our solutions. Now, I will move on to our expenses.

Our third quarter non-GAAP operating expenses were 182 million, slightly above our guidance but the added expense came with significant added revenue. Non-GAAP operating margins were 15.9% in Q3, up from 14.9% in the same quarter last year and for the first nine months, operating margins were 13.8%. As you know, we made investments in the first half of the fiscal year to help drive accelerated revenue growth. Those investments are now paying off and will drive further revenue and margin growth in the fourth quarter. Our third quarter non-GAAP expenses include several -- excuse me, exclude several items: 10.1 million of stock-based compensation, 2.8 million of acquisition-related intangible asset amortization, 5.9 million of net restructuring for consolidation activity from past acquisitions and the streamlining of our management structure, and 2.1 million of in-process R&D related to the acquisition of Mathsoft.

Moving on to the balance sheet, our cash balance ended at 174 million, down from 224 million in the second quarter. We used 64 million in cash for the acquisition of Mathsoft, including associated fees, and 10 million for a tax payment related to a settlement with the IRS. This settlement and payment resulted in a release of tax reserves which provided a $6.1 million benefit to our GAAP tax provision. We have excluded this benefit from our Q3 and year-to-date non-GAAP net income presentation. DSOs in the third quarter were 68 days compared to 67 days last quarter and 65 days in the same period last year. And the increase in accounts receivable is due to the addition of Mathsoft accounts receivable as well as the effect of currency movement. And deferred revenue was 232 million, flat versus the second quarter. Organic deferred revenue was seasonally down as expected but the acquisition of Mathsoft and currency movement offset this seasonality this quarter. Deferred revenue actually grew 30 million from the same quarter last year due to maintenance revenue growth and the acquisitions of Arbortext and Mathsoft. Okay. Now let's turn to our outlook.

Just to reiterate, we have seen the investments we made in the first half of the year begin to pay off and we have good visibility into next quarter. Our guidance for the fourth quarter of 2006, which ends on September 30th, is as follows: Revenue of 217 million to 225 million, which represents 11 to 15% year-over-year growth. As a reminder, PTC acquired Arbortext in the fourth quarter of last year, so the fourth quarter of this year will reflect more of an apples-to-apples revenue comparison than we had earlier in the year. On a GAAP basis, fourth quarter total costs and expenses are expected to be between 193 and 198 million and earnings per share are expected to be between $0.15 and $0.19. We expect non-GAAP operating costs of 180 to 185 million, consistent with our performance in the third quarter, and we anticipate earnings per share on a non-GAAP basis to be between $0.26 and $0.30. The non-GAAP operating costs exclude the following estimated costs and expenses in the fourth quarter: About $10 million of expense-related to stock-based compensation and about 3 million of acquisition-related amortization expense. So, our revenue and EPS guidance for the fourth quarter implies non-GAAP operating margins of between 17 and 18%.

With respect to other below the line items, we expect other income to be fairly insignificant for the fourth quarter. We anticipate taxes to be approximately 8 million and we expect diluted weighted average shares outstanding to be somewhere between 113 and 114 million shares for the fourth quarter and full year. Okay, so, what does this guidance mean for the full year? Well, based on our performance for the first nine months, our full-year expectations are as follows: Revenue of 826 to 834 million, which represents 14 to 16% year-over-year growth. On a GAAP basis, full year EPS is expected to be between $0.46 and $0.50. And we expect non-GAAP EPS to be between $0.88 and $0.92 for the full year. And once again, the non-GAAP operating costs exclude the following actual or estimated items: About 30 million -- $39 million of expense related to stock-based compensation, approximately 10 million of the acquisition-related amortization expense, the write-off of in-process R&D of 2.1 million that we recorded this quarter relating to the Mathsoft acquisition, the restructuring charge of 5.9 million recorded this quarter, and the income tax benefit of 6.1 million we recorded this quarter.

Okay, in summary, we hope you share our excitement about our performance in the third quarter and the first nine months of 2006. We are confident in our outlook for the fourth quarter and in our ability to achieve our longer-term goal of 1 billion in revenue and 200 million in non-GAAP operating income by 2008. Thank you for your time today, we look forward to your questions, and at this point I'm going to turn the call back over to Meredith.

Great, thanks Neil. Okay Laurel I think we're all set for the Q&A.

Certainly. [OPERATOR INSTRUCTIONS]. Our first question comes from Richard Davis. Sir, your line is open.

Thank you very much. With regard to the Arbortext and I guess to a lesser degree Mathsoft, I remember -- I think Arbortext you had a combined product starting in April. Could you just talk about -- I mean at least in general purposes, how the pipeline has changed with those two products in your pipeline? And how it feels? Because obviously you had some optimism and you executed well this quarter, but the real question is just kind of how does that feel, like it's layering out for the balance of this year and then hopefully into next year?

This is Jim. I will take the first cut at it. Maybe Dick wants to add some color. So, first of all, having the combined offering is sort of a prerequisite to get some of the leverage that you really want to get out of the acquisition. So, in the case of Arbortext, I believe it was May that we delivered the integrated offering and in the case of Mathsoft, it's really August. That is to say next month, that we will deliver the integrated offering. So, I think in both cases that represents an accelerator or the point at which the leverage starts to really kick in. The business feels a little stand-alone prior to that point and it feels like part of an integrated solution after that point. So, I think it's already helped us in terms of the pipeline with Mathsoft -- I'm sorry, with Arbortext. And we expect the same kind of behavior to start shortly with Mathsoft.

Got it. And then Windchill was a little better than I expected. Is it fair to say that with MatrixOne being swallowed, agile continuing to kind of wallow around, is it fair to say that the kind of the integrated solutions seem to be winning, where you can kind of say look, we have got soup-to-nuts? It's all integrated and it's a single back end. Does that -- I mean it seems like that's what's happening. Is that a fair categorization?

I think that's a perfect categorization. And to make the point, integrated solutions seem to be winning. I think we're the only ones who seem to have an integrated solution. Dassault doesn't even claim really to have integration, other than they're hiding the Matrix product, the ENOVIA product and the SmarTeam product behind the same family brand name, called ENOVIA. But other than that they're not integrated. And I think the reality is the SmarTeam -- I'm sorry, team -- the realities of the UG/TeamCenter solution, not really being integrated. There is no center in TeamCenter, that reality is starting to catch up with them a little bit. So, I think that the desire to have a truly integrated soup-to-nut solution is definitely the number one underlying factor driving our Windchill performance.

Got it. Okay, great. I will turn it over to other folks. Thanks very much.

Thanks, Richard.

Jay Vleeschhouwer, your line is open.

Thanks. Good morning. Question first about the quarter, you had a good sequential increase in desktop license revenues, but pro units were down sequentially, by a couple of hundred anyway. Did you see a significant and perhaps even sustainable increase in ASPs in the quarter to have driven that desktop license number sequentially? And are you seeing an abnormally-high level of modules being added back into the base?

Well, Jay, basically we had pretty good performance, in particular, on the high-end seats and one module sales and upgrade sales, as well. So, one of the things we've been seeing a little bit this year more of, in particular this quarter, was consolidation in some large accounts where they might have had multiCAD environments. And a little bit back to Richard's question about the integrated Windchill story -- I think customers -- I know they bought more Pro/ENGINEER, particularly in the high-end accounts than more recently, and there was some competitive displacements up there, where they bought the value of this product development system story. So we got some pretty good leverage both on the enterprise and the desktop because of that combination. And I think we're going to see more of that.

The ultimate benefit, when we talk about an integral story, a common data model and so forth and the integration with Pro/ENGINEER is that our solution is easier to use and easier to deploy for the customer, so there is a faster return on investment, a faster impact on their business. That's really what's driving sort of the acceleration in our growth right now. Windchill 8.0 came out about a year ago and we've been building some good whip during the course of the year. I think we talked about that at the user group meeting back in June that we started to see some real acceleration in the whip and these combination deals. And we see the same thing for the fourth quarter and even potentially into next year.

You mentioned, Dick, that PLM spending is growing. Which corroborates something we've seen, as well, in some of the surveys we've done, but it's an interesting question because if there's this dichotomy developing between the value of integrated systems versus unintegrated or poorly integrated, why would the spending for the latter grow at all? And hence spending for the whole category grow? I mean wouldn't it be more likely that the nonintegrated solutions would be, let's say, flat rather than seeing spending improve at all. And so maybe you could just sort of explain, as you see it, why total spending is improving, even though there is a growing disparity between the value of different kinds of systems?

Well, I think that if we go back to some of the themes that we've been talking about -- and I know you hear it from a lot of other places -- this whole concept about 24-by-7 ENGINEERING or the globalization of product development is an absolute reality. And big companies and medium-size companies are not going to win if they don't go offshore. So, the requirement to manage that engineering, building material, the product structure, the versioning and all that, that is more critical today than ever before. And I think that's what's driving the spend.

Customers have been in in the last couple of weeks and it's the same theme. They're opening offshore design centers to go along with their manufacturing centers and they need to connect people, in a much more powerful way. I think that if you just think about it logically, if you don't have -- if you have an integral story with a common database and no gateways like we have, that's a much easier system to deploy than the ones our competitors have with multiple data models and multiple gateways. Gateways are cause for concern, lost information and more difficult to use. So, our competitors have good products and they have big installed bases and they're going to continue to see their revenue grow. It's just that I think that ours is growing at a faster rate right now because of the [user use] implied in our solution.

And then lastly, how far along is IBM in ramping up its resource commitments for your relationship with them? Was the growth you saw in Pac Rim predominantly attributable to their now working with you in that region, backfilling for Dassault?

No, I wouldn't say that, Jim. I mean I think the relationship with IBM is strong and it's important to us. And, again, we just started that in January and IBM is a big company and it takes time to sort of train the people and so forth. And the relationship is solid. We've added some additional territory since we first signed the contract to include Latin and South America and Taiwan, for example. But really most of the growth came from our direct sales and indirect channels. And the IBM part is growing, but I'm going to comment more about that, I think, as we get into next year.

Okay, thanks, Dick.

Tim Fox, your line is open.

Thank you. Good morning. First question was around your channel and the continued success there. I was wondering if you could talk a little bit about what do you think that is driving the success in the channel and whether or not at this point Windchill is becoming a more meaningful part of those revenues? I know that the discussions we've had with some channel partners is that they're very excited about that pipeline, but we had the impression that it's going to be more later calendar year '06, early '07. If you can just talk about that channel a little bit it would be helpful. Thank you.

Yes, Tim, it's Neil. What's driving the success of our channel this year, the primary driver, I would say, is what we've done in Asia-Pac. So, we had tremendous growth in Asia in the channel, in the most recent quarter. Particularly in the Pacific Rim. Very strong growth for our reseller revenue. And I think we've mentioned previously that we have in the past couple of years kind of built out our channel in North America and Europe more aggressively, but really hadn't made those same kind of inroads in Asia-Pac. And now we're starting to make those inroads and we're seeing the results.

In terms of the second part of your question, in terms of how meaningful is Windchill contributing -- in terms of contributing to channel revenue, of our 300 or so plus channel partners, still only about 50 of those channel partners actually sell Windchill today and are trained to sell Windchill. And it represents a relatively small revenue contribution for PTC -- or it will represent a relatively small revenue contribution in this fiscal year. We think it's a big opportunity down the road, but it's a relatively small contributor to the growth of our channel today.

Okay, that's helpful. And now the second question was around Pro/INTRALINK. At your user conference you talked a little bit about some of the statistics about who had converted the percentage of the base that had moved to 8.0. And then the percentage of the base that had actually moved to a full Windchill offering, which, obviously, includes an incremental license opportunity. Any update there on how that conversion has taken place? Is it -- is the conversion happening at the pace you expected? And if you have any particular penetration numbers at this point, that would be helpful.

Yes, just to reiterate for people who don't have that data, I think if I remember correctly we said about a third of our customer base by the end of the calendar year would have made the migration to the Windchill base Pro/INTRALINK software. I feel like that's as good or probably slightly better than we would have forecasted. And then we said that 40% of them were doing an upgrade move and 60% were doing a lateral move. So, there was an incremental license sale involved in 40% of those customer moves. And, again, I think that's probably better than we would have forecast as well because the 60% who do the lateral move may subsequently do a license upgrade, as well. So, it feels like that program is going pretty darn well and a good contributor to our overall success story here.

Great, thank you. Congratulations.

Thanks.

Barbara Coffey, your line is open.

Sure. A couple of questions sort of looking at the success across both the Windchill and Wildfire is -- are you seeing in the combined accounts -- what kind of sales cycle is this? And are you working with partners on this or is IBM helpful or are there other partners participating in any of these deals?

Well, the -- I don't think the sales cycles have changed much -- I wouldn't say they've changed much. And they sort of depend on the size of the account and the opportunity. I think that's been pretty consistent. In terms of the partners, I mean we're more partnered with IBM in some of geographies that we've described, which really today China is the principal geography. And so we have got some good partnership activity going on with them.

We do, from time to time, work with other partners on what I'd call just sort of named-to-account opportunities, where our partners are invited to come in and participate and help out the end user in a decision. But by and large most of our -- for example, the larger deals that we talked about, the 36 deals over a million -- 16 deals over a million for 36 million, generally that's not driven by partners. That's our direct sales force.

Okay. And as you were saying, are you -- is your pipeline of accounts sort of becoming more active because of this urgency of -- over geographic expansion? Or is there something sort of that you can point to as -- is that what I should be looking at as the reason for sort of continued growth in this?

Well, -- yes the other point, certainly that's one thing. The other thing is our solutions have become easier to use and deploy. And so that's resulting in faster customer adoption. We actually talked about, in the June user group meeting with the whole group there, we talked about the visibility we saw on large accounts. I don't know if anybody believed us, I don't think you really did given sort of the reaction, but we specifically said there that we saw a pretty big increase in the pipeline and it came true. We see the same kind of thing for the fourth quarter.

If I could just add a couple of comments -- I think what's happened is this discussion moves to global product development, is PLMs -- we stopped talking about something that would be nice to have and we started talking about something that's critical to have for survival. And that's a more interesting discussion. So I think people see this solution as not optional but required. And then they like the strength of PTC's products and now they see the financial strength. And it just -- it helps to keep things moving forward either as expected or potentially to even accelerate the overall business.

Okay, that's helpful.

Our next question comes from Yun Kim, your line is open.

Thank you. First, congratulations on a strong quarter. The desktop license revenue was very strong in the quarter and there seems to be a strong momentum there. Do you think this momentum can be sustainable into the fourth quarter and just wondering was there a one-time catalyst that happened in the quarter, like a one large deal that drove some of this strong performance? Basically because it was so strong, I'm not sure how the desktop license business should perform sequentially in Q4, up or down. Thanks.

There really was no -- there was no single large transaction in the deal that I would say exceeded 3.5 or 4 million in license revenue. So, as we noted in the report, there were 16 transactions that accounted for 36 million in deals over 1 million. So, there were no real huge transactions. It was just sort of across-the-board.

We're capturing market share in the high end. If you look at CATIA and UGNX we are growing at a much faster rate than both those companies' products. And they're good products, but we're winning today. I'm not sure it's sustainable at the same growth that we had last quarter. It was a pretty nice quarter, but there's a lot of momentum and a lot of activity for Q4 and for the foreseeable future around this whole story about this integrated product development system. And it's really sort of paying off for our customers. We have great reference accounts and that's really adding to the overall value of the sale.

Thanks. And Neil, besides the higher commission in the quarter, was there anything that drove the operating cost a bit higher than what you were expecting for the quarter? And then also, can you give us some insight into the services margin? Since like the consulting margin improved but overall services margin didn't really improve that much, just wondering what are some of the dynamics going on there? Thanks.

First of all, higher commissions was the largest contributor to our spending increase associated with the incremental revenue. And then secondly, on services margin, our services margins were about 15% for the quarter, just -- our net margins, that is, just to put that in perspective. Those margins three years ago were 3%. Though we've had a significant improvement year-over-year every year in our services margins. And they're currently kind of parallel with our overall operating margin rate and we hope that we can continue that trend.

Okay, great. Thank you. Great quarter.

Thanks.

Philip Alling, your line is open.

Thanks much. Question with respect to revenue from larger deals -- obviously, you know that was unmaterially in the quarter. Could you give us a sense, really, as far as the visibility you have on revenue from large deals going forward? And should investor expectations be that that's going to be a more meaningful percentage of your total revenue in subsequent quarters?

Yes, Philip, it's Neil. I can't tell you the Q3 from our large deal perspective is repeatable, but we definitely see a lot more large deals in the pipeline than we did a quarter or two quarters ago or certainly last year. So -- and when I say large deals, to Dick's point, we didn't have any 5 or 10 million deals this quarter, so, we're talking about deals that average somewhere between 1 and 3 million. And I think the trend is going to continue that they become an increasingly important contributor because I think that generally speaking IT spend for PLM is on the rise and that's going to be manifested in more large deals for PTC.

But we also had, Philip, really good performance in the channel and in just the base business across-the-board. So I don't want to discount that and say that the quarter had the upside only because of the large deals. It was really across-the-board, that performance. But the Q is nice and Arbortext is helping drive that. The broader footprint that we have, the commitment to this integral story and the associativity where you can now take a CAD model and embed it in a technical document and make it associative. These are things that customers cannot do today. That solution doesn't exist from any other supplier and that vision is driving sort of a sense of confidence I think on the customer's part that's compelling them to invest in our solutions.

Well, Dick, I appreciate additional color there. Just with respect to following on there as far as the channel is concerned, your numbers were up strongly there also in the quarter. But could you give us a sense about what impact the Mathsoft acquisition may have had on the channel revenues because presumably most of those sales are going to go through the channel?

Yes, the Mathsoft helps. Remember, we only had Mathsoft for two months out of the quarter. And it was sort of going through a little bit of a transition phase. So I wouldn't say that it helped dramatically, but it did help that definitely is a channel product. And a nice one.

Philip, our revenue growth in the first two quarters of the year without Mathsoft in the channel was 16 and 18%. This quarter it was obviously 28%. So you could probably assume that we did as well or better on organic and then we had some nice uplift as a result of the acquisition, as well. [multiple speakers].

All right thanks, Meredith, and just a final question from me, then, is with respect to the CAD seats sold in the quarter, could you give us -- you have in the past given us the metric there about the percentage that were -- foundation package, -- what was that in the quarter, please?

I don't have the percentages right in front of me. We had about flat performance from a seat perspective with the low end. So, as good as we've been doing, which has been very good. And then the higher end seats, we saw kind of come in a little bit more there. A lot of what was driving those, the license revenue, was upgrade revenue, so, people that were on a $5,000 package that upgraded to a 13 or $20,000 package or module, right, Mechanica and all the great modules that we sell along with Pro/ENGINEER. So, growing that customer footprint, when we capture them with a $5,000 seat and sell more to them over time that was one of the big drivers of the license revenue growth.

But presumably, given the strength at the high end, the foundation package represented a corresponsively smaller percentage of seat sales?

Right, smaller than it had. In the last couple of quarters I think it's been like 85%. So, maybe back down to 80% or so.

Good enough. That's what I have for now, thanks.

Before our question from Sasa Zorovic, I'd like to remind parties, *1 should you have a question, please. Sir, you may go ahead with your question.

Thank you. So my first question would be to update us, obviously, I guess the business in Japan has started to turn around. But if you could update us with the status there and also you have a manager for the country now on board?

So, we have a number of candidates that are -- have been going through the process and we do have one in particular that I think -- I would say we're close to. You always have to be a little bit careful in terms of concluding that deal because things can happen. But we made a lot of progress there. And we're not happy with the Japan performance, although it's been improving quarter-by-quarter in terms of -- the decline has been smaller and smaller. And in a constant currency basis, we were actually pretty close to year-over-year performance in Q3.

The other thing, Sasa, is that there have been a number of other companies that have had some disappointments this quarter and even ones that did okay. And just about all of them have pointed to the fact that Japan has been a difficult market. So, I think that some of the issues that we've seen there are related probably to our own execution and some of them are more macro, with respect to the economy in Japan and spending and things like that.

Okay. And then I guess my follow-up question would be regarding your use of the cash, any plan for the buybacks here or it's all still being kept for acquisitions?

Well, our current transaction -- this is Neil -- is to keep our cash and use it for acquisitions that we think make a lot of sense for the Company. We do discuss the issue of share repurchase from time to time, discuss it with the Board, as well. But we haven't made any changes at this point from our previous stance, which is we're using that cash to fuel acquisition growth.

Thank you, I will get back in line with more questions.

Next question?

At this time, I'm showing no further questions. Excuse me, we do have a question. Richard Williams, your line is open.

Thank you. I wondered if you could give us the operating cash flow number in the quarter? And also CapEx, D&A if you have those?

Yes -- hang on one second.

Sure.

Operating cash flow was 14 million in the quarter.

Okay.

And CapEx was 5 million in the quarter.

5 million, okay. And any change in tone of business from your perspective?

In tone of business?

Right.

You mean our level of optimism around the business?

Right.

No. I think -- those people who attended the user conference in June found us to be relatively bullish about our prospects. I think our third quarter results reflect the fact that -- in fact that was the way we felt and for a good reason. And I think we continue to feel that way for the fourth quarter.

Okay. Thanks very much. Good luck.

You're welcome.

Sasa Zorovic, your line is open.

Thank you. So, basically my question would be regarding IBM, you did mention that you are now working with them in, oh, Latin and South America, also Taiwan. If you could update us basically, what potential is regarding some other geographies; for instance, what should we expect regarding those with IBM?

Yes, Sasa, I would -- I don't think there's any additional geographies to talk about right now. I mean I think IBM has their own strategy today about what they want to do in the whole PLM space that they've been working on. And it's a pretty broad strategy for all their product line. It's an exciting strategy. And we're playing a small role today and we will sort of see where it goes. We have to go execute into territories that we're in and we will just sort of see what happens during the balance of the year.

When you mentioned that 21% of your revenue came from the channel, would it be possible for you to break that out by geography?

Not the absolute dollars, but I can give you growth rates.

Please.

So, in North America, our channel growth for the quarter was in excess of 25%. In Europe it was about 20%. In Japan it was about between 5 to 10% and in Asia-Pacific the percentage is so high that it's like meaningless, it's over 100%. [Laughter ]

Great. And then my final question just clarification a little bit about some of the data you provided around the currency impact, as I understand you correctly, it's been about a penny on the bottom line on a year-over-year basis, something around slightly over 3 million on the topline year-over-year. How about quarter-over-quarter where all that ended up?

Quarter-over-quarter, it actually moved in a way that started to benefit us. But that impact was minimal.

Yes, we gave -- the information we gave you, Sasa, was -- the third quarter, year-over-year and the full year year-over-year --.

Year-to-date.

Yes, excuse me, year-to-date. Both of those numbers were a negative impact on the Company. As Meredith said, quarter-over-quarter it's a positive impact, but it's minimal. And it may be more significant in the fourth quarter.

It was a positive impact [inaudible].

So to clarify, basically, you did benefit current quarter-over-quarter. On the topline you had a positive impact on the topline as well as on the bottom line from currency, correct?

That's correct.

But it had a negative impact sequentially on expenses.

And that sort of sequential positive basically impact was negligible meaning like $1 million, not more than that, roughly?

Right. Meaning that the net offset between the positive revenue and the negative expense was --.

Insignificant.

-- insignificant.

So, the impact between the two -- how about just the topline impact?

Sequentially, it was favorable by a little bit less than 4 million.

Great, thank you very much.

Okay, well, thank you all for the time this morning. And we have -- we do feel like there's some real good momentum in the business. The customers are pretty excited about the products. Turnover is almost nonexistent in the sales force, in particular, which is always a good sign in terms of their feelings about their prospects as we head into the fourth quarter. And we'll look forward to getting together again in early November. Thank you.

That does conclude today's conference call. Thank you all for participating.