PTC Inc (PTC) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to PTC's fourth quarter and fiscal 2006 results conference call. [OPERATOR INSTRUCTIONS]. I would now like to introduce Meredith Mendola, PTC's Vice President of Corporate Communication. Please go ahead.

Great. Thank you, Michele. Good morning, everyone. I hope you can hear me. Participating on the call will be Dick Harrison, our President and Chief Executive Officer, and Neil Moses, our EVP and Chief Financial officer. In addition, Jim Heppelmann, our EVP and Chief Product Officer and Barry Cohen, EVP of Strategic Services and Partners are here to participate in Q&A.

Before we get started I would like to remind everybody that during the course of the conference call we will make projections and other forward-looking statements regarding future financial performance, business trends and other future events. We caution you that such statements are only predictions and that actual results may differ materially from the results projected in these statements. We refer you to the risks detailed in the Company's 2005 annual report and Form 10-K, our Q3 2006 10-Q and the Company's other reports filed with the SEC from time to time.

A replay will be available, if it works, until 5:00 p.m. Eastern Monday, November 6 at 203-369-3183. additionally, this conference call is being webcast and a replay will be available through our website at PTC.com until Monday, November 6 at 5:00 p.m. Also on our investor website, you will find a document with Q4 and fiscal year financial and operating metrics, which we will discuss on this call. After our prepared remarks we will hold an Q&A session. In order to keep this moving, please limit yourself to one question and one follow-up. Thanks for being patient with our technical difficulties at the beginning of the call. Let's get going with Dick Harrison.

Okay. Meredith, thank you. Good morning, everyone. Thank you for joining us on our fourth quarter and fiscal 2006 earnings call. Today I want to talk to you about our progress toward achieving our goals. Then Neil will walk you through the financials in detail and we'll take your questions after that.

During fiscal 2004, we set a long-term goal for ourselves to return to $1 billion in revenue with 20% non-GAAP operating margins by 2008. We also shared this goal with analysts and investors. By that time we had made significant changes to our distribution model and transformed our products. We had just finished a heavy cost-cutting exercise that had not yet begun to grow. Now that we have more than two years into this long-term financial plan, we have completed the necessary ingredients for a a successful financial turnaround. We have healthy organic growth in multiple lines of business, product categories and geographies. We have an operating plan that supports this growth at incremental margins. We have a customer-driven M&A strategy that has helped us to build on our vision for the market and finally, we have a very large growing and happy customer base that increasingly demands our solutions.

So with $855 million in revenue and 15.5% operating margins for fiscal 2006, it seems that we are well past the inflexion point in-- our financial turnaround. We are very confident in our ability to achieve our 2008 goal. I would like to share with you some of the 2006 results that I find most interesting. First, our 2006 desktop solutions revenue grew 12% with organic growth significantly higher than overall market growth. We don't believe there is a fundamental change in the market growth rate, but do believe that we are taking share from our competitors right now. Since our desktop solutions business is still more than 65% of our total revenue, this is very exciting.

Second, we achieved record Enterprise Solutions revenue in each quarter of 2006. Here, too, our organic growth rate is much higher than the growth rate of the market. Third, our license revenue growth of 26% for the full year was a breakout for us. This is a very important measure of our success, although it is likely to continue to be weighted more heavily toward the second half of the fiscal year. Fourth, our performance in North America with revenue growth of 33% is outstanding. We typically see customer trends begin in North America, so we are excited about the potential in other geographies, as we bring our solutions to more and more companies around the world.

Additionally, our 2006 revenue growth in the Pacific Rim was 34%, principally an organic number. China, in particular, has grown from a fairly small portion of our revenue a few years ago to a thriving and significant PTC business. This part of the world is expected to grow as a manufacturing economy for years to come and PTC is well-positioned to capitalize on that growth.

Finally, our operating leverage this year was very good. I believe we can accelerate it even further next year as we work toward our 20% operating margin goal. In our press release, we mentioned three key differentiators that are leading to our success. Our expanding solution capability footprint, our single platform architecture, and our understanding of customer challenges. I would like to describe these in more detail, because I think they are important for the understanding of our market dynamics.

None of these factors can be changed overnight, either for us or for our competitors. In fact, it took us years to gain advantage in the product area and build up the process knowledge that informs our entire customer approach. We have been talking about these factors for years and will continue to improve our offerings in these areas. First, on our expanding solutions set, we have been executing on a very careful strategy to build and buy new technologies that expand our offering in unique ways.

Our acquisitions of Arbortext and Mathsoft are great examples of this. Both of these solutions have become an important part in winning new business versus the competition. Likewise, our most recent acquisition of software is very exciting because it fills the gap in our existing offering. It is a powerful and necessary piece of a complete solution for technical publications. Our customers love these acquisitions.

The second differentiator is our single integral platform, which we completed in 2005. The problem we are trying to solve for our customers is complicated. Multiple point solutions targeted towards multiple pieces of the problem actually exacerbates the problem. Now that we have a broad set of capabilities on a single integral platform, customers are realizing great value from the simplicity of these deployments. More and more we are seeing customers shy away from multiple disconnected applications and years of hidden integration costs. They don't need to compromise with PTC solutions.

And third, our expertise around customer processes is a significant advantage. For years we have built up intellectual property that helps customers in multiple vertical markets realize value in their product development process. This IT informs all areas of our business from sales to services to R&D. It has helped us to prove return on investment for a customer looking to invest in PLM for the first time. It has helped us to improve product development productivity for companies that have been customers for years. It has allowed us to grow our services offerings and profitability, and most importantly, it has driven customer satisfaction to an all-time high for PTC.

Companies that have never accepted an invitation to look at PTC are coming to our headquarters to learn how we can help them realize value through our software and service offerings. And they like what they see. Let me share an example from Q4 that illustrates all three of these differentiators. Dell Computer is the number one provider of computer systems worldwide. A long-standing customer of Pro/ENGINEER and Pro/INTRALINK, Dell has expanded its relationship with PTC during the last year, culminating in its selection of PTC as its new enterprise provider in Q4 2006. The expansion began with Pro/ENGINEER, as Dell made the decision to standardize on our solutions for mechanical computer-aided design.

This was an important validation of the scalability of Pro/ENGINEER. It is powerful enough for sophisticated design and analysis, but it has the ease of use that is attractive to more casual engineers and designers. Then last fall Dell upgraded from Pro/INTRALINK to our new Windchill-based version to take advantage of performance improvements of the new web architecture. In the winter, Dell chose PTC Arbortext solutions to transform its technical publications process. Dell wants to be able to configure its documentation to match each of the millions of custom-configured computer systems it ships annually. With our solutions and process expertise in the area of technical publications, PTC was a natural choice for Dell.

With these key pieces in place, Dell made the important decision in Q4 to purchase Windchill for enterprise PLF. Here, all of our key differentiators came together. Dell determined if by using PTC solutions, it can take a best of breed approach without sacrificing on total cost of ownership, due to the individual strength and breadth of our solutions on a single platform architectures. More and more customers are coming to this conclusion to get the maximum benefit in product development.

To summarize, we had an excellent year measured by financial results and customer success. I want to personally thank our customers, partners and employees for helping us deliver on an outstanding year. Customer spending remains healthy and we believe that PLM is growing as an IT spending priority. We are on track to deliver our long-term financial goals and our growing market share along the way.

I'll now turn the call over to Neil for details on the quarter and our guidance, and I look forward to taking questions in a few minutes.

Thanks, Dick, and good morning, everyone. We're pleased to have you on the call this morning. I'm going to provide color on our financial results and operating metrics for the quarter and full fiscal year, followed by our outlook for fiscal year 2007. And then we'll open up the call for questions.

First, our high level income statement results are as follows: Total revenue for the fourth quarter grew to $246 million, up 26% from the fourth quarter of 2005. As a reminder, we anniversaried the Arbortext acquisition in the fourth quarter so our year-over-year performance in Q4 includes the contribution of Arbortext in both 2005 and in 2006.

We achieved 20% non-GAAP operating margins in the fourth quarter, and our non-GAAP net income was $43 million, up 73% from the same period last year. Our non-GAAP earnings per share was $0.37 in the fourth quarter, compared with $0.22 in the fourth quarter of 2005. Currency movements in an immaterial revenue and EPS impact in the fourth quarter of 2006 compared to the prior year. And for the full year, total revenue was $855 million, up 19% from 2005. Our non-GAAP operating margin for the full year was 15.5%, and our non-GAAP net income was $113 million, up 30% from fiscal 2005. Our full year non-GAAP earnings per share was $1 compared to $0.78 last year. Currency movements negatively impacted revenue by about $17 million and pretax earnings by about $0.07 per share for the full year.

Now let's talk about revenue metrics. Total license revenue in the fourth quarter was $85 million, a 39% improvement from Q4 2005. This license growth came across multiple products and geographies and in large deals, as well as smaller accounts. Additionally, license revenue growth in the quarter also reflects incremental revenue from our recent Mathsoft acquisition. Total service revenue in Q4 was $63 million, up 34% from the prior year.

We also achieved significant service margin improvement with this growth by focusing on making our implementation services more repeatable and by selling higher margin training services. And total maintenance revenue for the fourth quarter grew 12% year-over-year to $98 million. This growth is a reflection of our growing customer base, as well as the addition of revenue from our Mathsoft acquisition. And for the full year, license revenue grew 26% to $263 million. Services revenues were 31% to $220 million, and maintenance revenue grew 8% to $371 million.

In the second half of the year, our license revenue grew faster than our services revenue. This enabled us to significantly improve operating margins. By geography, our revenue was as follows. North America delivered revenue growth at 38% year-over-year to $116 million in the fourth quarter. 8 of our top 10 deals were in North America this quarter.

Europe delivered 21% growth to $74 million in the fourth quarter. This growth was 16% at constant currency. One of our top ten deals came from Europe this quarter. In Asia-Pacific, revenue grew 12% year-over-year to $56 million in the fourth quarter. This growth was 14% at constant currency. The Pacific Rim delivered 53% growth from the same period last year. Partially offset by an 18% decline in revenue from Japan. Revenue from Japan declined 15% year-over-year on a constant currency basis but was flat sequentially. We have hired a new sales manager for Japan and are making other improvements in our sales, marketing, services and financial organizations to help improve our results there.

For the full year, revenue from North America grew 33%. Europe grew 13%, or 17% at constant currency and Asia-Pacific grew 6%, or 10% of constant currency. The results in Asia are comprised of Pacific Rim growth of 34% and a decline in Japan of 14% from 2005, or 8% at constant currency.

Our reseller channel grew 34% to $47 million and reflected excellent performance for Pro/ENGINEER and related modules, as well as the addition of Mathsoft. This growth is a key part of our long-term success, as the company to our buying our engineering solutions today are good candidates for Windchill and Arbortext in the future. For the year, reseller channel revenue grew 24% to $172 million and represented 20% of total revenue. In the fourth quarter, we had 19 large license and service revenue transactions over $1 million each for a total of $53 million. We had two revenue transactions that were over 5 million each in the quarter. Our deals over $1 million more than doubled in revenue contribution from the year-ago period. For the full year, our large revenue transactions contributed $142 million in revenue, which is up from $85 million in 2005.

The success we've had with large customers is encouraging for two reasons. First, many of these companies are repeat buyers who are adopting multiple PTC solutions. Second, it demonstrates the success of the changes that we've made to our distribution model so that our direct sales force can focus on larger strategic accounts. With that said, these larger transactions are well distributed and no single customer represents more than 3% of PTC's revenue.

Let's move on to our product categories. Total fourth quarter desktop solutions revenues grew 23% year-over-year to $159 million. The highest growth in desktop solutions revenue for the quarter came from license revenue, which grew 38% year-over-year to $52 million. License revenue growth for desktop solutions was due to strength in sales at entry level and mid range packages of Pro/ENGINEER, as well as sales of modules and upgrades. Additionally, sales of our ship building solution CAD 5, as well as the acquisition of Mathsoft, contributed to the revenue growth in the quarter. Fourth quarter desktop solutions consulting and training service revenue was up 33% year-over-year to 28 million. This revenue growth is primarily related to strong sales of training services. Fourth quarter desktop solutions maintenance revenue was up 12% year-over-year to $79 million and reflects continued growth in Pro/Engineer customers, as well as the addition of Mathsoft customers to the maintenance base.

For the full year, total desktop solutions revenue grew 12% to $561 million. License revenue grew 20%. Services revenue grew 17%, and maintenance revenue grew 6%. We are particularly excited about the acceleration in the growth of our desktop business in the second half of our fiscal year. Moving to Enterprise Solutions revenue, total fourth quarter Enterprise Solutions revenue was 31%-- excuse me. Grew 31% year-over-year to $86 million, another record revenue quarter. The strong growth in this product category came from all lines of business. Q4 Enterprise Solutions license revenue was $32 million, up 40% year-over-year. This growth was primarily from increased sales of Windchill, PDM link and related modules, Windchill project link, and our visualization software.

Fourth quarter enterprise solution consulting and training service revenue grew 34% year-over-year to $36 million, reflecting increased demand for implementation services following licensed transactions for both Windchill and Arbortext solutions. Enterprise Solutions maintenance revenue grew 13% year-over-year for the fourth quarter, reflecting continued Windchill and Arbortext customer success. And finally for the full year, total Enterprise Solutions revenue grew 35% to $294 million. License revenue grew 36%. Services revenue grew 43%, and maintenance revenue grew 21%.

Now I'll move on to our expenses. Our fourth quarter non-GAAP operating expense was $197 million, above our guidance because higher revenue in the fourth quarter yielded higher variable expenses, such as sales and service commissions and full year bonuses. We drove significant operating margin improvement, despite the higher expense. For the year, we achieved about 2 points of margin improvement in sales and marketing expense due to increased sales productivity and revenue leverage on marketing spend. We also achieved about 1 point of margin improvement in G&A expense due to revenue leverage.

Finally, the net margins in our consulting and training business continued to improve, although our overall cost of services as a percentage of revenue increased from 2005. This was due to the negative impact that currency had on our maintenance revenue and on our resulting service margins and gross margins. As a reminder, our fourth quarter non-GAAP expenses excluded several items. $11.2 million of stock-based compensation, which includes a non-cash charge of $2.3 million, related to our recently completed review of historical stock option granting practices, and $3.1 million of acquisition-related intangible asset amortization.

Okay. Moving on to the balance sheet, our cash balance ended at $183 million, up from 174 million in the third quarter, and down from $204 million at the end of 2005. During the year, we used $75 million for acquisition, $10 million for income tax payment we described in the third quarter, and we made a $4 million contribution toward our pension plan.

Our cash collections have been strong all year, with DSOs in the fourth quarter at 67 days, and similar results throughout the year. Our cash flow was impacted by an increased amount of extended payment term financing we offered to customers during the year. We offer this financing primarily to large customers with solid payment and credit histories, and the amount of financing increased this year due to the large increase-- excuse me. Due to the increase in large deal activity in 2006.

Though it initially dampens our operating cash flow, we view the ability to offer internal financing as an advantage when competing against companies who do not have balance sheets as healthy as ours. In 2006, we offered extended payment term financing on approximately $55 million worth of orders. That amount was about twice the amount internally financed in 2005 and we don't expect the amount to grow significantly in 2007. Deferred revenue was $211 million, down from the third quarter of 2006 due to seasonal changes in our deferred maintenance balance, but up from $200 million in the same quarter last year.

Okay. Now, let's turn to our outlook for 2007. As Dick mentioned earlier, it's been over two years since we set our fiscal 2008 goals of reaching $1 billion in revenue and 20% non-GAAP operating margins. We are on track to achieve these goals. In 2006 we made investments in our business in the beginning of year that drove significant revenue and operating leverage in the second half of the year.

Looking to fiscal year '07, our plan is similar. We expect our operating margin and EPS to be lower in the first and second quarter of 2007 than it was in the fourth quarter of 2006, though we do expect operating margin and EPS to show year-over-year improvement in each quarter. In fact, we expected to be about a 6 to 8 percentage point increase in operating margins between the first and fourth quarters of fiscal year 2007. We also expect to show more operating margin leverage on incremental revenue for fiscal year 2007 than we did for fiscal 2006. This leverage will be a continuation of the efforts we've made since 2004, primarily in sales and marketing productivity and training and consulting services profitability.

Additionally, we acquired ITEDO in October. ITEDO's revenue for the past year was approximately $5 million. We expect the acquisition to be slightly dilutive to GAAP net income for fiscal year 2007 due to the incremental amortization expense. However, we expect the acquisition to have a neutral effect on non-GAAP net income and a net impact of the acquisition will be immaterial. But we have added $5 million of revenue and expense to our fiscal 2007 forecast.

Now let me give you more detailed targets for the first quarter and for the full year 2007. Our guidance for the first quarter of 2007, which ends on December 30, 2006, is as follows: Revenue of 215 to $220 million, which represents 12 to 14% year-over-year growth. On a GAAP basis, first quarter total cost and expenses are expected to be between 200 and $203 million, and earnings per share are expected to be between $0.09 and $0.11 We expect non-GAAP operating costs of 187 to $190 million, and anticipate earnings per share on a non-GAAP basis to be between $0.19 and $0.21

The non-GAAP operating costs exclude the following estimated costs and expenses in Q1. First, approximately $10 million of expense related to stock-based compensation, and secondly, approximately $3 million of acquisition-related amortization expense. Our revenue and EPS guidance for the first quarter implies non-GAAP operating margins of 13 to 14%.

Okay. Now let's look at our full year guidance. We expect our revenue for the full year to be approximately $945 million, representing about 11% year-over-year growth. We expect GAAP operating expenses to be about $834 million, and non-GAAP operating expenses to be about $780 million. We expect GAAP EPS for the full year to be between $0.70 and $0.75, and non-GAAP EPS to be between $1.15 and $1.20.

Non-GAAP operating costs exclude the following estimated items. First, approximately $40 million of expense related to stock-based compensation and secondly, approximately 14 million of acquisition-related amortization expense. Our revenue and non-GAAP EPS guidance for the full fiscal year 2007 implies continued organic growth and operating margins between 17 and 18%. With respect to other below the line items, we expect other income to be insignificant for the first quarter and full year. We anticipate our effective tax rate to be approximately 22%, and we expect diluted weighted average shares outstanding to be about 115 million for the first quarter and 116 million for the full year.

Okay. Stay with me. I'll be done in just a couple of minutes. There are three additional items I would like to address before we close. The first is a remind their we have director and officer-restricted stock vesting dates approaching. Because we have been given restricted stock, it is immediately taxable upon vesting, officers and directors will sell some shares to cover tax obligations within the next week or two. Additionally, some of us will sell a portion of the vested shares to monetize our fiscal year 2006 bonuses, which were given to us in performance-based restricted stock instead of cash bonuses that were awarded in previous years. We will file all necessary form 4s with the SEC once these trades take place.

The second item I would like to address is an update on our ongoing litigation with Rand. As you may remember, Rand filed a lawsuit against PTC back in 2003. We have recently begun settlement discussions with Rand and there is a possibility that we will finalize this matter during our first quarter. We do not expect that any settlement would be material to our annual net income. If a settlement is reached prior to the filing of our 2006 10-K, we would treat this as a subsequent event and adjust our 2006 results. If a settlement is reached after we file our 10-K, this would impact our first quarter and fiscal 2007 results.

The results we have reported today and the guidance we have given for the first quarter and full year of fiscal 2007 do not reflect any expenses associated with the potential settlement of this litigation. But, again, we do not expect that settlement to be material to our annual net income. Okay. The third item relates to our valuation allowance against U.S. deferred tax assets. For fiscal year 2006, we have concluded that the full valuation allowance, which was established in 2002 is still required.

Based on our improved financial performance, however, we have begun to anticipate the reversal of this previously recorded valuation allowance sometime during fiscal year 2007. At the time of the reversal of the valuation allowance, PTC would record a one-time non-cash income tax benefit, which would result in a significant one-time benefit to our GAAP net income for the period in which it is recorded. However, this benefit would be excluded from our non-GAAP results. The current valuation allowance is about $100 million and it will continue to be reduced by the amount of U.S. profit we generate in the future, until a reversal of this allowance is warranted.

2007 financial targets outlined earlier do not currently include this potential non-cash benefit. Once we reverse the valuation allowance, we will return to recording a full income tax provision for U.S. profit on our income statement. Therefore, our effective tax rate on pretax income is likely to move to the 35 to 40% range once we reverse this allowance. However, our cash tax payments will continue to benefit from net operating loss carry-forwards that we expect to utilize for the foreseeable future and therefore, we expect our cash tax rate to continue to be approximately 20 to 25% of pretax income. We will provide an update on these items as appropriate in the future.

So in summary, we hope you share our excitement about our performance in 2006. We are particularly pleased where our organic both in both Enterprise Solutions and desktop solutions and the fact that that growth is outpacing the overall market. This gives us a high degree of confidence in our outlook for double-digit organic revenue growth in 2007 and gives us increased confidence in our ability to achieve our goal of $1 billion in revenue and 20% in non-GAAP operating margin by 2008. Thank you for your time today and for your patience. We look forward to your questions. At this point, I'll turn the call back over to Meredith.

Great. Thanks, Neil. And I think, Michele, we are ready for questions.

Thank you. [OPERATOR INSTRUCTIONS]. The first question comes from Jay Vleeschhouwer. You may ask your question. Please state your company name.

Merrill Lynch. Good morning. Dick, I would like to ask you to talk a bit more about the overall market. At the conference presentation back in June, management made an interesting quote, which was the following, and that is the market is being fought over not by the vertical, but by the size of the company. You may remember saying that.

I'm wondering if you could elaborate on what that really means in terms of current selling activity and how it's translating into revenue, you know, focusing obviously on the small accounts now through the channel. You have been growing your direct sales force some more over the past couple of years so. What exactly did you mean by that view of the market and similarly, you also see some of your competitors seeing deceleration or declines in the high end CAD business, why wouldn't the same eventually catch up to some of the Pro/E business?

Okay. That's a loaded question, Jay.

That's all one question, you know.

I'm not exactly sure what I, what that referred to, that quote. I hope you have the full quote there. But it sounds like-- basically, if I just back up, we really approach the market actually from both perspectives, so our sales force today, the 370 direct reps are really increasingly targeted on those largest accounts around the world on a named account basis and then all other accounts are now managed by the channel. So it's really a named account program and then all else is the channel. That's working pretty well for us, as you can tell by the numbers. Inside that dedicated large account sales force, we've partitioned that sales force into verticals, so in the U.S., there is an aerospace and federal group, an automotive group and high tech group and so forth.

So where it's possible in certain geographies don't lend themselves to that, but where possible, we have verticalized the sales force, as well as certain components of the product with respect to templates and so forth and functionality. So really I think we have sort of an overlay with respect of the commitment to the high end as well as that vertical approach, which is paying off for us. The vertical approach gives our sales and service people sort of a technical expertise. For example, we're doing pretty well in the footwear and apparel marketplace. That's a dedicated large account sales and services sales organization that goes after those accounts, with a proprietary solution actually. So I think that's paying off for us.

The other part of your question, I think sort of alluded to the Pro/E growth vis-a-vis our competitors, and this is a, sort of a pretty interesting phenomenon that's happening right now. I believe based on your report on the Katia results, which I think declined 4% and UGS, those are the principle competitors that we have in the high end of the space. UGS has declined 3 or 4% for each of the last eight quarters, I believe. When you juxtapose that up against the growth of organic Pro/E growth this year, particularly in the last six months, that organic Pro/E growth rate in the past six months was a pretty high number. It's double-digits. So we're capturing market share there, Jay, because the other two competitors are declining.

Now, we believe that actually the enterprise solution Windchill sales, the deployment of Windchill in the enterprise and now increasingly Windchill 8.0 which came out a year ago to vault the Pro/E files, we're seeing some sort of consolidation in these large accounts of CAD decisions, or of CAD deployments where, a major company has moved to Windchill in the enterprise, as well as the engineering department to manage the Pro E files and now they are going back and consolidating those CAD decisions and giving us pretty large orders to take out competitors on the high end. So, you know, 80% of our revenue still comes from the high end. The channel's doing 20%. That high end of the CAD market, we're really taking market share these days.

Okay. Just the second question, then, also at the meeting a few months ago, the company acknowledged that your average reseller productivity could be better. The overall reseller business is growing, as you point out, but the average could improve by comparison, for example, with some of your more established channel competitors. And I'm wondering if you could perhaps comment on that, or how you foresee that improving in '07.

Yeah, Jay, this is Neil. I say, we reached the point in North America and Europe where the issue isn't the number of resellers that we have. It's improving the efficiency of, the reseller relationships that we already have. So definitely we're focused on reseller productivity in those two geographies. In Asia-Pacific the answer's a little bit different. We have really just begun in the past 12 months to build out our reseller channel in that region of the world aggressively and so our focus there is more on capturing new resellers and kind of increasing PTC mind share in the reseller community.

We definitely improved the reseller productivity in the back half of the year, since we saw you in the June timeframe at that user group meeting, particularly in the fourth quarter. The resellers had really excellent productivity and we've just begun to give them some of these new products, so they actually just received-- had its own channel, which is not that large, but we've just now begun to give on October 1, we gave MathCAD to all the PTC Pro/Engineer and link resellers and we're going to do the same with ITEDO in the January timeframe. So I think with the current mix of products, the momentum in the business and the new products, we're going to see that channel productivity increase this year.

Thank you.

Great. Next question, please?

Thank you. Richard Davis, you may ask your question, and please state your company name.

Richard Davis, Needham. So, Dick, I guess the IBM relationship, I guess it's almost a year old and you've been talking to them. Clearly IBM's a great firm in terms of account control. How do you think this relationship is shaping up kind of versus your expectations, and where do you think it's going? Just curious what your thoughts are there.

Well, we've-- I think we've tried to say all along that a couple of things. First of all, if we can compete in the marketplace with our solutions versus our competitors in sort of a green field, that means without IBM helping, that's going to be an advantage for us. So we've accomplished that in certain markets where IBM and Dassault no longer work together. Incidentally Dassault's numbers, which on the CAD business in particular, which were down 4% year-over-year, that reflects the fact they have taken back from IBM, recaptured maintenance and reseller margins, 50% of that margin. So there are actually year-over-year decline is much more severe than the 4% they reported. So that's one point, is that we want to compete sort of in a green field, Richard.

The second point is we have a direct sales force. We would like to work with IBM and we are in those geographies and some emerging opportunities in the U.S. and Europe, based upon what the customer really requires or what the customer wants from both of us. So we have opportunities where the sales forces are working together on identified customers. We're not looking for them to resell our products. We would like to have sort of a complimentary joint selling approach where we represent our products. They represent their great middleware, hardware and global services solution and together we provide a complete solution for the customer.

So I think we're sort of right where we want to be. It's been a good year. I wouldn't point to any dramatic increase in our revenue this year because of the IBM relationship, but it has given us sort of a more neutral or green field approach vis-a-vis our other competitors.

The second part of the question would be I guess the Dell deal is a replacement. Why doesn't this signal kind of a beginning in the change of the market in which kind of a version 1, 1.0 niche PLM guys start to get bounced out of the customers that may have bought the product four or five or six years ago? Do you think that's a possibility?

Well, yes, I do. What happened to Dell, and I sort of gave a sort of a long description there, but basically what happened was, a year ago, a year ago, we didn't have -- Windchill didn't manage the Pro/E files directly in a way that the customers could use. We just brought out Windchill 8.0 about a year ago. Came out in July '05.

The first six months, nobody did too much with it with respect to vaulting the Pro/ENGINEER files in the engineering department. But that Windchill 8.0 release sort of completed our vision about having one common, simple executable for all aspects of the company. So Dell upgraded to Windchill 8.0 in the January timeframe, while they were in the midst of sort of an enterprise PLM valuation. They standardized on Pro/E Wild Fire 2, upgraded to PDM link 8.0, the Windchill version and they're vaulting all of their files into Windchill, managing all the daily activity. Based on that success, they bought Arbortext because they wanted a custom-configured document with a PC-- reach directly in and, to the vaulted Pro/E files in Windchill and extract the information they needed.

They saw that vision and then took a look at what they were doing in the enterprise area with the competitive product, which is sort of a traditional, what I would call sort of an in-between company and decided to replace that whole system with Windchill and basically complete the puzzle. So I think the problem with the Agiles and Matrixes and the companies that are sort of in the middle, they don't have any heritage at the CAD side, don't have any heritage in ERP side. Customers do not want a whole new data model in the middle of this already complicated problem.

This is Jim. If I could just add $0.02 to that, I think at Dell in particular, but we've also talked about some other accounts like Festo recently, we're getting a perfect storm between the alignment of what our organic development projects do and what our acquisitions do. In I take you back to 2004 and our acquisition of Ohio Design, it was a small acquisition, but the technology we bought from managing electronics design data, you can imagine how important that is now when it's bundled into our solution at Dell. Because what Dell really needs, to Dick's point, they have a mechanical design problem and a data management problem. They have a similar product problem for electronics design, they have an enterprise PLM problem, they have technical publication solution-type problem and they look at PTC and they say, wow, there's one system that does all 6 that. So I think our acquisitions, we've been buying small, very strategic technologies that are very strategically additive f to what we do. Some of our competitors keep buying the same thing, three and four times over. You add those together and you don't really get anything more than had you in the first place and it's a big differentiate tar out in the marketplace.

We had a high number in those deals that we talked about, there were a significant number of replacements, of competitive products in the PLM arena that had gotten a footprint inside our install base over the last 5 or 6 years, principally sort of from the late '90s till the early 2000s, not so much in the last two or three years, but going back four or five years ago. We had significant number of Matrix, Agile UGS replacements, even Anovia replacements this quarter and the other thing is that this Windchill 8.0 deployment where we're managing-- Windchill product, we haven't even scratched the surface of the install base. We're at like 1% of the install base of old INTRALINK users, so we see a lot of runway as we go back into the install base and upgrade them to Windchill to manage the Pro/E files, and then upsell them with the enterprise version of Windchill.

Got it. That's real helpful. Thank you very much.

Thank you. Thank you. Sasa Zorovic, you may ask your question and please state your company name.

Hi. This is Sasa Zorovic with Oppenheimer. With Japan, if I got that directly, you mention the in the fourth quarter that Japan was flat sequentially. I remember last quarter it was, started to be up sequentially. If you could tell us a little bit more, how-- what the status is in Japan and how with the new person starting, this is likely to evolve and why was it flat rather than continuing the trajectory of being up sequentially?

Okay. So maybe just a couple of general comments and then, Neil, if you want to have some other ones, you can add in there. First of all, Sasa, and I'm taking responsibility for, you know, underperformance in Japan this year. But I can tell you that, and I'll get back and talk about what some of the reasons are, but I can tell you that in general, technology companies across the board have had difficulty in Japan. So we have a PTT issue, which is bigger than that of some other companies, but I believe when IBM made their announcement a few weeks ago, they said that they grew in Japan for the first time in five quarters. SAP has had problems in Japan. Lots of companies have had some trouble in Japan during the past year.

Ours has been further complicated by what I would say the wrong leader as the head of Japan. We didn't have a Japanese national. It contributed to a higher rate of turnover, an so we lost some momentum in some of our largest accounts. We've replaced that person with a Japanese national who started. He's on board. I think that's going to really help with respect to the culture and the retention and the overall sort of mood that's happening there and, the only good news from a bad year in Japan last year is that we're going have pretty good comps this year and I think you're going to see some upside in the Japan numbers as we get into '07.

Could you be a little bit more specific as to what his plan is about Japan and how can he sort of deal in this overall environment in somewhat weaker tech spending than in Japan?

Well, the person that we hired actually came from HP, which has a terrific organization in Japan, and he's got 30 years of experience, so we've got that kind of experience there. And he's really going to adopt, I think from a high level standpoint, he's going to adopt the model that's pretty similar to the one that we use around the rest of the world. We're going to have better focus and concentration of direct reps in the largest accounts.

We are present in 20 of the 26 largest Japanese accounts. Hitachi, Fujitsu, Toyota, we just got a deal with Honda. We are really well positioned in these large accounts, but I don't think our sales force was necessarily well managed and targeted on those accounts. So we're deploying the sales reps appropriately on large accounts.

That will open up the SMB space for the channel and we're out there recruiting additional channel partners as well as investing in the current channel partners. There's some verticalization that we're doing in the sales force, along automotive and high tech, which are the two principal vertical markets that we serve there and, again, I think that you're going to see some improvement in '07 in the Japanese market.

One thing that's really helped us, Sasa, that is that Toyota has moved their deployment. They now have close to 2500 active users on Wild Fire 2 and Windchill 8.0. So from a reference standpoint, our largest worldwide customer has moved up and has deployed the latest technology that we have available and so we're using that to go back to our install base in Japan, which is generally slower to move than it is in other countries and we're talking Sony, Hitachi, Fujitsu and others about the fact that we have a tight and very good deployment of the latest technology in that market.

So if we can use that to convince the others to move, there's a huge install base that will move to PDM Link 8.0 and then we can upsell them with Arbortext and some of the other products that we're talking about.

Okay, thank you.

Great.

Thank you. Tim Fox, you may ask your question and please state your company name.

Hi, thank you. Tim Fox with Deutsche Bank. Good morning. Neil, if we could just dive into the operating cash flow commentary a little bit more, I think at the beginning you had been talking about $100 million or so in operating cash flow and it came in around 65. Discussing some of the reasons why, can you give us what operating cash flow would have been had you not done that level of internal financing, is there any way to think about how that would have come out for the full year?

Tim, it would have been right about $100 million.

Okay.

So it would have been on target with the numbers that we have spoken to you about earlier.

That's between the internal financing and the tax payment that we made.

Which was a net of about 16 million, I believe?

Right, exactly.

Okay. And on that same question, what are you looking at for a fiscal '07 operating cash flow number, presumably you've be doing more of these large deals and more of this financing. Are we looking at a similar operating cash flow level as to '06 with just the growth in operating margin expansion, or is it going to be above that?

We're expecting operating cash flow for fiscal year '07 to be between 100 and $120 million, Tim.

Okay.

So significantly higher than it was in '06. I will-- I should probably comment on Q1. Q1 is typically our lowest seasonal cash balance of the year, and that's because sales commissions from the prior year and bonuses from the prior year are paid out during that period of time. So probably what we anticipate is the cash balance that drops down to the $140 million range in Q1, but for the entire year we expect 100 to $120 million pickup off of the $180 million balance that we ended the year at.

That 140 million also includes the payment for ITEDO, $17 million.

Right. That's very helpful. Second question is you touched on a little bit earlier, Dick, if you could just comment a bit more on the fact that a percentage of your install base does have some competing PLM solution in place and I'm wondering if you could provide us with a sense of about how big the competitors have in your install base and as a follow-up there, particularly on Matrix 1, what you have seen after their acquisition by Dassault, has there been any change in their position competitively or their go-to-market strategy? Thank you.

Sure, Tim. I think basically that, matrix 1 and Agile is a group, they were both doing a little over-- combined they were doing 250 million and they probably did, a third of their revenue on on base, a third in Dassault base, and a third in the UGS base. So we're going back and recapturing ours because of the power of this integral model. We're going have a lot of success with that. The-- I think Matrix, you know, we probably haven't really seen much change. We replaced them in a number of accounts this quarter. I'm not really sure how critical they are to the Dassault story at the end of the day, they're over here in the U.S. We just haven't seen a lot of momentum with Matrix since the acquisition and don't really expect to. It's the exact opposite strategy from the one that we have that's winning.

So matrix represents yet another enterprise offering to go along with SmarTeam and Anovia and so forth. They're further complicating their message to their installed base and I think they're going to have to rationalize that because the customers don't want three or four data models when they can go to PTC and have a better solution with one. And that's really, as I said earlier, what's driving that CAD business. That desktop business grew 23% in the fourth quarter. Well, the only inorganic component of that was MathCad, so the numbers are -- organic Pro/E growth in the desktop is in the high teens, and, we're getting big consolidation deals where those customers are seeing-- Pro/Engineer has grown in the last six months at a rate close to Adventure and Solid Works, and it's 80% on the high end of the market, and we're seeing big consolidation deals where we're taking advantage of the strength of that total solution and replacing UG in the high end at a pretty fast rate.

Great. Thank you.

Okay. So it is 11:00. However, because of the technical difficulties, I think we should take a couple more questions here.

Thank you. Barbara Coffey, you may ask your question. Please state your company name.

Sure, Kaufman Brothers. Just a quick question. When you're looking at the high end CAD market, historically this has been a market that's very sticky and that once Pro/E or Katia or any of the products get in, it's very hard to displace them and yet you're saying you're having sort of market share gains. Is there a change in that dynamic, or is there something else I should be thinking about?

Go ahead.

Yeah, this is Jim. I think there are some pretty interesting dynamics happening there. One thing, is as people look to put in place efficient processes, for example, they want to globalize their operation, now they look and say having a mixed CAD environment is very problematic because we can't easily and readily exchange data back and forth. So I think we're seeing maybe two different things that affect your question. One is we see a lot of standardization within accounts that have a mixed CAD environment. They are saying, hey, PTC is our partner on a go-forward basis. Let's standardize everything across the board on PTC's offerings. That's driving a lot of growth on the high end. Second thing is, there are some compelling events out there. U.G. is basically killing the Ideas product line and that's throwing a fair number of customers into some amount of discomfort around what's our go-forward strategy, switching from Ideas to UG and switching from Ideas to Pro/E are viewed largely as the same sort of effort. So I thin there's also that opportunity for us to go in and displace the number of Ideas accounts. So probably there's some amount of both contributing to a pretty high growth rate.

The other thing, these acquisitions are helping Pro/Engineer. You take the MathCAD offering where they can do predictive engineering and you take this MathCAD product and put it next to Pro/Engineer, the output from MathCad drives the Pro/Engineer geometry. So that plus Itedo, those kinds of little applications strengthen the overall position of Pro/Engineer from a competitive standpoint.

And then as I think Jim sort of touched on as well, just this whole offshoring this, globalization, is just-- the customers have to do it and it's really hard. So to do it in a mixed environment, in some cases, they are finding it cheaper to just go standardized. We had a -- I don't have permission to talk about the name of the company, but a $20 billion industrial company that, makes compressors and industrial equipment out there had probably 200, 300 CCUG products and 500 seats of Pro/ENGINEER and they standardized on Windchill about 2 years ago, they upgraded to the 8.0 version about six months ago and the CEO came for a corporate visit back in the May/June timeframe, and he said "I want you to help me get this UG stuff out of here." We got a big order in consolidated all the CAD seats.

So the UG seats are gone, 2 or 300 of them, and that account has 800 seats of Pro/ENGINEER with Windchill PDM link in the engineering department, as well as the enterprise. We're now talking to them about Arbortext and MathCad. So that's the power of this single integral data model. We're actually a little surprised by it to tell you the truth, that the Windchill deployments could accelerate or drive those CAD pieces like that, and I don't think our model anticipates the same kind of growth in '07 that we saw in the last six months, but it's pretty interesting what's happening with respect to the desktop right now.

Thank you.

Thank you. Your next question comes from Philip Alling. You may ask your question. Please state your company name.

Bear Stearns. Thanks very much. With respect to the $1 million plus revenue transactions in the quarter and the year, obviously strong performance there, to what extent does your guidance for fiscal '07 reflect sort of continued trends in growth in large deals and really what can you share with respect to visibility in large deal pipeline?

Yeah, I think our-- Philip, it's Neil. Our pipeline continues to be strong. There has been some suggestions that maybe the economy is slowing down and that IT spending is slowing down. Our business, we feel like the momentum continues to be very positive. As far as large deal activity, we expect that to continue. Naturally we wouldn't expect to see the type of large deal activity in the first and second quarters, or even the third quarter of next year that we saw in the fourth quarter of this year, but on a year-over-year basis, our expectation at this point is that large deal activity is going to continue to grow.

Okay, and just a follow-up question, then, as far as the seat growth, Windchill seats in particular in Q4, much higher than we had projected. Could we give some color on the 32,000 Windchill seats in the quarter and sort of how we should be thinking about Windchill seat growth going forward.

This is Meredith. I think that the number that we saw in Q4 was just a phenomenal number. As we indicated in the press release and on the conference call, we did have two large deals in excess of $5 million in the quarter, one of which was primarily Windchill and that carried a lot of seats with it. I don't believe that 32,000 seats is something that, you should expect to see carry into Q1, but we're going to take it right now. It's great performance and, overall if we sell more software, like we expect to do next year, for the full year blended we should be selling more seats. But generally speaking, it was a good mix of PDM link, related modules, like parts link and supplier management and saw good visualization numbers and we saw good project link, so it was a really good mix of software.

I think you're going to see more of this sustained upgrade of the old intralink to PDM link. Those deals are all over the forecast. We have an announced retirement of the old Intralink product that takes place in about 18 months, so the customers are aware that intralink 3.3, the old 10-year-old client server version, which is a good product, that old product actually helped the Matrixes and the Agiles and some of the other PLM competitors in our install base because the customers could rely on vaulting the Pro/E files directly pretty easily and then Matrix or Agile would reach in to the intralink database and take their information that they needed.

Well, by obsoleting that product and as good as it was, the functionality now is inside Windchill and it's even better and putting a time line on that, about 18 months out, that's creating for our customers a little bit of a sense of urgency around upgrading. So that's another market that's going to add to Windchill seats. All of those PDM-link seats that we vault the 200,000 or so Pro/E users that are out there, those are all upside deals for us.

Thanks.

Okay.

Thank you. Rob Crystal, you may ask your question and please state your company name.

Goldman Sachs asset management. I apologize. You may have just answered this question. I had to step out for a minute. In terms of guidance on the big deals, Neil, are you excluding deals over a couple million dollars in your '07 guidance? Did I understand that right?

Well, we don't explicitly design our guidance around large deal activity, but certainly we discount a little bit of 2006, particularly in the two deals that we did in the fourth quarter in developing our forecast for 2007. What I said about large deal activity, Rob, was that we expected to increase year-over-year, as it has been this year. Although certainly sequentially it will decline because we don't expect to see the kind of large deal activity in the first through third quarters next year that we saw in the fourth quarter of 2006.

Right.

Overall the pipeline is very strong and that large deal activity is likely to continue.

Right, and could you maybe put some general, I don't know, maybe it's parameters around sort of the activity has been accelerating in large deals, you think-- my sense is from your commentary, you don't think these one or two deals were one-offs.

You mean could we see more deals in excess of $5 million?

Yeah, in excess of $3 million, I guess.

We absolutely can and we probably will. We just don't build the, the model for the year around those deals. So they become upside deals. But there's no reason to expect we-- in the install base with the size of the base that we have, the 40,000 customers and the large accounts we've talked about that we won't do those kinds of deals. We have actually more products than ever to bundle in and sell when we talk to those customers about those large opportunities. And I think in many respects this PLM market is still just now in it's infancy. I think it's just really starting to mature.

Okay, great. Thanks a lot, guys. Good job.

I think we'll see some good, big deal mix, but, again, as Neil was saying, fourth quarter was so good, we're working on the pipeline today. It will be better than it was a year ago in the first quarter, but it will be a little bit less than it was in the fourth quarter.

So I think that's, that's it for today. Thank you very much for the time and I apologize for the delay, technical delay in the beginning. Again, we'll look forward to speaking with all of you when the snow flies here in January. Thanks.

Thank you. This concludes today's conference call. Have a nice day.