PTC Inc (PTC) 2008 Q1 法說會逐字稿

Good morning, Ladies and Gentlemen, and welcome to PTC's first quarter fiscal year 2008 results conference call. At this time, all participants are on listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

I would now like to introduce Meredith Mendola, PTC's Vice President of Corporate Communications. Please go ahead.

Thanks, Brian. 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 Executive Vice President and Chief Financial Officer. In addition, Jim Heppleman, Executive Vice President and Chief Product Officer, and Barry Cohen, Executive Vice President of Strategic Services & 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 2007 Annual Report and Form 10-K, and the in Company's other reports filed with the SEC from time to time.

A replay will be available until 5 p.m. Eastern Monday, January 28th at 402-220-9786. Additionally this conference call is being Webcast, and a replay will be available through our website at PTC.Com until Monday, January 28th at 5 p.m. Also, on our Investor website, you will find a document with Q1 2008 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 yourself 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 the call over to Dick.

Meredith, thank you. Good morning, everyone. Thank you for joining us on our first quarter 2008 earnings call.

We are off to a good start in 2008, and are on-track to deliver our full year revenue and operating margin targets. Revenue from large deals and the channels grew significantly year-over-year. We delivered another record maintenance revenue quarter, and we made great progress toward our profitability targets, with non-GAAP operating income growth of 34% year-over-year.

We are aware of investor concern about the economy. We are reading the same headlines you are, however, we also have the benefit of speaking with hundreds of customers and channel partners on a regular basis. Our customer base has never been more secure, and we have never had a better, more complete, more relevant solution to sell them. I will share with you the perspective we gained from working with our customers, and will highlight the factors that give us confidence in our competitive differentiation and our outlook.

Let me start by saying that our offerings provide many benefits for customers, including improving innovation, reducing time to market, and increasing quality. However, there are two major reasons why customers have been buying our software during the past couple of years. First, our software provides infrastructure for the globalization of Product Development. This trend started in manufacturing production a long time ago, but only started becoming prevalent in engineering within the last few years. I am sure you appreciate the well-established historical trend here.

Every time there has been a major globalization trend over the past 30 years, Company investment and supporting infrastructure lasted at least 10 years. We are not only confident that our customers will continue this trend, but we believe that globalization will only accelerate in a more difficult economic environment. PTC has the industry's best and most complete solution to address globalization.

The second major driver for customer investment has been IT consolidation. This trend also has a well-established historical precedent in other markets like ERP. The technologies that support Product Development within the manufacturing companies today are highly fragmented and disjointed. Therefore, they are costly to maintain and cause process issues, particularly in a global or distributed execution environment.

Our largest customers have realized that by investing in the PTC Product Development system, they can replace dozens and sometimes hundreds of disparate applications, and eliminate the cost of maintaining them. This is not a trivial task, but more and more customers are choosing PTC's single architecture to consolidate legacy applications, and automate manual processes. Like globalization, we believe the IT consolidation trend will continue for years to come, and could accelerate in a restrictive spending environment.

Next, I would like to highlight internal factors that should drive our business this year. We are at the beginning of the product cycles for our two most significant products: Windchill 9.0 and Pro/ENGINEER Wildfire 4.0. Each of these releases is focused on quality, ease of use, and new customer-driven capabilities. Each has new chargeable modules that should provide us with additional growth, as customers upgrade to the new releases over the coming year or two.

We also continue to migrate our Pro/INTRALINK customers to Windchill. We have seen a pick-up in both migrations and scheduling of migrations since the launch of Windchill 9.0. We have migrated 25 to 30% of our INTRALINK base to-date, and we expect to continue these migrations throughout the year. This drives services revenue, and more importantly, drives future license and maintenance revenue, as it opens up the Windchill and Arbortext opportunity within the existing installed base.

Next, our acquisition strategy has helped us deliver a very broad offering to customers, with cross-selling opportunities for us, no matter where customers are in their investment cycle. When a Pro/ENGINEER customer is looking for data management and collaboration capabilities we sell them Windchill. If they need engineering calculations or CAM capabilities, we have MathCAD and Pro/TOOLMAKER. When a customer needs technical publication support, we have Arbortext solutions.

With our new acquisition of CoCreate, we will execute a similar strategy of surrounding the existing CoCreate explicit modeling tools, with a broader Product Development system. The acquisitions themselves have given us new revenue streams, but our careful integration strategy has provided us with an offering that makes sense for customers, as they consolidate their IT environments. We will continue to execute on the acquisitions we have already completed, and we also will work to add others that make sense, both strategically and financially.

Finally we continue our efforts to improve our profitability. This is a very important initiative for us. We started the year with first quarter non-GAAP operating margins of 18%, through profitability gains in Sales and Marketing, Services, and through our globalization strategy. We expect our profitability to grow throughout the course of the year, and are confident in our ability to achieve at least 22% non-GAAP operating margins for the full fiscal year.

All of these trends and initiatives not only support our 2008 plan, but also support our ability to achieve our long term targets of $1.5 billion in revenue, and 25% non-GAAP operating margins by 2010. Although there is investor concern about the economy, we believe our pipeline supports our ability to achieve our goals for 2008 and beyond.

Now I will turn the call over to Neil, and I look forward to taking your questions in a few minutes.

Thanks, Dick, and good morning, everyone. Our first quarter 2008 financial results reflect solid execution of our strategy. I will discuss our results in detail, and then provide our outlook for the second quarter and full fiscal year. And then we will open up the call to questions.

First, our high level Income Statement results for the first quarter are as follows: Total GAAP revenue for the quarter was $241.2 million, and non-GAAP revenue which excludes the deferred maintenance revenue writedown associated with the CoCreate acquisition was $242.5 million. Both GAAP and non-GAAP revenue grew 9% from the same period last year. Non-GAAP operating expenses were $198 million, and our non-GAAP operating income grew 34% year-over-year to $44 million, or 18.2% of total revenue. This represents a 330 basis point improvement from the first quarter of 2007.

And our non-GAAP earnings per share were $0.26, up from $0.23 last year. Our non-GAAP tax rate in the year ago period was about 21%, and in the current quarter it was 32%. If the prior period had been taxed at the 32% rate, our year-over-year earnings growth would have been 35%.

Okay now let's turn to revenue metrics. All of which are based on GAAP total revenue of $241 million. Our total revenue growth of 9% reflects both organic revenue growth, as well as one month of CoCreate revenue. Revenue by line of business is as follows: License revenue grew 1% year-over-year to 67 million in the first quarter. We delivered growth in revenue from new license sales across all of our major products, but much of that growth was offset by a decrease in revenue from Pro/ENGINEER upgrades and modules.

We are currently at the end of the Pro/ENGINEER Wildfire 3.0 product cycle, and have just launched Pro/ENGINEER Wildfire 4.0. The revenue decrease for upgrades in modules is in-line with a typical pattern for this stage in the product cycle, and we expect to see sales of modules and upgrades grow again in the coming quarters as our customers adopt Wildfire 4.0.

Among our other major product families, Arbortext showed the most significant growth year-over-year, and MathCAD continues to deliver solid growth. Windchill license revenue following a record quarter in Q4 was flat year-over-year, but for the two quarters combined, was up 22%. Consulting and training services revenue grew 10% year-over-year to 60 million in the first quarter.

This increase was the result of continued growth in training and IP services, process consulting, and Windchill implementation consulting, partially offset by our continued efforts to use more channel and specialized partners to provide MCAD consulting services. This initiative has enabled us to significantly improve our consulting utilization, and our services net margins, which more than doubled year-over-year, and will continue to be a focus in future quarters.

First quarter maintenance revenue grew 13% year-over-year to $114 million. This growth is the result of a combination of factors including recent license revenue growth, continued improvements in customer satisfaction, favorable currency movements, and the acquisition of CoCreate.

Okay, by geography, our revenue was as follows. North America revenue declined 2% year-over-year to $85 million in the first quarter, due to a decline in North American services revenue. Our channel grew in excess of 20% in North America, as we continue to evolve our distribution model. Four of our Top 10 license and service customers were in North America this quarter.

The first quarter revenue from Europe grew 23% year-over-year to $102 million, or 10% at constant currency. Europe has been growing significantly for several quarters now, as our larger customers adopt our Product Development system, and our European channel continues to grow rapidly. Three of our Top 10 license and service customers were in Europe this quarter.

In first quarter Asia Pacific revenue was up 5% year-over-year to $55 million, or 3% on a constant currency basis. Their performance was driven by 7% year-over-year growth in the Pacific Rim, and 3% growth in Japan. In the first quarter, three of our Top 10 license and service customers were in Asia Pacific.

And finally our revenue metrics related to customer size are as follows. Revenue from our reseller channel grew 26% in the first quarter to $60 million. Growth came from all major geographies, and was the result of both organic revenue growth, and the addition of the CoCreate channel. Our reseller channel contributed 25% of our total revenue in the quarter. This model continues to help us improve our profitability, and increase our reach to small and medium businesses around the world, and we expect to continue to see our channel grow faster than the overall business.

We also continued to grow our revenue contribution from our larger customers. In the first quarter we had 12 license and service revenue transactions over $1 million each, for a total of $32 million, versus 12 large transactions for a total of $28 million in license and service revenue in the first quarter of 2007. This is evidence of continued success in our strategic account program.

Now, I will move on to our spending and operating margins. First quarter non-GAAP operating expenses were $198 million. The first quarter expense for stock-based compensation was $11 million, and our acquisition-related amortization expense was $6 million. We had a restructuring charge in the quarter of $10 million related to our globalization strategy, which consisted of $3 million of severance payments, and $7 million of facilities restructuring. On a GAAP basis, total Q1 expenses were $226 million.

Our non-GAAP operating margin improvements were the result of several factors, including sales and services model evolution, globalization, and the immediate accretion provided by our acquisition of CoCreate. As a percentage of revenue, cost of services decreased year-over-year by more than 170 basis points in the first quarter.

This is the result of our efforts to improve services profitability through utilization improvements, revenue mix shift, and partner programs. Sales and Marketing expense as a percentage of total revenue decreased by more than 250 basis points year-over-year. This is the result of the continued evolution of our distribution model, and recent globalization initiatives, partially offset by some investment in sales rep capacity. PTC had 390 quota carrying reps in the first quarter of 2008, versus 380 in the first quarter of 2007.

R&D as a percentage of total revenue was flat year-over-year, as we continue to invest in both our core Pro/ENGINEER and Windchill products, as well as our acquired products. And G&A expenses as a percent of total revenue were higher than usual, due to one-time expenses associated with a restatement we did in the first quarter. Our non-GAAP operating margins of 18.2% were 330 basis points higher than the year ago period, and would have been 19.5%, or a 460 basis point improvement, without the one-time G&A expenses I described earlier.

This gives us increased confidence in our ability to deliver 500 basis points of operating margin improvement for the full fiscal year, especially since future quarters will include a full quarter of CoCreate revenue and margin. Total headcount was 4,642 at the end of the first quarter, up from 4,049 at the end of the fourth quarter, due to our acquisitions during the quarter, partially offset by headcount reductions, taken during the quarter.

Okay, moving on to the Balance Sheet. Our cash balance ended at $215 million. That was down from the fourth quarter due to acquisition activity, but higher than expected on strong receivables collection. Our first quarter operating cash flow was $17 million, compared to the use of $16 million in cash for the same period last year. During the quarter, we used approximately $50 million in cash on acquisitions, and also repaid $15 million of our $220 million debt obligation on the CoCreate acquisition.

Accounts Receivable decreased $24 million from the fourth quarter due to strong collections, and DSOs were 73 days, compared to 80 days in the first quarter of 2007, and 74 days in the fourth quarter of 2007. Deferred revenue came in at $236 million, up from $206 million in the first quarter of last year, as a result of growth in the number of customers on maintenance, the contribution from acquisitions, and the effect of foreign currency. Deferred revenue was up sequentially from $227 million at the end of the fourth quarter, due to the contribution from acquisitions, partially offset by the typical seasonality of maintenance billings.

Now let's turn to our outlook. As Dick mentioned earlier, we remain confident in our ability to achieve our revenue and operating margin targets for 2008. Additionally, we have changed our assumption for our future GAAP and non-GAAP tax rate to about 37.5%, from 40% previously. This essentially adds about $0.05 of earnings per share to our previous 2008 earnings guidance.

Our outlook for the second quarter ending March 29 is as follows. We expect GAAP revenue to be between $248 million and $258 million, and GAAP earnings per share to be between $0.10 and $0.14. We expect non-GAAP second quarter revenue to be between 250 and $260 million, and non-GAAP earnings per share to be between $0.24 and $0.28. The non-GAAP revenue and earnings expectations excluded deferred maintenance revenue writedown of about $2 million associated with our acquisition of CoCreate, and the following second quarter estimated expenses and their tax effects.

First, approximately $12 million expense related to stock-based compensation. Second, approximately $8 million of acquisition-related amortization expense, and then finally about $3 million of restructuring expenses related to our continued globalization program. We expect our cash balance to be approximately $260 million at the end of the second quarter, and this includes the retirement of approximately $50 million of debt during the quarter.

For the full year, we expect GAAP revenue to be about $1.055 billion, and GAAP earnings per share to be between $0.66 and $0.77. We expect non-GAAP revenue to be about $1.060 billion, and non-GAAP operating margins to be at least 22%. Non-GAAP earnings per share should be between $1.17 and $1.27 for the fiscal year, and that the up from our previous guidance of $1.12 to $1.22 per share.

The non-GAAP revenue and earnings expectations excluded deferred maintenance revenue writedown of about $5 million associated with our acquisition of CoCreate, and the following full year estimated expenses and their tax effects. First, approximately $45 million of expense related to stock-based compensation; secondly, $32 million of acquisition-related amortization expense; third, about $2 million of in-process Research and Development expense related to acquisitions we completed in Q1, and then finally, approximately $15 million of restructuring expenses related to the continued globalization program.

Based on current assumptions, we expect our interest expense from the CoCreate acquisition debt to be about $8 million for the full year, and as I mentioned before, we expect the GAAP and non-GAAP effective income tax rate to be about 37.5% of pre-tax income. However, we expect our cash tax rate to be about 25% of pre-tax income for the foreseeable future. Diluted weighted average shares outstanding should be about $119 million for the second quarter, and about $120 million for the full year. Finally, we expect to repay approximately $120 million of our CoCreate debt in fiscal year 2008, leaving a balance of approximately $100 million at year-end.

Thank you for your time today. We look forward to your questions, and at this point, I'll turn the call back over to Meredith.

Great, thanks, Neil. All right, Brian. I think we are ready to open up the call for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Greg Dunham from Deutsche Bank. Your line is open.

Hi, yes, thank you. The first thing I would like to hit on is the product cycle and the transition of Wildfire. How historically have those transitions been, and what are your expectations going forward in this particular case?

Let's take, this is Jim. I think what happens, there is not a huge disruption as we go from one release to another because as you know, we sell perpetual licenses and maintenance, but what you will find out is for example, if we launch a release say Wildfire 4.0 that has new models in it, then we take those new modules back to the base, and it takes a little bit of time to ramp that up, and then we will sell those new modules to the base over a period of time, and then over a longer period of time we will begin to saturate the opportunity, and those modules will tail off, so it has virtually no impact on the maintenance revenue other than to bolster it and keep it strong.

It has little impact on new license sales, other than it makes the product more competitive and may increase our win rate, but it does cause sort of bell-curve type distribution of module revenue over time. So I think the point Neil made during the conversation is that our module sales based on Wildfire 3.0 was slowing down, but now with the launch of Wildfire 4.0 we have got a set of new modules we can take back to the base, so we expect module sales to climb in the coming quarters.

That makes sense and then on the maintenance front, that actually was a lot stronger than I would expect it, but is that due to renewal rates, or pricing, or can you talk a little bit about how that has performed relative to your expectations?

Yes. The maintenance business has performed extremely strong for really the past 12 to 15 months, Greg, this is Neil. Obviously the addition of CoCreate helps there as well, because almost 2/3 of their business is maintenance revenue, but even excluding CoCreate, if you just look at kind of organic constant currency maintenance revenue performance, we were up 7% year-over-year, which is a great number.

It really just means the customers are using the software, they like it. They are deploying it. And then the services number too was good for the quarter, which increases the utilization of seats that are out there, and I think bodes well for license revenue in the back part of the year.

Yes, makes sense, I will pass it along. Thanks.

Our next question comes from Ross MacMillan of Jefferies. Your line is open.

Yes as we have seen the North American business for you guys slow over the last couple of quarters, can you just talk to that kind of deceleration, and maybe be more specific as to where you see it happening most? Is there any way to distinguish between verticals or direct-versus-channel, or anything you can talk about with regard to North American deceleration? Thanks.

I will take a shot at it Ross. The channel for North America grew pretty nicely. I think the maintenance was pretty nice in terms of the deployment. The services numbers in North America --

Service business was down, and that is the primary reason North America was down.

I would just characterize actually North America as sort of being where we think it is. It is okay. I think that we have described in the past couple of calls the fact that things are a little bit, I don't know, maybe I would call it tighter, so that we are getting a little more scrutiny around the ROI, from the, when we are going through the process of getting deals approved, there is just a little more scrutiny around the return on the investment and so forth, and a couple of extra signatures.

So I do think because of the economy, things are a little bit slower, but from our standpoint as we have described, companies must globalize, so we are able to build an ROI with them. It is just that it gets a little more scrutiny, and we probably see some deals happen not quite as quickly as we would like.

Now in just about every case though, if something didn't quite happen when we want it to, it ended up happening subsequently, so I am not at all panicked about North America. I think it is more difficult, but at the same time, I think we have a pretty good plan and we are doing pretty well in North America.

Just to add to what Dick said, this is Neil, you harken back to Q3, when we had a difficult quarter last year. All the deals that were on the table in the last week of Q3 have subsequently closed now, and we had a couple of deals in Q1 that we are trying to get over the goal line, and aren't going to happen now until Q2, one of which has already closed, so the deals are happening. It is just the timeframe is extended.

Other little anecdotes for example, the corporate visit center today, this week is packed. You can't even get a room down there, so companies are visiting, and that is a good sign. People are not slowing down in terms of their search, and we did a first quarter, or a second quarter forecast roll up for North America, and I think based on the early forecast that North America sales in Q2 are going to be up over Q1. So I think it is tougher out there, but I don't think that it is dismal.

That is fair, great. And then just another just for point of clarity, two things for Neil. So the $3.2 million of one-time costs associated with the restatement, should those effectively just completely disappear in Q2, and then the second one for Neil is just on the CoCreate, or the debt that you have that you talked about $8 million of interest expense from that debt this year. I just wanted to confirm that is $8 million for the year, and then you said you are paying it down, so you are going to pay down 120 or so this year? Are those the right numbers? Thanks.

Yes. Those numbers are correct. Everything you just said about our debt related to the CoCreate acquisition is accurate. With respect to the $3.2 million we incurred in Q1, related to the restatement, that will largely go away in Q2 through Q4. We do have some ongoing expenses associated with the litigation that we are involved with with the GELC, but that expense will amount to less than $0.5 million a quarter going forward, based on our current estimates.

Okay, that's great, thank you.

Yes.

Our next question comes from Sasa Zorovic with Goldman Sachs. Your line is open.

Thank you. My first question would be, if you could provide us with a growth for the overall Company on an organic basis, or equivalently, how much really was CoCreate in the quarter, and also if you could tell us what it was sort of constant currency for the various regions?

So we are not going to be disclosing going forward, this is Neil, CoCreate revenue specifically. I can tell you anecdotally that CoCreate exceeded both its revenue and its expense plan, or I should say beat both its revenue and its expense plan for the month, the one month we had it in the quarter. I don't know how significant that information is, but because it is one month worth of data, but we had a good month in CoCreate, and then I am sorry, you also asked a question about what our --?

How much did the regions grow constant currency basis year-over-year?

I think we gave you that information. Europe grew 10% at constant currency, and I think we said that Asia Pacific, 3% of constant currency, thank you.

Okay, and then my following question is like this, so if I am getting things right, the lower tax is adding $0.05 to guidance, right?

For the full year that is correct.

The prior guidance used to be $1.12 to $1.22, and now it is $1.17 to $1.27, so basically the tax explains is the difference in the guidance?

That is correct also.

Now you did beat though in the first quarter, so then it means for the remainder of the year you are taking the EPS guidance down?

No, we beat because of the tax. The Consensus was $0.23 and we came in at $0.26, and the difference was the discrepancy between where the tax rate actually came in, and what our guidance implies. So there was also that one-time expense in there. So overall, we feel really good about the quarter, and we feel good about where we are at this point in the year.

Thank you.

He just thinks our earnings guidance is conservative is really what he is saying. He might be right.

Our next question comes from Jay Vleeschhouwer with Merrill Lynch. Your line is open.

Thanks. I would first like to ask about sales and distribution, and then a technology question. On the sales side, Dick, what is the expectation for further expanding on the direct side? Do you still have the objective of getting to 450 at some point, and on the channel side, what are your assumptions or goals for further adding capacity and/or productivity in the channel, each of your competitors, most particularly SolidWorks earlier this week, is communicating pretty strong growth objectives to their channel, both in terms of total growth and capacity expansion. And so the question is, what your expectation are in that respect as well? And then a follow-up for Jim on technology.

I thought I was going to get the technology question and Neil was going to get the sales question. I think on the direct side, Jay, we said we added 10 reps in the quarter year-over-year, so we have expanded that and we feel pretty good about sort of the headcount plan, in terms of staging it during the course of the year.

I think really, I don't think we had an objective ever to get to 450 this year. I would say it is more in the 420 range, that we said we will go from 380 to 420, adding about 10 reps per quarter, and we are still on-plan to do that. I think that would give us nice, that would be up about 10%, so that is pretty good incremental capacity, given that we haven't added any capacity for the last three years. In addition to that, we have improved productivity expectations on an ongoing basis from the direct side of the salesforce.

I think the channel is doing really well. We invited the channel for the first time ever to our Awards trip, our President's Club, down in Mexico the first week in January, and mixed them together with our direct salesforce, in terms of team building, we are pretty much complete in terms of territory alignments, the direct salesforce now is almost entirely named accounts, and any account that isn't named is a channel account. I think our channel, you can check with them, and I am sure you do, feels pretty good about the program.

One of the reasons I was really interested in the CoCreate acquisition was that it brought us additional channel capacity. Most of their revenue is channel-related, and so if you add the CoCreate channel to the PTC channel, we probabl have, we are in the range of 400 or so channel partners, and we have an ongoing program out there with them, in terms of cross-selling products at the right time, and so forth, and good expectations for channel growth.

We said that the channel as a percent of revenue increased year-over-year from 21% of revenue, to 25 or 26% this quarter, and as you know in the past we have said that in 2010, we want the channel revenue to account for 30% of our total revenue, so we are well on our way toward that goal. It is an important part of our strategy, and really gets as much attention today as our direct business.

A clarification first in what you just said before I ask about the technology. How much of the absolute and proportionate growth in the channel business was a result of your having reassigned the channel not that long ago, I think it was a couple of thousand extra accounts to give to them, that you took away from Direct.

And then on the product side for Jim, first, what do you think are the most leverageable core technologies that CoCreate has, that you can propagate through distribution, or integrate with the rest of the product line? What, for instance, did you communicate last week that the industry analysts in that respect, and then competitively on the technology side, you always say, have said for years, that architecture matters, and you talk about the single development system, and so forth.

With Dassault shortly going to announce their new PDM architecture, based around Matrix superseding some of the issues they have had in their architecture, first have you heard anything about that, and secondly, if they in fact do move to a more unified architecture, does that change the competitive situation at all?

That was 10 questions right there.

(laughter)

That is your going away present, Meredith

We don't have a number that we know, Jay, that we track that would say what those accounts necessarily were doing. We probably did know what they did in the preceding eight quarters, we could go find that out, but I haven't tracked that. It has certainly added to the channel, in some respect. It did add some incremental capacity in terms of revenue to that channel, but it also took down services capacity and revenue for us on an equal basis, if not more so, so I would sort of call it a wash.

Jim will probably do the technical stuff better than I, but I will tell you it is a far stretch to call Dassault's new strategy around PDM, that is built on a product matrix that was released in 1990, but I will hear Jim's comments on it.

Okay so first on the CoCreate question, I would probably focus on two pieces of technology that are most interesting. First of all the core modeling, maybe three pieces. The core modeling tool for explicit modeling. We talked about that a lot this past week at our press and Analyst meeting.

We do believe there is a viable market segment for explicit modeling, and there is a number of other competing companies who have explicit modelers. We happen to have with CoCreate 80% market share in explicit modeling, so we think that is an interesting market to grow a little bit, and it is also a nice compliment to Pro/E. When a Company is looking for the most powerful modeler, they are going to go in the direction of Parametric modeling, and end up at Pro/ENGINEER if they really want the most powerful approach.

On the other hand, if they want the simplest possible approach, they should skip all Parametric modelers, and start talking about explicit modeling, because it is fundamental simpler, and then we will have CoCreate and an 80% market share, so we think that is pretty interesting.

A second thing is a standalone 2D tool. I don't want to overplay that, but there is an opportunity to sell some of that in our base, because Pro/E helps you create 2D drawings of 3D models, but sometimes people just want a few seats of standalone 2D drawings. Historically we haven't had a solution, so they went out and bought a few seats of AutoCAD, but now we do. And then a third thing which is sort of interesting is some of their collaboration tools, especially the OneSpace Live product, which is an application session-sharing technology for graphic intensive applications, it works pretty well, so that might find its way into Windchill.

One comment I did want to say, as part of the analysis with we did in the last quarter, is we noticed that CoCreate has 300 customers with 25 or more modeling seats, and so those all sound like pretty good Windchill prospects because of this 10:1 ratio, so you could say there is a 300 new install base customers that are at least 250 seat Windchill opportunities, and if you do quick back of the napkin calculations, that is a couple hundred million dollars of Windchill revenue out there in the installed base for us to go get, and I think it will take time for us to do that, but that is a big upside as well to the CoCreate acquisition.

On the architecture subject, I do believe architecture matters, and quite frankly I am flattered at what Dassault is trying to do, which is pick one architecture, so that they can better compete with us, and UG/Siemens is trying to do the same thing, finally pick one, so each of them have an effort to pick one of the myriad architectures they have, and try to concentrate their efforts on that. As Dick said, neither of these products are new. Windchill is a newer, more comprehensive solution than the MatrixOne product.

We have been doing battle with MatrixOne for years, and we kind of won that battle once already, so we are happy to go at it again with an even bigger lead, and the same thing with the Iman product, which is the basis for the team center unified, but what is more interesting is by consolidating on a single architecture in both cases, they are going back to a large base of customers and saying, you have to switch architectures to move on to the one, so if you happen to use MatrixOne, you are pretty pleased with Dassault's new strategy around an old architecture, but if you use the ENOVIA LCA product, or if you use the SmarTeam product, or the ENOVIA BPM product, you are pretty disappointed and pretty frustrated now that this is the latest pretty girl in the Dassault line-up, the latest new architecture, it is the fourth time they have played this game in the last four years.

What is it going to be next year? Which one?

I know. It depends on who they acquire. I am just saying customers are frustrated, and for us that is a great opportunity. We tell them, listen, there is one safe choice in the market, one architecture, that is going to be here in 5, 10, 20, 25 years. It is called Windchill. Everything else is up for grabs.

And we don't know, I can't tell you what the Windchill product revenue will be, the enterprise revenue this year but it is between 425 and $450 million for the year? The Windchill numbers, and that is significantly larger than Matrix is like $100 million business.

The Windchill revenue from PTC is larger than the sum of the Matrix revenue, the LCA revenue, the VPM revenue, and SmarTeam revenue from Dassault. There is a significant difference between our one product and the sum of their four, so we are in pretty good shape there.

So Jay, it is okay that you asked 10 questions because we answered 12.

(laughter)

Thanks, Meredith.

Our next question comes from Andrew Matorin with Bear Stearns.

Thank you. If you could talk a little bit more about the sales cycle, I think Dick, you had suggested that some of these slipped deals from Q3 '07 had all closed, and maybe there is one that slipped from Q1 that has closed in Q2. If you could talk a little bit about has the sales cycle lengthened measurably more recently, than say three months ago, six months ago, and what are your customers talking about with respect to kind of their appetite?

I would say in the U.S. that the sales cycle probably has gotten a little bit less predictable, and that is sort of a proxy for a little bit longer. I don't really think we have seen any change in Europe, where we are really executing well. We are executing in Europe at a really good rate, and Siemens, Dassault, and SAP are all headquartered in Europe, and we are outperforming them in their backyard.

That is actually pretty interesting for us there, in terms of the strength of the product and the sales execution. The U.S. though, and I mean Asia I think is sort of, I haven't seen any difference in the sales cycles in Asia as well. The U.S. though is a little more difficult. It is sort of hard to quantify it, does the sales cycle goes from 12 months to 15 months? That is hard to say. We did have a deal that we thought we could get, for example, in December, and it came in the first week in January, just didn't quite, it was over a million dollars, just didn't quite cross the line, and we had as I said pretty good visibility in the U.S.

And a Q2 first pass forecast for the U.S. is solid, so for the March quarter, we got the guys together and went to it, and it is pretty solid but at the same time, those deals over a million, I would say are a little bit more difficult to forecast today than they were six or nine months ago.

And this is a follow-up to that. I mean, obviously there is concern, the concern about the economy started in the U.S. but seems to be spreading globally at this point, so have you re-examined your expectations then, with Europe and even Asia-Pac as far as --?

We haven't seen that and our forecast for again the Q2 first pass forecast is still early in the quarter, for Asia it was up, and for Europe, they basically had a strong forecast as well. So we are not seeing that right now. And I wouldn't underestimate the points we make in a way.

The companies that are facing a more restrictive environment might spend on our infrastructure, in order to move capacity offshore, so if they are going to go take things offshore to India or China, they are going to need our infrastructure, in order to realize the savings from deploying in lower cost countries. In some ways it is going to help us.

Okay, thanks.

Thank you.

Next question comes from Sterling Auty of JPMorgan. Your line is open.

Thanks, hi guys. Just want to understand a little bit better, I think you mentioned in your prepared remarks the Windchill license revenue was flat, but if I look at the metrics page, the new seat sales were up by about 20%. Just remind me or help me understand to connect those two dots.

Yes, Sterling that is a good question. That is absolutely right. Seat count was up pretty considerably, and what is going on is that we had more seats, more sales of seats out into the enterprise, as opposed to the engineering department this past quarter.

and the ASP on those seats, those are 'light seats' as opposed to 'heavy seats,' so the ASP on those seats is lower, leading to the flattish license revenue but actually, longer term that is a really good sign, because obviously our strategy is to extend from the engineering department out into the enterprise, with respect to Windchill licenses.

Just to elaborate on that point remember I said there are 10 typically 10 Windchill seats for one [guest] seat. Well, some of those fractions, some of those 10 would be heavy seats and some would be light seats, but the fact that we're moving these light seats means that this is being deployed as an enterprise solution, not typically an engineering solution.

We had some really interesting wins, that I don't think we have permission to talk about during the quarter, but I can sort of tell you in Europe, we had some major wins. There was one customer, a big customer that was using Dassault product that was a joint venture between two companies in sort of the telephony business, and they were using Dassault products on one side, and Siemens products on the other side, and they did a benchmark, and for the joint venture, they chose Pro/ENGINEER ing and Windchill for the Company.

There was a major industrial let's call it, it is automotive-like company, $100 billion company, where we replaced about 125 seats of Catia in the chassis area, and it was predicated on a bigger Windchill replacement that we have been winning during the last two years in this Company. So we had some really interesting wins, competitive wins, replacements in the marketplace, which again are a testimony to the strength of our Windchill or enterprise products. It has become a really big business for us, and it is growing at a fast rate, and we are winning technically in the marketplace.

What is the differential in ASP between the two, and then my follow-up question is actually, when you look at the source of the budget that is used to buy your software, can you kind of characterize that, is it coming out of IT budgets, is it coming out of operating budgets of segments? Just talk to us about where the customers are sourcing the payments?

Yes, I am sorry what was the first part of that question again?

The difference in ASP between a heavy and light seat in Windchill?

It is about a 2:1 ratio.

Thanks.

Okay. In terms of the source, it really differs, if customers are buying heavy engineering, or heavy seats in Windchill, it probably would be more likely to come out of the engineering department. If they are buying light seats in Windchill, it might be more likely to come out of the IT budget.

Or operations.

Or an operations budget. But also the other thing is that there is an opportunity for customers to capitalize these purchases, and I think that that is another kind of potential, if you will, good news situation in that, if there are going to be constraints in spending, we think it is going to hit OpEx first and CapEx second, if at all, and so we do see customers looking definitely a lot of questions about, hey we want to make sure that we can kind of capitalize this purchase type of thing.

Okay, great. Thank you.

You are welcome.

Our next question comes from Yun Kim from Pacific Growth Equities. Your line is open.

Thanks. Neil, I apologize if you already explained this. Just wondering if you addressed the higher than expected G&A expense for the quarter, and whether there was some one-time events or not?

Yes, we did talk about it, but I am happy to mention it again. We had a $3.2 million one-time charge in Q1, associated with the GELC/Toshiba issue and the subsequent restatement of our financials, and that charge came through in Q1, so we don't expect that to be recurring. I also mentioned a little bit earlier on, there will be ongoing expenses associated with the litigation, but there will be a few hundred thousand dollars a quarter, rather than a few million dollars a quarter.

That one-time charge cost us $0.02.

Yes.

Okay, thanks. Barry, consulting revenue accelerated in the quarter, you mentioned that pick-up in the INTRALINK adoption is helping that business. Do you expect your consulting business to grow at least in the high-single digit growth rate for the year, and would that require you to accelerate your hiring plans, or can you just simply accommodate that growth with the improving utilization rate?

Well that is a good question, and I think we expect to see that as Neil explained in the Windchill enterprise, and the process and education, that is offset a little bit by our continual plan to go to partners with our MCAD consulting services, so blended that will give us maybe a 6 or 7%, or 6 to 8% possible service growth, and as part of our service business, we are deep into this globalization process, so it will require some additional capacity.

A lot of that capacity is coming from our offshore solution centers, where we have a dual plan. One plan is to increase our capacity for more efficiency, based on what we call solution centers. Also, as we have developed what we call a realized value of platform, we are able to break our work packages in such a way that we can take some of the work that was traditional done at a customer site offshore, and help increase our profitability, so that is what I would say.

And just the net result of all of that was our services net margins were 11% out of the gate in Q1, and that number compares to 5% in the year ago period, so that we are really off to a good start there.

Okay and lastly, Dick, can you talk about what are some of your thinking regarding the direct sales headcount growth, and sales productivity going forward? Basically with the channel contribution growing at a faster rate than the overall license revenue growth, and basically the sales headcount growing only modestly the productivity of your direct salesforce is declining. Is it something that you plan to address, do you expect this trend to be temporary, as some of your new hires ramp up? Thanks.

Yes, I think if you look at the last few years sales productivity has increased pretty dramatically, and I don't really see any reason why that won't increase. We have a plan to add 10 reps per quarter roughly, 10 reps per quarter this year. We're on track I said after the first quarter, we have added the 10, but they are not going to contribute with the sales cycles that we are describing. Those 10 reps really aren't going to contribute until well into the back half of the year, and on into 2009, so I think we are pretty happy with the plan we have to add the capacity, both in the channel as well as the direct side, and I think we will get some good productivity out of those additions in the back half of the year, and really more into 2009.

Yes, just to maybe, this is Neil, echo what Dick said, what is really happening, remember we have a three tiered distribution model now right, so we have these strategic accounts where the growth has been very, very good. Upwards of 20%, and at the high end, and then we have our channel business at the low end, which grew 26% in the most recent quarter.

So the part of our business that is more challenged is the mid-market, which used to be kind of this geographic direct territory, rep account-based program. And that is where we continue to see more accounts through the channel, and continue to take those reps and move them up the food chain, to focus on these larger more strategic accounts, so where we are adding the rep capacity is in the area of our distribution channel where we are most productive, which is our large account program.

Okay, great. Thank you.

Thank you.

Our next question comes from Richard Davis of Needham. Your line is open.

With regards to your relationship with IBM that you were trying to build out in China, would you describe that as better than, equal to, or less than expectations say versus a year ago, in other words kind of how that relationship is going in as much as Dassault and IBM are in at least some markets kind of going their separate ways?

Yes, I think Richard, I would say it is probably neutral. IBM has different sort of strengths and weaknesses in different geographies, and I would say that in China, their relationship with Dassault collapsed obviously, and ours is pretty good there, but at the same time, I wouldn't say that the IBM salesforce has a strong application sort of way of selling in that marketplace. They are still selling a lot of hardware, middleware, and things like that, and I don't think they are as sophisticated, with respect to go-to-market around partners and applications in China as they are in other places.

We have had some good wins with them and there are some people in the salesforce that understand the benefit of selling applications, but I wouldn't say it is as mature as we would like it to be. I think it will improve in the next couple of years.

Got it, okay, thank you very much.

Sure.

Thanks, Richard.

Our next question comes from Mike Olson with Piper Jaffray. Your line is open.

Hi, everybody. Just a question on the INTRALINK 3 upgrade. I think originally you talked about a June '08 cutoff date for that, and can you talk about the extension that you are giving customers, and is that for all INTRALINK 3 customers, and I guess [inaudible] 25 to 30% of it [inaudible]

Mike, Sorry, the second question that you asked completely broke up. We heard the first one about the extended support.

You mentioned that you [inaudible] INTRALINK base to Windchill? How much is being migrated?

Okay, by the end of the year.

So the first question was just a technical question on the maintenance deal. So we offered a let's call it a rider on the maintenance contract. If you paid this rider plus the maintenance contract then you could buy another year's worth of support.

At the end of the day, we are moving a massive number of customers on to a different platform, and while we want to push them along there is a balance there. You don't want to push too hard either, so we are giving customers an extra year, I think that is good because a lot of them probably would like to move to the 9.0 platform, which we have enhanced dramatically in this area and getting really good feedback, so this extra time will allow some of them to go to the 9.0 platform.

I think by the end of fiscal '08, I am not sure we have a pre-set answer, but I think there is going to be a lot of activity in fiscal '08, and I think some of it will dribble into fiscal '09 as well, so I would probably say we will be at 50 to 60%, we are kind of looking at each other here.

There is a lot scheduled, so there is a lot of it that has becomes scheduled. 9.0 has some real advantages in terms of performance and ease-of-use, and each release has gotten significantly better from 6 to 7 to 8 to 9, so 9.0 shipped in September, and not only is it winning conversions, but we are winning new benchmarks.

All right.

One more question or so, is that the where we are?

The tax rate, Neil, 37% of the full year, 37.5% for each of the remaining three quarters.

For the full year.

Okay, thanks. I will turn it over.

Thanks, Mike.

Okay, our last question comes from Steve Koenig with KeyBanc. Your line is open.

Thanks for squeezing us in. One question on guidance here. I believe at the end of October your qualitative comments around guidance included license growth on the order of 10% organic, and kind of flat services growth. I wonder if you are still, if that is still kind of your expectation for how guidance is going to be going forward? It seems like we are hearing now, that services should be a little bit higher. Does that mean effectively license growth may not get to that 10% organic level? How would you characterize your growth composition of revenue growth going forward here?

Steve that is a really good question. It is Neil. The first thing I want to say is we are pleased to be able to reassure firm our guidance, and actually increase it based on the lower tax rate, in the face of a somewhat difficult economic environment.

With respect to license versus service, I think it is really premature. I think that is a good question, but Q1 is one data point and typically, we are going to look for at least a couple of data points, in terms of how our business is progressing, before we decide whether or not we think there is a mix shift here, so we are going to give it through the second quarter, and see how our license and services businesses perform, and then we will probably have more to say about that.

Okay, thanks a lot.

Thanks, Steve.

Okay, I think that is it. Thank you very much for the time today. From our standpoint, we are just about executing against our plan with our customers. We are keeping an eye on the economy, and I think in the U.S there are some issues, but those issues actually represent some opportunities for us, and that is what the we are talking with our customers about.

We have got a big football game coming up here, Go New England! I know most of the country is rooting against us, but we think we are going to win that, and that will give us our second championship this year after the Red Sox victory.

So I look forward to talking to everybody in April, and especially my friends from New York! Take care.