PTC Inc (PTC) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to PTC's second quarter fiscal year 2011 results conference call. After brief comments by management we will go directly into question and answer session. (Operator Instructions). As a reminder ladies and gentlemen, this conference is being recorded. I would now like to introduce Kristian Talvitie, PTC's Senior Vice President of Financial Planning and Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone. Thanks for joining us on our Q2 results and outlook call. Before we get started, I would like to remind everybody that this call and Q&A session may include forward-looking statements regarding PTC's products or anticipated future operations or financial performance. Any such statements will be based on the current assumption of PTC's management, and are subject to risks and uncertainties that could cause actual events and results to differ materially.

Information concerning these risks and uncertainties contained in PTC's most recent Form 10-K and Forms 10-Q on file with the SEC. All financial measures in this presentation are nonGAAP financial measures, a reconciliation between the nonGAAP measures and the comparable GAAP measures located on the Investor Relations page of our website at www.ptc.com. With us today on the call is Jim Heppelmann, Jeff Glidden, and Barry Cohen.

And with that, I would like to turn the call over to Jim.

Thanks, Kristian. Good morning, and thanks for joining us everybody. Let me start by saying that I think all-in-all, Q2 was a very strong quarter. I won't tell you it was a perfect quarter, but I will say that I am very excited about the underlying strength of our business that was demonstrated. While we posted a quarter that was ahead of our plan and at the top of our guidance range, we can still see some relatively obvious ways we can make the business even stronger going forward. We feel there is room for improvement, and with that the potential of even stronger performance in the future.

Let me start by reminding you that since 2009, I have been saying that the primary measure of our success is our ability to deliver on this 20% earnings growth per year through 2014. So against that goal, Q2 represents another good quarter under our belt. And with very strong performance from our maintenance business and with surging demand for our Creo CAD solutions, we're confident that we'll deliver the 20% to 25% earnings growth that we've been guiding to here in fiscal 2011. So factoring in the 25% earnings growth that we had last year, finishing 2011 in this guidance range would put us well ahead of the required pace at the 40% mark of that five-year plan, with strong momentum going forward. I talked to you a number of times about how our 20% earnings growth plan is rooted in four factors, being growth, leadership, efficiency, and predictability.

So I would like to reflect back on Q2 and actually the first half of fiscal 2011 from the perspective of that framework. In the area of growth, we said we would like to increase our organic growth rates into the low-teens and drive toward a 13% growth CAGR over the timeframe of this five-year plan. We remain confident that we have strong growth prospects with our Windchill PLM and our Arbortext SIS, or Service Information System business, and similarly with our license revenue. But to get to the low-teens overall, we said we needed to increase the growth rates of CAD and the growth rates of our maintenance business, both of which have been growth laggards in recent years. So over the past two years we put in place a number of initiatives to drive growth in these areas, including our Creo strategy for CAD, and a series of new business policies and operational improvements in our maintenance business. Quite frankly, the success we have now demonstrated in those areas has surpassed my expectations.

So the biggest challenge we have at the moment is balancing the various growth opportunities against our capacity. As you know, we have the same sales force selling both Creo and Windchill, and the strong demand we have seen for Creo in the first half clearly takes selling cycles away from Windchill, suggesting we should be thinking about and probably working on remedies to what may currently be a capacity limitation to our growth opportunity. On the leadership front, we had another good quarter securing domino accounts that we have been using to demonstrate our ability to take market share in tough competitive environments.

So included amongst the three accounts was our first true Creo domino, which was a large Japanese electronics company, who decided to sweep out a mix of Dassault and Siemens tools, in favor of an across the board standardization on Creo. A second account was a significant European industrial company, who replaced an SAP/PLM strategy, and the third was TJX, a local and large retailer here in Boston, who has multiple store brands, and started with a long list of 15 vendors, and ultimately selected PTC from a short list that included Siemens and Dassault. So we have good momentum there, and we feel we are well on track for our goal of 30 dominos by year-end.

On the efficiency front we made a lot of progress with big improvements in maintenance and much better services margins in Q2. Also in Q2, we began to migrate our R&D spending towards our longer term business model, though in reconfiguring these resources we incurred a $3 million one-time severance cost in the quarter, that serves to match the progress we have made. But that progress will now become more apparent in future quarters.

And then finally on a predictability front, our goal is to evolve toward a business mix that has less quarterly volatility. That means a strong emphasis on our portfolio of annuity customers, and a significant optimization of our maintenance business that we have been working on. The 24 large deals in this quarter, this past quarter, as well as the 22 in Q1 demonstrate that, yes, we are building a solid base of dependable annuity accounts, if you look at the average deal size this year you can see that we haven't had the mega deals, those licensed transactions larger than $10 million that we saw last year. At least we haven't had them yet. We remain hopeful we might see some of those.

But nonetheless, we remain at or above our plan and revenue and EPS outlook for the year, because this base of annuity customers is really forming up nicely. So above all, I think this quarter shows how far we have come on the predictability front, that we can reach the high end of our guidance range without mega deals, and even if a few licensed deals slip, such as we saw in the federal and defense arena in the midst of the Federal budget chaos during Q2.

So to summarize the quarter, we saw Creo demand at levels we haven't seen since the mid-'90s, but that level of activity stole some thunder from our Windchill business. We are seeing the combination of strong license growth in recent quarters, coupled with tighter business policies translate into real strength in our maintenance business that should persist in a long time going forward. In terms of headwinds we mentioned in our prepared remarks that we saw a few big Windchill deals in the federal and defense sector slip, due to the Federal budget crisis that nearly shut down the government. But with that crisis now resolved we remain optimistic we will land those deals in the back half of the year. We also absorbed a $3 million severance in the quarter.

So when you net all that out we still landed at the high end of our guidance ranges, so I would have to say it was a very solid quarter, yet we all know we could have done better. So with Windchill, Creo, Arbortext, and soon MKS all showing strong growth possibilities, we are going to commit ourselves to ensuring that we have the balance and the capacity to capitalize on the full opportunity going forward. If we succeed in doing that, we should be looking at a situation of increasing organic growth going into next year, and then with MKS layered on top of that, we could very well be looking at an upper-teens growth opportunity in 2012. That would put another year of 20% earnings growth within reach based on revenue growth alone. And then we wouldn't have to stretch too far to meet or surpass that goal again for the third year of this five-year plan.

On a different note, you will notice that yesterday we announced a management change in our sales organization that I think is going to be a big positive going forward. Paul Cunningham was a 22-year PTC sales veteran with a long list of accomplishments. But with a new CEO and a new CFO wanting to reshape the Company and move the business forward, I think we are better served by having some fresh energy and new ideas coming out of the sales leadership position.

Bob Rinaldi who we have appointed to that position has done very well running our North American commercial business over the past several years, he has been very strong. And in years prior to that he played a number of roles but in particular played a strong role in recruiting and developing our current channel sales leader, our current European sales leader, and our current Asia Pac sales leader. So I think that Bob Rinaldi is just what we need, enough experience with the PTC system to take over without missing a beat, yet someone who is going to bring new energy, a fresh perspective and credible work ethic that is going to help us evolve our distribution channel to the next level. So Paul's departure was very amicable, and we wish him the best in his new pursuits. I am sure he will do well.

Finally in closing, I would like to remind you, you are invited to our Investor Day on June 14th at our Planet PTC event in Las Vegas. This is our worldwide customer group. It is a great opportunity to meet the team, see the newly-released Windchill 10 and Creo 1 products, learn about the MKS transaction and what that acquisition is going to mean to our models going forward, and so forth. Please follow up with Kristian if you have an opportunity or an interest in participating.

With that, I will turn it over to Jeff Glidden to see if he has any comments to add.

Great, thank you very much Jim. I will just make a few brief comments on Q2, and then some comments on our guidance for Q3 and the balance of the year. Just adding a few comments on the revenue mix, as Jim cited, our license revenue is up 15%, and we were impacted by lower than our estimates and lower than prior periods business from our US Federal operations.

Just a reminder, traditionally, approximately 10% of our business over the past number of years has come from US Federal, so that was down in the quarter. At the same time, our commercial business, excluding the US Federal, was very strong and licensed revenue in those areas was up approximately 25% year-over-year. We cited the services revenues were up 19%, it is really reflecting the strong PLM license business of last year translating into deployments this year, and major customers and those are progressing well. Maintenance revenue was really a highlight up7% to $132 million, again focused on policies and disciplines, and really the value of the maintenance programs that we provide to our customers.

A second comment would I like to make is on business leverage. Q2 operating margins expanded 210 basis points from 13.6% last year to 15.7%. It is really reflecting the leverage in the overall model, and on a 12% revenue growth we are able to deliver 30% EPS growth. A key highlight in the quarter was cash and cash flow. Cash increased $77 million, and we ended the quarter with $260 million in cash so we are very pleased with that. A couple comments on MKS acquisition, we will give you a little bit more update in June as Jim cited. Just to reiterate, we will be funding that acquisition through a combination of borrowings approximately $250 million off of our credit agreement and existing cash of about $54 million.

We also plan, will continue and plan to repurchase some $55 million worth of stock during FY 2011, so we continue to have very strong cash position and be able to be in a place to fund those continued repurchases. And I will really close with a few brief comments on guidance. As cited in the prepared remarks and in the press release, we expect revenue for Q3 to be $275 million to $285 million. This reflects year-over-year growth of approximately 13% to 17%. So accelerating growth in the quarter. And nonGAAP EPS of $0.28 to $0.32 per share. This is up approximately 30% to 50% year-over-year, again reflecting good leverage in the model.

For FY 2011, we expect revenue growth of 11% to 12% or $1.120 billion to $1.130 billion. We are continuing to make investments to support our long term growth, and at the same time we are focused on operational effectiveness to drive margin expansion, for FY 2011 we expect nonGAAP operating margins to be between 17% and 18%, up from 15.6% in FY 2010. And clearly we expect our FY 2011 nonGAAP EPS between $1.20 to $1.25.

Thank you for joining us and we will now open it up for your questions.

Thank you. At this time we are ready to begin the formal question and answer session. (Operator Instructions). Our first question comes from Mr. Jay Vleeschouwer from Griffin Securities.

Thank you. Good morning. Jim, I would like to ask you about sales execution which you highlighted in your comments and in the prepared remarks, you used a phrase about the dilutive effect of strong desktop on PLM sales that you had not used before, which is to say you have not really said in the past that there is a somewhat either/or quality to desktop sales and PLM sales when Windchill has had very strong quarters you have not suggested that that's somehow taken away from desktop execution or sales. So could you talk about how you can improve execution or productivity with what you have today in sales, and otherwise what are your plans for expanding capacity?I think that was one of your priorities for fiscal 2011, and a follow-up?

Yes. That is a good question I am glad you brought it up, so we could talk a little more about it. You should imagine that we have a certain capacity. And if you look at the commercial numbers worldwide, setting aside the aerospace and defense numbers, we had some pretty good results. And that capacity was fully utilized. But a typical sales guy, there are only so many hours in a day and when you have strong demand coming for Creo, and sometimes from the same customer, you go work on that project. And so what happened is we had a lot more hours spent selling CAD last quarter, than we did spend selling PLM.

Now, the reason we never talked about it in the past is it was implicit. Jay sorry, I am looking at Jeff here, in the past, the CAD story wasn't so exciting. So all the resources spent their time selling Windchill, and that was a huge boost to the Windchill business. But what has happened is with the CAD business, with this Creo launch, and quite frankly, with the strong economy and demand for more seats, we sort of, the CAD business has stolen back some of the resources that maybe rightfully always were due to the CAD business,but in the meantime had spent their time and energy working on Windchill deals, because there was so much more demand.

So I think when we say dilution, what probably we mean is there was a rebalancing of energies away from PLM toward CAD, and that just tells us that we have a limit on capacity that is the governing problem here, and that we probably need to think about more capacity. But I think our capacity outside this aerospace and defense sector, or really Federal and defense sector was quite productive, and we really became limited by capacity more than anything.

Your single largest source of revenue is still, if I am not mistaken ProE or Creo maintenance, larger than license revenues or Windchill license and maintenance. The question there is over the last year, you have had according to the data sheet, a 7,000 unit increase in your active installed base for Creo. By my calculation, over that same last 12-month period, you have probably sold, inferring to the license revenues, something around 20,000 new seats of Creo, give or take. And this has been the case now for the last couple of years where there has been a significant difference between net improvements in your maintenance base versus adds to new units. I know there is always a lag in maintenance, but this is a seemingly considerable one and I am wondering if you can talk about when there might be more upside in the active base numbers.

Well let me start here, and Jeff can jump in. First let's just talk about our maintenance business. I mean we are now forecasting for the full year numbers far in excess of our plan, and far in excess of our original guidance for maintenance. And we think that strength will continue. So if you say why is that, well, number one factor, we had very strong license growth a year prior. So there is a one-year lag factor for sure here.

And the second thing is we changed some policies. As I was becoming CEO and Jeff was coming on as CFO, we took a look at some of our policies and said why do we do it that way, let's change it. And the combination of these two factors has added 3 or 4 points of growth to a maintenance revenue stream that is 45% of our revenue. So it is pretty exciting. So I think that you are going to see next year a strong Creo maintenance business, and I think that that strength will persist across the board into next year and beyond.

Alright. And lastly, same question I asked Dassault yesterday on their call. Could you comment on the possibility of your Windchill business, obviously less than the CAD business, but are you seeing improvements in the profitability of that part of the business?

Yes. I would be happy to take that. So I think as we said, the mix of business there is very important. The margins on license in both our CAD business and PLM are very, very strong. They are as you know in the license side it is 95% margins along with maintenance in the mid to upper-80s. Services with lower margins.

As that mix continues to shift to maintenance and license, we would believe that is the case certainly for the year if not for this quarter, we will continue to see margin expansion in that side. And we said, reiterating Jim's perspective from prior quarters, our goal is first and foremost to improve the profitability on that business, as well as get Creo growing. So right now I think we have got both of those and we will continue to expect improving and building profitability in the PLM business.

Yes. I think just looking at this four-box here, and this is only one quarter's worth of data. But it all comes down to mix. If license and maintenance begins to outweigh and then dramatically outweigh service, that business is going to become very profitable. And I think just looking at the numbers here, we have now read a position where license plus maintenance is greater than service.

And I don't have the trend here, but I anticipate that that trend has been continuing to improve over time and I think we will continue to see that going forward. The growth in the Windchill maintenance business should not be missed here. That is very important. The fact that business is clipping along in that upper-right box at a 15% growth rate is pretty interesting.

Thanks, Jim.

Thank you. Sterling Auty from JPMorgan Chase.

Yes, thanks. I want to drill into the PLM business. So you talk about the federal and the aerospace and defense, and I think you talked about a couple large deals that slipped, but the fact that you bring down the license growth estimate for the year seems to indicate that it is more than just a couple of slipped deals. So can you talk to us in a little bit more detail about the demand environment, not only in those weaker but in the other areas relative to what you have seen in the last couple of quarters?

Yes. Jim here again. Let me first say we didn't plan for a strong year in federal and aerospace and defense. We are aware of the macro situation and we planned accordingly. But what did catch us by surprise was a couple of deals that we thought we were going to get, suddenly in the midst of this we are shutting down the government crisis, nobody wanted to spend any money on anything because they weren't sure what was happening. So these deals slipped. We think we will get them.

But I think we as a management team said clearly our maintenance business is well ahead of plan. And clearly our license business is not well ahead of plan. Although keep in mind we had a very aggressive plan. So I think we said, we either need to take our guidance up, or we need to switch the mix around and derisk it all a little bit, and we just thought it was a prudent move to fix the mix, add a little bit more maintenance and take some of the pressure off license, and so give you a different guidance mix that gets us to the same result. I am not sure we would give up on the idea of the license plan we had. But I think we would admit that we are going to need a big back half to hit that original plan of 20% to 25%. It is more likely we will end up in the 15% to 20% range, which quite frankly we are still proud of.

And Sterling, this is Jeff. I will just add we have been very focused on building these annuity accounts, really focused on that recurring maintenance stream. And when we look at the overall year, we basically, I would suggest, taken the license number down by approximately $10 million to $15 million, and reflected that in increased maintenance. And that trade is always a good trade where we are more disciplined on the maintenance side. Because that represents an annuity that net $10 million will come year in, year out. We feel very good about it. It improves the predictability, it is fundamentally a wash on margins and profitability, but it gives us a much better and predictable and annuity streams that we really like.

I think the main point is you are asking too is we're not seeing a lessening demand in Windchill at all. 24-plus of deals reflects quite a strong robust quarter. Our pipeline is very strong for that. Last quarter, 22 of those deals. So we are seeing that. I think Jim alluded too, is if you look at last year versus this year and you look at the number of mega deals above $10 million, we haven't seen those deals this year and--

--yet anyway.

We haven't seen those deals yet, and certainly if we got one of those mega deals in, it would change our outlook and those mega deals are not predictable kinds of deal, they sort of come together and coalesce based on the business planning of our customers, so I think we feel very strongly that the demand is there, that Windchill is very healthy and that we see and we will continue to see a growing pipeline in relation to Windchill.

But when you say aerospace and types of deals that it pops sometimes, there are some domino accounts, like an Airbus, can you just give us some confidence that the annuity-like stream out at some of those domino accounts in those industries that you pointed out as weak continue to be good?

Yes. Can I just make a clarification? Normally we have a segment we call federal aerospace and defense. For purposes of today's conversations we have been trying to take aerospace out of it, because the aerospace industry quite frankly is just fine. It is the federal and defense sector that is under the government spending pressure. That does not generally apply to the aerospace sector. So that should alleviate your fears there.

Great. Last question would be when you talk about capacity constraints and having to deal with that, in my mind I have to try to, the margin expansion opportunity versus the increased investment necessary that you might need to drive the top line. If you invest more heavily in sales and marketing capacity, what is the other lever you that can pull on to drive more market expansion?

R&D spend something one we have talked about many times. And look at our R&D numbers, subtract $3 million severance costs and see what they look like. I think they are pretty interesting and indicative of our movement to take R&D spending back to sort of normal levels of historical spend, so that would be a key opportunity.

But let me reiterate something I say each time. We are working backwards from 20% earnings growth. We are not going to come to you with a plan that says we have a lot more growth opportunity here, but sorry, we are going to blow the margins. We are going to stay committed to this 20% earnings growth. It is baked into our strategy, it is baked into our compensation. You can pretty much take it to the bank that we are going to do everything we can to deliver on that 20% earnings growth. It is just a question of what combinations of revenue growth and margin expansion get us there. The more revenue growth the better from my perspective because the expansion opportunity, the margin expansion opportunity doesn't go away. That just becomes more years of sustainability of this goal, because we can always continue to do that in years six, seven, and eight, if we have been able to getting there on more revenue growth than we anticipated.

Great. Thank you, guys.

Thank you. Next question, Ross McMillan from Jefferies.

Thanks. Jim, I was curious just because of the original license guidance and where you guys turned out. How big is that federal and defense business for you? What sort of magnitude is it for Parametric?

Yes. Our traditional and really looking back over the last four years, US federal has been approximately 10% of our business. So, again, that's apiece of the business that we feel very good about. There were some deferrals that occurred this quarter. I think clearly we have got some long term macro trends there related to federal spending and defense. That is going to continue to be a healthy business but probably at a smaller percentage of the business. That said, as we cited earlier our commercial business was up better than 25%. That is really the key driver, in my mind, for the growth going forward.

Just to add a little more color, typically, we have reported our federal aerospace and defense business is about 20% to 25% of our business in a typical year. You could basically say aerospace is half of that and federal and defense is the other half would be a good way to look at it. So that said, the federal spending is divided across many different parts of the federal government, some of which are doing just fine. No one is trying to cut Homeland Security spending. So it is Army, Navy, Air Force, it is NASA, it is Department of Energy and the nuclear weapons complex, it is lots of different programs that have independent customer relationships with us. When you add them all together, it becomes this 10% or 11% of our revenue.

Great. And then on Japan, you actually look fine there. Any thoughts about, do you have any views as to whether there could be a delayed impact in Japan? Just curious because your actual license growth seemed to be pretty good there?

You want me it take that?

I can. First I will cite and say we have about 250 people in Japan, and the good news is they were all safe and some of their families were impacted, but we were very pleased with the leadership in Japan. and really how people worked through it. I think Jim has been there a couple times both just before and just after the event. So the business was good, and there was no real impact on the quarter. Typically, this is a strong quarter for us in Japan. We usually see Q2 being strong, and that was consistent. I think we are still cautious as I'm certain what will happen in the next couple quarters with Japan, but I think long term it is a very resilient economy and culture. We would expect continued growth. We have great leadership there and I think the long term view will continue to be very, very strong in Japan, but there is some uncertainty about the next couple of quarters.

Yes in Japan we had a very good quarter, and that said I don't think all of our problems are magically fixed. I think on the path to better and better, stronger and stronger business, this was an extremely strong quarter. And we think things are getting better but I don't think they are that much better instantly.

Our leader over there is extremely good. You should know that a fair amount of that licensed revenue the majority of it was closed after the earthquake. So I think companies didn't just stop spending money. Jeff mentioned I traveled over there. I was actually supposed to go there the Saturday immediately after the earthquake, but I postponed it a bit. I traveled from Narita to Tokyo to Nagoya and back. Incidentally brought a radiation detector with me. I didn't see a single speck of evidence that an earthquake had ever happened along that route, and my radiation detector didn't pick up any radiation.

So I think the Japanese people who are immediately involved around the area of the earthquake and the nuclear plant, it is a big deal. But I think by the time you get to Tokyo it is just my personal sense is that it seemed far away from the people in Tokyo. And they were in the office working and you look over Tokyo and there are a million high rise buildings it seems, and there isn't a single one of them damaged, or anything else. It is not like somehow it is not as bad as the US media seems to report it. But I don't really want to say it is not bad, because I think if you are in that immediate area, it is pretty bad. But I think a good amount of our customers aren't there.

That is helpful. A couple quick other ones. As you think about your revision to your full year license, and Jeff, I think you described it as about a $15 million reduction, how did you kind of gauge that? I am curious as to how you kind of got to that level of license growth?

We look at the business holistically, so we look at both license maintenance and service in aggregate. And as we said, we have got major deployments underway in the services side. We have seen a mix shift I think is actually healthy in some cases between more maintenance higher annual streams from the maintenance side versus license, so I think the mix is actually a positive signal for us, and it is really based on pipeline, and outlook customer plans and programs.

So I think the lift that we are seeing in maintenance I think is terrific, and is very sustainable, and at the same time in a number of cases because we are not forecasting large deals, we are perhaps a little bit more conservative on what we thought the license numbers could be this year. I think as Barry cited there are some big deals out there to be worked. Those are yet to be closed.

Okay. And the very last one, just on the severance in the R&D area, could you maybe just add some color, you mentioned automotive. I wasn't quite clear just what actually you are doing there?Thanks.

Okay. Well, you will remember last quarter when we announced the HKMC contract and the accounting hit we took for it, and so forth, many people said does that mean you are hiring new people. And we said no. We are going to repurpose, we are going to take our R&D spending down and the net effect is a transfer of resources from R&D to services from an accounting perspective. The only thing is in taking down those R&D resources, we had to pay out some severance. So I think it really was associated both with our general automotive strategy, and then specifically with the HKMC contract, and rejiggering our resources to align with what we told you last quarter.

Is it actually a transfer of employees from you to the customer?

No, no. Think it have as a transfer of employees from largely North America to Korea. But a lot of North Americans don't want to move to Korea, so it became a termination of some employees in North America and hiring of some employees in Korea. Now some of the employees in Korea are not working necessarily directly on the HKMC project we announced we were opening an R&D center in Korea to really build some automotive expertise as a Company strategy around that. But a fair amount of them are people doing work in that contract for which we described the accounting last quarter.

Got it. That is helpful. Thank you.

Can we try to limit the questions to one question and one follow-up? Thanks.

Thank you. Richard Davis from Canaccord.

Okay. I have 13 questions. So first a tactical one. Is the Q4 guide does that include the MKS revenues or not?

It does not.

Okay. Got it.

We will give you an update on that in June

Got it. I didn't think so but I wanted to make sure. And then the second one is in your opinion is Windchill 10, a margin-driving vehicle for you, and also should we kind of adjacent to that question assume that if I were a salesman, I would kind of be preselling this to my customer base saying hey look, we have got Windchill 10 coming out, it is a really whiz-bang improvement maybe you should buy this. The point is, does that give you at least notionally some cushion in your PLM business as the second half of this year rolls out?

Yes so in the first part of the question is Windchill 10 a margin driver, I would say yes, because really two reasons, number one it reduces the degree of customization. A fair amount of customization has been user interface tweaks, and then a fair amount has been functionality gap filling historically, and with 10 of course there is a lot more functionality, but more importantly I think the era of customizing the user interface is coming to an end. So there should be less customization therefore less services, therefore a better license to service mix. The second thing that is very important is we should also have faster adoption, thereby leading to the next license order, which again improves the license to service mix over the course of a year or so. So I think it should help a lot with the margins.

And then regarding the preselling, I think there was a concern that this launch of Creo was going to hurt our CAD revenue, and in fact the launch of Creo has, in part, I want to give the economy some credit here, but the launch of Creo has caused our CAD revenue to explode, and the explosion of CAD demand has hurt our Windchill revenue. So I think Windchill 10 is neutral on Windchill revenue. If anything, mildly positive but I think it is really this transfer of selling cycles over to the CAD side of the house because of such strong demand for Creo.

I don't think anybody on this call thought we were going to post a 57% license increase in our CAD business in those large accounts in Kristian's upper left box. I think we are all extremely pleasantly surprised. And if we could get all these cylinders hitting at the same time this is a different Company than the one we are talking about here today even. It is pretty interesting, but we need to execute better on multiple dimensions

Got it. Thanks a lot.

Thank you. Yun Kim from Gleacher.

Thank you. I just wanted to ask you regarding the business dynamics and the Creo in the quarter. So the Creo doesn't get released until the summer. So I mean you explained that the economy contributed to certain segments of the CAD business in front of a major release. Are there any other dynamics that show that strength in the quarter?I mean could it be a possibility that people now wanting to buy Creo and that is why they are buying the older version before it gets released?

No. Let me take you through the story again here. Nothing has changed here, but I want to remind you kind of about the facts, because it is probably hard to remember all of this stuff. We used to have three discrete products, Pro/ENGINEER, CoCreate, ProductView. And in Creo we came up with a new concept that blends these three together in a pretty interesting way. So Creo is actually the successor to three product families.

Now Pro/ENGINEER and CoCreate were never cross-sold in the past. So with our branding we went back and renamed, because all three of these products are now upward compatible to Creo. We went back and renamed Pro/E to be Creo Elements Pro, we renamed CoCreate to be Creo Elements Direct, and ProductView to be Creo Elements/View. So those are the three products that we are selling today.

And what has happened is suddenly we are seeing a tremendous amount of cross-sell. We are seeing the Parametric customers who formerly had Pro/ENGINEER begin to buy the Direct product, formerly known as CoCreate, and vice versa in particular. So we are seeing a cross-sale having been unleashed in anticipation of a unifying product that actually blends the two together in a more perfect way. So that is pretty exciting. But again, I think that is exciting and we have evidence that this Creo launch has made a difference, but I don't really want it take away from the fact that people are hiring more mechanical engineers, and they simply need more seats as well. So it is really probably first and foremost better economy, secondarily maybe one-third of the factor is the cross-sell we that we have unleashed in anticipation of the unification.

Okay. Great. That is very helpful. And I just want to make sure, given the constraint in your sales capacity that you mentioned, do you plan to accelerate sales hiring in the second half of the year?

Yes. I think we are going through a planning process on that dimension right now. I would anticipate our June Investor Day might be an opportunity to give you an update on that. We have not yet authorized that. Normally going into the next fiscal year starting October 1st, we would authorize a new wave of capacity. The question for is us is can we accelerate that, and begin some of that hiring in anticipation of next year earlier than October 1, and that is an open question that we can give you an update on in June.

And I want to sneak one last one in. Jim, what had been the initial reception regarding the Windchill 10 release so far? Thanks.

It is extremely positive. We had one small VAR account that told us it took a day to install it, and go into production the next day. A very small customer like 8 seats, or something like that. We have had many, many big customers, participate actually in the development of the software, and then comment on it afterward. So I think Windchill 10 is going to be a blockbuster release. I think it is a little unfortunate for the Windchill fans out there that the Creo blockbuster release stole some of Windchill's thunder, but trust me that Windchill 10 product will prove very material to our results going forward.

Okay. Great. Thank you.

Thank you. Steve Koenig from Longbow Research.

Good morning. Thank you. I guess I will start with my easy question first, and then have I got a little bit more involved one. The short question is, can you all explain how you will differentiate MKS from the embedded systems functionality that Dassault has?Are you all approaching the market differently, or do the products compete pretty head on?

Well Dassault formerly had no capability in this area. They about, I don't know maybe a year ago, acquired a little company called Geensoft, which was I think a $6 million revenue company based somewhere in Europe. So Dassault bought a small little player, who has stitched together some open source products. We bought the industry leader, or are in the process of acquiring the industry leader who is doing $75 million in revenue. So I suppose you could say the two compete, I think that we have the industry-leading platform, the best technology, the most customers, the broadest footprint, the number one position by a factor of ten. So that is how I would characterize it, Dassault will be a competitor, but we think they are not necessarily a strong competitor

Got it. That is very helpful. And then the more involved question, is about just wanting to get your updated view on the market growth rates in the CAD and the PLM segments, and then how you guys will compare to that?And the backdrop for this would be just in looking at organic growth rates from you guys versus Dassault. We don't have the [UG] numbers last year, you guys were ahead of them in growth and PLM really drove that. The last couple of quarters they pulled even, pretty much on those organic constant currency growth rate.

Hang on Steve, Dassault hasn't posted any organic growth rates in four quarters now, because they are rolling IBM into their numbers.

Yes. We are doing that backing, we are looking at the combined IBM/Dassault 12 months ago, versus what they are doing now. It is somewhat of an organic calculation. But leaving that aside, I guess my real question is, you referred to the PLM market the upper right box as kind of a 15% business, so I am wondering what you think the growth rate is there, both the market and for you guys and kind of same question for CAD?

Yes. I think I am reading the same data Kristian gave me as they gave to you here. But looking backwards, it has sort of been an upper single digit, 8% to 10% let's say percent growth for the PLM industry, and CAD has probably been 3% to 5%. We have been a strong overperformer in the PLM segment, because we had a 17% growth CAGR in that upper right box, or actually that right column, during a period for many years while the industry was growing 8% or 9%. We have doubled industry growth historically in PLM, and we have probably lagged industry growth in CAD by a point or two. Maybe the industry was growing 4%, and we were growing 2% or 3% during much of that period. 2009 aside, when nothing was growing for anybody.

I think going forward, we think we are going to continue taking market share in PLM. We didn't necessarily take any this quarter. But this quarter we probably took a lot of market share in CAD, certainly from a revenue standpoint. I would expect that this phenomenon of explosive growth in CAD will probably temper itself a bit over time, and that the growth in our Windchill PLM business will accelerate again. And I think we will probably get back to a situation where we are a low-teens organic grower based on a Windchill rate greater than low-teens, and a CAD rate in mid to currently I believe mid to upper-digits for some time now. Mid to upper-single digits.

Upper single digits.

Yes.

Thank you.

Okay. I think we have time for two more callers.

Okay. Ben Rose from Battle Road Research.

Go ahead, Ben. Okay. Looks like we lost Ben. Can we take the next one?

Hello?

Go ahead Mr. Rose.

Sorry. On HKMC can you give you any update on any milestones that have been reached thus far, and your perspective on how things are looking going into this next portion of the year, and then a follow-up would be, and I will limit myself to one follow-up, would be any evidence that HKMC is turning the heads of others in the automotive industry?

Yes. I think just to be honest, Ben, it is a little too early on both of those fronts. Most of our early milestones at HKMC have really been around mobilizing the resources to do the project, and we are doing fine there. But it is too early to declare ourselves ahead of or behind schedule in any meaningful way. And then I think on the sales front, I certainly couldn't point to any revenue, but I think we have engaged now in a series of conversations where people want to hear about what is going on at HKMC. Incidentally, these same automotive companies want to hear about what are you going to do with MKS, because MKS has quite a bit of traction in the automotive industry as well.

Okay. Thanks very much.

The last question comes from Mike Olson from Piper Jaffray.

Okay. Thanks it is a quick one here, back to this question about resources going into Windchill versus the CAD side, and the focus shifting somewhat back to CAD, you guys have clearly been taking share in PLM over the last few years, is it possible that with Creo and all of the resources you are putting in on the CAD side that we will actually see an increasing ability to gain share on the CAD side, or is it more the case that competitor implemented CAD systems are just generally too sticky to push out and replace?

I think we are going to take some share. I mentioned we had our first Creo domino, the first account where we could say this really was a situation where they liked the Creo story better than these competitors, and decided to turn of competitor seats to standardize on Creo. I anticipate we will have more of those going forward. One of the interesting things about Creo, we talked about any mode modeling, any bomb assembly, any data adoption, et cetera, this any data adoption concept, really allows Creo to bring data in from other CAD systems in a much more meaningful way than has been historically possible, and used that data productively going forward. So I do think we are going to be able to take share, and I think really it is going to be this combination of the story of Creo, Windchill, Arbortext, MKS, Relex, et cetera, that just becomes so compelling that one becomes increasingly tempted to bite the bullet and switch out the CAD tools as well. Some of our competitors have probably not done themselves any favor by being a little heavy-handed with their customers. So there is also a base of frustrated customers out there, from one competitor in particular, that are somewhat vulnerable. And so I think we will be able to take some share.

Alright. Thanks a lot.

Great. Thanks very much everybody for the questions. And we look forward to seeing you all, or any of you who can make it to Las Vegas in June for another update. Thanks again.

Thank you for participating in today's conference call. This concludes today's call. Please disconnect at this time. Thank you.