PTC Inc (PTC) 2011 Q3 法說會逐字稿

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

Hello, thanks. Good morning, everyone. Thanks for joining us on our Q3 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 assumptions 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 as contained in PTC's most recent Form 10-K and Forms 10-Q on file with the SEC, all financial measures discussed on this call are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measures is located in our prepared remarks document on the Investor Relations page of our website at www.PTC.com.

With us on the call this morning we have Jim Heppelmann, Jeff Glidden, Barry Cohen, and Kristian Talvite. I'd like to turn the call over to Jim.

All right, thanks, Tim. Good morning, and thank you all for joining us. I'm pleased that we've been able to announce another solid quarter of business here in Q3, with total revenue growth of 20% and non-GAAP earnings growth of 52%. Those are pretty good headline numbers. Our revenue growth was well above our guidance range, but even if you back out the MTS contribution and look at the organic component, that revenue was above our guidance range. And our non-GAAP EPS came in at the very high end of the guidance range we had given you a quarter ago.

We had a relatively balanced growth of 21% in the desktop business and 20% in the enterprise arena. We had very strong demand for maintenance with 17% growth and services at 27% growth. And our license growth rate improved to a very respectable 18%. Again, I think these are all very solid numbers.

During the quarter, at our Planet PTC customer event, we formally launched the Creo product, which transformed a great story and a strong vision into a reality for us. At that event, we received some tremendous customer feedback, as well is great reports coming out of the event from press and industry analysts. All this buzz about Creo, dating back to the October event in Boston, has translated into a lot of sales activity, which in turn has translated into a surge in expansion orders from our existing customer base, and a noticeable increase in new customers captured by our reseller channel. We continued the recent trends in this business as we posted another very strong Creo quarter with license revenue up more than 40%.

During the quarter, we also closed the MKS acquisition. MKS is a very exciting and very strategic acquisition for us, and it will add to our revenue growth opportunity far into the future. With the Integrity product, MKS had become the leader in helping companies develop the embedded software that goes into manufactured products. The number of software engineers within the engineering departments of our manufacturing customers is growing at a very fast rate as products become increasingly sophisticated and increasingly filled with electronics and software control systems. So, Integrity provides a very compelling standalone sales opportunity, which gives us a great way to penetrate new accounts, even when there is not a PLM or MCAT opportunity readily available to us.

At the same time, when the software development strengths of Integrity are combined with PTC's historical strength in hardware development and PLM, now we have a very compelling and completely unique solution for customers. So, we are very bullish on the Integrity opportunity, and you'll note in our guidance that we increased, by a bit, our expectation for the contribution of MKS in our Q4 outlook.

We shipped our blockbuster Windchill 10 release earlier this year. And in Q3, our enterprise business began to show good signs suggesting that the rebound that we have been predicting to show in the back half of this year is underway. Total enterprise revenue was up 20% in the quarter; license revenues were up dramatically from last quarter, though flat with the tough year-over-year comparison. And the maintenance and services business continued to post very strong growth numbers, as customers proceeded with their deployments and ongoing use of the software.

We saw better performance from our federal aerospace and defense vertical, and we also secured two important new domino accounts. One of the domino accounts is in the electronics and high-tech vertical, and the second represents another major win in the retail and consumer vertical, where we have a fabulous win streak going, and a lot more runway in front of us. You will notice, of course, that we had a lot of big deal activity in Q3, and about one-third of this activity came from this portfolio of domino accounts. So clearly, Windchill is on track, as we continue to demonstrate our ability to capture market share, and then to leverage those new accounts to expand our growth opportunity.

So incidentally, last week I was in Korea, and had an opportunity to participate in the steering committee meeting with Hyundai. While the scope and the timeline of our PLM project at Hyundai suggests this project will always be a challenge, we are in fact executing well, and the customer was pleased with our progress. I'm personally convinced that the main thing that's holding us back from achieving even stronger enterprise numbers is the ceiling that we've hit with our sales capacity. As we discussed in June, we are now addressing this issue, and we are in the process of executing some fairly aggressive plans to expand our capacity, starting here in Q4, and then continuing on a fairly consistent basis throughout fiscal year 2012. So, with this capacity challenge being addressed, we remain very bullish on Windchill and on Integrity. And we expect therefore, to maintain high growth rates in our enterprise business well into the future.

Moving toward the summary here, we started the year with the revenue forecast of 10% to 11% growth, which would get us from $1.1 billion to $1.12 billion. And we coupled that with an earnings forecast of $1 per share, so that was our starting plan. Now we feel that our performance through the first three quarters of fiscal year 2011 puts us in a great position to now deliver a much more interesting plan. Now, we are talking about 14% to 15% revenue growth, which would get us somewhere in the range of $1.15 billion to $1.16 billion, and we're talking about an earnings per share of $1.20 to $1.24.

So, while I think we started the year with a good plan, per our guidance, we are now in a good position to beat that plan by four to five percentage points in revenue growth, and similar to meet or exceed the 20% earnings growth component of that plan as well.

At our recent Planet PTC Investor event in Las Vegas, we talked a bit about our preliminary thinking about fiscal year 2012. In the model we shared, which I would characterize as something well short of official guidance, which we will give to you at the end of Q4. But that model suggested we expect to see growth rates further improve in 2012 into the mid teens overall, and that with this mid teens growth level, we felt that another year of 20% earnings growth was readily achievable.

So, if I back all the way up to our Investor event of 2009, you will remember at that time, we outlined a five-year plan that suggested we could deliver a 20% earnings compound average growth rate over this five-year window, which would get us to $1.6 billion in revenue and $2 a share. So, now as we approach the last quarter of the second year, and we begin to think more about the third year, we think we are in a great position to meet, or perhaps even exceed, the 2014 goals.

So, while I think there's always room for continued improvement, I'm pleased with the progress we're making, and how we are doing overall. Thank you, and with that I will turn it over to Jeff Glidden for some financial commentary.

Thank you Jim. I will just provide a little additional color on Q3 results, and then we will move to guidance for Q4 and the full year. As Jim cited, we are very pleased with the results in Q3, and it was a busy quarter. Q3 financial performance really reflects the leverage in our financial model, as non-GAAP operating margins expanded 440 basis points to 17.6%. Cash flow was strong. We generated $48 million in cash flow from operations, or $0.40 per share. DSOs improved to 56 days, reflecting again, strong cash flow and good delivery against commitments to customers.

On the capital side, we repurchased 1.8 million shares of PTC stock for $39.9 million, and we completed the MKS acquisition funded by cash and $250 million of borrowing from a revolver. And we ended the quarter with $261 million in cash, up $1 million from a quarter ago.

With our third quarter results, we also announced that we were reviewing a compliance issue in China involving payments by certain business partners. We have identified and investigated the potential issue as part of our ongoing compliance program. We have engaged outside legal and accounting advisors to complete an investigation, and we have notified US government authorities of the potential issue. Based upon our review today, we have not identified any material impacts to our business operations or financial condition. Our review is continuing, and we will provide further updates as appropriate.

I will close with our Q4 guidance and outlook for the year. Again, this assumes the foreign exchange rate of $1.45 to the euro. Again that's been fairly choppy, so we're cautious and always look -- watch that very, very closely.

For Q4, we expect non-GAAP revenue of $320 million to $330 million, and EPS of $0.40 to $0.44 per share. This guidance reflects our decision to hire additional sales reps in Q4, as Jim cited. For fiscal year 2011, we expect non-GAAP revenue growth of 14% to 15%, or $1.15 billion to $1.16 billion. For fiscal year 2011, we expect non-GAAP operating margins to be between 17% to 18% up from 15.6% in fiscal year 2010. And we expect non-GAAP EPS to be as Jim cited, $1.20 to $1.24. We thank you for joining us, and we will now open it up for your questions.

(Operator Instructions). Our first question comes from Mr. A Jay Vleeschhouwer from Griffin Securities.

Thank you, good morning. A few questions. The first, the third quarter, your Desktop licenses were down sequentially, and your Enterprise licenses were up sequentially, which was the reverse of what happened in the March quarter. And so the question is, would you attribute that inverse relationship to what you have talked about in terms of sales capacity or production? Or do you think perhaps we are beginning to see the signs of some slowdown in what has been a CAD market recovery in the preceding two quarters?

Jay, this is Jim. It's hard for me to read too many trends into those data points, because on one hand, there is a sequential story. And on the other hand, there is a year-over-year story. And the seasonality in these numbers and so forth, and the numbers move around a little bit. So I think in general, we expect to move in the direction you're suggesting, which is strength returned to the enterprise numbers, somewhat at the expense of or perhaps in general, a reduction in strength in the CAD numbers. As much as I'd like to keep posting quarters of 40% license growth in the CAD business, I'm a little reticent to project that. So, I think the trend is headed that way, but I can't read as much into this one data point as you might be suggesting there.

Okay. That's fair. Could you be more specific as to the amount of sales capacity you are looking to add?

Yes, Jay. This is Jeff Glidden. We ended the quarter with approximately 420 sales teams. It's our goal, I think we cited this at the Planet PTC, it's our goal to add approximately 100 additional sales teams over the next year. We started that hiring really already in Q4. It reflects, by the way, just our confidence in the market. I think we've got the demand; we see the demand. We've probably got a strong a product position as we've ever had.

Okay, just two quick last follow-ups. When you look at what is still your single largest revenue line item, desktop maintenance, that had a pretty good sequential increase and year-over-year increase in Q3. Do think that we are now finally beginning to see an inflection in the Pro-E active maintenance numbers that might carry into fiscal 2012? Is that customers signing onto maintenance to get access to Creo, or perhaps you could talk us through some of that maintenance trend?

Well, you can help me here, Jeff, but generally the trend in maintenance tends to follow about a year behind the trend in licensing. One of the things I am excited about is it's pretty clear that we should have a strong desktop maintenance year in fiscal 2012, following on the backs of a surprisingly strong license year here in fiscal 2011. I think that you are probably right. We are at that inflection point where the maintenance is now starting to reflect the license trend that began several quarters prior, and I think we will be able to continue now, a positive maintenance trend in the Desktop business for some time.

Jay, I would just add I think the teams have done just a great job on renewing maintenance, picking up back maintenance, they've been very strong on the programs. I think the customers really recognize the value, and I think we have been extremely pleased with the performance. We say it's sustainable, and just so we don't miss it, we broke the million seat mark in Windchill this quarter as well. I think all signs are very strong in the maintenance business.

Okay. And just lastly, one of the things that was left a little unclear coming out of the event in Las Vegas last month was how the Creo pricing or customer spending by existing customers would map from what they already had, or what came before in the customers deployment, to what has been delivered now or will be delivered. It's basically a question about how much run rate or incremental run rate you might get from existing customers as you rollout Creo. Thanks.

I think probably the bulk of the Creo upside has come from the base, although part of that is the former CoCreate based tending to buy the Pro-E product. And part of it is the former Pro-E base is tending to buy the CoCreate type capabilities. So, a lot of it is cross sell, and some of that, of course, started even in advance of the Creo 1 release. But I would tell you I speaking yesterday with our reseller channel head, Bob [Cosas], and new account production in the reseller channel is at multi year highs right now. And that's mostly new accounts adopting the Creo product. I think it's in the mid-20s growth rate right now in terms of new account production, which is great, it's fantastic trend. Now, those are small accounts, and they don't necessarily move the needle that much in the short-term on the financials. But over time, they become pretty important to us. So I think that we are definitely seeing a significant measurable uptick in new account production, but the bulk of the upside revenue we've had probably comes from the existing base.

Thank you. Next question. Yun Kim from Gleacher Company

Thank you. Jim and Jeff, can you help me reconcile why the number of seven-figure deals are up so much from last year, yet the PLM license business was flat. Does that mean all the incremental seven-figure deals are mainly CAD driven? Or is the PLM deal size trending lower from last year. If you can help me, what trends you are seeing around seven-figure PLM deals, that would be very helpful, thanks. Thanks.

Just a few comments. I think first, let's not lose sight of the large deals, or the activity is terrific. Pipeline is building, and as I think Jim said, looking at trends in a short window is somewhat helpful. But I think what we said at midyear was we felt that PLM business was strong, the pipeline was good, and just the large deal activity has been good. So I would expect and say that we've good activity with both Creo and with Windchill. And I think the trend is, as Jim described, is we would expect more PLM large deals, as well as Creo deals as we go forward. So I'm not sure I have any more specific comments than that at this point.

Maybe I could just clarify something, Yun. So, there were 27 large deals in the quarter. And I said about one-third of them came from the domino accounts. That does not mean that two-thirds were CAD, because maybe another third came from install-base accounts that weren't domino accounts, but were purchasing Enterprise software. So Windchill was well represented in the big deals. CAD also did well, particularly because we used to not have any big CAD deals. So I would say that the CAD number was up significantly, but the Windchill number was also up significantly, both in terms of deal count and overall revenue. So the big deals are going well. I think part of what happens is when you don't have enough capacity, people tend to congregate around the bigger deals. And maybe what we need to do is put more capacity in below those people, and make sure we are pursuing enough base business as well. I think we're doing well in the dig deals.

The other thing, Barry here, is those 27 deals, they also represent license and service. So it's not just $1million dollar plus license deals and improved service and most of that service revenue that's in those big deals are enterprise PLM accounts that are installing and adopting the Windchill technology.

Got it, thank you. And then you guys mentioned in your prepared remark that services margin is being impacted by the Hyundai-Kia engagement. Is there any visibility to when this impact on service margin will end? And is there any way to quantify how much the impact was in the quarter?

I'd say that this is the previously announced, that is not new news on Hyundai. This is, back to Q1, the lost contract we discussed at that point, and the fact that -- by taking the loss up front, it made the rest of the project break even. And break even does not produce good services margins. This is not a new phenomenon; this is just a continuation of that phenomenon. Part of what I think we were trying to say there is if we could back that out, the rest of the services margins actually look better than they appear. I think that's the point we were trying to make.

How long do expect that this engagement is to go?

The project runs through the calendar year.

Okay got it.

And then we will negotiate a next phase, and I'm confident that the next phase will be on more favorable economic terms.

Got it. And then Jeff, what is your plan regarding the credit line you tapped into? How soon you plan to pay back and will that impact your Share Repurchase Plan?

I think as you saw, we did both this quarter. We continued the Stock Repurchase Plan. We would expect to complete the $55 million as we planned for the year, so that's another $15 million in the fourth quarter. We will continue on that, and I think we shared when we did the MKS deal that we would expect to pay that line off at a pretty good clip, probably, certainly within the next I would say eight to 12 quarters. And it will really give us a lot of flexibility. I think we are in good shape. As you saw, we generated significant cash again in the quarter, and I think we will expect to be paid probably between $40 million and $50 million of that back just in Q4 alone.

Okay great, thank you so much guys.

Thank you. Blair Abernethy from Stifel Nicolaus.

Thank you. Just wanted to dig in a little more on the PLM domino backlog. In particular, as you've been winning these large mandates in the last two years, trying to get a sense of what your expectations are now around the license and consulting services mix from these large wins. And how far out into the future, how big is that backlog looking?

Well, I think our services business, they are looking at four to six quarters of visibility into their backlog. As we sit here today, we are pretty comfortable. We know with relatively close precision what the fiscal year 2012 services number is already. But I think more importantly, it's not our strategy to grow the services business as fast as we can. What we have right now is an effort underway to try to build out a partner ecosystem to which we could give more and more of the services. But the truth is, the demand right now exceeds the ability of PTC and our partners to keep up with. I think we are in an area of strong demand, but a strategy that says increasingly shift some of that services demand to partners. And we are trying to bridge our way to that future state.

Just two other comments just to make sure we're clear, we have backlog, or orders in hand for services. We also have a significant pipeline of new opportunities or extensions to current opportunities in the PLM space. With many of the large accounts, and work with them very directly, on three product road maps, those may not be committed orders at this time, but they are really a pipeline of activity that we feel pretty good about.

Okay great. That's helpful, thanks. And just another question on the large deals in the quarter. Can you give us a sense of the vertical performance, or what seems to be working better for you in Q3? And also was there any contribution in large deals from MKS?

On the second part of that question is no. Not in the partial quarter that we had.

Recognize MKS was really only one month with the month of June. MKS was not a particular contributor to large deals. I think Jim cited verticals in terms of we a return of activity in Aerospace and Defense. Again we are cautious long-term on the government business. But, at the same time, we have seen good performance there. Industrial was good. We cited retail and consumer as a large domino win, along with some of the high-tech businesses. And again, a relatively newer vertical for us is medical devices, and that is a good market and has good outlook as well.

Yes and I think automotive, Hyundai and some of the other OEMs and the big suppliers as well. I think was actually -- the truth is, it was pretty good balance. It is not concentrated in one area, as we think about it here.

Okay great, thanks guys.

Sterling Auty from JPMorgan.

Thanks, hi guys. I want to go back and revisit the PLM business. So, can you talk to us a little bit about the pipeline and the aging of some of the deals that are in there? Meaning, is the pipeline continuing to grow? Have you re-scrubbed it? And is the demand side from the customer perspective growing and is it purely a capacity issue like it was last quarter? Or is there lengthening of sales cycles and decisions on the customer side?

I don't think there's a lengthening of decisions. I think the pipeline is pretty strong. We've been here in a sales management meeting for two days, looking at the pipeline for Q4, or Q1 of next year and really for the balance of the year. I think the pipeline looks pretty good. It is just a question of where does the sales guy spend his time? When the customer says -- calls up and says, "I heard about this Creo thing. Can you come tell me about it?" And then that turns into more activity, which pretty soon turns into a purchase order discussion, then that sales rep gets a little distracted from what he had normally would have been doing, which was pushing the ball forward on the Windchill side.

So I think what we need is we need more capacity so that we can of both of those conversations, not one or the other. And that probably means we need reps to have fewer accounts, and more time per account to carry on multiple conversations. So I think that's why we think it's a capacity issue, not a demand issue. Nobody at PTC or in our whole ecosystem here really envisioned that we were going to have the Creo year that we had this year. Surpassed everybody's expectations, management included here. It came a bit at the expense of our ability to spend as many cycles on the Windchill business as we would have projected to do at the beginning of the year.

Listening to your comments, it sounds like you believe that, obviously, it is not a sustainable growth rate. It would be great if it was, but it's probably not. So as that starts to moderate or trend back towards what looks like an industry average growth, a concern that we might hit a blip or a pause as they turn their attention back to PLM. But to re-jumpstart those conversations or hose focus, it may not be an instantaneous thing, and could you get some disruption as they shift the attention back from the CAD buyer to the PLM buyer?

What I think you have is two overlay factors going on simultaneously here. On one you have an improving economy; our customers are hiring engineers. They are expanding their deployment of CAD technology, and so forth, so there's an economic factor. And then separate from that, there's an exciting new product factor. And these things are overlaying each other, and sometimes it's hard to assign a certain weighting to each of these separate factors. I definitely think the economic factor will run its course. But we'll be left with the new product factor, which I think is also interesting. So I would anticipate, and I've said this previously, that we will revert to a growth rate that is noticeably superior to the growth rate we would have had, had we not had this new product. So maybe we would have thought this business was a 3% to 5% grower. I think post Creo, we think this business is a 5% to 8% grower on a go-forward basis after the economy factor runs its course.

Last question and I will jump back into the queue. Is there a sense that you can give us when we should look for a re-acceleration in PLM, just from the fact that you have been hiring new sales capacity, and it takes time for them to ramp up? Is there any sense when you expect to get enough productivity out of the new sales capacity that it moves the needle, and we start to see the pickup in PLM?

First of all, if we talk about PLM in general, we did have a 20% growth boarder in our Enterprise business.

Let me be more specific then. I think there's a lot of us that are looking at the licensing. I think we're all very impressed with the service and the maintenance and hoping the service is also a leading indicator. But I think we want to see the license growth return to it because it seems like that had been the engine of growth for the Company for a number of years.

That's fair. I was just trying to remind everybody in the big picture, the business is growing nicely. But you're right; we need to focus on the license. I think in Q4 here, we will be disappointed if we don't post a positive year-over-year license growth number in Q4. And then I think we would be disappointed if we didn't, throughout next year, continue to post increasingly positive year-over-year license growth numbers. So I think we feel like it just snuck up on us a little bit. It takes a quarter or two to react to it, both to remind people to focus on the right things and to add in more capacity, so that they don't have to make so many trade-offs and so forth. But I think in Q4, we would expect to give everybody numbers you're happier with and that trend would continue.

Got it, thank you.

Thank you. Matt Hedberg from RBC Capital Markets.

Thanks, guys. In your prepared remarks, you talked about an SMB business that continues to show sign of improvement. Could you give us a little bit more granularity there? Obviously a license on both sides of the business had a good quarter, and how sustainable is that as we look into next year?

If you look at that [four box], we had 14% growth in SMB CAD on the backs of 22% license growth. And we had 10% growth in SMB/PLM on the backs of 33% license growth, and I think both of those businesses are doing well right now. The way the SMB business typically works is we win the CAD business first. We grow that footprint for a while, and then we bring in the PLM component. I think this is a place where PLM almost always follows CAD. I think that the introduction of new oxygen, new accounts into this SMB space is very important. I think there was a period of time where that was difficult to do, because our CAD product was viewed as old and tired. Right now our CAD product is viewed as the most exciting thing in the industry, and people want to talk to us. They are pulling again, which is something that we hadn't had for awhile. I think that trend in the CAD business is very sustainable. It took longer for the SMB business to react to the improving economic situations. I think that now we are in a pretty good spot there, and I think we will continue to see some good numbers coming out of our reseller channel going forward.

That's great. And then from a geographic perspective, obviously North America continued to lead the way with very strong growth, whereas the rest of the world was mid to upper single-digit growth. Can you comment, more specifically, on what you saw in Europe? Was there any disruption in Europe, or is it a continued slower international recovery?

This is Jeff. On the one hand, I would say we are cautious on the economic outlook in Europe, particularly, but we've got very good activity. We are getting some boost from currency, and so that has helped the reported numbers, and I think when you take currency out, we had modest growth. That said, I think the activity in Europe and the strength of our European business and team is very, very good. And so I would say, we are cautious, but I think we would look to the next and subsequent quarters notwithstanding some major disruptions in Europe, we have a very, very solid pipeline of activity, and would expect to post good results for Europe in the next quarter.

That's great. Thanks Jeff. One last question, you've had MKS under your belt now for about two months now. Obviously, you took your Q4 expectations up by about $5 million. Reflecting back over the past couple months, is there anything that you have been surprised with to the good side thus far?

Yes, I think the diligence period was a little strange for us, because it was a public-to-public deal involving a Canadian public company, and so normally we get much more intimate during the pre-close period than we were allowed to here. I think what we found is the cultural fit is very positive. These guys come to our meetings, and you can't always tell who is who anymore. They already fit right in and think the same way. The technological concepts inside their products are pretty much aligned with the same ones we have. We always talk about this concept of an integral architecture, and it's not just coincidence that their product is named Integrity, because they talk about an integral architecture as well. I think there is some very good cultural alignment, very good strategic alignment. So I would say that thus far, and we are early here, but thus far, a significant integration post-merger integration project is going better than we might dare hope it would.

And then with taking the Q4 expectations up a little bit, the $75 million for next year or north of $75 million is pretty consistent from your analyst day. Ultimately, how conservative could that be versus what you've seen in the integration thus far and getting a sense for your comfort level around the number next year? Thanks.

I would reiterate Jim's comments, we are very pleased today we've got a good pipeline of activity. But that said, we're only two months into it. I think we're very comfortable with the $75 million, and we would generally say, we think there's upside to that because of the market opportunity. But I think it's too early for us to give you much more than that.

Certainly, our early findings would suggest that $75 million number is not a stretch number. That's a good conservative number that we ought to be able to beat, and as Jeff said, positively exceed.

Great, thanks guys.

Thank you. Richard Davis from Canaccord.

Thanks. You are winning these domino accounts, and then you are exploiting from them. So the two questions I have tie in to one another. Has your -- it sounds like your experience sounds promising at this point to exploit from these beachheads. Are those wins coming against firms like Dassault and UGS? And then secondly, because really what I'm trying to do is to grapple with if I think about your history, you're a big direct sales Company in the 1990s. And you went channel in the 2000s, and now you're going back to direct sales because the deal sizes have gotten big again. So I'm just trying to modulate around that. It sounds to me like you are very confident you can exploit from there. But do you have some examples and case studies that tell you that it safe to dip in the water and add 25% to your sales capacity?

On the first part of your question, the number one and two contributors to the domino program would be Dassault and Siemens, and they're probably about ties. And number three would be SAP. There's a number of domino situations where their customers from tried SAP-PLM, and essentially came to the conclusion that wasn't the right solution. So I think, two years ago already, Richard, I remember we gave you a model that we called the domino monetization model. And it predicted how we thought revenue streams would materialize after a domino win. And I think that model has proven to be remarkably accurate. And it's just a model, but basically we said we get a little upfront project, mostly services. We execute on that. That turns into a more significant license order, and then service. And then the maintenance starts to become more meaningful, and we execute on that, and there's another phase of expansion and so forth.

And I think if you look at it, I said about one-third of the 27 domino's -- about one-third of the 27 large accounts -- large deals, excuse me, were coming from the domino accounts. Well, there were only two new domino accounts in the quarter. So, even if they gave us significant transactions, that meant that a number of the pre-existing domino's also gave us significant new transactions. So I think that model has proven very accurate, and we do feel like were sales reps would give us the ability to pursue more domino accounts. These things take time and energy and so forth, and when you start -- if you are a sales guy, and you are in a situation where you have more opportunity than you have time to pursue, then you tend to congregate your resources and your energy, concentrate your resources and energy around the big deals that are most sure. And I think what we need to do by adding more capacity is push people a little bit outside this comfort zone, and make them go out and develop more new business, start new campaigns, development customers, etc. And I'm pretty confident we will be able to do that.

Got it. Thanks.

Thank you. Steve Koenig from Longbow Research.

Hi. Good morning, thank you. I'd like to come to an issue that Investors have talked about a while ago. I don't know that we have talked about it much recently. But could you all update us on the progress on profitability of your Enterprise segment?

Steve, good question, and we don't specifically breakout profitability on Enterprise and Desktop. I think you know that the margin, really the mix of products are what makes a huge impact there, with license and maintenance driving very significant, 90% margins with services having lower margins. So we actually look at that -- those trends over time. We also look at it within an account. And I think as Jim has described, you'll sell licenses. You will follow that with services. And over time, the profitability of these accounts will actually build as you build that maintenance space. And the same way, the PLM business will build.

What we've seen this year is a lot of services revenue, particularly in the enterprise space, driven by all the license sales of last year. So, right now, you'd look at it and say, we've got a lot of services mix. We think as those implementations are completed, we will sell more license; we'll sell more maintenance. And the profitability of those accounts will then again expand to the margin. I think the patterns that we have seen have been very consistent. I think what we are looking at this year is really the phenomena of a lot of (inaudible) [equipment] systems that were sold last year being installed. Again, as I think as we look at it, we feel very good about the growth in the profit expansion in the business as well as in the enterprise.

Yes, I don't know, Jeff, maybe there's some rule of thumb, I am looking for the numbers here to back it up. But probably if license plus maintenance is greater than service, then the business is profitable.

Margins would be favorable, --

And the more so, that mix moves us in the direction of license plus maintenance, the more profitable the business is.

Correct, and let me just add a point. With Windchill 10, one of the goals of that was to be able implement these systems out of the box, at a more rapid pace. And to the extent that as we start and will be implementing Windchill 10, that should allow our customers to implement faster with a lower service component over time. And obviously, therefore generating additional revenue stream on the product side, as well as on the maintenance side.

Great, that is helpful. If I may ask one follow-up. I would like to dig into for a second the implications of your large deal strength. Is part of that -- I understand reps are congregating around larger deals when there is lots of opportunity. Is part of it though, as well, possibly due to the business policy shift in focus, causing maybe some shift away from modules and the upgrades? And if that is so, then what are the implications for best exploiting the Creo cross-sell opportunity, which I would think that maintenance renewals could represent a good time to sell Creo into the Pro-E base for example.

It gets a little tricky here, because I think the underlying phenomena is different in the Enterprise business versus the Desktop business. The Enterprise business is not really a modules and upgrade business, it's really more of a new seat business, and sometimes an expansion of the footprint does come into effect. But on the other hand, the CAD business, the Desktop business is very much a modules and upgrade business. The modules and upgrade opportunity with Creo has basically yet to start, because that was something we couldn't sell until those products were released. And we just released them, of course, in June. I think that there definitely is an opportunity around a maintenance renewal or even separate from one, to go do a Creo deal to upgrade the seat configuration to contain new modules, and so forth. And perhaps to add some new seats of direct to the Parametric base, and so forth.

So I think that's very interesting, but I think on the Windchill side, it's a different phenomenon. Most of our significant Windchill orders come from new wins, and then expansions of those wins into more seats, more departments, more geographies, what have you.

Great, thanks a lot guys.

Thank you. Ross MacMillan from Jeffries.

Thanks a lot. I apologize if this has been asked already. I got onto the call a little late this morning. But I just wanted to step back and talk about license. We started the year at 20% to 25% growth. We are now down to 15%. You managed to do that while keeping EPS guidance the same, really. I guess that's due to the strength in maintenance in particular, which is great. But I guess I have two questions on license. The first is that last quarter, when you took down the range for the first time, you still, Jim, I think said that you thought the original plan was possible. So now with this further revision, that seems a bit less likely, and I guess I'm curious as to what changed.

And then the second question is related to this. Is there anything we should take away with regard to pipeline build and/or managing, if you will, the transition from 4Q to 1Q, and maybe managing that pipeline and that transition from a big fourth quarter into first quarter. In other words, are you building more of that pipeline and visibility by making these changes to the license growth rate for this year? Thanks.

I will you hit the second question there, Jeff. Just on the first question, I think part of the problem with the license growth this year is that we probably didn't have enough capacity in place, if we are honest with ourselves, and with the benefit of hindsight here, to deliver on the 20-plus license growth. But I think the second thing is, we got off to a slow start. But we did 15% in Q2; we just did 18% in Q3, and I think if you look at our guidance range for Q4, it's in the 15% to 20%, let's call 18% again. So, I think in the back half of the year, we are going to deliver 18% license growth, which is comfortably in the middle of the range of 15% to 20%. I feel like maybe we were a little too bullish, particularly as it relates to capacity, to underline that bullishness. But I think that we are in a pretty good place, and if we can inject a little bit more capacity and catch up, then we ought to be able to sustain license growth in 15% to 20% range for some time going forward.

And relative to the Q4, Q1 transition, we always have -- Q4 is seasonally our strongest quarter. It's driven heavily, obviously, by the sales compensation and so forth for direct reps. I think we will continue to see pipeline build, and obviously adding sales capacity will help that. I just give you one other flavor for Q1 is that's also a strong quarter for us in terms of the channel, because their fiscal year ends, generally ends in December. We have a little bit of a holiday buoyancy that occurs in the first quarter, which is the fourth calendar quarter which will help us in Q1. And we'll just have to watch this build on both capacity and on pipeline. And we will keep you apprised as we see changes, or hopefully, positive inflection points. That is what we are looking for.

That's great. And maybe one quick follow-up. On Arbortext, any update there in terms of timing? Any color around when we should start to view that as a more meaningful revenue contributor? Thanks.

I think there is some significant deals in the pipeline here, even for Q4. Part of the Arbortext story, and I think we told you this probably at the Investor event, is we have some significant new capabilities coming that transformed this story from a technical publishing story into more of a next generation service information system story. For example, the type that Caterpillar has talked about with you guys about in the past. So some of the new capabilities that help that transition or transformation take place are coming this quarter. So, I think you're going to see us have some pretty interesting transactions around the Arbortext business this quarter. And then having just spent a couple days here with sales management, I would say that the longer-term pipeline, the fiscal year 2012 pipeline, suggests that Arbortext will grow faster than Windchill or Creo next year. So I think that will be a situation where Arbortext is extremely strong growth, Enterprise being a much bigger business of course, will have impressive growth. And then we would expect Creo to return to more sustainable levels at that point.

Great, thank you.

Thank you. We have time for two more questions. Rafael Garcia with Morningstar.

Yes, good morning. Thanks for taking my question. You guys have been experiencing solid growth in the PLM segment over the last three years. However, it looks like Autodesk is finally ready to make a more decisive move into the PLM space. So my question is, how are you guys positioning the Company to invent your PLM market share in the SMB and Enterprise segments? That's it for me. Thank you.

(Inaudible) It's hard to say, because we need to see a little bit what Autodesk really does here. Autodesk is starting to talk about PLM, but I will actually point out, this will be their fourth run at a PLM strategy. So they are zero for three, and maybe the fourth one will be a big success, I don't know. But I do know this. PLM is something that isn't just about products. When we sell PLM, we help companies transform their business processes. And that's one of the reasons there are a lot of services involved. Autodesk has a channel and a distribution mechanism that does not align with that idea as well. So, Autodesk is good at moving products; they are not good at helping companies transform business processes.

I'm not sure they know that yet. I'm not sure they know that's required yet. I think that Autodesk might put some PLM in the cloud, and I'm not sure that's going to matter if their resellers aren't able to sit down and work through process transformation and financial value propositions associated with changing the way you develop products from an as it is to a 2B model and so forth. I just don't think that, for sure in the enterprise space, Autodesk is not even going to be able to engage in an intelligent conversation. And I think in the SMB space, their resellers are just one step different than a store shelf, basically. I think it's going to be difficult for them.

I think we have one more question?

Thank you. Jay Vleeschhouwer from Griffin Securities.

Thanks, a couple follow-ups. Jim, I would like to ask about the active base data that you have put in your prepared remarks. And it's very interesting to watch those trends. First, I know it's just an average, but your Windchill base is roughly seven times as large as your active CAD base. I'm wondering if that's a number that you think about or manage in some way, or what you think it means that, that number is so much larger than the CAD base, which has only been growing very slowly, at least recently. Secondly, do see some opportunity for perhaps increasing the revenues per license in the PLM base? Right now, you're probably getting maybe one-tenth as much per seat in PLM under maintenance, as for an (inaudible) average Pro-E seat. And do you see some possibility for increasing the former for Windchill maintenance? Thanks.

I think Jay, for many years, we said we felt the seat opportunity in a given account for Windchill was 10X to 20 X the seat opportunity in that same account for CAD. We are headed there. As you mentioned, we are at a 7x ratio right now. That said, we're selling Windchill to a lot of accounts that never bought any CAD. You can't just take our CAD base times seven and say that's our opportunity. When you think of some of these big retail accounts, the targets for example, they don't have any Creo and we are selling them many, many Windchill seats. And we have had a terrific run of those type of accounts. And then on the other hand, we're selling a lot of Windchill accounts that use somebody else's CAD tools, use Catia or UGNX, or what have you. So I think that we feel like this ratio will continue to develop in the direction you have said.

I think there's also an opportunity to increase the CAD seats in this cross-sell in this direct to Parametric and Parametric to direct technologies should as well help with the cross-sell and could drive up the number of CAD seats, thereby further increasing the number of Windchill seats. So I think from a seat count standpoint, we expect this trend to continue indefinitely.

The second part of your question was really about the ASP, the average seat price. I think there is two competing trends there. On one hand, the footprint of Windchill gets bigger and deeper, and we do have more modules that we can pile into an existing seat, and then the price of that seat and that user goes up. But on the other hand, we keep folding in more and more casual users, as we expand to that bigger ratio. As you go from 7 to 1, to 10 to 1, to 20 to 1, you are involving more and more casual users who would expect to pay much less per seat than the more concentrated users that preceded them. So I think these two factors balance each other out, and I can't really predict that the average maintenance per seat will go up. I think the two factors might counterbalance each other, and we would see about the same trend, if I had to guess.

Okay, great, thanks.

I think that concludes the call, thank you for joining us. Speak to you next quarter.