PTC Inc (PTC) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to PTC's second-quarter fiscal year 2013 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.

Thanks, Evan. Good morning, everybody. Thanks for joining us. We are hosting our Q2 and outlook call.

Before we get started, I'd 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 is contained in PTC's Form 8-K filed yesterday and our most recent Form 10-K and Forms 10-Q on file with the SEC.

All financial measures in this presentation 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 is Jim Heppelmann, our CEO; and Jeff Glidden, our CFO. With that, I'd like to turn the call over to Jim.

Thank you, Tim. Good morning, everybody, and thank you for joining us here on our second-quarter fiscal 2013 earnings call.

Overall, I am pleased with our Q2 results, which I would characterize as reflecting solid execution in a tough selling environment. Our license revenue and overall revenue came in roughly as expected and, once again during the quarter, we kept a strong focus on margins, which allowed us to deliver an earnings result that was above our guidance range and substantially ahead of last year. Also, relative to last quarter, we saw an improved balance of the organic business and the acquired Servigistics business. Our services revenue was down slightly year-over-year, primarily due to slower license growth in recent periods driving less overall services demand. While PTC service revenue has slowed, our service partners are continuing to ramp their bookings and delivery capabilities at a brisk pace.

We don't see a slowdown in PTC services revenue as an issue because, as we've discussed, our overall margin expansion strategy requires that we have less services revenue in the mix in addition to higher margins on the services work that we do perform. So while less services revenue has the effect of slowing our overall growth rate a bit, it is actually helpful to our margin expansion strategy. I feel that this quarter's gross margin performance demonstrates that this strategy is paying off.

When we spoke to you 90 days ago, we were expecting a tough second quarter but we were hopeful that we would see some improvement in selling conditions as we moved into the back half of fiscal 2013. In hindsight, I would say that Q2 played out as anticipated but the most recent manufacturing data points suggest that the back half situation is not yet improving. And the earnings results of a number of enterprise software companies suggest that we're not alone in our view of a difficult macro environment. The latest manufacturing industry reports, some of which you can find on our Investor webpage, indicate that European and Japanese manufacturing is in a difficult recession and that US manufacturing recovery has stumbled as well recently. Together, those regions represent about 85% of our revenue, so while we are hopeful of improved selling conditions going into fiscal 2014, our new guidance for fiscal 2013 assumes no meaningful improvements in the back half, plus the additional challenges of a more difficult foreign exchange rate and an assumption that partners continue to take on more of the services demand.

As I've said previously, during this period of slower growth, the Management team at PTC remains focused on margin expansion and we believe that our earnings guidance -- at the range of $1.70 to $1.80 -- is achievable in this environment. Despite the difficult short-term economic headwinds, we remain very excited about our longer-term strategy. On a competitive basis, we had a very strong quarter, landing four new domino-type accounts in Q2. One of the key wins came from the customer whose large PLM purchase was blocked one year ago by an acquiring company. We were pleased that after a lot of follow-on analysis and debate between this customer and this acquirer, the decision for PTC ultimately prevailed. Though I'll point out that the current contracting arrangement is different than the large upfront deal we were closing in on a year ago.

On a broader note, we continue to hear customers and prospects say that they feel that PTC is headed in the same direction they are, toward a vision of smart products, created for global markets and delivered with or even through a services strategy. We see many traditional product companies both adding smarts to their products and as well beefing up their after-sales service and revenue strategies. In parallel, the most advanced companies are going further than that and are already implementing Power-by-the-Hour for jet engines, medical diagnostic equipment that's deployed on a pay-per-use basis and even delivering offerings such as the Hubway bicycles-as-a-service and the Zipcar automobiles-as-a-service that we have here in Boston.

That means that for our manufacturing customers, the environment is changing quickly. And with our newer ALM and SLM strategies complementing strong CAD and industry-leading PLM offerings, PTC is uniquely equipped to help these customers transform in the response to the disruptive forces they are feeling around smart products and service-based business models. With this strategy, we've captured a lot of customer interest and we've built a solid pipeline of opportunities that we can now see and monitor. With our focus on margin expansion, we are creating a business model that has a lot of leverage so when the environment improves, we will be very well-positioned. But in the meantime, here in the difficult environment of 2013, we are working diligently to ensure that we deliver a fourth consecutive year of earnings growth in or around that 20% range.

So with that, I will turn it over to our CFO Jeff Glidden who will review some of the key financial metrics for the quarter.

Thank you. As Jim said, we are very pleased with our Q2 earnings performance. Non-GAAP gross margins increased to 72.5%, operating profit margin was 20%, and we delivered EPS of $0.41 per share. Our favorable earnings performance in Q2 resulted from a combination of lower overall spending and favorable revenue mix. As part of our plan to achieve our FY '13 operating margin targets, we have reduced staffing by approximately 4%. And we will continue to closely monitor and control spending levels throughout our business.

Turning to the balance sheet, we ended the quarter with cash of $241 million. In the second quarter we generated $83 million in cash flow from operations, repaid $60 million in debt, repurchased $19 million of PTC stock, and spent $5 million in capital expenditures.

Now looking ahead to our outlook for Q3 and FY '13, given the macro environment and the headwinds from foreign exchange, we are reducing our full-year revenue outlook while maintaining our EPS guidance. For FY '13, we expect revenue to be $1.305 billion to $1.315 billion, including license revenue of $350 million to $360 million, support revenue of approximately $650 million, and services revenue of $305 million. This outlook reflects the unfavorable impact of currency of $10 million from our prior guidance, the lowered license and maintenance outlook reflecting the continued slowdown in the manufacturing sector, and we have reduced our service revenue estimates to reflect both the unfavorable macro factors coupled with a strategy to direct more services revenue to our services partners. As we continue to expand our services partner ecosystem, we are also clearly focused on driving our services margin to greater than 13% in FY '13 and to 15% by FY '15.

We remain committed to expanding margins and driving increased profitability. We are targeting to expand our FY '13 operating margin to approximately 21.5% with the EPS guidance, as Jim cited, of $1.70 to $1.80 for the year. I would note that we are holding our EPS outlook for fiscal 2013 despite the negative currency impact of approximately $0.04 per share from our prior guidance. For Q3, we expect revenue to be in the range of $315 million to $330 million, including license revenue of $80 million to $90 million. We expect to deliver non-GAAP EPS of $0.40 to $0.45 a share. We also estimate our non-GAAP tax rate to be approximately 22% in Q3 and 22% for the full year.

And finally a few comments on uses of cash for FY '13. In addition to the acquisition of Servigistics, which was completed in Q1, we expect to repay some $120 million in debt and to repurchase approximately $55 million to $75 million in stock during the year. Thank you for your support and I will now turn the call back over to Tim Fox.

Thank you. Evan, we are all set for questions.

(Operator Instructions)

Jay Vleeschhouwer, Griffin Securities.

Jim, Jeff, I noticed in your prepared remarks that there was a sequential decline in your active base of CAD seats, which has typically been your largest source of revenue, or the maintenance from that. Do you expect Q2 to represent the low point in terms of your active base of CAD seats or might there be some further decline over the balance of the year? And, in addition, the Servigistics license revenue was down sequentially from Q1. I understand that newer business can be somewhat volatile but how do you think about that as any kind of a leading or coincidental indicator of the business? For instance, do you see customers like Caterpillar and others cutting back in that area and potentially subsequently cutting back in other areas as well?

Jay, this is Jeff. I will take the first piece of that and Tim will take the second. On the CAD seats, this is a seasonally slower quarter for us typically and so we would expect, while it is a slightly lower, it's really a seasonal thing, some timings, and we would expect to see that CAD seat number go back up in Q3 and grow from there. So as you know, we look deeply at all of the -- both attach rates, retention rates, and so forth, and we feel very good about those metrics.

Jay, it's Jim. Good morning. On the second part of your question, around Servigistics and maybe SLM in general, Servigistics was down sequentially but keep in mind last quarter while it was our first quarter, it was their fourth quarter. And to be fair, they greatly overperformed the expectation we had for them in our first quarter. In our second quarter, being what would have been their first quarter, they exceeded our plan, so it is down sequentially, I would say for seasonality reasons and partly for big deal reasons. That is a big deal business. But we're pretty pleased with the performance they put up this quarter. It was above plan and, in our view, a solid performance, not quite the blow-out type of quarter they had previously, but nonetheless pretty solid. So on the SLM side, we're not seeing at Caterpillar or anywhere else people stopping these projects or slowing these projects down. Everybody, for every project that involves information technology, irrespective of what part of their business and how it is deployed, they are just being more careful. Companies whose own revenue is either not growing or, in the case of a lot of European and Japanese manufacturers, actually declining, [they] are all just very carefully where they commit resources and spend their money. So that said, I feel like SLM is one of the safer places to be across the spectrum of opportunities that an information technology company could find themselves.

Okay. Just two follow-ups, one on product, one on customer. You mentioned that the large customer that had missed or contributed to the miss in the March quarter in year-ago, now closed but the terms of the revenue recognition were somewhat different, perhaps not quite as much up front -- could you elaborate on that at all and is that at all indicative, do you think, of the way other large-deal customers might go in terms of their structuring of the deals? And then lastly in the product side, could you just update us on your thinking on the timing of releases this year -- for instance, the Windchill X-24 release, is that still coming out in the next couple of months and anything else you can comment on in terms of your release schedule or even philosophy towards [ideal] releases?

On the customer point, we've always had a situation where some customers are willing to take a bigger upfront commitment typically in exchange for a bigger discount, whereas other customers want to be a little conservative and do a smaller upfront project, prove to themselves that it works, and then place follow-on orders. And you should think of this customer, flipped from that first model of a bigger upfront commitment to the second model of a smaller upfront commitment, but I will tell you we have in the contract some pretty big options to expand this thing -- pre-negotiated expansion options. So that project is a good project, we would have loved to get the mega deal that we were expecting to get last quarter but there is some goodness in having it spread out over time, as well. So -- now the question is, is that typical of what would we see from other customers? Yes. It is. In this recent period of macro difficulties, more and more big deals end up being small -- a series of smaller deals or a smaller deal now instead of a big deal now and then as things pick up, we have almost a backlog, if you will, of opportunity from these same customers. So that is a bit one of the issues that is making the big deal business harder in this economic environment.

On the product side, from my perspective, our product plans are more or less on target. We do have releases coming out throughout the year but if I say what are the things that are really moving the needle and most critical, it is the releases we have already [shut]. It is the Creo 2.0 software, which is now seeing a strong wave of adoption in the customer base. As you know, Creo was a reinvention of our Pro/ENGINEER flagship product line and when we came out with the Creo 1.0 software, we won lots of accolades and lots of awards but we didn't win a lot of adoption because customers said, hey, it is great but it is different, and when things are different, I like to wait for release 2.0. So release 2.0 now is getting a lot of adoption and some great customer stories about productivity improvements by simply upgrading to this new release of software and so forth. And then on the Windchill side, we are now working on what is essentially Windchill 10.2, but if I back out, Windchill 10.0 was a big release because that really updated the Windchill user experience by a whole generation, similar to what we had done with Creo. 10.1 was important because it was again that second release of this new experience; 10.2 now adds more and more capabilities to that and what we're doing is important but I would actually say what we have already done in the last year or two is the most important stuff.

Sterling Auty, JPMorgan Chase.

Just want to follow up on one of the earlier themes and, Jim, you partially answered it some I just want to go a little bit deeper. You talked about some of the challenges other enterprise software companies have had as well. A lot of us are trying to get a better understanding. Do you think customers just have smaller budgets than what we realize coming into the year and that is why we are seeing the lower spending? Do you think it's they have got budgets to do more but they are holding off to see what happens economically for the back half of the year or something else?

Sterling, first of all good morning, what it's really that latter category, where much like PTC, there is a plan to spend some money and then there is suddenly a more conservative [box here], people looking at forecasts, whether it is industry forecasts, GDP forecasts, what have you, and saying, boy, I am not sure this year from a revenue standpoint is going to shape up the way we were thinking it would even a quarter or two ago. Let's just be conservative and not yet commit all of that money. So a lot of it is a confidence factor around budgets that have been issued. There's probably some amount of the budget wasn't issued but even where the budget was issued, customers are dealing with a confidence factor and we understand that well at PTC because we are dealing with a confidence issue and that is why we will manage down our spending so that we can hold that $1.70 to $1.80 earnings guidance even on somewhat softer revenue.

Okay and can you give us a sense from a vertical industry perspective, is more of the sluggish outlook concentrated in one or two verticals and maybe -- it has been a little bit, can you give us an update as to maybe your top three verticals at this point?

Yes, so the verticals have jumped around. I would say the only thing that is notable right now is of course the defense. Typically we speak about aerospace and defense but in this case, I would separate the two because commercial aerospace is quite strong, the Embraer type of win from a quarter ago, all the work we're doing with Airbus and Eurocopter and so forth, as well as the Chinese aerospace firms. So on the commercial side, there is a generational change of aircraft happening that is driving those companies to do pretty good business. On the defense side, both aircraft and otherwise -- other types of equipment -- that's coming from government budgets which are in full on crisis mode right now so the defense side is a difficult place to be right now. And historically that was pretty good business for PTC so that is an issue now that actually dates back six, eight quarters since that has been under a lot of pressure but that is probably the place where we have given up the most ground. If I look at the best places, generally our electronics business is doing well. Our life science business is doing pretty well. Our retail business is doing pretty well. Our automotive business is doing okay. It was doing really well a year ago and now we're comparing in some respects against that really well period and it is not up as much, again, but still at levels much higher than it was two and three years ago. So that is a quick view of what I see happening.

Matt Williams, Evercore Partners.

I am just curious -- and I don't know to what level of granularity you are comfortable around -- talking about this, but obviously a big portion of the guidance downtick is related to services revenue and your expectations there. Within that, how much of that is related to just the slower license growth and how much of it is related to successfully offloading some of that business to your partners because obviously the partners' bookings were up very high in this quarter and just trying to get a sense going forward what baked into that?

Good morning, Matt, and I noticed you picked up coverage on the Company recently, so thank you for that. Glad to have you with us. It is a very good question because if you look at the guidance downtick in revenue, you are exactly right. There was a chunk that is related to currency and then there is a big chunk that is related to services. And what I would say is the overall body of services demand is down a bit naturally because license sales have been softer of late. That said, our services partners are growing quickly and there would be a theoretical opportunity for us to [call] back some of the revenue they are taking if our objective was to grow our own services revenue. We think that would be short-term thinking because in the long term we want this service economy to continue to grow and the success they're having is actually pretty important to where we are trying to go in the longer run and we don't really care to disrupt that.

To call back some of that revenue that while it boost sour revenue number it isn't that helpful quite frankly to our profitability [start]. So just to put this in perspective, when we began this partner program more aggressively a year two ago, at the time we said that we want our partners to move from doing roughly 20% of the deployment work and we're doing 80% to get to a balance more like 50%/50% over a -- for let's say year period. Well, this year, they will do about 30%. So the growth rate for a partner ecosystem to go from doing 20% to 30%, they need 50% growth. So their growth rates are high and our growth rates are low and we are resisting the temptation to try to disrupt some of their growth to drive some of our growth because that is not really our strategy. So that is a good chunk of the takedown and it is a takedown that, that particular piece we don't feel bad about.

Great. That makes a lot of sense. And just maybe one follow up if I could. Just a little commentary from you guys on the conditions in the Americas relative to EMEA and Asia Pacific where it looked like maybe a little bit of stabilization in those areas and maybe Americas was a little bit lighter than you are anticipating but just maybe a little bit of color there? Thanks.

Yes. Okay, thanks. That is a good question, too. Personally, I am more pleased with the results we got out of EMEA and Asia Pacific than I am regarding North America. There is no doubt that the North American recovery has stumbled. You saw that in the March PMI data where after quarters -- many quarters of successive improvement, suddenly there was a substantial drop in March and it surprised everybody. So I definitely think that the US had a recovery going, that recovery was disrupted, that hurt companies who were counting on that US recovery, including PTC. Our results were not great and that is compared against a year-ago period where they were not great either. Our results in Europe were okay but compared to -- in a more difficult situation they were okay. So our European guys did relatively well given their environment. I think if you look at -- let's just look at Asia in general. Our Japan business did phenomenal though let's not get too excited because a couple of large deals moved that significantly and a few large deals don't constitute an overall trend. But in China there is an overall trend. There is an overall trend of good consistent solid performance in an economy that's slower than used to be but a heck of a lot better than everywhere else in the world so I feel pretty good about what is happening in the [back rim].

Great. Thank you, guys.

Matt Hedberg, RBC Capital Markets.

I'm wondering if we take a step back from a product delivery perspective. Obviously, your Servigistics business has some SaaS components, but could you talk about the longer-term strategy about how you see maybe customer demand -- obviously it seems like customers are choosing for smaller implementations thus far. How do you think about SaaS in your overall strategy?

Good morning, Matt. There are two elements to SaaS. One is a pricing model -- an economic model -- and the second one is a technical delivery model. And we can almost look at these things a little bit separately and that is because in the PLM camp there is not a big push to have the delivery come from the cloud but there is growing interest in a different economic model, for example, term purchases or things like that as opposed to perpetual purchases and that is true of CAD, as well, by the way, that we do see interest in term purchases. In the SLM camp where we do have somewhat of a SaaS business already, there's a much bigger appetite for both the economic model and the delivery vehicle. So you're going to see us get incrementally more aggressive around SaaS both as an economic and a delivery model in the SLM business and in the PLM business, we will explore taking more deals on a ratable basis but of course that is not helpful for revenue in the short term and there's also probably an opportunity for more of a managed service approach where PTC plays a bigger role in both deploying and owning the technology after it is deployed even if it is not up in some public cloud in a shared tenant -- multi-tenant system.

That's very helpful. And then maybe a quick one for Jeff. The midpoint of your license guidance, is that dependent on any mega deals?

So the way we look at this -- we clearly have large and mega opportunities in the back half. We look at the current quarter guidance to get to the low end of the range, we don't count on a mega deal to get into the mid or the upper end. We would expect that there are some mega deals that could happen. Sometimes we may have a couple of those, as Jim would say. They may come together like we described the deal from a year ago, maybe at a smaller rate but we might get a couple of those. So we feel we've appropriately -- we've been prudent on the guidance for Q3.

Great. Thank you.

Maybe, Matt, if I could just add $0.02 to that. One year ago, in the May timeframe, we began the go-live process for Salesforce.com and modern-day pipeline management here at PTC. And so we really have a data point from Q4, Q1, and Q2 as it relates to close rates against pipeline coverage. And if we look at our pipeline for the back half of the year, and we look at those close rates and apply those rates to the pipeline we have, we are in pretty good shape. That said, we're trying to be a little conservative to say that close rates probably won't be better and might even be a little worse depending upon what happens with the economy. So we are conservative on the guidance, as we should be, but have a decent looking pipeline just concerned of timing and whether deals closes -- big deals or small deals and things like that.

Great. Thanks, guys.

Richard Davis, Canaccord.

How would you characterize -- you've planted a handful of these domino accounts -- have they -- it was a land-and-expand strategy and I'm just trying to figure out -- do you feel that it has done as well as you wanted it to? In other words, have you expanded off those beachheads or whatever phrase you want to use, or is there still work to be done and how would you think about that?

If you go to the big deal table that we give you -- well, first of all, good morning, Richard -- but if you go to the big deal data that we publish for you, you can see that, that data is customers that we did a lot of revenue within the quarter, not necessarily just license revenue but license and service revenue in the quarter. And what typically happens is that a lot of those big deals in the current quarter are actually dominoes from previous quarters following us along for a large number of quarters. So for example, I am sure Embraer, while it was on the list last quarter as a big license transaction, it will be on the list this quarter with a lot of follow-on services work and it will be there for a few more quarters and then at some point there's more license opportunity again at Embraer -- in this case, particularly on the SLM side, so we have done a good job of continue to monetize the wins that we have, where we probably suffered the bottleneck -- is our ability to keep winning these things at the rate that we had been back in 2011 for example when the manufacturing economy was going gangbusters.

Got it. Thank you very much.

Yun Kim, Janney Capital Markets.

Following up on the services question, couple of speakers ago, can you give us some sense on what drove that huge traction that you generated from partners all of a sudden? You mentioned in the prepared remarks, 200% of year-over-year bookings growth from your partners. Was there a special incentive that was given and also how lumpy is this transition going to be going forward and whether you have the capacity to manage any lumpiness?

So if you look at the services bookings number -- first of all, let's note that it is a bookings number as opposed to a revenue number, which means if the services guys take a big booking, that number surges even if their revenue has to be delivered over several quarters. So definitely in the 200% there were some bigger lumps of bookings so it would be inaccurate to think that those guys are running at a continuous 200% growth rate. It was 200% in the quarter and I already told you the math suggests that you've got to be running somewhere near 50% on a continuous basis to get to the objectives we are aiming for. So there definitely was some lumpiness. Now, for you guys in our services number we don't publish bookings. We talk to you about revenue. And there tends not to be lumpiness in revenue simply because when we get a big lumpy booking that gets then spread over time in more of a steadier stream of revenue. So you see from us revenue, that particular comment, that Tim wrote about was a bookings comment.

Okay, but do you expect maybe -- from a simply -- the resource capacity point-of-view, do you expect the transition to be more of a lumpy like a big-deal driven or do you expect the transition to be more smooth -- smoother -- so you won't see any impact on your -- not only on your revenue number but also on the margin side as well because sometimes if you do not have capacity and there is demand, you may have to hire third-party contractors?

Yes. So these partners are in effect third-party contractors, just that we're not passing the paper through our books. So generally these partners want to have margins much less than PTC. Many of these partners are companies you know -- they are [Accentures] and so forth -- who have pretty good margins but a lot of them are specialist PLM system integrators that operate in a region like Europe or something and they are companies you have never heard of. Some of them also are resellers who sell and service our products in SMB but might service some of our customers at the low end of our direct space and again those are companies that aren't household names and don't run at the kind of margins we do. So they are more able to absorb the lumpiness because they're not reporting publicly every 90 days in what is happening.

So from a PTC perspective, we do not anticipate lumpiness in our revenue results. We think that the service partners can absorb these lumps without people really seeing that because they are generally not doing public reporting of them and they like these big bookings. So what is really happening is, when a deal is being pursued, PTC is typically in one of three modes -- either we are going to do the whole thing ourselves or the opposite end of the spectrum is we're not going to do any of it, and the middle ground is, we're going to share it. And I would say, smaller deals and in certain geos, we tend to offload the whole thing, and then bigger wins, we tend to share. For example, in the Embraer deal, we shared a big chunk of the services work to deliver that thing over time so our partner got a big booking and so did PTC but we are sharing that one.

Okay, great. Thank you for a very thorough answer to that. I have another question. So given that you have a wide range of products with both Servigistics and MKS acquisitions in recent years, and along with other smaller acquisitions, can you just talk about how you are progressing in terms of cross-selling opportunity over all? Is there any specialty [nan] generation program to monetize on cross-selling opportunities, any sales incentives and has anyone shown any interest in doing a large ELA -- across the product type of deal? Thanks.

Yes. I'm actually pretty pleases now with our cross-selling opportunity. If we take SLM first, we have quite a substantial SLM pipeline and it really comes from three areas -- PTC guys selling traditional PTC stuff; Servigistics guys selling traditional Servigistics stuff; and then the third camp is PTC guys starting to fill a pipeline of Servigistics stuff. And there's a lot of that going on right now. And PTC traditional sales guys feel like the Servigistics stuff is pretty natural conversation to start with a customer you have it good relationship with. So on the Servigistics side it is going very well in terms of both post-merger integration and cross selling. If I reflect back on MKS, our strategy had been to keep that a little separate for a year. You might remember, we thought -- our thinking at the time was this business is a business we are not in, we should let the Management team operate it for a while as we get to understand it and so forth.

But going into 2013, we collapsed those two together much more and really integrated this thing more mainstream so -- such that the PTC sales force was actively selling the ALM offering. And I would say there too, we have both a pretty nice looking pipeline now, much of which has been created by traditional PTC sales reps but also some big wins. There is a very large high tech company in China who has become a very significant PLM customer of ours over the years and we have now begun the ALM journey with them in this past quarter. So that is a good example, just one antidote, but a good example of an account that MKS never could not have gone to and yet for us it is a nice expansion of a very meaningful relationship we have in a region they did not even have coverage.

Perry Huang, Goldman Sachs.

I wanted to ask another question about Servigistics. Based on Servigistics revenue for the first half of the year, it looks like guidance implies a slightly lower revenue contribution in the back half, if you assume full-year revenue of about, say, $80 million to $90 million. And the seasonality looks it differs from the overall business, which typically accelerates somewhat in the back half of the year. Is this due to the strong first quarter that Servigistics had or is it based more on what you are seeing in the pipeline?

It is the effect of overlaying the Servigistics seasonal model into the PTC seasonal model because whereas PTC sees this fiscal year as quarter one, two, three, four, Servigistics sees it as quarter four, one, two, three. And that is a little bit why Q1 is so strong and we are not necessarily thinking that that will have the same, let's call it, hockey stick that we would see in the PTC numbers.

Got you. That makes sense. And if I could for a follow on, a quick question around guidance. It looks like the full-year revenue range was tightened to a spread of $10 million -- it was $30 million the last time it was provided. Given that there is still the back half of the year to go and also considering the current business environment, what are the underlying assumptions given your comfort in a tighter range at this point? Based on Jim's comments earlier, it sounds like it is based on what you're seeing it the pipeline and the close rate assumptions you're making?

As Jim said -- Perry, this is Jeff -- the pipeline continues to build, that feels good. There's clearly -- when we look at the back half, we think we have got a number of -- a good handle around the opportunities and as a result of where we see ourselves today we've tightened that range up a little bit and probably taken the high end down a little bit, because of macro factors and think we have a good visibility into the pipeline. We left it a little broader and a little more open, a $15 million range for the quarter partly just to reflect the questions that we have around timing -- will a deal close in June or July, typically we have a very strong -- a stronger back half and a particularly strong Q4. So we just have tuned it a bit and feel pretty good about the visibility we have at this time.

Yes, that make sense. Thank you.

Ross MacMillan, Jefferies.

Can I ask about cost -- so I'm try to understand the layering in, if you will, of the cost reductions because we did have some headcount come out of the business in March and I noticed that in Q2, your operating expenses were actually still up slightly year-over-year but nicely down sequentially. And Jeff, you said headcount now was about 4% lower, so I was just trying to understand, when I think about 4% lower headcount, is it wrong to assume of operating expenses down 4% for example in the second half of the year or can you frame how this layering effect of the headcount reductions is going to flow through operating expenses? Thanks.

Sure. I'll do that. Recall that in September and October, when we acquired Servigistics, we actually it added 400 people to the whole Organization. And so from that base, we have taken about 4%, about 250 or so, out of the base, and I just make a couple of comments, we did take some actions in October, and then early in January, and so by doing that early January, we got more of a benefit in the second quarter the we might have provided as guidance. We've also held and as you know we are holding on all areas of spending whether that be travel, et cetera, et cetera. So we're holding on program spending, too. So we are pleased with the cost position, really the cost structure that we execute to and that helps us going forward. I would expect while we have taken those actions, we've got some seasonal things like Planet PTC that occurs or PTC Live now that occurs in June so there would be likely that you would see a sequential small uptick in spending in Q3 and then potentially again in Q4 really related to commissions and end of the year programs. So we've got a pretty good base of cost structure. We will continue to manage and monitor that but would expect this to increase slightly sequentially in Q3 and again in Q4 and because you really can't do a full comparison to last year because it didn't include Servigistics.

Yes. That's helpful. That's really what I was looking for. Thank you. And then just maybe on sales capacity, one of the things you guys have talked about for some time is that you don't have a need to hire because you're still basically up significantly organically and inorganically on quota-carrying reps and they're still obviously not as productive as we would like them to be in a normal macroeconomic environment. Just to be clear, is that still the ongoing assumption and so hiring won't really turn until you have conviction that you are seeing the improvement and maybe more importantly, hiring won't return until you get back to appropriate levels of productivity? Thanks.

Yes. Good morning, Ross, this is Jim, and I will take the first stab at that. So if you look at the capacity data that is in Tim's prepared remarks, you can see there was a period where we cranked up capacity a lot both acquired and organically. And in theory, we have not yet harvested the full benefit of that capacity yet. And is fair to say that our productivity numbers are unimpressive and by getting much more productive, we could drive a lot of upside growth. However, having said that, it is actually harder to make people more productive than it is to add more of them. So the prudent thing for us to do is to make sure we have the right balance of assumptions. I don't think we feel like we can grow a lot just based on productivity yet there is ample room over a long period of time to grow a lot based on productivity improvement.

So in the short term, we've been holding the headcount flattish, it was down slightly but I'm going to put that in the category of [round off] there so we were holding capacity flattish and trying to ramp productivity. There are two factors at war with each other. One is the people we have added in previous period are gaining tenure and experience and pipeline and they are becoming on one hand more productive, and then on the other hand, this whole macro overlay of headwind is canceling out some of that progress and the net is our sales guys as a whole are slightly more productive right now than they were, let's say, a year ago. We would probably hoped they would be much more productive but the macro factor definitely creates somewhat of a headwind on that productivity expansion.

Great. That's helpful. And maybe one last one, just big picture, so in the last couple of years with Servigistics and MKS the prior year, you've made some, what I would call reasonably large acquisitions with consideration values in the $200 million to $300 million range. Just without being specific, what are your thoughts around future M&A? Are we in a period where it is unlikely that we would see deals of that size as we go forward over the next few quarters or how would you frame your thought process around M&A? Thanks.

Our thought process is when we find companies that seem to fit really well, at prices that make sense, and if we have the capacity to do it, then the stars start to align and we get really interested. That is what happened with MKS and that is what happened with Servigistics. I would say we don't have a strategy or a goal to do a certain amount of M&A, we really have a strategy to build a great Company, see M&A as a lever, and then look for those special opportunities like MKS and Servigistics. Just for the record, we are pretty proud of how those two companies have performed and not only that, but the strategic differentiation that we have been able to create. I talked a little bit about smart products and service business models and those -- that is exactly where we have gone. And the interesting thing is, as we have gone there, we have become more interesting to a very large range of customers and incrementally more different than Siemens and Dassault. That is not really where those two companies are headed. And so we're becoming more and more relevant and more and more differentiated thanks to those acquisitions and at the same time those acquisitions are performing pretty well for us.

Chris Hogan, Barclays.

The one quick question I had was just around federal as you guys get into your Q4 and obviously the end of the federal fiscal year. On a year-over-year basis, do you expect to see a better close to the federal fiscal year than you saw last year and maybe just talk about what your expectations are at this point?

Yes. Chris, this is Jeff Glidden, thanks for the question. There's a lot of uncertainty on the federal side. It would be not prudent to speculate on it. We have got a lot of good activity, a lot of good history with the federal government so we continue to support it but the sequester and budget challenges, it just keeps getting kicked down the road while we think there's some really interesting opportunities. I don't think I have ever seen this much uncertainty on where it may land. So we're going to continue to pursue but it would be very -- wouldn't be appropriate to be anything but cautious on it until we get a better view of budgets and so forth. Even where things are budgeted, the funding sometimes does not come through so good activity but we have got to be very cautious there.

And, Chris, good morning it is Jim, just anecdotally, I am aware of some large potential federal transactions that are in the pipeline but we have kept them out of the forecast for essentially that reason.

Okay. That's helpful. And then the last one I had, I know you have talked about it a little bit but the resiliency of -- and I know you guys like to be careful how you characterize this -- but maybe the resiliency of the SLM business relative to PLM and CAD, can you talk about how you see that benefiting the broader resiliency of the Company as a whole -- it becomes a bigger part of revenue as we move forward here?

Yes, okay, that is a good question. Just to be frank about what we know and don't know, we have an intuition and maybe a few anecdotal suggestions. And a couple quarters of data that suggest SLM can hold up better in a counter-cyclic federal environment. When people slow down their pursuit of new product development efforts and launch of new products, they then turn to a strategy of how can we get more revenue by servicing the products that we already have in the market. And then completely separate from the economy, there is a very large secular movement toward after-sales service strategies, like I said in my opening remarks, going so far in some cases as product as a service. So we feel like there is a secular trend toward SLM and then separately there could be a -- some kind of -- I don't know if it is counter-cyclic or just holds up better in a difficult environment trend as well. We don't have enough data, though, really prove that out but we see some suggestions that that story is true and if it is true, then the larger our SLM business gets, the more it will both pully PTC in good times as well as bad when you look at the bigger secular trend as well.

Great. That's helpful. Thanks a lot.

Blair Abernethy, Stifel.

Jim, just a couple of quick ones on the PLM business. If we look at Windchill 10.0 -- has been out there for a couple of years now, can you talk to what's the -- what percentage of your base or how far into your base are you today and how is it trending?

So, Blair, good morning. I do not have any particular data set in front of me on that to answer that question but my own intuition and from many campaigns I am aware of and customers I know, I would say that we are well past the 50% point where more than 50% of our base is on 10-point-something. Anecdotally, I am thinking it is probably 75% of the base but I honestly do not have a data set in front of me to give you the exact number.

Okay, that's fine. And then secondly, just to clarify, you had said you're looking at or considering ratable pricing for PLM. Is that accurate and if so, what kind of timeline are you looking at there?

Yes. Jeff might want a stab at this [later]. We [think PTC] have the ability to do term pricing and on occasion we did. It is not heavily favored by the sales force whose compensation structures do not align with it so that is the underlying issue, is, do we want to adjust compensation structures and to the extent we do that, then that also has the effect of moving some amount of forecasted revenue out into the future as well so we got to think that through. So we're interested in doing that. It is not a simple conversation.

Just to add from a customer standpoint, we clearly -- if that is what the customer wants to do, if they want a term program -- one year, two year, three year -- that is certainly available to them and we will make sure we do not miss the customer opportunity but it is a small piece of our business we are seeing probably more interest in it but I wouldn't say it's a trend presently.

Yes and then a few of the data points that we have where we have done this -- what is interesting is that the customers aren't doing it to save money, they are generally trying to do it in my view to move from a CapEx model to an OpEx model. And in my view, they'd probably pay us more. But from our perspective then that comes over time as opposed to upfront so that is the dilemma I spoke about.

Okay. That's great. Thanks very much, guys.

We have time for one more, Evan.

Steve Koenig, Wedbush Securities.

So you guys have been pretty upfront here about how [preliminary] the environment is in manufacturing. So it's not a surprise that you are being more cautious on full-year license expectations. But it looks like you've stabilized them year-on-year and your guidance implies this continues in the back half, even organically. So I'm interested here in -- maybe a little more color around, what are the Company-specific drivers that are helping stabilize that license execution? And in particular, maybe, where do you feel about your -- how do you feel about your sales execution capability, where you sit now, say, versus a year ago in terms of organization and process? We know about your systems change. And then I do have a follow up as well?

Yes. Okay, that is a great question, Steve. Good morning. So when I think about PTC's Company-specific drivers, I do feel like we have stabilized the organic business. The organic business is flattish but in an environment where 85% of our revenue is coming from customers that are in recession, so that is a little bit the way I see it. And if I think, well why is that, on one hand, the accounts versus a year ago are easier than they would be in other periods of course. But we have some good things going for us. There is a lot of interest in SLM, both the organic stuff as well as the Servigistics stuff. There's a lot of interest in ALM and quite a brisk pipeline there. This smaller business we call supply chain management, which is both sold to retail companies and as well to manufacturing companies for analytics of supply chain decisions like material properties for [reach] and so forth, that adds quite a nice pipeline. And then our Creo pipeline doesn't look bad right now. As we start to move through this product cycle it is looking more and more optimistic. So I do think we have some Company-specific product cycles and/or secular trends and/or better execution on post-merger integration such as the case of MKS that are starting to solidify things even in an environment that is not as bad as 2009 but it is pretty difficult.

Okay and then the follow-up is really related to that. A little more color here on both direct and indirect. On the interact side, we were a little surprised to hear your channel is selling Servigistics and seems pretty excited about it. We didn't realize that was going through indirect.

Yes it is.

There also seems to be a lot of positives -- a lot of excitement around Windchill Essentials in the mid-market. So -- that is the interact side. And then on the direct side, maybe, could you just explain a little bit more about when the Servigistics reps got folded and you're not counting that in your flat quota carrier so those folks are supporting bigger quotas and could help boost productivity, isn't that right?

Yes. Let me take a cut at this for a minute, Steve. The first piece, Servigistics is basically a direct model for us and there may be some misunderstanding -- there's a small amount of the channel.

Let me clarify what is going on there. In our SLM [story], and the Servigistics and the organic stuff -- within the organic stuff, there are some pieces of technology around 3-D documentation and technical documentation in general. For example this company we acquired several years ago called [Aitido], pieces of Arbortext, there is a piece of technology called Creo Illustrate that is in fact sold by the channel more as an extension of the engineering environment into technical publishing, not as the enterprise transformation toward a service business model. So there is a piece of revenue that they are getting credit for and that is legitimately so. But it would be inaccurate to think that they are out selling Servigistics.

Okay. Okay, thanks for that. And then I'm wondering, Windchill Essentials, any color there? Is that helping? And lastly, just maybe last bit of question here, little bit of color on how you folded those Servigistics reps in, are they being counted in your quota-carrier headcount and how is that dynamic actually working?

Yes, okay so on the first piece, PLM Essentials is off to a great start. We have had a nice market response to that, some pretty good progress building pipeline and some great customer anecdotes and so forth. So far, so good, or even better than that. As it stands right now, the Servigistics overlays are -- or the Servigistics sales force is viewed as overlays. So you are right, that that is a new body of overlays that we have created in last year, which at some point in time will be repurposed into more direct roles which will give us added capacity without added cost. That is a form of sales organization productivity. Not necessarily rep productivity but productivity at the Organizational level and productivity at the level of what does the Company spent on sales and marketing as a percent of revenue.

Got it. Okay, thanks a lot for the additional color. That's all I have.

Great. Thanks, folks. Before handing this back to Jim for closing remarks, just a few advertisements here. We're going to be attending three conferences in May. First will be the Jefferies TMT Conference on May 7, followed by JPMorgan's Global TMT Conference on the 16th, and then lastly Barclays Global Tech Conference on May 22. So again, thanks for joining us, and I will turn it over to Jim for closing remarks.

Good, thanks Tim. Well thank you all for spending your time with us here this morning. A lot of great questions. Again, in closing, I feel pretty good about the quarter. It is a tough environment but we executed well and we are in a position here where we're going to continue to execute on earnings growth and when the environment becomes less tough and we can add a bigger dose of revenue growth, things get incrementally more interesting [yet] at that [point]. So we feel pretty good about where we are, which isn't to say everything is great but we feel like the Company is doing the right thing in a tough environment and setting ourselves up for better days ahead as well. So thanks a lot for joining us and have a good rest of the day. See you.

This does conclude today's conference. You may disconnect at this time. Thank you.