PTC Inc (PTC) 2014 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to PTC's fourth-quarter fiscal year 2014 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 Mr. James Hillier, PTC's Vice President of Investor Relations. Please go ahead.

Thank you, Deborah. Good morning everyone and thank you for joining us on today's fourth quarter fiscal 2014 earnings call. As a reminder today's call and Q&A session may include forward-looking statements regarding PTC's products, our 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 are contained in PTC's most recent Form 10-K and 10-Q on file with the SEC.

Unless otherwise indicated, all financial measures in today's call are non-GAAP financial measures. Reconciliations between the non-GAAP measures and the comparable GAAP measures is located in the Q4 2014 press release and prepared remarks documents on the investor relations page of our website at www.PTC.com.

With us on the call this morning is Jim Heppelmann, our President and CEO, and Jeff Glidden, our CFO.

With that I will turn the call over to Jim.

Thank you, James Hillier. Good money to all of you and thank you for carving time out of your day to join us on our fiscal 2014 Q4 earnings call this morning. There's a lot to talk about as we wrap up 2014 and transition into fiscal 2015. It will be hard to squeeze it all into this one call so I would like to start off by reminding you that we have our Investor Day scheduled for November 13, one week from today at the NASDAQ market site in New York. So we will introduce a few new topics today and we will plan to go much deeper into these topics at the event next week.

We were pleased to see our fiscal 2014 end on such a strong note. Our fourth-quarter results exceeded the high end of our guidance ranges for license revenue, total revenue and earnings per share which in turn allowed us to deliver a solid full-year fiscal 2014 result that also exceeded our expectations for license, total revenue and EPS.

Having achieved our 20% EPS growth goal for a fifth consecutive year, I think we can put 2014 into the win column. Our performance against this aggressive goal has created a lot of believers both inside and outside the Company as we have driven our EPS from $0.80 per share in 2009 to $2.17 per share in 2014.

On a geographic basis, the fourth quarter mirrored the full-year results. We saw solid growth in the US and in Europe. In Japan, we had modest growth at constant currency but saw that growth dissipate as a result of currency movements.

Our Asia Pac business continued the recent trend of disappointing performance particularly in China where the economic and political situation continues to be a strong headwind for us.

Our core CAD and extended PLM businesses have rebounded well for both the fourth quarter and for the full year in each case increasing their growth rate by about 10 percentage points over 2013. Our SLM business posted disappointing results for the quarter and for the year as we worked our way through a pipeline rebuilding effort following the Servigistics acquisition. As we exit 2014 however, the SLM pipeline is strong and we are anticipating a solid uptick in the performance of that business as we go into 2015.

If I were to separate our IOT business, Internet of Things business, from SLM, the IOT business would not have a comparable in fiscal 2013 but I can tell you that the ThingWorx and Axeda companies that we have acquired have both grown considerably versus their own year ago comps and we expect to build on this momentum at PTC. The numbers are not yet large and the partial year results didn't have much effect at all on PTC's 2014 results but a complete year coupled with the growth rates we have been seeing means that this contribution will grow quickly and begin to move the needle a bit already in 2015 and increasingly more so as we move further out into 2016, 2017 and 2018.

We believe that the strategic moves we have made since 2009 and especially those we made in 2014 give us a tremendous opportunity to create a new era of growth at PTC. The Internet of Things is the number one topic of interest right now in the field of information technology and PTC has a legitimate opportunity not only to play in this market but to emerge as a bona fide leader. And it isn't just an interesting adjacent market for us, I truly believe it will redefine what CAD, PLM, ALM and SLM are all about.

At PTC after spending more than two decades helping customers create physical products with CAD and PLM, over the last five years we have in helping our customers expand into smart products with ALM and to optimize their after sales service business with SLM. The Internet of Things is really about connecting these smart products to the Internet to create feedback loops that inform not only the owner or operator but the engineers who created the products, the service department who needs to keep them up and running and the sales and marketing department who want to optimize their relationship with the customer.

The power of smart connected products to transform the way that products are created, operated and serviced is spelled out in some detail in the cover story of the November 2014 issue of Harvard Business Review which was co-authored by Prof. Michael Porter and myself. I encourage you to take a look as it will provide tremendous insight into how PTC is thinking about this opportunity.

As the existence of the article itself might imply, I have invested a tremendous amount of personal energy into understanding this phenomenon and long ago I came to realize that the products our customers manufacture are the things on the Internet of Things and that our industry can't really do justice to the term lifecycle management of these things without enabling and then leveraging these powerful feedback loops.

So the Internet of Things is not just an interesting new business opportunity to pursue, it is also an opportunity to dramatically improve the capabilities, value proposition and differentiation of our CAD, PLM, ALM and SLM offerings. We will show some exciting evidence of what I'm talking about at our investor event next week.

At our sales kickoff last month, I witnessed an incredible buzz because our sales teams in the field are realizing how exciting it is to talk to customers and prospects about smart products, connectivity and then optimizing their service offerings and business models. This message really resonates and we tend to find ourselves in the corner office relatively quickly.

This conversation takes us to a different world where our traditional competitors cease to be relevant because they simply don't have this solution set. Because we see so much opportunity to both upsell existing accounts and to penetrate new accounts, we are dedicating a segment of our salesforce to pursuing new IOT opportunities in 2015. This sales segment will focus primarily on landing new logos with IOT outside our current customer base. As we land these new logos, we will work to expand our position by introducing SLM which is really the killer app for IOT as well as ALM, PLM and even CAD technologies over time.

This strategy is an extension of what we did very successfully last year when we segmented our sales group into full product line sellers, product development sellers and service sellers. Bob Rinaldi, our EVP of Sales, will cover this during his presentation at Investor Day next week.

Between the various segments of the sales force who are either landing or cross-selling IOT solutions, we expect that by the end of 2015 we will have approximately 400 IOT accounts which is roughly double the current level and $40 million to $50 million of run rate IOT revenue. That will give PTC a strong claim to IOT leadership.

The success that we are having with IOT is a catalyst that is causing us to accelerate the evolution of our business model and to adopt subscription at a faster rate. Obviously our support revenue is slightly more than half of our total revenue already and that is subscription based. But of the roughly 30% of our revenue that has historically been classified as license, the amount that is subscription is increasing quickly.

In 2013, about 4% of our license revenue was term or subscription-based and recognized ratably. In 2014, about 8% of our license revenue was term or subscription-based and in 2015, we are projecting that about 15% of our total license and subscription services business will be subscription-based whereas 85% will be perpetual. So you can probably see why we need to begin to disclose the size of this very valuable revenue stream. You will see good detail about it in our Q1 earnings release in about 90 days.

There are a few key factors that are driving this rapidly expanding subscription business. First, our IOT business is built around the acquired ThingWorx and Axeda businesses that are already subscription-based because that is the model these companies deployed from their inception. But our research with customers shows considerable interest in subscription pricing beyond that. Our customers like the flexibility of being able to reconfigure what they use on a periodic basis. They like the ability to draw from their OpEx budgets which the buyers directly control rather than from their CapEx budgets which they frequently must share control. And of course smaller companies like the opportunity to get started with less upfront capital needs.

In many cases they not only want subscription licenses but they want cloud services as well to have a full SaaS type of engagement. Customers have definitely shown so far that they're willing to pay a premium price to gain these extra advantages.

Obviously this rapidly expanding subscription business has the effect of pushing more revenue into the future which adds pressure to near-term revenue and profitability. At the same time, these subscription contracts have a substantially higher net present value to PTC. The guidance numbers we have shared in the press release and in the prepared comments already contemplate that 85% of our license and subscription solutions business will be booked on a perpetual basis in 2015 with subscription being the balance.

But of course if the subscription part of the mix were to come in even higher, it would impact those numbers to a degree yet it would bode well for the long-term health of the business.

Please do keep in mind that in addition to the revenue that we report in the license and subscription solutions line of business, we would expect to end the year with a meaningful amount of additional bookings whose revenue will be recognized in future periods. We will disclose and report this information each quarter so that you can fully appreciate its value but we are not planning at this point in time to guide to it.

With respect to having a hybrid model, our position in 2015 is that we will offer a premium price subscription model as an option to our customers who have traditionally done perpetual business with us but we will not actively push the business yet in that direction. We will hold the compensation roughly neutral for our salesforce so that the customer preference shows through. Naturally with more data, we may recalibrate our position with respect to the attractiveness of this model to our customers as we get through 2015 and beyond.

Looking forward to 2015, we feel that we have a great plan. If you were to think about it at constant currency, we are guiding to what would be very respectable license and subscription solutions growth rates and we are guiding to EPS growth north of 15% at constant currency. Both of these growth rates are inclusive of the fact that a growing percentage of our license and subscription solutions revenue will be subscription based. But as you know, foreign exchange rates have changed dramatically on a year-over-year basis and this has a significant impact on both our revenue growth and our earnings growth.

There are of course other headwinds that we are mindful of. The macro headlines coming out of Europe over the past few months have been quite pessimistic so we are not planning for a repeat of the growth rates we saw in 2014. We are not expecting to see a rebound in the situation in China yet in 2015 either. But after adjusting for currency and taking a prudent view of the macro situation, we feel that we still have a relatively strong plan for 2015.

We are feeling good about the long-range plan through 2018. We believe our growth prospects are improving as our mix of business naturally shifts over time toward market segments like SLM and IOT that have stronger market growth rates and we continue to believe we have more margin expansion opportunity as we move from the mid-20s margins of today towards that 28% to 30% goal.

The team is very proud to have delivered five consecutive years of 20% EPS growth and we are ready to sign up for four more years of 15% EPS growth going forward.

I have downloaded a lot to you here this morning and I'm sure there will be many follow-up questions. We will probably get to a few of them today but I will remind you again that our Investor Day event scheduled from one week from today will provide a great opportunity to get much deeper into all these different and exciting topics.

With that, I will turn it over to Jeff Glidden, our Chief Financial Officer.

Thanks, Jim. As Jim said, we are very pleased with our 2014 results. Financial highlights for the year include the completion of three key strategic acquisitions, ThingWorx in January, Atego in July, Axeda in August. We expanded our credit facility to $1.5 billion in September with a very positive and supportive group of 16 banks.

In July, our Board of Directors approved a multiyear capital allocation strategy to use approximately 40% of free cash flow to repurchase PTC stock. The Board also authorized the Company to purchase up to $600 million a PTC stock through 2017. In August, we launched an accelerated share repurchase program to purchase $125 million worth of PTC stock. This share repurchase program is in place and we expect it to be completed in our second quarter and we would plan to repurchase additional shares during FY15 consistent with our long-term goal.

During the year we expanded our operating margins by 300 basis points to 25% and we increased cash flow from operations by 36% to $305 million.

A cornerstone of our financial program has been the expansion of operating margins and our commitment to deliver annual EPS growth of 20%. Clearly and consistently we have delivered against these financial goals.

While we have accomplished a great deal to date, we have also built a solid foundation for the future. We have established a set of key goals, targets and programs to deliver 15% EPS growth through 2018. Our key long-term targets include annual revenue growth of 6% to 10% including revenue from strategic acquisitions. We have invested in sales programs and technologies such as salesforce.com to enhance sales execution and to increase productivity. We consistently utilize pipeline and sales activity metrics to plan, manage and improve our performance.

We plan to expand operating margins to 28% to 30% by 2017 and into 2018 and beyond. This will be accomplished by driving improvements in overall productivity, continued expense controls and disciplines coupled with improving margins in our professional services business. We continue to build out our partner ecosystem and plan to increase our services margins to 20% by 2018.

Please note that cloud services which traditionally have been reported within our services line of business will in the go forward model be included in our subscription line items.

We expect our longer-term sustainable tax rate to be 18% to 20% through 2018 and through programmatic repurchases of PTC stock, we plan to reduce PTC share counts to approximately 112 million shares by 2018.

While we are confident in our long-term plans and opportunities as we enter 2015, we are faced with near-term headwinds from currency and the increasing macro uncertainty in global markets.

Over the past several months as Jim said, we have had very significant unfavorable shifts in currency. When compared to 2014 currencies, the weakening of the euro and the yen have the effect of reducing our FY15 revenue by approximately $50 million or about 4 percentage points of growth and reducing our EPS by approximately $0.15 per share or 7% of growth.

Given this background, we expect FY15 revenues to be between $1.365 billion and $1.385 billion and we expect EPS to be between $2.33 and $2.40 per share. For the first quarter of 2015, we expect revenue to be between $310 million and $325 million and EPS to be $0.47 to $0.51 per share.

Finally, I look forward to seeing all of you at our Investor Day in New York next week. We appreciate you joining us today and now I will turn the call back over to James Hillier.

Thank you, Jeff. Deborah, can you please give instructions for the Q&A process please?

(Operator Instructions). Matt Hedberg, RBC Capital.

Thanks for taking my questions and great end to the year here. I'm sure we're going to get into this a lot more at Analyst Day next week but I'm wondering if you could walk us through maybe some of your high-level assumptions that you pointed out over a three- to five year period the [NPV] of a subscription is likely to exceed that of a perpetual license.

Okay, Matt, I will take that. When looking at pricing models that we think are both attractive to the customer and attractive to PTC. And as Jim said, we will initiate this with more of a premium program to give people flexibility. It's the concept of if you buy the car or if you rent the car or the home you are going to pay more for that flexibility. So when we look at it, the models that we put together on a three-year basis are typically slightly favorable on NPV and when you go beyond that to four and five and well beyond, the NPV is significantly better.

I would just say that as you know, many of our customers have been with us for a decade or more and so over the long run, we think this is a very favorable trend in the overall financial outlook for the business and you will also see this as we will report bookings and annual contract value, but you already see the trend and the impact on deferred revenues. Deferred revenues increased by about $45 million last year in part reflective of the new models and those shifts. So I think we are seeing that in a positive way which is positive cash flow and future revenue recognition.

That is great. That is very helpful. I'm sure we will get into it more next week. Then obviously there is a lot of variables that can impact next year's numbers and I understand you are not guiding to metrics like billings here but should we expect both billings and cash flow to grow faster than revenue and earnings as we move through this transition?

So the answer is yes on billings, on cash flow, I would expect it to grow at roughly the same rate as billings with one caveat, we have a few -- we have identified this in the prepared remarks, we are doing some additional funding on pension programs as we close out some of those program so that will have a negative effect. It actually feels more like a capital contribution but it shows up in operating cash flow. So I think that is about $45 million of funding for pensions as we close out what was the Computervision US pension and we fund some incremental, these are pensions by the way that we acquired as we did acquisitions, we inherited these. We are basically looking at those as things we can get cleaned up.

So I would say generally I would expect cash flow to grow at roughly the rate of billings which would be faster than revenue and probably similar to EPS.

Got it. Very helpful. Thanks again, guys.

Sterling Auty, JPMorgan.

Thanks. Wondered on the subscription program, is this going to be -- we see a number of other software companies utilizing what I would consider a token-based subscription so each product has a certain token value and you give the customer the flexibility to swap in and out of different products. I am wondering if that is going to be the basis and are they going to be able to swap among any of the products or are you going to kind of compartmentalize and say okay, you are going to have a design suite where you can swap between or an IOT SLM suite that you can only swap between those products?

Good morning, Sterling. That is a good question but in fact our program will not be token-based. Customers will subscribe to seats of software at varying capability levels and for the duration of the subscription, that is what they subscribe to.

Now when that subscription comes up for renewal and we will have one-, two- and three-year subscriptions, so when that comes up for renewal then there is always going to be an opportunity to say well, I don't think I had quite the right bill of material here, can we reconfigure it a little bit? But we are going to do that at renewal points, not constantly throughout the duration based on the token-based system like you described.

Okay. I wasn't clear, are you actually going to -- you gave the kind of 400 IOT customers as one example. Are you going to give some sort of subscriber metric either quarterly or annually?

Yes, we are.

Okay. Last question, on the SLM --.

Sterling, if I could just back up and give you a little bit more detail. We have quite an interesting package of metrics that we will share with you at our Investor Day that we will report but of course the first actual reporting with those metrics will happen 90 days from now which is why you haven't really yet seen those metrics in this earnings report because it is difficult to recast our old business that way. But we will report our new business with the new set of metrics that we will take you through at the Investor Day.

That is fair enough. Fair enough. Last question, on the SLM side, I am glad you did address it but I am curious, the sales pipeline in SLM, is there any issues in terms of the product feature functionality? In other words, was there any type of product roadmap items that you were trying to accomplish that maybe customers were waiting for or is this really isolated to a sales execution issue?

I think it is mostly a sales execution issue. After we acquired the Servigistics business, they came in the door with a pipeline and we were all over that pipeline and closed a lot of it and then lifted our heads up and said oh oh, we weren't building enough new pipeline. And in fact, we had to go train people and build up the capacity and so forth.

So I think we didn't manage that as well as we should have just to be frank and we feel like we have made up for it in the duration or in the course of the year but sales cycles are a little long. So if you get started late, it takes you a while to catch up but we are at that point where we feel like the pipeline looks pretty good going into 2015 and our forecast for SLM looked pretty good and so forth. But I'd really say it was a sales and management execution miscue.

Okay. Thank you, guys.

Steve Koenig, Wedbush Securities.

Thanks, gentlemen, and congratulations on a great quarter. I wanted to just dig into guidance a little bit and get your help parsing it. There is obviously a lot of numbers there so just a couple of questions there. And the first one, the mix of subscriptions in your license and solution stream, when we look at those numbers it looks like that mix shift is almost entirely from the acquired subscription stream. It doesn't look like there is assumptions for very much transition in the core business to subscription so can you help us separate those two factors in terms of how it shifts the mix?

Yes, Steve, I'm glad you asked that question and I'm going to take a stab at it and Jeff while bat cleanup when I am done. If you look at that subscription business, for us to do that much subscription business in a year we must already have a lot of it sort of booked and in fact we do. So if you look at 15%, roughly half of that is the run rate of the IOT business.

Let's call a quarter of it to be the run rate as a cloud services business and roughly a quarter of it to be the run rate of let's call it core business, things like CAD and PLM that might have been term or subscription contracts we landed last year. What is frustrating of course is when we talk about a mix of revenue, that is quite different than a mix of bookings because much of the success we plan to have that we are forecasting to have in 2015 in terms of securing new IOT business will show up as bookings but not as revenue. And that is why I say this of course is the world of subscription where bookings are so important to understand where the business is going and revenue kind of only tells you where it has been.

So we think that you are right, much of the 15% can be described by run rate. There is some new business but most of the new business we secure in 2015 will show up in the subscription revenue of 2016, 2017 and beyond.

Got it. Okay. All right, so one more question on guidance and then one quick follow-up. You had some commentary about the macro but it doesn't look as if -- your guidance is not really negative. In fact adjusted for currency it is pretty okay. Maybe macro is the difference between the high end and low end of guidance. How should we think about how you factor the choppy macro environment into your guidance?

I think at one level we factored it in by assuming that while we just ended a fantastic growth year in Europe that Europe next year is going to be relatively flat. And while we just finished a disappointing year in China, we also kind of assume that China next year will be relatively flat. So I think already it is built into a certain degree into our guidance at that level.

Now we assume that the US would continue doing well because the US has been doing well I think at the macro level and it has been doing well in the PTC numbers. So we assume steady as she goes in the US but relatively flat in Europe and China and kind of more or less steady as she goes in Japan as well subject to the FX problem we have talked about.

Okay, great. Thanks. One quick follow-up, guys. So Jim, you talked about reminding us the actual subscription revenues lag the bookings and you expect to have some good success in fiscal 2015. So in thinking about the long-term guidance that you just gave for 6% to 10% revenue CAGR I believe it was including acquisitions, how should we think about how much of that is organic and how that layers in over time, next couple of years below that and then getting above that towards 17, 18? How should we think about that?

Steve, I think there is two important angles to think about this. One is mix of organic versus acquired and then the second one would be mix of perpetual versus subscription. I explained that our subscription has been growing four, eight, 15 and I think you have to think out through 2018 what is the assumption and let me say the assumption we have is that it would roughly double. So by 2018 while hitting the numbers we have talked about, we are assuming that we would have roughly 30% subscription mix which I think is pretty good because that means unlike most subscription companies, we are delivering strong earnings growth off a strong earnings baseline even while folding that in.

So, Jeff, do you want to cover the assumption on organic versus acquired?

We have identified the 6% to 10% would assume 2% to 4% contribution from acquisitions, that is historically what we have done, one year it might be a little bit more, another year a little bit less if they are subscription type companies that may be building at a different rate than a perpetual business but about 2% to 4% on acquisitions.

We have assumed relatively stable economic outlook after 2015 with constant currency is the way we forecast it. So this year is obviously muted in particular by the currency change.

Yes, and Steve, maybe I should also say we will take everybody through this at our Investor Day but if you look at the segments in which we do business, you have a CAD market that is growing sort of mid-single digits at best, maybe 4% to 6%. You have a PLM business that is growing 6% to 8%. ALM maybe 7% to 9%. You have an SLM business somewhere in the 10% to 15% range and in the IOT market, that is growing around 40%. And so you can imagine that as we prosecute our business that the SLM and especially the IOT businesses are going to grow fast and become a bigger and bigger piece of our pie and as that happens, our whole pie will grow faster.

So I am pretty optimistic actually that we are going to see improving growth rates as we move through that 2018 if we do in the IOT business what I think we are perfectly capable of doing and quite frankly have the right to do based on the position we have already created for ourselves.

Great. Thanks a lot, guys. That is helpful and we will see you in New York in a week.

Matt Williams, Evercore Partners.

Good morning, guys. Thanks for taking the questions and congrats on a strong fiscal 2014. Just high level, I'm sure we will probably hear a little bit more about it in a week's time but just from a sales sort of hiring and go to market standpoint, I guess number one, can you provide any color on sort of your plans around maybe additions to quota carrying reps going forward or is this going to be a situation where you are going to leverage the sales staff that you already have in place?

Number two, is there any risk around sort of sales execution? You guys have made some nice headway there switching to this type of subscription ratable model. Are you taking some steps to try and mitigate any sort of execution headwind there?

Yes, Jeff, do you have the sales headcount numbers handy there?

We ended the year at about 360 quota carrying reps and I think we saw a nice productivity improvement last year so I think I would just add that I think we are looking at driving productivity overall and importantly also focusing a set of the sales teams on really some of the new businesses. So I think that is the situation to continue to drive productivity. We will be adding folks to drive some of the new businesses, we did acquire some folks and I think we will first drive productivity and secondly, add sales capacity as we get through the year.

I think if you look at FY14, our average sales headcount was probably around 350, Jeff? I think as you look at 2015, it will be in the 360 to 370 range. So we will have a little bit more capacity largely because we have acquired some capacity.

But as Jeff said, what we are really focusing on is not a big expansion in capacity but to continue to refine our go to market model to continue to get better productivity and as we all know there is plenty of room for improved activity. We have made tremendous progress but we are a long way from being done capturing the opportunity to improve sales productivity.

Now on your second question about managing risk, we are trying to be careful there. You might remember last year we put in place a segmented sales model that all still all reported to the same guy. But we said we need to spread out where we put our focus a little bit. We can't have everybody doing everything because then some things don't get done at all. So we segmented into service sellers and product development sellers and then full product line sellers. That we felt worked pretty well. We rebuilt the service pipeline as we have talked about and have a lot of momentum there and did just fine in the core business. So that felt like a good move.

What we are really doing here is we are adding one more segment which is IOT sellers to that model and what we are basically saying is if we are going to go out and hunt for new accounts, let's hunt with IOT because that is so compelling right now. It is the hottest topic out there. Everybody wants to talk about it and we have a very strong position without the kind of entrenched competitors that we have when we go try to mount a CAD or PLM campaign. So I don't think it is actually a huge risk. We are basically saying let's concentrate the hunting of new accounts in this area where we believe based on evidence we have already the hunting will be so much more productive.

So I don't think it is a big change, it all still reports to the same guy, Bob Rinaldi. It is sort of one more piece on top of what worked so well last year. Time will tell but I am pretty confident we will execute this strategy well, both holding what we have in the core business and then adding a lot of new logos and new bookings in the IOT business that actually don't help that much in 2015 revenue but really set us up to lead in that category and grow much faster in 2016, 2017 and 2018.

Great. That is helpful. I appreciate the color. Maybe just one quick follow-up, just at a high level. I'm wondering, Jim, if you could talk a little bit about from a sort of competitive/partner standpoint, you've got IBM making a little bit more noise around IOT. GE seems to be really sort of doubling down on their IOT effort. Is there any real change in the landscape out there and I guess specifically to GE, could you give us an update on your partnership there and how that seems to be going?

Yes. So first let me hit IBM. I think IBM is a competitor and to some extent it is IBM and a bunch of little companies you have never heard of. But I don't think IBM has the product suite that we have. They have Websphere and they have busloads of programmers and stuff like that but they don't really have the solution set we have but they are IBM and that is a company to take very seriously.

GE is a very different story. We love GE. GE is a very big customer of ours. We are contributing some elements into their industrial Internet strategy. We are working to get more of our stuff in their strategy but they are not really a competitor. Because even though they are talking about taking their stuff to market, what they are really talking about -- if you dig into it and I have -- is where they sell hardware, jet engines, turbines, medical devices, they would like to sell industrial Internet solutions to help optimize the way those things are in particular serviced. So that is great.

I love GE. I think that the more GE talks about industrial Internet the more it helps us. I frequently say to customers if you are impressed by what GE is doing and don't have the billions of dollars to spend opening your own center with 800 developers out in Silicon Valley, then that is fine, I have that in a box. I will put a pretty ribbon on the box and we will ship it to you and you can have the same thing for pennies on the dollar. It is pretty interesting to people.

Great. Thanks for the color guys. Appreciate it.

Saket Kalia.

Good morning, guys. Thanks for taking my questions here. So first, for Jim, Jim, for subscription customers, I know you talked about the option for remixing at renewal but besides kind of the CapEx to OpEx trade, what do you think are the biggest positives for a customer switching from perpetual to subscription?

Okay, so it really is first and foremost about flexibility. We all went to college and when we graduated from college, did we all go buy a house? No. Probably every single person on this call went out and rented an apartment. Why? Well, we just weren't sure what to lock in on yet and maybe we didn't have the capital so we all rented for a while and that gave us a lot of flexibility. We could upgrade to a better apartment later or we could move to a different city if our job changed. I mean that flexibility is worth a lot and we all paid more for that apartment than we might have paid had we purchased a house because at least with the house, if the payments were high we would have been creating some equity which of course we are not creating in our apartment.

So I mean, it is just a model that from a possibility standpoint has value and people are ready and prepared to pay for that value. But the OpEx CapEx thing is very, very important. When you go talk to the VP of any department, he or she has a budget and he or she can spend their budget but as soon as you start talking about CapEx, that is a different process. That is a process that involves many different people. It is sort of shared money, typically that is only revisited once a year. I mean it is very difficult relatively speaking to get something into a CapEx budget versus and OpEx budget. So it is a lot simpler to free up OpEx dollars. And then of course, they see that I don't have to buy all the shelfware to get a good price and so on and so forth.

So I think there is good value for customers. They are willing as we all are, to pay more for that just like we all pay more for rental cars or even leasing cars or apartments than we do to buy the asset. But I think there is also people out there who feel like if I'm going to lock into this for a long time and I'm very comfortable, I should buy it because I will save money.

So I think it is just a matter of what attitude does the customer come to the table with but this idea of flexibility is important because people for dozens of years in this industry have bought things only to realize that wasn't quite the right thing but the seller won't take it back and therefore it became a write off. They like the flexibility to reconfigure at least at renewal time.

Got it. That makes sense. So just for follow-up, I know it is a long way away but, Jeff, I think you mentioned that about 30% of the perp subscription line in 2018 should be kind of subscription. How should we think about that split between cloud services versus term/subscription? Then if you just look more holistically at the model in 2018, how much of that total revenue would you say is quote unquote reoccurring?

Okay, so on the cloud service, I would expect that to be something approximating 20% of that, the balance being really --.

80% is software.

So that piece I think if you looked at the total mix right now, we are 51% support, that will continue to grow. So I would say when we get out there we are going to be close to 80% of our revenue was going to be recurring very predictable revenue again with the growth in deferreds and I think an improving cash flow picture as a result of the shift. So think of it is going from 50 maybe 55 last year.

80% is probably a little high, 70%, 75% because we were just talking out loud here. If we say 30% of licenses is 10% of revenue so you would add another 10% to the 50% to 55% and you would be at 60% to 65% of our business would be recurring at that point.

I think one other key element I will say is our services business what we are doing is a lot more with our traditional professional services being partner driven with business we do being higher margin so if you look at our long-term outlook, we have actually increased the gross margin percentages because of both the services and the mix so we think those are both positive.

That is a factor just the math on that would be if the services revenue which is today 20% to 25% of our revenue, if that were to decrease substantially in the mix of course that means that the proportion of the total revenue that is renewable would climb by another 5 points or so.

Sure. Very helpful. Sorry, if I could squeeze in one last one and it was a great segue with what you just mentioned, Jeff, on the margins. You kept your 2017 -- fiscal 2017 operating margin target unchanged at 28% to 30% despite what is probably going to be a higher -- what will be higher mix of subscription through that time. Do you think you need more restructuring to get there or maybe you could just help us understand what is letting you keep that target despite the shifting top line?

I think a couple of things. If you look, the shifting top line as we just described improves the overall gross margin and if you look at the rest of the model, we have fairly well held sales and marketing as a percent of revenue relatively constant and that is in part of probably would have come down some without a subscription shift because you have got the work and activity that you are putting into selling has a deferral effect. So we have basically held the sales and marketing expenses constant as a percent of revenue. We have also reflected a slight increase in R&D because of the technology intensity of both our existing business and future business. So I think those are the kind of shifts that we have made which are I would describe them both as kind of reinvestments of that additional gross margin in both incremental sales to grow the business and incremental R&D to really make sure that we have fully funded on those lines.

I would also add a couple more pieces of color to that. One is that in 2014, we have been carrying on our books a very expensive startup company but particularly when we added Axeda to the ThingWorx business, we gained a lot of scale and that business is quickly kind of approaching a breakeven point and at some point tier will become a profitable business and that will help a lot to take some pressure off us.

At the same time, I don't think it would be accurate for us to say we are going to get to 28 to 30 without any restructuring events between here and now. We have had a series of restructuring events on our way from 13 to 25 and I could foresee that there will be need for more of those here and there between now and 2018.

I would just add second, that is particularly driven in part by acquisitions. When you do the acquisitions when we added a number of people, when we do in acquisition, we have got to organize and rationalize that at times and in many cases we are just really shifting resources so that is in part driven as Jim said by a drive for profitability but also an integration and rationalization of acquisitions.

Got it. Thanks very much, guys.

Jay Vleeschhouwer, Griffin Securities.

Thank you. Good morning. Jim, how are you thinking about the new model offerings as a means or opportunity to either drive new user acquisition within your existing base or outside of your base. I understand what you said about 15 perhaps just focusing more on traditional accounts and not pushing too hard on subscriptions just yet but longer-term particularly for CAD and PLM and let's put IOT to the side for the moment, do you think there is an opportunity here as some other companies with model changes have seen, to bring in more volume of users?

Well, let me say just holistically at the top level, our interest in subscription is driven first and foremost by an expanding addressable market, expansions particularly in IOT where we think that business is subscription, should be subscription and so forth. So when we talk about the mix of subscription at 15% now and going to 30% over time, a lot of that is simply because the IOT business is modeled to be growing faster during that timeframe and to be mostly subscription.

Now that said, I do think if I come back really to your question which is back in the core business how does it look? I think that what we have seen is that customers are, they are actually willing in some cases to be more aggressive with a subscription contract than with a perpetual contract again for fear of buying a busload of shelfware and then finding out it is the wrong stuff.

We have done some really great subscription contracts even in the big deal business last year. I mean you realize if you go through the math I said roughly a quarter of the 15% is run rate from the core business. So we already have a substantial chunk of subscription in the core business.

But I think if we go now to the reseller space, I think it is a huge boon for the resellers because these guys are doing business with small and medium-size companies that frequently just don't have the financial wherewithal to buy assets or to buy them in volume to get better pricing and so forth. So they are much happier in many cases to go with a subscription model. So I think it does give us the ability to go down market and even to just appeal more broadly in that market of small and medium-size companies.

Okay. Along the same lines, how are you thinking about having to change if at all your current product release schedule or at least the major releases? You have been on about an 18 to 24 month schedule for the major Creo and Windchill releases. Do you think that again as we have sometimes seen with other companies having made model changes you need to accelerate the pace of releases commensurate with or supportive of more of a time-based model?

Yes, I mean I don't think at this point in time we see subscription driving a change to the cadence of our release schedule. Maybe we will think differently as we get deeper into it but I think right now keep in mind we are really talking more about subscription than SaaS. There is an element of hosting or what we call cloud services here but we are not really talking about a pure SaaS model. We are saying it is the same software, it is just do you want to buy it or rent it? And at this point, we are kind of typically building our release cadences around innovative ideas we have, sometimes competitive responses to things, sometimes customer satisfaction or whatever we might need to fix a usability problem in a piece of software and we need to fix it quickly or something like that.

So I think that my view would be in the near term those factors will be more important drivers of release cadence than a subscription but maybe I will get educated. I am open to that.

And lastly, for Jeff, this might be the last opportunity to ask a question of him. The prepared remarks referenced what sounded like two possibly nonrecurring items that helped your license revenues in the quarter. Perhaps you could quantify one was reference to a nice piece of business for what you called a heritage product, I assume one of your older CAD related products and it sounds like the old NKS business had a particularly strong quarter sequentially and year-over-year if you could talk about those two things?

So first of all, Jay, let me say if you are going to be a New York, I'm going to see you next week so this won't be the last time. But no, feel very good about that. The two comments on the heritage product that is within the CAD product line. We had a large customer that had used some products that historically and they did make a large purchase and really committed to stay with that product. So that was in the CAD space, it is not Creo but it is an older CAD product.

On NKS, it was the performance year-over-year on a percentage basis was that but it was off base of comparison I think we feel good about ALM long-term but I would just caveat or caution a little bit of the percent change year over year is in part because of the soft compare. Those would be current perspective and I will see you next week I hope.

Maybe I'll just add for everybody's benefit, we are making progress on our CFO search. We are sort of working our way now through a short list of very good-looking candidates. I think we don't have any imminent announcement here but I think we are more or less on schedule as we expected to be with that CFO replacement for Jeff.

In the meantime, you can hear today and see next week that Jeff is fully engaged in the business and we have 100% confidence in him and it is just a healthy situation we are working our way through and I think we will have a productive conclusion to that late this calendar year, possibly into next calendar year depending upon if there are some delays in the start time or something like that but Jeff has committed to hang around until such time as we have completely transitioned everything and then he will go spend some time doing all those other great things in life.

So I hope to see all of you guys next week and with that I will turn it over to James.

Thanks, everyone. Just one more plug again for our fiscal 2015 Investor Day. That is going to be taking place next Thursday, November 13, from 8 AM to 2:45 PM at the NASDAQ market site in Times Square New York. For those of you who want to attend and haven't registered yet please feel free to contact me and we will get you registered. The event is also going to be webcast with a link on our investor page at investor. PTC.com and we look forward to seeing everyone next week.

Thank you very much. Goodbye everybody.

This concludes today's conference. At this time all participants may disconnect. Thank you.