PTC Inc (PTC) 2016 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PTC 2016 third-quarter conference call. During today's presentation, all parties will be in listen-only mode. Following the presentation, the conference will be open for questions.

I would now like to turn the call over to Tim Fox, PTC's Vice President of Investor Relations. Please go ahead.

Thank you, Chris, and welcome to PTC's 2016 third-quarter conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the call will be open for questions.

Today on the call, we have Jim Heppelmann, Chief Executive Officer; Andrew Miller, Chief Financial Officer; and Barry Cohen, EVP of Strategy. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today on our Investor Relations website.

During this call, PTC will make forward-looking statements including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found on PTC's annual report on Form 10-K, Form 10-Q and other filings with the US Securities and Exchange Commission, as well as in today's press release. The forward-looking statements, including guidance provided during this call, are valid only today, July 20, 2016. PTC assumes no obligation to update these forward-looking statements.

During the call, PTC will discuss nonfinancial -- non-GAAP financial measures, and all measures discussed are non-GAAP unless otherwise noted. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most direct comparable measures can be found in today's press release, made available on our website.

With that, I will turn the call over to PTC's CEO, Jim Heppelmann.

Thanks, Tim. Good afternoon, everyone, and thank you for joining us.

Let me begin with a brief review of the third quarter. Q3 was another strong quarter as we executed well across our key operating and strategic objectives. Bookings of $105 million were $5 million above the high end of our guidance range, and we delivered a subscription mix of 58%, which was 10 percentage points higher than the guidance target for the quarter. We will provide additional details on our subscription transition throughout the call, but our program is clearly gaining further traction and, based on our updated guidance, we're now tracking more than a full year ahead of our plan.

Given the upside we delivered this quarter on subscription mix, our reported revenue and EPS were below our guidance range because we deferred more licensed revenue into future quarters than we had projected in our guidance. However, the long-term value that the subscription model yields for our business and for our shareholders far outweighs the short-term optics in our reported results.

To summarize our progress this past quarter, I will frame my discussion around the three key initiatives that we are focused on to maximize long-term shareholder value.

As a reminder, they are, first, to increase our top-line growth; second, to continue our margin expansion; and, third, to convert to a subscription business model. I will start with growth.

Q3 was a strong bookings quarter with year-over-year growth greater than 30% and sequential growth of over 20%. Our IoT business delivered a very strong results with bookings up 50% sequentially from Q2 as we saw a number of larger expansion deals with existing customers from both our direct sales channel and from our growing partner ecosystem. Year over year, our reported IoT growth was driven primarily by Kepware, which we acquired early in Q2 of this year.

Excluding Kepware, results were relatively flat, but I will remind you that we had three very large perpetual deals last Q3, totaling over $9 million in bookings. Excluding these three large deals, IoT saw significant growth in bookings and transaction count, both from our direct customers and from our partner ecosystem.

Again this quarter, we continued to make progress with our Industry 4.0 Smart Manufacturing strategy and, together with a partner, landed a significant Q3 expansion with one of the world's largest multinational consumer goods manufacturers, who will be using a ThingWorx-based solution to drive their smart factory strategy. Kepware, our market-leading industrial connectivity solution, delivered solid results in Q3, and we see significant cross-sell opportunities as we help organizations optimize critical manufacturing processes.

We landed 63 new ThingWorx logos in the quarter, bringing our year-to-date total to 194. As we discussed last quarter, we will continue to update you on this new logo metric as is currently defined through the balance of the fiscal year. But at that point, the metric may need to be remodeled because it does not accurately reflect the new way we engage accounts via the premium program that we recently put in place.

In addition to our strong IoT operating performance in Q3, our thought leadership and momentum in this exciting growth market was on full display at LiveWorx event in early June. We believe LiveWorx has become the preeminent event in the connected world. Live attendance doubled from our 2015 event and, including those who joined the live stream, we had over 9000 participants during the week, including 350 attendees at our partner summit. We featured numerous live customer examples showing how augmented reality, IoT, and machine learning, coupled with CAD and PLM and SLM, promised to completely change the way we will interact with things in the future.

We leveraged LiveWorx to launch a number of exciting and in many respects groundbreaking technologies that show how we are marrying our core solutions with our ThingWorx and Vuforia technology platforms. Let me take a moment to highlight a few of these new solutions.

First, we introduced Vuforia Studio Enterprise, a powerful new tool for authoring and publishing augmented reality experiences. Vuforia Studio leverages our AR platform, our CAD visualization and illustration software, and the ThingWorx IoT platform to enable users to author augmented and virtual reality experiences such as machine dashboards or technical service instructions without writing any code. Our timing on AR is great because just as Pokemon Go has captured consumer attention, ARVR is becoming one of the most exciting, new and growing tech sectors for the enterprise. Vuforia Studio really stole the show at LiveWorx.

Subsequently, or more recently, the industry analyst firm, Blue Hill Research, published a report about Pokemon Go last week that claimed this is a generational introduction to the true potential of augmented reality and the experiences associated with interacting with one's environment. The report went on to say that PTC is the key arms and platform dealer of augmented reality in the enterprise, and then added that, as odd as it sounds, Vuforia has to be seen as the leading platform for Pokemonifying your business.

It was a fun report, and I have asked Tim to put a copy of it on our Investor Relations website or a link to it. Clearly, we are excited to have such a strong position in this exploding market opportunity.

Coming back to LiveWorx, we also introduced new connected service solutions, including PTC remote services and connected services parts management, both of which leveraged the ThingWorx platform. PTC remote service enables services support technicians to remotely identify, diagnose and resolve issues while continuously monitoring key performance parameters and connected equipment.

PTC connected service parts management enables service organizations to utilize data directly from connected assets to accurately forecast and plan service parts demand, improved service levels, increased uptime, and improve service profitability due to lower spare parts inventories. We believe these out-of-the-box SLM applications will help companies move faster to leverage IoT to transform their service models, generating significant value for both of their internal operations and their customers.

The growth opportunity and the results in the new business are exciting, but you will remember, we are also strongly focused on improving execution in our traditional solutions business. The early results of these efforts, with particular focus on go-to-market activities, to help drive solid Q2 bookings performance, continued again in Q3 with bookings up over 30% year over year and midteens sequentially. Craig Hayman and his team are adding rigor to our sales and marketing management while driving our subscription transition, our support conversion program, and our pricing and discounting initiatives. We believe our strong Q3 results in the core business are another promising indicator that these efforts are really starting to show results.

Let me turn now to our second top level initiative to drive shareholder value, which is to further increase our margins. In Q3 of 2016, our operating expenses were above the high end of our guidance range. This was due primarily to higher sales incentive compensation, driven by tremendous overperformance on our key strategic objective of becoming a subscription company, as well as higher overall bookings performance. With the progress we are making on the subscription transition, we made a deliberate decision not to modify our sales commission plans midyear as we don't want to risk impacting our momentum. However, our sales incentive compensation plants and targets are reset at the start of each fiscal year, so this OpEx variance will not be an ongoing aspect of our overall cost structure.

On an apples to apples basis, where we adjust for subscription mix differences, even with the higher sales commissions, our operating margin would be flat with last year. You can count on the fact that we remain committed to margin expansion and continue to see a path to non-GAAP operating margins in the low 30s% once the business model fully normalizes from the transition.

Our third key top level initiative is our transition to subscription. In Q3 of 2016, the mix of subscription bookings was again well ahead of our guidance. Andy will elaborate further on the subscription mix in a minute, but let me reiterate my earlier observation that, based on a revised FY 2016 guidance of 48% subscription mix for the year, we are now on pace to beat our prior FY 2017 target a full year early.

Wrap up, we at PTC continue to focus on three levers that can drive significant shareholder value: top-line growth, profit expansion and the subscription transition. On the growth front, we remain committed to winning in the new technology platform business, and we are encouraged by another quarter of improved execution in the core solutions business.

On the margin expansion front, financial discipline will remain one of our cornerstones as we drive toward non-GAAP operating margins in the low 30s% post-transition. And on the subscription front, we are off to an exceptional start in the first three quarters of FY 2016, well ahead of our original transition plan, and aggressively pushing forward.

With these three levers, I am pretty confident that we are well-positioned to drive substantial value for our shareholders.

And, with that, I am going to turn the call over to Andy Miller, our Chief Financial Officer.

Thanks, Jim, and good afternoon, everyone. Please note that I will be discussing non-GAAP results unless otherwise specified.

Bookings of $105 million were $5 million above the high end of guidance. We believe the upside was again driven by improved go-to-market execution and contribution from our support conversion program. Timing helped as well with a few deals closing earlier than forecasted.

On a year-over-year basis, bookings increased 31% in constant currency and 25% excluding Kepware. Subscription comprised 58% of total bookings versus our guidance of 48% and versus 16% in Q3 2015. Subscription ACV in the quarter was $30 million, well ahead of our guidance of $22 million to $24 million.

Subscription adoption trends were consistent with Q2 where we saw a strong performance in every segment, every geography, and in both our direct and indirect channels. In our solutions business, PLM and SLM continue to lead the pack in the 55% to 70% mix range, but CAD is quickly closing the gap with 50% mix in Q3, due in part to continued progress in our channel.

In our direct business, subscription mix was in the high 60% range, and in the channel, subscription mix was in the mid-30% range.

Regionally, the Americas, Europe and Japan far outpaced the Pac Rim where sales enablement activity is still in the early stages.

Q3 subscription performance benefited from our support conversion program that we launched in Q1. Again, this quarter, the incremental ACV from conversions drove a portion of our overperformance. In the third quarter, 19 customers, including some very large customers, converted their support contracts to subscription. At an ACV uplift, that continues to generally range from 25% to more than 50% above the prior annual support amount, although this quarter in total, it averaged near the higher end of that range.

The volume of conversions ticked down modestly from Q2, driven by the timing of large customer support renewals and customer budget cycles. However, the incremental ACV this quarter in dollars was about the same as last quarter. You should expect quarterly variability as this program continues to ramp and mature.

And even if a customer chooses not to convert at the present time, we are focused on appropriately monetizing our relationship with that customer. For example, this past quarter, we had four customers defer converting. Yet, because they had below market support rates, we renewed their support for the upcoming year at market rates which were about 25% higher than they had been paying.

I will remind you that our current long-term business model does not include any assumption that our large support revenue base transitions to subscription. So this clearly represents upside to our long-term business model, and we expect this could be something that plays out over multiple years.

Turning to the income statement, total third-quarter revenue of $290 million was down $14 million year over year as reported. We estimate that subscription mix negatively impacted total revenue by about $38 million compared to last year, and professional services were down about $3 million as we continue to execute our strategy to transition certain engagements to our partner ecosystem. Adjusting for these two items, revenue would have grown by about $26 million, including about $6 million from Kepware.

Compared to our guidance, we estimate that adjusting for the higher mix of subscription, our total revenue would have been approximately $301 million, which would have been above the high end of our guidance.

On a reported basis, software revenue was down 4% year over year due to the higher mix of subscriptions. Excluding mix, software revenue would have increased 11% with currency configuring less than 1%.

Approximately 81% of our Q3 software revenue was recurring, up from 73% a year ago. Annualized recurring revenue, or ARR, was approximately $780 million, which grew 6% compared to Q3 2015 and 5% sequentially. Clearly, this growth in recurring software revenue represents a very positive trend in our business and will drive cash flow in subsequent quarters.

Operating expense in the third quarter of $175 million was above the high end of our guidance range, due primarily to higher sales commissions, driven by overperformance on subscription and on total bookings.

Q3 operating margin of 14% was below our guidance range of 16% to 17% and down from Q3 last year due to the higher subscription mix. We estimate that adjusting for the higher subscription mix compared to our guidance, operating margin would have been 17%, at the high end of our range, and adjusting for the year-over-year change in subscription mix, operating margin would have been flat with last year at 25.5%, despite the sales compensation headwinds in the quarter.

EPS of $0.26 was below guidance, also due primarily to a higher subscription mix, which we estimate negatively impacted EPS by about $0.09. We would have beaten our high-end by $0.02 at our guidance mix with lower income taxes contributing about $0.01.

Moving to the balance sheet, cash and investments were down $29 million from Q2 2016 as we repaid $60 million of debt and made acquisition earnout payments of about $9 million. We had strong adjusted operating cash flow in the quarter of $67 million and adjusted free cash flow of $60 million. Year to date, adjusted free cash flow is $231 million, which exceeds the high end of our full-year guidance of $225 million.

Now turning to Q4 guidance, let me remind you of some of the general considerations that we factored in. First, while we are pleased with our continued solid bookings performance this year, we attribute our performance primarily to improved execution and our support conversion program and remain cautious of the global macroeconomic environment.

We also acknowledge that the recent Brexit vote has created political and economic uncertainty for the UK that could potentially impact the broader euro zone. While our direct UK revenue exposure is in the low single digits as a percentage of total revenue and we don't believe that we have experienced any impact from Brexit on our business thus far, we think it is prudent to remain cautious on the overall macroeconomic backdrop.

Second, while subscription results have been very strong year to date, we are only three quarters into our subscription transition program, and it is still new to much of our sales force. And, thus, it is challenging to forecast the rate of customer adoption, the pace of our transition, and the overall impact to near-term reported financial results. Third, our guidance assumes current foreign currency exchange rates.

With this in mind, we now expect bookings in the range of $370 million to $380 million for fiscal 2016. This is up $8 million from our guidance last quarter at the midpoint and $3 million at the high end, due to better performance. To put this updated guidance in perspective, I will remind you that when we started the year, our constant currency bookings guidance called for flattish growth versus FY 2015 as we built caution into our guidance to account for possible disruption for the last (inaudible) organization and the difficult macroenvironment.

At the midpoint of our current FY 2016 bookings guidance of $375 million, growth is now approximately 6% constant currency, excluding Kepware bookings this year with lasting improvements in our operational execution. We expect to exit the first year of our multi-year strategic financial model with bookings exceeding the plan we shared with you last November.

On the subscription front, we now expect 48% of our full-year bookings will be subscription versus our guidance last quarter of 44%. This means we expect to exceed our FY 2017 goal in FY 2016. We expect subscription ACV of $90 million to $92 million. This is up $10 million from the midpoint of our guidance last quarter, and this is double our initial ACV guidance we gave at the start of the year.

We expect total revenue in the range of $1.16 billion to $1.165 billion for FY 2016. This is down from our prior guidance due to the higher mix of subscription bookings.

We continue to expect an increase in our services margin by about 130 basis points to 16% and remain committed to a 20% services margin by FY 2018.

FY 2016 operating expenses are expected to be $667 million to $669 million, an increase of $8 million at the midpoint, to reflect higher incentive compensation as we continue to drive the accelerated pace of our subscription transition this year and reflect the higher bookings guidance. As Jim noted earlier, these costs are not part of our ongoing cost structure, and we will design our compensation plans and business targets for FY 2017 accordingly.

With the higher mix of subscription and operating expense, we are now guiding to an operating margin of approximately 17% versus our previous guidance of 18% to 19%. It is important to note that, based on our updated bookings guidance for the year, having maintained our previous subscription mix assumptions for the back half of the fiscal year, our revenue guidance would have exceeded our previous targets, and our non-GAAP EPS guidance would have been in line with our previous targets, despite increased sales commissions.

We are now assuming a tax rate of 7% to 8% for the full year, resulting in non-GAAP EPS of $1.36 to $1.41 per share based upon about 115 million shares outstanding. We now expect adjusted free cash flow between $236 million and $239 million, which at the midpoint is approximately $13 million above the high-end of our original guidance and for Q4 assumes breakeven free cash flow and modestly positive adjusted free cash flow.

In Q4, adjusted free cash flow excludes restructuring payments of $5 million to $8 million. Q4 reflects the typical seasonality of billings and cash flows in our support business.

For the fourth quarter, we expect bookings in the range of $111 million to $121 million with about 46% subscription mix. This represents 7% to 17% constant currency bookings growth off of a very strong Q4 last year with Kepware representing about 500 basis points of that growth.

By the way, for the second half of FY 2016, our guidance implies constant currency bookings growth of 17% to 23% over last year with Kepware representing about 600 basis points of that growth.

We expect total revenue in the range of $305 million to $310 million for Q4. We expect OpEx in the range of $170 million to $172 million and an operating margin of approximately 19% to 20%. We are assuming a tax rate of 8% to 10%, resulting in non-GAAP EPS of $0.36 to $0.41 per share, based upon approximately 116 million shares outstanding.

Before we move to Q&A, I want to update you on our stock repurchase plans. Given the significant overperformance of our subscription transition this year and our outlook for the increased mix shift going forward next year, our operating profit and EBITDA are lower than in the past and lower than we had planned as we started FY 2016. The more rapid the transition to subscription, the deeper the profit and EBITDA trough, but also the more rapid the recovery. Our debt covenants restrict our borrowing capacity based upon our EBITDA. A simple rule of thumb is that $1 less EBITDA equates to about $4 less borrowing capacity. As a result, we believe it is prudent at this time to defer stock buybacks, given the strong momentum of our subscription adoption.

I want to stress that this is just a deferral, and because returning capital to shareholders is a fundamental element of our capital strategy, we fully intend to resume buybacks at the appropriate time when cash, free cash flow and our borrowing capacity return to more normal levels as we begin to exit the subscription trough.

As we complete our FY 2017 business planning over the next two months, we will have a better view of our subscription mix by quarter next year, and we should then be able to update you on when we expect to resume our stock buybacks.

With that, I will turn the call over to the operator to begin the Q&A.

(Operator Instructions) Matt Hedberg, RBC Capital Markets.

Congrats. Well done this quarter. It is great to see the momentum here.

One point on the guidance -- and I know, Andy, you talked about increased, potentially, some macro uncertainty out there. I believe you just beat your licensed subscription bookings metric by about $10 million this quarter. I think you raised the full year by $8 million. Is the delta there more of that uncertainty, or is it potentially more license revenue in Q4? Just maybe a little bit of color on that.

It is really the timing. We base -- our view of Q4 didn't really change from our view of Q4 last quarter. A small amount of bookings that moved from Q4 into Q3.

So the overperformance for the full year is very much based upon strong performance in Q3, but we also felt strong enough about our forecast for the fourth quarter that we pulled the bottom end of the range up substantially.

Got it. That's helpful. And then, Jim, at LiveWorx, I mean, one of the things that I think we get asked from a lot of investors is the CAD base. Can that -- is there innovation coming, stabilization in that base? And when you guys talked about a cloud version of Creo or CAD, could you talk a little bit more about the expectations for that, the timing of that and maybe how feature-rich that is versus an on-prem offering?

Yes. I think the cloud-based CAD will come in some vases phases. Some early phases involve repositioning the product largely in its current form, but served through a cloud SaaS model. And then, subsequent to that, we are likely to go into some deeper phases where we do more fulsome remodeling of the architecture to fully optimize it for the cloud.

So I think you're going to see us take some steps that allow somebody to purchase Creo sort of as you know it now in the cloud SaaS model, and then I think you will see the product evolve from there in more significant ways that represent something a little bit more to what we think. But that will be an option. We are not going to take it off the market in its current form. We have got a lot of customers who, quite frankly, use it on-premise and like it that way. So this, for us, will be an optional way to deliver the power of Creo.

So you see it as more incremental to the base rather than potentially a cannibalistic product?

Yes, yes. We are definitely not trying to flip the base to cloud. If some of them want to go there, absolutely. I think what we see as an incremental opportunity to do a better job participating in the low end with different pricing schemes, different delivery schemes. Quite frankly, digital marketing schemes, things like that that have kind of not really been in our playbook here to date.

So I think this means we run the CAD business as we know it, and we pursue an incremental opportunity enabled by a different technological delivery and go-to-market model.

Saket Kalia, Barclays Capital.

First one is for Andy. Andy, another nice quarter in terms of growth in the subscription mix. The guide for next quarter is for that mix to go down, which I guess implies a higher pipeline of perpetual contracts. Could you just maybe talk about the likelihood that some of those might opt for scripture instead? Presumably, these are -- in the fourth quarter, some of these are coming from the larger customers. What has that conversation been like as larger customers kind think about perpetual versus subscription?

So clearly, the sales force will try to move them from perpetual to subscription. Some of those larger customers all have CapEx budgets. They have already planned it this way, and it may not be possible. Others we have seen, we have been successful. We base our guidance on what we see in the pipeline as we start the quarter, and so that is basically our assumption. And, of course, Q4 typically has the greatest number of large deals. And so the fact that more would be perpetual certainly is a reasonable outcome, despite how hard we push, given the fact our large customers really may not have had time to adjust how they can buy during this particular cycle.

The one thing that I am happy to share is that the large deals we had last quarter, in Q3, and we had a big uptick on that compared to a year ago, three-fourths of them ended up going subscription.

Yes. And I might just add for some color here, I kind of remember having similar conversations 90 days and 180 days ago. The thing to remember is that our sales cycles are not short. So all of these opportunities started some time ago as perpetual, and that is kind of the buying understanding we have with our customers for years and, in some cases, decades. So the sales guys are working hard to flip these things to subscription because, amongst other things, they make better compensation, as you have heard.

But we don't know if they will succeed or not. So we go back to the data we have on our salesforce.com system and that is what we have to work with. I think anything above that is just sort of a shot in the dark. And we hope to exceed it, but we're going to go with the data we have and hope it is a number we can beat.

The one thing I will remind you is, we actually only have three quarters of really having full force discussion program. So we, for example, recently did a deep dive by product, by geo, by channel looking at what percentage of the deals have been subscription, one quarter in a row, two quarters in a row in each of those cuts. And it looks great when you see lots of parts of the business that are predominantly subscription two quarters in a row, but then you have to step back and realize it is only two quarters.

So it has just a moved to very, very quickly, which we are pleased with, but we need to be prudent on our expectations of how this goes.

Sure. Makes sense. And for my follow-up, maybe more for you, Jim, Jim, could you just maybe talk about some of the market development that you have done around IoT, around the freemium model and maybe embedding some of that capability into Windchill 11. I guess maybe more specifically, what tools are customers getting a taste of through that freemium model or through version 11? And then, what is the carrot that you kind of offer them to use ThingWorx in a bigger way?

Yes. Well, on the market development side, we not only have a combination -- we have a freemium developer site where you can gain access to ThingWorx, download ThingWorx, start creating some apps, try it out in a freemium model. You can do the same with Kepware, and you can do the same with Vuforia. These are three different experiences, but then they are cross-linked. So like, if you like one, well, then, you could link over here and try this complementary mix capability that links to it, and that would be great.

That really went live right around the time of LiveWorx, but the adoption is great. And I think in some places like Vuforia, it is off the charts. I mean, I think since LiveWorx we've probably added 40,000 more developers to the Vuforia site. It is really unbelievable, and the interest level in AR is skyhigh, and we really have something special there.

So I think the freemium thing is really the way that people want to investigate new technologies. They don't really want a sales call. They want to play with the technology and try building something and gain their own experience and see how good it is, how strong it is. And, if they like it, yes, then maybe they will take a sales call to talk about what would an enterprise deal look like or something like that.

So I think the freemium model is very good. And then you asked, what do we use to compel them to buy? Really great technology. I think we feel like each of Kepware, ThingWorx, and Vuforia are head and shoulders above anything you compare them to. So we want people to go through that process of making the comparisons.

If I move over to Windchill 11, and let's just say our core business in general, we have now begun the process of releasing products that contain ThingWorx, but are used for PLM or SLM or what have you. A good example is Navigate, which is a product we launched at LiveWorx, and we are going to sell an amazing amount of Navigate this year already. And what it really is, is a really slick product built on ThingWorx that taps into Windchill and other systems, and customers quite like it.

So we are pretty bullish on that. It has had a pretty strong reception since the launch, and our forecast for it looked pretty strong and so forth. So we are excited about that.

I also mentioned two SLM products we launched at LiveWorx that have ThingWorx built into them. So the first phase was really to sell these platforms as raw technology. And the second phase of our growth strategy is to begin to release new versions, new generations of our traditional products that are IoT and ARVR enabled, and that is now starting to happen. And I think it is an exciting time for us because that could be a very big contributor, not only to our growth, but ultimately to us retaining a leadership position in these hot fields of IoT analytics and ARVR.

Steve Koenig.

One for Andy here and one for Jim. First for Andy, let's see. Andy, did you comment -- or did I maybe miss some commentary in the prepared remarks about percentage of large deals in the quarter? I saw that you expect that to be at the lower end of the range going forward, but how were they for the quarter? Can you help characterize that?

Large deals were recently strong for the quarter at the higher end if you compare it to prior PTC quarters. So it was -- we said previously 30% to 50% of our bookings came -- come from large deals. It was near the higher end of that. Not quite 50%, but near the higher end of that.

This was a generally a good sale quarter.

Yes.

Which hasn't been true of late.

Yes. And, to be frank, we saw a 31% constant currency bookings growth. We don't believe that is the ongoing growth profile for the business. That is the variability of having, frankly, strong performance, a lot of large deals, strong execution, and, frankly, a compare against not necessarily really strong performance a year ago, as the economy suddenly weakened.

Yes. Okay. I will segue to my second question, then. So this one is -- starting with that, the big expansion deal you had with the consumer company in Q3, which was about using ThingWorx for Smart factory. Was this with a partner, or was this direct? And, more generally, maybe, Jim, if you could just comment on factory automation is starting to look like one the lead horses for ThingWorx here in some of the use cases, and you all are -- it looks as if you're getting more involved with that. You don't have a lot of -- you don't have, historically, a lot of experience with factory automation, but it looks like you will be developing that and working with partners. Maybe, do you want to comment on the outlook for that use case in particular?

Yes. I think it is a great question. I think, if you look at some of the reports that have been written by the big thinkers -- McKinsey and so forth -- they almost all identify factory automation as one of the biggest of all IoT use cases. So number one, if you want to be a leader, you probably should play in that space.

Now, it turns out that the heritage of ThingWorx actually comes from that space. The guys who founded ThingWorx had previously founded a company called Lighthammer that they sold to SAP, and it became the basis for SAP's manufacturing automation strategy. Before that, a couple of them had been key players at Wonderware, which now is owned by Schneider and so forth. So there is a deep sort of heritage, if you will, in manufacturing automation in the product. And then, of course, manufacturing automation is almost the sole heritage of Kepware.

So we have some technical jobs, but I think you are right. We feel like that is a domain that PTC has been on the edge of. We help people design products and then design the process by which they will manufacture those products, but then when the factory starts, we are kind of done. We are doing manufacturing engineering, not manufacturing execution or manufacturing operations.

So we don't have as much domain expertise. That is why we targeted partners. So we are looking for some horses we can connect our cart to, and we have some good ones. GE, of course, being one. And so this deal was done through a partner, and they took a piece of the deal, and there was still a pretty substantial piece for us. So we think that this is a very exciting opportunity, one a leader should play in and one that, particularly when paired up with partners, we absolutely have a compelling solution and the right to play in. So we are going to go after it.

Sterling Auty.

So you did a good job right at the beginning of the year kind of factoring in some of the macro uncertainty. You talked about that in the guidance, but I guess what I am curious about is maybe give us some insight as to what you saw in the closed rate and discussions near the end of the quarter and the beginning of this quarter around any Brexit impacts or other things on the macro side.

So our close rate actually were a little higher than they had been in recent quarters -- this past quarter. And, frankly, our sales pipeline supports the guidance that we have laid out for next quarter, using all of our analytics around historical close rates which we look at by deal size, by segment, by geography, by almost any cut you could possibly imagine.

And so at this point in time, we think we have been appropriately cautious of the broader macro environment and taking into account Brexit in the guidance that we have given. As I mentioned, we didn't see an impact, but clearly it hit like just in the final week and a half. So you wouldn't expect companies would be able to react that quickly to it. We are watching it closely, but, frankly, we think we have been appropriately prudent in our guidance.

Yes. Sterling, Jim here. If I could add to that. Craig Hayman is a bit of a machine here, and he has made some pretty powerful changes -- some people changes, a lot of process changes, a of attitudinal changes, and we are just executing better.

So I think the view of management at PTC is the economy is not better, but we are doing a better job with the things we do control. We are closing deals better. We are pursuing deals better. So I just think there is a lot of improvement and execution with discounting less. A lot of things that are helping us on the execution side are probably offsetting a macro environment that is no better than we thought it would be.

Got it. And then on the IoT front, you mentioned the tough compare with the $9 million of perpetual deals last year. Can you give us a sense, what was the subscription mix within the IoT business this year, and is there a way to think about the growth rate year over year if those $9 million worth of deals went subscription last year?

Well, I think we are generally talking about bookings growth. So whether they are subscription or perpetual, we generally would book them more or less the same. So it doesn't. But if you --

You have to look at -- given the size of that business, if you do $9.5 million in three deals --

Yes. Do you remember the total revenue of IoT revenue in the quarter? Ballpark, anyway.

It was like, I don't know, midteens.

So we are saying $9.5 million of midteens came from three deals, and this year we were roughly flat if you take those three deals away, which means this year we had actually many more deals of much smaller size. We should have much healthier mix. It is good to make the quarter any old way, but it is a lot better to make a quarter on the backs of a broad set of small- and medium-sized deals than a couple of grand slam home runs.

That's great. But what percentage of the bookings in IoT was actually subscription this quarter?

Let me look that up. Part of that is because (multiple speakers).

It is Tim. Excluding Kepware, that business is largely subscription.

So a year ago, we didn't have Kepware. But a year ago, a number of ThingWorx deals, which we allowed to be sold provisional at the time, so three of the biggest ThingWorx deals a year ago went perpetual. So there is like apples, oranges and bananas here. Because now we have Kepware, which is almost all perpetual, but if you set that aside, almost everything that is left is subscription. So it would be a big shift toward subscription in the pure ThingWorx sales year over year.

Right. So I will give you the number. It was 62%, but basically Kepware of which we shared was about $5 million of bookings, and I will give you the year ago. Tim is pointing at the number. I have it in front of me. It was 62%, but about $5 million of our bookings were Kepware, which were all perpetual.

So it is predominantly subscription. There was a large -- one large perpetual deal, but it was a fraction -- I mean, it was between $1 million and $2 million compared to $9.5 million a year ago. Does that put it in perspective for the IoT business? It is predominantly subscription other than Kepware, and we are actually (multiple speakers) on the Kepware business.

Yes, yes. Definitely, we would like to see if we could take Kepware to subscription. In the meantime, we have only owned it for a quarter and a half year.

And a year ago, it was 25% subscription. Okay?

Okay. Thank you.

And the perpetual deal, incidentally, came through a partner.

Yes.

So, in some cases, partners say I sell perpetual. Then we have to think about whether or not we will take that order, and I think we would rather take it than not.

Got it. Thank you.

Jay Vleeschhouwer.

Jim, could you comment on what you are seeing or anticipating among the half dozen various industries that you report out? I understand that the percentage of revenue from the industries in any event, even (inaudible) model change, will have varied from quarter to quarter and, of course, compounded now by the model change. But underneath all of that, when you look at the various addressed end markets organically, any key trend that you can comment on when we think about that with respect to some of your peers? It seems rather some slowing in automotive and electronics, but a pickup, on the other hand, in industrial. And so perhaps you could comment on that.

My comment would be maybe about the opposite. And, again, it is very much influenced by big deals. So it is hard to read too much into this. But one place we did exceptionally well was retail. We have a significant and growing retail business. There was a period of time it slowed a little bit, but it is really come on strong here in FY 2016 all year long. So that, for us, was our overall best year-over-year performance.

If you look at aerospace and defense, if you look at life sciences, if you look at electronics and high tech, those all grew to varying degrees. Life science is a little stronger than the others I mentioned. And then, the one place where we had a bit of a decline year over year was industrial products. But, again, I don't read too much into this because I am looking at the data quarter by quarter and it jumps around a lot.

So definitely, the industrial sector has not been a great place to do business. We do a lot of business with the Deeres and Caterpillars, and they are all suffering a little bit right now. So that, for us, is not a great place. But we didn't have a terrible quarter. It was still our highest contributor of revenue in the quarter.

Product question for you, Jim, and then finish up with a financial question for Andy. At LiveWorx, there were a number of interesting product sessions. You commented already on Navigate, which was among the interesting sessions, and you commented on cat in the cloud. My question is, if you could comment on the roadmap for Windchill. You have got a pretty specific set of releases coming. The (inaudible) release later in the year, a couple more next year. How would you think about those in terms of possible incremental business impact and competitive differentiation, particularly given what is going on in the larger PLM space?

Yes, I have a slightly different view right now on products, and it is a view we introduced at LiveWorx, which was this idea of customer transformation journeys. So what we think is that this new technology enables fundamentally new, different, and better ways to run certain business processes. And you might remember at LiveWorx, we highlighted four of them. Digital engineering could be done in new and exciting ways. We highlighted Agile. Companies could adopt a multi-disciplined Agile development process, and then we highlighted manufacturing and we highlighted service.

So more and more, we think about now how would you use elements of our existing product suites and our new technology to systematically transform the way you do engineering. And it is kind of like an orthogonal view to selling more Windchill and more Creo. It is sort of like, how would you use Windchill, Creo, Vuforia, ThingWorx analytics to do engineering in a different way, and that is a methodology that Craig has introduced. I think it is a very good one. We are still doing the releases. It is just the kind of way we think about it is less about what is coming in this next product and when can we take customers to this even greater level of transformation by combining some different solution capabilities and technologies and so forth.

So it is a different way of looking at it. It kind of takes me off staring at product release schedules and thinking more about the transformation roadmap, which is something that I think we owe the world more detail on. We introduced it at LiveWorx, but we need to go deeper so people understand that better. We did talk -- Andy and Tim and I did talk about maybe having an investor webcast to give you guys some deeper access into what we are talking about, and I think that is something we will probably reach out to you to schedule at some upcoming point.

Okay. That sounds good. Finally, for Andy, given the upside in the subscriptions booking proportion for the quarter and the guidance, have you begun to perhaps rethink that 70% bookings mix that you have talked about toward the out years of the guidance period or the forecast period?

Yes. We are actually analyzing that right now as we do our business planning, and so we will clearly give you the best update we can when we release our Q4 earnings. We are starting to look at -- we have certain products in certain geographies that for two quarters in a row have been over 80% subscription in the direct channel, for example. And so we are starting to look at those and think through, should we, frankly, move completely to subscription for those products and at what point in time? We have also released a number of products like PTC Navigate is available only as a subscription product. So most of the -- or many of the new products that are coming out are only available subscription.

So we are analyzing all that stuff, but then I want to remind you it has only been three quarters. And so it is not like we have been on the transition for two years. We have got tons of data that we are able to figure out what real trends are. We are actually having to continue to kind of segment our analysis, take out a big deal, see if the trends are still there, looking at buying not just by dollars, but by transaction counts, things like that to understand kind of where we are at and where we want to end up.

Yes. I think it is an important question, and we ask ourselves that question all the time, but we are just -- there was a process of planning next year, which we are halfway through, and it is just too early to make that call here on this particular phone call.

Ed Maguire, CLSA.

I was wondering if you could characterize the competitive environment in IoT platforms. I know you had not seen much change since Cisco's acquisition of Jasper, but I think there is ongoing interest in the partnership between GE and PTC and some of the differences between Predix and ThingWorx. If you could provide a bit of color, that would be really helpful.

Yes. I think the competitive environment overall hasn't fundamentally changed, but there is a lot more noise. There are many more stories out there that you can listen to. But I think ours, number one, has evolved a little bit, and I will give you some insight into that in a second.

And then, number two, it is still a very strong story. So our story has evolved in a couple of important ways. We have folded in Kepware and we folded in Vuforia, and those are really sexy, important, critical capabilities. We have them. Nobody else does. And ThingWorx itself is fundamentally a really great product.

So we have a very strong technical product.

Now, the place we have evolved is we have decided not to fight the infrastructure war. Rather than say, send your data to PTC and we will stuff it in our cloud, we now say, hey, if you want to put your data on Amazon or if you want to put it on Azure or various other places, we support those. We actually participated in the SAP SAPPHIRE conference, and we showed how you can put data onto a cloud platform and still use ThingWorx to process it and so forth.

So we have backed out of that idea of we are going to have a competitive computing infrastructure sort of based on that comment that friends don't let friends run by data centers or something like that. I'm trying to think it was [Chuck Phillips from Infort] who had that comment.

But anyway, as it relates to GE, GE is a partner, and there were some reports written out there suggesting otherwise. But GE is a good strong partner of PTC's. They are, in fact, the partner who helped us secure a very large order in the spark manufacturing space. It was good for them; good for us.

We have at PTC an aspiration to become an even better partner with GE. We are partnered with part of GE. We would like to partner with all of GE. That is what we are working on. So we don't put GE in the competitive column. We put IBM in the competitor column and so forth. But that really hasn't changed that much other than there is a lot of noise. People say, do you compete with Amazon, and then we have to explain no. In fact, they don't really have products like Kepware and ThingWorx and Vuforia. They provide infrastructure. We are happy to run on their infrastructure. Therefore, it is a combination that makes a lot of sense together. But that conversation no doubt slows us down a little bit as we have to spend more time explaining all these different combinations to people.

Great. And I would just like to circle back to the augmented reality technology. It was really quite on display in compelling fashion at LiveWorx. From your perspective, does this -- is it changing conversations with customers in terms of your competitiveness versus in the core CAD and PLM markets, or is this essentially just a value-add that you expect could potentially provide incremental ASP lift, for instance, for customers over time?

Well, I think in the near term is it is an exciting differentiator that helps us look different and generate more ASP. I think long-term it is bigger than that, and that is why there is so much excitement. A lot of people are saying that AR and AR hardware is the next-generation mobile device. Today, you carry a screen in your pocket, and there is a screen in your car, and there is a screen on the wall in your house, and there is a screen on your computer, and there are screens all over the place, maybe tomorrow you will put the screen on your head and everything you look at will have digital displays without needing to have their own unique proprietary hardware screens. I am just looking in my office here. I have a water cooler and I have a coffee maker and they both have screens.

So I think the reason that Microsoft is spending billions of dollars and the reason Google is spending billions of dollars and Facebook is spending billions of dollars and others, quite frankly, is this idea that there is a generation of hardware beyond mobile and it is AR devices. And the reason that is so exciting is because you can blend digital data onto physical objects and give an integrated physical digital experience.

Now, that is what is exciting to us because physical digital, that is what IoT is all about. So IoT is a way for us to get information from the physical world, combine it with everything we already knew digitally from CAD and PLM, and then turn around -- in analytics -- and turn around using Vuforia to augment this back into the field of the view of the user.

So when I look at my coffee maker, it says, Jim, you need to add water, and I am going to have to walk over to read that on the screen. It just shows up. And if I say, how do I do that, it then takes me through a process using CAD models to explain the process of adding water to my Keurig coffeemaker over there.

So it is a powerful idea where IoT, CAD, PLM, and SLM because that is one of the primary use cases, and manufacturing per our earlier discussion, because that is one of the primary use cases, all of this stuff comes together and aligns unbelievably. And PTC is in such a special spot because we have all this stuff and we have the know-how and the vision and the technology to go do it, and we are showing people.

When I read that report, basically it said, if you like Pokemon Go, now you understand what AR is about. If you go to work and say, how could we use AR here at work, you are going to end up talking to PTC because all roads lead to PTC when you start talking about AR and the enterprise.

So, anyway. We are very excited about it. I think, as you witnessed, this subject that AR kind of stole the show at LiveWorx, it wasn't really the number one thing we planned to talk about, but it is the number one thing that everybody at the show wanted to talk about because they can't believe it. It is one of those experiences when you see it, you just say, oh, wow, I didn't know he could do that. And then your mind starts spinning about all the possible applications of it in your business or your personal life or whatever.

So it is an exciting place we are happy to be in such a unique and strong position with our technology and our big ideas about what to do with it.

And we are showing no questions at this time.

Okay. Thanks, everybody. I want to thank everybody for joining us today. On the investor front, we're going to be heading out on the road for some marketing in August and then kick off the busy fall conference season with Citi's Tech Conference in early September. We look forward to seeing you at one of these events. If not, we will update you on the Q4 call in October. Of course, in the meantime, if you have any questions, follow-up on today's call, please contact PTC's IR and, if not, we will speak with you soon.

Thanks for your interest in PTC and have a great evening.

Thanks, everybody. See you in 90 days, if not sooner. Bye-bye.

And that concludes today's conference. Thank you for your participation. You may now all disconnect. Have a wonderful night.