PTC Inc. (PTC) Q3 2011 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to PTC's Third Quarter Fiscal Year 2011 Results Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce Tim Fox, PTC's Vice President of Investor Relations. Please go ahead, sir.

Thanks. Good morning, everyone. Thanks for joining us on our Q3 results and outlook call. Before we get started, I'd like to remind everybody that this call and Q&A session may include forward-looking statements regarding PTC's products or anticipated future operations or financial performance. Any such statements will be based on the current assumptions of PTC's management, are subject to risks and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties is contained in PTC's most recent Form 10-K and Forms 10-Q on file with the SEC. All financial measures discussed on this call are non-GAAP financial measures. A reconciliation between the non-GAAP and the comparable GAAP measures is located in our prepared remarks documents on the Investor Relations page of our website at www.ptc.com. With us on the call this morning, we have Jim Heppelmann, Jeff Glidden, Barry Cohen and Kristian Talvitie. With that, I'd like to turn the call over to Jim.

All right. Thanks, Tim. So good morning, and thank you all for joining us. I'm pleased that we've been able to announce another solid quarter of business here in Q3 with total revenue growth of 20% and non-GAAP earnings growth of 52%. Those are pretty good headline numbers. Our revenue growth was well above our guidance range, but even if you back out the MKS contribution and look at the organic component, that revenue was above our guidance range, and our non-GAAP EPS came in at the very high end of the guidance range we had given you a quarter ago. We had a relatively balanced growth of 21% in the Desktop business and 20% in the Enterprise arena. We had very strong demand from maintenance with 17% growth and services at 27% growth. And our license growth rate improved to a very respectable 18%. So again I think these are all very solid numbers. During the quarter, at our PlanetPTC customer event, we formerly launched the Creo product, which transformed a great story and a strong vision into a reality for us. At that event, we received some tremendous customer feedback as well as great reports coming out of the event from press and industry analysts. So all this buzz about Creo, dating back to the October event in Boston, has translated into a lot of sales activity, which in turn has translated into a surge in expansion orders from our existing customer base and a noticeable increase in new customers captured by our reseller channel. We continue the recent trend in this business as we posted another very strong Creo quarter with license revenue up more than 40%. During the quarter, we also closed the MKS acquisition. MKS is a very exciting and very strategic acquisition for us and it will add to our revenue growth opportunity far into the future. With the Integrity product, MKS had become the leader in helping companies develop the embedded software that goes into manufactured products. The number of software engineers within the engineering departments of our manufacturing customers is growing at a very fast rate as products become increasingly sophisticated and increasingly filled with electronics and software control systems. So Integrity provides a very compelling standalone sales opportunity, which gives us a great way to penetrate new accounts even when there's not a PLM or MCAD opportunity readily available to us. At the same time, when the software development strengths of Integrity are combined with PTC's historical strength in hybrid development and PLM, now we have a very compelling and completely unique solution for customers. So we're very bullish on the Integrity opportunity. And you'll note in our guidance that we increased by a bit our expectation for the contribution of MKS in our Q4 outlook. We shipped our blockbuster Windchill 10.0 release earlier this year. And in Q3, our Enterprise business began to show good signs suggesting that the rebound that we've been predicting to show in the back half of this year is underway. Total Enterprise revenue was up 20% in the quarter. License revenues were up dramatically from last quarter, though flat with the tough year-over-year comparison. And the maintenance and services business continued to put up -- to pose very strong growth numbers as customers proceeded with their deployments in the ongoing use of the software. We saw better performance from our federal aerospace and defense vertical, and we also secured 2 important new domino accounts. One of the Domino accounts is in the electronics and high-tech vertical and the second represents another major win in the retail and consumer vertical, where we have a fabulous win streak going and a lot more runway in front of us. You'll notice, of course, that we have a lot of big deal activity in Q3 and about 1/3 of this activity came from this portfolio of domino accounts. So clearly, Windchill is on track as we continue to demonstrate our ability to capture market share and then deleverage those new accounts to expand our growth opportunity. So incidentally, last week, I was in Korea and had an opportunity to participate in the steering committee meeting with Hyundai and while the scope and the timeline of our PLM project at Hyundai suggest this project will always be a challenge, we are, in fact, executing well and the customer was pleased with our progress. So I'm personally convinced that the main thing that's holding us back from achieving even stronger Enterprise numbers is the ceiling that we've hit with our sales capacity. But as we discussed in June, we're now addressing this issue and we're in the process of executing some fairly aggressive plans to expand our capacity starting here in Q4 and then continuing on a fairly consistent basis throughout FY'12. So with this capacity challenge being addressed, we remain very bullish on Windchill and on Integrity and we expect, therefore, to maintain high growth rates in our Enterprise business well into the future. So sort of moving towards a summary here. We started the year with a revenue forecast of 10% to 11% growth, which would get us from $1,100,000,000 to $1,120,000,000 and we coupled that with an earnings forecast of a $1 per share. So that was our starting plan. So now we feel that our performance through the first 3 quarters of fiscal year '11 puts us in a great position to now deliver a much more interesting plan. Now we're talking about 14% to 15% revenue growth, which would get us somewhere in the range of $1,150,000,000 to $1,160,000,000 and we're talking about an earnings per share of $1.20 to $1.24. So while I think we started the year with a good plan, per our guidance, we're now in a good position to beat that plan by 4 to 5 percentage points in revenue growth and similarly to meet or exceed the 20% earnings growth component of that plan as well. At our recent PlanetPTC investor event in Las Vegas, we talked a bit about our preliminary thinking about fiscal year '12. And the model we shared, which I would characterize as something well short of official guidance, which we'll give to you at the end of Q4, but that model suggested we expect to see growth rates further improve in 2012 into the midteens overall. And that with this midteens growth level, we felt that another year of 20% earnings growth was readily achievable. So if I back all the way up to our investor event of 2009, you remember at that time we outlined a 5-year plan that suggested we could deliver a 20% earnings compound average growth rate over this 5-year window, which would get us to $1,600,000,000 in revenue and $2 a share. So now as we approach the last quarter of the second year and we begin to think more about the third year, we think we're in a great position to meet or perhaps even exceed the 2014 goals. So while I think there's always room for continued improvement, I'm pleased with the progress we're making and how we're doing overall. So thank you and with that, I'll turn it over to Jeff Glidden for some financial commentary.

Thank you, Jim. I'll just provide a little additional color on Q3 results, and then we'll move to guidance for Q4 and full year. As Jim cited, we're very pleased with the results in Q3 and it was a busy quarter. Q3 financial performance really reflects the leverage in our financial model as non-GAAP operating margins expanded 440 basis points to 17.6%. Cash flow was strong. We generated $48 million in cash flow from operations or $0.40 per share. DSOs improved to 56 days, reflecting again a strong cash flow and good delivery against commitments to customers. On the capital side, we repurchased 1.8 million shares of PTC stock for $39.9 million, and we completed the MKS acquisition, funded by cash and $250 million of borrowing from our revolver. And we ended the quarter with $261 million in cash, up $1 million from a quarter ago. With our third quarter results, we also announced that we were reviewing a compliance issue in China involving payments by certain business partners. We have identified and investigated the potential issue as part of our ongoing compliance program. We have engaged outside legal and accounting advices to complete an investigation, and we have notified U.S. government authorities of the potential issue. Based upon our review today, we have not identified any material impacts to our business operations or financial condition. Our review is continuing and we'll provide further updates as appropriate. I will close with our Q4 guidance and outlook for the year. Again this assumes the foreign exchange rate of USD $1.45 to the euro. Again that's been fairly choppy, so we're cautious and always look -- watch that very, very closely. For Q4, we expect non-GAAP revenue of $320 million to $330 million and EPS of $0.40 to $0.44 per share. This guidance reflects our decision to hire additional sales reps in Q4 as Jim cited. For fiscal year '11, we expect non-GAAP revenue growth of 14% to 15% or $1,150,000,000 to $1,160,000,000. For FY '11, we expect non-GAAP operating margins to be between 17% to 18%, up from 15.6% in FY '10. And we expect non-GAAP EPS to be, as Jim cited, $1.20 to $1.24. So we thank you for joining us, and we'll now open it up for your questions.

[Operator Instructions] The first question comes from Mr. Jay Vleeschhouwer from Griffin Securities.

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

Jay, this is Jim. I mean, I think it's hard for me to read too many trends in those data points because on one hand, there's a sequential story and on the other hand, there's a year-over-year story. And there's seasonality in these numbers and so forth and the numbers moved around a little bit. So I mean, I think, in general, we expect to move in a direction you're suggesting, which is strength to return to the Enterprise numbers somewhat at the expense of or perhaps, in general, a reduction in strength in the CAD numbers. As much as I'd like to keep posting quarters at 41% license growth in the CAD business, I'm a little reticent to project that. So I think that the trend is headed that way, but I can't read as much into this one data point as you might be suggesting there.

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

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

Just 2 quick last follow-ups. When we look at what is still your single largest revenue line item, Desktop maintenance, that had a pretty good sequential increase and year-over-year increase in Q3. Do you think that we're now finally beginning to see an inflection in the Pro/E active maintenance numbers that might carry into fiscal '12? Is that customer signing on to maintenance to get access to Creo? Or perhaps you could talk to us through some of that maintenance trend.

Well, you can help me here, Jeff. But generally, the trend in maintenance tends to follow about a year behind the trend in license. So one of the things I'm excited about is it's pretty clear that we should have a strong Desktop maintenance year in fiscal '12 following on the backs a surprisingly strong license year here in fiscal '11. So I think that you're probably right. We're at that inflection point where the maintenance is now starting to reflect the license trend that began several quarters prior. And I think, we'll be able to continue now a positive maintenance trend in the Desktop business for some time.

Jay, I would just add, I think, the teams have done just a great job on renewing maintenance, picking up back maintenance. They've been very strong on the programs. I think the customers really recognize the value. And I think we've been, I'll just say, extremely pleased with the performance. We say it's sustainable and just so we don't miss it, we broke the 1 million seat mark in Windchill this quarter as well. So I think all signs are very strong on the maintenance business.

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

Well, I think, probably the bulk of the Creo upside has come from the base. Although, part of that is the former CoCreate base tending to buy the Pro/E product and part of it is the former Pro/E base tending to buy the CoCreate-type capabilities. So a lot of it is cross-sell and some of that, of course, started even in advance of the Creo 1.0 release. But I would tell you, I was speaking yesterday with our reseller channel head, Bob Kocis, and new account production in the reseller channel is at multiyear highs right now. And that's mostly new accounts adopting the Creo product. I think it's sort of in the mid-20s growth rate right now in terms of new account production, which is great. It's fantastic trend. Now those are small accounts and they don't necessarily move the needle that much in the short term on the financials. But over time, they become pretty important to us. So I think that we're definitely seeing a significant measurable uptick in new account production but the bulk of the upside revenue we've had probably comes from the existing base.

Next question, Yun Kim from Gleacher & Company. Yun Kim - Gleacher & Company, Inc.: Jim and Jeff, can you help me reconcile why the number of 7-figure deals are up so much from last year, yet the PLM license business was flat? Does that mean all the incremental 7-figure deals are mainly CAD driven? Or is the PLM deal size trending lower from last year? If you can help me what trends you are seeing around 7-figure PLM deals, I think that will be very helpful.

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

Maybe I could just clarify something, Yun. So there were 27 large deals in the quarter, and I said about 1/3 of them came from the domino accounts. That does not mean that 2/3 were CAD business because -- maybe another 1/3 came from installed base accounts that weren't domino accounts, but were purchasing Enterprise software. So Windchill was well represented in the big deals. CAD also did well particularly because we used to not have any big CAD deals. So I'd say that the CAD number was up significantly, but the Windchill number was also up significantly, both in terms of deal count and overall revenue. So the big deals are going well. I think part of what happens is when you don't have enough capacity, people tend to congregate around the bigger deals and maybe what we need to do is put more capacity in below those people and make sure that we're pursuing enough base business as well. But I think we're doing well in the big deals.

The other thing about those large deals -- Barry here, it's 27 deals, they also represent license and service. So it's just not $1 million plus license deals and improved service and most of that service revenue that's in those big deals are Enterprise PLM accounts there, installing and adopting the Windchill technology. Yun Kim - Gleacher & Company, Inc.: Got it. And then you guys mentioned in your prepared remarks that services margin is being impacted by the Hyundai-Kia engagement. Is there any visibility to when this impact on services margin will end? And is there any way to quantify how much the impact was in the quarter?

Well, I'd say that this is the previously announced. That's not new news on Hyundai. This is sort of back to Q1, the sort of loss contract we discussed at that point. And the fact that by taking the loss upfront, it made the rest of the project breakeven, and breakeven does not produce good service margins, okay? So this is not a new phenomenon. This is just a continuation of that phenomenon. Part of what I think we were trying to say there is if we could back that out, the rest of the services margins actually look better than they appear. I think that's the point we were trying to make. Yun Kim - Gleacher & Company, Inc.: How long do you expect that disengagement to go on?

The project run through the calendar year. And then we'll negotiate a next phase, and I'm confident that the next phase will be on more favorable economic terms. Yun Kim - Gleacher & Company, Inc.: And then Jeff, what is your plan regarding the credit line you tapped into? How soon you plan to pay back without impact to your share repurchase plan?

I think, as you saw, we did both this quarter. We continued to stock repurchase plan. We'd expect to complete the $55 million as we planned for the year so that's another $15 million in the fourth quarter. We'll continue on that and I think we shared when we did the MKS deal that we'd expect to pay that line off at a pretty good clip, probably -- certainly within the next, say, 8 to 12 quarters. And it will really give us a lot of flexibility. So I think we're in good shape. As you saw, we generated significant cash again in the quarter and I think we'll expect to be paid probably between $40 million and $50 million of that back just in Q4 alone.

Blair Abernathy from Stifel, Nicolaus. Blair Abernethy - Stifel, Nicolaus & Co., Inc.: Just wanted to get a little more on the PLM domino backlog. In particular, as you've been winning these large mandates in the last 2 years, trying to get a sense of what your expectations are now around the license and consulting services mix from these large wins, and how far out into the future? How big is that backlog looking?

Well, I think our services business, they're looking at 4 to 6 quarters of visibility into their backlog. So as we sit here today, we're pretty comfortable, we know with relatively close precision what the FY '12 services number is already. But I think more importantly, it's not our strategy to grow the service businesses as fast as we can. What we have right now is an effort underway to try to build out a partner ecosystem to which we could give more and more of these services. But the truth is, the demand right now exceeds the ability of PTC and our partners to sort of keep up with. So I think we're in an area of strong demand, but a strategy that says -- increasingly shift some of that services demand to partners, and we're just sort of trying to bridge our way to that future state.

And just 2 other comments, just to make sure we're clear. We have backlogs or orders on hand for services. We also have a significant pipeline of new opportunities or extensions to current opportunities in the PLM space. And with many of the larger accounts, we'll have and work with them very directly on 3-year product roadmaps. Those may not committed orders at this time, but they're really a pipeline of activity that we feel pretty good about. Blair Abernethy - Stifel, Nicolaus & Co., Inc.: Okay, great. That's helpful. And just another question on the large deals in the quarter. Can you just give us a sense of the vertical performance? What seemed to be working better for you in Q3 and also was there any contribution in large deals from MKS?

The second part of that question is no, not in the partial quarter that we had.

Yes. Recognize MKS was really only 1 month with the month of June. So MKS was not a particular contributor to the large deals. I think Jim cited verticals in terms of we saw a return of activity in aerospace and defense. Again we're cautious long term on the government business, but at the same time, we've seen good performance there. Industrial was good. We cited retail and consumer as a large domino win along with some of the high-tech businesses. And again relatively newer vertical for us is medical devices, and that is a good market and has good outlook as well.

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

Sterling Auty from JPMorgan. Sterling Auty - JP Morgan Chase & Co: I just wanted to go back and revisit the PLM business. So can you talk with us a little bit maybe about the pipeline and the aging of some of the deals that are in there? Meaning, is the pipeline continuing to grow? Have you restruct it? And is the demand side from the customer perspective growing and it's purely a capacity issue like it was last quarter? Or is there a lengthening of sales cycles and decisions on the customer side?

I don't think there's a lengthening of decisions, I think that the pipeline is pretty strong. We've been here at a sales management meeting for 2 days, looking at the pipeline for Q4, for Q1 of next year and really for the balance of the year. And I think the pipeline looks pretty good. It's just a question of where does sales guys spend his time? And when the customer says -- calls up and says, hey, I heard about this Creo thing, can you come tell me about it. And then that turns into more activity, which pretty soon turns into a purchase order discussion, then that sales rep gets a little distracted from what he normally would have been doing, which is pushing the ball forward on the Windchill side. So I think what we need is we need more capacity so that we can have both of those conversations, not one or the other. And that probably means we need reps to have fewer accounts and more time per account to carry on multiple conversations. So I think that's why we think it's a capacity issue, not a demand issue. Nobody at PTC or sort of in our whole ecosystem here really envision that we were going to have the kind of Creo year that we had this year. It's surpassed everybody's expectations, management included here. And it came a bit at the expense of our ability to spend as many cycles on the Windchill business as we would have projected to do at the beginning of the year. Sterling Auty - JP Morgan Chase & Co: Listening to your comments, it sounds like you believe that, obviously, it's not a sustainable growth rate. It'd be great if it was, but it's probably not. So as that starts to moderate or trend back towards what it looks like a industry average growth, are you concerned that we might hit a blip or a pause as we turn our attention back to PLM, but to re-jump those conversations or those focus, it may not be an instantaneous thing and could you get some disruption as they shift the attention back from the CAD buyer to the PLM buyer?

What I think you have is 2 overlaying factors going on simultaneous here. On one, you have an improving economy. Our customers are hiring engineers. They're expanding their deployment of CAD technology and so forth. So there's an economic factor. And then separate from that, there's an exciting new product factor. And these things are overlaying each other and sometimes it's hard to assign a certain weighting to each of these separate factors. I definitely think the economic factor will run its course. But we'll be left with the new product factor, which I think is also interesting. So I would anticipate and I've said this previously that we will revert to a growth rate that is noticeably superior to the growth rate we would have had, had we not had this new product. So maybe we would have thought this business was a 3% to 5% grower, I think post Creo, we think this business is 5% to 8% grower, sort of on a go-forward basis, after the economy factor runs its course. Sterling Auty - JP Morgan Chase & Co: Last question, I'll jump back into the queue. Is there a sense that you can give us when should we look for a re-acceleration in PLM just on the fact that you have been hiring new sales capacity and it takes time for them to ramp up. Is there any sense when you expect to get enough productivity now that new sales capacity that it moves the needle, we start to see the pickup at PLM?

Well, I think, first of all, if we talk about PLM, in general, we did have a 20% growth quarter in our Enterprise business, so I don't... Sterling Auty - JP Morgan Chase & Co: Well, let me be more specific. I think there's a lot of us that are just looking at the license number. I think we're all very impressed with the service and the maintenance and hoping the service is also a leading indicator. But I think we want to see the license growth return to it because it seems like that had been the engine of growth for the company for a number of years.

Listen, that's fair. I was just trying to remind everybody the big picture, the business is growing nicely. But you're right, we need to focus on the license. I think in Q4 here we'll be disappointed if we don't post a positive year-over-year license growth number in Q4. And then I think we would be disappointed if we didn't, throughout next year, continue to post increasingly positive year-over-year license growth numbers. So I think we feel like this snuck up on us a little bit. It takes a quarter or 2 to react to it, both to kind of remind people to focus on the right things and they add in more capacity so that they don't have to make so many trade-offs and so forth. But I think in Q4, we would expect to give everybody numbers you're happier with and then that trend would continue.

Matt Hedberg from RBC Capital Markets.

In your prepared remarks, you talked about an SMB business that continues to show sign of improvement. I guess, I'm wondering could you give us a little more granularity to there? Obviously, license on both sides of the business had a good quarter. And then I guess, how sustainable is that as we look into next year?

Yes, I mean, if you look at that 4-box, we had 14% growth in SMB CAD on the back of 22% license growth. And we had 10% growth in SMB PLM on the backs of 33% license growth. So I think both of those businesses are doing well right now. The way the SMB business typically works is we win the CAD business first, we grow that footprint for a while and then we bring in the PLM component. So I think this is a place where PLM almost always follows CAD. So I think that the introduction of new oxygen, new accounts into this SMB space is very important. I think there was a period of time where that was difficult to do because our CAD product maybe was viewed as old and tired. Right now our CAD product is viewed as the most exciting thing in the industry and people want to talk to us. They're pulling again which is something that we haven't had for a while. So I think that, that trend in the CAD business is very sustainable. It actually -- it took longer for to SMB business to react to the improving economic situations. But I think that now we're in a pretty good spot there, and I think we'll continue to see some good numbers coming out of our reseller channel going forward.

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

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

That's great. And then one last question. You've had MKS under your belt now for about 2 months now. Obviously, you took your Q4 expectations up by about $5 million. Kind of reflecting back over the past couple of months, is there anything that you've been surprised with to the good side thus far?

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

And I guess, with taking the Q4 expectations up a little bit, how -- the $75 million for next year or north of $75 million is pretty consistent from your analyst day. I mean, ultimately, I guess, how conservative could that be versus sort of what you've seen here and sort of the integration thus far and just kind of getting a sense for sort of your comfort level around that number next year?

I would reiterate Jim's comments. We're very pleased to date, we've got a good pipeline of activity but that said, it's only 2 months into it. So I think we're very comfortable with the $75 million and we would, I think generally say, we think there's upside to that because of the market opportunity. But I think it's early, too early for us to give you much more than that, but...

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

Richard Davis from Canaccord.

So you're winning these domino accounts and then you're exploiting from them. So the 2 questions I have kind of tie into one another. It sounds like your experience sounds promising at this point to kind of exploit from these beachheads. Are those wins coming against firms like the FSO [ph] and UGS? And then secondly -- because really what I'm trying to do is grapple with if I think about your history, you're a big direct sales company in the '90s and you kind of went channel in the 2000s and now you're kind of going back to direct sales because the deal size have gotten big again. So I'm just trying to modulate around that. It sounds to me like you're very confident you can exploit from there, but you have some examples and case studies that tell you that it's safe to dip in the water and add 25% to your sales capacity?

Yes, I mean, on the first part of your question, the number one and two contributors to the domino program would be the SAW and Siemens and they're probably about tied. And number three would be SAP. There's a number of domino situations where there are customers who tried SAP PLM and essentially came to the conclusion that wasn't the right solution. So I think 2 years ago already, Richard, I remember we gave you a model that we call the domino monetization model. And it sort of predicted how we thought revenue streams would materialize after a domino win. And I think that model has proven to be remarkably accurate. And it's just a model. But basically, we said we'd get a little upfront project, mostly services. We execute on that. That turns into a most significant license order. And then service and then the maintenance starts to become more meaningful, and we execute on that. And there's another phase of expansion and so forth. And I think if you look at it, I said about 1/3 of the 27 dominoes -- about 1/3 of the 27 large accounts -- large deals, excuse me, were coming from the domino accounts. Well, there were only 2 new domino accounts in the quarter. So even if they gave us significant transactions, that meant that a number of the pre-existing dominoes also gave us significant new transactions. So I think that, that model has proven very accurate, and we do feel like more sales reps would give us the ability to pursue more domino accounts. These things take time and energy and so forth and when you start -- if you're a sales guy and you're in a situation where you have more opportunity than you have time to pursue, then you tend to congregate your resources and your energy -- concentrate your resources and energy around the big deals that are most sure. And I think what we need to do by adding more capacity is you push people a little bit outside of their comfort zone and make them go out and develop more new business, start new campaigns, develop new customers, et cetera. And I'm pretty confident we'll be able to do that.

Steve Koenig from Longbow Research.

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

Okay, Steve, good question. And we don't specifically break out profitability on Enterprise and Desktop. I think you know that the margin -- really the mix of products are what makes a huge impact there with license and maintenance driving very significant 90% margins with services having lower margins. So we actually look at that -- those trends over time. We also look at it within an account. And I think as Jim has described, you'll sell licenses, you'll follow that with services and over time, the profitability of these accounts will actually build as you build that maintenance base in the same way the PLM business will build. What we're seeing this year is a lot of services revenue, particularly in the Enterprises space, driven by all the license sales of last year. So right now you'd look at it and say, we deal with a lot of services mix. We think as those implementations are completed, we'll sell more license, we'll sell more maintenance and the profitability of those accounts will then again expand in the margin. So I think the patterns that we've seen have been very consistent. I think what we're looking at this year is really the phenomena of a lot of systems that were sold last year we've installed. And again I think as we look at it, we feel pretty good about the growth and the profit expansion from the business as well as in the Enterprise.

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

Margins would be favorable.

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

Correct. And let me just add a point, the Windchill 10.0, one of the goals of that was be able to implement these systems more out-of-the-box at a more rapid pace. And to the extent that as we start and will be implementing Windchill 10.0, that should allow our customers to implement faster with a lower service component over time and obviously therefore, generating additional revenue stream on the product side as well as on the maintenance side.

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

Yes. I mean, it gets a little tricky here because I think the underlying phenomena is different in the Enterprise business versus the Desktop business. The Enterprise business is not really a modules-and-upgrades business. It's really more of a new seat business. And sometimes an expansion of the footprint does come into effect. But on the other hand, the CAD business, the Desktop business is very much a modules-and-upgrade business. So the modules-and-upgrade opportunity with Creo has basically yet to start because that was something we couldn't sell until those products were released and we just released them, of course, in June. So I think that there definitely is an opportunity around the maintenance renewal or even separate from one to go do a Creo deal to sort of upgrade the seat configuration to contain new modules and so forth. And perhaps to add some new seats direct to the parametric base and so forth. So I think that's very interesting, but I think on the Windchill side, it's a different phenomenon. Most of our significant windchill orders come from new wins and then expansions of those wins into more seats, more departments, more geographies what have you.

Ross MacMillan from Jefferies. Ross MacMillan - Jefferies & Company, Inc.: And I apologize if this has been asked already. I got on to the call a little late this morning. But I just wanted to step back and talk about license. We started the year at 20% to 25% growth. We're now down to 15%. You manage to do that while keeping EPS guidance the same really, so I guess that's due to the strength in maintenance, in particular, which is great. But I guess I have 2 questions on license. The first is that last quarter when you took down the range for the first time, you still, Jim, I think said that you thought the original plan was possible. So now with this further revision, that seems a bit less likely. And I guess, I'm curious as to kind of what changed? And the second question is related to this, is there anything we should take away with regard to pipeline build and/or managing, if you will, like the transition from 4Q to 1Q and maybe managing kind of that pipeline and that transition from a big fourth quarter until first quarter? In other words, are you building more of that pipeline and visibility by making these changes to the license growth rate for this year?

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

And relative to the Q4, Q1 transition, I mean, we always have Q4 as seasonally our strongest quarter. It's driven heavily obviously by the sales compensation and so forth by direct reps. So I think we'll continue to see pipeline build and obviously adding sales capacity will help that. I'll just give you one other flavor for Q1 is that's also a strong quarter for us in terms of the channel because that fiscal year ends and generally ends in December. So we have a little bit of a -- I'll call it a buoyancy that occurs in the first quarter, which is the fourth calendar quarter, which will help us in Q1. And we'll just have to watch this build on both capacity and on pipeline and will keep you apprised as we see changes or hopefully, positive inflection points. That's what we're looking for. Ross MacMillan - Jefferies & Company, Inc.: That's great. And maybe one quick follow-up. Just on the Arbortext, any update there in terms of timing? Any color around when we should start to view that as a more meaningful revenue contributor?

Yes, I think there's some significant deals in the pipeline here even for Q4. Part of the Arbortext story -- and I think we told you this probably at the investor event, is that we have some significant new capabilities coming to transform this story from a technical publishing story into more of a next-generation service information system story. For example, the type that Caterpillar has talked about with you guys in the past. So some of the new product capabilities that help that transition or transformation take place are coming this quarter. And so I think you're going to see us have some pretty interesting transactions around the Arbortext businesses this quarter. And then having to spend a couple days here with sales management, I'd say that the longer-term pipeline, the FY '12 pipeline, suggest that Arbortext will grow after than Windshield or Creo next year. So I think that, that will be sort of a situation Arbortext has extremely strong growth. Enterprise being a much bigger business, of course. We'll have impressive growth and then we would expect Creo to sort of return to a more sustainable levels at that point.

We have time for 2 more questions. Rafael Garcia with Morningstar.

You guys have been experiencing solid growth in the PLM segment over the last few years. However, it looks like Autodesk is finally ready to make a more decisive move into the PLM space. So my question is, how are you guys positioning the company to advance your PLM market share in the SMB and Enterprise segments?

Well, it's hard to say because we need to see a little bit what Autodesk really does here. I mean, Autodesk is starting to talk about PLM, but I will actually point out this will be their fourth run at a PLM strategy. So they're 0 for 3 and maybe the fourth one will be a big success. I don't know. But I do know this, PLM is something that isn't just about products. When we sell PLM, we help companies transform their business processes and that's one of the reasons there's a lot of services involved. And Autodesk has a channel and a distribution mechanism that does not align with that idea at all. So Autodesk is good at moving products. They're not good at helping companies transform business processes. And I'm not sure they know that yet. I'm not sure they know that, that's required yet. So I think that Autodesk might put some PLM in the cloud and I'm not sure that's going to matter if their resellers aren't able to sit down and work through process transformation and financial product value propositions associated with changing the way you develop products from an as is to a to be model and so forth. I just don't think that -- for sure in the Enterprise space, Autodesk is not even going to be able to engage in an intelligent conversation. And I think in the SMB space, their resellers are just one step different than a store shelf, basically. So I think it's going to be difficult for them. I think we have one more question.

Jay Vleeschhouwer from Griffin Securities.

A couple of follow-ups. Jim, I'd like to ask about the active base data that you've put into your prepared remarks, and it's very interesting to watch those trends. First, I know it's been average but your Windchill base is roughly 7x as large as your active CAD base. And I'm wondering if that's a number that you think about or manage in some way or what do you think it means that, that number is so much larger than the CAD base, which has been growing only very slowly, at least recently. And secondly, do you see some opportunity for perhaps increasing the revenues for license in the PLM base? Right now you're probably getting maybe 1/10 as much per seat in PLM under maintenance as for [indiscernible] average Pro/E seat. Do you see the possibility for increasing the former for Windchill maintenance?

Well, you think, Jay, for many years, we said that we felt the seat opportunity in a given account for Windchill was 10x to 20x the seat opportunity in that same account for CAD. And so we're headed there. As you mentioned, we're at sort of a 7x ratio right now. But that said, we're selling windchill to a lot of accounts that never bought any CAD, so you can't just take our CAD based on 7 and say that's the opportunity because when you think of some of these big retail accounts, the targets, for example, they don't have any Creo and we're selling them many, many Windchill seats and we've had a terrific run of those type of accounts. And then on the other hand, we're selling a lot of Windchill to accounts that use somebody else's CAD tools, use CATIA or UG NX [ph] or what have you -- SolidWorks. So I think that we feel like this ratio will continue to develop in the direction you said. Now I think there's also an opportunity to increase the CAD seats in this cross-sell of direct to Parametric and Parametric to direct technologies should as well help with the cross-sell and could drive up the number of CAD seats, thereby further increasing the number of Windchill seats. So I think from a seat count standpoint, we expect this trend to continue indefinitely. The second part of your question, I think, was really about the ASP, the average seat price. I think that there is 2 competing trends there. On one end, as the footprint of Windchill gets bigger and deeper and we do have more modules that we can pile into an existing seat and then the price of that seat and that user goes up. But on the other hand, we keep holding in more and more casual users as we expand to that bigger ratio. As you go from 7 to 1, to 10 to 1, to 20 to 1, you're involving more and more casual users, who would expect to pay much less per seat than sort of the more concentrated users that preceded them. So I think these 2 factors balance each other out, and I can't really predict that the average maintenance per seat will go up. I think the 2 factors might kind of counterbalance each other, and we would see about the same trend, if I had to guess.

That concludes the call. Thank you for joining us. Speak to you next quarter.