PTC Inc. (PTC) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to PTC's Third Quarter Fiscal Year 2012 Results Conference Call. After brief comments by management, we will go directly to a question-and-answer session. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce Tim Fox, PTC's Vice President of Investor Relations. Please go ahead.

Hi, thank you. Good morning, everyone. Thanks for joining us on our Q3 results and outlook call. Before we get started, I would like to remind everybody that this call and Q&A session may include forward-looking statements regarding PTC's products or anticipated future operations or financial performance. Any such statements will be based on the current assumptions of PTC's management and are subject to risks and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties is contained in PTC's Form 8-K filed yesterday and in our most recent Form 10-K and Forms 10-Q on file with the SEC. All financial measures in this presentation are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measures is located on our Prepared Remarks document on the Investor Relations page of our website at www.ptc.com. With us as always this morning is Jim Heppelmann, Jeff Glidden and Barry Cohen. With that, I'll turn the call over to Jim.

Thank you, Tim, and thank you to all of us for joining us on the call here this morning. With revenue up 10% and earnings up 24% at constant currency, we're pleased to see Q3 come in as a solid quarter. We did not close the mega deal we spoke of 90 days ago, but we were able to backfill with other deals, including deals that grew in size as the quarter progressed. So in the end, we were able to come in toward the high-end of the revenue range, especially in the license category even though everything didn't go our way. I would characterize our performance in Japan and Asia-Pac as being very good. Our performance in Europe as solid and our performance in North America is unimpressive, but in line with our most recent guidance. Looking across our 5 business segments, the CAD, PLM, ALM, and supply chain management businesses performed within a reasonable range of the expectation that we had for each. Our service lifecycle management or SLM business, stood out again this quarter with a growth rate that was much stronger than the other segments and substantially stronger than the company's overall growth rate. We're excited about the prospects in each segment and continue to believe that the growth opportunity created by this portfolio of 5 businesses is compelling and will support our long-term goals. In the third quarter, we continue to make great progress on margin expansion and the $0.37 of EPS came in well above the guidance range and allowed us to raise our EPS guidance for the full year. We believe that this quarter's EPS performance once again demonstrates the seriousness of our commitment to margin expansion and earnings growth even we're confronted with a more difficult revenue environment. We are now live with salesforce.com and we're operating with much better data and as we look at Q4, we see a strong pipeline particularly in North America. At the same time, we see increased pressure from foreign exchange rates and see no reason to expect improvements in the top macro environment we're all in right now. Thus, we're holding our Q4 and FY '12 revenue forecast flat with the exception of making currency adjustments. Looking ahead to FY '13, we are now actively engaged in the planning process for the new year and at this point, we do not yet have a final plan or guidance that we can share with you. But I can tell you now already that the bedrock of our plan will be strong earnings growth that targets $1.70 to $1.80 EPS range. To provide some context to the planning process, I'll remind you that our timeless FY '15 model assumes 11% to 13% annual revenue growth and 2 percentage points per year margin expansion. However, assuming that today's FX rates hold true with FY '13, due to currency alone, our FY '13 revenue plan would lose $40 million or about 3 percentage points of revenue growth. So considering that big FX hit, plus taking into account the likelihood of a continued difficult macroeconomic environment, our planning process is leaning toward an FY '13 recipe that involves more moderate revenue growth, coupled with aggressive margin expansion. But in any case, our objective would be to drive toward 20% earnings growth with that recipe. So with that, I'll turn it over to Jeff.

Thank you, Jim. Just a few comments on our Q3 results and then I'll discuss our outlook for Q4 and the full year. As Jim said, we're very pleased with our earnings performance in Q3 as non-GAAP operating margins expanded to 18.6%. This improvement is primarily due to increased services margins coupled with diligent headcount and expense management. Overall services gross margins improved from 5% in Q3 of FY '11 to approximately 14% in the current quarter. During Q3, we eliminated some 41 additional positions, further reducing our expense run rates. We expect that these reductions will benefit our quarterly expenses by approximately $1 million in Q4. A highlight of the quarter with cash and cash flow. Cash increased to $238 million. We paid down our revolver by $20 million and repurchased $20 million of PTC stock. Cash flow from operations of $64 million reflects excellent customer collections. For the first 9 months of 2012, we have generated $197 million in cash flow from operations or approximately $1.63 per share. Turning to our outlook for Q4 and for FY '12. Our revenue guidance for Q4 is $320 million to $335 million. And again, as Jim cited, this reflects approximately $10 million of unfavorable headwind on FX. For the full year, our revenue range is $1,255,000,000 to $1,270,000,000. We expect Q4 non-GAAP EPS to be $0.44 to $0.50 per share and for the full year outlook of $1.46 to $1.52. And again, just reiterating, this guidance assumes the euro at 1.20 and that's down from the 1.30 that we've cited in the last quarter. As discussed previously, we are committed to driving our long-term non-GAAP operating margins to 20% to 25% -- 25% to 27% by 2015. We thank you for your support and will turn it back to the operator, Marla, to open it up for question-and-answer period. Thank you.

[Operator Instructions] Our first question comes from Yun Kim from ThinkEquity.

First, just wanted to ask you, can you give us some sense on how many 7-figure deals were follow-on deals from ongoing PLM projects? And how do you see that particular mix of -- those types of deals playing out over the next several quarters?

Let's see, do we have that data?

We cited large deals and I'm not sure we have exactly your information. We can get that -- get at that. The total of large deals, this would be more than $1 million of license and service. It was up nicely. It was 34 transactions. We did have 1 large deal that was in the $1 million to $5 million range that actually expanded in the quarter. So we had 1 deal that was over $5 million, $34 million that were greater than $1 million and have generated about $75 million. So I think we feel quite good about these transactions. A number of these were follow-on deals as well. So again, the recurring revenue stream, we feel pretty good about and I think as Jim cited, there's a lot of activity and pipeline building really particularly in North America that gives us, I think, a good level of confidence about our outlook for Q4.

Okay. So just looking at the average deal size for 7-figure deals, looks like you've been trending towards more on the low end of the range, historical range over the last couple of quarters. Is that something that we can completely expect given the current environment out there? And is that something that you feel comfortable handling with the -- in the sales capacity coming more or less the growth around that becoming more limited?

Okay, good question, let me -- the average has been pretty consistent around just over $2 million on those transactions, $2.2 million in the quarter. That's very consistent with prior periods. I think that's a reasonable -- generally, we've seen that between 2 million and occasionally, the upper 2s, but I would say $2 million to $2.5 million is what we'd expect. We do have a lot -- a number of large opportunities out there that we are pursuing.

Yes, I think -- just looking at the date here myself, I think what causes this number to bounce around. There's sort of a baseline of the lower 2s, and then I think it's the presence of several mega deals that averages everything up in some quarters. So I think that's really the trend. I think it's hard to read much into this as a trend.

Okay, great, and then -- and Jeff, can you just quantify the -- what could be the foreign exchange impact on this for revenue balance at the end of the September quarter? If we use your rule of thumb, you at first [ph] expect about $8 million to $10 million impact?

Our assessment, because it's a large quarter, it's approximately $10 million in revenue and that's the 1.20 versus 1.30. So that would come off the top of the revenue guidance that we provided in Q3 for both the quarter and the year. So it's about $10 million. That would normally translate into $0.02 to $0.03 of unfavorable impact on EPS. And obviously, given our guidance, we are reflecting that we'll mitigate that impact by basically managing expenses and we're also, I think, very pleased with the services margins that are running ahead of plan. We're now outlooking for that year comfortable with 12 percentage points of services margins. As we cited, we're actually at 14% in this quarter.

So we should expect more or less the same kind of impact on the deferred revenue balance, right?

Deferred, it was the key part of the question.

Okay, deferred will be seasonal. We have 2 periods where -- particularly at the end of the year, January is the biggest single period, but I think the maintenance -- it's really driven by maintenance and the maintenance, all the maintenance rates are positive. There is some seasonality in there.

He's asking about the FX adjustment on the deferred balance.

Right. We reflected that in our guidance. So the guidance, it will come down slightly and we've reflected that in our guidance as well.

Okay. And then just lastly, if you could just talk about different trends that you're seeing in different verticals, which are doing better than others and whatnot?

Yes, let me see if I have the vertical data here in front of me. I didn't -- when I look at it previously, I didn't notice any substantial trends on a vertical basis. No, I'm sorry. I'll look for this and comment on it. Well, here we go. I got it. I mean, there is not a substantial trend. There's some big numbers in verticals that are small. So the law of small numbers. But I think in general, pretty much steady as she goes across most of our main verticals. The exception, of course, maybe worth pointing out is aerospace and defense, which we've sort of told people all along that's going to be tough sledding this year, given what's going on with fiscal spending in the government and so forth.

Our next question comes from Richard Davis with Canaccord.

It's actually DJ, on for Richard. So Jim, it sounds like even from conversations we had last quarter, you guys are making a shift in sales headcount strategy from kind of aggressive growth to improving productivity. So I guess, any color on kind of the timing of this decision? Is it preemptive cost control efforts? Is it worries about macro demand? Do you feel like you're approaching full capacity? Just help us think about that.

Well, let me point out a couple of things first. So our sales headcount was flat versus last quarter. However, that's sort of hides the trend and we actually added a fair amount of new capacity, but then restructured the ALM sales force and merged it into the PTC sales force and in doing that, turned over some people. So you should think that we restructured, that took headcount down and then we hired new capacity and took it back up. So we actually did add some important new capacity in the quarter, but I just think that capacity is up 26%. Revenue is not up 26%. So there is some progress we need to make on lifting our productivity. And I think you're going to see us keep hiring, just not at the same rate and I think it really does come down to the macro environment is not as optimistic as it was when we started hiring at this more aggressive rate, and I think we should just make sure we mask the two, [ph] so that we don't get too far out over our skis, [ph] with capacity that's not productive in light of the economy.

Yes. And I guess maybe the follow-up to that would be you hit on the salesforce.com implementation. You said you guys are up live now. I guess, help us with where you are in that process. Are we kind of still in the data population phase? Or is it fully ramped to the point where we think you could see enhanced productivity in Q4 and looking forward?

So let me tell you, what is in the system right now is our mainstream direct sales force. What's not in the system yet, but will be coming online, is our resellers and the ALM pipeline just because that was being operated until this past quarter through a separate sales force here at PTC, and that's all part of a plan to bring these people in over time. So we have the data in the system. I'd say we're in the phase of making sure the data is complete, and I think it's firming up, and then we're in the phase of trying to understand what it means. Having this data for the first time, we need to calibrate our expectations against it. But I'll certainly tell you, when we think about our guidance for Q4, we're much happier to have this data as we you give the guidance than we were in previous quarters where we did not have this level of fidelity on exactly what was in play, what's the real potential upside, what's the potential downside. So we have much better clarity to that. But again, with the exception that clarity does not get extend over the retailer network or over the ALM sales force.

Our next question is from Sterling Auty with JP Morgan. Sterling P. Auty - JP Morgan Chase & Co, Research Division: I want to follow-on that a little bit. But in particular, in North America, Jim, you kind of described this lackluster. Is the lackluster portion as you got salesforce.com up and running and scrubbed the pipeline maybe it wasn't as robust as you thought? Or how much of it was sales execution because it feels this is the second quarter in a row that North America was not that great.

Yes, so if we back up to 50,000 feet, look at North America, year-to-date, total revenue we're up double-digits. Year-to-date, license revenue we're down mid single digits. I think what the pipeline is telling us and sort of what my gut was maybe telling me was that we have a quarterization problem with a big hockey stick in Q4 and we see that in the pipeline. So we had perhaps a relatively weaker pipeline of opportunity in Q2 and Q3 and a relatively overweight, stronger pipeline of opportunity in Q4. So what we want to do here in Q4, let's go just execute on our pipeline. Post a pretty good quarter in North America in Q4 and we might end up with a year that from a license revenue standpoint it's somewhere around flat, which would still be unimpressive, but somewhere around flat, and then total revenue would be up double digits. That's our goal. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay. But how do you then manage that going forward? I think you talked about pipeline build. Is there a an ongoing strategy to fill the top of the funnel and do a little bit better job in terms of the managing and the timing of it?

Yes, absolutely. I mean, as you know, the presence or not of big deals in this pipeline, skews things considerably. So I think we've shared with many of you that a key strategy is we need to go direct a lot of this capacity together with marketing into building pipeline of base business of sort of deals under 1 million, including in the mid-market, so that we get a more robust pipeline and the big deals move toward being gravy rather than potatoes. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay. Last question is around the PLM business. In this microenvironment and specifically the domino deals that are out there, I'm kind of curious what you're seeing in terms of implementation plans. Are you seeing customers that are either holding back or slowing implementations? Or are things still kind of full speed ahead?

Yes, I think things are relatively full speed ahead. In fact, I know of a couple of companies what are, for PTC, as domino opportunities that are actually struggling on their own top line and bottom line, forging ahead with PLM programs because they see this as part of a get-well program for the long run. So I'm not seeing any major programs that we're pursuing canceled and I'm actually been surprised that some of them are continuing forward in the context of how those companies are performing themselves.

Our next question is from Matt Hedberg, RBC Capital Markets.

Obviously, the Pacific Rim in Japan had a very nice quarter, several large deals that you mentioned. I think in the prepared remarks, you also talked about expecting fewer large deals in the coming quarters. I guess, I'm wondering how sustainable is the growth there? And do you think you'd drain the pipeline there? Or just kind of talk just about the pipeline in APAC.

Yes, so, Jeff, you can comment too here. It's Jim. No, I'll start. I think that we had an exceptionally good quarter in PacRim, but the trend has been pretty good for a long time. So I think what we're saying is that inside the good trend, we spiked above the trend. We're not sure that, that spike is the new trend, but if we revert to the old trend, that's not a bad trend, but pretty decent growth. So I think we're just cautioning you guys, don't get ahead of yourselves thinking our PacRim business is exploding to some new level. It's been performing well. We think it will continue performing well, but perhaps it performed exceptionally well in this past quarter and that's not sustainable on a repeatable basis.

That's helpful. And then, I guess, in terms of Europe, I think you've quantified it as a solid quarter. I guess, I'm wondering, specifically, I know the German market is a large percentage of European business, how is that market in particular?

The German market for us is very good.

Yes.

In fact, our results as reported are relatively flat and in constant currency, European results, I think, were up 9%. So that's pretty good. There aren't that many companies continuing to post those kind of growth rates. Coming off, by the way, a fabulous year in Europe last year. So last year, our European business grew 24% and against those comps, we're continuing to post on a constant currency basis pretty impressive numbers this year.

And maybe just to add to that, roughly half our business in Europe is in Germany. We then go north to Scandinavia. So I think when we look at this, most of our larger comps are really driven by global GDP that's clearly going to be impacted by any downdraft in European activity, but pretty solid companies and our exposure is largely Germany and North with some good business as well in France.

That's helpful. And then Jeff, obviously, you had good results from the services businesses quarterlies from a margin perspective. I think you took up the range, you're now expecting 12%. I think in the past, you've talked about mid-teens growth there. I mean, kind of in a baseball analogy, what inning do think you are in terms of service margin evolution?

So we said mid-teens, and I think we're running ahead of our plan that we set at the beginning of the year. I would say you're -- actually, the good news is we're a year into it and we're probably -- results are about 2 years into it. So I think we're probably still in the early stage of this, Matt and there's more to come on this. So I think the guys have executed extremely well in services and I think there's some more upsides.

Yes, I mean, maybe to add some color, I think, a legitimate question is does our progress so far suggest we could do better than mid-teens ultimately, and we're not going to give you an answer on that today, but I think we're asking ourselves that question.

That's very helpful. One last question. In terms of your 4Q guidance, can you talk to us about the number of megadeals within guidance? And are you seeing any additional approval steps? I think you said you had one that didn't close, but you had one this quarter upsized to a megadeal. A little bit more color on that would be help for 4Q.

Yes, I mean, I think, first of all, we have a number of megadeals in play in Q4, and our guidance reflects relatively conservative close assumptions, sort of like the high end of our guidance range would still be less than 50% hit rate against the megadeals. So I think we're relatively conservative there. We're not planning to clear the table by any means in our guidance. I think in this past quarter -- naturally, one phenomenon in here is the hockey stick phenomenon that tells the sales guys, you got to get these deals done by the end of the year, which causes some of them to stack up in Q4 and that's always been the trend here and I haven't figured out yet how to change that trend. But I think what happened in Q3 is the one deal we were pursuing slipped into Q4 and another deal, as our sales guys want to do, they're trying to make these deals as large and significant as possible, and they managed to take a deal that was just under the megadeal thresholds and push it to just over the megadeal threshold by getting some more customer requirements in there. So I think the quarter -- let me maybe say one comment. That megadeal that happened in the quarter was not unexpected. It just got a little bit larger and became a megadeal, but it was forecasted slightly all along as a slightly less than megadeal, so that didn't -- it's not like we got lucky there. It's just that deal came in slightly larger than we had forecasted it. So I think we had conservative close assumptions in the past quarter that served us well and we'll carry those sort of conservative close assumptions into Q4.

Our next question is from Blair Abernethy with Stifel Nicolaus. Blair Abernethy - Stifel, Nicolaus & Co., Inc., Research Division: Just 2 things. I want to follow on the megadeal commentary. Jim, can you give us just more color on what products were involved with the one that you booked this quarter? And the one that was missed and that slipped in -- back in Q2, is that still out there and what product areas does that focus on?

Yes, the deal that did come in this quarter was CAD and PLM. The deal that slipped was PLM. And going back to the Q2 deal, the very large European deal we had talked some amount about, that was a PLM deal. That is not in play this quarter. So far as we're concerned, it may or may not be in play next year, but we're working through a dicey political situation there where the customer wants to buy our software, but fighting against the powers that be in the acquiring company around corporate standards and so forth. Blair Abernethy - Stifel, Nicolaus & Co., Inc., Research Division: Okay, great. And then second question is just around maintenance and I wonder if you can just shed some color on the Creo seat count has been sort of flat for 3 quarters now. What's happening below the surface there? And in particular, how are you trending on the direct modeling side of things?

Yes, I think what sort of happened is, as you know, you need to sell a fair amount of new licenses to keep the maintenance seat count flat. And our year-to-date license growth rate, last year was pretty impressive. This year, it's relatively flat with that. So with relatively flattish license revenue, it's hard to maintain or even harder to grow the seat count on maintenance just given turnover in the renewal rates. So I think we've not yet monetized much of the real opportunity with Creo. I think that's going to be a strong focus as we go into next year. Now that we have the Creo 2.0 product out, we have a much more solid offering before we had an exciting story. But our release 1 offering, now we have an exciting story in the release 2 offering and I think a strong focus in our sales organization next year is let's go harvest more of that opportunity and bring more of it to the bottom line. Blair Abernethy - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And on the direct modeling, how has that been trending?

As rest of the business is trending, more or less flattish license revenue overall and flattish seat count.

Our next question is from Raimo Lenschow with Barclays.

Can you talk a little -- if I look at the metrics that you give in terms of desktops, enterprise PLM versus CAD/CAM, the one area that seems to be growing much better is kind of, I agree it's a small number, is the PLM on the mid-market where you sell indirectly. Can you maybe talk a little bit about the trends there, especially given the noise that we also hear out of Autodesk around that area?

Yes, thank you for your question. So it's been a focus of ours to take our PLM business down market over the last few years into the resellers space, and I think we're making great progress there. They -- those guys continue to post good numbers quarter-after-quarter, and I think that there's a substantial opportunity for PLM in this sort of mid-market/resellers space and we're doing a good job of executing on it. Gross rates there are pretty high and we don't forecast them to slowdown dramatically at any point in the future here.

Our next question is from Ross MacMillan, Jefferies & Co. Ross MacMillan - Jefferies & Company, Inc., Research Division: So I had 3 questions. The first is just on Q4 license guidance, which looks actually like it's below normal seasonality at the midpoint and about end line with normal seasonality at the high-end of the range. Aside from foreign exchange, which we understand will have an incremental negative impact on Q4, what other factors are influencing the way you guided for the license number for Q4?

I don't think there were other factors. I think we attribute the change in our Q4 license guidance purely to FX.

Ross, if I can just add that just FX alone would have a negative impact versus prior quarter outlook of $3 million to $4 million on license, and so the factors we look out are clearly pipeline build. We take into account macro factors and so forth. I think the good news is we feel pretty good about pipeline, but we have a very significant headwind in terms of the FX. If you look at the normal seasonality, we typically are up $20 million to $25 million sequentially in the fourth quarter. And I think if you look at the guidance that we provided, we're providing guidance that's very similar to that against a headwind of very negative FX. Ross MacMillan - Jefferies & Company, Inc., Research Division: Understood, and then -- go ahead.

I was just going to add that the current headwind on foreign exchange when we consider our planning for '13, we're assuming that the euro stays at 1.20. That alone, while it takes $10 million out of Q4, it takes $40 million off of revenue for next year and would have a negative effect of $0.08 to $0.10 a share, and it's really our goal based on what Jim articulated earlier to maintain the targeted earnings, which means we've got to mitigate through margin expansion and expense management that negative impact to currency. So obviously, we can't control it, but we're trying to do everything we can to mitigate it both in Q4 and for next year at the same time. Ross MacMillan - Jefferies & Company, Inc., Research Division: That's helpful. So just maybe to -- on that point, you provided that 170, 180 range for next year without obviously guiding, but assuming that's still on the premise of the euro being a 1.20 to the dollar

That's correct. So that reflects the negative effect of the euro on our FY '13 outlook, so absolutely correct. Ross MacMillan - Jefferies & Company, Inc., Research Division: Great. I wanted to ask just about productivity per reps because you made comments obviously that you're going to moderate the pace of hiring and look to get more productivity per rep. By my math, if I just simply do, let's say, the average of the last 2 quarters versus the direct rep license sales, it looks like because of the pace of your hiring, productivity on average is maybe down something around 20% relative to last year. So I guess the question is, let's just assume you didn't hire any more sales capacity, am I right in thinking that you believe the current sales capacity you have will be able to support, let's say, in a more normalized environment something in the order of about 20% higher license sales?

Yes, I think that's a reasonable assumption. Just to make it clear to everybody, as we bring in new heads in the initial time period, these heads are not productive at all, and then they grow in productivity over a period of time, but the infusion of so many less productive new heads averages down the productivity of the whole sales force. So you're right, that in lifting that productivity back up to the levels they used to be at, we could generate a lot of growth. And I think that's the point is we now have the capacity to deliver an FY '13 growth number that would be pretty good, and so probably what we ought to do is focus on productivity and then later in the year, later in the FY '13 year, start thinking about do we need to continue to add more productivity -- or I'm sorry, more capacity that supports growth beyond the FY '13 year. But certainly, we shouldn't need more capacity delivered in FY '13. It's just we don't want to get behind on it either because this productivity needs time to ramp, so we got to try to stay ahead of it. Ross MacMillan - Jefferies & Company, Inc., Research Division: That make sense. And then just the last one for me. You've maintained your revenue growth rate in terms of your long-term target. But I just wanted to understand the sensitivity, if you will, so is there any way you can help us understanding if the 3-year growth rate isn't 9 or -- 9 to 11, but it's 7 to 9 or 6 to 8, whatever parameter you want to use, do you still think you could achieve the 200 basis points per year of operating margin? Or is there any reason we'd have to think about tempering that on a modestly lower revenue run rate?

Yes, I don't think that our growth rate and our margin are quite as interlocked as you might model them to be because we were pretty clear back in February that our company's margins should be 10 points higher. And one might even argue with slower growth, you should even have higher margins. So I think our view is we need to go after core inefficiencies in our business model, sort of irrespective of growth rate. And to the extent revenue slows down, we might try to have margin expansion speed up, and so we feel like we're committed to this earnings growth. A little bit irrelevant of exactly which revenue growth rate you peg in there. It's just we might tweak the recipe a little bit, depending upon the revenue growth rate you start with as an assumption.

Our next question is from Perry Huang with Goldman Sachs.

I wanted to ask a follow-up question about the Pacific Rim. Was China -- which is up 9%, I think it was down 10% last quarter, was China sort of the key factor for the large deal activity and strength in the region? And also was this new deal activity or was it maybe related to some deals that originated in 2Q and closed in 3Q?

Yes, I mean, so first of all, there were no megadeals in China nor any deals really even close to the megadeal range. So there wasn't like 1 or 2 really huge deals. There were a number of million-dollar plus deals. And just off the top of my head, all of them that I can think of were pre-existing customers expanding their deployments.

Got you, okay. And if I could just for a follow-up, for Windchill and Integrity, with the anniversary of the MKS acquisition, could you kind of talk about how the sales force has cross-selling both products now? And what sort of traction you're seeing so far?

Yes. So as a post merger integration strategy, we kept the Integrity sales force separate from the PTC sales force for a year, and that gives us some chance to get to know the business a little bit before we mess with it too much. But we clearly see strong interest in demand in the PTC base for the Integrity product. So we decided last quarter, okay, we've hit the 1-year anniversary. And while we had planned to make changes at the fiscal anniversary, we've decided instead in Q3 already to begin making these changes a little bit ahead of schedule to go after this revenue synergy opportunity that's just obvious to us. So we're, right now -- in this quarter, we've restructured the sales force, so that there isn't such a strong line of separation between people who sell PTC products like Creo and Windchill and people who sell Integrity. Now the PTC guys are increasingly also selling Integrity, and we're beginning to see that kind of stuff enter the PTC pipeline in Q4 and going into next year.

Our next question is from Jay Vleeschhouwer from Griffin Securities.

Jim, I'd like to ask first about a couple of possible product catalysts for you in fiscal '13. At your conference in Orlando early last month, you announced or previewed 2 fairly interesting new offerings. One is a small deployment version of Windchill. The other was the option to model it that you talked about. Could you perhaps talk about your plans or expectations for how those might play out next year? Then a couple of follow-ups.

Yes. Well, I think the Windchill for SMB version is just a simpler version that allows our resellers to more quickly move through a sales cycle and then more quickly move to a deployment cycle into a production customer. So it's a simplified version of Windchill. It's just plain easier. So I think that that's something the resellers have been asking for. So even while they have been posting pretty good numbers, they've been telling us, if we could make this product a little simpler, we might be able to do even better. So I think that will continue to -- that will add some tailwind, if you will, to the success we're having in PLM and SMB. And then this Options Modeler, that's a pretty futuristic capability and maybe I'll see if I can explain it in plain English quickly what it really means. So what happens is the customers increasingly produce products that are highly configurable. It's like if you go to purchase an automobile, you can decide which features and options you want included in that automobile you're going to pick up into it. The problem from a CAD standpoint is that CAD assembly modeling traditionally has been static. And when you start having products that are configurable, then you end up with millions of hypothetical combinations that could be created and you have a static CAD assembly modeler, so you actually can't model many of these hypothetical configurations because it would simply take too much manpower. So we've produced a concept that's part Creo, part Windchill that blends together a dynamic modeler of assemblies. So if you said I want a piece of heavy construction equipment with this kind of a front-end and this kind of a back-end and this kind of tires and this kind of engines and this kind of emission control system. Then between Windchill and Creo, not only could they figure out what parts would be required, but they can put it together in 3D and make sure it would work for you. So it's a very interesting futuristic capability. I think that that's something -- that's not a get-rich-quick scheme because it requires customers to make some fundamental transformations to the way they create products, but it's pretty darn interesting. So I think that one will play out over a longer period of time. But boy, I'll tell you when we show that to customers, their jaw drops and then they begin the process of saying how would we actually make that change because we certainly could see the value in making it.

Okay. Just a follow-up on your sales and distribution. Could you talk about the relative capacity and productivity of your mid-market direct coverage, where you've been doing some hiring versus your named accounts reps? And along the same lines, in light of the changes that you made in the reseller channels, revenue line and available number of accounts, at least, domestically, is it at all conceivable that your indirect business, at least on the desktop side perhaps, might be lower in fiscal '13 than in fiscal '12 in light of some of these coverage or structural changes that you've made?

Well, I don't think we expect this to affect the reseller revenue much because in our coverage model, there's always been a gap in these mid-sized accounts that were too big and complex for the VARs to handle. They might be multi-geography accounts or simply complex accounts and the VARs may have some difficulty with that, and then they were too small for the direct guys to cover. So we've always had a meaningful coverage gap in the middle of the pyramid, and we're pushing resources down into that. Now some of the resellers say, "Some of those accounts, I don't mind if you take them because they scare me. They scare me because I might run huge sales cycles. I might not be able to get the deal. I might not be able to implement the deal if I get it. It's a very expensive risky proposition for me to go after accounts that size. If we could work together and allow me to work in my sweet spot of complexity and then you take those accounts, it's okay." So our resellers have not been super successful in that space and our direct guys have basically abandoned it because they moved up market. So I think that putting new capacity in this area is basically going after our brand-new incremental opportunity and this new capacity, if you would look at the productivity numbers right now, we should probably check in with, I think, it was Blair that had a pretty good view on that. They're not that productive yet because they're all brand-new. But boy, they're building some pretty nice pipeline that we can see in salesforce.com and it's interesting. So as these guys ramp and continue to build and then mature that pipeline, we see this is a largely incremental revenue stream that we're going to be able to tap.

Okay. And then lastly, I guess, it's a part maintenance question for Jeff. First, geographically, your largest source of maintenance revenue is in Europe and are you seeing that attach and renewal rates are steady there? Or any signs of some possible brewing weakness in the maintenance business at Europe? And lastly, Jim, earlier, you mentioned that in order to move the active Creo base number significantly, you gave a sort of a normal attrition, you would need to sell a significantly more number of new licenses. If for the sake of argument over the last, let's say, 8 to 10 quarters, your average new license volume on the CAD side is, let's call it, roughly 6,000 units a quarter, where do you think you would have to be in order to significantly move that number net of attrition in the base?

Jay, let me just go back to the first piece for a minute, and really looking at both attach rates and renewal rates, they continue to be very, very solid and they really are in all fields and including Europe. So we're getting very high attach rates and the renewal rates continue to be very strong, and I think we're selling lot of value with the new products that we're delivering. Our customers see the value. It's critical to them. They continue to take the maintenance programs. I think we've done a nice job with those. So I would say it's steady as she goes in a positive way on all of the maintenance metrics and that includes Europe. We are slightly lower on renewal rates in Asia-Pac, although, those are trending upwards as well. So I think the renewal rates and attach rates and even recapture rates has been good. Where people were off maintenance, we brought -- the team has brought a number of people back onto maintenance because I think value is selling in the new releases of software.

Maybe rather than give you the specific answer, I'll kind of walk you through the equation. There's a base of customers. If you have a 90% renewal rate, that means them 10% of them are going to attrit, so you have to sell them enough to replace the 10% that attritted. However, there's another factor that we call win backs, and that is perhaps somebody who attritted in the past changes their mind, and said, "I wish I hadn't done that." And then we have a program to get current with maintenance again that we call win backs. And since the introduction of Creo, we've had a lot of win backs. People maybe said, "Perhaps, I'm not sure Pro/E is the answer." Suddenly say, "I changed my mind. I actually think Creo is the answer. Can I get back on the program?" So our -- we've been able to maintain the seat base relatively flattish even with license growth that in some quarters theoretically wasn't enough to offset the attrit rate, but it's really the combination of new licenses plus new win backs minus attrition based on renewal rates. That's the equation.

Our next question is from Ben Rose, Battlerose Research.

Jim can you comment at all on progress you're making at HKMC? And also whether you're seeing any additional interest in your products from the other automotives, OEMs at this point?

Yes, I mean, I was in Korea 2 weeks ago. I visited the powers that be at HKMC. This isn't new news, but we did successfully complete the Phase I deployment. They gave us a follow-on purchase to purchase more seats. There is from an opportunity standpoint both more seats yet that could be added as they bring more vehicle programs because they have, let's say, roughly half of these vehicle programs in the system at this point. So they're going to bring in more vehicle programs into Phase I while we simultaneously deploy Phase II. So we're kind of working in parallel on an expansion of Phase I and an expansion -- a new Phase II as well. And then separate from that, we're having conversations with them about ALM. That's a pretty interesting topic and they're out thinking about what their future options are there. We're starting some conversations around our supply chain stuff, some of which is in interesting them and so forth. So I think HKMC is going well, and will be a diamond account for us for years to come if we continue to execute like we have been. And then with respect to the other automotive OEMs, I think if you could look into our salesforce.com system, you'd see a number of other automotive OEM, PLM and SLM opportunities now in the pipeline. A lot of these things are risky and political and so forth. But certainly, there are other companies who say, "Boy, I wish I have what HKMC has." And so that story captures their attention and even scares them a bit. So we've been able to leverage it pretty well, and I think we'll continue to do so and with some luck, we'll land some more new automotive OEM domino accounts probably in the next fiscal year.

Both in the U.S. and Europe or ...

I would say largely outside the U.S.

Okay. And then one other question. The ANSYS acquisition of an embedded software a company caught our attention recently, and I wanted to know if you could make any comments there specifically. It looks like ANSYS has been more of an adjacent player, not a direct competitor, your thoughts on what may have motivated them to sally forth into embedded software.

Well, I think at some level ANSYS has a vision a bit like PTC, but not competitive. Let me explain my view of it. I think their vision is that products aren't purely mechanical. So they once upon a time were fairly mechanical and then they drifted into the electronic space and then they drifted into the software space, but really always on the analysis side of things, and we're more on the creation and management of things. So we've not really competed with them and don't really see this new acquisition as competitive with our ALM story either. But I think we're sort of kindred spirits in our belief that we got to deal with the whole product, crossing mechanical, electronic and software disciplines. And we'll both pursue our side of that strategy and we hopefully, we're both good companies and hopefully, we won't end up in competition. But right now, we definitely are not.

Our next question is from Steve Koenig with Wedbush.

Jeff, if I could just start with a housekeeping question on MKS and 4CS. It was a year ago you got MKS towards the end of that quarter, I thought. So I'm wondering is the revenue number, the $20.5 million this quarter, is that a stub number or is that the full quarter and same question for the organic growth rates that you cite?

Okay, so the number for this quarter for both of those, of approximately $20 million would compare to some -- a number which was only a partial quarter last year. I think we had about $5 million or $6 million in revenue a year ago from MKS. There was no 4CS, so it's up -- the comp, when we look at it on constant currency or when we look at it on organic -- I'm sorry, organic, we take that out, both numbers out. So it's consistently recorded on the organic basis.

Yes, Steve, just to be clear, as I recall, we closed the MKS deal in early June.

Yes, right around June 1.

So we had one quarter of that and we closed the 4CS deal, as I remember, in early August.

Okay. So just to be clear, the $20.5 million, is that the revenue in the full quarter this quarter or only for the first 2 months of MKS?

No, it was the full quarter.

The full quarter? Okay, that's what I needed to know. Okay, perfect. And then I wanted to know maybe just a little color on the units, business units, what drove the SLM outperformance? When do you expect SIS to be more broadly available? And then on MKS, so sequentially, those results were down from last quarter, then any comments there? Is it sales force reorg? Is that the factor or quarterly volatility, et cetera?

Yes, maybe on the second question, I didn't write down the first one. But on the second question, there was reorganization of the sales force, but I think we've also lumped MKS and 4CS together, and I would say that within that combo, MKS is -- ALM is doing better than the 4CS stuff. So I think it's probably not meaningful change. But yes, there has been some disruption in the salesforce, which in the short-term, is never good, but I think already in this quarter, is producing some interesting new pipeline as we're finally going after this revenue synergy that kind of was the fundamental reason we made the acquisition in the first place. Can I go back to the SLM question?

Yes.

Now that we have salesforce.com, it's very interesting to look at, for example, coverage ratios and I can tell you that right now, SLM, we have the highest coverage ratio of pipeline opportunity to revenue. And I think if you ask why is that, it's a place where the sales guys have migrated to because the customers want to talk about it. There are more and more companies who have service strategies around revenue and profit. PTC has a very interesting story. There aren't that many companies lining up to compete against us, and we're viewed as a very credible player who could bring a lot of value. When I was in Asia a couple of weeks ago, for example, I talked to a large Japanese industrial company. They're around $30 billion right now. They plan to go to $60 billion by 2020. And of that $30 billion of incremental growth, roughly $20 billion of it is going to be services in their model. So think about that, a $30 billion industrial company right now with a small service business wants to be a $60 billion company with a massive services business, and we're talking to the very top executives in the company because they view PTC as a pioneer that could make a big difference in their pursuit to transform the way that they service their products and to create service advantage with it. So it's interesting and I think our pipeline is filling up and this is a place where we're pretty optimistic for the long run about what the opportunity is.

This does conclude our question-and-answer session. I'll turn it back to the speakers.

Okay, thanks for joining us. Just one quick preview here. We're going to be heading to 2 investor conferences next month, the Oppenheimer Tech Conference on August 14 and Canaccord Genuity shortly after on the 15th. That wraps it up. Thanks for joining us this morning, and we'll be speaking with you soon.

All right. So thanks a lot, everybody, appreciate the time that you gave us here this morning from your busy day, and appreciate all the support and good questions that you had. Thanks, and we'll see you at one of these events or else in 90 days.

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