PTC Inc. (PTC) Q2 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to PTC's Second Quarter Fiscal Year 2013 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.

Thanks, Evan. Good morning, everybody. Thanks for joining us. We are hosting our Q2 and outlook call. Before we get started, I'd like to remind everybody that this call and Q&A session may include forward-looking statements regarding PTC's products of our anticipated future operations or financial performance. Any such statements will be based on the current assumptions of PTC's management and are subject to risks and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties is contained in PTC's Form 8-K filed yesterday, and our most recent Form 10-K, and Forms 10-Q on file with the SEC. All financial measures in this presentation are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measures is located in our prepared remarks document on the Investor Relations page of our website at www.ptc.com. With us on the call this morning is Jim Heppelmann, our CEO; and Jeff Glidden, our CFO. With that, I'd like to turn the call over to Jim.

Thank you, Tim. Good morning, everybody and thank you for joining us here on our second quarter fiscal 2013 earnings call. Overall, I'm pleased with our Q2 results, which I would characterize as reflecting solid execution in a top-selling environment. Our license revenue and overall revenue came in roughly as expected. And once again, during the quarter, we kept a strong focus on margins which allowed us to deliver an earnings result that was above our guidance range and substantially ahead of last year. Also, relative to last quarter, we saw an improved balance of the organic business and the acquired Servigistics business. Our services revenue was down slightly year-over-year, primarily due to slower license growth in recent periods driving less overall services demand. While PTC service revenue has slowed, our service partners are continuing to ramp their bookings and delivery capabilities at a brisk pace. We don't see a slowdown in PTC services revenue as an issue, because as we've discussed, our overall margin expansion strategy requires that we have less services revenue in the mix in addition to higher margins on the services work that we do perform. So while less services revenue has the effect of slowing our overall growth rate a bit, it is actually helpful to our margin expansion strategy. I feel that this quarter's gross margin performance demonstrates that this strategy is paying off. When we spoke to you 90 days ago, we were expecting a tough second quarter, but we were hopeful that we see some improvement in selling conditions as we moved into the back half of fiscal 2013. In hindsight, I would say that Q2 played out as anticipated, but the most recent manufacturing data points suggest that the back half situation is not yet improving. And the earnings results of a number of enterprise software companies suggest that we're not alone in our view of a difficult macro environment. The latest manufacturing industry reports, some of which you can find on our Investor web page, indicate that European and Japanese manufacturing is in a difficult recession, and the U.S. manufacturing recovery has stumbled as well, recently. Together, those regions represent about 85% of our revenue. So while we're hopeful of improved selling conditions going into fiscal 2014, our new guidance for fiscal 2013 assumes no meaningful improvement in the back half, plus the additional challenges of a more difficult foreign exchange rate and an assumption that partners continue to take on more of the services demand. As I've said previously, during this period of slower growth, the management team at PTC remains focused on margin expansion, and we believe that our earnings guidance, the range of $1.70 to $1.80, is achievable in this environment. Despite the difficult short-term economic headwinds, we remain very excited about our longer-term strategy. On a competitive basis, we had a very strong quarter, landing 4 new domino-type accounts in Q2. One of the key wins came from the customer whose large PLM purchase was blocked 1 year ago by an acquiring company. We were pleased that after a lot of follow-on analysis and debate between this customer and its acquirer, the decision for PTC ultimately prevailed. Though I'll point out that the current contracting arrangement is different than the large upfront deal we were closing in on a year ago. On a broader note, we continue to hear customers and prospects say that they feel that PTC is headed in the same direction they are, toward a vision of smart products created for global markets and delivered with or even through a services strategy. We see many traditional product companies, both adding smarts to their products, and as well beefing up their after-sales service and revenue strategies. In parallel, the most advanced companies are going further than that, and are already implementing power by the hour for jet engines, medical diagnostic equipment that's deployed on a pay-per-use basis; and even delivering offerings such as the Hubway bicycles as a service, and the zip car automobiles as a service, that we have here in Boston. That means that for our manufacturing customers, the environment is changing quickly, and with our newer ALM and SLM strategies, complementing strong CAD and industry-leading PLM offerings, PTC is uniquely equipped to help these customers transform in the response to the disruptive forces they're feeling around smart products and service-based business models. With this strategy, we've captured a lot of customer interest and we built a solid pipeline of opportunities that we can now see and monitor. With our focus on margin expansion, we're creating a business model that has a lot of leverage. So when the environment improves, we'll be very well positioned. But in the meantime, here in the difficult environment of 2013, we are working diligently to ensure that we deliver a fourth consecutive year of earnings growth in or around that 20% range. So with that, I'll turn it over to our CFO, Jeff Glidden, who will review some of the key financial metrics for the quarter.

Thank you. As Jim said, we are very pleased with our Q2 earnings performance. Non-GAAP gross margins increased to 72.5%, operating profit margin was 20%, and we delivered EPS of $0.41 per share. Our favorable earnings performance in Q2 resulted from a combination of lower overall spending and favorable revenue mix. As part of our plan to achieve our FY '13 operating margin targets, we have reduced staffing by approximately 4%, and we will continue to closely monitor and control spending levels throughout our business. Turning to the balance sheet. We ended the quarter with cash of $241 million. In the second quarter, we generated $83 million in cash flow from operations, repaid $60 million in debt, repurchased $19 million of PTC's stock and spent $5 million in capital expenditures. Now turn -- now looking ahead to our outlook for Q3 and FY '13. Given the macro environment and the headwinds from foreign exchange, we are reducing our full year revenue outlook while maintaining our EPS guidance. For FY '13, we expect revenue to be $1,305,000,000 to $1,315,000,000, including license revenue of $350 million to $360 million, support revenue of approximately of $650 million and services revenue of $305 million. This outlook reflects the unfavorable impact of currency of $10 million from our prior guidance, the lowered license and maintenance outlook reflecting the continued slowdown in the manufacturing sector, and we have reduced our service revenue estimates to reflect both the unfavorable macro factors coupled with a strategy to direct more service -- services revenue to our services partners. As we continue to expand our services partner ecosystem, we are also clearly focused on driving our services margin to greater than 13% in FY '13 and to 15% by FY '15. We remain committed to expanding margins and driving increased profitability. We are targeting to expand our FY '13 operating margin to approximately 21.5% with the EPS guidance, as Jim cited, of $1.70 to $1.80 for the year. I would note that we are holding our EPS outlook for fiscal 2013 despite the negative currency impact of approximately $0.04 per share from our prior guidance. For FY -- for Q3, we expect revenue to be in the range of $315 million to $330 million, including license revenue of $80 million to $90 million. We expect to deliver non-GAAP EPS of $0.40 to $0.45 a share. We also estimate our non-GAAP tax rate to be approximately 22% in Q3 and 22% for the full year. And finally, a few comments on uses of cash for FY '13. In addition to the acquisition of Servigistics, which was completed in Q1, we expect to repay some $120 million in debt and to repurchase approximately $55 million to $75 million in stock during the year. Thank you for your support, and I will now turn the call back over to Tim Fox.

Thank you. Evan, we're all set for questions.

[Operator Instructions] Our first question today comes from Jay Vleeschhouwer with Griffin Securities.

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

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

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

Okay, just 2 follow-ups, one on product, one on customer. You mentioned that the large customer that had missed -- or contributed to the miss in the March quarter a year ago, now closed. But that in terms of the revenue recognition were somewhat different, perhaps not quite as much upfront. Could you elaborate on that at all? And if not all indicative, do you think of the way other large-deal customers might go in terms of their structuring of the deals? And then lastly, in the product side, could you just update us on your thinking on the timing of releases this year? For instance, the Windchill X-24 release, is that still coming out in the next couple of months? Anything else you can comment on in terms of your release schedule or even philosophy towards annual releases?

Yes. So on the customer point, we've always had a situation where some customers are willing to take a bigger upfront commitment, typically in exchange for a bigger discount, whereas other customers want to be a little conservative and do a smaller upfront project, prove to themselves that it works and then place follow-on orders. And I think you should think that this customer flipped from that first model of the bigger upfront commitment to the second model of a smaller upfront commitment. But I will tell you, we have in the contracts some pretty big options to expand this thing, sort of prenegotiated expansion options. So I think that, that project is a good project. We would have loved to get the sort of mega deals that we were expecting to get last quarter, but there's some goodness in having it spread out over time as well, I guess. So now the question is, is that typical of what we would see from other customers? Yes, it is. I mean, I think in this recent period of macro difficulties, more and more big deals end up being small -- a series of smaller deals or a smaller deal now instead of a big deal now. And then as things pick up, we have sort of almost a backlog, if you will, of opportunity from these same customers. So I think that's a bit one of the issues that's making the big deal business harder in this economic environment. On the product side, from my perspective, our products plans are more or less on target. We do have releases coming out throughout the year. But if I sort of say what are the things that are really moving the needle, and most critical, it's the releases we've already shipped. It's the Creo 2.0 software, which is now seeing a strong wave of adoption in the customer base. As you know, Creo was a reinvention of our Pro/ENGINEER flagship product line. And when we came out with the Creo 1.0 software, so we won lots of accolades and lots of awards, but we didn't win a lot of adoption, because customers said, "Hey, it's great, but it's different. And when things are different, I like to wait for release 2." So release 2 now is getting a lot of adoption and some great customer stories about productivity improvements by simply upgrading to this new release in software and so far. And then on the Windchill side, we're now working on what's essentially Windchill 10.2, but if I back up, Windchill 10 was the big release, because that really updated the Windchill user experience by a whole generation, sort of similar to what we have done with Creo. So 10.1 was important because it was, again, that second release of this new experience, 10.2 now adds more and more capabilities to that. And what we're doing is important, but I would actually say what we've already done in the last year or 2 is the most important stuff.

Our next question comes from Sterling Auty with JPMorgan Chase. Sterling P. Auty - JP Morgan Chase & Co, Research Division: I want to follow up on one of the earlier themes. And Jim you've partially answered this, I just want to go a little bit deeper, you talked about some of the challenges other enterprise software companies have had as well. And I think a lot of us are trying to get a better understanding. Do you think customers just have smaller budgets than what we realized coming into the year, and that's why we're seeing the lower spending? Do you take it they've got budgets to do more, but they're holding off to see what happens economically for the back half of the year? Or something else?

I think, Sterling, I think though it's really that latter category where, much like PTC, there is a plan to spend some money. And then there is suddenly a more conservative posture [ph], people looking at forecasts, whether it's industry forecast, GDP forecast, what have you, and saying, "Boy, I'm not sure this year, from a revenue standpoint, is going to shape up the way we're thinking it would even a quarter or 2 ago. Let's just be conservative and not yet commit all of that money." So I think a lot of it is a confidence factor around budgets that have been issued. There's probably some amount of the budget wasn't issued, but I think, even where the budget was issued, customers are dealing with the confidence factor, and we understand that well at PTC because we are dealing with the confidence issue, and that's why we'll manage down our spending, so that we can hold that $1.70 to $1.80 earnings guidance even on somewhat softer revenue. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay. And can you give us a sense from a vertical industry perspective? Is more of the sluggish outlook concentrated in 1 or 2 verticals? And maybe, I think it's been a little bit, can you give us an update as to maybe your top 3 verticals at this point?

Yes. So the verticals have jumped around. I would say the only thing that's notable right now is, of course, the defense. Typically, we speak about aerospace and defense, but in this case, I would separate the 2, because I think commercial aerospace is quite strong, the Embraer type of win from a quarter ago. All the work we're doing with Airbus and Eurocopter and so forth, as well as the Chinese aerospace firms. So on the commercial side, there is a generational change of aircraft happening that's driving those companies to do pretty good business. On the defense side, both aircraft and otherwise, other types of equipment, that's coming from government budgets which are in full on crisis mode right now. So the defense side is a difficult place to be right now. And historically, that was pretty good business for PTC, so that's an issue now that actually dates back, I don't know, 6, 8 quarters since that's been under a lot of pressure. But that's probably the place where we've given up the most [indiscernible]. I think that if I look at the best places, generally, our Electronics business is doing well. Our Life Sciences business is doing pretty well. Our Retail business is doing pretty well. Our Automotive business is doing okay. It was doing really well a year ago, and now we're comparing, in some respects, against that really well period. And it's not up as much again, but still at levels much higher than it was 2 or 3 years ago. So that's a quick view of what I see happening.

Our next question comes from Matt Williams with Evercore Partners.

I'm just curious and I don't know to what sort of level of granularity you're comfortable around sort of talking about this, but obviously a big portion of the guidance, sort of down tick, is related to services revenue and your expectations there. I guess, within that, how much of that is related to just the slower license growth? And how much of it is related to successfully kind of offloading some of that business to your partners? Because obviously, the partners' bookings were up very high in this quarter. I'm just trying to get a sense going forward what sort of baked into that?

Yes, okay. Well, Matt, and I noticed you picked up coverage on the company recently, so thank you for that. Glad to have you with us. It's a very good question. Because if you look at the guidance down tick in revenue, you're exactly right. There was a chunk that's related to currency, and then there's a big chunk that's related to services. And what I would say is the overall body of services demand is down a bit naturally because license sales have been softer of late. That said, our services partners are growing quickly, and there would be a theoretical opportunity for us to claw back some of the revenue they're taking if our objective was to grow our own services revenue. We think that would be short-term thinking, because in the long term, we want the service economy to continue to grow. And the success they're having is actually pretty important to where we're trying to go in the longer run, and we don't really care to disrupt that to claw back some of that revenue, that while it boosts our revenue number, it isn't that helpful, quite frankly, to our profitability story. So just to put this in perspective, when we began this partner program more aggressively, I don't know, a year or 2 ago, at the time we said that we want our partners to move from doing roughly 20% of the deployment work and we're doing 80% to get to a balance more like 50-50 over a 4, let's say, year period. Well, this year, they'll do about 30%. So the growth rate for our partners to go from -- a partner ecosystem to go from doing 20% to 30%, they need 50% growth. So their growth rates are high and our growth rates are low, and we're resisting the temptation to try to disrupt some of their growth to drive some of our growth because that's not really our strategy. So that's a good chunk of the take down, and it's a take down that, that particular piece, we don't feel bad about.

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

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

Our next question comes from Matt Hedberg with RBC Capital Markets.

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

Yes. I think there are 2 elements to SaaS: one is a pricing model, an economic model; and the second one is a technical delivery model. And I think we can almost look at these things a little bit it separately. And that's because in the PLM camp, there is not a big push to have the delivery come from the cloud. But there is growing interest in a different economic model. For example, term purchases or things like that as opposed to perpetual purchases. And that's true of CAD as well, by the way, that we do see interest in term purchases. I think in the SLM camp, where we do have somewhat of a SaaS business already, I think there's a much bigger appetite for both the economic model and the delivery vehicle. So I think you're going to see us get incrementally more aggressive around SaaS, both as an economic and a delivery model in the SLM business. And I think in the PLM business, we'll explore taking more deals on a ratable basis, but of course, that's not helpful for revenue on the short term. And I think there's also probably an opportunity for more of a managed service approach where PTC plays a bigger role in owning -- both deploying and owning the technology after it's deployed, even if it's not up in some public cloud in a shared tenant, multi-tenant kind of system.

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

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

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

Our next question comes from Richard Davis with Canaccord.

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

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

Our next question comes from Yun Kim with Janney Capital Markets.

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

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

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

Yes. So these partners are, in effect, third-party contractors, just that we're not passing the paper through our books. So generally, these partners run at margins, much less than PTC. Many of these partners are companies you know, the Accentures and so forth, who have pretty good margins but a lot of them are specialist PLM system integrators that operate in a region like Europe or something and they're companies you've never heard of. Some of them also are resellers who sell and service our products in SMB, but might service some of our customers, at the low end of our direct space. And again, those are companies that aren't household names and don't run at the kind of margins we do. So they're more able to absorb the lumpiness because they're not reporting publicly every 90 days in what's happening. So I think that from a PTC perspective, we do not anticipate lumpiness in our revenue results. We think that the service partners can absorbed these lumps without people really seeing that because they're generally not doing public reporting on them. And they like these big bookings. So what's really happening is when a deal is being pursued, PTC is typically in one of 3 modes, either we're going to do the whole thing ourselves or the opposite end of the spectrum is we're not going to do any of it and the middle ground is we're going to share it. And I would say, smaller deals and in certain deals, we tend to offload the whole thing. And then bigger wins, we tend to share. For example, in the Embraer deal, we shared a big chunk of the services work to deliver that thing over time, so a partner got a big booking, and so did PTC but we're sharing that one.

Okay, great. I have another question. So given that you have a wide range of products with both Servigistics and MKS acquisitions in recent years and along with other small acquisitions, can you just talk about how you are progressing in terms of cross-selling opportunity overall? Is there any like a specialty management generation program to monetize on cross-selling opportunities, any sales incentives? And has anyone shown any interest in doing a large ELA across the product type of deal?

Yes. I'm actually pretty pleased now with our cross-selling opportunity. If we take SLM first, we have quite a substantial SLM pipeline, and it really comes from sort of 3 areas: PTC guys selling traditional PTC stuff, Servigistics guys selling traditional Servigistics stuff, and then the third camp is PTC guys starting to fill up a pipeline of Servigistics stuff, and there's a lot of that going on right now. And I think PTC, traditional sales guys, feel like the Servigistics stuff is pretty natural conversation to start with a customer you have a good relationship with. So I think, on the Servigistics side, it's going very well in terms of both post-merger integration and cross-selling. If I reflect back on MKS, our strategy had been to keep that a little separate for a year. You might remember, we thought -- our thinking at the time was this business is a business we're not in. We should let the management team operate it for a while as we get to understand and so forth. But going into 2013, we collapsed those 2 together much more and really integrated this thing more mainstream. So such that the PTC sales force was actively selling the ALM offering. And I would say, their too, we have both pretty nice-looking pipeline now, much of which has been created by traditional PTC sales reps. But also some big wins. There is very large high-tech company in China, who has become a very significant PLM customer of ours over the years and we've now begun the ALM journey with them in this past quarter, so that's a good example, just one anecdote, but a good example of an account that MKS never could have gotten to. And yet for us, it's a nice expansion of a very meaningful relationship we have in a region they didn't even have coverage.

Our next question comes from Perry Huang with Goldman Sachs.

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

I think it is the effect of overlaying the Servigistics seasonal model into the PTC seasonal model because whereas PTC sees this fiscal year as quarter 1, 2, 3, 4. Servigistics' sees it as quarter 4, 1, 2, 3 and that's a little bit why Q1 is so strong and we're not necessarily thinking that, that will have the same, let's call it hockey stick, that we would see in the PTC numbers.

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

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

Our next question comes from Ross MacMillan with Jefferies. Ross MacMillan - Jefferies & Company, Inc., Research Division: Can I ask about costs? So I'm trying to understand the layering in if you will, of the cost reductions because we did have some headcount, come out of the business in March. And I noticed that in Q2, your opening expenses were actually still up slightly year-over-year but nicely down sequentially. And yes, I think you said, headcount now was about 4% lower. So I'm just trying to understand, when I think about 4% lower headcount, is it wrong to assume operating expenses down 4%? For example, in the second half of the year? Or could you sort of frame how this sort of layering effect took the headcount reduction that's going to flow through operating expenses?

Sure, we'll do that. Recall that in September and October, when we acquired Servigistics, we actually added 400 people to the whole organization. And so, from that base, we've taken about 4%, about 250 or so out of the base and I just make a couple of comments. We did take some actions in October. And then early in January, and so by doing that early January, we got more of a benefit in the second quarter than we might have provided as guidance. We've also held and as you know, we're holding on all areas of spending whether that be travel, et cetera, et cetera. So we're holding on program spending too. So we're pleased with the cost position, really, the cost structure that we execute to and it helps us going forward. I would expect, while we've taken those actions, we've got some seasonal things like PlanetPTC that occurs or PTC Live now that occurs in June, so there would be likely, that you'd see a sequential small uptick in spending in Q3 and then potentially again in Q3 -- in Q4 really related to commissions and end of the year programs. So I think we've got a pretty good base of cost structure. We'll continue to manage and monitor that but would expect this to increase slightly sequentially in Q3 and again in Q4. And I think because you really can't do a full comparison to last year because it didn't include Servigistics. Ross MacMillan - Jefferies & Company, Inc., Research Division: Yes, that's helpful. That's really what I was looking for. And then just maybe on sales capacity. One of the things you guys have talked about some time, is that you don't have any tire because you're still basically up significantly, organically and inorganically on quota-carrying reps. And they're still obviously not as productive as we would like them to be in a sort of normal macroeconomic environment. Just to be clear, is that still the ongoing assumption, and so hiring won't really turn until you have conviction that you're seeing the improvement, and maybe more importantly, hiring won't return until you get back to appropriate levels of productivity?

Yes. Ross, this is Jim, and I'll take the first stab at that. So if you look at the capacity data that's in Tim's prepared remarks, you can see there was a period, where we cranked up capacity a lot, both acquired and organically. And in theory, we have not yet harvested the full benefit of that capacity yet, and I think it's fair to say that our productivity numbers are unimpressive. And by getting much more productive, we could drive a lot of upside growth. However, having said that, I think it's actually harder to make people more productive than it is to add more of them, so I think the prudent thing for us to do is make sure we have the right balance of assumptions. I don't think we feel like we can grow a lot just based on productivity yet there is ample room over a long period of time to grow a lot based on productivity improvement. So I think in the short-term, we've been holding the headcount flattish. It was down slightly but I'm going to put that in the category of round-off area. So we're holding capacity flattish and trying to ramp productivity. I think that there are 2 factors at war with each other. One is the people we've added in previous period are gaining tenure and experience and pipeline and they are becoming, on one hand, more productive. And then on the other hand, this whole macro overlay and headwind is sort of canceling out some of that progress and the net is our sales guys as a whole are slightly more productive, right now than they were, let's say, year ago. We probably hoped they be much more productive, but I think the macro factor, definitely creates somewhat of a headwind on that productivity expansion. Ross MacMillan - Jefferies & Company, Inc., Research Division: Great, that's helpful. And maybe one last one. Just big picture. So in the last couple of years with Servigistics and MKS, the prior year, you've made some, what I would call, reasonably large acquisitions with consideration values in the $200 million to $300 million range. Just without being specific, what are your thoughts around future M&A? Are we in a period where it's unlikely that we would see deals on that size, as we go forward over the next few quarters or how would you frame your thought process around M&A?

Yes. I think our thought process is when we find companies that seem to fit really well, at prices that make sense, and if we have the capacity to do it, then the stars start to align and we get really interested. That's what happened with MKS, and that's what happened with Servigistics. I would say, we don't have a strategy or a goal to do a certain amount of M&A. We really have a strategy to build a great company, see M&A as a lever and then look for those special opportunities like MKS and Servigistics. Just for the record, we're pretty proud of how those 2 companies have performed and not only that but the strategic differentiation that we've been able to create. I talked a little bit about smart products and service business model and those -- that's exactly where we've gone, and the interesting thing is as we've gone there, we become more interesting I think, to a very large range of customers and incrementally, more different than Siemens and Dassault. That's not really where those 2 companies are headed and so I think we're become more and more relevant and more moderate differentiated, thanks to those acquisitions and at the same time, those acquisitions are performing pretty well for us.

Our next question comes from Chris Hogan with Barclays.

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

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

And Chris, it's Jim. Just anecdotally, I'm aware of some large potential federal transactions that are in the pipeline, but we have kept them out of the forecast for essential that reason.

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

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

Our next question comes from Blair Abernethy with Stifel. Blair H. Abernethy - Stifel, Nicolaus & Co., Inc., Research Division: Jim, just a couple of quick ones on the PLM business. If we look at Windchill 10, it's been out there for a couple of years. Can you just talk to what's -- what percentage of your base or how far of your base are you today and how is it trending?

So, Blair, I don't have any particular data set in front of me on that to answer that question, but my own intuition and from many campaigns I'm aware of and customers I know, I would say we're well past the 50% point where more than 50% of our base is on 10-point something. Anecdotally I'm thinking it's probably 3.4 of the base. But I honestly don't have a data set in front of me to give you the exact number. Blair H. Abernethy - Stifel, Nicolaus & Co., Inc., Research Division: Okay, that's fine. And then secondly, just to clarify, you had said you're looking at or considering ratable pricing for PLM. Is that accurate, I guess, and if so, what kind of timeline are you looking at there?

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

And just add from a customer standpoint, we've clearly, that's what the customer wanted to do if they want a term program, 1 year, 2 years, 3 year, that is certainly available to them, and we'll make sure we don't miss the customer opportunity. But it's a small piece of our business. We are seeing probably more interest in it, but I wouldn't say it's a trend presently.

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

The final question today comes from Steve Koenig with Wedbush Securities.

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

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

Okay. And then the follow up is really kind of related to that. Maybe a little more color here on that, both direct and indirect. On the indirect side, we were a little surprised to hear your channel is selling Servigistics and seems pretty excited about it. We didn't realize that was going through indirect. There also seems to be a lot of positives, a lot of positives, a lot of excitement around Windchill essentials in the mid-market, so that's the indirect side. And then on the direct side, maybe you could just explain a little bit more when the Servigistics reps got folded and you're not counting that in your flat quota carriers. So those folks are supporting to your quotas and could help boost productivity, isn't that right?

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

Let me clarify what's going on there. In our SLM story, the Servigistics and the organic stuff, within the organic stuff, there are some pieces of technology around 3D documentation and technical document in general, for example, this company we acquired some years ago called ITEDO, pieces of ArborText. There's a piece of technology called Creo Illustrate that is in fact sold by the channel, more as an extension of the engineering environment in the technical publishing, not as the enterprise transformation towards a service business model. So there is a piece of revenue that they are getting credit for and that's legitimately sold [ph]. But I -- it would be inaccurate to think that they're outselling Servigistics.

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

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

Great. Thanks, folks. Before I hand this back to Jim for our closing remarks, just a few advertisements here. We're going to be attending 3 conferences in May, first will be the Jefferies TMT Conference on May 7th, followed by JPMorgan's Global TMT Conference on the 16th, and then lastly, Barclays Global Tech Conference on May 22nd. So again, thanks for joining us, and I'll turn it over to Jim for closing remarks.

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

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