Good morning, ladies and gentlemen, and welcome to PTC's Second Quarter Fiscal Year 2014 Results Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded. I would like to introduce James Hillier, PTC's Vice President of Investor Relations. Please go ahead, sir. Thank you.

Thank you, Rowan. Good morning, everyone, and thank you for joining us on today's second quarter fiscal 2014 earnings call. As a reminder, today's call and Q&A session may include forward-looking statements regarding PTC's products, our anticipated future operations or financial performance. Any such statements will be based on the current assumption of PTC's management are subject to risks and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties is contained in PTC's most recent Form 10-K and 10-Q on file with the SEC. Unless otherwise indicated, all financial measures in today's call are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measures is located in the Q2 2014 press release and prepared remarks documents on the Investor Relations page of our website at www.ptc.com. With us on the call this morning is Jim Heppelmann, our President and CEO; Jeff Glidden, our CFO; and Barry Cohen, EVP of Strategy. With that, I'll turn the call over to Jim.

Thank you, James Hillier. So good morning to all of you and thank you for joining us here on our Q2 earnings call. I'm pleased that we are able to report a solid second quarter with license revenue up 8% at constant currency, total revenue up 5% at constant currency and earnings per share up 18% at constant currency. These results are primarily organic in nature with acquired businesses contributing just $4 million of revenue, together with a modest earnings headwind, due in particular to investments we've been making in the ThingWorx business that positioned in for strong growth. Our most recent quarters, the third consecutive quarter where we've seen organic license growth rates increase, taking us from the mid-single digit negative growth territory 4 quarters ago, and progressing along a vector for the double-digit positive growth rate, we hope to achieve as we get into 2015. This, of course, assumes the economy continues to solidify as it has been of late. While the manufacturing economy does appear to be improving in general, we still felt some challenges in the quarter, and these challenges are reflected in our results. Our business in North America was strong and our European results showed good improvement, but we posted a relatively weak quarter in Japan and in Asia-Pacific. The Japan issue appears to be mostly deal-timing related, as we have a very strong Japanese forecast for Q3. The situation in Asia Pac is more complicated. With PTC joining a list of tech companies who have been posting relatively weak results in Asia Pac due to a combination of economic slowdown and turmoil associated with new policies being implemented by the new Chinese government that took over in 2013. So even with the Asian challenges that I've described, PTC has sufficient pipeline strength to…

Well, thank you, Jim. As Jim said, we're pleased with our financial results for the second quarter. Revenue improved to $329 million and non-GAAP operating profit increased 27% to $80 million. However, a higher tax rate in Q2 of '14 resulted in non-GAAP EPS growth of 17%. As previously discussed, we expect our fiscal '14 tax rate to be approximately 25% as compared to 21.6% in fiscal '13. This higher tax rate is principally due to a shift in mix of geographical profit, driven largely by an increase in revenue from our U.S. operations. In addition, our fiscal '13 tax rate was benefited by the reinstatement of the U.S. R&D tax credit by Congress for both 2013 and 2012. Our Q2 non-GAAP operating margin increased by 440 basis points to 24.4%. This increase is attributable to continued expense management discipline, coupled with higher gross margins in our global services operations. We continue to have very good cash collections from our customers, and generated $111 million in cash flow from operations. We ended the quarter, with cash of $270 million, paid down $50 million of debt and repurchased $40 million of PTC stock. Clearly, a highlight has been the acquisition of ThingWorx, which was completed on the first day of Q2. In January, we expanded our credit facility to $1 billion and extended the maturity into 2019. So all in, we completed another very busy quarter and a productive quarter. And at the mid-year, we have delivered earnings per share of $0.98 for the fiscal first half for a year-over-year increase of 26%. Now looking ahead to our outlook for Q3 and the full year. Macro indicators suggest that we're in the early stages of an economic recovery with improvements expected from manufacturing output in the U.S. and Europe, with continued softness and uncertainty in the Pac Rim. Given this background, we expect Q3 revenue to be in the range of $325 million to $340 million, and we expect to deliver non-GAAP EPS of $0.48 to $0.52. For the fiscal year '14, we have increased our full year guidance by $5 million, and we have increased our non-GAAP EPS to a range of $2.05 to $2.15. Again, we appreciate you joining us today. And I will now turn the call back over to James Hillier.

Thank you, Jeff. Rowan, we're now ready to begin the Q&A process.

[Operator Instructions] The first question comes from Sterling Auty.

Given the commentary around ThingWorx, can you give us a little bit more detail in terms of the contract structure. You mentioned subscription, but what do you think the average contract lengths based on these early discussions might look like? And secondarily, based on the interest that you're seeing so far, what is the type of environment that ThingWorx is going into? Meaning, is there a particular type of technology that you're already seeing a trend that's embedded on the products that ThingWorx will actually kind of manage the data coming back off of?

Good questions, and good morning, Sterling. So first of all, on the contract length. If you look at the deals that are closing in the ThingWorx world, they tend to be either 1- or 3-year subscriptions. Prior to us, a quarter in the company, they were signing people up for 1-year and we said, wouldn't it be a better idea to sign them of for 3? So they switched to that model without much pain. So sort of was 1 shifting to 3. What we tend to have in terms of contract size is a of proof of concept projects. People are excited but they need to go do something, shopping around the company, show it to their boss, et cetera, to do a bigger project. While there are some companies who have been doing connectivity for a while, maybe under the heading of condition monitoring or something like that and these people I think, can move more aggressively because they say, hey, that's just a better tool to do something we're already doing at scale. But there's a lot of projects that are, just to be clear not huge but if we win those projects, we then become the vendor that grows with them as their program grows over time. So not huge contracts, typically, but important sort of design wins, if you will, that lock us into their business going forward and then take in over a period of 36 months, if it's a 3-year commitment. In terms of where they're coming from, definitely, the sweet spot right now is industrial. Our company buys some things on the edges, maybe some electronics, maybe some commercial vehicles, things like that, but typically, expensive business-to-business type assets that live for a while and need to have routine service and maintenance and monitoring and so forth. So equipment, HVAC, elevators and escalators, electronics, stuff you'd find in a big data center and then trucks, buses, things like that, that similarly need to be monitored and maintained and so forth. So that's kind of that -- it's probably the tip of the spear. Those people are mostly eager to get going. I think that the big automotive companies are all formulating strategies but of course, they need to be a lot more careful about it, and they are taking their time and trying to decide what's going to be proprietary and what do they want to buy for the market and so forth. So they're probably a step behind.

Okay. And then my one follow-up question would be you called out both extended PLM and SLM. In particular, the extended PLM, can you give us a little bit more insight into where you saw the pickup in strength and the pickup in demand within the extended PLM portfolio? And if you think that's sustainable from here?

Yes, a lot of it was follow-on deals with the customers that have already purchased with us. We see extensions in PLM per se, that would be the Windchill, as well as extensions and add-ons with ALM and with some of the other quality programs and so forth. So, I'd say, large customers really, I think with a higher level of confidence, Sterling, that's fine, we've got a couple of additional deals that became megadeals that upsized during the quarter and was really reflective of customers being more confident about extending what they already have and then looking at adjacent revenue streams.

Yes, just to add a couple of comments without naming names. I'd say, like large European automotive firm OEM gave us a pretty substantial expansion. A large German industrial company gave us pretty substantial, relatively new order. I mean, we had done a little bit in the company, but the whole company committed to this technology going forward. A large U.S. automotive supplier gave us a very substantial order, again, that was an expansion of the program we had started sometime ago. So this sort of follows the pattern that sometimes, the first order isn't that large but like in the case of this U.S. automotive supplier, you circle back and you get a couple more pretty substantial orders over time as this thing spreads across more users, more divisions, more functionality and so forth.

The next question comes from Matt Hedberg from RBC Capital Markets.

Really, I like to see the growth in CAD, I think the third straight quarter as you mentioned the growth there. Can you remind us again where we are in the Creo upgrade cycle and maybe talk a little bit more about when a large customer, say Caterpillar, migrates to Creo, what that means for the ecosystem of that particular customer?

Yes. Well good morning Matt. and that's a good and interesting question. So I think at the last earnings call, we said we were sort of at that tipping point, the 50/50 point, now we're at, let's call it the 60% point or so. Where the majority of customers are now on Creo. And I got to tell you, I mean, our Creo R&D team has really done a fantastic job because customers who go through this migration process are so happy with both the result that they have when they're done but also the process of going through it. I mean, more than one customer have told me this is the single best major technology migration we've ever done. Because it was not very painful and everybody is so happy. So in fact, Caterpillar has gone to Creo 2.0 and they're pretty happy with it. Pretty good results and so to your question, what happens is that Caterpillar says to the supply chain hey, suppliers, we're using Creo 2.0 now and please upgrade yourselves because while we can take your Pro/ENGINEER data and use it, you can't take our Creo data back into Pro/ENGINEER. It's sort of forward compatible, not equally reverse compatible as is typically the case in software. So then all of the Caterpillar suppliers upgrade. Now, it turns out that a couple of quarters ahead of Caterpillar, John Deere did the same thing. So suddenly you now get the whole industrial vertical, both the OEMs and suppliers starting to count out all converge on a Creo environment because it's just better for everybody. And again, it's a good story because people are pretty happy when they get there. That's not always been the case with technology in general and it's quite frequently, not been the case with CAD migrations in our industry. So for us that really unlocks then this upsell opportunity with all the new stuff.

That's great. Thanks, Jim. And maybe for Jeff, the service margins are impressive, I think they're almost 19%. I know you talked about targeting at least, I think you said greater than 15% for fiscal '14. Clearly, you're beyond that now. Can you remind us where those you can get to longer term? And then I think even more importantly, how much of more services revenue can be offloaded to the partner ecosystem? I know that's been an issue in the past.

Well, so a couple of things. The long-term target that we put out there is to get to 20 points, 20% margin in the services business and as we said before, to continue to build out the partner ecosystem really to give the customers more choice and that's also a piece of our enhancing our margin business. I just want to make a comment on the quarter, it was an excellent quarter. There were some discrete items in the quarter that caused the margin to be higher than we had anticipated, and so I just feel a little bit cautious we're going to -- we're pretty -- fairly comfortable, we'll get to 15 points this year, for the full year I think there's some upside to that, Matt. But almost 19% was an unusually strong quarter. We're very pleased with it. But we'd be a little bit more cautious on the next couple of quarters in terms of the outlook. But I think very confident about building that, I think, Matt Cohen has taken over that business. He's a great leader and will continue to very strongly drive to those goals and beyond.

Hey Matt, Jim here. If I could just add. Within the mix, we're talking about a service business that overall is going to have slow growth to little growth. If you break that into some segments, it -- as we reported, it includes this managed service business, which is really subscription revenue. But we need to put that in one of our reporting lines and it's not maintenance, it's not license, so that's where it ends up. So that, we'd like to grow fast. And then there's also an education business, e-learning and training and so forth. And that's a high-margin service business we quite like and we like to grow there fast. So inside a -- the third element just to be clear is let's say, it's in the professional services consulting fees. So inside an overall business that's flat to low growth, you got 2 elements we're trying to grow fast and one that's quite frankly is declining in size intentionally as we offload that to the partners because that's a little low-margin piece that we'd like to continue to farm out to an ecosystem. So that's the way we think about it. If you look at the all-in number, little bit of growth. If you were to break it into the constituent pieces, 2 things growing, one shrinking by design.

The next question comes from Ross MacMillan from Jefferies.

When we look at the data on large deals for the last 3 quarters, it's been really, really strong. I think this quarter was up 35% and I think on average, over the last 3 quarters, up 20%. So obviously, growing much faster than the group average, if you will. Can you just describe maybe the dynamics that are driving that? And if we sort of look below the large deals, what's happening in the sort of core ramp up business? And is there something changing in your model or is there some reason why we got this dynamic that's playing out right now?

Yes. Thanks, Ross, and good morning. So, I mean, the main dynamic is playing out right now is the economies getting better. And that causes deals to get larger. Now if you look at this large deal activity and the discussion about 3 megadeals and so forth, let me first say for everybody's benefit that we define a megadeal as greater than $5 million. So if it's $4.9 million, it's not a megadeal. If it's $5.01 million it is a megadeal. All 3 of these megadeals were just barely over the line. So they weren't $10 million, $15 million deals, they were small megadeals, if you will. If you look at the data in the prepared remarks that we sent out, if you compare year-over-year, you can actually see the average deal size of the large deals is down slightly, which tells you that the real strength wasn't the megadeals, but it was in the lot of between $1 million and $5 million deals that would fit into this category. If you look sequentially, it's up just a little bit and then of course, year-over-year, the count I'm talking about here, year-over-year, the count is up nicely. I attribute that to the economy, because when the economy is difficult, we'll press to get the deal done even if it's smaller size. Okay, you can't do that deal, can you do a deal half that size and so forth. When the economy gets better, people feel a little better about spending money. They tend to agree that let's make this deal a little bit bigger because I have some budget and it's good time to use it and so forth. So I think it's mostly the economy that does this. I think if you look at the strength in big deals and then you look at the category below it, you could say, well, there appears to be less deals in the category below it. I would say only because a bunch of them migrated into the big deal category. So personally I don't think there's any issue here. I think it's all goodness. We actually do like big deals and megadeals, I want to remind everybody. We try to be careful around how do we guide and so forth, but I don't want anybody to think we don't like big commitments, mega commitments and so forth. That makes for a great company when our customers say, hey, I really do want to get married and move in with you. So we do like that concept. We just have to be cautious about when we give you guidance what are our assumptions about a couple of big deals closing or not closing such that, if we're wrong, or the timing is slightly different than we don't disappoint you.

That's very helpful. That makes a lot of sense. A couple of quick follow-ups. Just one on the CAD business and Creo. We've seen that license growth for the last 3 quarters. What -- aside from basically, I guess, the question is should we see any change in support revenue growth or support attached or seat growth? Or do you think that's really more in this sort of consistent level that it has been for some time, specifically on the CAD business?

Yes, I think, our Q2, first of all, is always a seasonally weaker challenged quarter for our support business in general. But I think we do expect to see modest seat growth in the CAD business. Again, I think our operating is pretty strong right now. And it's not just for design but right now, if you watch Airbus put together airplanes or Embraer put together airplanes, they may model the components and CATIA, but when it's time to do a digital markup, the software they use is called Creo. And that's expanding in the Beauvias and we've talked about our win at EMEA and so forth. So more and more truck companies automotive companies, if you watch Honda put cars together, half of the car is modeled in Creo, half of it's modeled in CATIA, maybe even 1/3, 2/3, but when it's time to say what that entire car look like? All that stuff comes into Creo. So I think that we're starting to get some mojo back in our CAD business. Don't want to get ahead of ourselves because it's still a mature market. But the question is can we hold our own in this mature market? I'm feeling better about that on the strengths of how good this Creo product really is as compared to the predecessor Pro/ENGINEER.

That's great. Last one. Just on ThingWorx. I heard you described that business model as a subscription model. What are the -- how do you price the product? What are the things that determine how you scale with the customer from a pricing perspective?

Yes, Ross, that's a great question. So ThingWorx is principally priced according to how many things are connected and how many people are connected. So in one deployment, you might have 10,000 connected things and 100 connected people. In the next deployment you might have 100 connected things and 10,000 connected people. It all depends on the nature of the business. So that's the basic model. Now where it gets a little tricky is if those 10,000 things are jet engines they're having one discussion, and if those 10,000 things are toothbrushes, you're having another discussion. So it ends up being a bit of negotiation to kind of take that pricing model, which people generally agree with, but sort of adjusted to the practical realities of the situation at hand. So -- but that's the basic approach.

The next question comes from Yun Kim from B.Riley & Company.

Following up on Matt's question before Ross. So where are we in terms of traction with large system integrated from sales perspective? Are we getting to a point where they may be potentially coming to you with opportunity? Or are we still at a point where they're just simply helping you out with a closing of the largest opportunity out there? And also, in that regard, how much of your large deals were influenced by system integrators?

Yes. Good morning Yun. Another interesting question. I think you got to look at the different elements of our business. If you look at PLM, Well, let's first just take off CAD. System integrators don't play a role in the CAD business, there's not much services to be done. But if you move to extended PLM, there's a substantial amount of services that can be done. I think in PLM, because that market's sort of middle-aged, let's say, not mature but not nascent either. I think the system integrators by in large, want to be neutral. They want to tell the customer, you pick the technology, I'm happy to deploy it. I think though if you switch to some of our newest stuff, like SLM and Internet of Things, we're starting to see a different behavior. System integrators would love to be our preferred partner for SLM because that's a highly differentiated story. And similar thing with IoT or even if you want to just call it connected SLM or something like that, I think there's much more interest there. So I think that they're probably following us in the core business of extended PLM, and more helpful in helping us beat the bushes and drum up business in SLM and prospectively, in IoT.

Okay, great. And Jim, do you see any interest from customers regarding the ThingWorx business from deploying it from a cloud or hosted model perspective? And if that's the case, do you see yourselves building a little data center to support that?

Another interesting question. So I think most, more significant customers don't want that. And the reason why is, let's say, you're a large equipment manufacturer. The data coming off your equipment is highly valuable. And most people want to bring that data right into their data center, own it, control it, whatever. So to be frank, most customers appreciate the fact that this is software, not cloud because if it was cloud, they'd actually push back and say, "I'm not giving you my data." And if it's not their own data center, they outsource it to Amazon or something like that. They're not looking for a cloud, they're looking for analytics and application capability to put in their cloud. Incidentally, we're not that far away from Splunk, who also has a similar model, selling software that you put into your cloud of choice. Now that said, all that said, we do anticipate there will be some probably minority in the near term, but we'll see over time. Some set of customers who would like a hosted solution. And as you know, we have this manu-service [ph] business now that's doing both SLM and PLM, so there is actually an effort underway to prepare an offering for ThingWorx in the cloud, if people want that. I'm just telling you from my own experience being on dozens of sales calls, I'm not -- amongst the bigger companies seen a lot of pull for that yet.

Okay, great. That's sounds very good. And Jeff, deferred revenue came in very strong than normal, I think the sequential increase is almost doubled the historical rate. Is that simply you're going to buy better renewals in maintenance business or was there some one-time item in there? Or anything?

Yes. So renewals are very good. One of the things that's a little funky is in the quarter, our quarter last quarter, prior quarter, ended on December 28. There's a bunch of renewals that occur on the 31st or the 30th. Those actually land in our second fiscal quarter. So if you looked at it, we were sequentially, we were down in deferred a bit at the end of Q1 and I said, "Don't worry about it, it will come in strong in January." And that's exactly what we saw.

The next question comes from Raimo Lenschow.

Just briefly, if you -- if I look at the number of sales guys you talked about that you were kind of slightly below par and I saw in this quarter, now you start to ramp up again, how do you think about the ramp up on the sales force now as you go for a year, especially given your comments that the economy is getting better? So what's the kind of discussion you have on kind of expanding a little bit on the sales and marketing line again?

Yes, I mean, we did mention last quarter that we had sort of accidentally fallen a little behind, and there has been a push to begin the process of catching up and some progress has been made. Raimo, what I would say though is we need to balance that with our aspirations around improving sales productivity as part of our aspirations around improving our operating margin. For us to get to the sort of, let's say, 28% to 30% operating margin targets that we've talked about, we need a little bit more sales productivity. We've actually had quite a bit in the last 4 years or so, but we need a little bit more. So I think what you should expect is that we would be growing sales capacity slightly less rate than we're growing revenue, license revenue in particular, with the difference being improvements in productivity.

Yes, okay. So where -- if you think about the productivity, where in -- are you at, I know how difficult it is to put a percentage number on like would you see that, like how much room is there for our productivity increase?

Yes, I mean, I think we give you the data that you can reverse engineer productivity we give you a number of sales reps, should give you license revenue. If you go around that map and compare it to our peers, there's ample room for productivity improvements.

Yes, okay and peer, you would -- you look more at the kind of the direct industry peers or more of the software?

More -- let's say, particularly enterprise software peers, but you can even think of blended average. If you compare us to some desktop peers and allocate 40% of our business to that, and compare us to enterprise peers and allocate 60% of our business to that, that's kind of the way we tend to look at it and you'll see that we're substantially below average at this point and therefore, ample room for improvement.

Yes. And then the other question I had is on the PLM side, so the double-digit license growth again, which is kind of great to see. And if you look into the rest of the year or like if you look at the outlook, you obviously mentioned already like the economy, people are getting happier due to bigger projects again. Are there any other factors like renewals of volume license deals, et cetera, the kind of could play a role here as well that I should be aware of?

Well, I think, the biggest factor is the economy, the second biggest factor is a good product that customers like. I think that other -- big deals come and go, and if we have a renewal, we'd certainly try to leverage that. But that's not leverageable if you don't have an opportunity to deliver some real value and you haven't proven yourself and so forth. So I'd say, yes, compelling event to go -- try to get a transaction done in a given quarter or whatever. But that's no basis to buy software if the customer doesn't feel like they like the software and are getting great value from it. So that to me is a factor. I wouldn't consider it to be a primary factor.

The next question comes from Jay Vleeschhouwer.

Jim, I'd like to follow up on Raimo's question on a moment ago about sales capacity. At the analyst meeting in December, you gave a nicely detailed table showing your capacity by region and functions such as FPL and PV and so forth. To the extent you do add in sales capacity, in which functional or geographic area do you think you might tend to add, relatively more? And on the productivity question, how do you tend to balance not overweighting or underweighting a particular product area or part of the company. Historically, PTC has had a bit of that issue where sales may overweight a focus on one area underweight in another and that some times, historical has affected your productivity. And lastly, on the distribution question, with respect to channel, you brought in some new channel management about 6 months or so ago. Is there anything in the works that might change the revenue profile of the Channel business? Is there any thought been given, perhaps, to unwinding some of the changes you made 2 years ago vis-à-vis the channel?

Okay, Jay. That was a series of questions. I'll do my best, and we'll have to circle back for another loop. So first of all, if you look at our sales capacity, I mean, Jay, you've known the company for a long time. What I would say is over the last let's say, 5 years for sure, we've become a lot more analytical, we use a lot more data for planning and so forth. What got us in trouble more than if you go back farther than that, actually, was one big generic sales force that sold whatever they wanted and in some years, they sold a lot of PLM and forgot to sell CAD and a couple of years, they sold some CAD and so forth. So we become much more analytical and good credit here to Jeff and his finance team. To say where the growth opportunity. And how should our capacity be deployed not by zip code, but by covering the right growth opportunities. And so I think, what you saw at that December 5 event, I believe, it was, was a some segmentation happening in our sales force where we said we've got some really great, let's call them house accounts, we should have very senior account managers who can sell everything we have to that customer because the customer really prefers one face if they're strategic. But at the same time, then, we need some people selling CAD and PLM and we need some people selling our service offerings and now, I would say some people selling our Internet of Things offerings. So we're trying to be a little bit thoughtful as to where would we put this capacity. So if I kind of just generalize it now, one place you're going to see a…

Understood. With respect to ThingWorx, at the Microsoft Developers Conference, a few weeks ago, there were number of sessions hosted by Microsoft on Internet of Things. And while PTC and ThingWorx weren't explicitly mentioned, a lot of the technical language was very similar to what you say in terms of their technology being used, for example, as a development platform, they spoke about communications backbone, backbone monitoring data streams and all of that. So the question is how do you see them and Intel, which was also at the conference, either as partners or perhaps competitive offerings from any of the same kinds of tools and platforms and so forth, that you speak off?

Yes. So the first thing is neither of those companies I would consider to be competitors at all. If you look at what ThingWorx does and please do join us for the upcoming event, we'll make that clear. Microsoft and Intel don't have products like that. They have products lower in the technology's stack. So for example,ThingWorx, sits on top of a database. Microsoft saying, "Hey, you could use our database technology for that." So I did look through that -- I didn't attend the event you attended but I did scan through the press release and the announcement they made and so forth. And what I took away from that is Microsoft saying, we have a lot of technology that could play a role in the Internet of Things. And here's our deal for how all of this technology we have could be meaningful. What they didn't really say is that we have a specific Internet of Things offering that's going to blow your socks off, and that's what PTC is saying, or you could use PTC's technology ThingWorx on top of some of that Microsoft infrastructure and everybody's happy, and then there's other infrastructure if you want other than Microsoft. And quite frankly, a lot of their stuff is more big data oriented Hadoop and stuff like that, then it is SQL server-based. But customers will make those kind of choices as they go.

All right. If I could just squeeze one more in. With respect to the base number and I think Ross or Raimo asked this earlier, but is the sequential flatness in the CAD and SLM and PLM base count numbers largely a seasonal function or within the CAD number for example, are you seeing some erosion in the non-Pro/E part of that base where there's other older products that you acquired, is that where you seeing perhaps some erosion?

Yes. I'm glad you asked that question because, I'm sorry, I was thinking you were asking a different question about deal size. You're on seat count.

Yes.

Yes, I mean, I think we feel like this is sort of seasonal trends. I think, if you look at the 243 number, it's down a small bit from the previous quarter. It's up versus the year-ago timeframe. If you go back it's up versus 2 years ago.

If you looked at that Q2, year ago, it went down slightly. So I think, we'd look at that as kind of seasonal. I think Jim's described particularly on Creo, the adoption of 2.0, the benefits of that so I think, we feel overall quite confident in it but I would describe it -- I think we did describe it as largely a seasonal shift just Q2 over Q1.

Yes, Jay, in the meantime, I found a little bit more specific data here, that'll also be helpful so let me share that. If you look at the core Creo, that is the stuff that used to be called Pro/ENGINEER. That number's up, sequentially and it's up substantially year-over-year, up 6,000 seats year-over-year. What there is attrition in is some other stuff, CADs and maybe a little bit of attrition in the CoCreate base and some of those people are trading because they're flipping over to Creo and so forth. So I think that's what you see is the core business, pretty strong, some of the legacy stuff trading a little bit and maybe some of that legacy is trading simply because it's converting over to the core stuff.

The next question comes from Steve Koenig from Wedbush Securities.

Just 2 pretty quick ones here. First is you commented last quarter on close rates. You'd seen them weakened a little bit from Q4. How did they trend this quarter and where do you see those going? And then I have one follow-up.

Yes, Steve. So close rates actually weren't much better this quarter. In fact, it might have even ticked down a little bit. So we felt like strong pipeline, our guidance said be careful, prudent guidance with the right way to look at it. That's kind of how we're looking at Q3 and Q4, as well. If close rates were to be stronger, we could do better but we're not ready to believe yet that they will be.

Yes, another way we look at is maturity of the pipeline and we're doing better as Jim said, having salesforce.com and that information is very helpful. And when we look at the total pipeline, that's always very interesting because that's really forward-looking. Maturity is what actually closes in a current period. And I think we are encouraged by the total build and as the pipeline matures, the close rates of that mature pipeline is probably the key. So it's not one dimension in terms of calling what the close rate is.

Okay. So I guess the follow-up, my follow-up there would be how do you reconcile kind of the weaker close rates with your observations and inferences about your large deal count increasing due to a better economy? Help me reconcile those 2 things, and then the follow-up I was going to ask as well, what is your pipeline look going forward as far as large deals are concerned?

Yes, Steve, I'm not sure I have the complete answer. I mean, I think that the better economy has definitely manifested itself in the strong pipeline. The close rate, I would expect it to be higher. I think it probably was if we look at it regionally, and I'm sorry, I don't have that data in front of me. I would anticipate it was actually higher in North America and Europe and probably we gave up some ground in Japan where some deals slipped out of the quarter, and in Asia-Pacific for reasons I previously mentioned. We're not talking about massive changes in close rates here. But a couple of percentage points actually matters a lot. If you're trying to have $3 in the pipe for every $1 in the forecast, then if you're close rate goes up by a percentage point or down by a percentage point, it starts to matter in a meaningful way.

And what are you guys seeing looking forward in the pipeline, as far as large deals are concerned or potential upsizing of deals that are there?

Yes. I think we've been consistent all along that we have a good pipeline of large deals for the year. We've always said it's difficult to know for certain which quarter they will come in. But that we had sort of more than 2 handful of fingers worth of big deal opportunities in the pipeline. But we still do, in fact, I think at least 1, maybe 2 of the so called megadeals we got last quarter actually weren't in the pipeline as megadeals, they just grow during the course of the quarter into that size just across the line. But I think, we feel like we have a pretty good pipeline in the back half of the year. And again, we're trying to find the right balance of optimism and conservatism, so that we don't get out ahead of ourselves, but we got a lot to work with.

The next question comes from Matt Williams from Evercore.

I just I'm curious around ThingWorx and as you're getting into discussions with customers. How ready are these customers from, I guess, from a technological standpoint and from a capability standpoint, to really try and harness what ThingWorx brings to the table? And I guess along with that, how much sort of evangelizing are you guys doing around sort of the capabilities and what's possible with ThingWorx?

Well, there's a huge amount of interest, let's start with that. So when we call up people and say, "Can we come talk to you about it?" They say, "Oh boy, that's timely," because we just had this internal strategy meeting and so forth. Down in New York City, I think it was 2 weeks ago, we had a forum where we invited a dozen CEOs, and so a dozen CEOs flew in from all over, in this case, the U.S. to talk about what does the Internet of Things mean to a manufacturing company? And these were big name companies, big name CEOs. So that's the kind of attention we can get here. I mean, if I ask a dozen CEOs to come learn about CAD, they say, "I'm busy that day." But they're pretty darn interested. And they came and we've had another -- we had a forum here in the Boston area, a couple months ago, I'm trying to remember if it was March, probably February, I guess it was. And it was dramatically oversubscribed. I mean, we feel kind of bad because we had far too many people in the room and it was crowded, and the sound wasn't right and so forth. Again, a lot of interest. So let's start with that. A lot of interest. Now the truth is, these companies understand this is important. They understand they need to do something. It's not crystal clear to them what they need to do, and I'm not even sure they're entirely ready, but what ThingWorx does is lowers the bar of entry dramatically. This is a rapid application development environment that allows a business analyst, not even an IT guy, but a business analyst, to sit down and say, "Let's try something." If we have…

Great, that's helpful color. And then maybe just one more follow-up on ThingWorx. I know the plan, at least, initially for this year, was to primarily sell it as a standalone solution. Down the road, I think the integration capabilities of some of your other offerings is very compelling. So any update around sort of what's going on behind the scenes there in terms of trying to help close the loop between ThingWorx and the PLM and SLM offerings, in particular?

Yes. There's a lots of progress being made and its high priority within the company. ThingWorx is a very productive development environment. So it's not that it takes a long time to develop the code. It takes more time to figure out what exactly should we do. A little bit like the customer story I was telling you. But we have this large customer event, this PTC live event in this year in Boston mid-June, I think it starts June 15. We will showcase a whole bunch of connected PLM, ALM, SLM and everything else using ThingWorx. There will be a huge showcase and we're expecting a lot of attention around PLM, and that's how does IoT change PLM, and there's a separate event for SLM, and then there's a standalone event for IoT kind of all coterminous here, a standalone event for IoT for everybody else who's just interested in all the other interesting things you can do with technology like this. So certainly, put that on your calendar. That'll be a good opportunity to see kind of the public unveiling of -- what we think is going to be some pretty exciting stuff.

We have one more question from Ben Rose from Battle Road Research.

With all the discussion around automotive, I realize that historically, it hasn't been your largest segment but could it, in fact, become the largest customer segment this year. And then just a second question around the defense component of aerospace and defense, which I know has been weak in the last year or so is that particular subsegment beginning to come back?

So Ben, this is Jeff. On the verticals, just in general comment our largest vertical is core industrial and that was a very good performance in the quarter. So we saw good movement in industrial. Probably the fastest growth was in automotive and automotive is an important vertical, and it is growing in a pretty rapid rate. I don't see it eclipsing the core industrial, but it was very strong. I would add just retail and consumer was also strong and aerospace and defense was really largely flat, maybe down slightly with aerospace being probably the commercial side, stronger and the defense side, slightly weaker. So that would be just the color I'd give you one on the verticals.

Yes, maybe just to add, Ben. While automotive is growing nicely, it's half the size of industrial. So it's unlikely it could pass industrial in this year. Maybe longer term, but industrial is actually a real sweet spot for SLM and IoT. So I don't think that'll happen. But what I will say in our automotive business, our CAD business had some juice. Chances are, if anyone of you guys go up in a parking lot and get in your car you're starting an engine and the transmission design of Creo. So there's lot of Creo in the supply chain and then the OEMs in the powertrain side of the business. PLM, we're doing pretty well, particularly in commercial vehicles and as you know we've got this big Hyundai win a couple of years back that's blossomed nicely. And then ALM is really interesting in automotive, because automotive -- automobiles have tons of software in them the software is safety critical. We don't want to find out your antilock brakes don't work because there's a bug in some third tier set and the supplier's gone. So there needs to be very careful traceability and change management up and down the supply chain, and that's what our Integrity product was really great at -- is really great at. So Integrity, we won the ALM business at Hyundai, following our win in PLM. There's 3 by my count, European Automotive OEMs, 2 in passenger vehicles, 1 in commercial who are moving in the direction of standardizing on Integrity for ALM and so forth. So we have a very compelling story for automotive. It's just it's also very compelling for industrial.

Okay, I think that brings us to the conclusion of the questions. So I want to thank you, all, for dedicating your time with us here this morning. A lot of great questions, a lot of good discussions. I think in summary, you sense we had a strong quarter and we feel good about the business. We feel like our strategy is more differentiated than ever. We're in a better strategic position, both relative to our customers and relative to our competitors and it feels like we've been in long time. That said, not everything is perfect in our business or in the economy, and so we're trying to continue to be cautious in the near term, so we don't get ahead of ourselves and disappoint anybody, but that's kind of the mode we're working with and we'll close out on that. So thanks a lot for joining us this morning. Goodbye.

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