Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PTC 2015 Second Quarter Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect this time. I would now like to turn the call over to Tim Fox, PTC's Vice President of Investor Relations. Please go ahead.

Good afternoon. Thank you, Bob, and welcome to PTC's 2015 third quarter conference call. On the call today are Jim Heppelmann, Chief Executive Officer; Andrew Miller, Chief Financial Officer; and Barry Cohen, EVP of Strategy. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today at www.ptc.com. During this call, PTC will make forward-looking statements including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in forward-looking statements could be found in PTC's annual report on Form 10-K, Form 10-Q, and other filings with the US Securities and Exchange Commission, as well as in today's press release. Forward-looking statements, including guidance, provided during this call are valid only as today's date, July 29, 2015, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website. With that, I would like to turn the call over to PTC's CEO, Jim Heppelmann.

Thanks, Tim. Good afternoon, everyone, and thank you for joining us for a review of our third-quarter 2015 results. Our Q3 revenue of $304 million was in line with our July 9 announcement of preliminary results and slightly below our guidance range. EPS of $0.53 exceeded the preannounced range and was above the high end of our guidance range. We believe that the challenging macroeconomic conditions, particularly in the Americas and China, impacted our ability to close large deals in our core business which, as you know, is sensitive to changes in the manufacturing economy. While we remain confident about the long-term growth prospects of our core business based on our broad solutions portfolio and new customer wins and engagements, the current macro climate is proving to be more difficult to navigate than we had anticipated. On a positive note, however, we delivered very strong growth in our Internet of Things business, closing a number of significant deals amongst large industrial companies that are adopting our platform for their IoT initiatives. In fact, three of our eight large deals in the quarter were IoT deals. IoT license revenue represented more than 20% of our total license revenue, and we added a record number of new IoT customers. Despite macroeconomic headwinds, results so far this year have been better than the headlines would suggest. In constant currency, our software revenue has grown 6% for the first nine months of FY 2015. And even with professional services down 9% year to date due to our strategy to shift more of our lower-margin professional services engagements to our partner ecosystem, our total revenue is up 2% in constant currency year to date. Also, despite a modest shortfall in our license and subscription solutions revenue relative to guidance, we were able to achieve a…

Thanks, Jim, and good afternoon, everyone. Please note that I will be discussing non-GAAP results unless otherwise specified. Total third-quarter revenue of $304 million was down $33 million year over year as reported. $31 million of the decrease was driven by FX, and $7 million of the decrease was lower professional services revenue, consistent with our strategy to migrate more service engagements to our partners. On a reported basis, software revenue -- which consists of license, subscription, and support -- was down 7% year over year. However, after adjusting for currency, we delivered 2% year-over-year growth. Support revenue was up 6% on a currency-adjusted basis. This was partially offset by license revenue that was just below the low end of our guidance and down 6% year-over-year constant currency. It should be noted that we face a tough Q3 2014 license comparison, a quarter in which our CAD and extended PLM license revenue grew more than 20% year over year and in which we had 21 large deals. In our core business, most notably in the Americas and China, we saw deal sizes compressed and deals delayed at the end of the quarter. While we entered the quarter with caution about the macroeconomic environment, Q3 results suggest potentially greater challenges than we had anticipated, and we entered Q4 with greater caution about the manufacturing economy. Approximately 60% of our Q3 2015 revenue came from recurring business, up from 53% in the year-ago period, reflecting growth in our ratable revenue streams including subscription, cloud, and support revenues. Clearly, the growth in our recurring revenue represents a very positive trend in our business and will drive cash flow in subsequent quarters. Turning to our subscription licensing model, our subscription offering has now been available for three quarters. As we discussed last quarter, we…

Thank you. [Operator Instructions] Our first question is from Mr. Matt Hedberg from RBC Capital Markets. Sir, your line is open.

Hey guys, thanks for taking my questions. I just wanted to start off -- you guys made some comments that there is a strong preference towards subscription pricing. And I'm curious, when you look at your core CAD and PLM, is there a way to think about the percentage of subscription bookings coming from the core at this point?

I will take that question. We recently conducted studies with actually well over 300 of our customers. McKenzie did this for us and identified across all of our segments of the business that there was a preference for subscription, and it was pretty much the same preference in every single division. The core divisions as well as the rest. One of the primary drivers is as they evaluate the business case for subscription or for perpetual, one is the relationship between the two prices, and the other is the term of their business case. And they tend to use business cases in the four- to 4.5-year range. So for us, with customers that are very, very sticky, you can see how we can substantially increase the customer lifetime value while offering something that is economically quite attractive to them over their business case.

And then maybe a follow-up to that, there were several IP deals that went perpetual this quarter. I'm curious, what drove that behavior this quarter, and would you expect that option to go away here potentially past the end of this fiscal year?

It was primarily customers that historically always purchased perpetual with us, and essentially that was their preference. And we offer -- up through the end of this quarter, we offer perpetual and subscription in our price book for IoT. We are moving more aggressively to subscription-only and IoT as we move forward.

Yes, Jim here. Let me just add a little more color on that because I think this is a point of some confusion. I think we were clear that we told our sales guys you can sell it either way this first year. We are going to kind of measure customer reaction. If you look at -- the vast majority of transactions have been subscription, but then a couple of big ones came in perpetual. So we didn't really foresee that coming, but these were customers that we have relationship with. They love the technology, they wanted to buy it perpetual. And, quite frankly, we had a situation in place where the sales guys were allowed to sell it that way, so they did. I think that as far as subscription phase 2, we will revisit all that and try to steer it a little bit more in the future than we told you we were trying to do this year.

That's helpful, Jim. And then maybe one last one for Andy. As attrition -- as the transition accelerates here, you just talked about your long-term margin targets intact. But I would assume if this transition accelerates, operating margins might come down in the short term. I guess first of all, is that correct? And second, how should we think about cash flow through this transition? I would assume that would fare better. Maybe just a little bit of color on that would be helpful.

We've laid out a 2018 operating margin target to 20%, 30% with a subscription mix assumption in that year of 30%. So clearly as we're going through the transition, it's more than 30% that would impact revenue in operating margins. You can count on us that we're going to be, one, giving you guideposts so you can see what the revenue would've been. And, two, we're going to be managing the cost structure of the business as if it were still a perpetual business. So we're not going to -- the expenses are going to basically track to the same margin target. So as we exit the transition, you'll see us right back on track. The other point I would make is that cash flows tend to catch up -- come out of the trough of the transition earlier than the revenue does simply because, depending upon the average length of your subscription contract, they at least make annual payments in advance. So generally you come out of it faster.

Thank --

We will give you a lot more on this as we basically lay out what next year is going to look like and what the subscription transition is going to look like.

That's helpful. Thanks, guys.

Our next question is from Sterling Auty from JPMorgan. Your line is open.

Yes, thanks, two questions guys. First on the macro part, that's the one that I'm getting the most pushback from investors looking at the results from some of the industrial companies. But more importantly, looking at what the [settle] (inaudible) put up in terms of their results, how do we characterize what you are seeing relative to the strength that they had put up in their results? Is there any type of maybe market share shift or anything else that we need to worry about?

Sterling, it's Jim here. How are you doing? I don't think there's any competitive dimension in this discussion here. I think that we are in a series of businesses and Dassault is a series of businesses. Our CAD and PLM businesses most directly correlate to Dassault's Catia and Enovia businesses. And I think over the last three years, the growth rates of those have been remarkably similar. Now, Dassault is in some higher-growth businesses like SolidWorks, and we are in some higher growth businesses like IoT. But I think you can't really compare -- Dassault is structured differently than we are, and I think that that has helped them in this quarter because the SolidWorks business performed well and, like you saw, so did our IoT business. But we have a big exposure, of course, on the -- in the CAD and PLM.

So maybe just the follow-up to that one just real quick -- as you look at the Americas, industrial, is there anything that you can do, any levers that you can pull, to help improve? Or do we just kind of have -- for that part of the business, kind of ride it out?

I think -- you know we are somewhat in these more mature businesses correlated, for example, to the PMI index. And that fell a fair amount in the US within the quarter. And in China, it's kind of been in negative -- that is to say, less than 50 territory for a couple of quarters in a row now. So just let me hit China first. It wasn't that long ago when the China manufacturing economy was growing double digits, and now it's contracting. And on top of that, there is some political things going on that make it difficult for US technology companies. So China is a difficult environment for virtually every American technology company right now selling in the manufacturing industry. I think in the US, we do a lot of business with global industrial companies, and the strengthening of the dollar has made it very difficult for them to export. And their own results look comparatively bad, much worse than at the beginning of the year. So I think that they are retrenching a little bit, and that's causing some pain for us. So I think that that's really behind what's going on. It's just the big deals -- if you look at the big deal volume year over year, the big deals are substantially less. And so I think companies have just been reticent now. I think we're still doing smaller deals, and I think that as the cycle moves through and so forth, I think we will see that pick up again.

And I had two things I want to add. One is we had the macro challenges and we also had a really tough compare. And while I don't want to overplay it, it is important to note that Q3 a year ago, our core business bookings in CAD and PLM grew over 40% and our revenue grew over 20%. So that was an extremely tough compare that, even with our guidance, we were not going to be putting up strong numbers. So you can't look at one quarter of us versus one quarter of Dassault without looking under the covers at how those compares existed. The second thing is that one thing I think you can count on from PTC is that if we assess that there is a trend in the -- whether it's a macro tech trend or a market trend that we have to adjust to deliver a consistent earnings growth, you can pretty much count on the fact that we will definitely look at our cost structure as something that we may consider adjusting if need be to continue to drive from these growth.

Got you. And then the other question that we're getting a lot of is on the subscription transition, as you look into different pricing dynamics, do you think there's going to be the opportunity to take legacy customers that are paying maintenance and getting them onto a subscription format? As well as, are you going to consider, at least in some areas, because it sounds like IoT, you are -- are you going to consider the elimination of perpetual altogether?

We actually have a work stream focus on our existing customers and how we transition them, both their new bookings to that often are under volume agreements -- how we transition them to subscription. And we are also assessing how we might transfer their maintenance bases potentially to subscriptions. So that is something that we are focused on, and we are actually looking deal by deal at the new ones coming up on what could offer be that would be something that would be good for them and good for us. So that is part of it. But at this time, I do want to highlight that the focus is the license bookings moving to subscription. But we are assessing how we could leverage support as well on that. Jim here again. I just want to go back to -- just to kind of remind you what we told you last November and so forth at our investor day. We said for the first year, we want to just measure and get to know this a little bit. And then I think the whole purpose of subscription phase 2, as Andy said, is to figure out what does it look like at steady-state and how fast can we get there. So there's a lot of very good analytics happening. And we're just not quite done, so we're not ready to tell you the answer here in the call. But I think that as we go into next year, we're going to outline a pretty good program you're going to like to get to the destination as fast as possible so we don't linger in this transition period unnecessarily long.

Great. Thank you.

The next question is from Steve Koenig from Wedbush Securities. Your line is open.

Hi, gentlemen, thanks for taking my question, maybe I've got a follow-up or a housekeeping item too. I'm wondering with the macro environment that you're seeing in manufacturing, are you seeing conditions continue to deteriorate? Q2 and Q3 was worse than you thought it was. I guess where I'm headed with this is would you expect the business -- the core business in constant currency to stabilize by the time this annualizes, for example, in Q2 next year? Or are you seeing the macro just continue to deteriorate so that we can't know if that annualizing of the comps is going to stabilize things?

Yes, I'll take a pass, and Andy, you can (multiple speakers). I think, again, if you look at the big deal count -- the number of large deals we did a year ago, the number of large deals we did this year -- it only takes a couple handfuls of transactions to slide, and you get a material difference with these big transactions. So I think that what's happened is the bigger transactions are getting a lot more scrutiny. And people aren't saying no; they are just saying not quite yet, and then it slides into the next quarter. So I think as we look at Q4, we expect to get and in fact already have closed a number of the Q3 transactions that slid. But then we are left with the concern, might Q4's transaction slide into Q1 if we continue to have the same sort of backup. But, yes, I don't think this is necessarily just getting worse and worse and worse. I think that there was a huge change in currency, if I recall, in our Q2 that it's still kind of a shock factor as we go into Q3. I don't think it's worse; I just think that when our big deals start sliding, then it's hard to post the type of numbers that we want to post.

Yes, okay, that makes perfect sense, Jim. You know, then, I wanted to [Multiple Speakers] --

The one thing I would add to that is what we are seeing is the pipeline looks very strong, but the on-time close rate actually has gone down. That's actually what we're seeing. So it is taking a bit longer to close in this quarter than it did last quarter, for example. The close rate ticked down just a little bit.

Got it. Okay. Thanks, Andy; that's helpful, too. I wanted to ask in terms of a follow-up, just two quick ones. One is you have done some subscription deals in the core business. Are those generally some kind of multi-year deal that then renew, or is it some kind of different structure? And would you expect a radically different structure in phase 2? And then one last housekeeping question.

Some of the big deals in the past were multi-year. And we would expect subscription deals in the quarter to be one-, two-, or three-year deals. Generally, that's typically what you see. Our average length, because we have a lot of IoT deals now that are shorter, is somewhere between one and two at this point and holding pretty consistently.

And Andy, have those been ratable every quarter, or is there a lot of (multiple speakers) just recognized?

It's ratable.

It's ratable. And it sounds like the phase 2 could be pretty similar.

As far as the length of the subscription offering? Yes, very likely we will offer one-, two-, and three-year. That's pretty standard to offer those. And the longer it is, you get a little bit better price than short.

Got it, okay. And last question is kind of a housekeeping one. Can you give us any sort of color on as we try to look at organic on Atego and Axeda, which were not present in the prior period. Any sense of the contribution there?

Organically, year to date, we are low single-digit down in software revenue. Now, the way the Company calculates that is we actually -- we tend to grow those acquisitions, but the way that the Company has always historically captured that is we assume that growth is inorganic. And so if you actually look [Multiple Speakers] four quarters have actually passed. So to put it in perspective, for example, we are expecting this year to grow the IoT bookings by more than 150% on an apples-to-apples basis compared to having exceeded it in last year. So -- but that, the way we report organic, inorganic, we would be telling you that that acceleration in growth and that more than doubling of the customer base is all acquisition related, when truly it's organic. So we'll revisit how we actually should share that with you probably as we enter next year.

Okay. And just to clarify, the organic software year to date, low single digit down, is that constant currency?

Yes, yes.

Got it. Okay, great. Thanks a lot, gentlemen.

Bob, I think we've got time for maybe one more question, please.

The next question is from Saket Kalia. Your line is open.

Hey guys, thanks for fitting me in here, I appreciate it. First, for Jim -- Jim, can you just maybe dig into it -- not to beat a dead horse, but can you just dig a little bit deeper into the macro headwinds that you felt like you faced in the core business? Is this the sort of behavior where customers are just pausing, or is this something where you can maybe see headcount cuts down the road in engineering headcount?

I don't have a crystal ball, Saket. I think that the US PMI a quarter ago was $55.7 million, which is a decent number, and within a single quarter, it fell to $53.6 million. That's not a disaster, but it's a bad trend, and I think that causes people to just take stock for a minute and say hey, let's call a timeout and figure out what we're doing here. And I also think a similar result -- Andy shared with me a statistic from about a week ago that said of the S&P 500, companies that have reported roughly two-thirds had beat on earnings, only one-third had beat on revenue. And the average revenue, if I remember correctly, was down 5%.

4.1%.

4.1%. So when the companies -- that's our typical customer. And when our typical customer looks at the revenue as reported thanks to currency being down 4.1%, and somebody has got a big transaction they want to pull the trigger on, they might just say hey, let's just call a timeout and reconnoiter here a little bit. I don't think the US economy is in crisis. I think it just went through a shock factor associated with FX. And people have to process that a little bit, and then hopefully we'll go back to business. But Andy said this and I said this, this management team has a good reputation for managing our cost structure, and we've posted pretty good earnings results. And, quite frankly, if not for FX and mix change this year, this would be the best year of all. So we've been committed to that. We've always stepped up when we had to make sure that the Company was generating profits a little bit independent of what was happening in one geo or one segment or what have you. So I think you should expect and you should see the credibility here that we will continue to manage that as best we can. We can't react within a quarter, but certainly we are sensitive to that the Company needs to continue to increase its earnings independent of what's happening in the moment out there in the outside world.

Got it. That's really helpful. And then just one follow-up. Andy, you mentioned sort of the four- to 4.5-year kind of business case that I guess the customers that you're surveying are kind of looking at. As you revisit your subscription pricing later on this year, do you anticipate that break-even point for perpetual versus subscription to be significantly different than what maybe other software transitions have seen? I want to say let's call it 2.5 to 3 years, where the two sort of -- revenue streams kind of equate to each other? Or how do you think about that?

Okay, I don't want to give you the answer yet, because we're not done. First off, we are -- we actually have some very good analysis that shows exactly -- basically the demand elasticity, at what point people prefer subscription over perpetual and how it falls off. I will share that our current pricing at 60% only really attracts people who absolutely, absolutely want subscription. But there -- we have -- what I will share is that we have the opportunity, given the stickiness of the software, frankly to tremendously increase the lifetime value of the customer. Easily in that 20% to 40% range that you hear most software companies talk about. So we are feeling good about that based upon the studies that have been done so far, but we're not quite done. So I don't want to give you the answer yet.

Got it, fair enough. Thanks very much, guys.

I know you want it, but --

Thanks.

Okay. I guess that brings us to the end of the call, but thank you all for joining us here again this afternoon. And just sort of in summary, there was some good news in the quarter and some things that we are not happy with, and then some external pressures on us from macro and FX and so forth. I think we are pretty proud, though, of the earnings results, and we are extremely proud of the IoT results. And I think we need to continue to work hard on the core business to make sure that that performs as well as possible given the environment that we are in. So we look forward to talking to you again in 90 days. In 90 days, of course, we will have a much better look into FY 2016 and into subscription phase 2 and a lot of other things I know you're interested in. So look forward to talking to you then. Thank you and goodbye.

That concludes today's conference. Thank you for participating. You may now disconnect.