PTC Inc

NASDAQ:PTC

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon ladies and gentlemen. Thank you for standing by, and welcome to the PTC, 2018 Third Quarter Conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. This call is being recorded. If anyone has any objections you may disconnect at this time.

I would now like to turn the call over to Tim Fox, PTC's Senior Vice President of Investor Relations. Please go ahead.

[Tim Fox, Senior Vice President of Investor Relations]

Good afternoon, and thank you Kim, and welcome to PTC's 2018 third quarter conference call.

On the call today are Jim Heppelmann, Chief Executive Officer; Andrew Miller, Chief Financial Officer; and Barry Cohen, Chief Strategy Officer. Today's conference call is being broadcast live through an audio webcast and a replay of the call will be available later today on our Investor Relations website.

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 the forward-looking statements can be found in PTC's most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and other filings with the U.S. Securities and Exchange Commission, as well as in today's press release.

The forward-looking statements including guidance provided during this call are valid only as of today’s date July 18, 2018 and PTC assumes no obligation to update these forward-looking statements.

During the call PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. The 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 Investor Relations website.

With that, I would like to turn the call over to PTC's CEO, Jim Heppelmann.

[Jim Heppelmann, Chief Executive Officer]

Great! Thank you, Tim. Good afternoon everyone and thank you for joining us. As usual, I’d like to begin with a review of the third quarter results and then provide some perspectives on the significant milestones and progress that we achieved during the quarter.

Q3 was a solid quarter across the board, with standout performance in our IoT segment. Assuming FX rates had remained constant with our guidance back in April, bookings and recurring software revenue would have been at the high end of our guidance and total software revenue would have exceeded the high end of our guidance.

As reported, total revenue was at the high end of our guidance despite lower professional services revenue and operating margin and EPS, each came in above the high end of our guidance.

Bear in mind that our results this quarter benefited from a higher than forecasted amount of perpetual license revenue, driven by a geographic mix of booking that were slightly more weighted to AsiaPac, where we still offer perpetual licenses. We’ll discuss our subscription program in more detail later in the call, including today's announcements to end perpetual licensing globally on January 1, 2019.

While subscription mix was lower than our guidance, ACV was within our guidance range and with the global end of life on perpetual coming in two quarters for all products except Kepware, we remain on track with the recurring revenue projections that underlie the long range model we presented at LiveWorx.

Momentum around our recurring revenue model continued in Q3, driving software revenue growth of 10%, recurring software revenue growth of 15% and ARR growth of 15%. This is the sixth consecutive quarter of double digit ARR growth.

Total differed revenue grew 33% year-over-year and 91% of our software revenue was recurring this quarter. These metrics make it clear that we’ve established a solid foundation for our growth going forward.

Bookings grew 26% to $113 million, near the high end of our guidance, even in the face of FX headwinds in the quarter. Overall we were pleased with our bookings performance through the first three quarters of the fiscal year and believe we are on track to the constant currency bookings growth we had previously guided.

To summarize my comments here in Q3, I’ll once again orient my discussion around our three strategic initiatives designed to maximize long term shareholder value, which are first, to increase our top line growth; second, convert to a subscription model; and third, expand our margins.

Let me start by discussing our progress on the growth front. I will mostly frame my comments around our year-to-date growth performance. Year-to-date bookings grew 15% overall and 11% in constant currency. From a geographic perspective, Americas has delivered solid performance with 8% bookings growth and as compared to a strong growth of 17% over the same period last year.

Europe, year-to-date bookings grew 3% in constant currency, but also against very strong results in fiscal ’17 where we had 26% constant currency growth. Also the $7 million mega deal that we closed early in Q4 of ’17 instead of Q1 of ’18 as originally planned, significantly impacts Europe’s year-to-date bookings growth percentage.

As we discussed with you on our Q2 earnings call, our outlook for Europe called for strong sequential bookings growth this quarter due to the timing of large deals and the European team came through with 25% sequential, constant currency bookings growth in the third quarter.

Performance in APAC with year-to-date constant currency bookings growth at more than 20% has been driven by solid performance in China, Taiwan and Korea and benefited from an easier comparison due to a weak Q3 performance in Japan.

Japan continued to progress well on its recovery, driving sequential growth again in Q3 and is tracking to a full year recovery plan. Based on our performance in Japan year-to-date and a good forecast for Q4, we believe we put our FY ’17 challenges in Japan behind us.

Turning now to our business unit performance, let's start by discussing IoT, which is of course our highest growth business. For those of you who joined our June LiveWorx event, you were clearly exposed to some of the industry's most cutting edge IoT technology, you saw a strong partner ecosystem that helps us to engage customers around the globe, and if LiveWorx got your excited about PTCs’s momentum in IoT, then our Q3 results will add an exclamation point.

Our bookings growth in the quarter well exceeded the estimated market growth rate. IoT bookings in the quarter were basically neck-to-neck with PLM bookings. Customer expansions once again accounted for over half of our ThingWorx bookings and the number of six figure deals grew by a record 80% year-over-year driven by these expansions. If you exclude the eight figure mega deal from Q1, 2017, then year-to-date IoT bookings growth is well above the 30% to 40% estimated market growth rate.

Recurring IoT software revenue growth accelerated again in Q3, posting 7% sequential growth and 33% year-over-year growth, reflecting the compounding benefit of our maturing subscription model that’s now starting to happen.

During the quarter we saw strength across the major IIoT use cases, geographies and vertical markets. I'll begin with SCO or Smart Connected Operations which you may recall is a $500 million market growing north of 40%. PTC is uniquely positioned to win in this market with a combination of ThingWorx, Kepware and Vuforia, and with the new partnership we secured with Rockwell Automation during this past quarter.

Through this partnership, which addresses the major secular trend of IT an OT convergence, PTC and Rockwell will align our respective factory automation technologies and both companies will sell a combined software suite into our respective markets. This will significantly increase PTC’s credibility and our go-to-market capacity in smart connected operations.

On top of that Rockwell automation will invest $1billion in PTC and Blake Moret, the company's Chairman and CEO will join our Board of Directors. Though it's only been a month and we're still really just getting started, we see ample evidence that this partnership will really move the needle for us.

In Q3 we closed new and expansion SCO deals in both discrete and process manufacturing. Some examples of new wins include for example in high tech a win at Hitachi; in semiconductors a win at Micron Technologies, and in automotive a win at a leading Scandinavian automotive OEM.

In the SCP or Smart Connected Product market we closed a number of meaningful expansions and new engagements. NCR signed a major expansion for the next generation of IoT offerings for the retail and hospitality industry. With their massive point of sale presence, NCR represents a major channel at the retail for our IoT business, nearing in some ways, what Rockwell Automation brings to us an industrial automation.

In the medical device space, we landed a nice deal with Medtronic and lastly within SCP we expanded our OEM relationship with telecom equipment giant Ericsson, who's embedding ThingWorx and Vuforia studio into their IoT accelerator platform. Ericsson too represents a major go-to-market channel into their customers, which are the global telecom providers.

In augmented reality, as I am sure many of you witnessed at LiveWorx, PTC has some incredible technology that addresses a variety of use cases across the industrial landscape. Our AR business is reported within the IoT number, but it we draw more specifically into AR, we achieved record AR bookings in the quarter, almost triple the year ago quarter and up almost 50% sequentially.

While it's still early in this market, Vuforia has been put into production at an accelerating pace and we now have over 10,000 enterprises who have purchased or are test driving this technology for service and maintenance instructions, factory operator instructions and virtual product demonstrations.

We have a very strong leadership position in AR. Interest levels are sky high and we are seeing commercial adoption accelerate. I'm confident that we're seeing another [inaudible] performance and then we’ll become increasingly material to PTC’s growth-rate over time.

On the partnership front we were pleased to see continued momentum with our strategic partnership with Microsoft. We closed Cannon new joint deals in the quarter and as mentioned at LifeWorx, there are more than 100 active joint opportunities in the pipeline globally.

One great example of our collaboration was a Q3 win at Alecta, which is a medical diagnostics company, who will implement ThingWorx and Azure IoT to connect thousands of customer assets, providing visibility into product performance and maximize uptimes for clinicians across the globe. And beyond the collaboration with our ThingWorx IoT platform we continue to deepen our partnership around Microsoft dynamics for connected deal service, and of course there's a lot of exciting collaboration happening with Microsoft’s HoloLens and Azur team’s on the AR and VR front or what Microsoft calls MR for Mixed Reality.

We are very excited to begin ramping our strategic partnership with Rockwell Automation. As you can imagine, a host of activities have kicked off around sales and services enablement, account targeting, branding and product integration planning amongst many other work streams. We look forward to providing you updates on our progress with Rockwell over the coming quarters.

To summarize on IoT and AR, Q3 was another strong indicator that adoption of these technologies is accelerating across a wide range of vertical markets, geographies and use cases. Our growing ecosystem of partners further strengthens PTC’s leadership position in these exciting growth market, so let me turn now to our solutions business.

Year-to-date double digit CAD bookings growth, as well all paced market growth rates and our outlook for the balance of the year remains strong. CAD continues to benefit from our go-to-market optimization initiative, evidenced now by 10 consecutive quarters of double digit bookings growth coming out of our reseller channel, as well as a very strong product offering.

On the CAD product front, Creo 5 which was released back in March has some breakthrough new capabilities for additive manufacturing, sometimes called 3D printing that we highlighted at LiveWorx such as fully integrated topology optimization. This is a major competitive advantage in the market today because no other CAD tool can optimize geometry within the CAD environment. Others do optimization by exporting the data out of CAD and into stand alone software that runs outside the CAD tool, but then the date that is created can’t easily be returned to the CAD environment, which effectively creates a broken tool chain problem. We don't have that problem would Creo.

Now complementing our internal product development in CAD, we announced an exciting new strategic partnership with ANSYS at LiveWorx. We will be embedding ANSYS’s breakthrough real time simulation called Discovery Live inside Creo to create the first fully integrated CAD and real time simulation solution. This announcement and demonstration was one of the biggest highlights a LiveWorx, and this amazing technology combination will expand Creo’s competitive market position for years to come.

We're planning an initial launch of Creo with embedded Discovery Life simulation later this year, and overtime we plan to integrate the full breadth of ANSYS simulation suite into Creo. So stay tuned for more details on the ANSYS relationship over coming quarters as well.

Turning to PLM, following a sequential decline in Q2 due to the timing of large deals, the PLM team delivered a solid Q3 with year-over-year growth in the low double digit. Year-to-date PLM bookings are tracking just ahead of market growth rates and the Q4 pipeline is very solid. We continue to expect this business to deliver a full year growth at or above the market.

Let me turn now to our second top level initiative to drive shareholder value, which is our transition to a subscription model. We delivered subscription ACB within our guidance range despite FX headwinds, but due to a very strong Q3 performance in AsiaPac where we still sell perpetual licenses, perpetual revenue was higher than forecasted. This resulted in a subscription mix of little below our guidance, but still up 1,400 basis points from Q3, 2017.

Subscription adaption trends remain strong across the globe and today we announced that as of January 1, 2019 we’ll be ending professional licensing globally, except for Kepware. We're very pleased with the momentum around our subscription transition and we have high confidence in our long term subscription and recurring software revenue targets we provided to you in June.

Let me wrap-up my comments by discussing our third top level initiative to drive shareholder value, which is to further increase our operating margins. In Q3 our operating margin was above the high end of our guidance, due primarily to higher perpetual license mix and was within our guidance range when accounting for mix, even despite FX headwinds. We expect greater than 200 basis points of margin expansion in fiscal ’18, then to achieve rapidly accelerating margin expansion in fiscal ‘19 and beyond, driven again by the compounding benefit of multiple years of our maturing subscription model.

In closing, I'd like to reiterate our commitment to the exciting long range plan for PTC that we shared a few weeks ago at LiveWorx. We've made great progress over the past few years, as evidenced by the performance of our core business, by our leadership position in the high growth IoT and the AR markets while our business model transitioned to subscriptions and are focused on disciplined cost and portfolio management. We're firmly on track to transform PTC into one of the premier software companies in the world.

With that, I'll turn the call over the Andy who will review the financial highlights with you.

[Andy Miller, Chief Financial Officer]

Thanks Jim and good afternoon everyone. Please note that I'll be discussing non-GAAP results and guidance.

Q3 bookings of $113 million were near the high end of our guidance despite a $2 million FX headwind, representing year-over-year constant currency growth of 23%. I will remind you that Q3 ‘17 presented relatively easy compare due to Japan’s under performance last year, but overall we are pleased with our bookings result. Year-to-date bookings have grown 11% constant currency and 13% constant currency if you adjust for that $7 million mega deal that closed early in Q4 ‘17 instead of Q1 ‘18.

Total revenue was at the high end of our guidance and operating margin any EPS were above the high end of our guidance. Results in the quarter benefited from the higher than forecasted perpetual revenue. Offsetting this upside however was an FX headed if just over $3 million and $4 million lower than forecast professional services revenue. Also note that adjusted for FX, recurring software revenue would have been at the high end of our guidance range.

Total revenue of $315 million was up 8% year-over-year. Software revenue was up 10% despite a 1,400 basis point increase in our subscription mix. Subscription revenue grew 69% and total recurring software revenue grew 15%. Approximately 91% of our Q3 software revenue was recurring.

Total differed revenue, billed plus unbilled, increased year-over-year by $301 million or 33%. Billed deferred revenue was up 4% due to the timing of quarter end, which was June 30 this year versus July 1 last year. Recurring billings on July 1 this year were about $39 million. So on an apples-to-apples basis, billed deferred would have increased 12%.

ARR grew 15% year-over-year to almost $1 billion. Our support conversion program continues to progress well with 22 direct customers converting their support contracts to subscription at an ACD uplift of more than 50%. And in our channel, the new program continues to gain traction with 92 conversions in the quarter. We believe that the conversion opportunity within our customer base is substantial and will play out over many years.

Continuing towards the P&L, OpEx of $186 million was within our guidance range, and Q3 operating margin of 18% was 90 basis points above the high end of our guidance. EPS of $0.36 was $0.02 above the high-end of our guidance. We estimate that higher than forecasted perpetual revenue and a lower tax rate together drive a $0.06 benefit offset by the negative impact from FX and lower services revenue resulting in $0.02 of upside to the high end of our guidance.

Moving to the balance sheet, cash and investments of $321 million were down $34 million from Q2 ‘18 and we completed the ASR program repurchasing 100 million of stock.

Now turning the guidance. We are adjusting our guidance to reflect current FX rates. We expect bookings in the range of $451 million to $468 million, a reduction of $5 million at the midpoint due to the $7 million negative impact from currency. This represents growth of 8% to 12% year-over-year or 12% to 16% when adjusting for that $7 million megadeal that closed early.

We now expect the subscription mix of 77% for the full year, reflecting a higher expected proportion of overall bookings from APAC, where we still offer perpetual software until January 1, 2019. We expect to exit the year around 82% mix and to achieve our 85% target makes in FY ‘19.

As Jim mentioned in his prepared remarks, we are confident that this modest mix shift does not impact achieving the long term targets we provided at LiveWorx . We expect fiscal ‘18 total revenue of $1.248 billion to $1.253 billion, a decrease of $5 million at the midpoint from our previous guidance, driven primarily by FX headwinds of $11 million and a decrease in professional services revenue, both partially offset by higher perpetual license revenue.

We are raising total software revenue guidance by about $3 million at the midpoint to $1.08 billion to $1.084 billion, driven by higher perpetual revenue, partially offset by FX. This represents growth of 9% to 10% despite a subscription mix 800 basis points higher than last year.

Fiscal ‘18 recurring software revenue is expected to grow 14%, driven by approximately 68% growth in subscription revenue and recurring software revenue is expected to exceed 90% of total software revenue for the year. We now expect operating margin of approximately 18% to 19%, an increase of 100 basis points above our previous guidance, with rapid acceleration beginning in fiscal ‘19 as the compounding benefit of multiple years of our maturing subscription business model is realized.

With the tax rate of 8% to 9% for the full year, we expect EPS of a $1.41 to a $1.46, an increase at the midpoint of approximately $0.08 over our previous guidance, which is growth up 22%. We have provided an EPS bridge in the guidance section of our prepared remarks document to assist you in modeling the puts and takes from our prior guidance.

We continue to expect fiscal ‘18 free cash flow of $210 million to $220 million, year-over-year growth of 96% at the midpoint. Adjusted free cash flow is expected to be $214 million to $224 million, which excludes $4 million of cash payments related to our October 2015 restructuring. As with operating margin, we expect free cash flow to accelerate significantly in fiscal ‘19 as the subscription model matures.

Turning to Q4 guidance, we expect bookings in the range of $135 million to $152 million. Revenue is expected to be $318 million to $323 million. Q4 operating expenses are expected to be $180 million to $183 million resulting in operating margin of 21% to 22% and EPS to $0.41 to $0.46.

With that, I'll turn the call over to the operator to begin the Q&A

[Operator]

Thank you [Operator Instructions]. And our first question comes from Steve Koenig with Wedbush Securities.

[Jim Heppelmann, Chief Executive Officer]

Hello Steve.

[Andy Miller, Chief Financial Officer]

Hi Steve.

[Steve Koenig, Wedbush Securities]

Hi everyone. Thanks very much for taking my question. Let's see, if I have only one, I'm going to ask you guys, any sign of trade frictions impacting the global demand environment? You guys are in a pretty good position to see those kind of impacts and anything – kind of expectations around that coming up.

And if I could just ask you the IoT software revenue, recurring grew nicely. The total software revenue decelerated a little bit from the nice Q2 performance. Just can you parse that out a little bit what’s happening with perpetuals and in IoT was there some swing there?

[Andy Miller, Chief Financial Officer]

Yeah, let me let me answer that one. Basically the subscription mix in IoT went up 1700 basis points from a year ago. We had a large, almost $2 million perpetual order a year ago which helped to the revenue a year ago. So it’s all driven by subscription mix. The recurring IoT software revenue grew 33%. I think we were 25% or 26% with the fact that the we had a big perpetual revenue number a year ago.

[Jim Heppelmann, Chief Executive Officer]

Yeah and on the question about trade friction, I mean we had overall a strong bookings quarter and it was solid here in the U.S. So you know I ask myself the same question, but I don't think we have any evidence right now of that, it’s something we should keep an eye on, but I think as of this moment we haven’t seen anything.

[Operator]

Thank you. Our next question comes from Saket Kalia with Barclays Capital.

[Jim Heppelmann, Chief Executive Officer]

Hello Saket.

[Saket Kalia, Barclays Capital]

Hey Jim, hey Andy, hey guys. Thanks for taking my question here. You know maybe for you Jim, strong performance in APAC where perpetual is of course more the norm; I think we saw that in this quarter’s mix. We are also discontinuing perpetual worldwide starting January 1. Can you just talk about culturally where that region is in accepting subscription and how well you think the sales force is trained to perhaps sell that way in a region after January 1?

[Jim Heppelmann, Chief Executive Officer]

Well, I think the way to look at this Saket is, if we were to go a little bit deeper into the different regions of APAC, Japan has been strongly on subscription for a long time and really the latter has been China. But if you look at Q3 of a year ago about a third of our business was subscription and if you look at this past Q3 in China, about two-thirds of our business was subscription, so actually the trend is quite positive. And you know I think at some level, if you ask what do Chinese customers want? Well, they want to steal our software mostly, that's what we've learned over the years.

So, I think to a certain extent we look around and see how other companies have been successful with subscription models in China and the answer is absolutely and so we're not really worried about cultural support. You know we think we've got a good business model. We are two-thirds of the way there and made amazing progress in the last year. You know we just need to finish the job and that's what we are planning to do.

[Andy Miller, Chief Financial Officer]

And Saket, one thing I want to add is you actually said what the norm is to buy perpetual. With two-thirds being subscription, the norm is actually subscription for us there now. So one is, you've got to frame it from that perspective. Simply the fact that we just, that we still offer perpetual, just a modest shift in mix of geos, a couple of large deals frankly is what drives the over – that subscription mix number is highly sensitive. Pretty much even million dollars is a percent.

[Jim Heppelmann, Chief Executive Officer]

Right and you know we had we a strong bookings quarter. Frankly we had a strong bookings quarter in China and a lot of the upside ended up being perpetual. So you know we're not reading much into this, and it actually doesn't mean much, because pretty soon there won’t be a choice and we're pretty confident that customers will keep buying our software, because that’s actually the trend.

[Operator]

Thank you. Our next question comes from Ken Talanian with Evercore ISI.

[Jim Heppelmann, Chief Executive Officer]

Hello Ken.

[Andy Miller, Chief Financial Officer]

Hi Ken.

[Ken Talanian, Evercore ISI]

Hello! Thanks for taking the question. Actually just to follow up on Saket‘s question. Do you attribute any of the strength in APAC to perpetual pre-buying that might present a headwind next calendar year?

[Andy Miller, Chief Financial Officer]

Not yet, not yet. We think there'll be a little bit in the fourth quarter and we even got a program running for that and we have an assumption and obviously we have good experience of end of life now in America and Western Europe. So it gives us a little bit more data to determine how much we think is going to happen in the fourth quarter, but the bigger piece will be in the first quarter.

The other thing I’d say is that you know the size of that business compared to Americas and Western Europe is so much smaller that even though, you would think behaviorally they might drive perpetual buy, it's just not that big of a business.

[Jim Heppelmann, Chief Executive Officer]

Yeah, and keep in mind, we didn’t announce the end of perpetual sales until today. So unless those customers were listening in on investor conversations like this, they would have no reason to really understand that's coming. So I don't think that was the factor. I think that just there was some deals where the customer had a strong preference and our sales guys had a strong preference to close the deal and that’s what happened.

[Operator]

Thank you. Our next question comes from Monika Garg with KeyBanc.

[Jim Heppelmann, Chief Executive Officer]

Hello Monika.

[Monika Garg, KeyBanc]

Hi. Thanks for taking my question. I have a question on the bookings guidance range. You know looking at Q4, bookings guidance range is about $17 million between low end $135 million, high end $152 million. But if I look last year or last quarter, the range has been kind of more tighter, somewhere $8 million to $10 million. Is anything leading to a larger range and what needs to happen for bookings to come towards the high end of the range? Thanks.

[Andy Miller, Chief Financial Officer]

So, you know first off you got to realize that the guide is about 40% higher than a typical quarter for us. So it makes sense it should be bigger and frankly we looked back historically at our performance in the fourth quarter, a quarter where there is a lot more big deals and there tends to be more variability. You know for example last year we ended $12 million I think it was above the high end of our guidance. The year before we ended up $21 million above the high end of our guidance. The year before I don’t know the exact amount of the guidance, but I know we were well over for example the internal forecasts.

So we think it’s more appropriate for us to have a bigger guidance range in the fourth quarter, especially because big deals can be subject to timing and a big deal can move the number and there's a lot more of them in our fourth quarter than in other quarters.

[Operator]

Thank you. And our next question comes from Jay Vleeschhouwer with Griffin Securities.

[Jay Vleeschhouwer, Griffin Securities]

Thanks. Hi, good evening. Hello.

[Jim Heppelmann, Chief Executive Officer]

Hi Jay. Yeah, we are here. We’re waiting for your question.

[Jay Vleeschhouwer, Griffin Securities]

Sorry. This question is for you Jim. You’ve assembled over last year or so quite a good set of partnerships and in history of the company which you know I go back ways with you, it's pretty unprecedented in terms of business and technology partnerships.

The question I have is, how are you managing that? That is to say you have you, Matt, Andy, Barry, etcetera at the top of the company managing that and cultivating that, but how are you permeating these relationships more deeply in the company, both in terms of technology, business and in the field, and so that’s kind of a broader corporate question.

And then just a shorter term question for you Andy, your services revenue were below expectations, you pointed out. Is there anything going on in there in terms of the timing, mix or scope or number of engagements that we should be aware of or is it mostly currency?

[Andy Miller, Chief Financial Officer]

Actually only a small amount of currency, primarily just timing of some of the big engagements, that’s really the driver. And we continue to try to make sure we are doing the most valuable part of an engagement and have a really strong ecosystem and so we continue to kind of partner with them and try to give them as much as we can, because it makes them – helps them drive demand frankly to our platform.

[Jim Heppelmann, Chief Executive Officer]

I think if I could say you know, we want to forecast and guide as accurately as possible. That said, a decline in service revenue kind of washes off our back. It doesn't mean that much loss, because it’s not our strategy to grow that business.

But coming back to your first question, I do think we are doing something that is unprecedented with partnerships. You know sort of like what we've done with operating margins was unprecedented and getting back to double digit growth rates was unprecedented for much of the time you tracked our company Jay.

But I think you know we looked and said, ‘hey, we do want to be one of the best software companies in the world and what are all the things we need to do and we have subscription, and growth and profit, but ecosystem, whether it’s the SIs or the partnerships with Rockwell and ANSYS and Microsoft and I might add MCR and Erickson and so forth. So we think the partnerships are very important.

Now we have done a special thing already with Microsoft and Rockwell and that is we've taken one of our long term executives, Tony DiBona, and put a little organization together and said, ‘Tony you head that organization and your job is to make these partnerships successful.’ So this is an executive who's reporting to me and his job is to make Microsoft and Rockwell successful.

Now he's a bit of an overly function, so the revenue will still roll up your math and so forth, but you know we want to make sure that we have people who are dedicated and it is their day job to do the right amount of enablement and support and over lay sales support and so forth and so that we are doing in terms of managing these partnerships.

We’ll probably do something like that with ANSYS, but it's just a bit premature because we don’t have the product to market yet, so that's really mostly at this point an R&D project. But I do think we are doing different and unprecedented things to try to make these partnerships work and I'm pretty optimistic it’s going to work, because Tony is a very talented executive when it comes to managing a project like this.

[Andy Miller, Chief Financial Officer]

The one thing I would add is in addition to Tony and his team, right now there's very specific and dedicated for Rockwell, program management at both companies that are driving combined work streams around account targeting, sales enablement, product integration, there's a whole set of work streams and in fact today there was a – in fact this week there's been a summit and there are 50 Rockwell folks here, including a number of senior exects, basically launching all of these work streams and launching the entire program, so we can really accelerate the success we hope to have here.

[Operator]

Thank you. Our next question comes from Rob Oliver with Baird.

[Jim Heppelmann, Chief Executive Officer]

Hello Rob.

[Rob Oliver, Baird]

Hi guys. Hi, how are you? Thanks for taking my question guys. Jim, a question for you. Obviously there's a lot of enthusiasm about the Rockwell partnership on the smart connected operations side. But on smart connected products, you know two of three reference customers that you listed were potential channels and I just want to talk a little bit about kind of where we are in the evolution of SEP and then perhaps get a little bit more color on how you kind of view those potential channel relationships. Thanks guys.

[Jim Heppelmann, Chief Executive Officer]

Yeah, actually Rob that’s a very insightful question, because what happens is we actually do have trouble sometimes determining when is one of these logos a customer and when is it a channel, because in many cases like if you take – if we take NCR for example, they want to put the thing that works in their point of sale you know, let's call them cash registers just to simplify things and they want to deliver that product to the customer site and then monitor it. So at that point they are customer.

But now they say you know, we actually want to go into the store and offer a set of services and frankly the ability to connect assets from vendors other than ourselves, so now they start looking like a go-to-market partner. Sort of like the equivalent of Rockwell is doing that in factories and NCR is doing it in stores.

So I think many SCP customers end up actually not just using the technology, but delivering services to their customer for hire based on the technology, and then they end up you know actually paying us a royalty for that. So it’s an interesting question. I mean it is a good thought to have. I don't care whether customers are partners as long as a they are successful, it's going to be great either way.

I think though for us the breakthrough with SCP is really the partnership with Microsoft, because the thing that's always true in a smart connected product use case is there’s products all over the world and you want to collect data and bring it back to some central source. That source by definition is going to be a cloud and its either going to be a private cloud or public cloud.

If it’s a private cloud we’ll just sell software. If it’s a public cloud, we don’t want to be competing with Microsoft, you know what I am saying. ‘Okay, we have a cloud for you,’ no we don't want to have a cloud we want to have a partner named Microsoft who has that infrastructure, because we don't want to be putting a proposal that you know in front of the customer that Microsoft sees as competitive. Because then we end up in an unhealthy and unnecessary competition.

So I think that the partnership with Microsoft is really, really important and I'm very pleased with the performance we had in this past quarter. It feels like we wanted to see some good evidence that that partnership is working and in fact we did, so it feels pretty good.

[Andy Miller, Chief Financial Officer]

The other thing is the 10 deals that we closed, they're actually a little bit larger than our first deal that we typically closed ourselves. So that’s our actually interesting, 10 is a small number so I don’t want to call it a trend, but there is definitely – they are larger.

[Operator]

Thank you. Our next question comes from Sterling Auty with JP Morgan.

[Jim Heppelmann, Chief Executive Officer]

Hello Sterling.

[Sterling Auty, JP Morgan]

Hey, thanks guys. So I want to drill in on the commentary and the talk of the strength in the second half from Asia has been factored into the guidance. Well based on the guidance for the second half, I guess it would imply that maybe another region is not as strong as what you originally had in the guide. Kind of curious which region that might be if that's the right read and kind of the factors for it?

[Jim Heppelmann, Chief Executive Officer]

Well you are talking about a few million dollars on $450 million and $460 million midpoint. So when we – we have multiple paths to get to our final number. As we look at the most likely outcomes of those paths, it’s a little bit more weighted to APAC where we actually have a little bit more perpetual revenue.

I mean we basically took our fourth quarter guide down by 3% as far as the mix. So that’s just one or two deals looking one way or another. We had to make a call and that’s the call we made. There's no – bottom line is, is that the GEOs are – America is performing to our plan, AMEA had a nice recovery, APAC is a little stronger than we expected. Japan’s hitting the plan for the year, has a nice Q4 forecast. So there is nothing to read into that.

[Operator]

Thank you, our next question comes from Gabriela Borges with Goldman Sachs.

[Gabriela Borges, Goldman Sachs]

Great, good afternoon. Thanks for taking the question. Jim, maybe just on Discovery Live, I’m curious, maybe based on the feedback that you've gotten since the announcement and your understanding of the composition of PTCs CAD base, do you have a sense for what percentage or what types of customers within the CAD base would be interested in buying through the Discovery Life partnership?

And then one clarification for Andy if I could. I think you mentioned a couple of times that there are large deals in the pipeline for PLM in 3Q and 4Q of this year. Just curious how the volume of large deals comprise relative to loss Jim? If there is anything interesting happening there from a vertical standpoint? Thank you.

[Jim Heppelmann, Chief Executive Officer]

Okay, I’ll take the first question on Discovery Life. So just to simplify things for the benefit of everybody, think of Discovery Life being like a spell checker in a word processing document. You used to write a lot of text and then you’d stop writing and you would spell check and you’ll find all the mistakes. You’ll fix them all and then go back to writing more new text.

And now like in Microsoft Word that spell check is running all the time and as you're typing or misspelling a word, it's already showing you that doesn't look like a word to me and if you make a capitalization mistake its correcting itself. So now take that kind of metaphor if you will and bring it over to CAD. We used to design, design, design, stop designing and go simulate find a whole bunch of problems, try to fix them all and then go back to designing. Now as you design its watching over your shoulder and literally every change you make, it tells you what are the implications of that change and that's a long way of answering your question. But I want to say is who wouldn't want a spell checker in Microsoft Word. Anybody on the phone call here that have no use for a spell checker?

So I think that everybody wants it, every single user and probably especially the ones that are creating geometry would benefit from this capability. Now we would have to figure out its kind of amazing thing and we don't know how fast and how far the penetration will go, but I will tell you, we should end up with a very high penetration of this technology into our CAD base. I would be surprised if that didn’t happen.

[Andy Miller, Chief Financial Officer]

And your second question, so in the third quarter large deals were back in our normal range, so we had a lot more than we had obviously the quarter before. The pipeline we had a lot more and we closed a lot more, we had good closed rates in the quarter and as we look at Q4, it looks like the Q4 pipeline with lots of large deals, including the average size is a little big larger frankly in the fourth quarter typically than in other quarters. So it looks like a Q4 pipeline in the software company.

[Operator]

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

[Jim Heppelmann, Chief Executive Officer]

Hello Matt.

[Matt Hedberg, RBC Capital Markets]

Hi guys, thanks for talking the questions. I wanted to circle back on Azur, you know at Analyst Day I think Jim you may have mention there are about 100 deals that you guys were working on. I know you just said on a prior question that we're quite happy with the results.

I'm wondering if you could give us a little bit of an update on what those deals look like. I'm curious, are most of these from customers within your base are using added functionality or are these – is a lot of net new. Just trying to get a better understanding for what that customer profile looks like?

[Jim Heppelmann, Chief Executive Officer]

Yeah, give me a second, I actually have a list here and I have to be careful, because I probably can’t tell you the names. But let me try to see if I could characterize them. Hang on, okay I found the page.

So let me first say, jut looking at the list, its lots of different types of customers, many of which are not our current customers and some are. I see a couple medical device companies. I see you know three of four, let's just call them diversified industrial companies. I see a few electronics companies. So you know – and frankly half the names on the list I don't know. So that doesn’t prove they are not our customers, but they are not significant customers or I would recognize their name.

So I do think it's kind of just a mixture. You know we're being successful working customers we may already know, but we're also being successful pursuing new prospects that neither one of us knows them or maybe Microsoft knows them and we just found them or perhaps Microsoft introduced them to us. So it's kind of a – it's a good combination which I think is a good thing.

[Operator]

Thank you. Our next question comes from Matthew Broome with Cowen & Company.

[Matthew Broome, Cowen & Company]

Thanks. How was demands for Navigate during the quarter?

[Jim Heppelmann, Chief Executive Officer]

Strong quarter for Navigate. Strong quarter for PLM, usually means a strong quarter for Navigate, but it was a strong quarter for Navigate, one of the highest ones actually historically.

[Andy Miller, Chief Financial Officer]

I don’t think it was a record, but it was…

[Jim Heppelmann, Chief Executive Officer]

Not a record, but it was very close.

[Operator]

Thank you. Our next question comes from Gal Munda with Berenberg Capital Market.

[Jim Heppelmann, Chief Executive Officer]

Hello Gal.

[Gal Munda, Berenberg Capital Market]

Hey guys. I just had a question on the PTC and Rockwell partnerships. You guys said that there’s some programs that have kicked off now. Lot of – already had some time to maybe asses where you guys are seeing the potential to go-to-market together and if you look at that, can you talk a bit about the customer overlap if you've managed to kind assets that space. How much of the customers from your base overlap with them and how much them and maybe proportionally then show what the opportunity is when they go out to market with IoT offering as well.

[Jim Heppelmann, Chief Executive Officer]

Okay yeah, that's an interesting question. Let me first say that during the coding process we actually did person some customers together and we did do field integration of the products just to test the whole thesis with real live customers and those tests came back very positive.

So we actually do have some sales campaigns running, but let's say we are not trying to figure out how to make that much larger, because Rockwell has roughly 35,000 major customers and several thousand people in their sales force, I think a 1000 of which carry a quota. So to us that’s a massive channel to market, but it takes work to train and enable such a channel.

But coming to your question about the overlap under lap, I’d say it’s about a third overlap and two thirds under lap. For example, Rockwell has quite strong presence in pharmaceutical. PTC does almost nothing in pharmaceutical. Rockwell does a lot in chemicals, food and beverage, you know these are not typical, oil and gas, mining and material.

These are – now we both do automotive. However it turns out that Rockwell has incredible strength in North American automotive and for PTC that’s a relative weak spot. So I think there's a kind of a mixed, but I think definitely what will happen is Rockwell Automation to be precise will bring PTC into a lot of new accounts and we in turn will bring Rockwell Automation into lot of new accounts.

So I think there is the immediate selling of the combined suite, but then how could each of us leverage. You know could Rockwell once introduced into a PTC account sell more industrial automation hardware for example? Perhaps. Could PTC sell CAD and PLM and other products that we have in our suite? Perhaps. But I think if we just kept it at the level of cross selling our respective IT, OT convergence suite, you know that by itself could be very, very interesting.

[Operator]

Thank you. Our next question comes from Shankar Subramanian with Bank of America Merrill Lynch.

[Jim Heppelmann, Chief Executive Officer]

Hello, Shankar.

[Shankar Subramanian, Bank of America Merrill Lynch]

Hi guys, thanks for letting me ask the question. I have a question on the automotive side. Could you add some color on the BMW deal, how it is progressing, and maybe as a follow-up, how is the conversation with other OEMs? Can you see any large deals or partnerships coming up in the next three to six months? Thanks.

[Jim Heppelmann, Chief Executive Officer]

Yeah well, first of all, the BMW dealer that’s a very large project and therefore we are still relatively in the early phases, but it's going very well. In fact we had a contingent of BMW executives business in the last couple of weeks and it was a very, very positive meeting. So I think you know things are going well on that project.

Now in terms of how do we take that other automotive companies. Well, let me first say the project we're doing with BMW is a special project that you know BMW needs and its highly valuable and I'm not exactly sure every other customer would need it you know. It's just between us, SCP, you know order configurator and then SCP production management system. We're helping BMW figure out if we're going to build that our as configured that way in one of these 19 batteries, a specific one, how would you build that? What would be to build material and so forth? So that's a good project.

Now that said, we have a lot of stuff going on in the automotive business right now, but particularly IoT in factories or what we call an SCO. I mention the Scandinavian project. I can tell you BMW's interested. We're doing some projects I previously talked about on these calls. Toyota, there's a number of suppliers. This is in North American and the automotive companies we’re talking to that Rockwell is helping us. So there's lots of stuff happening in the automotive industry. I would characterize it right now that the biggest entry point into these accounts appears to be IoT in the factory.

[Operator]

Thank you. Our next question comes from Sterling Auty of JP Morgan.

[Jim Heppelmann, Chief Executive Officer]

Hello Sterling.

[Andy Miller, Chief Financial Officer]

Welcome back. Sterling?

[Sterling Auty, JP Morgan]

Yep, sorry about that. I was on mute. I am back. So just one follow up question on the subscription mix commentary on 2019 that you're on target to hit the 85% with elimination of perpetual on January 1. If Kepware is the only perpetual that’s available for three out of the four quarters of fiscal ‘19 and you're still expecting 85% mix, does that kind of suggest that Kepware is north of 10% of the booking? Or really is that 85% mix you know something that you could probably blow through in terms of subscription?

[Andy Miller, Chief Financial Officer]

No, Kepware is not anywhere near 10% of the bookings. Okay, but we are going to try to drive our subscription mix as high as we can. 85% is a good model for today and we’ll update you as we see ourselves going above that.

[Jim Heppelmann, Chief Executive Officer]

Yeah, you know maybe when we think about down the road guidance next year some, you know we'll look at what's the right number, but that’s the number we’ve had out there and I think at this point just having announced today, we're not ready to revisit that yet. We certainly hope we can – I don't want to use the term bolt through it, but let's say surpass it.

[Andy Miller, Chief Financial Officer]

Yeah.

[Operator]

Thank you. That concludes the question-and-answer session I'll turn the call back over to Mr. Heppelmann.

[Jim Heppelmann, Chief Executive Officer]

Okay, great. Thank you, operator. Thanks to all of you who spent an hour on the phone with us here, I appreciate that. You know I think if you step back and look at our Q3 results, you know it's obvious once again that we're making good strong progress against our three strategic goals, our growth subscription and margin expansion. I know and you know that that will drive a lot of a long term shareholder value, so we feel good about the progress we're making and we hope that you do too. So thank you and have a good evening. Bye-bye.

[Operator]

Thank you for joining today's conference. You may disconnect at this time.