PTC Inc

NASDAQ:PTC

Earnings Call Transcript 2018-Q4

[Operator]

Good afternoon, ladies and gentlemen. And thank you for standing by, and welcome to the PTC 2018 Fourth Quarter Conference Call. During today's presentation, all parties will be in a listen-only mode and the conference is being recorded. Following the presentation, the conference will be opened for questions.

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, PTC, Inc.]

Good afternoon. Thank you, Gabriel. And welcome to PTC's 2018 fourth 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 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 and guidance provided during this call are valid only as of today's date, October 24, 2018 and PTC assumes no obligation to update these forward-looking statements. During the call today, PTC will discuss non-GAAP financial measures. These non-GAAP 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 and made available on our Investor Relations website.

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

[James E. Heppelmann, PTC, Inc.]

Thanks, Tim. Good afternoon, everyone, and thank you for joining us. As usual, I'd like to begin with the review of the quarterly and annual results and then provide some perspectives on the significant milestones and progress that we achieved throughout fiscal 2018. Q4 of fiscal 2018 was another strong quarter and it closed out another strong fiscal year, where we demonstrated near flawless execution of our strategic and operational objectives. In the fourth quarter, we delivered record quarterly bookings of $149 million and ACV of $60 million, both at or near the high-end of our guidance range.

We delivered a subscription mix of 81%, our highest level of subscription bookings to-date. Despite modest FX headwinds, total revenue was near the high-end of our guidance. Our operating margins expanded over 350 basis points year-over-year and EPS was at the high-end of guidance. In Q4, the momentum around our recurring revenue model continued with recurring software revenue growing 13% and ARR growing 12% year-over-year and crossing the $1 billion mark for the first time despite the FX headwind. This was the seventh consecutive quarter of double-digit ARR growth. Total deferred revenue grew 29% year-over-year and 90% of our software revenue was recurring this quarter. Essentially, all of the key Q4 metrics were positive, which again demonstrates the solid foundation for growth that we've established.

If I look back to the fiscal 2018 guidance we gave you a year ago, our FY 2018 results were also very strong. We came in at the high-end of the bookings range and we landed above the high-end of our guidance ranges for revenue and EPS.

As we close out 2018, we're right on track for the 2023 long range plan that we outlined in June at LiveWorx and squarely on track relative to our aspirations to be one of the premium companies in the software industry.

Fiscal 2018 is another year that we can put in the win column. To drill a bit deeper into our quarterly performance, I will again orient my discussion around our three strategic initiatives to maximize long-term shareholder value, which are: first, to increase our top-line growth; second, convert to a subscription model; and three expand our margins.

Let me start by discussing our progress on the growth front. Bookings growth accelerated in fiscal 2018 to 11% overall driven primarily by IoT which represented about 25% of our bookings for the year. While IoT didn't quite surpass PLM in the full fiscal 2018, it was close and we expect IoT to handily surpass PLM to become our second largest source of bookings in fiscal 2019, which shows that we built a new growth engine with scale.

With an increasingly larger portion of our business growing at an accelerated level, the overall growth at the company continues to rise giving us increasing confidence in our long range growth targets. From a geographic perspective, Americas delivered very strong performance in fiscal 2018 with 20% bookings growth. Europe bookings declined a bit, but that's compared against very strong results from fiscal 2017 when we had 28% constant currency growth. Also the $7 million megadeal we closed early in Q4 2017 instead of Q1 2018 significantly impacts Europe's full year growth percentage. APAC grew more than 20%, driven by solid performance in China, Taiwan and Korea and benefiting from improving performance in Japan. Japan had another solid quarter with double digit bookings growth and delivered on its full year recovery plan.

Turning now to our business unit performance, I'll start by discussing our high growth IoT business, which we report inclusive of augmented reality. IoT had good Q4, capping off a strong year. IoT growth was driven both by new customer acquisition and by expansions, with the latter accounting for over 60% of fiscal 2018 ThingWorx bookings. The acceleration of IoT expansions over the last year can be seen by the size and pace of six figure deal activity in fiscal 2018, which increased 50% relative to fiscal 2017. Q4 IoT software revenue was strong once again, posting 7% sequential growth and 42% year-over-year growth, reflecting continued strong bookings growth and the compounding benefit of our maturing subscription model.

Over the past two years, our IoT bookings have grown at a CAGR near the higher end of analysts' 30% to 40% market growth rate estimates and above the growth assumptions that we've built into our long range targets going forward. During fiscal 2018, there was broad-based momentum across major industrial IoT use cases, geographies and vertical markets. Let me begin with SCO or smart, connected operations, which is one of the faster growing sub-segments of the industrial IoT market and one where PTC is uniquely positioned.

In addition to having what is widely recognized by industry analysts as the leading SCO solution in the market today and a rapidly growing stable of referenceable production customers, we're beginning to leveraging a new large scale global distribution channel in the form of our partnership with Rockwell Automation. This strategic partnership which you recall we launched in June unites a powerful combination of technology, domain expertise, market access and global distribution that both parties believe is unrivaled.

Our partnership is off to a great start and we were pleased to see Rockwell closed several key deals in Q4, even though we're still in the early days of this venture. There were two particularly notable wins that I'd like to discuss. The first is that Rockwell Automation landed a ThingWorx deal with a major North American automotive OEM, who by the way was not a meaningful PTC customer previously.

The second is that Rockwell has closed a ThingWorx deal with a leading global metals and mining company based in Australia. These deals demonstrate how we at PTC can benefit from Rockwell's strong customer relationships, brand presence and market reach, as well as access to industries outside of PTC's traditional end markets. With solid progress on product integration and sales enablement, we see a growing pipeline that suggests this partnership will be a key element of our growth story in coming years.

Elsewhere in SCO, we closed numerous new and expansion deals in both discrete and process manufacturing. Examples of some of the wins include further expansion in food and beverage with Carlsberg, in automotive with Volvo Truck and Piaggio and in the industrials with incorporation in Stanley Black & Decker. In the SCP or smart, connected product market, we've recorded new wins and expansions in aerospace and defense like at Northrop Grumman and industrials such as Kawasaki and Kubota and communications like EchoStar and in high-tech and electronics such as Fujitsu.

The Microsoft partnership is very important to our SCP strategy and I was in Redmond this past week, meeting with top Microsoft execs to review progress. Keeping in mind that the partnership was announced in late January, we closed 28 Microsoft co-sell deals during the balance of fiscal 2018, which suggests – off to a great start working together.

At this point, there's more than 180 active co-sell opportunities in the global pipeline. We're beginning to see the strength of Microsoft's global reach extend beyond SCP and into a growing number of SCO and augmented reality opportunities. In Q4, Microsoft partnered with us to close an SCO deal with Polaris in the U.S. and an AR deal with Plantronics in Mexico.

Furthermore, we continue to deepen our partnership around Microsoft Dynamics for connected field service and with the Microsoft HoloLens and the Azure teams on the mixed realty front of AR and VR. Drilling deeper into our augmented reality business, which I'll remind you today is reported within our IoT number. We had another strong quarter with AR bookings showing 100% growth over the year ago quarter and for the year, bookings topped $20 million.

Early customers are using AR primarily for service and maintenance work instructions, factory operator instructions and virtual product demonstrations. Examples of customers adopting Vuforia include Bose in their automotive division, Royal Enfield, a leading India-based motorcycle manufacturer, and a leading Japanese automotive OEM, who is leveraging AR for service use cases in their factories. While it's still an early market, AR is showing promising signs of commercial adoption across the industrial landscape and given our strong leadership position in the market, we're confident AR will become increasingly material to PTC's growth rate over time.

To summarize on IoT and AR, Q4 was another strong data point, suggesting that adoption of these technologies continues to accelerate across the range of vertical markets, geographies and use cases.

Let me turn now our Solutions business. FY 2018 was another solid year for our CAD business. Looking back over the past two years, CAD has delivered a bookings growth CAGR in the high single-digits while outpacing overall CAD market growth rates and well ahead of the lower single-digit growth assumptions built into our long range targets.

The initiatives we've been driving to optimize our go-to-market strategies both direct and channel have paid dividends as have our new investments in capabilities such as cloud-based augmented reality design review and additive manufacturing.

As we look ahead to FY 2019 and beyond, we're very excited about our strategic partnership with ANSYS, which is nearly ready to kick into gear. It took significant development work to build ANSYS's real-time simulation technology into Creo, but the project is on schedule and the initial launch of a version of Creo that has ANSYS Discovery Live simulation embedded will happen in the first quarter – this first quarter. This software which continues to shock customers when they see it, will be in the hands of numerous strategic customers shortly and broader commercial shipments to the entire customer base will start in the second quarter.

Keep in mind that we are focusing the initial efforts of the partnership on ANSYS Discovery Live, but we plan to integrate the full breadth of the ANSYS simulation suite into Creo over time. Stay tuned for more details regarding the broader strategy to follow in the coming quarters.

I trust you'll see that in an industry that's known for meaningless partnerships, the relationships that PTC has developed with Rockwell Automation, Microsoft, and ANSYS are very real and they're becoming very productive.

Turning to PLM. Following a solid Q3 with year-over-year growth in the low double digits, our PLM business finished the year with Q4 bookings ahead of plan and up 33% sequentially. Over the past two years, core-PLM has grown at a bookings CAGR just ahead of market growth rates.

In addition to strong core-PLM technologies, our cloud-based multi-CAD augmented reality design review technology and our Navigate technology for multi-system orchestration, remains squarely in the sights of industrial customers embarking on broad-based digital transformations. With Navigate, we're uniquely positioned to expand our customers PLM footprint outside of engineering and we remain bullish about the long-term growth driver in our PLM business.

Switching to our second top level initiative to drive shareholder value, which is our transition to a subscription model. Subscription adoption trends remain strong across the globe and we ended FY 2018 with 76% of our new license bookings from subscriptions. While this was modestly below guidance due to a strong mix of bookings coming from geographies that could still sell perpetual in FY 2018, it was a dramatic 800 basis points increase over FY 2017.

As Andy will discuss in more detail later in the call, based on our performance in FY 2018 and the end of perpetual licensing globally as of January 1, 2019 except for Kepware, we're raising our long-term subscription mix target from 85% to 95%. This change drives our recurring software revenue to 98% of total software revenue by FY 2020, which of course further benefits our financial model over the long-term.

Let me discuss our third top level initiative to drive shareholder value, which is to further increase our operating margins. We have been carefully managing OpEx throughout the subscription transition and we expect that margins will expand rapidly as we exit the subscription trough. Aligned with that expectation, in Q4, we saw our operating margin improved by more than 350 basis points year-over-year and for the full FY 2018, our operating margin improved by over 200 basis points.

As we discussed in prior quarters, FY 2019 will be an inflection point in our model with operating margins expected to be up approximately 400 basis points to 22% followed by 400 to 500 basis points of additional expansion annually through FY 2021 when we expect to reach operating margins in the low 30s. But there will be more coming after that as we expect to continue to expand margins toward our new target of 37% by FY 2023.

As we wrap up 2018, I'd like to reiterate our commitment to the exciting long range plan for PTC that we've first shared at LiveWorx in June and updated today, including delivering $850 million of free cash flow in FY 2023. We made great progress in 2018 as demonstrated by the performance of our core business, by our leadership position in the high growth IoT and AR markets, by solid progress in our business model transition to subscription and our focus on disciplined cost and portfolio management. We're firmly on track to continue to transform PTC into one of the premier software companies in the world.

Reflecting on the business at a point of transition to a new year, I'm very proud of the PTC team's track record. If you look all the way back to fiscal 2010 when the current team took over, you'll see that this company has been on a roll for a long time.

At this point, it should be clear to everybody that PTC has pulled off an amazing transformation. Back in 2010, we were viewed as a mature, low growth, low margin, perpetual company and most investors didn't see much of a future. But through a series of bold changes that we've executed with surprising success, we've positioned PTC to become one of the preeminent software companies in the industry. It started with a commitment to deliver 20% earnings growth per year for five years that I remember making publicly nine years ago on the earnings call this month.

We've delivered against that promise and kept the margin expansion story going from there. Next we outlined a bold vision for growth that was built around a promise of IoT and AR, a strategy that we said would add new growth and reinforced core growth and we've delivered against that. Andy Miller joined the team and we followed his lead as we outlined an aggressive subscription conversion strategy and PTC's execution of that program has been nearly flawless.

At this point, PTC is emerging as a premium software company, a cutting edge technology leader with high growth, high margins and high recurring revenue. Against the Rule of 40, PTC is creeping up on 40, but with a long range plan that aims for 52. Perhaps most important in the boardroom of every industrial company, there's a conversation happening around digital transformation and no software company is in a better position than PTC to provide the technology solutions and knowhow that these companies need to drive their digital transformations.

We find ourselves in a target rich growth environment now with so many more opportunities available to us, as we leverage high performance computing in the cloud, artificial intelligence, generative design, additive manufacturing, IoT and AR and VR to help our customers overall how their businesses work. I'm incredibly proud of what the PTC team has achieved as I look in the rearview mirror and very bullish about the future that I see through the windshield.

With that, I'll turn the call over to Andy, who'll review the financial highlights of the fourth quarter and fiscal 2018 with you. Andy?

[Andrew D. Miller, PTC, Inc.]

Thanks, Jim, and good afternoon, everyone. Please note that I'll be discussing non-GAAP results and guidance. Q4 bookings of $149 million were near the high-end of our guidance, representing year-over-year growth of 4% and 14% if you adjust for the $7 million megadeal that closed early in Q4 2017.

For the full year, bookings grew 11% and 15% after adjusting for that megadeal. Despite FX, total revenue in Q4 was up 5% year-over-year and software revenue was up 7% despite a 900 basis point increase in our subscription mix. Subscription revenue grew 62% and total recurring software revenue grew 13%. Approximately 90% of Q4 software revenue was recurring.

For FY 2018, total revenue grew 7%, driven by 10% total software growth despite an 800 basis point increase in subscription mix. Total recurring software revenue grew 14% and subscription revenue grew 70%. Total deferred revenue billed plus unbilled increased by $318 million year-over-year or 29%. Billed deferred revenue was up 9% year-over-year despite FX.

ARR grew 13% year-over-year constant currency and exceeded $1 billion for the first time. Our support conversion program continues to progress well with 40 direct customers converting their support contracts to subscription at an ACV uplift of approximately 50%. Our channel program continues to gain traction with 106 conversions in the quarter.

As we highlighted at LiveWorx in June, the like-for-like uplift from conversions are not factored into our growth assumptions beyond the current fiscal year. And given that we are still in the early innings from a penetration perspective, we believe that the conversion opportunity is substantial and will play out over many years.

Continuing through the P&L, Q4 operating margin of 21% was within our guidance range and EPS of $0.45 was at the high end of our guidance. For FY 2018, operating margins expanded 220 basis points to 18% and EPS of $1.45 grew 24% further indication that having exited the subscription trough, our profit expansion is accelerating as expected.

Now turning to guidance. Note that for the following guidance, it's based on ASC 605. We've provided ASC 606 guidance also in our press release and prepared remarks, as well as in a presentation posted to our Investor Relations website that provides details on the impact of ASC 606.

Given the lack of comparability to historical financial results under ASC 606, we will focus our FY 2019 earnings results and guidance on ASC 605 and would encourage the sell-side analyst to submit ASC 605 estimates for consensus purposes.

Let me begin by providing some context on our FY 2019 guidance and our long-term financial targets, as it relates to three key items; FX, subscription mix, and our financial statement tax rate.

First, global currencies have been volatile over the past year. And as a result, we estimate that for the full-year FY 2019 based upon current rates, FX is an approximate 250 basis point headwind to our reported bookings and revenue growth with the more acute impact in the first half of the fiscal year. We've adjusted our FY 2019 OpEx accordingly, so that this current FX headwind won't impact our ability to achieve our long-term targets.

Second, as Jim mentioned earlier on the call, based on strong global adoption of our subscription offerings and perpetual end of life on January 1, 2019 for all products except Kepware, we are increasing our long-term outlook for subscription mix from 85% to 95%, which we expect will drive a subscription mix of 88% to 90% for fiscal 2019.

And third, a change in tax law enacted by the U.S. Treasury in late September 2018, results in an increase to our non-GAAP financial statement effective tax rate to the higher end of the 15% to 20% range we provided you in June. These three factors have been incorporated into our guidance and impact revenue and EPS as compared to the assumptions we've previously provided you.

Let me begin with the full year. We expect bookings in the range of $500 million to $520 million, which represents growth of 10% to 14% constant currency year-over-year. We are raising our subscription mix guidance to a range of 88% to 90% for fiscal 2019 and expect to be exiting the year with subscription mix in the mid 90%. Note that this higher subscription mix assumption of 400 basis points at the midpoint equates to more than $20 million lower software revenue in FY 2019, but benefits us over the long-term.

We expect fiscal 2019 total revenue of $1.32 billion to $1.34 billion which represents constant currency growth of 8% to 9% year-over-year driven by software revenue constant currency growth of 9% to 11% despite a subscription mix 1,300 basis points higher than fiscal 2018. Note that we expect the higher subscription mix will result in $54 million lower perpetual revenue in FY 2019 at the midpoint as compared to last year. It clearly benefits us over the long-term.

Recurring software revenue is expected to be $1.108 billion to $1.12 billion representing constant currency growth of 16% to 17%, and recurring software revenue is expected to be 95% of total software revenue for the year, an increase of 500 basis points over fiscal 2018. We expect fiscal 2019 operating margin of 22%, an increase of approximately 400 basis points year-over-year, reflecting accelerating software growth and continued OpEx discipline.

The midpoint of our OpEx guidance represents just 300 basis points of growth year-over-year, below our longer term target of half the rate of bookings growth. Beyond fiscal 2019, we continue to expect 400 to 500 basis points of annual margin expansion through FY 2021 to the low 30% range as the compounding benefit of multiple years of our maturing subscription business model is realized.

With an increase to our financial statement effective tax rate to 18% to 19%, we expect EPS of $1.65 to $1.75 which is approximately 20% growth at the midpoint year-over-year. We have provided a bridge in the guidance section of our prepared remarks to assist you in assessing the impact on revenue and EPS of foreign currency, subscription mix and tax rate relative to the assumptions we provided in June. Adjusted free cash flow is expected to be $273 million to $283 million, which excludes $18 million of cash payments related to the restructuring we announced today. Free cash flow including the restructuring payments is expected to be $255 million to $265 million with negative free cash flow in Q1.

Note that our free cash flow guidance includes a higher than usual amount of CapEx FY 2019 of approximately $40 million with a significant portion in the first quarter related to the leasehold improvements in our new Boston headquarters. And we expect CapEx to decline back down to historical levels of around $30 million in fiscal 2020. As with operating margin, we expect free cash flow to accelerate significantly in fiscal 2020 as the subscription model matures.

In FY 2019, we remain committed to a balanced capital strategy and in addition to the $1 billion ASR, we entered into in Q4. We intend to repurchase shares equal to at least 40% of our FY 2019 free cash flow. Such share repurchases will begin in the latter part of Q2.

Turning to Q1 2019 guidance, first, it's important to note for your Q1 2019 models that the quarter only has 90 days, fewer days than in Q4 2018 or Q1 2018, resulting in lower recurring revenue which is recognized on a daily basis. Based on our Q1 guidance, one day of recurring software revenue equates to approximately $3 million. We expect bookings in the range of $100 million to $110 million, revenue is expected to be $318 million to $326 million, Q1 operating expenses are expected to be $179 million to $182 million, resulting in operating margin of 21% to 22% and EPS of $0.37 to $0.42.

Turning now to our long-term financial targets. First, please note that there is no change to our bookings growth targets provided in June which assumes a 13% CAGR to fiscal 2023, based on our new 95% subscription mix target, which clearly benefits our model over the long-term, we are reducing fiscal 2021 revenue, non-GAAP EPS and free cash flow, but the higher subscription mix does not negatively impact fiscal 2023 targets. In fact, it creates a tailwind.

As it relates to the tax rate change, we do not expect this to negatively impact our free cash flow targets for fiscal 2021 or fiscal 2023. But we do expect an impact to our financial statement income tax expense and the resulting non-GAAP EPS. Our new long-term targets are as follows for fiscal 2023; total revenue is unchanged at $2.4 billion growing mid-teens and software revenue is also unchanged at $2.2 billion, growing mid-teens. Subscription mix is now 95%, so recurring revenue is now expected to be 98% of total software revenue, an increase of 300 basis points.

Non-GAAP operating margin is unchanged at 37%, non-GAAP EPS is now $6.30 versus the previous guidance of $6.50 due to higher financial statement in tax expense. And we continue to target free cash flow of $850 million for FY 2023. We have posted an updated long-term financial model presentation outlining these changes on our Investor Relations website.

Before I turn the call over to the operator, let me spend a moment to address the workforce realignment announced this afternoon. With the growth opportunity in front of us in the Industrial Internet of Things and augmented reality, the strategic partnerships we announced last fiscal year and our continued commitment to operating margin improvement. We are realigning our workforce in the beginning of fiscal 2019 to shift investment to support these strategic high growth opportunities. This action will result in a small restructuring charge of about $18 million in fiscal 2019. The majority of which will be paid in the first quarter.

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

[Operator]

Thank you. At this time, we'll begin the question-and-answer session. Our first question comes from Ken Talanian with Evercore ISI. Your line is open.

[James E. Heppelmann, PTC, Inc.]

Hi, Ken.

[Andrew D. Miller, PTC, Inc.]

Hi, Ken.

[Kenneth Talanian, Evercore ISI]

Hi. Thanks for taking the question. So I guess first off, given your geographically diverse business, can you give us a sense for what assumptions around the global macro you're making for – in terms of demand for fiscal 2019 guidance?

[Andrew D. Miller, PTC, Inc.]

Our current view of the global macro is that it remains stable. We're clearly aware of some of the trade concerns that are out there, but we haven't seen that reflected in our results. For example in the recent quarter we ended, a high number of large deals, the normal number of large deals in a fourth quarter, the deals tended to upsize. So we saw the same types of behavior we've seen in many quarters. We're watching, but the environment appears stable. If you look at the PMIs, they've ticked down a little bit except for North America has ticked up a bit, but they're still in solid growth territory. Do you want to add anything, Jim?

[James E. Heppelmann, PTC, Inc.]

No, just that I don't think we have on over dependency on any one geo, we're coming off a pretty good year, where frankly Europe didn't perform super great and therefore we're not overly dependent on remarkable things coming out of Europe or anywhere else, we have a good balanced plan.

[Kenneth Talanian, Evercore ISI]

Okay. And could you give us a sense for how your fiscal 2019 IoT expansion pipeline compares to fiscal 2018? And what if any feedback your customers have given you in terms of a willingness to invest in IoT in the event that their business slows down or I guess in a more – in a worse scenario we go into a recession?

[James E. Heppelmann, PTC, Inc.]

Well, I think, first of all, our IoT pipeline is quite strong and it's the reason we're plowing resources into this space is because we see the market is very interested in what we have to sell for IoT and AR, but also some of the things we're doing in Microsoft and ANSYS and so forth, Rockwell. So I think we feel good about the pipeline. We don't have a crystal ball to tell us if things would change. But I think right now we're feeling strong. We feel like our products are viewed as extremely important to end customers and there's a lot of demand for them and we're trying to make sure we have resources positioned to capitalize on that demand.

[Kenneth Talanian, Evercore ISI]

Great. Thank you very much.

[Andrew D. Miller, PTC, Inc.]

Thanks, Ken.

[James E. Heppelmann, PTC, Inc.]

Thank you.

[Operator]

Next question comes from Ken Wong with Guggenheim Securities. Your line is open.

[Andrew D. Miller, PTC, Inc.]

Hello, Ken.

[James E. Heppelmann, PTC, Inc.]

Hi, Ken.

[Ken Wong, Guggenheim Partners]

Two if I can. So, Jim, you highlighted variety of partnerships and obviously we're probably most focused on what you guys are doing with Rockwell. As we think about fiscal year 2019, any help in terms of how that partnership is contributing to bookings growth?

[James E. Heppelmann, PTC, Inc.]

Yeah. I mean, Rockwell is a significant company with a significant footprint in this SCO space. They have about 35,000 customers doing what you can loosely call smart, connected operations. It's really industrial automation, but SCO was sold into the industrial automation base and they have somewhere around 1,000 sellers. So it's a huge customer base with a huge distribution channel. They're very committed to PTC. I think we haven't disclosed the exact numbers, but we have said that Rockwell has made substantial commitments to PTC. So we know we're going to get a lot from Rockwell and they're putting their money where their mouth is. They're handing out the quotas to deliver against that. They're training the people, I mean they're taking it very, very seriously. So some good signs, we've landed a couple of accounts that we've been knocking on the door for decades already and we're pretty excited about the possibility here.

[Ken Wong, Guggenheim Partners]

And then Andy, if I could just a quick kind of as we think about the changes in the long-term financial model. I mean obviously, you guys kind of gave some of these targets just a few months back. Is it really just the coming pipeline and just what you've seen after announcing the end-of-life, that's kind of reinforced your belief that subscriptions is moving along so much faster than expected?

[Andrew D. Miller, PTC, Inc.]

Well, the main thing that happened we completed our operating plans, we have another quarter behind us where we saw subscription mix in both Americas, EMEA be well above the 85% in the quarter just ended. And we saw APAC subscription mix increase and so all those factors together reinforce our commitments that we are going to be fully subscription with the exception of Kepware. And so we've reflected that on long range plan, which is of course goodness for our long-term model, modest impact free cash flow in FY 2021 of $15 million, but clearly give us great tailwinds to that $850 million in FY 2023.

[Ken Wong, Guggenheim Partners]

Got it. Thanks a lot guys.

[Andrew D. Miller, PTC, Inc.]

Thank you.

[James E. Heppelmann, PTC, Inc.]

Thanks, Ken.

[Andrew D. Miller, PTC, Inc.]

So one – there's another comment I wanted to make about the long range plan. If you actually look at where we ended FY 2018 from all the metrics recurring revenue at the higher end of our guidance for example. It's clear that we start FY 2019 better positioned for that long range plan than we had laid out even back in June.

[James E. Heppelmann, PTC, Inc.]

Okay. Operator, next caller.

[Operator]

Okay. Next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is open.

[James E. Heppelmann, PTC, Inc.]

Hi, Jay.

[Jay Vleeschhouwer, Griffin Securities, Inc.]

Thanks, good evening. Hi. I'm going to avoid the morass of the ASC 606 discussion, so let's talk about a couple of organic things. Jim, you highlighted again the resurgence of the CAD business, still your largest, and let me ask you about that, when you look back over the last couple of years and when you're thinking out over the next couple of years, can you comment on how much of that improvement is retooling or upgrading phenomenon within your base, which would ultimately be limited. Or are you in fact seen a growing contribution from new customers, if it works for Creo. And then similarly, how are you thinking about the increment from Discovery Live, you talked about some arithmetic on that at LiveWorx, was that just an example or when you talked about one quarter penetration of the Creo base or is that something you're explicitly aiming for, then I have a follow-up.

[James E. Heppelmann, PTC, Inc.]

Yeah. Okay. Well, the first thing I would say on the retooling of the existing base versus new sales, our reseller channel has done really well in the past year.

[Andrew D. Miller, PTC, Inc.]

More than double-digit growth for the past two years.

[James E. Heppelmann, PTC, Inc.]

Right. So they are real – I mean none of us CAD vendors are flipping big accounts anymore. That ended some years ago, but there's a lot of new accounts coming in as startup companies and so forth and that's where our channel plays. And so the fact that the channel has done so well, but really it can only happen if we're taking a good amount of share in new customer pursuits. So I feel pretty good about that – less frankly because the product has improved so much, it always had a terrific engine, it just the user interface and so forth, got a little tired and that's all behind us now. Product looks great, works great, viewed as the premium product in the industry.

Looking forward, we are exceptionally excited to bring this ANSYS stuff to market. I mean it is jaw dropping when people see the demonstrations of it. Particularly jaw dropping to see what ANSYS technology can do inside a CAD system Creo. And you just watch people, it's unbelievable. So we are very bullish, I don't want to give you specific guidance, but we do think that 25% penetration is a target that's achievable over some period of time. And it will be a big tailwind for what we're doing.

Now further out beyond that, there's a couple other tailwinds that aren't quite as close in let's say the ANSYS stuff. To be clear, we're going to take orders for ANSYS in Q1 here in fiscal 2019, not a lot yet, because we're really doing a roll-out to preferred customers to make sure we get good feedback and tweak anything before we turn it loose and open the floodgates. But beyond ANSYS additive manufacturing, topology optimization and the bigger topic of generative design, there's a lot of stuff happening in the CAD world, that's this really changing kind of what people think of CAD.

And I think PTC is very well positioned now with ANSYS and with other technologies we've been developing and talking about. So I actually think PTC is probably more bullish on CAD than we've been the decade or maybe even in two decades, frankly. This business feel like it's got a lot of legs and we'll continue to perform reasonably well, I'm not going to tell you it's going to be a double-digit growth business for a long period of time. But I think it's got a lot of momentum and there's a lot more opportunity because the industry is changing and creating this new opportunity and we're well positioned to capitalize on it.

[Andrew D. Miller, PTC, Inc.]

And, Jay, one thing I'll add is while our aspirations are certainly very high and we're excited about it, we have a low single-digit growth factored into that long range plans.

[Jay Vleeschhouwer, Griffin Securities, Inc.]

A follow-up on support conversions. How are you thinking about that by geo? I mean, if my math is right, it looks like EMEA support revenue is at least as large as in the Americas. And would that then perhaps by geo suggest a substantial remaining support conversion opportunity there?

[Andrew D. Miller, PTC, Inc.]

Yeah, there's a bigger support conversion opportunity in Europe than in the Americas, but it's still quite sizable in the Americas as well. The Americas has done more conversions as you would expect, the sales people that are closer to headquarters tend to jump on these things more aggressively, but EMEA actually has accelerated the last couple of quarters. And they are not that far behind as far as the number they've done in the enterprise space and then big opportunity in, frankly, Japan, where they have done only a handful, but quite sizable ones.

[Jay Vleeschhouwer, Griffin Securities, Inc.]

Thank you.

[James E. Heppelmann, PTC, Inc.]

Thanks, Jay. Operator, next question please. Gabriel? Hello?

[Operator]

And our next question comes from Steve Koenig. Your line is open.

[James E. Heppelmann, PTC, Inc.]

Hello, Steve.

[Steve R. Koenig, Wedbush Securities, Inc.]

Hey, thanks for taking my question guys. Hey thanks for sharing us the details of ASC 606 on the call back in Jay's remarks. So we do look forward to hearing that another time. I do want to ask you guys, so kind of like Q3 you skewed again a little heavier to Asia. ACV was okay, but it kept a lid on the subscription mix a little bit. What's your sense of what's happening in Europe and what are you doing about it execution wise or is it more of a macro issue? Any color there would be helpful. And then just to add on my quick follow on will be, can you discuss any – I know you are early days in seeking to move – new initiatives to move renewal rates up further and just any commentary there that would be helpful too? Thanks guys.

[Andrew D. Miller, PTC, Inc.]

So first, Steve, I do want to clarify that it takes like one, small seven figure deal frankly in one geo versus another perpetual versus subscription to be that 1% difference in the subscription mix. And we've actually gotten smarter, you notice for FY 2019 we gave you a range for the subscription mix of 88% to 90%. So because it's not perfect, we don't close every large deal in the pipeline and we're trying to do our best to guess which ones are going to close and which ones aren't.

Now APAC clearly was strong with growth more than 20% in bookings. EMEA, while down in fact if you look at the – EMEA down in the 10% range. If you actually adjust for that megadeal that closed in EMEA in Q4 2017 versus Q1 of 2018 then EMEA for the year just flipping it from one year to the next would have been almost flat, still not great performance. But we had 28% constant currency growth last year. And if you took that big deal out of last year, they still have low 20% constant currency growth. So EMEA has been executing fine. We always aspire to do better, but they actually – there's just lumpiness frankly by big deal contribution. We would never have an operating plan for example for EMEA to grow 28% constant currency.

[James E. Heppelmann, PTC, Inc.]

Yeah, another thing I would point out, if you look at the PMIs Europe was superhot and they've cool down, but they have been throughout and remain well above the PMIs in Asia. So I think we're really talking about good situations versus great situations and maybe Europe schooling from really great, just good or something like that I don't know. But we don't feel right now concerned about what we see in terms of pipeline and opportunity in Europe.

[Steve R. Koenig, Wedbush Securities, Inc.]

So just to clarify, sorry. So you're not, there's lumpiness here and you're not seeing any sort of execution issues that need to be addressed. Is that a fair read?

[Andrew D. Miller, PTC, Inc.]

That's a fair read, yes.

[Steve R. Koenig, Wedbush Securities, Inc.]

Okay. Got you. And then, you guys are doing some work on renewal rates. Any update there, any color you can give there?

[Andrew D. Miller, PTC, Inc.]

Yeah, it would actually our best quarter ever when it comes to renewal rates. So we continue to progress ahead of our plans.

[Steve R. Koenig, Wedbush Securities, Inc.]

Awesome. Great. Thanks a lot guys.

[Andrew D. Miller, PTC, Inc.]

Thanks.

[James E. Heppelmann, PTC, Inc.]

Thanks, Steve.

[Operator]

Next question is coming from Matt Hedberg with RBC Capital Markets. Your line is open.

[James E. Heppelmann, PTC, Inc.]

Hello, Matt.

[Matthew Swanson, RBC Capital Markets LLC]

Hey guys, this is actually Matt Swanson on for Matt. Andy, can you talk a little bit about how you're thinking about subscription price increases. I don't think you've done any since you've done the transition. And then just kind of elaborate on that, how important the innovation, the product portfolio is the company's pricing power.

[Andrew D. Miller, PTC, Inc.]

Yeah, so we raised subscription prices by 5% on October 1, and in certain geos where the currency moved even more, we've raised it more aggressively than that. So we did our first subscription price increase. Our industry does tend to raise prices every year and we're no longer trying to promote subscription over perpetual as we only have, as we stand now just over two more months left of perpetual. So we've raised those prices. Of course they don't go into effect until a renewal comes around and their pricing is off of the new subscription price list.

The second question, probably a good one for Jim, just as far as how innovation gives us pricing power. Fundamentally...

[James E. Heppelmann, PTC, Inc.]

Well, I think what I would say is that innovation puts us in an opportunity to win the deal. And I don't think the price of the software is the key criteria...

[Andrew D. Miller, PTC, Inc.]

No.

[James E. Heppelmann, PTC, Inc.]

...in selecting a vendor, it's the fitness and the belief in the technology. And I think when it comes to fitness and belief in the technology, nobody wants to pick the wrong vendor. And I think PTC does not feel like the wrong vendor to anybody right now. We've got a lot of momentum, a lot of brand recognition. We do exceptionally well in all the big analyst reports from Gartner and Forrester and a bunch of other guys.

So I think we have some flexibility not to play a price game, and still win the deal and not make it about pricing, it's about innovation and quite frankly the fitness of your product to solve the problem and to remain viable then for years to come because it's sticky stuff and you're not going to use it for just a couple of years. So you want to make sure that this vendor is going to be in the game for a long time and people feel good about us.

[Andrew D. Miller, PTC, Inc.]

The one other thing I'll add around pricing efforts, so I'm going to start talk about pricing strategy and then pricing realization or discounting. Pricing strategy, we did a conjoint pricing study, and October 1, introduced new pricing and packaging for Creo, which we think gives us an opportunity frankly to drive people to higher price points and raise the overall average price of a Creo seat. So that was a study done last spring and effective October 1.

The PLM Group has also done their first conjoint pricing study and they are pricing and repackaging Windchill and they think there's great opportunity as well to strategically realize more from customers. That study is done and January 1 pricing and packaging for PLM will – new pricing and packaging will roll out.

And we've just embarked on ThingWorx and Vuforia Studio. We're embarking on a conjoint pricing study there as well. Again, to optimize pricing from a strategic perspective to make sure that we've got the right, kind of good, better, best types of offerings that enable us to optimize revenue.

On discounting, we continue to drive lower discounts. And as we enter fiscal 2019, we told you about our deal scoring, where reps make more commissions if they give less discount to get an A deal versus a B, C, D or F. Well, we made it harder to get an A or a B or a C once again this year. So every year that has driven our average discount down and we expect it also to drive it down further in FY 2019.

[James E. Heppelmann, PTC, Inc.]

Yeah, in fact, I mean we are talking about what, 15, 20 points?

[Andrew D. Miller, PTC, Inc.]

Yeah.

[James E. Heppelmann, PTC, Inc.]

...of improvement.

[Andrew D. Miller, PTC, Inc.]

Yes.

[James E. Heppelmann, PTC, Inc.]

Since we put this program in place a couple of years ago, saw dramatic improvement and one takeaway from that, is when the sales guys see differential comp, they don't discount much, which tells you we never had to discount in the first place. So it actually is a comment about pricing power, is that maybe some years ago, when we had a discounting problem, we were just frankly too willing to give away a discount that you didn't need to give away. Maybe it lubricated the deal, you got it sooner with less work, but frankly that extra little bit of work was worth it because the deal became substantially bigger. So I think it's a proof point that we do have some pricing power and that frankly we were misusing it in the past and we've made great progress. We really don't have a discounting problem anymore.

[Andrew D. Miller, PTC, Inc.]

Yes.

[James E. Heppelmann, PTC, Inc.]

It's a problem that dogged us for a decade and a half and it's kind of behind us now.

[Matthew Swanson, RBC Capital Markets LLC]

That's great. And then if I can ask one more to Jim, going to the workforce realignment, I guess when we talk about IoT being bigger than PLM next year, and I think we've talked about long-term IoT being the largest business. Is there a way to think how close the workforce would be ready for it being the largest business, is this one step in the right direction or do you think it will have to be kind of continuous changes to realigning the workforce further?

[James E. Heppelmann, PTC, Inc.]

I think, you should think of this as almost like ASR on a stock buyback, one big upfront step and then the rest of them aren't such a big deal. So we've been making alignment but as we went into this new year and really looked at the size of growth, the opportunity we have with IoT and AR, we said, we've got to move a lot of resources and we've got to do it quickly. So we did take a restructuring charge. I don't think you should expect us to take a restructuring charge annually, but I think we will continue to migrate resources into the places where they get more growth.

The amazing thing is we have 6,000 employees now and we had 6,000 employees a number of years ago, and it's the reason why we've been able to keep driving margins up, maybe we have a few more than 6,000, but relatively flat employment over a period of five years, while the growth really has materialized, it's how we've driven margins up, and it's a strategy we've got to remain disciplined and stick to.

[Andrew D. Miller, PTC, Inc.]

The other thing I'll add is that, this past planning cycle, the sales and marketing team really did a much stronger portfolio analysis frankly to cutoff the long tail, which is where you get a lower return on your investment, to make sure that we had the right reps in the right geographies on the right products to drive the optimal growth, that is really our opportunity out there. And that's what drove a good piece of the restructuring charge. We looked at profitability in every single country and where the profitability didn't make sense, we basically moved resources out. Accepted that maybe we'll have a little bit lower bookings in that country, but we have a lot more opportunity by putting in those sales and marketing resources in an area where there's really growth for IoT and AR. So it was the type of portfolio management, that's easier to do in R&D around how many people you have working on a product. And we did that quite rigorously on the go-to-market side.

[James E. Heppelmann, PTC, Inc.]

The other point just to add, it came up in the discussion, but we also solved for FX in our earnings program.

[Andrew D. Miller, PTC, Inc.]

Right.

[James E. Heppelmann, PTC, Inc.]

So we were even more aggressive on portfolio management because we said, we have to come out of this with the right configuration of resources and we have to solve for FX at the same time. So that's really why we took the restructuring charge. And again think of it like an ASR, it's the way that accelerates the first phase of something.

[Andrew D. Miller, PTC, Inc.]

Yeah, when FX goes against you, we have two levers; pricing which we executed on and then frankly, how much we spent, so you have to adapt to the environment you're playing in, and so we did that.

[Operator]

And our next question comes from Saket Kalia with Barclays. Your line is open.

[James E. Heppelmann, PTC, Inc.]

Hello, Saket.

[Saket Kalia, Barclays Capital, Inc.]

Hey, Jim. Hi, Andy, thanks for taking my question here.

[Andrew D. Miller, PTC, Inc.]

Hi.

[Saket Kalia, Barclays Capital, Inc.]

I'll just keep it to one, in the interest of time. Andy, it was helpful commentary on the moving parts in the fiscal 2021 guide. But maybe just to dig a little deeper, it seems like the higher subscription mix call it 10 points is taking out, let's call less than $100 million in revenue. And it looks like we're taking about $15 million out of the free flow target for fiscal 2021 as well. My question is, can you just talk about that revenue dynamic a little bit as well as the associated cash flow and if we're sort of reading that correctly?

[Andrew D. Miller, PTC, Inc.]

Yes. If you actually do the math it's less than a $100 million, but those targets are rounded. So the target before was rounded, the target now has rounded, so everything is rounded to $100 million all the revenue lines that we've done. We actually did the math, it's like $65 million or something is the actual difference on revenue, just 10% higher mix. So 10%, if you took our bookings that we just guided $500 million to $520 million, assume 13% CAGR moving forward take it to FY 2021 and then took 10% of that, that's how you get about $65 million difference in revenue. And the free cash flow is also frankly we had a little bit of cushion in there. So it ended up being just a small take down to the free cash flow with that higher mix. But it does give us frankly a tailwind to the FY 2023 free cash flow target.

[Saket Kalia, Barclays Capital, Inc.]

Got it. Very helpful. Thanks, guys.

[James E. Heppelmann, PTC, Inc.]

Yep, thank you.

[Operator]

Okay. And with that I'll turn the call back over to Jim Heppelmann for closing remarks.

[James E. Heppelmann, PTC, Inc.]

All right, great. Thank you, Gabriel. Well, and I thank everyone for joining us on the call and spending an hour with us. I think if we all step back and look at fiscal 2018, it was a pretty good year. We did some amazing things on partnerships with Rockwell Automation, and the ANSYS, and Microsoft, our IoT and AR business did well. Our bookings and software revenue growth accelerated, customer success and renewal rates was a great story, conversions were good, cost management was great, margins were up. So it was a very good year.

We're about 60 days from wrapping up the end of almost all perpetual licensing with one little exception. So we're almost done in terms of moving to subscription. We'll soon be there. And then it will take a while for it to catch up to us in terms of the profit and in revenue growth. But anyway we're in a great place. We're doing well on the growth front. We're doing well on the profit front. We're doing well on the subscription front. We're in a great place, we think we can and will drive a lot of long-term shareholder value. So thanks and have a good evening, talk to you in 90 days, if not sooner.

[Operator]

And with that, we'll conclude today's conference. Thank you for participating and you may disconnect at this time.