James Hillier - James E. Heppelmann - Chief Executive Officer, President, Member of National First Executive Advisory Board and Director Jeffrey D. Glidden - Chief Financial Officer and Executive Vice President.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division Sterling P. Auty - JP Morgan Chase & Co, Research Division Steven R. Koenig - Wedbush Securities Inc., Research Division Matthew L. Williams - Evercore ISI, Research Division Saket Kalia - Barclays Capital, Research Division Jay Vleeschhouwer - Griffin Securities, Inc., Research Division.

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

Thank you, Deborah. Good morning, everyone, and thank you for joining us on today's fourth quarter fiscal 2014 earnings call. As a reminder, today's call and Q&A session may include forward-looking statements regarding PTC's products, our anticipated future operations or financial performance.

Any such statements will be based on the current assumptions of PTC's management and are subject to risks and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties is contained in PTC's most recent Form 10-K and 10-Q on file with the SEC.

Unless otherwise indicated, all financial measures in today's call are non-GAAP financial measures. Reconciliation between the non-GAAP measures and their comparable GAAP measures is located in the Q4 2014 press release and prepared remarks documents on the Investor Relations page of our website at www.ptc.com.

With us on the call this morning is Jim Heppelmann, our President and CEO; and Jeff Glidden, our CFO. With that, I'll turn the call over to Jim..

Thank you, James Hillier. Good morning to all of you, and thank you for carving time out of your day to join us on our fiscal 2014 Q4 earnings call this morning. There's a lot to talk about as we wrap up 2014 and transition into fiscal 2015. It will be hard to squeeze it all into this one call.

So I'd like to start off by reminding you that we have our Investor Day scheduled for November 13, 1 week from today, at the NASDAQ MarketSite in New York. So we'll introduce a few new topics today, and we'll plan to go much deeper into these topics at the event next week. We were pleased to see our fiscal 2014 end on such a strong note.

Our fourth quarter results exceeded the high end of our guidance ranges for license revenue, total revenue and earnings per share, which, in turn, allowed us to deliver a solid full year fiscal 2014 result and also exceeded our expectations for license total revenue and EPS.

Having achieved our 20% EPS growth goal for a fifth consecutive year, I think we can put 2014 into the win column. Our performance against this aggressive goal has created a lot of believers, both inside and outside the company, as we've driven our EPS from $0.80 per share in 2009 to $2.17 per share in 2014.

On a geographic basis, the fourth quarter mirrored the full year results. We saw solid growth in the U.S. and in Europe. In Japan, we had modest growth at constant currency but saw that growth dissipate as a result of currency movements.

Our Asia Pac business continued the recent trend of disappointing performance, particularly in China, where the economic and political situation continues to be a strong headwind for us.

Our core CAD and Extended PLM businesses have rebounded well for both the fourth quarter and for the full year, in each case increasing their growth rate by about 10 percentage points over 2013.

Our SLM business posted disappointing results for the quarter and for the year as we worked our way through a pipeline rebuilding effort following the Servigistics acquisition. As we exit 2014, however, the SLM pipeline is strong, and we're anticipating a solid uptick in the performance of that business as we go into 2015.

If I were to separate our IoT business, Internet of Things business, from SLM, the IoT business would not have a comparable in fiscal 2013, but I can tell you that the ThingWorx and Axeda companies that we have acquired have both grown considerably versus their own year ago comps, and we expect to build on this momentum at PTC.

The numbers are not yet large, and the partial year results didn't have much effect at all on PTC's 2014 results.

But a complete year, coupled with the growth rates we've been seeing, means that this contribution will grow quickly and begin to move the needle a bit already in 2015 and increasingly more so as we move further out into 2016, 2017 and 2018.

We believe that the strategic moves we made since 2009, and especially those we made in 2014, give us a tremendous opportunity to create a new era of growth at PTC.

The Internet of Things is the #1 topic of interest right now in the field of information technology, and PTC has a legitimate opportunity not only to play in this market, but to emerge as a bona fide leader. And it isn't just an interesting adjacent market for us. I truly believe it will redefine what CAD, PLM, ALM and SLM are all about.

At PTC, after spending more than 2 decades helping customers create physical products with CAD and PLM, over the last 5 years, we've been helping our customers expand into smart products with ALM and to optimize their aftersales service business with SLM.

The Internet of Things is really about connecting these smart products to the Internet to create feedback loops that inform not only the owner or operator but the engineers who created the products, the service department who needs to keep them up and running, and the sales and marketing department who want to optimize their relationship with the customer.

The power of smart connected products to transform the way the products are created, operated and serviced is spelled out in some detail in the cover story of the November 2014 issue of Harvard Business Review, which was coauthored by Professor Michael Porter and myself.

I encourage you to take a look, as it will provide tremendous insight into how PTC is thinking about this opportunity. As the existence of the article itself might imply, I've invested a tremendous amount of personal energy into understanding this phenomenon.

And long ago, I came to realize that the products our customers manufacture are the things on the Internet of Things, and that our industry can't really do justice to the term life cycle management of these things without enabling and then leveraging these powerful feedback loops.

So the Internet of Things is not just an interesting new business opportunity to pursue. It's also an opportunity to dramatically improve the capabilities, value proposition and differentiation of our CAD, PLM, ALM and SLM offerings. We will show some exciting evidence of what I'm talking about at our investor event next week.

As our sales kicked off last month, I witnessed an incredible buzz because our sales teams in the field are realizing how exciting it is to talk to customers and prospects about smart products, connectivity and then optimizing their service offerings and business models.

This message really resonates, and we tend to find ourselves in the corner office relatively quickly. And this conversation takes us to a different world, where our traditional competitors cease to be relevant because they simply don't have this solution set.

Because we see so much opportunity to both upsell existing accounts and to penetrate new accounts, we're dedicating a segment of our sales force to pursuing new IoT opportunities in 2015. This sales segment will focus primarily on landing new logos with IoT outside our current customer base.

As we land these new logos, we'll work to expand our position by introducing SLM, which is really the killer app for IoT, as well as ALM, PLM and even CAD technologies over time.

This strategy is an extension of what we did very successfully last year when we segmented our sales group into full product line sellers, product development sellers and service sellers. Bob Ranaldi, our EVP of Sales, will cover this during his presentation at Investor Day next week.

Between the various segments of the sales force who are either landing or cross-selling IoT solutions, we expect that by the end of 2015, we'll have approximately 400 IoT accounts, which is roughly double the current level, and $40 million to $50 million of run rate IoT revenue. That will give PTC a strong claim to IoT leadership.

The success that we're having with IoT is a catalyst that's causing us to accelerate the evolution of our business model and to adopt subscription at a faster rate. Obviously, our support revenue is slightly more than half of our total revenue already, and that is subscription-based.

But of the roughly 30% of our revenue that's historically been classified as license, the amount that is subscription is increasing quickly. In 2013, about 4% of our license revenue was term- or subscription-based and recognized ratably. In 2014, about 8% of our license revenue was term- or subscription-based.

And in 2015, we're projecting that about 15% of our total license and subscription services business will be subscription-based, whereas 85% will be perpetual. So you can probably see why we need to begin to disclose the size of this very valuable revenue stream. You will see good detail about it in our Q1 earnings release in about 90 days.

There are a few key factors that are driving this rapidly expanding subscription business.

First, our IoT business is built around the acquired ThingWorx and Axeda businesses that are already subscription-based, because that is the model these companies deployed from their inception, but our research with customers shows considerable interest in subscription pricing beyond that.

Our customers like the flexibility of being able to reconfigure what they use on a periodic basis. They like the ability to draw from their OpEx budgets, which the buyers directly control, rather than from their CapEx budgets, which they frequently must share control.

And of course, smaller companies like the opportunity to get started with less upfront capital needs. In many cases, they not only want subscription licenses, but they want cloud services as well to have a full SaaS type of engagement. Customers have definitely shown so far that they're willing to pay a premium price to gain these extra advantages.

Obviously, this rapidly expanding subscription business has the effect of pushing more revenue into the future, which adds pressure to near-term revenue and profitability. At the same time, these subscription contracts have a substantially higher net present value to PTC.

The guidance numbers we've shared in the press release and in the prepared comments already contemplate that 85% of our license and subscription solutions business will be booked on a perpetual basis in 2015, with subscription being the balance.

But of course, if the subscription part of the mix were to come in even higher, it would impact those numbers to a degree, yet it would bode well for the long-term health of the business.

Please do keep in mind that in addition to the revenue that we report in the license and subscription solutions line of business, we would expect to end the year with a meaningful amount of additional bookings, whose revenue will be recognized in future periods.

We will disclose and report this information each quarter so that you can fully appreciate its value, but we're not planning, at this point in time, to guide to it.

With respect to having a hybrid model, our position in 2015 is that we'll offer a premium-price subscription model as an option to our customers who've traditionally done perpetual business with us, but we will not actively push the business yet in that direction.

We'll hold the compensation roughly neutral for our sales force so that the customer preference shows through. Naturally, with more data, we may recalibrate our position with respect to the attractiveness of this model to our customers as we get through 2015 and beyond. Looking forward to 2015, we feel that we have a great plan.

If you were to think about it at constant currency, we're guiding to what would be very respectable license and subscription solutions growth rates, and we're guiding the EPS growth north of 15% at constant currency.

Both of these growth rates are inclusive of the fact that a growing percentage of our license and subscription solutions revenue will be subscription-based. But as you know, foreign exchange rates have changed dramatically on a year-over-year basis, and this has a significant impact on both our revenue growth and our earnings growth.

There are, of course, other headwinds that we're mindful of. The macro headlines coming out of Europe over the past few months have been quite pessimistic. So we're not planning for a repeat of the growth rates we saw in 2014, and we're not expecting to see a rebound in the situation in China yet in 2015 either.

But after adjusting for currency and taking a prudent view of the macro situation, we feel that we still have a relatively strong plan for 2015. We're feeling good about the long-range plan through 2018.

We believe our growth prospects are improving as our mix of business naturally shifts over time toward market segments like SLM and IoT that have stronger market growth rates, and we continue to believe we have more margin expansion opportunity as we move from the mid-20s margins of today towards that 28% to 30% goal.

The team is very proud to have delivered 5 consecutive years of 20% EPS growth, and we're ready to sign up for 4 more years of 15% EPS growth going forward. I've downloaded a lot to you here this morning, and I'm sure there will be many follow-up questions.

We'll probably get to a few of them today, but I remind you again that our Investor Day event scheduled from -- 1 week from today will provide a great opportunity to get much deeper into all these different and exciting topics. With that, I'll turn it over to Jeff Glidden, our Chief Financial Officer..

ThingWorx in January, Atego in July, Axeda in August. We expanded our credit facility to $1.5 billion in September with a very positive and supportive group of 16 banks. In July, our Board of Directors approved a multiyear capital allocation strategy to use approximately 40% of free cash flow to repurchase PTC stock.

The board also authorized the company to purchase up to $600 million of PTC stock through 2017, and in August, we launched an accelerated share repurchase program to purchase $125 million worth of PTC stock. This year, repurchase program is in place, and we expect it to be completed in our second quarter.

And we would plan to repurchase additional shares during FY '15, consistent with our long-term goal. During the year, we expanded our operating margins by 300 basis points to 25%, and we increased cash flow from operations by 36% to $305 million.

A cornerstone of our financial program has been the expansion of operating margins and our commitment to deliver annual EPS growth of 20%. Clearly and consistently, we had delivered against these financial goals. And while we have accomplished a great deal to date, we have also built a solid foundation for the future.

We have established a set of key goals, targets and programs to deliver 15% EPS growth through 2018. Our key long-term targets include annual revenue growth of 6% to 10%, including revenue from strategic acquisitions. We've invested in sales programs and technologies, such as salesforce.com, to enhance sales execution and to increase productivity.

We consistently utilize pipelines in sales activity metrics to plan, manage and improve our performance. We plan to expand operating margins to 28% to 30% by 2017 and into 2018 and beyond.

This will be accomplished by driving improvements in overall productivity, continued expense controls and disciplines, coupled with improving margins in our professional services business. We continue to build out our partner ecosystem and plan to increase our services margins to 20% by 2018.

Please note that cloud services, which traditionally have been reported within our services line of business, will, in the go-forward model, be included in our subscription line items.

We expect our longer-term sustainable tax rate to be 18% to 20% through 2018, and through programmatic repurchases of PTC stock, we plan to reduce PTC share counts to approximately 112 million shares by 2018.

While we are confident in our long-term plans and opportunities, as we enter 2015 we are faced with near-term headwinds from currency and the increasing macro uncertainty in global markets. Over the past several months, as Jim said, we've had very significant unfavorable shifts in currency.

When compared to 2014 currencies, the weakening of the euro and the yen have the effect of reducing our FY '15 revenue by approximately $50 million or about 4 percentage points of growth, and reducing our EPS by approximately $0.15 per share or 7% of growth.

Given this background, we expect FY '15 revenues to be between $1,365,000,000 and $1,385,000,000, and we expect EPS to be between $2.33 and $2.40 per share. For the first quarter of 2015, we expect revenue to be between $310 million and $325 million, and EPS to be $0.47 to $0.51 per share.

And finally, I look forward-looking to seeing all of you at our Investor Day in New York next week. We appreciate you joining us today, and now we'll turn the call back over to James Hillier..

Thank you, Jeff.

Deborah, can you please give instructions for the Q&A process, please?.

[Operator Instructions] The first question comes from Matt Hedberg from RBC Capital..

I'm sure we're going to get into this a lot more at Analyst Day next week, but I'm wondering if you could walk us through maybe some of your high-level assumptions that -- I think you pointed out over a 3- to 5-year period, the NPV of a subscription is likely to exceed that of a perpetual license..

Okay. Matt, I'll take that. And we're looking at pricing models that we think are both attractive to the customers and attractive to PTC. And as Jim said, we'll initiate this with more of a premium program to give people flexibility. It's the concept of, if you buy the car or you rent the car or the home, you're going to pay more for that flexibility.

So when we look at it, the models that we put together on a 3-year basis are typically slightly favorable on NPV. And when you go beyond that to 4 and 5 and well beyond, the NPV is significantly better. I would just say that, as you know, many of our customers have been with us for a decade or more.

And so over the long run, we think this is a very favorable trend in the overall financial outlook for the business, and you'll also see this as we'll report bookings and annual contract value, but you already see the trend and the impact on deferred revenues.

Deferred revenues increased by about $45 million last year, in part reflective of the new models and those shifts. So I think we're seeing that in a positive way, which is positive cash flow and future revenue recognition..

That's great. That's very helpful. I'm sure we'll get into it more next week. And then obviously, there's a lot of variables that can impact next year's numbers, and I understand you're not guiding to metrics like billings here.

But should we expect both billings and cash flow to grow faster than revenue and earnings as we move through this transition?.

So the answer is yes on billings. On cash flow, I would expect it to grow at roughly the same rate as billings with one caveat. We have a few -- we've identified this in the prepared remarks. We are doing some additional funding on pension programs as we close out some of those programs. So that will have a negative effect.

It actually feels more like a capital contribution, but it shows up in operating cash flow. So I think that's about $45 million of funding for pensions as we close out the -- really what was the Computervision U.S. pension and we fund some incremental. These are pensions, by the way, that we acquired.

As we did acquisitions, we inherited these, and we are basically looking at those as things we can get cleaned up. So I would say generally, I would expect cash flow to grow at roughly the rate of billings, which would be faster than revenue and probably similar to EPS..

The next question comes from Sterling Auty from JPMorgan..

I wondered on those subscription program. Is this going to be -- we see a number of other software companies utilizing what I would consider a token-based subscription. So each product has a certain token value and you give the customer the flexibility to swap in and out of different products. I'm wondering if that's going to be the basis.

And could they -- are they going to be able to swap among any of the products? Or are you going to kind of compartmentalize and say, "Okay, you're going to have a design suite where you can swap between -- or an IoT SLM suite that you can only swap between those products"?.

Yes, Sterling. So that's a good question, but in fact, our program will not be token-based. Customers will subscribe to seats of software at varying capability levels. And for the duration of the subscription, that's what they subscribe to. Now when that subscription comes up for renewal -- and we'll have 1-, 2- and 3-year subscriptions.

So when that comes up for renewal, then there's always going to be an opportunity to say, "Well, I don't think I had quite the right bill of material here. Can we reconfigure it a little bit?" But we're going to do that at renewal points, not constantly throughout the duration, based on a token-based system like you described..

Okay. And I wasn't clear -- are you actually going to -- you gave the kind of 400 IoT customers as one example.

Are you going to give some sort of subscriber metric either quarterly or annually?.

Yes, we are..

Okay. And last question. On the SLM....

Let me -- Sterling, if I could just back up and give you a little bit more detail. We have quite an interesting package of metrics that we'll share with you at our Investor Day that we'll report.

But of course, the first actual reporting with those metrics will happen 90 days from now, which is why you haven't really yet seen those metrics in this earnings report, because it's difficult to recap the old business that way. But we'll report our new business with the new set of metrics that we'll take you through at the Investor Day..

That's fair enough, fair enough. Last question, on the SLM side, I'm glad you addressed it, but I'm curious, the sales pipeline in SLM.

Is there any issues in terms of the product feature functionality? In other words, was there any type of product road map items that you were trying to accomplish that maybe customers were waiting for? Or is this really isolated to a sales execution issue?.

Yes. I mean, I think it's mostly a sales execution issue.

After we acquired the Servigistics business, they came in the door with a pipeline, and we were all over that pipeline and closed a lot of it and then lifted our heads up and said, "Uh-oh, we weren't building enough new pipeline." And in fact -- then we had to go train people and build up the capacity and so forth.

So I think we didn't manage that as well as we should have, just to be frank, and we feel like we've made up for it in the duration -- or in the course of the year, but sales cycles are a little long.

So if you get started late, it takes you a while to catch up, but we're at that point where we feel like the pipeline looks pretty good going into 2015. And our forecast for SLM look pretty good and so forth, but I'd really say it was a sales and management execution miscue..

The next question comes from Mr. Steve Koenig from Wedbush Securities..

I wanted to just dig into guidance a little bit and get your help parsing it. There's obviously a lot of numbers there. So a couple -- just a couple of questions there.

And the first one, the mix of subscriptions in your license and solutions stream, when we look at those numbers, it looks like that mix shift is almost entirely from the acquired subscriptions team. It doesn't look like there's assumption for very much transition in the core business to subscriptions.

So can you help us separate those 2 factors in terms of how it shifts the mix?.

Yes, Steve. I'm glad you asked that question, and I'm going to take a stab at it, and Jeff will bat clean-up when I'm done. If you look at that subscription business, for us to do that much subscription business in the year, we must already have a lot of it sort of booked, right? And in fact, we don't [ph].

So if you look at the 15%, roughly half of that is the run rate of the IoT business. Let's call 1/4 of it to be the run rate in the cloud services business and roughly 1/4 of it to be the run rate of, let's call it, core business, things like CAD and PLM that might have been term or subscription contracts we landed last year.

And what's frustrating, of course, is when we talk about a mix of revenue, that's quite different than a mix of bookings because much of the success we plan to have that we're forecasting to have in 2015 in terms of securing new IoT business will show up as bookings but not as revenue.

And that's why I say this, of course, is the world of subscription, where bookings are so important to understand where the business is going, and revenue kind of only tells you where it's been. So we think that you're right. Much of the 15% can be described by run rate.

There are some new business, but most of the new business we secure in '15 will show up in the subscription revenue of 2016, '17 and beyond..

Got it. Okay, all right. So one more question on guidance, guys, and then one quick follow-up. The -- you had some commentary about the macro, but it doesn't look as if it's -- your guidance is not really negative. In fact, adjusted for currency, it's pretty okay.

Maybe macro is the difference between the high end and the low end of guidance? How should we think about how you factor the choppy macro environment into your guidance?.

Well, I think, at one level, we factored it in by assuming that, while we just ended a fantastic growth year in Europe, that Europe next year is going to be relatively flat. And while we just finished a disappointing year in China, we also kind of assume that China, next year, will be relatively flat.

So I think already, it's built-in to a certain degree into our guidance at that level. Now we assume that the U.S. would continue doing well because the U.S. has been doing well, I think, at the macro level, and it's been doing well in the PTC number.

So we assume steady as she goes in U.S., but relatively flat in Europe and China, and kind of more or less steady as she goes in Japan as well, subject to the FX problem we talked about..

Okay, great. And then one quick follow-up, guys. So Jim, you talked about reminding us that the actual subscription revenues lag the bookings and you expect to have some good success in fiscal '15.

So in thinking about the long-term guidance that you just gave for 6% to 10% revenue CAGR I believe it was, including acquisitions, how should we think about maybe how much of that is organic? And how that layers in over time, next couple of years below that and then getting above that towards '17, '18? Is that how -- how should we think about that?.

Well, I think there's -- Steve, I think there's 2 important angles to think about this. One is mix of organic versus acquired, and then the second one would be mix of perpetual versus subscription. I explained that our subscription has been growing 4%, 8%, 15%, and so I think you have to think, out through 2018, what's the assumption.

And let me say the assumption we have is it would roughly double.

So by 2018, while hitting the numbers we talked about, we're assuming that we would have roughly 30% subscription mix, which I think is pretty good because that means, unlike most subscription companies, we're delivering strong earnings growth off a strong earnings baseline even while folding that in.

So Jeff, do you want to cover the assumption on organic versus acquired?.

Yes. We've identified the 6% to 10% would assume 2% to 4% contribution from acquisitions. That's historically what we've done. One year it might be a little bit more, another year, a little bit less. If they are subscription-type companies, that may be building at a different rate than a perpetual business, but about 2% to 4% on acquisitions.

We've assumed relatively stable economic outlook after '15 with constant currency is the way we forecast it. So this year is obviously muted, in particular, by the currency change..

Yes, and Steve, maybe I should also say, we'll take everybody through this at our Investor Day, but if you look at the segments in which we do business, you have a CAD market that's growing sort of mid-single digits at best, maybe 4% to 6%.

You have a PLM business that's growing 6% to 8%; ALM, maybe 7% to 9%; you have an SLM business that's somewhere in the 10% to 15% range; and an IoT market that's growing around 40%.

And so you can imagine that as we prosecute our business that the SLM and especially the IoT businesses are going to grow fast and become a bigger and bigger piece of our pie, and as that happens, our whole pie will grow faster. So I'm pretty optimistic actually that we're going to see improving growth rates as we move through that 2018.

If we do, in the IoT business, what I think we're perfectly capable of doing and, quite frankly, have the right to do based on the position we've already created for ourselves..

The next question comes from Matt Williams from Evercore Partners..

Just high level, I'm sure we'll probably hear a little bit lot more about it in 1 weeks’ time.

But just from a sales, sort of hiring and go-to-market standpoint, I guess, number one, can you provide any color on sort of your plans around maybe additions to quota-carrying reps going forward? Or is this going to be a situation where you're going to leverage the sales staff that you already have in place? And I guess, number two, is there any risk around sort of sales execution? You guys have made some nice headway there, switching to this type of subscription ratable model.

Are you taking some steps to try and mitigate any sort of execution headwinds there?.

Yes.

Jeff, do you have the sales headcount numbers handy there?.

We ended the year at about 360 quota-carrying reps, and I think we saw a nice productivity improvement last year. So I think -- I would just add that I think we're looking at driving productivity overall and, importantly, also focusing a set of the sales teams on really some of the new businesses.

So I think that's the situation to continue to drive productivity. We'll be adding folks to drive that new -- some of the new businesses. We did acquire some folks, and I think we'll first drive productivity and, secondly, add sales capacity as we get through the year..

Yes.

I think if you look at FY '14, our average sales headcount was probably around 350, Jeff?.

Yes..

And I think as you look at '15, it will be in the 360 to 370 range. So we'll have a little bit more capacity largely because we've acquired some capacity. But as Jeff said, what we're really focusing on is not a big expansion in capacity, but to continue to refine our go-to-market model to continue to get better productivity.

As we all know, there's plenty of room for improved productivity. We've made tremendous progress, but we're a long way from being done capturing the opportunity to improve sales productivity. So now on your second question about kind of managing risk, we're trying to be careful there.

You might remember last year, we put in place a segmented sales model. It all still reported to the same guy, but we said, we need to spread out where we put our focus a little bit. We can't have everybody doing everything because then, some things don't get done at all.

So we segmented into service sellers and product development sellers and then full product line sellers. That, we felt, worked pretty well. We rebuilt the service pipeline, as we've talked about, and have a lot of momentum there, and did just fine in the core business. So that felt like a good move.

What we're really doing here is we're adding one more segment, which is IoT sellers, to that model, and what we're basically saying is if we're going to go out and hunt for new accounts, let's hunt with IoT because that is so compelling right now. It's the hottest topic out there.

Everybody wants to talk about it, and we have a very strong position without the kind of entrenched competitors that we have when we go try to mount a CAD or PLM campaign. So I don't think it's actually a huge risk.

We're basically saying, "Let's concentrate the hunting of new accounts in this area, where, we believe, based on evidence we have already, the hunting will be so much more productive." And so I don't think it's a big change. It all still reports to the same guy, Bob Ranaldi. It's sort of one more piece on top of what worked so well last year.

Time will tell, but I'm pretty confident we'll execute this strategy well, both holding what we have in the core business and then adding a lot of new logos and new bookings in the IoT business that actually don't help that much in 2015 revenue but really set us up to lead in that category and grow like -- grow much faster in '16, '17 and '18..

Great. That's helpful. I appreciate the color. And maybe just one quick follow-up, just at a high level. I'm just wondering, Jim, if you could talk a little bit about -- from a sort of competitive/partner standpoint, you've got IBM making a little bit more noise around IoT. GE seems to be really sort of doubling down on their IoT effort.

Is there any real change in the landscape out there? And I guess, specifically to GE, could you give us an update on sort of your partnership there and how that seems to be going?.

Yes. So just first I'm going to hit IBM. I think IBM is a competitor, and to some extent, it's IBM with a bunch of little companies you never heard of. But I don't think IBM has the product suite that we have. They have WebSphere and they have busloads of programmers and stuff like that, but they don't really have the solution set we have.

But they're IBM. That's a company that you ought to take very seriously. GE is a very different story. We love GE. GE is a very big customer of ours. We are contributing some elements into their Industrial Internet strategy. We're working to get more of our stuff in their strategy, but they're not really a competitor.

Because even though they're talking about taking their stuff to market, what they're really talking about, if you dig into it, and I have, is where they sell hardware, jet engines, turbines, medical devices, they would like to sell Industrial Internet solutions to help optimize the way those things are, in particular, serviced. And so that's great.

I love GE. I think that the more GE talks about Industrial Internet, the more it helps us. I frequently say to customers, "If you're impressed by what GE is doing and don't have the billions of dollars to spend opening your own center with 800 developers out in Silicon Valley, then that's fine, I have that in the box.

I'll put a pretty ribbon on the box, and we'll ship it to you. And you can have the same things for pennies on the dollar." It's pretty interesting to people..

The next question comes from Saket Kalia..

So first for Jim. Jim, for some of the subscription customers, I know you talked about the option for remixing at renewal.

But besides kind of the CapEx to OpEx trade, what do you think are the biggest positives for a customer switching from perpetual to subscription?.

Okay. So it really is, first and foremost, about flexibility. We all went to college, and when we graduated from college, did we all go buy a house? No. Probably every single person on this call went out and rented an apartment. Why? Well, we just weren't sure what to lock in on yet, and maybe, we didn't have the capital.

So we all rented for a while, and that gave us a lot of flexibility. We could upgrade to a better apartment later. We could move to a different city if our job changed. I mean, that flexibility is worth a lot, and we all paid more for that apartment than we might have paid had we purchased a house.

Because at least, with a house, if the payments were high, we would have been creating some equity, which, of course, we're not creating in an apartment. So I mean, it's just a model that, from a flexibility standpoint, has value, and people are ready and prepared to pay for that value. But the OpEx, CapEx thing is very, very important.

When you go talk to the VP of any department, he or she has a budget and he or she can spend their budget, but as soon as you start talking about CapEx, that's a different process. That's a process that involves many different people. It's sort of a shared money. Typically, that's only revisited once a year.

I mean, it's very difficult, relatively speaking, to get something into a CapEx budget versus an OpEx budget. So it's just a lot simpler to free up OpEx dollars. And then, of course, they see that, "I don't have to buy all the shelfware to get a good price," and so on and so forth. So I think there is good value for customers.

They're willing, as we all are, to pay more for that, just like we all pay more for rental cars or even leasing cars or apartments than we do to buy the asset, but I think there's also people out there who feel like, "Hey, if I'm going to lock in to this for a long time and I'm very comfortable, I should buy it because I'll save money." So I think it's just a matter of what attitude does the customer come to the table with.

But this idea of flexibility is important because people, for dozens of years in this industry, have bought things only to realize that wasn't quite the right thing, but the seller won't take it back. And therefore, it became a write-off. So they like the flexibility to reconfigure at least at renewal time..

Got it. That makes sense. And so just for a follow-up. I know it's a long way away, but Jeff, I think you mentioned that about 30% of the perp-subscription line in '18 should be kind of subscription.

How should we think about that split between sort of cloud services versus term/subscription? And then if you just look more holistically at the model in '18, how much of that total revenue would you say is "recurring?".

Okay. So on the cloud service, I would expect that to be something approximating 20% of that, balance being really the....

80% their software..

Yes. So that piece, I think if you looked at the total mix, right now, we're 51% support. That will continue to grow.

So I would say when we get out there, we're going to be -- close to 80% of our revenue is going to be recurring, very predictable revenue again with the growth in deferreds and, I think, an improving cash flow picture as a result of these shifts. So think of it as going from 50%, maybe 55% last year..

Yes. 80% is probably a little high, 70% to 75%, because if -- we're just talking out loud here. If we say 30% of license is 10% of revenue -- so you'd add another 10% to the 50% to 55% and you'd be at 60% to 65% of our business would be recurring at that point..

I think one other key element, I'll say, is our services business. What we're doing is doing a lot more with our traditional professional services being partner-driven with business we do being higher margin. So if you look at our long-term outlook, we've actually increased the margin, gross margin percentages because of both the services and the mix.

So we think those are both positive..

Yes, that's a factor. Just the math on that would be if the services revenue, which is, today, 20% to 25% of our revenue, if that were going to decrease substantially in the mix, of course, that means that the proportion of the total revenue that's renewable would climb by another 5 points or so..

Sure, very helpful. And sorry, if I could squeeze in one last one, and it was a great segue with what you just mentioned, Jeff, on the margins. You kept your 2017 -- fiscal '17 op margin target unchanged at 28% to 30% despite what's probably going to be a higher -- what will be a higher mix of subscription through that time.

Do you think you need more sort of restructuring to get there? Or maybe if you could just help us understand what's letting you keep that target despite the shifting top line..

So I think a couple of things. If you look, we -- the shifting top line, as we just described, improves the overall gross margin.

And if you look at the rest of the model, we fairly well held sales and marketing as a percent of revenue relatively constant, and that's in part -- it probably would have come down some without a subscription shift because you've got -- the work and activity that you're putting into selling has a deferral effect.

So we've basically held the sales and marketing expense to constant as a percent of revenue. We've also reflected an increase, slight increase, in R&D because of the technology intensity of both our existing business and future business.

So I think those are the kind of shifts that we've made, which are -- I would describe them both as kind of reinvestments of that additional gross margin in both incremental sales to grow the business and incremental R&D to really make sure that we have fully funded on those lines..

Yes. Saket, I would also add a couple of more pieces of color to that. One is that in 2014, we've been carrying on our books a very expensive startup company. But particularly when we added Axeda to the ThingWorx business, we gained a lot of scale.

And that business is quickly kind of approaching a breakeven point and, at some point here, it will become a profitable business. And that will help a lot to take some pressure off us. At the same time, I don't think it would be accurate for us to say we're going to get to 28% to 30% without any restructuring events between here and now.

I mean, we've had a series of restructuring events on our way from 13% to 25%, and I could foresee that there will be a need for more of those here and there between now and 2018..

And I'd just add, Saket, that that's particularly driven in part by acquisitions. When you do the acquisitions -- when we added a number of people when we do an acquisition, we've got to organize and rationalize that at times. In many cases, we're just really shifting resources.

So that is, in part, driven, as Jim said, by a drive for profitability but also an integration or rationalization of acquisitions..

This question comes from Jay Vleeschhouwer from Griffin Securities..

Jim, how are you thinking about the new model offerings as a means or opportunity to either drive new user acquisition within your existing base or outside of your base? I understand what you said about '15 perhaps just focusing more on traditional accounts and not pushing too hard on subscriptions just yet.

But longer term, particularly for CAD and PLM -- let's put IoT, put it to the side for the moment.

Do you think there's an opportunity here as some other companies with model changes have seen to bring in more volume of users?.

Yes. Well, let me say just holistically at the top level. Our interest in subscription is driven, first and foremost, by an expanding addressable market, expansions particularly in IoT, where we think that business is subscription, should be subscription and so forth.

So when we talk about the mix of subscription at 15% now and going to 30% over time, a lot of that is simply because the IoT business is modeled to be growing fast during that time frame and to be mostly subscription. Now that said, I do think -- if I come back really to your question, which is back in the core business, how does it look.

I think that what we've seen is that customers are -- they're actually willing, in some cases, to be more aggressive with a subscription contract than with a perpetual contract, again, for fear of buying a busload of shelfware and then finding out it's the wrong stuff.

So we've done some really great subscription contracts even in the big deal business last year. I mean, you'll realize -- if you go through the math, I said roughly 1/4 of the 15% is run rate from the core business. So we already have a substantial chunk of subscription in the core business.

But I think if we go now to the reseller space, I think it's a huge boon for the resellers because these guys are doing business with small- and medium-sized companies that frequently just don't have the financial wherewithal to buy assets or to buy them in volume to get better pricing and so forth.

And so they're much happier, in many cases, to go with a subscription model. So I think it does give us the ability to go down-market and even to just appeal more broadly in that market of small- and medium-sized companies..

Okay. Along the same lines, how are you thinking about having to change, if at all, your current product release schedule or at least the major releases? You've been on about an 18- to 24-month schedule for the major Creo and Windchill releases.

Do you think that, again, as we've sometimes seen with other companies, having made model changes, you need to accelerate the pace of releases commensurate with their support of a -- more of a time-based model?.

Yes. I mean, I don't think, at this point in time, we see subscription driving a change to the cadence of our release schedule. Maybe we'll think differently as we get deeper into it. But I think right now, keep in mind we're really talking more about subscription than SaaS.

There is an element of hosting or what we call cloud services here, but we're not really talking about a pure SaaS model. We're saying it's the same software.

It's just, do you want to buy it or rent it? And at this point, we're kind of typically building our release cadences around innovative ideas we have, sometimes competitive responses to things, sometimes customer satisfaction or whatever and might need to fix a usability problem in a piece of software and we need to fix it quickly or something like that.

So I think that my view would be, in the near term, those factors will be more important drivers of release cadence than in subscription, but maybe I'll get educated. I'm open to that..

All right. And just lastly for Jeff. This might be the last opportunity to ask a question of him. The prepared remarks referenced what sounded like 2 possibly nonrecurring items that helped your license revenues in the quarter that perhaps you could quantify. One was referenced to a nice piece of business for what you called a heritage product.

I assume one of your older CAD-related products. And it sounds like the old MKS business had a particularly strong quarter, if you could -- sequentially and year-over-year, if you could talk about those 2 things..

Okay. So first of all, Jay, let me say if you're going to be in New York, I'm going to see you next week. So this won't the last time, but no, we feel very good about that. The 2 comments on the heritage product, that's within the CAD product line.

We had a large customer that had used some products historically, and they did make a large purchase and really committed to that to stay with that product. So that was in the CAD space. It's not Creo, but it's an older CAD product. On MKS, it was -- the performance year-over-year on a percentage basis was up, but it was off a soft compare.

So I think we feel good about ALM long-term, but I would just caveat or caution a little bit of the percent change year-over-year is in part because of the soft compare. So those are the current perspective, and I will see you next week, I hope..

Yes. And maybe I'll just add for everybody's benefit. We are making progress on our CFO search. We're sort of working our way now through a shortlist of very good-looking candidates. I think we don't have any imminent announcement here, but I think we're more or less on schedule as we expected to be with that CFO replacement for Jeff.

In the meantime, you can hear today and see next week that Jeff is fully engaged in the business, and we have 100% confidence in him. It's just a healthy situation.

We're working our way through, and I think we'll have a productive conclusion to that late this calendar year or possibly into next calendar year, depending upon if there are some delays in the start time or something like that.

But Jeff is committed to hang around until such time as we've completely transitioned everything, and then he'll go spend some time doing all those other great things in life. So I hope to see all you guys next week. And with that, I'll turn it over to James Hillier..

Yes. Thanks, everyone. Just one more plug, again, for our fiscal '15 Investor Day that's going to be taking place next Thursday, November 13, from 8:00 a.m. to 2:45 p.m. at the NASDAQ MarketSite in Times Square, New York. For those of you who want to attend and haven't registered yet, please feel free to contact me, and we'll get you registered.

The event is also going to be webcast with a link on our Investor page at investor.ptc.com, and we look forward to seeing everyone next week..

Thank you very much. Bye-bye, everybody..

This concludes today's conference. At this time, all participants may disconnect. Thank you..