Tim Fox - Vice President and Investor Relations James Heppelmann - President and Chief Executive Officer Andrew Miller - Executive Vice President and Chief Financial Officer Barry Cohen - Executive Vice President and Chief Strategy Officer.

Saket Kalia - Barclays Capital Matthew Hedberg - RBC Capital Markets Steve Koenig - Wedbush Securities Sterling Auty - JPMorgan Securities LLC Jay Vleeschhouwer - Griffin Securities Kenneth Wong - Citi Investment Research Rob Oliver - Robert W. Baird & Company, Inc. Kenneth Talanian - Evercore ISI Monika Garg - Pacific Crest Securities.

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the PTC 2017 Third Quarter Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions.

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

Good afternoon. Thank you, Christine, and welcome to PTC's 2017 third quarter conference call. On the call today are Jim Heppelmann, Chief Executive Officer; Andrew Miller, Chief Financial Officer; and Barry Cohen, Chief Strategy Officer.

Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today on our Investor Relations website.

During this call, PTC will make forward-looking statements, including guidance as to future operating results, because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements.

Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and other filings with the U.S. Securities and Exchange Commission as well as in today's press release.

The forward-looking statements, including guidance provided during this call are valid only as of today, July 19, 2017, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures.

These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our Investor Relations website.

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

Thanks Tim. Good afternoon, everyone, and thank you for joining us. Our Q3 financial performance was solid and overall we continue to make important strides against our major strategic initiatives during the quarter.

Revenue and EPS were at or near the high end of our guidance, and momentum around our recurring revenue model progressed further in Q3 with total deferred revenue growing 38% year-over-year and Annualized Recurring Revenue or ARR growing 11% year-over-year. Our license and subscription ARR crossed the $300 million milestone in the quarter.

However, after six quarters of very strong bookings momentum, sales execution issues in Japan drove booking results below our guidance range. Japan missed its plan by $11 million and bookings declined $12 million from a strong Q3 last year.

Year-to-date Japans bookings are down $20 million versus last year, which is an issue that’s been a drag on otherwise great bookings performance so far this year. While in the first half of the year, exceptionally strong performance in the Americas and Europe was able to offset weaker performance in Japan. In Q3, that was not the case.

There were a few more large deals in play in the Americas and Europe that could have offset our Japan performance, but we were unable to close them in the quarter. Let me take a moment to provide some color on Japan and the steps we have taken to remedy the situation. About a year-ago, we reassigned our Japan Country Manager to the U.S.

to drive some larger global initiatives and to further his professional development. During his seven-year track record, running Japan for PTC, this executive grew bookings at a CAGR of 14%. When his job changed last year, we thought he had adequate bench strength in Japan.

However, it became apparent that we did not, because the leadership change expose the sale execution issues that affected this quarter and a performance year-to-date. To address this, we’ve already relocated the former country manager back to Japan, where he is leading the team there as we will fall remediation plan.

This leader knows our Japan business well and it has prospered under his leadership. So we're simply reverting back to what was a very successful configuration. We're confident we can get this region back on track in the coming quarters. In terms of the macro situation, the PMI in Japan was 52 in June, which was 10th quarter of modest expansion.

While 52 is not particularly strong, we believe it suggests the challenges are mostly internal the PTC and therefore under our control. We do not believe there's been any change in the competitive landscape in Japan and the deals that didn't close remain in the pipeline.

As we address Japan, we're pleased with our performance in the Americas, Europe and in our global channel. Year-to-date in constant currency, Americas bookings growth is in the high teens. Europe's bookings growth is in the mid-20s and our channel has grown in double-digits for sixth consecutive quarters.

What does this all mean for Q4, our Q4 pipeline is very strong and our forecast is not dependent upon us fully facing Japan in the fourth quarter, they will get started. Taking everything into account, our current Q4 forecast and guidance is essentially unchanged from last quarter and we believe our long-term business model remains intact.

Now back to more specifics on Q3. To summarize my comments regarding how our business is performing, I will give the frame – the discussion around the three key initiatives that we focus on the maximized long-term shareholder value.

As a reminder first, to increase our topline growth; second, to convert to a subscription business model; and third to continue our margin expansion, let me start by discussing progress against our growth ambition.

We remain focused on and committed to achieving sustainable double-digit growth by returning our core business to mid single-digit growth consistent with the more mature CAD and PLM market, while growing our IoT business in the 30% to 40% range consistent with the faster growing IoT market.

That combination would create low double-digit overall growth for PTC. So against that goal, even with headwinds from Japan based on our Q4 forecast, we expect our CAD and core PLM businesses to achieve bookings growth at or slightly above the market for fiscal 2017 and our IoT business to achieve bookings growth above the 30% to 40% range this year.

In IoT, we had another solid quarter with strong contribution from customer expansions, which accounted for over 40% of our bookings and the number of six figure deals grew sequentially and year-over-year primarily driven by these expansions.

New bookings continue to come from a variety of vertical markets and use cases with the manufacturing operations, optimization use case taking the lead followed by service optimization for smart connected products.

During the quarter, we closed expansions with a leading food, beverage and snack company, several global aerospace and defense OEMs, and a number of leading medical device companies.

Even though these customers are generally still in the early days of their IoT journeys, adoption is gaining momentum as customers drive increasing value for their IoT initiatives and are relying on PTC to be there IoT partner.

This momentum was on display at our LiveWorx event in May, which continues to set the standard for IoT events across the industry.

More than 8,000 attendees from 44 countries were exposed to some incredible new innovations from PTC including a growing stable of industry specific solutions from both PTC and our IoT partner ecosystem, and plenty of tangible evidence that IoT is becoming a strategic lever for the industrial economy.

At LiveWorx, we introduced ThingWorx 8, further solidifying PTC’s position as an IoT platform leader. Building on the success of ThingWorx Navigate, we introduced a new lineup of apps for manufacturing that are easy to deploy with a rapid ROI.

We believe these apps provide PTC with yet another powerful set of solutions to address the significant industrial IoT opportunity for optimizing manufacturing operations. We also announced the ThingWorx Studio now supports native authoring and publishing of augmented reality experiences for the Microsoft HoloLens.

Recall that ThingWorx Studio is our codeless authoring environment that enables content creators to quickly create, deploy and then consume interactive AR experiences. The HoloLens is currently the industries most powerful wearable device and studio can deliver amazing experiences on it, so we are very excited about this new development.

ThingWorx Studio has been generating incredible customer interest overall as evidenced by our trial program, which now has over 3,000 enterprises test driving the technology with an accelerating pace of customers moving studio into production deployments.

Our vibrant partner ecosystem is key to any platform strategy and the ThingWorx team delivered some key wins in Q3 including an agreement with Vodafone, who is building ThingWorx based solutions for Smart City applications.

We closed a significant deal with another global communications company, CenturyLink that plans to leverage ThingWorx for their Smart City use cases as well.

And finally on the partner front, we secured a multi-year agreement with Analog Devices, who plans to go-to-market with ThingWorx based solutions targeting a range of industrial and the agriculture use cases. To close on IoT, we recently received two Compass Intelligence IoT awards including IoT Company of the year.

Our strong technology and market position receive further validation from a top tier industry analyst when IDC published their MarketScape report on IoT platforms, which placed PTC squarely in the leadership category and recognize PTC as the IoT market share leader. Turning now to our Solutions business.

I’d like to preface my comments by reminding you that we had very strong solutions bookings performance in Q3 of 2016, which grew 30% year-over-year creating difficult compare as especially across our core business. And of course weakness in Japan this quarter pressured our solutions booking performance as well.

That said, when we take a deeper dive into Q3 performance, we saw a positive momentum in several important areas of the core business that I wanted to highlight. In our CAD business, our resurgent reseller channel continues to benefit from our go-to-market initiatives, delivering 20% constant currency year-over-year bookings growth.

From a geographic perspective, we saw a strong CAD bookings in the Americas and in Europe with bookings growth of 19% and 25% year-over-year respectively. And when we look at our CAD bookings globally on a year-to-date basis, we have outpaced market growth rates despite the Japan headwinds.

In core PLM booking were up 5% sequentially from Q2 2017 driven primarily from strong performance in the Americas. Year-over-year PLM was down for the quarter as expected due to a tough compare against the mega deal last Q3.

Year-to-date core PLM is in the mid single-digit range and based on our Q4 forecast we expect core PLM to grow at or slightly above the market growth rate.

The PLM business continues to benefit from sales of ThingWorx Navigate, which we recall as our combined Windchill and ThingWorx offering that enables customers to deploy PLM technology to a broad set of end users across the enterprise.

In Q3, we landed ThingWorx Navigate bookings across the variety of vertical markets including Automotive, Aerospace, Med Devices and High-Tech, which supports our view that this offering will resonate across thousands of enterprise Windchill customers, creating a significant long-term opportunity to drive continued PLM growth.

Lastly in our Solutions business, we continue to see lumpiness and variability in SLM with SLM bookings down year-over-year.

To close out on a growth front, given the very strong bookings performance for the first half of the year with our Q4 guidance and the broad strength across Americas, Europe and channel, we believe we remain on track to achieve our long range growth plan.

Let me turn now to our second top level initiative to drive shareholder value, which is our transition to a subscription model. The Q3 2017 mix of subscription bookings was a little below our guidance due to our bookings performance highlighted earlier. We also had one large IoT deal that closed as a perpetual license.

Subscription adoption continues to gain traction and based on our forecast, we expect the subscription mix to rebound in Q4 to 68%.

With our plans to move to a subscription only model in the Americas and Western Europe beginning in Q2 of 2018 and with additional subscription programs coming on line each quarter, we remain confident in our long-term subscription mix and recurring software revenue targets.

Let’s turn to our third top level initiative to drive shareholder value, which is to further increase our operating margins. In Q3, our operating margin was within our guidance range, with operating expenses down $1 million from last year.

As we look across the balance of the year, our expectation still holds that fiscal year 2016 was the trough for full-year operating margins, with an improvement of 100 basis points to 200 basis points expected this year.

Beyond fiscal 2017, we expect to deliver even more rapid margin expansion as the subscription model begins maturing and increasingly the revenue we've been deferring begins to contribute to each quarterly period. Andy will take you through the guidance details later in the call.

To wrap up, PTC continues to make strong progress on our three levers to drive significant shareholder value, topline growth, our subscription transition, and our profit expansion.

On the growth front, our strong technology position and broadening partner ecosystem puts us in a good position to capture our share of the exciting high growth IoT market.

We have made significant improvements across the broader business over the past two years as exemplified by our year-to-date constant currency bookings growth in the Americas and Europe of 17% and 26% respectively and by our double-digit growth in worldwide channel.

We believe we have the right team and plan in place to fix Japan and we expect that issue to be a temporary bump in the road. On the subscription front having exited the trough and seeing the revenue and earnings growth starting to fall into place as expected, it’s clear we are in the final stretch of our business model transition.

And on the margin expansion front, financial discipline remains one of the cornerstones as we drive towards non-GAAP margins in the low-30s post transition. With that, I'll turn the call over to Andy..

Thanks, Jim, and good afternoon, everyone. Please note that I'll be discussing non-GAAP results. Bookings of $90 million were $5 million below the low end of guidance due to sales execution in Japan, where at the end of the quarter, the forecast dropped significantly. On a year-over-year basis, Q3 bookings decreased 13% constant currency.

The decline is almost entirely due to performance in Japan, but also due to a tough compare against a very strong Q3 2016 when we delivered bookings growth greater than 30%. Year-to-date bookings are at 7% constant currency, despite Japan impacting year-to-date growth by almost 800 basis points.

Subscription comprised 64% of bookings versus our guidance of 68%. The shortfall from our guidance is due to the bookings mix and due to one large IoT deal that closed as a perpetual license. The weighted average contract length remained approximately two years.

Total deferred revenue billed plus unbilled increased year-over-year by $251 million or 38% to $909 million as of the end of Q3 2017. Billed deferred revenue was up $40 million or 9% year-over-year.

Note that we believe total deferred revenue billed and unbilled combined is the most relevant metric as there is a seasonality to the timing of our recurring revenue billings throughout the year and due to the timing of our fiscal quarter ends. Subscription adoption trends were generally consistent with Q2 2017 with the exception of Japan.

In our Solutions business, SLM and PLM led the way, with subscription mix in the 70% to 80% range, and our direct CAD business was in the high-70s. Our support conversion program continues to gain attraction.

In the third quarter, 29 customers including both very large customers and about a half dozen mid-sized channel customers converted their support contracts to subscription, at an ACV uplift that was once again over 50% above the prior annual support amount.

Additionally for those large enterprise customers who did not convert this quarter and signed new support contracts instead their ACV increased more than 20%, and I’ll remind you that we do not include this increased support ACV in our bookings results.

We believe that the conversion opportunity within our customer base is substantial and will play out over many years as we introduce new incentive programs including a channel conversion program launched at the beginning of July and a new conversion program targeting our enterprise customer based that will launch at the beginning of FY 2018.

Q4 has an especially large pipeline of these large enterprise conversion opportunities. One last point about conversions, we call that we include only the incremental ACV in our bookings results, not the full contract value of the new subscription contract.

Turning to the income statement, total third quarter revenue of $292 million was at the high-end of our guidance range and up 2% year-over-year in constant currency, despite a year-over-year decline in professional services revenue of $7 million.

Q3 was the second quarter of year-over-year revenue growth since launching our subscription program at the beginning of fiscal 2016, highlighting that we have exited the subscription trough.

Software revenue was up 5% year-over-year constant currency, despite an increase in our subscription mix, including 133% growth in subscription revenue and 11% growth in total recurring software revenue. Approximately 87% of Q3 software revenue was recurring, up from 81% a year-ago.

Operating expense in the third quarter of $174 million was down $1 million from last year and Q3 operating margin was within our guidance range of 15% to 16%. EPS at $0.28 was at the higher end of our guidance range.

One note on currency in the quarter, we saw the dollar weak and against the euro, but we also saw currency movements in countries where we had a little revenue at significant OpEx such as India. Also recall that we hedge near-term results, locking in prior rates.

As a result, currency ended up having an immaterial impact on our results in Q3 as well as on our year-over-year comparisons. Moving to the balance sheet, cash and investments of $311 million were up $19 million from Q2 2017, driven primarily by $78 million of adjusted free cash flow. During the quarter, we repurchased $35 million of stock.

Now turning to guidance for Q4 and the full-year, but first as a reminder, we hedge foreign currency. So much of our Q4 FX exposure with hedge before the dollar weakened in Q3 and four are unhedged exposure, our guidance assumes approximately current rates. As we enter Q4, our pipeline is very strong.

While we are not counting on immediate improvement in Japan, we feel very good overall about Q4. We expect bookings in the range of $120 million to $130 million and a subscription mix of 68% for the fourth quarter.

We expect total revenue in the range of $303 million to $308 million, including $84 million to $86 million of subscription revenue, an increase of approximately 110% year-over-year. At the midpoint of our guidance, Q4 recurring software revenue is expected to grow 12%. Total software revenue is expected to grow 9% and ARR is expected to grow 12%.

We expect our services margin to be 18% and we expect OpEx in the range of $173 million to $176 million down 4% at the midpoint from last year. This was a result in non-GAAP operating margin of approximately 18% to 19% and EPS of $0.33 to $0.38.

For the full fiscal year 2017, our Q4 guidance results in a bookings range of $395 million to $405 million, which is a $10 million reduction at the midpoint, reflecting our Q3 bookings. Excluding the $20 million SLM booking we closed in Q4 2016 in constant currency this represents 4% to 6% growth.

From a subscription perspective, our full-year guidance is now 67%, simply to reflect 64% mix in Q3. For fiscal 2017, we expect total revenue in the range of $1.163 billion to $1.168 billion, which at the midpoint represents 2% growth and is in line with our previous guidance despite Japan's Q3 booking shortfall.

This includes subscription revenue growth of approximately 130% and total recurring software revenue growth of 10% at the midpoint. We expect our services margin will increase by about 150 basis points to 18% and we remain committed to a 20% services margin in fiscal 2018.

Fiscal 2017 operating expenses are expected to be $680 million to $683 million flat year-over-year at the midpoint. We continue to expect our fiscal 2017 operating margin to be in a range of 16% to 17% representing a 100 basis point to 200 basis point improvement in operating margin over last year.

We are assuming a tax rate of 8% for the full-year resulting in non-GAAP EPS of a $1.17 dollar to a $1.22 per share, which is an increase of $0.01 per share from our previous guidance at the midpoint. We continue to expect adjusted free cash flow between $158 million and $168 million.

Adjusted free cash flow excludes about $40 million at fiscal 2016 restructuring payments and $3 million of legal payments for matters previously accrued in fiscal 2016. With that, I'll turn the call over to the operator to begin the Q&A..

Thank you. At this time we will begin the Q&A session. [Operator Instructions] And our first question is from Saket Kalia of Barclays. Line is now open..

Hello, Saket..

Hi, guys.

How are you?.

Good..

Thanks for taking my questions here. First, maybe to start with you Andy. I think it was mentioned in the prepared remarks that the fourth quarter pipeline is strong and the bookings guidance is roughly consistent with what was implied last quarter.

And so can you just talk about whether you assume some of those slip deals from the third quarter specifically in the Americas and Europe are going to close.

I guess why the confidence maybe more broadly? Why the confidence in the fourth quarter bookings guide being roughly similar to before?.

Yes. So the confidence is based on the size of the pipeline as well as our analysis of the stages of the deals in the pipeline. We are not counting on Japan returning fully in the fourth quarter. We also recognize that there we have a fixed sales capacity and there's only 91 days in every quarter.

So we don't believe that the deals that moved from Q3 that we close in Q4 are going to be suddenly a blip that enabled us to recapture the Q3 miss and how that be incremental to Q4, only a certain number of days to sell.

If you actually look in at our Q4 bookings as a percentage of our full-year represents about 31% of the year which is right in the range of history as well. So every way we surround it, it makes sense.

And the only other thing I did mention we have a very strong pipeline also with conversion deals, which are converting people who frankly were previously on our volume purchase agreements and that is provide us a compelling event and that also we think is extremely helpful as we look at the forecast..

And Saket if I could just clarify one thing, the deals the slipped in the Europe and in the U.S., I referenced that in my commentary. It's not so much they slipped, but that we weren’t able to accelerate them to backfill the late developing situation in Japan.

So I don't want to you think that they slipped more that we weren’t able to accelerate them to save the day quite frankly with the problem in Japan..

Understand. That’s helpful. Maybe my follow-up for you Jim. On your prepared remarks, you talked about that same long-term formula driving double-digit bookings growth.

And so the question is, do you think that the hiccup in Japan could maybe impact that model as you look out the fiscal 2018?.

No not really because, again it's not like we have problem in Japan and no leadership to go fix it. We simply need to reinstall the leadership profile. We have reinstalled the leadership profile that was exceptionally successful.

If you go back, we really have had a pretty consistent successful business in Japan for seven years and that's when the current leader. Yes, well, he joined seven years ago. He did a fantastic job of guiding our Japan business for seven years. We basically promoted him.

And then ended up with a backfill problem, so we told them take one for the team here we need to go back and fix it. So there's no person in the entire world more prepared to reinsert themselves in our Japan operation and get the machine running again than the guy who successfully built and operated the machine for seven years.

So we have high degree of confidence, but it could take a little bit of time..

Saket, I also want to put the machine perspective as far as how it influences our long-term business model. We basically missed our ACV by just over $3 million, so it's $750,000; $800,000 a quarter is the revenue impact.

Now what we don't disclose in bookings, I mentioned how – when someone doesn't, we’ve had in the DPAs, we’ve had about half of our customers deferred doing a conversion and instead sign up for higher support where we typically get 20% to 25% more from their support. We never record bookings for that, but it does increase our ACV.

So for example, that’s something that mitigates the exposure that we have from this ACV miss. The fact that next quarters guidance is intact. The ACV we expected to be what we expected to be before. We basically have just over $3 million a year challenge that we have to fill and we've got plenty of ways to fill that..

Understood. That’s very helpful. Thanks guys..

Yes. Thank you..

Thank you. Our next question is from Matt Hedberg of RBC Capital Markets. Line is now open..

Hello, Matt..

Hey guys. So I guess my first question is for Andy. It's kind of a two-part question. In the last quarter, you talked about the idea of using a carrot more so than a stick within the enterprise with the good, better, best program, I believe you called it in terms of conversion to subscription revenue.

So I guess a two-part question would be can you give us a little bit more color on some of the new conversion plans that you mentioned? I think in the enterprise start of fiscal 2018, I think you mentioned the channel to sort of July.

And then the second question, what would you have to see for the idea of more of a stick mentality? Is that something that's still maybe a ways off?.

Yes. So let me first share the two programs. So in the channel program, which started July 2, I guess. Essentially there are four Creo extensions that are – that previously generated very little in revenue, but there’s things that customer’s desire.

And so you can take three or four of those for an increase in your ACV year-over-year maintenance contract of 25%. Now the list price for those is much, much higher. So our joint pricing study showed about half our customers in the channel were interested in that. So that's an interesting program there.

So it's a Phase III,I think is what that program is called. In the enterprise space, we have essentially a program that good, better, best. The better is pretty much like what we play – the play with the largest customers, you get a restack and remix and all these other benefits some enhanced support offers and e-learning.

The 15% which we do not intend to introduce initially when we start this in the beginning of 2018, you would not get the restack, which is one of the biggest things people value.

And at the 35% there was an interesting cohort of customers interested in that for essentially enhanced support capabilities and the e-learning capabilities that really don't cost us anything, so that's what those programs are the stick. The Autodesk carrot and stick, I think their situations are little different from ours.

I believe it's because they have customers that may not be on maintenance and this carrot stick gets those customers to actually be a pain for the technology every single year. And our situation is little different from that, most our customers are already on maintenance. So we don't need the stick just to get them on to paying this every year.

It's more giving them something they value that they're willing to pay more for. We’ll watch their program closely. I understand it's going well so far. We'll watch it closely and see if there are aspects as it that might make sense for us though..

Got it. Thanks. And maybe just – just one quick follow-up for Jim, I just want to make sure crystal-clear on Japan, I think you might correct and saying that you don't think there's anything macro related? You think this is all internal execution. I'm just getting a few emails on that.

I just want to make sure is from sort of understand the macro aspect of Japan? I think you mentioned, PMI in Japan?.

Yes, PMI is 52. Yes, we think this is an internal problem not a macro problem. Therefore a problem we can fix..

Great. Thanks guys..

Thanks Matt..

Thank you. Next question is from Steve Koenig of Wedbush Securities. Line is now open..

Hello, Steve..

Hi, Steve..

Hi, guys. Thanks for taking my questions. I'd like to start with the Japan execution.

Maybe could you guys drilldown one more level and talk a bit about understand that you had the personnel change and that you're changing the former leader back and can you talk about what sorts of issues the leader will address? I mean was that involvement in individual deals? Was that involvement in visibility, process changes, maybe just a little bit more color there?.

I think you nailed the key points. I mean definitely his personal involvement in the larger deals and cultivating the customer relationships. I mean he had always done that. I think the backfill guy was not in there, so good at it.

But I think also just the sale hygiene to make sure that we were expecting things and that things were progressing as they should - and the things are good sales manager does to our surprise, work really getting done..

To make sure deal every week is progressing toward the finish line. Right, so he is implementing methodology cosmetics that PTC I think I have sense they audited 20, 30 years ago. So that’s been already reimplemented and they're trained all the sales reps on that into the message, all the basic blocking and tackling an enterprise software..

And let me just give you a little bit more context again. In Q1 in Japan, we were very disappointed and started talking about is this a problem or was it just a one quarter blip in the transition to the new guy and so forth. Q2 was only a mild disappointment, a much better than Q1.

But still not quite at planned, so but we were feeling like maybe this is getting better. And then Q3 was a disappointment of a larger scale than Q1 and Q2 put together and that's what we said, okay, it's got to be change right now. So we immediately implemented to change.

The leader completely understands what he needs to do and why I need to do it and quite frankly he's going back to that and sort of sell me just reputation and rebuild kind of the excellent operation we had going there. So I think we're in good shape, but we're disappointed that this stock up on us should happen that way. It's on us. We own it.

We're going to go fix it..

Okay..

It was actually the worst Q3 in the seven years, which is how far back we checked..

I'm sorry which is what Andy?.

It was the worst Q3 as far back as we could find numbers quickly, which is seven years..

Okay, got it..

For Japan only..

I was going to ask if you can remember – I can't remember anything is about in his specific region that suddenly came to roost that that suddenly, so that's helpful. I did want to ask on IoT.

Can you tell us a little bit more about on how things are going with your major partnerships in IoT? And how that translating through revenue and kind of what your outlook is for your sales mix you know working with those partners?.

Yes, Andy, I think we're still at the place where about two-thirds of the IoT business is generated through the PTC channel without one-third through partners.

Now we did land a couple of very big partners, Vodafone and CenturyLink are Analog Devices are very substantial companies who are placing very large bets on IoT and looking to ride our horses as they do so. So that's mostly looking forward, but I think we continued in the last quarter to see the sort of success we had previously seen.

With lot of course to see partners take on even more without seeing the PTC channel give anything up that's our aspiration, but I think it's – I don't to say we're satisfied because I'm not sure we ever will be or should be satisfied but I think we're making progress. By the way all three had – it wasn’t just signing the agreement.

They all bought this quarter..

Yes..

Got it. Okay, thanks a lot guys..

Thanks Steve..

Next question is from Sterling Auty of JPMorgan. Line is now open..

Hello, Sterling..

Yes, thanks. Thanks hi, guys. I want to ask the question this way because we're all getting hit with the same email questions. Take Japan out of it.

If you look at your plan in Americas for booking and your plan for Europe, did those two regions meet or exceed plan or did either of those regions fall short as well?.

I think the two of them together were over the plan, yes..

Yes. Here's some math on it. I mean we did $90 million in bookings against the guidance of $95 million to $105 million and Japan fell $11 million short. If Japan would have landed on plan, we would have been in $101 million, the upper half of the range. If Japan would have missed by a couple million, we would have been in the middle of the range.

So we really feel like it's a concentrated problem in one area and it’s a problem that’s three quarters deep, we got to go solve it..

And the other thing critical to know, you've got year-to-date booking growth, 17% in the Americas, 26% in Europe, double-digit in the channels. I mean the business is strong broadly at this point with significant problems that we are dealing within Japan.

Finally, the other thing we look at is, if you look at the volume transactions, the volume transaction is actually up from year-ago in high single-digits..

So we did 10% more transaction than we did a year-ago when we had substantially higher bookings, which is a good thing. It means that customers are not buying our software. It’s just a concentrated problem around larger deals in one geography..

Yes. So sorry to be nit-picky, but Andy you said Americas plus Europe just to drill that next layer….

I think one was up by a couple percent – I mean down by couple percent, the other one was up by more than that, it was smaller, but I mean it's close..

In terms of – yes, because Europe [in some of way] in terms of bookings, but….

Deal can move it either way in either [Geo], so this is software..

I understand that, but I'm getting specific questions around the Americans, it's clear based on the growth rates that Europe accelerate in the third quarter, so there's questions that I'm getting just wondering did Americas fall short and is there anything that we should read into that?.

I mean Americas had a decent quarter, Europe had a better than decent quarter, and Japan had a terrible quarter, and China was kind of somewhere in the mix. So that's the story. Had Japan delivered is part of the plan; we would have been in the upper half of the guidance range..

That's clear.

Last question, within Japan is there any particular focus whether as we get some CAD versus PLM or just across the board?.

It’s across the board, but it wasn’t with the channel. So the channel performed well. It was the direct business across the board..

Yes. The channels are much smaller in Japan and the rest of the world..

Got it. Thank you, guys..

Yes. Thank you..

Thank you. The next question is from Jay Vleeschhouwer of Griffin Securities. Line is now open..

Hello, Jay..

Good evening and thanks guys. I'll ask you the Japan question too. Let me ask it this way which is what is it about Japan that makes your business there so susceptible to know the country manager is.

It's been a long time, but if I think back over the last couple of decades, we've seen this before, I mean longer before you were CEO Jim, but this has happened before as you probably recall.

So what is it about the local market there where this really matters who's in place and that sets and we've seen also with some of your peers in Japan, so it's not only you. So that's a question number one and then a follow-up..

Okay. Well, Jay you and I have discussed Japan many times, but quite frankly not for a while, so if you go back PTC did – if you go back more than seven years, PTC was struggling on and off with Japan.

The main problem we had is that we always relied on an expat partly because we never had a local Japanese leader with good enough English skills whom we trusted who trusted us, who could communicate effectively with us, so the easy answer was send an expat over there.

Now Japanese culture and Japanese business culture is very different than anywhere else in the world and Japanese companies and executives only do business with people they deeply trust. They do not trust expats acts. They see them as temporary solutions and can't build a relationship with because in two years this person won’t be here anyway.

So the guy we hired seven years ago was a Japanese national. We pushed him out of Oracle. At the time, he was the number two person from Oracle. He has a decent English skills.

He quickly built a good strong relationship with the PTC management team here in Boston and quickly built good strong relationships with the customers in Japan and we’ve then had a period of pretty decent stable consistent growth in Japan at which point we more or less promoted the guy.

And he wanted and we wanted to give him an international experience and so forth for career development reasons.

And he backfilled with a person that we didn't know as well because we always have this great executive standing between us and this person and we collectively missed an understanding what was happening and didn't catch it until it had best, but now we’ve got it, again reverted back to the previously successful configuration and we think that's a winning recipe, proven recipe we should be able to fix it..

Okay. My follow-up for Andy, actually a two-part bookings question. Would it fair to say that to date the support conversion bookings, the way you counted has been not quite tenth of the total LMS bookings number.

And then secondly, could you say what your PLM bookings momentum would look like if we were to strip out Navigate?.

The first question is like-for-like because as we’ve mentioned, we got more than 50% more this quarter and actually the prior two quarters as well, about half of that is the like-for-like typically, so that 25% uplift is just the conversion and then they're buying more software at the same time which has taken it up to over 50% for the last three quarters.

So if you just look at the like-for-like, it tends to be in the low to mid single-digits range as far as how many millions of bookings, so it would be probably closer to the 4% to 5%, but of course, we’re selling more software at the same time. I don’t have the PLM growth rate without Navigate.

That’s the way I would look at it and I wouldn’t look at it that way because it’s all ….

Yes. I mean the sales team spends their time selling Navigate mostly in the existing PLM accounts, but as new functionality that brings new users on board. So in a way this Navigate Solution isn't any different than any other capability we might come out within the new release that we would be able to sell under the base to expand the user count.

So we could strip it out. What we've done Jay that we think is more appropriate as we allocate the bookings credit and the revenue half and half. We say that in fact it should be counted as PLM revenue to a degree and it should be counted as ThingWorx revenue to a degree.

So we're very transparent in that we allocate 50/50 and that to us is the reasonable genuine way to report it to you..

Okay. Understood. Thank you..

Thank you..

Thank you. Next question is from Ken Wong of Citi. Line is now open..

Hello, Ken..

Hey, guys. You guys characterized the Q4 pipe as a good conversion pipeline. And you guys typically kind of called in your pipeline as hey comes in as perpetual and well soon it goes out as perpetual.

Can you maybe elaborate a little bit on the dynamics there that make you guys feel it's a better conversion pipeline?.

It’s because of the – we have more customers and more dollars relative to volume purchase agreements that expire in this quarter than in prior quarters. So those are the ones where we have a stick..

Right. So again, to take you through this, let me just step back, volume purchase agreement means sometime in the past our customer purchased a large volume of software and negotiated a low maintenance run rate as a package. But that was for a period of time, generally three years sometimes one or two.

So at the end of that period of time the maintenance discount expires and they should return to standard off-the-shelf rates. Now of course they don't want to do that. So in the past, we would try to get another perpetual booking from them, say buy more volume and we'll lock you again in that rate and if we really did.

Now what we're saying is we don't want a perpetual transaction. We either want you to convert to subscription and then it will be more because there's you know an uplift plus typically we’ll upsell or you're going to have to renew your maintenance at a higher rate typically 25% more.

So the key thing though as it forces them to make a decision in the quarter, so they're going to make some decision that's the so-called compelling event. There's going to be a contract signed here.

It's only a question of what the contract says, not if there will be a contract because these are large companies that are not going to let maintenance expire. So if they choose to extend maintenance and pay more that actually is not a bad thing. It is not.

And Andy said this and it's important to understand that additional maintenance they pay, we do not count as a booking. Now it does show up downstream in the revenue number, so it's a very good thing, but we don't count it as a booking.

We only count it as a booking if they convert subscription and then only the incremental above and beyond the run rate that has been in place is considered to be a booking. So extending the maintenance is good, converting in a subscription is even better. The key thing is something's going to happen because I'm not going to let it expire.

So the combination of having a good pipeline in general and then a fair number of these bigger deals in the pipeline having this compelling event attach to them tells us that we go lot to work with and some good things in our favor..

Yes.

And then if you think about that conversion opportunity with the end of life coming in calendar year 2018, I mean what's the early feedback and any pushback, any potential last chance buying from customers?.

Again because most our customers are maintenance or on maintenance. It's hard to figure out who would go after that last perpetual buy because they already have access to the next version. The product is long that stay on maintenance. I'm sure there's something there we frankly don't know what it is. We do not believe.

It is likely to be anything like what Autodesk for Adobe experience way back win, it simply because of the fact that our customers are maintenance. So it's not like there's a strong of a compelling event when we ended a lot of perpetual.

If you look at it, our large deals at this quarter, every large deal except one with subscription, last quarter every large deal was subscription. I think the quarter before that every large deal was subscription. So our largest customers already buying this way and in Americas in the channel, 75% of the bookings this quarter were subscription.

So we've made so much progress that we think that this is just a catalyst to kind of get those – our pay attention across the goal line frankly to have a subscription business model..

Got it, right..

One little point I want to clarify there to Ken is we will still renew maintenance contracts. It's just the new orders will only take as subscription, so just not to allow anybody.

If somebody has a maintenance contract, they renewed five times will allow them to renew at the six time and seven time and in eight time, but when they want to buy more, which how much time to buy the more in a subscription model..

Got it. Got it. All right. Thanks a lot guys..

Okay..

Thank you. Next question is from Rob Oliver of Baird. Line is now open..

Hey, guys. Thanks for taking my question. Just to follow-up on Ken’s line of questioning.

Maybe just to touch on the ThingWorx deal that closed as a perpetual license deal, can you give us a little more color on that and then is any sense that maybe Jim you announced in the last quarter of the end of life for perpetual for solutions in IoT is maybe causing some people to think about perpetual license for IoT deals ahead of that deadline to just maybe a little more color on that deal? Thanks..

First, the color I gave you is we have done large IoT deals in the past that went perpetual. Usually it's the first bid deal with a customer and in the past every deal asset and it’s been subscription and that’s a fully what we expect in this particular case as well. So we will take an IoT deal to make sure we get the business.

But at that point time, what it’s build into their solutions et cetera. We will do everything we can to make sure every bit of business after that goes subscription.

Yes, if we would have stood our ground in only taken a subscription deal to be frank, which still be talking to a customer about it because they simply weren't prepared to move forward and we didn't see any reason to keep talking about it. So there's a second point I want to clarify a little bit, which is our subscription mix.

If you look at the bookings we did on the perpetual side as compared to the guidance, we basically executed on the perpetual side just as we guided. The shortfall was really on the subscription side and that's because it's mostly larger direct deals that were framed up as subscription, so – in Japan..

If you actually look at our subscription mix across the world, our mix in APAC, which Japan is the biggest country there actually declined from last quarter and from the year-ago by double-digits and that was simply because the subscription business didn't close..

Got it. And are the customers – it sounds like it makes sense you guys are able to take that business and perpetual to get that business and assure your value.

Our customers can be ready to make that decision on a subscription starting Jan 1?.

Yes. The vast majority – I mean I'm sure – so long-term we laid out an 85% subscription mix because just like any subscription company, if you go to Adobe, they still sell perpetual licenses.

So there will be one every once in awhile, we're not going to lose the business or delay a strong partnership win because we can't agree on the license side on the very first deal..

Got it. Thank you guys very much..

Yes. Thank you..

And the other thing I would say is that from the broader prospective, customers are used to buying subscription or cloud. It's not I think really even ask about. Will you sell this for me perpetual? That's not a common question nowadays because there aren’t many companies it sell perpetual licenses..

Thank you. And our next question is from Ken Talanian of Evercore ISI. Line is now open..

Hi Ken..

Hi guys. Thanks for taking the question. First off is a point of clarification, you mentioned that some of those large deals in Europe and Americas that might have helped you offset the Japan weakness.

I was curious if any of those actually closed since the quarter end and then where are you in closing those?.

Again, I just wanted to be clear. It's not so much that those deal slipped is that we've tried to accelerate them because this problem in Japan was coming in as fast and hard and we didn't want to have this conversation with you. So we tried to accelerate them. The customers weren’t ready. We were unable to accelerate them.

We expect to close the deals in Q4. We expect to have a strong July. I don't have a report yet actually as to what's closed in the quarter because it's early and we've been working on close in the last quarter. But we expect to have a strong July. We think we will have a strong July.

I mean the sales team is committed to it because we want to get ahead of it this quarter and make sure that we don't get surprised again. So again, these are the deals where to get, to be frank when we get to this point, we're not competing with anybody. We're competing against the clock.

Are we going to get the deal this quarter? Are we going to get it next quarter? That's what we're competing with and we've failed to accelerate something because where we thought the customer might be ready, they weren’t.

Now the reason we bring that up is because actually in Q1 and Q2 we did have some success covering up for problems in Japan with over performance in the U.S. and Europe, so we went back to that recipe, but we were unable to pull it off..

Okay. And you maintained your free cash flow guidance for the year and there is a nice uptick in deferred revenue.

I was just wondering if you could help frame essentially the tailwind for free cash flow through the end of the…?.

Yes. So Ken, I'm going to take you back. We only missed the ACV by just over $3 million. That’s the amount of impact on free cash flow in the fourth quarter, but mitigating that to a good extent is the fact that these conversions that went support instead of subscription we got more than 20% more on those.

So it takes it down to like an impact of $1 million to $2 million on Q4 free cash flow. So we didn't need to change our guidance for the fourth quarter. And we had a great strong free cash flow in Q3, $77 million adjusted free cash flow..

Right.

You seem to be about 70% or so there already with…?.

Yes. We have to do free cash flow of $35 million. I think I have it here. Adjusted free cash flow in the mid-30s in the fourth quarter and we've been all over that forecast..

Okay, great..

Why don’t we go to the next question?.

Christine. We have time for just one more question. Thank you..

Thank you. Last question is from Monika Garg of Pacific Crest. Line is now open..

Hi, Monika..

Hi. Thanks for taking my question.

First, your fiscal 2021 targets, you’ve talked about 10% bookings CAGR given what we saw in the quarter, do you see any risk in your bookings built on it?.

Well, Monika, first just to put where we are in perspective, year-to-date we've got 7% constant currency bookings growth and that's been negatively impacted by Japan. We’re down $20 million in the first three quarters Japan this year versus last year. In Japan, we're just flat. We have grown our bookings 15% year-to-date.

So that’s the impact of having the performance we've had in Japan. It’s 800 basis points of growth. So we’ve still feel confidence in that 10% bookings growth that’s part of our long-term model.

And if we actually look at what we modeled to end, recurring revenue and ARR and bookings for this year for that long range plan given out November and where we expect to end the year now, it’s pretty much right on. That's why we feel good about the long range plan..

Got it.

So is it fair to think that after the Japan issue is fixed [indiscernible] back to this 10% bookings growth?.

Yes. We would expect that..

Yes, absolutely..

Okay. Thanks. That’s all. End of Q&A.

Okay. I think that concludes our questions. Thank you, Monica. So obviously there's a lot of discussion here about Japan and deservedly so, because we have a problem we have to go fix. We do think it's a very fixable problem.

We don't have to find some savior from the outside and we just have to reinstall the proven savior we have and we think we're going to fix this problem. If we fix this problem then we're right back where we were kind of in the first half of the year.

We feel good about things and feeling good about our long-term long range plans and our shareholder value creation models and so forth.

So we think that this new leader is going to give us this trust that we need with the customers and give us the sales execution and discipline that we need with the sales team and we're going to get right back to business. So I’d like to thank you all for joining us on the call and spending your time with us this afternoon.

We're proud of what we've accomplished on our journey. We're proud of the shareholder value we've created. We think the Q3 shows we're continuing to gain ground on key elements of our strategy, but we have to go fix this problem in Japan.

So we think we're going to do that and we're going to get back to talking about growth, subscription, and profitability expansion that have been working for us. We hope to see you sometime in the next 90 days, perhaps at an investor event and if not, we look forward to talking to you again in 90 days on the call.

So thank you very much and Christine that concludes our call..

Thank you. That concludes today’s call. Thank you for your participation. You may now disconnect..