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Executives

Cornelius Moses - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Barry Cohen - Executive Vice President of Strategic Services and Partners

C. Harrison - Chairman and Chief Executive Officer

James Heppelmann - President, Chief Operating Officer, Director and Member of National FIRST Executive Advisory Board

Kristian Talvitie -

Analysts

Sterling Auty - JP Morgan Chase & Co

Blair Abernethy - Thomas Weisel Partners Equity Research

Alexander Zorovic - Janney Montgomery Scott LLC

Yun Kim - Broadpoint AmTech, Inc.

Ross MacMillan - Jefferies & Company, Inc.

Richard Davis - Needham & Company, LLC

Ben Rose

Steven Koenig - Longbow Research LLC

Jay Vleeschhouwer - Ticonderoga Securities LLC

Parametric Technology (PMTC) Q2 2010 Earnings Call April 28, 2010 8:30 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the PTC's Second Quarter Fiscal Year 2010 Results Conference Call. [Operator Instructions] I would now like to introduce Kristian Talvitie, PTC's Vice President of Corporate Communications. Please go ahead.

Kristian Talvitie

Great. Thanks and good morning, everybody. Before we get started, I'd like to just quickly remind everybody that this call and Q&A session may include forward-looking statements regarding PTC's products or 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 forms 10-Q on file with the SEC.

All financial measures in this discussion are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measure is located in the press release and prepared remarks documents on the Investor Relations page of our website at www.ptc.com.

With that, I'd like to turn it over to Dick Harrison for a few opening comments, and then we'll right into Q&A.

C. Harrison

Thanks, Kristian, and welcome, everybody, today. We feel like we had a really nice quarter. Again, as we saw in Q1, license revenue grew in excess of 50%. 54% again, so we're greater than 50% at the halfway mark in the year in terms of license growth. We'll get into more detail on it, but we had growth in all products, in all geographies. Those of you that know our 4-box, we saw good license growth and just growth in general in all those four categories, and that just suggest strength across the entire business.

We have maintained our guidance in the face of about $18 million sort of headwind in currency for the back half of the year, which is effectively raising the guidance, and we'll talk more about that. The number of big deals, 18 deals over $1 million was substantial. It was greater than it was in the same quarter in 2008 and really suggests, and I'll confirm it for you, there's an underlying pipeline of big deals, deals greater than $1 million that's at least twice the size that it would've been a year ago at this time.

So with that, let me open it up to questions and answers.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Sterling Auty from JPMorgan.

Sterling Auty - JP Morgan Chase & Co

The one area that, I guess, I need better explanation is what you characterize as the lingering hangover in the Services business, I would've thought that some of the services revenue would have either been coincident, meaning in parallel with the improvement license or even a precursor to a certain extent. Give us more explanation as to why -- I think you characterized the weak license in the first part of 2090 on Windchill is actually affecting some of the services business now. I didn't quite understand that.

James Heppelmann

Sterling, it's Jim Heppelmann. I think one way to think about the Services business is if you imagined or sort of hypothesize an average services engagement of lasting four to six quarters, then what you realize is you sort of have a rolling portfolio of services engagement, and the new quarters we're adding now are not yet offsetting the quarters that are of projects that are wrapping up. So I think it's a very positive trend, and Barry can comment in a minute that the bookings are strong for new business going forward. But we're suffering this hangover of projects that were not started back in 2009 because of the bad economy are now part of that portfolio, of that rolling portfolio services projects. And thus, the services revenues is down, but we all know pretty clearly that where license go, services will follow. So we sort of look at it -- it's more or less a type of backlog going into next year that we absolutely should expect to see that services revenue coming online next year.

Barry Cohen

The only point I'd add there it's -- when you look at the results and where we are in terms of bookings and revenues, it's a little lumpy. So when you look at North America with license revenue, which is pretty okay in 2009, service revenue actually in North America is pretty strong. And we see some of the lag is in [indiscernible] where the license was softer during 2009 like in Europe and Asia. So we're already seeing the rebound in North America, and we sort of -- we certainly expect the rest of the rebound to take place in the latter half of the this year and the beginning of next year.

James Heppelmann

I think just sort of summary, for us to post the quarter we did on a combination of revenue that was extra heavy on license and a little bit softer in services. First of all, that's not really bad news by anybody's measure.

Barry Cohen

No.

James Heppelmann

But it's also a problem that will and almost by definition must correct itself going forward just given the nature of -- you sell the software and then you follow with the implementations over four to six quarters that follow.

C. Harrison

I think just to add to that, Jim, just a little bit, if Sterling were sitting in our staff meeting, as we talk about it, we view it in light of a slightly different problem, which is we see an acceleration of services potentially coming given all the license revenue. And so as we sort of do our planning the back half of this year and next, we know there's going to be services that are going to accelerate. And part of what we want to do is offload that to partners for the medium-sized accounts and so forth, and that's one of the things that we actually spent a lot of time on.

Operator

Next question comes from Jay Vleeschhouwer from Ticonderoga Securities.

Jay Vleeschhouwer - Ticonderoga Securities LLC

Following up on that last comment about the progression of services. I'd like to tie that into the profitability of the Windchill or PLM business. If you look at the most recent quarter, over 40% of the Enterprise or PLM business was in services, less than 10% of the Desktop or CAD business was in services. So I would have to imagine that the PLM business while growing has a fairly minimal margin versus the CAD business. And I'm wondering if you could talk about how you see that profitability progressing on the PLM side either from revenue scaling or diminishing the proportion of revenues from services.

C. Harrison

It's another one that we do spend a lot of time on. In terms of the profitability, I mean, one of the things that we're seeing with the license growth on the Windchill side and the maintenance growth on the Windchill side, which we're focused on. As those become a bigger and bigger part of the overall Windchill slash Enterprise revenue number, then the profitability will go up. As we've talked about in the past, we have a sales force that sells all products, and so we have to do allocations when we try to predict what the profitability is and they're not exact, but we do think the Windchill business is profitable, and we think that it's going to become increasingly profitable, as again, we get bigger and bigger license and maintenance numbers. Part of that is our ability to provide services which we want to do for the most important accounts and the most profitable accounts because they're long-term service engagements with predictable kinds of margins, and then we want to offload other services to medium-sized accounts to a growing partner program that's getting better and better at deployments.

Jay Vleeschhouwer - Ticonderoga Securities LLC

Do you expect that in the third quarter that maintenance revenues will finally bottom and then improve sequentially thereafter?

C. Harrison

Yes, I think if you think about -- we're obviously being hurt the most on maintenance from FX Jay. I think either in the third or fourth quarter, we're going to see that, that bottoming that you described and growth up for that quarter [ph].

Jay Vleeschhouwer - Ticonderoga Securities LLC

Finally, in your data sheets, of course, you do the install base comparisons, and we continue to see some erosion in the non-Pro/E and non-Windchill -- all other categories in terms of sequential and year-over-year base count. So the question there is when do you think we'll see a turn in that active install base for those smaller brands? And then more broadly, how do you think you're doing in terms of multi-product sales and really configurations and growing the smaller brands?

C. Harrison

I'll answer the first question and maybe, Jim, you want to way-in on the second question in terms of the smaller products in our portfolio. I think you're referring to active seats on maintenance, Jay, for the all other category. I think we're going to look at that probably bottoming at the same time that we see our maintenance revenue bottom we just talked about during Q3 or Q4. So I think we've talked about the fact that there is a -- we have a little bit of a hangover in both the services and maintenance business associated with last year's license revenue. With what's happening with license revenue this year, obviously, that turnabout is going to come fairly quickly. And as I said, it's either going to be Q3 or Q4. Jim, do you want to comment on the strength of our performance in our -- if you will, products related to Pro/E and Windchill?

James Heppelmann

I think you mean products other than Pro/E and Windchill that might be bundled with or sold to the same customers. I think Arbortext in particular, we're pretty optimistic about, we didn't disclose Arbortext number though, I don't believe. But I think that the Arbortext revenues were up nicely last quarter, and we're sort of forecasting Arbortext to be a decent growth engine, sort of going forward 2011 and beyond. So we've sort of rejuvenated that strategy. We talked about that a little bit at our press day back in February, but we've rejuvenated that strategy, and that business appears to be back on a growth factor, and we're pretty optimistic that, that will be a long run. Quite frankly, that business will be a significant contributor. I think if you go to Mathcad, we're in a bad product cycle position with respect to Mathcad where we're on the brink of launching this new Mathcad Prime, which is a substantial over hall of the Mathcad software. And everybody knows it's coming but yet, it's actually in the market in a preview form, but it's not in the market in a final ship form. So I think that, that puts a little bit of pressure on the Mathcad product, and then I think the rest of the stuff is probably small enough that it's difficult to read much into one quarter's data.

Barry Cohen

One more thing, Jay, just to be more specific I think about the maintenance. The maintenance number bottomed out in Q2. Q3 in constant currency maintenance will be above Q2. That's what I would tell you.

Operator

Next question from Richard Davis from Needham & Company.

Richard Davis - Needham & Company, LLC

Quick question with regard to -- you mentioned kind of, I think it's accurate but it so goes license, so go services in terms of a follow-up. If I'm buying $100 worth of perpetual licensed software from you, guys, how much roughly will I have to spend on services over the next four to six quarters? Is the ratio 1:1, 1:2, whatever, those kind of things?

C. Harrison

I think at one level, if you just look at our license and service revenue, typical steady state services is equal to license or slightly greater. I think that Windchill is probably a little bit more strongly balanced towards services and with Pro/E less so balanced toward services. So I would say, yes, I mean where we sell $1 at Windchill, we're going to sell somewhere between $1 and $2 of services in the next six quarters, in that same dollar of license revenue.

James Heppelmann

There's two phenomenon going with the Windchill business. One is those attach rates, if you will. The amount of services that attach to a dollar of license revenue are coming down over time because we're doing more and more out-of-the-box implementation with Windchill. But the other phenomenon is that Windchill is growing as a percentage of our total revenue. As a result, we expect our Services business longer-term to grow kind of in-line with PTC's overall growth objective, which you know are in the 12% to 15% range.

Barry Cohen

I think the ratios definitely have come down to the rate like 1.2 from what it used to be like two would be good to the out-of-box thing. The other thing you see is when customers actually do the first implementation, it's heavy-duty on process redefinition and some heavy-duty service work. But then as they move out, the service work actually declined in relation to some of the new licenses they buy to expand their footprint.

C. Harrison

An engagement in the early days, maybe more heavily weighted towards services. And as that customer relationship matures about two, three years into it, it's moving more towards a pure maintenance and license engagement. If I could back up on this portfolio of six quarters idea, what I was really trying to say is that the services revenue we did this quarter is a function of the licenses we sold six quarters ago, five quarters ago, four quarters ago, three quarters ago and so forth. In fact, the licenses we sold this quarter, actually, don't have much impact on services revenue this quarter. They have impact on services bookings, but very little of those bookings were delivered against the license deal, for example, that came in the last two weeks of the quarter. So you can't really look at licenses this quarter as affecting services revenue this quarter. You'd have to think of services revenue this quarter being slightly affected by license revenue this quarter, more affected by license revenue one quarter prior, two quarter prior, three quarter et cetera. And as you backup into the three quarter, four quarter, five quarters prior, license revenue is pretty soft. And again, that's why I like to say that where licenses go, services will follow, but it may follow three to four quarters behind that trend.

Richard Davis - Needham & Company, LLC

Then the follow up would be on the domino beachhead accounts, what are your expectations and how as an outsider would you track your success of expanding from those kind of footholds and things like that. And at least notionally, I had figured the way to think about that is you get a domino account and then maybe a year later, you have a decent shot to expand from that position, obviously, there's exceptions to the rule. But is that the proper way to think about it? Is that how you think about the opportunity?

C. Harrison

Yes. If you remember back at our investor day, was it last October, we provided a monetization model of dominos, and we said that there's sort of a competition phase, and then there's a win. But following the win in the first year, you might have sort of $1 million to $3 million in revenue, and it might be dominated by services. And that's to get an initial implementation stood up at which point is typically a license buy. And then from there on, at that point in time, you have a somewhat contained deployment. It may be contained organizationally. It may be contained by program. It may be contained by geography. And so after that, you go into a series of successive expansion. Move onto the next program, move to the next business unit, move over to the next geography what-have-you, and that, that domino may provide us many successive orders for software and services and maintenance for years to come. We provided some examples. I provided one notable example of a customer who had expanded the system nine years in a row with successive license and maintenance deployment. So that's kind of the model. Not that much of revenue at the time of win, but it joins this portfolio of annuities particularly one and two years later. And then remains there for some long period of time.

Richard Davis - Needham & Company, LLC

And so that's still intact and that has not changed?

C. Harrison

No, absolutely not.

Operator

Next question comes from Steve Koenig from Longbow Research.

Steven Koenig - Longbow Research LLC

I have two questions that are somewhat related, so I'd like to ask them both upfront. The first question is would love to get some color on Large Deals. There a lot of Large Deals in the quarter, but AFPs were lower. I'm assuming there were no megadeals, call it $5 million or up just for the sake of having a definition. So I'm curious, what's your assumption on these kind of megadeals going forward? How much are they baked into your Q3 or your Q4 full year guidance? So that's question number one. And if I may, let me put quick question two on the table since it's somewhat related. It's pretty atypical to see 50% to 100% license growth rates for a public software company. Can you provide some color on what drove the 100% growth in PLM licenses? And then what do you expect for that trajectory going forward as well?

C. Harrison

Maybe I can start on the Large Deals and then we'll try to hit the latter. On the second question, we have a distinct and, I think, recognized increasingly competitive advantage, which is driving the license revenue. We've talked about the domino accounts, their displacements deals, so we're outside of our install base. We're certainly upgrading our install base and broadening our footprint and that accounts for a good part of the license revenue growth. But what's complementing that, which is really important, and it's not just the dominos, there's a whole list like an ArvinMeritor. We don't call it domino. We secured that deal last quarter. It was a Dassault replacement in an automotive account, supplier account. So there's a whole list of displacement deals that are active that are contributing to that license revenue growth. When we look at the -- sort of the big deals, and we had 18 deals over $1 million in Q2. Two years ago in '08, we only had 16, which was a really good quarter. So we've surpassed in Q2 of '010 the number of deals over $1 million that we have two years ago, which is really a good sign. What you see on the -- let's call these Larger Deals or deals over $1 million, from time to time, one of them or two of them or three could become a megadeal. And in Q1, we saw some of those commitments from the customer, the initial commitments were particularly large, and that gave upside to the results. If we look at the forecast, for example, for the back half of the year, there are in the pipeline, in our forecasting system, almost 100 deals that are greater than $1 million. And so we know we're going to have a very, very strong back half of the year. A year ago it was probably 35 deals. At this time, there were over $1 million for the back half of the year, so it's substantially higher. Some of those deals are going to grow to be megadeals, and the customer has a choice to make. They can start with, as Jim was describing, maybe more of an initial kind of a $2 million pilot. But in some cases, the ROI is so compelling that they'll do a bigger kind of deployment right upfront. And in that case, you're going to see upside to the forecast. So we've tried to give you guidance based on a nice number of these greater than $1 million deals coming in at traditional deal sizes in the $2.5 million range and to the extent that we get more of them that are bigger, and we do see some, then there's upside in the forecast.

Cornelius Moses

Maybe just adding one thing Steve, this is Neil. If you look at the geographic dispersion of these larger deals, that was really encouraging as well. 10 of those deals came in from outside of the U.S. so more than half. If you look at Q1, almost all the Large Deals we did and we only did 10, came from the U.S. So we're definitely seeing some recovery from an international perspective, both from a license perspective and from a large deal perspective.

James Heppelmann

Steve, it's Jim. I want to go back to your second question, just add some more color. Personally, I think there are three factors that are driving this phenomenal level of license growth that we're showing this year. One is the economy is improving. And clearly, that helps a lot. The second thing is I think PLM as a category for customer investment is hot right now. I've seen some surveys, for example, that rank it near to top of CIO priorities for investment in 2010. And then the third thing is market share. We are taking a lot of market share. So the sort of -- the economy's generally better, people are feeling good about spending money, then they say a place where we ought to prioritize spending is PLM. And then by the way, the PLM vendor and solution to buy is PTC. And I think that those three factors are helping us. Now the economy, once it's improved, and we have a set of good economy comps compared to good economy comps a year from now, that will be less of a factor in terms of license growth, so that will take some of it away. But I think this issue of PLM being a hot category and PTC taking market share, those are phenomenons that should be around for quite sometime and really drive some pretty decent license growth next year even when we don't have the comp against the bad economy like we do now.

Operator

Alexander Zorovic from Janney.

Alexander Zorovic - Janney Montgomery Scott LLC

Yes. So specifically, I would like to get [indiscernible] your color regarding geographies. so I guess Japan has been somewhat of a straggler for quite sometime, and it continues to be. What do you attribute that to? Does it continue to be just very specific to Japan or what's sort of going on there, if you could comment.

Cornelius Moses

It's Neil. We talked about Japan's performance. First of all, Japan license revenues is up 34% year-over-year, so we had a very good quarter in Japan from a license revenue perspective. I think overall performance in Japan was down slightly year-over-year, although up very, very much sequentially. I think, first of all, we have new leadership in Japan who is now been on board for about six months. We're very, very happy with the person that we brought on-board to run our business there. Secondly, we are starting to see more Large Deal activity in Japan as well. We're making good progress with our reseller channel, and I think we're poised to see kind of continued growth in the Japanese market for the first time in some time.

Alexander Zorovic - Janney Montgomery Scott LLC

My second question would be regarding your M&A activity. So that used to be sort of a very key part of your growth strategy. If you could update us there as to what your thinking is. Obviously, you were purchasing some share back during the quarter. Do you see that as a better way to deploy your cash at this point than acquisitions? If you could comment please.

C. Harrison

I'll comment on the general strategy of M&A. And Neil, I'll allow you to address this specific question on buyback. We have the strategy of 20% sustainable earnings growth, and we think that the way we're going to get 20% sustainable earnings growth is this so-called win in the market strategy. PLM is a growing segment. We're going to go on to become the clear leader. We're going to take market20% share. We're going to generate a lot of organic growth, and that will be the main part of the 20% earnings growth engine, if you will. I characterize it as three-parts revenue growth and one-part margin expansion, if you remember. Now that said, there -- acquisitions can play into this, but we don't have a strategy to go acquire 20% earnings growth. We have a strategy to get it largely organically and complement that with that acquisition. I think there's two things, two areas where acquisitions make sense. One is little technology tuck-ins here or there. We made a small acquisition in the last quarter or, so carbon information modeling technology to help people understand the greenhouse gas implications of early product design and so forth. That's all interesting. They typically bring little revenue and quite frankly in some cases, no margin to the company when we do those. But we work them into the solution and they become meaningful sometime later when we take them to market as part of our overall solution. And then secondly, I think we want to be opportunistic. There's a sort of changing software market out there, and we might get some opportunities here and there to opportunistically take down something that's bigger that might give us an entrée into a new market segment or something like that. I would say that's not a strategy but we want to be open to opportunities that may be presented to us but sort of working backwards always from a strategy of 20% earnings growth and a fundamental belief that, that's mostly going to come from organic revenue growth.

Cornelius Moses

Just add to what Jim said and give you some insight as to how we think right or wrong. What we've been talking about from a competitive standpoint, which is reflected in the dominoes and the other displacements is that we have this single data model that enables everybody in an organization to know that the product information is true and accessible. And our competitors don't have that. They're trying to copy that today. Dassault with V6 is an attempt to copy Windchill, and Siemens with the unified product is an attempt to do the same thing. While they're trying to do that, and it's going to take them years, and we'll see if they're successful, we've been broadening our footprint. We've already solved that riddle around a single data model. So now we're building out an application footprint that enables our customers to deploy an out-of-the-box solution, and that's important to us. We're extending our advantage by broadening that footprint with applications such as Arbortext, Product Analytics, SharePoint. So to Jim's point, we're going to build some of those applications. And in some cases, opportunistically we've been doing these little technology tuck-ins to complement that footprint. And again, it gives us an extension, a competitive advantage when we go in and do these deals. So that's really sort of how we think about it. Integral Data model, broadening footprint vis-a-vis our competitors and absolutely a competitive advantage in terms of out-of-the-box. One of our big customers that we've talked about locally here, defense contractor -- 50,000 seats deployed, 97% out-of-the-box. One of the EADS defense companies, one of the six divisions as replaced Siemens and SAP with Windchill in the last year since we won that agreement, 99% out-of-the-box. And these deployments are replacing systems that are basically 90% customized. So that's our story to the customer, and I think you'll see acquisitions, small ones if we can, again, expand our competitive advantage.

Operator

Ross MacMillan with Jeffries & Company.

Ross MacMillan - Jefferies & Company, Inc.

Just on the big deals, I guess the question I had was you're clearly growing very nicely in volume relative to last year, and you're tracking almost to the '08 levels. Just as we think about it, is this really a volume game? I heard you, Dick, talk about 100 deals in the pipeline versus, like, 35 last year. So it sounds like, although some of these can be upsized, it sounds like your guidance is really based more on the volume that you're seeing. That's question one. And then question two is just so I understand what's happening on maintenance, it looks like some of the impact is because of the higher value Pro/E maintenance seats coming off as you sort of ramped Windchill seat growth. Are we getting the same attach rate on maintenance with Windchill as we had historically with Pro/E?

James Heppelmann

Ross, let me take a shot at the forecast and the big deals and the volumes. I would basically say that you're right. Our guidance is predicated on a growing volume of nice size deals. We said earlier too, though, we're seeing recovery in the channel, so it's across all aspects of the products and geographies. But when we look at those deals over $1 million, those are certainly an important barometer, and the number is growing at a very, very fast rate, and we track it weekly. You might also have observed that we decided to add 90 people in the sales organization. It's approximately 30 sales reps, 30 application technical support people and 30 business development people that basically create leverage across the sales organization by freeing up the sales people so they don't have to do the value propositions and the ROI calculations. We have teams of people that support the sales guys. We didn't add those people. We added them simply because we saw this volume increasing. So again, we're seeing a great deal of volume in those transactions of $1 million and greater. Many of which are in our competitors install bases. And I think we're going to continue to see that grow. Some of those could grow to become megadeals. And again, that's just an aspect of how quickly the customer wants to make their investment. On the maintenance side...

Cornelius Moses

It's Neil. The Windchill maintenance attach rate is 100%. We require customers to attach maintenance on Windchill. So it's actually higher than Pro/E, and I'd say renewal rates are comparable to Pro/E.

Operator

Blair Abernethy from Thomas Weisel and Partners.

Blair Abernethy - Thomas Weisel Partners Equity Research

Just a follow up on the sales adds. Can you just clarify when those -- have all those 30 new reps been added already or what are you kind of look at in the back half of the year?

Barry Cohen

I don't know exactly where we are in the 30 reps. Again, don't discount the 30 business development people because they're going to make more productive and effective, potentially 100 reps they would support throughout the geographies in these large accounts.

Cornelius Moses

But we're at about -- on reps, just reps now, not AEs or business development people. We're about 375 today, on our way to 400. So we're in the early stages of adding that capacity.

James Heppelmann

Yes. We authorized that capacity in early March essentially, and the hiring process started. Probably not many of those people have been landed yet, maybe a smaller percentage and the rest will be coming on, I'd say, actually this month and next month.

Barry Cohen

But probably impactful next year. If you look at the ramp up time and the training time in building the prospect base, I don't think we're forecasting a lot of return from that investment this year. It's more with an eye towards having good growth next year.

Blair Abernethy - Thomas Weisel Partners Equity Research

Could you just give us an update on the progress with the ProductPoint, and sort of what your longer term expectations are there now?

Cornelius Moses

Yes, I think we had a pretty good quarter. We've been disclosing a number of transactions. And I think we did 106, Kristian, against sort of a goal of 400. So we're this quarter at a run rate that would help us meet that goal, perhaps even exceed it. They've typically been transactions sold through our channels, so the revenue contribution's not that meaningful yet. But as transaction volumes increase and the maintenance volumes increases and so forth, that will become meaningful. The other thing is we're approaching the sort of release to timeframe, where we're going to have a pretty significant follow-on-release which we think will make that product that much more interesting. But again, that product's doing well. We sort of defined our criteria for doing well in the early days is transaction volume because we're trying to get market share. And against that criteria, which we've shared pretty openly with you, I think we're doing pretty well.

Operator

Yun Kim from Broadpoint.

Yun Kim - Broadpoint AmTech, Inc.

ProductPoint obviously is doing well. Can you just talk about what exactly is the end gain for that ProductPoint? Are you looking at that as more of a platform play and eventually monetizing the install base by selling more add-in modules? Or -- I think you just talked about more on transaction volume basis initially. What does that really mean?

Cornelius Moses

Yes, so you're right. It is a bit of a platform play, and there's maybe two different angles. But, let's say for SMB, we're selling an initial ProductPoint offering. We have three more major SharePoint products come into market that would complement that and would provide up sales from that initial ProductPoint sale. So we're working on a PPM offering, product program portfolio management. We have a social product development, how to use Web 2.0 technologies, that's a new offering and then a third offering behind that. So I think, definitely, it's a platform and particularly in SMB, we'll leave the ProductPoint and up sell it. I think in larger accounts, it gives us a whole new discussion to have in what might otherwise be a difficult account, to sell PLM. So we might go into a large corporation who has a competitor's PLM environment installed and they might say, we're all fine on PLM, thanks. We say, well, do you have a SharePoint strategy? And they quite frankly, more often than not, the CIO says, yes, we do have a SharePoint strategy. And then we say, well, would you like to have a conversation about how SharePoint could be a little bit more useful on your product development processes? And they say, yes, I would like to have that conversation because quite frankly, the competitors aren't having it with me. So I think it's also a new entry point, a new sort of door, if you will, to penetrate some of the bigger accounts as well. But first and foremost here, it's an SMB strategy in the short term.

Yun Kim - Broadpoint AmTech, Inc.

Barry, going back to our favorite topic here today. I understand the lag between initial bookings and then revenue recognition of services business. But specifically, I'm just trying to reconcile the Consulting business coming in weaker than what you were expecting at the beginning of the quarter. Do mega sized projects typically take longer to plan and because of it, the delay in the Consulting business that we saw in the quarter? Or were there simply just sudden unexpected delays in the implementation work during the quarter?

Barry Cohen

I think that's a good question and it's a little bit of both. I think when you have -- we're doing a lot more because of out-of-the-box now, people are not customizing. They're doing a little more process redefinition. That upfront work takes a little longer to start the project in terms of deployment. So I think that's happening. And, I think as well as some of the book -- when the bookings come in has a relationship to how much revenue of that you can take in the quarter and that has an affect as well.

Cornelius Moses

Let me make a prediction. A year from now on this call, you guys, will be asking a lot of questions about how much services we have in the mix and is that becoming a profitability problem and all that kind of stuff.

Barry Cohen

That's the real problem.

Yun Kim - Broadpoint AmTech, Inc.

Can you just give us an update on your Channel business and what kind of investments are you making into that business right now? I think you made a comment a while back that you wanted the Channel business to continue to move up the value ladder in terms of deal size? Do you still feel comfortable with that growth strategy for your Channel business?

Cornelius Moses

It's Neil. I think right now, most of the investments that we made that we talked about a minute ago in terms of sales capacity, were made in the Direct Sales force at this point in time, and the reason for that is we're seeing the rebound really in our Direct business right now, and particularly in that upper right hand box with Windchill, large enterprise deals. So I think we've talked previously about the fact that we think our Channel business is about 30% of revenue now. It's probably going to stay there for the time being. We'll address the question of whether we make further investments in our Channel business as we head into next year in kind of July, August timeframe. We do see some improvement in the channel. If you will, our lower left hand box had 35% license growth in Q2. So that was encouraging. But I think that recovery is a little bit more slow than we've seen in the Direct space, and so probably additional investment isn't warranted at this point in time.

Yun Kim - Broadpoint AmTech, Inc.

Is there any new product release coming out on the low end part of the market or the desktop part of the market that could maybe re-energize the Channel business?

C. Harrison

Nothing we're ready to talk about today. I think you're aware we have road maps for Pro/E, and we just did release a major release of CoCreate. That's a pretty good traction, CoCreate 17. But Dick's sort of referring to some bigger ideas we have that aren't ready for prime time yet.

Operator

Ben Rose from Battle Road Research.

Ben Rose

With regard to these 200 Windchill competitive displacements that you see out there. Could you give us a rough sense these days with regard to where you see the greatest opportunity vis-a-vis the install base of Dassault, Siemens and Oracle?

C. Harrison

I think if we sort of look back at the last years or so, actually, it's pretty even across both the Dassault and the Siemens base,, maybe a little bit more towards the Dassault base. Some of the matrix install base accounts have been particularly vulnerable. They're waiting for the V-6 platform, which has been promised now for three years, and it must be eminent at some point. The unified ones have been promised for four years, I don't really know if it's any further along. Both of those systems that when we do see them trying to get some foothold are still heavily customized deployments. We don't actually see any live deployments out across the world. But when we see customers attempting to deploy them, they're heavily customized, which is again a big advantage for us as we look at our out-of-the-box system. But it's probably -- I guess to answered your question more specifically, I'd say it's 60% Dassault, 30% Siemens, 10% kind of others, including SAP, [indiscernible]. Funny enough though, I'd say if you had to pick a single product that we're having the most success displacing, it would be the Matrix product from Dassault, which funny enough is the basis for the V-6 strategies. So even the customers who have Matrix are frequently saying, we're done, we're out. We're not going to V-6.

Ben Rose

In given your strength in the industrial and electronics verticals, particularly kind of large midsize companies where I have to think Oracle is off in the database being used by your customers on the ERP side. Are you seeing any resurgence from Oracle, if so, not so much from a displacement of the actual product, but any resurgence from Oracle in terms of having a more forceful thrust into the PLM market place?

C. Harrison

It's Jim, I'm looking at Dick here. I think neither one of us -- we both spend a lot of time with the sales force. Neither one of us really engage in many discussions with the sales force about Agile competitions. So it just seems like after Oracle acquired Agile, things went quiet and have remained pretty quiet ever since.

Cornelius Moses

I think that's true. When we do the corporate visits I'm trying to think back as you ask the question on a corporate visit and we were in Europe last week flying around and visiting with customers and so forth. Anecdotally, I can't think -- or a transaction that happened this quarter. I can't think of one that was really dominated by a discussion around Oracle. The Agile product never really did sort of capture the authoring information, electrical, mechanical, embedded software. It was always -- it was actually more of an ERP application at the far end of the design process. It might have overlapped in the process. It sort of got closer to where the ERP people had their application, so we don't really see it that often. And I can't imagine it doing particular well.

Operator

Sterling Auty from JPMorgan.

Sterling Auty - JP Morgan Chase & Co

Just a follow-up on the headcount additions, the incremental investment. At this point, are you happy with the incremental investment for this year? How much capacity it adds? Or is there showing incremental investment from a headcount in any of your operational areas that you think would be necessary either this year or at the very beginning of next year?

James Heppelmann

It's Jim here. I think, Sterling, the way to look at it is normally, as we approach fiscal '11 starting October 1, this summer we would go through a planning process of authorizing some additional expenditures based on the business plan we see for FY '11 and so forth. This year, we did something sort of different and, quite frankly, a bit unique, in that we were significantly ahead of our 20% earnings goal at midyear. And so we said let's get started on some of those investments now, realizing that, to Dick's point earlier, someone you hire October 1 doesn't really contribute in the first quarter, maybe starts to contribute in the second quarter, but they provide a meaningful contribution in Q's3 and Q4. So we basically said, lets start some of those hires two quarters early. So that by the time October 1 rolls around, some of these people hit the street running. The bottom line is we've kind of made an early investments in FY '11 based on being ahead of our plan substantially here in FY '10. But going into FY '11, I expect that we'll have an opportunity to make an incremental investment that probably is larger in magnitude than the one we've already made, but we need to go through that planning process yet.I think we need to see what happens in the back half of the year.

Operator

Our final question comes from Jay Vleeschhouwer from Ticonderoga Securities.

Jay Vleeschhouwer - Ticonderoga Securities LLC

Two broad follow up questions on market trends. First Jim, you made a remark earlier that you've seen some recent surveys that suggest PLM has moved up in priority, perhaps fairly high up on the list, and it seems to have taken about a decade for PLM to get there. It had typically been fairly low in priority. So the question is what do you think's changed to make PLM now more of a verb and not just an interesting acronym? And secondly, I suppose I have to ask obligatory cloud question. Dassault, particularly their solid works business have made quite a lot of commentary recently about their intentions for putting apps on the cloud that may entail some possible changes in licensing models and the like away from your industry. Oracle had a fairly well attended event yesterday for customers on cloud computing here in New York. So something's going on obviously. I'm just curious as to your thoughts on the cloudiness issue.

James Heppelmann

Yes, let me say in general, if you look at where IT spending's going right now, it's going into enterprise applications. And within enterprise applications, I think we all know that the ERP thing is a bit run its course. So I think companies are saying we need to move on, find that next opportunity to bring some business process advantage to our company, and it isn't ERP. We've been there, done that. Any advantage we ever thought we had there has matched by everybody else anyway, and there is no next generation of that concept. So I think some of the growth problems you see for SAP is because their market segment has matured, whereas PLM is not at all mature. And I think there's been some real focus shifting to hey, this PLM thing is another form of business process advantage, and quite frankly, it maybe a more enduring form of business advantage anyway. So I just feel like there's ample evidence out there that it's not infrastructure and so forth that spending is going into it. It's really applications and within applications, it is PLM. So there's a couple of different surveys, you go find them yourself. But couple of different surveys that suggest that trend. And then on the cloud issue, we've been on the cloud. We're ready to be on the cloud. We are on the cloud in a limited way right now. But I don't think that the cloud in and of it self changes that much in our industry. It's a different sort of deployment option. This is an application that runs on a server and whether that server's in your data center or up in somebody else's being run for you and delivered to you as a service, what that technology does and the business advantage it brings to you is what's most important. I don't think SolidWorks is going to go on any big growth spurt because they're putting apps in the cloud. I just don't feel like the cloud has proven itself in many industries quite frankly. There was actually an interesting reported I read recently on where the cloud has worked, and where it hasn't worked. The truth is, it's worked well in pretty select industries like CRM and there's a whole lot of industries it hasn't been very impactful to. So we'll keep monitoring it, but we've had this Windchill on-demand thing for quite some time. Agile had an on-demand solution. The arena guys previously known as bomb.com have a pure cloud solution. So the idea of clouds for PLM is not a new idea, but it is an idea that really hasn't seen much adoption on the customer side and I pointed out many times before that there's a technical issue around bandwidth and large data sets. And then there's a sort of emotional issue around the protection of critic crowned jewels type IP. People are just a little afraid to put the latest thinking of their corporation, their latest design up into a cloud when they're not 100% sure that it's safe up there. It seems like it should be but it's a real concern that doesn't seem to go away.

Cornelius Moses

So again, thanks for listening in this morning, and we actually feel really good about the back half forecast, about the pipeline and the big deals. I actually think in many respect, we spent too much time on services. It's not a concern for us. We're aware of the situation. But as Jim said and I tried to say as well, we have a broader concern about it which is the license revenue is going to dictate much higher services volumes, and it's going to be a different kind of a problem for us as we try to ramp up to address it. So again, thanks for your time this morning, and we'll look forward to talking to you again in the summer. Thanks.

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