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Executives

Barry F. Cohen - Executive Vice President of Strategy

Jeffrey D. Glidden - Chief Financial Officer and Executive Vice President

Tim Fox -

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

Analysts

Yun S. Kim - ThinkEquity LLC, Research Division

Blair Abernethy - Stifel, Nicolaus & Co., Inc., Research Division

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Steven R. Koenig - Longbow Research LLC

Richard H. Davis - Canaccord Genuity, Research Division

Ben Z. Rose - Battle Road Research Ltd.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Parametric Technology (PMTC) Q4 2011 Earnings Call October 27, 2011 8:30 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to PTC's Fourth Quarter Fiscal Year 2011 Results Conference Call. After brief comments by management, we will go directly into the question-and-answer session. As a reminder, ladies and gentlemen, this conference is being recorded. I would now to like introduce Tim Fox, PTC's Vice President of Investor Relations. Please go ahead.

Tim Fox

Thank you. Good morning, everyone. Thanks for joining us on our Q4 results and outlook call.

Before we get started, I would like to 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 current assumptions of PTC's management and are subject to risk and uncertainties that could cause actual events and results to differ materially. Information concerning these risks and uncertainties as contained in PTC's most recent Form 10-K and Forms 10-Q on file with the SEC. Also, financial measures in this presentation are non-GAAP financial measures. A reconciliation between the non-GAAP measures and the comparable GAAP measure is located in our prepared remarks document on the Investor Relations page of our website at www.ptc.com.

With us today, we have Jim Heppelmann, Jeff Glidden and Barry Cohen. With that, I'd like to turn the call over to Jim.

James E. Heppelmann

All right, thank you, Tim. Good morning, everybody. I'm pleased to report that Q4 was a solid quarter with strong results really across the board. Quarterly revenue was a record high for PTC, up 27% year-over-year while operating profit was up 62% from what was a relatively strong Q4 last year.

We posted solid growth across our license, maintenance and services lines of business. We delivered in the quarter a good balance of Desktop and Enterprise growth, and we believe that the improvement we've seen in our Enterprise growth rates, starting back in Q3 and continuing now into Q4 reflects the effects of our effort to ramp sales capacity as we've been discussing. We won 3 new domino accounts in Q4, and with that, we succeeded in reaching our goal of 30 for the year.

Additionally, there were a couple of substantial deals that we were pursuing in Q4 that were completed actually in Q1, so we're off to a good start here already in fiscal year '12. We posted a good overall year in FY '11 with momentum in growth rates increasing throughout the year and leading to an all-time annual record revenue level for PTC of $1.17 billion.

On the earnings front, our non-GAAP EPS growth rate of 26% topped last year's 25% EPS growth, meaning that we've now exceeded our 20% EPS growth goal for a second year in a row, and we've moved a bit further ahead of the pace required to hit our $2 per share EPS target in 2014.

There were some other important transformations that happened in FY '11 that has set us up well for FY '12 and beyond. First, the new leadership team is in place and working well together. As you know, over the last 2 years, we put in place a new CEO, a new CFO, a new EVP is heading up the sales, services, R&D and marketing organizations. In that same timeframe, we've restructured the Board of Directors and brought in 4 new members that had significant enterprise software experience and combined them with some of the previous talent that we retained from the manufacturing industry and from academia. So the new Board is functioning well, and they have a laser focus on increasing shareholder value.

In FY '11, we launched a new generation CAD offering called, Creo, and that product went on to see growth that far exceeded our expectations at the beginning of the year. While much of that growth can be attributed to a better economy and a rebound in cash spending levels, we believe that at steady state, this new technology will add 3 to 5 points to the low single-digit growth rates that we had been forecasting a few years ago prior to the advent of Creo.

In the prior lifecycle management, our PLM arena, we launched Windchill 10.0, which was really a very significant major new release of what has become our flagship offering. Windchill 10.0 is a product that customers find to be very compelling, due to both substantial improvements and ease of use in adoption as well as a lot of new capabilities, like product analytics and quality lifecycle management.

On a related note, I'm pleased to report that the Hyundai Kia implementation is going well, and we're on track to complete Phase 1 of the HKMC Enterprise PLM initiative by calendar year end. We had a big year in the retail and consumer industry, with important new wins at customers like Sears, Ralph Lauren, Esprit, Dick's Sporting Goods, Tommy Bahama and a long list of other major retailers. These customers have turned to PTC for help in optimizing product development across very distributed global supply chains.

The retail vertical continues to be very strong growth driver for PTC, and we think that the supply chain optimization solutions that we pioneered for these retail customers represent an incremental growth opportunities for PTC in the coming years as we introduce the same capability back into some of our traditional verticals like electronics, industrial, aerospace and automotive, who also have globally distributed supply chains helping with product development.

On the corporate development front in 2011, we made a sizable acquisition in MKS, which opened up an entirely new growth opportunity for PTC in helping our customers to develop the software that goes into or alongside the manufactured products. We typically refer to this type of software as embedded software. This is a hot topic amongst our customers right now due to the trends in the product development industry toward more electronics and software. And the Integrity product is recognized as the leader in this embedded segment of the application lifecycle management or ALM market. The embedded segment is clearly our focus area, and it's where some of the strongest growth in the ALM market is coming from. The integration of MKS is proceeding smoothly, and you will probably note that we had strong results from our first full quarter of Integrity sales in Q4.

So to add to that late in the year we acquired a company 4CS, which is not large, but has significant strategic value, and it helps us to continue to transform our Arbortext story from a very tactical technical publishing capability we acquired back in 2005, into what's becoming a very strategic service lifecycle management or SLM offering. SLM, which is a market segment covered by industry analysts, represents another new market segment for PTC. And significantly increases the opportunity size for our Arbortext offering.

Incidentally, the service information system implementation at Caterpillar that many of you are aware of is going very well, and we received a substantial follow-on order in Q4 to fund the next phase of this deployment.

So in summary, we continue to have strong prospects for growth in PLM; we have really upgraded our growth prospects in CAD with the introduction of Creo; we see our supply chain or SCM opportunity developing nicely; we've acquired our way into the new growth opportunity in ALM; and we've transformed Arbortext into a stronger growth opportunity by expanding into SLM.

So with all that opportunity, we feel that our long-term growth prospects are stronger than ever. So having accomplished all of that transformation I mentioned, while at the same time delivering a solid year of 26% EPS growth on the back of 16% revenue growth, I'd like to take a second to thank the new leadership team, and as well, the new Board for their hard work and dedication throughout the year. We're all pleased to be able to put FY '11 into the wind column and turn our full attention to FY '12.

Looking forward then, we're providing a relatively strong growth outlook for FY '12 that is based on our current pipeline and forecast data. At first glance, it might seem too strong. Keep in mind, however, that the 2012 guidance of mid-teens overall revenue growth on the back of 20% license growth, includes a full year revenue contribution from the MKS acquisition, plus a secondary contribution from the 4CS acquisition. We assume that organic contribution of low to mid-teens licensed growth is consistent with last year's actual. Because of the acquired revenue, and the fact that in 2012, we will have significantly more sales capacity, the overall license growth target feels more conservative than the headline number might otherwise suggest.

So overall, we're moderating our organic revenue growth aspirations somewhat in FY '12 by intentionally dialing back our services growth targets.

Obviously, as you know, we want to expand our operating margins, and it's clear to us that continuing to have services growth rates like we've experienced in FY '11 isn't really the right way to get there. So in FY '12, we plan to hold our organic services growth rate to high single digits. To do that, we'll be relying more on partners like Accenture's and others. And at the same time, were going to redouble our focus on driving solutions that fundamentally require less services.

Of course, the acquired revenue streams of MKS and 4CS will add a nonorganic contribution to our services growth. But I think that, inclusive of that contribution, we will have a services growth in the low- to mid-teens, which is roughly half the rate of fiscal year 2011, and a rate that helps drive a more profitable revenue mix.

We also plan incremental improvements in our services net margins, which we expect to be in the high-single digits in FY '12. This will provide additional support towards expanded profitability. So with the mid-teens overall revenue growth comprised of a more profitable mix than last year, our goal of 20% earnings growth feels realistic for FY '12.

So naturally, this guidance assumes a relatively stable economic environment. We're fully aware of and fully mindful of all of the concerns about the economy. We see the headlines every day, but feel that we should rely more on the forecast in pipeline information that we have at our disposal even if this data doesn't completely correlate.

We're going into FY '12 with a good head start, a plan that delivers solid growth in the year. But at the same time, we're going to keep our ear to the ground, and we've prepared contingency plans in case we see signs of the economy softening in a way that's impactful to us.

For example, while we remain full speed ahead on hiring related-to-sales capacity, we've already begun to moderate other forms of spending and hiring. So with our -- the effect of that, by the way, showed somewhat in our Q4 EPS results. So with our contingency planning, we feel that we're in a position to dial back spending and hold 20% earnings growth even on softer revenue growth than we're currently forecasting. Of course, if the economic environment were to weaken drastically, it would become increasingly difficult and then even impossible at some point, the hold that 20% earnings target. But we don't really foresee that happening at this point.

On the other hand, if the economy does not soften substantially, we could be in a position to deliver some earnings outside, based on the spending and hiring restrictions we've put in place. So when you balance those upside and downside scenarios together, it seems appropriate to stick with our middle of the guidance range of 20% earnings growth on the back of 14% to 15% revenue growth for fiscal year '12.

So finally, I want to bring to your attention an Investor Relations Day that we are planning to host in New York on February 7 of 2012. We plan to use this forum, which will follow our Q1 earnings call, to provide an update on our FY '12 deals, to discuss our market position and our opportunity in the CAD, PLM, ALM, SCM and SLM segments where we do business and to provide an updated perspective on longer-term revenue and earnings goals. Tim Fox, our Head of Investor Relations will supply you with more information about the specifics of this event as we get closer to it, but for now I simply ask you to mark the date on your calendars.

And with that, I'll turn it over to Jeff Glidden, our Chief Financial Officer.

Jeffrey D. Glidden

Thank you, Jim. I'll make a few additional comments on the quarter and then summarize our guidance for Q1 and FY 2012.

As Jim cited, total Q4 non-GAAP revenue of $341 million was up 20% -- 27% year-over-year, driven by 19% year-over-year PTC organic revenue growth, coupled with $23 million in revenue from our MKS and 4CS acquisitions.

Q4 non-GAAP operating profit increased by 62% year-over-year to $77.5 million, and EPS increased to $0.47 per share. Higher than anticipated tax rate and other expense items negatively impacted our reported Q4 EPS by approximately $0.02 per share, while our Integrity business contributed positively, adding $0.01 per share to our non-GAAP EPS in the quarter.

Clearly, our highlight of the past year has been our focus on driving higher profit margins while investing to capitalize on the long-term growth opportunity. In Q4 2011, our non-GAAP operating margin increased to 22.7%, up from 17.8% in Q4 of 2010. And for the full year FY 2011, we have expanded operating margins from 15.6% to 17.7%. This 210 basis points improvement results from increased sales and R&D productivity. While we have increased our R&D spend to $203 million in FY '11, we've also realized significant operating leverage as these new products have been delivered to market, such that our R&D expense as a percent of revenue has declined from 19% in the prior year to 17.3% in FY '11. And we've realized increased sales productivity as our sales and marketing spend has declined from 30.1% to 29.2% in the same timeframe.

On the balance sheet, we ended the quarter with $168 million in cash. During the quarter, we repurchased $15 million of PTC's stock; and we completed the acquisition of 4CS for $15 million; we purchased capital equipment of $10 million and paid down $50 million on our line of credit.

In addition, we've renegotiated the revolving credit agreement with our banks to extend this agreement through August of 2016 and add more favorable rates. Turning to our outlook for Q1 in FY '12, as Jim cited, we enter the year facing a very uncertain global economy. We're continuing to add sales capacity, and at the same time, we're being very disciplined with our broader spending and staffing plans.

Our key goal for FY '12 is to drive at least 1 percentage point improvement in operating margins. We expect approximately half of this gain to come from higher gross margins and the balance from leverage and operating expenses. Our longer-term goal is to drive non-GAAP operating margins to 20% to 22% by 2014.

As noted previously, approximately 25% of our business is transacted in euros and changes in FX will impact our reported results. Our guidance for the first quarter and for FY '12 assumes $1.40 U.S. dollars to the euro. This rate compares to USD $1.45 to euro in our Q3 guidance. And this change would have the effect of reducing our expected FY 2012 reported revenue by some $15 million. For Q1, we expect non-GAAP revenue of $305 million to $320 million and EPS of $0.28 to $0.32 per share.

While we're off to a good start in the new year, we have broadened our guidance range for the quarter to reflect the present level of macroeconomic uncertainty. For the fiscal year 2012, we are raising our non-GAAP revenue guidance from $1,320,000,000 to a range of $1,330,000,000 to $1,340,000,000. And we expect our non-GAAP EPS to be $1.48 to $1.52 per share.

We expect our full year 2012 non-GAAP tax rate to be approximately 24%. We plan to purchase approximately $50 million of PTC stock during the year. We also expect stock-based compensation to be approximately $51 million or 3.8% of revenue for 24 -- 2012, and we expect our longer-term stock-based compensation to trend towards 3% of revenue.

In summary, we are very pleased with our financial results and progress in 2011, and we're off to a very good start in FY '12.

Thank you for joining us, and we'll now open up the call to your questions.

James E. Heppelmann

Operator, questions, please?

Question-and-Answer Session

Operator

Yes, sir. Our first question today comes from Yun Kim with ThinkEquity.

Yun S. Kim - ThinkEquity LLC, Research Division

You mentioned that you are directing more business to the system integrated this year. Can you just tell us how you are achieving this, and whether there will be additional investments that you have to make to ramp up the SI channel? Are you expecting Accenture to be your biggest SI partner this year? And then also, where are they in terms of the resources today, and do they have specific plan to increase their resources this year? Or is it more contingent on the amount of business that you bring to them?

James E. Heppelmann

Yes. Well, Yun, first of all, it's a series of questions. Hopefully, I'll capture all of them in my answer here. I think it starts a little bit with a philosophy and an attitude and a compensation program. It isn't designed to maximize the revenue. So in the past, we've had a compensation program that paid our services guys on operating margin dollars, which meant the more revenue they brought in, even if it was at margins that, maybe we don't like, the more revenue they brought in, the more compensation it could earn. So we're changing that immediately or have already changed it to really an operating margin percentage, which is -- we're saying we want more profitable revenue, not necessarily more of it but more profit in the revenue. And then we have in fact, invested quite a bit now in our partner program infrastructure that's ready to kind of help transition some of the incremental opportunity for services to our partners. We've had a partner program in the past. I think, we're just going to get much more serious about it in FY '12. That does cost some money, but that's all baked into our planning assumptions already. And then with respect to the actual partners, Accenture, I would say, is emerging as our strongest partner right now. But certainly, we have other strong partners and sometimes on a geographic basis, it might not be Accenture at all or perhaps on an industry basis. But I think we're certainly starting to get a lot of momentum and a lot of projects with Accenture. I feel like it's capturing their attention as well, and they're starting to sort of double down on their side of the investment as well.

Barry F. Cohen

I have one more point. This is Barry. Just as our service organization itself is being [indiscernible] on the partner economy until they're invested in growing that service economy, which is a very important change for us going into 2012.

Yun S. Kim - ThinkEquity LLC, Research Division

And then just in terms of the visibility that you have going into this year, can you give us or share with us any metric regarding the visibility that you have, especially around large deals? I think last year, you told us that you had 79 annuity customers who spent at least $2 million of revenue, representing 44% total revenue. Wondering where that particular metric is tracking for fiscal year '11 and then where do you expect that to trend this year?

James E. Heppelmann

Yes, Yun it's Jim. I'll take a first stab at that, and Jeff can add. One of the metrics I like is the amount of revenue we continue to get from these domino wins. And keep in mind that domino wins, by definition are competitive takeaways. There's also a series of just good, healthy in the family accounts that look exactly the same, other than being competitive takeaways. So what we're starting to see is relationships that are really very annuitous [ph] to PTC, and we're starting to build a large portfolio of them. That's really where we want to take the focus of the attention next year from dominoes to annuities, because we want to show you the whole portfolio, how many accounts are in that portfolio, and how many of those accounts are doing a lot of business with us now, year in and year out. And so that's what I like is that we're building up a steady kind of bedrock of big accounts doing a lot of business with us every year as we're on a journey of continuous improvement in the product development processes.

Jeffrey D. Glidden

I would just add Yun that this -- in the prepared remarks, we cited 103 large transactions in the year. That's up from 70 a year ago, a very significant growth there representing $248 million of revenue, better than 85% of our revenue in any given year comes from our existing customer base. So that's a very -- gives us good visibility, good understanding. And I think the expansion of the sales team is giving us better coverage of those accounts, as well as penetration into new accounts. So I think the visibility in programs are improving, and we feel pretty good about that.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Okay, great. And then one last question for Jeff. Cost of license revenue saw a big sequential bump in the quarter, what's going on there? And is this the new baseline going forward?

Jeffrey D. Glidden

Our margins on license have traditionally been in the mid to upper '90s. And so we'd expect that would continue as we go forward. So I feel very comfortable with the margin and the mix as we cited before. So I'm not sure I have any specific comment on the quarter, other than to say it's always been consistently in the upper -- mid to upper '90s.

Operator

Our next question comes from Matt Hedberg from RBC Capital Markets.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

I guess -- MKS had a very nice quarter here, out of the gate here. And I guess one of the things that we liked about that transaction was the ability to cross and upsell. It's still early, I imagine, but is there any -- do you have any sort of anecdotal evidence that MKS brought you guys into certain deals or vice versa?

James E. Heppelmann

Yes, it's Jim here, Matt. Let me say right now I think that the ability to cross and upsell is greater than we anticipated it to be. In fact, we're having to push back a little bit on some of the efforts to do so because we don't yet have the infrastructure in MKS to engage MKS in all the PTC accounts where the sales guys want to pull them in today. So it looks very promising, and I think that this acquisition over time is going to prove to be an extremely good move on PTC's part, based on sort of the anecdotal evidence we see of revenue synergy at this point.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

That's great. And then in terms of global results. Obviously, you guys had a very strong results -- essentially across all geographies. With the 26% constant currency growth in Europe, I mean what changed there? Was it execution on your part? Or I mean, how do you kind of account for the strength there?

Jeffrey D. Glidden

Matt, this is Jeff. Europe has been a very significant market for us. And I think traditionally, it's been about 38% of revenue. For this year, it was 40%. We're very much focused in Central Europe, Northern Europe and have just a very large installed base, particularly in the industrial sector, which has been very strong for us. So I think it's been very, very good execution by the team in Europe. I think we have got a great base of customers, and we've just continued to both expand with those customers and add new customers. So I'd say probably good opportunity and good execution by our team.

James E. Heppelmann

Yes, maybe just add a little color to that. I think in the Scandinavia area, we've had some incredible competitive wins in the last few years, really kind of cleaning up competitively. And that's translated into a lot of annuity accounts and a lot of revenue that we just didn't have a few years ago. And then I think if you go back to Germany, the sort of mid-sized and in larger German industrial companies, the German automotive suppliers and so forth, I mean, we've just had fantastic business with them. And I think they're doing well. We all hear about the bad economy in Europe, but I don't think the German industrial companies are doing poorly at this point.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Great. And then one last question for Jeff in terms of the license, guys. I think you guys did a good job of really differentiating the organic and inorganic license targets to get to the 20% for the full year. I think you also indicated that your guidance now assumes a pretty stable economic environment. Yet the Q1 range is pretty wide between 6% and 26%. What -- I mean, can we assume that the 6%, is that sort of things getting significantly worse? And the 26% is things getting materially better in sort of a mid point of 16% is sort of the stable economic environment?

Jeffrey D. Glidden

I think that's reasonable. I think there's more upside based on activity. We were just honestly being very cautious as we were putting our notes together. The level of uncertainty we felt it was just prudent to broaden that range. Clearly, we're driving towards the -- from the mid to the upper end of that range and that's the visibility that we have. But as you know, and we can anticipate, there could be a few deals that we get to the end of December that push into January. So it's really just that caution. I think the overall activity is very, very good, and we feel very confident in the year, a little bit of caution on the Q1 numbers.

Operator

Our next question comes from Richard Davis with Canaccord.

Richard H. Davis - Canaccord Genuity, Research Division

So the mid and high-end CAD -- a two kind of part question. But mid and high-end CAD hasn't been a growth business for about a decade, so what I'm trying to figure out is, is all that was -- with all that was needed is kind of integration of kind of 2D history-free CAD and in the Pro/E and then rebranding the product and then that created a tipping point? Or are we seeing kind of pent-up demand from underserved accounts that, frankly, were maybe used in other vendors that weren't investing as much as they should. And then if so, kind of how do you gauge -- what's the evidence that you have that this is more than just -- the burst of growth will last more than a few quarters? Because I think that's a question that people including myself are trying to noodle over.

James E. Heppelmann

Yes, Richard, it's Jim here. I think it's really kind of a balanced combination of those 2 factors. I think definitely there was a situation if you go back to the 2008, 2009, where our customers were questioning our commitment to the CAD business. And maybe some of them were not making investments with PTC because they weren't sure if PTC would be their vendor 5 and 10 years down the road. So I think that, plus then the bad economy of 2009, caused a certain amount of pent-up demand. And in 2010 and now especially in 2011, the economy has been much stronger in the CAD sector. And I think that our customers -- I mean it's just fun to go to customer meetings right now and talk about CAD, because they are blown away by Creo. Just -- it's just emanating vision and leadership and so forth, and so people who maybe question whether or not this company was going to be in the CAD business long term, are back to questioning whether we're going to regain leadership of the CAD business in the long term because we have a really exciting product. So I think they're going back to buying things that they maybe had tabled for a while. And then we bring in the second factor, which is we have so much new stuff to sell. So what I've been telling people is I think that the factor of the economy and the pent-up demand will play itself out at some point, and then we're going to switch to the factor, which is we've got a lot of new stuff to sell. And keep in mind we have a massive customer base here. So we have a lot of new modules and new capabilities to hold direct modeling, flexible modeling type stuff you mentioned. And we have 27,000 companies to go sell that to. And if we sell each one of those 27,000, even a little bit of this new stuff, it produces very big numbers. So I think -- I view it that the economy thing will play out and that the real factor, the Creo real factor is just getting started, and that will carry on for a number of years now.

Richard H. Davis - Canaccord Genuity, Research Division

Got it. And then a quick tactical question and then I'll bump out. On the maintenance guidance you guys have, if you kind of analyze your maintenance guide at $155 million, gets you to a full year already. And I'm unclear -- so if that's true, but if you're also signing all sort of big license deals, why wouldn't that show up in the maintenance increase, in terms of why wouldn't that number grow faster than just kind of a straight line? Or is that just being conservative?

Jeffrey D. Glidden

Richard, there's a lag effect. That's the probably the #1 thing. So as we sign new deals, they beget maintenance revenue streams in subsequent quarters and subsequent years. So I think we're still very, very positive about all the metrics, both tax rates, retention rates and so forth. And I think our modeling would suggest that there's a reasonable growth that we put in there. Again, it's off a large installed base, and I'd just remind everyone that we really blew away that number this year. And so there will be a lag effect, which means in '13, we'd see another significant and attractive increase in maintenance as we close out the -- close all of the new business that we expect to -- in '12. So it will be a continuing sustainable growth revenue stream for us.

Operator

Our next question comes from Ben Rose with Battle Road Research.

Ben Z. Rose - Battle Road Research Ltd.

A couple of questions. Now that the HKMC first phase is coming to a close, Jim, could you talk a little bit about your expectations for next year as it pertains to license sales, perhaps to HKMC? And then a second question is for the supply chain optimization that you -- the product you've been selling in the retail industry, who are you encountering there in terms of competition?

James E. Heppelmann

Yes. Okay, those are good questions Ben. So with HKMC we are wrapping up this first phase, and it's gone as well, or quite frankly, better than I would have expected, given the complexity versus the timeframe we had to execute in. So things are in good shape there. That means there will be a second phase. I don't necessarily want to tell you what the negotiations are at the moment with HKMC, but what I will tell you is we're not going to lose money on the second phase, that this is going to be a project that's not an investment, but sort of over-reaping the rewards to the investment we made in Q1 of FY '11. So I think there'll be a significant license component to it. It will undoubtedly be a significant services component as well, but that's going to be fully funded in the transaction all in will be a pretty positive-looking transaction. On the second question about our supply chain optimization, who are we competing with, this is probably the newest sector of PLM. You wouldn't find many retail companies using PLM 5 years ago. And what happened is all of the PLM vendors sort of jumped into it at the same time. It started really with -- this kind of supply chain stuff should be done by ERP companies perhaps, but they just missed the boat completely, because it's too much churn. It's too dynamic. It's too many suppliers, too many changes, too fast. And so I think that the ERP and traditional supply chain vendors basically don't have a solution here. So PLM was sort of forced into this, forced into duty, if you will, solving this problem. And what happened is all 3 of us, PTC, Siemens and Deso [ph] jumped into this. I would say at this point, in our view, Siemens has nearly exited the business. They had a couple of wins. And the most notable, which have switched over to us at this point, and our win rate against Deso [ph] is sky high, sort of a route almost, in this particular sector. It's a little harder in other sectors, but I would say the most competitive sector PTC's in right now is supply chain. I mean the place we have the strongest competitive advantage is the supply chain sector and these big retail accounts because our win rate is approaching 100%. It's not quite there, but it's very high.

Operator

Our next question comes from Blair Abernethy with Stifel, Nicolaus.

Blair Abernethy - Stifel, Nicolaus & Co., Inc., Research Division

Just looking for an update on the Windchill 10.0 upgrade cycles, can you just give us some sense of where that is? And how that's being received in the base? How quickly you think that's going to disperse? And then also on your 3 domino wins this quarter, were those PLM or CAD? And just some color on whether they were, displacements are not?

James E. Heppelmann

Yes, okay, on the second question, of the domino wins, all 3 of those were PLM wins. On the first question of Windchill 10.0 and adoption rates and so forth, I'd say that Windchill 10.0 is doing well. Right now, we have sort of a very large body of upgrades happening within our customer base that we're involved in, sort of like double to what we had been in the prior 6-month period. So I think what happened is -- customers upgrade on a regular basis, but in anticipation of Windchill 10.0, some people held off a little bit, and now there's a huge wave of upgrades moving through the system. So I think the feedback has really been phenomenal. One of the things we did -- and I don't mean to go technical on you here as the former CTO, but we adopted this agile or Scrum development method a couple of years ago. And in that method you involve a lot of customers in the R&D process. So in this particular case, 50 to 60 customers actually punched the code while it was under development and gave us their feedback and so forth. And so when Windchill 10.0 came out with this new user interface, it was more or less perfect. In fact, there was a customer that told me the other day, it was like Christmas, I got -- just when I looked under the tree and I got just what I wanted. So I think that was a good situation, and I think the customers are excited. And there's a big wave of upgrades, and it's starting to show as well now in the competitive work that we're doing.

Operator

Our next question comes from Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

I'd like to ask first a 2-part question, actually about maintenance. First, in Q4, you had an unusually large increase in Enterprise

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and year-over-year. And I'm wondering if you could break down the components of that in terms of the

[Audio Gap]

some previous quarters. Any reinstatements you may have done in Q4 or even pricing? So that's the first part. And then secondly, as the impact of annuity accounts and large deals grow, what do you think that might mean, if anything, for maintenance seasonality? The reason I ask is when you look at one of your larger peers' maintenance business, they have very pronounced seasonality in Q4 then it drops off in Q1...

[Technical Difficulty]

Jeffrey D. Glidden

Jay, we may have lost you. We can't hear.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Can you hear me now?

James E. Heppelmann

We can answer the second question. We might need you to restate the first one, just because some critical parts to your question disappeared on us. But I -- on the second question, I know what you're referring to, which is -- one of our competitors has quite a sawtooth in their maintenance. And I don't really understand that myself, Jay, because of course, for us, all of this maintenance is recognized ratably. So independent of when you land the renewal of the contract, it just all then gets spread out over a long period of time, which actually makes it very difficult to have big spikes and values. So I don't foresee us having a lot of seasonality other than sort of consistent with what we had in the past, which is minor seasonality compared to the company you're talking about. So I don't see that happening. If you look at, back in 2009, in the depths of the depression, our maintenance slowed down from sort of mid-single digits to kind of flat, and then it picked back up again. I mean, we just didn't have big spikes. This particular company you're talking about has it going up 10% and 15% -- up and down 10% and 15%, and I can't actually understand how that works myself.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Okay, let me repeat the first question. Sorry I broke up. In Q4, you had unusually large increase in Enterprise maintenance revenues, both sequentially and year-over-year. And I'm wondering if you could break that down in terms of previous quarter's license volume flowing now into maintenance, reinstatements, pricing and anything of that kind?

Jeffrey D. Glidden

Yes. Jay, this is Jeff. So a couple of things. We've had very good metrics all year. Again, reiterating attach rates, renewal rates, et cetera. We've had programs that recapture seats as well, where people may have been off maintenance. I think all of those have been successful. The impact in Q4 is continued organic growth. We posted a year-over-year 24% growth in maintenance. 16% of that was organic; the other 8% came from the acquisition, particularly MKS. They have a large installed base, a good installed base, and so that was really the differential between -- in Q3, we were up 17% with some very small impact of MKS; organically 16% in Q4, plus MKS. The nice thing is now that rolls forward, creating a new base for us, going into 2012.

James E. Heppelmann

Yes I think that sort of another take on your question is probably the biggest reason for that spike was acquired maintenance. A secondary reason is probably some currency impact, but the fundamental strength in maintenance is constant currency organic maintenance growth. And what's really interesting is some of the policy changes we made 4 or even 5 quarters ago, produced a gift that keeps on giving. Because if we negotiated, let's say back in Q2, a renewal at much better rates or if we took a new deal at much better rates than we might have previously, because we take all that revenue ratably, it continues to have a positive impact in all the quarters going forward as well. So I think there's sort of a snowballing as well of all the positive impact of prior policy changes in the portfolio of maintenance. Let's say, customers or maintenance accounts renewing into these better terms and policies that we now have in place.

Jeffrey D. Glidden

And I think as you'll see, Jay, just adding a couple of other comments in that the Windchill seat counts have gone way up, and they've progressed all year. It's really reflective of the revenue and implementations that began well over a year ago, now flowing through as active seats and being now under maintenance. So I just think that the team has done a great job, and we'll continue to look for them to continue to drive those metrics and drive those numbers.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Just 2 follow-ups, if I may. When you think about your large deal pipeline in geographic terms, what are your thoughts about the Europe for fiscal '12? The reason I ask is that the majority of the increase in large deal transactions in fiscal '11 were in Europe. You would have some increase in Asia and some -- a couple in America, but the bulk of it was in Europe, particularly in the second half. And then lastly, for Jim, what are your thoughts about your opportunities, particularly at the automotive OEM level? There would seem to be some ferment, let's say, in terms of what's going on with the larger car companies and what they're thinking about in terms of PLM infrastructure. So what are your thoughts in terms of being able to win additional business there, particularly in competition with Siemens?

James E. Heppelmann

I'll take that second question first, and then Jeff you can circle back to the first one. I do think you correctly identified that there's a wave of change threatening to happen in the automotive industry. And I think that this show stands to probably give up some share. If I had to sort of read the tea leaves, and I think you might agree with me on that. And I think that PTC and Siemens stand to gain some share. Now I'll tell you Siemens, as you know, is in a strong position. But PTC with the wins at Volvo truck and then especially the wins at Hyundai, we've certainly improved our standing in that community. And as you know, people are saying it would have been easy for Hyundai. It would have been a noncontroversial position to switch from Deso [ph] to Siemens, but instead they switched to PTC, why is that? And as you know, the Hyundai guys view themselves as leading the next wave, not following the last one. And if others see things the way Hyundai does, then we stand to pick up a lot of market share in automotive. I don't want to predict that yet. I'm certainly optimistic, but I'm really excited about the fact that I think there's going to be a lot of change going on. And in the past, with no change, there's no opportunity. And so with change, there's great opportunity. It's just a question of how much can we capture?

Jeffrey D. Glidden

And now going back to the question on large deals, clearly, Europe was a very, very strong performance to both a year in the quarter. By the way, that activity and that pipeline has continued to build and transact as we entered FY '12. So Europe is doing very well. We expect that to continue. That said, I think our largest growth in the pipeline ahead is in the U.S. with the Americas, and we had a very good year, but we've also seen very substantive growth, particularly in high tech electronics, along with industrial, particularly along -- and as Jim cited, retail is another area. But I think the pipeline growth is probably most significant as we look ahead in the North American market.

Operator

Our next question comes from Steve Koenig with Longbow Research.

Steven R. Koenig - Longbow Research LLC

I just wanted to bounce -- to ask the questions other way then maybe one follow-up. I'm wondering, Jeff, can you remind us the deferred being down, looks like a seasonal pattern. What's behind that? And another question on the cash flows. Even if DSOs had been more normal this quarter, the quarter may be not quite so back-end loaded. Cash flow doesn't look like it would've been great. They're not growing -- didn't grow at the level of earnings. How should we think about this going forward and maybe what drove that?

Jeffrey D. Glidden

Sure, two things. First on deferred, it's a seasonal pattern that our big renewal times are really December and January and then in the middle of the year. So if you look at our deferreds and you look at them historically, you'll see it builds at the end of the year and into Q1. That it comes down slightly in Q2, rebuilds and at the end of Q3, our fiscal year, it'll be down slightly at the end of the year, which it was. And all of that, the good news is that whole business is building nicely and gives us great cash flow. So I would say, we feel very good about that, and that pattern is very consistent, all the metrics look good. In the quarter, the cash and cash flow, basically, breakeven in cash flow. It's really reflective of a significant increase in receivables, which is good for the future. And a piece of that example, I think, we cited. 4CS was added in September. There was about $5 million worth of receivables with virtually very small amount of revenue in the period, so that added about a day to DSOs. If I look at overall at our accounts receivable, we're actually in better shape than we've been in many, many years in terms of past dues and so forth. So we feel very good, we actually had very good sub-cash collections in the first part of the quarter. So I would say I feel very good about where we are in terms of receivables. And I think we've outlooked for the year. We'll generate significant amounts of cash. We'll buy better than $50 million worth of stock. We expect to pay down about $100 million in debt over the course of the year. So I think their cash and cash flow position feels very good to me.

Steven R. Koenig - Longbow Research LLC

Okay, I guess if you were to add back the litigation expenses last year and adjust for DSOs, you think cash flows will grow here at the level of earnings?

Jeffrey D. Glidden

Yes, they should be very close to our operating, non-GAAP operating margin, should be very, very close to cash flow. And to your point, yes clearly, last year we had a $52 million litigation settlement that occurred in the first quarter of last year. That was -- if you adjust for that -- and again DSOs, to the extent that we're typically right around 60 days adjusting for 4CS, we were at 61 days. The good news is we've got a lot receivables. The good news is that will all convert to cash.

Steven R. Koenig - Longbow Research LLC

Okay, great. And then if I may, just a little bit on the large deals and also the services outperformance we saw in Q4, were there any $5 million to $10 million whale-type deals? Were they -- and were they skewed to services? Was there any doing services work before the licenses came in, et cetera? If you could give us some color on that large deal activity and that services outperformance, that'd be helpful.

Jeffrey D. Glidden

Okay, so the first things on the -- we disclosed, as you know, the large deal transaction. We had 30 large deals that transacted. The average value of those was $2.8 million. That was up slightly, but in the zone from where we've traditionally been. We're usually between $2 million and $2.5 million. So we did a few additional larger deals, but nothing -- in terms of the average, we're very, very consistent. Jim did mention that we had a significant follow-on transaction with Caterpillar, so that will probably be one of the larger transactions, and we don't specifically disclose more gate bigger than that. But I'd say overall, we feel pretty good about where that mix is.

James E. Heppelmann

And maybe, Steve, to be honest, the Caterpillar transaction would qualify as a whale, but we only took a small piece of it in the quarter.

Jeffrey D. Glidden

That correct. So that's a real good point because that is an annuity stream that we'll see over the next quarters and years that will continue to return to us. On the services side, a lot of the services growth has been, as we've discussed earlier, the implementations of Windchill from transactions in sales of both 2010 and the early transactions in '11. And so most of those, we think of services as both a lagging and leading indicator. That is after we've sold the Windchill, we're in the major deployments. As those deployments get completed, as we talked, for example, HTMC, we'd expect follow-on license revenue as those are completed. So if they -- the services level of activity is high for a substantial value for our customers, and it's the leading indicator for the next wave of additional license sales.

Steven R. Koenig - Longbow Research LLC

Okay, that's great. Now if you don't mind, I've got one follow-up for Jim that he might like to answer. I'm wondering, Jim, can you give us any commentary on uptake of Creo, particularly direct? I'm just wondering, is there a potential that this history-free modeling could see a big adoption wave over the coming years? Or are we more likely looking at something that's going to be a niche, or at least say, a complementary method to Parametric?

James E. Heppelmann

Yes, I'd say personally, the latter. I don't think the standalone history-free modeling is going to take over the world. In fact, the opposite has happened in the last 15 years. The Parametric modeling is taking over the world. But I think that the combination of the 2 really make a good powerful combination, either one by itself, leaves half the people frustrated because Parametric modeling, if you're a power user, it is much better. On the other hand, if you're a casual user, the direct modeling is better. And because in any given company, half the people are power users and half are casual users, what you really want is a system that can meet both needs in a fully compatible way. And that's kind of the promise of Creo. And so I think that there's a few people out there with standalone direct modelers. I just don't see them taking over the world, because they'll leave the power users very frustrated.

Operator

Our next question comes from Sterling Auty with JP Morgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

You talked about the leverage you're getting in the sales capacity that are -- sales area. But I'm wondering specifically, the new capacity that you brought online over the last couple of quarters, how are they ramping in particular in terms of their productivity?

James E. Heppelmann

Well, I think there's 2 sources of new capacity. One is we've unwound to a certain extent, overlay organizations within the company and taken people who were overlaying the mainstream sales force and moved them into the mainstream sales force. And these people become productive quite quickly because maybe they used to even be in the mainstream sales force. So they don't have a long learning curve, they just need a different charter. And then there's the people we're hiring. And I think the people we're hiring, by and large, haven't contributed much yet because the learning curve there is several quarters long. So I think that the hires we started to make in Q3 and Q4 are becoming meaningful now in Q1 and Q2. And that'll sort of be the trend throughout the year is that we're getting more and more benefit. We are attracting a series of primarily activity metrics to make sure that people we hired are doing something. And we're encouraging them to be setting up meetings and customer visits and all that stuff, which is an important part of the learning process. And I think just a lot of that kind of activity happening right now.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay. And then on the European performance in the quarter, you have in the breakout -- sorry, in the supplemental remarks, the number of large deals. But what I'm curious about is, how is the performance in Europe in terms of the direct sales versus the channel in the region? Where did you get more bang for the buck this quarter?

Jeffrey D. Glidden

I think, in general, Sterling, it's been our direct side. It's been the large accounts. We're very strong and active there. And -- so I would say it's really our direct sales organization that has been driving that growth. And I expect with the large scale deals we're doing and the complexity, that'll continue.

James E. Heppelmann

The channel had quite a good year though.

Jeffrey D. Glidden

And a good year, yes. I won't say it, but I'd just say the big transactions to speak specifically to that, that will be through the direct organization.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay, and last question. On the prepared remarks, a nice sprinkling of Arbortext through there. Just want to make sure that I walk away with the right interpretation. What's been the performance there? And what's your expectation for 2012?

James E. Heppelmann

Yes, I think that, one of the things that we want to do at this February event is go deeper into the market segments we're in as opposed to the product mix. Because to some extent, when we say Arbortext, like the Arbortext project at Caterpillar, it turns out it involves a whole lot of Windchill and a good dose of Creo as well. So what we're really saying is we should talk to you about our service lifecycle management offering. We should talk to you about the service lifecycle management segment, the competitors, the growth rate, the market share, et cetera. And we want to -- well, let me take you back in June at our PlanetPTC event, we sort of unveiled that framework. And I think at this February Investor event, we want to take you a lot deeper in it because, in fact, we think that the SLM solution we have right now is unique and powerful. And we think there are a lot of Caterpillar life accounts lined up behind Caterpillar. And we want to tell that story with some richness at that February investor event. But it's definitely an area where we're going to see a lot of growth. I say all that just because when we say Arbortext today, we don't -- we actually mean something much more than that company we acquired back in 2005 now. That's the richness I want to give you in February.

Operator

And our final question comes from Ross MacMillan with Jefferies.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Either Jim or Jeff, you obviously made a change to called plans last year around maintenance discounting. Is there anything that you're setting up as we go into fiscal '12 on similar lines? Anything we should be thinking about that could have implications for the model?

Jeffrey D. Glidden

On the maintenance side, I think that's been a highlight this year. We talked about attach rates, renewal rates, recapture has been very good, as well as discipline on pricing. And again, that's I think been a very strong program. And I would just anticipate that, that will continue in the years ahead. And as we said earlier, that makes our maintenance business a very sustainable growth area for the business. And it's really, as we cited earlier, as we generate new license sales, that lags quarters and months behind, but builds a nice annuity stream behind it. So I'd say the maintenance side is steady as she goes, continues to see that being very successful. I think one of the changes that we've talked about in the model and for the year would be services. And just harking back to rate growth this year to implement programs, we're building up a partner ecosystem, and we do expect our portion of that to be more strategic, more high value add on many fronts. We've got a very high utilization and a talented group, and they create significant value in our customer base, but it will grow at a slower rate with higher margin. So as we look to 2012, we'd expect slower growth on services, higher margins. And just a reminder that our '11 results included the impact of the HKMC deal early in the year and that cost us about 2 percentage points on gross margin and services. So with that behind us and the programs that we just described, I think we look at services being a very significant opportunity for us this year.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Great. And just one related to maintenance. Last year was a somewhat different year from a normal seasonal trend in Q2. Fiscal Q2, when maintenance declined, can you think forward to that this year and help us understand how you're thinking about that fiscal Q1, Q2 transition on maintenance?

Jeffrey D. Glidden

Usually, Q2 is a little bit softer, but we would expect it not to be a decline, but to be at a pretty consistent level just because of the base we have. So while it is seasonally a little bit slower, I wouldn't expect to see a decline in the second quarter, but would expect it to look similar to our Q1.

Ross MacMillan - Jefferies & Company, Inc., Research Division

One last one for you, Jeff. Just on the cash flow, I think it was asked earlier, just wanted to be sure I got that. So you think cash flow from operations will approximate to non-GAAP operating income in fiscal '12?

Jeffrey D. Glidden

Yes. And again, that's going to adjust -- the adjustment would be working capital, really receivables. So depending on the timing and seasonality, it could be plus or minus the change in receivables, but that's always -- our AR is very solid, very high credit. So that's the caveat on the change. But fundamentally, we'll be generating cash at a level of non-GAAP operating profit.

Ross MacMillan - Jefferies & Company, Inc., Research Division

And the very last one for Jim. So obviously, the service lifecycle Arbortext's piece is starting to come to fruition. I think you got through some milestones with a big customer. There were a number of other customers, I think, on a council, who were also, I guess, contributing to the spec, very interested in how this was evolving. How do you -- how fast do you think some of that might translate into new opportunity, new business for PMTC?

James E. Heppelmann

I think that we will see a nice growth rate for Arbortext here in 2012. I think it'll be one of the stronger elements in growth in the company portfolio as those other accounts come into the picture, and I think that's the run that's going to last a decade. Because we're onto something that feels pretty important here, and we have a solution that's relatively unique, not really a good competitor lined up against it. And a lot of customers in the industrial sector, in the automotive sector, anybody who's producing things that lasts a while and get serviced and maintained and warranty claims and tech support calls and so forth. They're pretty interested to talk to us. So I think it'll be a growth leader here in FY '12. And our portfolio, it's not huge yet, sort of medium-sized, but I think it will be a growth leader. And I think it will become a substantial business for us over the next decade.

Jeffrey D. Glidden

Okay. So I think with that, we're probably out of time, and I don't want to keep everybody longer than we need to here. Jim, I don't know if you have any final comments.

James E. Heppelmann

Sure, just to wrap up. As Jim mentioned, stay tuned for some more details regarding our event in February. We also remind everyone that PTC is going to be participating in 2 upcoming investor events in New York City, the RBC Software Symposium on November 15, followed by a UBS Global Technology and Services Conference on the 16th. Again, thanks for joining us this morning, and we look forward to talking to you again on our Q1 earnings call.

Jeffrey D. Glidden

Okay, great. We appreciate your time and your support, everybody, and look forward to seeing you again in 90 days, if not sooner. Thanks.

Operator

This concludes today's conference. You may disconnect at this time.

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