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Executives

Tim Fox

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

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

Analysts

Ben Z. Rose - Battle Road Research Ltd.

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

Richard H. Davis - Canaccord Genuity, Research Division

Steven R. Koenig - Longbow Research LLC

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

Yun S. Kim - ThinkEquity LLC, Research Division

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

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Parametric Technology (PMTC) Q1 2012 Earnings Call January 26, 2012 8:30 AM ET

Operator

Good morning, ladies and gentlemen and welcome to PTC's First Quarter Fiscal Year 2012 Results Conference Call. After brief comments by management, we will go directly into the question-and-answer session. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce Tim Fox, PTC's Vice President of Investor Relations. Please go ahead.

Tim Fox

Thanks, Evan, good morning, everyone. Thanks for joining us in our Q1 results and outlook call. Before we get started, I'd 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 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 presentation are non-GAAP financial measures. Reconciliation between the non-GAAP measures and the comparable GAAP measures is located in our prepared remarks document on the Investor Relations page of our website at www.ptc.com. With us this morning, we have Jim Heppelmann, Jeff Glidden and Barry Cohen. And with that, I'd like to turn the call over to Jim.

James E. Heppelmann

Thanks, Tim. So thank you, and welcome to all of you who are spending your time with us here this morning. As you saw on our press release last night, PTC is off to a good start in fiscal 2012 with solid Q1 results. Just a quick note that throughout my comments here this morning, I'm going to be referring to non-GAAP numbers.

In Q1, revenue of $320 million was at the high end of our guidance and up about 20% year-over-year with about 12% of that growth being organic. The revenue mix was aligned with our expectations with Enterprise revenue increasing 21% organically, and 38% overall, while Desktop revenue was up 5%, all of which, of course, was organic.

EPS was $0.35 a share, which was up 59% year-over-year and well above our guidance. That's largely because operating margins were better than 18%, a full 5 points higher than a year ago. So Q1 looks to me like a solid quarter largely devoid of surprises other than perhaps the positive element of higher margins driving higher EPS.

I'd like then to move on to the bigger news in the press release, which is the changes we're making to our profitability outlook, both short and long term. You will note that we significantly raised our profit guidance both for FY 2012 and for our longer term model. To provide some context, you will recall that after I became president in 2009, we outlined to our shareholders a goal to deliver a 20% EPS growth rate for 5 years through 2014. Our strategy was to do this by growing revenue about 12% annually and combining that with operating margin expansion of about 1 percentage point per year, resulting ultimately in an operating margin target of 20% by 2014.

In terms of actual performance, we've been able to exceed the EPS growth goals in 2010 when we had 25% EPS growth, and again in 2011 when we had 26% EPS growth. If you look at how we've accomplished that, you'll see that we've been achieving the 12% revenue growth goal on average, but we've been adding more like 2 percentage points of margin expansion per year.

This year, in FY '12, we are again expecting to meet or exceed our revenue growth goal of 12%, and we feel confident that we will expand margins by another 2 percentage points to take our margins to around 20% for the year. And with Q1 coming in at 18.4%, this seems like it'll be achievable.

Note that if we do achieve our 20% margin target here in 2012, that puts us already at the finish line of the original FY '14 margin expansion plan, which essentially causes our FY '14 goals to be no longer meaningful.

So with a couple of years under my belt, and with Jeff having been with us for more than a year, we've had a lot of time to analyze the business. We feel comfortable we can maintain that same level of revenue growth going forward and also think there are some changes we can make that would allow us to commit to the 2 percentage points per year margin expansion until such time as we drive our margins into the upper 20s where they arguably should be.

So with that in mind and with our 2014 goal becoming obsolete, we are retiring the FY '14 goal and have provided a new set of targets for the 2015 time frame, which is to drive an 11% to 13% revenue growth rate while increasing our margins to the 25% to 27% range.

If you play this out at the midpoints, it would suggest revenue of around $1.85 billion and EPS of about $3 a share in the 2015 time frame.

These goals are attractive, so I want to spend a little time to give you some more insight into the changes that we are making to make them achievable. I'd like to caution that I don't expect to accomplish much more than to simply overview them in this call. But I'd ask that you plan to join us at our February 7 investor event to get the full detail behind PTC's strategy and our business model going forward.

Starting back in the late 1980s, PTC has operated with a functional organizational model for most of our existence. We ultimately found, as most companies do, that as we grew beyond a certain size and complexity, the functional model starts to break down because it's difficult to focus on different opportunities that have different characteristics.

In 2009, after I became president, we created several business units to focus on some of the new opportunities that we felt were adjacent to the core businesses of CAD and PLM. And of course, in the core businesses, we continued to operate with a functional organizational model. These business units were generally structured around acquired businesses such as Arbortext, Mathcad, InSight, which was the Synapsis acquisition, Relex, and then more recently, the acquired MKS business.

The focus of these business units really paid off on the growth dimension as each of these business unit has outperformed its original growth goals. And at the same time, Jeff and I could see that these business units, which were quite deep, were also creating a level of inefficiency in terms of extra sales, services and management overhead.

So knowing that our margins are trailing many of our peers, starting last summer, we performed a deep dive analysis on our profitability situation, and we concluded that, structurally, PTC should be able to achieve operating margins in the upper 20s, similar to our peer companies. This is about 10 points higher than PTC achieved in fiscal year 2011.

Our analysis showed inefficiencies in sales, mostly in terms of overhead ratios, were costing us about 5 points of margin relative to peers and a combination of services revenue mix and services margins were costing us another 5 points relative to peers.

But we can see that inside these challenges are some great margin expansion opportunities. So we've created an organizational realignment that focuses our strategy and solution planning work around 5 market sectors while retaining the vast majority of our sales, services, R&D and marketing resources in a more efficient functional model.

The 5 market sectors which are: CAD; ALM, or Application Lifecycle Management; SCM for Supply Chain Management; SLM for Service Lifecycle Management; and of course, PLM are all very interesting opportunities, but they have different market sizes and growth rates, different competitors.

We're trying to solve different problems and we're offering different value propositions, so we need to deeply understand each opportunity individually, yet in many cases, they can share the same technology like Bill of Material or 3D graphics. The solutions need to work together and they can be sold to the same customers. So for maximum efficiency, we'd like to share technology, as well as sales and services resources across all 5 market sectors.

This is essentially a type of matrix organization model that's fairly typical of larger, more complex offer companies like PTC. It will allow us to continue to have the customer focus necessary to achieve the revenue growth success we've been seeing, yet we think we can drive significantly higher margins going forward.

As we've moved to implement this organization realignment, we've been able to capture a number of efficiencies in the short term, which led to the reduction in force and restructuring charges that we mentioned in the prepared remarks and that Jeff will comment further on in a second.

That's about as much overview as I have time for here today. I'd like to reiterate that at our February 7 Investor Day, which is less than 2 weeks away, we'll take you through a much deeper dive into this overall strategy, as well as provide insight into the dynamics of each market sector and the progress we're making to efficiently expand our sales capacity and to continue to improve our services mix and margin.

We're excited to share this strategy with you, and we feel that talking about the actual market sectors in which we compete will give you a much better understanding of our business and its opportunities than the Desktop and Enterprise framework we've been using for some time.

Of course, we'll continue to provide Desktop and Enterprise reporting through the balance of FY '12 to give you time to get comfortable with this new perspective.

So with that, I'd like to thank you again for joining us here today, and I'll turn it over to Jeff Glidden, who will take you through some of the financial highlights of the quarter.

Jeffrey D. Glidden

Thanks, Jim. I will make a few comments on the quarter and provide our guidance for Q2 and FY '12. As Jim cited, we delivered very good financial results from Q1 despite an unfavorable headwind from currency movements. As we began Q1, we provided revenue guidance of $305 million to $320 million based on FX assumption of $1.40 per euro.

During the quarter, the dollar strengthened such that our average rate for the euro was $1.37. This lower FX rate would have had the effect of reducing our Q1 revenue guidance by some $4 million to $5 million, with balanced revenue growth in all regions, with our European business leading the way, growing 24% year-over-year.

By the way the majority of our European business is generated in Germany, Switzerland, United Kingdom, Scandinavia, France and Benelux. I would also note that our European customers are typically large and global in scale, and while they could be impacted by a slowdown within Europe, they tend to be more influenced by global GDP.

Non-GAAP operating income increased by 66% to $58.8 million or 18%, and EPS increased to $0.35 per share. The significant improvement in profitability in Q1 is due in large part to improved gross margins in our services business coupled with slower growth in operating expenses.

You will note that our non-GAAP tax rate increased to 25.3% in Q1, and for the year, we are now expecting a tax rate of approximately 25%. This higher tax rate is primarily due to the fact that the R&D tax credit expired as of December 31, 2011, and has not yet been re-enacted by Congress.

On the balance sheet, cash increased in Q1 to $187 million reflecting some $36 million in cash flow from operations. DSO increased to 63 days, up 1 in the first quarter from 62 days at the end of FY '11. This one-day change is reflective of a seasonal increase at the end of the calendar year, as we typically see a number of customer payments collected during the first week in January.

As Jim mentioned, we announced the restructuring and realignment to be completed in our current fiscal quarter Q2. As of December 31, PTC's worldwide employment was approximately 6,100 employees. We are planning to reduce staffing by some 3%, and we'll be taking a pretax charge of approximately $20 million in our second fiscal quarter. We plan to complete this restructuring during the quarter and expect to generate approximately $5 million in related benefit per quarter beginning in Q3. The $20 million restructuring charge will be excluded from the company's non-GAAP earnings.

Turning to our outlook for Q2 and FY '12. We entered 2012 facing a very uncertain global economy. We're continuing to add sales capacity to expand -- to address our expanded market opportunities. In the same time, we'll be very disciplined with our broader spending and staffing plans. While our current levels of business activity remain high, we respond to any changes in the economy and customer spending as appropriate.

As you know, approximately 25% of our business is transacted in euros, and the changes in FX will impact our reported results. Our guidance for the second quarter and for FY '12 assumes $1.30 per euro. This rate compares to $1.40 in our Q1 guidance. And this change will have the effect of reducing our Q2 guidance by approximately $7 million and reduce our full year FY '12 revenue by some $25 million.

In addition, this currency headwind would have the effect of reducing our EPS by some $0.05 to $0.06 per share for the fiscal year. For Q2, we expect non-revenue -- non-GAAP revenue of $305 million to $320 million and EPS of $0.32 to $0.36 per share.

Despite the stronger U.S. dollar and unfavorable currency impact of $25 million on FY 2012, we are providing non-GAAP revenue guidance of $1,310,000,000, to $1,330,000,000 for the year. And based upon our lower cost structure and improving gross margins, we are raising our non-GAAP EPS guidance to $1.58 to $1.62 per share. And as Jim stated earlier, we are committed to driving our non-GAAP operating margins to 25% to 27% by 2015.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Ben Rose with Battle Road Research.

Ben Z. Rose - Battle Road Research Ltd.

Jim, I wanted to know if you could comment on HKMC now that the first phase of the relationship has been passed here, outlook for the second phase and follow-up from there, I guess.

James E. Heppelmann

Yes, sure. Well, I think you probably all saw the press release we've put out a couple weeks ago, including a nice quote from a very high level Hyundai Kia R&D executive. So the first phase of the project is in fact closed out successfully, probably one of the projects I'm most proud of in my entire career here at PTC in terms of the level of work that had to be done in the time frame in which to do it and many difficulties sort of in the environment, yet we performed very well. So there's 2 things that are happening now. One is in expansion of the users of that first phase. As you might recall, we did not get a significant software order upfront. We had one, but it was not significant. So now there will be an opportunity to add a lot of users to this Phase 1 system, and then simultaneously, we're also negotiating the Phase 2, let's say, functionality expansion. So there'll be kind of a Phase 1b, which is just more users, and then in parallel, the beginnings of negotiation of a Phase 2, which is an expansion of the functionality and then ultimately the user base of the system from there. So I think we expect to get some interesting revenue streams from HKMC. Whether that happens here in Q2 or in Q3, I'm not 100% sure, but it's in the works and that's the direction we're headed.

Ben Z. Rose - Battle Road Research Ltd.

Okay, great. And secondly, we've been reading quite a bit recently about some of the problems that the automotive manufacturers have had specifically relating to their electric car initiatives and some of the difficulties in terms of, I guess, the integration of embedded software and the traditional automotive components. Are you seeing any new opportunities with regard to your combined PLM and ALM solutions in any of the other major automotive OEMs?

James E. Heppelmann

Yes, absolutely. I would say that we have many such campaigns underway. I'd actually say that the place where we have the most activity with the integrity ALM business is in the automotive industry, because as you mentioned, there's been such a proliferation of embedded software in an automobile. An average luxury automobile has as many lines of code in it as PTC has across all our product suite. So they're very complex software devices at this point and a lot of that's developed by suppliers, so there's a supply chain elements to it, there's a huge quality discussion, as well as systems engineering discussion, which is how to actually design a strategy for the integration of hardware and software into an operating vehicle that meets the customer requirements. So it's definitely a hot spot, and I think will continue to be the #1 market opportunity for our ALM business.

Operator

Our next question comes from Sterling Auty with JPMorgan.

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

Wanted to start with the 11% license growth organically in the quarter, looks like you expect it to accelerate. What is it that you expect to drive that acceleration whether it be particular vertical industry, geography or even large-deal activity?

Jeffrey D. Glidden

Sterling, this is Jeff, so the first half of the year, if you take our guidance plus Q1, we're looking for organic constant currency license growth of 13% to 14% and then the back half would be upper teens, 18 to 20. So there is a plan and assumption that we step up in the back half, I think it's a combination of things. Some of the major customers that we've been working with, additional follow-on orders and pipeline that we see there. Secondly, I would say sales capacity. As you know, we've been adding significantly to the sales capacity, a lot of that is been higher in the last 6 months. It's really the back half of the year where that starts to kick in. So we're looking for probably about 5 percentage point increase in growth in the back half, primarily due to both add-on and follow-on business with our customers, installed base, the new sales capacity. And just on a vertical basis, we've seen very significant strength in industrial, particularly, auto, that Jim mentioned earlier, high-tech electronic and retail. So those would be the areas that we see as significant strength. I don't really have any additional comments on the geos, but I think, there's enough opportunity as we add capacity and we're, by the way, adding capacity in all geographies, really to address what we think is additional customer and market opportunities.

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

Okay. And then, Jim, I know you want to save for the Analyst Day the deep dive into the 5 segments, but can you add just a little bit more clarity in terms of -- I wasn't completely sure. Are you talking about dedicated sales staff for each of those opportunities and dedicated R&D, or I didn't understand it within the matrix, what components are going to be shared across the entire company and what ones are going to be focused within each of those areas?

James E. Heppelmann

Yes. Let me say, today, the business units we have are quite deep. They have their full dedicated sales, full dedicated service, full dedicated R&D. That's the as-was model. Okay? And so what we're trying to do is 2 things. We're trying to make the business units thinner, so it is really more of a matrix than an operation, because we think that's going to be much more efficient. And then the second thing we're trying to do is make sure that the 2 biggest businesses we have, CAD and PLM, also have a business unit. So we're restructuring the depth of these business units and also the coverage. We're going to cover 5 of the main things, not just the small things on the edge of the business. So I think that what you're going to see is actually not a lot of dedicated sales and services. What you're going to have is business planning, profitability management. You're going to see strategy, some amount of marketing particularly the preparation of the value proposition and so forth, but I think, at the end of the day, we don't really want too much sales overlay. That's one of the things we're unwinding and creating a big efficiency advantage. I'll give you an example, if you take a customer like Caterpillar, for example, whereas, you know we've been doing a lot of this Service Lifecycle Management business. That's an account that already had a PTC rep on it because they were a CAD customer. And so now, when we bring in Service Lifecycle Management, we'd like the rep who covers that account to also cover the Service Lifecycle Management opportunity. That rep needs some expertise, but they don't really need another rep with a commission program and so forth. And so in the past, we've been giving them another sales rep. Now we have 2 sales reps working on one deal, which means there's sort of an overlap of quota. When we get the one deal, both reps are happy, but I'm not, because I have 2 reps that landed one deal. So we're trying to avoid the idea of overlaying sales reps with sales reps. We're trying to overlay sales reps with domain experts, which is a much more efficient model for us going forward.

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

Got it. And then last question, on the services part of the business, seems to see a nice uptick here. Looking at both the growth and the profitability, is this directly correlated with the return to growth or the acceleration of the PLM business?

James E. Heppelmann

Yes. I mean, I think right now, I would characterize PLM services demand as very high. Now we've talked about services, mix and margins, and what we're trying to do is drive down the mix and drive up the margins. But I'll say, the faster we drive up the margins, the less pressure there is to drive down the mix. So I think what happened this quarter is, in order to keep up with the demand, we had partners take a lot of it, but there was still a lot that PTC needed to take, so we took that. But the good news is we took much higher margins than we would have last year. And I think, overall, our margin plan for the year we characterize is around 9%. That's almost a doubling. I think it's an 80% improvement roughly from last year. So I think there is a lot of demand for services. We're not trying to become a fast-growing services company, but as the margins on that services business go up significantly, the growth is okay for us.

Jeffrey D. Glidden

If I can add a couple comments on that. At the Investor Day, Marc Diouane who took over the services business about a year ago, will be providing, I think, a very in-depth review of the services business. I think it's really his leadership that has driven the increase in profitability today, as well as the goal we'll cite and show you how we move to 15% over the longer term. So I think it's a pitch for the come to the Investor Day, but also to really get a good understanding from Marc as well.

Operator

Our next question comes from Richard Davis with Canaccord.

Richard H. Davis - Canaccord Genuity, Research Division

So you haven't historically like called out supply chain specifically. I mean, you've kind of talked about it at a high level. So what do you guys mean by supply chain, kind of what functionality is in the unit today? What new functionality do you expect to add? And do you feel like you know the right buyers of supply chain, because depending on how you define it, it's sometimes sold to a different part of the organization?

James E. Heppelmann

Yes, and those are very good questions, and I'll take a cursory level stab at them here, Richard, but again, we'll give you a lot of details on the 7th. Let's start with our retail PLM business. What we call retail PLM is something sold to the supply chain organization because the big retail companies by and large don't even have engineering departments. So we've been selling PLM to supply chain in the retail business for a long time, and it's really to plan what are we going to have in the stores, on the shelves in the fall season, and who's going to supply it to us and how do we manage such that if you have, let's say, clothing outfits coming from 7 different suppliers that they're all using the exact same fabric that we purchased and allocated to them and so forth. So it's really supply chain optimization; really, which suppliers to use, which materials to use. And then the second piece we've added to it is supply chain analytics. For example, our ability to help companies comply with this European REACH Regulation, which is essentially trying to analyze the aggregate chemistry of a product to make sure that you don't have too much bad stuff in it that could end up in a landfill polluting water supply some day. In order to do this aggregate chemistry analysis, you basically have to go chase down data from all these different suppliers on all the chemistry related to their contribution to the product. And so we have in this -- what we use to call InSight, a pretty good product suite for doing that, that's getting a lot of traction right now. So I'd say we're going to call it Supply Chain Management because that's the name of the market sector, and what we really want to be able to show our investors is the market segments we play in and what is our role and how do our growth rates compare to the market growth rates and who are the competitors and so forth. So the market segment is called Supply Chain Management. I would say our strategy is supply chain optimization during the strategic planning phase.

Operator

Our next question comes from Steve Koenig with Longbow.

Steven R. Koenig - Longbow Research LLC

Let's see, just a couple ones here. First one, probably for Jeff here. Jeff, on the maintenance revenue streams, as you begin to annualize the initiative you put in place last year to adjust the sales comp model and the policies for discounting maintenance. As it analyzes, how do you think about maintenance growing from there on out?

Jeffrey D. Glidden

Sure, so first of all, I think the programs that have been implemented have been terrific. As we -- just to reiterate, we are comping the sales teams on first year maintenance which has been very, very helpful. Attach rates, renewal rates and recapture rates, I think have trended and not been trended, but have been driven in a positive direction. If you look at it, I think, for the quarter, our organic maintenance number was -- growth was 9% to 10%. We think we can maintain help upper-single digits organically, and I think that's a great place to be. And again, as we drive this license revenue up, that will have a positive effect on it and the acquisitions added to it, so we'll be positive. So I think we're very comfortable with upper-single digit growth organically on a constant-currency basis.

James E. Heppelmann

One of the things, if I could add, Jeff. Steve, you probably think of PTC's maintenance renewal rates sort of being in the upper 80s, right? If you broke that into let's say Desktop and Enterprise, I'd rather break it along these segments, but for today, Desktop and Enterprise. Our Enterprise renewal rates are mid to upper 90s and the Desktop sort of mid to upper 80s. So I think when you start averaging those 2, and as more and more of our revenue shifts towards the Enterprise side, that's been happening for years, it's driving up that composite renewal rate year over year over year. And I think that will continue to add an element of growth too because we're sort of plugging the leak, if you will, to a certain degree on the renewal rate.

Steven R. Koenig - Longbow Research LLC

Okay, great. And then for the follow-up, guys. Curious about -- usually, we see deferred revenues maybe tick up slightly in the Q1, just any commentary there. And also were there any very large deals in the quarter like anything in industrial in Europe, et cetera?

Jeffrey D. Glidden

So Steve, on the deferred maintenance, we have a very strong maintenance renewal period effectively on January 1. So typically, that's about $25 million worth of deferred maintenance renewal that actually gets booked the first week of January. Last year, it was booked actually in the last day of the quarter just because of the timing of the end of the quarter time frame. So maintenance renewal number, while it was down this first quarter, is really reflective of the cutoff of 12/30 rather than 1/1, so maintenance renewals were very, very strong, and you'll see a big uptick in Q1, which is the normal expectation. The second part of your question was, can you just repeat that for me?

Steven R. Koenig - Longbow Research LLC

Large deals.

Jeffrey D. Glidden

Large deals, right. We cited 24 large deals. The average deal size ticked up a bit to $2.9 million. So as you know, those are very, very important. And we continue to expect -- I think generally, we've been in the $2.5 million -- $2.2 million to $3 million range, and we'd expect those to continue.

James E. Heppelmann

Yes. Maybe, Steve, to get more precise. We've, in the past, used this term megadeal to mean something more than 5. And there was, I believe, one megadeal in the quarter, and that came from a European automotive company.

Operator

Our next question comes from Ross MacMillan with Jefferies.

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

Jeff, you gave some color on the longer-term Pro services gross margin. Just within this year from a guidance perspective, you've obviously started break out that gross margin. What should we be thinking about on the Pro services gross margin for this year?

James E. Heppelmann

For this year, we're targeting approximately 9% and I think we're at 7.5% or so this quarter. I think it'd be appropriate to be looking at that approximately 8% to 9% for the next quarter, tracking up towards 9% as we close out the year. And I think we have a very good shot of achieving 9% for the full year as well.

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

That's helpful. Another question that I had was answered, so maybe I could just ask about geographic trends. One of the things that's interesting in your business is obviously Pac Rim x Japan was not growing as fast as some of the more mature markets. I guess, we're all conditioned to think that Pac Rim has faster growth than Western Europe and the U.S. Can you just help us understand what's happening there and how you think about growth in those markets?

James E. Heppelmann

Yes, it's Jim here. I think as I talked to other CEOs and people in other software companies, I think in general, there's been a modest slowing of growth in China in the last 12 to 18 months. I anticipate that's a phase we're going through and so forth and it will pick up again, but I don't think we're planning on a blowout year from China here. I think we're planning on a solid year.

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

Okay, that's great. And then just housekeeping. On the $200 million of debt, Jeff, what's the thinking about repayment of that?

Jeffrey D. Glidden

For the full year, we'd expect to be at a -- pay that down by approximately $100 million in the year, so we'd expect to end the year going from $200 million down to $100 million. We will repurchase stock, and about $55 million worth of stock we'll repurchase. And I think our CapEx will be somewhere around $28 million to $30 million for the year. So those would be the uses of cash. And the good news, by the way, Ross, as you know, as we continue to drive profitability up, we drive cash flow up. So we continue to be very pleased as you saw in Q1, which is usually a breakeven cash flow or cash quarter. We generated $36 million in cash flow from operations. So I would expect we'll continue to build from here. And I think you'll all be very pleased with not only the operating profit improvement and leverage, but the cash flow.

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

Great. And then just one high-level one. I know there's more to come at the Analyst Day and these are great steps that you're taking to improve the profitability of the business. Just in terms of managing this process of restructuring, can you give us a sense of how you're thinking about phasing through these changes which obviously could be disruptive to the existing sales structure? Any color on that would be great.

James E. Heppelmann

Well, maybe I would say, we've actually been working on this for a very long time and are mostly done with it at this point. If you think -- actually, we used to have our Analyst Day scheduled for November. And I don't remember, Tim, the time frame we switched to February, but the reason -- that was probably back in September or so. And the reason we did that is we said we're doing all these changes, and it would be great to wrap them up and then be able to take the -- take all of you through them in some amount of detail and talk about what we've done as opposed to what we're thinking about doing or something like that. So I feel like most of the turmoil -- the most tumultuous quarter we expect is the one we just wrapped up in terms of all the changes we're making, the organizational, personnel changes and so forth. So there's a little bit more work to do, and we need to settle in place here in this coming quarter, but I feel like we're in a pretty good place with most of this behind us.

Operator

Our next question comes from Yun Kim with ThinkEquity.

Yun S. Kim - ThinkEquity LLC, Research Division

Question on the expected improvement in gross margin in your fiscal year '15 plan. I know you guys will go through details in couple of weeks here, but how quickly do we have to ramp up the capacity in your top system integrator channel to effectively outflow the implementation work? Like you pointed out, that the consulting business remains your fastest growing part of your business. Is the improvement in the overall gross margin likely be more back-end loaded towards the end of the full year period? Or do you see that improvement becoming more gradual? Just trying to get a handle on how we should be monitoring the progress.

James E. Heppelmann

Yes. I'll get the first part, you get the second part, Jeff. On the first part, regarding the systems integrators. Yes, we are expecting to ramp that business. The business that we sort of delivered 2 system integrators, we would expect that to grow much, much faster than our own services business. And at this point, we're on target. That business is growing extremely fast. So I think, it's definitely a strategy to try to rein in our own services growth such that it's less than license growth and the mix gets incrementally better, not incrementally worse. But I think in the short term here, there's just more demand in the short term than we're able to -- than we were anticipating, let's say.

Jeffrey D. Glidden

So on the question on profitability and margin. We'll introduce and we'll talk about this in February. But we're kind of looking at what we describe as a front 9, back 9 approach, which is, front 9 is basically driving efficiency from where we are today. And I think that's what Mark is doing to drive us to 9% this year. And I think there's another 1 to 2 percentage points improvement just from driving efficiency, and we have high utilization of the team today, et cetera. So that can get us a good part of the way. The backside will be much more strategic drive, which is the partner program which takes a bit of time, we'll be building that out, as well as having the solutions. And we'll talk more about this, being more complete that'll allow our partners, as well as our customers and ourselves, to implement these programs in a much shorter time frame, which would be more complete, lower overall cost, therefore, greater value to the customer and greater margins to us. So I think we can see a couple percent improvement just on operating efficiency. And then to get to 15% is really a drive about strategic value that we can deliver through the solutions.

Yun S. Kim - ThinkEquity LLC, Research Division

That sounds great. Hopefully, those investments will pay out in terms of lower sales and marketing costs, as well as your large system integrator picture -- pitch PLM solutions out there too. The other question...

James E. Heppelmann

Absolutely. We would anticipate and hope that, that does start to come full circle.

Yun S. Kim - ThinkEquity LLC, Research Division

Yes. The other question that I have is visibility around large deals. I think I ask this question almost every call. Can you just share with us the level of visibility that you have around large deals? Are you starting to see a greater mix of follow-on deals? I think you mentioned Hyundai Kia deal potentially over the next couple quarters, or is your large deal business still primarily driven by customers starting new PLM initiative?

James E. Heppelmann

I would say it's a mix of both, but probably weighted in favor of follow-on deals. But that said, there's some big kind of first-time deals we're tracking right now, too, that are pretty interesting, that we historically would've characterized as dominoes. I can think of a half dozen big ones right off the top of my head here that I don't want to name necessarily, but we're chasing some big new customers. And then there's the Hyundai type, but, okay, let's go back and expand that deployment and turn it into a financially, more interesting engagement.

Yun S. Kim - ThinkEquity LLC, Research Division

Okay, great. And then, Jeff, can you just quantify, if you can, the impact on foreign exchange on the deferred revenue balance, whether that will be -- I don't know if it actually showed up in the quarter or not, but would it actually show up more meaningfully in Q2 deferred revenue balance?

Jeffrey D. Glidden

We've considered it in our balance, and to give you the specific numbers, what I really like to do is -- I have the data, I just don't have it with me, but we've considered it in the guidance for Q2 and for the full year, but what the effect is on the balance, it's about 25% of the balance. You can do the math. We'll come back to you, but it probably has an effect of -- about $10 million would be the effect on the maintenance stream for the year. About 25% is the total FX effect. So approximately 40% of that will be maintenance, but I can give you a more precise number later in the day.

Yun S. Kim - ThinkEquity LLC, Research Division

But the question is, does the foreign exchange impact on the deferred revenue balance -- would that be more meaningful in Q2 deferred revenue balance or Q1, because it sounds like there's a lot of bookings that happened on January 1?

Jeffrey D. Glidden

So it'll really be -- the balance that we opened the quarter with will be adjusted, and then we'll be booking all the new activity at the current rate. So the adjustment really occurs -- there's 2 questions here, really. One is what's the adjustment to the balance, the opening balance? And then that's what I gave you was the $10 million impact is kind of the full year impact of currency just on the maintenance revenue stream itself.

Operator

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

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

Jim, I'm just wondering if we could drill in a bit more on the Caterpillar project in the sense sort of where you're at in terms of moving towards productizing service information.

James E. Heppelmann

Yes. I think we mentioned last quarter we received a pretty substantial order, which we are recognizing basically as we complete the project, including some software that was complete at the time of the order and some that is being completed, other elements of the project that are being completed over time here. We're probably about a year from having the project 100% complete, but throughout this time frame, there are incremental elements, including some last quarter that were released. So I think you should think that we're building out a whole new product suite based on components we had and components we're developing. And between now and a year from now, everything's done, but maybe now, 2/3 to 3/4 of it is shippable. And by the way, what we're starting to do with other customers now is start them down the same path with the components that are ready to go. So I think you should -- and we'll talk about this again on February 7. You should be thinking that we have a few more Caterpillar-like projects lined up, probably of a lesser magnitude, probably with less services because we won't need to do as much work. But there certainly is a lot of interest in that solution. I think the Service Lifecycle Management, if I could just go off on a mild tangent here, this is really going to be an interesting business for PTC, because customers are very excited by what the vision we're talking about and the impact that this could have on the service business, which in large companies tends to be a huge source of revenue and an even bigger source of profit, and they're looking at PTC as having a completely unique ability to optimize that. And the Siemens and the SAW and SCP, sort of traditional PLM competitors, aren't even relevant here, which means, now we have a way to go sell something to the accounts that would have been difficult to get into from a PLM standpoint or CAD standpoint. And I think you're going to see us in the coming year, let's say, announce some Services Lifecycle Management wins in some pretty surprising places.

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

Okay, great. And just shifting gears over to the PLM side. I'm just wondering if you could comment a bit more on -- over the last 2.5, 3 years, you've put together 30 domino wins, primarily PLM. How was that -- what's sort of your level of confidence that these things are going to rollout? And does this give you a pretty high level of visibility into your services this year?

James E. Heppelmann

Yes, I think, again, let's just go back to the Hyundai Kia data point. It's one of the largest companies in the world, it's the fourth largest and fastest growing automotive company. They selected us, and 11 months later, we turn the system on in productive use. So I think we know what we're doing now and we're getting pretty good at it. And I think this speaks to ultimately some of the margin expansion opportunities we expect to see over time, which is as we get better and better at deploying these things, we start to approximate a cloud model. Whether it's on premise or in the cloud, it doesn't matter in terms of having a system that's pretty much ready to go. And that's our ultimate goal, and I think we're making terrific progress. And I think this new organizational model will shine very bright lights on things that need to be focused on, and I'm confident we're going to continue to make a lot of progress.

Operator

Our next question comes from Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Jim, I'd like to start with a couple of product and geographic questions. On the product side, a couple of things around pricing and installed base. First, with respect to Pro/E. Over the last 3 fiscal years, it seems the ASP for Pro/E has been declining year-over-year each year, and I assume that's largely a function of geo mix and channel mix, but what's your thinking from here about the stability or potential future increases, if any, in the ASP for that part of the business, which of course, is still a considerable part of your revenue? And then, question around the Windchill installed base and whether that license number that you speak of in the active base number is equivalent to the number of users, or put another way, could you talk about the number of licenses per user? Once upon a time, PTC used to talk about Pro/E modules per seat to connote the intensity of usage per user of various Pro/E related products. And I'm wondering if you have some similar kinds of metrics around Windchill licenses per user.

James E. Heppelmann

Yes, okay, let me hit the first question, which is CAD ASPs. So one of the things that's happening, Jay, is as we launched Creo, well, first, we acquired CoCreate, and then blended that together with Pro/ENGINEER into this concept called Creo. We now have a much broader product suite that appeals to many more casual users. And in fact, one of the things we'll show you on February 7 is our sales of direct modeling seats have skyrocketed. Now that's sort of a less sophisticated system typically sold to a more casual user at a lower price point. So I think I wouldn't read too much into the ASPs, because I think we're starting to blend apples into our oranges and it causes the ASPs to look different. I mean, you do a lot of analysis on this, so you'll have to figure out how to think about it. But I see it as a very good trend that we're blending in a whole new type of seat albeit this seat comes in at a lower price point, and therefore, it averages down the ASP. So I don't think the ASP of the Parametric seats is falling at all. I think we're blending in these other seats. And then if I move on to your Windchill question, the numbers that we quote there from Tony DiBona, our maintenance guy, are intended to approximate human beings, not modules. Now sometimes, we don't get all the data. They don't actually tell us how many human beings they have and so forth when they buy a certain number of seats, but we're not talking about modules. When Tony says we have, I think it's 1.25 million or so Windchill seats, he's not saying we've sold 1.25 million Windchill modules. He's saying we've sold a base seat 1.25 million times and there are many modules stacked on top of those base seats. So think of it as base seats that typically would map one-to-one to a user.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Okay, a couple of follow-up questions. Geographically, Europe is your single largest market in terms of maintenance revenue. It did rather well in fiscal '11. And I'm wondering what you're seeing now in terms of continued momentum of the kind that you saw last year for the maintenance revenues there, and as well, large deal momentum in Europe which was a big contributor to fiscal '11. So outside of the mega auto deal that you cited, what else are you seeing in terms of large deal momentum in Europe?

James E. Heppelmann

Yes, I mean, think our European guys are doing exceptionally well right now. That's the best performing geography we have in the company at the moment. And it's not just auto, it's very widespread and it's not just big deals. I think, our view of -- there's this ongoing disconnect between what you read on the front page of The Wall Street Journal and we see in our pipeline and our results. And I think that in Europe, our pipeline is strong, our win rate is strong, we're selling to global companies. This is the key thing to think about here, and Jeff said this earlier. But we're not selling to companies whose customer base is in Italy or Greece or Spain. We're selling to companies like Volkswagen and their supply chain and so on and so forth who are shipping products around the world. And they're not really indexed against what's happening to European debt crisis. They're indexed according to what's happening in the world economy more so. So I think, we feel like these European companies, particularly the German and Scandinavian ones, are doing pretty well. And we're doing a very good job expanding our market share and executing in that opportunity.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Okay. And then lastly, could you talk about where you are in terms of the plan to move to annual releases of Creo and Windchill? Will Creo 2.0 go by the middle of this year, Creo 3.0 first half of next year and so forth?

James E. Heppelmann

Yes, I mean, it's better to ask that question of our R&D guys, on February 7, because we'll want to put it in the context of these segments. One of the things we're going a lot with segments is it's less of a product-centric story. When we talk about Service Lifecycle Management, what we want to talk about is service information, warranty management, things like that, not Windchill, Creo, this that. So what you're going to see happen, to a certain extent, is Windchill kind of becomes a platform in the background. It's a contributor of technology, and it will still rev [ph], of course, but we'll talk a lot more about the solutions and what level of sophistication they have than the component building blocks of them going forward. But that said, yes, we've been moving to implement this annual plan, and it's more or less on track.

Operator

Our next question comes from Matt Hedberg with RBC.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

I guess, Jim, on the Desktop side, obviously, you guys have come up with some very, very nice quarters of growth. And with the 5% growth this quarter, is that a reasonable rate to think about for the balance of this fiscal year? Could it, in fact, take down maybe a little bit off of the very strong Q2 through Q4 of last year growth rates?

James E. Heppelmann

Yes, we've been seeing 5% to 8%, and I think that's probably the numbers we'll continue to see here. I think, if you look at the 5% this quarter, it was pretty good number but compared against a year ago quarter where there was 36% growth, so we're 5 more than the 36% we were last year, that's a pretty good number, and I think we expect more or less that kind of trend to continue. We have a lot of runway to continue selling all the new stuff in Creo to the base. And I think we see our win rate in new opportunities and displacements going up. We're working on some really interesting CAD dominoes that we would -- never would have been possible without Creo, but now suddenly, people see something in Creo they just don't see from other people.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Great. And then a mechanic's question for Jeff on the headcount reduction. I believe it's about 180 starting this quarter. How shall we think about that spread across the expense line of the P&L?

Jeffrey D. Glidden

So it's really pretty broadly distributed across. What we've done is really taken out any redundancies, really in any and all functions. So I think, we can give you more detail, but I think we've given you the model for the longer term and we're trending towards that. With probably the -- in terms of the model, the greatest efficiencies over time will be achieved in the services piece. Along with sales, I would expect the marketing, which is today will continue roughly at the rate it is. R&D, we guided to the 16%, 17% range, which is down from 19% a year or so ago. Our G&A, we'd expect to be holding roughly in the low 7% range. So I think it was -- we didn't impact, per se, any particular function necessarily more than others. It pretty much was across the board.

Operator

And we have no other questions in queue at this time.

James E. Heppelmann

Just if I could, I want to correct a minor mishap from a previous comment. Somebody asked earlier about big deals, and I said, I thought there were 2 megadeals, more than 5. I'm sorry, I said, I thought there were 1, it turns out there were 2. So just in the background here, we've...

Jeffrey D. Glidden

One in Europe and one in the U.S.

James E. Heppelmann

Yes, right. A European automotive company and a U.S. electronics company.

Tim Fox

Okay. Great. So we'll wrap up. Thanks for your questions. Please see our IR section of our website for details on the Analyst Day and registration information. PTC is also going to be participating in 2 upcoming investor events in San Francisco, the first, the Goldman Sachs Technology and Internet Conference on February 14, and followed by the Morgan Stanley Technology Conference on February 28. Thanks for joining us this morning, and we look forward to speaking with you again on our Q2 call.

James E. Heppelmann

If not, earlier, at February 7. All right, thank you, all. Thanks. Thanks very much.

Operator

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

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