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Executives

Jeff Glidden - EVP & CFO

Tim Fox - IR

Analysts

Parametric Technology Corporation (PMTC) Barclays Capital Global Technology, Media and Telecommunications Conference Call May 22, 2012 2:25 PM ET

Unidentified Analyst

Okay, thanks for joining us for our next session. We've got Jeff Glidden and Tim Fox from Parametric here. You might not know my background. I have been covering the CAD CAM space, so my coverage of that so for quite a long time and so I have been looking at Parametric for quite a while now. Actually I have to say the last six months have been very, very interesting. And just obviously from some of the events that kind of triggered a lot of these in the short term, but some more from the way how we have seen in the same change of management, we have seen a change in focus and that’s something I wanted to explore with you on stage here as well. But you know, I have to say like in spite of that it is mounting a little bit. Let’s just may be you kind of first recap the last few months within the business for you. We had kind of a really very successful start of the year and very interesting Financial Analyst Day and then obviously the trouble around Q1. Initially everyone thought well that's Parametric again, but I have to say frankly that is one of the worst reporting season I’ve seen in software for a long time, especially for Q1. So, maybe let's start with that. So what happened from your perspective as to where we are now and kind of – let's help you understand a little bit things better with what kind of went right there.

Jeff Glidden

I will take that. And before we start, I am going to have Tim just give us a little few comments on any comments we make today.

Tim Fox

So spare with me, but today’s presentation and Q&A may include forward-looking statements regarding PTC’s products or anticipated future operations or financial performance. Any such statements will be based on our current assumptions of PTC’s management are subjects to risks and uncertainties that could cause actual events and results to differ materially. These risks and uncertainties are on our Form 8-K, 10-K and 10-Q on file with the SEC.

Question-and-Answer Session

Jeff Glidden

Alright now, back to the question. So just to be clear, this is really, we just reported our second quarter, so our fiscal year-end September. So, maybe perhaps, let me back up a little bit and say, we ended the fiscal year 2011 very strongly, had a very good year, revenues were up 16%, earnings were up 26% and our fourth quarter was very strong. We continued that with a very strong Q1, over-performed and over-delivered in Q1 and then disappointed in Q2.

So, from a context from the mid-year point, we’re still on a very nice track. So we had a disappointing Q2 with revenues up 12% and earnings up 15% which was below our guidance. So but it was still an up quarter for us. At the mid-year point our revenues were up 16% and earnings were up 35%. So we feel that we’re on the right track and I think the discussion we’ve had is we have a lot of large enterprise customers, very large customers that are key to our business and while we do disclose large deals, we also disclose what we call mega deals. And a mega deal for us in $300 million quarter, these are significant where a customer will buy $5 million of license software or greater.

And we had two of those in the fourth quarter of last year, a strong finish, great quarter. Q1 we had two and we had none of those in the second quarter and we are out looking for several. We’ve had, there were several that could happen and as we indicated, one in particular and actually two were impacted by change of control that was beyond our control if you will. That said it is still incumbent upon management to plan and forecast on those and while they are -- they did not close, they're still in the hunt if you will. So we have a disappointing second quarter, but I think fundamentally a very good first half.

And we look to the back half to be an improvement from that. That said we provided more conservative guidance for our third quarter and said while there is some large customer opportunities in that we are going to basically take any very large mega deals out of our guidance and provide guidance basically assuming none of those happen. I think that’s an appropriate thing to do and I think the questions we get so you gave us some long-term strategic goals and so forth particularly around margin expansion and growth and we believe those are intact. So our long-term through 2015 guidance is revenue growth of 11% to 13%, that's primarily organic as well as expanding margins from mid teens to mid 20s.

So we think we are well on that way and we are up actually, we are targeting to expand margins by a minimum of 100 basis points a year with a current target of 200 basis points a year for the first half and we are up better than 200 basis points year-over-year. So I think the pieces is still intact, we did miss the second quarter but I think we have a pretty reasonable outlook for the back half of the year which will keep us on track for that long term set target.

Unidentified Analyst

And I mean the one thing I have to say is you are not the only vendor, like I mean the problem is that it's the large deals, but it seems to also be some issues that you know people were and finally it has been decided, yeah so. In that respect what excites me about you guys and now wanted to hear a little bit of your ability to kind of manage your own business and manage your own business better when compared to well what kind of margin levels you have seen before, so can you may be expand a little bit in terms of where, when you also started the company not too long ago, what did you see there and what kind of excited you to kind of come out with involvement that actually looks from a margin expansion perspective, what is exciting in software?

Jeff Glidden

So let me take another step back if I may. I joined -- for everyone that may not know I joined the company about 18 months ago right at the end of fiscal year 2010 which ended in September and Jim Heppelmann took over as CEO at that time and I knew PTC for many years as I was the supplier when I was at RSA. So we used the RSA token and the company knew the boom days of CAD and thought that was behind us. And then I met Jim Heppelmann and I really understood what the company could be, we have a fairly mature but very solid CAD business, that's about 600 million today. We have a larger business that is in the enterprise PLM space that today is about $650 million going to $700 million I think this year that is high growth. It is a nicely growing business where we have been growing that in excess of 15% to 20% each of the last several years and I think we will do that again this year. So it's really a mature business and a nicely growing enterprise business.

And within the context of that when I met with Jim, the target then was 100 basis points improvement a year to get us to 20 points of property margin and we looked at it really, pretty shortly after I joined and so we think that's under bid and that there's bigger opportunity in terms of we saw about five percentage points opportunity in gross margin and about 5% in operating expenses giving us the 10 points.

We spent probably nine months working through the details of those plans and really presented that to investors in the January-February timeframe. I think all of that's intact and I think we can get there and a couple of the pieces that we've been working hard on has been both license, maintenance and service and the two that we've had probably the most impact on in the near term has been maintenance which the renewal rates, the [tax] rates and recapture rates are terrific.

We've been more disciplined on the pricing and discounting on maintenance and I think in the past there's been some propensity on making discounts either services or maintenance to get license revenue. We said let's take a long-term view, our customer view and say there's more value there and change that model.

In addition on the services side, we do about 25% of our revenue in services and we will be there basically architecting and implementing a lot of these solutions and if you looked at our results for ’11, the margins on that service business was about 4% to 5%. The outlook for this year that we get to 9% to 10% right now we are at better than 10% and we are looking for the year and to 11% for the long-term goal 15%.

So I think we've made some good progress and its really, I think through Jim’s leadership we've taken our customer view, a long-term view and a metrics view and I think all of those are benefiting our performance.

Unidentified Analyst

If you look, I mean it's obviously then as you look into the things that maybe it didn't go as well in the past and then the things that you [can do] in the future from my perspective that should require a lot of change management because it's like a behavior that needs to be changed in the organization. Can you may be talk a little bit about the perception that you've seen so far and then kind of implementation of the kind of new product guidelines within the organization and where are we at this stage, is that more (inaudible) for both of you?

Jeff Glidden

Yes, so we are on the, I would call it first year of a multi-year program. I think being metrics driven. Jim’s an engineer and by the way by education I am an engineer so we align on data and metrics which is helpful but there is a fair amount of cultural change that is we have not historically taken you to a long-term view or as much of a data view.

So that's been bit of a change and there are some areas I mentioned like maintenance and service that really have made great progress, we are also implementing new systems and we talked about this, we are implementing CRM systems so for a billion dollar software company we did not have the CRM system in place.

It's not a panacea but its indicative of the need for better visibility, better data and the fact that it wasn’t there is also telling. A year ago we embarked on implementing salesforce.com that's configuration, integration and so forth. That has been completed in terms of the IT work and we are right now rolling that out to the sales teams, so we've got about 200 teams strained again it will take us some number of quarters for that to really benefit us but we are really moving from what was a process that was a 90 day view of the world with a little bit beyond that to one we were saying now we want a rolling four and six quarters view of the world and really understand at a more granular level where we are in the sales process.

[We] really are intent to help our sales teams sell and close business and to give us better visibility so that could be mutually beneficial. And so we are on that path and I think we are a year into that and a year from today I think we will be able to give you a lot better feedback on how successful that's been. But I think it’s been a key ingredient in terms of change in the business.

Unidentified Analyst

That’s the one thing. How do you see that even if it's going through an economic downturn? I mean, did you think about the changes you are implementing into new business and the benefits you will see out of that. I mean, its important scenario and may be something as well as some people think, what's the story about the margins that will come out of (inaudible)?

Jeff Glidden

Okay. So a couple of things. When, based on my experience, and we went through this at the beginning of last year, we do a fair amount of scenario planning. So we will have a plan, with a set of goals that we think are very attractive and aggressive. Then we will come up and say to you, if the world doesn’t turn out to be the way we thought it would be either from macro factors or through execution issues, what is a plan B or a plan C and I will say that we’re tracking well on those plans while we have little bit slower growth.

We’ve adjusted our spend rates. We’ve been tightening down for well over a year and really checking spending and I’ll just reiterate, while we’ve been checking that spending, we’ve been investing in sales capacity.

So another key piece of the puzzle. We’ve not added sales capacity for about four years. A year ago, we set a task to basically increase our sales capacity by about 25%. We felt the market was there, the products are there and we're continuing on that path. Despite a softer Q2, we’re not backing off at all. We’re probably a little tighter on everything else to make sure that we can effectively fund those capacity additions that really set us up for growth in ‘13 and beyond. So sales capacity along with putting in better CRM tools are keys to the puzzle.

Unidentified Analyst

Yes, okay. And so from that perspective like, if you look at the leverage that you have, I mean, you still (inaudible) if it doesn’t grow as well and you still have kind of the margins the one that you can (fill)?

Jeff Glidden

So we do scenarios, lets say, for growth at a slower rate, what we do and how we would do that to make sure we achieve and deliver to the shareholders. So I think those levels are in place might just add as a point of reference that the management team has several levels of bonus that are tied to basically our delivering operating margin and margin expansion.

So that our interests are very much aligned without a shareholder that is the first things that if we don’t achieve our targets it comes out of our pockets. And so we have a pretty good alignment and you know that’s a clearly a key goal in the short-term that’s cash compensation and that what entire management team is paid out of that basically bonus is tied to operating profit dollars for the annual plan and then the essentially the equity piece is tied to basically metrics that are driven around margin expansion.

So I think the intensives are there and I think independent of that we’ve done a pretty good job of scenario planning that if we grow to slower rate how do we moderate spending.

Unidentified Analyst

Yes. And just trying to list it up a little bit of looking into the bigger picture and more to long-term growth opportunity for guys. You mentioned before (inaudible) the [mature] market but we have week over opportunity in PLM and maybe that sounds [fear] in terms of we saw one of your competitors that also coming out (inaudible) connect with a very low end solution there were some (nervousness) from my client about that would impact you which you know frankly, kind has been want to put as (inaudible) to you how do you see that it’s a kind of PLM markets playing out because its seems from a low end its really decrease of opportunity that they kind of should be something that is interesting for you from the high end and I see a lot of moving parts from the automotive guide making [efficient] were. If I look at the Korean deal that you just won a while ago it kind of looks very interesting and looks like finally that market is moving above?

Jeff Glidden

So I’ll take the Korean deal afterward, I am going to differ to Tim for a minute and just for those that they don’t know Tim all of his background, he spent 11 years as self right analyst and knows both obviousness and our competitors as well. So I think from that side if I can ask you to speak

Tim Fox

No, that’s against. I appreciate.

Unidentified Company Representative

Came to the (inaudible) came to the (inaudible) joined up.

Tim Fox

But the question on (inaudible) is couple of different dimensions, I think clearly most of the work that we have done and independent people have done relative to our overall market opportunity for PLM, it is still irrelatively underpenetrated market even though its been [freshly] available for decade now. They are still 7000 to 8000 large commercial industrial customers out there that aren’t using really any tools from a PCC or (inaudible) or so (inaudible) the best emerging in the market.

So when we look at probably 15% to 20% penetration rate relative to the high end market if you will, [upright] markets. So we still think its pretty one opportunity of growth from a green field opportunity and to a point some market share shifts in the high end with some of the other major vendors.

You know relative to the other [desk] I am offering and cloud in general I think included they have got designs to move into what is a very large and installed base in their 2D and 3D manufacturing base to the extend they can actually move up market I think is quite challenging on a lot of funds and the technology is one question but I think they consulted the sales, there is some services that is wrapped around it. It is effectively a wholesale change of DNA that they need to do actually get to that sort of hardened enterprise level sales so not (inaudible) business so it's a great company but frankly its just not something that we see as competitive threat in the near term or really in the immediate term.

Unidentified Analyst

Right.

Tim Fox

Yeah, I would add a couple of things on our solution, our Windchill product is web based and cloud enabled as it is today so that would be original 10 years ago. Most of our large customers deploy essentially that as a private cloud internally, and so that's -- the architecture is there. The vast majority of our large customers are not interested in a host of solutions but do it themselves.

And for security reasons, you think about the data that we're dealing with, it's one thing if you've got customer information, it might not be great, but if you get the product design information before a product's release, that's catastrophic for a customer. So security is a big issue. That said, we are web-based and cloud-enabled. We also have a partner that will provide hosted solutions.

So we've been providing hosted solutions to a number of customers. And it's a small number for about six years. Now relative to SaaS, per se, most of our customers are very happy with a perpetual license and maintenance model, and have looked at it and said, gee, over five years, that's actually lower cost than if I look at a SaaS model.

That said, we offer term licenses where there'll be one, two or three-year terms or multi-year terms, if a customer wants that. So from an economic standpoint, we can lay out something that looks quite like SaaS, and if they want it hosted, we have that solution. So if the market requires and need, and we see that as something we need to do, we'll do that.

Unidentified Analyst

And then going back to the Korean --

Jeff Glidden

Right, so the Korean one is a very interesting situation. So Hyundai Kia Motors selected PTC just about a year ago. It was all bake-off. And the interesting thing is we won the bake-off with what was then Windchill 9.3. It was in January that we announced that and we started to roll-out the planning for that. We realized that the capabilities that they were really looking for.

We had some gaps with 9.3, even though the benchmark was successful. And we deployed 10.0, which was a release that was available broadly to customers in April of last year. And in March, we began deploying that at HKMC. And that was completed on time and on budget in October of this past year.

So one of the nice things is the solution is more complete, more user-friendly, and we were able to deploy a major new customer in less than nine months. So that's a statement about what the opportunity is, to the extent that we can do anything with a more complete solution and shorten the cycle to implementation, we create value for customer sooner.

Second piece of that, it was a small number, it was a couple hundred licenses with services that we deployed. And then Phase 2 was just begun, and we said at the beginning of the calendar year that we expect to have additional licenses from HKMC in the first half of the calendar year. We actually had a follow-on transaction with them in the first quarter.

So we're on to Phase 2 and that will take us probably another 18 months. And fundamentally, what they're doing is they started in one development center and they've rolled out through 12. So we're now moving from the first center to the next two or three. We'll complete that. When that's successful, we'll go to the next roll-out.

So it's really developed very nicely, and I will say they're a very aggressive and successful company and I think their target is to go -- they've come to number five worldwide in terms of market share with a goal of getting number four. I won't make any comments about their success or not in that, but they're a very successful and aggressive partner and we enjoy it.

Unidentified Analyst

And then, maybe it's a question more for Tim. If you look at new business, you have like -- as I said, they're slightly more mature partners (inaudible) but they've also seemed to be like more growth areas and kind of avenues in (inaudible) acquisition there. Can you just try to help us to understand their overall rationale behind those deals and where do you think kind of the long-term growth is going for the company?

Tim Fox

Sure, it's a great question. So I think we've laid out a vision where we had effectively the MCAD piece of the business, which is about half the business. And then what we call PLM, we've broken into four segments now really, that has four different end buyers necessarily within the same customer base. So for instance, you've got an engineering group that looks at both mechanical designs.

So we've got the tools in Korea to address that. With the acquisition of MKS that you mentioned, we now have solutions quite unique frankly within our peer group to address software development, and particularly embedded software development, which is a huge growth area for most of our customers. It's a real gaining area for many of the products they actually get to market.

Most of the issues that you're seeing in some of these products within software, it tends to be the software that's getting in the way of getting the products out the door. So to the extent that we can cross-sell those software solutions into our installed base, as well as go into other manufacturers globally that may use our competitors', PLM or MCAD solutions, we can then expand our footprint.

So you've got that software piece. At the other end of the spectrum, from an aftermarket services perspective, we've been developing solutions with Caterpillar that a lot of has accounted for. It's a pretty unique offering that really is very much in all alike hard dollar saving solution that ties the fundamental engineering data all the way through the aftermarket services, and gives them a capability to deliver in a digital fashion.

All of the tools that they need, they do today manually. So we've launched that program. That's going to be commercially available to our broader customer base. We think there's a significant market potential there.

So again, it's rather than going after kind of brand-new, unique industries out there, we have an opportunity to cross-sell within very large global customers, outside of the engineering department, into the broader enterprise, in the supply chain planning piece of it, as well as in the aftermarket services. So we've effectively doubled our market opportunity in a matter of two years.

Unidentified Analyst

Yeah. And one of the difficulties of having investors, I'm sure you have as well as (inaudible) about longer -- toward the growth targets, you've talked about on a top-line perspective. And I've seen all the new markets that you're going in, can you just maybe talk a little bit also about could you explain that revival of the MCAD trail part of the business?

Jeff Glidden

So for many years, I think PTC was seen as not driving as much innovation into the MCAD market that maybe some of our competitors have. And really what Creo has launched, in many cases, not just an evolutionary change to the way you can actually do CAD design, but have added multiple applications to that whole footprint expansion capability, as well as adding direct and parametric modeling together.

We think it's going to give us an opportunity to actually grow back in line with, if not so, better than the market, which frankly would be a vast improvement over the growth that we've seen in that market, which was essentially flat for a number of years. So Creo is a couple different growth dimensions there.

One being extended footprint. The other being a combination of direct and parametric modeling within the installed base. And we think we can get some -- actually this year it was going to be difficult compared to the boom that the oil industry saw last year. But on an ongoing basis, that's a very solid base of business, with good single digit growth market opportunity for us, and very profitable.

Unidentified Analyst

Yeah, okay. I think we have time for one or two questions from the audience, if there are any questions. One right in the front of you?

Unidentified Analyst

So Dick used to love using the term domino accounts, that you guys knock down these domino accounts and had a lot of success with that. And I think that according to which rode the larger outside growth for maybe last 12, 24 months, how many more dominos are left? Is that part of the issue on the slowing growth? You guys have a bag of deals missed, a bag of deal domino, how many are left?

Jeff Glidden

So let me say the question was on dominos. And we define dominos as large accounts that were competitive in nature. So it had to be a competitive situation. And there were companies that had more than $10 billion in revenue. So we added 30 of those over a couple of year period. That's still a very important piece of our growth.

We're not reporting them per se with a concept that we're saying that's important to add $10 billion companies but also $5 billion, $1 billion, and so forth. So clearly, new customer acquisition is a key part of the strategy. I think we did cite and we still embrace a couple of the big deals that -- and one in particular would have been a definition of a domino.

And what we find is it's very important to add those large new accounts, one, for the initial deal, but more importantly, for the follow-on revenue. They become very nice revenue streams. And about 85% of our business in any given year comes from our installed base.

So managing that is very, very important, but adding on the front-end and the new sales capacity that we're adding, is really targeted to adding net new accounts. So I think the dominos and then the next level down, so not just $10 billion, but $5 billion, $1 billion, and in fact $100 million accounts as well. So a new account acquisition is absolute key.

Unidentified Analyst

I think we're just a minute over time, so Jeff, Tim, thanks for joining me here. Thank you.

Jeff Glidden

Well, thank you.

Tim Fox

Thanks, Ron.

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