PTC Inc. (NASDAQ:PTC) Q2 2018 Earnings Conference Call April 18, 2018 5:00 PM ET
Tim Fox - Senior Vice President, Investor Relations
Jim Heppelmann - Chief Executive Officer
Andy Miller - Chief Financial Officer
Ken Talanian - Evercore ISI
Matt Swanson - RBC Capital Markets
Steve Koenig - Wedbush.
Jay Vleeschhouwer - Griffin Securities
Ugam Kamat - JPMorgan
Monika Garg - KeyBanc
Matt Lemenager - Baird
Alexander Frankiewicz - Berenberg Capital Markets
Shankar Subramaniam - Bank of America
Good afternoon ladies and gentlemen thank you for standing by and welcome to the PTC 2018 Second Quarter Conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. Today's call is being recorded. If you have any objections you may disconnect at this time.
I would now like to turn the call over to Tim Fox, PTC's Senior Vice President of Investor Relations. Please go ahead.
Good afternoon, and thank you Shue and welcome to PTC's 2018 second quarter conference call.
On the call today are Jim Heppelmann, Chief Executive Officer; Andrew Miller, Chief Financial Officer; and Barry Cohen, Chief Strategy Officer. Today's conference call is being broadcast live through an audio webcast and a replay of the call will be available later today on our Investor Relations Web site.
During the call, PTC will make forward-looking statements including guidance as to future operating results based because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's most recent Annual Report on Form 10-K, quarterly reports on Form 10-Q and other filings with the U.S. Securities and Exchange Commission as well as in today's press release.
The forward-looking statements including guidance provided during this call are valid only as of today April 18, 2018 and PTC assumes no obligation to update these forward-looking statements. During this call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. The reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our Investor Relations Web site.
With that, I would like to turn the call over to PTC's CEO, Jim Heppelmann.
Thanks Tim. Good afternoon everyone and thank you for joining us.
I'd like to begin with the review of the second quarter results and then provide some perspectives on the significant milestones that we achieved in the quarter. Our Q2 financial performance was strong and we continue to make important strides against our major strategic initiatives during the quarter.
Revenue, operating margin and earnings per share each came in above the high-end of our guidance. Momentum around our recurring revenue model progressed further in Q2 with software revenue growing 12% and ARR growing 15%. This is the fifth consecutive quarter of double-digit ARR growth.
Total deferred revenue grew 43% year-over-year. Importantly more than 90% of our software revenue was recurring this quarter. These results clearly demonstrate that we've established a great growth platform for our business going forward.
We delivered a solid bookings of $99 million, which was at the midpoint of our guidance. We had one large deal forecasted in Q2 that instead closed in the early part of Q3, which otherwise would have landed us near the high-end of guidance. Timing of larger deals can be a bit unpredictable. However, we're pleased with our bookings performance in the first half see a strong pipeline for the remainder of the year and remain committed to our double-digit bookings growth target for fiscal '18.
To summarize my commentary on Q2, I will again orient my discussion around our three strategic initiatives designed to maximize long-term shareholder value, which are, number one to increase our top-line growth; number two to convert to a subscription model; and number three to expand our margins.
So let me start by discussing our progress on the growth front. Given that we're at the midpoint of our fiscal year, I'll frame my comments around our first half performance. First half bookings grew 10% overall, 5% in constant currency and 9% in constant currency when adjusting for the early close of the $7 million mega deal, we called out at the end of Q4 last year.
You recall that last year we grew bookings 20% in the first half of the year. So we performed reasonably well against a very tough compare. From a geographic perspective, America has delivered good performance with 7% bookings growth against very strong first half growth last year of 36%. Europe bookings are approximately flat year-over-year in constant currency, but also against very strong first half performance in fiscal '17 where we had 26% constant currency growth.
Also the $7 million mega deal we closed early in Q4 instead of in Q1 as we had expected significantly impacts the perspective on Europe's first half growth. Europe was down sequentially and year-over-year in Q2. We expected this at the start of the quarter and it was reflected in our guidance which is based on the timing of large deals in the pipeline throughout the year primarily coming from our PLM segment.
For Q3, we expect significant sequential bookings growth in Europe driven by a strong large deal pipeline. Performance in APAC with first half constant currency bookings growth of 9% has been driven by solid performance in China, Taiwan and Korea. Japan has made continued progress on its path to recovery delivering as usual significant sequential step up from Q1 to Q2, and appears to be tracking to its full year plan which calls for modest growth.
Turning now to our business unit performance. Let's start by discussing IoT, which is our highest growth business. We had another good quarter with strong contribution from customers expansions accounting for about half of our [indiscernible] bookings and the number of six figure deals grew 45% year-over-year driven by these expansions. If you exclude the 8 figure mega deal from Q1 of 2017, IoT bookings growth for the first half of fiscal '18 is in line with a 30% to 40% estimated market growth rate, we've spoken of.
IoT recurring software revenue growth accelerated in Q2 posting 13% sequential growth and 31% year-over-year growth reflecting the compounding benefit of our maturing subscription model that's now starting to happen.
Let me share some customer examples that highlight the wide variety of vertical markets, geographies and use cases where PTC's industry leading IoT technologies are being put into production.
I'll start with smart connected operations, what we call SEO, which is all Industrie 4.0 factory automation. During the quarter, we closed an expansion deal in the Americas with one of the leading global food and beverage companies to extend their Industrie 4.0 initiatives across their entire manufacturing footprint. This latest ThingWorx expansion is part of a long-term deployment plan targeting up to 20 new plants over the next 18 months.
Also in the Americas, Exxon Mobile is leveraging ThingWorx to build condition based analytics and maintenance apps that provide operational and asset optimization.
Meanwhile in the European aerospace and defense market, Airbus is launching a new ThingWorx space application in its manufacturing environment to guide shop floor operators through complex procedures in order to improve production quality.
And in China, we closed an SEO deal with the airframe company called AVEC who is using ThingWorx to drive factory operational efficiencies by deploying what they call connected operational intelligence, which aggregates analyzes and delivers insights from disparate silos of assets, enterprise systems and operators.
Lastly, in what for PTC is a greenfield market of process manufacturing recall that last quarter we highlighted two new wins one with a very large Swiss-based food and beverage company and one with the global brewing company Carlsberg. I'm pleased to report that both customers have already signed expansion deals with PTC providing tangible evidence of the rapid ROI that ThingWorx can deliver on the field.
Turning to smart, connected products what we call SCP, which is the traditional use case for IoT. We closed a number of meaningful expansions and new engagements. Southwest Airlines which is an existing PTC service parts management customer shows ThingWorx to enhance their part planning operations by integrating data from other systems with the goal of reducing parts shortages and critical long lead parts.
In the medical device space, one of our global Boston-based Medtech customer has signed an expansion deal to connect the next generation product platform enabling improved device management, more efficient doctor and surgical processes and ultimately improve patient outcomes.
On the partnership front, you remember in late January, we signed a strategic partnership with Microsoft that aligns both companies around the combination of ThingWorx and Azure IoT. We were pleased to see this new partnership yield result right out of the gate as we close several smart, connected product engagements in the quarter including a significant joint-win with a well-known elevator company. This company will deploy ThingWorx together with Microsoft's Azure IoT Hub to deliver the next generation advanced condition based and predictive maintenance across their installed base of elevators.
Behind the scenes of the early commercial success with Microsoft there's a lot of exciting work going on globally around sales enablement and pipeline collaboration, which is a testament to the power that both teams see in the complementary stack of IoT technology that PTC and Microsoft delivered together to the industrial market. It's important to know that the scope of our partnership with Microsoft extends beyond the ThingWorx out of IoT platform into collaboration with Microsoft Dynamics for connected field service. And there's a lot of exciting collaboration happening with Microsoft's HoloLens and Azure teams on the AR and VR front what Microsoft calls Mixed Reality or MR.
So we have a multifaceted relationship, but IoT really acts as the core pillar knitting all of the other parts together.
With PTC and Microsoft emerging as complementary leaders in Mixed Reality, I'd like to touch on the momentum that PTC is seeing around our Vuforia based technologies. Vuforia is being put into production now at an accelerating pace across the number of industrial use cases. Vuforia developer ecosystem has surpassed 450,000 developers and ThingWorx studio which is based on the Vuforia now has nearly a 8,000 enterprises who have purchased or at least test driving this AR technology for a broad range of industrial use cases including service and maintenance instructions, factory operator instructions and virtual product demonstrations.
We landed a number of ThingWorx studio production wins in Q2 including the world's largest aerospace and defense manufacturer as well as Cannondale and Briggs & Stratton, which speaks to the growing interest for AR across different types of industrial settings. While it's still early days for AR, we have a very strong leadership position. Interest levels from customers are sky high and we're seeing commercial adoption begin to accelerate.
To summarize on IoT and AR, Q2 provided another proof point that adoption of these technologies is becoming a major strategic differentiator for industrial companies across a wide range of vertical markets, geographies and use cases. Our growing ecosystem of partners including major players like Microsoft further strengthens PTC's leadership position in these exciting growth markets.
Let me turn now to our solutions business. Year-to-date CAD bookings have considerably outpaced market growth rates and our outlook for the balance of the year remains very strong. CAD continues to benefit from our go-to-market optimization initiatives evidenced now by nine consecutive quarters of double-digit bookings growth in our reseller channel as well as a very strong product offering.
On the CAD product front, we launched Creo 5 in March. Creo 5 introduces breakthrough new capabilities for additive manufacturing or 3D printing if you prefer. Such is fully integrated topology optimization. It also delivers integrated Computational Fluid Dynamics or CFD. These are the capabilities that are in Creo for the first time.
As with every release Creo 5 is full of productivity enhancements for our users including significant improvements in the areas of mold machining and multi-CAD collaboration. Creo 5 is a major step forward for Creo and it shows the CAD world that PTC remains a force to reckon with.
Following a strong Q1 PLM declined sequentially in Q2 as we had expected due to the timing of large deals in the pipeline. On the first half basis, PLM bookings are tracking at market growth rates. The PLM pipeline for the back half of fiscal '18 looks good and we expect this business to have a strong backup and deliver a full year growth at or above the market rate.
Finally, our SLM business which you may recall has been performing below our expectations for a number of quarters posted solid results in Q2 highlighted by service parts management wins at Airbus and Pratt & Whitney. You will recall that we reorganized the SLM team under new leadership several quarters ago and the signs that this business will respond and improve are encouraging.
To close-off my commentary on the growth front, the first half of the year is off to a very good start and based on our outlook for the balance of the year, we expect to deliver double-digit bookings and recurring software revenue growth for the fiscal year.
Let me turn now to our second top level initiative to drive shareholder value, which is our transition to a subscription business model. Our Q2 subscription mix of 78% was up 1,100 basis points in Q1 reflecting the end of professional license sales in the Americas and in Western Europe. The 78% was just slightly below our guidance due to the one large deal that slipped from Q2 to the beginning of Q3.
I also want to highlight that this past quarter 91% of our software revenue was recurring the highest level to-date. And despite a subscription mix that 700 basis points higher than Q2 a year ago, our software revenues still grew 12%. Overall, we're very pleased with the momentum around our subscription transition and we have high confidence in our long-term subscription and recurring software revenue targets.
Let me wrap-up my comments by discussing our third to-level initiative to drive shareholder value, which is to further increase our operating margins.
To start, I like to point out that we hit a very important milestone in Q2 by achieving professional services margins of 21% surpassing for the first time ever the 20% target that we've been promising and tracking toward for years. I want to congratulate Matt Cowen and his services team because it's been a long but steady march from the sluggish single-digit service margins, we used to have to today's margins in the 20% range, which I trust most of you would agree is best-in-class for a captive professional services business.
It will take a few more quarters to prove that the 20% services margins are the new norm, but I'm confident that Matt and team will prove that out. And of course, once they do, we'll ask them to aim higher. In Q2, our operating margin was above the high-end of guidance and was an improvement of 160 basis points over Q2 of '17.
As we continue to progress through the back half of the subscription transition, we expect to deliver continued operating margin expansion in fiscal '18, and then, achieved rapidly accelerating margin expansion in fiscal '19 and beyond driven by the compounding benefit of multiple years of our maturing subscription model coming into play.
In closing, I'd like to reinforce our commitment to the long range plan. We have to transform PTC into one of the premier software companies in the world. Our current plan says that by 2021, we will achieve revenues approaching $2 billion with double-digit growth rates and margins in the low 30s. At our Lifeworks event in June, in Boston, we will have an embedded investor track where we plan to give you an updated view over 2021 targets and to extend our long range plan out through 2023 to give added transparency to the substantial value creation engine that we're building for our shareholders. I think you'll enjoy seeing how compelling our business looks when all of the business model transition effects are finally behind us.
With that, I'll turn the call over to Andy who will review the financial highlights with you.
Thanks Jim. Good afternoon everyone. Please note that I'll be discussing non-GAAP results and guidance.
Q2 bookings of $99 million were at the midpoint of our guidance despite a large forecasted deal that did not close until the beginning of Q3. If we had closed this deal on time, bookings and ACV would have been near the higher end of our guidance and subscription mix would have been 79% in line with our guidance.
As we anticipated when we guided in January, Q2 bookings grew 4% as reported and were about flat in constant currency against a very tough compare primarily driven by the timing of large deals in the pipeline across the year. Large deals those over $1 million were actually at historically low levels in the quarter just as we had anticipated back in January based upon the opening pipeline.
Yet we still delivered nearly 100 million in bookings a testament to the broad strength in our base business. With significantly more large deals in the pipeline as we enter Q3, we expect a material up tick in large deal bookings which is reflected in guidance.
Revenue, operating margin and the EPS all exceeded the high-end of our guidance and we had an exceptionally strong free cash flow. Total deferred revenue billed plus unbilled increased year-over-year by $382 million or 43%. Billed deferred revenue was up 1% due to the timing of quarter end, which was March 31 this year versus April 1 last year. Recurring billings on April 1 this year were about $79 million, so on an apples-to-apples basis, billed deferred revenue would've increased 17%.
ARR grew 15% year-over-year, the fifth consecutive quarter of double-digit growth. You will see from our guidance that we expect to hit $1 billion in ARR next quarter. Our support conversion program continues to progress well with 34 enterprise customers converting their support contracts to subscription and in our channel, the new program that we launched in Q4 '17 continues to gain traction with 115 conversions in the quarter. We believe that the conversion opportunity within our customer base is substantial and will continue to play out over many years.
Turning to the income statement, total second quarter revenue of $308 million was $3 million above the high-end of our guidance and up 10% year-over-year. Q2 was the fifth quarter of year-over-year revenue growth since launching our subscription program at the beginning of fiscal '16 highlighting that the subscription trough is well behind us.
Software revenue was up 12% year-over-year despite a 700 basis point increase in our subscription mix. Subscription revenue grew 71% and total recurring software revenue grew 15%. Approximately 91% of Q2 software revenue was recurring, a milestone the first time we crossed the 90% threshold.
Operating expense in the second quarter of $179 million was within our guidance range and Q2 operating margin was 60 basis points above our guidance range of 16% to 17%. EPS of $0.34 was $0.02 above the high-end of our guidance.
Moving to the balance sheet, cash and investments at the $355 million were up $13 million from Q1 '18 and we repaid $100 million of debt. Free cash flow for the quarter was $106 million and today we announced that we will be executing a $100 million accelerated stock repurchase program beginning on April 20 that we expect to complete this quarter.
Now turning to guidance, we are raising top and bottom line as well as free cash flow guidance. And there is no change to our full year bookings guidance since the large deal that slipped from Q2 was closed in early Q3. We continue to expect bookings in the range of $455 million to $475 million. This represents growth of 9% to 13% year-over-year or 12% to 17% when adjusting for that $7 million mega deal that closed right at the end of last year instead of during Q1.
We continue to expect a subscription mix of 80% for the full year and expect to exit the year in the mid 80% range. We expect fiscal '18 total revenue of $1.25 billion to $1.26 billion an increase of $13 million at the midpoint of our previous guidance driven by a $10 million increase in recurring software revenue.
We've increased our subscription revenue guidance to 475 million to 480 million growth of approximately 70% year-over-year. Fiscal '18 recurring software revenue is now expected to grow 15%. Total software revenue is expected to grow 9% to 10% despite a subscription mix of 1,100 basis points higher than last year. And ARR is expected to grow in the mid teens.
Note that we expect recurring software revenue to exceed 90% of total software revenue for the full year.
We continue to expect operating margin of approximately 17% to 18% with rapid acceleration beginning in fiscal '19 as the compounding benefit of multiple years of our maturing subscription business model is realized. With a tax rate of 9% to 11% for the full year, we expect EPS of $1.31 to a $1.41, an increase of $0.02 over our previous guidance which is growth of 16% at the midpoint.
We are also raising our fiscal '18 free cash flow guidance by $15 million to a range of $210 million to $220 million, year-over-year growth of 96% at the midpoint. Adjusted free cash flow is now expected to be $214 million to $224 million, which excludes 4 million of cash payments related to our October 2015 restructuring.
As with operating margin, we expect free cash flow to accelerate significantly in fiscal '19 as the subscription model matures.
Turning to Q3, we expect bookings in the range of 105 million to 115 million. Revenue is expected to be $310 million to $315 million. Q3 operating expenses are expected to be $184 million to $187 million up sequentially due to LiveWorx and commissions resulting in an operating margin of 16% to 17% and EPS of $0.30 to $0.34.
With that, I'll turn the call over to the operator to begin the Q&A.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Ken Talanian with Evercore ISI. You may go ahead.
Thanks for taking the question. I was wondering if you could talk about the initial results you're seeing from the Microsoft partnership, how you expect that to evolve and whether there might be some other similar partnerships in the works?
Sure. So I think the Microsoft partnership was signed just before our last earnings call. So we talked a little bit about it. But anyway, we basically had two months to execute the partnership. So, there's a fair amount of sales, training and enablement that needs to happen in pipeline building and so forth. But I think what's exciting is Microsoft sees us as their go to market partner into the industrial world. And we see them as our core partner. And so any time we're talking to a customer about our cloud-based solution, which is almost all the time when talking about smart, connected products because they're trying to bring data from many distributed products together in the cloud.
Then we're bringing Microsoft now into the fold. So Microsoft is seeing PTC contribute a lot of deals into the joint pipeline. And vice versa when they have a customer who wants to take Azure IoT and apply it to an industrial problem maybe integrated with Dynamics maybe not, they tend to now point their customer toward PTC. So for the most part just being frank, we're getting started and doing sales enablement and pipeline building. But it turns out there were a couple of customers who were -- let's say hoping for such a configuration because maybe previously PTC had presented one solution and Microsoft presented another and the customer saw merit in both and not that much overlap. But maybe we positioned ourselves at the time as competitors.
So there's a couple of quick and easy deals that came in. The elevator company I spoke of a few others I think we even talked about the Colfax when we had the last earnings call. So there's a couple of them that quickly dropped in place because it was the perfect answer. We could stop positioning against each other and just go solve the problem together.
So we're very excited and we're excited because again it's a partnership around IoT, but it's a bigger industrial partnership that also involved Dynamics makes a whole lot of HoloLens and Mixed Reality technology. Microsoft loves what we have and of course we think they have the best device in the HoloLens. So lots of stuff going on there. It's likely that we will pull PLM and CAD into this, but I'd say not a top priority. We'd like to focus our energy first on IoT and Dynamics and augmented reality, but it's a very exciting partnership.
Now, I don't really need another cloud partner at this point. I'm pretty happy with Microsoft. But of course, we're looking for other partners, we've spoken of our desire for example to have a similar strong partner that might help us in Industrie 4.0 factory automation. That's a space where in my view we're selling a surprising amount of ThingWorx technology and Vuforia technology, but frankly we could sell a lot more if we had a partner who had a customer base and gave us more credibility and so forth because most people don't think PTC as a provider of factory automation amazing technology. We happen to have a very good product.
So we're definitely looking for partners of all types. But I'd say there's a couple of killer partnerships in industrial world that we really want to have and Microsoft was one of them and industrial automation partner would be a second.
The next question comes from Matt Edward with RBC Capital Markets. You may go ahead
Thanks. Hey, this is actually Matt Swanson on for Matt. To just kind of looking from a PMI perspective, it seems like it's been historically strong over the last year. And I was curious if you guys are seeing that strength in the macro environment. And then, just have you noticed any sort of difference in buying behavior or reacting to the macros in the subscription versus your previous licensing model?
Yes. We have got a couple of questions there and they're very complicated.
Bottom line is -- the economic backdrop remains very strong. PMIs are still in solid growth territory and they did tick down a little bit in Europe for example but still Europe I think it's 56.6. So still in solid strong growth territory and we see that in both the performance in the first half of the year as well as in the pipeline as we move to the rest of the year.
Subscription in a good or bad economy actually is a preferred way to buy because it frankly reduces the customer's risk at making a complex low information decision. So because we're embed with them in their success because if they're not successful in deployment and when the subscription runs out they can simply churn off. So you'll notice we raised our guidance this quarter as we continue to improve retention rates on our path to -- frankly their goal is to become best in class because the opportunity is there, we have sticky software.
So we want to become best in class. We're driving customer success programs across the organization to continue to drive higher renewal rates because it those will have a significant impact on our financial performance when you look at the size of the recurring revenue base. So fundamentally subscription is something where we and the customer together work for success whereas in a perpetual money and in a perpetual model it's really take the money and run as a software company.
Yes. And I might add to the second part of your question Matt. Andy mentioned that big deals in the quarter of Q2 were at historically low levels and yet we had a solid quarter, which means that small deals must have come in, in very large volumes to offset the smaller number of big deals. And of course it takes a lot of small deals to offset even one big deal. So I think what we're seeing and the channel success proves this out is a high volume of transactions. I think the transactions are smaller. One reason being the business model encourages that as Andy said. But I think in general, we're seeing the strong economy result in a lot of transactions and a lot of these transactions start small but then grow over time.
So I think we're in a good place, economy is decent. It may be downgraded from really great to just pretty good, but it's still pretty good. And that bodes well for us and we're seeing it in the volume of transactions.
The next question comes from Steve Koenig with Wedbush. You may go ahead.
Thanks guys. Can you hear me okay?
Okay, great. Yes. So definitely want to ask you and your thinking around the accelerated buyback. I think that's the first time we've seen that at least in a while. And if you wouldn't mind I'd love to sneak in on the types of ThingWorx are doing. The Microsoft deal tilt at DP and judging from your comments, Jim you expect them to be more tilted more towards smart connected products. I'm wondering if now the gate deals, did you do many of those in the quarter, are they going to be more factory floor like the BMW deals. Any color there as well I mean much appreciated.
Okay. So on the ASR because we did have such very, very strong free cash flow. And ASR frankly technically takes the share off the street faster than we could buy them. So April 20, frankly 80% of the shares that we're buying back will be returned to us.
And then we also get a discount half of the average price that the rest of the shares are purchased during that quarter. So basically we just get to take share off the street faster reduce our share count more effectively. You will actually see that when you look at Q4 that the share count does down in Q4.
So that's the reason behind it. It's a very efficient way for us and of course the banks makes money through the volatility of the stock. They got algorithms telling them when to buy. So that's why. We did it in 2014.
Okay. I've forgotten that.
I mean just frankly for various reasons we got a little behind where we wanted to be. And that's the way to catch up.
And then, the second part of your question, Microsoft is our partner. And almost by definition SCP solutions require a cloud end service, so we're directing those all to Microsoft. If you do what SEO work, factory Industrie 4.0 type deployment that could be either on premise or on the cloud. And frankly a lot of this is on premise today. So if they want that in the cloud then Microsoft is our answer. They wanted on premise, we just give them the software and they might put it on their own servers.
Microsoft has a story that sort of coming out around what they call Azure stack, which is a primary software stack that you could put on premise to get capabilities that look like Azure in the cloud. And I think that might become an important part of our story over time. I'm not sure that it's fully accepted in the market, yet, but imagine that's maybe coming which would cause us to work more with Microsoft across the board. Now frankly most of the Navigate is sold into engineering departments.
And very few engineering departments are in the call today. So most of that ends up being on premise could change over time. We're starting to sell more and more PLM in the cloud.
And there's a discussion about putting our PLM in the cloud on Azure. So, lots of good stuff happening there. We did of course sell Navigate in the quarter, it was a reasonable quarter.
We are north of 50 million.
So it's been a nice product. We would like to keep that going and park a few more next to it frankly in the portfolio.
Awesome. Great. Thank you so much guys.
The next question comes from Jay Vleeschhouwer with Griffin Securities. You may go ahead.
Thanks. Good evening.
Jim let me ask you about the role of customers IT in the selection or deployment processes for IoT or for any of the rest of your portfolio. And the reason I ask is twofold. Last year as I'm sure, one of your large competitors won a major consolidation transaction with a major aerospace company. And having just come back from that vendor's customer conference couple days ago, it sounded to me as though IT was a major factor in deciding to consolidate in the way they did with that particular vendor. And I'm wondering therefore if you're seeing any development like that in your selections were besides engineering, besides manufacturing you're going to have to convince IT and perhaps Microsoft could help you in some of these situations where that might be the case.
And then, a quick follow-up to something you said in the last call that you were having numerous conversations with automotive companies beyond BMW and Toyota. And I'm wondering if there's an update there particularly since there seemed to be some selections imminently from at least one U.S. car company and one Japanese car company.
Yes. Okay. So on your first question regarding the role of IT and let's say ThingWorx predict selections. To be frank it's all over the board. On one hand cloud in general I think has to a degree lessened the role of IT, a lot of companies actually have gone to solutions like Salesforce.com and things like it because they don't have to negotiate with their internal IT department. So I think in general, cloud is one option different than working through IT. But I think forward looking IT organizations are now starting to say we can help you with that.
And then, in the factory there is a lot of OT technology. So a lot of digital hardware and software all those programmable logic controllers for example that run control algorithms and run our Kepware software. Frequently IT is not involved in that. So IT owns IT but somebody else owns OT. And of course, ThingWorx basically had a foot in both camps.
So I mean, the honest answer Jay is, it just depends it's kind of a mix and I'm not sure the trend is strongly one way or the other.
Now the good news is, we PTC have historically strong relationships with CIOs because that's been our historical Windchill customer. So we're not afraid of CIOs, we quite like them actually because for 20 years now in our Windchill business, we've been selling to them. They've always played a key role in that. But anyway that's my honest answer which is it's mixed and I think the trend probably is a little bit away from CIOs but not dominantly so.
Back to your question about auto companies. I think a couple of interesting things happening. By the way, let's start with yesterday the CIO of BMW gave a presentation to an industry event, I guess there were like 800 people at the presentation. And he clearly laid out how important Windchill was as this bill of material back role now going forward.
So that kind of credibility is immensely helpful to us. I'll tell you there has not been another transaction like that in the last quarter. There aren't that many automotive companies and they're not switching that frequently. But, I will tell you this, yes, there is an American automotive company, we're being evaluated for ThingWorx based projects. It's way too early to say we are going to win that. But, I'm hopeful and optimistic. I mean we have a good technology and I think it fits well. Of course, we have competitors and we have to work our way through that whole evaluation process.
But definitely there's a lots of good opportunity for PTC following this bill of material from engineering down through to manufacturing, which is the BMW project. And then, trying to bring new levels of automation into the factory environment, which is more the type of project that the American OEM is looking at right now.
So I'm optimistic but no big moves to deliver to you here as a result of Q2
The next question comes from Sterling Auty with JPMorgan. You may go ahead.
Hey, hi. Hey guys, this is actually Ugam Kamat on for Sterling. I had a quick question for you. So you reached your revenue guidance for 2018 by around $15 million, but bookings you -- reiterated your bookings guidance. I mean you talked about closing the deal in the third quarter which had slip on the second quarter, but just wondering what is leading to bookings being reiterated. It is that we are seeing any change in duration or any other moving parts over there?
So bookings was reiterated simply because had we closed that deal just a little bit earlier right at the end of -- right at the end of Q2, we would have been a the higher end of our guidance. So there is no reason to change our guidance. Our pipeline now for the back half of the year, we even have better visibility to that. So therefore, the guidance is what makes sense based upon our pipeline. And as we speak you to today that deal is already closed. And frankly that deal has no impact on our revenue guidance by itself because the subscription starting at the same time it was going to start whether it close on the last day of last quarter or the first day of this quarter.
The other point I want to make is that the reason we raised the revenue guidance is because we're seeing continued improvements in our renewal rates. We have a focused effort that's been going on for many quarters now. We've reorganized functions. We've done a huge McKinsey study. We're developing plays for every type of product through every type of channel in different countries to drive customer success because we do target the best-in-class net renewal rate. And we're not there but we're making good progress on that half and we're determined to get there. So we make progress faster than we'd originally expected. So we raised revenue guidance to reflect that.
Maybe just to add to sense to that. We did organize recently with EVP of Worldwide Field Operations and we put underneath this person for the first time sales proactive customer success which is a new function we didn't have a year ago or maybe 18 months ago.
18 months ago. We had it a year ago.
We put technical support. We put professional services and we put renewal sales. So now the entire lifecycle of touch with the customer is managed by one organization. And as Andy said, we did that with an ambition to elevate our renewal rates, or quite frankly lesser our churn, but elevate our renewal rates to industry standards and industry best in class standards and we are making good progress, faster than we had and therefore guided against. So it's really good news, really good news not just for fiscal '18 but didn't go forward in the '19, '20 and beyond.
Yes. Awesome that was really helpful. Thank you so much.
The next question comes from the line of Monika Garg with KeyBanc. You may go ahead.
Hi. Thanks for taking my question. Looking at the booking guidance FQ3, this could mean FQ4 bookings would be around 150 million-ish at the midpoint, maybe could you talk about confidence in achieving the same? Thank you.
It wouldn't be our guidance if we weren't confident in achieving the range.
Yes. And I think if you look at the seasonal pattern of our bookings.
Yes. It's right on track.
It's consistent with the seasonal pattern. So, it's a reasonable expectation for us to put out there.
The next question comes from Matt Lemenager with Baird. You may go ahead.
Good afternoon. Yes. This is Matt on for Rob Oliver today. I have a question on the IoT business, the large deal volume. I think you said up 45%. Was that broad base strength similar to what I think Jim you called out in a question earlier with regard to maybe the business -- the core business that the large deal volumes were maybe a little bit lower or mega deals, but being more broad based strength making up there. Is that a fair way to describe the ThingWorx traction this quarter less kind of mega deals and more broad based strength?
Yes. Let me just be careful though because as mega deal has a very specific meaning more than $5 million [shop of] [ph] booking. And large deal in our vernacular also has a specific meaning of more than $1 million. So the real strength in ThingWorx came not from large deals, but from those medium sized deals, the six figure deals as opposed to the seven figure deals.
And what's happening again, we discussed this in the last quarter, we're doing a lot of smallish deals as people are trying it out like if we have 20 factories very few people would buy for 20 factories. They would buy for one and therefore one work they might buy for five and if five work they might buy for all 20. And somewhere in going from 1 to 20, we're going to get some meaty transactions. We can have it all at once, it might be a large deal, if it happened over a series of deals. It might be a series of six figure deals. But definitely, if you look at the volume of bookings -- the volume of bookings, and then, there is the -- how much of the bookings come from meaty follow-on transactions typically six figure deals occasionally seven figure deals. And a lot of that is coming from -- a lot of the quantity of bookings in terms of dollars is coming from these six and sometimes seven figure deals.
Got it. That's helpful. Thank you.
The next question comes from Alexander Frankiewicz with Berenberg Capital Markets. You may go ahead.
Hi. Thanks for taking my question. I was just wondering what will be the impact of the end of perpetual licensing have on Americas and Europe? Is this being one of the reasons we had smaller deals on average or is that just…
Every large deal by the way last quarter was subscription. The deal that slipped was subscription, the pipeline moving forward on a large scale is a subscription. And as we look at the quarters prior to end of life, the large deals were virtually all subscription within occasional exception here or there for many, many quarters. So yes, no impact there.
Again, fundamentally a large deal buying it under subscription and -- is a way to for the customer to ensure that us PTC are kind of embed with them for their success.
Okay. Perfect. And then also…
So it's a lower risk way to buy.
Okay. Thanks and then also just how confident are you in FY'18 guidance today versus previous quarter?
Well, obviously, we're closer to -- we are half a way done. We're more confident because we frankly have half of it done and we have better view to the pipeline for the rest of the year.
Yes. I think we had solid quarter. We're pleased with where it landed. It could have been better and this one deal came in few days earlier. But, it came in anyway, so we're kind of right back to the place if they did come in, in the last quarter and we feel good about it. We've got a good pipeline. Lot of stuff to work with a lot more big deals in play which we expect will help us to contribute to bigger booking numbers in Q3 and Q4. But, I think we probably as Andy said feel of anything more confident because we're deeper into the year and we're on track.
Yes. We actually used the word materially more large deals in the third quarter.
Okay. Perfect. Thank you so much.
Thank you. The next question comes from Shankar Subramaniam with Bank of America. You may go ahead.
Thanks for -- hey, hi. Thanks for taking the question. So, I have two questions. One is on IoT another one is PLM. First on IoT, thanks for providing all the examples in the use cases. Obviously, you have a lot of success in the past in terms of implementation. And can you -- based on the learning you've had so far, just want to understand a little bit around the current issue that are faced with the market like what prevents or what prevents the customer from adopting IoT? Seems like CIOs are focused on digital transformation and definitely there is customer demand, but just want to understand that any bottleneck for adoption and how you are trying to dissolve it?
So what I would say is, to us the biggest challenge if you will is making sure we and the customer can articulate the use case and the value proposition. And so what I say is, I think you've seen this over the past quarters in our narrative that we've focused more and more on SEO and the SCP and industrial. We are not talking a lot about smart farms or cows connected to the Internet or anything like that, which ThingWorx can do. But, it's hard to get the deal closed because it's hard to articulate the value proposition.
But when we go into the factories we can talk about precisely what the use case is precisely what the benefit is, same if we go into smart, connected products instead of talking about connected service. Same when we take Navigate into and engineering. So I think the thing that gets you bog down is selling pie in the sky concepts that you don't have a proof points and you don't have credible value propositions for us.
So if anything as we've operated in this IoT business, we've continuously narrowed the focus back to industrial. If I just start over I would narrow the focus right upfront. But, we kind of learned along the way here. But nonetheless, I think we are now focused on the sweet spot of the market. All of the study say, this is where 70%, 80% of the entire opportunity is anyway. So that's really what we're focusing on and we're trying to waste fewer cycles chasing dreams in adjacent industries.
And Shankar, the only thing I would add is, this is my fourth software company, I've been around this for -- in multiple companies for more than 20 years. These markets develop at a very normal pace, it can't get a snowball rolling downhill because basically you've got great technology meeting a problem. But at the same time, you have to have industry analysts who say, yes, this software actually works to solve that problem. You got to have more and more customers who are getting success with it. That lowers the risk about investing in that technology. And that's essentially how it's developed.
So the fact that more customers are expanding how virtually every industry analysts out there has put PTC and ThingWorx in the leader quadrant. Those are all the factors that actually frankly typically determine the winners in the software market. And so this is actually playing out like I've seen almost every software market I've followed for a long time.
Got it. Thanks for that. And on the PLM, I want to just understand some more on the competitive dynamics, especially how customers are thinking about open source PLM solution with this software solution bought from you and your European peers because it seems like Aras is finding some success in terms of selling seeds into the heavy industry market. But, you are also growing a PLM booking. So longer term, do you see customers kind of doing a mix of implementation between open source and software solutions or is it going to be predominantly the solutions you are selling into the market?
Yes. I think Aras is having some success at the edges. A lot of their wins are sort of strange projects in the core of the company a little bit like how HoloDesk can claim that every major manufacturing enterprise has tons of 2D seeds of auto-CAD. But it's not their CAD system. So I think Aras is starting to win a lot of deals like that sort of not the mainstream system but maybe a test management system over in one department or something like that.
So I think they're probably doing okay but I don't think that there's that much to the open source story. I think they dangle that out there, but I don't think it's actually core to their value proposition and I don't actually think if it were that it would help them because I think in this industry, PLM is very complex and there's not a vibrant open source community in the PLM universe. And customers don't want to take on development responsibility for the core technology stack.
So I think that that may be talking about open source is a good way -- good conversation starter, but I think at the end of the day they're selling PLM fairly traditional looking PLM into pockets around the edges of the major systems that companies have deployed. So putting it another way, they're not a major competitor to us at this point. They may occasionally show up in accounts where we're trying to show up. Aras announced a win at BMW some quarters before we did. But when we competed for really big business at BMW, they weren't even in the list of competitors. And they wouldn't have been because BMW would never bet that important mission critical system on an open source strategy when there is no ecosystem of developers around that open source community.
So I'm saying that's a great conversation starter, but I don't think it's a serious business strategy. But I am saying they're having some success in pockets like pockets at BMW, pockets elsewhere, but I don't think they're yet displacing any mainstream systems.
Got it. Thank you.
Thank you. Participants please stay on the line for Jim Heppelmann to give closing remarks.
Great. Well, thank you, Shue. So, I'd like to thank everybody for joining the call and spending your time with us this afternoon. When we step back and look at Q2 results, I think it's obvious we've again made solid progress against our three strategic pillars of growth subscription and margin expansion. And this is a combination I think we all agree will drive substantial long-term shareholder value.
So in closing I want to again extend an invitation for you to join our flagship technology conference call LiveWorx in Boston on June 18th. I hope you can join us because in addition to the opportunity to mingle with PTC's ecosystem of customers, partners and employees and of course each other. You'll be able to attend this extended investor session that we planned to host at this year's event. And we're going to have some good new information about our long range plan for you at that time as well as other things.
So if you're interested please reach out to the PTC Investor Relations team that Tim Fox heads and he'll provide registration details. So we hope to see at LiveWorx or at another upcoming investor event, and if not we'll look forward to speaking with you in about 90 days when we report next quarter.
So thank you and have a good evening.
That concludes today's conference. Thank you all for participating. You may now disconnect.