Jan 24, 2008
Executives
Richard Harrison - President and CEO Neil Moses - Executive Vice President and CFO James Heppelman - Executive Vice President and CPO Barry Cohen - Executive Vice President of Strategic Services and Partners Meredith Mendola – Vice President of Corporate Communications and Investor Relations Contact
Analysts
Greg Dunham - Deutsche Bank
Ross MacMillan - Jeffries & Co.
A. Sasa Zorovic – Goldman Sachs Jay Vleeschhouwer - Merrill Lynch Andrew Maiorin – Bear Stearns Sterling Auty – J.P.
Morgan
Operator
Good morning ladies and gentlemen and welcome to PTC's first quarter fiscal year 2008 results conference call. (Operator instructions).
I would now like to introduce Meredith Mendola, PTC's Vice President of Corporate Communications. Please go ahead.
Meredith Mendola
Thanks Brian. Good morning everyone, and thank you for joining us today.
Participating on the call will be Dick Harrison, our President and CEO, and Neil Moses, our Executive Vice President and CFO. In addition, Jim Heppelman, Executive Vice President and CPO, and Barry Cohen, Executive Vice President of Strategic Services and Partners are here to participate in the Q & A.
I would like to remind everyone that during the course of the conference call we will make projections and other forward looking statements regarding future financial performance, business trends, and other future events. We caution you that such statements are only predictions and that actual results might differ materially from the results projected in these statements.
We refer you to the risk details in the company's 2007 annual report and Form 10-K, and in the companies other reports filed with the SEC filings. A replay will be available until 5:00pm Eastern, Monday, January 28th, at 402-220-9786.
Additionally, this call is being web cast and a replay will be available through our website at www.ptc.com until Monday, January 28th at 5:00PM. Also on our website you will find a document with Q1 2008 financial and operating metrics which we will discuss on this call.
After our prepared remarks, we'll hold a Q & A session. In order to keep this moving, please limit yourself to one question and one follow up.
If you have an additional question you'll need to get back in the queue. I will now turn the call over to Dick.
Richard Harrison
Okay Meredith, thank you, good morning everyone and thank you for joining us on our first quarter 2008 earnings call. We were off to a good start in 2008 and are on track to deliver our full year revenue and operating margin targets.
Revenue from large deals and the channel grew significantly year over year. We delivered another record maintenance revenue quarter and made great progress toward our profitability targets, with non-GAAP operating income growth of 34% year over year.
We are aware of investor concern about the economy. We are reading the same headlines you are.
However we also have the benefit of speaking with hundreds of customers and channel partners on a regular basis. Our customer base has never been more secure, and we have never had a better, more complete or more relevant solution to sell them.
I will share with you the prospective we gain from working with our customers, and we'll highlight the factors that give us confidence in our competitive differentiation and our outlook. Let me start my saying that our offerings provide many benefits for customers, including improving innovation, reducing time to market, and increasing quality.
However, there are two major reasons why customers have been buying our software during the past couple of years. First, our software provides infrastructure for the globalization of product development.
This trend started in manufacturing production a long time ago, but only started becoming prevalent in engineering within the last few years. I am sure you appreciate the well established historical trend here.
Every time there has been a major globalization trend over the past 30 years, company investment and supporting infrastructure lasted at least 10 years. We are not only confident that our customers will continue this trend, but we believe that globalization will only accelerate in a more difficult economic environment.
PTC has the industry's best and most complete solution to address globalization. A second major driver for customer investment has been IT consolidation.
This trend also has a well established historical precedent in other markets like ERP. The technologies that support product development within the manufacturing companies today are highly fragmented and disjointed.
Therefore, they are costly to maintain and cause process issues, particularly in a global or distributed execution environment. Our largest customers have realized that by investing in the PTC product development system, they can replace dozens, and sometimes hundreds of disparate applications and eliminate the cost of maintaining them.
This is not a trivial task, but more and more customers are choosing PTC's single architecture to consolidate legacy applications and automate manual processes. Like globalization, we believe the IT consolidation trend will continue for years to come, and could accelerate in a restrictive spending environment.
Next, I'd like to highlight internal factors that should drive our business this year. We are at the beginning of the product cycles for our two most significant products, Windchill 9.0 and ProE/Wildfire 4.0.
Each of these releases focused on quality, ease of use, and new customer driven capabilities. Each has new chargeable modules that should provide us with additional growth as customers upgrade to the new releases over the coming year or two.
we also continue to migrate our Pro/INTRALINK customers to Windchill. We've seen a pickup in both migrations and scheduling of migrations since the launch of Windchill 9.0.
We have migrated 25 to 30% of our INTRALINK base to date, and we expect to continue these migrations throughout the year. This drives services revenue and more importantly, drives future license and maintenance revenue as it opens up the Windchill and and Arbortext opportunity within the existing installed dates.
next, our acquisition strategy has helped us deliver a very broad offering to customers, with cross selling opportunities for us no matter where customers are in their investment cycle. when a Pro/ENGINEER customer is looking for data management and collaboration capabilities, we sell them Windchill.
If they need engineering calculations and capabilities we have Mathcad and Pro/TOOLMAKER. when a customer needs technical publications support we have Arbortext solutions.
With our new acquisition of CoCreate, we will execute a similar strategy of surrounding the existing CoCreate explicit modeling tools with a broader product development system. The acquisitions themselves have given us new revenue streams, but our careful integration strategy has provided us with an offering that makes sense for customers as they consolidate their IT environments.
We will continue to execute on the acquisitions we have already completed, and we will also work at others that make sense both strategically and financially. Finally, we continue our efforts to improve our profitability.
This is a very important intitiaive for us. we started the year with first quarter non-GAAP operating margins of 18%/ |Through profitability gains and sales of marketing, services, and to our globalization strategy, we expect our profitability to grow throughout the course of the year, and are confident in our ability to achieve at least 22% non-GAAP operating margins for the full fiscal year.
All of these trends and initiatives not only support our 2008 plan, but also support our ability to achieve our long term targets of 1.5 billion in revenue, and 25% non-GAAP operating margins bu 2010. Although there is investor concern about the economy, we believe our pipeline supports our ability to achieve our goals for 2008 and beyond.
Now I'll turn the call over to Neil, and I look forward to taking your questions in a few minutes. Neil Moses Thanks Dick, and good morning everyone.
Our first quarter 2008 financial results reflects solid execution of our strategy. I'll discuss our results in detail, and then provide our outlook for the second quarter and focus for the year, and then we'll open up the call to questions.
First, our high level income statement for the first quarter are as follows. Total GAAP revenue for the quarter was 241.2 million, and non-GAAP revenue, which excludes the deferred maintenance revenue write down associated with the CoCreate acquisition was 242.5 million.
Both GAAP and non-GAAP grew 9% from the same period last year. Non-GAAP operating expenses were 198 million, and our non-GAAP operating income grew 34% year over year, to 44 million, or 18.2% of total revenue.
this represents a 330 basis point improvement from the first quarter of 2007. And, our non-GAAP earnings per share were $0.26, up from $0.23 last year.
Our non-GAAP tax rate in the year ago period was about 21%, and in the current quarter it was 32%. If the prior period had been taxed at the 32% tax rate, our year over year earnings growth would have been 35%.
Now let's turn to revenue metrics, all of which are based on GAAP total revenue of 241 million. Our total revenue growth of 9% reflects both organic revenue growth, as well as one month of CoCreate revenue.
Revenue by line of business is as follows: Licensed revenue grew 1% year over year to 67 million in the first quarter. We delivered growth in revenue from new licensed sales across all of our major products, but much of that growth was offset by a decrease in revenue from Pro/ENGINEER upgrades and modules.
We are currently at the end of the Pro/ENGINEER WildFire 3.0 product cycle, and have just launched Pro/ENGINEER WildFire 4.0. The revenue decrease for upgrades and modules is in line with the typical pattern for this stage in the product cycle and we expect to see sales of modules and upgrades grow again in the coming quarters as our customers adopt WildFire 4.0.
Among our other major product families, Arbortext showed the most significant growth year over year and Mathcad continues to deliver solid growth. Windchill license revenue following our record quarter in Q4 was flat year over year, but for the two quarters combined was up 22%.
Consulting and training services revenue grew 10% year over year to 60 million in the first quarter. This increase was the result of continued growth in traning and IT services, process consulting, and Windchill implementation consulting, partially offset by our continued efforts to use more channel, and specialized partners to provide Mcad consulting services.
This initiative has enabled us to significantly improve our consulting utilization and our services net margins, which more than doubled more than year over year and will continue to be a focus in future quarters. first quarter maintenance revenue grew 13% year over year to 114 million.
this growth is the result of a combination of factors including recent license revenue growth, continued improvements in customer satisfaction, favorable currency movements, and the acquisition of CoCreate. By geography, our revenue was as follows: North America revenue declined 2% year over year to 85 million in the first quarter due to a decline in North American services revenue.
Our channel grew an excessive 20% in North America as we continue to evolve our distribution model. Four of our top ten license and service customers were in North America this quarter.
First quarter revenue from Europe grew 23% year over year to 102 million, or 10% at constant currency. Europe has been growing significantly for several quarters now, as our larger customers adopt our product develop system and our European channel continues to grow rapidly.
Three of our top ten license and service customers were in Europe this quarter. First quarter Asia-Pacific revenue was up 5% year over year to 55 million, or 3% on a constant currency basis.
the performance was driven by 7% year over year growth in the Pacific Rim and 3% growth in Japan. In the first quarter, three of our top ten license and service customers were in Asia-Pacific.
Finally, our revenue metrics related to customer size are as follows. Revenue from our reseller channel grew 26% in the first quarter to 60 million.
Growth came from all major geographies and was the result of both organic revenue growth and the addition of the CoCreate channel. our reseller channel contrubited 25% of our total revenue in the quarter.
this model continues to help us improve our profitability and increase our reach to small and medium businesses around the world, and we expect to continue to see our channel grow faster than the overall business. we also continue to grow our revenue contribution from our largetr customers.
in the first quarter we had 12 license and service revenue transactions over $1 million each, for a total of 32 million, versus 12 large transactions with a total of 28 million in license and service revenue in the first quarter of 2007. this is evidence of continued success in our strategic account program.
now, I'll move on to our spending and operating margins. first quarter non-GAAP operating expenses were 198 million.
the first quarter expense for stock based compensation was 11 million, and our acquisition related amoritization expense was 6 million. we had a restructuring charge in the quarter of 10 million related to our globalization strategy, which consisted of 3 million of severance payments, and 7 million of facilities restructuring.
on the GAAP basis, total Q1 expenses were 226 million. Our non-GAAP operating margin improvements were the results of several factor, including sales and services model evolution, globalization, and the immediate accretion provided by our acquisition of Pro/CREATE.
As a percentage of revenue, cost of services decreased year over year by more than 170 basis points in the first quarter. this is the result of our efforts to improve services profitability through utilization improvements, revenue mix shift, and partner programs.
Sales and marketing expense, as a percentage of total revenue, decreased by more than 250 basis points year over year. This is the result of the continued evolution of our distribution model and recent globalization initiatives, partially offset by some investment and sales rep capacity.
PTC had 390 quota carrying reps in the first quarter of 2008, versus 380 in the first quarter of 2007. R & D as a percentage of total revenue was flat yea over year, as we continue to invest in both our core Pro/ENGINEER and Windchill products, as well as our acquired products.
G&A expenses as a percent of total revenue were higher than usual, due to one time expenses associated with a restatement we did in the first quarter. Our non-GAAP operating margins of 18.2% were 330 basis points higher than the year ago period, and would have been 19.5% or a 460 basis point improvement without the one time G&A expenses I described earlier.
This gives us increased confidence in our ability to deliver 500 basis points of operating margin improvement for the full fiscal year, especially since future quarters will include a full quarter of CoCreate revenue and margin. Total head count was 4,642 at the end of the first quarter, up from 4,049 at the end of the fourth quarter, due to our acquisitions during the quarter, partially offset by head count reductions taken during the quarter.
Moving on to the balance sheet, our cash balance ended at 215 million. That was down from the fourth quarter due to acquisition activity, but higher than expected on strong receivables collection.
Our first quarter operating cash flow was 17 million compared to the use of 16 million in cash for the same period last year. During the quarter, we used approximately 50 million in cash on acquisitions, and also repaid 15 million of our $220 million debt obligation on the CoCreate acquisition.
Accounts receivable decreased 24 million from the fourth quarter due to strong collections, and DSOs were 73 days compared to 80 days in the first quarter of 2007 and 74 days in the fourth quarter of 2007. Deferred revenue came in at 236 million, up from 206 million in the first quarter of last year as a result of growth in the number of customers on maintenance, the contribution from acquisitions, and the effect of foreign currency.
Deferred revenue was up sequentially from 227 million at the end of the fourth quarter, due to the contribution from acquisitions, partially offset by the typical seasonality of maintenance billings. Now let’s turn to our outlook.
As Dick mentioned earlier, we remain confident in our ability to achieve our revenue and operating margin targets for 2008. Additionally, we have changed our assumption for our future GAAP and non-GAAP tax rate to about 37.5%, from 40% previously.
This essentially adds about $0.05 of earnings per share to our previous 2008 earnings guidance. Our outlook for the second quarter, ending March 29, is as follows.
We expect GAAP revenue to be between 248 million and 258 million, and GAAP earnings per share to be between $0.10 and $0.14. We expect non-GAAP second quarter revenue to be between 250 and 260 million, and non-GAAP earnings per share to be between $0.24 and $0.28.
The non-GAAP revenue and earnings expectations exclude a deferred revenue maintenance write down of about 2 million, associated with our acquisition of CoCreate, and the following second quarter estimated expenses and their tax effects. First, approximately 12 million of expense related to stock based compensation.
Second, approximately 8 million of acquisition related amortization expense. And then finally, about $3 million of restructuring expenses related to our continued globalization program.
We expect our cash balance to be approximately 260 million at the end of the second quarter, and this includes the retirement of approximately $50 million of debt during the quarter. And for the full year, we expect GAAP revenues to be about 1 billion and 55 million, and GAAP earnings per share to be between $0.66 and $0.77.
We expect non-GAAP revenue to be about 1 billion and 60 million, and non-GAAP operating margins to be at least 22%. Non-GAAP earnings per share should be between $1.17 and $1.27 for the fiscal year.
That’s up from our previous guidance from $1.12 to $1.22 per share. The non-GAAP revenue and earnings expectations exclude a deferred revenue maintenance write down of about 5 million, associated with our acquisition of CoCreate, and the following full-year estimated expenses and their tax effects.
First, approximately 45 million of expense related to stock based compensation. Secondly, 32 million of acquisition related amortization expense.
Third, about 2 million of in-process research and development expense related to acquisitions we completed in Q1. And then finally, approximated 15 million of restructuring expenses related to the continued globalization program.
Based on current assumptions, we expect our interest expense from the CoCreate acquisition debt to be about 8 million for the full year. And as I mentioned before, we expect that the GAAP and non-GAAP effective income tax rate to be about 37.5% of pretax income.
However, we expect our cash tax rate to be about 25% of pretax income for the foreseeable future. Diluted weighted average shares outstanding should be about 119 million for the second quarter, and about 120 million for the full year.
Finally, we expect to repay approximately 120 million of our CoCreate debt in fiscal year 2008, leaving a balance of approximately 100 million at year-end. Thank you for your time today.
We look forward to your questions, and at this point I’ll turn the call back over to Meredith.
Meredith Mendola
Great, thanks Neil. All right, Brian, I think we’re ready to open up the call for questions.
Operator
(Operator instructions) Our first question comes from Greg Dunham with Deutsche Bank. Your line is open.
Greg Dunham - Deutsche Bank
Thank you. The first thing I’d like to hit on is the product cycle in the transition of Wildfire.
How historically have the transitions been and what are your expectations going forward in this particular case?
James Heppelmann
This is Jim. There is not a huge disruption as we go from one release to another because as you know we sell professional licenses and maintenance.
But what you’ll find out is for example if we launch a release, say Wildfire 4, it has new modules in it. Then we take those new modules back to the base.
It takes a little bit of time to ramp that off. Then we’ll sell those new modules to the base over a period of time, and then over a longer period of time we’ll begin to saturate the opportunity and those modules will tail off.
So it has virtually no impact on the maintenance revenue, other than to bolster it and keep it strong. It has little impact on new license sales other than it makes the product more competitive and it may increase our win rate, but it does cause a sort of bell-curve type distribution of module revenue over time.
So I think the point Neil made during the conversation is that our module sales based on Wildfire 3 was slowing down, but now with the launch of Wildfire 4 we’ve got a set of new modules we can take back to the base again. So we expect module sales to climb in the coming quarters.
Greg Dunham - Deutsche Bank
That makes sense. And then on the maintenance front, that actually was a lot stronger than I would have expected.
Is that due to renewal rates, or pricing, or… Can you talk a little bit about how that performed relative to your expectations?
Neil Moses
The maintenance business has performed extremely strong for really the past 12 to 15 months, Greg. This is Neil.
Obviously the initiative of CoCreate helps there as well because almost two thirds of their business is maintenance revenue. Even excluding CoCreate, if you just look at organic constant currency maintenance revenue performance, we were up 7% year over year, which is a great number.
James Heppelmann
It really just means that customers are using the software, they like it, and they’re deploying it. The service is number two is good for the quarter, which increases the utilization of seats that are out there and bodes well for license revenue in the back part of the year.
Greg Dunham - Deutsche Bank
Makes sense, I’ll pass it along. Thanks.
Operator
Our next question comes from Ross MacMillan with Jeffries & Co. Your line is open.
Ross MacMillan - Jeffries & Co. Thanks.
As we’ve seen the North American business for you guys flow over the last couple of quarters. Can you just talk to that deceleration and maybe be more specific as to where you see it happening most?
Is there any way to distinguish between verticals or direct versus channel, or anything you can talk about with regard to North American deceleration. Thanks.
Richard Harrison
I’ll take a shot at it Ross. The channel for North America grew pretty nicely.
I think the maintenance was pretty nice in terms of deployment, the services numbers in North America were down a little bit. Neil Moses Services were down.
That is the primary reason why North America was down. Richard Harrison I would just characterize North America as being where we think it is.
It’s okay. I think that we’ve described in the past couple of calls the fact that things are a little bit tighter, so that we’re getting a little more scrutiny around the ROI from the – when we’re going through the process of getting deals approved, there is just a little more scrutiny around the return on the investments and so forth and a couple of extra signatures.
So I do think that because of the economy things are a little bit slower, but from our standpoint, as we’ve described, companies must globalize. So we’re able to build an ROI with them, and it’s just that it gets a little more scrutiny, and we probably see some deals happen not quite as quickly as we like.
In just about every case, though, if something didn’t quite happen when we wanted it to, it ended up happening subsequently. So I’m not at all panicked about North America.
I think it is more difficult but at the same time I think we have a pretty good plan and we’re doing pretty well in North America. Neil Moses Just to add to what Dick said, Ross, this is Neil.
You'll hearken back to Q3 when we had a difficult quarter last year. All the deals that were on the table in the last week of Q3 have subsequently closed now.
And we had a couple of deals in Q1 that we were trying to get over the goal line, and aren’t going to happen now until Q2, one of which is already closed. So the deals are happening, it’s just the time frame is extended.
Richard Harrison
Other little anecdotes – for example the corporate business center this week is packed. You can’t even get a room down there.
So companies are visiting, and that’s a good sign. People are not slowing down in terms of their search.
We did a first quarter, a second quarter forecast rollup for North America, and I think based on the early forecast that North America sales in Q2 are going to be up over Q1. I think it’s tougher out there, but I don’t think it’s dismal.
Ross MacMillan - Jeffries & Co. That's fair, great.
Just another for a point of clarity, two things for Neil. The 3.2 million of one-time costs associated with the restatement – should those effectively just completely disappear in Q2?
And then the second one for Neil is on the CoCreate, or the debt that you have, you talked about 8 million of interest expense that from that debt this year. I just want to confirm that’s 8 million for the year.
And then you said you’re paying it down. So you’re going to pay down 120 or so this year?
Are those the right numbers? Thanks.
Neil Moses Yes. Those numbers are correct.
Everything you just said about our debt related to CoCreate acquisition is accurate. With respect to the 3.2 million that we incurred in Q1 related to the restatement – that will largely go away in Q2 through Q4.
We do have some ongoing expenses associated with the litigation that we’re involved with, with the GELC. But that expense will amount to less than $0.5 million a quarter going forward, based on our current estimates.
Ross MacMillan - Jeffries & Co. That’s great, thank you.
Operator
Our next question comes from Sasa Zorovic with Goldman Sachs. Your line is open.
A. Sasa Zorovic – Goldman Sachs
Thank you. My first question would be if you could provide us with a growth for the overall company on an organic basis, or equivalently how much really was CoCreate in the quarter.
And also, if you could tell us what was the constant currency for the various regions.
Neil Moses
We’re not going to be disclosing going forward, Sasa this is Neil, CoCreate revenue specifically. I can tell you anecdotally that CoCreate exceeded both its revenue and its expense plan, or I should say beat both its revenue and expense plan for the one month we had it in the quarter.
I don’t know how significant that information is, because it’s one month worth of data. But we had a good month in CoCreate.
And you also asked a question about what our…
A. Sasa Zorovic– Goldman Sachs
How much did the regions grow constant currency basis year over year?
Neil Moses
I think we gave you that information. Europe grew 10% at constant currency, and I think we said that Asia-Pacific grew 3% at constant currency.
Thank you.
A. Sasa Zorovic – Goldman Sachs
My final question is like this. If I’m getting things right, the lower taxes is adding $0.05 to guidance, right?
Neil Moses
For the full year, that's correct.
A. Sasa Zorovic – Goldman Sachs
The prior guidance used to be $1.12 to $1.22 and now it’s $1.17 to $1.27.
Neil Moses
That’s correct.
A. Sasa Zorovic – Goldman Sachs
So basically the tax explains the difference in the guidance.
Neil Moses
That’s correct also.
A. Sasa Zorovic – Goldman Sachs
Now, you did beat though in the first quarter. So that means that for the remainder of the year then you are taking the EPS guidance down.
Meredith Mendola
No, we beat because of the tax. The consensus was $0.23 and we came in at $0.26, and the difference was the discrepancy between where the tax rate actually came in and what our guidance implied.
There was also that one-time expense in there so, overall we feel really good about the quarter and feel good about where we are at this point in the year.
A. Sasa Zorovic – Goldman Sachs
Thank you.
Neil Moses
He just thinks that our earnings guidance is conservative is really what he’s saying, he might be right.
Operator
Okay. Our next question comes from Jay Vleeschhouwer with Merrill Lynch, your line is open.
Jay Vleeschhouwer – Merrill Lynch
Thanks. I’d first like to ask about sales and distribution, then a technology question.
On the sales side Dick, what’s the expectation for further expanding on the direct side, do you still have the objective of getting to 450 at some point? And on the channel side what are your assumptions or goals for further adding capacity and/or productivity in the channel, each of your competitors, most particularly Solid Works, earlier this week, is communicating pretty strong growth projectives to their channel, both in terms of total growth and capacity expansion and so the question is what your expectations are in that respect as well and then the follow-up for Jim on technology.
James Heppelmann
I thought I was going to get the technology question and Neil was going to get the sales question. I think in the direct side Jay, we said that we added ten reps in the quarter, year over year so we’ve expanded that and we feel pretty good about sort of the, the head count plan in terms of staging it during the course of the year.
I think, really our, I don’t think we had an objective ever to get 450 this year, I’d say it’s more in the 420 range, that we said we’re going to go from 380 to 420 adding about 10 reps per quarter, and we’re still on plan to do that. I think that will give us nice excess, that'd be up above 10% so that’s pretty good incremental capacity given that we haven’t added any capacity for the last three years.
In addition to that we have improved productivity expectations on an on-going basis from the direct side of the sales force. In think the channel’s doing really well, we invited the channel for the first time ever to our awards trip, our president’s club down in Mexico, the first week in January and mixed them together with our direct sales force in terms of team building where we’re pretty much complete in terms of territory alignments, the direct sales force now is almost entirely named accounts and any account that isn’t named is a channel account.
I think our channel, and you can check with them, and I’m sure you do, feels pretty good about the program. One of the reasons I was really interested in the CoCreate acquisition was that it brought us additional channel capacity, most of their revenue is channel related and so if you add the CoCreate channel to the PTC channel, we’ll probably have in the range of 400 or so channel partners and we have an on-going program out there with them in terms of cross-selling products at the right time and so forth and good expectations for channel growth.
We said that the channel has a percent of revenue increased year over year from 21% of revenue to 25 or 26% this quarter and as you know in the past we’ve said that in 2010, we want the channel revenue to account for 30% of our total revenue. So we’re well on our way towards that goal.
It’s an important part of our strategy and really gets as much attention today as our direct business.
Jay Vleeschhouwer – Merrill Lynch
A clarification first on what you just said before I ask about the technology. How much of the absolute and proportionate growth in the channel business was a result of your having reassigned the channel not that long ago, I think it was a couple of thousand extra accounts to give to them that you took away from Direct, then on the product side for Jim.
First, what do you think are the most leveragible core technologies that CoCreate has that you can propagate through distribution or integrate with the rest of the product line, you know, what for instance did you communicate with last week to the industry analysts in that respect. And then competitively on the technology side, you always have said for years that architecture matters and you talk about the single development system and so forth, with Dassault shortly going to announce their new PDM architecture based around matrix super-ceding some of the issues they’ve had in their architecture, first, have you heard anything about that and secondly, if they in fact do move to a more unified architecture, does that change the competitive situation at all?
Meredith Mendola
That was ten questions right there
Jay Vleeschhouwer – Merril Lynch
That’s your going away present Meredith.
Richard Harrison
We don’t have a number that we know of Jay, that we track, that would say what those accounts necessarily were doing. We probably did know what they did in the preceding eight quarters, we can go find that out but I haven’t tracked that.
It certainly added to the channel in some respect, it did add some incremental capacity in terms of revenue to that channel but it also took down services capacity and revenue for us on an equal basis if not more so, so it’s sort of I’d call it a wash. Jim will probably do the technical stuff here better than I, but I will tell you it’s a far stretch to call Dassault’s new strategy around PDM, you know that’s built on a product matrix that was released in 1990, but I’ll hear Jim’s comments on it.
James Heppelmann
Okay. So first on the CoCreate question, you know, I’d probably focus on two pieces of technology that are most interesting.
First of all the core modeling, maybe three pieces, the core modeling tool for explicit modeling, we talked about that a lot this past week at our press and analyst meeting, we do believe that there’s a viable market segment for explicit modeling, and there’s a number of other competing companies who have explicit modelists. We happen to have the CoCreate 80% market share in explicit modeling so we think that that’s an interesting market to grow a little bit and it’s also a nice complement to Pro-E, you know when a company’s looking for the most powerful modeler, they’re going to go in the direction of Parametric modeling and they’re going to end up at Pro Engineer, if they really want the most powerful approach.
On the other hand, if they want the simplest possible approach, they should skip all parametric modelers and start talking about explicit modeling because it’s fundamentally simpler and then we’re going to have CoCreate in 80% market share. So we think that’s pretty interesting.
A second thing is a stand-alone 2-D tool, you know, I don’t want to overplay that but there’s an opportunity to sell some of that in our base because, Pro-E helps you create 2-D drawings of 3-D models but sometimes people just want a few seats to stand-alone 2-D drawings, historically we haven’t had a solution so they went out and bought a few seats of Auto-CAD but now we do. And then a third thing which is sort of interesting, is some of their collaboration tools, especially the one-space live product which is application session-sharing technology for graphic intensive applications works pretty well so that might find it’s way in to Windchill.
You know one comment I did want to say though, is that part of the analysis we did in the last quarter, is we noticed that CoCreate has three hundred customers with twenty five or more modeling seats and so those all sound like pretty good Windchill prospects because of this 10 to 1 ratio, so you could say that there’s three hundred new install based customers that are at least two hundred and fifty seat Windchill opportunities. And if you do some quick back of the napkin calculations, you know, that’s a couple hundred million dollars of Windchill revenue out there, in the install base for us to go get and I think it’ll take time for us to do that but that’s a big up-side as well, to the CoCreate acquisition.
On the architecture subject, I do believe architecture matters, and quite frankly I’m flattered at what Dassault is trying to do, which is pick one architecture so they can better compete with us, and UGS/Siemens is trying to do the same thing, finally pick one, so each of them have an effort to pick one of the myriad architectures they have and try to concentrate their efforts on that. As Dick said, neither of these products are new, Windchill’s newer, more comprehensive solution than the MatrixOne product, you know, we’ve been doing battle with MatrixOne for years, we kind of won that battle once already so we’re happy to go at it again with an even bigger lead.
And the same thing with the iMan product, you know, which his the basis for the team center unified, but what’s more interesting is by consolidating on a single architecture, in both cases, they’re going back to a large base of customers and saying “you have to switch architectures to move onto the one”, so if you happen to use MatrixOne, you’re pretty pleased with Dassault’s new strategy along an old architecture but if you use the Enovia LCA product or the SmarTeam product or the Innovia VPM product, you’re pretty disappointed, and pretty frustrated now that this is the latest pretty girl in the Dassault line up, you know, the latest new architecture. This is the fourth time they’ve played this game in the last four years.
Richard Harrison
What’s it going to be next year?
James Heppelman
I know, it depends on who they acquire. I’m just saying, customers are frustrated and for us that’s a great opportunity, we tell them, “listen, one safe choice in the market, one architecture, is going to be here in 5, 10, 20, 25 years, it’s called Windchill, everything else is up for grabs”.
Richard Harrison
And we don’t know, I can’t tell you what the Windchill product revenue’s going to be, the enterprise revenue this year but it’s going to be between, what, 425 and 450 million for the year, the Windchill numbers, you know, that’s significantly larger than Matrix, is like $100 million business.
James Heppelmann
The Windchill revenue from PTC is larger than the sum of the Matrix revenue, the LCA revenue, the VPM revenue and the SmarTeam revenue from Dassault. There’s a significant difference between our one product in the sum of their four, so we’re in pretty good shape there.
Meredith Mendola
Okay. It’s okay that you asked ten questions because we answered twelve.
Jay Vleeschhouwer – Merrill Lynch
Thanks Meredith
Operator
Okay our next question comes from Andrew Maiorin – Bear Stearns, your line is open
Andrew Maiorin – Bear Stearns
Thank you. If you could talk a little bit more about the sales cycle, I think Dick you had suggested that some of these closed or some of these flip deals from 3Q 07 had all closed and maybe there was one that flipped from 1Q that was closed in 2Q, if you could talk a little bit about, has the sales cycle lengthened measurably more recently than say three months ago, six months ago and what are your customers talking about with respect to kind of, their appetite?
James Heppelmann
I would say in the US, the sales probably has gotten a little bit less predictable and that’s sort of a proxy for a little bit longer. I don’t really think we’ve seen any change in Europe where we’re really executing well, incidentally we’re executing in Europe at a really good rate, and Siemens, Dassault and SAP are all headquartered in Europe and we’re outperforming them in their backyard, that’s actually pretty interesting for us there in terms of the strength of the product and the sales execution.
The US and Asia, I think is sort of, I haven’t seen any difference in the sales cycles as well. The US though is a little more difficult, it’s sort of hard to quantify, did the sales cycle go from twelve months to fifteen months, that’s hard to say.
We did have a deal that we thought we could get for example in December and it came in the first week in January, just didn’t quite, it was over $1 million, just didn’t quite cross the line and we had, as I said, pretty good visibility in the US, and the Q2 first past forecast for the US is solid, so for the March quarter, you know, we got the guys together and went to it and it’s pretty solid but at the same time, those deals over $1 million, I would say are a little bit more difficult to forecast today than they were six or nine months ago.
Andrew Maiorin – Bear Stearns
And this is a follow-up to that, I mean, you know, obviously there’s concern, the concern about the economy, started in the US, but seems to be spreading globally at this point, so have you re-examined your expectations then with Europe and even Asia pack as far as…
James Heppelmann
We haven’t seen that and our forecast, for again it's Q2 first past forecast. It's still early in the quarter, for Asia was up and for Europe, you know, they basically had a strong forecast as well.
So we’re not seeing that right now, and I wouldn’t underestimate the points we make in a way, the companies that are facing a more restrictive environment, might spend on our infrastructure in order to move capacity offshore, so if they’re going to go take things offshore to India and China, they’re going to need our infrastructure in order to realize the savings from deploying in lower-cost countries. In some ways, it’s going to help us.
Andrew Maiorin – Bear Stearns
Okay. Thanks
Meredith Mendola
Thanks Andrew.
Operator
The next question comes from Sterling Auty of J.P. Morgan, your line is open
Sterling Auty – J.P. Morgan
Yes thanks. Hi guys.
Just want to understand a little bit better, I think you made mention in your preparatory remarks that the Windchill license revenue was flat but if I look at the metrics page, I think the seat count, the new seat sales were up by about 20%. Just remind or help me understand, to connect those two dots.
Neil Moses
Yes Sterling that’s a good question, it's Neil, that’s absolutely right, seat count was up pretty considerably and what’s going on is that we had more sales of seats out into the enterprise as opposed to the engineering department this past quarter. In the ASP on those seats, those are quote/unquote light seats as opposed to heavy seats, so the ASP on those seats is lower leading to the flattish license revenue.
But actually, longer term, that’s a really good sign because you know, obviously our strategy is to extend from the engineering department out into the enterprise with respect to Windchill licenses.
Richard Harrison
Just to elaborate on that point, you remember I said there’s ten, typically ten Windchill seats for one (inaudible) seat, well, you know, some of those ten would be heavy seats and then some of them would be light seats but the fact that we’re moving these light seats, mean that this is being deployed as an enterprise solution not, simply an engineering solution
James Heppelmann
We had some, you know, really interesting wins that I don’t think that we have permission to talk about during the quarter, but you know, I can sort of tell you that in Europe we had some major wins. There was one customer, a big customer, that was using Dassault product, it was a joint venture between two companies, in sort of the telephony business and they were using Dassault products on one side and On the other side, he did a benchmark and for the joint venture they have chose pro Windchill for the company.
There was major industrial, lets call it – its an automotive-like company, a $100 billion company, where we replaced about 125 seats of [Katia] in the area, and it was predicated on a bigger Windchill replacement, that we have been winning during the last two years in this company, so we had some really interesting wins, competitive wins replacements in the marketplace, which again are a testimony to the strength of our Windchill, enterprise products. It becomes a really big business for us, and its growing at a fast rate, and we are winning technically in the marketplace.
Sterling Auty – J.P. Morgan
What’s the differential on as, between the two, and then my follow-up question is actually, when you look at the source of the budget that’s used to buy your software, can you kind of, characterize that as coming out of IT budgets? Is it coming out of operating budgets of segments?
Just kind of talk to us about where the customers are sourcing the payment?
Neil Moses
What was the first part of that question again?
Sterling Auty – J.P. Morgan
The difference in ASP between a heavy and a light state of WindChill?
Neil Moses
It's about a 2:1 ratio, and then in terms of the source, it really differs, you know if customers are buying heavy engineering, heavy WindChill. It probably would be more likely to come out of the engineering department if they are buying light (inaudible) WindChill.
It might be more likely to come out of the IT budget or an operations budget. But, also the other thing is that there is an opportunity for customers to capitalize these purchases, and you know I think that that’s another kind of potential, if you will, good news situation, in that, if there is going to be constraints in spending, we think its going to hit Apex first and CapEx second, if at all.
And so, we do see customers looking, you know definitely a lot of questions about hey, you know, we want to make sure that we can kind of capitalize this purchase, type of thing.
Sterling Auty – J.P. Morgan
Okay great. Thank you.
Operator
Our next question comes from Yun Kim from Pacific Growth Equities. Your line is open.
Yun Kim - Pacific Growth Equities
Neil, I apologize if you already explained it. Just wondering if you addressed the hard and expected GNA expense for the quarter and whether there were some (inaudible) or not?
Neil Moses
Yeah, we did talk about it. I am happy to mention it again.
We had a $3.2 million one time charge in Q1, associated with the GELC/Toshiba issue and subsequent restatement of our financials, and that charge came through on Q1. So we don't expect that to be recurring.
I also mentioned a little bit earlier on, that there will be ongoing expenses, associated with the litigation, but there will be a few $100,000 a quarter, rather than, you know, a few million dollars a quarter.
Yun Kim - Pacific Growth Equities
Thanks. Barry, I am consulting revenue accelerated in the quarter, you mentioned that picked up in the intralink option at the end of the quarter, you mentioned, is helping that business.
You expect your consulting business to grow at least in the high single digit growth rate for the year and would that require you to accelerate your hiring plans or can you just simply accommodate that growth with improving utilization rate?
Barry Cohen
That’s a good question and I think it is what, we expect to see that as Neil explained in the WindChill enterprise and the process and education, that’s to offset a little bit by our continual plan to go to partners with our Emcad consulting services, so you know, blended that will give us may be a 6 or 7% or 6 – 8% possible service gross. As part of our service business, we are deep into this globalization process, so a lot of it will require some additional capacity.
A lot of that capacity is coming from our offshore solution centers, where we have a dual plan. One plan is to increase our capacity for more efficiency based on those, what we call off shore solution centers.
Also, as we developed, what we call a realized value platform, we are able to break our work packages in such a way, that we can take some of the work that was traditionally done at a customer site offshore, help increase our profitability.
Neil Moses
And, you know, that the net result of all that was our services net margins were 11% out of the gate in Q1 and that number compares to 5% in the year ago period, so that we really off to a good start there.
Yun Kim - Pacific Growth Equities
And lastly, Dick, can you talk about what are some of your thinking regarding these direct sales, headcount growth and sales productivity going forward, basically with a channel contribution growing at a faster rate, than the overall license revenue growth, and basically the sales headcount growing only modestly? The productivity of your direct sales force is declining.
Do you plan to address, do you expect this trend to be temporary? Are some of your new highest ramp up?
Thanks.
Richard Harrison
Yeah, I think if you look at the last few years, sales productivity increased pretty dramatically, and I don't really see any reason why that won’t increase. We have a plan to add roughly ten reps per quarter this year.
We’re on track. I said after the first quarter we have added the ten, but they not going to contribute with the sales cycles that we’re describing.
Those ten reps really aren’t going to contribute until well into the back half of the year and into 2009. So, I think we’re pretty happy with the plan.
We have to add to capacity, both on the channel, as well as the direct side, and I think we will get some good productivity out of those additions in the back half of the year, and really more into 2009.
Neil Moses
Just to echo what Dick said. What’s really happening.
Remember, we have a three tier distribution model now, right. So we have these strategic accounts where the growth has been very, very good, you know upwards to 20%, at the high end, and than we have our channel business at the low end, which grew 26% in the most recent quarter.
So the part of our business that is more challenged is the mid-market, which used to be kind of this geographic direct territory rep account based program, and that’s where we can get to [cede] more accounts to the channel, and continue to take those reps and move them up the food chain, to focus on these larger, more strategic accounts. So where we adding the rep capacity, is in the area of our distribution channel, where we are most productive, which is our large account program.
Operator
Our next question comes from Richard Davis, Needham. Your line is open.
Richard Davis, Needham & Co.
With regards to your relationship with IBM, that you were trying to build out in China. Would you describe that as better than equal to or less than expectation, say, versus a year ago, in other words, kind of how that relationship’s going, in as much as they are in at least some markets, kind going of their separate ways?
Neil Moses
Yes, I think that Richard, I would say its probably neutral, the IBM has different sort of strengths and weaknesses in different geographies, and I would say that in China, you know their relationship with the [So] collapse obviously, and ours is pretty good there, but at the same time, I wouldn’t say that the IBM sales force has that strong application, sort of way of selling in that market place. They are still selling a lot of hardware, middleware and things like that.
I don't think they are as sophisticated with respect to go to market around partners and applications in China, as they are in other places. We have had some good wins with them, and there are some people in the sales force that understand the benefit of selling applications, but I wouldn’t say it is mature as we would like it to be.
I think it will improve in the next couple of years.
Richard Davis, Needham & Co.
Okay thanks very much.
Neil Moses
Sure.
Operator
Our next question comes from Mike Olson, Piper Jaffray. Your line is open.
Mike Olson, Piper Jaffray
Hey everybody, just a question on the interlink three upgrade. I think you originally talked about a June '08 cut-off date for that.
Can you talk about the extension that you giving customers. Is that for all interlink three customers (inaudible).
Unidentified Company Representative
Mike, sorry the second question that you asked completely broke up. We heard the first one about the extended support.
Mike Olson, Piper Jaffray
You mentioned that (inaudible)
Unidentified Company Representative
The first question was just a technical question on the maintenance field. So we offered, let's call it a rider on the maintenance contract.
If you paid this rider plus the maintenance contract, then you can buy another year’s worth of support. You know, at the end of the day, we are moving a massive number of customers, you know onto a different platform, and while we want to push them along, there is a balance here, you don't want to push too hard either.
So giving customers an extra year, I think that’s good, because a lot of them probably would like to move to the 9-0 platform, which we have enhanced dramatically in this area, and getting really good feedback, so this extra time will allow some of them to go to the 9-0 platform. You know, I think by the end of fiscal 2008, I don't know, I am not sure we have a preset answer, but I think there is going to be a lot of activity in fiscal 2008, and I think some of it will dribble into fiscal 2009 as well.
So, you know, I would probably say 50%-60%, we kind of looking at each other here. There is a lot scheduled.
There is a lot that has become scheduled. 9-0 has some really advantages in terms of performance and ease of use.
And each release has gotten significantly better from 6 to7 to 8 to 9. So, 9-0 shift in September, there is – not only is it winning conversions, but we are winning new benchmarks.
Mike Olson, Piper Jaffray
“(inaudible)” for the year, 57.5% for each of the remaining three-quarters?
Neil Moses
For the full year.
Mike Olson, Piper Jaffray
Okay. Thanks Ill turn it over.
Operator
Our last question comes from Steve Koenig, KeyBanc. Your line is open.
Steve Koenig, KeyBanc Capital Markets
Thanks for squeezing us in. One question, on guidance here, I believe that at the end of October, you know your qualitative comments around guidance included license growth on the order of 10% organic and kind of flat services growth.
I am wondering if that is still kind of your expectation for how guidance is going to be going forward. It seems like we hearing that now services should be a little bit higher.
Does that mean effectively, license growth may not get to that 10% organic level? How would you characterize your growth, composition of revenue growth on forward here?
Neil Moses
Steve, that’s a really good question. Its Neil.
So the first thing I want to say is that, you know, that we are pleased to kind of be able to reaffirm our guidance, and actually increase it based on the lower tax rate in the face of, you know, somewhat difficult economic environment. With respect to license versus service, I think it's really pretty mature.
I think that’s a good question, but Q1 is one data point and typically, we are going to look for at least a couple of data points, in terms of how our business is progressing before we decide whether or not we think there is a [make shift] here, so we going to give it to the second quarter and see how our licenses and services business perform. Then we will probably have more to say about that.
Steve Koenig, KeyBanc Capital Markets
Okay thanks a lot
Neil Moses
I think that’s it. Thank you very much for the time today.
From our standpoint, we’re done executing against our plan with our customers. We’re keeping an eye on the economy and I think in the US, there are some issues, but those issues actually represent some opportunities for us, and that’s what we talking with our customers about.
We have got a big football game coming up here. Go to England.
I know that most of the countries rooting against us, but I think we going to win that, and that will give us our second championship this year, after the Red Sox victory. So I look forward to talking to everybody in April, and especially my friends from New York.
Take care.