Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PTC 2017 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. I would now like to turn the call over to Tim Fox, PTC's Vice President and Investor Relations.
Please go ahead.
Good afternoon. Thank you, Christine, and welcome to PTC's 2017 Q2 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 website. During this call, PTC will make forward looking statements, including guidance as to future operating results.
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 ks, quarterly report on Form 10 Q and other filings with the U. S. Securities and Exchange Commission, as well as in today's press release. Forward looking statements, including guidance provided during this call, are valid only as of today's date, April 19, 2017, and PTC assumes no obligation to update these forward looking statements.
During the call, PTC will discuss non GAAP financial measures. These non GAAP measures are not prepared in accordance with generally accepted accounting principles. A 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 website. With that, I'd like to turn the call over to PTC's CEO, Jim Heppelmann.
Thank you, Jim. Good afternoon, everyone, and thank you for joining us. Our Q2 results represent another strong quarter for PTC, continuing the momentum we've built over the past 5 quarters. In Q2, we once again executed very well across our key strategic and operational objectives. Bookings of $95,000,000 were $5,000,000 above the high end of our guidance range, with strong IoT results paired with solid execution in our solutions business.
On the subscription front, the 71% subscription mix for Q2 was well above our guidance of 60%. We will provide additional details on subscription transition throughout the call. But at this point, we feel our program has gained so much market traction that it was time to take the next step. So we announced today our plan to transition to a subscription only model in the Americas and Western Europe beginning on January 1, 2018. This decision represents an important milestone as the effect of this change will be PTC driving toward 100 percent subscription mix in these geographies that represent about 70% of our business.
Once again, the strong subscription mix had the effect of dampening our reported revenue results in the quarter. Nonetheless, before adjusting for the difference in mix relative to guidance, our Q2 revenue, operating margin and EPS were all within our guidance ranges. Had our subscription mix been the 60% that we guided to, our revenue margins and EPS would each have been well above the high end of the respective guidance ranges. And lastly, the benefits of our recurring revenue model transition were on full display in the quarter with our billed or on balance sheet deferred revenue growing by $117,000,000 sequentially. With the key metrics so strong across the board, to use a baseball analogy, I'd say that PPC hit the ball out of the park in Q2.
To summarize my color commentary regarding how our business is performing, I will again frame my discussion around the 3 key initiatives that we focus on maximize long term shareholder value. As a reminder, they are first to increase our top line growth second, to convert to a subscription business model and third, to continue our margin expansion. Let me start by discussing progress against our growth ambition. As we outlined during our financial outlook webcast last November, our goal is to achieve sustainable double digit growth by having our core business return to mid single digit growth consistent with the more mature CAD and PLM market, while having our IoT business grow in the 30% to 40% range consistent with the faster growing IoT market. That combination would create low double digit overall growth for PTC.
So against that goal, Q2 was another solid quarter with year over year total bookings growth of 11% despite a tough compare against a strong Q2 over performance last year and it reflects solid execution in both parts of the business. In IoT, we had another strong quarter with bookings once again growing faster than the market, which we believe is growing at the 30% to 40% rate. Expansions accounted for over half our bookings and the number of 6 figure deals grew by more than 60% year over year, primarily driven by these expansions. New bookings came from a variety of vertical markets and use cases with the manufacturing operations optimization use case taking the lead followed by service optimization for smart connected products. During the quarter, we closed expansions with a large Japanese automotive OEM, a global electronics OEM and a number of leading medical device companies.
Even though these customers are generally still in the early days of their IoT journeys, they are clearly deriving value from their IoT initiatives and they are relying on PTC to be their IoT partner. There's been a lot of buzz about augmented reality generated recently by Facebook and Snapchat. That technology is fun for consumers, but it will be transformational for enterprises. You may not have thought of it this way yet, but if IoT brings data from the physical world into the digital world, where it can be analyzed and understood, then augmented reality takes the resulting information from the digital world and overlays it back on the physical world to put it in context. Because AR is not very interesting without a source of real time digital content about the physical world, IoT and AR make a great combination together.
As I've highlighted over the past few quarters, we're really excited about our new ThingWorx studio offering, which allows authors to use drag and drop techniques to create dynamic AR experiences driven by live IoT content. This closed loop happens in real time, so that by simply looking at a connected product to a smart device, you see everything you need to know about it. Essentially, we can put a heads up display on anything using your phone, tablet or HoloLens or other smart glasses. With the addition of Studio into ThingWorx, you can think of ThingWorx as being an IoT system with an AR front end or you can think of ThingWorks as an AR system with a dynamic IoT content pipeline. Enterprise customers are absolutely captivated by this powerful combination of integrated technologies.
You can see it in their facial expressions during a demo and only PTC has anything like this. The growing buzz from Facebook and Snapchat and Microsoft is great because it keeps driving interest up as enterprises ask us how to use this technology in their business. And as they come to understand that AR is impractical for enterprise use cases without IoT, they end up talking only to PTC. Drafting behind the momentum created by our pilot program, which attracted nearly 2,000 enterprises so far in just 8 months, late in Q1, we launched the commercial version of Studio. This tool democratizes AR for the enterprise and we already have several $1,000,000 of bookings for this new product under our belt as early pilot customers have transitioned into production.
We look forward to sharing additional metrics around Studio in the coming quarters. Switching to the IoT partner front, in the quarter, we announced an initiative with McKinsey to create a global network of Industry 4.0 digital capability centers. This is important because McKinsey has become the thought leader regarding the power of IoT to transform industries. Using solutions from PTC, the digital capability centers are designed to support companies at every stage of their digital transformation journey, incorporating a live production environment, digital showcases with demonstrations of Industry 4.0 Technologies as well as workshops to promote skills training and awareness of Industry 4.0. The first center opened to visitors in Aachen, Germany on March 30, with plans for openings in Singapore, Beijing, Chicago and Venice to follow.
In addition to McKinsey, PDC is partnering with a variety of other leading companies across the technology landscape on Industry 4.0 initiatives, including Deloitte, HP Enterprise, National Instruments and OSIsoft. To sum up on the IoT front, we believe that the clear leadership and market momentum we have established were again validated by our strong Q2 performance and we look forward to providing further insight into our IoT business at LiveWorx in May. Stay tuned for more details regarding LiveWorx at the end of the call. Turning now to the performance of our solutions business, improved operational execution again drove solid Q2 results. CAD led the way with double digit bookings growth, driven by strength in our reseller channel, where go to market initiatives launched in fiscal 2016 continue to bear fruit.
In the channel, our Get Active campaign showed strong results. This program gives customers who are not on support one last chance to become active by moving on to subscription. We also recently launched a new channel conversion program to convert existing CAD channel support customers to subscription. There is a lot of exciting activity going on in our CAD business and we look for continued positive results from this business moving forward. The core PLM business performed well again this quarter with bookings in line with market growth rates.
Once again, PLM benefited from a strong quarter for Navigate sales. Navigate, you remember, is a combination of Windchill and ThingWorx technologies. A great example of Navigate's growing traction in the market is the Q2 deal we signed with BAE Systems Australia, a long time strategic Windchill customer where the key value driver was the ability to create easy to use navigate apps for a broad set of end users to enable access to information from multiple enterprise systems. We believe this value driver will continue to resonate across thousands of enterprise windshield deployments in our customer base, creating a significant long term opportunity to drive continued PLM growth. Lastly, in our solutions business, we saw some variability again in SLM as we have seen in the past with SLM bookings down year over year primarily due to the lumpiness and timing of large deals.
Let me summarize our progress relative to bookings growth. With a strong technology advantage in an exciting high growth market, our IoT growth plans are on track. With continued improvements in focus and execution, as well as leverage of our new technologies, we're seeing continued improvements in our core solutions business. Building on the strength shown throughout fiscal 2016 and the Q1 of 2017, Q2 was the 5th consecutive quarter where we have exceeded our bookings growth targets. We would love to keep that going, but naturally our guidance takes a more cautious approach.
Let me turn now to our 2nd top level initiative to drive shareholder value, which is our transition to a subscription model. The Q2 2017 mix of subscription bookings was once again well ahead of our guidance. We saw strong adoption in every segment, in every region and in both our direct and indirect channels. We are raising our full year subscription mix guidance to 68% from 65% and with adoption in the Americas and Western Europe consistently in the mid to high 70s, we have decided to pivot to a subscription only model in these regions by January 1, 2018. I will leave it to Andy to elaborate on how our subscription program is further evolving later in the call, but suffice it to say that I believe the finish line for our transition is now coming into Veo.
Let's turn then to our 3rd top level initiative to drive shareholder value, which is to further increase our operating margins. In Q2, our operating expenses were within our guidance range and despite subscription mix coming in well above guidance, we nonetheless delivered operating margin within our guidance range, a testament to the consistent operational discipline you've come to expect from PTC over the last 7 years. As we look across the balance of the year, our expectation still holds that fiscal year 2016 was the trough for full year operating margins with an improvement of 100 to 200 basis points expected in fiscal 2017 and even more rapid margin expansion as the subscription model begins maturing and increasingly the revenue we have been deferring begins to contribute to each quarterly period. Andy will take you through the guidance details later in the call. Before I conclude, let me address the global macroeconomic backdrop.
Recent PMI data has pointed to some modest improvements in sentiment in North America and Europe. In our view, it is too early for us to say that this translated into a change in buying behavior within our customer base. As of now, we believe that our recent performance has been primarily driven by improved execution. Given the unpredictable nature of the current geopolitical environment, until we see signs of improving sentiment leading to a shift in customer buying behavior and budgets, our guidance continues to assume a somewhat mixed macro. To wrap up, BTC continues to focus on a program that has 3 levers to drive significant shareholder value, top line growth, the subscription transition and profit expansion.
On the growth front, our momentum and market position in IoT highlight the tremendous opportunity in front of us and we are encouraged by another quarter of solid execution in our core solutions business. On the subscription front, following exceptional performance in fiscal twenty sixteen, the first half of fiscal twenty seventeen has been another strong step towards transforming our business model. On the margin expansion front, financial discipline remains one of our cornerstones as we drive toward non GAAP margins in the low 30s post transition. All things considered, Q2 was another solid quarter of progress in PTC's transformation. With that, I'll turn the call over to Andy.
Thanks, Jim, and good afternoon, everyone. Please note that I'll be discussing non GAAP results unless otherwise specified. Bookings of $95,000,000 were $5,000,000 above
the high end of guidance. On a year over year basis, Q2 bookings increased 11%. For the first half of fiscal twenty seventeen, bookings were up 20% year over year constant currency and 16% year over year constant currency organically. Strong execution drove the over performance, but the timing of deal closures may also have benefited Q2 by a modest low single digit $1,000,000 amount. Subscription comprised 71% of total bookings versus our guidance of 60% and subscription ACD in the quarter was $34,000,000 well ahead of our guidance of 24 $27,000,000 The weighted average contract length remained approximately 2 years.
Once again this quarter, the strong subscription results contributed to a significant increase in our total deferred revenue, billed plus unbilled, which increased year over year by $223,000,000 or 34% to $881,000,000 as of the end of fiscal Q2 'seventeen. In addition, as we outlined on our Q1 call, the timing of support billings along with subscription renewals and strong new subscription billings in Q2 led to a $117,000,000 or 31 percent sequential increase in billed deferred revenue. Note that we believe total deferred revenue billed and unbilled combined is the most relevant metric as there is seasonality to the timing of our recurring revenue billings throughout the year and due to the timing of our fiscal quarter ends. Subscription adoption trends were consistent with Q1 2017, where we saw strong performance in every segment, every geography and in both our direct and indirect channels. IoT had another strong quarter with subscription mix of 73% despite Kepware being virtually all perpetual at this time.
Essentially, all of the ThingWorx bookings were subscription this quarter. In our solutions business, SLM and PLM led the way with subscription mix in the high 70% to low 80% range and CAD improved to the low 60% range due in part to continued progress in our channel. In our direct business, subscription mix was 79% and in the channel, subscription mix increased 1200 basis points sequentially to 55%, led by the Americas and Europe, where over 2 thirds of the channel bookings were subscription. Regionally, the Americas, Europe and Japan far outpaced the Pac Rim, where adoption trends continue to lag the other geos. G2:seventeen subscription mix benefited from our support conversion program and the incremental ACV from conversions drove a portion of our bookings over performance.
In the quarter, 35 customers, including some very large customers and about a half dozen of larger channel customers converted their support contracts to subscription at an ACV uplift that was once again over 50% above the prior annual support amount. We believe that the conversion opportunity within our customer base is substantial and will play out over many years as we introduce new incentive programs to both our direct and channel customers. However, you should expect quarterly variability as this program continues to ramp and mature. For conversions, I'll also remind you that one, we only include the incremental ACV in our bookings results, not the full contract value of the new subscription contract. And 2, our current long term business model does not include any assumption that our large support revenue base transitions to subscription.
So this represents upside to that model. Turning to the income statement, total second quarter revenue of $281,000,000 was up $7,000,000 year over year. The first year over year revenue growth in 9 quarters, highlighting that we have exited the subscription trough. Compared to our guidance, we estimate that adjusting for the higher mix of subscription, our total revenue would have been approximately $291,000,000 which would have been above the high end of our guidance of $285,000,000 On a reported basis, software revenue was up 5% year over year. Adjusting for the higher subscription mix, we estimate software revenue would have increased 6% year over year.
Approximately 88% of Q2 software revenue was recurring, up from 82% a year ago. Operating expense in the Q1 of 163,000,000 was at the midpoint of our guidance range. Q2 operating margin of 16% was within our guidance range of 16% to 17% despite the higher mix of subscriptions due to strong bookings performance and cost discipline and represented an increase of 200 basis points year over year. We estimate that adjusting for the higher mix compared to our guidance, operating margin would have been 19%, well above the high end of our range. EPS of $0.30 was at the higher end of guidance.
We would have beaten our high end guidance by $0.07 at our guidance mix. Moving to the balance sheet. Cash and investments were up $68,000,000 from Q1 2017 and total debt declined $20,000,000 driven primarily by cash flow from operations. Now turning to guidance for fiscal 2017. Let me remind you of some of the general considerations we've factored in.
First, we attribute our strong bookings performance primarily to improved execution and our guidance assumes the global macro environment will remain somewhat mixed. Also, the timing of deal closures may have benefited Q2 modestly by a low single digit $1,000,000 amount, negatively impacting Q3 by the same amount. 2nd, while subscription results have been very strong in recent quarters, it remains challenging to forecast the exact pace of our transition and resulting impact to near term reported financial results. 3rd, our FX assumptions in our guidance approximate current spot rates. FX changes since our guidance a quarter ago in total have been relatively minor and as such do not significantly impact our full year guidance.
With this in mind, for the full year fiscal 2017, we are maintaining our bookings guidance range of $400,000,000 to $420,000,000 Excluding the $20,000,000 SLM booking we closed in Q4 'sixteen, in constant currency, this represents 7% to 12% growth, ahead of our long term business model presented last November. Also recall that we just raised constant currency bookings guidance by $12,000,000 last quarter. From a subscription perspective, we are raising our fiscal 2017 mix from 65% to 68%. As Jim mentioned earlier on the call, we announced plans today to move to a subscription only licensing model for our core solutions and ThingWorx platforms in the Americas and Western Europe on January 1, 2018. We will continue to assess market conditions and our license offerings in other regions and for Kefware, which is virtually all perpetual at this time.
For fiscal 2017, we expect total revenue in the range of $1,162,000,000 to 1,172,000,000 which at the midpoint represents 3% growth in constant currency. This includes subscription revenue growth of approximately 130% and total recurring software revenue growth of 12% constant currency at the midpoint. We expect to increase our services margin by about 150 basis points to 18% and remain committed to a 20% services margin by fiscal 2018. Fiscal 2017 operating expenses are now expected to be $673,000,000 to $683,000,000 a small $3,000,000 increase from our previous guidance to account for FX, primarily in India and Israel, but remains flat year over year at the midpoint of guidance. With the increase in our subscription mix guidance to 68%, we are trimming our fiscal 2017 operating margin guidance by 100 basis points to a range of 16% to 17%.
This represents a 100 to 200 basis point improvement in operating margin over last year, reflecting our progress on our subscription transition. On a mix adjusted basis, we are targeting an operating margin improvement of about 100 basis points to about 28%. We are assuming a tax rate of 8% to 10% for the full year, resulting in non GAAP EPS of $1.13 to $1.23 per share based upon about 117,000,000 shares outstanding. Reflecting the higher guidance subscription mix, this is a decrease of $0.07 from our previous guidance at the midpoint. With the 300 basis point increase in our subscription mix guidance for the year, we are reducing our adjusted free cash flow guidance by $12,000,000 We now expect adjusted free cash flow between 158 $168,000,000 Adjusted free cash flow excludes about $40,000,000 of fiscal 'sixteen restructuring payments and a $3,000,000 $3,000,000 of legal payments for matters previously accrued in fiscal 'sixteen.
For the Q3, we expect bookings in the range of $95,000,000 to $105,000,000 which represents growth of between minus 8% and 1% on a constant currency basis. I will remind you that we had very strong bookings in Q3 'sixteen, where we exceeded the high end of guidance by $5,000,000 and delivered 31% constant currency growth with very strong IoT performance, creating a tough comparison for Q3 2017. Also Q2 2017 may have benefited modestly by the timing of deal closures, which otherwise we would have expected in Q3. We expect a 68% subscription mix with subscription ACV of $32,000,000 to $36,000,000 We expect total revenue in the range of $288,000,000 to $293,000,000 for Q3, including $75,000,000 of subscription revenue, an increase of approximately 130% year over year. We expect OpEx in the range of $168,000,000 to 173,000,000 and an operating margin of approximately 15% to 16%.
We are assuming a tax rate of 8% to 10%, resulting in non GAAP EPS of $0.24 to $0.29 per share based upon approximately 117,000,000 shares outstanding. Before we move to Q and A, I want to update you on our stock repurchase plans. Because we believe that we have exited the subscription trough and based upon our cash forecast, we intend to resume stock buybacks later this quarter at 40% of free cash flow. With that, I'll turn the call over to the operator to begin the Q and A. Operator?
Thank you. We'll now begin the Q and A portion of the call. Please limit yourself to one question and one follow-up. If you have additional questions, please return to the queue. Our first question is from Steve Koenig of Wedbush.
Your line is now open.
Hi, Steve. Thank you
very much. And the operator got my name right. That's good. Great. Hey, let's see.
Let me just start with a kind of a green eyesight type question for Andy here. The free cash flow guide looks like it was reduced. When I look at it relative to the prior guide, it looks like the reduction, at least on a percentage basis, is somewhat bigger than the reduction in your net income guidance for your operating margin guide. Am I looking at that the right way? Is there I mean, I'm just wondering why would the free cash flow be going down a little faster than net income?
Yes. So fundamentally, it's because of frankly movements in prepaids and deferreds. But the bottom line is the way to get to that free cash flow reduction. Our rule of thumb is every point of subscription more subscription mix, we raised it 300 basis points, that's the 12,000,000 dollars You really have to go into because of our timing, Q4 was you know what I mean, but that's the fundamental reason.
Okay. Sounds good. Let me move to one for Jim here. Jim, you spoke about Studio and created an interesting vision of the opportunity for manufacturers using AR in conjunction with IoT. I'm wondering, your guide obviously doesn't get that precise long term in terms of what products are in the guide.
But I'm wondering, to what extent could that represent upside and how do you think of the magnitude of the ultimate market opportunity?
Yes, I mean, it's a good question, Steve. I think, on one hand, there's a classic definition of IoT that does not include augmented reality. On the other hand, there's a definition of augmented reality that in most people's minds doesn't include IoT. Personally, in the enterprise business, I think they belong together. I think that generally speaking, most forecasts for the AR market have even higher growth rates than the IoT market.
So if nothing else, this should accelerate either the market or our opportunity relative to the market. I think there is a huge amount of interest. Now I think this is a much earlier market. AR is not quite as far along as IoT. And in particular, one thing that would break the dam open would be better wearable smart glasses.
The whole lens from Microsoft are huge step forward, but I could think of a couple of ways to improve them further. It's rumored and Mr. Zuckerberg spilled that rumor a little bit more yesterday that there are much better glasses coming. And so for me, we want to be ready because we think that the glasses are uninteresting without content to show in them. And getting the content ready and the engine to feed content into glasses is its own project and we want to make sure by the time the glasses are ready that we have an unbelievable engine to feed content into them.
So that's why we are pushing on it so hard. And the day that you find a pair of glasses that looks like the one Zuckerberg was showing yesterday, I am going to be pretty excited. But I think if nothing else, this is just it's a tailwind to say as this IoT business gets bigger and bigger, are we confident PTC can sustain our growth rate and this is something that ought to be helping us.
Great. Thanks a lot guys.
Thank you. Thanks, Steve.
Thank you. Our next question is from Sterling Auty of JPMorgan. Your line is now open.
Hi Sterling.
So the CAD growth has been really consistent over the last several quarters. Where do you where would you say that demand is coming from? Is it going up market, down market, any particular industries in particular?
First, let me confirm, it has been double digit growth for 5 consecutive quarters, which is nice. And Andy maybe has a little bit more factual detail, but to me, it's down market. Our channel is doing exceptionally well. Yes. And that's a combination of, I suppose, on one hand, product improvements, but more importantly, many go to market and operational improvements that have been implemented in the past couple of years that are starting to work really well.
Yes. To add to that, we brought a new channel leadership about 3 years ago from frankly our competitors. And they have been maturing the channel every single year as well as working with the channel to add more sales headcount. And so that's a big driver. At the same time, we refocused you'll recall that we increased the segmentation of our sales force going after our enterprise customers to make sure we had people who were cat sellers that were appropriate number of them to go after the opportunity there.
And that, I'd say, is the other efforts that has driven results.
It's very
much, I think, an execution on the go to market side at this point.
Excellent. And then one follow-up question on the IoT space. You're talking about expansion deals for the last couple of quarters. Is there a sense of the pace of how frequently customers are coming back to buy? And how penetrated is your biggest customer at this point?
Well, I think I'm not sure if the pace itself has picked up, but it's just that with every quarter, we have more seeds planted. And so what's happening is, if all the seeds are maturing at the same speed, the portfolio of projects that we started through freemium and other techniques through our lend and expand model is growing bigger and bigger. So, I think it's more that there are more projects and if the hit rate is the same, but against the larger portfolio projects, we're going to have more growth. Now, what I would say in terms of how penetrated our largest customers, there is only 1 or 2 that are penetrated to any appreciable degree. So, I mean, there is a couple of we had a very large deal, I think it was last quarter.
So that one's a little bit more penetrated. But in general, penetration rates are exceptionally low.
Yes. Even for our largest customers, I would say they're early in their IoT journeys, if you think of where they want to be in 5 years' time.
That makes sense. Thanks guys.
Thank you.
Thank you. Our next question is from Matt Hedberg of RBC Capital Markets. Your line is now open.
Hey guys, congrats on the quarter. Wondering if I can get a little bit more color on the end of life of license. I guess I'm wondering how should we think about additional incentives to drive existing license customer conversion to subscription contracts? I guess I'm wondering in the top 500, but also the next 1,000 customers. And should we expect to see a run on license purchases the closer we get to that deadline?
Or is it still too early to tell?
So let me address that. We have Jim talked about the fact that we're introducing new conversion programs. So as we've been mentioning over the last couple of months, we were doing conjoined market and pricing analysis to identify, frankly, how could we provide something in our subscription offer that was of value to customers and we did that both separately for the channel and our enterprise customers, very much focused actually on CAD for the channel. And those studies came back that there is a substantial opportunity for both. So in the channel program, what we found was that there were basically 4 modules that we don't sell very much of that customers would be willing to convert subscription and pay a premium over what they've been paying for maintenance, if they have the option to get 3 of 4 of those.
So you can see a program. There's we're not introducing a stick program for the channel. It's all carrot. You're going to see a program where you get the benefits of subscription, the flexibility, things like that. You get and you get these technical capabilities, these modules that they didn't have before, you can take any 3 or 4.
And for that, the study shows we should get 15% to 25% more and that frankly more than half our channel customers would be interested in that over time. In the enterprise space, where we don't have a stick, we also did some pretty sophisticated pricing studies. And what we found was that customers actually want a conversion program that's a good, better, best program. And in the good program, they'd be willing to pay 15% more than their maintenance. They don't get re stack, so that would be perfect if you have the perfect configuration of software today, but you get the other flexibility benefits, you get remix and things like that.
In the better program at a 25% premium, you get improved customizable e learning, you get a higher level of support, advanced support, I think we call it and you get reset and that's worth 25% more for them like for like. And then there is a 35% best program where you frankly get an even higher level of support and higher level of e learning and few other things. So you'll see us introduce a good, better, best conversion program for our enterprise customers where we don't have to stick. One thing I will share though, in that one, just under half we're interested today in a conversion. There are still customers who are afraid that if they give up their perpetual license, then they're going to give something up.
Now I think that will change over time, but that's where it stands today based upon our market studies.
Can you hit the second question about whether we might see a perpetual buy?
Yes. We know that others have seen a perpetual buy right at the end. So we could see 1, which of course would mean in that quarter, it could mean our subscription mix is a little bit less, but frankly, that's fine.
Got it. And then maybe just one quick one. Deferred revenue, I believe, you said it increased by $117,000,000 and that's what we see on the balance sheet. But on the cash flow statement, it looked like it was up $39,000,000 sequentially. I'm wondering, am I reading that right or why the discrepancy between cash flow and balance sheet?
So, actually, there's technical rule number 1, there's technical rules about how you do a cash flow statement that things don't always tie to the balance sheet. But the other reason there is we disclosed this in our Qs that back in the I think it was the 90s, the company so they would have a DSO metric that was reasonable. DSOs take your daily revenue, take your revenue divide by the number of days and that's your denominator and your numerator is your AR. But because there was so much deferred revenue that wasn't that was still in AR, it would make AR look like it was this ridiculous number. So to get an apples to apples, what they did was they take that deferred revenue amount and they move it out of AR into other assets.
And so frankly, the bottom line is, it's really what you see in the cash flow statement is the cash impact in deferred revenue in the quarter. There's a big piece of it that isn't collected yet. You know what I mean? It's still sitting in receivables. In this case, it's sitting in other current assets.
The other option we could have done back 20 years ago was we could have actually added the deferred revenue to the revenue and divided by 91 days in the quarter to get a daily basis and compare that to receivables. So it was all meant to get an apples to apples comparison. You get the same DSO number pretty much no matter how you do it. But anyway, we can take it offline, but it's a complicated thing the company has been doing for 20 days.
20 years. Yes. And Matt, I want to
thank you for asking Andy that question
and not me. All right. Who's next?
Thank you. The next question is from Ken Wong of Citi. Your line is now open.
Hello, Ken. Hey, guys. How is it going? So building a bit on Matt's question on the end of perpetual. So you mentioned maybe some pull forward on just purposes next year at the beginning.
But I guess how should we think about that 85% target for the year? Is that do you feel that that has kind of upward bias or downward bias because of this new program?
I'm going to time time giving you anything. That's our current target that we laid out in November. We haven't done our business planning for next year. We're doing Kepware is the one area where we've not gotten subscription traction. And so given the fact that despite our attempts, people still buy all perpetual for the most part.
We're actually recently commissioned some more studies around subscription with Kevware, how could we bundle, how could we price. And until we really understand Kevware, that's 5%, 6% of our bookings. So that's one piece there.
Could I add, Ken, that January 1, of course, is the end of the fiscal Q1 of the next year. So to the extent that it was a pre buy, it would probably more likely happen in Q1 of 2018 than Q4 of 'seventy four.
And figuring that how that might impact as well. So at this point, you should assume 85% clearly with an upward bias over time, over the long term, very gradually like asymptotically approaching a higher number. The thing I'll highlight, this quarter again, 88% of our software revenue was recurring in the quarter we just had.
Got it. And then a question on just the total deferred. So I think we have a good history of what bill deferred trends like in Q3, kind of give or take decline of mid single digits. When we think about total deferred, should it map to what we've seen historically on the build deferred? Or is that
We expect it to grow in the double digits year over year every quarter moving
forward. Got it.
Thank you. That's a good answer.
Thank you. And our next question is from Ken Talanian of Evercore ISI. Your line is now open.
Hi, guys. Thanks for taking the question here. So I just wanted to touch on guidance. You've held your license and subscription bookings guidance for fiscal 2017 constant, essentially since 4Q 2016 despite the beats in the first half of the year. And then as you look out to the second half, high end of your guidance for 3Q is flattish year over year.
I understand it's a tough comp and then I understand that 4Q should also be down based off the large deal. But I was just curious what are the key reasons you might exceed your guidance? And how do you view your second half pipeline versus what you're seeing in the first half of this year when you guided in 4Q?
Yes. So first, let me address something that in your question that you might have missed. Last quarter, we held our top line bookings guidance of $400,000,000 $420,000,000 against a stronger dollar. And so that actually was a $12,000,000 increase we did last quarter to our guidance in constant currency. Otherwise, we would have had to lower guidance, but we actually held it, which means in constant currency, we effectively raised guidance by 12,000,000 dollars So this quarter, we didn't raise guidance.
We were $5,000,000 over our high end, but there was probably 2,000,000 dollars that was by our estimate stuff that we had expected in Q3. So that's really a flip between the 2. So that's kind of where we are at this point, given what we've done with our guidance. Now, when you look at second half growth, it is going against really tough compares even if you exclude the SLM deal. So last year, we grew 31% in Q3.
And so just to be flat, we've guided down 8 plus 1. So just to be roughly flat, it's huge against that number. In fact, if you look at last year
If you think of it from a CAGR perspective, you're talking about 15% CAGR over the 2 years. Over 2
years, yes. So you'll recall we had a mega deal in the Q3 and that we sequentially grew bookings by $19,000,000 from Q2 to Q3 last year. So that's a challenging comp. Then when you actually get to Q4, you'll see if you exclude that SLM deal, behind of our guidance is 9% growth and it was a really strong Q4 even excluding the SLM deal. So in fact, I think the total growth in Q4 last year without that was still in the low 20% range.
We're not saying we're a 20% growth company. We're saying we're a low double digit bookings growth company. We think our guidance is appropriate. If you actually look at the linearity in the quarters that we're laying out here, it makes a lot of sense. The macro still seems mixed to us.
Pipeline looks we always base our guidance on our pipeline and our analytics around the pipeline. We don't get ahead of our skis there.
Okay, great. And just as a follow-up, obviously, you've accelerated the transition to a greater percentage of your business coming from subscription. I'm curious, how should we think about your path towards your fiscal 2021 free cash flow targets given this accelerated plan?
Well, first off, the end results, clearly, we're not we have not come off the 85% yet, okay. So I want to make sure you're clear on that. Stay tuned for as we exit this year and we've done our business planning and we'll give the best guidance we can. More subscription is always better for our business model, but we also have to be realistic. There are you can go back to the Adobe space and still have some perpetual revenue.
So we're not coming off that. Clearly though, our bookings that we're guiding to right now at 7% to 12% constant currency bookings growth is more than we included in our November guidance or not guidance, but our November model outlook that we gave for the long term. So it's very helpful. And because this business is subscription, the compounding or stacking benefit helps the next year and the year after that. So the net I would say is, this year certainly seems to give us confidence in that long term model that we've laid out there, which certainly has an attractive free cash flow number, attractive EPS number by 2020 2021.
Great. Thank you very much. That helps.
Thanks, Kevin. Thanks, Kevin.
Thank you. Our next question is from Saket Kalia of Barclays. Your line is now open.
Hello Saket. Hey guys.
How are
you doing? Thanks a bunch for taking my questions here. So let's start with the end of perpetual. Since it's regionally focused, again, Americas and Western Europe and we're excluding Kepware, can you give us a sense for maybe historically how much perpetual revenue would essentially be rerouted from the income statement? And then what would that bookings impact be?
Is that a net neutral on bookings or could that be a smaller deal size? Just any color on those mechanics?
Okay. So those 2 geos are Americas and Western Europe are about 70% of our bookings historically. Is that what you were looking for?
Yes.
Okay, good. And we're still assessing the other geographies. That's the key thing. I think, Kepler is a good example. We haven't gotten traction there, but we're not giving out.
We're going out there trying to figure out what is really going on in that market. The competitors don't offer subscription. How can we is there value customers want and can we make sure to bundle that for them? What we did do with Kepware since we acquired them is now you have to buy support when you buy Kepware. They used to hardly ever sell support.
Now there's 100% attach rate to support. So we're basically doing our work to understand what could we do there. Frankly, what could we do to monetize the customer and grow the business more effectively? That's really what our objective is. Subscription is a way that works in the rest of the business.
We'll figure out what works for Kepware. Other things that we are also looking at is as Kepware is integrated with other parts of Same Works, it's sold subscription.
Right. And the corollary around that was, I guess, let's say 70% of perpetual sort of gets rerouted. Would that be a net neutral to the license and subscription bookings metric? Or any just any color there in terms of how that might change once you end of life perpetual?
I don't expect it's going to our customers have demonstrated they want to buy subscription. So I don't think it's going to change demand for our products in the marketplace. Other than the fact that what we've been hearing from our channel partners is it's actually easier sell. The hurdle is lower. Customers tend to buy more because they're paying in monthly payments as opposed to writing a big check upfront.
So all the reasons why subscription or cloud has done well broadly in software apply to us. And we've certainly seen, for example, in conversions, where people do a conversion, the value of that flexibility is worth something to them, but on top of it, they buy some more at the same time. Often, the incremental buy is bigger than the uplift for just the conversion. So I think there's a help there. The one thing we have highlighted is with subscription people tend to do land and expand.
And like this quarter, the amount of business from large deals was actually just below that 30% to 50% metric we said previously as far as what percentage of our bookings come from large deals, deals over $1,000,000 was actually just below that. So the strength this past quarter was just very broad business strength across geos,
across products,
across healthy channel with healthy deal sizes.
Yes. Another way to think about it, Saket, is the percent subscription in Americas and Europe already is, let's call it, upper 70s. And rather than aiming from upper 70s to mid 80s, we would be aiming for, I don't know, mid 90s, Yes. Right. So there's not that much runway left here actually.
And we're going to try to just eke out the last chunk of it and not settle at 85, but push on because in a perfect world, if we get to 100, I think everybody on this call would be happy with that.
Sure. If I could just ask a follow-up. Can you just talk a little bit obviously deferred revenue and unbilled kind of in focus. Can you talk about the mix between those 2, Andy, in terms of billed deferred versus unbilled and how that might change, if at all, in your long term model?
I'll be honest, I haven't thought about that because I don't think it's that very important. To be perfectly frank, The key thing is right now customers, as I mentioned, the average length of a contract remains about 2 years. We don't want to sign contracts that are more than 3 years. You could see a little lift in that toward something above 2. Many companies I'm aware of have something in that 2.4%, 2.5% average term.
We actually made it challenging for our channel to sell more than 1 year subscriptions in the past. So just from an operational perspective, so I would think that's going to float up a little bit, but we still build just 1 year in advance. That's going to make the unbilled piece be a little bit bigger if that floats up. But we basically build annually. We're not changing that because that's the norm.
Right, right, Brian. Got it. That's it for me. Thanks a bunch, guys.
Thanks, Brian. Thank you.
Thank you. Next question is from Monika Garg of Pacific Crest. Your line is now open.
Hello, Monika.
Hi. Hi. Thanks for taking my question. First, kind of follow-up on the last question. Given your peers in especially in the European markets are still offering perpetual license and you're talking about kind of discontinuing perpetual.
Maybe could you give some examples, have you talked to channel, all your customers and any risk you see losing your customers to your peers?
I don't believe we have any risk that we're going to lose customers due to peers because we sell our software from a subscription perspective. And I'll give you that for I'll give you just a few data points. So one thing we did before we made this decision was we actually went out and surveyed all of our channel partners and took that feedback to make sure they were ready, that they felt heard, that they felt their customers were ready and it came back tremendously positive. They love the subscription model. One of the interesting things was they actually highlighted that the cash flow challenge that we all hear about, they figured that out and they're managing it.
Now of course, our channel partners different from some other companies had a much bigger recurring revenue base to start with. So that helps them get through that. So it's very, very positive. The one thing they do want, they rate themselves that they could be better at selling it. And so we took note of that immediately and they're in at LiveWorx and there'll be a whole lot more sales enablement for their people about how you actually can sell subscription more easily and sell through any professional objection that someone might have.
So I think it benefits us as opposed to hurts us, Because again, think about it, our channel partners, it's always you can do one thing really well. If you try to do 2 things well, you'll probably do both of them not very well. So here they will become expert at selling subscription and they don't have to figure out how do I handle the I can simply say we don't sell perpetual, we sell subscription and add it there. You're not trying to be good at 2 things at once.
Yes. I think the key point is with technologies like CAD and PLM, which are fairly complex, mission critical enterprise technologies, the technologies you select, particularly if you're buying more, if you're buying more, there's no way you're going to switch based on a pricing model, because the switching costs are dramatically higher than the price of buying more with a different model. And then I think when you look around, particularly if you go out and look at new technologies, they are all subscription anyway. So I feel like Andy is right that there is not a lot of risk here. Again, the market is telling us now that the vast majority of people given the choice are going to go that way.
And the vast majority of new products coming to market are subscription. So it feels like there is so much the snowball rolling down the hill here on subscription has gotten so big that every passing quarter, there's fewer people complaining about it.
The only other thing I'll say is, I Googled I know that there I've read some reports from some of you about one of our competitors where some of their customers are vocally not liking their change. However, I Googled Adobe and around their end of life of perpetual and it looks exactly the kind of noise from their customer base looks exactly like what you're seeing around Autodesk and yet it certainly worked out well for Adobe. Yes.
And then that was slow
at A13 when you wouldn't believe how everyone said they were going to drop it and on.
And then
it just slowed sales force down and so on.
Yes. Yes. Thanks for the details. And then just a follow-up, Andy, on revenue recognition topic 606, maybe could you update us? Do you expect any impact on revenue recognition from that?
Thank you so much.
Yes. So first off, remember it affects us for fiscal 2019, not fiscal 2018. So we're 9 months behind everyone else. So we're continuing to do our analysis to figure out what our conclusions are around 606. And we haven't finished.
So I can't tell you what our conclusions are yet. When we do, probably I would guess in our Q3, 10 Q would be when we first disclose and have a conclusion around 606. The one thing I will share with you is that the SEC did open the door for at least staying ratable on an annual basis when they introduce kind of a time element to determining how you recognize revenue. So that is clearly an option for us if some of the other ways that others on prem software companies or other software companies are trying to get there. If those don't seem to work for us, then we have that other option available as well.
I want to remind you, we chose to be a subscription company because it is we it's how our customers want to buy. They value it. So since they value that and we're giving them something they value, we monetize those customers more effectively. That's why we did it. Being ratable is certainly something we would like to continue at least on an annual basis because it makes it easier for you to understand our results.
So we would certainly like to stay ratable and that's kind of where our desire is.
Yes, the primary benefit is a better business model for us and our customers. The secondary benefit is ratable revenue. And so even if there's questions on the second part, the primary part still holds. And we're going to do what we can to keep the ratable stuff in place. All right.
Operator, do we have any more calls?
That's the last question in queue. And please stay on the line. We'll turn it over back to Jim Heppelmann to close out the call.
Yes, great. Okay, thanks, operator. I want to thank everybody for joining us on the call and spending a fairly long call with us here this afternoon. Again, I think if you step back and look at our results this quarter, it's pretty clear that across our 3 strategic missions of driving up the growth rate, driving up profitability and converting to subscription, we're making great progress. So the last thing I want to say is talk a little bit about LiveWorx, tell you about it and encourage you to attend.
So LiveWorks is a unique opportunity to hear from a wide variety of industry thought leaders and to get hands on experience with lots of technology and software applications and then the network with more than 6,000 projected customer and partner attendees. So the focus of the event is on the convergence of physical and digital worlds and the opportunities that are unleashed by that convergence in product design, manufacturing operations and improved service. So, LiveWorx will be held in Boston from May 22 to 25 at the very large Boston Convention and Exhibition Center, not far from the airport at all. We are going to have an investor session on Tuesday, May 23 during the event and we hope that you are able to join us. If you would like to join us, of course, reach out to our IR team and they will help you with the registration details.
So we hope to see you at LiveWorx and if not, at another investor event or on the call in about 90 days again. Thank you very much. Bye bye.