PTC Inc. (PTC) Earnings Call Transcript & Summary

So next, we have PTC. We have Kristian Talvitie, Chief Financial Officer; and Joe Biron, Chief Technology Officer. Kristian, are you on the line?

We are. Yes. Good morning.

Good morning. Thanks for joining us. I thought we'd start out for people that are on of line or in the room who are not familiar with your story.

And maybe could you give us a quick overview of what PTC does and why should we look at it as an investment today.

Yes, sure. So PTC is a global software and services company that empowers digital transformation for primarily industrial, A&D and electronic company. We bucket our solutions really into 3 primary product groups. First, our core product groups, which really -- a product group, which really includes CAD and PLM. Then we also talk about our Focused Solutions Group, or FSG, which includes service lifecycle management, application lifecycle management technologies for a broad set of customers. And then lastly, we talk about our growth product group, which really includes Internet of Things, augmented reality and also our recently acquired Onshape, which is a native SaaS multitenant CAD and PLM platform as well. We employ about 6,000 people worldwide. And our -- from a financial perspective, our ARR, which we define as our active contract base, the annual contract value of our active customer base at the end of Q1 was about $1.158 billion. In addition to that, we do sell approximately about 30-ish million of perpetual licenses for one product offering that we have primarily and do about $160 million in professional services work as well. So that's kind of who we are in a nutshell.

Thanks for that. And given the current environment, it's understandable, and you did host a call on Tuesday night. Maybe for those in the audience that weren't able to join or -- the call, can you maybe walk us through what the key highlights were?

Yes. Sure. So we did host a call Tuesday night. We filed an 8-K and post the material in conjunction with that. And really, the kind of highlights of that call were, number one, we just want to make sure that we're maintaining an open line of communication with our investors and analysts and others in our ecosystem, make sure that they understand what we know about the rapidly evolving situation. The way I kind of think about it is if I owned a business and somebody was working there, I would want an update from them, even if that update was, we don't really know right now or here's what we know. And so that was the intent of the call to just be proactive. Not intended to update on our FY '20 guidance. Just intended to share what we know and also kind of stress-test the model. There are some nuances with the metrics that we use, namely ARR, that if not properly understood, could -- it could lead to some, maybe, misconceptions about what might happen under various scenarios. So what we said on the call was really for Q2, which, for us, ends in March here, quarter-to-date, we haven't seen any material disruptions to the business. That said, we have seen some meetings being postponed, being pushed out. And we, like our customers and competitors and everybody else in the world, are really trying to figure out how we continue to conduct a business that we need to conduct while keeping our employees and families and customers' employees as safe as possible, leveraging low-touch technologies in order to continue to conduct business. So as it relates to the model, what we had also done was try to -- we had provided back in November at our Investor Day kind of 4 scenarios to help illustrate how the business would perform under different assumptions. And in essence, there was an optimistic case, a market case, a pessimistic case, and then we actually also did a 2009 redux where we kind of took the impact to the business in 2009 and apply those actual impact to our 2022 model right to our long-range plan back in November, and now we thought it would be helpful for folks if we actually took those same assumptions and apply them to fiscal '20 because of some of the nuances in the business in the near term, namely backlog. And so in doing that math, really, the first case, which was the pessimistic case, which assumed core new bookings growth, was flat on a year-over-year basis. Our Focused Solutions Group, or FSG, new bookings were down 5% on a year-over-year basis. And then the growth markets, we actually cut the new booking growth in half from what it was in the market case and then held churn constant. And as we apply that math to the model, we end up with actually 12% year-over-year constant currency ARR growth here in fiscal '20. And then taking it a step further and using the 2009 redux model, if we all recall how choppy things got with the macro in 2009, what we had seen at that time was that new bookings were down across the board about 30%, and there was not really actually a material impact to churn. So the retention numbers, retention percentages stayed about the same. And so applying those factors to 2020, we actually end up with, in this model, 10% year-over-year constant currency growth. So that was a long-winded answer to -- but just trying to recap briefly what we tried to communicate here on Tuesday. And there you go.

That's helpful. Maybe if we can switch a little bit and elaborate on the reporting metrics. You've moved to particularly the ones that are focusing on annual recurring revenue and free cash flow. So under this regime, churn is kind of an outsized importance. And you've laid out plans to reduce this by 150 basis points in your long-term plan or by fiscal '24. Can you maybe highlight what steps you're taking to make that happen?

Yes. Sure. And first, actually, also one point of clarification. When we talk about ARR, it is not annual recurring revenue. It is not defined as such -- it's not revenue because for PTC, under ASC 606, the -- we don't have a ratable revenue recognition across all of our product lines, so you can't actually do the, we'll call it, normal ARR math of last quarter x4. So we actually use what we think is a cleaner metric, which is the annual contract value of active contracts at the end of any given period, right? So I just wanted to clarify that. We don't call it annual recurring revenue, but we do call it ARR. So back to your question about churn. I think there are 3 main buckets of things that can help us improve churn or reduce churn over the next few years through the LRP. Some of them are structural in nature. And I'll give you a couple of examples on that, which is, for example, in our IoT and AR solutions, which are newer technologies, and frankly, we're evolving the solutions that we're offering when we first acquired ThingWorx, and we're selling our IoT product, it was really a platform at the time, a development platform for customers. And what we found is that companies actually don't want a platform to develop their own solutions. They actually would prefer, we'll call them, "out-of-the-box" solutions that they can just deploy either on their products or in their factory settings. And with AR as well, we've rapidly migrated to a solutions mindset there as well. But with that all said, we still have some maturing to do of both the customer base and the technology continues to mature. And as that happens, we believe that we will just naturally see some of the churn that we're seeing in those segments produce. And by the way, those are our highest churn segments, which isn't really surprising either because they're new technologies and you got a lot of customers that are just testing them out, seeing how they can deploy them and get value out of. So that's kind of one side on the structural piece. On the other side, there are geographies like, for example, China, where, historically, we had been selling perpetual licenses there, and our maintenance renewal rates in China were in the 30s because primarily of cultural buying habits in that market. As we've now migrated the subscriptions and now have a mix of both perpetual support and subscriptions in that market, what we've seen is that our retention rates are actually now north of 50%, and we think that, that is a reflection of how we're engaging with our customers and really that subscription model because, obviously, if they go off subscription, they don't have access to the software anymore. So we think that as that continues to mature as well, we'll also see some natural uptick, some structural uptick in our retention rate. So that's on the structural side. I would also say on the operational side, there are things that we can do. Number one, continue to expand our customer success organization, which we established almost 2 years ago, but are continuing to evolve that and continue to figure out ways to ensure that our customers are adopting and getting the most value that they can possibly get out of the solutions that they're deploying. So that is really focused on helping our customers get value. And the other piece of, we'll call it, operational -- or other area for operational improvement, I think, is also deploying technology to try to get -- telemetry technology to try to get a better understanding of how our customers are actually using the software, what they are using, what they're not using, and this will also help our customers as well as help us understand where we need to focus. And then lastly -- so that was the operational. And then lastly, I'd say there are some commercial things that we can try to impact as well. Notably, historically, PTC's policy around renewal contracts was that we would do just annual renewal contracts, and we want to start moving towards offering customers the ability to do multiyear contracts as well. So I think as we continue to refine those offerings and get them into the -- out into the market, that should also further provide an opportunity to improve churn over time.

Great. And I guess if we look at the other levers of your long-range plan, you share plans to achieve growth of 13% to 17%. What are these levers of pricing in new ACV in the business to support this level of growth?

Yes. Sure. So maybe just some -- also some quick math here. If you think about our business -- and we put this out actually in a -- in an 8-K back in September as well when we rolled out the new reporting metrics. We put out a little metrics that showed how new ACV and churn improvement and -- impact ARR growth. And the basic premise was that with no growth in new bookings and no improvement to churn, we would actually grow our ARR by 10%. And now as might imagine, we, obviously, do not believe that we're in a no new bookings growth scenario here over the next few years. We think we have attractive products that really can provide significant value to our customers. So we expect to continue to actually grow our new bookings, and we just talked about ways that we think we can improve churn. So if you use that 10% as the starting point and then think about the additional, call it, 150 that we put in there -- 150 basis points that we put in there for churn improvement, you're almost at 12% right there. And then with some incremental bookings growth over time, we think that we can get into that range, the 13% to 17% range that we talked about.

Great. And you've been going through a business model transition for the last 4 to 5 years, and you still have about $400 million of perpetual support. They could potentially convert to subscription. Where are you today on that initiative? And what is the potential -- upside potential over the time frame discussed alongside a long-range plan?

Yes. So let's start with it this way. We actually view the support as a subscription. It is a subscription. And frankly, we want to make sure that our customers are getting the value that they want in the way that they want it. So we're, at this point, happy to have customers on support. We do believe that there is incremental value to be had by migrating to subscriptions. So we offer subscription migration path to customers who want to do that. But I think the right way to think about that $400 million run rate is, over time, we believe that $400 million is actually going to turn into about $500 million, and that will be either through a combination of price increases over time and some amount of those customers converting to the higher value subscription offerings. And I think that's just the way that we think about it. And I know there have been considerable focus on reporting against some of those conversions over the past few years. That's not really a reporting focus for us right now.

Got it. You recently acquired Onshape for roughly $500 million. For those who don't know, it's a cloud-based CAD tool meant for the mainstream design market. But what was the rationale behind that acquisition?

Yes. So the CAD, frankly, and PLM industries are really pretty well entrenched. Those technologies have been around for a long time. There are really 4 main market participants, all who have very powerful, but on-prem, solutions that have been out in the market for a long time. And Onshape is really the first company that we've seen that offers a native multitenant SaaS, CAD and PLM offering. And if you're a believer, like I am, that there are -- there's lots of incremental value for customers in leveraging SaaS solutions versus on-prem solutions, then you would come to the conclusion that this industry, like many other software -- parts of the software industry is eventually going to migrate to SaaS from the on-prem world, right? There's just too many benefits for customers for that not to happen. And so that was really the rationale. In the short term, it actually opens up some new markets for PTC to participate in that we haven't historically participated in, namely, the kind of higher growth, we'll call it, smaller business end of the spectrum. But we also think that as larger companies begin to understand the incremental value from moving to SaaS that it will move up the stack. And frankly, at our November Investor Day, we had an interesting case study. One Onshape's larger customers is a $2-plus billion industrial supplier, had actually migrated off of a legacy on-prem, CAD and PLM solution, and they're migrating completely to Onshape SaaS platform, right? So again, I'm not suggesting that, that's going to happen broadly here in the short term. But over the long term, we do believe that will happen as well. So to us, it's a pretty exciting opportunity. It gets us some great technology. It gives us some great thought leadership and business leaders that come along with that acquisition, and we're thrilled to have them as part of the PTC family and thrilled to be able to offer some of this cutting-edge technology to companies around the world, the way of the future.

Great. And then maybe on the same topic, what is your go-to-market strategy at this stage? And do you expect some contribution to your fiscal '24 targets? And maybe how meaningful could that be?

Yes. So over the past few years, Onshape has put the vast majority of the -- their investment into developing the technology and really only recently started thinking about expanding their go-to-market investments, and that's right about the time that we actually acquired them. So we are continuing to invest in their -- in the go-to-market machine, if you will, for that technology. And it's still nascent at this point, but we are continuing to invest and broaden the reach. In terms of impact to the LRP, as noted before, we actually do include Onshape in our growth product groups. And so it's actually implied or actually even stated in those growth scenarios, particularly around the market and the optimistic scenario, depending on how rapidly companies start to realize the benefits of SaaS and migrate in that direction.

That's helpful. And Kristian, maybe could you -- in the last quarter, there was some notable trends in the PLM where you recorded double-digit growth. How sustainable do you think that is?

Yes. I think that PTC, even over the past couple of years, has actually been outpacing market growth rates for both CAD and PLM. I think that part of that is structural in nature, meaning we have some things that are happening in the business, i.e., the subscription transition that had been going on underway -- that have been going underway for the past couple of years and has really wrapped up last year, but we're still seeing the lingering impact in the model this year that will continue to drive above-market performance in both CAD and PLM here in the short term. I think longer term and implicit in the LRP, we think that we will continue to grow in line with the market over the period of the LRP. Although I'm pleased to hear Monica's comments on digital transformation and how companies are really starting to realize more value from their CAD and PLM platforms more broadly throughout the organization, so I -- we definitely concur with her thesis there, and that's what we think we're seeing in the market as well as customers figuring out that there is significant value to unlock as they leverage more broadly these technologies.

Thanks, Kristian. I wanted to turn my questioning to Joe. Joe, PTC is a key player in the IoT space with the ThingWorx brand. Can you describe the major use cases for the audience?

Yes. Sure. So our customers are either product manufacturers whose products are used in mission-critical settings or customers that themselves have mission-critical operations. And to a large extent, there's significant overlap there. So we think of the use cases falling into 2 major categories, what we'll call, smart connected products and smart connected operations. So in the example of smart connected products, as I sit here in Boston Seaport, I am equally distant between Boston Medical and Mass General Hospital. We have many medical device customers whose products show up in those hospitals, and their service teams are probably sitting at home today in their pajamas diagnosing problems with not patients but with the machinery, so that those medical device manufacturers can deliver on their service contracts with the hospitals. And so that's an example of a mission-critical product using our customers' customers operations, in this case, the hospital and the medical device manufacturer. In smart connected operations, in manufacturing, we see discrete product manufacturers and process or continuous goods manufacturing, food and beverage, corn flakes, oil and gas and what have you. Their mission-critical operations depend on the productivity of the plant. And that productivity is, to a large extent, a function of the machine uptime. So the machinery that is making the goods, CNCs, robots, et cetera. And so IoT software and implementations can help proactively monitor that equipment and alert the operators to perhaps preventative maintenance, use of analytics like machine learning to make even further distinct predictions about when to perform maintenance so that the uptime and productivity of the operation is paramount.

That's helpful. And maybe, like, can you broadly discuss who do you compete with? How differentiated is ThingWorx versus the competition?

Yes. Sure. So as you mentioned, ThingWorx has been in this IoT game for a while now, and we think we've got a very mature product. A function of that maturity is our acquisition over the last several years of fundamental-enabling technology. IoT connectivity, connectivity is, of course, table stakes for IoT. You need to be able to connect to the machinery, acquire its data and translate that data into something meaningful, analytics, augmented reality, et cetera. So I would call those fundamental technologies, and we've spent a fair amount of time integrating and making sure that those technologies work together cohesively. And we're at the point now where the maturity in our product leads us to match the maturity of the market, which is no longer playing with technology for experiment but needing to put solutions into practical reality this year. And so with all that is preamble for our competition, ostensibly, if you look at analyst reports, we show up alongside Siemens with their MindSphere product, B3AI, SAP with their Leonardo products, Software AG. In practice, it's not very frequent that we find ourselves in competitive situations with those companies. In fact, our primary competitor, if you will, and this sounds cliché, but I assure you it's not, is our customers' internal IT and their understanding of what it takes to implement an IoT solution and thinking that they can develop it on their own. So we're working very closely with our partners and the analyst firms to educate the market on the complexities of IoT implementations and how it can be vastly simplified when you use a vendor with a platform like ours. So in short, there are, of course, competitive products on the market, but our biggest competitor, again, sounds cliché, but it is practical reality, is our customer and their IT departments, thinking that this is something that they can take on, on their own. And that's a function again of -- the majority of the market isn't quite completely educated on the IoT paradigm. They still think of it as some technologies that can be glued together by internal IT, and we're trying to educate that market instead where you should use a platform like ThingWorx that has all of those hard problems already figured out. And by the way, we now have use cases and applications that codify the business value that you're looking to achieve.

Great. And when you look at the industrial IoT market today, where are we in terms of the maturity curve perspective? Are we still in the early innings of that adoption?

No, I don't think we are. If you use the Geoffrey Moore sort of maturity curve, I'm imagining it in my mind's eye, there's the innovators in the early stages of a market. I think we've crossed the chasm. I think I probably owe Geoffrey Moore $1 for saying that. I think we're now in the early majority and at the precipice of the mainstream part of the market. And this has informed our product strategy and our go-to-market strategy to get higher up the stack, so to speak, and move away from commodity technology. Again, we've spent the last 5, 6 years acquiring that fundamental technology, gluing it together, making it work in an integrated fashion. Now we see the clear opportunity and have been executing on the opportunity to solve our customers' business problems that are recurring throughout our customer base and codify those problems into prebuilt applications and what we call solution building blocks. And I'm happy to report that our customers are now looking at IoT as a C-suite-driven initiative, part of an overall digital transformation objective, which may be inclusive of their entire product life cycle from design with CAD and PLM and then into operations and service with IoT and augmented reality. But that top-down-driven nature of our customers' own programmatic viewpoint has really helped our teams be closer to the business value. And Kristian mentioned earlier our approach, one of our approach is to making sure we keep churn at a minimum and, in fact, roll back the amounts of churn that we've seen in our IoT product. It's completely about our customers' programmatic maturity, the way they view the initiative on their side and the way our customer success teams have aligned with those programs and the technology to deliver value, value first, not technology experiments.

And then you have several partnerships with Microsoft and Rockwell Automation, for example. Can you briefly explain the selling motion and technical integration with those 2 partners?

Sure. So with Microsoft -- and I just mentioned how we're seeing ourselves move up the technology stack and more into the solution building blocks for our customers. We knew that we needed a partner that had might in the cloud with a global footprint and fundamental technology that we could snap on to with the Microsoft Azure IoT services, for example. And so not only does Microsoft check all of those boxes from the technology and global availability perspective, but also, importantly, they have a go-to-market muscle for manufacturing, having served the manufacturing industry for a number of decades. Windows still exists and has existed on HMI screens and SCADA systems and manufacturing plants since the '80s. So Microsoft understands manufacturing, and they had the right fit of technology to complement what we're looking to do and help us accelerate our moving up the stack. With Rockwell Automation, of course, much more experienced and as an incredible customer base in manufacturing operations, having sold their controllers, variable speed drives and so forth to manufacturers of all types, for quite a long time, a very established brand name. They have the domain experience in manufacturing shops and, importantly, account relationships with the very same customers that first have a very significant overlap with PTC but may not have viewed PTC as their manufacturing technology to run in the plant, even though we do have a very viable product and ThingWorx there. So the Rockwell relationship has helped us really combine forces with the accounts that we already had shared together and establish that credibility together. So go-to-market motions are a bit different between Microsoft and Rockwell. For Microsoft, we primarily co-sell with Microsoft or our account teams joined forces together, and we go in together to evangelize to the customer on our joint solution. But ultimately, the customer buys from Microsoft and buys from PTC together with the exception of our customers that choose the PTC cloud offering where, like, obviously, we bundle the Azure services required to deliver our ThingWorx platform to our customers. With Rockwell Automation, Rockwell takes a derivative of our ThingWorx platform to market directly in the form of their -- in FactoryTalk innovation suite with bundles, ThingWorx, our Kepware server connectivity suite and the Rockwell FactoryTalk analytics products together in a cohesive offering for a manufacturing customer.

Great. And maybe on the Microsoft partnership, if you already didn't highlight it, is there anything that's -- that we think -- you think is underappreciated that may become more clear in the next 12 to 18 months?

Yes. Well, for one thing, what I often tell customers and analysts, it's easy to look for partnerships in the world between technology companies. Most of the time, that's just you share each other's logos on your websites when you talk about your partnerships. This partnership is a real partnership. First of all, we have quite a deep co-selling pipeline and a number of customer wins per week per quarter. But also as a product leader myself, what really makes this feel like a true partnership is that our product teams are working together. I have my product management and engineering teams spending time in workshops in Redmond, Washington. I have Microsoft folks here in our Boston and Portland main offices, hand in glove, working on products together. Now we will ultimately take that IP to market independently as part of our joint solutions. But the collaboration between the product teams is something that, quite personally, I think, is a rarity, something that I have not seen very often in my career. So that's one aspect of the partnership that I think is hard to see from the outside. Another aspect that I think is hard to see from the -- for the uninitiated is the impact of standards on this maturing industrial IoT market. Having been personally involved in many standards initiatives in IoT for the last decade, many of them sponsored by industry coalitions and, to some extent, telecommunications companies, all with the best intentions, all with the best idea of how those standards did manifest, but there has, to date, not been an 800-pound gorilla or a partnership or ecosystem that has really put forward a practical de facto and official standard to allow our technologies to move into the mainstream in a more rapid fashion. So we're working with Microsoft on adoption of standards like OPC, which is a manufacturing standard that has been emerging in the EU and is starting to cross over the pond, so to speak, to North America. And that's an activity that we think is going to pay dividends into fiscal year '21 and fiscal year '22. It'll add some thought leadership to the conversations, but importantly, help our customers get value quicker from the ecosystem in a more repeatable way. So again, something that's hard to see from -- for the uninitiated, but something that I think is going to be very impactful for us.

Great. And then maybe for our last question, you have some really interesting growth opportunity -- and with industrial AR. How does IoT and AR business complement each other?

Yes. That's a great question. We think we have a pretty unique view, or I should say, a progressive view on that, and I think the rest of the market is starting to catch on. With IoT, there is, of course, an influx of data from the connectivity of these machines that would be very difficult for the operators, service technicians, users of systems that help them keep those operations online. They need a better way to receive those signals without having to look at a desktop computer or have to scroll through pages of reports. So from one angle, augmented reality is, in many cases, the perfect way to represent the status, the future status and potential remedial activities for a machine or an operation to a human operator in a hands-free way, putting the data in the right context, overlay it onto the right environment at the right time. And so from one perspective, it's helping the data get to the human operators' eyeballs in the best fashion. And in other ways, it's helping the visualization of very complex repair procedures that are typically done with a printed manual in a very experienced field service technician. The augmented reality matching of remote service through IoT, giving remote service technicians in a proactive indication that a machine requires maintenance to the life cycle of that event where a field service technician shows up on-site in front of the machine and has access through AR to this augmented reality, AR, to the current status of the machine and an animated repair procedure. That has just been a fantastic combination. As Kristian mentioned, as we're looking to more fully describe and holistically describe solutions to our customers, we are trying to not position ThingWorx as one set of solutions and Vuforia, our augmented reality platform, as a different set of solutions, but rather 2 technology platforms that can be combined in the form of use cases and value-driven use cases through codified solutions that combines the elements of both technology. Frankly, our customers don't come to us and ask to buy IoT technology or augmented reality technology. They ask us for solutions, and those 2 technology paradigms go together like chocolate and peanut butter.

Great. That's very helpful. Thank you for joining us. That was Kristian Talvitie, CFO; and Joe Biron, CTO of IoT at PTC. Thank you.

Thank you.

Thank you.

So I think we have a coffee break right now. Thank you for joining us.