PTC Inc. (PTC) Earnings Call Transcript & Summary

My name is Jackson Ader. I'm on the software technology team here at JPMorgan. This is our Thursday session, afternoon session. We're very happy to have the team from PTC here. Again, hit us with any questions in the Q&A, if you find them. But Kristian and Mike, if you guys want to introduce yourselves, and then PTC, will get into the Q&A.

Yes. Great. Thanks, Jackson. My name is Kristian Talvitie. I'm the Chief Financial Officer at PTC.

Good afternoon. This is Mike Campbell speaking. I am the General Manager of PTC's Augmented Reality business, the Vuforia business. I've got a long history at PTC and have a background in CAD and have done some work in the IoT business as well. So happy to be here today with you, Jackson.

Great. So I think most people are probably familiar with the core business of PTC. But Kristian, if you just want to spend a minute, give us a little background on the end markets, the -- and maybe the core business segments as you break them out into those kind of 3 main segments would be really helpful.

Yes. Sure. And actually, also, I think my legal counsel would want me to remind everybody that we may be making forward-looking statements and everybody should feel free to refer to the safe harbor language, which is prominently placed on our Investor Relations website. So with that said, a super-brief overview of PTC. It's about a 30-year-old software business, founded really as a pioneer in the CAD market and was one of the leading players in the CAD space for the first decade of its existence and then migrated into PLM for really kind of the next 10 years, and has also been a leader in PLM industry. And then from there, continue to branch out with other product offerings in ALM, application lifecycle management; SLM, service lifecycle management; and then more recently with IoT and AR. And then our most recent acquisition was actually in the SaaS engineering software space with the acquisition of Onshape in November. And so we take those businesses, and in our reporting, what you'll see is we break them out into core, which is really our CAD and PLM portfolio, it makes up about 70% of our ARR, and it is growing in the high single-digits, low double-digit ARR growth range. The ALM, SLM, et cetera, we put into our Focused Solutions Group category. These tend to be, we'll call them nicher but very valuable solutions for our customers. And there, the growth rate is really more in the low single digits. And then lastly, we have our growth product segment, which really includes IoT, AR and Onshape. And those combined are approaching about 20% of our ARR and also -- as it should be evident from the name Growth product group are the growth of the product portfolio today.

Right. With it, I think it's a perfect segue into Mike apropos here. If you want to speak to the growth segments, what is driving the growth, in particular, in augmented reality?

Yes. I mean it's -- these are quite interesting times. The growth segment is -- a lot of that is focused on a message for our industrial enterprise customers. We have about 30,000 of those today around the world. Largely in -- largely, traditionally, as you might expect, in discrete manufacturing, but our Growth products as well as the investments we made there as well as some of our partnerships, specifically the strategic partnership with Rockwell Automation, has also opened up opportunities for us in process manufacturing as well. So -- and what's driving the growth there, again, is really the industrial enterprise desire for digital transformation to leverage the value of industrial IoT in the factory, in their service businesses to gain greater insights into what's going on and to really optimize a variety of those processes. Specifically, if we double click on AR, which we would see as quite symbiotic with IoT. We think about IoT as sort of digitizing information from the physical world, and AR is a great way to present those digital insights that we can help people gain back in the context of the physical world. And the core value prop there is really presenting relevant information to people where and when they do their work. So there's a big focus on frontline workers. Those frontline workers may be in a factory, they may be doing assembly, inspection work. They may be a field service technician out in the field. And there are tons of use cases across other areas as well, sales and marketing, for product visualization and things like that. But really, it's this explosion of digital content and a desire to improve workforce productivity in the face of a lack of technically skilled workers, aging workers, baby boomers retiring, those are all sort of compelling factors that our customers think about when they contemplate our AR offering. And then, of course, most recently, the COVID crisis has really sort of put an accelerator on some of those challenges, if you will.

Yes. Can we just talk about the impacts of COVID, Kristian, from either a demand standpoint or a financial standpoint that you're seeing in the short run or maybe the long run as well?

Yes, sure. Great question. As we talked about on our recent earnings call, we did see some pressure, particularly on larger deals in the last few weeks of the quarter. That said, I think we still ended up posting 11% ARR growth for the quarter. But we were beginning to see some of that pressure that started in China, which is a smaller geography for us, starting to spread into Europe and a little bit in North America. And so now as we look to Q3 and back half of the year, the forecast actually calls for and we're starting to see a rebound of activity in China, but we're still cautious on the amount of pressure that we're going to see in the European and U.S. theaters, in particular.

And PTC had done a pretty good job really laying out the different scenarios in which you -- how you get to the long-term targets, whether it's continued growth, a mild recession, a 2008/2009-type of recession? So what -- with those scenarios in mind, what do you expect this COVID-19 recession to look like relative to what you had previously put out?

Yes, that's a great question. I think that the answer is, at this point, it's pretty much anybody's ballgame. I'm not sure that anybody can call whether this recession is a V, a modified V, a U, an L, what the shape of the recovery is going to look like. So as we think about that in both the short term and the long term, I think about what the long-term impacts of this environment are going to be, and our belief is that this is actually going to drive companies to either accelerate or start where they haven't yet their own kinds of digital transformation initiatives. And so over the long term, we'll see how that plays out. Certainly, in the short-term environment, where there's pressure out there, as we laid out in the guidance range. So how much pressure still remains, I think, to be seen and for how long.

Is there any possible impact on the ramps deals that PTC has signed over the last couple of years? And could you just spend a minute maybe talking about what these ramp deals actually are and how they're structured? And how they play a role in ARR's growth even during times of pausing in new bookings?

Yes, sure. So for us, these ramp deals are generally multiyear, let's call them, 3-year engagements. And the customer would like -- knows that they're going to embark on, we'll call it, an enterprise deployment. And they know that they want to ramp seats up over time, and they're willing to make a time-based commitment in return for contracting purposes, and we're actually happy to have that happen. We want our customers to be committed to the technology. We want to be committed to them to making sure that they're going to get value from it. And so as it -- as we get into these ramp deals, the way they flow into our ARR metric is really -- I mean, I would think about it like invoicing. It's the amount that we're going to invoice or have invoiced is what's in ARR. So if you start small, with a smaller portion in year 1 and then ramp to year 2, the incremental amounts and incremental again in year 3 would actually flow into backlog for us, which, as everybody knows, we don't actually report. But you can see the impact of it in our guidance, for example, some contribution from that as well. And I think your real question was are we seeing customers now, given this environment, rethinking their contractual commitments. And the answer is there's a small handful that are, most of them are not. And in general, we try to be, what I would say is, customer friendly while being commercially responsible when we're thinking about engagements with our customers. Obviously, we want them to be successful. Obviously, we want to do what we can to help. But if we're talking about changing a contract midstream, they wouldn't just be a one-way street.

Right. There could be some potential long-term benefits. I mean, you don't like to maybe characterize it in those terms. But the COVID disruption will likely lead to some secular adoption maybe in terms of CAD in the cloud? And Mike, in augmented reality, so you touched on it a bit at the very beginning, but Mike, how do you think the augmented reality and maybe IoT could benefit from maybe a remote work environment moving forward?

Yes. I mean, I think that a lot of the technology that we're delivering is particularly relevant, considering travel bans, considering social distancing, many of the challenges that we're all facing. And for our industrial customers, our IoT software provides them the ability to, in some cases, remotely monitor, remotely service important pieces of critical equipment. AR is proving to be particularly valuable, as I alluded to, frontline workers, they're not able to work together as maybe they once were. They may not -- you may not be able to send 2 service technicians and somebody in the field may need help. So many of our tools were developed specifically to help with this idea of knowledge transfer, sharing of knowledge, whether it's TeZet domain knowledge that an expert may have or whether it's sort of engineered procedural guidance, things like that, and AR has a particularly relevant place there. We -- you may know, Jackson, and others on the call may know that we have a particular offering called Vuforia Chalk, which is really targeted at helping people that are remotely in the field, engaged with experts that are not there and leveraging AR to more effectively communicate. At the beginning of the crisis, we made that available for free to everybody, not just to our customers and prospects but really anybody that was interested and could benefit from it, and that program has seen a great uptake. We've got literally tens of thousands of people that are engaged with that program. Many that we marketed to and promoted this to ourselves, but many, many more that either were invited by somebody who is involved in the program or something like that, and they're getting real benefit out of this. And then sort of the third element, as you said is, is SaaS-based engineering tools. The nature of a tool like Onshape is that it is, first and foremost, high availability. Accessible within 15 seconds in your web browser, you're up and running. You don't need to worry about VPN. You don't need to worry about a high-powered workstation. You don't need to worry about licensing it. It just works. So as engineering teams have been forced to work remotely, frankly, they haven't skipped a beat with Onshape. And then furthermore, the collaborative nature of a SaaS offering like Onshape makes it very easy for teams to continue to work together. And then lastly, we should, of course, recognize that even some of our core offerings like Windchill, which was designed and architected to be web-based, also deployable or accessed, let's say, in a browser, those customers have continued to be productive. So I think there's -- there are many examples of where customers have been able to hold the line on productivity and others where they've been able to take advantage of what PTC offers, and even maybe to some extent, thrive a bit in the face of the pandemic.

And this is -- we got a question from the audience in the Q&A queue, actually that follows up on the augmented reality portion. When you're standing up a business, from scratch and brand-new use cases across essentially every single customer, what are the challenges that you have faced? How have you overcome them? And then I would assume -- and one thing that we hear a lot from investors is that is this something that is a "need to have type of product?" Or is it something that maybe is ancillary, and it's nice to have when times are good? So if you want to take that in part, that would be great.

Yes, great question. So first off, on the lessons learned, I think that if we reflect back on our ThingWorx journey, our IoT journey at PTC, we started that journey with a tool set, right? Basically, an application enablement platform that could be used for a lot of different things. And over the past decade, we have become much more -- it's become much clearer that what the market wants are solutions. They want fast time to value, role-based, very guard-railed solutions to solve particular problems. And I think that we have tried to apply those learnings to our AR story as well. And now of course, we have a ton of flexibility. It's early days. There are a lots of different possibilities, lots of use cases. People have different challenges, and we have a portfolio that allows us to meet many of those challenges, but we have been very successful as we have become more, again, role-based use case specific with our offerings. If you look at a tool like chalk or something we introduced, actually, just about a year ago, our expert capture offering, those products have seen really nice traction in the market. And I think it's because they are focused on a particular problem that the customer understands, so we can very -- sort of in the early stage, identify potential value, and then deploy those offerings and the customer can see that we fulfill the promise of that value. And sort of tying that into the second question, I think as we move to discussions around real tangible value -- what kind of value? Well, that could be worker productivity. It could be quality of the processes they're participating in. In many cases, it's safety and regulatory compliance requirements that are being met with these offerings. And I think when that's the conversation we're having, these quickly become tools that I need. When we're doing -- when we're in a project because it's fun or interesting or highly exploratory, those are the nice to have, right? Those are the first things to go in light of a crisis. But we feel like we're beginning to drive many more examples of incremental value, and again, that puts us into the really required category.

Great. Okay. Kristian, can we move back maybe to the core PLM, CAD? What has that market growth rate been in the last couple of years? PTC has clearly been able to, I believe, outgrow that. But what are we seeing now as we stand on kind of the edge of the unknown here, especially maybe in the larger deal segment?

Yes. So those markets tend to grow in the mid- to high single digits, generally. And I think that PTC has, for the past 2 to 3 years, outpaced market growth rate in both of those segments, CAD and PLM. And I believe, probably will still for the next couple of years. However, I guess we'll see what happens over the next couple of years. But as we sit here today, I would say that some of that is mechanics-based right and switching from selling perpetual to subscription, you get some tailwind from that, that's just a model mix shift. And there has been still some amount of activity on customers who want the flexibility that comes with the subscription offering migrating from support to subscription. Now that is nowhere near the level of activity that we've seen, the company saw over the past 3 years. It still happens in pockets. We'll see what happens if that flexibility becomes more attractive as a result of, we'll call it, the COVID crisis or something like it, we'll see what that does. So I think longer term, our expectation is that those markets -- that those groups for us will grow in line with the market growth rate over an instant. There is a window where we were outpacing it, but that's what the growth is. And then to your point around deal sizes, and the impact of perhaps the current macro environment or economic environment on deal sizes, I think I would break that out into a couple of different categories. And you can have new deals that are new implementations, new deployments that are still large, a customer wants to start off and do a big PLM or maybe a big IoT deployment. And those are certainly under a little bit more pressure right now, given that many people are working from home and people aren't actually in the office or in the factory to stand those deployments up. But then you also have larger deals that are expansions of existing deployments. And those don't require the same level of, we'll call it, on-sightedness, in order to get that going. Right? But no, we're -- you've got companies that are rightly so being cautious with their pocketbooks right now and trying to figure out what the new normal looks like and what the shape of the recovery looks like. And I think we'll see spending resume as people get more comfortable with an understanding of what that looks like.

You mentioned the model transition, right, from kind of an on-premise license and maintenance to subscription and that is still being a tailwind even in this year. A follow-up question from the audience was how much of the -- if we just take 11% ARR growth, how much of that is related to migrating subscription customer, I apologize, support customers to subscription?

A very nominal amount. I would say that actually, probably the bigger impact, and I would put it at around maybe a 1% tailwind was the ending of perpetual license sales, particularly in the Asia Pac region last year. So we're no longer really selling perpetual licenses there. It's really all subscription, and that has a larger impact. And again, I put that at around 1 -- probably around 1 point of growth.

In terms of deployment, how much of your business is -- and Mike, please jump in because I know that your area has some cloud deployments. But how much of PTC right now is software running on the customer's premise? And how much of the business is running in the cloud or on a SaaS basis?

Yes. Great question. So we have, we'll call it, pure native multi-tenant Saas, which is really Onshape, and frankly, even a portion of Vuforia, but that is going to be in low single digits of ARR, probably the [Technical Difficulty] ARR right now. Then there is also a portion, we'll call it, private cloud, which is mid-single digits as well. So if you lump those together, it's a question of you talking about pure multi-tenant or you talking about single-tenant private cloud. But the combination of those is approaching 10% of the overall ARR.

So Mike, what about -- yes, sorry, go ahead.

Yes. I would say, in the AR business, in particular, there are essentially 4 products in the portfolio today and 3 of them are true SaaS, right? Those were built through multi-tenant SaaS. One of those is offered on-prem or PTC hosted. And about 50% of the customers choose on-prem and about 50% chose hosted. But going forward, what you will see are more and more SaaS offerings developed certainly within the Vuforia suite, and there'll be more coming as we really embrace what Onshape has brought to PTC in terms of foundational SaaS, infrastructure back end platform for us to leverage in more and more places.

Do you think that the AR business -- how much of your activity is just standalone, I would like an AR deployment? And how much of the AR activity is coupled to something or maybe where you tie yourself to an Onshape deployment or a ThingWorx deployment versus standalone?

Yes, about 2/3 of the business is integrated with another PTC offering. So a lot of the value that we're delivering comes on the backs of, first off, the AR posture that we show up with leverages PTC's domain knowledge, right, where we're acutely focused on industrial enterprises. But the fact that we show up with an AR portfolio that understands 3D geometry, that leverages change and configuration management, that's tightly integrated with our IoT suite, those are huge differentiators for us. So that gives us another muscle to flex, and it's compelling to the market. So it's about 2/3 where customers take that -- take advantage of that integration. That said, there are certainly cases where the value of AR stands on its own, where a customer has a particular pain point, they have a problem, we've got a solution, and they're happy to buy from us as well. And that also, of course, is an upsell opportunity in the future.

Is that -- I mean, the fact that 2/3 of your business is coupled with other PTC, and there's a lot of partnerships as well in these growth areas, does that make the sales maybe have a little bit more friction during slowdowns like we're seeing right now?

No. Because we've really taken an open strategy. When we -- having a long history in CAD, I understand a lot of the complexities of data interoperability and getting locked into the system. So one of the things that we were very careful about was to take a very open approach. Whether it's 3D data, whether it's other forms of digital data, you can bring all of that into our AR portfolio no matter where it comes from. Now does it work better with PTC offerings? Does it work great with ThingWorx, great with Windchill, great with Creo? Of course, it does. But there's an openness to our strategy that we intentionally built in, in order to avoid creating that friction point you're alluding to.

Okay. Great. A couple of minutes left. Kristian, we actually had an early question from the audience about capital allocation, your -- let's see, was it your -- how comfortable are you with debt levels, leverage targets? Anything you can give around capital allocation?

Yes. So right now, we're a BB rated -- BB rating. I think we'd like to maintain that rating. I think it gives us flexibility as it relates to the capital markets. Overall leverage is on a, I guess, relative basis and it depends what you're comparing to, but whatever 2.5x right now we think is fairly conservative. But I don't know, I mean, I don't know that we would be looking to lever up more meaningfully for an extended period. But should an acquisition come along that was attractive, we may for a period of time. But again, I think the overall idea that the capital structure that we put in place, with the bond offering that we just did here in February, $1 billion of 2 tranches of notes at fairly attractive rates, we think is a great place to be. We're going to be paying off the original $500 million tranche here imminently. So we'll be left with about $1 billion of debt, a modest amount drawn, a little over $100 million run right now in the revolving credit facility, which will continue to pay down over time. And I think that's how we think about it.

Okay. Great. Kristian, Mike, thank you so much for joining us today. Thanks everybody in the audience for your questions. Enjoy the rest of the day. It's good to talk to you guys. Take care.

Likewise. Thank you.