PTC Inc. (PTC) Earnings Call Transcript & Summary

Good morning. Welcome, everybody, on the line. I'm Johannes Schaller, head of the software research team at Deutsche Bank here in Europe. And it's my pleasure that I have with me on the line, Kristian Talvitie from PTC. He's the CFO of the company. Kristian would like to start with a few introductory remarks about the business in general before we go into our fireside chat. We have a Q&A tool online. Please, anytime during this fireside chat, feel free to post questions, and I will basically ask them on behalf of you. So with that, Kristian, please, over to you.

Yes, great. Thanks, Johannes. Thanks for having us at the conference here today. Just quickly for any folks who may not be so familiar with PTC, I'll do a couple of minute overview of the company and how it's transitioned. And then we can get into talking about some of the business environment that we're in. And of course, as a reminder for everybody, we may be making forward-looking statements on this call, so we would please refer you to the safe harbor language and risk factors that are outlined in our press releases and periodic filings with the SEC. With that, again, PTC is a little over a 30-year-old software business that over the years has gone through numerous evolutions to stay relevant for our customers. Those happened along many vectors. Obviously, the company started as a CAD, computer-aided design, business over 30 years ago. It then had gone through a, we'll call it, product portfolio evolution, expanding into PLM, product lifecycle management, into SLM and more recently into the Internet of Things and augmented reality. And again, this is really trying to deploy all of these technologies for industrial use cases, if you will, which is primarily the end markets that we serve. So that has been one interesting vector. We'll cap that off, and I'll return on my second point with the acquisition of a company called Onshape almost a year ago. And this relates a little bit to the business model evolution, so that was the technology evolution that we just talked about, the business model evolution. When the company started, it operated under a perpetual licensing model with its customers. And about 5 years ago, actually embarked on transitioning to a subscription-based business model, which now, as of last year, is effectively complete. We really only now enter into commercial arrangements that are subscription based, which is really the way the market wants to consume technology increasingly these days. And then related to that point, this acquisition of Onshape has actually positioned the company to go through a further evolution which is the migration from on-premise delivery, on-premise delivery model to a SaaS delivery model for our products. So all the while, the company has been evolving the product set, the commercial model and now the technology model, and also over the past 5 to 8 years, has done a good job at also delivering on margin expansion through really [ effective ] cost discipline and investing in the places where we think is most appropriate to invest. So today, PTC is about 6,000 employees globally. We'll do north of $1.2 billion in ARR and deliver approximately $210 million of free cash flow this fiscal year. So that's the company in a nutshell. With that, I'll turn it over to Johannes for any questions that you might have.

Great. Thank you very much, Kristian. Maybe starting off with some of your recent commentary. I think last week at another conference, you reaffirmed your 2020 ARR guidance, and you also commented on ARR growth in fiscal '21. Were you surprised by the negative stock reaction to those news? And also maybe do you want to provide a little bit of additional commentary on what you said last week?

Yes, sure. I think it's fair to say that we were a little surprised to see a negative reaction to what we thought was positive news about our outlook for the quarter. Over the past few months, we've strived to be, we'll call it, overly communicative with investors than -- more so than normal just given the levels of uncertainty created by the global pandemic. And as a reminder, what we said was that there had been no material change in customer behavior, both on the new business front and as it relates to churn. And therefore, we reaffirmed the 10% to 12% constant currency ARR growth range for the year. I also did remind investors that deal timing matters, but that's certainly not new news. And wasn't meant to suggest that we've seen any changes in the business. Again, the demand trends on new and renewal activity are in line with expectations that we set at the end of last quarter. As it relates to fiscal '21 color, we were simply providing a modeling framework for ARR growth next year, the same modeling framework we actually used about a year ago when introducing the ARR model. And what we were showing was that with flat new ACV and no churn improvement, that ARR would grow approximately 9% next year. So obviously, if either new ACV grows or churn improves, ARR growth would be right back in the double digits. And we said that as a placeholder for modeling purposes, and we get this question often from investors, what is this year's performance look like the impact could be next year? We said that we think that a high single-digit to low double-digit ARR growth for next fiscal year is appropriate. Now we will be providing fiscal '21 guidance on our Q4 call. And at that time, we'll provide more context around key assumptions, particularly around the macro environment and how we see demand trends playing out over the next 4 quarters. So stay tuned for that. And then lastly, we also reiterated that over the medium term, given the market position we're in, given the strength and breadth of our product portfolio and the very solid customer base that we have that we're confident that we can deliver double-digit ARR growth and attractive free cash flow generation over the medium term. So hopefully, that helps, Johannes.

It does. Thanks, Kristian. I think that's very clear. Maybe taking a step back, talking a little bit more about the bigger picture in the medium and long term. I mean the current COVID crisis, obviously, generally speaking, reacted as an enabler for digital transformation across sectors and specifically appears to be accelerating the shift to the cloud as legacy on-premise systems have often proven to be not very reliable, if you have a large number of remote users. So can you discuss how that affects PTC, demand for your products currently? And how you think that will affect your business in medium and longer term?

Yes, sure. Great question. We certainly agree that the COVID crisis has highlighted the challenges of using on-premise software and that this will be, for sure, a catalyst for SaaS adoption in our industry and other part of the software industry as well. That said, our customers have been able to keep their remote teams productive by arming them with appropriate workstations. We've worked with them to make sure they've got appropriate licensing and then they're using, in many cases, VPN to stay connected to their on-prem servers. The challenge in the early days was primarily with CAD, which is a desktop technology. But as I said, I think customers have adjusted to the new environment. They're trying to stay as productive as possible. On the PLM front, however, the shift from work -- the shift to work from home has been much smoother. Windchill is a thin client, browser-based solution, which has proven to be invaluable to our customers in keeping their teams connected and collaborating.

Got it. So you previously made some remarks around working on a SaaS version of Creo and Windchill. And you said it's an ongoing process with a mid- to long-term target for completion. Do you ever see the current post-pandemic shift really accelerating maybe this time line from a development perspective for you? And could you provide a bit more color around how existing customers can leverage cloud-enabled and multi-tenant versions of your product offerings?

Yes, sure. So also drafting a little bit off the previous question, we do think that the COVID crisis will prove to be a tipping point, if you will, for SaaS adoption in the engineering software space. As such, as you point out, we are working fast and furious on development efforts to cloudify Creo and Windchill. I think it's fair to say that normally this would be a fairly daunting task migrating 20-, 30-year-old technology into a multi-tenant SaaS environment. However, fortunately, because of the acquisition of Onshape that I referenced earlier, we have a scalable production-ready multi-tenant SaaS platform, which is what we call Atlas, to leverage, which we believe will save many years of development time and millions of dollars of investment. So to be clear, the SaaSification of Creo and windchill onto Atlas will certainly take years -- a few years to complete. But when we're done, we'll have an attractive option for our existing customers to seamlessly move to SaaS without disrupting their current 3D models or workflows. We see this next transition from on-prem to subscription to SaaS as a meaningful monetization opportunity as well. Customers are going to be shedding significant overhead burden, both time and expense in many forms associated with hosting and maintaining complex global engineering software platforms. And we believe that this will be of significant value to them, and they will be willing to pay for it.

Maybe a related question to that. I mean, obviously, the security and data protection point has always kept certain CAD and PLM customers a little bit on the sidelines transitioning to the cloud. Do you think those security aspects and perceived risks, let's call them perceived risks, are subsiding a little bit now with the pressure that some of these companies have seen after they went through the COVID crisis this year?

Yes. I do. It's a great question. And I do think that, number one, it's an important concern for customers; number two, we actually also have been investing significantly in security as well. And I do think that customers are becoming incrementally more comfortable in general with cloud environments, right? They've seen it play out across other parts of the software portfolios that they leverage in their day-to-day operations. And like anything, I think people also had concerns around what would happen with video conferencing technologies, to use a simple example, and they've been around for a while, just haven't seen the adoption that has been driven now by the work from home environment that we're all in. And so kind of being forced, if you will, into these hands -- into this hand, I think, has opened the eyes and minds, if you will, of many folks around advancing various parts of their technology portfolios, and that includes which systems they want to operate in a SaaS environment as well.

Kind of staying with the cloud theme, talking a bit more specifically maybe about CAD and the cloud. I mean you already mentioned Onshape a few times. Maybe just start with, can you talk a little bit about when you kind of first saw that asset, what you saw in Onshape, what you liked, what you maybe believed you couldn't do yourself? And then over the time, the acquisition process, owning it, looking deeper into the business, kind of how that perception has evolved, which, I guess, that is always a relatively normal thing in any M&A process?

Yes. It's a great question. When -- we obviously have known the Onshape team for a long time. The founders were also the previous founders of another very disruptive force in the CAD industry going back 20 years. And so we certainly knew who they were, and we're watching what they were up to. As we first started getting a little bit deeper into the technology, to be honest, I think we were a little surprised, impressed, for sure, with the level of technology that they had created, right? The performance of the Onshape application is remarkable. And really, we think, also a game changer in how people, customers will think about how they can actually work, collaborate, increase time to innovation, if you will, with a SaaS-based CAD and collaboration tool like Onshape and which, by the way, is the industry's only pure multitenant SaaS platform. So we certainly were smitten with the technology, if you will, and at the time, believed that, certainly in the early days, what it would help us to do is to access parts of the market that PTC has perhaps traditionally been underrepresented in, really more in the SMB space. It's a large part of the market dominated by on-prem software tools like SolidWorks and Inventor. And as we got further into it, came to appreciate really the power, if you will, of the multitenant SaaS platform, which we now call Atlas, and how we could leverage that more broadly across the PTC product portfolio. Again, that part's obviously, a longer-term investment, longer-term play. But certainly, we're very optimistic on the opportunity that, that creates. And then perhaps more related to the near-term environment, the interest that we've seen in Onshape has certainly accelerated since the time we acquired them last November. Pipeline is up substantially from when we first acquired them and continues to build. So -- and just given that level of interest, it's also caused us to think a little bit differently about how we were maybe planning to go to market with Onshape and to try different avenues. So as an example, we've been leveraging some of our platinum channel partners to go after this market, and we're seeing some early traction with that strategy as well. So lots of opportunity here in both the short term and long term created really because of this acquisition.