PTC Inc. (PTC) Earnings Call Transcript & Summary

Thanks, everyone, for joining us. My name is Sterling Auty. I'm software analyst here at JPMorgan. I'm very happy to have with us the team from PTC, we have Jim Heppelmann, who is CEO; Kristian Talvitie, who is CFO. Guys, thanks for joining me. I really appreciate it.

Yes, you're welcome. Glad to be here, Sterling.

Maybe just to get kicked off, the question on kind of leading off all of my sessions with is. Can you give us a sense of what did the pandemic really do to PTC's business, well, the good and the bad?

Yes. Well, I think there's also short term and long term, too. I think let's start with the bad. In our IoT sector in the short term, it slowed us down. It slowed us down just because companies didn't really want people in their factories, hooking on IoT systems, stuff like that. So we saw a bookings off happened a year ago. And fortunately, now most of it has come back, especially over the last 3 quarters. But I think it's good for IoT in long term. Because I think that companies more than ever have a deeper appreciation for digital and a deeper appreciation for anything that helps them affect the hybrid workforce, do things remotely, et cetera. And then I think if you look at other parts of our business, PLM, augmented reality, SaaS, all of these actually were helped by the pandemic. Helped in the sense that they helped people implement work from home. They help people do remote support of workers that were out in the factory with augmented reality. So I think that all told, particularly over the longer term, meaning once the short-term kind of effects are gone, and I think they largely are for any way headed there. I think it's very good for the business longer term.

Do you think that there's a little bit of pent-up demand, and we get a little bit of a splash back, whether it's an IoT or just a broader business?

Yes. In our case, the PMI indices are very high, particularly in the U.S. and particularly in Europe. And we've seen quite strong bookings growth in the last 3 quarters that we reported. They've all been in pretty strong quarters. So I think we're seeing the spend come back in the system. Now PMIs might help drive bookings. And then bookings over time work their way into ARR, so there's no direct connection from PMI to ARR, but an indirect connection through bookings. So last year, our business held up well as bookings declined a little bit during COVID. And this year, it's continuing to hold up well, and we'll start to accelerate modestly, I suppose, over time going forward as these strong bookings work their way through the system.

How do we also think about just the margin impact with just the timing of maybe return to business travel, for example?

Yes. So if you do a quick rough math, you can almost find -- you can find roughly 4 points of margin tied to travel the way we used to know it. So that's a lot of that went away quickly, and it's helped us and many other companies produced some pretty strong earnings reports. I think our view is that it's not all coming back. We won't let it all come back. So we're going to cap travel and those types of expenses at about 50% of the level they used to be. Because I think the pandemic showed us that we can do a lot more virtually than we ever thought we could, including rolling a high-touch sales force, which we would have thought impossible, and yet, actually, we did just fine with it. So I think you saw a lot of help in the near term, and then we'll have to give some of that back longer term.

Yes. I think that's the case for everybody. Listen, you got off to a really strong start to the fiscal year. But yet, when I think about the guidance through the year and what it implies it seems like there might be some slowdown. And I think some of this is just the accounting treatment that you guys have as well. But how do you think about what you guys kind of baked into the guide?

Yes, you want to take that one, Kristian?

Yes. Sterling, I think you're referring to revenue, right? So again, I think we would try to focus investors on ARR as that's what we focus on ourselves and I think our ARR guidance for the year, since Q4, when we issued the guidance has remained, for all intents and purposes [ this time ]. We're looking at 10% to 12% organic constant currency ARR growth and should be about that midpoint of that range every quarter throughout the year on a plus then the addition of 4 incremental points from the Arena acquisition. So it gets to the total 14% to 16% ARR growth for the year. On a revenue basis, as you know, ASC 606 has some interesting effects on revenue recognition for us and some of the main variables that impact revenue recognition are term lengths. This is both new deals as well as renewal contracts. We also have support to subscription conversions. And so as those variables can be difficult to predict, and so as those come in, they can drive more upfront revenue recognition than was originally anticipated. So again, I think from a business performance perspective, we're solidly focused on delivering that 10% to 12% ARR growth for the year.

Perfect. I was hoping that you were going to do the accounting because I think you're one of a handful of companies that are disproportionately impacted by the accounting change. So I think the ARR and cash flow commentary is important. One of the questions that came in from investor just as we're talking about the pandemic, they just wanted to ask, as we're entering a new normal phase, what do you have on your radar screen in terms of what you want to get better at in order to drive more efficient growth? So I think that's asking how do you drive even more profitable growth under the new normal?

Yes. I think a key thing there, Sterling, is to not give back all the efficiencies of working digitally. PTC historically has had a very high-touch direct sales force, and it involved a lot of planes, trains and automobiles, hotel rooms. And then for a year, we've proved to ourselves, we don't need any of that really. Now I'm not sure it's sustainable forever, but I can't fathom that we would never go back to the way it used to be. We kind of learned some new tricks, let's build on that. So I definitely think in terms of go-to-market efficiencies, there's something there that will live with us for years to come.

All right. Great. I saw Kristian walk away. I'm like damn, did I say something wrong? Let's turn to the growth segment. Jim, for those that are a little bit newer to the story, I'm just trying to get their hands around the PTC story. What's kind of in this growth segment? And what are some of the major trends that you're expecting to drive the growth?

Yes. Our growth segment really represents a collection of disruptive new technologies that are really adjacencies to our core business. So there is our IoT business, ThingWorx. There is our augmented reality business, Vuforia. And then our 2 SaaS properties SaaS-based CAD, which is Onshape and SaaS-based PLM, which is arena. And I think what they all have in common is they're all major new waves of digital innovation. IoT is its own form of digital innovation where we're connecting physical things to the Internet and get them to try to figure out how to better manage those fleets of things or better operate a factory full of assets. I think for augmented reality, that's a huge breakthrough of human productivity. If IoT makes things more productive, well, augmented reality makes people and in particular, frontline workers more effective by bringing the digital information out into that work environment. And then SaaS, Onshape and Arena, we feel like this industry is going to transition to SaaS. And maybe the power structure of the industry will be different in the future than it is looking backwards. And so we've positioned ourselves to be the disruptor to help push the market to go to SaaS even faster because we now have a clear leadership position there. So anyway, they're all exciting. You put them together, it's about $0.25 billion of recurring software revenue. Last quarter organically, it grew upper 20s. We'd like to see it grow with the 3 handle, and I think we'll get back there once the COVID situation continues to grow. But anyway, it's a major growth engine for the company.

To get there, the 3 handle, is that a pickup in the IoT and then just continued strength in kind of the Arena and Onshape areas? Is that how you get back to a 30% plus?

Yes. I'd say the thing that has been pulling us down is IoT. Because, again, IoT suffered a slowdown during COVID. But again, the bookings strength in IoT has really come back quite a bit. So I'm optimistic that sometimes when we bring in bookings, they don't immediately move into ARR. Some of them end up in this category we call deferred ARR where they're just waiting for the right time [ to come when they be connective ]. So certainly, we've seen some much improved strength in IoT bookings, some of that has to wash through into ARR to get the full effect.

PTC has been kind of on the leading edge, driving a lot of the IoT development, but especially with kind of that pause in the pandemic, how do you see the competitive landscape in that space? Because it felt like in the beginning, you had the platforms like the AWS, et cetera, where a lot of the data was stored, yet you were kind of the front end to it in terms of being actually deployed on the things. How is that all developed? And what does that market look like now?

Well, I think the market has evolved and customers have pushed us in the case of PTC to move up the stack. Customers are saying, "Hey, I don't really want a platform, I can go build a solution with, I'd like to just have the solution. I'd like to have business applications that used IoT data as opposed to IoT platforms that I could use to create business applications." And that's because our customers are industrial companies. They don't have the talent, the know-how or the patients to go build these solutions. So I think that's helping in a way because Microsoft is kind of at the horizontal level down below. PTC is up the stack closer to the solutions. But of course, our solutions run on their horizontal infrastructure. And then that all comes together at the customer side.

In terms of -- and we've talked about this for a couple of years. Where are you in the development of those kind of vertical-specific applications because we've also watched companies, whether it be Aspen Technology or even some of the system integrators, like Deloitte, go down that path as well. So what does that competitive landscape look like?

Yes. Well, today, the solutioning is done at the customer site by PTC or more likely one of our system integrator partners like Deloitte. Again, that takes time, it costs money. And then the customer ends up with a bespoke solution that has some ongoing cost of ownership challenges. So what PTC has been doing is building its way up the stack. And in our case, we have a solution kind of our first super solution coming to market in the September time frame, our Q4, which is called digital performance management. But it really is a ready-to-go solution that kind of connects like I have this image, I had a physical recently, and he gave me an EKG, and they took all those little tab sensors or electrodes or whatever and stuck them on my body and then sat back and measured it. And that's kind of how our solution works. We connect to the things in the factory. And then immediately, like the EKG machine, tell you what's going on and what the problems are. And then you can go about making changes and seeing how well the change has worked. And if you solve that problem, go after the next biggest problem, and so you can be kind of in a continuous improvement process with a business application that happens to use IOT, but it's a business application with enough complexity that no customer would have ever figured it out and probably couldn't have afforded to pay a system integrated to develop it even if they knew how. It's a substantial project.

Absolutely. Let's switch gears and talk a little bit about SaaS and specifically, with Onshape and Arena, are they being run as kind of stand-alone and sees under the PTC umbrella? Or how much are they being integrated into like a core SaaS platform?

Yes. So we have a 2-part SaaS strategy at PTC. One is Onshape and Arena, which are pure next-gen SaaS platforms we acquired. They're really in the lower half of the market, if you think of the market like a pyramid, they're in the lower half, where the receptivity to SaaS is highest, and they're basically out winning new logos. They're taking business from competitors and from companies who are buying their first solution and whatnot. The second part of the strategy is to take our higher-end properties, Creo and Windchill. And as we say, SaaSify them, which means convert them to SaaS, so that we can lift and shift the customers and bring them into the world of SaaS with a strategy that's not disruptive to the customers using the software. That's all going to work on the same platform. So what we did after we acquired Onshape is we took the platform the Onshape team had built called Atlas, and we're now building Creo and Windchill under that same platform. Vuforia is already on it. Of course, Onshape is on it. And Arena is in the process of climbing onto it. So PTC is going to be an enviable position of having a whole pure SaaS portfolio on a common platform with some low-end products disrupting down there and some high-end products to bring the customer base forward.

And then how did you see -- in terms of the high end, are you seeing any of your competition moving in that SaaS direction as well?

In our world, the company who's done the most is Autodesk with the whole Fusion 360 story, that's a low-end story, however. In fact, it's kind of an ultra-low-end story. So that's not relevant in the upper part of the market. In the upper part of the market, there aren't well-formed strategies. Dassault has a strategy, but it involves -- Dassault actually building out cloud infrastructure, kind of in competition with Azure or AWS, which I don't think customers are really interested. And it feels like a suicide mission. You don't want to follow along. And then Siemens has done very little. So I think amongst the more high-end products, PTC is head and shoulders ahead, thanks to all the work that was done by the Onshape team really over the last 7 years already.

Another question that came in from investors. Just taking a step back, how would you characterize your competitive advantages?

Well, I think we have a unique portfolio of very strong products, Creo and Windchill, ThingWorx, Vuforia, Onshape, Arena, they're all independently very strong products. But this whole idea of CAD, PLM and IoT and AR working together to connect the physical and the digital worlds together is pretty unique and, frankly, very compelling to customers. So customers see that IoT is kind of a PLM concept, the Internet of Things, the things are manufactured products, why would you connect manufactured products, the Internet, except to better life cycle manage them, [ e.Go ], IoT is kind of an advanced PLM content. So if you're PLM customer or prospect, PTC has a story that's quite different. And then as well, augmented reality is like IoT, but for workers. So that's also compelling and fits together. So I think we have a unique portfolio of really great products. And the portfolio is great, but each product all by itself is upper right quadrant, magic quadrant-type position.

Turning back to SaaS for a moment. Is there a strategy to motivate the migration of your existing users over to Saas? Or do you want to just have the leading platforms to be ready to give your customers the choice of when they make?

I think they are independently motivating themselves and COVID was very helpful there. We do surveys of customer readiness or receptivity to SaaS. And about 1/3 of our customers were interested in SaaS before COVID. And when we did the last survey, it's more like coming up by 90%. Now -- and tell me about SaaS because I think I'm interested. So it's gone from pushing back to pulling on it now. And for us, we -- the real objective is to give the solution in place is I think there are plenty of customers who would be happy to buy it if we're ready to go.

So if we turn now more to the core as we think about emerging from the pandemic and hopefully, economy is opening back up on back of increased vaccination, what is it -- what's the demand profile look like for CAD and PLM?

Well, CAD, historically, is tied to hiring of engineers. You don't need more CAD seats if you don't hire more engineers. So kind of as goes hiring so goes CAD bookings. PLM though is a different animal. PLM is now viewed as a major digital transformation platform, kind of like an anchor platform, anchor system of record, if you will, for all the product data. And I think a lot of industrial companies say just how much digital transformation can we do if we don't care about product data we manage, I mean, really. So PLM is suffer -- or not suffer, benefiting from better optimism. PMI is really a measure of optimism about the future. And companies are feeling good about the future, and they're saying, let's get going with that PLM project. And in PLM for all the employees you already have, you don't have to generally hire new ones, although that would drive some seats still. So I think PLM really has been outperforming CAD. CAD has been outperforming the market, but PLM has really been a strong business here at PTC. And I would really say it's digital transformation driving it.

And how well positioned are you to outgrow the market growth rates in each of those segments?

Well, I think we have the best product, the best solution. That's helpful because in competitive situations, we tend to have a pretty high win rate. That's one thing. Second thing is we have a business model being full subscription, that is much easier to grow than some of our competitors who are really still selling perpetual. And perpetual is great when you get the deal, but of course, then that deal goes away and you have to replace it. I mean you've already counted that revenue, whereas ours is recurring, so we keep going in. And then I think -- what was the third point I was going to make. Anyway, I'll stop with those 2 points.

Yes. No problem. Would you say that when you look at -- let's dive into CAD first and then come back to the digital transformation? Because I want to go deep there. But in terms of the CAD competitive landscape, we've always had that kind of low, mid, high-end ranges and different market share dynamics. Went through a phase, the last couple of revs of Creo market share gains, how does that stand today? Is that something that you can continue? And what's some of the key features that you think will help that happen?

Well, I think if you go by growth rates, certainly PLM has -- or I'm sorry, CAD has been taking market share for some years now. I mean Dassault's high-end CAD products had deep negative growth rates last year, whereas we had pretty strong upper single-digit positive growth rates. So there's sort of 15 points of distance between us, which means some -- certainly, some share of the spend is shifting around. I think a couple of things have happened with respect to Creo, the product itself. One is we put the ANSYS technology in it, which is very compelling. And now Creo has sort of undisputed best-in-class simulation, which is helpful, not just upselling simulation deals, but the winning they can't see in the first place. We introduced some new technology around generative design, which is quite a breakthrough, and we think we have the best generative design technology. We have great additive manufacturing capabilities and great model based model-based designed, it's called capabilities. So in general, Creo is viewed now is a pretty darn good CAD system for a medium or large company. I think smaller companies prefer Onshape because it's so much easier to use and it has adequate functionality to meet their needs, which are usually a little less extreme.

So if you think coming out of pandemic, I mean we would talk -- if we go back 2 years ago, I think CAD being, as an industry, are low single digit because you're right, tied to just engineer head count changes. And then if you gain share, maybe it's mid-single digit. But as we come out of the pandemic, is there a chance that we go through a period of time where CAD just in general on uptake and head count becomes more of a mid- to high single-digit and you could grow double digits? Or is that too far to pursue?

Well, I think the SaaS strategy is going to be very helpful, Sterling, because what we want to do is use the technology that was pioneered by the Onshape team to create a new experience with Creo that is compatible with Creo look and feel and Creo data, but SaaS. So you don't have the cost of ownership and upgrades and all that stuff anymore. One of the main reasons we're doing this, there's 2 reasons we're doing this whole SaaSification of the core, one is because customers want it. We think the market is headed there, and it will be to our benefit to be ahead of everybody. The second thing is it's a great financial point. If you have $1 of ARR on-premise, and you, as we say, lift and shift that into the cloud, it becomes $2 of ARR. So we have $1 billion of ARR, almost $1 billion right now of Creo and Windchill. And if we could get some large percentage of that to lift and shift and in the process double as it goes to SaaS, I mean, we'll drive strong growth for many years to come. So I think our view is we're 3 years into upper single-digit growth for CAD. Expect that to continue in the near-term and expect in the mid-term, the SaaSification tailwind to show up and probably keep us outgrowing the market for many years to come.

Well, that's great. On the PLM side, you talked about the digital transformation, but I'm curious how much of the demand that you're seeing is brand-new implementations of PLM in different ways versus maybe replacement of what I would consider legacy PLM solutions?

[ Some of both ]. If you take the brand now, we talked a lot about this Navy contract we won. And that's a brand-new digital transformation. What they want to do is operate and maintain the ship readiness by using PLM as the digital definition of the ship, basically a digital twin for each ship configuration. And they need a PLM system that can handle that much complexity and Windchill can. So the Navy is not yet our biggest customer, but it's a ramp deal, and if all proceeds as planned, it will ramp into being our biggest customer. And then shifting in a different direction, Oracle bought this company Agile some years back and pretty much has systematically lost the customer base one by one to PTC. So that's been a great gift. SAP gave us a great gift recently. SAP announced they were backing out of PLM. And said, please go by your PLM from Siemens. I think a customer who got left at the altar by SAP isn't really going to heed their advice. They're going to go out and look at the market and see who's best-in-class and they find PTC. So we've also done some pretty nice deals following up on that nice gift from SAP. So SAP and Oracle have been very helpful to our cause, and there's a lot more where that came from.

When you talk about these ramp deals for those that are newer to the space, what is the ramp deal?

Yes. A ramp deal, and I should call out that the Navy is a special ramp. A ramp deal normally would be where a customer wants to make a substantial commitment to our software. And they're looking for terms that reflect that substantial commitment, discount and so forth. The problem is they say, I just can't take all the software at once because it takes me a while to deploy it. For example, if I'm turning dumb factories, into the smart factories, and I have 10 dumb factories. I'll commit to software for 10 smart factories, but it's going to take me 2, maybe 3 years to get all 10 of them deployed because it's a project at each one. So we call that a ramp. The customer might say, I'll commit $1 million in year 1. I'll commit that in year 2, that will ramp to $2 million. And then year 3, that will ramp to $3 million. So that's a case where we would say $1 million went into ARR as soon as the project started, and $2 million went into deferred ARR. We don't say 2 plus 3 equal 5. No, no, we just use the annualized value and put it in deferred ARR. So that's a good arrangement where the customer makes commitments to us. We give them a lesser discount, but they don't have to set all the software on the shelf where they're waiting to deploy it. They kind of draw in a committed ramp over time. The Navy contract is a little different because the federal government has the right. So the Navy, there's a plan to ramp it, but not a contractual commitment. So it's not technically a ramp, I kind of characterize it that way. It's like a ramp, but special case because government funding process.

Exactly. Yes, the contracting constraints of the government. Another question came in for investors. Do you have any concerns that given your history of high-touch sales, maybe that's what customers really valued. So as you switch more to the low touch in an effort to retain cost savings, could that open up an opportunity for customers with a high-touch approach to come in and squeeze you out?

Well, I think we're going to end up going halfway back, but I'm not worried about it. And I'm not worried about it because we've had 3 consecutive quarters of really strong bookings growth. So we're making this model work. And it's a little bit like the meeting we're having right now. I mean the truth is I'd rather be sitting with you in a room in New York, Sterling. But this isn't that bad. And actually, it's quite efficient. So I think that like all things work from home, 100% is not sustainable, but maybe a hybrid model is sustainable, where it's 50-50 or something like that, and we don't travel near as much as we used to.

Why don't we hit it, make sure we hit on some of the long-term thoughts, long-term goals, et cetera. You've made a number of acquisitions of late. How do you think about attainment of some of your long-term goals in terms of organic versus inorganic?

Yes. Well, when we talk about the future, we're always talking organically. We don't have a strategy that says we're going to acquire 3 points, 4 points, 5 points of growth per year. We don't have a strategy like that. We make acquisitions, but really much more opportunistically when they meet the circumstances. And the circumstances might have to do with how the market is developing, like SaaS, with Onshape and Arena. And the circumstances also have to do with the financial characteristics of the target. Right now, our shareholders largely value us on free cash flow, and we have quite high rates of growth in free cash flow and ARR as well. So for example, I wouldn't want to make an acquisition that slowed down free cash flow growth or slowed down ARR growth. So you say, okay, it's got to be accretive to free cash flow into ARR, those things are a little hard to find because our performance level is reasonably high. And a lot of the companies that are for sale, either don't have the profit or don't have the growth. They either look like a VC company or a PE company. And we're looking for something that has a good, healthy, strong top and bottom line grower. So we're getting picky, I guess, is the bottom line. The bar is high.

It's good to be in a position where you can be picky, that's for sure.

Yes.

Let's talk a little bit about partnerships. Let's start maybe with Rockwell. What's the latest in terms of the progress that you're having with them?

Yes. Well, like Rockwell is principally an IoT and secondarily an AR partner. So some of the slowdown that happened during COVID didn't affect just PTC. It affected Rockwell as well. And in fact, their revenue growth was negative for a while there last year. But like PTC, they're seeing some real strength come back into the business. So the partnership of late has had quite a bit more strength than it did, say, a year ago. And we're projecting that to move forward. So it's a good, strong partnership. Rockwell takes us many places. We would not be able to get to by ourselves because we don't know the company. We don't have the relationships they have, et cetera, don't know the use cases like they do. So to us, it's just a -- it's a path to a market segment that would be harder to get to alone. And we're happy to have them.

Another question from an investor, how would you characterize the margin contribution from the growth in core verticals?

Well, the core business is quite profitable. The growth business is not profitable. It's an investment business. And the way you ought to think about that, is there are 4 businesses within the growth portfolio. They're all on J-curves, the classic startup company, J-curve, where you lose the money first and then you stop losing so much and then you break even, and then you start making a lot. So you could take all of those 4 businesses, which are in different spots on their own J-curve. For example, Arena is quite profitable. ThingWorx is approaching profitability. But if you lump them all together, you'd have 1 dot, 1 composite dot, that's underwater. It's not as underwater as it used to be, meaning the worst is behind us. They are getting increasingly profitable going forward. And it's really just a question of growing into profitability. If ARR goes up 30% and spending goes up 10%, you're going to be a lot more profitable. And so like I said, ThingWorx, which is the biggest one, is making good progress toward profitability, much better position than it was in, like, 2 years ago. And we always said, by the time it gets to $200 million, it really should be close to breakeven. And I think it probably will be, but that will be next year's model when we look at it.

And last question along those lines, where...

Maybe what I could say, though, just so I could show it. If we're valued on free cash flow and those 4 start-up businesses are net consumers of cash flow, then apparently, they're negative value within our share price, which seems a little surprising to me. And said differently, if they were to get to breakeven or get to a decent level of profitability, which they should. There's a lot of upside there in our free cash flow simply from those growth businesses starting to contribute.

All right. Perfect. That you nailed it right on the spot, right at the time mark, Jim? Kristian, thank you. Really appreciate you joining us today.