PTC Inc. (PTC) Earnings Call Transcript & Summary

Good morning, and thank you, everyone, for joining us. My name is Elizabeth Elliott, and I'm an analyst on the Morgan Stanley Software Equity Research team. I'm pleased to have with us today at the NASDAQ conference, PTC's CFO, Kristian Talvitie. Thank you so much for joining us, Kristian, and we're really looking forward to your insights. Just as a reminder, we are taking audience Q&A and questions can be submitted via the box on the webcast screen. And for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, Kristian, thank you again for joining us.

I think a good place to start for investors that aren't as familiar with the PTC story, can you just spend a few minutes describing your business from a product portfolio, vertical market and geographic perspective?

Yes, sure, Elizabeth, and thanks for having us here at the conference. And of course, I would be remiss if I didn't remind everybody that we may be making forward-looking statements, and those come with inherent risks and uncertainties, and we try to outline those risks and uncertainties in our Qs and Ks that are available on our website or in our periodic SEC filings. So please refer to those. Yes. So in terms of the business, PTC is about a 35-year-old software business, approaching about $1.5 billion in ARR, or annual run rate, of our subscription contracts today. It's a global company, approaching 7,000 employees worldwide. We serve primarily product companies, manufacturing companies that make products and leverage our technology to do so. The portfolio that PTC has is comprised of CAD, or computer-aided design, software as well as PLM, product life cycle management, software. That's what we call our -- kind of our digital thread, the core group. We've also -- have a group of products that we call our focused solutions group, which include things like service life cycle management, application life cycle management as well. And then we've also expanded, over the past few years, in the Internet of Things and augmented reality technologies and leveraging those customers who are designing and manufacturing products. And then lastly, we have also recently made a couple of acquisitions that are also in the CAD and PLM space, one called Onshape and one called Arena. And what's unique about those 2 assets relative to the rest of the portfolio and, frankly, the competitive landscape is that they are both native SaaS applications. We lump them into what we call our Velocity group. And we chose that name because it's -- those products are really focused on customers who want to design products in a different way, right, leveraging more kind of agile processes in product design phase and have found that actually leveraging native SaaS capabilities allows them to design and collaborate in a different fashion than leveraging more kind of standard tools. So that's kind of the product rundown and vertical and geographic market perspective.

Awesome. Thanks so much for providing all that background to kick off the conversation and definitely want to dig into some of those SaaS products in a couple of minutes. So you just closed out your fiscal '21 with growth at the high end of expectations. Can you just lay out the groundwork for what drove that solid growth over the last year? And what the demand outlook -- what the demand outlook is heading into fiscal '22?

Yes, sure. Thanks. We did end fiscal '21 with ARR growth of 17%, 12% organic growth. Part of that was -- the difference was really the Arena acquisition that we made earlier in the year, a 12% kind of organic constant currency growth, which was the high end of the guidance we had provided at the beginning of the year. The pandemic has been an interesting time, I guess, for us to all live through, and it's impacted businesses in different ways. And I guess what I would say is, on the one hand, it's actually I think gotten our customers who were thinking about digital transformation to thinking about perhaps accelerating their investment in digital transformation. And so as a consequence -- as a partial consequence of that, we actually have seen solid strength in PLM in particular. It's been growing well above market growth rates. We've had now a couple of years of very solid growth on the PLM front. CAD continues to perform as well above market growth rates and at the high end of our expectations as well. And on the flip side, the -- what we call the growth product segment in our digital thread category, which is really the IoT and AR technologies, IoT, in particular, has been impacted negatively from the impacts of the pandemic. We've seen more difficulty in getting on site and therefore, launching, we'll call it, new programs with customers. On the other hand, where we've seen steady performance has still been an expansion deals in the IoT space. So wrapping all that up, I guess, the main message was that IoT or the growth segments came in at growth a little bit less than we had anticipated at the beginning of the year and the core came in. The core came in at the high end, so we came in at the high end of expectations and actually had pretty solid bookings performance and ended the year with very solid bookings performance in our fourth quarter, which leads us to our setup for fiscal '22. We've provided guidance in the range of 10% to 13%, which will be our fifth consecutive year of double-digit ARR growth, assuming, of course, that we land in that range. This is based on solid execution -- continued solid execution of existing contracts. We've seen improvements in our renewal rates. We expect to continue to see some improvement in renewal rates this year. We have a good pipeline going into fiscal '22. And so I think we feel pretty good about the range that we've provided.

Great. And I just wanted to dig in on that, the fiscal '22 kind of guidance in that fifth year of double-digit growth in ARR that implies. In your midterm, you have guidance for more mid-teens growth. So can you just give us some color on what gives you confidence to accelerate ARR growth to the mid-teens? And kind of what are the pathways and the biggest levers to get there?

Yes, sure. That's a great question. So there's kind of a few different pathways that we can get there. Part of it is seeing the growth segment's return to more growth, which we do expect the IoT/AR group to accelerate back into the 20%, something with the 2 handle range here in fiscal '22. Won't happen in Q1, but then as we get into Q2 and Q3 and beyond, we think that we should start to see that growth starting to accelerate. Those markets are still in relatively early innings. So we think that there's actually a lot of opportunity within those spaces to continue to leverage the IoT and AR technology to solve customer problems. We've been investing, for example, in DPM, digital performance management, which is really an out-of-the-box solution that -- is an IoT out-of-the-box solution that was just recently launched. So we'll see how that plays in the market, but we have good hopes for that. And then additionally, as we've talked about, over the past few quarters, we're also looking to leverage the SaaS platform that really came with the Onshape acquisition, which we call Atlas here internally, and leverage that SaaS platform more broadly across the, we'll call it, the heritage product portfolio, really starting with Windchill. And -- but then ultimately moving across the broader portfolio as well. And -- so we think as we start to migrate more to SaaS that will also create a multiyear compelling opportunity for value creation for our customers and ultimately, which should drive incremental growth for PTC as well. So I think those are some of the main levers that are out there that we think can continue to drive our growth.

Great. And then kind of you -- one of the big things at the last earnings call was the fact that you're kind of reorganizing the business, giving a new reporting structure, specifically aligned to some of these more growth buckets versus some of the core buckets. So what was the rationale for doing kind of the reorganization of the business as we head into fiscal '22? What are the benefits that it brings? And what are the biggest incremental investments that you guys need to do to get that done?

Yes. Good question again. Thank you. So one of the things that I think is really interesting about the PTC story, as I said at the beginning, it's a 35-ish year-old stand-alone software business. There aren't a ton of those left out in the world today. And I think it's been able to remain so because PTC has done a good job over the years at evolving to meet the needs of its customers, to meet the needs of the market. And this started back in the 2000 time frame, as we went from being just a CAD company to being a CAD and PLM company, continuing to expand the product portfolio into, as I said, SLM and ALM, and then further into IoT and AR. Also starting around 2016, the company underwent a program to evolve from selling perpetual licenses to selling subscriptions. Those have largely been on-premise subscriptions, but -- because that's how customers increasingly want to buy. And today, the vast majority of our software contracts are all subscription contracts. And now, continuing with that evolution, customers also want to continue to evolve how they're consuming the software and that really is in a SaaS fashion, right? They don't really want to own the hardware. They don't want to own the infrastructure to host the software. They don't want to run it. They don't want to be in the data center business. And they want the benefits of SaaS in general, improved collaboration, et cetera. And so as we've undergone these changes over the years, that's required different kinds of changes. And this most recent change that we announced on our last call was really a reorganization to better align our, we'll call it, go-to-market functions, but more specifically, our kind of post-sales functions with a more SaaS-like operating model. So trimming down internal silos, making sure that the customer experience is better. They have now 1 sales person and 1 customer success person. Those will be their primary contacts. Previously, there were multiple contacts in the post sales environment. So we're trying to drive more efficiencies through that transformation. And then at the same time, also freeing up some investment to accelerate this move to SaaS, and that includes investing incrementally more in Atlas, the SaaS platform, which again, we want to leverage not only for Onshape but across the broader portfolio, investing in R&D both in the core as well as in Onshape and Arena, as well as continuing to invest in expanding the go-to-market footprint for Arena as well as we leverage that investment. So those are the primary buckets of where the investment is going and why we did it really to make for an overall better customer experience in interacting with PTC as well as making sure that we're operating in a more efficient manner as well.

Great. And then you highlighted how PTC is growing faster than peers in some of these areas like CAD and PLM, really benefiting from that leadership in the SaaS products, Onshape and Arena. Why has it been that competitors have been so slow to move on to a SaaS platform, kind of why is it so hard to do? And if you could just spend a couple of minutes on how that -- how your strategy is different from peers and how that SaaS mix impacts your financial model kind of longer term?

Yes. So different parts of the software space have moved at different rates to the cloud, right, to SaaS. If you think about CRM today, you think primarily about cloud applications increasing in sale for ERP as well. That hasn't historically really been the case for what we can call the industrial software space. But we are seeing increasing demand from customers. We're actually seeing competitors that are also now talking about strategies to migrate to the cloud. And so there's just a lot of signals in the market that point to customers want to -- they want to move from on-prem to SaaS. And so that's what we're doing. In terms of why it's been so difficult, it's a really good question. I think part of it's been really just, we'll call it, market readiness. Many customers, certainly, the PTC serves leverage designs for many, many, many years. And so they're reluctant to want to switch off of a CAD or a PLM system because they have all kinds of business processes tied up and -- tied up around that technology and product IP tied up in those assets. So they're reluctant to try to migrate off of those to start fresh. So that's the approach that we're going to take, which is actually migrating Creo and Windchill incrementally to SaaS so the customers can start getting the benefits, as with incremental features and functionality, customers can start getting the benefits of SaaS while still being able to leverage all that kind of rich product information that's so valuable to them. So it will be, we call it, upwards compatible. So that's the plan.

Awesome. Super helpful there. And then I wanted just to dig in a little bit more on kind of the IoT and AR segment because that is a big contributor to how you guys get to your midterm ARR growth for mid-teens. So kind of taking a step back, you had the deceleration during COVID and then it's expected to kind of reaccelerate. Where are you seeing the most traction in the portfolio? Is it from your kind of existing customer base? Or is it kind of net new customers for the IoT and AR products? And overall, how do you see the market just developing in order to support that growth?

Yes. So I would say that the -- in terms of accelerating, we have seen improvement every quarter in bookings for IoT throughout fiscal '21. So that -- those are a leading indicator, if you will, to ARR that follows. So that's one piece of it. The majority of it has been, as I said, particularly during the pandemic, the majority of it has been through expansions with our existing customers, although we are starting to see new customer bookings start to tick up as well, which I view as a positive sign. Clearly, more opportunity on both fronts as we continue to land new customers and then work with them to put these solutions in place and expand over time with them. Yes. So I don't -- I think that answers your question. If I'm not clear enough there, please feel free to poke at it in a different way.

No, that was super helpful. And then just taking a step back, is there a benefit to combining the CAD, kind of the PLM side with the IoT kind of AR side? And can you talk about some of the leverage that you can get between these technologies? And how important is the differentiation in combining multiple of these products, the growth side being able to drive the core side?

Yes, sure. That's a great question. And so just stepping way back for 1 second, as we articulated on our Q4 call, really we're aligning around, we'll call it, 2 groups: one, which we call the digital thread, which is really CAD, PLM, IoT and AR; and the other, Velocity, which is around Onshape and Arena. And we do think that there is a benefit to having this kind of digital thread portfolio and that there is significant cross-sell opportunity within that customer base for these kinds of technologies. We've certainly seen that over the years with CAD and PLM, where the cross-sell has been extremely strong. And we think that there's continued opportunity to expand the cross-sell motions for IoT and AR into those -- into that customer base as well.

Great. And as a reminder to everyone, we are taking Q&A. So questions can be submitted via the box on the webcast screen, and thank you for those that have started to come in, and we'll kind of weave those through. And one of the questions we've got in particular, how do you see the competitive landscape within AR? And how is that evolving?

Yes. AR is certainly a pretty nascent market really for the space that we operate in, right, which is, again, we call it, industrial AR. I think we've got some good solutions out there in the market today. There's more problems that we can go and try to solve. I think there's some technology advancements in general that are continuing to happen with, for example, eyewear for workers on the factory floor, et cetera, that will continue to open up new opportunities to leverage this technology. And right now, I think we're in a leadership position from a, we can call it, broader-based AR portfolio perspective. There are certainly other competitors out in the market. They tend to be smaller, more point solutions than in the portfolio that we've put together today.

Great. And then to strengthen some of the assets that you have in the portfolio, you've built some very interesting acquisitions or strategic alliance, I should say, with companies like Microsoft, ANSYS, Rockwell. Can you talk about the nature of some of these strategic alliances? Kind of where is it competitive? Where is it cooperative? And what are some of the recent advancements that you've had in these partnerships?

Yes. Sure. So just as a reminder, about 1/3 of our ARR actually comes through our reseller channel, right? We have actually hundreds of resellers around the world and about 1/3 of our ARR comes from -- through that channel. Some of the notable ones in partnerships that you talked about, Microsoft, ANSYS, Rockwell. Each one of them is somewhat different in their own way. I'll start with Rockwell. Rockwell is actually another reseller of PTC's technology, in particular, IoT, AR and with relatively recently extended and expanded reseller agreement with Rockwell, they also -- they can also sell PLM as well. I think Rockwell is building its own portfolio of software assets and capabilities, and PTC's products are a very good complement to what they're trying to do with their customer base, and it's a great way for us to get out into the market and get into some customers that we maybe haven't had access to before. So that's kind of Rockwell in a nutshell. They're a reseller of our technology. ANSYS, the partnership with ANSYS, on the other hand, where we are a reseller of ANSYS's technology. And really, if I was going to sum up their mission in a way is democratize simulation. And that's -- they're trying to get simulation further upstream in broader use throughout the customer base, and that's why we're partnering with them and reselling their simulation technology along with our CAD products. We've seen some interesting traction on that front. And I think it does help with the overall positioning, and PTC does get good accolades from industry analysts across all of our product families, whether that's CAD, PLM, IoT, AR for being innovative. We're in upper right-hand quadrant of most of those magic boxes. And I think this is a complement to that and helps keep us competitive out in the market as well. And then lastly, Microsoft. That relationship is more of a go-to-market with partnership. And again, if you go back to that SaaSification and cloud strategy, for example, where we're seeing some traction with Microsoft is customers do want to move to the cloud. And so sometimes, we'll do, we'll call it, single-tenant SaaS in particular, for PLM and leveraging the Microsoft relationship there in terms of our cloud capabilities. So interesting opportunities presented by all.

Yes, certainly. And with about a minute left, I want to try to squeeze in 1, maybe 2 and weave in some of the customer questions -- investor questions on this one. But term rates improved 130 bps year-over-year, that was ahead of guidance for 100 bps. Kind of what is the outlook for further improvement kind of going forward? And any metrics on competitive retention or win rates in your business that you're willing to share?

Yes. So I think we should see another 100-ish basis points improvement in churn. That's what we said in our guidance here at Q4 for the year. As -- and that's really driven by a few different things. One is the IoT and AR technologies continue to mature and those markets continue to mature. We think that we'll see churn rates in those segments improve. Those have been well above averages or the more mature CAD and PLM churn rates. So those have been coming down, and I think will continue to come down this year. So that will be 1 driver of churn improvement. And the other is just really some continued improvements in execution on our part, making sure that we're doing the right things by our customers and also making sure that we're capturing an appropriate amount of our price increase opportunity with customers as we execute. So those are a couple of things. And then obviously, the reorganization we talked about earlier. We're hopeful that, that will also improve the overall customer experience. And over time, that could also lead to some ongoing benefits.

Awesome. I think there's a lot of really interesting things going on between kind of IoT, AR, seeing how that market kind of matures and how you guys have a strong hold there already and just kind of the SaaSification that you're leading in CAD and PLM. So we're really looking forward to kind of seeing what PTC does in fiscal '22. And we're kind of -- with our time there, so thank you so much for joining us today.

Elizabeth, thanks very much for hosting us. Hopefully, we'll get to catch up in person next time.

Yes, definitely. Thank you.

Thanks.