PTC Inc. (PTC) Earnings Call Transcript & Summary

Okay. Well, hey, good morning, everyone. Welcome to day 2 of the Barclays TMT Conference. My name is Saket Kalia, I cover software here at Barclays. Very happy to have with us this morning the team from PTC. We've got Kristian Talvitie, Chief Financial Officer; as well as Matt Shimao, Head of Investor Relations. We've got about 25 or 30 minutes together. Maybe what we'll do is I could lead some fireside chat for maybe 15 or 20 minutes. And then would love to make this interactive, any investors on the webcast, if you've got any questions, just feel free to shoot me an e-mail at [email protected]. I'll do my best to get through as many of those questions as we can in the time that we've got. So maybe with all of that as a foundation, Kristian, Matt, thanks so much for being with us here today.

Great. Thanks, Saket, for having us. Appreciate the opportunity. And one last foundational piece which my lawyers would remind me that we'd be remiss if we didn't remind everybody that we may be making forward-looking statements, and those come with inherent risks and uncertainties, which we try to detail in our risk factors in our press releases and periodic filings with the SEC. So I would please refer everybody to look at those as well.

Absolutely. Thanks, Kristian. Kristian, there's so much to talk about here. And actually, by the way, just so everybody knows on the webcast, it seems PTC is going to be hosting the Analyst Day next week, virtual, of course. And so I'm sure we're going to dig into a lot there as well. But there's just so much happening in the business here, a lot to talk about, SaaS transition, restructuring, et cetera. But even before we get there, Kristian, I'd love to talk a little bit about just the underlying strength in the quarter in Q4. I guess I'm wondering, can you just touch a little bit on some of the things that you are most proud of from Q4 as a CFO just in terms of the business?

Yes, sure. Great question. I think Q4 really just wrapped up, we'll call it, a solid year for PTC. I think we came in at the high end of our ARR guidance range. We had a very modest beat on free cash flow, a strong bookings quarter as well. So I think there's just a lot of momentum, if you will, in the business right now. That was our fourth year of double-digit ARR growth. And as we said in our press release, we're guiding to a fifth year in fiscal '22, which started for us back in October. So all in all, I think it was a solid quarter, a solid year.

Got it. Got it. Helpful. And I think a point that was interesting here last quarter was not only did PTC beat constant currency ARR, but also did that while growing deferred ARR, which is interesting. But I just wonder as a point maybe we didn't touch on as much -- at least I didn't touch on as much, right, when we're recapping the quarter. And I think one of the reasons for that is sort of the phenomenon of ramp deals, maybe to go 1 level deeper into the mechanics here, Kristian. Can you talk us through an example of a ramp deal and how it impacts ARR? I think that maybe could put Q4 as a result into just a bit more context.

Yes, sure. And I think that's right. We did -- when you say beat, when you mean consensus, but it was still the kind of high of our guidance range from an ARR perspective, but we also ended the year with about $20 million more in deferred ARR than we had planned at the beginning of the year, which I think speaks to the underlying strength of bookings that we saw throughout the year. And to your point, a good chunk of that is due to ramp deals. And as we even said on the call, the vast majority of that and deferred ARR actually will start in fiscal '23 and beyond. But it's contractually committed business with PTC and really these ramp deals, we have seen increasing in favor. I think they're good for PTC because we get a good long-term commitment from a customer. They're good from the customer's perspective. They lock in a road map and lock in attractive pricing. And so we're able to actually plan and grow that partnership with the customer together. And so what I mean by that is, we could have a deal. And those SKUs, we'll call it round numbers here, that's maybe a $2 million, what we would call, booking. And when we say a $2 million booking, what we really mean is the exit run rate of that contract is going to be $2 million in ARR in the last 12 months, what we would expect to renew going into the next period would be that $2 million. However, because of the rollout plan, it may have started off with $500,000 in year 1, ramping to $1 million, so an incremental $500,000 in year 2 and then ramping to the $2 million, for example, in year 3. And so as you know, Saket, what we do is we put the active portion into ARR. So in year 1, we would put $500,000, which is what we bill a customer that goes into ARR. And in that case, the remaining $1.5 million would flow into deferred ARR. In that example, we would then, in the following year, in the second phase of the ramp started, we would bill a customer $1 million. We would add an incremental $500,000 into ARR, and we still have $1 million left in deferred and so on. So hopefully, that makes sense in terms of the mechanics of ramp deals and why they're attractive to customers and why we think they're healthy for PTC.

Yes, absolutely. It's the deferred ARR metrics very helpful as well to kind of get some perspective on those ramp deals. Kristian, maybe just to put a bow on Q4. In fairness, I think 1 of the parts of the business that maybe came in a little bit lower than what some were expecting was the IoT business. And so I just wondered, can you just talk about what do you think is driving that in sort of IoT ARR growth and do you think that business unit could be that 25%-plus type of ARR grower, right? And you tell me if that range is right. But if you could sort of reach that aspirational growth target that we'd once hoped?

Yes. It's a great question and a super fair point, right? We did end the year with what we call the growth segment, which is really kind of IoT and ARR combined at kind of mid-teens growth, which obviously has been lower than what we think the longer-term opportunity is. That said, we also think that, that segment of the business has been more heavily impacted by the pandemic. And so we saw growth slow. We saw bookings slow in fiscal '20. We actually had bookings growth -- year-over-year bookings growth in IoT every quarter in fiscal '21 as well as kind of sequential bookings growth in fiscal '21. So we are starting to see some turnaround there. And we do think that we will end fiscal '22, I think what we said on the conference call was with the 2 handle on that growth segment in fiscal '22. Now that won't happen in the first quarter. We expect to still be in that kind of mid-teens starting to see some growth return in Q1 -- by Q2, Q3, Q3 we should certainly see a 2-handle back on that business, and we'll see how the whole macro environment and Omicron and et cetera, play out, but we still think that the long-term prospects for the growth businesses and what we now call our digital threat offer a good long-term growth opportunity for PTC.

Got it. Got it. That's helpful, Kristian just about sort of the return to growth here that we should see in '22. And I want to come back to the IoT business here in a few minutes. But I think the most interesting part of the last call was this accelerated transition to SaaS and the changes that, that drives. And again, I know we're going to talk a lot about this at Analyst Day next week. But maybe just first off, what do you think were the drivers for deciding to do this now in FY '22? And not later as at least some of us thought might happen in terms of transitioning to SaaS, why now, maybe is the question?

Yes. It's a great question. And I guess I would phrase the answer this way, which is we've been transitioning to SaaS for some time now. We -- even before the Onshape and Arena acquisitions, we had some SaaS products in our portfolio. I think retail PLM. We've had some Windchill SaaS, largely single-tenant Windchill SaaS some [indiscernible] Vuforia et cetera. And we've seen increasing demand from customers. That was partially the impetus for the initial acquisition of Onshape, which, as we articulated at the time, also came with a SaaS platform that we now call Atlas and then further led to the acquisition of Arena. So continuing to expand the SaaS portfolio continuing to monitor demand signals from our customers. And frankly, we've seen a number of competitors as well, talking about their own kinds of SaaS transition. So I think there's a lot of data points that point to why now is it actually a good time to accelerate the investment? We had been investing. This was really just an acceleration of the investments that we were already making in SaaS. So let me pause there and see if that makes sense.

Yes. Yes. I mean if I had to summarize that, right, it just kind of felt like the momentum was building, right, partially from the customer, right? Also, it seems like just some of the investments that you've made as well were kind of building the momentum. So makes a ton of sense.

And we've been talking now for a number of quarters about leveraging Atlas more broadly across the product portfolio and so on. So in that sense.

Yes. Absolutely. Absolutely. Maybe just will dovetail a little bit off that last point. But I mean, understanding that it's early still, Kristian, I mean what are you hearing from your sales teams and customers as you talk more about SaaS-based CAD and PLM? I guess where do you think the market is in terms of accepting SaaS in these product areas that have historically literally for decades been on-prem, like what does the appetite feel like now from the customer side?

Yes. I mean we're starting to hear more and more questions about it having more interest in it. As I mentioned, we actually do have a Windchill SaaS business already previously, that's been growing largely really through -- it's been customers requesting it, not really us out helping to drive it. We've kind of done it on request only, if you will, and part of this acceleration is actually to now go out and make sure that the sales teams are actually leading with a SaaS-first offer, particularly on Windchill, and obviously, as we continue with the other parts of the portfolio that were SaaS as well. But that's what we've been seeing is increasing...

Yes. Yes, absolutely. Got it. And maybe just from a product perspective here, Kristian. I mean -- what needs to happen? And maybe I'll just maybe I'll just focus this on Windchill because it feels like that's going to be the first part of the portfolio that we'll see that higher SaaS adoption. What needs -- and you correct me there if I'm wrong. But what needs to happen from a product perspective for -- to Windchill to shift that to SaaS while kind of leveraging the Atlas platform? And how long does it take, do you think?

Yes. It's -- that's also a good question. I think that -- let's start with the last 1 first. It's going to be a multiyear long-term shift to SaaS. I think we would expect to be selling both on-prem and SaaS here for some time to come. What's interesting about Windchill is this already a browser-based product. And so really with Windchill, it's going to involve getting customers upgraded really to the most current version of Windchill and making sure then that we're putting the back end in place -- the back-end infrastructure in place to be able to drive efficiencies on our end more from, we'll call it, a multi-tenancy perspective. And so it's leveraging the platform and the product road map to continue to leverage that platform. And then at the same time, we'll be doing work on the back end infrastructure as well.

Got it. Got it. Again, so much more that we could dig into there, but maybe just to...

We'll get a lot more into that at the Investor Day next week as well. So...

I have no doubt. I have no doubt. Maybe just on the time we've got left, maybe 1 area we can shift to is just the rethinking of the customer success organization, can you just, I guess, walk us through 1 level deeper, how customer success worked before FY '22? And how it's going to look going forward?

Yes, sure. And if we put the restructuring in the context, I'm going to broaden it a little bit more still and maybe explain a couple of the moving parts. But remembering that PTC had historically been a perpetual business, and then we went through the subscription transition. And as we went through the subscription transition, we really started to add incremental capabilities, in this case, customer success organization, which had other facets to it as well, like customer experience and so on. But those were really layered on top of the existing kind of perpetual organizational model. And we felt like if we were going to be accelerating into SaaS then we also needed to be organized more like a SaaS company to be able to really drive that growth efficiently. And so there were a few moves that we made. One was this Atlas platform that really used to, we'll call it, be report, if you will, into Onshape. We took that out and moved it up into the office of the CTO. He has a broader purview across the entire organization so that we can make sure that we're meeting the needs of the other products in the portfolio over time and that they're also able to effectively leverage it. So that's 1 piece moving that up in up into a broader sphere. Then secondly, I would also say in -- we have our field organization, which is really comprised of sales, customer success, professional services and embedded in that field organization over time, we had tech support that actually sat in the field organization and even the cloud business that we had the hosting component of that also sat in the field organization, really under professional services. And as you know, in a SaaS business, the product and the infrastructure are really much more intertwined than in an on-premise business. So we took both tech support and the cloud business out of the field and merged them in with the product organization so that we can actually start acting and thinking in that sense, more like a SaaS business from a product perspective. And then in the rest of the field organization, we also took a look at how that was organized relative to what we see with other, we'll call it, [indiscernible] out in the market and how we're servicing our customers. And [indiscernible] we did away with some silos, those silos all come with management layers. So we were able to reconfigure that organization to come up with what we call this kind of 2-in-the-box model, which is we have a sales organization that is largely on in fact, I think we'll end the year with modestly more salespeople than we had last year. So the coverage model there is largely intact. We'll continue to evolve that and tweak that as we've been doing over time, but then pairing them up really with a customer success person that has the right skill set so that a customer really has 2 touch points. They have their salesperson, the same salesperson they had before and now a customer success person as opposed to 6, 7, 8 different individual silos in PTC that we're reaching out to them separately. It was somewhat confusing for customers sometimes and also certainly inefficient for PTC. So again, all of this, as we now decide to push more aggressively into SaaS, we felt like we needed to be organized as well as a company in a way that would allow us to really do that. So hopefully, that all makes sense.

That does. That does. That's really helpful, Kristian. And I know we're going to get a lot more into that and some of the the recasting of sort of how everything was presented. But maybe just from the time that we've got left, I'd love to move to some of the modeling questions here for you. And I guess maybe to start with gross margins. I think it's safe to assume, right, that with a greater SaaS business will come greater hosting costs as well. But actually, I'm kind of curious about another part of the business, which is services, right? In a bigger SaaS world, how do you think about -- in a bigger SaaS business, I should say, how do you think about the size of the services business going forward? I mean in the past, we've seen PTC maybe optimize the mix of that services business, right, in terms of what could be done by a partner versus what can be done by PTC. How does the services business change, if at all, with a greater services -- with a greater SaaS business?

Yes. I think that we'll continue to leverage. We already have a pretty extensive services partner ecosystem. And I think we'll continue to leverage that ecosystem really as we press more heavily in the SaaS. So a lot of them have a lot of good experience there as well. And I think that's the way that we think about that.

Okay. Got it. Got it. Maybe staying on the modeling points here, Kristian. I guess Jim has talked about how the transition here may not have the sort of the same valley right, on the income statement and cash flow as transitions in the past have seen that so any other transitions have to go through. Since the business is already largely on subscription, can you just flush the mechanics on that out just a little bit?

Yes, sure. So I think it's really a great question. Interesting question. It gets back a little bit to why we also focus on ARR and free cash flow as opposed to the income statement and the income statement measures. But you'll remember Saket, when we went through the subscription transition, that is when we actually saw -- and maybe it's easier to focus it if we talk about billings, right, and then ultimately, free cash flow, we saw that valley -- we saw that valley during the subscription transition when we were going from perpetual pricing to subscription pricing. And so the billing mechanics changed. And now we're really starting to come out of that valley. And we have been now for the past, I guess, a couple of years. But that valley, which led to lower billings for a period of time and then building from there also then drove cash flow performance down as well. And so now as we think about the SaaS transition, actually migrating more customers to a SaaS environment is actually just going to be incremental billings for us because we already have the subscription billings. So the incremental hosting piece, if you will, is incremental billings. Obviously, comes at different margin profile than software margins, but it's incremental nonetheless. So it would be incremental to both billings or ARR as well as to free cash flow. Now on the -- if I just dig in for 1 second on the P&L, we may actually see still TBD exactly how successful we are, but we may actually see a revenue slowdown. But as you know with ASC 606 for an on-premise subscription company, we still recognize a lot of upfront revenue approximately depending on the product, approximately 50% to keep it round numbers upfront of the TCV of the product upfront with the remaining ratable over the term. Now as we migrate one of those customers, for example, to a subscription environment, it's going to move to fully ratable over the term. So depending on where they are in the contract cycle and so on, we may actually see some pressure on revenue, but that's from an accounting perspective, not from a billings perspective or a cash flow perspective.

Right, right. Or an ARR perspective, right? I would argue that makes ARR just an even more important metric going forward? It has been in the past, but just even more so going forward?

Yes, that's right. And this is why I often make the point that actually ARR plus our trailing 12-month perpetual license plus trailing 12-month professional services revenue that really is our cash generation for our billing. And those -- if you add those 3 up, at any given quarter, they are a very close proxy for billings in that period, which is why I use a little bit ARR and billings somewhat interchangeably.

Yes. Fair point. It's a very fair point. Well, just in the time that we've got left, Kristian, I was wondering if you could just finish up with some mechanical stuff? There's just a lot of, I don't know, news flow or just misunderstanding out there around PTC's relationship with Rockwell, right? And so just to sort of level set here for everybody, right, can you remind us a little bit about the current state of the Rockwell partnership, both from a reseller perspective as well as a Rockwell investor perspective? Does that make sense?

Yes, sure. It does. I mean those are 2 separate agreements, right? So maybe we'd start off with remembering that. And I think it was last October-ish where we actually expanded and [indiscernible] the original reseller agreement for another 3 years. So that's 1 piece of it. And then separately, they had their ownership position, which they still maintain. And I think that Rockwell has said recently that they intended to sell down some portion of their position, at the same time reminding everybody that they also have said that Blake intends to continue in his role as a director on PTC's Board. And so what that means is that they would need to maintain, obviously, at least a 5% stake in order for that to happen. Those are comments from Rockwell. So if and when and how they choose to sell down some portion of their position, they obviously can do so. There are some contractual requirements to make sure that it happens in an orderly fashion, but that's the state of play. I think that we both feel that the reseller arrangement provides a lot of opportunity for both Rockwell and for PTC. I think Rockwell use PTC products as an important component of their growing suite of software assets as well, but we really do bring the, we'll call it, IoT and ARR. And with the expanded reseller agreement, they're also able to sell PLM. So we bring those components to their factory top automation suite, and we still think that they have large reach into the market and can help get us into some customers that maybe we haven't had access to in the past. So I think we both think that there's a good opportunity for us to continue that partnership.

Okay. Got it. Got it. Well, as always, Kristian, so many more questions to ask, but also want to be respectful of your time. Again, just for everybody here on the webcast, PTC is going to be doing an Analyst Day next week. I believe it's next Wednesday kind of late morning. I'm sure Matt and IR can get you on the details that you need. I'm sure it's going to be a great and very helpful event. But until then, Kristian, Matt, thank you so much for taking the time. We really appreciate you being with us here this morning.

Great. Saket, and thanks for some good questions as well. Appreciate that.

Absolutely. All right, folks. Enjoy the rest of your day.