PTC Inc. (PTC) Earnings Call Transcript & Summary

So my name is Jason Celino. I'm the vertical software analyst here for KeyBanc. And I'm very pleased to welcome in person PTC's CFO, Kristian Talvitie. Maybe first, just as an intro for people in the audience and the people on the webcast, maybe do you want to start off with PTC introduction, a little bit about yourself too?

Yes, sure, Jason. First of all, thanks for having us. And then obviously, before we get into any of the discussions, my lawyer would want me to remind everybody about the forward-looking comments that may or may not be made during the course of this conversation and the risk factors that are clearly outlined on our website and in our press releases and our periodic filings with the SEC. So I would encourage you all to go and review those at your leisure. As far as PTC is concerned, PTC is a little over 30-year-old software business. Today, we're about 6,500-people-strong worldwide. We'll do about north of $1.6 billion in ARR or annual run rate, effectively billings, here this year in our fiscal '22. We expect to generate adjusted free cash of about $450 million this year. PTC really focuses on improving the product development and, we'll call it, manufacturing and service operations of our customers that span from industrial to aerospace and defense, to automotive, med device, high-tech devices, so those kinds of customers around the world. And that's the product suite that we have, which has really been receiving lots of accolades from industry analysts and alike across the entire portfolio, ranging from CAD to PLM, to SLM, to IoT and AR as well.

Okay. Excellent. So I wanted to kind of start off with the core business. So the CAD business has been growing double digits for the last couple of years; PLM, in the mid-teens. Both of these are better than market growth rates. So can you just speak to what's driving the strength in the core and then maybe what is assumed for maybe the more near term?

Yes, sure. It's a great question, Jason. Thanks. You're right, I think we've been having now similar growth rates going on 16, 17 quarters in a row in the core, CAD growing in the high single digits and PLM in the kind of low to mid-double-digit range pretty consistently. I think that's driven by both, we'll call it, solid and stable demand market in general that we see for CAD and PLM. I think in PTC's specific situation, there's also a business model aspect to it, meaning we, during 2016 to 2020, converted from an on-premise perpetual model to really primarily an on-premise subscription model. But I think that has its own impact on growth rates and relative to market growth rates. And then lastly, and in particular, as we think about PLM where the growth rates have been higher still, it's our belief that this digital transformation theme, if you're a believer in that theme, and we certainly are, then the part of the enterprise that we serve for our customers, PLM is really the backbone for that digital transformation initiative, connecting CAD through, again, engineering in the manufacturing and in the service operations. So I think that's also been a good driver for us as well.

Okay. Maybe going a little deeper a little bit. A couple of years ago, people were worried that some of PTC's competitors were gaining share, particularly in PLM. But over the last 2 quarters, I think it's been interesting that you've announced some displacements. You had Volvo and then, most recently, Schaeffler. Has there been any change in the competitive environment? Or is this more of a go-to-market benefit?

Yes, it's interesting. And to be honest, I'm not sure where those concerns, even from a couple of years ago, might have really come from. Both PLM and CAD markets have historically been pretty sticky markets for both us and our competitors, particularly at the high end. And there really hasn't been a lot of share shift. Sure, occasionally, you see some moves here and there. But I don't think it's really been our perception that there was that kind of meaningful movement even over the past couple of years. As I said in the opening comments, in CAD and PLM, we do continue to get upper right-hand position in the Magic Quadrants and the like, in the industry analysts, in terms of both the technical capability of the offering and what customers are really looking for, customer experience. So I think we are positioned quite well from a technology perspective and, obviously, as everybody does, continue to evolve our go-to-market operations.

Okay. And I do want to ask some questions on the Windchill SaaS transition. But maybe before we get there, just tying it in with Arena, I think it's accelerated nicely to like 20% or around those levels. This is an uptick from kind of those prepurchase levels of in the mid-teens. What's driving this, particularly with maybe since you bought them?

Yes, another good question. And I mean Arena was really a very well-run organization when we bought them. I think the kind of previous management team, previous ownership, had really driven a lot of focus into that business, focusing them on verticals where they had really good product market fit and really keeping them focused primarily in the U.S. as well. And as now they've become part of the PTC family, I think we're starting to see some of the benefits of some of the reach that we have as well as some of the investment that we are putting in to try and expand and their reach into adjacent verticals but also in the go-to-market footprint even in the U.S. but also expanding into Europe as well. So it's really been a solid acquisition for us. It's actually pretty fun to watch it continue to perform.

Okay. Interesting. On the last earnings call, Jim kind of explained it well, but Dassault has had some success -- well, not some, but very good success in the past with having both the high end and the mass market CAD, PLM product with their CATIA and Solidworks. So with PTC, you've got Creo and Onshape. And then you've got Windchill and Arena. Can you just segment the differences and what the ideal customer would be for both of those?

Yes. It's a super interesting question. And really, with the reorganization that we announced as we started fiscal '22, one of the things that we also did was try to highlight, and you'll see it in our reporting, when we talk about our Digital Thread business and then we talk about our Velocity business. And the Velocity business is really Arena and Onshape. And part of the reason that we did this was to really highlight exactly that, the kinds of markets and customers where we think the products are the right fit. And it really has more to do with customers who are looking for really agile and, we'll call it, rapidly changing product development cycles as contrasted to other companies where you may reuse or have much longer product development cycles where they reuse designs purposefully and intentionally through many cycles, if you think about how long an airplane is out in the market and how long you'd be able to maintain that versus on the lower end products that are turning over rapidly where you're not really reusing in those product designs. And so that was really the intent with this Velocity moniker because that's where we see the good product market fit. It doesn't mean that, that doesn't have a place even in some organizations that you might normally think of as being more, we'll call it, Digital Thread-like in their needs. There are pockets even in those organizations. And so we wanted to make sure that we were kind of trying to call out the product market fit. It's not necessarily smaller companies versus big companies. It actually has to do with the kind of product and the product development capabilities that they want to embed in their development activities.

Okay. And for the last 14, 15 minutes, I wanted to talk about the Windchill SaaS opportunity. Maybe first, as we start, what gives you confidence that now is the right time to push this to the customers?

Yes. Sure. Another good question. And for those who would like a longer explanation on this, I would encourage you all to go and watch our Investor Day presentation, which was from mid-December of 2021. There's a pretty long explanation of this. I think that the fact of the matter is that, over the years, we have acquired various kind of SaaS properties. And we have been selling SaaS into our customers, but it hasn't really been a concerted kind of push effort in order to do that. It's really been driven either more by the products that we had acquired or by end market demand which even includes PLM, which we do sell also kind of a SaaS version of PLM today. But that hasn't been our push and our focus. It's really been responding to market demand. So to that point, broadly speaking, across our portfolio, about 15% of our ARR right now is actually SaaS. And we continue to see those kinds of signals from the market. And that's been growing, by the way. That part of the business has been growing faster than just the stand-alone software component of the business and has been doing so for some time. So we continue to see signals like that from the market. We actually also see competitors that are slowly making their own forays into SaaS-ifying their portfolios, which is all positive, encouraging signs as well. And then again, with the Onshape acquisition in particular, that came with Atlas which was the kind of SaaS platform which, for the past couple of years, we've been investing in and leveraging more broadly across our own product portfolio. And so it just felt that now is a good tipping point for us to start being more aggressive in trying to actually lead with SaaS instead of respond with SaaS in the market, if that makes sense.

Yes. No, that makes a lot of sense. And maybe for this next question, PTC, you went through the subscription model transition. So that was a pricing change to the customer. And then with this Windchill SaaS product, it will be a deployment change for the customer. I guess from their perspective, would the deployment change -- I hate to use the word change -- but would it be a bigger difference to them versus the pricing change?

Yes. Well, so even if you think about the pricing change, I'm actually loathe to think about it just as a pricing change.

Well, yes. Pricing change is like the wrong name.

It's really a customer engagement model change is what I would say because yes, how you're pricing is different but also, in this case, with the subscription model, the flexibility, for example, that the customer gets in moving from a perpetual ownership model to a subscription model increases substantially, right? So there's actually a ton of benefit to the customer in making that change. And so that value obviously gets shared between the customer and, in this case, PTC, in our case. And I agree with you that with SaaS transition, which I also agree is largely a delivery model change, there is value that is created. Some of it is, I don't know, more mundane. They don't have to buy servers or storage or have system admins. Okay. Fine. And there's real value in the customer for not actually having to be in that business. But then a good chunk of it is how they're able to use that software now when it's deployed in the cloud and collaboration becomes easier, working from anywhere becomes easier, working on different kinds of devices becomes easier. And I think that that's really where the customer is getting value from migrating to a cloud deployment or a SaaS deployment versus an on-prem deployment.

Okay. And I'm curious on your thinking here, so at the Analyst Day, that was a big focus, talking about the SaaS transition. But we still don't have the product in GA yet. Usually, we get the product and then companies announce transitions. But you guys did it a little differently. I guess can you kind of go into that?

Yes. Sure. So a, we've been working on the product. We talked about Atlas a little while ago. We've been actually working on this now for a couple of years, frankly. And secondly, with the transition of moving to SaaS, there were some other organizational changes that we really wanted to and needed to make, frankly, in order to accelerate this SaaS-ification piece. So as an example, we had a cloud ops organization that actually reported into our professional services organization. That's one example. We had a tech support organization that also reported into our "field" organization. And that's really an old, kind of perpetual on-prem organizational model concept. And so we've pulled that back and migrated that all in with the products. So you have more of a DevOps mentality. You have the folks that are building it, also running it and maintaining it. And so without making some of those changes, I guess I would argue you couldn't even really move towards a SaaS model without rethinking how you've organized your business. And so there was a considerable amount of effort that went into thinking about some of the organizational design changes that needed to happen in order to allow us to really go after the opportunity. And because of disclosure requirements as a public company, that was the order that we really had to adhere to, make those organizational changes in order to set us up to be able to really get after it. And the product will be out here with the new pricing and packaging, I think, early next quarter.

Okay. Great. Well, I'm sure we'll be keen to see that come out. Software investors have a lot of examples of different transitions. When people talk about subscription transitions, obviously, PTC comes up. So when we think about the SaaS transition, first for Windchill, right? When I think of PLM, I'm trying to compare it to other applications. One thing that has gotten me with some simulators, maybe like ERP, right? So I think with ERP, it's a very customized workload. Decades of customizations have been done. So with PLM, I wonder how much of that workload or that application is typically customized? Or is ERP not the right other application to think about?

I mean it's not a perfect comparison, but I think it's a pretty reasonable analogy. Then maybe the way to think about it is, depending on what version, for example, of Windchill you're on, you may have more or less customization. And certainly, in earlier versions, customers were doing more customizations. We've obviously taken that market feedback and built that into the newer, kind of more subsequent conversions. It doesn't mean that there aren't still customizations that are out there, configurations that are out there. So I think it's a fair-enough analogy. And frankly, I also think that's part of really the value proposition for the customer, in addition to the stuff that we just talked about, to actually move to SaaS. Jim likes to call it the last upgrade that the customer is going to do because, frankly, when you're upgrading an on-prem, highly customized environment like that, every time you do it, it costs you millions of dollars, countless man-years of effort just in order to get some new features and functionality that's been released in the software. And obviously, the idea in moving to a SaaS deployment model and more multi-tenancy is that you don't have to do that. So it is going to require the final upgrade, if you will, and preparing to accept the new version. But then once you're on that, the customer shouldn't have to spend money like that with SIs or even PTC's PS organization on an ongoing basis over countless years to upgrade. And by the way, not wait multiple cycles, right? They might not upgrade every time a new version comes out. They may wait 2, 3 cycles to upgrade, which isn't really ideal for them because they're paying for the newest, freshest software and, again, easier and much less costly for them to take advantage of in a SaaS delivery model.

And then the other equation with the SaaS transition is the uplift, right? So I think at the Analyst Day, you said that it was about a 2x or at least 2x uplift from the on-premise to the single-tenant product. But if this is going to be a multi-tenant product, very natural to think you can maintain at least the 2x. But to convince that the customer needs to know kind of the incremental value that they're getting, maybe can you just walk through kind of what the pitch would be?

Yes. So I mean, again, I think we've done that here through 2 or 3 different questions. And I really do think it's not a price question, it's a value question, right? And sure, there is a price question. I actually think that in the end, the customer is actually going to be paying less. The question is just who they're paying it to. Are they paying it to SIs or professional services organizations to do their upgrades? Are they buying hardware? Do they need a building to put the hardware in? Do they need the HVAC equipment; do they need the sys admins, right? So all that spend is happening. Anyways, they're going to be spending less ultimately. It's just that it's not going to be distributed across all of those dynamics and instead, how that lesser spend gets allocated, in this case, the PTC. That's what we think drives the uplift. So it is really much more value to them. A, they're out of some of that business they don't want to be in; b, we just talk about setting them up for taking advantage of future upgrades, certainly much more efficiently, much more cost effectively, as well as then just the deployment model and better collaboration, better work from home, better work from anywhere, et cetera. So I think that's really the value prop.

Perfect. Well, I think we've probably exhausted that topic. So maybe for this last minute, we can change it to something else. I did want to maybe ask about free cash flow. So I think you've laid out certain targets over the next couple of years, but I'm curious on the flexibility of the drivers, right? So I think one of the incremental things coming out of the Analyst Day was the expense management aspects of it. So maybe can you just speak to some of those drivers and the durability of where the growth could come from?

Yes. So I think for those folks who follow PTC and have followed PTC for some time, I don't think I would be out of line in saying that I think PTC has a proven ability really to manage expenses effectively. And the scenarios that we outlined at the Investor Day contemplated, we'll call it, a range of ARR growth ranging from kind of low double digits to mid-teens plus. And obviously, there's a number of different factors that go into it: how successful we are with the SaaS acceleration; various parts of the businesses, how they're performing. And ultimately, that comes down to, we'll call it, bookings growth, churn improvement. And really, from a free cash flow perspective, I guess what I would say is, depending on where we are in that trajectory of bookings growth, we would manage our expenditures accordingly, right? So we're obviously not going to spend the same amount on sales and marketing or, necessarily, even R&D, for a business that's growing low double digits versus something that's growing in the mid-teens. So I think we would calibrate accordingly. That's how we think about it.

Perfect. Well, the blinking red dot says we're over, but I really appreciate you, Kristian, coming in person. It's very informative, and I hope everyone had some good value out of it.

Jason, thanks again for having us. Thanks, everybody, for your time.