PTC Inc. (PTC) Earnings Call Transcript & Summary

Hi, everyone. I'm Joe Vruwink from the vertical software team here at Baird. Our next presentation comes from PTC. They are one of the best-known companies involved in the design, engineering, manufacturing and [ serving physical products ]. When you hear the term Digital Thread, that's really PTC at this point, across their CAD, PLM, IoT and augmented reality offerings. Pleased to have with us today from the company, Kristian Talvitie, he is Executive Vice President and CFO; and Matt Shimao, Head of Investor Relations. This is going to be a fireside chat format. Those in the audience that have questions, you can e-mail Session1@rwbaird, and I'll get those on the tablet. But before Q&A, I wanted to turn it over to Kristian and Matt just for an introduction of PTC. So thank you.

Thanks, Joe. Thanks for having us. And obviously, before we get started, I would remind everybody that we may be making forward-looking statements, and you should please go to our website or refer to our periodic filings with the SEC, forms 10-Q, 10-K, to review our safe harbor language and keep that in mind as we talk about forward-looking events. With that, PTC, thanks for the kind words and introduction, PTC is about a 30-year-old software business, that is, as you say, a purveyor of technical or some, call it, industrial software, CAD, PLM, industrial applications of Internet of Things and augmented reality technologies, the, really, I guess, the core of it. We'll do -- we're about 6,500 people across most of the globe today at this point. And one of the things that I think is actually really remarkable about the company is its ability to -- and history and ability to evolve and keep pace and stay relevant for its customer base. Over the years, PTC was originally founded, for example, as a CAD business, sold perpetually on-premise software over the years, that evolved from just CAD to CAD and PLM, SLM, service lifecycle management, ALM, Internet of Things, augmented reality, all being deployed into our customer base. So that's kind of one evolution that's happened over time. Another evolution that's happened over time has been the migration off of a perpetual model, first to an on-premise subscription model where the majority of our business is today, but also now migrating from an on-premise subscription model to a SaaS delivery model, again, really driven by customer demand. So PTC has really evolved as a business and as, frankly, as a partner, supplier to our customers over the years. And it's -- I'm pleased to be here representing them today.

And we were talking before coming in, macro is a big topic right now. And I actually think PTC did one of the better jobs this past earnings season in just addressing the topic head on, telling people, here's what we're assuming, we're seeing certain things, not seeing certain things, you do your own stress testing, but here's what we're seeing. I guess embedded in this, kind of a multipart question. One is what are some of the big assumptions as investors think about PTC this year, and probably bookings and churn would be the 2 big ones, and how that's going to influence your results? And then part b would be, is there any corollary to now versus 2020 versus 2009, where you would say we're seeing similar things, and so this is what we're taking into account, or know it's completely different for this reason or another and so here's what you should know?

Yes. A complex question. So let's try and distill that down a little bit. I think, obviously, the macro environment is definitely different than it was in 2020 and certainly in 2009. I think part of the message that we were trying to articulate is that the business is -- because of the model transition, from perpetual to subscription and where we are today, the impact of those macro environments is actually very different on PTC as a business. So just contrasting 2009, for example, and those kind of the 2 most severely impacted quarters by the early days of the pandemic, our new bookings were down around about 30%. And that was also true in 2009, really for the whole year, our perpetual license revenue was down about 30%. So we really had, back in 2009, negative overall growth, obviously significant impact on cash flows, which impacts our ability to continue to invest and invest in our technology and customers. Whereas in 2020, despite bookings being down kind of the same magnitude, the business, we actually grew 11%, so -- and cash flow. So the business is just set up in a very different way to weather different kinds of macro environments. And what we were trying to articulate now is, yes, there's uncertainty. There's obviously what's going on in the -- in Ukraine. There's what's going on with some COVID in, for example, China. And those -- are those impacting the business, can those -- how much could those impact the business, I think, is what's on everybody's mind. We're trying to provide, in our guidance, the -- a reasonable view of how we think the business is going to perform here over this quarter and the next quarter, being mindful of those situations. But we haven't seen the same level of impact that we saw even in 2020 or 2009. We have not seen that kind of impact yet here in the back half of what was our fiscal '22. So...

Okay. Now if we go back to December, PTC had an Investor Day, actually, the stock has outperformed since that Investor Day, which is kind of a remarkable statement for what -- given what's happened in software. But I think a key message out of that, one is it speaks to some of these enduring characteristics after the business model has transitioned. The other thing is that there's parts of PTC which are not contributing at their maybe full effect, their full potential at the moment. And so there were a lot of things addressed at the Investor Day that can come on and contribute incrementally, which can actually drive an acceleration in ARR. Now guidance for this year has already increased. So I would imagine that the trajectory is still in a good spot. What would be some of those kind of incremental contributors over the 3-year forecast horizon that you would still point to?

Yes. So I think some of the potential tailwinds for growth here, certainly in the earlier years, is the SaaS transition of the core of starting with PLM and then next, will be moving on to CAD with our Creo product. But that transition, we think, is actually going to last well beyond the 3 or 4 years that you were talking about, but should also provide a growth tailwind for us. In addition to that, and we'll see how this plays out, but obviously, the IoT and AR product segments have been impacted by the, well, we call it the macro environment, certainly by the -- during the COVID pandemic. And they were certainly impacted more than some of our other product segments. And I think those, the markets, in general, have slowed down. It's due to the nature, I think, largely of getting -- being more on-site in order to deploy those technologies and so on. So we'll see, over time, if those market growth rates can grow or resume growth, resume towards the growth expectations, that we have to be super clear on this, they're still growing in the mid-teens, which is still accretive to our overall growth. But your point is, historically, they have been something higher, pushing 30%. So to the extent that those market dynamics return, that would obviously be a tailwind as well. We're going to continue to monitor that pretty closely though and make sure that we're investing, I think, accordingly across the portfolio. So I mean, I do think that there are a few dynamics that help the business. Importantly, in the core, which is really the largest piece of the business, you have this digital transformation phenomena that's going on. And if you are a believer in that digital transformation is a thing and it's here to stay, then I would say, in the part of the enterprise that we serve, PLM is really the backbone for that digital transformation. So I think that's also a tailwind that sticks with us here for quite some time.

Just to stay on PLM because a lot of your peers tend to lead with CAD and then they also have product data management or maybe a PLM offering. And I think one of the unique aspects of PTC is they've always been, Creo and Windchill, kind of on an equal footing. They're both viewed as important together, but also respectively. And now, you're starting to see, in my view, more of your customers and the industry kind of wake up to this idea that PLM actually has a virtue beyond just inside an engineering department. Can you maybe elaborate on getting into the concept of digital transformation, what PLM is allowing an organization to do?

Yes, sure. You want the finance nerds version of PLM. Basically, I guess, the way I would say it is you're exactly right, when it started off, it started off as product data management. So you're creating product data in your CAD application, and it's being stored somewhere. And that somewhere was really your PLM system. PLM, over the -- it's had a lot of investment over the last 20 years, and it's actually broadened in its capability. It's really allowed for much more collaboration, both internally within the engineering departments and internally more broadly throughout an organization. And this is really part of the digital transformation, and it's thinking about how else could you really leverage that kind of rich product data and what other parts of the organization could you leverage them in, i.e., can it be leveraged in sales and marketing; could it be leveraged in field service; if you're going out to repair something, would it be helpful to actually have a digital representation of that product that you're looking at trying to service; can it be leveraged on the factory floor in order to help make your -- improve -- drive continued improvement in your production facilities; and so on. And really, that is the concept of the digital thread, how do you take that information and use it across your ecosystem internally and in certain cases as well with your suppliers that are providing parts to you as you're developing these products.

Now I'll give you a finance question. You talked about this as one of the first areas as you embark on more of a multi-tenant SaaS journey. PLM is going to be kind of the first main focus. What is the financial implication of that, both from an ARR standpoint, but is there incremental investment? Or are you able to plug that into kind of the PTC machine and still get your intended kind of leverage from a bottom line standpoint?

Yes, great question. So let me try to oversimplify it and -- but provide a directionally correct expectation here, which is, today, if you sell $1 of on-premise software, that generally comes in, we'll call it, low 90s gross margin percentage. So to keep the math very simple, let's just call it 90. As we move to a SaaS delivery model, we actually think that the ARR will approximately double. So that dollar will go to become $2. It will still be less spend for the customer in entirety based on everything that they're currently spending on, but it would be more, in this case, to PTC as the vendor of the SaaS solution. However, that now comes with the delivery cost, the infrastructure, et cetera, in order to host and deliver that software. So now, that $2 in the end, we think we should be able to target around the 70% gross margin. It may not get there exactly out of the gate, but as we continue to invest and refine the solutions, we think that there's a solid path to get there. So basically, the math is you're taking $1 of 90% gross margin and taking it to $2, 70% gross margin.

Okay. One question we get, given some of the acquisitions that PTC has made, where you now have Arena, you have Onshape, alongside Windchill and Creo, kind of the product market fit between the 2 and how much overlap there is, since we're talking about PLM, maybe it makes sense just to stay on Windchill and Arena and where both of those brands kind of exist in the market.

Yes. I mean I think it's maybe worth characterizing putting it in context this way. As you know, the majority of the business right now is what we call the Digital Thread organization, which has the core Creo and Windchill as well as FSG, which includes service lifecycle management, application lifecycle management, et cetera, and then the IoT and AR pieces. Arena and Onshape, we put into a category called the Velocity business unit. And I think the crux of it is really in the name there. And where we think that the right product market fit for those products isn't so much a customer size. Like sometimes, we get the question, are you focusing on the SMB segment. Well, not necessarily. Really, it's more around how they're looking to develop products and design their products. And for companies that are using, we'll call it, more agile product development methodologies, we think that those solutions are actually a pretty good fit. Companies that have more of a platform mindset that are developing products that are actually refined and used for extended periods of time, think planes, trains, automobiles, they have a different kind of design practice. And right now, that's where kind of Windchill and Creo tend to play the best. It's not to say that in any given organization, they wouldn't actually have a need or couldn't have a use for both kinds, different parts of the organization. But I think that's just the way to think about it, is like how they're developing and the kinds of products they're developing and which is the better tool set for it.

Going back to the front part of your answer and referring to the reorg that happened, where Digital Thread is now a dedicated business unit across kind of your 4 well-established pieces. Just in terms of the timing of that change, does it indicate that customers are now maybe more mindful of buying all together? There have been a few kind of marquee customers. Like I think Volvo Truck and Bus was one at the end of last year that is using everything. How typical is that approach today? And does this organization drive better readiness to capitalize on a market opportunity, or is it really meant to kind of evangelize and make customers more aware that this is possible?

Yes. So we'll call it the reorganization was really meant to do a few different things. One was actually put us in a better position to capitalize on the SaaS transition in general. You could make an argument that, in certain ways, we were still organized like a perpetual software business. So part of that reorganization, for example, was moving our -- we had a cloud delivery organization, but they were embedded within our professional services organization. It's actually taking that piece and actually moving it in with the product, where it makes more sense. You could go and ask other SaaS company leaders if they thought about breaking out their cloud delivery and taking in professional services. I'm not sure many of them even understand the question. Anyway, so that was part of the reorganization. Part of it was also kind of in the customer-facing functions, really as well, and simplifying the customer experience with PTC. In certain cases, customers had 6, 7, 8 different touch points, depending on what they wanted to contact PTC about. Now we've kind of narrowed that down to 2 primary touch points, so it's a much simpler model there. Now I also think that it does help provide an internal focus, right, and understanding better of some of these customers and the opportunity to really continue to drive cross-sell. It's not that we don't have a fair amount of cross-sell. In fact, Windchill and Creo is a great example of what's happened over the years. Cross penetration there is extremely high. And we've started to see some of that with the IoT and AR technologies as well. But it is meant to help facilitate that process with customers. So a little bit of it is continuing to evangelize, and a little bit of it is setting us up to be able to execute against that.

Okay. Okay. Just to spend some time on IoT specifically, and both Jim and you over recent quarters have kind of provided a bridge. Here is how we get back to 20%-plus growth in some of the inputs relative to mid-teens growth currently. So maybe that would be helpful to walk through. But I'm more interested in digital performance management, which is this new product that has been introduced. And I think it probably speaks to the fact that IoT as a product within PTC has been spoken about for some time and has always had very grand ambitions. It might actually seem to have more, I guess, grounding in reality, in that you have some alignment between the industry, embracing customers, doing pilots, and I think this is a new interesting product that kind of rounds everything out. So maybe just a conversation on the evolution of IoT and where things stand currently.

Yes. So I think that, that market has evolved, our view of it and even the product set. When we originally acquired ThingWorx, a number of years ago now, it was really a rapid application development platform. And that's what we were selling to customers. And the pitch, if you will, was you can build your own IoT apps 10x faster using this rapid application development platform. Well, obviously, with the benefit of hindsight and many joint journeys with our customers, what I think we and our customers have come to appreciate is that they don't actually really want to be in the application development business. They have their own products that they want to sell. And what they're really looking for is an out-of-the-box solution that they can just deploy to solve the problems they have. And so that's kind of been the journey that PTC has been on with the IoT platform, is moving it into more and more of a out-of-the-box solution. And the culmination of it, maybe it's just the beginning of the journey, the culmination of the end of the beginning of the next chapter is really with DPM, which is Digital Performance Management, which is an out-of-the-box solution that we now can sell to customers and into the market. So I think that's a sign that the market may be maturing and certainly, our software is maturing, and we'll see how it plays out [ then ].

I think there was a Winston Churchill quote in there, end of the beginning, beginning of the end. If -- this is a bit of an end summary question, but we're talking about things that you target, 20% to 30% growth from there's going to be more SaaS revenues, less presumably on-premise revenues over time. If we think a few years out, what does PTC start to look like in terms of, I don't know, share of ARR coming from SaaS? Or anything you would relate the future relative to where we are today?

Sure. I mean as -- big picture, about 15% of our ARR, which is our annual run rate, which is effectively our software billings, today, about 15% of those billings are from SaaS products that we have. We think that, in about 5 years' time, if we put a stake out that far, we think that north of 30%, 30% of our ARR, will be from SaaS applications.

Okay. Okay. When you step back and think of what your pure cohort is doing because it seems that everyone now is kind of embracing this journey at the same time, what would you call out as being different about PTC's approach to cloud?

Yes. So I mean, I think you're right, you are seeing finally, in the technical or industrial software space, more and more discussion of SaaS, right? There was a time, a few years back, when actually nobody thought that SaaS was coming to technical software. So on the one hand, I think that that's positive, that we are seeing it. We're not the only one saying it. Actually, lots of other folks participating in the space are intending to move in that direction, which means they're hearing it from their customers as well and so on. So I would look at all that and say that's great. It's a good sign that we're not the only ones calling for this. We're seeing it. The -- in terms of what's different, that gets in to be a kind of a complex question, is, first of all, you need to even think about the difference between let's take Windchill and Creo. Windchill is and was always a browser-based [ app ], right? So that's already one of the main tenets of actual SaaS delivery, [ of app-based now, that ] you've got to work on the back end. Whereas Creo, for example, [ is an executable, so it's a file ]. And so when you start thinking about the rest of the competition, I think you need to also think about what kind of transition they're intending to go to, what they -- everybody's definition of SaaS is perhaps slightly nuanced, so understanding what it is exactly that they're intending to do and then understanding their road map to get there. I'm sure it will be different for everybody and even the products within their portfolios. But the broad message is I think the race is on. I think we're very well-positioned.

Okay. Okay. I think we are almost out of time. So I guess, I'll leave it there. But please join me in thanking PTC.