PTC Inc. (PTC) Earnings Call Transcript & Summary

Great. Let's get started, everybody. So good morning, and welcome to Day 2 of the Stifel Cross Sector Insight Conference. My name is Adam Borg. I'm an Analyst on the software team here at Stifel. Really excited to be here with all of you in person. Next up, we have PTC. Really excited to have Kristian Talvitie, CFO; and Matt Shimao, Head of IR here in supportive of the conference for a number of years. So really happy to have you. Just in terms of format, we'll have a fireside chat. I'll kick it off. We'd like to make this interactive. So hopefully, you guys have some questions, and we'll love to get to all yours as well. So with all that, Kristian, thanks so much for being here. And I think you have a safe harbor you like to share us.

Thanks, Adam. Yes. Thanks for inviting us. It's a great conference, great venue. So we appreciate the opportunity. And yes, I'll just remind everybody that we may be making forward-looking statements during the course of this conversation. And obviously, those come with inherent risks and uncertainties, and we have a pretty detailed list of risks on our SEC filings, press releases, et cetera. They're on our website and on file with the SEC. So I would encourage you to please go and read our risk factors in our safe harbor language.

Perfect. So with all that, maybe for those, maybe a little bit less familiar with PTC, just a quick background about the company and the big opportunities you're going after.

Yes. Great. PTC is, in my view, really kind of a remarkable company. It's a 30-plus-year-old software business, has evolved over the years in many ways, and that, to me, is actually part of a special sauce that really makes PTC who it is today, and that evolution has been on multiple vectors, but it's always been with customer needs in mind. We started off back in the '90s as a really just a CAD company. Obviously, back in the day, it was a perpetual on-premise software company. And today, our guidance for this quarter be a midpoint of about $1.65 billion in ARR, what we call ARR, which is our annual run rate or effectively our annual billings on software. There's some additional professional services, implementation services and a very small amount of perpetual $20-ish million left, but that makes up our annual billings really. So a pretty decent sized company today, global, about 6,500 people worldwide. The vectors of evolution part of it has really been expanding from just CAD into PLM, product life cycle management, into other adjacent categories like service life cycle management, like application life cycle management, as well as getting into the Internet of Things and augmented reality and really leveraging those technologies in an industrial setting. We serve companies that make products, think John Deere, think Toyota, Raytheon. So companies that are actually making physical products and using our digital technology to do that more efficiently, whether that's on the design side, in service operations or on the factory floor. So that's been one evolution of the company, which has really been on the offering side and again always with kind of customer need in mind and adoption of newer technologies and deploying them into our space. Another vector really has been the evolution of, we can call it, the commercial model. We went from, as I said, starting off being a perpetual company from -- up until about 2016 through kind of 2019, 2020 we went through a subscription model transition. And as we kind of started 2020 virtually, virtually all of our software billings were subscription in nature that proved to be somewhat fortuitous. And we'll probably talk about it later, but the difference in the macro disturbances in 2009, for example, versus 2020 had a very different impact on PTC as a business. So that commercial evolution, again, that was with -- really with customer need in mind that's really increasingly how people want to, we'll say, acquire things. They don't really want to buy software anymore. They want to subscribe to it. It doesn't apply to just software. But in our case, it's the software evolution. So that's been an interesting evolution. Profitability enhancements over the years. This is my second term at PTC. I was actually with PTC from 2008 through 2016, left for about 3 years. I went to a couple of other privately owned software companies here in the Boston market and then was afforded the opportunity to come back to PTC 3 years ago. But when I started, we had, back in 2008, 2009, it was a $1 billion-plus enterprise software business, and we were doing non-GAAP operating margins of somewhere in the 18 percentage point range, and that's been a long march over time. Today, more, frankly, high 30s, pushing 40%. ASC 606 kind of muddies that up a little bit, but that's been a pretty remarkable transformation as well in profitability of the business. And now lastly, the most recent shift that we're on is really the delivery model shift. So when we went from a perpetual business to a subscription business, we were still delivering the software on-premise, right? It was still being shipped to the customer and they were deploying it. And we've seen across many other parts of software, I think, CRM, HR systems, even ERP, the migration to the cloud. And for a long time, the technical software space that we play in was kind of a hold out. but we've been seeing increasing demand over time. And at our last Investor Day late last year announced our intentions to accelerate this transition to SaaS across our portfolio. And frankly, even over the past 2 or 3 years, we've made a few acquisitions that have really actually helped this push to SaaS with properties like Onshape, which is really the industry's only SaaS native CAD application arena, another SaaS native PLM application and then most recently a company called Intland which is also a SaaS-based ALM application. And we're leveraging -- with that Onshape acquisition, it came also with a SaaS platform, which we call Atlas, which we're leveraging now more broadly across the overall product portfolio, starting with Windchill and then we'll be moving on to Creo and other parts of the portfolio as well in a multi-year transition as we transition the delivery model from on-prem to SaaS as well. So that's a pretty comprehensive overview of the company and maybe sets up a few questions for.

I think you just outlined the rest of the conversation right there. So thanks for all that. Let's just talk about the macro for a minute. Obviously, I'm sure you're not going to give an intra-quarter update, but I'd love to take one if you were willing to offer it. But I think investors are really pleased to see that the durability of the business coming out of, I guess, 3Q in terms of strength across geographies. Europe led the way in terms of growth. Bookings has led ARR growth for 6 straight quarters. What's really leading to this strong demand environment that you're seeing just given the cautious overtones that we're seeing out there? And two, one thing I think Jim talked about a lot lately was just the durability of the model, right? The size of the ARR base, the lower level of churn that you're seeing and the strong new bookings I just mentioned, how does that all face in terms of uncertain macro volatility?

Yes. And my lawyers do listen to these conferences. So you're right, I'm not going to be giving an intra-quarter update. So yes, it's interesting. I guess -- we're conscious of the macro environment, and that's a broad statement meaning there's different dynamics in different parts of the world that are in different phases of, we'll call it, uncertainty. You think about, for example, the COVID outbreak in China and the impact that that's having, obviously, the situation in Europe and more specifically in Ukraine and the related -- potentially related impacts that, that could have. But as we saw last quarter and looked at the pipeline entering this quarter, there haven't been, we'll call it, the same -- certainly the same level of severe impacts that we saw back in March, that first couple, whatever, quarters of 2020 when the pandemic first hit globally or back in 2009. So we're conscious of it. We haven't seen certainly that level of impact, both in March of 2020 and in 2009. -- those disruptions actually took bookings down at one point in 2009, It was perpetual and obviously, subscription in 2020. But there was a bookings impact of about a 30% decline. And again, not seeing that level of disruption yet, we'll see how things play out. But I think we tried to be mindful of that in the guidance that we gave. In terms of the durability of the business model, and it's really a great question because if I contrast to when 2009 and bookings were down at that point, perpetual license revenue was down 30-ish plus percent. A couple of interesting dynamics. One, overall revenue was down, cash flow was down. We responded somewhat differently as a business. The one thing that wasn't really impacted back in 2009 was our maintenance renewal rates, right? The software that we provide tends to be pretty sticky. So we didn't really see a significant change in software renewal rates back in 2009. You contrast that with 2020, and bookings, again, were down kind of 30-ish percent really for 2 quarters, not the full year like in 2009. But even still, even with that decline, our ARR, so again, remember, our billings, we actually grew 11% in 2020 through the pandemic, cash flow not impacted. Billings were up. So it's definitely a very different business model. And maybe the easiest way to explain it or simplify it is if we break it down to just new bookings and churn, which you remember, we use super round numbers just to illustrate a point. If we do about $300 million of new bookings in a year and have churn of about $100 million, we're going to add an incremental $200 million to our base, right, and off of approximately $1.5 billion, that's 12, 13, that particular math is 13% growth. So even if you were to suspect a 30% downturn in bookings for 4 quarters, call that another $100 million of the $200 million, you still have an incremental $100 million of ARR that's going to be added to the base. So you're still actually going to have, in that case, with that math still high single-digit growth. We will still grow cash flows, et cetera. And obviously, if we saw that kind of downturn, we would slow hiring and respond as a responsible business would to the environment. So I think the cash flow impact will also be mitigated. But it's definitely a very different operating model as a subscription business as compared to a perpetual business. And just given the scenario that I just outlined, I think, helps illustrate that.

Super helpful context. One thing I find really interesting is that just design software in general has been a lagger to the cloud. We've been seeing that. It's both a product -- a function of the product, also a function of customer awareness. But it seems like that's really been changing over the last couple of years. Obviously, Onshape is a good example of that, Arena, et cetera. So you've been really deliberate in your journey to SaaSify the portfolio, obviously, not just acquiring these high-quality assets, but also reenergizing your existing assets and you have a road map with Windchill Plus and obviously with Creo, et cetera. So maybe help us give the state of the union just on what's customer readiness for SaaS, especially upmarket for design software? And where exactly are we with our journey, especially with the SaaSification efforts with Creo and Windchill?

Yes. So you're right, we have been adding SaaS properties to the portfolio for sure. I think that's also definitely a signal from the market that they are becoming more ready. In addition, over the past few years, we actually have been selling largely Windchill on a, we'll call it, single tenant model into our base. So there actually has been demand. That's just how we had approached it at the time. And I think we continue to see incremental interest from the customer base in the SaaS delivery model. I look at -- also we'll watch the technical software space and the competitors, and you see incremental comments from others that play in the same space as us that are also talking now about SaaS and thinking about their own journey to SaaS. And I think that actually just bolsters our feeling of what we're seeing from our customer base as well. So I think the journey is going to be a long one for a variety of reasons. In some cases, it's the complexity of customer requirements. In other cases, it's actually just a -- it's a big move to shift an entire market. If you think about CRM, that took a long time before CRM is really effectively now all SaaS delivery, right? But that was a long march. And I think we're going to see a similar long march in the technical software space. For PTC more specifically, as we laid out in our Investor Day, approximately today, approximately 15% of our ARR is SaaS, which includes the single tenant piece of it, but also includes Onshape, Arena, et cetera. And we think that over the next 5 years, we think that's going to double to about 30% of our ARR. And obviously, we expect our ARR to be growing. So it's not just a shift. There's -- but in any case, we expect that about 30% of the ARR will be SaaS in about 5 years' time, which should tell you that we think it's going to be a long transition to migrate the entire customer base there. But I think that that's the direction that the market seems to be heading in.

Really helpful. Maybe just focusing on Windchill+ for a minute that, again, is the multi-tenant PLM solution that you guys announced back in April. So I'd love to understand what the strategy is around moving your existing installed base to Windchill+? Obviously, you announced a I guess a divestiture around your professional services business. But what's kind of the strategy to move these customers to Windchill+? What kind of uplift should we be expect as this happens? And it sounds like it's potentially a 5-plus year journey, but how should we think about the duration of this conversion opportunity?

Yes. Definitely, 5-year plus maybe even double that kind of journey, first of all. Second of all, I think, in terms of the uplift, what we have seen really with the single-tenant implementations is that it's approximately a 2x uplift. Now remembering that, that actually -- well, that's more dollars, if you will, to PTC, it's less dollars in aggregate spend for the customer, right? So it's actually still an extremely interesting value proposition for the customers. That's just the -- we'll call it, the net impact to PTC. That's what we've seen. That's in the ballpark of what we're expecting here as we continue this migration. In terms of where we are in this journey, relatively early still, Windchill+ was just really, we'll call it, formally released here this quarter -- earlier this quarter. And in terms of the migration plan, we're trying to be pretty deliberate while still allowing for excitement from the market, if you will. So a few factors that we look at, customer readiness and that can be any range of things from how complex their environment is to where they are in their upgrade cycle to also kind of what industry they're in. And so we're taking a pretty holistic approach at analyzing the customer base, reaching out where we think there's an appropriate opportunity and we should be talking with them. And then obviously, any kind of inbound interest and requests we'll obviously respond to appropriately. That's on the migration of the existing customer base. With new sales, our intent is fully to lead with the SaaS offering as the primary offer for any kind of new implementations going forward. So it's really thinking about new implementations, new customers as well as then how we migrate the base.

Got it. And maybe just one quick follow-up. One of the benefits that you guys have talked in the past about Windchill+ is the ability, given its multi-tenant to see the efficiencies in the back end, which I translate to be gross margin improvements. How should we think about gross margin from, call it, core single-tenant hosted -- single-tenant Windchill versus multi-tenant Windchill+, how should we think about that differential?

Yes. I think that we'll say over the longer term, we think that 70-ish percent gross margins is a good way to think about at least an interim target here for us for the multi-tenant Windchill. I think in the early days, it might not quite get to that, but there's additional improvements that we're making across the back end that we think will drive it there over time. And so suffice it to say that that's higher than what the single-tenant implementations have been historically. There's one other piece that comes up sometimes in questions, especially when we start talking about the SaaS transition. And I know that most folks here well versed in SaaS transitions. They've seen it across multiple industries, multiple different companies. And what happens is what Jim like to refer to as the valley of death, which I tried to rebrand as Paradise Valley, but he wasn't going for it back at that time. But that valley of death where you actually see your top line coming down, you're converting perpetual dollars to subscription dollars. And not only does your top line come down, but your investment actually doesn't change. It's just the amount of cash you're bringing in. So subsequently, your cash flow is also negatively impacted really for kind of a 3-, 4-year period. And I guess I'd just remind everybody that we went through that from 2016 to 2019, 2020 when we were doing the commercial model transition. So now as we move to SaaS, the incremental ARR is, in fact, all incremental and it will be incrementally positive to cash flow as opposed to creating another valley of death. Because of ASC 606, it looks kind of funny from a revenue perspective and from a P&L perspective, but we try pretty hard to articulate the business on a, we'll call it, cash in, cash out basis. And that's really what the ARR, why we focus on ARR as our top line metric and free cash flow as the bottom line metric. But that comes up periodically in questions, and I just wanted to point that out.

That's great. What questions -- what do you guys have on your mind? Great. Just on the core business, right? I think what's been really impressive is just the durability of both Creo and Windchill. I think there's been 18 straight quarters of double-digit growth there. What's really been leading to the strength and just simply how durable is it going forward?

Yes. Another great question. Thank you. I think they're both pretty mature markets, right, CAD and PLM. And so we've seen, we'll call it, solid and resilient just overall market performance over that period and certainly even before that and have, at this point, no reason to expect that, that underlying market dynamic would change with an exception, which is what I would say is this theme of digital transformation. And that has been something that's been talked about for quite some time in many companies, if not, most companies are going through some form of digital transformation. I think the pandemic and the associated move to work from anywhere has maybe accelerated, not pulled forward, but just accelerated, companies need to transform digitally. And if you're a believer in digital transformation as a thematic theme, I guess, can be a thematic theme, then I would say, for the part of the enterprise that we serve, PLM is really the backbone for digital transformation for a company that wants to take the part of the enterprise that we serve, and continue to transform that digitally. So we see that as also driving incremental PLM demand into the future. And then lastly, the business model difference between a perpetual and a subscription business. And if you want the nitty gritty math, Jim goes into a little bit of a dissertation at the Investor Day. It's all on our website, but just to demonstrate the math of growth and growth rates in the perpetual environment versus a subscription environment. And so that continues to also add a tailwind to that. Additionally, one last thing that I guess I would point out is we have been improving our churn rates as well. And I think that there's some room to continue to move there. And that obviously will bolster ARR performance as well over time.

Got it. Let's spend a minute on IoT and AR. I think this is an area of the portfolio that probably candidly hasn't lived up to expectations. I think we all would have had several years back. So -- that said, the new digital performance management, DPM solution seems to be some excitement around that, not just with yourselves, but with Rockwell as well. So maybe talk a little bit about just the IoT and AR markets, how they've evolved in recent years? Maybe talk a minute or 2 about DPM and why we're excited about it? And what's the opportunity, not just with direct sales, but obviously with Rockwell for DPM?

Yes. So IoT and AR and the application of that technology into an industrial setting, I think over the long term, we're still very bullish on the value that, that can bring to our customers. So we still think that those are great long-term investments for us. I think you're right. I think that the market in general perhaps has not grown as fast as people would have expected over the past 5 years. If we look back 5 years ago, I think that's also true for PTC. I think we've been pretty candid about that as well that our growth rates in that space haven't quite lived up to the expectations that we might had back then. I think that the pandemic in particular with site closures also impacted the IoT solutions that we were deploying did involve quite a bit of getting on site helping set up and configure new IoT deployment. So I think that was certainly impacted during the pandemic. But overall, I think that the growth rates are slightly different. Now probably also worth pointing out that those markets for us are still growing. Last quarter, 16%, still accretive to the company's overall growth rate. We think that those markets, we think that we'll get back to, as we've said, something with a 2 handle here by the end of the year in what we call the digital thread growth space, which is IoT and AR, and we'll be mindful going forward about what we think those growth rates might be in going into the future. And to the extent that we think they're growing faster or slower, we'll also be mindful and adjust spending as we would anywhere else in the portfolio as well. But again, long term, we think there's still great opportunities. DPM is actually one of the tailwinds that we see in IoT. That market in general, if you think back to when we acquired ThingWorx many years ago, it was a rapid application development platform, right? We were selling a platform to customers so that they could develop their own IoT applications. The tagline was you could do it 10x faster if you were using ThingWorx. Well, fast forward now many years, and I think everybody would agree that these companies don't actually want to be in the software application development business. They actually just want to subscribe to applications that are out-of-the-box that can solve a problem that they have. And so our product strategy has been evolving over the many years to move more and more towards these kind of out-of-the-box solution mentality and DPM is really the first full out-of-the-box IoT solution that we have, digital performance management, DPM which we just launched here recently, had a few early customer wins, good pipeline. So I think that that's actually -- we're pretty excited about that and excited about the feedback that we're getting from the market. But again, early days, we'll see how it plays out, but that's really the intent and the intent going forward is to continue to focus on out-of-the-box applications.

Awesome. Well, with that, I think we're out of time. Everyone, thanks so much for being here. Kristian, really appreciate the support, and I love Paradise Valley. Take care.

Thanks, Adam.