PTC Inc. (PTC) Earnings Call Transcript & Summary

Well, thank you, everybody, for joining us. With me on stage, I have the CFO of PTC, Kristian Talvitie. Just making sure that I got that right. So Kristian, thank you for joining us. Appreciate you being here today. Just maybe for the audience that may not be as familiar with PTC, it would be great if you could give maybe a brief overview of yourself and then just where PTC fits into the software world.

Sure. And thank you for having us. This has always been a good conference, so we appreciate the return invite. And before we get started, I guess, my lawyers would want me to remind everybody that we may be making forward making -- forward-looking statements and there are inherent risks and uncertainties, and we have our risk factors outlined in our press releases and various SEC documents, including forms 10-Q and 10-K, all available on our website or obviously the SEC website. So I'd encourage you to go look at those risk factors. In terms of PTC as a business, PTC is about 6,500 people worldwide. It's about a 30-plus-year-old software business, focusing primarily on developing software that helps companies design, manufacture and service their products. We'll do about $1.65 billion in ARR, that's around the midpoint of our guidance for this fiscal year, which ends September 30. And by way of definition, for us, ARR means annual run rate, the annual run rate of our subscription contracts. So in essence, that's our annual billings, which will grow in the kind of low teens, 12%, 13% here this year. So that's kind of the growth rate of the business, the size, the scope. And a very broad brush view of what kind of solutions we offer.

Yes. No, that's helpful, and we're going to unpack some of that. So I know the business is structured into 2 segments, so there's Digital Thread and there's Velocity. I was wondering if maybe you could unpack for us what the strategy is for the digital thread business? And what encompasses that? And then we'll double-click on the other side as well.

Yes, sure. So -- and we actually even break the digital thread out into 3 primary components. The first being core. We call the core, Digital Thread - Core, which is really our CAD and PLM or product life cycle management software. We also have then the digital thread, what we call focused solutions group. And these tend to be very sticky pieces of software, whether it's kind of retail PLM or servigistics, spare parts management, service applications or ALM application life cycle management tools that encompasses mostly what FSG is for PTC. Those tend to be lower growth markets. So -- but again, essential and valuable products for our customers. And then the last piece is what we call the digital thread growth components, which is really our IoT and Internet of Things and AR augmented reality technologies. And so that's really the core. And we break it out like that because they have different growth rates. So we're just trying to make sure people understand what the -- we'll call it, growth algorithm looks like for the business.

Yes. And so I think that's a good transition point to the ARR side of the story. You mentioned it briefly, but ARR is growing low double digits. So for your cloud ARR, it's been growing about twice the rate of PTC overall. Is that being driven by new customers or migration of existing customers?

Yes. So first, I think it's probably worth pointing out that in last December, we had an Investor Day and we outlined actually a strategy to start more aggressively, if you will, migrating our solutions into the SaaS delivery model. We had been selling kind of reactively to market demand, some of our solutions in a SaaS delivery model, but it's really more of a single tenant model. So now just here in April, we launched what's called Windchill+, which is our multi-tenant version of Windchill. So we've got our initial discussions going on with customers about that. And when we talk about existing versus new customers, the intent is really to lead with Windchill plus in this case with the multi-tenant SaaS delivery model for any new customers or new PLM implementations. Obviously, if they want to go with an on-prem version, we'll go along with that as well. But much of the single tenant business that we had built up over the time has actually been existing customers wanting to migrate off of their premises into a cloud delivery model. So we feel like this transition is really actually being brought about by customer demand. That's the direction they want to go in. It was very similar to the migration from perpetual to a subscription model. That was also really driven by customer demand. That's how they wanted to engage with us on a commercial model. So...

Great. Maybe like how far along are you in that process of migrating customers over? Are we early in that transition? Or are we relatively far along? And what prevents customers from moving over to a SaaS offering?

Well, in terms of migrating them to the multi-tenant SaaS offering, we're very early on. Again, we just launched it in -- for PLM, we just launched it in April. So definitely early days there. And as we think about other parts of the portfolio, CAD, for example, that development work is still underway. And I suspect that next year, at some point, we'll be ready to start migrating some CAD customers or offering a CAD SaaS solution for Creo. Obviously, Onshape is already a native SaaS product. So fairly early days in the transition. A long way to go.

Great. And so maybe if I step back and think about the -- then the overall growth that you've experienced in that digital threaded core ARR, it's been double-digit growth for 4 or 5 years on a quarterly basis. What's driving that growth? Is it gaining more market share? Is it expansion within your existing base? How should we think about that?

Yes. I think it's been 18 quarters now of double-digit ARR growth in the core, which is CAD and PLM combined. I think that there's -- we'll call it maybe a couple of main drivers. One being this theme of digital transformation. And to the extent that customers are looking to digitally transform in the part of the enterprise that we serve, and PLM is, in fact, the backbone of that transformation. So that has been a tailwind. And I think that the pandemic and work from anywhere requirements has added some interest in companies wanting to accelerate their digital transformation journey. So I think that has certainly been helpful for the growth rates there. And I think if we're talking relative to overall market growth rates, and we do think we've been outpacing the market. There's another component, which is really the subscription model, the mechanics of that subscription model are just different than the mechanics of the perpetual licensing model. And I think that plays into growth rates compared to the market as well.

Understood. I wanted to get back to the Analyst Day that you mentioned from December of 2021. You laid out a 3-year ARR framework for FSG, core growth and the Velocity segment. Could you maybe unpack what the drivers are by segment based on that ARR framework that you gave back in 2021?

So if you're talking about the -- let me try it this way. So the core, we think, is going to grow in the low double digits. That's really because of the things that we just talked about, digital transformation, primarily as well as those are mature, steady markets and have been growing at steady rates for quite some time. FSG, we've said we think is going to grow in the low single digits. We kind of put a 0% to 5% range on that. Again, great products, just not as growthy as some of the other ones. That said, we did just complete an acquisition of a German company called Intland that has a product called Codebeamer, which is a SaaS ALM application, which is a good complement. We actually have an on-prem product -- ALM product, but this is a -- this will be a good addition into that portfolio. And frankly, I think with that addition, we're probably looking at closer to the -- closer to the higher end of that 0% to 5% range than the lower end as that continues to gain momentum. And then the growth part of the business, the IoT and AR right now. Last quarter, we're growing about 16%. We think that we're going to get to -- back to a 2 handle on the growth with that business hereby the end of the year. So that's, I think, the way that we think about those growth rates.

That's helpful. I wanted to dig into Windchill a little bit. I know you mentioned Windchill+ the multi-tenant offering. But in Windchill, just more broadly, it's been doing particularly well the last few quarters. And so I'm curious, is that -- how much of that is a benefit from COVID-related tailwinds versus PLM just becoming a more strategic investment area for your customers, what's driving that success at Windchill?

Yes. I actually think those 2 were kind of co-mingled, right? I think that the -- again, if we go with a thematic kind of digital transformation, it's really a journey. It's not a fixed, I'm going to invest x amount, and I'm going to start and be done. It's a journey that companies are going on. And I think that the pandemic actually just heightened or crystallized the need for embarking on that journey or maybe even accelerating that journey for a lot of companies. And I think that's what's been fueling some of the demand that we're seeing.

Great. That's helpful. I know that's like one of the big challenges for us as investors and analysts is dimensionalizing some of those. So that's helpful to dig through. Maybe in your -- in the market, competitive displacements have been rare because the switching costs are just high in these businesses. Do you think the move to SaaS will open up the potential for you to displace some of your competitors and gain more share?

Yes. It's a really good question. And I think probably way too early to make that call. I think you're right. I think that the switching costs are extremely high. The software from us and our competitors is extremely sticky. That said, I think it does potentially create that opportunity to create a compelling event, at least for a company to want to evaluate if they were going to switch. It would be a big endeavor and going from an on-prem environment to another on-prem environment may not be compelling enough to really warrant that. But going from an on-prem environment to a SaaS environment, that may in fact pique some of the interest. So we'll see how this continues to play out over time, but it's definitely an interesting potential opportunity.

Great. And then if I think about PTC, there's a lot of products in the portfolio. And so I'm curious, could you dig into maybe what the cross-sell opportunity is for your growth portfolio and to your core customer base? And how we should think about that ramping over time?

Yes, yes. So I think, number one, the good news is PTC has a very large and stable customer base. Many of them have been customers for many, many, many years. And they have seen the, we'll call it, the value of the products that PTC has brought to market over the years. And so a good example of that is the PLM and CAD or Windchill and Creo cross-sell that has happened over the past, jeez, 20 years. And that cross-sell is actually very high. the success rate that we've had there. And I think that within some of the newer technologies, again, like IoT and AR. I think that the -- there has been some cross-sell. I think there's opportunity for more. And certainly, even where that's happened, the opportunity to continue to expand the IoT and AR footprint where the expansion opportunity is actually quite large. I think that leaves a long runway for us.

Got you. And maybe sticking on the theme of selling, let's talk about the go-to-market strategy. I know the company is most of the way through restructuring of the field organization. What drove this restructuring? And I have a couple of follow-up questions based on the answer.

Yes. So the restructuring, which we announced in Q4, was actually also part and parcel of the announcement of accelerating move the migration to SaaS or moving more to SaaS. And really, I would think about that restructuring in a couple of different parts. On the one side, I would think about it on the product side. So as we talked about earlier, we have been selling a single tenant version of Windchill, for example, that we've been hosting, and we had a cloud organization that was managing that. That cloud organization actually reported into our -- up through our professional services business. And then like a good perpetual company, we also had a tech support organization that reported into the field organization. And now that we really want to hasten the approach to SaaS because we think that's -- the time is right. We needed to think about how we were organized. And frankly, you wouldn't see a SaaS company out there that has their cloud operation as part of a professional services. It's really part of the product, right, as -- like tech support as well, it's really part and parcel of the product. So that was one part of the reorganization. And then the second part, again, if you think about the just the legacy of PTC, which was born originally as a perpetual license company that went through a transition to being a subscription company, still primarily on-premise subscription, but a subscription company. That started the need for us to think about kind of organizational structure and customer success, which was never really a term in the good old perpetual days. In the SaaS world and the subscription world, customer success takes on a different meaning, and you see a lot of companies with customer success orgs. So we had layered a customer success organization on top of the old we'll call it, perpetual org structure. And now as part of this overall SaaS migration, we actually wanted to rationalize some of that because it was getting -- there were many different silos that customers needed to interact with in order to get issues resolved. And so we wanted to simplify that whole customer engagement model and has moved to what our CEO likes to call the 2 in the box model, where we have a salesperson and a customer success person. And those are the primary focal points for the customer engagement. And so that's the broader context for why we have this reorganization. It was really actually to help us facilitate this migration to SaaS.

Great. And where are we at in terms of the status of that? Have we gotten -- was there any disruption as a consequence? And are we through that restructuring process?

We're largely through the restructuring process. There is still a short tail of things that are still happening here in this quarter, and I suspect there will be some cash payments till next quarter. But the bulk of it is actually already complete. The bulk of it where, particularly the disruption could have happened. It was really in Q4 when we were doing the planning. And then in Q1, when the initial effort was underway. So I think that we're largely through it. We should still see some restructuring payments in Q3 and Q4. But...

Got you. I want to maybe switch gears in the last few minutes that we have left and I want to rip the band-aid off, everybody is asking us questions about the macro environment. So I'm going to go ahead and get it out of the way with you as well. Just what are you seeing based on your conversations with customers or behavior that you have with new prospects? Any feedback that you can give on the macro environment from PTC's perspective?

Yes. I mean here, up through the end of last quarter, we hadn't actually seen any significant impact. Obviously, there's some impact. We actually exited our business in Russia and Belarus. That was about $4 million of ARR. So we exited there mindful of the demand pressures in China with the COVID lockdowns that were happening and obviously watching with great interest what's going on otherwise in the European theater here, but we haven't really seen that translate into significant demand pressure at this point.

Great. I think that that's fairly consistent with what most of the software companies are telling us. So it's just it's a question investors have been asking us and we'd like to pass that one right on through. And so the company has been, as we talked about, delivering really saw double-digit ARR growth. And I know the focus has been on accelerating that top line. But I think it's in an environment like this balance also matters, and I think investors appreciate the free cash flow that PTC generates. And so maybe just how should we think about those free cash flow targets that you set at the Analyst Day and the progress toward them?

Yes. We have no reason at this point to change those free cash flow targets. I think that we'll -- we're well on target to hit this year's free cash flow number. I think that also given the uncertainty in the market, we tried on our last quarter's conference call to do some high-level math to help illustrate the resiliency of the model, both the top line and then we can talk about how that flows through. So maybe I'll just spend a minute and try to recreate that. If you think about our overall ARR base starting the year is about $1.5 billion, round numbers, if we do about $300 million of new bookings and have about $100 million of churn. That means that we'll be net adding about $200 million, so about 13% to the ARR base. And if we then compare and contrast a couple of the more notable downturns that we saw on the, obviously, a couple of quarters in 2020 and even 2009, what we saw in the business, the way the business was impacted in both of those situations, the top line, the new bookings were down around 30%. In both cases, it was longer for 2009. It was really the whole year. 2020, it was really just 2 quarters. But also in both cases, there was some limited pressure on the renewal, but we did not see significant changes or significant pressure there, again, to your point earlier about it being very sticky software. And so what happened was actually in 2020, we grew our ARR 11%. We grew our billings 11%. We grew our cash flow, which was in stark contrast to 2009 when it was a perpetual license model, and we lost, in that case, 1/3 of our $100 million in bookings, $100 million in license revenue. That put pressure on total revenue, put pressure on cash flow, which makes you have to react differently as a business as well. We didn't lay anybody off as a result of the COVID pandemic. We're able to continue growing, continue investing in the business, which is good for customers. And I think also just shows really the resiliency of the model. So maybe an easy way to think about that.

Great. And then maybe kind of to close it out here since we're almost at the top of the half hour, just how do you think about capital management with that context, right? The company generates good cash flow. The growth is accelerating on the ARR side. How do you think about M&A, which the company did a recent acquisition of Intland software, which you mentioned, but also just maybe capital allocation more broadly with the cash flow that you're generating?

Yes. So I mean, obviously, first and foremost, we would invest back in the business and in the growth of the business. And then I guess the way to think about capital allocation, maybe more broadly is what we've said is our intent over the longer term would be to return about 50% of our free cash flow to investors via share repurchases. The caveat on that is if we were to end up over 3x levered because of some M&A activity, et cetera, we would then pause the buyback, focus on rapidly delevering and then it would be a blend of delevering and buying back shares, returning capital that way.

Great, Kristian, for your time. We'll leave it there, but really appreciate you joining us and learning more about PTC today, and thank you for your time.

Thanks for having us.