PTC Inc. (PTC) Earnings Call Transcript & Summary

Okay. Excellent. Good morning, everyone. Welcome to Day 1 of the Barclays TMT Conference. Very happy to have listed team from PTC. Of course, we've got Jim Heppelmann, Chief Executive Officer. Out in the audience, we've also got Mike DiTullio, President of the Digital Thread business. And I think Matt Shimao, Head of Investor Relations, is somewhere here. He might be outside.

Yes, he was going to get coffee.

Excellent. There we go. There we go. So just to frame the discussion here. We've got about 30 minutes together. Let's take the first 20 or 25 minutes for some fireside chat here with Jim, which I know is going to be fun. And then after that, let's make this interactive. If you have any questions, just pop up your hand and we'll get a mic around and hopefully make it fun that way. Any folks on the webcast, if you have any questions, just feel free to shoot me an email. We'll try to get as many questions as you can. So with all of that as a framework, Jim, thanks so much for being with us here today.

You're welcome.

Always a pleasure. Yes. No, absolutely.

Lots to discuss, right, from -- I mean, between the last quarter the Analyst Day. Maybe just a good place to start to make sure we're all on the same page. Maybe, Jim, you could talk about the quarter and the strength that you guys saw in Q4. I mean what were you most proud of from Q4 just in terms of the business performance?

Yes. Well, Q4 was an all-time record sales quarter for us, which was great. It was up from the year ago Q4, which had been a blockbuster quarter. So we saw some pressure in small deals, as we talked about, but then offset that with medium-sized and larger deals. So from a sales standpoint, it was great. Probably the thing that was even more exciting is that our churn rate just continues to improve to like really low levels of churn or really high levels of renewal. Our software is very, very sticky. And we have a lot of programs to continue to drive the churn rate in a good direction. And we made a lot of progress last year, 193 basis points of churn improvement in the year versus a goal we had shared with investors to try to get 100 points. So it was a great quarter. Ramped off are a great year from a booking standpoint, from a churn standpoint, a great year from an ARR growth standpoint, 15% organic growth and 16% overall. And then a great year on the margin front on the cash flow front where we hit record levels of margin and record levels of cash flow. So it's fantastic year.

Yes. Absolutely, absolutely. I want to dig into multiple parts of that last quarter. But I think one of the things that certainly I value, and I know a lot of the folks in the audience will is, you spent a lot of time with customers traffic flow. And I think you've got a great finger on the pulse just with what customers are saying right now, particularly on the end markets that your customers are serving. What are they telling you about their willingness to spend right now? How do they think about 2023, because there's a lot of noise there, right from inflation perspective?

Yes. It's a very strange time in the market. There's all these bad headlines and woe is me, the economy is going to fall apart. But actually, most of my customers can't keep up with demand for every customer. Thank you, Matt. That's in the what was me category, there's a handful of them that are basically saying, we can't hire, we can't keep up with demand. When I shared last night over dinner, I'm trying to buy a pickup truck. You can't buy a pickup truck. There are not in the lot. You can order one, it's 4 months. There's certain features they want allow you to order because the supply chain problems aren't yet solved. So there's a lot of companies out there that have huge amounts of demand and in some cases, backlog that they're working on. So I don't know the customers appear not to read the Wall Street Journal, if I'm honest with you. Some do. And where you see the woe is me tends to be smaller companies who are battening the hatches down just in case. Not necessarily that their business has turned down, but they don't have the staying power and they're worried if the economy gets bad, they will wish they had been very conservative on spending. So we're seeing a little bit of that, but in general, lots of demand in the automotive business, the truck business. 2 of our top 5 customers have names like Raytheon and Lockheed Martin and Defense business has never been better. They both make missiles with our technology and all that stuff is being shipped over to Ukraine, is done in our technology. So lots of demand in that sector. Lots of demand in energy, including clean energy and old-fashioned energy, where we need new ways to move it around and so forth. So I think in general, the customers are much more optimistic when you're talking to them than the PMI suggest it should be.

I was going to say that, right? Historically, we've looked at PMIs and have thought about that as a may be a good indicator of what the PTC would look like but it doesn't seem like.

And there was some correlation to PMI in our bookings, not our ARR, but our bookings historically, but we're not seeing that now. That correlation has been broken over the last year.

Yes. That's really interesting. I think it's also interesting just the concept of backlog because a lot of the -- some of the other companies that I cover that serve the construction industries are talking about backlogs in construction. That's an interesting concept in manufacturing as well to actually have a little bit of visibility into their own businesses and backlog.

Yes, for sure. I mean I visited a truck company in Scandinavia, and they have a huge backlog of diesel trucks. And meanwhile, they're making electric trucks, too. And what they're saying is that companies like Walmart and Amazon who deliver things to consumers in trucks, wish those trucks were electric because their consumers would like them more. So there's like a massive backlog in electric trucks and they're made on the same production lines as the diesel trucks are made on. So I mean, they don't see any macro problems, like best business they've seen in a long time.

Yes, yes. So that was not what's saying, I'd love to dig into just the core business here. And I think a really great place to start would be the PLM market. Because I tell you, Jim, it feels like the market has actually gone through a little bit of a renaissance. I was wondering if you could dig into that a little bit. Historically, PLM grew moderately faster than CAD, right, thinking back over the prior years, but now you're seeing much faster growth in PLM. What do you think is driving that?

Yes. I think PLM has become a very strategic system of record for digital companies. CRM as their system of record for customers. ERP is their system of record for finance data, maybe for production schedules, and PLM is the system of record for the product. It's got the definition of the product and all the configurations of the product can or has -- can and has been made in, it understands how the products should be manufactured, it understands how the product should be serviced. And it understands that if you make a change to the product, how do you roll that change down into manufacturing, how do you roll that change down into service. And so there's a lot of investment in digital transformation. And I think industrial companies just say how far could we get with digital transformation if we didn't address what it is that we do, which is we make products. We need the product data under control.

Yes, absolutely. Maybe a similar question just on CAD. In -- on the CAD market, that is, in my mind, this is the part of the business that, I guess, academically, should ebb and flow with employment. And so maybe it's a little bit of a macro question as well, but as you talk to those customers, do you think customers are going to keep their engineering employment stable next year, such that we continue to see the CAD market grow? Or is there a risk that maybe we start to see some changes in employment, which eventually trickle down to the CAD market?

Yes, that makes sense. Our CFO did some research into this, and I don't have the data in front of me here, but I know exactly what it says, and that is over the last 30 years, the investment in R&D really has not ebbed and flowed with the economy. It's been kind of continuous gradually up. R&D investment didn't really go down in 2009, and it's because the engineers that understand -- that build your products, I mean, in their brains is the entire know-how, the crown jewels of your company. And you can't lay those people off and hire replacements back 6, 12 months later because the replacements don't know at all what the people knew who were laid off. So you can lay off production workers. They're just following instructions. You can hire back other people that follow instructions, but the engineers, they're not following instructions. They're the source of the instructions. And they're hard to replace. So people hang on to them as long as they can.

Sure, sure. So we kind of talked a little bit about the CAD and PLM markets. Maybe if we zoom in a little bit to PTC's PLM business, that was really helpful last quarter. How we got to see a little bit of an apples-to-apples compare for the PLM business that really shows that PTC is a category leader here in PLM with the biggest and would be the broadest PLM business. And so maybe the question is, is it as simple as PTC is benefiting from a strong PLM market, they're a category leader, and that's why PLM ARR growth has been so healthy? Or do you think that PTC is taking share from others?

Well, 3 years ago, we weren't the category leader. But along the way, we passed the SAP and then more recently, we passed Siemens to become the category leader. So in a market that is a good strong market, we're clearly doing a lot better than everybody else. We've provided a bridge in our recent Investor Day to help explain this, but there's a couple of main factors. Number one, we're a recurring revenue model, they're not. So our recurring business is always going to grow faster when selling the same amount of seats because the seats stack up over time. And then a perpetual model, it gets a big lump upfront, and then it goes away, and you have to replace it again next year. So that's worth 5 points of growth right there. The second thing is we are taking share. And the third thing is we have a little bit more SaaS in our mix than they do in theirs and SaaS makes deals bigger. So if we were 100% SaaS and they were 0%, we'd be a lot bigger. Every deal would be twice as large. But it's that combination of market is in a good place, and there are some parts of the market that are particularly growthy, like ALM and SLM right now, and we're better represented there than this business model, then share shift, then SaaS mix. And so we're growing 20% in the market that's growing 12% or 13%. But for the last 2 quarters, Siemens posted negative numbers. So PTC had plus 20%, Siemens last quarter had minus 2%. I think they may be going through a valley of death business model transition, but we're on the other side of that. They probably got ahead of us back when we went through that change. But now we're through that change, and they're sliding down into the dark spot.

Yes, absolutely, absolutely. You bring up SaaS and maybe it's a good segue just into that topic because I think that was a really important topic at Analyst Day and I think, frankly, an important growth driver in the years going forward. I think that some investors question whether customers of your core Creo and Windchill tools are really willing to move their tools and designs into the cloud.

Yes.

And -- you spend a lot of time with customers. You've done a lot of due diligence there. What makes you think that your broader customer base is ready for that move to SaaS?

Well, first of all, our Windchill PLM software is and always has been web-based. So you fire up a web browser, you log in, you don't know if that server is in the data center down the hall or if it's up in Azure, Amazon, you don't know. It actually works exactly the same anyway. So Windchill is particularly ready to go to the cloud, kind of always has been ready. The thing we wanted to change on our side is we wanted to get out of the single-tenant hosting business and get into the multi-tenant Software-as-a-Service business. And we wanted to do that for profitability reasons. It doesn't look any different to the end customer, but it looks different to our P&L. So that's why we're going to the multi-tenant version of Windchill based on our Atlas technology. . For Creo, I was explaining to some analysts this morning that think of Creo as being like Excel. And I say Excel because you all probably use Excel. And you're all probably power users of Excel. It's got a lot of capability. It takes years to really learn everything Excel can do. And if somebody came to you and said back in the era where Excel was on-premise desktop technology, hey, we've got this great thing in the cloud called Google Sheets. Do you want to go there? You would have said, no. No, because I don't want to learn a new tool and especially now, if I can bring all my spreadsheets with me and have them work flawlessly. And what if we said, they'll work 95% flawlessly. There's a couple of formulas here and there that might not work. And I'm sure over time, you'll find the problems. You wouldn't go. When Microsoft came out though with Office 365, and said, I'll take you to the cloud. I'll manage all that software for you from now on. I'll give you some better collaboration features. And by the way, the user interface will be exactly the same and all your data will come forward flawlessly. You'd say, okay, the world did say, okay. We at PTC said, sure, sounds great. I don't even remember when we did it because there was no drama. So that's what we're doing with Creo. We're doing with Creo what Microsoft did with Excel, and that is make it very painless to move into a SaaS environment so that you no longer have the cost of ownership of this on-premise technology, and you can benefit from many, many SaaS advantages, including collaboration features and so forth. Good model for what we're trying to do.

Sure, sure. Now I think it was several quarters ago where you talked about the economics with -- maybe we'll focus on Windchill, right, because that's generally available. Windchill Plus, I should say, with Windchill Plus basically for a customer, I think the economics for something like if they're paying $3 for the software plus all the hosting and all the support you can provide it in a SaaS form factor and they can pay $2 all in. But that would be an incremental dollar for you, right, in terms of what you're going to be for the software. So maybe that long-winded preamble there. What's been the feedback from Windchill Plus so far, understanding that it's been early? And what has that multiplier effect been? I think we talked about 2 times, has that been working out?

2:1, again, $1 of on-premise to the cloud and serve back would be serve back for $2. So it's -- that's sort of an industry ratio. So far, we're doing better than that. The lowest deal we've done with Windchill Plus has been at 2.4, and there's been a few of them in the 3s. And one of the reasons why that's happened is the price is roughly double, but a lot of times, we revisit the discount, right? And in the perpetual world, that world was filled with you buy more upfront, I'll give you a bigger discount. You buy even more, I'll give you an even bigger discount. And so the world of perpetual software had very large discounts and the world of SaaS software does not. Salesforce doesn't give 60%, 70% discount. So they couldn't. So what's happening is, as we get in this conversation about the cloud, we say, well, the price is higher, but that discount, we've just got to rediscuss that because that's a perpetual discount. Those level of discounts don't exist in the cloud world.

Sure.

So we're getting double whammy and kind of hadn't really predicted the discount side, but that's proved helpful. Bigger price, lower discount.

Sure.

And still value for the customer. We're delivering more value to them. They're saving money. And so it's really a little bit of an argument of how are we going to split it, right? How much do you get to save? How much do you pay to us for this higher value service?

Right. Because of course, you're taking on the hosting costs as well, right? And all the costs and updates. Well, for sure.

Sure.

I know that we focused on the Windchill Plus because again, that's what's generally available. What's been the early feedback on Creo Plus? I don't think that's generally available.

It's not generally available.

Not yet. But I think we're expecting that for next year. I don't want you to announce anything. But -- are there any sort of early observations from beta customers on?

Yes. We're certainly talking to people. There's a lot of interest, but we don't have it in their hands yet. But -- again, we're just setting the expectation just like Office 365. Same product, you don't have to administer it anymore.

Got it. Got it.

And if you all remember, remember like when somebody used to send you a xlsx file for the first time and you said, oh, I don't have the version that can open xlsx files. Can you please down save it to xls and send it again? Like that kind of conversation used to happen all the time because we're all on these different versions. I haven't had that conversation with anybody in years because most companies have gone to Office 365, and we're all more or less on the latest version, and we just don't have to even think about that stuff anymore.

Yes, yes. Interesting. So we're at the very early -- we're in the very early innings of a conversion to SaaS. But we also have a very sizable, and I would argue lucrative maintenance base here as well. At Analyst Day, you spoke about that maintenance conversion opportunity a little bit. Can we just talk a little bit about the goals for converting that maintenance to SaaS over time? And how long do you think it could take those customers to convert to SaaS?

Well, I mean, actually, the amount of maintenance is left is not that large.

Sorry, I mean subscription. I mean subscription.

Okay. Yes, yes. All right. So -- yes. So just with Windchill and Creo, there's about $1 billion of ARR on-premise subscription. And our view is that not all of those companies will move to the cloud. For example, the U.S. nuclear weapons are designed in our software. They're not going to the cloud, okay? I pretty much don't even need to have that conversation with them. They're on an air-gap network right now. But most companies actually are quite interested. And even the defense companies are getting interested, the Lockheeds and the Raytheons. They 5 years ago, would have said don't talk to us about that. Now they say, well, help us understand what you're trying to do because it's coming. Not today, but it's coming. But your mainstream auto, industrial, those kind of companies, they're ready for the cloud. In fact, many of them have initiatives in the company that move everything to the cloud. We're just -- they're not going to the cloud because of us. It's just -- they're going to the cloud, and we're one of the pieces that have to go. So we have this $1 billion of ARR on-premise. We think as we bring it to the cloud, it will be $2 billion, but we don't expect to get it all. So we're estimating 70%. And we're being conservative in saying over 10 years. So that's $700 million of incremental ARR, we think we can generate in the coming decade on top of normal sales, cross-sell, upsell, new sales, new logo, whatever. So it's a nice growth fill-in. And we said probably phenomenons like this kind of taken on an S-curve. It takes a little bit of time to get going. It accelerates and then ultimately tails off as you get into the long tail. So we're sort of suggesting that year 1 and 2, which would be part of '22 and '23. It won't be that noticeable. But as we get into '24, '25, '26, '27, it should be a good growth tailwind for a number of years there.

Yes, absolutely. And I think at Analyst Day, we also talked about I think PTC salespeople are particularly incentivized, right, to sell SaaS as well.

Yes. Well, the simple first thing is it makes a deal twice as big. So if you're going to sell $1 million on-premise deal and you convince the customer to take it as SaaS, it's a $2 million deal. So right away, you're going to double your commissions. And then even on top of that, we have some additional sweeteners. That's sort of -- we're going to prime the pump mode where we're not worrying exactly like could we pay them a lesser rate on a SaaS deal. Right now, we're like, let's just get the sales force excited about SaaS and have them fill the pipe up with those kind of opportunities wherever they can. So I think over time, we'll get a little bit more nuanced about rates paid on on-prem versus SaaS. But right now, we're saying you'll make more money. Go for it.

Yes, absolutely. I think it's a good segue to ARR growth. And I think one of the most useful slides from last quarter is when we think about that guide, the sensitivity of that guide to bookings growth and churn. And correct me here if I'm wrong, but I believe the high end of your guide of 14% constant currency ARR growth assumes churn would actually increase and bookings would only grow moderately. And I think you said on the call that, that would probably be a disappointing outcome for you personally.

Yes. I mean the way to look at it is the business grew 15% organically last year, and our guide for Q1 is 14% to 15%. So the business is kind of running at that 15% growth rate. Something probably bad is going to happen in the economy, but it hasn't happened yet. So we don't exactly know what's going to happen, how bad it will be, how long it will last. We don't have a crystal ball. So we just said, let's just give the entire range that represents some conservatism, so being prudent. And let's describe how bad would it have to get to get down to the 10% growth rate. It's pretty bad, actually. I think at the 10% rate, we were talking about 200 basis points of churn degradation -- 100 to 200...

100 to 150 basis points.

100 and -- yes, okay. So 15% year-over-year decline in bookings, new sales, and 100 points worse churn. Again, it was 193 points better last year. So we'd be moving in the wrong direction materially. And that still gets us to 10% growth with much higher margins. Our margins are going up 450 basis points, cash contribution margins, next year. So even there, we would have strong free cash flow growth relative to most other companies that are caught up in the same problem. So again, we don't have a lot of science behind that range. We just said we're going to give a very prudent range. And so that nobody panics will explain what it would take to get to the bottom, the midpoint and the high end of that range. And in the high end, it's like modestly bad news, in the midrange is more bad news and in the low end is a lot of bad news.

Yes, absolutely. I thought that was helpful. We've got about 7 or 8 minutes left here. Maybe before I move to profitability in ServiceMax, any questions here from the audience? . Okay. Jim, maybe just -- I mean, you teed it up just when we were talking about cash contribution margin. Maybe -- and I know that the income statement is a little tough to read, but go with me here for a second. I think we always looked at OpEx growth just as a rule of thumb historically to grow at about half the rate of ARR growth. But that's materially different this year. I think on back of the restructuring, I guess the question for you is, what changed in the business that you're still able to grow, I mean, at the low end, double digits, right, on ARR, but OpEx still stayed relatively controlled?

Yes. So a year ago, at the end of fiscal '21, we did a restructuring to pivot ourselves toward a cleaner SaaS model, and we took out 350 heads, which saved us a lot of money, but we had a big restructuring charge that covered it up. So you didn't see that in last year's free cash flow. But as we go into this year, the restructuring charge is gone and that comes through. Then at the end of Q3, we announced that we were making a change to do some internal resourcing shifts. Our IoT and AR businesses we had hoped would be 30% growers, they ended up being just under 20%. And so we said, okay, well, a business is growing 20%, you don't need to spend as much as you normally spend for a business growing 30%. So let's dial the spending back to be kind of in line with the growth rate and shift those resources inside the company, don't restructure them, don't lay them off. Shift them into other parts of the company that have open heads, open headcounts, and then close the open headcount. So we closed 500 positions as a consequent to that. A lot of people said, why are you doing that? And the answer is, well, because we're good stewards of the company. We're doing things you should do but the consequence is we basically avoided 500 hires and removed 350 people. So we're going into fiscal '23 at a headcount level that looks sort of like fiscal '20 or '21. In other words, we've already battened down the hatches. And we'll have a big chunk of margin expansion on top of a good chunk of margin expansion last year. So we're in good shape on spending. Now that means this year, we will have pretty flat spending on 10% to 14% ARR growth. I think going forward, you could imagine it will be back trending towards that 50% of ARR growth rate.

Makes sense. Makes sense. So far, we've kind of focused on the organic part of PTC's business. I think another big announcement from the last call was, of course, the acquisition of ServiceMax. And so I just want to touch on that here a little bit in the 5 minutes or so that we've got left. . PTC had a very successful partnership I believe in 2015 to 2017, you correct me there on the years with ServiceMax. Maybe the question is, why did it make sense to bring it in-house at this point?

Well, because partnerships are hard to make work because that partnership ended when GE acquired them. GE said, we acquired you, so you'd be part of GE, not partners with PTC. So that's kind of the problem sometimes with partnerships, especially when the counterparty is vulnerable. So we wanted to acquire the business back then, we couldn't afford to. We thought it was worth $400. We believed it would take $700 million to buy it and then GE paid $1 billion. So -- sorry, we didn't participate. Then it came back out of GE into Silver Lake. Silver Lake, of course, had to do a carve-out, which was a bit messy, put in the new management team and get the business going again. We wanted to buy it from Silver Lake then, but they said, no, we're going to do it, market is hot. Of course, you all know the market collapsed days before they were going to do their SPAC IPO. So that left Silver Lake sitting there with a business that was all prime to be a high-growth, low-profit IPO, and what are they going to do? Well, they need to sell it to a strategic. Silver Lake is 3 to 4 years into it with this asset, and there's no IPO coming anytime soon, as you would know. So they basically said, well, then we should restructure this business, so it would look like a tuck-in to a strategic. Take out the public company infrastructure we just put in because the strategic is not going to need that. And back off on the growth at all costs and get to kind of more of a rule of 40 type of thinking. . So the company we're buying actually looks quite different than the company described in the S-1 filing of the SPAC IPO. We're buying a company with mid-teens growth and low 20s margins. Pretty attractive, and we're paying multiples that are less than our own. And so the deal is accretive to growth. It's accretive to free cash flow. It's a great financial deal and it's a great strategic fit that we've been pursuing for years.

Yes. Yes, absolutely. I think you addressed a little bit of this question here in your response, but I think we said -- just to make sure we're on the same page. I think we said it's expected to add about $160 million in ARR, I think, you said it was growing mid-teens. Maybe the question here is, are there further opportunities for its...

Oh, there are tremendous sales synergies, which take a little bit of time to develop. So we said about $170 million. And our own guidance is...

Sorry, on ARR. Apologies.

Yes, right. And our own -- it'd be like roughly 10% more, 11% more than we would organically do. So that will give us an organic growth rate of 10% to 14% and then adds 10 or 11 points more for ServiceMax. But in year 2 and 3 and 4, there are enormous synergies. I mean that's why we won the partnership in the first place. It plugs a hole in our offering that has remained there throughout. And it has great synergies with our IoT business, great synergies with our augmented reality business, with our Servigistics business, which has been kick in butt, great synergies with our Arbortext business, which has been doing well and fundamentally consumes CAD and PLM data. So it's really just part of our digital thread story. It's a great strategic fit, great product. Customers are very, very happy and a great financial deal as well.

Yes. That's great. That's great. Before I go on to our last question here. Any last questions here from the audience?

Let me add one more thing about ServiceMax, please. People were generally pleased with our midterm free cash flow guide of $825 to $875. And that's despite an FX environment that's putting $50 million or more of headwind, this Section 174 tax that I think Kristian sized that $70 million to $80 million. So we have some massive headwinds. It turns out that ServiceMax is quite a substantial tailwind. So that acquisition also has its fingerprints on that nice free cash flow guide. And if we get a little bit of help from FX, which has already improved and a little bit of help, if you can all convince your legislators to delay or resend that stupid 174 tax, those would be very, very helpful to us in the out years in particular.

Absolutely. That's interesting. Thanks for adding that, Jim. Maybe one last question here in the time that we've got left. And just from a high level, I understand it's a bit of a financial question. But one question we're trying to ask to all of the companies here at the conference is, how much of your ARR roughly comes from new logo business? And I mean, just given all the years that PTC has been around, how has that sort of fared? How is new logo business fared in recession and prior recessions?

Well, it's a strange question because normally, we start with a small deal and then grow it and grow it and cross sell something else and grow it and so forth. So new logos actually come in as fairly small deals, initially. They end up quite large later. But that means the actual new logo contribution is not that high, even though over time, it will be. So yes, for us, it would be 10% or less.

Okay. Well, I think that's about all the time that we have. Jim, Mike, Matt, thanks so much for the time.

My pleasure.