PTC Inc. (PTC) Earnings Call Transcript & Summary

Good. We got the spotlights blinding us up here. Thanks a lot for everyone being here today. I'm Brett Klein from the Morgan Stanley Technology Investment Banking team. Thrilled to have on stage with me Jim Heppelmann, CEO of PTC.

Jim, you recently hit over 12 years at PTC, spend action pack, taking PTC from a leading provider of PLM and CAD. You've done a recurring revenue transition. You've expanded into industrial IoT, augmented reality, you've led the SaaS transformation in your category. And the Board just re-upped you for 3 years. What do you see today at PTC that has you so excited for the future?

Yes. I mean there's a lot to be excited about. As you know, we've become one of the fastest growers in the sector, especially by this metric of recurring software revenue, or ARR. We are becoming one of the highest margin players in the sector, and we use this efficiency metric of what we call operating efficiency, but how much of the cash flow we get converts to -- or how much of the incoming cash converts to cash flow. And so we're really starting to creep up on best-in-class growth and profitability performance. And what I'm excited about is I think there's a lot more where that came from. We're taking a lot of share in our core CAD and PLM businesses. They've both been double-digit growers 5 years in a row, which 15 years ago, you would have thought impossible. And this transition to SaaS is extremely interesting because we have a very large installed base of on-premise subscription software. It's already subscription, but it's on-premise. And so now we have an opportunity to, let's say, claw that back in a way, bring it to the cloud and serve it back to the same customers as SaaS. And the reason that's interesting, there's lots of compelling reasons for the customer, but for us, every dollar of subscription we have on-premise becomes $2 of SaaS subscription when served back to the customer, which means we can go back to an installed base that's paying us $1 billion of ARR right now and convert some or most of that in the coming years to SaaS, which would double it. So massive tailwind of growth that's going to help us for 5 to 10 years to come. And I think it just means that PTC is in a position to continuously deliver best-in-class growth in our sector for years to come.

It's really amazing. And let's quickly double down on the SaaS because for some time, people said, maybe even your competitors still say that designers, engineers didn't want to move to the SaaS world, but PTC has been very forward in moving to SaaS. And you've got to be hearing that from customers. That's where they do want to be. So just what is the dynamic out there from the end users when you move to the cloud?

Well, I think historically, our market has been slow, a laggard as a vertical market meant-- well, let's say, B2B enterprise software, in general, is more than 50% SaaS. But in our segment, it's about 5% SaaS. Now I'm a techy, and I've been watching this trend for a long time. And what I saw is that there were two reasons why companies were reluctant to go to SaaS. One is security. Our product has a database of intellectual property, and they were afraid it would get hacked in the cloud. And the second thing was performance. It's also complex computing, and they weren't sure. But both of those problems have been solved. In fact, the security problem has been flipped upside down, where people say, we better get this stuff out of the data center and into the cloud -- a public cloud, a superscaler cloud so it can be more secured.

Actually it's more secured. Yes.

Right. So that argument has flipped on its head, and then the performance problems have largely been solved. And so back in 2019, PTC acquired a start-up company called Onshape, started by the founders of SolidWorks. They did a peer SaaS multi-tenant CAD product. And to be honest, when we were looking at that product, I said this dog is going to hunt and it's going to be disruptive. And if we were to acquire this technology, we would not only own this disruptive new product, but we could migrate the disruptive technology into our mainstream CAD and PLM products. which we've done with our Atlas platform. So I think we're just in a very interesting place where the industry is starting to tip and we're out front in sort of best position to take advantage of it.

That's fantastic. Let's take a step back on a big picture. PTC sells to real-world companies that are actually out manufacturing, designing, building things, operating in the real world, and a lot of investors are asking about the macro. What are you hearing from your customers right now? How is the environment out there for them?

Yes. I mean, I'd say generally strong with pockets of great strength and some pockets of weakness. Pockets of great strength, for example, would be what we call federal aerospace and defense, defense-related products, which that business is on fire right now. And for PTC, companies like Raytheon and Lockheed are in our top 5 customers. And they're very, very large customers who are making large investments right now. Other places like medical devices is doing well. And a lot of places like automotive, electrification or especially software within automotive is strong, and we have a great presence there. So there's some positions of great strength, and then there are some areas that are a little bit weaker. And I'd classify small and medium businesses who are concerned about the macro, maybe starting to hunker down a little bit. So we have less exposure to SMB but it's still important if you want the business to click across all fronts. It would be nice if the SMB business were stronger. But in general, PTC is doing well. We beat our Q1 guidance. Raised it for the year. I feel pretty strong that the guidance we have out there actually allows for quite a substantial downturn that we don't necessarily think is going to happen.

That's fantastic. And then just maybe geographically, U.S., Europe, Asia, many strengths/weaknesses from that perspective on the macro front?

Yes. Again, on the macro front, I'd say China has been slow, and that's macro and geopolitical and COVID all wrapped together in one big hairball. Europe has been surprisingly strong, and maybe the defense is helping us there a little bit. But in general, automotive business has been strong in Europe. So Europe has been surprisingly strong versus macro expectations. And then the U.S. has been consistently strong throughout. So if you look at it geographically, you don't see as much discrimination as if you look at it by size of the company.

Okay. Great. Before we get into maybe more of a product-level discussion, at a high level, PTC talks about enabling its customers to drive sustainable innovation. Talk to us about the sustainability portion of PTC and how you're doing that for your customers?

Yes. So if manufacturing companies want to be more sustainable, and I mean lower their carbon footprint, it isn't long before they realize they need to revisit their products. Because 80% of the carbon footprint of a product is determined by decisions made in engineering. So if you want to change that carbon footprint, you have to go upstream into engineering, make sure engineers are aware of the implications of design decisions and that they're reconsidering them, even understand how green or not green is this product design I have in front of me. So this is a special place where PTC can move the needle, and we're focusing on it now. We're going to talk quite a bit about that at our upcoming LiveWorx customer conference. It's also a new dimension for our partnership with ANSYS because ANSYS has a key piece of technology that would married with PTC's technology. Really allows us to provide a lot of insight in to the degree of sustainability of a given product design and ideas for how to go about adjusting it to make it more green.

That's great. We'll dig into a little bit of the product discussion here, and I'll bifurcate the discussion. So I'll start with your stalwart areas. Creo CAD and Windchill PLM. By the way, you founded Windchill back...

Decades ago. yes.

Before it became part of PTC. These products have been part of the PTC portfolio for decades, but they're still driving real growth. What's the trends here?

Yes, our Creo CAD business has been growing at low double digits, 10%, 11%, 12%. And our Windchill PLM business organically has been growing upper teens, some quarters, 20%. Really, what's happening is we've done a lot of work to these products that differentiate them well in the industry and align them well to digital transformation trends that are happening out there. I can give you a couple of examples. One trend, of course, would be sustainable design. Another trend would be companies have a strategy to have a higher return on capital by introducing new product variants, which create growth. But those variants reuse common platforms, which means common manufacturing and service capacities they already have. So more revenue without building new factories, for example, or carrying new spare part inventories and whatnot. That's a strategy that customers like Volvo AB, trucks, buses, construction equipment, they're all over that strategy. And they feel like it accounts for a large percentage of their pretty high profitability. And they use the justification of moving to platforms really as a justification for moving to PTC. They said PTC technology fits a lot better than what we've been using. So they've, over a period of years, swapped somebody else out and swapped us in. And it's an example of a real growth driver for us.

That's great. Speaking of digital transformation, it's a key theme that you just mentioned. Some of your customers have started utilizing 3D models across engineering, but also across manufacturing and service. How do you think about the growth potential of this trend, no longer just in the 2D drawing world?

Yes. Yes. I mean in our -- a lot of our customer conversations, there's this phrase model-centric. And what they mean is model-centric instead of drawing-centric. And this is important because engineers for decades have been creating 3D models to kind of conceptualize the product design, make sure all the parts fit together, simulate them, whatever, but then there was a process of dumbing down those 3D models to 2D paper drawings, PDF, if you wish, and sending the drawings out to the supply chain and out to the factory and out to the service department. A lot of cases, the recipients of those drawings remodeled them back into 3D models because they said, I actually need the 3D data. So model-centric means let's get rid of drawings, finally, once and for all. It's a gut-wrenching business process transformation because drawings are the lingua franca of many supply chain activities. But it introduces a massive wave of improved efficiency. So this concept of being model-centric, of course, for us, drives a lot of seats. I don't know if you know this, but if I model -- if I send you a PDF, I can make an attachment to an e-mail and you get the PDF, you open it, you look at it. If I send you a link to a 3D model, it's not a file, it's hundreds or thousands of files. They have to have the right files and the right versions and the right recipe to put them together, which means I'm going to send you a link to a PLM system. And instead of clicking and opening a PDF, you're going to click on a link and I'm going to deliver to you a 3D annotated model, which is great and lots of efficiency, but lots of PLM seats. So for us, it's a huge magnifier on the number of PLM seats that an enterprise needs to have in place in order to go model-centric.

That's great. Really helpful detail. Turning to the other side -- or a different side of the portfolio. You acquired cloud-native offerings. You mentioned Onshape earlier for CAD, but also Arena for cloud PLM. These two businesses, while still smaller in scale within PTC, are growing at multiples of the market growth of CAD and PLM. What's driving that high growth of these areas?

Yes. I mean they're disruptive technologies. They're peer cloud. The Onshape 3D CAD system was created by the same team that created the SolidWorks 3D CAD system, which is kind of, let's say, the most seats out there. So this is designed to be a disruptor of the previous generation, particularly SolidWorks technology. And it's just so easy and it brings new real-time collaboration. It actually enables agile product development for hardware, not just for software. So it's kind of a transformative moment for companies, especially smaller ones who are able to process these bigger changes quickly, to rethink where we go in with our CAD and then as well, Arena with our PLM solution. Arena, in particular, appeals to companies who like to use contract manufacturing. So a lot of start-up companies are trying to bring an idea of the market quickly, and Onshape is great with that. And then work with the supply chain to have it manufactured for them. And that combination of products is just nailing it right now for that particular market opportunity. Let me just say, it came up in a discussion this morning with an investor. We did what Adobe did with Sigma. We just did it a lot earlier. So we didn't have to pay $20 billion, right? We saw a technology coming that was going to be disruptive. And we said, you know what? Sure, we'd like to have that technology in our portfolio and let us be the disruptors instead of the disrupted. And just for fun, PTC was actually disrupted 20 years ago by SolidWorks. So my own point of view, because I was at PTC when that happened. My own point of view is we can't possibly be disrupted by the same team twice, can we? So anyway, we acquired that team and their business, and now we're on the offensive side of it.

Get them on your side, that's awesome analogy there. Most recently acquired ServiceMax. That's a business that -- several years ago, you actually had invested in when it was a private business, but now own it. Just closed earlier this year. What do you see with the opportunity as ServiceMax is a part of PTC that's much bigger than what ServiceMax could do on their own?

Yes. It's a couple of things, a little bit related to what we've been talking about. One is model-centric service. How can you reuse that data created in engineering, again, in service, particularly when servicing complex products where you have to understand the product in order to service that? That would be one thing. The second thing would be to complete the product life cycle. We talk about product life cycle management. If you look at the life cycle of a complex industrial product, it's engineered, it's manufactured, it's used or operated by the customer and it's serviced. So now we have a complete solution where this model-based data flows down the digital thread from engineering through manufacturing and out service. And it's quite compelling. Again, for PTC, it's a multiplier on the number of seats that we have. Just for fun, we had a workshop at PTC and one of our elevators in our high-rise building was not working. It was an Otis Elevator. And so I was talking to Neil Barua, sitting here in the front row, the CEO of ServiceMax, joking around a little bit. And I said, "Those elevators are designed in our software in Creo and Windchill." And I went and did some follow-up work and it turns out Otis has 60,000 employees, 1,000 to 2,000 in engineering, 40,000 out in the field. So like Neil, buddy, this 40,000 seats at Windchill out there, can you help me go land them? We're using the same data. So it's very, very compelling for us.

That's great. And in your own materials announcing you had the infinity loop. What are some of the cross-sell opportunities you see? You've hit on some of them already. But taking the ServiceMax product into the PTC customer base and then some of the product synergies?

Yes. So there's kind of two dimensions of synergies at the product line, and then I'll come back to selling. So first of all, PTC already sells 4 products to service departments. We sell Arbortext, which is for technical publications made from model-based data; we sell Servigistics, which is for parts optimization so that you can meet all your service level agreements with much smaller spare part inventories; we sell our IoT software for remote monitoring, predictive analytics, and we sell our augmented reality software to bring model-based data down into the service process. So bringing ServiceMax in gives us kind of a hub-and-spoke model, where ServiceMax is the hub and these other technology become spokes. So it knits together our whole suite into a suite as opposed to discrete products. The second thing is that whole service suite knits into our CAD and PLM suite. So kind of like two hubs linked together and then the Service Hub having spokes as well. So there's lots of product synergy. I mean, we have a fair amount of engineering work to do to bring it all to life. But selling synergies, it's easiest to look at it this way. For every customer that ServiceMax has right now, PTC has about 10 customers of matching profile. So it's a huge cross-sell opportunity to sell ServiceMax into PTC accounts, leveraging incumbent positions we have and of course, to sell -- cross-sell within the service suite as well. So I'm pretty excited about it. It takes a little bit of time to get this all ready and ready to go, but there's going to be a real revenue synergy here for us.

That's fantastic. We're going to put in a quick plug for LiveWorx coming up May 2023. I hope to be there this year myself.

Can I comment on that for a minute because we were inviting our...

Yes. Yes, please.

This is a customer conference. Customer partners also an investor conference. If you want to get to know PTC, we have a track for you but you sit next to customers in sessions, listening to product managers and so forth, it's really an immersive opportunity. It's not to come and listen to PTC management in a private room, it's to actually go out and swim with the fishes learning about and interacting with the customers.

I can vouch I've been -- and really was an eye opener and helped me learn more about your own business. You previewed a little bit that at LiveWorx this year, you'll go deeper on PTC's Plus strategy. So I don't want you to kind of bear things that are saved for that day. But what can you share at a high level for the investors in the room around the Plus strategy? And what they should expect at LiveWorx?

Yes. So we have these well-known products, Windchill, Creo Vuforia, ThingWorx that are, to a large degree, on-premise today. So we've come up with a concept we call the Plus strategy, Windchill Plus, Creo Plus. These are the multi-tenant SaaS versions of the same products that are upward compatible. So if a customer has Windchill on-premise, we're showing them what they could be doing with Windchill Plus in the cloud. If they have Creo on-premise, we're showing them what they could do with Creo Plus. Now it's the same base product plus SaaS, but plus a lot more, plus deeper integration, plus new innovation that's happening on the cloud side, plus better cost of ownership, plus regular upgrades, keeping you on the latest versions, all that all the benefits of SaaS you get from anything from Salesforce to Work data, Office 365. So it's an exciting moment for us to really launch this whole new parallel SaaS strategy that's upward compatible for the current products.

Might need to rename it the triple plus or quadruple plus strategy. That sounds really exciting. I look forward to being at LiveWorx to hear more. Let me take a quick pause here and see if there's any questions from investors in the room. So wave your hand up. I got one over here. We'll bring a mic over quickly.

Just a quick question on the credit rating. Is that something that the company thinks about when handling capital allocation?

Well, I think we're comfortable with the credit rating we have, and we certainly wouldn't want it to go down. I think probably what's underlying the question is when we acquired the ServiceMax company, our debt level rose up to 3.4x. I think it is. In a couple of quarters, we'll have it back down to a 2 handle. We're generating a tremendous amount of cash this year. I think we're currently guiding to $570 million, right, Matt?

$575 million.

I want to make sure I said that right. So $575 million of cash flow. We'll pay that debt off in 2 years. Basically, you're paying down to a level sooner than that, that lets us go back to buying shares back as we previously had.

Here, we got. One right down here in front. Here comes a mic.

Just on Onshape. Could you maybe talk a little bit about the differences and the benefits that you bring to a customer and this having been designed from the ground up as a multi-tenant product versus SolidWorks and Autodesk migrating on-premise products to the cloud? And maybe secondly, you talked about Volvo. And so it looks like a standardization deal on you. Is that a trend you're now starting to see that customers in the industries want a suite provided by a vendor rather than stitching together CAD data management from different vendors?

Yes. Okay. So on the first question of Onshape, the key thing about Onshape is it's a pure cloud system. It actually has a database in the cloud that all of the users are transacting against. So there's no concept of files. You log in a web browser, you interact with 3D data, which means everybody is working at the same time on the same data. So it's a real-time collaboration across the company up and down a supply chain. Why that's important? Is if you wanted to do agile product development, develop hardware like you develop software, which is going to happen and it's going to be transformational. You really need tools that allow you, for example, to do daily builds every day see the latest changes from everybody. If a file is checked out to a supplier and they're not going to send it back for 2 weeks, you can't do daily builds. So this idea of scrum teams, everybody being able to access the 3D data without any preconditions, no special hardware, no special software installation, just log in and participate, it's going to be a breakthrough. And I'm very, very excited about -- not that Onshape is cloud-based CAD, but cloud-based CAD enables a disruptive way of developing products. And agile product -- agile software development has completely taken over software, but not hardware. Now we have an opportunity to do that. And then the second question was -- yes, Volvo standardization. So yes, Volvo did standardize on PTC. And I'd say ANSYS as well. So I think what customers want is a suite of good products, great products that work together. And they want them from customers that are open and give them choices. So for example, Volvo didn't standardize on PTC in one failed swoop. They first decided to use our PLM in part of the company. Then they decided to use our PLM in all of the company. Then they decided to use our CAD product. But in each case, the new products had to work with the old ones. So it requires a very much open approach. Where you're not saying throw all that stuff away and buy all this new stuff for me, but you're willing to take it a piece at a time, prove some value and position yourself to get the new one. There's a lot of companies wondering what they're going to do next. And I think this idea of best-in-class products that are open and work together are very attractive.

Any other questions from investors? All right. I've got a few. I'll give you one more shot. We have about 5, 6 minutes to go. Jim, you referenced the recent earnings release and the raising of guidance, but let's just go back to that quickly. So yes, you put out a great number to start the year, brought up guidance for the full year. There's still uncertainty out there though. But what gave you guys the confidence early in your fiscal year to raise guidance already at this point in time?

Yes. I mean coming off a year of 15% organic growth and steering into what could have been a pretty bad economy, we were a little bit wondering how to guide without a crystal ball. And so we guided 10% to 14% organic growth, which is quite a -- room for quite a bit of slowdown. And so in Q1, we did see some pockets of softness, as I mentioned, particularly in SMB, but not at all what it would take to cause the low end of that growth to be any more viable. So we took up the bottom of the range, which takes up the midpoint. We basically went from 10% to 14% to 11% to 14%. And again, it's just because even though we saw some pockets, we were actually prepared for something much worse in our guidance. So I mean, hopefully, we'll do that again as the year progresses, but let's take it one quarter at a time.

Excellent. Let's turn to margins and cash flow as well. Unfortunately, rifts have been very frequent around tech this year. But you actually came out on the most recent call and highlighted the cost initiatives and operating initiatives you've actually implemented over the past year -- 2 years, frankly, and don't anticipate the need for any reductions. What things have you done to be in this unique position?

Yes. I mean we're in the middle of a very large margin expansion phase right now. This efficiency margin, again, how cash inflows convert to cash flow. If you look at that, last year, we were at 32%. This year, we're guiding to 37%. And we're guiding that by fiscal '25, we should be at 40%. And I'm telling people, there's room beyond that because we think the glass ceiling, you don't hit that until mid-40s. But really what's happening is we're looking at a very large margin expansion based on actions we took many quarters ago. One was a restructuring we took at the end of fiscal '21, which then gave us a restructuring charge in fiscal '22 that kind of obfuscated some of the real progress we made, canceled out some of the margin expansion. Of course, now that restructuring charge is behind us and all that margin is coming through. So we -- basically, we're ahead of it, a little bit like the Figma story being a few years ahead of it. We were leaning out our cost structure 6 and 8 quarters ago. And now we're sitting here looking at a major expansion in margins and feeling pretty confident about it. Like we're not out over our skis at all. In fact, for us, we're planning to hire 300 people. Now for us, pulling back would be like don't hire 300 people or don't hire all of them, but we're nowhere near layoffs and nowhere near any kind of restructuring. We just feel like we're in a really great position.

That's fantastic. Let me check any more questions in the room from investors in the last minute or 2 here? If not, all right, Jim, one last one then for me and then we can wrap here. But you kind of hit on this is my first one. But looking out 5 years from now, let's just say, how do you envision PTC? And that I get to the excitement of all the opportunities for you.

Yes, I mean I've been, as you know, for a long time, working to make us the premier company in the sector, and we're getting there. We passed most everybody in growth rate, kind of mid-teens organic growth and we're getting there on margins. This cash controversial margin, 37% going to 40%. That's pretty high in our peer group. So I really do think PTC is positioned to be the best-in-class peer amongst peers. And we're sitting here right now at kind of a multiple discount. It's a little hard to understand, and I think probably won't persist. And therefore, it's quite an opportunity for us and our stakeholders to participate in some meaningful upside.

Incredible. Jim, thank you so much for being here. Thank you for being a partner of ours. We look forward to continuing that LiveWorx, May 2023. Be there.

Great. All right. Thank you, all.

Thank you, everybody.

Thanks. Bye.