PTC Inc. (PTC) Earnings Call Transcript & Summary

Okay. We'll get going. Hi. My name is Steve Tusa. I'm the electrical equipment and multi-industry analyst at JPMorgan. Wondering why I'm here. I've taken on a bit of an expanded role covering some of these industrial software names, including PTC today. We have ANSYS coming tomorrow, and I also cover Autodesk. Today, we're very happy to have CEO of PTC, Jim Heppelmann with us. As usual, we'll do a little fireside chat here, and then we'll open it up for Q&A a little later. There is also an ability to provide some questions on the Event Center website if you'd like me to handle those. But with that, Jim, thanks so much for being here.

I think for more of the generalist crowd in the room, maybe just discuss the high-level macro drivers of why CAD, PLM and then the expansion into ALM, which you highlighted at LiveWorx last week, what the drivers are there, why that's so exciting and why that can be kind of an above-average growth story from a market perspective over time?

Sure. So just real quick at a very high level. We're in a category of software called product life cycle management. And that's both a broad category. And then sometimes within that broad category, there's a subcategory also called product life cycle management, so it's confusing sometimes. But basically, the life cycle of a product, say, an MRI machine in the hospital is it's engineered and that can take months or sometimes years. It's manufactured that can take days or weeks. And then it's used by the customer and serviced and supported for decades. So engineer, manufacture service. PTC has a set of products, about 9 brands that are used across the engineering, manufacturing and service phase. Some of the things that make us different is we have a computer-aided design, product called Creo. We have a kind of best-in-class product life cycle management that is the system of record for the digital product called Windchill. We have IoT solutions that are used both in the factory and out in the field. We recently acquired a company called ServiceMax, which does the service solution. Along the way, we also acquired a company called Codebeamer, which is for software, and it turns out that more and more of the bill of material of say, an MRI machine or anything like it is made up of software. So we also have best-in-class tools for managing the software and the software development process for the software that combines with the hardware to make the product. So I think we're unique in the field of ALM, SLM best-in-class with Windchill, Creo is quite great. And then we have a SaaS strategy that's also quite a growth driver. Our industry is historically on-premise industry. And now the industry is kind of waking up to SaaS and PTC is leading the charge to take the industry there. That's interesting from a growth standpoint because whereas an on-premise seat of software might just hypothetically costs $1 per year, that same seat of software delivered to SaaS would be $2 per year. So there's quite a growth opportunity associated with selling seats as SaaS, but also going back into the customer base and converting on-premise seats to SaaS seats of the same software and getting the uplift as well. One last thing is our business model is different than most of the companies we're compared to. Most of the companies we're compared to still have a large mix of perpetual software. We PTC are about 92% software, of which 98% is recurring subscriptions, whether they're on-premise or SaaS, either way, recurring subscription. So that's a growth year model, a much more resilient model. And it's really helped the company perform well even when some of our peers have struggled a little bit in the recent macro time frames.

So let's talk about that SaaS transition you guys are going through that usually the term transition is thrown out for a software company. It's immediately people step back and they're worried about it. This one is looks very accretive unlike prior transitions. But you guys introduced Creo Plus at LiveWorx last week. Maybe talk about how that launch -- what you may be learned from Windchill+, which is well underway at this stage of the game, how you may apply that to Creo Plus and how the expansion of that may end up looking a little bit different and how that can accelerate this SaaS strategy.

Yes. The conversion or business model transition, we previously did perpetual to subscription and that valley of death associated with that was painful, but it's well behind us now, 100% done with that. So the transition from on-premise to SaaS is just upside. Deals just become bigger. There's no downside, no accounting, no deferral of anything. So it is accretive. We launched our first main product there called Windchill+, the Plus version of Windchill last May about a year ago. And then just last week, you were there, we launched the Creo Plus version of the CAD product. These things are a little bit apples and oranges. Windchill is a central enterprise information management system, a big database in the sky, if you will and Creo Plus is really a desktop application downloaded and managed from the cloud. So what do we learn? Well, I think the key thing is our industry is excited about SaaS, but really needs to get educated a lot now. So we knew it would take a while to educate them. And of course, last week's LiveWorx event a big customer event, which we hadn't been able to have due to COVID for a number of years. We had it last week, attendance was great. And we were really able to show our customers what does it take to take your on-premise system and bring it to the cloud and to talk about the value proposition, the extra features, functions, capability that you get as well. So we're off and running. And I think the Windchill conversion is starting to show some good momentum. And the Creo, of course, is just getting started, but it's actually a simpler conversion as well so I think it will get traction faster.

Maybe talk about why it may be simple. And also, as you went through this process with Windchill, maybe some realizations along the way, perhaps some surprises for you.

Well, let me deal with the second part. I don't think we're surprised. I mean we had said from the beginning that it's a growth tailwind, but it will take the shape of an S curve, which means it takes a little bit of time to get going and then should accelerate and then many years later, would tail off. We said that because it's a project to move your system from on-premise to the cloud. And it's a project that has to be planned. It costs money. It takes time and resources and therefore, has to be justified, which means a sales cycle. So we knew we'd have to run sales cycles with Windchill+. We did that quite successfully. We have hundreds of such opportunities in the pipeline right now being worked, a few across the finish line, the field kind of headed that way. With Creo Plus though, it's a lot easier because we're really -- we're not moving all the software to the cloud. We're allowing people to kind of have a refreshed download like Microsoft Office works. So if you use Excel, PowerPoint, Word and you went to Office 365, it's kind of similar to the old office, but now essentially managed as a SaaS offering. So just different technological architectures being pursued just given the nature of the products, one being a central database, the other one being a desktop application.

Are you seeing adoption at certain customers, whether it's by size or by vertical. I know we discussed a little bit at the event last week that government customers maybe are a little bit further down the pipe on that. But how do you expect to kind of the phasing when you look at small, medium-sized versus large or any kind of vertical that may be more interested in converting in...

Yes. I think there's very broad interest and then pockets where it's harder. So almost let me pick on the places it's harder. Defense companies, for example, aren't that excited about moving their data to the cloud and to the extent they're going to, they have a lot of special considerations. So we've deprioritized them kind of said that's a later phase. China, Chinese companies aren't allowed to use American Cloud Solutions, period. So we need a whole different strategy, and therefore, we've deemphasized that a little bit. But everywhere else, and by everywhere else, I mean retail, general industrial, automotive, aerospace, commercial, these companies are very interested in not owning the software, just using it. I like to say, when you go to plug on your iPhone to charge it, you want to plug your phone -- your charger into the outlet. You don't want to have to know how the power plant on the other side is operating and how to upgrade it and so forth. That's -- you just want the electricity, you don't want the power plant. And that's what our customers are saying, we want to use the software. We don't want to do the care and feeding for these complex systems. So PTC, if you could keep that? Or if we could give it back to you, that would be great because we're just looking for the benefits.

Can you provide some of the -- ultimately, as you look out some of the bridge to that ARR growth that you've highlighted over the next several years? what are some of the more important factors? Obviously, the SaaS transition is one of those. Is there anything around price and volume that you expect to change as this progresses?

Yes. I mean I think if we were to bridge. So PTC has been growing 13%, 14%, 15% organically. And this year, you can add another 10 or 11 points on top of that for acquired growth. But if you look at the organic piece, I'd say the #1 thing is expansions. Our software, we tend to get an initial implementation, customer wants to try it out and then they expand it and expand it and expand it. So the #1 driver of growth is expansions. #2 would be cross-sell. We have 9 brands, and we're always selling the second product to the customer who bought the first one and then we're selling the third product after they bought two and so forth. We're very good at that, and frankly, have built these products that way. A third thing would probably be new logos. We're winning new deals. Our products are very competitive. Now a lot of times the new logo win is small and then expands from there. The fourth thing then would be price increases. Obviously, we've been through an inflationary period here where we could get away with quite aggressive price increases and people expected that actually. And then if you take SaaS, because of the S-curve shape, I'd say it's not a big driver of growth, looking backwards. It's not a huge driver right now, but it's starting to show up. And I think as we look forward into '24, '25, '26, it should become a real driver, a real tailwind for growth. And it will move up that list of kind of growth drivers that I just went through. Exactly how fast we've taken a fairly conservative view, so as to not get ahead of ourselves, but it should definitely be a growth driver that would either lift the growth rate of the company or offset other factors, macro or otherwise that might be slowing us down.

It would appear you guys are taking a bit of market share. Can you maybe discuss how you feel you're positioned versus your big competitors in these 2 areas. There's a couple that stand out that are public companies that comment all the time, Siemens, Dassault. Autodesk has a business as well. Maybe if you could just talk about how you think you're positioned to differentiate it versus those guys?

Yes. So let's take PLM where the difference is most stark. So the PLM industry is generally said to be growing at 8%. And PTC is clipping along in the upper teens. So how do you more than double the growth rate of the industry? So first of all, we have a very competitive product, best-in-class product by far, and we definitely are winning more than our fair share of business, so we are taking share. But on top of that, we have a recurring business model and we're being compared to people that don't. And that's worth some meaningful amount of growth. I characterize it's 3 to 5 points of growth right there. Simply because it's much easier to grow a recurring model with sticky software than a perpetual model where you sell the big deal and then next year it goes away and you got to resell another one just to be even again. Another factor would be cloud. We're now about 1/4 SaaS across the portfolio. And again, the competitor might get the $1 order, we get the $2 order. And of course, to the extent we convert $1 to $2, that's a growth driver as well. And then the other factor is there's a couple of subcategories, ALM and service software, SLM, we call it, you can call it service, if you want. These categories are growing much faster than the 8% of the PLM market. So we also have a mix within PLM this growth year. So there's a series of factors. And the bottom line is we're not taking as much share as it would appear. We're simply configured differently, better business model, growth of your assets and we're compared to people who are positioned somewhat differently and can't deliver from their portfolio the same level of growth we can from ours.

And what about on the CAD side?

It's kind of a similar story on the CAD side there. The market has grown 6%, 7%, and we've been growing 10% or 11%. And again, I would give us that business model advantage. We're any time you compare a recurring revenue model to a company doing perpetual nobody would go through that valley of death if it didn't produce this growth on the other side, right? So we're through that valley of death compared to people who aren't. Some who might even be venturing into it, which hurts their reported growth. So I think there, again, very competitive product, better business model. The relationship with ANSYS is important. That's been a growth tailwind. We embed ANSYS technology in our CAD product. That's a key strategy for ANSYS as well because they want to shift left, as they say they want their software to be used not to correct bad designs, but to produce good ones, the first time around. Now in order to produce a good design, you need our software, which is the authoring and their software, which is the simulation checking and validation, if you will, running at the same time together as a single package. So we licensed technology from ANSYS, build it into our product and sell it. And that too has been a good growth driver for us.

You guys made a pretty bold move with ServiceMax, and you presented it last week, I thought really intuitive, the ALM strategy that you're coming at here. Maybe just talk about how differentiated and I feel forward-looking that strategy really is and how that -- how early on you see that manifesting itself in the marketplace?

Yes. If you remember, I said an MRI machine takes months to years to engineer, days to weeks to build and it's operated for decades. During that decades of the product life cycle, you need to really be aware of what's going on with the product. What problems are developing, what parts have been changed, what service activities have been done. You might have heard this term as maintained configuration or as maintained bill of materials. So the actual bill of material of the product keeps changing as you swap out parts and swap in newer ones, you do software upgrades, whatever. So none of the companies in our industry really had nailed this after-sale service activity. Now ServiceMax is specialized in that. So acquiring ServiceMax and bringing it into the PTC portfolio really gives us a full solution for engineering, manufacturing and service that none of our competitors have. I mean, none of them have the service part. They may have parts of engineering and manufacturing. So it's a unique, powerful and creates a lot of value for the end customer.

Maybe just talk -- any early on -- I mean I'm sure you guys in the due diligence, investigated what types of cross-selling opportunities there were. Any early examples of wins here or where are customers most interested? Where is the path of least resistance to customers coming together and using the full package?

Yes. Well, first, it's interesting to note that about 25% of ServiceMax customers were already PTC customers, having made independent decisions to buy from 2 different companies because they understand the value of both softwares working together. So that's pretty good traction without anybody actually trying to make it happen. So of course, now we're promoting it. But many examples, this MRI machine I picked because ServiceMax has a lot of traction in the medical device industry and so does PTC. So there's a lot of alignment. That's like the happiest hunting ground because we're both so strong and we just have to connect the lines together. But anywhere there's a long life cycle complex product that's used for years or decades and requires ongoing service. These are complex, highly engineered products. So understanding the design of the product is pretty important when you're trying to service it. Anywhere that happens, we've got a great connection.

And are you looking to displace competitors? Or is this just more kind of content from the existing customers?

Yes. In the service space, it's mostly homegrown software. Especially for these, what we call asset intensive. Just real quick, there's 2 kinds of service, one that's asset-intensive, one that's not. Not asset intensive, it would be like if you -- your home Internet isn't working and you call Verizon and then they send somebody out with a truck, the person driving that truck doesn't really need to know anything about you or your equipment because it's all commodity stuff. And if the cable modem doesn't work, they're just going to throw it away and install a new one that they have in the truck already anyway. It's probably even a newer generation. Now that MRI, nobody's going to throw that MRI away. And by the way, if it's down, that means we didn't get today's appointments done. We had to cancel them all. And we can't reschedule them tomorrow because we got a full book of appointments tomorrow and the next day and the next day and the next day. So this equipment when it goes down, it's a big problem. And in order to fix it, you have to have a technician that's qualified. You have to have the right parts on the truck. You have to have the right tools and the right software versions, whatever it might take. And you need to know a lot about the asset. There could be 2 MRI machines sitting side-by-side that are actually quite different, even though visually, they might look the same, but in terms of the parts they would need and so forth, they could be quite different. And so that is what ServiceMax excels at. And most of the time when customers don't have ServiceMax, they have custom homegrown software.

And when you think about the growth opportunity there, what do you see as far as organic? And then how much can this combination add from a top. I know you're not assuming revenue synergies per se in the near term, but like how much can the cross-selling add to that.

Yes. I mean the expectation we set was that post acquisition on an organic basis, the ServiceMax software would grow mid-teens and that as the selling synergies leaned in, that would take it to upper teens or potentially a 2 handle. So this is a business that comes in at the same growth level more or less as the company and should, over time, prove accretive to growth.

Obviously, a hot topic, not only in technology, but in the slower growth industrial companies I cover. AI generative design, maybe talk about how you guys are positioned on that front and what you're seeing early on. It wasn't a big topic of the show last week. Was more of a sidebar, but maybe discuss how that influences PTC.

Yes. I mean PTC already has 3 applications of AI in the market. One is around computer vision to recognize an object in the real world in a camera based on the CAD models for such object. And keep in mind, we can configure the CAD models many different ways so we can recognize many different configurations of the physical object. I'll spare you how that happens. It's very interesting, though. The second thing is our IoT software that collects telemetry from example, medical devices at hospitals or clinics is studying that telemetry, saying, is there a message here, predictive analytics to try to anticipate problems and head them off before they become down failures. And then the third is actually generative design in 3D. So there's lots of buzz of course, about ChatGPT. And what's cool about ChatGPT is it's easy. You provide text in and it gives you a text out. It might be software code coming out, it might be written works, whatever. We have a technology that you provide a framing of a problem in 3D and it provides you a full solution back in 3D to actually design the 3D parts for you. So you might say, for example, Here's the space I have to work with, keep the part within these boundaries. It needs to interface to these 2 bolts over here and to this bearing over here, and it's going to have to carry a load of however, whatever force you want to put on it. And I want it to be made out of plastic, aluminum, steel, titanium, whatever and I want it to be 3D printed or castable or whatever. So you give it the parameters and then it says, okay, here's the perfect design. And it's really pretty spectacular because it comes up with designs that few people would have thought of actually sort of like ChatGPT in 3D.

And I mean what stages is this product? And are you seeing a decent amount of interest? I mean how long have you had something like this?