PTC Inc. (PTC) Earnings Call Transcript & Summary

Great. Good morning, everybody, and thank you so much for joining and joining the 2023 Stifel Cross Sector Insight Conference. I'm Adam Borg. I'm an analyst on the software team here at Stifel. Super excited to have with us Kristian Talvitie and Kevin Wrenn from PTC. We're going to kick it off with some questions. We'd love to take this interactive. So again, Kristian and Kevin, thanks much for being here.

Great. Thanks for having us, Adam. And just before we get started, my lawyers would like to remind everybody about our safe harbor other languages and the risks and uncertainties of forward-looking statements. Please refer to our website and periodic SEC filings for a comprehensive list.

Great. So Kristian, you've been a supporter of the conference in the past. And maybe just for those who may be a little bit newer to the story, a very, very brief background about the big opportunities that you're going after?

Yes. Great. Thanks again for having us. And so just briefly, PTC is a publicly traded software company. It's been public since I think, 1988. Today, we're about $2 billion in revenue. We serve what I would call the technical software space, so primarily developing products that help companies design manufacture and service their products, generally complex, longer lifecycle products you could think John Deere, Caterpillar, so on and so forth across a range of industry ranging from industrial to aerospace and defense med device to automotive, some of the larger verticals for us. About 7,000 people worldwide growing top line in the, we'll call it, low to mid-teens here over the past couple of years organically. This year, we'll be north of 20%. We did an acquisition about 1.5 quarters ago. So acquisition there and margins somewhere approaching about 40%. So that's the story.

No, that's a great overview. And maybe a couple of topics will be very top of mind today, macros being one of them. So I'd love to talk about what are the macro dynamics that you're seeing, and how do we think about the impact either to new business to upsells to churn? And how you think about the evolving macro landscape in the context of the guidance that you've given?

Yes. It's it's a mixed environment out there for us. We're all reading a lot of the same research I'm sure, and we're kind of seeing that out in the field as well. As we commented on our past few calls, we have seen some pockets of softness in China, although China is about 5% of our business, but even still, we've seen some softness there, particularly some spots in the SMB space, certain geographies in the channel for example, the channel space for us, which is what primarily serves the SMB. And then oddly enough, that's been contrasted with pockets of strength that we're seeing elsewhere. Right now, the defense industry is doing pretty well. So A&D actually has been doing pretty well for us. Their automotive has been doing pretty well. We did another acquisition almost a year ago ALM product. We were in the ALM application lifecycle space before. We've been in it for about 10 years. This is a much more modern product, small, but really, really doing well in the market and has continued to do well. So we're seeing good pockets there. And then lastly, there's an undercurrent of what I would call, digital transformation that I think continues to help drive the business overall. And in particular, with PLM product lifecycle management, and frankly, if a customer -- we're all going through digital transformations of some sort and in different parts of the organization. We're going through our own as well right now. But if a customer wants to go through a digital transformation or start that journey in the part of the enterprise that we serve, PLM is really the backbone for enabling them to get on that journey and get on that path. And so we've just seen some strong undercurrents from this digital transformation theme as well. Now how does that play out in the numbers, and the guidance we gave on our most recent conference call. What we actually said was we were expecting new business or bookings to be on an organic basis, flattish compared to last year. Last year was a record year for bookings for us. So flattish bookings augmented with incremental bookings from Codebeamer and ServiceMax, 2 of the acquisitions we've done. So we think we'll be in bookings growth territory for the year. And with churn, we guided to about 5.5% churn. We've actually seen better than that in the first half of the year. But for guidance purposes, we said we would expect 5.5% or continued better improvement. So even in this uncertain macro environment, for example, churn has been a pretty solid spot for us, and that's how that plays out of the numbers.

That's a great overview...

if I can actually add one last piece on that because again, PTC having been a public company now for almost 35 years, we've gone through a lot of transition over the years. Obviously, born as a perpetual business back in the day. And then in the kind of 2014, 2015 time frame, we went through a business model transition and went from really a perpetual commercial model to a subscription commercial model, still selling primarily on-premise software, but in a subscription way. And we actually got through that transition in kind of 2020 was really the very tail end of that. Timing proved fortuitous given and the COVID started. And having gone through that transition now, 98% of our software sales which is the vast majority of our business anyways, we have a pretty small professional services business, and that continues to decrease. But our software being a subscription model makes the business model very resilient as well. And we've seen that in the cash flow performance of the business here over the past few years since we came through that. Despite some of the uncertainty during COVID and frankly, despite some of the uncertainty that we're seeing now around the macro, so.

That's really helpful. Maybe, Kevin, to chat with you for a minute. So let's just start with the core CAD and PLM businesses of Creo and Windchill. Both have seen really solid and durable growth in recent years. CAD has been growing, call it, high single to low double digit, which -- with Creo, Windchill has been growing a little bit faster, call it, mid-teens, both above market growth rates, right? So I'd love to understand, and Kristian talked about this a little bit, but what's leading to this above market growth rate? And really, why should this be sustainable going forward?

Yes. So let me just start by, I think what's ultimately fueling the growth is digital transformation, like Kristian talked about. So if you think about our customers. They make complicated equipment using lots and lots of parts. It takes them a few years to engineer it. It takes them a few years to figure out how to manufacture it. And then usually live out in the field for a decade or more. We say long and interesting service life. And so because we have other parts of the suite like we have an AR business, an IoT business and ALM business, when they engage with us, they see a digital transformation use case where we're showing them IoT data in augmented reality in a service procedure, let's say. And we're delivering 3D service procedures to the service technician in order to be more efficient and hit first on fixed rate, hit the commitments to customers, et cetera. When our customers see that, they realize that actually they have all of that data in engineering, in requirements and in systems models and, of course, CAD models and engineering bills of materials and manufacturing bills of materials, service bill of materials, specifications, the list goes on and on and on. At that moment, they realize, okay, all of that data can help me digitally transform not just by product but manufacturing and service, but I have to clean up my digital life kind of thing. They have to go back and make better CAD models with PMI information. They have to be more disciplined about changing configuration, managing the configurations of the product and then being able to flow that data through the rest of the enterprise, say, like, ERP and MES, et cetera. And so what happens is they see that kind of future of digital transformation, but their first step is to do that, which is clean up their digital life. And that's what's driving let's say, core demand in seats for CAD and seats for PLM. And then on top of that, there is the business model difference, which adds, what is it, 1.5 points?

Yes, different for CAD and PLM, but yes, it adds more as well.

And then now as we go through a SaaS transition, there'll be another business model differentiation. And so we think that the digital transformation trend is going to go on for a decade or more. I mean it's complicated transformation our customers are going through. The other thing that's just starting, which is, I think, a secular trend as well, which is many of our customers are among the largest footers in the world. And so they've made a lot of commitments to be more in green in the 2030, '40 and even 2050 range. And so we're talking to them about a better way to design. If they're going to be more environmentally sustainable and their product lives in the field for 30 years, the core of them hitting their greenhouse gas goals has to be transforming the product as well. And so that's actually just starting. So we feel like we have a couple of secular trends in digital transformation and sustainability. And then, of course, the technical software industry is going through this transition to SaaS. And so those are 3 things that I think should go on for the next decade or so.

That's great. And maybe just building upon the SaaSification efforts. So LiveWorx, that was a great conference a few weeks back. And the plus strategy around, obviously, Windchill+ has been introduced last year, Creo+ formally announced a few weeks back. It's just so interesting that design software is one of the laggards in terms of cloud adoption relative to almost all our other areas of software. So maybe help us understand why is cloud -- why has cloud been a laggard, SaaS been a laggard in design software? And what are the advantages that your new Windchill+ and Creo+ solutions offer that could help bring the industry forward to a more modern solution.

Yes. So first, I mean, I think it all comes down to the slowness has to do with people being worried about IP protection. And still, we have industries and even particular customers in industries that are forward thinking that are saying, listen, cloud, not for me, for now, that attitude is changing. I remember one of our customers in Europe Infineon the sponsor for the account, they said, "You need to guarantee us that you're always going to have an on-premise version of Windchill" which, of course, we did because we're committed to that. But because they said we're never ever, ever going to go to the cloud. But now all of a sudden, 5 years later, we're talking to them about potentially moving to the cloud. So then what's the advantages of, let's say, the plus strategy at PTC. So there is several levels. The first level is all of a sudden, you're not going to have to have hardware you're not going to have to have a system administrator. We're going to keep you up to date on the latest versions of the software. We're going to manage the compatibility matrix between all of our software so that you're always on the right version of Creo and Windchill and Codebeamer, et cetera. And so a lot of that, let's say, IT work to keep the engineering and manufacturing service. We take that on. But the next level really has to do with, let's say, kind of next-generation collaboration and interoperability between -- and data flows between the systems. And that's, of course, between hours, but it's also being able to deal with integrations with important other even on-premise systems like ERP and MES, quality systems, et cetera. Because if you think about it, we have picked our largest customers, let's say, there's 9,000 Windchill customers. If you're going to go out and do 9,000 integrations on premises, that's a little bit more difficult than if those integrations are now in our hands, and we're controlling that for the customer. So it enables them to be more modern, more, let's say, have a more rapid digital transformation. And so that's the end, next-generation collaboration next generation, let's say, analytics on part reduction, process analysis, et cetera. So those are the things that will, let's say, accrue to the users and the companies beyond just the cost savings and managing the IT infrastructure.

Thanks for that, and Kristian, as I think about the SaaSification strategy, Windchill+, Creo+, how should we think about not just the pricing outlook, which you've shared in the past, but also the gross margin impact over time, which you've also talked about, how should we think about the arc of those 2 impacts as the installed base versus SaaS over the next decade?

Yes. Well, we'll talk about it over the next, I guess, we can do it over the next few years. Perfect. And actually, for those interested in more of the math, we did a slide on this at our Investor Day back in November. So that deck is still on our website. You can go see the math there. The point is we think that as customers migrate from our on-premises to our SaaS solutions, what's going to happen is, first of all, the customer is going to save some money, and there's a value transfer, if you will, between other vendors. And we think that if they're spending $1 today with us, they'll probably spend about $2 with us, and in the meantime, probably save another $1 or more of their own spend. Now the -- so you go from $1 to $2 in the on-premises software, the gross margins low to mid-90s keep the math simple, we'll just call it 90%. So you're going from $1 of top line at 90% gross margin to $2, I think over the medium term, we're targeting about 70%, probably starts a little bit lower than that in the early days but you're going to $2 at $0.70. So there is some gross margin percentage pressure but the actual gross profit dollars should increase. Now the last thing to remember, and this is what's highlighted on that slide, is given the amount of on-premise software that we still sell and continue to have out in the market, the overall impact to PTC's gross margin over the next, whatever, 3, 4, 5 years, should be negligible. We're in kind of 81-ish percent gross margins today. And even if you took aggressive assumption that said, starting next year, all of our new sales were going to be SaaS and we weren't selling more on-prem, but we still have all those on-prem renewals. And we don't think that's going to happen. I'd love for it to happen. I just don't think that it's going to happen that quickly. Even then over the course of 3 to 4 to 5 years, I think it only actually puts about 1 point or 2 of pressure on the overall gross margin. So you're going from kind of a little bit above 80% to a little bit below 80%. The last piece of that is we also continue to shrink our own professional services business. We have more implementation partners and may continue to absorb a lot of that work. We want to be a software company, and we want the folks who were great at doing implementations to do that. We'll do what we need to, but that's been a shrinking part of the business, obviously, also lower margin. So that's a little bit of a tailwind to the gross margin uplift as well.

Really helpful. So this is either for Kristian or for Kevin, on ServiceMax, right? So we started talking about your most mature biggest contributor there are products with Creo and Windchill, and let's segue to you the newest addition of the portfolio the $1.4 billion acquisition of ServiceMax earlier this year, the largest acquisition you guys have done. So you guys have always been involved with SLM in the past service lifecycle management. So logistics has been a good product for service parts management. But it almost felt like you're half pregnant, if you will, in SLM, not fully invested. And clearly, ServiceMax is a big commitment to going deeper into SLM. So help us understand why is now the right time to go deeper into SLM and the opportunity you see with ServiceMax across the broader portfolio.

Yes. So as I talked about before, few years to engineer, a few years of manufacturer, 10 to 20 years in the field. We always felt like many of our customers make much more money from the service part of their business than they do in their let's say, new equipment sales. And to your point, we've been in SLM for a while, more than a decade with SPM and with Arbortext. But now we actually had a place where we get eyeballs of service technicians because it's ServiceMax is a field service management system. It's about the efficient dispatch service technicians for asset intensive service, which is, as I talked about, matches with PTC customer base, these big complicated pieces of equipment with a long and interesting service life. And so now you can imagine that this idea of data flowing from PLM, whether it be spare parts list or service instructions, service bulletins, et cetera, all those things can flow from Windchill out into ServiceMax, but then also service information can flow back from service technicians back into engineering for better next-generation products and even better, let's say, improvement in products that are currently in the field. And so that's the general flow. So all of a sudden, now we have this closed-loop product lifecycle management. And we also have the opportunity that we're looking at with ServiceMax of managing it has maintained bill of materials. So think about a practice in the field, you'd know exactly what was on it, which you could also give you a much better customer experience, be more efficient with service, et cetera. And so all of a sudden, we have this kind of infinity loop of kind of data flow that we can inact. And you can imagine that we could supercharge, let's say, ServiceMax with IoT and AR to inform service technicians, make that more efficient, build remote service app in the middle of ServiceMax, leverage next-generation computer vision and visualization to help them in efficient, safe and, let's say, high-quality service for our customers, for their customers. And so it's a natural edition. It's also competitively differentiating. We're the only ones that have a big presence in service, if you think about us and Siemens and [ the so and so ]. We feel good about the assets we have now to get this Infinity loop really flowing with ServiceMax is the central, let's say, system of record in service for us now almost like Windchill is an essential system of record and engineering.

That's great. Kristian, maybe talking about the longer-term model for a minute. So a couple of thoughts here. So first, think about your midterm targets are around mid-teens ARR growth, $8.25 to $8.75 in terms of free cash flow, both really attractive targets. So I guess question one is, what's leading to even faster levels of free cash flow growth, call it, 20% plus, I think the CAGR is closer to 25% plus. So what's leading to even faster levels of free cash flow growth than call it, low to mid-teens top line growth in coming years. And as you think about those long-term targets, what are the deciding factors that will get you either near the lower end of those ranges or the higher end of those ranges?

Yes. It's a great question. So we have been growing cash flows faster than top line here for the past few years. Part of that was coming out of the subscription transition. Part of it's been kind of the ongoing margin enhancements that we've been undertaking really for almost a decade now. And frankly, I think there's still some more room to go on that. Over the midterm, I think there's more opportunity there for us. So that should continue to help drive cash flows faster than the top line. There's a couple of other competing factors if you think about tax for example. On one hand, we have some tax attributes that help on the other hand, you've got Section 174 that is kind of going the other way. So there's some puts and takes there, but general operational perspective. The margin enhancement opportunity is what is going to drive that over the medium term. In terms of getting to the higher end or the lower end of the range, I wish it was a simple answer. I'll give you as simple an answer as I can. There's a couple of factors that we certainly watch. One is FX that can have an impact either way. Obviously, interest rates are another one, although right now, we are working and committed to working down the variable debt that we have and over the course of next year. By the end of this year, we're starting our fiscal '24, we should be at about 3x levered, and we should have most of that variable that debt paid off as we get into fiscal '25. So rapid debt paydown. But even still, interest rates, FX. And then lastly, it's really the overall macro and the growth dynamics of the business, generally for investors to help think about a long-term model. We talk about our OpEx growing at approximately half the rate of ARR that's a rule of thumb on how to think about it over the longer term. That actually isn't how we really manage the business. We actually watch what's going on and coming in the door and going out the door and try to adjust spending accordingly. So again, this year, really in a mixed macro environment, we've been pretty judicious with spending. Maybe a simpler way of saying it is, if we had flat bookings, I'm not 100% sure why we would need more people. Now on flat bookings, we'd still have I don't know, low teens ARR growth, so low teens kind of billings growth. So we'd still have growth and growth in free cash flow. But you wouldn't really need more people, so you'd see kind of margin expansion that way. On the flip side, if and when things turn around and we start to see more growth and depending on which parts of the business, we're really seeing that growth in. We'll obviously put investment behind that when it makes sense to actually do that spending. So in those cases, we may be spending in a little bit of a higher rate. But again, it would be in the pursuit of growth and kind of proven growth. So that's how I think about it. There isn't a simple -- more growth is going to lead to the higher end because that may not be true that may lead to more investment and not less growth is going to lead to the lower end may not be true because that means demand is lower and spending is more cautious. And like I said, that's how we've been operating this year. The first half, we were pretty cautious on spending. And now in the back half we've actually released some funding in certain parts of the business, particularly in Codebeamer, actually and continuing to invest and drive some of the SaaSification efforts that Kevin was talking about earlier. So that's maybe a more realistic way to think about how we manage the business. But if you're going to do a model that has a steady macro assumption over time, I think that OpEx at half the rate of ARR growth is a good way to think about it.

Thanks for the really thoughtful response. I know we're short on time, it's about 1.5 minutes left, and I promised audience questions, and I failed. So any questions from the audience, I'd love to clear those ends. Great. Let's talk for a minute about partnerships. Obviously, the Rockwell partnership gets a lot of attention, which makes a lot of sense, but I want to talk for a minute first about the ANSYS partnership. It was great to see Ajei, the CEO of ANSYS on stage at LiveWorx with Jim. And I've always found the ability to embed real-time simulation ANSYS leading simulation directly within Creo as something pretty unique and compelling. And that partnership continues to evolve. So I'd love to hear more about what gives you, I guess, you excited about the partnership and if you're willing to share any type of materiality of how we could think about that relationship to date.

Why don't you have a crack here...

I'll give you the short version. So yes, I mean, we're pretty excited about it. Of course, ANSYS in the middle of Creo. You don't have to defeature miles. It's moving all the analysts left. All of our customers are moving in that direction. And we continue to put more and more sophisticated ANSYS solvers in the middle of Creo to continue to enhance that, and that's going very, very well. And I think the demand of customers is also starting to pick up because it was a little change in mindset there as well. So that's going well, and we're going to continue to go deeper. We announced the grant partnership at LiveWorx, which is -- that's a little bit of a bedrock for sustainability. So we start to centralize our materials database so that when engineers are using materials across our suite, not only do we get all of the mass properties and things like that for analysis work, we also can start to use it for sustainability analysis. And so that's also a really exciting part of that partnership that continues to grow. And we also have some things going on in simulation process data management with ANSYS. And so it's an interesting partnership. It's now at least 3 facets to it that are interesting.

And have you shared anything on materiality, last question?

We haven't really -- I would say, I think it's going well. It's obviously going well enough that we want to expand the partnership.

Great. Thanks, everyone, for joining. Kristian and Kevin, thanks for the time. I really enjoyed the conversation. And everyone, enjoy the rest of the conference.

Great. Thanks for having us again. Thanks, everybody.