PTC Inc. (PTC) Earnings Call Transcript & Summary

So I think we'll go ahead and get started. My name is Jason Celino. I am the vertical software analyst here at KeyBanc. I have the greatest of pleasure introducing with me Kristian Talvitie, the CFO of PTC.

Nobody has ever introduced me that way.

Well, I'm the first then. Yes. I think maybe the first question, we'll just get it out of the way, CEO transition. I know you can't speak for Neil or Jim, specifically, but I know you've had a lot of meetings over the last week. Maybe just speak to what the -- a little bit about it, maybe some of the feedback and how are you kind of thinking about it?

Yes, sure. And obviously, also, just before we get started, my General Counsel would be very upset with me if I didn't remind everybody about forward-looking statements and risk factors that are all outlined in our periodic SEC filings and on our website, so I would encourage you all to go and look at those as well. So thanks for having us here at the conference, Jason. And yes, it's exciting time at PTC. For those who don't know, Jim Heppelmann, who is the current CEO, has been CEO for, I want to say, the past 13 years, and been with the company for twice that amount, was the founder of Windchill, one of our largest product suites today. After a long run at PTC has announced his intention to retire. So that will be happening in -- whatever, February, in conjunction with our Annual Shareholder Meeting. Jim will officially hand over the reins to our CEO-elect that was just announced a couple of weeks ago on our earnings call, Neil Barua. Neil came to PTC with the ServiceMax acquisition. He's been with PTC now for about 7 months. He was CEO of ServiceMax for 4 years prior to that as well as CEO of another privately-owned software company as well. The transition process has been underway for some time. The Board it's one of their primary responsibilities. So that's been a process that's been underway for some time. They've also engaged outside help in terms of Korn Ferry, CEO succession practice. And he had been looking at various internal and external candidates. And then as Neil came into the mix with the ServiceMax acquisition, he actually showed up really well and impressed the right people and kind of got put into the mix and went through the whole vetting process, which was quite comprehensive and came through with very high marks and ready to take the job and ready to take it. Almost now, we have this kind of 6-month transition period where -- which I think is good from an orderly transition perspective, it gives everybody time to process the news, gives Neil some time to spend a lot of time with Jim and even the rest of the management team. Well, Jim, in particular, get out on the road, meet with customers, meet with partners, meet with employees around the world and obviously, shareholders, and we've been meeting with a lot of shareholders here over the past couple of weeks giving them an introduction as well to Neil. So that was really the process. So I think it's... [Audio Gap]

With PTC. And I guess, can you frame what you're seeing currently? And maybe any interesting thoughts from your most recent quarter?

Yes, the macro continues to be a -- it's a pretty murky environment. You see positive signs and negative signs kind of all over the place. And they don't always -- they don't necessarily always line up. You look at PMIs are -- have been getting progressively worse. Our business has actually been holding up pretty well. And then there are pockets where it's been softer. We've talked about before. This isn't a new incremental softness. This is just a softness we've been covering here for the past 3 or 4 quarters. But China continues to be soft. It's a relatively small part of the business, about 5% of the overall business. But the environment there continues to be soft. There are pockets in Europe, particularly through our channel, which generally tends to concentrate more on kind of the SMB space has been softer. Even in the U.S., back to that kind of SMB space, we see it with assets like Arena and even Onshape to a certain degree. That focus on that end of the market, and that seems to be soft. There's still selling software and so on, but it's just not as robust of an environment as it had been, we'll call it, a year or 18 months ago. On the flip side, we also see pockets of strength. We had acquired a few months ago a company called Intland, a product called Codebeamer, that's what we call it [ Co-beamer ]. It's ALM, application life cycle management, which is really for software requirements management and for companies that are putting increasing amounts of software into their products. This is increasingly important area for them to think about, and in particular, highly regulated industries like auto or med device, [ A&B ]. And we've been seeing some good pockets of actually strength with Codebeamer, for example. And then just generally speaking, we'll call it, fighting the headwinds. You also have tailwinds for some of the core parts of the business like CAD, PLM, which is just general, we'll call it, digital transformation that's going on in the part of the enterprise that we serve, which is kind of the engineering through to manufacturing and service, but the -- getting the engineering data more broadly leveraged throughout the organization, that's becoming digital transformation that's happening. And you're really leveraging -- the company's leveraging a PLM system in order to do that. So it's still a little murky out there. But...

Yes. I mean all things considered, PTC had a pretty good quarter. You accelerated ARR organically to 14%. So even if it is murky, you guys are executing well. Where would you say that source of strength -- or if you were going to bucket it into a couple of places, where would you say you're seeing it?

Yes. I mean probably the latter parts that I was just talking about, which is in PLM in particular, Codebeamer continues to execute well. I would probably highlight those 2 areas.

Okay. And then I don't want to get too technical, apologies for everyone in the audience. But you've done a pretty good job of positioning investors to think about sequential ARR, that whole process. I think in the beginning of the year, people questioned the second half ramp or the implied second half ramp. But you've gotten to flatten it. Maybe can you speak to why you've been able to flatten that ramp and maybe some of the strength from that?

Yes. Sure. To be honest, I think it's really just a function of math. We started the year with a wide range on ARR guidance for the year, 10% to 14%. And the full year ARR guidance because it's a year-over-year metric, that's actually the Q4 year-over-year compare. And just where we started with kind of midpoint of guidance after Q1, after Q2, after Q3, we've been raising the low end of guidance as the uncertainty around, geez, how bad could it get? And what would that do to the top line has just alleviated every quarter, and raising the low end of guidance, left the high end where it was. And frankly, it's just math then that the implied ramp just gets smaller throughout.

Okay. And then you mentioned the initial guide that you gave last year, the 10% to 14%. It sounds like you're thinking of the same framework heading in the next year. I know a lot of things and still need to happen, obviously, with visibility, but you're obviously confident enough to think of it that way. Maybe can you speak to what would need to happen to the business if you were to fall below 10%? And then what would need to happen if you were to see things at the high end, the 14%?

Yes. Sure. Thanks. And just to be super clear for everybody, we didn't actually provide official guidance.

I said framework. I said framework.

We said I wouldn't be surprised to see a framework like we used last year. I think those were my exact words. I would encourage everybody to read those from the conference call transcript. But in any case, I do think it's a reasonable framework especially given the ongoing -- we'll call it the ongoing uncertainty in the macro. To get to the low end or below the low end, well, let me try it this way. At the beginning of last year, when we gave this 10% to 14% range, we kind of bookended it, and we were talking about bookings, we'll call it, new business and said, for us to be at the bottom end of the range, new bookings would have to be down about 30%, and our churn would actually have to get worse by a couple of hundred basis points. So I think that framework generally holds. The reason that we picked those numbers, frankly, the down 30% is because that's actually what we saw. If you go back to 2009, although we were a perpetual business at the time, so it had a very different impact on revenue and cash flow, but revenue in particular. So it's not unfathomable that something like that could happen. Could it get even worse? Who knows? Sure. I guess it always could get worse. But that seemed like a pretty good low watermark. In terms of the churn, we actually get a lot of good questions from investors trying to understand what happens to churn in this kind of macro environment. And frankly, even if we went back and looked at some of the choppier periods historically, because the software is so sticky, we actually haven't really seen meaningful upticks in churn, but we thought we would build that in into that guidance scenario. So that's what would have kind of gotten us to the low end of the range. Same kind of situation here. To get to the higher end of the range or above the higher end of the range, I think we'd want to see more macro tailwinds happening to be honest.

Okay. And then you also provided some commentary on the framework for free cash flow next year, but I thought it was impressive that you were kind of saying regardless of what ARR will do, we feel pretty good of doing free cash flow of you said prior targets, those prior targets were $700 million to $750 million. So what enables you to have -- be so confident that regardless of what you do on the top line, you can still hit whatever free cash flow number you set you mind to?

Yes. It's another great question. It's a little bit how we -- actually a lot a it how we actually operate the business and how we run it. Meaning, in an environment like we're in now, where we're not really seeing, we'll call it, new sales growth. We're much more judicious in the investments that we're making. And because most of our top line inflows are all subscription-based inflows, and we're almost 98% of the software top line is all subscription. We have pretty good visibility into that. And so we're cautious about how and when and where we invest. And by the way, we said the same thing last year -- or this fiscal year at the beginning of the year. We said we were going to do $560 million in free cash flow regardless of that 10% to 14% range. Because if we're growing at the lower end, we're going to be even more judicious on costs. And frankly, if we're at the higher end, it means good things are happening, we're probably going to be investing more. And every quarter this year, we've actually ticked up the first 3 quarters. At least we've ticked up that cash flow guidance throughout the year and noted that we're actually even making some investments in certain parts of the business despite it being murky out there, certain parts of the business in the back half namely Codebeamer, some Windchill+ investment, in particular, were 2 of the bigger areas that we're looking at. So it's really about managing timing of spend. The churn is basically what it is.

I mean, staying on this free cash flow topic because I think it's important and then kind of tying this back to the CEO transition, should investors -- is it -- well, is it unfair for me to ask if investors should think of any change in some of this free cash flow focus? Because to me, it sounds like you've been kind of the architect on the free cash flow.

Yes. No, these are the 2 primary metrics for PTC for sure, which is ARR, which for us, again, is annual run rate, not revenue and free cash flow. For the reason just for the audience, the -- I won't get into the meat of it because I have on numerous conference calls in the past, but really the P&L is a very difficult tool for us to use because of ASC 606 revenue recognition. And so it makes it not a very useful tool. We don't actually use it internally for decision-making purposes. And so again, that kind of framework and model, I would not think is going anywhere anytime soon.

Okay. And I know you spoke to the confidence on next year's, and it sounds like it's just related to timing and certain tailwinds that you might see. But in general, over the next 2 years, PTC should grow free cash flow faster than the top line, right? So that means you have to drive leverage somewhere. So I guess how would you assign some of the nonobvious margin improvement, free cash flow improvement areas? I know you gave some layer cake picture in your deck in the corner. But maybe we'll start there, and I've got some questions after.

Yes. Again, I think the subscription business model is super powerful because again, we're kind of starting next year with the same, we'll call it, base level of free cash flow and building on that with incremental sales, right? And so just looking out, we do feel pretty comfortable with those targets with the level of investment that we think would be required. And again, if it was the lower end, that would mean turbulent macro. If it was the higher end, that would mean that we're going to be investing more. But again, a lot of our spend is really indexed more to bookings than to ARR growth. And I think that's important to remember. And because that's also how we make the decisions internally. So...

Okay. I know there's different buckets within OpEx. But when we think about budget discipline. How do we know you're not under-investing in important areas like R&D?

Yes. Well, number one, we don't think we are. We have a pretty disciplined approach to how, when and where we're investing. I'll give you a good example, actually. At the end of fiscal '22 as we were coming into fiscal '23, and we were thinking about investments. What we ended up doing was actually reallocating resources internally. A lot of that was actually on the R&D side. Reallocating them out of, in this case, really the kind of IoT AR business and into other areas that had, we'll call it, more tailwinds and still need like Windchill+, like some of the other parts of the business. And the reason that we were doing that was because we had been investing in IoT and AR like they were going to be growing top line in the 30-plus percent range. Well, we had done that for a number of years. And ultimately, I think we ended last year just short of 20%. And I kind of said, okay, we think 15% to 20% is probably right for that market for right now. They're still super important businesses for us. We think that the application of augmented reality and IoT technology in an industrial setting is a very exciting kind of long-term play. But we also said -- but we can't be investing in something like it's going to grow 30% when it's going to grow 15% to 20%. And so we've reallocated resources, what that ended up doing. Frankly, we closed, I think, around about 500 open recs that we would have hired otherwise into the business. And frankly, I think we've seen earlier this year in the tech space and some folks were -- had been hiring and were then shedding. So that's kind of the disciplined process that we go through. And again, it's not a one-size-fits-all. We just talked about it earlier. Even in the back half of this year, we're investing more into Codebeamer, more into Windchill+. Some of that investment is selective. And again, we manage it pretty tightly.

Okay. And then maybe last question on free cash flow. So obviously, different companies have explored different tactics to hit certain free cash flow targets and growth frameworks. How do we know that PTC is not trying to pull things forward, like others have done?

We bill annually upfront. I don't know what else to say other than that. That's the model that we have. There are various tactics, but I don't want the complications to be honest with you, really. And honestly, we have customers sometimes that say, "Hey, like we have the cash. We want to pay you the whole TCV right now." And sales team is like, "Oh, this is great." And I say, "No, tell them we don't want it. Thank you very much, just this year's bill, please?" So it's just the operating philosophy that we have.

Okay. Perfect. And then when we think about some of your different growth opportunities. The one that's more longer term, but seems to be getting kind of interesting is cloud. So with Windchill+ and Creo+, these have been launched in the last year. Maybe can you speak to what you're seeing there in terms of early feedback? And then what kind of like uplift we should see, if any?

Yes. So again, just for folks in the audience, we started talking about Windchill+ a little over about 1.5 years ago probably. And Creo+, we actually just launched at LiveWorx a couple of months ago. And those are really the SaaS versions of on-prem Windchill, which is the PLM product and on-prem Creo, which is the CAD product. This particular part of the software industry in general has been a laggard in terms of moving to SaaS relative to CRM, HCM, ERP, there are various reasons for that. I don't think we have enough time to get...

No. We have 2 minutes.

Various reasons for that. However, in the end, we do believe that this part of the industry as well is by and large, going to move to SaaS. We've seen tailwinds over the years, with customers actually wanting us to do private cloud implementations for them of Windchill, for example. We see it in other assets that we've acquired like Onshape first -- industry's first native SaaS-only CAD application, and we see it in discussions that we're having with our customers. So they want to move in that direction. The reasons for that, again, not enough time, but reasons for that for SaaS, why they want to do that? It's just, I think, in the end, a -- it's just -- it's a better model for the delivery of software and for the functionality that they can get let alone, they don't have to manage infrastructure for it. But it's a better -- and it allows better functionality and perhaps even security. So it is going to move. The question is how long is that going to take? Enterprise apps, it isn't just the software switch out. Now you've got processes charter embedded throughout an organization. So there's a matter of timing and when contracts are coming up for renewal, what version they're on, what industry they happen to be in, so they need to be ready. The software needs to be ready. But we're seeing some momentum here. Still early days, but we've got a few customers up and live. We've got a bunch more in the pipeline and the dialogue continues to...

Okay. And maybe since we only have a minute left, 2 closing, maybe 3 closing questions.

Speed round.

Yes, speed round. So we do a lot of informal survey work. We're trying to ask this to all of our presentations today, and we're not trying to make these hard questions. So yes or no. So exiting your quarter July versus exiting your previous quarter, would you say business has improved, business environment?

No.

Well.

See how easy that was. Yes, no.

And then second question, generative AI, do you think PTC can monetize it directly? Yes or no, yes or no.

It's a complicated question.

Okay, fine.

Yes, over time, but it's 3D modeling, not ChatGPT.

Got it. And then last question, I know this is your first Vail conference. First impressions for everything you've done so far.

Yes. I think it's actually -- it's a great environment. I think what makes it great is actually the people and the quality of the questions. So I'm happy to have made the trip out here. We've got a good set of meetings and a good set of questions. So thanks very much for having us.

Perfect. And with that, I want to thank Kristian for making the trip out and for everyone listening in today in person and online, and I hope everyone has a good week.

Thank you.