PTC Inc. (PTC) Earnings Call Transcript & Summary

All right. Well, good morning, I believe, still, everybody. Thank you so much for joining us. So my name is Hamza Fodderwala. I'm a U.S. software analyst at Morgan Stanley, and I have the pleasure of hosting Kristian Talvitie from PTC as the Chief Financial Officer. Before I begin, just a brief programming note. For -- if we're in disclosures or Morgan Stanley disclosures, please see the Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. With that, Kristian, thank you so much for joining us.

Well, Hamza, thanks for having us. And also before we get started, I'll remind everybody that we have disclosures as well and risk factors that are all outlined in our Qs and Ks and available on our website and the SEC website, and I would encourage everybody to go look at those risk factors. My legal counsel will be very angry if I didn't share that upfront.

Got to get those disclosures out.

So Kristian, maybe for investors who are newer to the PTC story, was wondering if you could provide a brief overview of the mission statement. Obviously, PTC is software for people who build and make things, which serves a few software companies of. So just talk a little bit about that and what the opportunity you see going forward?

Yes. Great. So PTC is about $2 billion in top line. We're about 7,000 people. We generated $587 million in free cash flow last year. We are a provider of technical software to companies to help them design, manufacture and service their products. And you can think about that in a wide range of spectrum, think about companies like John Deere or Volkswagen, Raytheon or Trek bicycles, right, all designed their products -- designed using PTC software. So that's -- it's a global company, obviously. About 35 years -- coming up on 35 years as a stand-alone public company.

Yes. Maybe just turning to the most recent performance. You capped off a pretty good year despite the macro being soft. Can you talk about some of the things -- some of the product initiatives that really drove the solid year for you guys?

Yes. So just as a reminder, we did -- top line growth was approximately 25%, which included an acquisition of a company called ServiceMax that we did at the beginning of our second quarter. On an organic basis, we did about 13% growth in our fiscal '23, we're on a September year-end in our fiscal '23. It was a solid year. I'd say it was -- it's the macro environment has been challenging, for sure. From a net new ARR perspective, we actually were about flat with the prior year. I think 2022 was a much more robust macro environment. That said, still kind of flattish in terms of new ARR generation on the top line, driven by solid performance in some of our core products like CAD, computer-aided design, grew about 10%. The market has been growing at a healthy, we'll call it, 7%, 8%. We've been outpacing the market. I think we would probably argue that's largely because of a business model, which we can maybe get into later. Another solid contributor last year was our PLM business, which is product lifecycle management and this is really allows for the collaboration and configuration management of those CAD designs, both within the engineering department and outside the engineering department. We've also seen some, we'll say, other pockets of strength, one being ALM, which is application lifecycle management. which is really test and requirements management for software. And you see more and more software going into products these days, so that's becoming important for our customers and the complexity of their product portfolio. And even if you think about cars, makes and models and you can have two of the same cars that have two different software configurations, kind of keeping track of all that is important for them as well. And then, lastly, I guess I would highlight -- so that's part of the cross-sell. I would highlight some of the cross-sell that we've also had with SLM, which is service lifecycle management. That was a big part of the ServiceMax acquisition that we did. That's what they do, field service management for complex assets in the field. So we've been seeing some early successes there. And then, lastly, we also are in the early innings of transitioning from a -- an on-premise subscription, already a subscription business model, to a SaaS delivery model. So it still remains subscription, it will just be a SaaS delivery model. So there have been a lot of different layers of kind of growth drivers that have been hitting at different times to help maintain the top line growth that we've seen.

Yes. Definitely want to dig into that. Before we dig into some of those growth drivers, I think there's been a CEO transition at PTC. Can you tell us how that transition is going and when Neil will take over as CEO?

Yes, sure. So there is, in fact, a CEO transition. The current CEO, Jim Heppelmann, has been CEO since -- about 2010. So he's been there for a long time. He's been a big driver of the strategy of the business and a lot of the evolution of the business over the past 15-plus years that he's been with the company. And on our Q3 call, Jim announced that he's going to be retiring and that the transition to Neil Barua, who actually was the CEO of ServiceMax that we acquired earlier in -- at the beginning of our Q2, is going to take place effective February 14, which is the date of our Annual Shareholder Meeting. And so that's when that transition is going to officially take place. In the meantime, Neil and Jim have been spending a lot of time together over the -- since the announcement was made and continue to do so, visiting customers, visiting employees, visiting other stakeholders like investors. Neil is actually out in California right now at a couple of other investor events as well. And so I think that it's actually going really smoothly. Neil is digging in. Jim is doing a great job at transitioning the business. And I don't really foresee any major hiccups coming into February 14.

Great. So let's talk about the many growth drivers that you have going on. So ARR is still growing, solidly double digits. You talked about the business model transition. With the move to SaaS, I believe there is a $1 billion opportunity or sort of a maintenance base that you see moving to SaaS over time. About 70% of that, I believe, is convertible. So $700 million opportunity over some time frame. Can you talk a little bit about that, what you're seeing from your customers in terms of the movement to SaaS? And what particular use cases fit well for a SaaS delivery model?

Yes. Well, there's a lot to unpack in there. So again, I guess I'd refer people to our Q4 or even Q3 earnings call materials. You'll see in there a couple of slides that talk about the layers of top line growth and layers of bottom line growth that we've been executing on really for the past decade. And it builds on a solid foundation of CAD and a steady market there, augmented by PLM getting into things like, on the CAD side, and we acquired a company called Onshape, which is really the CAD industry's only native SaaS -- CAD SaaS application. So that has been, again, small numbers, but has been a growth driver. We're seeing some momentum there, which is nice. We talked about ALM. We talked about SLM. We also help our customers deploy IoT or Internet of Things and augmented reality technology into an industrial setting to help improve worker productivity or help improve asset efficiency in a plant. So there are a number of different vectors of growth in addition to which you also mentioned this SaaS transition. And there is a point I'd actually like to clarify because, as I said, we've moved to subscription. So when you said maintenance base, that still implies kind of perpetual maintenance. We've really -- we went through the, what some people like to call, the valley of death. I always tried to brand that Paradise Valley and Jim never really went for that. But went through that valley of death, the cash flow valley of death, when we moved from a perpetual business model to an on-premise subscription business model. Now as we think about the opportunity to move the on-premise-based to SaaS, I think you size those numbers up about right, about a $700 million opportunity probably over the next decade or so. I think it will be -- we've kind of painted a picture of an S-curve of adoption where it's slower in the beginning and then it kind of picks up some momentum in the middle of the transition phase and then the last mile is always the hardest as well. So we're still in the early phase of that S curve. But I think that it should be a reasonable tailwind to growth, I think, for us. Obviously, the main driver is the functionality of the software, right, which is what you were really calling out. The delivery of it is helpful, but people are going to pick the software they want first and then how it gets delivered secondarily. But there are, of course, inherent benefits to SaaS, which include better collaboration, security, et cetera. So I think from our perspective, we do believe that this part of the software space, the technical software space, is eventually going to move to SaaS. It's just a question of how long that takes.

Makes sense. And pardon me for the language mistake there. So the other thing you talked about was some of the new product initiatives, you talked about PLM. Can you dig into the idea of why PLM is expanding within the organization outside of just core engineering?

Yes. So you probably need to get into the time machine a little bit and go back to the beginning of PLM. And what it really was in the beginning was a -- it was a vault, if you will, for CAD data. You had engineers that were using CAD to make designs and then they needed to store it somewhere, and it went into kind of PDM. And that allowed for rudimentary, we'll call it, collaboration within design teams and within the engineering department. And then if you think -- if you fast-forward over the past 20-or-so years, those capabilities have expanded tremendously and products have gotten more complex, partially because the software is much more capable and actually allows customers to do more things, which creates more need for the software, which is an interesting virtuous cycle. But now we're seeing leading customers really thinking about their PLM system as the system of record for their product design data, for product DNA, and figuring out how to leverage that more broadly throughout an organization. So it isn't just about collaboration within an engineering department. It's also about configuration management for complex products, which can be very complex to manage, but very useful for them in addressing the needs of their end customers. And that's really just within -- it enables them to think about platform strategies for the products that they're building, which helps them reduce cost but provide more customizable products for their customers, right? So that's within the engineering department. And then you start thinking about, well, how could we take that product DNA and really leverage it more broadly? Wouldn't it be great if we could use that information to help inform quality departments or manufacturing supply chain departments for the procurement of parts, for the assembly of the products? And ultimately, how do we leverage that information into the service department of those customers because generally what happens is you design a product, you manufacture it, you sell it and then it's lost to the OEM. And where we're going with the ServiceMax acquisition and the SLM strategy is really about creating that closed loop. You can now, if you were to think about a VIN number, if you will, for a product, you know what it was supposed to look like when it was designed, you know what it looked like when it was manufactured. Historically, when it's gone out of the field, you've lost all record of what's happened to that product. Through various service applications and a lot of the customers, we have had products that have 20-, 30-, 40-year life spans. So for them to actually be able to track that information and share that back -- all the way back into engineering to help improve the overall quality of the product and the service to the customer, that's how advanced customers are really thinking about the opportunity to leverage PLM as a system of record and leverage it to drive digital transformation in the part of the enterprise that we serve, which is the kind of design-centric -- design, manufacturing, service-centric part of the organization.

Got it. One point of follow-up on that then I want to open up to the audience for questions. There has been different vendors that have tried to go after that space from sort of the ERP, enterprise resource planning angle. Can you talk a little bit about the importance of having an integrated CAD and PLM strategy in order to address some of the use cases you talked about?

Yes. Sure. That's -- it's a really good question. And I think for those that have watched the history evolve over time, the CAD vendors have largely remain the same, right? There's a handful, 3, 4 of them, that have been around really since the late '80s. And then PLM, which started evolving really in the late '90s, early 2000s, there have been various players who have either tried to go stand-alone or tried to go to the ERP route. And if you were to look at the PLM market today, and this is just one guy's observation, but it seems that the PLM platforms that have the most market presence today are the ones that are owned by companies that have that CAD backbone, which makes sense because that's where all that product DNA is really created and that's what's being managed, configured, leveraged and shared all in that PLM system. So if you're missing that beginning piece, I think it makes it difficult.

Any questions from the audience? We have one over here.

Just wondering, how do you manage to differentiate yourselves from a customer perspective? Usually, what is your pitch and how do you convince the customer to transfer to you? Usually, if it's -- mainly, if it's like a system [indiscernible] kind of pitch because it's so sensitive in terms of information and stuff.

Yes. It's really a journey with customers and they're all at different stages -- on that journey, different stages of maturity. And so for us, it's really trying to meet them where they are on that journey, help them understand what other companies are doing, right, that we obviously can help share some examples of how they're thinking about leveraging the technology, and then just moving the ball up the field. There isn't -- I wouldn't say -- at least I haven't seen it yet, we'll see, maybe I'll eat my words, but I haven't seen anybody come out yet and say, hey, I want to buy this Digital Thread platform, the whole thing, soup to nuts. You generally start out and evolve. And as the organization matures and evolves, you then add incremental capabilities.

A quick question regarding your past partnership with Rockwell. They are now out. What did you learn from it? And how do you want to take those maybe smaller partnerships going forward or just being fully independent regarding those industrial partners?

Yes. So great question. Thank you. And maybe just a quick recap. Back in, I think it was probably 2018-ish or so, Rockwell entered into a partnership with PTC. There were actually two different and distinct parts of this agreement. One was a commercial arrangement where Rockwell is a reseller of PTC technology at the time. That arrangement also came with some contractual minimum commitments of how much volume they were going to sell, and at the same time, also exclusivity for certain accounts or regions, again, tied with those minimums. I'll come back to that in a second. Separately, there was a share purchase agreement whereby Rockwell had taken a 9% stake in PTC. As far -- and that now let's fast-forward to last year, our fiscal '23, Rockwell has now unwound the share purchase agreement. They've sold their position. However, that is separate and distinct from the commercial agreement and Rockwell actually still remains a reseller of PTC. They're actually one of our larger resellers, although over the past 5 years the commercial terms have changed. We've gotten out of minimum commitments and exclusivity in that way. But they're still a reseller of PTC technology. And they're building out their own software footprint, and I think we'll continue to augment that with PTC technology. And so from that perspective, I think the commercial arrangement is going okay.

Any other questions?

Okay. You recently came out with the SaaS versions of your products with Creo+ and Windchill+. Can you talk a little bit about the early feedback there? How big could that opportunity be and when it starts to show up in financials?

Yes. So thinking about this, I think about 2 years ago we started talking about Windchill+. And over the course of last year, started about a year ago, started talking about Creo+, Creo being the CAD platform, Windchill being the PLM platform. And this is actually really, a, all, again, being driven by what we would say, customer interest, customer demand. We -- for Windchill, in particular, as well as some of our other products, but for Windchill, we actually had seen demand for, what I would call, kind of private cloud instances, which we had been selling to customers because that's kind of -- that's what they wanted. And ultimately, with the other SaaS assets that we had acquired, including Onshape, including Arena, now ServiceMax, it actually just helped push us over the edge in terms of saying, okay, actually, that is where the market is going. That is what customers really want, really are looking for. So if we're going to do that, we don't want to be in the business of hosting thousands of private cloud instances. And in fact, I think we and the market would be better off moving to a SaaS version of Windchill and then followed by Creo. So again, we're in the early innings. Again, interest, I think, is solid from the market. I think we hear other competitors talking about SaaS as well, which I view as a good demand indicator as well. And I guess the last piece to note is we have some customers that are actually just probably never going to move to a SaaS environment for a variety of reasons. They're designing whatever nuclear weapons that just -- it's not going to put it in the cloud. So we're going to offer on-prem and SaaS versions for a long time. So it's the same code base. It's how, in fact, we're dealing with it on the back end to drive, we'll call it, the efficiencies of scale for us and the efficiencies of SaaS for our customers. So we think it's a good, long-term tailwind for the business.

Right. Maybe last couple of questions. Just on the targets, the business has gotten a lot more predictable in the last few years. How much variability is there to that year-end ARR number? Meaning how much has to go right for you to hit the high end of that target? And what needs to go bad for you to get to the low end?

Yes. So I think as we talked about earlier last year, I told you we did about the same amount of net new ARR as we did in fiscal '22, so kind of flat net new ARR. This year, the midpoint of the guidance range, while it does actually imply that there is some growth over kind of flat performance, there is some mechanical aspects to that, that include what we call deferred ARR, some people think about it as backlog, contractual commitments where we know that customers are going to be adding to their contracts over the course of next year. And so when you normalize for those at the midpoint of the guidance range right now, we're essentially calling for basically also flat ARR compared to last year, which would be compared to the year before net new ARR. For it to get better than that, I would think that we would need to see one or more of these growth vectors really kick into a higher gear or perhaps the macro economy in general to get a little bit more favorable. Different ways to think about macro, whether you look at GDP, whether you look at PMIs as an indicator. We look at a lot of -- we look at both of those as well as other variables. But for the macro to get a little bit better, that could take us above the midpoint. And obviously, below the midpoint would be continued erosion, if you will, in the macro environment, which I think could take us down to the lower end of that range.

And last quick question. ARR and free cash flow are the North Star metrics for any SaaS transition, including yours. You've talked about a $1 billion free cash flow by fiscal '26. Just your confidence level and visibility into that target?

Yes. I think that we feel pretty good about the free cash flow target, and I would say that even in a lower-than-targeted ARR range or top line range, we still feel good about the cash flow target really because of how we manage the business, right? And just to oversimplify that, we just talked about the midpoint of the guidance range being flat net new ARR. If that's the case, it implies kind of flattish bookings growth, if you will. And if that's the case, like why do we need to make more sales and marketing investment in order to sell the same amount that we had last year? And I would submit that we don't need more investment in G&A. We may, of course, choose to invest in R&D, but that's not going to help sales this year. That's an investment in the future. And so it really is how we manage the business and we think about weighing both long-term investments and when is the right time to start making investments in, for example, sales capacity. So I think there's a lot of levers for us to pull even if we don't -- the macro doesn't support the mid-teens targets that we had talked about.

Great. Kristian, thank you so much for your time, and thanks for everyone joining.

Thanks, everybody.