PTC Inc. (PTC) Earnings Call Transcript & Summary

We can get started. Hi, everyone. I'm Joe Vruwink. I cover vertical software at Baird. Our next presentation comes from PTC. PTC is one of the major companies providing engineering, manufacturing and service software for physical products. And increasingly, those 3 areas are being connected together. That's called a digital thread and that itself is a driver of results. Pleased to have with us today, Kristian Talvitie. He is Executive VP and CFO. This is going to be a fireside chat format. If there's questions in the audience, you can raise your hand or e-mail session 2 at R.W. Baird, and I'll ask them off the iPad. But maybe to begin, Kristian, just intro to PTC overview of the investment case, and we can take it from there.

Yes. Great. So Joe, first of all, thanks very much for having us. And then secondly, my General Counsel would be very angry with me if I didn't remind everybody of the safe harbor language and forward-looking statements and refer you to our risk factors and safe harbor in our periodic SEC filings and in our press releases, et cetera. With that, PTC is now about geez almost 35-year-old software business. We do -- we'll do this year, somewhere around $2.2 billion in ARR, which is annual run rate for us, which is it's a subscription business. So that's our kind of annual subscription billings. We're about 73-ish, 100 people worldwide. And as Joe pointed out, we provide technical software to companies to help them design, manufacture and service their products.

Maybe the level set on financials out of the gates. Last quarter, PTC made a recasting of midterm growth ambitions. It was mid-teens. Now it's low double-digit growth that comes under Neil Barua relatively new CEO and kind of his analysis of the business and resetting targets. Maybe just to start, what was the discussion as a team, kind of the input, the thought process that went into updating things and kind of the embedded assumptions going forward in that low double-digit growth framework?

Yes, it's a great question. I mean, I think in large part, I would actually say that it has more to do with, we'll say communication style than any like deep analysis of the business that's resulted in a different view of the opportunity. Neil had the opportunity to come in and reset where he wanted the bar set, which is in that low double digits, which we talked about on the call was he said, geez, it's -- our guidance for this year is 11% to 13%. So it's that plus or minus. I think if you were to empirically look back at the performance of the business over the past 6 or 7 years, it's ranged from 10% to 15% or 16% ARR growth through a variety of macro and other cycles in 2020. It was 10% growth. Again, we've seen that kind of mid-teens as well. And then here, last year, we did kind of 13% growth. This year, again, the guidance is 11% to 13%. So I think on average, over that time period, we've seen in that kind of 12-ish percent range. And so that's where we ended up feeling it was appropriate to set the bar. I think the opportunity remains to be able to try to do more than that, but also recognizing that things don't always work out. [ Jelly ] side up, things could be at the lower end of that as well. So I think that was really the framing and the discussion that we had.

And thinking of the current macro and how it can influence results when you set expectations appropriately and you're starting with a high gross retention business, it's harder to move things around when you're setting a higher bar and a lot of your growth comes from new ACV generation just factually speaking. And so I think it's worthwhile because the topic is coming up of PMI just softened. So does that mean things are getting worse and PTC is therefore going to start to trend worse. And through a recent history of PMIs being soft, the answer has been no. Your results have held in and been very good. Maybe we can talk about the elements of the model between both your customer retention or dollar retention. And then how you think about capitalizing on your new business pipeline to get to that double-digit framework kind of those 2 as inputs into the model.

Yes, sure. I mean not to dwell too much on PMIs, and we look at them as well as many other indicators. And I mean, I think broadly speaking, we would look at them and say it's somewhat of a barometer of the macro environment. And frankly, they've been sub-50 for kind of 6, going on 7 quarters here. And I think we've been pretty consistent in saying that the macro environment has not been great. It wasn't great last year. It hasn't been great this year. And we haven't really seen a change in that overall environment. I think is it -- as we start thinking about the opportunity for growth, there are a lot of different levers that we benefit from. On the one hand, there is a macro trend that we're seeing with many of our customers, which we would call it digital transformation. I know that's a very broad term and applies to many different parts of a business. But for the part of the business that we serve with our customers, if they want to digitally transform how they're designing, manufacturing, servicing their products, PLM is really the backbone for them to be able to do that. And so we continue to see solid interest and pipeline build within PLM. We also completed last year an acquisition of a company called Intland. The product was called Codebeamer. It's an ALM or application life cycle management product. It's really requirements management and test management for software code, particularly important for companies right now that are seeing more and more software injected into their products. You think automotive, med device, aerospace and defense and others across the board, where that's become particularly acute is in those highly regulated industries. So we've been seeing some traction with Codebeamer in the market as well. And then on the SLM side, we had some assets in SLM previously, which we augmented with ServiceMax and ServiceMax acquisition, which again, enables field service technicians. Many of our customers have long-lived assets that they are complex assets that have long lives and live out in the field. And so they need to dispatch service technicians to either install or repair those devices. And that's really what the ServiceMax technology does is help drive efficiency and improve quality in those operations, which are important to many of our customers because they can have thousands or tens of thousands of field technicians. And in many cases, that part of the business operates as a profit center for them. So I think we've got interesting portfolio that again seems to resonate with customers in terms of their digital transformation and what they're looking to do to continue to make themselves more competitive in the markets in which they compete.

So the ordered -- you just listed those of PLM, Codebeamer service both SLM and ServiceMax, that's the order you used in the most recent earnings deck 2. So you stayed on point with the messaging. But is that listed in a specific order because they're of magnitude, PLM is most important than Codebeamer than ServiceMax in terms of their growth contribution?

Well, I've been beating into keeping the order consistent. There were 2 that I didn't really touch on. One was the sales transformation and the other was Creo or CAD, which are also -- Creo is obviously foundational to what we do and foundational to that digital thread strategy and then, of course, the SaaS transformation, which I think is going to hit this part of the software industry as well like it has many other parts. And by this part, I mean technical software, whether that's CAD, PLM, whether that's simulation, whether that's EDA. I think that eventually the technical software space is going to migrate to SaaS as well just because in the end, I think it's a better delivery model. So no, not necessarily any particular order of growth there. But those are just kind of 5 of the key, we'll call them, dollar drivers of growth.

Just a focus on PLM. So as we've been talking this digital thread concept or an enterprise data solution, is really important because it becomes very material in terms of new incremental users, the contract values can get very large relative to traditionally how PTC interfaces. I'll come back to that. But for the moment, if you think of a traditional customer that has been using Windchill, how penetrated or commonplace is just PLM usage in that core persona? Like I'll throw out a number. We've heard 25% to 30% of new product development is maybe using PLM. So even in R&D, there's still an opportunity to grow. Is that generally borne out in terms of how Windchill has been growing. It's been with that traditional kind of R&D persona?

Yes, it's a great question. And I think that -- I think there's a lot of legs to growth still expanding Windchill within engineering departments, but then as you a little bit alluded to is getting outside of engineering departments. And to preface those statements, maybe it's worth thinking about a little bit of the history of PLM, which if you went back to the kind of 2000 -- early 2000s time frame when PLM really kind of became its own thing, it was then often more referred to as PDM or product data management. It was really for version control and we'll say even rudimentary collaboration within engineering departments at the time. You could fast forward now whatever, 25 years later, billions of dollars of R&D investment later in kind of PLM as a whole. And different companies have evolved their utilization of PLM in different ways. Some of them have taken a much, we'll call it, more robust viewpoint on how they could best leverage engineering data not only to make the engineering and design process more efficient or even evolve how they're developing products in the platform strategies and so on, but also thinking about how they can leverage that core product data which is really created in CAD and then kind of lives in your PLM system, how they can leverage that not only within an engineering department, but also outside into, for example, the quality department or supply chain or manufacturing or to, again, the field service technicians that we were talking about. And by the way, not only sharing the information outwardly, but also getting feedback and bringing that feedback back into the engineering department, where if there are design problems or efficiencies that could be changed, that's really where they need to be fixed anyways. Like you could do a crafty manufacturing engineer could figure out a way around a problem. But he can't actually or she can't solve the problem that's in the core design itself. So you really need to get that information back into the engineering department so that it can be fixed and leverage again more broadly. So that's the general premise and evolution. And different companies are at different stages in not only their adoption of PLM, but also how advanced they are in their thinking of PLM. But again, we're seeing some of our customers who are very forward thinking are leveraging it much more broadly.

There is an example shared on the last earnings call where I think you tripled the ARR associated with. It was a medtech customer tripled over 3 years. Is there -- that's just one example, but when you think of engaging with a customer and getting this multi-department rollout quality, supply chain, the field, is a tripling common? Or is there a rough framework, what TCV does if it's an enterprise deal versus an R&D-only deal?

Yes, it would be difficult to really kind of create a formula just because, again, like every customer is so different than where they are in their adoption curve and even how they're thinking about it. But suffice it to say that the opportunity is significant.

When you talk about having some progressive customers, are there industry groups that you find are more progressive at the moment than others? Or are certain industries for PTC faster growing at the moment?

Just on the PLM front is that -- because I mean, I would say not necessarily. I mean, we've got actually a couple of good examples that go across FA&D, for example, that are robust users. We just talked about some med device as well. You've got some industrial customers. So I think it's more customer-specific than industry-specific in terms of them thinking about the utilization.

One of the interesting things that have come up recently and I think PTC has been pretty active in resource balancing, rebalancing over time, which is how you typically gone on to exceed free cash flow targets. And I think Neil is going to continue this, but bring maybe different opportunities, scrutiny to the equation. . So it came up last quarter that there's resource rebalancing happening away from IoT and augmented reality towards Codebeamer towards ServiceMax, service lifecycle. What is it about this point in time where ALM and SLM just have a better ROI proposition?

Yes, I think actually, a lot of that -- so here, actually before I get to that, just for the general audience, I think it is important to note that it is a lot how we think about resourcing and resource allocation within PTC, and in particular, within R&D is how can we best allocate resources behind where we think the need is greatest or the opportunity is greatest and how do we leverage the resources we have to move to one technology, for example, or another solution to another. And we have been doing that for some time, and we'll continue to do it. It's part of the fabric of the enterprise, if you will. We value the people, the skill sets they have. And if we have been working on Project A, could they also be working on Project B. And that's what we mean by rebalancing. And the rebalancing that we talked about on the Q2 call, was actually rebalancing some talent from our IoT and AR teams. It was really the PLM to ALM and to Atlas as well, which is the kind of the SaaS platform, and that's primarily where that shift had happened. And even just putting this in context, some of those folks that were on the IoT AR teams, they had originally come from PLM to begin with. So I think it's good cross-pollination and great experience. And now we're actually bringing them back, if you will, to PLM, but they have a more holistic view of the portfolio which is exactly what we're looking for is this digital thread concept and how do we leverage IoT and AR as enabling technologies in PLM, in SLM. And so being able to move these resources around, I think, is helpful in that vein.

All these products can work together and yet cross-selling is a big initiative. What's the biggest challenge typically, is it things you can do? So the product integrations can just be better and therefore, it will be less of a heavy lift by customers when they want to adopt multi products? Or is actually part of the limitation, I suppose, change management on the part of the customer and just not maybe appreciating that like your earlier example, [indiscernible] field tech fixing an MRI machine that information is actually relevant design and engineering, but it just doesn't get connected right now.

Or they don't have a way to really connect it. So I mean for sure, there's education of the art of the possible technology continues to advance things that you can do in a PLM system today or your SLM system today weren't possible whatever 7, 10 years ago. So you do need to continue to educate the market on how things are advancing, how things work together. Obviously, PTC didn't own ServiceMax 3, 4, 5 years ago. So making sure that we're bringing customers along with that journey and making sure they understand. We're investing to keep up with their needs, their areas of opportunity that allows us to bring that comprehensive story to bear is certainly an important part of the journey. Obviously, making sure that the connections of the software is easy and functional as possible is always appreciated.

Our ALM and the service portfolio SLM, are both of those always applicable to CAD and PLM customers, like is there a very good overlap between all the industries that are using your products?

There's a decent overlap. And again, I think some of it not every industrial company has a huge field service organization. So you kind of need to think about it in that vein. And not every company is embedding software in their products at the same rate, right? I mean think of even cars, think about cars that are coming off the line today and how many hundreds of millions of lines of code are in those cars today versus even 5 years ago, let alone 10 years ago. I mean the market is rapidly evolving. And as it rapidly evolves, the needs of our customers continues to evolve. And that's what makes it so interesting, frankly.

You described PTC recently as the customer-friendly but commercially responsible organization which was Kristian's bumper sticker at the same time. But I use in response to a question of what's happening regarding price in this industry. And there's 2 ways to take this one of the big 4 in CAD over recent history. I don't think anyone has seen a gross retention improvement that matches PTC. So that's one element of customer success and that thing it stands by itself. The other is that we've been in an inflationary environment and certain vendors have been very aggressive. I think PTC has taken a little bit different of an approach. Sitting here now, do you feel like all of these past decisions actually give you kind of an advantage going forward in that you've maintained good relationships, you haven't been aggressive and certain of these levers. So going forward, there's maybe more optionality in your commercial relationships versus what other vendors are dealing with?

Yes. I mean I do think it is a core tenet. Again, PTC has been in business for almost 35 years. We have some customers that have been with us for almost 35 years. If we get engaged with a customer, we think of that as it's going to be a relationship that's going to last hopefully, decades and being overly aggressive on something like price may feel good in the short term, but it is not a recipe for a good, healthy 10-, 20-year kind of relationship that we want to have with our customers. Now also being commercially irresponsible is also not the right answer. So we need to find the right balance and make sure that we're treating our customers fairly, but also recognizing that we are trying to run a business, and we want to do that efficiently as well.

There was an updating in the proxy -- this year's proxy, where in terms of long-term performance that's now tied to do organic ARR. Does that kind of reflect something we were just talking about in that as part of the commercial relationship, you'd actually work towards longer duration relationships, longer commitments. And so organic ARR over the long term is therefore a more relevant kind of apples-to-apples comparison?

Yes. I mean I think that we view organic ARR growth as a good barometer of how we're -- how much value we're bringing to the market. And we could overlay some of the commercial terms. But again, under previous regimes, my predecessor was in favor, for example, of annual contracts. . I think that I actually tend to favor longer contracts. 3 years, I think is a -- would be a good target. We're not there yet. Over the past 4 or 5 years, we've gone from on average about 1 year to on average about 2 years. But I think that is a good target range and enables a healthy relationship between us and the customer, where we can get stability. They can get more price certainty. And I think it just helps evolve commercial relationship. And then again, over time, I mean, frankly, to a certain degree, it also derisks in very turbulent macros because many customers are signed up for long-term contracts. So in a short-term disturbance, they can't make a hasty decision, which they would have likely regretted later. Anyways, so I think there's some benefit to that. But over time, again, the idea with the subscription business is that we're continuing to provide ongoing value to our customers and growing value. And we think that organic constant currency ARR is the right way to think about that.

With a minute remaining, net leverage has come down quite a bit, stepped up for a period of time after ServiceMax, but now that's definitely in check, which is more flexibility and the cash generation going forward is going to be quite strong. How would you expect to deploy it?

Yes. I think that -- what we've been saying is that our general policy is under 3x levered unless we had a better use for the capital. We would look to return approximately 50% of the free cash flow to the shareholders to the owners of the business. Of course, again, always being mindful of M&A activity opportunities as they may arise. But we're -- again, we're well under 3x levered at this point. And as we said, as we close out the year here and another 4 months or so and start thinking about our fiscal '25 plan, we'll revisit the balance of share repurchases and debt paydown as we get into the fiscal '25 planning process.

That's great. We're out of time, but please join me in thanking Kristian.