PTC Inc. (PTC) Earnings Call Transcript & Summary

Good morning, again. I'm Tyler Radke. I co-head the U.S. software team here at Citi. Thanks for coming to the conference, day 1. We -- for the second presentation, I think this is the software track. We have PTC. We're joined by the CFO, Kristian Talvitie, Kristian, thanks for coming down. I think this is third or fourth year in a row you've come to our conference. So always appreciate the support.

I thought you'd just kick off just on kind of the changes at PTC over the last year. Obviously, it's a company that is -- had a great legacy in the space. You recently hired Neil as CEO to replace Jim as he went on his retirement. But just give us a recap of the last year. What have been the biggest changes that you've seen as Neil has taken over the CEO role?

Yes, sure. But not dodging the question but before I answer that, my General Counsel would be very upset with me if I did not remind everybody that any forward-looking statements, there's safe harbor language that's on our press releases. It's in our 8-K filings on our website. I would really recommend that you all go familiarize yourselves with the safe harbor line.

That's great. Yes. Well, look forward to the forward-looking statements.

So back to the CEO transition. Yes. So Neil Barua is now CEO. His official first day was February 14, also Jim's last day. Neil, for those of you who don't know, came to PTC via an acquisition. We had acquired a company called ServiceMax, probably about 1.5 years ago now. And he quickly demonstrated aptitude and interest, which was picked up and noticed and we ran a thorough CEO search process that included Neil and others. And Neil emerged as the right candidate, which has been great. So he's officially been in the seat for whatever that is, a little about 7 months now but was also CEO-elect for a 6-month period prior to that, spending a lot of time with Jim, out on the road with customers, with partners, with other constituents of the PTC ecosystem, employees, et cetera. And I think he's actually settled into the role quite nicely. I think he's understands the industry. He's been spending a lot of time with customers. So he's getting that firsthand perspective as well on what they value and how our unique product portfolio can be brought to bear to help them solve their critical business problems. So again, he [indiscernible] into the role. I think you were asking about what are some of the changes that maybe I've noticed. One change that I think he's been pretty consistent on and for those of you listened to the earnings calls or other -- go to other conferences where he's attending, he's pretty focused on top priorities, kind of the 5 top priorities. Now that said those have been priorities of the business for a long time, PLM, ALM, SLM, CAD and this past transition. So I think one of the bigger difference is really more in communication style. And so while we want to make sure that we're continuously communicating those, it doesn't mean that we're not still investing in IoT, we're not still investing in AR, we're not still investing in Onshape. The difference in communication style is when those get to be meaningful enough to be needle movers, we'll talk more about them. In the meantime, let's stay focused on the needle movers and let's get the organization also rallied around the needle movers. So that's been I think, a positive aspect that Neil has brought to [indiscernible].

And one of the changes that was announced most recently was sort of the, call it, elimination of the CRO role, Mike DiTullio, moved on to sort of be an adviser to Neil. So maybe a flatter kind of reporting structure. What -- walk us through the changes there. Is it, obviously, Neil has been spending a lot of time on the road meeting with customers. Is it, he wants kind of more of a hands-on approach in terms of managing the sales force directly or just walk us through kind of the thoughts find that change.

Yes. So there's no doubt that Neil definitely likes to be close to customers, close to product, for sure. And again, for those of you who'd followed the company for a long time, many of you will likely remember that predominantly during Jim's -- even during Jim's tenure, the organizational structure as it were, we have regional heads of sales, for example, for North America, for Europe or Asia, who all report to a global Head of Sales, who reported to the CEO. During transition process and help make sure that we were having an orderly transition process, Mike stepped into the COO role, which again, I think was helpful. And I think Neil would agree. But now that he's been in the role either as CEO-elect or CEO for over 1 year now, I think you wanted to -- he wanted to flatten the structure again because during Neil's initial tenure, you have that same structure, Head of North America reports to Head of Global Sales, who reports to a CRO, who then reports to a COO, who then reports to the CEO. So there were a couple of incremental layers that were added. And so those layers have been eliminated at least for now and technically, actually Mike DiTullio is still COO until the end of this fiscal year, so for the rest of this month and then help serve as an adviser for some period to Neil.

Yes. Got you. Shifting gears to what you're seeing out on the demand environment. The last couple of quarters, we've seen more macro pressure across the space. And in some ways, it's not new, right, deal cycles have been elongated for a while. But if you could just sort of compare and contrast what you're seeing at customers now versus the last 2 years? And then any thoughts in terms of how you're thinking about the business coming into your fiscal year-end?

Yes. So first of all, I'd say that the macro conditions have not been that favorable for going on, about 2 years now, not the past couple of quarters, I'd probably chalk it up to the past 8 quarters or so. It's a difficult selling environment, it has been. I think we've been consistent in that message. To be honest with you, I think you can actually see it in our results as well in our net new ARR, assuming we land here somewhere in the range or call it the midpoint of the range is going to be largely flattish for the last 3 years. So I think that it should be indicative of what the selling environment is like. As far as heading into the quarter, yes, I think Tyler, you know as well as I know that like any good blue-blooded enterprise software company last week of the quarter means a lot. So we'll see. We've got a good pipeline. But as you say, deal cycles have been elongated. It's still a tough macro.

Right. And one of the changes over the last couple of quarters was just sort of taking down medium-term targets down to low double digits ARR growth, which I think, many investors appreciate it, just it's kind of more of a realistic in view of what's going on in the macro environment. How do you sort of think about the sustainability of that double-digit growth? What are the levers for upside to that beyond just a macro improvement? Just walk us through sort of that decision and sort of what you're assuming in that -- those low double-digit targets?

Yes. So again, I'd go back, part of this is a style issue between Neil and his predecessor in terms of communicating the targets for the business over a medium-term window. I think that the low double digits is in and around what we've done here pretty consistently for the past, whatever 5, 6 years. There has been a low of 10% which was in 2020. There's been a high of 15% and I'm also talking organic constant currency numbers. So there's obviously been bigger highs if you take into account acquisitions but on a organic constant currency basis, high of 15% in 2022. And the rest of it on balance works out into that kind of 12 percentage range over the past 5 or 6 years. So I think we've demonstrated an ability to deliver, deliver at that kind of level with some variation, given some of the macro dependencies or macro environment, I should say. And I think that with the product portfolio that we have, the focus that Neil continues to drive into the organization, the market opportunity as we see it before us with PLM, with ALM, with SLM, CAD is obviously a mainstay, I think that the opportunity to continue to deliver at those levels, it remains. We have additional levers to continue to try to think about our own performance, we'll say, commercial optimization, for example, I think a good example might be churn which in 2019 was in and around 8.5%. We've cut that almost in half over the past 4 years or so. Me personally, I think there's room for continued improvement, albeit it will not be at that same pace going forward. But I think we have other opportunities in and around, we'll say, commercial optimization to continue to also to help drive ARR growth.

Yes. And despite all the challenging macro time period, I mean, the free cash flow has been very resilient. You've been able to maintain that, if not raise that pretty much every quarter. Can you just talk about the levers that you have and what you're able to do to offset some of these macro headwinds and shortfalls on the top line?

Yes. So it's a great question. Thank you. And again, for those of you that don't know the business that well, just kind of a brief infomercial. The way that we look at the business is really on a cash basis and it's because of the revenue recognition as it applies to PTC revenue doesn't really equate to cash collections or cash generation. And so there can be a lot of variability in revenue and therefore, any derivative off of revenue, whether it's margins or EPS that could make the company look like it's doing better or worse than it should be in any given period. I've done -- I know Peter loves these, I've done a teach-in, if you will, on this subject in our Q4 fiscal '22 earnings call. If anybody is interested, you can -- I'd refer you to that. But -- so we really do think about the business on a cash basis, cash generation and then cash expenditures out. And because essentially all of our software is on a subscription basis and we bill annually, we have some additional modest $20-some-odd million of perpetual license and about $120 million of services. The perpetual license will continue to get smaller. Again, the vast majority of our cash inflows are all paid annually. And on an expense basis, when we think about it, I think about it really also all in terms of subscriptions. Not only the subscriptions that we have to run the business, whether it's Workday or Salesforce or Oracle or other tools that we use to run the business that are also all subscriptions, whether it's rent for facilities that we have. And without being too crass, it's also the employee base, like once we hire somebody, they get a paycheck regularly, it's like a subscription. So we've evolved the budgeting process to really think more about the longer term and what it is that can sustainably invest in. And the -- maybe the biggest change has been, if we went back, what, over 5 years and I'll just use round numbers to make the point, if we had a guidance range of 10% to 15%, we had a plan that was somewhere in and around the high end, we'd give out budgets at the high end range. And then if we were progressing through a difficult macro and it looks like we weren't going to hit that end of the range, then we'd have to go through a whole exercise internally to put REX on hold or reduce head count and reduce other spending, which, to be honest with you, from the inside of a company is very distracting. It stops with any kind of positive momentum, you're working on negative things, not positive things and you can still get to the same outcome. What we've done instead is, we've altered that process and now using those same numbers, we would say, great, we'll start the year with budgets assuming the low end. And we'll have a prioritized list of things, assuming that it's going better, where we will be putting incremental investment. So that has helped us make sure that we're investing in line with what the current business environment actually tolerates. And I would stress the point that what we're really talking about and toggling about is incremental investment, right? We have a base of spend that we already do. And now we're really just talking about how incrementally we want to invest and then where we want to invest it, where we want to invest it in the business.

Got it. That's helpful framing. And I think sort of helped show the consistency on cash flow. And I think given the quarterly guidance, not a lot of other companies are able to do that. Wanted to talk a little bit about the growth areas of the business, and you sort of laid out the 5 things that Neil is focused on. Couple of them, I would say, we didn't hear as much about years past, things like ALM, even SLM. So I wanted to talk a little bit about Codebeamer and some of the trends going on in that space. What has made that acquisition so successful? And where are you seeing the biggest growth opportunities for that product?

Yes. So I mean, ultimately, I think it boils down to market demand and the evolving needs of our customers and maybe even more importantly, the evolving needs of our customers' customers. So to use maybe a simplistic example, if you were to look at an automobile that's produced today versus one that was produced 5 years ago, let alone 10 years ago, the amount of software in what have traditionally been hardware products across -- you can look at auto, whatever else, well, pick your example but the amount of software that's going into these products is increasing significantly. It has been and is expected to continue to increase over the next few years, which also means -- and that's also driven by demand from their customers, what features they're looking for, et cetera, which means that these companies need to adapt, which means they're hiring a lot more software engineers, which means they need tools in order to do their jobs. And the tool sets are becoming more and more complicated, in the sense that now you're combining software and hardware and you really need to be able to trace requirements, for example, especially in highly regulated industries. Again, think auto, think med device, where if God forbid, something should go wrong, you want to be able to isolate the problem as quickly as possible and get it addressed, let alone and the other regulatory concerns these customers might have. And so again, I think it's just the evolving product landscape for our customers that's driving the need.

Got it. Got it. And then ServiceMax is also another growth area. Obviously, that's very close to Neil's heart, as a former CEO there. At the same time, ServiceMax is a bigger ticket item. And I'd imagine one that is maybe a bit more cyclical, at least in terms of how customers are prioritizing those budget decisions. So can you sort of talk about where ServiceMax growth is now and where could it ultimately go, should you execute and maybe macro cooperates?

Yes. Yes. So; a, there's no doubt that ServiceMax is also -- it's an enterprise sale. It's not immune to the same pressures that we're seeing across the enterprise space, decisions being elongated, et cetera, et cetera. That said, we've been seeing this year more positive signs from cost opportunities into the PTC base. Some of it is actually -- has actually been really just ServiceMax being part of PTC. There's customers that they've been -- when they were independent, trying to call on for a long time and haven't really been able to get in the door for a variety of reasons and perhaps because of their status and the unknown of where they might end up. But now that, that's been solidified, we've seen some of those opportunities advance. Part of it is also just leveraging the PTC customer base as well. So we've seen positive signs there. And I think we're hopeful that as the conditions continue to evolve, we'll be able to capitalize on that opportunity. There's a lot of companies out there that think about their service operations as not only profit centers but as a competitive advantage in their space. And yet they're using either very antiquated or disparate tools or sometimes homegrown systems, Excel spreadsheets and they're looking at ways at advancing their competitive position. And for complex, long-lived assets that live in the field, ServiceMax is really a good solution for them. So I think we're hopeful that there's a lot of runway here.

Yes. And as you think about those 5 growth drivers you referenced earlier, is there a way to sort of rank order the biggest contributors to your net new ARR? I mean I imagine CAD and PLM, just given the scale of those businesses are still going to be the dominant drivers. But where are you sort of seeing the biggest pickup or at least as you look in the pipeline, where is kind of the strongest growth coming from in terms of these newer products?

Yes. I mean I don't know that we've broken it out really in that degree of...

Specificity. It's the tough one.

That is a tough word. In that level of detail about that, how about that? But I think you're right, that dollar-wise, the PLM, the CAD businesses are the larger ones. SLM, which is more than just ServiceMax also includes Servigistics and Arbortext and -- as examples, is probably the next largest contributor followed by ALM.

Yes. Got it. And the -- I think the last bucket in those 5 was this SaaSification strategy and, wanted to spend a little bit of time there. So I think, obviously, the history, there's been some acquisitions in the space, Onshape and Arena back in sort of Jim's tenure. I got the impression, I think some investors got the impression when Neil came in, not that SaaS took a back seat but he really leaned into the opportunities he saw around ServiceMax and Codebeamer. So maybe just talk about like, is there any more hesitancy that you've observed from customers in terms of this SaaSification push? Or is it still as big of a priority as it was maybe 1 year ago?

Yes. So you're right. Onshape, Arena were SaaS. ServiceMax, by the way, also SaaS delivery model. And I think that, just big picture, I actually think that the technical software space, like so many other parts of the software space are -- is ultimately going to move to a SaaS delivery model because in -- primarily, because in the end, it's a better delivery model for software. That said, it is a delivery model. and the more important piece is, what are you getting delivered. And so the real value is actually in the application, there is incremental value to be had from the delivery model. But what we're really focused on and I think what Neil has really focused on is making sure that we're delivering the real value to the customers. And then you would have the ancillary discussion around how you want that delivered, whether it's on-prem or via a SaaS delivery model. And again, a lot of these migrations are complicated, they're, you could have a PLM system that you've had for, whatever, 10 years, 15 years, so that has a lot of customization and your business processes are built around it. So what we're hearing from customers is, yes, there's continued interest in SaaS and one of the biggest areas where they need help is OCM, organizational change management in order to really drive that transition and get it over the goal line. So we're still booking new, net new, for example, Windchill+ SaaS transactions, or still seeing customers convert. I expect we'll continue to see that. But as you can sense from -- again, as you pointed out, from Neil's talk [indiscernible] the primary objective is let's focus on delivering the value that the customer wants. And then secondary question of how they want it delivered.

Got it. And I think in the past, you sort of talked about this S curve in terms of adoption for SaaS reaching 70% over 10 years. Is that still the right way to think about how you're thinking about this opportunity? Or any changes that you might make to that based on the trends you've seen over the last year?

No. I mean, at this point, we haven't said anything different. I still think that's right. Even, I said earlier, I think this part of the space is going to move by and large, to the SaaS delivery model eventually. I think it's just a question of time. Now there are certain customers that still maintain, are never going to move for -- because of the kinds of products they're working on. They're on air gap networks in general, they're not going to move. But I think those targets are reasonable, I think and I think we're seeing progression towards them. It's the amount of time that I think is the question.

Yes. So a common question we often get from investors is just look, PTC has been around for a while, CAD, PLM, relatively mature markets, yet you're posting really impressive growth. Those businesses have been growing pretty consistently in the double digits, especially PLM. Maybe we start on PLM but what would you attribute the strength in PLM to? There's been some discussion about PLM being in a renaissance, maybe some competitive changes to, if you could sort of help investors unpack what's been driving this higher-than-expected level of growth over the last few years? And is it sustainable?

Yes. Another great question. So I think we've probably talked about this a few times but I would start off. It's not the primary driver. But in terms of sustainability, I would start off by just reminding you again of the subscription model versus the perpetual model. The subscription model is a more sustainable growth driver just by the virtue of the model. So let's not discount that. As it relates to PLM, yes, PLM has been around for 20-plus years. But what it was and what it is and how it's used and viewed by customers has evolved over the years. If you went in the Hot Tub Time Machine, way back originally, it was really PDM, product data management. It was a vault for CAD files, check-in, checkout, managing your CAD files and offering kind of rudimentary collaboration. There were a lot of capabilities that were kind of customizations in the early days that allowed for a broadening of the scope. But still the preponderance of customers, I think, would have thought about it that way is kind of just PDM. Fast-forward to today and hundreds of millions, well, probably over $1 billion of investment in the tool set itself. And what you're seeing now is a lot more standard functionality that allows for much more than just CAD data management. It's collaboration not only within the engineering department but opportunities to collaborate on this kind of key product information outside of engineering with, whether it's the quality department and the customer or whether it's the supply chain or manufacturing or into service, in some cases, even into sales and marketing and leveraging the real product information, which is really housed in their PLM system, if they're using it that way and thinking about it that way. And I would submit that not all customers have gotten there. But again, some of our more sophisticated customers are really are thinking about it that way. They're thinking about their PLM system as their "system of record" for product information and leveraging not only communication out from engineering into different parts of the organization but getting feedback back into engineering where those changes can really be made if necessary, to a product, again, in the system where they need to be changed, so they can be reproliferated. So I think when we talk about PLM seeing a renaissance, I think what we're trying to communicate is that we're seeing more customers thinking more expansively about how broadening the use of their -- or expanding the use of their PLM system can actually be a competitive advantage for them in the markets in which they compete. Yes and as a consequence, we have been seeing pretty steady demand.

Yes, that's a great way of putting it, kind of almost redefining or expanding the traditional definition of PLM. I'm curious how much you think though the competitive side is also playing into that because I think one of your peers across the Atlantic has made some changes in terms of some of the newer versions of their PLM products kind of closing off access to other ecosystem partners that perhaps has created some customer confusion and frustration. Have you noticed any changes to your win rates or share gains? And anything that you think could be helping you on the competitive front?

Yes. It's still a difficult competitive environment. I think these things play out over time. It -- again, like any enterprise system, switching is difficult. It's costly. It's disruptive. So it's one of the -- it's frankly, it's one of the good points about the industry, is across the industry, I think we see high retention rates in general. On the flip side, it makes switching more difficult. So I would say we haven't seen a meaningful change in win rates. But again, yes, confuse and anger your customers long enough, ultimately, they may make another decision.

Right. Got it. On the -- I guess on the -- as you think about capital allocation, we talked about a number of the acquisitions the company has made between ServiceMax, Codebeamer, Onshape, Arena, how are you thinking about capital allocation from here between paying down debt, future M&A? What are areas that are interesting to you versus buyback or potentially a dividend?

Yes. As you point out, we took on a considerable amount of debt as we acquired primarily Codebeamer, ServiceMax over the past 2 or 3 years. We've been kind of diligently paying that down according to plan. We do have a, we'll call it, a stated policy of returning about 50% of our free cash flow to shareholders via share repurchases. Of course, while taking into account other strategic opportunities and of course, the interest rate environment. So we have put that on hold for the past couple of years, focused really on paying down debt. The interest rate environment is very different today than it was a couple of years ago. I think I mentioned on our last quarterly conference call that as we start thinking about next fiscal year, I think what we'd see is a site rebalancing, if you will, of capital allocation in fiscal '25, meaning I think you'll see us resume share repurchases probably in and around the $300 million level with the remainder going to continued debt paydown at this point. M&A opportunities are -- there's a couple of different kinds of them, they're smaller tuck-in ones we look at fairly regularly. Those can happen and shouldn't really have any impact on that kind of capital allocation decision. Larger ones are much more of a wildcard, difficult to settle in. I think we'd have to weigh opportunities as they come to market and whether or not we think it's a good strategic fit. In the meantime, we're focused on driving the free cash flow. We're focused on paying down debt and resuming share repurchases. Dividends, I do not believe are in the cards for us here in the -- at least in the short term.

Yes. Okay. In the last few minutes, I wanted to just get your perspective on how you're seeing the topic of generative AI play out across your customer base? What is PTC's strategy there? And how often is that coming up when you're talking to customers? And is that something that you're kind of at the front of the table, so to speak, in terms of having that strategic conversation?

Yes. So generative AI or even AI more broadly, I think is, customers are looking for how can they leverage AI to get better value out of the information that they have, or can it improve the use of the tool sets. As you know, for example, in CAD, a few years ago, we had acquired a company called Frustum that does generative AI for CAD. We have customers that are looking at it. We have customers that are using it but it hasn't really become a mainstream driver. So like customers are aware that it exists, it just hasn't -- the demand from them just hasn't materialized in a explosive way, as I think maybe you're asking about. So that's on the CAD front. On -- we've introduced in kind of pilot format, for example, copilots in ServiceMax. These are -- this is being well received by customers that are testing that out and they like to use of some of this technology. And then frankly, part of the overall message as well is that really the leverage AI, generative or otherwise, you do need to have your digital house as it were in order. And again, for the part of the enterprise that we serve, that largely means your PLM system in order and more expansive use of it and that will actually enable you to leverage AI more broadly across your organization. So we're seeing interest. We're going after opportunities methodically as we see them. But at this point, I also would not say that they are a significant demand driver.

And I guess on the other side of that, some software companies who've almost called out GenAI as a distraction or even a headwind to traditional IT budgets. Obviously, your customer base, it's the more cautious and conservative, not a kind of forward-leaning digital native customers or anything like that. Is that causing any distraction or reallocation of budgets as far as you can tell? Or is it sort of just a conversation but not anything negatively impacting the pool of spend that you're going after?

Yes. I haven't heard from any of our sales leaders that -- but that's a major issue for them in the field today. Again, that's today, who knows what happens, times evolve but we haven't heard that as of yet.

Great. Great. Well, Kristian, maybe in the last 1 minute or 2, I'll just open it up to you if you had any closing comments or thoughts that you wanted to share with the audience but I appreciate you coming down.

Tyler, thanks very much for having us. We always appreciate the invite and thanks to everybody in the room and I'm presuming this is webcast, so anybody on the webcast as well. I appreciate this interest and the support. And if you have any questions, I think you know how to reach us. You can find Matt Shimao, our Head of IR and/or reach out to me directly. We'll be happy to engage in a dialogue.

Great. Thank you very much. Thanks, everyone.