PTC Inc. (PTC) Earnings Call Transcript & Summary

All right. I think we're ready to go here. Good morning, everybody. Thank you for joining us for day 2 of this Nasdaq conference. I'm really excited to be here this morning with Kristian Talvitie, CFO of PTC. I'm Hamza Fodderwala, software analyst at Morgan Stanley. Kristian, thank you so much for joining us.

Hamza, thank you again for hosting us as well at this conference, one of my favorite conferences to attend. So really appreciate it. And also before we get started, my general counsel would yell at me if I didn't remind everybody about potential forward-looking statements and risk factors, et cetera, which you can find in our press releases and SEC filings that are on our website or on file with the SEC.

Great. Okay. And I should also mention for important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures.

With that, we'll kick it off. So you just capped off your fiscal year recently with over $2 billion in ARR, still growing in that low to mid-teens range and really strong free cash flow generation as well. Maybe you can talk to us a little bit about, at a high level, sort of the various growth drivers at PTC today and just the state of the industry within the technical software domain that you play in?

Yes. Sure. So maybe I'll even just start with a very high level on PTC itself. I actually was just in New York on Monday, had the opportunity to go and ring the opening bell at the Nasdaq to commemorate PTC's 35th year as a public company. So just putting -- it helps me put a little bit of perspective on the business. It's actually 40 years old, 35, 35 as a public company.

Congratulations.

Thank you. And today, as you said, PTC is a little north of, call it, $2.2 billion in top line with about 7,000 -- a little over 7,000 people worldwide. And we focus on technical software, really, we'll call it CAD, PLM, acronyms. Computer-aided design, product life cycle management, application life cycle management and even service life cycle management, which is really all for -- to help our customers design, manufacture and service their products ranging from bicycles to motorcycles, to cars, to trucks, to planes, to rockets. So across a pretty wide spectrum. The industry that we serve and the technical software space in general, again, a fairly mature industry. We have really kind of 2, 2.5 main competitors. The half -- the 2 main competitors being Siemens with their Siemens Digital Industries. They had acquired a company called UGS quite some time ago. And then there's another European company called Dassault Systemes that plays in the same space. And then the half is really we also compete with a portion of Autodesk's business. They do a lot of AEC. As you know, that isn't really what Siemens, Dassault or PTC do, we focus more on, we'll call it, the mechanical products, physical products that are being designed, manufactured and serviced around the world. So it's an interesting industry. I think across the industry, you would find that the software tends to be very sticky. We have very high retention rates. And again, I would think that applies across the industry. It's mission-critical software for the customers that we serve. They have to continue to evolve their product portfolio as the world continues to change and software becomes more important and the electrification of everything becomes more important. They're constantly redesigning their products as well. And speed to market is important to them. And that's really what we help them do.

Yes. I mean, it's, to your point, it's mission-critical software and a lot of like the competitors within this domain you tend to see very high retention rates, high margins as a result of that. And I know recently, you had a pretty big business model transformation over the last few years. Can you go into that a little bit? What's sort of changed? And how is that making sort of the business more predictable going forward?

Yes. So for the first, we'll call it, kind of 25 years of PTC's history, the commercial model was pretty typical of the software industry at the time, which was a perpetual license model. You sold a perpetual license and then the associated maintenance or support that went along with that. And then as the software industry continued to evolve, you started to see more kind of SaaS players coming into the market and that was really all on a kind of a subscription model. And we had actually even acquired a couple of subscription model-based companies along the way, and ultimately determined that this was the direction that the market wanted to move in anyways. And so we evolved our model from a perpetual model to a subscription model. Obviously, for the SaaS pieces where it naturally fits like that, but also for our offerings as well, which we -- that took probably about 4 years. And I'd say 2020 was the last year of that transition. And so now for the last 4 years, really 4 going on 5 years, we've operated essentially 99-plus percent of our software as a subscription, which the market seems to like. That's how customers want to buy. It offers more flexibility for them, et cetera. And so we felt like we've been on the leading edge of that transformation. And by the way, it has come with other benefits, the predictability, as you point out, with the high retention rates. That makes for a good backdrop for the financial discipline that we apply to the business as well and how we're thinking about investing in incremental investments in the business. And ultimately ends up working out well for our customers as well because even in, we'll call it, more turbulent macro environments, we're able to actually continue investing because we have that solid drop of cash flows, which, again, the benefits there, of course, accrue to the customers. So it's really worked out tremendously well. And again, I think if you looked at our financial results, I think you would see that it's worked out on that side as well.

Yes. And so I wanted to dig a little bit into the various pillars of the business, right? So PLM, there's ALM, there's SLM, which is based on your ServiceMax acquisition for a couple of years ago. And then there's CAD, which we all kind of know as the core of the business. On the PLM side, it does seem like that business has been a lot more durable. It's been expanding within your customer base a lot more. Can you talk a little bit about that, both inside as well as outside of some of the core engineering use cases?

Yes. I think it's a great question. And so I would agree with you that CAD is kind of the foundation, right? That's where companies -- tools that -- part of the tool sets that companies are using to design their products. And PLM in its early days really started off as a CAD data management system. It was a vault for CAD files. Now you fast-forward, whatever 20, 25 years, billions of dollars of investment and PLM today, especially for some of the more, we'll call them, forward-thinking companies that are out there are really thinking about PLM as a system of record for their product data. And what they're figuring out is how to leverage that rich product data not just to make their engineering departments more effective, more efficient, but how to share that information more broadly across the enterprise, whether it's into the quality department or in the supply chain or into manufacturing or even in the service organization. And creating also a feedback loop that comes from those various organizations that then actually makes its way back into the engineering departments where changes can be made based on those feedbacks, changes to the actual product design and then repushed out. And that's kind of what we call the Digital Thread. If you look at any of our marketing materials or listen to us talk, we'll talk about a Digital Thread and that's really what it is, is the sharing of this product information broadly throughout an organization, both outwards and then coming and getting that feedback loop working. And so that's really where the opportunity for PLM expansion is right now because, as I said, we have some customers that are more forward-looking and thinking about it and have adopted it somewhat more broadly outside of just core engineering. But I think that there's a lot of runway for companies to continue to do that, and that's the growth driver that we're seeing. We talk about it in different ways. Again, you'll hear us talk about digital transformation. This is what our customers how they would perceive these activities as they're transforming their businesses to become more effective to develop faster, better-quality products quicker. But for them, they would view it as really a digital transformation initiative. So we talk about digital transformation tailwinds. But that's ultimately what it means is helping them leverage that product information throughout the organization.

Yes. And then there's the ALM side and the SLM side, maybe talk a little bit about those 2 areas more.

Yes. So ALM, short for application life cycle management. And that's really the corollary, if you will, for software as opposed to hardware. So your CAD is you're designing a hardware component, but more and more products have more and more software in them. I mean, think about cars today versus cars even 5 or 10 years ago, tens of millions of lines of code in modern vehicles and it's just continuing to increase at a rapid rate. And what Codebeamer really does is helps with requirements management and test and validation of that software code so that companies understand what version of the software is where and that it's doing what it's supposed to do. And by the way, that they have traceability as well, particularly in what we'll call highly regulated industries that should, God forbid, something bad happen that they can quickly try to understand what happened, where it happened, why it happened and where else in their fleet, if you will, that code may be that needs to be fixed.

Got it.

So that's ALM. SLM, service life cycle management. And again, that's really for, what we'll call, long-lived assets in the field if you think about products that you're not bringing into the shop to repair, but you're sending a service technician out to fix that product. Many of our customers have products that live in the field for 20, 30 years. So for them, a, it's critical piece of their brand and product strategy to make sure that they have products that are performing well in the field. But b, in many cases, it's also actually a profit center for them. And so they're looking at ways of continuing improving the service quality and the efficiency of that delivery. In essence, you could think about it, making sure that the service technician is getting to the device that needs to be repaired with the right parts at the right time, the right work instructions in order to be able to do that work so they're not having to roll a truck. The person gets there, oh, I didn't bring that part with me and they've got to go back. It's inefficient. So that's really what kind of ServiceMax brings. We have some additional SLM capabilities as well in terms of spare parts management, inventory management software and some software as well that does, we'll call it, digital work instructions that really ties back to those CAD models as well. So when you're making a change in the CAD model, it's getting proliferated into the user and repair manuals as well. So that's SLM in a nutshell.

Great, great. And have you guys given disclosure on what percent of your customers are using multiple product categories? And conversely, maybe what is the white space, if you will, the opportunity within your installed base to sell more product?

Yes. We haven't specifically quantified it, but I guess I would tell you, directionally, the most overlap that we have now in terms of cross-sell is really between CAD and PLM, which really shouldn't be surprising because we've had PLM really the longest. That said, as we just talked about, there's still considerable opportunities to expand the PLM footprint in pretty much all of our customers. I think that opportunity exists. And then from there, we do a reasonable job with cross-sell. So for example, Codebeamer, although it's newer to the portfolio, it also is an upgrade over a previous ALM technology that we had. We had bought a company back in, I want to say, 2014, might be 2012 called MKS, they had a product called Integrity Codebeamers next generation. So that's replacing a lot of that. So we had a little bit of a head start with cross-sell in ALM just because of the previous product that we had. And then, of course, ServiceMax and we're seeing some green shoots there as well, partially with really actually just having ServiceMax now as part of the bag in PTC sellers, but PLM, ALM, ServiceMax, they're all long sales cycles. And frankly, I think we've also seen some benefit accrue really to ServiceMax just being part of PTC, meaning their customers that they've been calling on previously that they weren't really able to get into the door of as a stand-alone entity. But now as part of PTC, I guess the customer feels better that they have maybe more solid financial footing and a better path for the future. So we've seen some activity like that as well.

Just one last question, I'd love to open up for the audience as well. I was really impressed by sort of the efficiency that you run this business at. In the last earnings call, you talked about how you guys have grown ARR durably at mid-teens over the last for 4 years with OpEx that's been growing less than half of that. And then you guided to over $830 million in free cash flow for fiscal '25. I think the midterm target is $1 billion by fiscal '26. What's sort of driving that efficiency? And how much visibility do you have into that midterm free cash flow outlook?

Yes. Well, starting back with the subscription model and high retention rates, that actually does provide a good backdrop in terms of visibility and consistency to the model. And then I would say on top of that, we've layered on our own, we'll call it, disciplined approach to incremental investment in the business. And I mean, for anybody who's followed PTC for a long period of time, if you went back and looked from like 2000 to, whatever, 2015, 2020 even, in more years than not we actually had a restructuring for different reasons, which kind of creates havoc actually from a management of the business and an operating of the business perspective. Well, those all ultimately were helpful. They helped us globalize, they helped us become more efficient. It's still disruptive kind of from that standpoint. And so we've really turned that budgeting process around, if you will, and we think about a potential range of ARR outcomes for our business as we start the year and we'll set budgets at the lower end of that range and see how were progressing through the year. And as we get more and more comfortable that it's going to come in at a higher level than where we started, we'll release incremental funds into the business and prioritize those. And we've been doing that now for a couple of years. And what we found is it's actually just a much better way to operate. It's less disruptive. You're not giving people budget and then taking it away 2 quarters later. You're kind of just giving them incremental budget, which is, again, better for the operators and adds to the visibility as well on the financial results.

Any questions from the audience? Bit of a sleepy morning, I guess. Maybe just talk about some of the macro tailwinds in the business. So it sounds like the verticals you addressed within manufacturing, autos, a lot of the industrial areas that you address, it does seem like there's a lot of tailwinds. So you talked about digital transformation. There's talks about industrial AI, AI has been a big topic. But just in general, when you look at the verticals you're addressing, what are the biggest verticals? And then what are some of the opportunities and challenges that your customers are facing?

Yes. So the biggest verticals for us are really, we'll call them, industrial products followed by federal, aerospace and defense, automotive -- the automotive sector, including automotive supply chain, med device companies, high tech and electronics. Those are really the primary verticals that we serve. We have some other offerings that serve more targeted niches like retail, for example. But those are the primary ones. In general, I think the feedback, what these customers are looking for is really better quality, more innovative products faster. That's what they're looking to bring to market so that they're competitive in the markets that they're serving. But that really is the general theme. And so for us, it really becomes incumbent on can we continue to develop products that -- or in some cases, as you mentioned, we acquired ServiceMax, we acquired Codebeamer, can we develop or acquire products that are going to help our customers on their mission. And that's really been the recurring theme. And I think that speed just continues to increase for them. It becomes an increasing pressure for companies regardless, if you will, of the vertical that they're in. They all have their own time scales, but they're all compressing. And so that's -- we'll call it a general theme as well as then digital transformation that we talked about earlier, which ultimately gets back to speed and quality for them. In the meantime -- so those are, we'll call them, persistent tailwinds. In the meantime, some of the headwinds I think are well known to everybody. The world has gone through a number of and continues to go through a number of, call them, less favorable events, whether it's the global pandemic with COVID or some of the turmoil that obviously we're seeing in parts of Europe as well. And then there are industry-specific dynamics that are going on that, in some cases, can be tailwinds; in some cases, headwinds. So on balance, however, I would say if we looked at our results, we've been delivering pretty consistent, I'd say, on average, over the last, whatever, 5 years, organic growth. I think the average is probably about 12%. We just capped off last year with 12% -- 11-point-whatever rounding to 12%. So the business model, the solutions that we're providing have been pretty resilient even in what I'd consider to be a kind of challenging selling environment that we've been in. So we're obviously always looking to continue to optimize and improve even within a challenging environment. We recently announced some changes our to go-to-market organization. We're going to align more around verticals and get more, we'll call it, specialized across not just the sales teams, but customer success and marketing, the whole kind of go-to-market engine, bringing more technical resources into the organization. A lot of the stuff that we sell is fairly complicated, and that's what customers are also looking for. So we're continuing to refine our own operations as well to try to meet the challenges and opportunities in the world as they are today.

Yes. This might be a little bit of extrapolation, but it does -- so PTC is in the business of selling software to help people make things or help industries make things. And what we're seeing in the U.S., a lot of the West is there's a focus on onshoring again and there's a lot of fiscal support towards that endeavor. We have the CHIPS Act in the United States and a lot of various initiatives to bring manufacturing back. Does PTC see that as a longer-term opportunity? And have there been any tailwinds from that already?

It's a great question. The answer is it depends a little bit because like I said, in certain cases, we do help out our customers with manufacturing. But really, the core of it is still in the engineering, the design of the products. And so I think that there are some potential tailwinds as that happens. But it wouldn't be as direct as it might be with some other parts of the software space.

All right. Kristian, thank you so much for your time. Thank you for the audience for joining us.