PTC Inc. (PTC) Earnings Call Transcript & Summary

Thanks everyone for joining. Brett Klein from Morgan Stanley. With me I have Neil and Kristian, CEO and CFO of PTC. Excited to host them today for a fireside chat. I'll go through some questions and then open it up to the audience as a few and then wrap up. If there's -- we finish up the audience questions. Thanks again, guys, for joining today. Congratulations. PTC recently celebrated 35th year as a company, which is amazing. So let's start out with a high-level overview of PTC, just to level set for investors that may be new to the story. What does the company do and focus on?

Great. Great to be here. And in fact, we are we've celebrated 35 years of being a public company.

Public company, sorry.

And this May will be 40 years in existence, which is a great testimony to the great teams that have been part of PTC. And in terms of what we do, so PTC does a remarkable job providing software to help customers design, manufacture and service some of the most important products that all of us, our families to rely upon. Core areas of software that we focus on, computer aided design, 3D modeling, designing of very important products in the world. PLM, it's the recipe by which all the designs come together before it gets manufactured. ALM, a great product that we call Codebeamer is our forefront there, where take software requirements, traceability, test cases, et cetera, in an agile framework. And then SLM, particularly ServiceMax that allows for field technicians to really understand what products are actually doing in the marketplace going forward. So that's what we do in a nutshell and looking forward to the discussion.

Awesome. That's really helpful framing. Neil, I know I asked this last year, you were a couple of months in as CEO. You've been at PTC for, I don't know, a little over a year, I believe, at that point in time. A year later, in the seats, like what are some of the key learnings now on the business and the opportunity for the future growth?

Let me start with the customers. The customer base that we serve, 5 verticals that we're specialized in industrial manufacturing, medtech, federal, aerospace and defense, automotive and electronics and high tech. Those segments that we've been doing great work for the last 40 years and looking forward to many more years ahead, are really looking at digital transformation to keep up with all the pressures that we'll talk about today that are coming at them to produce complex products faster in a very volatile world that we live in. So really energized by the work we've done with customers and how much more opportunity there is to do digital transformation. Being here for the last year as the CEO, I'm surprised by the end markets, the maturity of how much they've actually digitized. It's actually in the early innings of transformation. So we looked at that as a great opportunity for PTC to serve them in a really good way. The second piece on customers is the feedback they're giving to PTC. Around the world, I've been obviously meeting with a lot of customers, they really look at us as the epicenter and you could see it in how they renew with us and the stickiness of the product, but how important it is for them to run the business. We're looking forward to replicating that across all the companies in the verticals that we serve, which we'll talk about as the go-to-market transformation that we instituted. In terms of the employees, by the way, and the company itself, it's incredible 40 years of vertical and domain expertise in these areas that we talked about, leveraging that at such a critical time for our end markets is just a gift that I got that now we're going to continue to leverage and build momentum on as we serve these customers more broadly.

That's great. And 40 years in, still a super innovative culture across the employee base, really fun to see.

Yes.

I mean speaking of innovations, we talked about ServiceMax, an acquisition PTC made a couple of years ago. We launched our first generative AI solution to the marketplace, stand-alone SKU for ServiceMax. We're going to Hannover Messe next month. We're going to talk about Codebeamer AI. We're going to talk about Windchill AI. And the reason why that's important is it illuminates how important having a data model underneath generative AI is. And that really speaks to what Creo, our CAD tool; Onshape, our CAD tool, Windchill, our PLM tool; Arena, our PLM tool and Codebeamer can do for our customers as well as ServiceMax.

That's really awesome. You talked about the driver of digital transformation. But what are some of the other key demands or challenges that your customers are facing in market today that they're coming to you and saying, help me with your solution, solve these problems in my business.

We live in an extremely remarkable time right now. And for the last number of years, we've been calling it a sluggish sales environment. What sluggish sales environment means in terms of a customer is that they're just dealing with so many things coming at them from -- we talked about supply chain volatility a number of years ago, which continues retiring workforce, software-defined everything. Now you got generative AI, where CEOs are coming back from conferences like this and telling their heads of engineering, we need generative AI to change our business or else we're going to be out of existence. And then you get what we've been getting geopolitically over the last number of years, but it's accelerated over just even the last 24 hours. All of that is causing a rethink of how companies are actually organized, how they're using digital tools to survive. And that's a great moment for us to rise to the occasion at PTC because we have the digital tools that will allow the best brands in the world to actually have existence in the next 2, 3, 4, 5 years. And I'm optimistic that over that time frame, the CEOs of these companies are understanding change is now the reality, and we have to actually modernize and we look forward to that opportunity to talk to our customers about how we could help them around that journey.

Okay. Great. You brought up AI, Generative AI. How do you believe your customers will be impacted by AI? And then how do you tie that into PTC's product road map with AI embedded in your own solutions?

Brett, every customer that we've been talking to, especially with the work we're doing in Generative AI at ServiceMax and Codebeamer, reveals the structured data model, particularly as our core focus around the core engineering capabilities of product companies around the world, it shows that unless you have a structured clean data model, the output of Generative AI is unusable. It might be usual, by the way, for salespeople, from marketing people, for finance people, but it isn't going to work for engineers, right? And what that highlights to them is we need to modernize our tech stack. We need to deploy PLM beyond just being PDM. We need to deploy it across our supply chain engineers, our compliance teams, our quality engineers to have a uniform data set that's integrated with some of their other systems to actually have outcomes actually result in a better business. And so we're bullish that Generative AI in a market -- end market that we serve has not matured technologically like many other end markets have, it is another spear that is causing the urgency to get your data house in order by which they can leverage Generative AI, which we're working hand-in-hand with our customers to deploy.

That's great. And I know you've been talking about just this data angle and like as one example, sharing PLM data with the manufacturing floor. Unpack maybe that example or a couple of other examples where data is being used from maybe a PLM tool that you have in other areas of operations and manufacturing.

Yes. We're going to start -- part of the go-to-market transformation is also around messaging about business value for the things that we do at PTC. So you're going to see a number of clarified messages to the marketplace around what we do. And part of that epicenter of what we do is we create product data, ultimately, intelligence that could be actioned upon to build faster, more complex products, the beauty of the products our end customers do, but do it faster in a complex world, right? And our tools allow that to occur. And what that means is taking PLM data, like the recipe of how a product actually can get configured to get manufactured that clarity on a real-time basis, if you're trying to move fast, has got to be delivered to the manufacturing floor which is a product that we just released called PLM work view instructions to the manufacturing floor, where a factory floor worker knows that's reconfiguring the manufacturing toolkit, that knows if there is a change in the design or change in the configuration, I don't have to wait until full completion. I could actually view that in real time so I can understand what changes they need to make on the factory floor. Same thing is going to happen on the service side. We've connected ServiceMax back to Windchill so that, that real-time feed of what's actually been served on the MRI machine and how it feeds in the product development process, it just has to speed up. And so that's the really fascinating part of unlocking product data by PTC to democratize that to move faster through an enterprise of the end markets that we serve.

Super interesting. Maybe just flipping back to AI as well. Just what are some of the initial use cases that you envision or have in market for AI with your customers. Give us a few examples.

So this is awesome. We've been working with Volkswagen and Microsoft on Codebeamer AI. And Again, I've been very consistent talking about AI needs to be practical and show real value versus being something we market to show excitement but it doesn't really create value to the end user. So in this example, an end user is a software engineer, right? And they have huge demands on their time for requirements management test cases. The amount of time software engineers spend doing monotonous work is taking away from the creativity of keeping up pace to deliver great products, right? So what Codebeamer AI does is it takes the Codebeamer infrastructure and looks up using large language models and an agentic architecture to really understand in this requirement that you're looking for as a software engineer at a defense company, there's thousands of test cases that we've done with a similar requirement instead of you making up the test cases, here it is in 3 seconds versus the 3 weeks you spent to rearchitect the test case. To you, it might seem like, wow, that's like not great. For the customer reaction to this is, wow, we could shorten that timeline by 2 weeks by which we can build better products. So those are the types of use cases that we're working through. And pretty energized at their real value with a vertical expertise that takes a look at all the regulatory requirements as well. That's the advantage of PTC doing this versus others.

Super cool. Kristian, let's pull you in here. Kristian, we're a few months into the calendar year and midway through the second fiscal quarter. How would you characterize the macro environment and spending environment across your customers?

Well, I mean we've been saying it for, I don't know, going on almost 10 quarters now. It's a sluggish challenging sales environment. There's -- you could look at -- one of the things we look at, for example, is PMIs. And PMIs have been sub-50% most of those months. And it just leads to prolonged decision-making amongst customers.

And then maybe specifically, within customers that are potentially impacted by government, to not you serving governments yourself, but maybe industrial, aerospace and defense, I know it's early and new, but what are you all hearing from them on the demand side? And any disruptions you're seeing with those verticals?

I think all of them are contending with how do we speed up our delivery of products. And how do we do it more efficiently? And how do we do it in concert with all the things that are changing around us. Last week, I was with a number of manufacturing CEOs. And they're looking at tariff input prices, how long it's sustained? Is it transitory? Is it permanent? Regardless of that, they've all thought through changes afoot so that they need to understand if we have to move manufacturing from Vietnam back to the United States or from Mexico back to the United States, I need to sort through what are the frameworks that I make that decision, what digital tools can I use to actually enable acceleration of that. And so the speed and the decisiveness in a complex world is at the forefront. Now does that mean that the floodgates open at PTC next quarter or the following quarter? That's yet to be seen. But from an opportunity perspective, PTC, what we're very bullish on is all these tension points that are increasing on a daily basis, if not hourly, is increasing the need for people to digitally transform their businesses. And fortunately, for PTC, these end markets have not transformed their businesses. So there's a lot of opportunity. How we get that within a quarter, within a year, is still the work we're putting in, but it's coming.

Certainly, and it sounds like PTC will be very fundamental to that ongoing transformation in a world with a lot of uncertainty.

Yes. I'll give you an example of coming back from a trip from China and a medtech company in China that I visited, they're developing MRI machines 5x the pace of new product introductions than the Western medtech companies, right? And so when I -- we come back to many of the customers that we serve with Creo and Windchill and other products, they're asking us, how can we deploy PLM faster? How can we integrate software requirements using Codebeamer faster into our product process because that Chinese competitor is starting to eat our lunch. And so all these tensions are creating the speed in a complex world, but still delivering with quality.

Excellent. We're going to pivot now. You referenced some of the go-to-market changes. Let's go in a little deeper last quarter. Some real announcements around changes to go-to-market or realigning sales, success, marketing to be more vertically integrated, brought in a new Chief Revenue Officer, Rob Dahdah. What prompted these changes? And I know it's still early, but are you starting to see them bear fruit already?

So backing up from last year, I've just completed 1 year as the CEO of PTC. And right out of the gates, we made a point of view around the strategic priorities of the company to be a refocus back on the core elements of the company. The CAD business, the PLM business, ALM and ServiceMax since we made that acquisition, and it ties back into some of the core systems. That was the refocus of the energy, the resource allocation that we started in earnest last year around this time. Post that, we also made the understanding, as you would expect a new CEO to come in, to look at where can we get better? And it was clear we were suboptimizing our go-to-market approach in terms of how we were organized internally, how we were leaving money on the table, the opportunity that we have to take more market share in terms of our existing customers, how we think about that, how we message it. And so we embarked upon a pretty -- not a pretty -- an extensive go-to-market transformation program that resulted in a number of things, including delayering of the business, verticalization of the business, surrounding the verticals with customer success, technical capabilities as well as marketing capabilities that pre this transformation was separated and siloed. That culminated in -- actually Rob Dahdah coming in, who is now hitting the ground running and he's 2.5 months in, and his heavy lift is still in front of him but we made a lot of changes in Q1 as per the go-to-market plan. And now we're working through how do we capture the path by which pipeline has great quality to it, how it moves faster, how we align around getting to higher close rates by which a greater body of our go-to-market organization has higher attainment as we get into thinking about the subsequent years ahead.

That's great. And I know the last quarter, you talked about the cross-sell opportunity. Just one example I picked up was Codebeamer, the ALM solution and the cross-sell into the PLM customer base. What are some of those top of mind cross-sell opportunities that you see across the portfolio?

So Codebeamer in Windchill. Windchill customers needing Codebeamer. Codebeamer customers looking at a broader PLM platform. That is up our wheelhouse. It's got a lot of energy momentum behind it. We mentioned a few of them on the earnings call last time around that being a great mechanism by which the nerve center of product data occurs on Codebeamer and Windchill. You'll also see the product development road map have incremental steps around how the 2 work more effectively in front of the end user. So a continued investment into that space, we believe, highly differentiated versus our competitors and a real need for our customers to speed up development. So that's great cross-sell. ServiceMax into -- which we talked a lot about the last few years, ServiceMax, how it ties back into our Windchill base of customers is a continued effort. There's momentum that's building there, the pipeline is growing the product team, our Head of R&D for ServiceMax is here in the crowd, has done a really great job building products that actually tie the 2 together, an integrated approach as well as create the generative AI capabilities that raise the profile of ServiceMax in relation to our core customers. So those are the main thrusts. Obviously, we've got a broad array of products that I don't talk about on our earnings call, Servigistics, a fantastic product that we cross-sell into the base, Kepware, the list is far in terms of the number of acquisitions we made, organic development, the company has made over the subsequent -- the last number of years, but the focus is around truly this nerve center product data intelligence, which is really the tying of PLM, ALM and bringing in data from ServiceMax.

Okay. That's great. And let's just go a little bit deeper on the ALM opportunity when you acquired Codebeamer, it was pretty automotive-focused from a vertical perspective, how broad is the opportunity across your other industries that you address for the Codebeamer products?

So we're clearly seeing continued strength in automotive. We have -- as I said on the earnings call, an important release that's coming out, Codebeamer 3.0, that creates scalability of that product, very differentiated. There's opportunity to continue to scale that business. Again, in automotive, you might look at the headline and say, "Wow, that's an industry getting under a lot of pressure." The good thing is that companies under pressure are thinking about how to survive and thrive over the next number of years. And Codebeamer does a really nice job of creating the foundation of software-defined vehicles, right, which is, in a combustion engine or an electric vehicle, you're going to need the software epicenter. So Codebeamer does well there. The reason why that's important in automotive, which plays into other verticals, is there's a regulatory element to when you release a product, a software release. If it causes any issues in a vehicle in a crash or something else, you have to trace it back to what actually was the issue? Was it a mechanical issue? Was it a software issue? So it plays really well to that. And Codebeamer has extremely strong traceability elements, that's again, differentiated in the market. That has flowed into medtech, which is also highly regulated. It -- tertiary or not -- just as important, I think, industry is federal aerospace and defense. Those are also -- those 3 segment. So that's enough for us to play with for quite some time are where we're really honing in our attention and our vertical approach from how we think about Codebeamer.

Okay. Great. Neil, you came over with ServiceMax 2 years ago. PTC's own the business 2 years now. What are some of the opportunities around ServiceMax you're really excited about? I know PTC addresses the full life cycle now from design, development, operations and service. How do you see the ServiceMax opportunity going forward?

So ServiceMax is a clear part of the differentiation of why you should deploy a PLM system called Windchill because Windchill now integrated with ServiceMax gives you full visibility of what happens to that product after it gets manufactured. So it's a very strong impetus for people to look at Windchill different than our competitive solutions. That includes, obviously, the Codebeamer inclusion, but also it's important to add ServiceMax to it. So that's point number 1. Number 2 is, from a vertical perspective, we've now aligned ServiceMax to be vertical-oriented where, as an example, we just FedRAMP certified our ServiceMax offering. And that federal aerospace and defense vertical that we have is really excited and energized by putting ServiceMax in the hands of already existing customers that previous to the certification a number of months ago weren't able to deploy ServiceMax. So we're thinking about it also in a vertical nature, again, from a product development standpoint, but also a messaging standpoint.

Okay. Great. Maybe I'll pause there and see if there's any audience questions for Neil or Kristian. Shoot your hand up, any questions? I'll give you another opportunity in a few minutes. Neil, could you provide us an update on SaaS uptake within your customer base? And SaaS has been in a lot of horizontal business apps. What are the unique benefits for SaaS within industrial manufacturers in your 5 major verticals?

So we continue to have a point of view that SaaS will be a framework and a tech stack that our customers deploy, not all of them, because some will always have the security needs of having an on-premise system. But over what I've been saying is over a 10-plus year -- 10-year time period, we believe SaaS will be a higher percentage of our existing base than we have on-premise, which is predominantly what Windchill and Creo are is on-premise currently in a subscription manner. We continue to see Windchill+ deployments more last quarter than the previous quarter and more forecasted this upcoming quarter than the last quarter. So we continue to invest in it. We continue to build our strength and deployments, automation of that seamless delivery. It's very important to us that the experience is what is necessary for SaaS to be shown as this is a lot better than what we have on premise. And so we're not pushing it to say you have to move to it. We are showing them all the value of when it's done right, why you should move to it. That's point number 1. Point number 2 is, we're really focused, Brett, into making sure regardless of deployment model, whether it's on-prem expansion of PLM or SaaS deployment of PLM, that our customers really understand the business value of why PLM should be broadly disseminated across their enterprise, meaning incremental seats is our focus area versus, "hey, let's just convert you to SaaS", irrespective of the business value because we know we could get an economic uplift. That is not what we're trying to do. We're trying to explain the reason why having a clean tech stack in Windchill+ has benefited, but you should deploy it across all your seats that need this intelligence to run a better business.

And for customers that do want to deploy SaaS, talk about the competitive differentiation and landscape of your offerings in SaaS versus some of the traditional competitors out there. Do they have true SaaS or no?

We believe we're far more well down the path of true SaaS on our core offerings than our competitors. And I'll leave you guys to do the research, if that's the case or not, but that's our view, and that's what we hear from customers. The real notion of SaaS is actually the conversion of a Windchill on-premise deployment to SaaS. And so it's a matter of time until they convert and it's on our timeline to determine when we want to convert them to a certain degree, obviously, in concert with their conversation, which is why I'm saying that, internally, we're investing into it. We're doing more deployments. We're creating a seamlessness by which it's easier for us to now go to customers and say, it's time you convert. But we're making sure the foundation is laid strongly before we make that the main point.

Okay. Great. Kristian, let's put you back in here, too. Very simple, high level on what are the key metrics investors should be looking at? What are you looking at each quarter to judge the performance and health of the business?

Yes. Thanks, Brett. Obviously, what we focus on is what we call ARR or annual run rate. It's the annual contract value, if you will, of our book of business. Essentially our billings for our software. And then on the bottom line, what we look at is free cash flow as the metric and the reason's simple, ASC 606 does some interesting things to the P&L, which to revenue, which then in turn any derivative metric off of revenue is somewhat convoluted whether that's gross margin or operating margin or EPS. So we tend to focus on ARR billings and free cash flow.

Cash is king. Talk through a little bit of your -- either one of you can answer this, actually, your framework around growth versus profitability? And then also maybe as you think about investments in the business, M&A, inorganic investments and return of capital, 2 separate questions.

I'll start, and Kristian, you could add. We see an opportunity with the demand in front of us. That transformation is ahead of us for our customers versus behind. So there's a real opportunity to deploy greater PLM capabilities, greater ALM capabilities, continued growth in what we've seen in the CAD market and then ultimately how ServiceMax relates back into the core. So we see the opportunity to be strong. In fact, over the last number of months, with the increased [ entry ] in the world, we believe the opportunity will continue to accelerate for customers needing to transform. How we do that has to be in a way that's deployed -- deploying our capital in an efficient way and effective way. And I think this company has done a great job before me and will continue going forward where we're really thinking about every bit of our resources. Is it actually driving value to our customers and ultimately, does it return value to our stakeholders. And it's a constant basis, and we're not taking anything to be sacred, it has to return that value. And when you do that, we're able to ensure that the free cash flow generation continues to be what we've seen over the last number of years, energized by that leverage that we get. And ultimately, some of the go-to-market transformation that we're doing, we've had strong ARR growth for multiple years, right? But that's underpinned by net new ARR that's been flat. And what we're really honed in on now with Rob's work, CK, our Chief Marketing Officer, the collective executive team is how do we foundationally lay the tracks for increased growth in net new ARR. And we're going to do the right things. But in a way that's not spending money frivolously just to chase something that we don't see. So we're going to be balanced around that. We feel the opportunity is there, but we will be good stewards of capital. That's really, really important to us. Your question on M&A, we're focused right now on organic. There's enough fish to fry right now. We believe there's enough opportunity around just getting our go-to-market machinery working at a good company rate and then we'll work on best-in-class to really be able to influence that net new ARR growth rate. And Rob is hard at work on that. It's going to take a few quarters to really drive that behavior. We're watching it carefully, supporting it carefully. We're focusing on that. That being said, we're getting a lot of inbounds from smaller companies. There's not a lot of companies out there in our industrial software space anymore. It's all been acquired for the most part. But there's still technology tuck-ins, et cetera, that we look at, and we'll stay aware of that, but the focus is on the organic work we're putting in this year. A lot of heavy lift that will allow us for confidence into -- as we exit this year into next year.

Great. Let me pause and give back the floor...

I was just going to -- then on the return of capital, I guess, piece of the equation. For the past couple of years, we've had a higher debt balance, if you will, part of the acquisitions that we did, ServiceMax, Codebeamer, et cetera. We've been diligently paying that down. And it paused any kind of share repurchase program that we had. We've started that up again this year. We'll continue to balance debt paydown with return of capital this year. I think we'll buyback somewhere in and around $300 million. But going forward, because of the stability of the model, the way that we bill, which is annually in advance, the predictability of both cash inflows and cash outflows leaves us in a position where I don't feel that we need to maintain a high cash balance to -- for the business. So to the extent that we don't have other uses for any of the cash that's generated, I would expect that, that would also then get returned to shareholders. So to think about it.

The question here upfront. If we have a mic, quickly. Hold on one sec, sir.

Regarding your AI [indiscernible] do you have any [indiscernible] speed and accuracy which industry group of your customers do you expect to be the first movers in adopting your AI offerings?

Yes. I think on the ServiceMax AI offering, it will be, first and foremost, that medtech end market because there are so many technicians out in the world with high value. And it's not only speed and quality, it's the cost effectiveness of technicians going out and repairing something at a clinic. So that's got a real great ROI on -- from a medtech perspective on ServiceMax AI. And again, that market will transform, but that will be the initial interest level we're seeing in the alignment. On the Codebeamer side, this is on anything that is related to regulatory software requirements and traceability whether it be automotive, federal, aerospace and defense or medtech, those 3 categories will eat this offering up and understand that you need Codebeamer also to leverage it. Windchill AI, will be -- still TBD, but we believe that will be across industrial manufacturers via relevant kind of use case and just digress for a second. Industrial manufacturers, call it, a $20 billion industrial manufacturer, spends about $400 million on redesigning a part that's already been designed multiple years prior. And so our Windchill AI will allow to have parts reuse, which actually equates to in the magnitude of $400 million to $500 million of savings because of all the rework that does, including you now speed up the pace of delivering an end product. So we're energized by this. But I think the AI offering will really make more prominent, the reason for why you should deploy PLM, ALM, FSM like ServiceMax across your infrastructure. The data model is very, very important. And I think that's what's being highlighted by our offerings.

Maybe one quick last one in the last 30 seconds. Long-term vision, call it, 3 to 5 years, Neil, for PTC. What do you think the business looks like?

I'm truly pump that there is a seminal moment right now in the world where product companies that we have been serving for 40 years are at near crisis levels. And PTC will play a strong part at making sure the products and the brands we all rely upon around the world, we actually save to drive a really great business. So that they could have another 100 years of existence. And we feel very honored for that and feel like we've been building up for 40 years for this moment. And the rest is up to our execution right now. So feel proud about and energized by that opportunity.

Awesome. Neil, Kristian, thank you so much for being here at the conference. Really appreciate it.