PTC Inc. (PTC) Earnings Call Transcript & Summary

All right. Making our way through the home stretch here on day 1. Thanks, everybody, again, as always. With us right now, Kristian Talvitie, CFO of PTC; and Matt Shimano. IR in the front row. Thanks, Matt. Kristian, for coming, as always.

Thanks for having us.

Yes. Your support has been unwavering through the year, so I do appreciate the attendance.

As is yours.

Let's -- generally, we start with kind of an overview of sort of what you guys just reported a couple of weeks ago. But top of mind that I just keep getting asked is some of the divestitures that you just announced. And we'll get into some of the overall underlying performance of the business. But maybe just starting with Kepware and ThingWorx. Could you talk about sort of the rationale? Strategically, there was a lot of effort, as you know, put into those deals back in the day. But I think the direction of those businesses has gone a little different than the core. Talk about some of the rationale behind these, and then we'll talk about some of the financial impacts.

Yes, sure. Happy to do so. But before we get started, my General Counsel would be very upset with me if I didn't remind everybody about our safe harbor language and forward-looking statement cautionary language that's all documented in a very detailed fashion in our press releases and on the website, files on file Forms 8-K and 10-K on file with the SEC. So please do take a look at those. But on to your question, the strategic rationale. So I think Neil has been in the CEO seat now for coming up on 2 years here soon. And I think he's been pretty unwavering from the beginning on what -- in his view, the core priorities of the business are and the strategy of the company is, which really revolves around CAD, PLM, ALM and SLM with underpinning or foundation of SaaS as a delivery model as well as AI embedded in the products. And you'll notice what I didn't really talk about there was IoT was IoT. And so we have been refocusing on the core and on the core priorities and think that it actually just made strategic sense to find a home for those businesses because they are good businesses, probably just better served for our customers in the hands of somebody who is focused on that part of the market. And so that's what we intended to do, which also provides strategic focus and clarity for the folks at PTC with everybody focusing on the kind of the core strategy, which is good for our customers and again, good for the IoT business as well with that kind of focus coming from the right owner. And so we undertook a process. It was a full process. narrowed it down to a handful of participants and ultimately determined that TPG was the right owner for this business.

That's great. Yes. And I guess I think you just gave fiscal '26 guidance both with and without. When we think even longer term, when we think about sort of how -- specifically on, I guess, both ARR and cash flow, what are sort of the longer-term implications of this? Do you think we -- I mean, ultimately like slightly higher growth, better profitability longer term? Like what's sort of the longer-term ramifications of this?

Yes. I think that there's -- I think it's clear even from our earnings materials that in recent years relative to the rest of the core portfolio, this business has been a drag, if you will, on growth. And so I think that, that is helpful over the longer term. In terms of the profitability of the business, I think that by now at this time with the sale of the business, the profitability of that business is largely in line with the broader company. So I think we tried to outline that as best we could. Again, in the earnings materials, I think in fiscal '25, we estimate that it contributed approximately $70 million of free cash flow. I think the way to think about that for '26, '27 and beyond is in fiscal '26, again, depending a little bit on the timing of the close, but we had an assumption around April 1 that it would actually be free cash flow neutral in '26 because, a, timing of collections; and b, as part of the transaction, we expect there will also be a period where there's kind of transaction -- transition services attend that transaction as the business migrates. And I think for the balance of '26, that will largely offset the cash flow differential in '26. I think in '27, we also said probably less than a $50 million impact to cash flows in '27.

Okay. So building that bridge, and you did a good job in the deck, but just to reiterate, you're talking about sort of including those businesses, still $1 billion-ish of free cash flow. In '26, obviously, that comes steps down a little bit. But how should we think about sort of like getting back to those levels as we sort of like anniversary this and move forward?

Yes. So I think that -- I mean, this would be my mental model. This year, I think we'll do about $1 billion of free cash flow, less somewhere in the ballpark of about $160 million, which is made up of taxes on the proceeds as well as divestiture-related fees. And so then as we start thinking about '27, in my mental model, I would actually start building off of the $1 billion. We then have the offset of kind of less than $50 million, which is left over from the transaction or the businesses, excuse me. And then I would probably add back still the $20 million of kind of CapEx -- incremental CapEx that we have this year in fiscal '26 as we move one of our -- actually our largest R&D center from one office into a new office. So like that I do not expect to recur next year. So I would kind of be building off of that, I guess, the rough math is 970 level.

Yes. Okay. Helpful. Now on the ARR side, you've always given a lot of thought to how you think about guidance, sort of the high end, low end of the range. And it feels like that low end is completely derisked. I guess taking the glass half side of it, what gets you to the higher end of that range? Macro is obviously a bit of a wildcard. But what are these things that you look for? You're like, well, this could actually -- let's think positivity here, Matt and I were just talking about the volatility of this market. But like what gets you to that higher end of the range in '26?

Yes. So I mean, I think just bracketing the guidance range in general, right? I think we -- Neil tried to do a pretty articulate job on the call of saying the low end actually accounts for some deterioration in macro, also tries to take into account potential disruption from the divestiture and the higher end of the range, I think, contemplates some continued positive momentum from some of the go-to-market evolution that we started embarking on last year. And then embedded within that range as well is the kind of deal structure volatility that we can see from quarter-to-quarter, which -- it's just part of the business that we operate.

Yes. What -- so the go-to-market changes, it strikes us that, that verticalization approach should start paying dividends. And maybe you're already seeing it manifest itself. How should we think about the benefit of that as we sort of anniversary these changes and start to think about how that sales force can be better aligned to target the opportunity?

Yes, I think that's right. And I think that it isn't just the sales force being aligned, and we always talk about it as go-to-market because it isn't just the salespeople, but it's sales and marketing and customer success, right, technical resources, all aligned around verticals and all focused on those customers in those verticals. And -- so I think I agree that, that is the right direction for us to be moving in. I think we've seen good progress. I think we saw -- it's difficult for me to point to any disruption that we saw last year, well, implementing these changes. And now it's a matter of really starting to see some of the benefits of executing on those changes. And then I would say, just to remind you that a lot of the sales cycles for PLM, ALM, right, larger enterprise deals, those sales cycles can run 9, 18 months, sometimes even longer. So it is going to take a little bit of time for that momentum to catch up and build there. But that's where we left room for improved velocity in the high end of the range.

And we talked about this when you reported, but are there -- the significant changes really were made last year. As you're sitting in this Q1, there's always tweaks as the sales force is want to do. But is there anything that you'd highlight that you sort of like we should be aware of in terms of anything incremental that could cause either some potential volatility or even opportunity?

No. I mean, apart from normal tweaks, tweaking compensation plans, tweaking territories, et cetera. I mean, of course, the disruption -- potential disruption from the divestiture, I covered that.

Yes. Yes. Okay. I want to drill on a couple of the businesses, but AI has obviously been a huge focus for the industry and for PTC for quite some time. I mean you guys -- like most organizations have been talking about AI before it was really given a name by the market. How are you helping customers think through leveraging this technology across the various businesses? And how do you think from a CFO seat, what does that mean from a monetization standpoint? Do you see there's an incremental opportunity with value that you were able to think about monetization differently or charge more or seeing higher commits? How do we think about AI layering into the model?

Yes. It's a really interesting question and interesting times that we live in. I think our view is that AI can definitely help our customers with their product development processes overall. And we talk about it as the intelligent product life cycle. And so there's a few different components to it. One, which we think is somewhat foundational is making sure that they actually have their data house in order, as we like to say. And a lot of that revolves around making sure that their data is in a PLM system and is clean and readily usable, if you will, by AI. And then -- so that's one whole part of the digital transformation that a lot of companies are going through anyways. And then on top of that, you want to start thinking about, well, what is the AI functionality that we can bring to bear for our customers. And I think the way that we like to talk about that is advise, assist and eventually automate. And so how can you -- if you think about those 3 words and how that works in a product development workflow and broadly across an enterprise, how does advise assist and ultimately automate work, which is making sure that engineers are able to find the right parts in a speedy fashion and the right parts or share information across department lines or other silos into regulatory or into quality departments. And so how can we help companies, again, find the right information, provide context around that information that's useful to them. So I think that's one way to do it with the advice and the assist and then ultimately automate will also come across disciplines, if you will. So if you think about AI and Windchill, there's -- that's just within the Windchill application and AI and ServiceMax and AI and whatever Codebeamer, but none of those systems really operate as silos and they actually all interact with other systems. In some cases, it's ERP systems or MES systems and so on. So can we bring to bear technology that is going to help that data sharing across those platform silos and even outside of kind of PTC's technology stack and into other technology stacks. They are vital to the whole product life cycle.

And then from a monetization standpoint, how do you -- because that's sort of the question is like it's great that we're providing AF features. But like is it table stakes? Is it incremental to the growth opportunity? How do you kind of think about that element?

Yes. So on monetization in general, I mean, just a general observation, I would think, as you know, we went from perpetual to subscription, subscription now to SaaS and ultimately AI. And going from perpetual to subscription allows you certain options with pricing, like you think about token models and so on and so forth, just even if it's on-prem subscription, going to SaaS opens that aperture up even further, and you can start thinking about consumption-type models. And again, with meter spinning and with AI, it obviously brings similar opportunities. That said, for right now, and it's still very early days for PTC. But right now, we've actually still gone with a kind of seat-based pricing even for the AI parts that we have out in the market. And again, it's so early that I think we're actually kind of just trying to figure out what is the way that customers actually want to consume. And so right now, we're trying to make sure we have the right value prop and a reasonable price point and then we'll continue to fine-tune based on customer requirements, the best way to price it.

So I mean, does that imply as you learn and as you continue to develop, there could be more of a consumption element to some of these.

We'll look at it Sure.

Yes. Yes. And is there much of a network effect? Because I think a lot of times, there's a real concern about customer data and privacy and training models on customers' data. But is there a broader network effect where the sort of the sum of the parts of the platform provides an overall sort of like higher buyer functionality for every customer? Or is it still very siloed in sort of how you think about leveraging data?

I would -- our customers tend to be very protective of their product IP.

Yes. Yes. And then in terms of SaaS, we've been talking about that for a while, and you guys have made quite a bit of advancements, not only just in Onshape and things like that, but also the core Windchill+ and Creo+. Talk about just -- and I think with AI, SaaS gets sort of like left behind in a lot of the conversations, but talk about sort of how -- where we are in that progression. You guys have never talked about like a forced transition and you're very sort of open to customers how they want to consume the product. But is -- do you feel like you still have that lead from a SaaS perspective? Because it really felt like you guys were far in front of most of your primary competitors from a SaaS perspective. Where are we in that sort of arms race from a SaaS perspective?

Yes. I think SaaS is still an underpinning of the intelligent product life cycle as we talk about and you see it on our slides. So in that sense, it's very much still part of the strategy. I think that you're right, I don't think we're going to go to a forced model and force a customer to consume the software in one way or another. But we are seeing consistent momentum with customers who do want to migrate, and we want to make sure that we have best-in-class offerings for them to migrate to.

Okay. Okay. And then ultimately, what I want to -- where I want to go is sort of how to think about a layer cake of growth with your various businesses. But ServiceMax, I think, Matt, we've had a number of conversations on this, too. It just it feels like such -- like if you're not using your guys ServiceMax or SLM, I don't know what your customers are doing. And so maybe that's the question. Like I mean, it feels like the cross-sell opportunity is so ripe and there. And obviously, you guys have a lot of initiatives across the entire business. But what's the unlock for ServiceMax?

Yes. I think that is -- I think that's right. I think we're still very much behind the strategy as initially laid out as part of the intelligent product life cycle and thinking about design through to service and the synergies that you get by sharing information back and forth or up and down that stack or the synergies that a customer would get by doing that. I think that last year, ServiceMax had a couple of headwinds. There were some leadership changes, particularly on the go-to-market side that happened. And then subsequently, we've also had some idiosyncratic churn events really on the ServiceMax side.

From a customer perspective?

Yes, there were just some unique -- no identifiable trend, unique kind of onetime events, somebody acquired somebody and they had a different strategy. And so there you have it. That's what we mean by idiosyncratic. And so it had a difficult year. I think that we'll continue to see some of that headwind into the first half of this fiscal year. But on the flip side, the momentum of kind of pipeline build and new business being booked, that we're starting to see that turn the corner.

That's great.

That is good.

You guys have so many businesses. We don't have time to go through all of them, but you've always been such great at these like mental models of thinking about, okay, here's how I think about cash flow build. And you've been very, very accurate in some of those builds over the years. Do you -- when you think about like that ARR build, is there a mental model that you're like, well, I think about a couple -- 3 points from PLM, a couple of points from Cat. Like is there some way that we should think about like a build or a layer cake to kind of get to, call it, high single-digit ARR growth?

Yes, that's a great question. And I think that we should probably take that and try to articulate that more clearly like an Investor Day, I think, would be an ideal.

Maybe said differently then, if you were to say, when we think about the growth element of the business, what are some of the -- what are you most -- and obviously, you come with a conservative lens as a CMO. But like what are some of these big blocks that can move that can start to drive -- again, it kind of gets back to that question about like the higher end of the growth algorithm this year.

Yes. I mean, again, I think a lot of it -- I mean here, I would say that the vast majority of things that we're doing is to actually try and drive growth in our net new ARR, right? And I would bucket it into maybe 3 broad categories. One is on the product side. And we've been investing pretty heavily in R&D over the past few years. We've almost doubled our annual R&D spend over the last 5 years or so. And that is really all in support of our customers and trying to bring to market capabilities that are going to drive growth. And that includes things like investing in the SaaS transition, like investing in tighter integration between ALM and PLM because we're hearing that from a lot of customers that, that would be super valuable to them and like investing in AI that we kind of just talked about. So there's a whole set of kind of product initiatives underway. There's a go-to-market evolution that we've been talking about, which is really all about us being better equipped to serve our customers, how we're going to market, how we're helping them. And that actually spans both across PTC's direct sales force as well as our channel partners, which are a broad extension of our sellers, right? And they represent about 1/4 of our ARR. So it's like it's an important route to market for us. And so again, trying to work across those vectors to make sure we've got the right kind of account coverage, the right kind of messaging that's going to resonate with customers so that we can help them. And then in the last piece, the last bucket, I would put it into commercial optimization. And that's been an ongoing process for a number of years at PTC. I think if you went back and looked at our churn in 2019, I think it was around 9%, a little over 9%. That has now come down. It's pretty well below 5% for the last couple of years. I expect it to be this year as well. And so I think there's just incremental opportunity for us to continue to improve on that part of the execution as well. So I mean, there's kind of 3 buckets there.

That's great. The other thing that capital allocation is always a subject near and dear to your heart in terms of thinking about deploying this cash. And you made a pretty significant change in how you think about maintaining cash balances. I forget when that was actually put in place, but it felt like you've certainly amped up the commitment to buy -- how do you think about with these cash flow levels, that balance between buyback, M&A, investing back in the business, how should we think about that? And I guess, specifically on the buyback element. It feels like with some of the proceeds here, there's going to be some significant activity on that front.

Yes. I think maybe the way I would try to articulate our philosophy, if we start with a couple of basic tenets. One, we believe that PTC should operate in a net debt position. And that's where we are now. We've done a -- I think we've done a very good job at bringing the debt levels that we've had down. So I think we're pretty good on that front. And as you said, kind of the cash balance just because of the subscription nature of the business and the predictability of the cash inflows and cash outflows, we definitely want to try to maintain as low a cash balance as we can. And I think that's been helpful over the past few years. We brought that down from, I don't know, call it, $350 million on average to -- I think we ended last quarter at about $185 million round numbers in terms of a cash balance, and we'll try to maintain a low cash balance. So with those 2 caveats in place, then the free cash flow that we generate, I think either. That would go towards any kind of M&A that we might want to do, which tends to be more focused now on kind of smaller technology tuck-ins that support the core. And to the extent that we don't use any of it for that, I would expect that we return the rest to shareholders via share repurchases.

So does that -- with the divestitures, that also -- it sort of implies that there's no big gaps that you're looking for right now. It feels more that you're sort of signaling more of these strategic tuck-ins as opposed to another ServiceMax or something of that nature.

Yes. I'll say it this way. That may be a little above my pay grade, but as best as I understand it.

Yes. So when we -- as we close here, I mean, it feels like, ultimately, the algorithm is the top line growth is it's a fairly tight range depending on the economic circumstances. The margin expansion is there. The buybacks are there. It feels like cash flow growth per share should continue to outpace sort of the ARR growth element. And is that sort of the right way to think about how you are kind of calibrating the business is kind of like thinking about free cash flow per share growth?

I think that's right, yes.

Yes. And ultimately, I think that's -- I mean, we've covered PTC for a long time, and we've always felt that there's a bit of a valuation gap with some of your peers. And it feels like as you continue to grow that cash flow per share at an accelerated rate, it feels like the market should reward that. but that -- it feels like that's the kind of the balance of growth and profitability that we should think about.

Yes.

Excellent. Well, we are out of time. Just hoping to get a question in from the audience, but we was we didn't even talk about a handful of items. But thanks again, Kristian. Thanks, Matt, for being here. It's always best of luck.

Thank you.