PTC Inc. (NASDAQ:PTC) Q1 2024 Earnings Call Transcript

PTC Inc. (NASDAQ:PTC) Q1 2024 Earnings Call Transcript January 31, 2024

PTC Inc. beats earnings expectations. Reported EPS is $1.11, expectations were $0.98. PTC Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Matt Shimao: [Starts Abruptly] operating results, because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC’s annual report on Form 10-K, Form 10-Q and other filings with the U.S. Securities and Exchange Commission, as well as in today’s press release. The forward-looking statements, including guidance provided during this call are valid only as of today’s date, January 31, 2024, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures.

These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today’s press release made available on our website. With that, I’d like to turn the call over to PTC’s Chief Executive Officer, Jim Heppelmann.

Jim Heppelmann: Thank you, Matt. Good afternoon, everyone, and thank you for joining us. There may be an issue displaying the presentation materials. So if you don’t see them, I invite you to go to investor.ptc.com, you’ll find the same presentation materials there and you can follow along. We are right now on slide three. I’m pleased to report that PTC’s Q1 results provided a good start to our fiscal ’24. We delivered solid financial results, while in parallel, making great progress on CEO succession. Over the past six months, Neil and I have run a textbook transition process and we’re nearing the culmination. We spent a lot of time together and traveled the world extensively to accomplish the goals we articulated of a seamless transition that ensures continuity in PTC’s strategy and momentum.

Neil is ready to be CEO. He understands our business well. He’s fully committed to our strategy and he has the full support of an outstanding executive team. I’m confident that PTC will continue to drive growth and profitability well as in the future under Neil’s leadership. With that, I’d like to turn it over to Neil to discuss the Q1 results. Neil?

Neil Barua: Thank you, Jim. We’re on slide five. Today, I’ll focus my comments on three topics: first, what I’ve learned about PTC over the past several months; second, the drivers of PTC’s durable and consistent growth; and third, driving further value creation with discipline and consistent execution. After my remarks, I’ll hand over the call to Kristian to take you through our Q1 results and our guidance. Then we will have a Q&A session. Up front, I’d like to say a big thank you to Jim for sharing his industry insight and wealth of knowledge over the past year. The transition has gone very well and has been helpful to have Jim participate as I’ve engaged with customers, employees and investors. I’m honored to be taking over the CEO role on February 14 with PTC on a solid trajectory.

Credit to Jim and the team, we have a great strategy based on a differentiated portfolio of assets and led by a strong team. As I said, my initial focus is on ensuring that we keep building on our momentum with disciplined and consistent execution. Turning to slide six. Our customers design, manufacture and service products. Most of our large customers produce and service the world’s most critical assets, for example, wind turbines, tractors, automobiles and MRI machines. The biggest learning I’ve had relates to what I am seeing in our customer base and how much we could do for them. Digital transformation has clearly taken hold with our customers, around the world, and finally is here to stay. Industrial companies can’t have manual, antiquated or disconnected workflows if they want to be competitive in today’s complex world.

Our customers need to modernize the portion of their operations that spans from design to manufacturing to service. Importantly, our core products are the essential foundation for that. Turning to slide seven. Industrial companies are still at early stages of leveraging product data effectively across their organizations, but they have started to move on in a meaningful way. We see the opportunity the same way our customers do. Digital transformation is a journey. Our broad portfolio provides a lot of opportunity to help our customers be competitive, irrespective of soft PMIs and economic cycles. Next on slide eight. My second major learning is that the overall PTC team is strong and capable. As I visited our offices around the world, I spent a lot of time doing skip-level, one-on-one meetings and town halls.

I was inspired by the caliber and spirit of our people. I was impressed by their extensive product understanding and deep customer relationships. Their enthusiasm is palpable. They realize the opportunity ahead of us and that we have a portfolio of capabilities to win big. Turning to slide nine. I also feel very good about the strength of my highly experienced leadership team and how we will operate, going forward. My style is to bring what I’m hearing from customers into the conversation and capture the energy and ideas from each team member. This collaborative framework is already working well. And as a team, we are making progress in aligning on PTC’s value-creation opportunities going forward, and our focus energies towards that. Let’s turn to slide 10.

On our past couple of earnings calls, we have been sharing this framework, which shows the cumulative drivers that support our top line growth. Fiscal ‘24 is expected to be our eighth consecutive year of double-digit organic constant currency ARR growth. A key point to understand is that our top line growth is sustainable, supported by the many layers of cumulative drivers that we have built over time. Each layer contributes to our ability and drive value for customers and as our customers continue to invest in digital transformation, our comprehensive product portfolio differentiates PTC. This is because PTC is the only company that can help industrial manufacturers drive closed loop product lifecycle management across engineering, manufacturing quality and service.

Moving to slide 11. We have also been sharing this framework on recent earnings calls which shows the cumulative drivers that support our bottom line growth. As with the previous slide, every layer in this framework is important. The key point on this slide is that our strong free cash flow growth in recent years is attributed not only to our solid top line growth, but also to our subscription license business model and strong operational discipline. I am fully aligned with Kristian on the paramount importance over free cash flow guidance, and we have a high-level of confidence in the targets we’ve provided. Turning to Slide 12. My philosophy on resource allocation is that focus and discipline are important. To that end, it is our view that we have a compelling portfolio in place.

The key things to get right are to focus on evolving customer needs and to drive strong and consistent execution towards that. To ensure this consistency, we will put a clear focus on our highest ROI opportunities. We will be disciplined and unemotional when it comes to prioritizing our time and resources on the products and product integrations that will create the most value for our customers. To use an analogy, we plan to put more wood beyond the most important arrows to ensure we drive the best outcomes for our customers and PTC. Let’s now turn our attention to these priorities. Expanding our PLM or product lifecycle management footprint at customers both within engineering departments and enterprise-wide. There are two main reasons for this secular trend.

First, PLM systems have evolved to meet the complexities faced today by industrial manufacturing companies. As just one example, the Volvo Group, whose Chief Digital Officer and Chief Technology Officer I was speaking to yesterday, uses Windchill to manage their platform product strategy, which leverages modular components. The sophisticated configuration management capabilities of Windchill have enabled the Volvo Group to produce more product variants while at the same time lowering their unique part count, which is good for the Volvo Group’s top line as well as their bottom line. Industrial companies have come to understand that their ERP systems are inadequate to handle these types of complexities. They now view their PLM systems as strategic and spending on PLM is in focus.

Secondly, industrial companies are facing competitive pressures and are looking for new ways to drive productivity and efficiency as they digitally transform. They also rearchitect their workflows to streamline inefficiencies and drive collaboration with their manufacturing, quality and service operations. Again, it is the PLM system that takes center-stage as this happens, because the PLM system is becoming the system of record for product data, and that makes the PLM system the epicenter for digital transformation of product companies. Increasingly, PLM systems are being leveraged as the backbone for sharing product data across departments, as well as with design and supply chain partners. This is good news for PTC. The market is coming to us where we are strong.

Another large value creation opportunity is cross selling. PTC has done this successfully over the years, and we have additions to the portfolio that are meeting evolving customer needs and therefore present significant opportunities for PTC: One is, ALM or Application Lifecycle Management, which is led by Codebeamer and is now augmented by our acquisition of Pure variants. Here we have the most modern and capable ALM solution in the market. Products now contain more embedded software than ever, and for many products there has been an explosion in the number of unique software configurations that need to be developed and updated over time. Codebeamer is the next-gen software development platform that enables industrial companies to manage this increasing level of complexity.

Pure variants augments Codebeamer with industry-leading software variant management capabilities, which is a key differentiator. While demand from the Auto industry and its suppliers are a strong driver of ALM growth, demand for ALM tools is expanding in other verticals as well due to the trend towards software-driven products of all types. Clearly, this is an interesting growth opportunity and we have been increasing our investments and focus in this area. A second cross-sell opportunity is ServiceMax. We acquired ServiceMax in January 2023 and the strategic fit with PTC is solid. For many of our customers, growing the services business is their top priority. As a system of record for high value, long lifecycle assets in the field, ServiceMax significantly enhances our SLM or Service Lifecycle Management portfolio, enabling PTC to now offer the industry’s first truly comprehensive solution for service process optimization.

The opportunity set here is large, and this segment is underpenetrated today, with most of our wins replacing homegrown or stretchy-based systems. ServiceMax has approximately 300 customers and PTC has approximately 3,000, with the exact same profile. Industrial companies that produce complex, high value assets. This provides us with clear cross-sell opportunities and we have now aligned the PTC sales teams with the ServiceMax sales specialists to go to market together. We are building momentum, but keep in mind that this will take some time to develop because sales cycles for this type of product are long given their new implementations for the most part. Clearly, continuing to grow CAD and converting our install base over to SaaS across all products are two additional opportunities, which overlap to some extent, because we will see conversion of Creo customers to our Creo Plus SaaS offering over time, much like Windchill plus.

For customers, moving to SaaS enables a different collaboration paradigm that brings significant productivity benefits, making real-time, multi-user collaboration possible. Beyond the productivity benefits, customers also want the lower total cost of ownership and improved security posture that SaaS offers. As we have stated previously, we see this as another 10-plus-year journey for our customers. We have visibility to solid growth in our core on-premise business; and therefore, don’t need to rush things and force customers to move before they are ready. The opportunity will be with us for a long time. Therefore, our focus is making sure our SaaS transition is done with an optimized customer experience. It is a tight community, so credibility and references are important.

Wrapping up on slide 13. I’m honored to be stepping in at such an exciting time. There are so many good things happening at PTC and so many opportunities to drive further value. In part because of the portfolio of products that Jim and the team built over the years and the distinct needs of the market, PTC is well-positioned to deliver sustainable ARR and free cash flow growth, based on layers of cumulative growth and profit drivers. We are putting, as I said, more wood behind the most important arrows to drive the best outcomes for our customers, and I am focused on working with the team to enhance PTC’s execution on the opportunities that drive the most customer and shareholder value. We plan to host an Investor Day this year and share more about our key medium to long-term opportunities.

We are working towards becoming more consistent with our messaging, and more focused in how we prioritize our time and resources. It is a great time to be at PTC because we have a clear path to unlocking a lot of value. With that, I’ll hand the call over to Kristian to take you through our Q1 financial results.

Kristian Talvitie: Thanks, Neil, and hello, everyone. Starting off with slide 15, PTC, again, delivered solid financial results in terms of both ARR and free cash flow, which we believe are the most important metrics to assess the performance of our business. Our constant currency ARR growth was 23% in Q1 and on an organic basis excluding ServiceMax our growth was 13%. Note, that we acquired ServiceMax in Q2 of fiscal ’23, so starting next quarter Q2 of fiscal ’24, we will no longer exclude ServiceMax from our organic results. To help investors understand our business performance, excluding the impact of FX volatility, we’ve been providing ARR guidance and disclosing our ARR results on a constant currency basis. At the end of Q1 our constant currency ARR was $2.016 billion, slightly above the guidance range we provided for the quarter.

In Q1, our cash flow results also came in slightly ahead of our guidance, with operating cash flow of $187 million and free cash flow of $183 million. As a reminder, our Q1 cash flows included a $30 million of imputed interest related to the deferred payment for ServiceMax. Our cash flow performance is driven by our ARR and operating efficiency. And in Q1, we extended our track-record of disciplined operational management, while continuing to invest in key priorities like ALM and SaaS. Turning to slide 16. Let’s look at our ARR growth by geographic region. Although FX continues to be volatile and the selling environment remained challenging in Q1, our constant currency organic ARR growth was solid across the Americas, Europe and APAC with growth in the low to mid-double-digits.

On APAC our year-over-year organic constant currency growth increased to 14% in Q1, compared to 12% in Q4. And in the Americas and Europe, our organic year-over-year constant currency growth in Q1 was comparable to what we saw in Q4. Turning to slide 17. Let’s look at our ARR growth by product group. In CAD, we delivered 10% constant currency ARR growth in Q1 with the growth, primarily driven by Creo. In PLM, our constant currency ARR growth was 33%, 19 points of this growth was attributable to ServiceMax; and therefore, our organic constant currency growth in Q1 was 14%. In PLM, our organic growth was primarily driven by Windchill and also supported by strong percentage growth in ALM, thanks to Codebeamer. Although the manufacturing PMIs have indicated a sluggish overall demand environment for many quarters now, our topline has shown good resilience.

Part of this is because of our subscription license model, our low churn rates and the propensity for our customer-base to prioritize R&D investments through challenging times. In addition, as Neil explained earlier, our solid ARR growth is being supported by the digital transformation journeys of our customers, which we believe is a secular trend. Moving to slide 18. We ended the first quarter with cash and cash equivalents of $265 million. Given the consistency and predictability of our free cash flow, we aim to maintain a low cash balance and prefer to maximize debt reduction. Our gross debt was $2.267 billion with an aggregate interest-rate of 5.7%. During Q1, our gross debt decreased by $55 million. We used $181 million of cash to paydown debt, which was partially offset by $96 million, primarily related to Pure Systems and the $30 million imputed interest payment related to the final payment for the ServiceMax transaction, which we discussed previously.

We were 2.8 times levered at the end of Q1 ’24, and expect that to trend down throughout the remainder of the year as we are prioritizing paying down our debt this fiscal year. We intend to use substantially all of our free cash flow to paydown our debt this year and expect to end the year with gross debt of approximately $1.7 billion. In connection with this, we have temporarily paused our share repurchase program and expect our diluted share count to increase by approximately 1 million shares in fiscal ’24. Heading into fiscal ‘25, we’ll revisit the prioritization of debt paydown and share repurchases. Our long-term goal assuming our debt-to-EBITDA ratio is below 3 times, remains to return approximately 50% of our free cash flow to shareholders via share repurchases while also taking into consideration the interest rate environment and strategic opportunities.

With that, I’ll take you through our guidance on Slide 19. We’re maintaining our fiscal ’24 guidance, and following our solid Q1 results, we believe we’re well positioned to deliver on our guidance for the full-year. For Q2, our constant currency ARR guidance range of $2.05 billion to $2.065 billion corresponds to year-over-year growth of 11% to 12%, I’ll get into more details on the next slide. On cash flows, we’re guiding to free cash flow of approximately $240 million in the second quarter. To help you with your models, we are continuing to provide revenue and EPS guidance, but as a reminder, ASC 606 makes revenue and EPS difficult to predict for PTC since we sell primarily on-premises subscription license — licenses and the way revenue is recognized from these contracts can vary significantly based on variables that we don’t believe are necessarily relevant to the performance of the business.

I actually did a teach-in on this subject on our Q4 ‘22 call that you may want to refer to, if you’re new to PTC. The summary is, we believe ARR and free cash flow, rather than revenue and operating income are the best metrics to assess the performance of our business. Importantly, we’ve maintained consistent billing practices over-time, and we primarily bill our customers annually, upfront, one-year at a time regardless of contract term lengths. So, our free cash flow results overtime are comparable. Moving on to slide 20. Here’s an illustrative constant currency ARR model for Q2 ’24. You can see our results over the past nine quarters, and the column on the far right illustrates what is needed to get to the midpoint of our constant currency ARR guidance.

This illustrative model indicates that to hit the midpoint of our Q2 guidance range, we need $41 million of sequential net ARR growth. Because our ARR tends to see some seasonality, the most relevant comparison is the sequential growth in Q2 of ’23 and Q2 of ’22. We believe we’ve set our Q2 ’24 constant currency guidance range prudently, which reflects an ongoing sluggish selling environment. Putting this into the context of the full-year, let’s turn to slide 21. Here is a repeat of the slide we showed last quarter, which illustrates what’s needed to get to the midpoint of our constant currency ARR guidance for fiscal ‘24. Looking at the full-year perspective naturally removes a lot of the quarterly volatility related to large transactions and ramp deal and start date dynamics.

As you can see on the slide, for illustrative purposes, even if the full-year is flattish with the last two years from a net new ARR perspective, given the incremental $20 million of deferred ARR in the back half, which we’ve talked about before, we would be at 12% growth for the year. We think the full-year guidance range of 11% to 14% balances both risk and opportunity. Finally, on free cash flow, we continue to have a high degree of confidence in our quarterly and full-year guidance because of the predictability of our cash collections and the disciplined budgeting process, we have in place. So in conclusion, PTC has strong portfolio and strategy and a great team of people with deep expertise and strong customer relationships. We’re focused on disciplined and consistent execution to ensure we deliver on the value creation opportunities we have ahead of us.

With that, I’d like to turn the call over to the operator to begin the Q&A session.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Joshua Tilton with Wolfe Research. Joshua, your line is open.

Joshua Tilton: Hey, guys. Thanks for taking my questions. I’ll try and sneak it, maybe two in here, if I can. Just the first one, I thought it was pretty interesting that you mentioned the selling environment kind of still remains challenging and sluggish this quarter. I guess my questions is, was it more challenging than you guys were expecting 90 days ago? Is it any better than Q4? And maybe kind of how do you expect that selling environment to be for the rest of the year?

Neil Barua: Yes. Thanks for the question. This is Neil. We haven’t seen any change. It’s been a sluggish sales environment for a number of years now, particularly around the approval cycles of our customers. It’s just taking a lot, and it has been for multiple years. Nothing has changed worse or better since I’ve been here during the transition time, and currently how we’re looking at Q2.

Joshua Tilton: And maybe given that answer and the guidance that’s kind of out there, it is implying that a lot of growth, especially in the net new ARR, is to come through in the second half. And, I guess maybe just remind us, I know you have the deferred ARR balance, but what’s kind of giving you guys the confidence in that second half net new ARR growth, especially in the context of the 2Q guide?

Neil Barua: Yes. I’ll start, and Kristian could add if I missed anything. First of all, looking at the pipeline of opportunities, I feel confident around the number and the size of the deals, the criticality of the customers, the importance of the customers that we’re working with hand-in-hand to get to a conclusion, to move them down this digital transformation journey. And so, when we look at that, that pipeline is interesting to us in a manner that gives us confidence around the guidance that we gave to you that we are now targeting. And so, that’s an element of it. Again, to be clear, this doesn’t assume that anything changes in the selling environment from now to the end of the year. There’s just an element of pipeline and a seasonality that we’ve always had, quite frankly, in the second-half, where these types of deals we’ve historically been able to close out and our intent is to do the same this year.

Joshua Tilton: Super helpful. Thank you.

Operator: Thank you. Your next question comes from the line of Clark Jeffries with Piper Sandler. Clark, your line is open.

Clark Jeffries: Hello. Thank you for taking the question. Great to see the resiliency of the business. Neil, I was hoping you could expand on your comments around the timeline for the cross-sell for ServiceMax. It seems like you’ve made some early progress in aligning the go-to-market. But could you help us think through what that success in cross-sell looks like in fiscal ’24? What it looks like in fiscal ’25? And what’s a reasonable timeline to reach its stride in terms of reaching the existing customer base as well? Thank you.

Neil Barua: Yes, Clarke, great question. Thank you for asking it. Look, the first year — since clearly, I’m very familiar with ServiceMax, given my background, the first year has been integration work and really getting to know the ways in which the ServiceMax team could interact in a precise way with the PTC team. We did that. We accomplished that. We had early success, which creates some momentum. Secondly, after we saw that, we’ve implemented a far more constructive and direct selling process by which the ServiceMax sellers are now very much tied into how the PTC sellers are going forward, in this fiscal year. And what that’s caused is two things. The customer base is now understanding of the PTC broader value proposition of the digital thread and why ServiceMax is so critical to be part of that, number one.

So that’s creating a level of interest, engage rate and, quite frankly, momentum that we’ve already been seeing. And two, the sellers now have a familiarity of speaking the language that’s necessary for ServiceMax to begin scale. I foresee this year to be a time period, given the sales cycles of ServiceMax, these are all new implementations for the most part, even if they are already existing PTC customers. That takes a bit of time. And I see this year as building that momentum by which, as we said when we made the ServiceMax acquisition, this is a mid-teens-plus grower. And my expectation is, this year is the building blocks by which the subsequent years really define that sustainable mid-teens growth over or above with ServiceMax.

Clark Jeffries: Perfect. I really appreciate the color. Look forward to the Analyst Day. Thank you.

Operator: Your next question comes from the line of Yun Kim with Loop Capital. And Yun, your line is open.

Yun Kim: Hi, congrats on a solid quarter, Jim, Neil and Kristian. ARR growth, Creo CAD has been incredibly resilient for a long time. How do you see that playing out this year? Can it keep growing in the double digit consistently this year? And do you need Creo+ to kick-in to provide a tailwind for it to keep growing in the double digits?

Neil Barua: Great question. And one of the great things with the transition with Jim is I’m far more well-versed in the amazing product that we have in Creo. And like you said, good performance from Creo. We expect that to continue. This is Creo on-premises, Creo throughout the course of this year, given the differentiation, given the strength of that product. And quite frankly, Creo+ is very limited, if at all, in terms of impacting our Creo results and the strength of it, in the near to maybe even the medium term. Like I said, that SaaS journey will be a 10-plus year journey. We’re already seeing the strength of Creo on-prem, feel like that double-digit growth is sustainable. Creo+ over time, as the market adopts it, is cherry on the top.

Yun Kim: If I could just sneak one in for Kristian. Kristian, I believe this is a big — much, much bigger year for renewals. Do you expect to continue to focus on increasing contract length? And remind us where we are in terms of overall contract length where that has been trending, and any update on the churn rate?

Kristian Talvitie: Yes. Hey, Yun, thanks for the question. Churn rate continues to be low and steady, so let’s start with that one. And yes, we will continue to try and move contracts to longer-term contracts, which we believe is beneficial for our customers as well as actually for PTC. So we’ll continue to try and move in that direction. And then lastly, I think, your question was around the average contract length, which as it stands right now, still hovers around a two-year term.

Yun Kim: Thanks so much.

Operator: And your next question comes from the line of Matt Hedberg with RBC Capital Markets. Matt, your line is now open.

Matt Hedberg: Great. Thanks, guys. And Jim, congrats on the run as well and Neil officially taking over on, I think, the 14th, you said. So great run, Jim and Neil, looking forward to this next journey here. I guess, I had a question, Neil. You mentioned — there’s been a lot of focus on Creo+ and Windchill+. And you had some comments in your prepared remarks on the SaaS transition. I don’t think a lot of people feel like this is really like what we typically see in a SaaS transition because I think you’re not trying to like push customers there, but to move to the SaaS variants. But just maybe how do you kind of philosophically think about that? And are there things perhaps that you can do to sort of show the functionality, that’s where it’s going in the plus variants? And I don’t know, maybe there’s some pricing or incentives that could drive that behavior. But it feels like it’s an accretive thing for you and beneficial to the customer as well.