PTC Inc.

Relations. Please go ahead. Good afternoon. Thank you, Adam, and welcome to PTC's fiscal 2024 third quarter conference call. On the call today are Neil Barua, Chief Executive Officer, and Christian Talbatia, Chief Financial Officer. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today at www.ptc.com. During this call, PTC will make forward-looking statements, including guidance as to future 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 four looking statements, including guidance provided during this call, are valid only as of today's date, July 31st, 2024, and PTC assumes no obligation to update these four 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. The 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, Neil Barua.

Thanks, Matt. In Q3, we again delivered solid constant currency ARR growth, up 12% year over year, demonstrating that our portfolio of products is resonating with customers. Our Q3 free cash flow growth was also solid, rising 29% year over year. Christian will take you through our quarterly results and forward-looking guidance in detail. Before we get into more detail, I want to recognize Mike DiTullio, who will transition out of the President and Chief Operating Officer roles at the end of the fiscal year and continue as an advisor to me into 2025. Mike's part in PTC's success has been profound over his tenure of more than 25 years. We certainly wouldn't be the company we are today without him. In addition, he's been a great partner to me as I've stepped into the CEO role. We've been discussing his future plans, and we both agree that it's the right time to start this transition process. When we start fiscal 25, we'll no longer have the COO position within our leadership structure. At this stage of my CEO tenure, my approach is to be close to the business and be more directly involved with operations and execution, especially for our key priorities. Accordingly, I will be assuming many of Mike's responsibilities. Additionally, I'd like to reiterate what I said on last quarter's call, which is that I'm turning over lots of stones and looking at everything in this company in order to usher in a new phase of focus and effectiveness across the entire company. To that end, while Mike's change was externally visible because we filed an AK, There are numerous other changes that we have already made and are making across many different areas of the organization. This is an ongoing process that we're doing with the intent of driving more effectiveness in the pursuit of our incredible growth potential. Let's move down to slide four, which highlights our product portfolio and strategy. As a reminder, our five focus areas are one, PLM, which is driven primarily by our windshield product. Two, ALM, which is driven by our CodeBeamer product. Three, SLM, which is primarily driven by Service Max. Four, CAD, which is driven primarily by Creo. And five, our continued focus on SaaS. These are the areas where we can create the greatest customer value and are the areas where we are focusing our resources and attention at the most basic level. our customers need to introduce new products at a faster pace and with higher quality. It is not unusual to hear from customers that they need to shorten their new product introduction timelines in half. That's not possible without digital transformation across their workflows, which is exactly what our products enable. It's also worth highlighting that we are bringing our suite of software offerings together to help product companies improve their competitiveness. Given the unique breadth and openness of our portfolio, we can enable end-to-end digital threat initiatives, which leverage a connected flow of product data across design, manufacturing, service, and ultimately reuse. A digital threat enables product companies to break down silos, streamline workflows, and achieve interoperability across departments, functions, and systems with a single version of truth. It also secures the quality, consistency, and traceability of product-related data, ensuring that the data is up-to-date, accessible, reliable, and actionable. With a digital thread, the right data is delivered to the right people at the right time and in the right context across the value chain. The demand drivers for our core offerings are strong, and our differentiated capabilities to drive digital thread initiatives are increasingly important to our customers. There is so much we can do to help our customers drive better business outcomes. To unlock this potential, I have started to focus on our operations, taking a fresh look at ways to continue driving improvements. On last quarter's call, we discussed rebalancing some R&D resources away from creating new standalone IoT and augmented reality applications to instead support growth of our core products. That was just the first step. Putting in place an organizational design that enables us to scale more programmatically will set us up for continued success in the future. We are now primarily turning our attention to optimizing our go-to-market and G&A activities. As I mentioned up front, we've leaned out the go-to-market management structure so there are less layers between me and our customers. At this point, we are moving forward without the chief operating officer and Chief Revenue Officer roles, and I will be working directly with our Head of Sales and Head of Customer Success. We are actively looking at every facet of our business to continue driving alignment and effectiveness across our entire company. It is about focusing on customer value and getting more effective with each dollar we spend to support them and capture that demand. The opportunities to achieve this are significant here at PTC. We are in the early innings of doing this work, and we expect the heavy lifting to continue in fiscal 25. I'd like to turn now to discuss three of our focus areas to illustrate the significant value we bring to customers. This quarter, I'll touch on what we have been seeing with customers of our Windchill PLM, CodeBeamer ALM, and ServiceMax SLM products. Starting with PLM on slide five. This is product lifecycle management and Winchell is our flagship PLM product. PLM systems tend to be really sticky and are mission critical for our customers. This is software that historically had the function of helping CAD engineers keep track of their CAD files. Now, PLM is at the epicenter of digital transformation initiatives and product companies. As I explained last quarter, product companies are increasingly focused on compressing the time it takes to get new products to market. And at the same time, their products continue to get much more complex, both to design and produce. The complexity becomes untenable. Quality and time to market gets impacted. Sooner or later, it becomes very clear that having an advanced PLM system is a strategic necessity. In general, Manufacturing companies have a long way to go in terms of their digital transformation journeys. And when a product company gets really serious about optimizing and automating their design and manufacturing processes, we tend to see large PLM expansion projects and step function increases in ARR as customers expand their windshield deployments in terms of both seats and functionality. A good example of this is our Q3 win at a supplier to the automotive industry that specializes in cabling and wiring harness solutions. Given the rise of software-defined vehicles and the importance of electronic wiring systems, the role of this company in the automotive supply chain has grown. It's interesting that this company already appreciated the value of leveraging their PLM system beyond engineering to drive better business outcomes. They are using Windchill within R&D, but they're currently using homegrown tools to drive collaboration across their engineering, supply chain, manufacturing, and quality assurance teams. Over time, maintaining their homegrown system became unsustainable from both a complexity and cost standpoint. They found it compelling that extending Windchill beyond engineering is easy to implement and provides quick time to value, and they decided to standardize on their Windchill system as their backbone for enterprise-wide collaboration around their product data. Turning to slide six, the second customer example for today is a medical equipment customer that has been using our Creo CAD and Windchill PLM products for years now. What's interesting is that this customer wants to unlock value by going with the digital thread approach I highlighted a few minutes ago. Our CodeBeamer ALM product helped to complete their digital thread vision. After being a CodeBeamer customer for about a year testing out the product, They decided they were all in and ready to move forward with their digital threat initiative, and in Q3, they signed a deal with us that will expand their ARR by 190%. As a reminder, ALM, or Application Lifecycle Management, helps engineers keep track of product requirements and tests to ensure that all requirements are met. This traceability is very important in safety-critical and regulated industries. including the automotive and medical equipment markets, and is growing in importance across other industries because of the trend towards software-driven products of all types. Products now contain more embedded software than ever, and for many products, there's been an explosion in the number of unique software configurations that need to be developed and updated over time. CodeBeamer is a next-gen platform that enables industrial companies to manage this increasing level of complexity. CodeBeamer is differentiated from legacy ALM offerings in two key ways. First, CodeBeamer has industry-leading traceability capabilities. And second, CodeBeamer also helps with time to market by supporting agile development processes. Consider, for example, What happens when a company has a product in the field that fails? Regulators immediately want to understand which version of the software that product had. It might even demand that more stringent new requirements be placed on new products the company makes. CodeBeamer is becoming the solution of choice to deal with this new reality. CodeBeamer is a big part of completing the digital threat vision for this customer because software plays such a critical role in their new product innovations. Before having CodeBeamer, they faced challenges managing their high volume of software requirements, which led to unnecessary delays in getting new products to market, as well as exposure to risk. As a medical equipment company, software innovation and regulatory traceability are front and center for this customer, and the value CodeBeamer brought to them gave them the confidence to rely on PTC in a more holistic way. They are expanding their Windchill and CodeBeamer deployments and will use Windchill as the foundation for their digital thread. The digital thread is becoming increasingly strategic to customers across many industries, as product companies see the potential to improve their competitiveness by managing the complete lifecycle of their products in a more integrated manner. What is most important to thread together can be different for different customers, but having visibility to a more complete picture and being able to gain actionable insights through a digital thread of product data is becoming table stakes. as the competitive environment continues to intensify across many industries. Turning to the third customer example for today, which is a ServiceMax SLM win on slide seven. SLM is Service Lifecycle Management, and one of our main products here is ServiceMax, the industry leader in field service management for high-value, long-life cycle products. In Q3, we landed a new PTC customer because of ServiceMax. This customer engineers, manufactures, and services industrial and electrical power systems around the world, and they like that ServiceMax has become part of PTC. The drivers behind this win were similar in many ways to the elevator company win we highlighted on last quarter's call. The point is that many product companies are not only focused on managing complexity and accelerating time to market, they are also looking for new sources of top line and bottom line growth. In this example, the customer had a CEO-led initiative to better leverage their install base to grow aftermarket revenue in a repeatable and cost-effective manner. Because of organizational silos, the customer currently has fragmented service business operation which impacts their field service productivity and customer service. They struggle to compete with smaller local vendors for aftermarket contracts to service their own products. The customer made the strategic decision that it was time to transform their service operations, and they selected ServiceMax. The ServiceMax system will be their software foundation and single source of truth for their aftermarket services and customer service initiatives. Before going out into the field, the ServiceMax application will help their service technicians understand everything they need to know about the specific product that needs servicing so that they can bring the right parts with them. The ServiceMax application will also schedule and route the field technicians efficiently and guide the field technicians through complex procedures. As typical of ServiceMax deals, the selection process is very thorough. and ServiceMax came on top based on product capabilities that aligned with the priorities of the customer to drive more proactive customer service, improve visibility into their installed base of products, drive higher aftermarket attach rates, and improve field technician legalization. Lastly, we also remain encouraged by our other focus areas that they didn't provide examples for this quarter, which are CAD and SAS. We have been reinvesting in our business, consistently growing our annual R&D investment footprint to provide greater value to our customers. In Q3, we made incremental progress in each of our five focus areas towards executing in a scalable fashion and focusing our investments on the product advancements that customers care the most about. As I emphasized earlier, you should expect to see a continued focus on aligning all our resources across all operational functions in this company behind our five focus areas. This is foundational work, and we will be disciplined about seeing it through. It will take time, and progress may not be linear, but we will leave no stone unturned, as I said, as we focus on scaling our business and further improving the consistency of our execution. With that, I'll hand the call over to Christian to take you through our Q3 financial results and future guidance.

Thank you, Neil, and hello, everyone. Starting off with slide nine, ETC again delivered solid financial results in terms of both ARR and free cash flow in a continued challenging selling environment. As you know, we believe ARR and free cash flow are the most important metrics to assess the performance of our business. To help investors understand our business performance, excluding the impact of foreign exchange volatility, we provide ARR guidance and disclose our ARR results on a constant currency basis. At the end of Q3, our constant currency ARR was $2.125 billion, up 12% year over year and within our guidance range. Our free cash flow results were also solid, up 29% year over year, while at the same time continuing to invest in our key focus areas. However, We came in a bit below our guidance of approximately $220 million due to timing. We have a high degree of confidence in our cash flow guidance and targets due to the predictability of our cash collections and the disciplined resource allocation structure we have in place. With the timing issues resolved, we continue to expect free cash flow of $725 million in fiscal 24. and continue to be confident that our business model positions us to deliver solid, predictable results. Turning to slide 10, let's look at our ARR growth in more detail. Starting with our product groups, in Q3, we delivered 10% constant currency ARR growth in CAD and 13% growth in PLM. Despite the overall demand environment, which has been sluggish for a couple of years now, Our top line has shown good resilience. Our solid ARR growth is supported by our unique portfolio with a solid footprint in high growth segments of the market and the digital transformation journeys of our customers. These underlying strengths are further supported by our subscription model, our low churn rate, and the propensity for our customer base to prioritize their own R&D investments through challenging times. Moving to our ARR by region, our constant currency organic ARR growth was solid across the Americas, Europe, and APAC with growth in the low to mid double digits. Across all regions, our year-over-year organic constant currency growth rates in Q3 were similar to the growth rates we saw in Q2. Moving to slide 11, first of all, Given the consistency and predictability of our free cash flow, we aim to maintain a low cash balance. As you know, our long-term goal, assuming our debt to EBITDA ratio is below three 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. Given the strategic acquisitions, namely ServiceMax and CodeBeamer that we've done over the past couple of years and the debt we took on to fund them, we paused our share repurchase program. As we've said before, we intend to use substantially all of our free cash flow to pay down our debt in fiscal 24. And as we've been saying, we'll revisit the prioritization of debt pay down and share repurchases when we get to fiscal 25. We were 2.2 times levered at the end of Q3. During the quarter, we paid down our debt by $195 million and ended Q3 with cash and cash equivalents of $248 million and gross debt of $1.8 billion. We continue to expect that we'll end fiscal 24 with gross debt of approximately $1.7 billion. Lastly, we expect fully diluted shares of approximately $121 million in fiscal 24, up by approximately 1.5 million shares year over year. With that, I'll take you through our guidance on slide 12. Reflecting our year-to-date performance and our outlook for Q4, we're updating our fiscal 24 constant currency ARR guidance, lowering the high end of the range by 20 million, and now expect to end the year with constant currency ARR growth of 11 to 12 percent. It's worth noting we're updating our our revenue guidance accordingly reducing the high end by 20 million we're reiterating our free cash flow guidance of approximately 725 million in fiscal 24 given our year-to-date performance and q4 outlook for q4 We're guiding for free cash flow approximately 83 million and constant currency ARR of 2.2 to 2.22 billion, which corresponds to year-over-year growth of 11 to 12%. We believe we've set our guidance appropriately. I'll get a little more into ARR guidance details on the next slide. But before I do, I'd also like to reiterate my favorite reminder. To help you with your models, we're providing revenue and EPS guidance. ASC 606 makes revenue and EPS difficult to predict for PTC since we primarily sell on-premises subscriptions. And the way revenue is recognized from these contracts can vary significantly based on variables that aren't necessarily relevant to the performance of the business. I did a teach-in on this subject on our Q4 22 call that you may want to refer to if you are 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 we primarily bill our customers annually up front one year at a time regardless of contract term lengths, so our free cash flow results over time are comparable. Moving to slide 13, here's an illustrative constant currency ARR model for Q4. You can see our results over the past 11 quarters, and the column on the far right illustrates what is needed to get to the midpoint of our constant currency ARR guidance. The illustrative model indicates that to hit the midpoint, of our Q4 guidance range, we need 85 million of sequential net new ARR growth. This is approximately 10 million more than we added in Q4 of the previous two fiscal years. And this year we expect to benefit from CodeBeamer cross-selling ServiceMax with an aligned and enabled Salesforce and approximately 5 million more deferred ARR than we had in Q4 of fiscal 23. We think our guidance range for Q4 and the full year balance both risk and opportunity. And looking out a little further ahead to our fiscal 25. And here, keep in mind that we're still in the middle of our detailed planning process. But I would not be surprised if our official fiscal 25 guidance, when we give it next quarter, was in the low double-digit ARR growth range, consistent with our medium-term targets and in line with our performance over the past couple of years. Again, balancing both risk and opportunity. I also anticipate our free cash flow guidance would be somewhere within the $825 to $875 million range we previously communicated. Additionally, as we think about capital allocation, I think you will see us resume share repurchases in fiscal 25 in and around the $300 million level as we balance debt pay down with returning capital to shareholders. Obviously, we'll provide our official guidance on next quarter's call, but we just wanted to provide some directional thinking that we feel pretty comfortable with given the recurring nature of our business model and the budgeting process we have in place. In conclusion, PTC has a strong portfolio, solid 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.