PTC Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
April 27, 2022

There are 8 speakers on the call.

Operator

Afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the PTC 2022 Second Quarter Conference Call. During today's presentation, all parties will be in a listen only mode and following the presentation, the conference will be open for questions. I would now like to turn the call over to Matt Schimmau, PTC's Head of Investor Relations, please go ahead.

Speaker 1

Good afternoon. Thank you, Savannah, and welcome to PTC's 2022 Second Quarter Conference Call. On the call today are Jim Heppelmann, Chief Executive Officer and Christian Talbotia, 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.

Speaker 1

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 ks, Form 10Q and other filings with the U. S. Securities and Exchange Commission as well as in today's press release.

Speaker 1

The forward looking statements, including guidance provided during this call, are valid only as of today's date, April 27, 2022 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 the quarters 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.

Speaker 1

Thanks, Matt. Good afternoon, everyone, and

Speaker 2

thank you for joining us. To simplify things, please note that throughout my commentary, I will be discussing all growth rates in constant currency. Turning to Slide 4, I'm pleased to share that PTC delivered another Strong financial performance in fiscal Q2. All of our metrics came in above our guidance and the strength was broad based across All segments and geographies. Of particular note, we saw organic ARR growth accelerate to 13% Despite the self inflicted churn caused by our decision to exit the Russia market, we ended Q2 with 1.56 $1,000,000,000 of ARR.

Speaker 2

Bookings grew faster than ARR and renewals were very strong. We also continued our track record of translating top line growth into even better bottom line growth. In Q2, our adjusted free cash flow performance was strong at $158,000,000 up 22% year over year and ahead of our guidance. The non GAAP operating margin of 42% in the quarter Was the highest we've seen. The margin expansion strategies we outlined at our December Investor Day are generating the results we expected.

Speaker 2

Moving to Slide 5. While we're monitoring the global macro and geopolitical situation carefully, We continue to see strong global demand environment for our offerings. Driving digital transformation across the product lifecycle Remains an important priority for our customers. Bookings were up mid teens in 0 year over year and the strength was broad based. Growth was strong in both Digital Thread and Velocity and across all three geographies.

Speaker 2

Q2 was the 6th Consecutive quarter that bookings have grown faster than ARR, which together with improving renewal rates creates an acceleration bias for ARR Growth. To help you understand the resilience of PTC as you think about any potential macro volatility that may lie ahead, I'd like to expand on our business model dynamics to ensure you appreciate why our business model provides us with confidence in our ability to achieve our financial targets in the back Let's take a look at Slide 6. On the left hand side of the slide, you can see that the 13% ARR growth we delivered in Q2 was based not just on Q2 performance, but also on the momentum we built over the previous 3 quarters as well. ARR growth is a rolling 4 quarter metric. So when we say ARR grew 13% in the 2nd quarter, We mean the entire book of recurring business is now 13% larger than it was at this time last year.

Speaker 2

While this rolling dynamic dampens the impact of bookings in any single quarter, such as the strong results in Q2, It also provides a foundation of stability and resiliency for the company. Remember that so long as bookings exceed churn, ARR will grow. Bookings currently exceed churn by a wide margin. To help you run your own scenarios, let me simplify the math By giving you some big round directional numbers to work with. Let's say PTC has around $1,500,000,000 in ARR.

Speaker 2

And on a run rate basis, we're adding $300,000,000 in annual bookings, while seeing $100,000,000 in annual churn. Over the next year, the $1,500,000,000 of ARR would step up by $300,000,000 and step down by $100,000,000 to grow to 1 point $7,000,000,000 which is 13% growth. That's consistent with our run rate performance. Note that because PTC provides Sticky Enterprise Software, our history in 2009 and again in 2020 shows renewals remain steady through a macro downturn. To better understand the sensitivity then of ARR to macro changes, let's start with a hypothetical scenario where bookings Stopped growing and remained flat indefinitely at $300,000,000 In that case, with churn being steady, ARR would experience double digit growth for several years and high single digit for several more years after that.

Speaker 2

If you're concerned about a downturn in Europe, which represents 40% of our business, you could create an alternate model where 40% of our bookings Declined by 25% for 2 quarters and then bounced back, in which case we'd still deliver 12% ARR growth over the forthcoming year. If you want to run a more draconian global macro downturn scenario, You could model a 25% reduction across all bookings for the next 4 quarters, in which case you still get 8% ARR growth Over the next year. Frankly, no matter what scenarios you might model, you'll consistently see that PTC has a very resilient business. Keep in mind that those were hypothetical examples because the actual results are considerably better. When bookings grow faster than ARR, as we've seen quarterly since the COVID rebound, it creates an acceleration effect for ARR.

Speaker 2

Improvement in renewal rates, which we've also been seeing are helpful as well. PTC is experiencing the benefit of these dual acceleration effects Right now, which is why we're raising our ARR guidance for the full year. In summary, while the company is in position to Accelerate ARR growth assuming conditions remain as they have been, we're also in good position to power through any potential macro slowdown with strong results As we did in 2020, when bookings design declined sharply for several quarters due to the pandemic before rebounding again. PTC's FY 'twenty ARR growth of 11% compared very favorably To our more cyclical industry peers who don't have the same recurring business model, some of whom even experienced top line declines In their comparable business lines. The takeaway from this discussion is that our subscription model, which took us years of hard work to put in place, is a wonderful thing and We'll keep PTC in a growth leadership position in our industry for years to come.

Speaker 2

Moving on, let's take a quick look Our Q2 ARR performance by geography on Slide 7 before turning to our business units. In Q2, we saw Strong ARR growth across all geographies. Our ARR growth in the Americas was 12%. All product segments grew With the main growth drivers being continued strength in our core PLM and CAD segments and another strong contribution from our Velocity business. In Europe, our ARR growth was 15% despite the Russia exit.

Speaker 2

We saw strong results across the board in Europe, With growth primarily driven by our core PLM and CAD businesses and strong growth in the IoT and AR segment. In addition, our velocity and FSG businesses delivered solid growth in Europe in Q2. Europe has the largest mix of channel versus direct, And the resellers continue to perform well. I know that investors are concerned about exposure to Europe and the macro environment there. So I'd like to reiterate that first, we're continuing to see strong bookings performance in Europe.

Speaker 2

And second, as I demonstrated quantitatively, Our model is highly resilient. Our ARR growth in APAC was 14% with our core CAD and PLM businesses again Being the main drivers. Next, let's look at the ARR performance of our business units, starting with Digital Thread on Slide 8. In our largest product segment, Digital Thread Core, we delivered another double digit growth performance in Q2 with 13% growth. Within this, CAD grew low double digits, while PLM grew mid teens.

Speaker 2

Bookings grew faster in each case. Reflecting on Q2 across the now 18 consecutive quarters of double digit ARR growth that we've seen in the core CAD and PLM business, This was the best performance yet, which I attribute to a combination of strong demand for digital transformation, Best in class sticky solutions sold in a recurring revenue model with low churn rates and the growth tailwinds from our SaaS initiatives. In our core business, our solutions are very strategic, and we're executing well and taking market share. You may have noted we also launched Windchill Plus during the quarter, which is our next generation differentiated core SaaS PLM solution. Windchill Plus contains the technology and operational improvements that enable higher profitability And is now becoming our lead Windchill sales play.

Speaker 2

Windchill Plus is just the tip of the iceberg of a bigger plus strategy. And you'll see us follow with Creo Plus and similar premium SaaS offerings in FY 'twenty three and beyond. In Digital Thread Growth, we saw ARR growth of 15%. While the sequential acceleration was modest, we made good operational progress And remain on track to get growth to a 2 handle by the end of the year. Following the launch of our new ThingWorx digital performance management solution, Which we abbreviate as DPM.

Speaker 2

In Q2, we landed our first nine deals across various different industries, including aerospace and defense, High-tech, Automotive and Food and Beverage. Though these were starter deals, average initial deal size was 6 figures. Rockwell brought in several of these DPM deals, and the DPM pipeline for both companies looks good going into the back half of the year. FSG had a great Q2 with 8% ARR growth. Servlogistics, Retail PLM and Arbor Test all performed well, Helping to drive solid results in terms of renewals and churn.

Speaker 2

Growth was particularly strong in the Americas and Europe. With FSG, our strategy is to keep delivering value to customers by having dedicated focus on each of these products, and I'm pleased to see that Before I turn to our Velocity business unit, let me run through a couple of quick customer stories That'll give you a taste of how customers are leveraging our digital transformation capabilities. I'll start with Bosch on Slide 9. Bosch is a massive global supplier of technologies and services. With 400,000 employees, including 75,000 engineers, A key challenge for Bosch is how to drive end to end digital transformation at scale.

Speaker 2

Bosch is leveraging their Windchill PLM system as a backbone In combination with Creo and ThingWorx to enable new and improved workflows. This specific example is about BOSSS using model based design capabilities of Creo and Windchill. By moving beyond the world of 2 d drawings and leveraging enhanced 3 d Creo data Across engineering, manufacturing and inspection processes, Bosch is driving improved productivity and bringing products to market faster. Next on Slide 10, Cummins is the world's largest independent diesel and gas engine manufacturer And an interesting ESG story that we help enable. Cummins has long made it a company goal to reduce their environmental impact And digital transformation is a critical part of their journey.

Speaker 2

By using generative design and ANSYS powered simulation Upfront, in their creo based design process, Cummins has been able to reduce material usage, create better products and accelerate time to market. Turning to the Velocity business on Slide 11. Year over year ARR growth for our Velocity segment was 27% in Q2, With both Onshape and Arena growing multiple times faster than the market, which demonstrates there's a distinct and vibrant segment of the CAD and PLM market That prioritizes SaaS and Agile Product Development as their number one buying criteria. With Onshape and Arena, PTC has a unique ability Service market segment and we're continuing to ramp both our velocity product and go to market investments. Let's move to Slide 12, where I'd like to take you through a velocity example showing how Arena is empowering Filtronics global team to deliver innovative products faster.

Speaker 2

Fieldtronic is using Arena's SaaS PLM solution to control product design and supporting documentation And to enable collaboration across globally distributed teams. The benefits of providing complete visibility into critical Product and quality processes are significant. For example, engineering change cycle time was cut by 50%, and the issue resolution time has been cut In half as well. Turning to Slide 13. We announced 2 transactions last week, and I'd like to recap both and provide some additional context.

Speaker 2

First, we announced an agreement to acquire Intland Software, a next generation application lifecycle management or ALM company For $280,000,000 For background, PTC entered the ALM market a decade ago when we acquired MKS And their integrity suite. ALM has become an important and well established offering within PTC's portfolio And it's sold both standalone and as a key subsystem of our Windchill PLM offering. The CodeBeamer family of software products from Inland is a next generation ALM suite that's fast becoming the new standard in Safety critical and regulated industries, especially in the large automotive industries where products are increasingly differentiated by the software. Bringing CodeBeamer into our ALM suite will bolster both ALM and PLM growth potential By significantly increasing our product strength and market momentum. Intland's a great company who matches their strong product with strong growth and Surprisingly good profitability for their size.

Speaker 2

We expect to achieve both revenue and cost synergies with this acquisition. When it closes, the acquisition is expected to add roughly a percentage point of inorganic growth to our FY 'twenty two ARR results. Itlin will join our existing ALM unit, so CodeBeamer ARR will be reported as part of our FSG segment. We expect this acquisition will increase the growth rates of FSG going forward, which we now expect to be consistently growing in the mid single digit range. 2nd, we announced an agreement to sell a portion of our professional services business to longtime partner ITC Infotech To further power our SaaS strategy, this moves a continuation of a long term strategy we've been executing to focus PTC's efforts on High margin software, while we look to a partner ecosystem to deliver the professional services that unlock the value of that software in the customer setting.

Speaker 2

As we ramp up the SaaS initiatives we described at our December Investor Day, a key component of the program Is the lift and shift efforts required to move on premise customer deployments into our SaaS cloud? With a large installed base, we're looking at the need for potentially thousands of services projects in the coming years. These are projects where PTC needs to play a direct role because at the end of each project, we will be taking ownership of the running system And carrying it forward. Rather than put our own professional services organization back onto a growth vector As we scale up to perform these projects, we're instead planning to transition some of our key PLM talent Into a new ITCI unit called DXP Services, thereby allowing the lift and shift capacity to scale on ITC's P and L rather than ours. This new DXP services unit will be our partner to run joint lift and ship projects, With DXP doing the upgrade and decustomization work that happens at the customer site and PTC Assuming the resulting system into our centralized SaaS operations.

Speaker 2

This is a professional services transaction, so it has no bearing on ARR. Christian will comment further on the expected financial impact of these two transactions. We expect both will close in Q3. To wrap up then on Slide 14, I'm very pleased with PTC's position and the opportunity that lies ahead. Our portfolio of products is unique and compelling And it aligns well the customer demand.

Speaker 2

Throughout the first half of FY 'twenty two, bookings and renewals have been strong And growth is accelerating as we enter the second half of what will be our 5th consecutive year of double digit ARR growth. We're poised to further accelerate growth As SaaS tailwinds blow harder in the coming quarters and as we gain momentum with DPM and other IoT and AR initiatives. Our profitability continues to expand following the changes we implemented at the start of the year and as our start up businesses continue to mature up their J curves. Our model has proven to be highly resilient even in the face of a slowdown like during the pandemic in 2020. We're raising our guidance for the Q2 in a row, and I think the company has never been in a better position to create shareholder value.

Speaker 2

With that, I'll turn it over to Christian for more details on the financial results. Christian? Thanks, Jim, and good afternoon, everyone.

Speaker 3

Before I review our results, I'd like to note that I'll be discussing non GAAP results and guidance, and ARR references will be In both constant currency and as reported. Turning to Slide 16.

Speaker 4

At the

Speaker 3

end of Q2, our constant currency ARR was $1,560,000,000 up 13% year over year. Our SaaS businesses in both the Digital Thread and Velocity Business Groups saw continued solid ARR growth in Q2 And represented a larger mix of our overall business, both year over year and sequentially. We delivered above the ARR guidance range we provided for Q2, which was for constant currency ARR of $1,540,000,000 to 1,550,000,000 On an as reported basis, year over year ARR growth was 11%. Foreign exchange was $32,000,000 headwind and our as reported ARR in Q2 was 1,532,000,000 In March, following the Russian invasion of Ukraine, we announced that we would discontinue business operations and sales in Russia. Exiting Russia had a $4,000,000 adverse impact on our Q2 ARR.

Speaker 3

We've accounted for the $4,000,000 impact as churn in Q2. Cash from operations of 100 and $42,000,000 in Q2 was in line with our guidance. Considering the $32,000,000 foreign exchange headwind to ARR, This was a strong outcome, reflecting expected seasonality and another quarter of solid collections performance. In Q2, free cash flow of $140,000,000 grew 21% year over year and included $18,000,000 in restructuring and other related payments. Adjusted free cash flow was $158,000,000 up 22% year on year.

Speaker 3

Free cash flow and adjusted free cash We're both ahead of our guidance due to strong cash from operations and also because CapEx in Q2 came in slightly lower than we'd anticipated. The main takeaway on cash flow is that despite the headwinds related to foreign exchange, we've been executing well and delivering on our targets. Q2 revenue of $505,000,000 increased 9% year over year. As we've discussed previously, revenues impacted by ASC C606, so we don't believe that revenue growth rates are the best indicator of our underlying business performance, but would rather guide you to ARR as the $1,000,000 in Q2 and our revenue on a constant currency basis was 511,000,000 Before I move on to the balance sheet, I'd like to provide some color on our non GAAP operating margin, which expanded to 42% in Q2, As Jim noted earlier, this compares to 37% a year ago. Revenue is impacted by ASC So other derivative metrics such as gross margin, operating margin and EPS are all impacted as well.

Speaker 3

Still, it's worth mentioning That our costs in Q2 benefited from the restructuring we announced in Q4. 6 months ago, we set an expectation that we would be eliminating some You can see the progress we've made in our Q2 results. We now have a more optimized operating structure And we believe the improvements we've driven are sustainable and will enable us to deliver non GAAP operating margin For fiscal 2022, roughly in line with our year to date performance. Moving to Slide 17. We ended Q2 with cash and cash equivalents of 307,000,000 Our gross debt was $1,280,000,000 with an aggregate interest rate of about 3.4%.

Speaker 3

During the Q2, we generated cash proceeds of $43,000,000 through the sale of our equity investment in Matterport. This in conjunction with cash From operations, we used to pay down $175,000,000 on our revolving credit facility in the second quarter. Regarding our share repurchase program, as we communicated last quarter, we've completed our planned repurchases for fiscal 'twenty two With $5,000,000 settling in Q2 and for the remainder of the year, we'll focus on delevering. Looking forward to fiscal 'twenty three and on a go forward basis, assuming our debt to EBITDA ratio remains below 3 times, our goal is to return Approximately 50% of our free cash flow to shareholders via share repurchases. Next, Slide 18 shows our ARR by product group.

Speaker 3

We post a set of financial data tables to our IR website It has our financial statements as well as ARR details. In that file, we share both constant currency and as reported ARR. As a reminder, when we calculate constant currency figures, we use our current year plan FX rates for all periods. Our fiscal 'twenty two plan FX rates are based on foreign exchange rates as of September 30, 2021. We're using these rates to calculate Currency figures for all quarters in fiscal 2022 and for all prior periods as well.

Speaker 3

To illustrate, you can see on the slide That we expect to report we expect as reported ARR to be lower than constant currency ARR for Q3 and fiscal 'twenty two. This is because of the FX headwinds and rate movements, which have moved significantly since September 30, 2021. Based on the exchange rates at the end of Q2, we expect as reported ARR for Q3 to be impacted by 32,000,000 And for fiscal 'twenty two, we expect the FX headwind to be approximately $34,000,000 This is important to remember in context of our guidance Because we provide ARR on a constant currency basis and if the exchange rate fluctuates significantly between now And the end of Q3, the expected impact to our reported ARR would also change. We do believe constant currency is The best way to evaluate the top line performance of our business because it removes foreign exchange fluctuations from the analysis, positive or negative. With that, I'll move on to guidance on Slide 19.

Speaker 3

We're raising our fiscal 'twenty two constant currency ARR guidance Based on our strong performance in the first half and despite our exit from Russia, the new range is now $1,640,000,000 to 1.6 $65,000,000,000 which translates to constant currency ARR growth of 12% to 13% For fiscal 2022. For Q3, we're guiding constant currency ARR to be $1,580,000,000 to 1.5 $95,000,000,000 At the midpoint, this equates to 13% constant currency growth. We continue to expect IoT and are to reach ARR growth of 20% or more by the end of the year and our FSG And velocity businesses continue to do very well in the market. That all said, the main driver of our fiscal 'twenty two ARR guidance RAISE is the strong customer demand we're seeing in our core CAD and PLM offerings, Which represented 70% of our ARR in Q2. We're maintaining guidance for fiscal 2022 Cash from operations at approximately $430,000,000 as our strong execution and operational discipline are helping us to offset FX headwinds and the Russia exit.

Speaker 3

Our guidance for Q3 cash from operations is $110,000,000 We've updated our CapEx guidance for fiscal 2022 to approximately 25,000,000 Which is down from about $30,000,000 that we said at the beginning of the year. And we're expecting approximately $5,000,000 of CapEx spend for Q3. Therefore, we're raising our full year free cash flow target to approximately $405,000,000 and guiding for Q3 Free cash flow of approximately $105,000,000 We continue to expect our normal seasonal Pattern in our fiscal 'twenty two cash flow generation, primarily driven by invoicing seasonality. The majority of our collections occur in the first half of our fiscal year and we continue to expect expenses to increase in the second half of fiscal Fiscal 2022 as we ramp hiring and our SaaS investments. Because As of these dynamics, Q4 is expected to be our lowest cash flow generation quarter.

Speaker 3

Our free cash flow guidance for fiscal 'twenty two includes $40,000,000 to $45,000,000 of restructuring payments compared to our expectation a quarter ago of $45,000,000 to 50,000,000 As some employees have otherwise departed PTC and some employees that were expected to depart have moved into new roles where we've been looking to buy. Both of these are good things. We have less restructuring payments and have been able to fill new open roles with good people in a challenging hiring environment. In addition, our fiscal 'twenty two guidance assumes approximately $5,000,000 of transaction related payments that were incurred in the first half of fiscal 22. Therefore, consistent with raising our free cash flow guidance, we're also raising our adjusted free cash flow target To approximately $455,000,000 For Q3, we expect approximately $10,000,000 of restructuring payments and $5,000,000 of transaction related payments, which were incurred in the first half, Bringing our adjusted free cash flow to approximately $120,000,000 Moving on to revenue.

Speaker 3

Despite foreign exchange headwinds and our Russia exit, we're taking the low end of our full year revenue guidance up by 25,000,000 Based on our Q2 beat and forecast for the remainder of fiscal 'twenty two. So our new revenue guidance range is $1,905,000,000 to $1,975,000,000 The year over year growth we're guiding to now is 5% to 9%. ASC 606 makes revenue difficult to predict for an on premise subscription company, hence the wide range. Note, revenue does not influence ARR or cash generation as we typically bill customers annually up regardless of contract term lengths. Turning to Slide 20.

Speaker 3

Jim provided some highlights earlier In terms of the financial impact we expect from the Inflin Software and ITC Infotech transactions we announced While both transactions are expected to close during Q3, we have not incorporated The expected financial impacts to our guidance because these deals haven't closed yet. We will officially update all financial metrics and guidance when we report our Q3 earnings. In the meantime, directionally, for constant currency ARR, we expect these transactions to have a Positive impact of approximately $15,000,000 in fiscal 'twenty two. We will report inland in our FSG product group Along with our other ALM assets and regarding free cash flow, we expect the transactions to have an immaterial impact to free cash flow in Fiscal 'twenty two is incremental as incremental operational cash flows are expected to offset the incremental transaction related fees and increased interest in the second half. And we expect these transactions to be accretive in fiscal 'twenty three.

Speaker 3

Going forward, as Jim explained, we expect these two deals to help us drive the adoption of our SaaS offerings. And over time, ITC the ITC InfoTech transaction is expected to result in lower professional services revenue, but not Expected to have a material impact on our profitability. Again, we'll provide a lot more detail at Q3 when we report our results and update All guidance metrics at that point. I'll close out my prepared remarks today by taking you through an illustrative constant currency ARR model on Slide 21. Here, we're showing our ARR progression over the past 6 quarters and an illustration of what is needed to get to the midpoint of our And currency ARR guidance for Q3 fiscal 2022.

Speaker 3

First of all, recall that in Q2 of fiscal 2021, Our ARR growth benefited due to the acquisition of Arena. So taking that into consideration, in the first half of fiscal 'twenty We added approximately $25,000,000 more ARR on an organic basis compared to the first half of fiscal 'twenty one. Next, calling your attention to the green box, this model shows targeted ending ARR at 1.5 $88,000,000,000 for Q3 and $1,653,000,000 for Q4, both at the midpoint of our guidance ranges. The illustration shows the sequential ARR that's needed in Q3 and Q4 to hit the guidance midpoints. As you can see, In the second half of fiscal 'twenty two, we need to add about the same amount of new ACV as we did in the second half of fiscal 'twenty one In order to hit the midpoint of our constant currency guidance.

Speaker 3

We believe we're well positioned to do that even given some of the macro concerns And noting that we also have more deferred ARR starting in the second half of fiscal 'twenty two than we did in fiscal 'twenty one. So hopefully that's helpful. And with that, we'll turn it over to the operator and begin Q and A.

Operator

Thank you. We'll pause for a moment to compile the Q and A roster. And our first question will come from Joe Greuwink with Baird. Please go ahead.

Speaker 2

Hello.

Speaker 5

Hey, great. Hi, everyone. I guess I'll start with A question on the macro and obviously appreciate the backdrop is dynamic and your model This point is built to withstand a lot of what I'm about to ask. But can you maybe just Contrast how customers are maybe talking to you about strategic investments and Some of your more complex implementation areas like PLM or IoT, maybe contrast how this is different today than it would have And then mid-twenty 20 or other periods that maybe have parallels to the past. And does it seem like Summaries are kind of separating strategic from the macro appreciating that the things they're committing to today Do you have longer term benefits and so that just kind of scope of conversation is different than it has been in the past?

Speaker 2

Yes, I mean, absolutely, Joe. Jim here. Keep in mind that PTC is really helping customers Plan and engineer and plan the production processes for products. We're not helping them to By and large, we're not helping them much to produce the product. So the supply chain problems really are production problems.

Speaker 2

And if you're having production problems, most companies don't see that as a reason to stop planning the next generation of products because Suddenly, production problems will be solved at some point. And then you'll be competing for who has the best next generation product. And I hope we didn't take the year off. So we don't really see any connection. And frankly, we didn't see much connection in 2020 either In that particular way.

Speaker 2

So I think the pandemic in 2020 Put a lot of momentum into digital transformation. People realize you can't execute a hybrid workforce, for example, without a system of record for product data, It doesn't work. So that momentum is carrying through and people are forging ahead with their strategies to implement, for example, PLM And CAD to advance their digital transformation, Niv, even if their factories are idle because they're Waiting on semiconductors or in some cases, wire harnesses that used to come from Ukraine and all that type of stuff. So actually, I was in Germany the last week of the quarter, and the customers I talked to were full speed ahead as it related to the PTC project. And we mentioned that we had a very strong bookings quarter in Europe.

Speaker 2

And again, that's net of A fairly if you put all that churn from Russia in Europe, it's material. It's like probably a point of growth, I'm guessing, for Europe. So I think we're doing well and sort of feel like actually conditions look pretty good. And at the same time, we can withstand a lot And still really deliver some impressive growth and free cash flow numbers.

Speaker 5

Okay. That's great. One follow-up just on how your approach to the wind chill transition to SaaS Mikey, evolving just as you publicly announced that now have had a chance to have conversations. It seems like a lot of your peers are Talking about success in their own cloud migration efforts, one specifically said things have accelerated recently. I'm just wondering if you're kind of getting the inkling that that could play out for PTC as you're dedicated to wind chill this point onwards?

Speaker 2

Yes. If you go back to our Investor Day, I'll remind you that we really feel like we're starting the 3rd phase of our SaaS project. And the wind chill part of it started back in the 1st phase. So for us, we've had a lot of success with cloud and it's one of the growth drivers for Windchill. It has been over the last 18 quarters.

Speaker 2

I think the difference is we didn't like the profitability of the cloud part The Windchill Cloud business as we used to do it. So this Windchill Plus is really our shift to the multi tenant model, Which to the customer doesn't look much different, but

Speaker 6

to PTC it looks quite

Speaker 2

a bit different and producing quite a different outcome in terms of profitability. So I think customers like the wind chill in the cloud before. They still like wind chill in the cloud. It's just PTC likes wind chill in the cloud better now. And that's causing us to open the floodgates a little more because it's more attractive business for us now.

Speaker 5

Great. Thank you very much.

Operator

Our next question comes from Adam Borg with Stifel. Hello, Adam. Go ahead.

Speaker 7

Hey, guys. Thanks so much for taking the question. Maybe just on IoT and AR, You talked about it last quarter even in the slide deck today, you talked about a continued focus on upselling and cross selling the installed base. I'd love an update here on kind of what you're thinking about the strategy going forward for upsells and cross sells as well as what is just remind us of the synergies to customers in terms of combining PTC's core TAD and PLM with your IoT and AR offerings? Thanks again.

Speaker 2

Yes. I mean, the key thing let's focus mostly on IoT because it's much larger. The key thing is there's 2 key use cases for IoT, 3 key use cases actually. 1 is smart connected products, which are the products you manufacture. The second one is smart connected factories or we call it smart connected operations.

Speaker 2

That's the products you buy and operate in your factories. And then the third one is really this Navigate strategy of bringing in information from a lot of different systems, kind of An environment that just makes lightweight users more productive and so forth. But anyway, all of our discrete manufacturers produce product and they all operate factories. So what we really said is for efficiency reasons and success reasons, all that stuff, we ought to focus on selling To our customer base with more veracity than just selling to anybody. And so Troy Richardson put in place a stronger focus on cross sell.

Speaker 2

And we're starting to see some, let's say, green shoots, particularly in DPM. Rockwell sold to the Rockwell base, but All the deals we sold really came from the customer base of PTC. That's good. And we think there's something there. So Keep in mind, when we think about IoT and AR in Q3 and Q4, there's a couple of things I want to point out.

Speaker 2

First of all, ARR is a rolling 4 quarter metric. So 3 of the 4 data points that say what's going to happen in Q3 are already in And 2 of the 4 data points that say what's going to happen in Q4 are already in. So we have some visibility. But now what we what the rest of it hinges on is bookings, And backlog or deferred ARR. And so we're looking at all this stuff.

Speaker 2

We look at the pipeline. We look at the forecast. We try to estimate bookings and we don't have a crystal ball and sometimes we're not perfectly right. But anyway, we have a read on what we think churn will be and that's what we're looking at and we're That's great.

Speaker 7

And maybe just as a very quick follow-up. It's great to hear their early success on DPM and Just talked about the Rockwell partnership as well and seeing some success there. Maybe just a few seconds on the State of the Union and where we are with Rockwell overall. Thanks again.

Speaker 2

Yes. Well, coincidentally, Scott General, the Chief Revenue Officer for Rockwell, happened to be at PTC today, so I had lunch with And we talked it over. And the truth is DPM is a better fit for Rockwell than is ThingWorx as a Platform, an IoT platform. And so Rockwell is leaning in, in their consulting arm Calypso is really leaning in And PTC is leaning in. So I think there's some promising, again, green shoots there.

Speaker 2

We were pleased to see Rockwell participate in DPM success right from the start. And I think it gives us a better foundation, if you will, to build success. It's a better fit For what both PTC and Rockwell are capable of, we're both solution providers. This is a solution versus a platform.

Speaker 7

Excellent. Thanks again.

Operator

Our next question will come from Jay Kleejshour with Griffin Securities. Please go ahead.

Speaker 6

Jim, Christian, are you? Jim, starting with you on the infant acquisition, Could you contrast the rationales for that acquisition and the addressable market From that acquisition, as compared with the rationales you spoke of 11 years ago, almost at a day when you bought MKS, Which ultimately became a relatively small part of the business. So what's different now in terms Let's say an ALM arms race that makes insulin, genuinely compelling and perhaps put it in Context of your overall closed loop lifecycle management strategy. And then secondly for you, Christian, by the end of the fiscal year, when you net out the effects of the Structuring, particularly in the field, minus the service headcount with the ITC transaction, the add back from insulin, Where do you think your headcount ultimately lands at the end of the fiscal year?

Speaker 2

Okay. I'll take the first one on inland versus integrity. I mean, It is fundamentally the same story. And I think we've had reasonable success with the Integrity product. But we had some challenges with the Integrity product that I think are fixed in this next generation CodeBeamer offering.

Speaker 2

Keep in mind that ALM is both a business by itself and it's a key subsystem of our PLM system, which therefore means it fuels our PLM success As well. But when I look at Integrity versus CodeBeamer, there's a couple of things that stand out. Number 1 is SaaS. We didn't have a SaaS solution. We didn't have a path to a SaaS solution with Integrity.

Speaker 2

It's much older technology. That's one thing. The second thing is Integrity Had its own built in source code management tools. And the entire development community has really shifted to tools like GitHub and so forth. It's very, very hard to sell against things like GitHub, which amongst other things tend to be free.

Speaker 2

So it turns out that CodeBeamer is designed to work with all these other modern tools out there. And then the third thing is CodeBeamer is really viewed as a Sexy, best in class user experience, all that kind of stuff. So we're really with CodeBeamer leapfrogging far Where we were with Integrity, leapfrogging the competition and we now have an offering that allows us to go back on the offense, Back into automotive companies, back into medical device companies, aerospace and defense companies, anywhere where people put safety critical or regulated Software into products. The thing in an automobile setting, and this is what I would have said 10 years ago, is you got to manage Software very carefully in the context of the automobile. You have a set of requirements for a new automobile.

Speaker 2

Many of those requirements get implemented into mechanical systems, But a bunch of them and more every day get implemented in the software. And a bug in the software is as bad, even worse than a failure at a mechanical part. And so there's deep concern by these automotive companies and then there's regulations around it that says if anybody in the supply chain Change is a line of code. You need to know which line of code they change. You need to know why they changed it, and you need to have a test to prove they didn't break anything.

Speaker 2

And so it's a very, very difficult software management environment. It frankly doesn't apply to a software company like PTC. We don't have any mechanical parts. So it's just software, but there it's software in the context of a physical product managed in CAD and PLM and that all needs to be integrated back together. So basically, inland is a next generation leapfrog move within our ALM and PLM strategies.

Speaker 2

Christian?

Speaker 3

Yes. Hey, Jay. Given all the moving parts It's obviously difficult to pinpoint precisely, but I'd say we're probably somewhere in the 6,700 range.

Speaker 6

Okay. So headcount would probably be end up being flat net by the end of the fiscal year, but on a larger base of revenue?

Speaker 3

It should be you mean flat year over year?

Speaker 6

Right, right. You ended fiscal 2021 at $6,700 actually that's where you think you'll end up, but you'll be a bigger company in terms of revenue.

Speaker 3

Yes, that's right. And I mean, I'm also trying to factor in somewhat challenging hiring environment. If possible, we'd like to see that. We could say 67 to 6,800. I'm just trying to be pragmatic.

Speaker 1

Yes.

Speaker 2

I mean, Jay, Jay, you look at this data, you know we have a lot of positions open on one hand. We have attrition on another hand, and then we're spinning some employees out through this transaction. So It is a little hard to net those out because it's difficult to pin down attrition and pin down hiring success, but headcount won't go up dramatically here the context of all that, it will probably be flattish. I mean, that's a reasonable approximation.

Speaker 6

Okay. Very good. Thank you, Doug.

Operator

Our next question will come from Yung Kim with Loop Capital. Please go ahead.

Speaker 4

Great. Thank you. Jim, Hey, you expect the amount of professional services work to increase with Part of the Windchill Plus adoption over the next several years. Obviously, you are taking advantage of that opportunity and offloading some of the professional services business to partners and whatnot. And your transaction with ITC illustrates that, but given the tight IT labor market out there, do you feel comfortable that You have enough professional services capacity to meet the potential demand for the around the winter plus lift and shift Adoption that you expect over the next several years.

Speaker 4

And overall, if you can just revisit the state of your Our ecosystem around implementation and deployment capacity and if you have any kind of investments that you're making beyond this transaction you announced today.

Speaker 2

Yes. So I think we have tremendous scalability in ecosystem. But just for the benefit of everybody, let's turn the clock back a little bit. If you go back 10 years, about a third of our revenue was services. And now it's 9% going to, I don't know, 6% or so As a result of this transaction.

Speaker 2

And what happened over those years in our quest for margins, which was very successful, We said, let's stop chasing services. Let's give it to the ecosystem. The ecosystem took that differential from us and added 10 times that on their own. So literally, the ecosystem is doing 1,000,000,000 of dollars of services around our stuff. It's not in one partner.

Speaker 2

It's in many, many, many partners. Some of them having names like Accenture and Deloitte and Cognos and not Cognos, Cognizant And Calypso and on and on and on, many having smaller firms you never heard of. So there's a lot of capacity out there. The thing is, these projects we can't just give to a partner because in the end, we're taking the systems into our running system. It has to be done Very carefully.

Speaker 2

We have for many, many years subcontracted work to ITCI. We could have subcontracted These projects to ITCI, but I said I don't really want that on our P and L because subcontracted projects tend to have even less margin than projects we do with our own employees, of course, there's So rather than build up a subcontracting business because we didn't really want to go hire all those people, we just entered into this arrangement. It's a great win win win. ITCI is happy to grow the services business. That's the business they're in.

Speaker 2

By the way, they're fundamentally an Indian company, so they have a deep reservoir of access to lower cost labor in India. And that will a lot of these projects will end up being done in India with their Indian capacity. And it will give us the Talent because we're seeding DXP with the best in the industry, which are PTC's own services employees. So DXP could have been a joint venture or something like that, could have been a subcontracting approach. We just said, you know what, we're a software company.

Speaker 2

We want to be High margin, high growth software, let's PTC focus on that and this is a good way to solve that lift and shift services capacity problem.

Speaker 4

Okay, great. And then just a quick question. I don't think anybody asked yet, but Jim, what is your expectation regarding the Windchill Plus adoption? At least the over the next several quarters in terms of the pace of the adoption.

Speaker 2

Well, We've been doing a lot of adoption of Windchill in the cloud, that Phase 1 offering. So we're just going to pivot that Windchill Plus now. Windchill Plus, by the way, so you know, is not just Windchill in the cloud. It's Windchill Plus a bunch of things, Plus all the Atlas benefits, plus single sign in across the suite, plus our workflow engine, our BPM workflow engine, plus Our visualization in the cloud capabilities. So we're really trying to create a differentiated offering, in part to help justify the higher Price point, but also to make it more attractive to go to the cloud.

Speaker 2

Just for fun, I tell people, think of like a first class seat on an airplane versus a coach seat. It isn't just that the seat's bigger. And you wouldn't want somebody to say, well, I want to sit in coach but have a bigger seat at a lower price point. That's sort of like saying, could I have a system integrator put my windshield system in the cloud for me? So what we're doing is offering a bundle of things.

Speaker 2

It's a bigger seat. It's a bigger TV. It's better food. You get to board first. You got plenty of room for your luggage, quicker access to the restroom.

Speaker 2

I mean, all those stuff That would be associated with a 1st class seat and can't be unbundled and bought off a Chinese menu. So that's really what we're doing with Windchill Plus and then we're going to follow the same strategy with the rest of the products as we're ready.

Speaker 4

Okay, great. Thank you so much. Yes.

Speaker 2

Thanks, Ed.

Operator

Our next question will come from Jason Celino with KeyBanc. Please go ahead.

Speaker 5

Great. Thanks for fitting me in. When I think about PTC's main segments, in the past acquisitions that we've seen over the last few years, We saw in shape for CAD arena for PLM and now insulin for ALM. What are the areas may PTC need to upgrade via make or buy

Speaker 2

Well, Keep in mind, there's a difference between things we have to do and being opportunistic when you find a really great company that's profitable and all that kind

Speaker 1

of stuff. I think that

Speaker 2

the main basis of CAD and PLM are covered. And then you know our IoT and AR stuff is already quite SaaS. About half of AR is sold to SaaS and more than half of I'm sorry, about half of IoT is sold to SaaS and more than half of AR. You might remember, we announced the AR capabilities available on that Atlas platform some time ago. So I think I don't think we need to acquire anything.

Speaker 2

There's no gaping holes. Probably integrity was the last important hole that we wanted to fill. And I don't think we would have bought inland if it weren't such a Strong company. It's disruptive in the market. It's growing fast and it's highly profitable.

Speaker 2

And that allows us to bring it in, in a Short term free cash flow neutral, mid- and long term free cash flow accretive kind of way, which works for us. So that's how we think about it, more Strategic and opportunistic as opposed to it's time to acquire something, what should we go get next?

Speaker 1

And Savannah will take our Final question for today.

Operator

And our final question will come from Matt Broom with Mizuho Securities. Please go ahead.

Speaker 1

Hey, Tim and Christine, thanks for letting me ask a question. I guess, where are you in terms of expanding vape and Arena's go to market activity across You resell our channel globally and does that become easier now that SaaS is sort of going more mainstream so to speak now that Wind Chill Plus is here?

Speaker 2

Yes. Well, first, let me say that most of Arena is sold direct, to be frank, with a Inside sales model. So there's not a big outside force. So what we've really been expanding to drive arena sales with some success is to globalize That largely inside model. An inside model is a great thing if you can get it to work.

Speaker 2

And PLMs, Particularly big PLM systems are kind of complex and probably require a higher touch model. But with Arena, so far, so good. We've been able to Scale this inside model. And so that's really what we're doing. Now our resellers are interested in selling it.

Speaker 2

And I think as arena goes up market and the deals get more complex, There'll be a need for a higher touch selling process. And yes, probably our existing resellers at some point will play a bigger role with Arena But right now that low touch inside sales model is working and it's a great thing to it's a great Model to have, if you can make it work. And so far, it sounds like we won't be able to.

Speaker 1

Perfect. Thanks very much.

Speaker 2

Okay. I think that was our last question, Matt, right? So thank you all for spending some time with us here today. And Matt tells me we're going to be very active on the circuit here in the next 90 days. We're going to be at like half a dozen different conferences.

Speaker 2

I'm going to few myself and Matt and Christian will be at others. So we might see you on the road and I hope so. I haven't seen a lot of you in a long time. It would be nice to see you face to face. And if not, We'll look forward to talking to you again in 90 days.

Speaker 2

As you can see, we're really feeling good about the business. We've put in place a lot Strategic moves, they're mostly working. We've put in place profitability moves that are working pretty well. And that's a good combination To have strong growth and strong profitability and it bodes well for us, particularly given the resilience of our model in good times and in bad. So I'll leave you with that thought and look forward to seeing you sometime in the next 90 days.

Speaker 2

Bye bye.

Speaker 1

And that will conclude

Operator

by taking my questions.

Speaker 3

Thanks everybody.

Speaker 1

Thank you

Operator

for your participation and you may now disconnect.

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Earnings Conference Call
PTC Q2 2022
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