Ptc Inc. Q3 FY2021 Earnings Call

Good afternoon ladies and gentlemen, thank you for standing by and welcome to the PTC 2021 Third Quarter Conference Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be open for questions. I would now like to turn the call over to Emily Walt, PTC's Senior Director of Investor Relations. Please go ahead, Ma'am.

Thank you, Peter. Good afternoon, everyone. And thank you for joining us for PTC's conference call to discuss our third quarter 2021 financial results. On the call today are Jim Heppelmann, Chief Executive Officer; and Kristian Talvitie, Chief Financial Officer. Before we get started, please note that today's comments included forward-looking statements, including statements regarding future financial guidance. These forward-looking statements are subject to risks and uncertainties and involve factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in PTC's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. As a reminder, we will be referring to operating and non-GAAP financial measures during today's call. Discussion of our operating metrics and the items excluded from our non-GAAP financial measures and a reconciliation between GAAP and non-GAAP financial measures are included in our earnings press release and related Form 8-K. Lastly, we’ll be referencing our earnings presentation today, which you can find posted on our IR website. And with that, let me turn the call over to Jim.

Thanks, Emily. Good afternoon, everyone, and thank you for joining us. I hope you and your families are well during these continued uncertain times. I'm pleased to share that PTC has welcomed many of our vaccinated employees back to our offices where requirements allow and we look forward to the day when we can do this on a global scale. Meanwhile, we're monitoring the growing concern with the Delta variant of the virus and hoping this new development doesn't lead to another round of business lockdowns. Before I dive into the quarter, I want to share some important news on the Investor Relations front. Emily has been doing a great job holding down the fort since Tim Fox left. But keeping up with IR demands is a big job and Emily was happy to hear that reinforcements are on the way. I'm pleased to announce the hiring of Matt Shamal as our new Senior VP of Investor Relations. Matt came to us as a recommendation from one of our largest investors and he came out on top following a thorough search process. Matt comes to us with a finance background in several successful stints on both the corporate side and the sell side of investor relations. He's a strategic thinker, and we're excited to bring him on board. Turning to Slide four, with three quarters behind us, our guidance for FY '21 has us right on track to deliver mid-teens ARR growth and $340 million of free cash flow this year. That would be a fourth consecutive year of double-digit top line ARR growth. And I anticipate we'll be discussing a fifth consecutive year of double-digit ARR growth when we guide fiscal '22 in 90 days or so. While the stronger PMI numbers that we're seeing can only be helpful, I'm pleased to see that PTC is earning a reputation as a company that can consistently perform at high levels in good times and in bad. In preparing for this call, I thought back to where we were a year ago. With shutdown orders in place, empty offices and factories, and schools contemplating how to educate from home. Against that chaotic backdrop, I'm very pleased with the results that PTC has been able to deliver right through the pandemic. Some years back in the days when our portfolio was narrower and sold in a perpetual model, our business was much more cyclical. But consistent, reliable performance is always what we strive for and we did the difficult work to earn that. The type of steady organic top line growth performance you see from PTC hasn't been the rule in our peer group, especially among our most direct CAD and PLM competitors. I attribute our superior performance to a better business model, to tremendous strength across our entire portfolio, and to growth drivers that are now more secular than cyclical. In terms of growth drivers, PTC is well positioned for the future. The new logo success of our Onshape and Arena businesses demonstrates the growing demand for SaaS technologies. We see PLM joining IoT and augmented reality as key digital transformation technologies for industrial companies and years of market outgrowth in the CAD business space owing to the innovation we've reignited there. Turning now to Slide five so we can get into the Q3 details. PTC delivered another strong performance in top line ARR and bottom line free cash flow in the third quarter. Bookings grew in the mid-30s, a strong rebound in comparison to a year ago when bookings declined. In the top line category, we had a very solid quarter, with ARR growth of 18% or 15% in constant currency to $1.42 billion. Growth was driven by solid performance in our growth businesses, continued momentum in our core business, where we again outpaced market growth, and by a solid contribution from Arena Solutions. On an organic basis, ARR grew 14% or 11% in constant currency in Q3, in line with our guidance. To close out the top line category, revenue growth of 24% as reported was driven by strong execution, aided by the impact of ASC 606 revenue recognition policies, plus of course, the Arena contribution. Switching to the bottom line category, we delivered strong free cash flow of $85 million and non-GAAP EPS growth of 34%, reflecting a combination of strong top line results, combined with continued operating expense discipline, even while we also invest for growth. We continue to feel confident about our FY '21 target of $340 million in free cash flow. Moving to Slide six, digital transformation remains our main secular driver of growth. You may remember last quarter I shared our new tagline, 'digital transforms physical'. These three words are captured in our logo and embody how PTC thinks about our long-term strategy. PTC is a digital company, but our customers do business in the physical world, making physical products in physical factories, and servicing those products at physical customer sites. In my live works keynote in June, and again at our global partner summit in July, I outlined the power of PTC's unique digital transformation story that has one foot in the digital world and one foot in the physical world. We tell customers that our 'digital transforms your physical', and by that we mean we help customers use digital to define, manage, connect, and augment physical products. Our portfolio is already transformative. But now with SaaS, PTC is at the very forefront of thinking about how customers will use digital to disrupt physical in terms of taking an entirely different approach across the hardware, software, and system administration of their IT systems. SaaS is surely coming to our market, as it has to so many other B2B software markets and PTC has carved out an enviable leadership position. We now have the most to gain from this disruptive force. With that as context, let's take a look at the respective contributions of the FSG, core, and growth segments of our portfolio. Moving to Slide seven, you'll see that ARR in our Focused Solution Group showed growth of 4% or 1% in constant currency, which aligns with that growth expectations for this segment. ARR growth for our core business was 14% or 11% at constant currency. Our growth segment saw 60% ARR growth with 23% organic constant currency growth, reflecting on one hand, some lingering hangover from COVID but counterbalanced by solid performances from our Onshape AR and Arena SaaS Solutions. Let's go a click deeper into the main elements of our large core and growth segments. Turning to Slide eight, our CAD team delivered another impressive quarter with ARR growth in the low double digits, reflecting growth across all geos and an improving demand environment. The additional features and functionalities that Creo 7 delivers, including Creo simulation live and Creo Ansys Simulation, continue to demonstrate the power and differentiation of Creo. In addition, last quarter, we announced Creo 8, which includes the generative design extension module called GTX, which is based on our Atlas SaaS platform. While it's still early days for Creo leveraging Atlas, this module is a great example of how PTC plans to deliver innovative SaaS-based capabilities as we systematically transition our core products to SaaS. On Slide nine, a great example of how CAD, generative design, and real-time simulation is making an enormous impact can be found at HPE COXA, a provider of product engineering solutions, and technology projects for the performance automotive and motorsports sectors. The company designs and manufactures car components and complete systems for some of the highest profile super premium sports car brands around the globe. Inefficiencies in a multi-step, multi-software approach to design were causing miscommunication between design and analysts teams, which delayed production times and caused customer satisfaction risks. By adopting fully integrated and streamlined generative simulation and additive technology workflows in Creo, HPE COXA simplified the design sequencing, reduced overall design and production time and improved design agility and time to market. Moving on to Slide 10, in our PLM business, you'll see that PLM continued to deliver very strong performance with another mid-teens ARR growth quarter. From a geographic perspective in Q3, we saw broad-based strength across all our geos and in our customer base, with a solid quarter in the reseller channel. And we saw increased demand for PLM through the Microsoft alliance. Another proof point suggesting more customers are understanding the critical role that PLM plays in their digital transformation initiatives. Incidentally, during the quarter, we won three more Partner of the Year awards from Microsoft. On Slide 11 we profile a win with Cellcentric, a Daimler truck and Volvo joint venture, which develops hydrogen fuel cell systems and believes that PTC's PLM solution is best-in-class. As the deadline of becoming an independent entity loomed on the horizon, Cellcentric knew they needed a PLM backbone in place quickly. PTC delivered our cloud-based Windchill offering, establishing a best-in-class application landscape for PLM in a great competitive displacement. Moving on to our growth businesses, I'll begin with IoT on Slide 12. IoT delivered high-teens year-over-year ARR growth driven by strength in Europe and APAC. Rockwell was the largest reseller of IoT in the quarter. On Slide 13, we discussed how Eaton, a multinational power management company, saw the need to deploy a digital transformation strategy across their enterprise. Our factory insights as a service, IoT application helped to deliver quick wins, forming a digital foundation upon which they can easily add more use cases. Eaton was able to realize multiple improvements including improved OEE, reduction in unscheduled maintenance, reduction in manual efforts, and 100% worker compliance with SOPs. Let me shift to our augmented reality business on Slide 14. The Vuforia augmented reality team again delivered strong results in Q3, with ARR growing across all geos. We saw improving retention and expansion rates, and the opportunity to cross-sell into the larger PTC portfolio is gaining momentum. This quarter we also announced the new ARR product, Vuforia Instruct, a unique Atlas based SaaS solution designed to enable enterprises to leverage 3D CAD data to create, deliver, and scale interactive AR work instructions to optimize inspection procedures. When you consider that two-thirds of manufacturers are still using paper based inspection processes, you can appreciate how Instruct delivers considerable value to our customers. Vuforia resonates with the customers we engaged through our alliance with Microsoft and one of the awards we won this quarter was Partner of the Year in mixed reality. On Slide 15, you'll see an innovative example of the use of augmented reality that comes from Stannah, a UK company dedicated to the design, production, and service of residential and commercial stairlifts. Stairlifts are customized systems configured for and installed in the consumers' homes to help those with difficulty navigating stairs, for example, to move from the first floor living room to the second floor bedroom. Stannah leveraged Vuforia to create an AR application that allows customers to see how a customized 3D hologram chairlift could fit in and work in their homes. With COVID limiting the amount of face-to-face interaction by sales and service teams, Vuforia enabled a customer-centric tool that could be used by sellers during the sales cycle to help potential buyers visualize a residential stairlift in their home. Stannah saw increased purchase confidence, improved differentiation against competitors and shorter sales cycles through improved customer communication. Turning now to Slide 16, Onshape delivered a very strong quarter, with ARR growth of 40% year-over-year. We had a very strong bookings quarter in the Onshape core commercial business with larger deal sizes and stronger renewals, thanks to a maturing product. Onshape continues to gain share in the education market tool, as schools and students turn to SaaS-based solutions for mobility and ease of everything. Looking ahead to Q4 we see a strong pipeline for both the commercial and larger account enterprise business. Turning to Slide 17, it's fun highlighting customer stories, especially when that customer is solving a problem through innovation. Delta Development, an R&D company specializing in military applications for cooling and heating systems in extreme environments, was contracted to design and manufacture an autonomous portable refrigeration unit for deployment by medics on the battlefield. The company was seeking to reduce its IT overhead, which had been taking up 20% of the engineering team's product design time. By moving from an on-premise CAD system that took a lot of care and feeding to Onshape, the time loss associated with software installations, licensing, and regular system upgrades was eliminated. They both reclaimed the 20% of their design capacity and at the same time enabled real-time collaboration on 3D designs across a distributed team environment. Moving to Arena on Slide 18. Arena continues its growth trajectory, delivering ARR growth of over 20%. Arena is seeing strong traction with upselling as they increase penetration in current customer environments and keep retention rates high. By all measures, Arena looks to be a great acquisition. I'm also pleased to note that we opened our first European Arena sales operation during the quarter. Turning to Slide 19, NEXTracker, a flex company, is one of the fastest-growing cleantech companies in solar, offering next-generation solar power plants with smart solar trackers and energy storage solutions. The company lacked a single source to track and manage its engineering design and development processes. They needed a better way to manage product information across distributed teams to enable automated approvals and to improve tracking and accountability. With Arena, NEXTracker was able to reduce review and approval times by nearly 60%, eliminate time zone delays with global partners and accelerate product introductions by 25%. Arena has helped NEXTracker significantly improve the way they design and get products to market. Naturally, I'm pleased that PTC has been able to complement the strong performance of Creo and Windchill in the traditional market, with breakout performance from Onshape and Arena in the burgeoning SaaS market of tomorrow. The success we're having with Onshape and Arena in the small and mid-market is 100% complementary to Creo and Windchill's success in larger companies. Geographic performance was strong on a global basis. And as shown on Slide 20, reflecting the performance trends we've seen year-to-date, America's ARR growth of 21% was driven by solid core performance and Arena. Europe ARR grew 9% consistent with several prior quarters, with strength in CAD, PLM and improving growth in IoT, as we work toward full recovery from COVID there. APAC delivered the fourth quarter in a row of mid-teens ARR growth with strong performance in core and growth businesses. Summarizing the state of the business, on Slide 21. We're pleased with the general good health of PTC across all of its different dimensions and moving parts and we look forward to wrapping up a great year of ARR and free cash flow growth here in FY '21. With that, I'll turn it over to Kristian to take you through more details on the financial results and guidance.

Thanks, Jim. Good afternoon, everyone. Before I review our results I'd like to note that I’ll be discussing non-GAAP results and guidance and most of the growth rate references will be in constant currency. So let me start off with a review of our third quarter results, and then we'll review guidance for fiscal '21. Turning to Slide 23, fiscal Q3 ARR of $1.42 billion increased 15% year-over-year and on an organic basis ARR grew 11%. Q3 free cash flow of $85 million was solid and in line with our expectations. Q3 revenue of $436 million increased 24% year-over-year as reported, or 19% in constant currency. Revenue performance was driven by strong execution, and also reflects the impact of ASC 606 on revenue recognition, as well as a modest contribution from Arena. The strong revenue growth along with continued financial discipline resulted in non-GAAP EPS growth of 34% year-over-year. Turning to page 24, I’ll begin with the balance sheet. We ended Q3 with cash of $366 million and $1.5 billion of gross debt with an aggregate interest rate of about 3.1%. We paid down $30 million on our revolving credit facility during the quarter. With our leverage ratio now less than three times, which we told you was our goal, we expect to be in the market buying back shares in Q4. Now, turning to guidance, Slide 25 highlights a few of the key guidance assumptions and while our assumption on the impact of currency on ARR has changed from neutral to approximately 60 basis points tailwind. The rest of our guidance assumptions remain the same as they have throughout the year. So putting our ARR guidance into perspective and turning to Slide 26. Last quarter, we told you that we expected fiscal '21 ARR to be $1.45 to $1.47 billion, a growth rate of 14% to 16%. This assumes 10% to 12% organic growth, 400 basis points from Arena and no FX impact. Our revised guidance range is now $1.45 billion to $1.47 billion, which is still 14% to 16% growth, and assumes 10% to 12% organic growth, 400 basis points from Arena and approximately 60 basis points of currency impact. Regarding ARR linearity in fiscal '21, we've delivered consistent organic constant currency growth around the middle of our guidance range for three quarters and we continue to expect the growth rate to be consistent in Q4 as we close out fiscal '21. Free cash flow is still expected to be approximately $340 million for the full year, growth of approximately 60% year-over-year. Our $340 million free cash flow target also includes approximately $15 million of acquisition-related fees, an additional $5 million of incremental interest we expect to pay this year due to the Arena-related debt. Approximately $18 million of an unforecasted payment due to a foreign tax dispute and also includes approximately $15 million of restructuring payments. This is offset by incremental cash flow from Arena and free cash flow is also net of approximately $25 million of capital expenditures. As a reminder, collections are stronger in the first half offset by the timing of expenses and headcount ramping throughout the year. And as you know, our bond interest payment will hit in the fourth quarter. So we've already delivered more than 90% of the free cash flow target for the year, which is in line with our expectations and has been. Now turning to the P&L guidance, we are raising revenue guidance and EPS guidance for the year. Our prior guidance for fiscal '21 was $1.710 to $1.740 billion, a growth rate of 17% to 19%. We're now expecting fiscal '21 revenue of $1.733 billion to $1.763 billion, a growth rate of 19% to 21%, which includes approximately 200 basis points from Arena and approximately 100 basis points from FX. We're increasing operating margin guidance both on a GAAP and non-GAAP basis, a GAAP operating margin increases from 15% to 17%, now to 17% to 19% and non-GAAP operating margin increases from 31% to 32%, now to 32% to 33%. Non-GAAP EPS guidance previously was $3.18 to $3.39 and our revised guidance is now expected to be $3.35 to $3.60. That's growth of 30% to 40%. Turning to Slide 27, our total ARR growth which includes deferred ARR was 12% on an organic basis in Q3, and we expect organic active ARR growth of 10% to 12% and are now expecting approximately $95 million in deferred ARR for the full year, which is up from what we told you last quarter of around $90 million. Wrapping up, we had strong financial performance again in Q3, we delivered double digit ARR growth while maintaining discipline on our expense structure. As we continue to navigate what still remains a somewhat unsteady macro environment. Year-to-date our performance has positioned us well to deliver attractive double digit top line growth and very strong free cash flow growth for the year. So with that, I'll turn the call over to the operator and we can begin the Q&A.

And your first question will come from Saket Kalia with Barclays.

Hey, guys, good afternoon, and thanks for taking my questions here. I'll keep it to one maybe for you, Jim. Lots of fun stuff to talk about with the business this quarter. But maybe just to get it out of the way, I think we all saw some of the announcements by Rockwell and PTC in the quarter. So I was wondering if we could get maybe your perspective on how some of those changes maybe sort of impact the economic relationship between you two and how if at all it may be impacts long-term PTC's long-term strategy, in your view. Does that make sense?

Yes, sure. Well, the biggest piece of news, of course, was Rockwell acquiring Plex for about $2.2 billion. So I would say first of all, everybody should know that Plex is 100% complementary to PTC. We have never competed with Plex at all. In fact, I know Plex pretty well, because it's run by Bill Berutti, who's one of my better friends in life and reported to me for a dozen years or so. Plex is a great company. We know who they were, we kind of had decided that wasn't quite the right fit for us to acquire. But actually, we're pleased to see Rockwell acquire them. And I think there's actually some opportunity for synergies between what Plex does and what PTC does. You might almost think that Rockwell's adding Plex in a way from my perspective to the innovation suite we build together. So I don't see any conflict at all. I think Rockwell will be probably sharing some attention cycles with Plex that maybe had been previously committed to PTC, so we'll have to see how that plays out. But in general, Rockwell is an important partner; they won a Partner of the Year award after they acquired Plex. So I think that the partnership is important. It's sort of built into the business as we run it today, and I don't see anything dramatic changing there going forward. There was also a question somebody else asked me; is Rockwell going to sell their PTC shares? And I would say you probably should ask Rockwell, but certainly, they have not suggested to us they're going to, and I think their public announcement said they were going to fund the Plex acquisition with new debt and cash on hand. So I don't think anything really changes in the relationship other than something new came in and on one hand, it's bringing new capabilities that might help us against competitors collectively, and on the other hand, we'll have to share attention cycles with it. So that would be my thought there, Saket.

Got it, very helpful. I'll hop back in queue. Thanks, Jim.

And your next question will come from Matthew Broome with Mizuho.

Hi Jim and Kristian. I guess just on that general theme. It'd be interesting to see how you sort of updated thoughts on M&A and in particular given recent market events on how you view the electrical CAD market as an adjacent opportunity? Clearly you did make an acquisition in that space itself last year.

Yeah, so you're probably referring to some activity between Autodesk and Altium, I'm guessing. So Altium is one of three main printed circuit board design software companies. And of course, there are other companies that provide integrated circuit software. The integrated circuit software really doesn't have a touch point with our world of CAD and PLM, but the printed circuit board design software does. We have a partnership with Altium. I'd like to find ways to strengthen that partnership, I don't really see us trying to acquire them. For one thing, we'd have to top Autodesk's price which I don't know that we're in the mood to do. And then secondarily, I don't think they want to be acquired. So I feel like there's a good opportunity there for us to do more in the partnership, both on one hand with Onshape and Arena, which are a nice fit in the lower part of the market with Altium, but also with Creo and Windchill, which are also a nice fit. So there are many Creo and Windchill customers who put circuit boards in their otherwise mechanical products. The same would be true of Onshape and Arena. So there's lots to do there in terms of a partnership; I don't see us trying to acquire them in the near term, given the circumstances, as I know them. We did make a small eCAD acquisition of actually a company called ECAD MCAD. But it really was a very small deal and it was at the interface of ECAD and MCAD, it was not ECAD capabilities, but it was the ability to import in real-time synchronization between an MCAD product, like Onshape, and an ECAD product like Altium. So it's actually going to prove useful in some of the integration activities that we want to do. But anyway, Altium is a good company; I'm perfectly happy if they remain standalone. And we, PTC, look forward to strengthening our partnership because there's lots of synergy on both sides of that partnership.

Got it, makes sense. And then I can maybe just quickly ask about general interest and demand for generative design with the new customer base. Have you seen this option within Creo and how close are we to seeing GD become an integral part of any sort of mainstream design process for cars, and planes, and so on?

Yeah, I think there's a lot of companies exploring it, trying it out, doing what-if scenarios and proofs of concept. And frankly, they get some pretty good results. But you know, it is a very different way of doing engineering. We always thought of computer-aided design, but actually, the computer wasn't so much aiding the designer, it was just simply documenting the ideas. But this really is computer-aided design, where the software is providing ideas to the engineer, as opposed to just capturing the engineer's ideas. That's a different process that people wrap their heads around; I'll follow AI around. But like I said, the results are pretty spectacular sometimes. So there's definitely a lot of interest. I think it will take a while to mainstream, but certainly, it's going to be a wave of growth in mechanical CAD over the next five years. I don't think it will come on super strong in the near term.

Alright, perfect. Thanks very much.

And your next question will come from Jason Celino with KeyBanc Capital. Your line is open.

Hey, thanks for taking my question. Jim, Onshape and Vuforia in the 40% growth, very impressive. But the growth segment did beat slightly to that 23% organic constant currency growth level. Is the overhang spill on IoT side, what gets that the turnaround?

Yeah, well, if you look at scale, Jason, about 75% of that growth segment in terms of scale is IoT. IoT is a much bigger business because we started a bit sooner and really had a lot of success with it. So, in a way, right now, as IoT goes, it has a big influence on the overall performance of the overall gross segment. So most of the slower growth was in IoT and most of it is still related to hangovers from COVID. So if we kind of look at what's happening on the sales front with IoT, I mean, sales have improved year-over-year, they're still not back to where we want them to be. But in general, what we're seeing is a good quantity of deals, but smaller deal sizes, which I just attribute really to conservatism around people doing IoT projects in factories, and in general as they come back to speed following COVID. You might remember too that we mentioned clearly at the beginning of the year that we had a 2-point headwind to growth; in our deferred, what we at the time called backlog, but deferred ARR was a 2-point headwind. Well, a lot of that headwind landed in IoT because that's the place where our sales were softest last year. So some of that is now coming home to roost. Now, it's not just what we sell in the quarter, but it's how much backlog did we also take advantage of maturing in the quarter, and that's another pressure that we'll work our way out of as we kind of round trip to COVID impacts of the back half of fiscal '20 and the front half of fiscal '21, let's say mostly in fiscal '20.

Okay, great, excellent. Thank you for the call. I'll get back in queue.

And your next question will come from Andrew Obin with Bank of America. Your line is open.

Yes, good afternoon.

Hey Andrew.

Hey, how are you, Jim, Kristian. Question about actually, question about Onshape. You sort of talked about more mature model and sort of approaching larger enterprise customers? Can you just talk about where we are in sort of, A, how larger enterprises and where are you in sort of transitioning this product towards your more core customer base away from small and medium businesses? And if I understood you correctly. Thank you.

Okay, Andrew, those are good questions. So first of all, when I use the term enterprise, I was using it as defined by the Onshape team, which generally means an account would take 15 seats or more. It's kind of a small definition of enterprise for the rest of us at PTC, but that's their definition. So I would say the definition of enterprise used by Onshape is a medium-sized company, and the commercial business is small companies. Now, I would tell you that it's just a different buying market. Our Creo software and our Windchill software for that matter, does not participate effectively in the market where Onshape and Arena are making hay right now. So it's all complementary. And in fact, honestly, we're borrowing a page from the solid strategy of 20 years ago when they had SolidWorks in the mid-market and CATIA and ENOVIA in the high end of the market. And those two products prospered side by side for 20 some years until they both do a bit old retired. But it's a strategy that works with market segmentation. And so I don't think that you're going to see Onshape and Arena put a dent into Creo and Windchill because, amongst other things, Creo and Windchill are adopting the SaaS technology called Atlas that makes Onshape so special. So when Onshape is stealing larger accounts, it's basically by and large stealing them from SolidWorks. And then cherry-picking a few others here and there, but they're starting to get some accounts whose brands you recognize. You might remember we had Garrett Turbo present at an investor day; I believe it was, that's a pretty large company that went from CATIA to Onshape. And really went for all the qualities of SaaS that they love. And of course, ease of use and other things of Onshape. So I think Onshape is an attractive product; it needs to mature more before it really could be a viable replacement for the high-end products, generally speaking, but I think it'll start to pick up a lot of medium-sized accounts and an occasional larger account, who may be is over served by the more expensive, more complicated technology they're otherwise using.

That's a great answer. Thanks so much. I'll get back in the queue.

Thanks.

And your next question will come from Ken Wong with Guggenheim. Your line is open.

Operator came back just in time. Thanks for taking my question. I just wanted to circle back on Rockwell real quick. I saw you guys mentioned that Rockwell became the largest IoT reseller. Just wondering, is that a new dynamic there? And as we think through some of the earlier discussion points you had with Saket's question, is that a position that you think kind of sustains going forward, kind of based on what we know?

Yeah, well, Rockwell as a reseller has been growing and growing and growing, and most of that reselling is in the field of IoT and AR, let's be clear on that. And we have many other resellers, but they're largely in CAD and PLM. So Rockwell has become an important reseller for sure of IoT and AR, and I don't see that ending. When I talked to Blake about how this fits in with his strategy even post-Plex, Blake says, Hey, I need an IoT platform, I need an AR platform, I even want to have a CAD and PLM platform available to me when required because his competitor, Siemens has that stuff, but not all of IoT and AR, but some IoT and lots of CAD and PLM. So, we remain important to Blake and there's nothing he acquired in the Plex acquisition that supplants any of the capabilities that PTC brought up in the Factory Talk innovation suite. So I think it’s Blake and Rockwell’s strategy, as I understand it, to add Plex to what they’re already doing with PTC. And I don’t have any issue with that whatsoever because I think it’s complimentary and like I said, maybe even some upside opportunities. I just noted that we’re going to be sharing some mindshare with Rockwell, who now has kind of another child in the family, let’s say, that’s going to need some attention too. So I don’t think it’s going to materially change our partnership.

Got it. Thanks. Thanks for the insight there, Jim.

And your next question will come from Blair Abernethy with Rosenblatt Securities.

Thanks. Hi, guys, Jim, nice quarter guys. Just want to dig in a little more on Arena, and now that you've ordered for 7ish months. Well, how are you thinking about the go-to-market there for the team? And as vis-à-vis Onshape's pipeline. Are you working those two in parallel, are they coming together? What sort of your thoughts there as we kind of move through into next year?

Okay, great question. So first of all, we're very pleased with the performance of Arena; it has, in fact, accelerated since the acquisition. Now, there are several things we're doing that I feel like aren't fully in the game yet. One of them is a link to Onshape. And in fact, we've built some technical integration between the two products, which is easy to do because they're both SaaS based. That technical integration has generated some rave reviews from customers. And if you think about it, any customer who wants SaaS for PLM, they have the religion, and they really want SaaS for everything, including CAD, and vice versa. So we do think there'll be some cross-selling there. That benefit might accrue more to Onshape in the near term because Arena accounts tend to be a little bigger, like wanting to see CAD accounts that might not need PLM. But Arena accounts could generate a fair number of KNCs, 15 or more. So I think there'll be some benefit in both directions; it might help Onshape first, but then the thing we can really do for Arena is to globalize the sales force because Arena really is a U.S.-based business, with a tiny bit of business in Europe, and essentially none in Asia other than sometimes an American company might have some users there, but they're not Asian companies. So we PTC, of course, are much more globally balanced and we have the capabilities to help them kind of spread their operation around the world pretty quickly. And that's underway and as I mentioned, we opened the European sales operation. By the way, Arena and Onshape both have basically inside sales go-to-market operations - they don't have sales reps living in all the different countries around the world next to the customers and so forth. So I think we're going to be able to generate some acceleration for Arena to even higher levels next year. But we still need to plan all that out. But we certainly have something to work with.

Great, thank you.

And your next question will come from Adam Borg with Stifel. Your line is open.

Great. And thanks so much for taking the question. Maybe just first on the IoT business, can you talk a little bit about there being a hangover? Just curious if you could comment a little bit more about the pipeline as you head into the important fourth quarter?

I believe that the growth rate of any ARR stream at PTC depends on several factors, including bookings, churn, start dates, backlog, and price increases. The IoT segment has faced challenges in terms of deal sizes for new bookings and a softer backlog, now referred to as deferred ARR. However, when we examine the pipeline and the forecast, we feel quite confident and optimistic. I anticipate that we will finish the year strongly, based on what we see in the pipeline. We are in a better position for the upcoming year. Bookings are up year-over-year, but they have not yet returned to our desired levels, primarily due to deal size rather than the number of transactions.

Super helpful. And maybe just as a quick follow-up, you talked to in earlier question about replatforming efforts in Creo and Windchill and obviously it’s a non-trivial undertaking. So just curious kind of how that's going and what percent of your R&D efforts are really focused on replatforming today and how that should evolve? Thanks, again.

Yeah, well, this is not going to be a big-bang approach; it’s going to be kind of a systematic module-by-module approach, and then in the end, we'll have it all replatformed. But if you look at what we did with the generative design extension, that's a good model to explain what we're trying to do. And that is, we want to be able to take key subsystems from Creo, Windchill in particular, and build them on Atlas, and deliver better value, more capabilities, and a better cost profile to customers through SaaS, and then take another module. And so a customer might incrementally buy more and more SaaS from us over time, and we envision this taking a few years. And then at some point, just flip the switch and say, I'll just take it all the SaaS. So again, don't think of it as Big Bang; think of it as incremental. Yes, it's a big development effort. The good news is, we're not trying to invent the platform, we're replatforming onto, that platform has been under development for seven or eight years for the Onshape guys, that's Atlas, and it's a fantastic platform, I mean, really great. So I feel like time will tell, but in the end, with Onshape, we're going to get a really great SaaS-based CAD system, but we're actually probably going to get something even bigger, which is the singular platform that powers PTC's next generation of software that's going to breathe another decade or so of growth into our Creo and Windchill product lines.

Excellent. Thanks so much.

Your next question will come from Matt Hedberg with RBC Capital.

Great, thanks, guys. This is Matt Swanson on for Matt. So Jim, really appreciated the commentary around the secular tailwinds towards digital transformation. But when we're starting to think about your customers, as they're presumably returning to on-premise, have you seen any changes in conversations around SaaS more broadly, and I guess, thinking more about, like, what's driving your customers towards that, especially from that enterprise segment, so that might not be a good fit for Arena or Onshape? What those customers are kind of doing right now as maybe a long-term plan as they watch what you're developing on Arena?

Yes, Matt, that's a great question. We've conducted an interesting survey with our Creo and Windchill customers to assess their interest in SaaS, and we've seen a significant increase in receptivity compared to last year. It has shifted from a minority to a strong majority who are expressing a desire for SaaS. It's important to note that Creo and Windchill are very established products. While customers want SaaS, they are hesitant to switch because changing CAD systems can be complex, especially for large users with extensive data history. If they could transition to SaaS within Creo or Windchill, that would be fantastic. The desire for SaaS is largely driven by the need for a mobile workforce and hybrid work strategies. If CAD software runs on a large desktop in the office, it poses challenges for remote work, such as needing another desktop at home and dealing with file transfers. It would be much easier if all data were stored in the cloud. For example, during the initial COVID shutdowns, Windchill continued to function well because it is web-based, allowing users to access it from any device. In contrast, Creo operates as a fat client executable reliant on multiple installed modules integrated with other software, making it challenging to replicate that setup at home. Many users resorted to virtual desktop infrastructure, logging into their work computers from home, but this often resulted in poor performance for CAD work, which relies on high graphics optimization. Users want more flexibility, the ability to work from anywhere, and they are looking for cost savings as well. They are eager to eliminate the need for system administrators and servers, which can incur significant costs. They prefer to pay based on the value received from the software rather than for maintaining infrastructure. Additionally, they want real-time collaboration capabilities, a feature lacking in traditional CAD systems that rely on check-in and check-out processes. With SaaS, they can work on the same file simultaneously, which is not possible with current systems. Ultimately, Creo and Windchill customers are looking for the advantages offered by platforms like Onshape and Arena without having to switch from their current products, and that is our goal in meeting their needs.

Yes, that makes a ton of sense. It's a really compelling value proposition. If I can add one more on digital transformation. You mentioned PLM as kind of part of that, of that growth group there. Can you talk a little bit about the progress and moving deeper into customers with PLM, kind of beyond those traditional use cases? It's something we've been talking about for a long time and I think it's always seemed really interesting.

Yes, I think what's really come to light, it always was true, but it's really much more appreciated now, is that PLM is the system of record for products. So PLM, in an industrial company, it's absolutely as important as your CRM system, which is the system of record for your customers, or your HR system for employees, or whatever. So, when companies think I really want these processes to be digitized and mobile, you become mobile and global and in all that. You realize, we need a reliable source of product data that everybody in engineering, manufacturing, service, marketing, sales, whatever can transact against. So we need one single system and we all need access to it. And so we're starting to hear that more and more that it's not about making the engineers more efficient, which was kind of the first generation of PLM. This is more about making sure that everybody across the company has access to the right product data because everybody is making decisions about products, pricing them, selling them, supporting them, manufacturing them, and we need to have accurate data and it needs to be two clicks away. And that's what PLM is, now being recognized as the system of record for products and industrial companies can't get very far down the journey of digital transformation without saying, hey, shouldn't we have a system of record for our products? I mean, honestly, they are product companies. So I think PLM is really emerging into something different. A quick example would be that maybe the contract we won, it's about product support; it's about everybody supporting ships, having access to data of all ships in the systems they contain, support data. And so we're using PLM concepts to support the operation of the ship, not the engineering of manufacturing, but actually, the operation of ships that were engineered and manufactured years ago. And it's kind of a good example of digital transformation versus engineering productivity.

Thanks for the time, guys.

Thank you.

Your next question will come from Jay Vleeschhouwer with Griffin Securities. Your line is open.

Thank you. Good evening. Jim, at your partner conference last week, aside from the sessions on sales programs and plans and the like, it was a very interesting roadmap session, which is the thing I want to ask about. It noted that as part of your Creo strategy, you have what was called five dimensions and for Onshape, six dimensions to the strategy plus various dimensions for the strategy for PLM of course. The question I have about the Creo and Onshape strategies is that's a fairly good list of executables. So how do you think about the ones that are perhaps most important on those lists for you to achieve, or perhaps the most difficult to achieve, which aren't necessarily the same thing? And then secondly, you referred to Microsoft a number of times; they're on the cusp of launching their manufacturing cloud. And I'm wondering how you're thinking about the opportunity for you in terms of drafting along with what they do with manufacturing cloud?

Okay, so first on the priorities, Jay, I don't have those lists in front of me, and I hate that off the top of my head; try to represent them all back to everybody. But what you should think of is, there are large engineering teams behind these products. In the case of Creo, 400 plus people working on it. In the case of Onshape, not near that many because it's a smaller, tighter product, yet younger product. But there's room with the level of resources we have in these products to have four or five priorities; that's down from 20 or 30 that they would otherwise do, they're trying to narrow down and focus on the key ones. So I think we have the capacity to execute four or five initiatives at a time in both of these products. We can’t execute 10 or 20, but certainly four or five big ones. And I guess you were wearing your hat as a partner that day on that conference. But we're just trying to share with our partners where we're going, what we think is important, and frankly, where we think the money is. So that's what's going on there. With respect to Microsoft and their manufacturing cloud. There's a lot of conversations going on between PTC and Microsoft about how to align PTC with that manufacturing cloud; they want us to, we want to, it's just a question now of figuring out what to do to make that happen. The fact that our former Chief Strategy Officer, Kathleen Mitford, just went over there is actually quite helpful because Kathleen and I are quite close and we've had some conversations since she's gone over there. And she's now able to help me, let’s say, coach me, and I'm building culture to make the company’s better aligned together. So there's a lot of good stuff happening with Microsoft; again, three Partner of the Year awards. I think the manufacturing cloud will be good for us. But there's some work to figure out, once they put it out there, how do we tightly align with it.

Thank you, Jim.

And that is all for our question-and-answer session for today. I will now hand it back over to Emily Walt for the closing comments.

Thanks, Peter. I'd like to thank everyone for joining us on the call today. We'll be participating in a number of virtual investor events this quarter and you can find all the details on our investor website. We look forward to seeing you on the circuit in the coming months. And again, thank you for your interest in PTC and have a great evening.

Thanks, everybody.

Thank you. Have a good day.

This concludes today's conference call. Thank you for participating. You may now disconnect.