Earnings Call Transcript - PTC Q1 2023

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the PTC 2023 First 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 Matt Shimao, PTC's Head of Investor Relations. Please go ahead.

Matt Shimao, Head of Investor Relations

Good afternoon. Thank you, Rob and welcome to PTC's first quarter 2023 conference call. On the call today are Jim Heppelmann, Chief Executive Officer; Kristian Talvitie, Chief Financial Officer; and Mike DiTullio, President of our Digital Thread Group. 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 be making forward-looking statements including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's Annual Report on Form 10-K, Form 10-Q and other filings with the US Securities and Exchange Commission as well as in today's press release. The forward-looking statements, including guidance provided during this call, are valid only as of today's date, February 1, 2023 and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website. With that, I'd like to turn the call over to PTC's Chief Executive Officer, Jim Heppelmann.

Jim Heppelmann, CEO

Thanks, Matt. Good afternoon, everyone and thank you for joining us. Turning to slide 4. I'm pleased to report that despite seeing some incremental macro softness, PTC delivered a solid first quarter to kick off fiscal 2023. On the top-line metric of ARR we came in at $1.603 billion, which was above the high end of our range and up more than 15% year-over-year. The strength was broad-based across all product groups and geographies. The strong Q1 ARR results put the company in a position to narrow our original 10% to 14% full year ARR guidance to 11% to 14% as we feel that the 10% outcome has become increasingly implausible with a solid Q1 behind us. Switching to our bottom-line metric of free cash flow we delivered $172 million ahead of our guidance and up 28% year-over-year. We raised our free cash flow guidance for the full year by $15 million. Currency had little impact to free cash flow in Q1, but it is expected to be incrementally helpful as the year progresses. On the subject of currency, I'll remind you that Kristian will cover the ongoing effects of foreign exchange fluctuations later in the call. Shortly after our first quarter close, we completed the acquisition of ServiceMax. ServiceMax is not included in the Q1 results we reported though we did incur some acquisition-related costs that were a headwind to our nevertheless strong free cash flow results in Q1. With the deal now closed, ServiceMax will be included in our guidance going forward. To recap the highlights of this business as now part of PTC, ServiceMax is used to manage the service processes for high-value long life cycle products. This has always been a sweet spot for PTC and we have many customers matching this profile. The strategic fit with ServiceMax is excellent and we're excited about the synergies we can generate by cross-selling from engineering to service and vice versa and also cross-selling between our various SLM offerings within the service domain. The financial fit is excellent too as the transaction is expected to be accretive to PTC's growth rate as well as the PTC's cash flow and this drove part of today's guidance raises. ServiceMax also increases PTC's total addressable market. The ServiceMax business has been growing in the mid-teens which is a few points faster than the market, but we see potential for the business to accelerate to high-teens growth over time as synergistic cross-sell opportunities are realized. Given the elevated focus on profitability that investors all share in today's market, I want to reiterate the margin expansion program that PTC management has been driving. The organizational realignment we did at the end of fiscal 2021 and the resource rebalancing work we did during fiscal 2022 have created an organizational model for PTC that's both highly efficient and fully sustainable. The actions we took proved prescient, as we're now well-positioned for a macro downturn. While many notable tech companies are announcing layoffs to come to terms with bloated cost structures, thanks to our proactive actions, we're entering this period of uncertainty with a very lean cost structure and we do not anticipate any need for layoffs or restructuring. In Q1, non-GAAP operating margin expanded to 36% compared to 35% a year ago. At the midpoint of our ARR guidance range, based on actions already taken, we continue to expect this operating efficiency to expand by another approximately 450 basis points in fiscal 2023, following the 300 basis point improvement we delivered last year. The significant operating efficiency improvement when layered on top of double-digit ARR growth is what drove the strong Q1 free cash flow result and is what will drive the 38% free cash flow growth we're guiding to for fiscal 2023.

Kristian Talvitie, CFO

Thanks, Jim, and good afternoon, everyone. 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. In Q1 2023 our constant currency ARR was $1.6 billion, up 15% year-over-year and exceeded guidance. Our SaaS businesses saw continued solid ARR growth in Q1 as well. The decline in professional services revenue is consistent with our strategy to transition some of our professional services talent and revenue to DxP our partner for Windchill+ lift-and-shift projects. As we've discussed previously, revenue is impacted by ASC 606, so we do not believe that revenue is the best indicator of our underlying business performance, but we'd rather guide you to ARR as the best metric to understand our top line performance and cash generation. Our free cash flow performance in Q1 was driven by strong execution based on a foundation of solid collections and cost discipline. Moving forward, we took out a $500 million term loan and increased the size of our revolving credit facility from $1 billion to $1.25 billion. The net of new borrowings and debt payoff in Q2, should leave us with $1 billion in high-yield notes, the $500 million term loan and approximately $450 million drawn on the revolver at the end of the quarter. The deferred payment for the ServiceMax transaction, due in October 2023 of $650 million. We expect our debt-to-EBITDA ratio to be approximately 3.4 times by the end of Q2. For fiscal 2023, we raised our guidance. We now expect cash from operations of approximately $595 million, up 37%; and free cash flow of approximately $575 million up approximately 38%. We expect our diluted share count to increase by a little under, one million shares. We expect to have substantially reduced our debt by the end of fiscal 2024.

Matt Hedberg, Analyst

Great, guys. Thanks for taking my question. Congrats on the strong results guys. Jim, you guys are pushing the envelope for SaaS beyond many peers that we talk to which is obviously, great. I guess a two-point question, do you think that's resulted in sort of a larger pipeline coverage ratio than maybe a year ago? And with your Plus strategy, do you think the opportunity for PLM and CAD replacements could accelerate as well?

Jim Heppelmann, CEO

Yes. Well, certainly the Plus strategy and SaaS here at PTC is helpful to the pipeline. When deals come in at SaaS, they come in twice the size as they would have been had they been on-premise. The interest level is quite high. I think if you come to LiveWorx, you're going to see lots of customers are going to come just to learn about SaaS because they're interested. I do think that some of our competitors are laggards with SaaS or they're doing SaaS in a pretty hokey way. For example, we have a French competitor, who is trying to become a hyperscaler. I think a lot of companies are going to say, 'I need to go to SaaS. If my vendor doesn't have a good story, I should shop around.' At PTC, we have mature proven products like Creo and Windchill that will be available in a true SaaS form. On the other hand, if you want to go full bore, clean slate, right from the start pure SaaS, we have Onshape and Arena, which are the most SaaS-like products in our industry. So I do think we'll get some amount of people moving to SaaS and switching vendors.

Matt Broome, Analyst

Thanks very much. Hi, Jim and Kristian. I guess firstly just how is ThingWorx growth during the quarter? Has it been impacted at all by the reallocation of resources there?

Jim Heppelmann, CEO

ThingWorx growth was pretty steady. There's no doubt that reallocation of resources isn't actually helpful just to standalone ThingWorx growth, but I think it's actually been quite helpful to PTC growth and very helpful to PTC cash flow. It’s probably not helpful to ThingWorx but very helpful to PTC altogether.

Tyler Radke, Analyst

Hey, hey, good evening, Jim. Good evening, Kristian. So a question just on the bookings commentary. So I think last quarter your base case was for flattish year-over-year bookings for the full year to kind of get to that 12% ARR growth obviously, pre-ServiceMax. When you say you saw bookings weaken, did bookings go negative during the quarter?

Jim Heppelmann, CEO

What happened in the quarter didn't align to any of our scenarios because bookings was a little softer and churn frankly was shockingly good. So we decided to quantify it, as 0.5 percentage point of slowdown. We had $8 million less in bookings than what it took to maintain a 16% growth rate, but $3 million more in bookings than what it took to hit the high end of the guidance range. The forecast looks good; the real question will be, post rates, does the business come in or not. Q1 while it was a little bit softer than the previous two quarters, actually it was not a bad quarter.

Saket Kalia, Analyst

Thanks for taking my question. I would like to delve deeper into the contrast between the softer bookings and the lower churn. Regarding the softer bookings, are those deals that are being delayed, still in the pipeline, or do you believe they will be postponed indefinitely?

Jim Heppelmann, CEO

I think it's mostly push. I mean, there’s no competitive dynamics, and generally, it's not being canceled because companies do need this technology. They're just delaying a little bit. If a company is hiring a lot of engineers, well, now they need to go back and buy more CAD and PLM seats for those engineers. There probably is a slowdown in hiring, which is slowing down expansions, but nothing structural happening.

Jason Celino, Analyst

Hey, Jim, hey, Kristian. Thanks for fitting me in. Maybe just a quick one. We've been hearing different customers and organizations trying to use PLM more within their organizations. When we think about the expansion, is it expanding to different departments and teams, or is product development just becoming a more critical role within an organization? I guess, how would you kind of quantify this secular dynamic?

Jim Heppelmann, CEO

PLM is moving from a nice-to-have to a must-have. This transformation is driving proliferation of PLM out from the engineering department into purchasing, manufacturing, and now into service technicians. I think that's what's happening is it's becoming a true enterprise system versus a departmental system while at the same time it's becoming a must-have rather than a nice-to-have.

Operator, Operator

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