Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PTC Business Model Review Conference Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the call will be open for questions. I would now like to turn the call over to Tim Fox, PTC's Senior Vice President of Investor Relations.
Please go ahead.
Thank you, Ted. Good afternoon, everyone, and thank you for joining PTC's conference call to review our business model and to revisit the growth scenarios we shared with you at our November 2019 investor meeting. On the call today with me is Christian Cavalcier, Chief Financial Officer. Before we get started, please note that today's comments, including forward looking statements including statements regarding future financial expectations. 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 most recent annual report on Form 10 ks and quarterly reports on Form 10 Q and filings made with the SEC from time to time. As a reminder, we'll be referring to operating measures today during the call. Discussion of our operating measures are included in our presentation and related Form 8 ks filed this afternoon. Lastly, references to growth rates will be in constant currency unless otherwise noted. And with that, I'd like to turn the call over to Christian.
Great. Thanks, Tim, and thanks, everybody, for hopping on a call here with us. So this Thursday, we'll be participating virtually in the Berenberg Design Conference and expect that there will be some questions on the current demand environment. So sharing this content beforehand gives investors time to review the materials. To accompany today's discussion, we've also posted a slide deck that's available on our Investor Relations website.
And for those of you with the presentation, please turn to Slide 3. In light of recent developments related to the global macro environment, we would like to share some observations about the current business climate and we'd also like to review key aspects of our business model and new reporting framework, which has some nuances to it given that we do not have ratable revenue recognition under ASC 606 for all lines of business despite having transitioned to a subscription business model.
As you
know, the key metrics we pointed to at our November Investor Day were ARR and free cash flow. And while ARR is a common term in the industry and generally means annually recurring revenue, often calculated as the prior quarter's recurring revenue times 4, we believe our ARR definition is a cleaner representation of customer commitments. So just to remind everybody of our definition of ARR, please refer to Slide 4. And at that November investor event, we also went through a fairly detailed description of some of the nuances of this metric, which is really the total annual contract value or ACV of our active book of recurring business at the end of any given period. As such, we think there are a few key factors to keep in mind while evaluating this metric.
1st is timing. We take the entire recurring ACV value of a contract into our ARR on the start date of the contract. So whether a contract starts or renews on the last day of 1 quarter or the 1st day of the next quarter, it matters from an ARR reporting perspective in a way that it wouldn't matter if we were looking at ratable revenue recognition. From an economic perspective, we think it doesn't matter, meaning we bill the ACV value in the same way that we would if we had ratable revenue recognition. The second factor is backlog.
This is adjacent to the timing comment. Again, we take the entire ACV value of a contract into our ARR on the start date of the contract. So if we book a deal in the last week of the quarter, but the term of the subscription doesn't start for another 10 days, we will not count the ACV value in ARR until the start date. This creates backlog. The backlog can come from deals booked in 1 quarter with a start date in a future quarter or backlog can come from multiyear committed ramp deals, meaning a customer agrees to a multiyear deal with volumes that scale up over time.
In the case of ramp deals, the ACV that goes into ARR is only the amount that is currently active and billed. Any future committed volumes will be added to ARR when that portion of the ramp starts. I highlight these two points because they also impact how we communicate with you, our shareholders and analysts. And while we strive to be best in class when it comes to disclosure about PTC's performance and outlook, we, like other subscription businesses, did not disclose new bookings or backlog on a quarterly basis, but rather focus on the total book of recurring business or ARR. Given the timing element described above, we moved to annual guidance at the beginning of this fiscal year when we moved to this new reporting framework as we believe this is a more meaningful way to gauge the performance of the business.
That all said, we appreciate the reporting framework we are using can create some confusion if not properly understood. At the end of the day, PTC is now for all intents and purposes a subscription business. And as such, we believe it has a much more resilient and less volatile business model than when it was a perpetual model. The purpose of this call is to help illustrate how this model and reporting framework is expected to behave in different scenarios. So to do this, we're going to leverage a few of the growth scenarios we shared at our November Investor Day, but instead apply those scenario assumptions to fiscal 2020.
So turning to Slide 5, let me begin by providing some color on Q2 2020. First, I'll remind you that we are in the final weeks of our 2nd fiscal quarter. And as you are aware, in the enterprise software market, quarters are generally back end loaded. And even though we are seeing some signs of softness in smaller pockets of our business, most notably airline and retail space, quarter to date, we have not observed a material disruption to our business due to the macro conditions. In fact, if we sold no additional business, new business in Q2, we'd be approaching low double digit year over year ARR growth in constant currency, and we still have 3 weeks left of business in the pipeline to close.
This is obviously not our plan, nor should it be taken as explicit guidance, but we thought it would be helpful to help frame Q2 ARR growth in the context of some conservative assumptions. Next, it's important to remember that FX impacts the total base of ARR at a point in time and is not an income statement rate. FX rates have been very volatile recently and actually at current rates, FX would be about 100 basis point tailwind to ARR growth on a year over year basis. So turning to Slide 7. Here, I would like to review the scenarios that we shared with you at our investor meeting last November.
Recall, we laid out 3 scenarios with FY 'twenty four ARR growth ranging from 13% to 17%, driven by different new ACV growth assumptions for our growth businesses. We also shared a more conservative 12% ARR growth scenario modeled after PTC's business performance in 2,009. For that scenario, we explicitly chose to model the 2,009 REDUX in 2022 so as not to imply we knew anything about the future macro environment. Thinking through these scenarios, the guidance that we provided at the beginning of this fiscal year is effectively the market scenario. Given the backdrop of the current global macro environment, which is still very fluid, we thought it would be helpful to apply the downside scenario assumptions to fiscal 2020 to illustrate the expected durability of our subscription business model even if we encounter a weaker demand environment and importantly to illustrate a nuance of this modeling exercise when applied to the near term, most notably the impact of backlog.
Again, let me stress, we are not trying to make a call on the macros here, way too early, and we're not affirming or updating our fiscal 2020 guidance. This is simply a refresher on the mechanics of our model to provide additional color on the potential near term trajectory of our business. So turning to Slide 8. In this scenario, The Pessimist, we used the same growth assumptions that we shared you in November for our various product groups and applied them to the remainder of Q2 through Q4 of fiscal 2020. We assume new ACV growth booked is flat in our core product group.
New ACV booked in our growth product group grows at half the market growth rate and new ACV booked in our focused solutions group declined 5% year over year. We also assumed no material change to churn. Even with these conservative new ACV assumptions, because of business already booked in Q1 and Q2 to date and our fiscal 2020 backlog, the resulting the result is ARR of approximately $1,250,000,000 or 12% year over year constant currency growth. Turning to Slide 9. In this more conservative scenario, the 2,009 REDUX, we again use the same assumptions that we shared with you in November, which called for a 30% decline in new ACV booked across all product groups and applied that to the remainder of Q2 through Q4 for fiscal 2020.
We also assumed no material change in churn rates. These assumptions are consistent with the actual business performance in 2,009. So even with a 30% decline in new ACV booked, because of business already booked in Q1 and Q2 to date and our fiscal 2020 backlog, we would expect to deliver approximately $1,230,000,000 of ARR or 10% growth year over year in fiscal 2020 on a constant currency basis. So to wrap up, I think you will agree we've built a strong and durable business model, one that is much better positioned to weather near term macro disruptions. Again, it's too early to know if the environment is going to materially impact customer buying behavior, but even under some pretty conservative assumptions given the strong position we have in our markets and visibility from backlog, we still have a line of sight to double digit constant currency ARR growth in fiscal 2020.
So with that, I'll turn the call over to the operator, and we can begin any Q and A if
there is First question in the queue is from Joe Derwent from Baird. Your line is now open.
Hi, Joe. Good afternoon. I wanted to maybe touch on the reseller channel. It came up on the last call as a source of strength. And as and I appreciate how uncertain everything is now, but there's maybe been a little more concern that the resellers are going to be more disrupted by travel restrictions.
So I'm wondering, have you seen that show up? Or was some of the strength you called out on the last quarter, is that continuing to be the case?
Well, for the first couple of months of this quarter, I think business had been progressing as usual. As I mentioned in the comments, we have seen in certain pockets impact. We've seen some meetings being postponed. But again, at this point, no notable material impact to the business performance quarter to date. Like I said, we still have 3 weeks to go.
And then yes, I certainly appreciate. And then just on the dynamics with your ARR and some of the visibility you've commented contributing to the step up in growth rates as we enter 3Q and 4Q. Is there any sort of learning, particularly even on the small areas of the business that are seeing like retail and travel? Is there any learning so far as customers have started to implement business continuity or maybe PTC's own business continuity has changed, whether some of the timing elements that you've been discussing in your ARR metric, could that potentially be pushed out as you see it given that things are still really fluid, but could that potentially be pushed out in terms of the timing you originally have planned for this year?
Well, I mean, here again, timing should always be a factor. I guess I would just remind everybody that the bulk of the business that we do is the renewals business, not the new business. And there are consequences for not renewing on time, right, which generally customers are leveraging the software and want to continue using it. So could we see some movement? I don't know if it's possible.
We'll find out in the next 3 weeks. And then of course on the ramp deals, I'm not sure if this is what you were getting at, but these are deals where customers are deploying and they are contractually committed to ramp at various points throughout their life cycle. And those roll in, again, throughout the rest of this year and in future years.
Okay, great. Thank you very much.
Thanks, Joe.
Next question is from Matthew Broome with Mizuho. Your line is now open.
Thanks very much. Hi, Christian. So I guess just in terms of your scenario analysis, do the free cash flow assumptions that you provided in November pretty much remain the same?
We're actually, you mean what over the LRP period?
Yes. I mean, just
We weren't trying to get into like a full blown LRP refresh here at this point. And we were just trying to make sure that people understood the dynamics of ARR, which for us effectively billings and not really rolling this out over a 5 year period at this point.
Okay. And just in terms of the softness that you've seen, have any products in particular been sort of most affected by that?
So and again, at this point, I think softness, let's just characterize this as some meetings being postponed, still TBD, whether or not that's going to actually impact the buying decision, just so that we're clear on that point. And then secondly, I think the answer would be right now, it depends on various geos and products. So certainly, there's a couple of the FSG products, right, retail, PLM, some service related stuff for airlines, as an example. But again, right now, we're talking more about behavioral changes as opposed to purchasing changes that we've seen to date.
Okay. That's helpful. Thank you.
Thank you, Matt.
Next question in the queue is from Jay Vleeschhouwer from Griffin Securities. Your line is now open.
Thanks. Good evening, Christian and Tim. First question has to do with any changes or decisions you may be thinking of operationally in terms of cost or expenses. The answer would seem to be no. You had a significant uptrend in the last few months in terms of your hiring plans, Open Rex for sales and R and D by GEO for America and Asia in particular.
As of this afternoon, just doing a quick spot check, it doesn't look as though that's changed. So you're not translating these observations about the business climate into any internal changes thus far as far as the hiring activity is concerned, if you could just comment on that. And then secondly, it's been some time since you disclosed your end market split in terms of percentage of revenue. But when you last did, the markets that you referred to on the call this afternoon were really no more than a high single digit percent of your business the retail and consumer segment that you used to report out? Is that perhaps the contribution still that you're seeing from those end markets?
Yes. Well, Jay, first of all, thank you for asking and answering both of your questions. But I think actually that you're spot on. Listen, as far as plans for hiring and staffing and even business continuity given the current macro environment, Obviously, we are watching intently what is happening, The safety of our employees, of our customers and health is a paramount importance to us. We're following CDC and WHO guidelines given the current environment and monitoring the situation.
As of yet, we actually still like I said, we haven't really seen any material disruption that would warrant any taking any action as it relates to doing anything else other than what we had anticipated doing, which is going out and building a great business and servicing our customers with great products. But obviously, we will continue to monitor the situation as it evolves. And in relation to your other question about industry breakouts, you answered that question as well.
Next question is from Adam Borg with Stifel.
Hey guys and thanks for taking the question. Just to build on Jay's last question, just given the move in oil prices, could you just remind us what your exposure is to the energy vertical? Thanks so much.
Yes, negligible.
Great. And maybe just as a quick follow-up, obviously professional services is a smaller but important part of the business to get customers live and it's a little bit over 10% of total revenue. Any of the disruptions that you're seeing, is anything related to that or getting your employees on customer sites or I'd love to hear anything more on that. Thanks so much.
Yes. As of right now, I would say that it's pretty much the same as we characterized for the rest of the business. We still have a lot of deployments happening, and I'm unaware of any major disruption due to not being able to get on-site.
Next question is from Saket Kalia from Barclays Capital. Your line is now open.
Hey Saket. Hey
guys. Thanks. Hey, Christian. Hey, Tim. Thanks for taking my questions here.
Thanks for hosting the call. Christian, maybe first question for you. Can you just talk about the IoT business a little bit with regards to the macro backdrop? I think in the past, some have maybe questioned the IoT businesses, secular growth versus cyclical, for example. Obviously, it's early to say with 3 weeks left to go into the quarter, but any light that
you can shed on that?
No, not really. I don't think again, it's definitely too early to say with 3 weeks left to go and really only the last week and a half being the major disturbance here in the force. So honestly, not much to comment.
Yes. No, fair point. Maybe the follow-up, just on the quarter. Can you just talk a little or not on the quarter, just a typical quarter. Can you talk about typical linearity in the quarter when it comes to new ACV?
And so far, I mean, excluding those couple of small verticals, is it fair to say that you're sort of seeing the quarter progress according to that typical linearity?
To date, our quarter seems to be progressed according to typical linearity.
Very helpful. Thanks guys.
Thank you.
Next question is from Tyler Radke with Citi. Your line is now open.
Hey, thanks a lot guys. Appreciate it. Christian, I wanted to ask you about some of the ramp deals. I know you made the comment that part of the ARR growth that you have this year is being driven by some of the ramp deals that are already contractually committed and will layer in. Is there any way to think about what that percentage of kind of the incremental ARR is being driven by ramp deals and deals that are contractually committed?
We're not really intending to get into starting to quantify and disclose backlog on a regular basis. I mean, I think it's fairly well implied in the outlook for this.
Okay. And then I noticed in the scenario analysis that you kind of use it as a baseline from the Investor Day. You weren't anticipating any changes in churn rate. I guess number 1, assuming the answer is no, but have you seen any changes in renewals? And I guess what gives you the confidence, especially if you're thinking about some of even if they're smaller end markets, but airlines that are under a lot of pressure right now.
What gives you confidence that kind of churn rates wouldn't change in the event of a downturn?
Yes, great. So quarter to date, we actually haven't seen any impact. And I think as most of you know, the window starts to close on when you can actually cancel or downgrade as you get towards the end of a quarter. So that's helpful from a nearer term visibility perspective. And then from a, I guess, more macro perspective, maybe the second part of your question, if we go back to 2,009, when there was another kind of large scale macro disruption, we didn't really see a change in our churn rates at that time.
What we did see was a pretty significant 30 plus percent drop in new business that was booked and related maintenance, which we would have sold at the time, come in. But in terms of actual churn, we didn't really see an impact at that time. And again, I think it goes back to the sticky nature of the software, the value that customers get from it. And so at this point, we didn't want to stray too far from the assumptions that we laid out in that Investor Day conference, which we think are reasonable assumptions. We're not trying to create a new model here.
We're just trying to apply that to the 2020 and help illustrate some of the new ones.
Thank you.
Thank you.
Next question is from Ken Wong, Guggenheim Partners. Your line is now open.
Hey, Ken. Great. Thanks, Christian. Thanks, Tim, for taking the time. Just a quick question on your geographic exposure.
Just wondering if you guys are seeing any pockets of softness in some of the various regions out there. Obviously, some are more impacted than others by the coronavirus.
Yes. So again, when we get back to the comments earlier about where we're seeing, big pockets of softness, we call it softness of activity or meeting activity, and that's where we're seeing it in places like Italy now or in China. Although that said, in China, we're still booking business, booking business this week, booking business last week. So it hasn't ground to a complete halt, but there are pockets of softness. I don't really know how else to say it.
Got it. And then just more of a housekeeping question, but just for clarity in terms of guidance, I wasn't totally certain whether or not this was not reaffirming guidance or just not commenting on guidance. Can you just clarify how we should be thinking about your outlook?
No, we're not commenting on it. This was really meant to be more of a educational session, if you will, on kind of the nuances of the model and reporting framework and how it would apply under to previously disclosed scenarios when applied to a current fiscal year. And really, the nuance there is around backlog. And so we wanted to try to help people understand what that impact looked like because it's not really as simple as take whatever your assumption for new business is and reduce it by whatever 30% in the 2,009 reduct scenario. It's actually significantly different
than that.
Got it.
And if I could just sneak in one kind of piggybacking on Saket's question on linearity, just any rough sense in terms of how much of the business does typically come in the final 3 weeks for a typical Q2?
So not for nothing, but it's a complex question because there is renewals business that actually still needs to come in. There is new business that needs to come in. Some of that new business is actually new business is going to go into backlog. Some of it's going to be new business that starts in this quarter. So we're getting into a again, part of the reason that we focus on total ARR and we're focusing on the year and that's where we are.
Got it. Thanks guys.
Thanks guys. Next
question is from Sterling Auty with JPMorgan. Your line is now open.
Thanks for doing this. I'd be curious if you could provide some comments. You've mentioned a couple of different things in terms of meetings postponed, etcetera. I think a lot of investors are just don't have a good feeling for the sales process. So how much are you still able to do remotely?
How much of it is electronically contracted, etcetera? Because I think there's some investors that still have just the perception in mind that salesperson has to be on-site with this huge long paper document to get it signed. So how much of the business, could you actually just go ahead in normal course of action as long as they're willing to spend, you could just contract without having to set foot in a customer's facility?
Well, if you could submit your question via the simile machine, we might be able to just kidding me. So here, there's no doubt that on the one hand, we still have a direct largely direct sales model. And even with resellers, it's a higher touch model and it's an enterprise sales model. That said, we do have remote capabilities, which are leveraged, more so in different parts of the world, both for sales, for training, even for implementation, that can all be done remotely, contracting can be done remotely. But practically speaking, we still do see on-site interactions as a piece of the equation.
Although given the current environment, customers and us, we're all trying to get crafty and figure out how we do that otherwise.
Final question in the queue is from Yoon Kim with Rosenblatt Securities. Your line is now open.
Thanks, Christian and Tim. Hey, thanks, Christian and Tim for setting up the call. So first of all, quick, since we're asking the vertical mix, remind us how big is your industrial verticals today?
It's about 30%.
Okay. And that hasn't really changed that much over the last several years, right?
No, it has not.
Okay, great. And then just so today, your ARR growth, I believe, is more sensitive around your churn rate than your new CV growth rate. Would that sensitivity around the ARR growth skew more towards your new ACV growth and less on the churn rate as we approach fiscal year before?
Sorry, what's the
Yes. So probably a better way to answer that is that the overall impact on the ARR growth rate coming from the improvement in the churn rate, would that impact will be less of an issue or less of a tailwind as we go to fiscal 2024 versus today? Well, can I just get the other way? So in your market growth scenario that you laid out, the assumption behind the current year fiscal year guidance, you are assuming a modest 150 basis point improvement in your churn rate over the next 4.5 years. What would happen if there's no churn rate improvement, but everything else is the same?
Yes. So you're again so Tim, you're trying to answer a different question, which is what the fiscal 'twenty four market growth outlook would be if we didn't have an improvement in churn. That might be something we can talk about offline, but it's that's not actually what we intended to do today. We were just trying to say assuming churn is about flat with fiscal 'nineteen, in that 0.5% to 8% range, but we had the same type of downdraft in bookings, what would fiscal 'twenty look like. So it wasn't tied to the fiscal 'twenty four numbers
at all. We're not trying to recast an LRP here.
All right.
So in your guidance for this year, which is under the market growth scenario, were you expecting any improvement in the churn rate?
Modest.
Okay, got it. That's it for me. Thank you so much.
Thank you. Thanks, Eun.
And I'd like to turn the call back over to Mr. Tim Fox.
Thanks, Ted. So again, thank you, everybody, for joining us on the call today. As Christian mentioned, we'll be participating virtually at the Berenberg Design Conference this Thursday, if you care to join. Otherwise, we'll look forward to updating you on our Q2 call in April. Thanks again for your interest in PTC, and have a great evening.
Thank you.
This concludes today's call. Thank you for your participation. You may disconnect at this time.