All right, good morning, everybody. Welcome to day three of the Oppenheimer Virtual Tech Conference. I'm Ken Wong, Software Analyst here at Oppenheimer. Very happy to have with me Kristian Talvitie, EVP and Chief Financial Officer at PTC. Kristian, good morning. Welcome.
Ken, thanks for having us. We appreciate it.
Yep, always happy to engage. Look, I think maybe to start off, touching on the most recent quarter, I don't want to call it an inflection, but I think not only me, but a lot of your shareholders felt that that was probably the most positive you guys have sounded in quite some time. Maybe just compare and contrast for us the start of the year to where we are now and kind of how that positions you guys for the close of the year.
Yeah, sure. Good question, Ken. Just before I get started, I know my General Counsel would be very angry at me if I did not point out, direct folks to our safe harbor language and our risk factors that are available in our press releases and on file, and forms 10-Q and 10-K on file with the SEC. I would definitely encourage everybody to review those. Now, back to your original question, the quarter certainly started off in an interesting way with Liberation Day. We were still in the, we'll call it, maelstrom of uncertainty in the beginning of the quarter. By the time we had the conference call, customers did not really have definitive outlooks on what was going to happen as a result of Liberation Day.
There was incremental caution for sure in their language, not caution around, hey, do we need the software, do we need to undergo digital transformation. It was really more around, hey, nobody really knows what's going on. It may be that once we move towards deal closure, this is going to get delayed or downsized by the powers that be at those respective customers, just given the overall uncertainty. I think that's what was reflected in the revised guidance that we gave last quarter. Also out of caution, we tried to model in a downside scenario of, what if things started to look more like the GFC environment or the COVID environment, what might that look like for PTC? That's what led to the kind of downside scenario of that guidance. As we progressed through the quarter, things seemed to stabilize much more.
I think that was obviously borne out in the results. We came in near the high end of the guidance range, certainly for net new ARR, came in for the high end of the guidance range. I think those kind of worst-case fears that we all might have had seemed to have alleviated. I think that's reflected in our current guidance. We took the low end up on the range, essentially taking that kind of scenario off the table for the year, now that we're down to one quarter left to go. As a reminder, we're on a September 30 year end. That's where we are. I guess just the last point on this, we've talked a lot over the past two to three years now about kind of the challenging macro environment. I would say that I'm not sure that the macro environment has really changed.
It just didn't get materially worse. I'm not sure it actually really got better, but it just did not get materially worse. I think that's what was reflected in the results in the guidance.
Understood. Arguably still, you know, hopefully something, you know, something better to come down the line. For now, just kind of stably bad seems to be how you're framing what's baked in.
Yeah, stably consistent with the same kind of challenging environment we've seen for the last number of years.
Perfect. As we think about the close of the year, how should we frame what needs to go right for you guys to be at the high end of that ARR range? Can we maintain in this stable environment and you guys execute to that number, or does that require some help from macro or go-to-market or whatever it might be?
Yeah, I think we need to execute on the opportunities we have. I think we feel very good about the pipeline that we have going into Q4. I think Neil commented on that on our most recent earnings call. I think we feel good about the opportunity and we need to execute on that. On top of that, I think the biggest variables going into where we end up in the range really probably comes down more to deal structure. Do we see more in-quarter starts or do we see more ramp deal type deals that get structured here in this environment? That's what we're working through this quarter with all the deals in play.
Got it. Maybe shifting gears a little bit, you guys made a big shift on the go-to-market when we entered the year, focused more on your core verticals. Maybe just a quick update, kind of where are we on that process? Are you done with all the changes and it's now just a matter of executing through those changes? Have you seen any data points you can share in terms of the progress that we're seeing there?
Yeah, and so just as a quick refresher, remembering that a lot of the planning that went into this happened in our Q4 of last year and our fiscal first quarter of this year. The actual changes were really implemented in the beginning of our fiscal second quarter. Those changes, when I'm talking, we're talking about those changes there, I'm really talking about getting the go-to-market organization aligned around the main verticals that we serve. Go-to-market isn't just sales. It means also marketing as well as customer success, folks in the customer success organization, pre-sales, post-sales, folks who are helping implement the software at our customers, or with our customers, getting those aligned around those core verticals. On the one hand, I would, and so what that involved was some, we'll call it some account reshuffling.
As you also might recall, there were certain positions that were eliminated, some of those in each of the kind of go-to-market organizations. Then there's been hiring back on the sales side. It's hiring back into the right areas. On the customer success side, it's making sure that we're hiring more technical resources, and so on. That shuffling was around account coverage, if you will, and territory optimization. On the one hand, I would say that yes, that part of the change is done. On the other hand, I would say territory optimization is an ongoing thing that needs to continue to happen in the future. I think we're just at a much better baseline than we've been at historically to continue that journey.
The other parts of the transformation, which include making sure that we have the right messaging to go with each of these verticals, which includes some of the cultural changes that Rob is bringing to the organization, those are actually still ongoing. A lot of that messaging has now been developed. It's being released into the field and put in front of our customers. It was tested before that and we'll continue to get feedback. So far, the feedback has been positive from both our own internal teams as well as what we're hearing from customers. That's good. That will also continue to be an evolution as customer requirements continue to evolve, as well as, you know, as our technology continues to evolve. I think we feel pretty good about where we are with the messaging at this point.
The other part of the cultural change that Rob is bringing is more focus on, we'll call it pipeline management, pipeline hygiene. It's coming from a very good place. He's looking to make sure that we have good pipeline, not only so that we have good visibility into out quarters, but also getting good visibility into what kind of requirements are tied to these pipelines. Are there R&D roadmap items that are open, but part of a decent sized chunk of that pipeline so that he can go back and try to influence the R&D organization to make sure, hey, are we working on X, Y, and Z because we've got a lot of pipeline tied to this? Where do we think we are with that? Then just the general hygiene as well, making sure that we're using consistent stages, consistent definitions for pipeline management, even internally.
Lastly, I think if I channel my inner Rob here for a second, he would also talk about elevating the message as part of the overall cultural change that's going on as well. If you think about it this way, what PTC sells is, or provides to our customers is, complex software that helps solve complex problems. It's very technical software. I think what he would say is we've been very good and it's been a rich part of PTC's heritage to be very good at that technical level and to be able to engage with customers at that kind of technical level. Also, a lot of what we're helping customers do is digital transformation. That's a bigger initiative.
If you think about it from a perspective of, well, we can arm the head of engineering, but now it's incumbent at that customer for the head of engineering to try and go sell that to the head of service and the head of manufacturing and the head of quality and regulatory and so on, which is more challenging when you're trying to sell internally across to a bunch of peers who have their own priorities and their own metrics. What Rob is talking about is elevating the message, making sure that we're getting the C-suite to understand not necessarily the technical components, but to understand the business value so that the C-suite can get behind it and really help push those initiatives.
The point being that with that kind of top-down pressure, it's a lot easier to get broader organizational alignment around digital transformation and this digital transformation initiative that's so important to our customers. He is also spending a good deal of time focusing on expanding our relationships with SIs that we've done as well, because a big part of his digital transformation is, of course, organizational change management, which is really where they excel as well and a big part of the transformation for the customer.
Making sure we're having the right messaging at the right level and not forgetting the deep technical expertise that's required, but making sure that we're providing air cover from the highest levels so that when we get to those technical discussions, they're exactly what they are meant to be, what's the best way to implement the software, and what kind of change do we need to do and what kind of benefit should we be expecting?
Perfect. With all these changes, I think one interesting dynamic you touched on is just aligning that product roadmap with the go-to-market changes. How should we think about maybe Rob incorporating pricing as a component of all this kind of product package, and pricing, and bundling? Is that something that we can see as a potential tailwind going forward? Any thoughts there?
Yeah, certainly, he brings a perspective around that to the organization, which I'm very much aligned with. I think that it's part of the overall transformation, and I think we'll continue to push on it. Of course, remembering that most of our sales are to existing customers, that's going to be an evolution over time because they're accustomed to dealing in a certain way. You know, we need to migrate off of that, but for sure, he's aligned and uses that as an opportunity going forward as well.
Understood. Just a reminder to the audience, to the extent you have any questions, feel free to submit that into the portal. I did just get one here, so I figured I might as well toss it out now. I know you guys aren't addressing, you know, long-term at the moment, but you're kind of in this environment as you look ahead with the go-to-market changes in play. How should we, at a high level, think about, you know, kind of the growth profile? In the past, you guys have said that this is kind of a low double-digit midterm grower. Has the environment changed that dynamic in a normal state? How would you characterize what you guys think you guys should grow?
Yeah, really, really good question. I think a couple of things. One, if we look back over the past few years, we've been delivering in and around flat net new ARR. The couple of years have their own nuances to them, but broadly speaking, in and around flat. We've also been saying pretty consistently for the past, I don't know, 10, 11 quarters that the macro environment has been challenging. I guess at a certain point, you need to really ask yourself, is this just the new normal? If so, what should we, could we, would we do differently to try to drive net new ARR growth, just assuming that this is the new normal from a macro perspective?
That's exactly what led us down the path of these go-to-market changes, some of the product initiatives, the ongoing SaaS initiative, the commercial optimization efforts that, a couple of those have been underway, but a couple of those are certainly newer. I think you've heard Neil talk about AI and the opportunity for AI there. All of those initiatives together, the intended result is to drive net new ARR growth.
Got it. I guess to kind of get back to those goals, executing on all of that, plus hopefully macro cooperating, is how we should think about it. Maybe shifting back now to kind of the product side of things, on PLM, clearly one of your core products, saw a resurgence during COVID, during all the digital transformation. As we think about this next transformation with AI, you've touched on it a little bit. I mean, do you see PLM kind of becoming more important to your customers? Are there opportunities to continue to see that business? I don't want to say re-accelerate just yet, but to see that business kind of step up in terms of priorities for customers.
I think our belief in general is that is a strategic imperative for our customers. You know, PLM, and you could think about it even more broadly, in our broader definition of PLM, which includes ALM, which includes SLM, but particularly on the product development and the product data side, how can we help our customers achieve their goals, which, if I completely oversimplify, boil down to developing new, even more complex, more sophisticated products faster to help them remain competitive in the markets that they play in. I don't think that those pressures have alleviated for our customers at all. In fact, maybe getting more acute in certain places.
Got it. Understood. Let's see another follow-up. On the call, you guys had touched on some elevated churn, and that would come back at the end of the year. Are those contracts still on track to come back later this year? This is from the Q1 earnings call.
Yeah, that was a couple of contracts and those are on track. I think some of the other elevated churn that we talked about was related to a smaller handful of events, probably more concentrated in SLM and in IoT, and in IoT in particular related to the end of lifing of a product that we had. That was not really a surprise to folks. They knew that was coming, and we had an off-ramp for them that we proposed. In many cases, they selected that off-ramp and in some other cases, they chose to go a different route, which caused some elevated churn there. That product has now been end of life. I don't think that comes back. On the SLM side, I think it has more to do with some customer-specific situations.
Divestitures, as an example, at a couple of customers led to different decisions, or M&A and divestiture activity.
The 3Q stuff sounds like probably not coming back. 1Q stuff still could resurface or still expected to resurface back half of this year, or I guess Q4 of this year now.
Or has already.
Got it. Understood. You touched on SaaS and cloud earlier. What does the customer appetite look like for SaaS now? You guys were taking a very measured approach. You weren't forcing anyone to go, but it did sound like on the recent call that there's maybe been a little more heightened interest. We'd love to get your take there. Does it start making sense to lean into some of these customers now?
I think that the delivery model question is certainly one that comes up with customers and their, you know, I mean, I think by and large, again, oversimplifying, but in many cases, SaaS is simply a superior delivery model. It is of interest to customers. It also comes down to the change attendant with migrating to SaaS, which isn't just shifting the backend. With SaaS comes more standardization. If you have a 10 or 15-year-old legacy on-prem system that needs to be migrated, that's also going to come with a lot of this OCM work that we talked about earlier. I think for customers, it's really a question of when is the right time to embark on that journey. It's certainly a theme that continues to come up.
Understood. In a recent customer event, we got the sense that perhaps new capabilities would be streamlined to Creo Plus and Windchill Plus, with maybe a bit of a lag to the on-prem customers. Should we view that as maybe the early stages of you guys trying to facilitate that transition to SaaS a little sooner? Any thoughts there?
Yeah, I mean, I think that's right. We do want to try to create some differentiation there, while making sure that, you know, we still have a large and important customer base that is on-prem. We obviously don't want to leave any of those customers stranded, if you will, as well. It's a balance that we're trying to strike and just trying to, again, help facilitate that discussion.
Got it. A follow-up question sent to me just on cloud, again, early days in terms of adoption there, but are you still seeing the type of economic uplift that you guys were initially thinking? I think it was a kind of roughly 2x. Any changes in terms of how that has played out?
No, I think that's still, you know, ballpark the right number. What the actual uplift is for any given customer situation depends on a whole bunch of different variables. Could be a little more, could be a little less, but I think that's still the right ballpark.
Perfect. I tried to delay asking about AI for as long as I could, but not surprising. This is always top of mind, especially in this current environment that we're in. You know, PTC serves as the sort of the system of record for product data. I guess how do you guys envision kind of your value in the ecosystem? To the extent you guys are kind of prioritizing AI development in your products, how do we see that get monetized over time? What's the feedback been from customers for any early use cases?
Yeah. Number one, I guess first point would be, you know, I think that you're spot on about, we'll call it system of record for product information and really for customers to be able to extract as much value as they can from AI. It starts with making sure that your own data house is in order, right? That again goes back to this whole digital transformation theme. An outcome of that is making sure that the data house is in order. Secondly, it's still early days in terms of the AI products that we have rolled out, right? Just last quarter, we actually started with ServiceMax AI. When we were talking about AI, just to be clear, what I'm talking about now is agentic AI use cases.
We've had generative AI in Creo, for example, for a number of years now, and I think Onshape more recently, through a previous acquisition that we did back in 2017. What we're really talking about now is agentic AI, so we're definitely in the early days of that. Again, just went GA last quarter. AI is certainly something that comes up in almost every customer conversation, and it's on our roadmap as well. I think here, kind of around the turn of the calendar year, plus or minus, you should see Codebeamer AI agents and Windchill agents also become GA as well. If you were to think about longer term, those are agents for ServiceMax within ServiceMax, Codebeamer within Codebeamer, Windchill within Windchill.
Over the longer term, I think you'd want to start to see agents working across those silos and eventually also agents interacting with other enterprise systems that our customers use. Now we're talking about the future. In terms of monetization, I think it's a really good question. As you know, most of the software that we, virtually all the software that we sell is on a per-seat basis. Even with ServiceMax, the agents that are now available, those are also priced on a per-seat basis. It does raise interesting opportunities for us to think about what the best way to monetize that is. Is it on a per-seat basis? Is it on a consumption basis? How is it that customers are going to be willing to pay for that, pay for that value?
I think we're in a bit of an evolving landscape there, but that's the path that we're on right now, starting off with on a per-seat basis and working through what the other alternatives might look like.
Understood. Let's perhaps switch over to numbers. It would seem a shame that we've got you here and not at least touch on some numbers. You've got that, or you had a $1 billion free cash flow target for next year out there. You guys are obviously progressing towards fiscal 2025, but there's also been some kind of puts and takes from currency and taxes and whatnot that could be in play. How should we think about where you stand as we approach that 2026 target? Help us think through some of the moving pieces.
Yeah, so one that has certainly been top of mind is, you know, is currency, FX rates, in general. I think where FX rates sit today, we've seen a little bit of tailwind, if you will, in the back half, but remembering that it was a pretty significant headwind in the first half. I think for the year, FX is still in that headwind for us this year, but if the rates stay where they are going into next year, that should be a net positive. Additionally, we've taken out some puts on the euro and the yen to help mitigate any potential, not all, but some of the potential headwind from a strengthening dollar should that happen throughout the course of next year. I think we view that as a comforting factor.
On the tax front, as you know, the OBBB has reversed some of the change that was introduced earlier as it relates to Section 174, the revenue code, which had to do with a capitalization of R&D capitalization and then amortization of R&D expense. The change really affects U.S. R&D; international R&D is still going to be capitalized and amortized. There will be some tailwind from that as well, which I think we feel also incrementally more comfortable with. Still some work to do to decide exactly which path we go down. There are different potential outcomes that are nuanced. We still have some work to do to figure that out, but net net should be a tailwind for us.
Of course, also, interest rates matter to a certain degree, although going into next year to a much lesser degree than we've seen over the past few years, because going into next year, I think we'll have probably around $1.2 billion of debt. $500 million of that's a high yield note at 4%. So you're left with about $700 million on a variable rate. The impact of interest rate changes is much more muted than it has been historically. Lastly, we need to figure out how we're going to end this year and, equally, what the plan for next year looks like. How much incremental ARR do we think we're going to add next year? What does our spending for next year look like as well? We're in the middle of our planning process, so that's all work to be completed.
Got it. On that last point, perfectly segues into a question that just hit my inbox, but you know, I realize you guys are not baking in go-to-market improvements just yet, not baking in macro improvements. Is the right way to think about that net new ARR, net new ARR, that it's stable to how fiscal 2025 closes out, like just based on the information that we have today?
I think we'll provide fiscal 2026 guidance when we issue our Q4 results. I think that's probably the best way to leave that one.
Got it. You knew someone was going to try to ask something ahead of time, but respect the game there. While we're here at the end, kind of comfortable with the current leverage levels, how should we think about the prioritization of deploying cash? I mean, buyback has been kind of a nice return this year, but you guys have also been a little more quiet on the M&A front. What are you looking at? What are you prioritizing?
Yeah, just to reiterate the general view on, you know, we'll call it capital allocation is, first a couple of fundamental things. Number one, we believe that PTC should operate in a net debt position. Number two, just given the consistency of the invoicing and the expenses that we have, and therefore the consistency of the free cash flow generation, we also think that we should try to run this business with as low a cash balance as we can. What that then ultimately means is, anything that's left, that doesn't get used, for example, for M&A, we think that should be returned to shareholders via share repurchases.
All right. Perfect. With that, I think we are right up on time. I don't have any other questions in my queue. So Kristian, thank you so much for taking some time out of your day to interact with us, and to the audience, really appreciate you guys all dialing in.
Great. Thanks, everybody. Thanks, Ken, for having us at the conference.
Thank you. Bye, Matt. Bye, Kristian.