PTC Inc

NASDAQ:PTC

Earnings Call Transcript 2020-Q3

[Operator]

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the PTC 2020 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 turn the call over to Tim Fox, PTC’s Senior Vice President of Investor Relations. Please go ahead.

[Tim Fox, Senior Vice President, Investor Relations]

Thank you, Valerie and good afternoon, everyone. Thank you for joining PTC’s conference call to discuss our third fiscal quarter 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 include 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 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, references to growth rates will be in constant currency, unless otherwise noted.

With that, let me turn the call over to Jim.

[Jim Heppelmann, Chief Executive Officer]

Thanks, Tim. Good afternoon, everyone and thanks for joining us. I hope you and your families continue to stay safe and well during this crisis. I’d also like to thank the extended global PTC team for their continued hard work and commitment during this time of disruption. Before I jump into a review of our quarter, I’d like to briefly reflect on the Coronavirus crisis, and review the headwinds and tailwinds that’s been creating for our business.

In terms of headwinds, we all know that the COVID-driven economic downturn is creating profitability and even business continuity concerns for many companies around the world. Naturally, some of the affected companies are PTC customers and prospects.

The second major headwind is the travel bans and work from home requirements, which slows down selling processes and interferes with on-site project work. As a result of these headwinds, we’ve seen pressure on bookings and some purchases get pushed out. Fortunately, to-date, the pressure has been somewhat less than we discussed in our guidance commentary last quarter.

Our Q3 bookings were down mid 20% year-over-year, which is slightly better than the expectations we shared of down 30% to 50%. Based on the current forecast, we expect Q4 bookings growth rate to improve sequentially.

The impact on renewal rates continues to be muted and we believe our previous guidance, suggesting a modest downtick and renewals remains an accurate assessment. So in aggregate, at this point, we think that the COVID crisis will continue to be a major headwind, but perhaps less so than we guided to last quarter.

I’ll remind you, however, that this situation remains very dynamic. And we don’t have a crystal ball to see what lies ahead in the future. Like everybody else, we’d sure like to see a vaccine become widely available.

At the same time, the COVID crisis is creating some strong tailwind still. We expect these tailwinds to persist for years to come long after the short-term headwinds fade as the health crisis passes. If there’s one thing the crisis has illuminated for our industrial customers, it’s the need to accelerate their digital transformation efforts.

In my LiveWorx keynote, I talked about the key learnings our customers have seen as a consequence of the crisis. They include the need to embrace the mobile workforce, the need for tools that better enable impromptu collaboration across supply chain partners. The need to bring digital to the frontline workforce and the need to push forward with remote monitoring and optimization of products in factories.

These needs very directly translate into elevated levels of interest for our PLM, IoT, Augmented Reality and SaaS solutions. The COVID situation is driving higher pipelines for Windchill for ThingWorx for the Vuforia and for Onshape. Each business is feeling the negative effects of the headwind still, but in cases like Vuforia and Onshape, the new tailwinds are strong enough to cancel most of the headwinds and these businesses continue to exhibit hyper growth rates.

With Vuforia and Onshape in particular, where we have a deal push because of economic concerns, a new one tends to pop up because of the needs of the new normal. When the health crisis is ultimately managed down through a vaccine or other means, I expect that PTC will be in a very strong growth position as the tailwinds blow uncontested. With that, let me now turn to our Q3 results.

Overall, we’re very pleased with our performance. We delivered 10% ARR growth, which was above our expectation of high single-digit growth. We delivered very strong revenue and APS and exceptionally strong free cash flow in the quarter. Kristian will get into the details later. So let me focus on providing color on the trends we’re seeing across our business segments.

From a geographic perspective, ARR growth was evenly balanced with 10% year-over-year growth across all three major geographic regions. One notable area of performance was in China, which posted mid-teens ARR growth and early indicator that the economy there is on the path to recovery, and that our subscription model is gaining traction.

Turning to our business performance by segment. Let me begin with our growth products, which as a reminder includes IoT, AR and Onshape. Growth product ARR grew 24% year-over-year, which is below our expectations for a normal environment. But consistent with the COVID dynamics we’ve discussed, which in particular, have extended sales cycles for new IoT customers.

Remember that IoT is where the physical world meets the digital world. And we typically have to engage the physical world in the initial setup phase, so that we can then remotely monitor and control it thereafter.

It’s hard, for example, to make progress, selling a smart factory project to a new logo if the factory shut down or you’re not allowed to go there for COVID reasons. But once the IoT systems in place, customers really see the value of remote monitoring and optimization and the expansion business remains brisk. Vuforia and Onshape are relatively less affected due to lightweight deployment models and their pure SaaS nature.

Let me provide you some highlights in these two areas, starting with AR. We delivered a solid quarter overall with record Vuforia-Chalk, enterprise sales and acceleration in a six figure AR deals and we added substantially to the burgeoning AR pipeline, which will serve us well in the fourth quarter and beyond.

You may recall that in response to the crisis back in March, we decided to provide free access to the Vuforia-Chalk, which is the entry level capability of the Vuforia-Suite that allows everybody to use their mobile device to see and markup real world frontline worker environments, such as factories and worksite. Chalk is proving to be incredibly helpful for remote support and problem solving.

The adoption of Chalk has been exceptional, with daily production usage levels across the customer base, now running 5 times higher than before we launched the program a few months back. All those companies using Chalk now represent an exciting upsell pipeline to pursue in Q4 and beyond.

Because of the strong adoption we’ve seen when we took the sales friction out of the way, we’re moving toward a freemium program that positions Chalk as a basic offering that’s an easy entry point into the broader Vuforia-Suite.

One of the most interesting upsell opportunities is the Vuforia Expert Capture, a more advanced AR solution, which was a key driver in large AR deals in Q3. Expert capture is tailor-made for doing knowledge transfer between frontline workers in the remote work situation that our industrial customers are currently navigating.

We had two notable wins in Q3 that highlight the value of our broader AR suite. The first is a leading US-based manufacturer of specialty measurement equipment, before the crisis hit, their services organization had kicked off an initiative to transform the way to deliver services to differentiate their offerings and improve operational efficiency.

When the crisis hit, they encountered new services delivery challenges, because of travel bans and on-site restrictions. PTC introduced the Vuforia Suite through this free Chalk program. And in less than three months, the customer adopted and deployed Vuforia Chalk and Expert Capture across the Global Services team, using Vuforia that now delivering highly effective remote support and are capturing best practices from internal experts for distribution to their end customers.

A second grade AR success story in the quarter was Philips Healthcare. As the COVID-19 pandemic unfolded, Philips needed to significantly ramp up ventilator production to address the growing healthcare crisis. They faced two significant challenges. The first was accelerating training of new staff required to enable 24/7 production shifts.

The second challenge was the travel ban which threatened to delay their new production capacity in India. PTC introduced Philips to our Vuforia Expert Capture solution and in less than 30 days, Philips was capturing expertise from technicians in the US, and remotely training new hires across the globe.

Despite facing the same COVID headwinds that were navigating across our business, our pure SaaS Onshape CAD business, delivered a strong quarter. The Onshape organization had a solid bookings quarter, added a record number of new logos and is tracking to achieve their FY ’21 – ‘20 plan.

It’s worth noting that in this challenging macro environment, Onshape’s growth rate is more than 30 percentage points higher than the well known mainstream product it’s most frequently displacing, which tells me that something interesting is happening. Another proof point for Onshape momentum is that the pipeline is 4 times larger today than when we acquired the company three quarters ago.

To support this strong demand, we’re making significant investments in Onshape go-to market, including expanding sales reach into Europe, which is a large market for design software. In Q3 Onshape also booked the first handful of orders from PTC’s reseller channel, a new program that was just launched. We believe getting PTC VaRs in the game will open another exciting vector of growth for the Onshape business.

We’re proceeding full speed ahead on the Atlas program too, which aims to generalize the underlying Onshape SaaS architecture and put it to work more broadly across the entire PTC product portfolio.

Work has progressed well on the Vuforia and generate design front and we’re working towards the day when there are versions of Creo and Windchill that are fully multi-tenant SaaS. Thanks to the underlying Atlas platform they share with Onshape.

Overall, we remain extremely excited about the opportunity to grow Onshape into the leading SaaS engineering design suite. As industrial companies rethink their innovation strategies for a new normal built around SaaS, there’s no better solution than Onshape.

Jon Hirschtick and John McEleney and the rest of the Onshape team have integrated seamlessly in the PTC and morale is very high. And they’ve never missed a beat in their frequent delivery schedules. Naturally, they love the Atlas strategy and we’re very pleased with how this acquisition is unfolding.

Lastly, in our growth business, I’d like to discuss IoT a bit more. As I mentioned earlier, we’ve seen pressure on new deal closure as a result of the COVID-19 crisis. While the new logo pipeline remains strong, the inability to engage with customers on-site, the scope and plan of the Enterprise Solutions has elongated sales cycles. But the interest level remains higher than ever. So we’re confident that as we see the environment begin to stabilize and engagement activity resume, we’ll get this part of the pipeline cranking back up.

Meanwhile, we did see solid IoT expansion activity in Q3, which is a testament to the value customers are realizing with ThingWorx. We saw a balanced expansion across both the smart connected products use case and the smart connected operations use case. And from a vertical perspective, we continue to see broad-based demand in a core industrial space in high tech and electronics, and in aerospace and defense.

But the real standout vertical in the quarter was the medical device industry, which has experienced less economic disruption during the crisis. Medical device companies like Abbott Laboratories and Hologic are continuing to expand their smart connected product deployments, enabling them to remotely monitor and service the product fleet seamlessly, despite the operational challenges caused by the pandemic.

Our partner, Rockwell had a relatively good quarter of AR and IoT sales with a strong sequential tick up in business. Like PTC, Rockwell saw strong expansion sales, which is great for the success of the partnership as we have landed a lot of starter deals previously.

Our partnership with Microsoft had a strong quarter across IoT, AR and PLM fronts. We were pleased to learn just recently that we won Microsoft’s Global Manufacturing Partner of the Year Award for second consecutive year. We’ve recently extended this partnership into a new class of IoT solutions, called Factory Insight as a Service.

This solution was launched a few weeks ago, is a three-way partnership with Rockwell Automation and Microsoft. Factory Insights as a Service is a turnkey cloud solution that enables manufacturers to achieve significant impact, speed and scale with the digital transformation initiatives. All three companies are taking it to market.

Lastly, on IoT, in addition to solid expansion activity and healthy backlog and pipeline heading into the fourth quarter, our confidence in PTC’s IoT market position was once again validated by the industry analyst community. Quadrant Knowledge Solutions identified PTC as the outright leader in industrial IoT platforms in this latest SPARK Matrix report, based on technology excellence and customer impact. We’ll put this report on our Investor Relations website for you to reveal.

To wrap up on a growth business, the punch line here is the COVID crisis creates a significant long-term growth opportunity for PTC, balanced against some near-term headwinds. We believe there are fundamental changes happening in the industrial economy that will play out in our favor over the coming years, bolstered by the strong alliances with Rockwell Automation and Microsoft, PTC is extremely well positioned to be a central part of the digital transformation strategies of our industrial customers.

Turning now to the core business, we’re very pleased with our Q3 performance with ARR growth of 10% once again, outpacing the market growth. The juxtaposition of Creo and Windchill being up are combined 10% in a quarter where DSOS, CATIA and INNOVIA businesses were down a combined 10% is interesting. I attribute that 20 point disparity to the great progress PTC has made to strengthen our products and to strengthen our business model.

Q3 was the 11th consecutive quarter that our core ARR growth rate has been in the double-digits. With such steady and predictable performance over a long period now, it’s obvious that we made tremendous strides, driving the cyclicality out of our core business. At this point, PMI fluctuations seem to have a more muted effect on PTC than they do on some of our peers.

PTC’s PLM business continues its streak of strong performance with mid-teens ARR growth in Q3. From a geographic perspective, PLM performance was broad based with double-digit growth across all three major geographies, led by the APAC region. The momentum in our PLM business was underscored by a major win with the US Navy, which we announced earlier this afternoon.

Following a rigorous competitive process against a dozen other technology providers that concluded with a small initial win a year ago, we conducted a successful pilot program and we’ve now won a substantial expansion agreement to power a cloud-based digital transformation and modernization effort around the weapons readiness and war fighting capabilities of the Naval Sea Systems Command. This project will drive a fundamental change in the way the Navy operates and supports its fleet of ships and submarines.

PTC software will be used to create a model based digital twin of each chip that will be used by more than 15,000 users and an expansive supplier network to optimize lifecycle costs and maximize operational availability. With additional options in place that could expand the ARR of this project to over $25 million in year five. This contract is poised to become PTC’s largest run rate customer so long as we successfully execute.

The Navy when reinforces, my earlier point about the digital transformation trends that are happening across the broader industrial economy and how they’re driving new demand for PLM. Our PLM pipeline looks strong and with many more digital transformation projects being discussed. We feel the prospects of a new wave of secular PLM growth are increasing.

Turning now to CAD. Our CAD team delivered a solid quarter with ARR growth in high single-digits. Growth across the GOs was mixed with APAC leading the way, followed by the Americas and Europe.

In Europe, which has our largest CAD channel exposure, sales were more severely impacted by the COVID crisis, given the patchwork of government shutdown across the regions. But CAD renewal rates were extremely strong.

We had solid results from Creo simulation live, our CAD solution that embeds real-time simulation from Ansys. We closed 10 expansion deals across a number of verticals like automotive, medical device and industrials. And we inked our first seven figure CSL deal with a large US government agency. It feels like we’re gaining some steam with CSL and we look forward to launching new marketing programs in the coming quarters.

And finally, our Focused Solution Group was flat, more or less it is expected given the difficult circumstances. With high profitability and low churn, this business continues to add real strength to the portfolio.

To wrap up my comments, I think it’s safe to say that we’re operating in unchartered waters as we navigate through this pandemic. However, I couldn’t be more pleased with our strategic position. And with our team’s execution in the face of these challenging times. We’re fully mindful of the headwinds the pandemic will place on new business, as we continue to target double-digit growth in ARR, revenue and EPS for the year. We’re confident that once this crisis passes, we’ll be well positioned to drive even higher levels of growth, margin expansion and shareholder value creation.

With that, I’ll turn it over to Kristian, who’ll take you through more details on the financial results.

[Kristian Talvitie, Chief Financial Officer]

Great, thanks, Jim and good afternoon, everyone. Before I review our result, I’d like to note that I’ll be discussing non-GAAP results and guidance, and all growth rate references will be in constant currency. Let me start off with a brief review of our third quarter results, and then spend the balance of the call on our outlook for the remainder of the year.

Q3 ARR was $1.21 billion, representing 10% year-over-year growth at constant currency, which was slightly above the guidance commentary we provided last quarter. The upside was driven by solid new ACV bookings, and only modest deterioration in churn which came in essentially in line with our forecast for the quarter.

Q3 revenue of $352 million was up 20% year-over-year, driven by 28% recurring revenue growth. As we’ve discussed previously, revenue is impacted by ASC 606 and related business policy changes. Operating margin of 29% increased approximately 1,200 basis points over Q3 ‘19. And lastly, non-GAAP EPS of $0.62 increased almost a 180% year-over-year.

Q3 free cash flow of $99 million was ahead of our expectations, driven primarily by the timing of collections, lower than allowed for customer concessions and lower than planned expenses such as travel and the virtual LiveWorx event. I think the key takeaway here is that even in the current macro environment, customers are clearly getting value from our solutions and paying largely on time.

Moving on to our balance sheet, following the redemption of the $500 million of 6% senior notes in May, we ended Q3 with $1.1 billion of debt, including $1 billion of senior notes with a weighted average cost of debt of 3.8% and $138 million outstanding on our credit facility. We ended Q3 with cash and marketable securities of $435 million. We believe this is a very attractive and stable debt structure, especially in light of the current economic backdrop.

Now, turning to guidance. Based on our Q3 performance and outlook for Q4, we’re raising the low end of our ARR guidance, and now expect year-over-year ARR growth of 10% to 12% on a constant currency basis, versus our previous 9% to 12% range.

At the low end of the ARR guidance, we expect new ACV bookings to be down approximately 30% for the back half of FY ‘20 versus our previous low end expectation of down 50%. At the high end of guidance, we continue to expect new ACV bookings to be down approximately 20% year-over-year and we’re still expecting churn of approximately 8% for fiscal ‘20.

It’s worth noting that despite these declines in new ACV bookings and slightly increased churn, we’re still able to target double-digit ARR growth, which is a testament to the strength of our recurring business model.

Before I get into the guidance details, there are few important factors worth reviewing as it relates to ARR. First, as a reminder, the way that we define ARR is the total value of active ACV or Annual Contract Value contracts at the end of the quarter.

This means the timing matters, both for new ACV bookings and renewal ACV bookings. In that, our subscription ACV is counted in ARR when contracts start. So, for example, if we book an order at the end of the quarter, but the start date is in the following quarter, it’s not counted in ending ARR for that quarter, but instead goes into backlog.

The key takeaway here is, that while we build a set of start date assumptions into our forecast and guidance, there’s always some risk that start dates move, and hence ARR and backlog change accordingly.

The second key factor is ramp agreements. A portion of our new ACV bookings are structured with annual committed ACV ramps that grow each year of the contract duration. The ramp agreements are great in the sense that they build future committed backlog which increases our ARR visibility in the future. However, if we book more ramp agreements than anticipated in any given quarter, this can also impact ending ARR and of course, backlog.

Given the current macro environment, where customers are more cautious about their budgets and deployments, we’ve seen an uptick in demand for ramp agreements. We factored some of this into our guidance. But we believe it’s important to call this out heading into what is our largest bookings quarter for the year.

So now for the specifics, we’re expecting fiscal ‘20 ARR of $1.24 billion to $1.2 6 billion, that’s a constant currency growth rate of 10% to 12%. Relative to Q3, our ARR guidance includes approximately $5 million of positive FX impact. And the quarter-over-quarter increase in growth is driven primarily by both normal seasonality of our business, as well as our backlog of deals booked in prior periods.

Turning now to free cash flow. For fiscal ’20, we’re expecting to deliver approximately $210 million which is an increase of about $10 million from our prior guidance, due to modestly higher expected ARR, solid collection activity and FX, and consistent with last quarter even though we haven’t seen a material change in customer payment activity, we’ve built in some cushion for potential customer payment concessions.

Please note that the interest payments for the two senior notes we closed in February will be paid in our fiscal second and fourth fiscal quarters, beginning this quarter, where the interests on the retired note was previously paid in our first and third fiscal quarters.

For the full year, free cash flow guidance includes $45 million in restructuring costs, $9 million of acquisition related payments, $65 million of interest payments and CapEx investments in the low to 20 - low to mid $20 million range.

Now turning to P&L guidance, we’re expecting fiscal ‘20 revenue of $1.42 billion to $1.43 billion, that’s an increase of $7 million at the midpoint of guidance, reflecting modestly higher ARR and subscription revenue. The resulting revenue range is growth of 13% to 14%.

On the expense front, we remain diligent relative to our headcount additions and continue to limit hiring to critical roles, primarily in our growth businesses. We continue to target operating expense growth in the lower single-digits for fiscal ‘20 and an operating margin range of 27% to 28%, which is an increase of 700 basis points to 800 basis points year-over-year.

Non-GAAP EP S is now expected to be $2.28 to $2.35, that’s an increase of $0.04 at the midpoint of guidance, and represents 39% to 43% year-over-year growth. A final point on guidance, you’ll note that the implied Q4 P&L guidance calls for a slowdown in year-over-year revenue and EPS growth. This slowdown is related to the accounting treatment of on-premise subscription revenue under ASC 606 and business policy changes we put in place in Q4 of ’19.

Subscription revenue under ASC 606 is also impacted by contract term length. So to the extent that term length change going forward, you should expect to see variability on a quarterly basis. That said, it is important to understand this has no impact on ARR or free cash flow as we continue to build customers annually upfront.

Also, please note that we’re guiding to a higher than normal seasonal increase in operating expenses for Q4. This is due in part to lower than normal expenses in Q3, with LiveWorx being held virtually this year, and other lower expenses such as travel, due to COVID related restrictions. And in Q4, we’re also expecting for normal higher commissions, an uptick in new hires and also there are four more business days in Q4 than Q3 which drives incremental improvements as well.

So to sum up with the caveats I described earlier about start date, timing and ramp contracts, we believe that our guidance to be appropriate. We continue to be diligent on expenses and protecting earnings without impairing our ability to make key investments in our growth businesses. And lastly, we have a strong and stable capital structure to support our profitable growth strategy going forward.

While we’re not providing fiscal ‘21 guidance at this time, it is worth noting that even under a scenario of prolonged economic softness, we would still expect solid ARR growth. And as a reminder, there will be additional free cash flow tailwinds in fiscal ‘21. Well, we expect CapEx to continue in the same mid 20s ballpark.

Interest expense is expected to decrease roughly $25 million compared to fiscal ’20, given our new debt structure, and assuming no restructuring, we would expect $30 million less of restructuring payments and assuming no acquisitions, another approximately $10 million less of actual acquisition related payments in fiscal ‘21.

One additional note for those of you building models for fiscal ’21. We will be moving to calendar quarters next year off of the modified four or five quarters we’ve had previously. We’ll provide more details on this topic next quarter.

So, wrapping up, we had another solid quarter, but recognize that the market is changing rapidly. We believe we’re very well positioned to perform during the downturn, and to continue delivering significant value to our customers, which in turn will drive ARR growth well into the future.

With that, I’ll turn the call over to the operator to begin Q&A.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Matt Hedberg of RBC Capital Markets. Your line is open.

[Matt Hedberg, RBC Capital Markets]

Well, hey, guys. Thanks for taking my questions. Hey, guys. Glad you’re all doing well. And it’s great to hear your voices again. Jim, I think what really is intriguing me and I started to dig into it a lot in some of the work that we’ve been doing is, you guys leveraging Atlas, which I think is obviously one of the crown jewels of odd shape.

You noted in your prepared remarks working on a SaaS version of Creo and Windchill and you said, you know, it’s still an ongoing process. I’m just wondering, could you provide a bit more detail on there and how you think about the timeline for that rollout? And how, you know, existing customers might leverage a SaaS version of Creo and Windchill?

[Jim Heppelmann, Chief Executive Officer]

Yeah. Well, Matt, good catch there. Because, you know, I think it really is ultimately a very large opportunity. But let me be clear, it’s kind of a mid to long-term thing, because we’re really looking at doing kind of a major redevelopment of those properties onto this platform. And

You know, the key thing for us would be to optimize for compatibility and continuity.

So I sort of – I have an analogy I’ve shared internally many times and probably help with investors as well. You know, if you think of Google Docs, it’s a completely fresh thought, fresh look at, let’s say, Office Productivity Suite. Meanwhile, you had Microsoft Office, which was on-prem.

But Microsoft came out with Office 365, which was SaaS, and companies like PTC might have been thinking about whether or not we should go to Google Docs. I mean, many, many do, and particularly new companies, but as companies who have been using Office forever, really do prioritize compatibility of data and user experience, but we like to have SaaS.

So you could imagine we could build a product that looks a lot like Creo. But it runs in the cloud and is multi-tenant, but you open up your same old files and you go right back to work with the same old user interface, much like you did with Office 365.

Meanwhile, Onshape’s over here are more like Google Docs, unbridled, unconstrained innovation, no legacy, trying to invent the next generation of application. So I think Onshape fights the fight against competitors and Atlas allows Creo and Windchill to bring their customer base with.

Again, it’ll take us, I’m going to say a couple of years to do this. You know, I partly tell you, because it’s part of our commitment, I really go to SaaS. It is a long-term monetization effort that’s significant, because while we’ve brought our customers from perpetual to subscription, there’s another and potentially bigger monetization associated with bringing them from on-prem into SaaS.

So I’m excited about that. You know, and really, to me, if the Onshape acquisition seemed expensive, I mean, it was, but what people didn’t realize is that we were getting both a breakthrough CAD system, but also a breakthrough CAD platform that will allow Creo and Windchill, you know, to get into that SaaS world years earlier than they would have independently and on a consistent platform. So that is, we bring our customers to SaaS, everything’s knitted together on a common platform as well. So we’re very excited about it. But you know, I want to be clear, it’s not a short-term strategy.

I think, though, if you’re looking about – let me just add one more comment. If you’re thinking about, are there any drivers for longer-term, strong growth in CAD and PLM, I would say, yeah, there’s kind of two that have captured my attention. One would be the movement of Creo and Windchill, the SaaS and the second one is something I mentioned which is the digital transformation story around Windchill that’s starting to get more and more traction.

[Matt Hedberg, RBC Capital Markets]

Thanks a lot, Jim.

[Operator]

Thank you. Our next question comes from Saket Kalia of Barclays. Your line is open.

[Jim Heppelmann, Chief Executive Officer]

Hey, Saket.

[Saket Kalia, Barclays]

Hey guys, thanks. Hey, Jim. Hey, Kristian, thanks for taking my question here. Jim, I actually maybe want to pick up on that last item that you just mentioned with Windchill and just PLM broadly. You know, can you just talk about that strength in PLM, ARR? You know, is it related to that digital transformation? You talked about a secular wave and PLM again? Is it market share gains? And how do you sort of think about that going forward?

[Jim Heppelmann, Chief Executive Officer]

Yeah, I think, you know, when I talk to my sales team, and when I spend a lot of time with customers, I think that, you know, in the past PLM followed CAD around, now it’s starting to follow digital transformation initiatives. And what really happens there is, industrial companies say, how could we think about, you know, taken ourselves through a digital transformation that didn’t involve digital product data, you know, being under control and well managed and so forth.

So I think like the Navy example, it’s got nothing to do actually with engineering. It’s about a model driven, you know, operation and support paradigm. And it’s got nothing to do with following CAD around. It’s really about how do you use that data to transform the way products are operated and serviced and supported, you know, during the lifecycle out in the field. And that’s a great example of the kind of initiatives we’re hearing more and more about, as people saying that product data could be useful for a lot more than engineering.

And if we want to try to do that, you know, this digital threat discussion, reuse it for manufacturing, reuse it for service, potentially use it for sales and marketing. If we want to do that, we got to get it under better control. And Windchill excels at that, you know, it’s already a SaaS and web-based system. And it differentiates well, you know, every single Magic Quadrant report you’ve seen in years Windchill’s way up front, in terms of its, you know, competitiveness, let's say. And I just think that digital transformation has become a real driver.

[Saket Kalia, Barclays]

Got it, makes sense. Thanks, guys.

[Operator]

Thank you. Our next question comes from Andrew DeGasperi of Berenberg. Your line is open.

[Andrew DeGasperi, Berenberg]

Thanks for – hi, how are you? Maybe just one or two questions. The first on Q4 ARR, I was just wondering in terms of the makeup of that guidance. Can you maybe elaborate a little bit how much of that is based on ramp deals versus brand new booking?

[Kristian Talvitie, Chief Financial Officer]

Well, as we’ve said numerous times before, we’re not getting into the specifics around that just but we do have a fair amount of visibility into the ARR. Again, it’s our largest bookings quarter of the year, which does make it a little bit harder to call around the – you know, the line of start dates and how much is actually going to come in this ramp deal.

But from a fundamental, you know, how much business are we selling out to the market perspective, I think we feel pretty good about the, you know, about the prospects for Q4. And we feel good about the, you know, the ranges we’ve put out with those caveats.

[Jim Heppelmann, Chief Executive Officer]

Yeah. And maybe just to add, Andrew. I mean, clearly, Q4 has forever been a seasonally strong quarter for bookings. And so it’s natural that it would be a seasonally strong quarter for backlog as well. So, you know, we start Q4 with kind of seasonally high backlog. And then we’re going to – and some of that new bookings will land in the quarter and some of it will go back in the backlog.

So again, what Kristian saying is, the real risk here is calling the timing of it, because how much of the new bookings lands in backlog versus in the quarter? I mean, that’s actually important to the way we report, although it’s actually not important to the – how well the business is doing. You know, the important thing there is, how much business do we go get? So I’d say seasonally, high. But we don’t really want to get into the details and percentages of it.

[Andrew DeGasperi, Berenberg]

That’s helpful. Just quickly on Onshape in terms of the channel, and how much you've essentially leveraged that, I mean, as at this point is it completely out there or is it just a select few that have been able to sell it? And if given the success, would you consider accelerating that process?

[Jim Heppelmann, Chief Executive Officer]

Yeah. So it’s a couple of dozen right now, but it’s a couple of dozen of the best ones, biggest investment. So what we did is, we said, you know, we have hundreds and hundreds of channel partners. But you know, there’s definitely a kind of a tail, let’s say to that. So let’s start with the biggest best ones, the ones who are in best position to invest in new sales capacity, because they’re still selling Creo and, and let’s go ramp them up and see how it goes. So we started that last quarter.

And by the way, we thought we would do this someday. But COVID convinced us we should do it right now. Because we just saw the pipeline just blossoming. And we said, you know, we just don’t have the capacity to execute on this. And there’s probably a lot more business that we’re not even finding. So, you know, that’s what we’re doing there, we’re taken a couple of dozen of our biggest and best resellers. They’re ramping up incremental new capacity. And they’re selling Onshape kind of into the lower end segment of the market, typically against SolidWorks. And they’re continuing to sell Creo kind of that’s slightly bigger and more sophisticated customers who, you know, for whatever reason really need that more advanced functionality of a higher end product.

[Andrew DeGasperi, Berenberg]

Thanks, Jim.

[Operator]

Thank you. Our next question comes from Adam Borg of Stifel. Your line is open.

[Adam Borg, Stifel]

Hey, guys and thanks for taking – hey, guys thanks for taking the question. Just a real question on OpEx as I think beyond this year, obviously I’m not looking for guidance, but you guys have done a great job this year, you know, limiting OpEx spend. Some of that is one-time in nature, some of that is expense discipline. How should we think about OpEx grows more qualitatively going forward just given the opportunities that you’re talking about and the attraction you’re seeing? I know we’ve talked in the past about OpEx going at half the rate of ARR. I’m just curious if that thinking has changed? Thanks so much.

[Kristian Talvitie, Chief Financial Officer]

Yeah, great, Adam. Good, good question. You know, I think as a general rule of thumb, I think that’s the right way to think about it. And that’s, you know, certainly where we, you know, start with our planning process and we’re in the middle of the planning process right now in any given year, we may, you know, flex that up or down. But over the longer-term, that’s definitely the, you know, the starting point. But again, it can fluctuate a little bit depending on timing and opportunities we see in front of us.

[Adam Borg, Stifel]

Great and maybe just a quick follow-up. Any comments on just recent business trends in July versus what you’re seeing in June? Thanks again.

[Jim Heppelmann, Chief Executive Officer]

All I would say is the quarter. You know, I was nervous as we came to the end of the quarter. And it was surprisingly not that stressful. So the quarter ended without a lot of fireworks and without a lot of angst and so forth it was actually quite relaxed. So that just tells me that it didn’t get worse. It probably held together and you know, gives me more confidence looking at the Q4 forecast.

[Adam Borg, Stifel]

Thanks again.

[Kristian Talvitie, Chief Financial Officer]

Thank you, Adam.

[Jim Heppelmann, Chief Executive Officer]

Thanks, Adam.

[Operator]

Thank you. Our next question comes with Tyler Radke of Citi. Your line is open.

[Tyler Radke, Citi]

Hey, thanks for taking my questions. I wanted to ask about the growth business, obviously, the ARR decelerated there and I think, you know, you call out some headwinds as it relates to, you know, selling some of these new IoT deals into customers, you know, where you have to be on site? I guess, how are you thinking about the trajectory of the growth ARR? Is this kind of the trough? And would you expect that to accelerate next quarter with the, you know, just overall ARR expected to reaccelerate?

And then, you know, in regions, whether it’s China or Europe, you know, that are further along the reopening. Are you starting to see any signs of those IoT deals starting to pick back up just as things start to reopen? Thank you.

[Jim Heppelmann, Chief Executive Officer]

Go ahead.

[Kristian Talvitie, Chief Financial Officer]

Yeah, sure. Tyler, good question. You know, again, you know I think that the demand environment still remains a little bit challenging out there. So we’re mindful of that. That said, echoing Jim’s comments earlier, we do have committed backlog, if you will, of ARR coming into Q4, so we would actually expect to see fairly solid ARR performance for the growth business in Q4, just given some of that visibility that we have. Over the longer-term, you know, start looking into next year. I think that part’s still open.

[Jim Heppelmann, Chief Executive Officer]

Yeah. And let me, maybe just say in Q4, you know, Q4 is always for us, a seasonally strong quarter. You know, we have a hockey stick in Q4. And we’re telling you, we expect Q4 to be down less year-over-year than Q3 was, which means they’re going to go a good step up. And it’s not possible to achieve a good step up in bookings without IoT playing a major role.

So there’s a lot of IoT business in our Q4 forecast, certainly a sequential step up. And at the same time, you know, we feel like we’re applying some conservatism there. So what I would say, Kristian said there’s problems in the demand environment, I’d actually say there’s problems in the closing environment, because the demand is high.

And so what we need to do in Q4 is called the right close rate. And I think in any case, we’re going to have a sequential step up that’s quite interesting, you know, in the IoT business, and therefore, this probably would be the trough in the in the growth rate of the growth business, ARR growth rate.

[Tyler Radke, Citi]

Right and then are you just seeing any type of demand differences in regions that are opening up faster than others?

[Kristian Talvitie, Chief Financial Officer]

Well, we have seen China, as an example, has continued to accelerate, which is, you know, good. That’s both a function I think of their economy opening back up a little bit as well as, you know, our subscription model. Customers getting more comfortable with the subscription model in that region as well. You know, I think on a geo basis, we are looking for continued strong performance in Europe and Americas as well, but on a, you know, growth percentage, I think APAC would be the leader.

[Tyler Radke, Citi]

Okay, thanks.

[Jim Heppelmann, Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Jay Vleeschhouwer of Griffin Securities. Your line is open.

[Jay Vleeschhouwer, Griffin Securities]

Thank you, good evening. Hey, Jim, let me start with you on a technology question referring back to LiveWorx last month, the most valuable part of the conference so the various roadmap sessions for the various products, and was good to see that you’re right hearing to the release cadences, particularly for Windchill and of course for Creo.

The question I have is, when you think about the upcoming releases that it just hit in December and June next year, what do you think will be the most incremental or catalytic, new features and capabilities, I’m highlighting PLM, because that’s where I think a lot of the flux is technologically and in terms of the end markets. So when you think about that, what do you think could be the drivers? And then additionally, how are you thinking about the incremental effect possibly of the new Creo ANSYS simulation product for the higher end product that coming out with in the fall?

[Jim Heppelmann, Chief Executive Officer]

Yeah, let me take the second question first. I mean, there’s two things simultaneously happening in our relationship with ANSYS. One is, we’ve seen a nice pickup in the first wave of the Creo simulation live. And then as you point out, we’re coming out with another wave of capability around the mainstream simulation suite that is called ANSYS AIM.

So, you know, while we’re getting momentum, we’re also now going to broaden the portfolio. And I think we’re optimistic about that. You know, PTC does have some capacity to sell simulation, we just decided we’d rather sell with ANSYS then against them. So I think we have a best-in-class simulation suite now within our CAD environment. And there’s customers certainly are interested in that.

So I think that ANSYS partnership will continue to gain traction accordingly. And then, you know, on this Windchill thing, I do think there’s two big things we’re working on right now. And without getting deep in the details, responding to this digital transformation moment, is one of them. And then, although it won’t ship in the near-term, you know, beginning to think about how do you go to a multi-tenant SaaS version or Windchill.

We do sell Windchill and SaaS today, but it’s single tenant. And what that means is that we don’t have all the upgrades – all the benefits of regular upgrades, you know, every three weeks, the whole basis is upgraded and so forth. But we’d like to go tackle that problem. We’d like to do I because it represents incrementally more value to the customer. And it represents incrementally more value of the PTC. I mean, frankly, less wasted energy by everybody.

Now, in the meantime, some of the things we are working on is even while it remains single tenant SaaS, we could do a lot to make the cost of ownership lower, which would benefit PTC when we provided the SaaS and benefit all those, all those customers who take it as on-premise. So I’d say again, those two things more related to responding to digital transformation moment. And that includes integration with IoT and integration with the Vuforia Suite and stuff like that. And then, you know, preparing both tactically and strategically for a better SaaS future.

[Jay Vleeschhouwer, Griffin Securities]

For Kristian, how do you think the contribution from your partners, the total number, so to say that you get from them might evolve? If it’s x today? Where do you think it might be 2, 3, 5 years from now and Microsoft has been very vocal in just the last couple of months about their commitment to the manufacturing market. They highlighted you.

There are multiple use cases they’re increasingly looking at, generally, but with what you do as well tied in. So when you think about all your partners, how does that footprint or ecosystem, whatever you want to call it proportionally, become more important to you?

[Kristian Talvitie, Chief Financial Officer]

Yeah, well, great question, Jay. I think that the, you know, the partner economy is extremely important to PTC. And, you know, that includes the more traditional partners as well as some of the more strategic as we call them alliances we’ve had recently –

[Jim Heppelmann, Chief Executive Officer]

And that’s the role in the global system integrators.

[Kristian Talvitie, Chief Financial Officer]

Global system integrators, but you know, again, Rockwell, Microsoft, you know, ANSYS as well. And so, you know, as we look out over multiple years, you know, I think that there is, you know, historically, let me say it this way, historically, the channel contribution has been, you know, mid 20s to kind of 30% of PTC’s overall business and as we look out over multiple years, we think that the opportunity for that is, you know, certainly to push, you know, the high 30s, approaching 40% of the, you know, approaching 40% of the business, you know, over a period of time.

[Jay Vleeschhouwer, Griffin Securities]

Thank you.

[Jim Heppelmann, Chief Executive Officer]

Thank you, Jim.

[Operator]

Thank you. Our next question comes from Andrew Obin of Bank of America. Your line is open.

[Andrew Obin, Bank of America]

Hey, thanks a lot. Just a question on Onshape. You know, you guys sort of highlighted that revenue in the quarter was in line with expectations. We’ve been hearing through channel checks that actually COVID locked down the fact that everybody works from home are actually stimulated a lot of demand for the product, a lot of interest. Do you see sort of the growth trajectory for Onshape being meaningfully impacted post-COVID of the next several quarters that we can notice from the outside?

[Jim Heppelmann, Chief Executive Officer]

Yeah, my view, Andrew is that two things are happening simultaneously. Some deals are being blocked, because companies are themselves in crisis mode and that tends to be larger deals. So there’s a headwind for sure, slowing actually down. But then is this tailwind, bringing in more deals that would not have, if not for COVID, probably wouldn’t have been in the forecast, meaning people are talking to us about because of COVID, I’m talking to you. And so we think right now, the headwinds and the tailwinds are cancelling each other out. And we’re basically on plan.

However, we think at some point, when the economic fear subsides a little bit. I mean, companies going out of business, don’t buy any software from anybody. But when they stop worrying about going out of business, and they start thinking about going back to business, then we think there’s just the tailwind.

And so the real answer is that, PTC has far more confidence in the future of Onshape than with the day we pulled the trigger on the acquisition nine months ago, we just feel like it was a great move both as a CAD tool, and then really something special in terms of this Atlas architecture that’s going to help us in many ways.

[Andrew Obin, Bank of America]

I mean just a follow-up question on-site access. Do you see any material improvement in July over June?

[Jim Heppelmann, Chief Executive Officer]

Again, our quarter is back-end loaded, okay. So we don’t close near as much business in June as we do in July. So for us, the risk would be that we didn’t close the business in July, but we did. Actually we landed our forecast came in above the guidance range we gave you. And so to us, July was certainly not worse than June and potentially better, because a back end quarter close more or less as expected.

[Andrew Obin, Bank of America]

Thank you very much.

[Operator]

Thank you. Our next question comes from Ken Wong of Guggenheim Securities. Your line is open.

[Ken Wong, Guggenheim Securities]

Great. Thanks for taking my question. Just one for you, Jim, you touched on this Navy deal potentially $25 million 5 years out from now, I guess how should we be thinking about the potential slope of that transaction from a ramp perspective? And then as we think about other areas of defense, is it fair to assume that this is something that could potentially map over to kind of other departments?

[Jim Heppelmann, Chief Executive Officer]

Yeah, okay those are both good questions. So first on the slope, let me just be clear, what we have is a pre-negotiated set of annual expansion options. We’re not calling it a ramp, because they’re not committed, they’re options. Okay, so think of it like a ramp, but without the commitment, therefore, none of it’s in backlog, none of it’s in ARR, none of that stuff. It’s just out there.

But they’re pre-negotiated and it’s a pretty steady ramp that would get us from the initial deal, which by the way, the Navy disclosed some information on this. So I’ll tell you, they disclosed that they had set aside $97 million for this contract. And they also disclosed that the first order was a little over $3 million. So think that we got a $3 million ACV order and there’s a series of additional orders, if you added them all together over all the years, you know, plus a little bit of services gets you to that $97 million, they’ve set aside for us. Now, again, just to be clear, we – the project needs to go well or you could imagine scenarios where we don’t get that full ramp.

Now, your second question.

[Kristian Talvitie, Chief Financial Officer]

So just to clarify on that, the first two years are in that 3, 3.5 –

[Jim Heppelmann, Chief Executive Officer]

Okay, first two years and then 3.5, right. Fair enough. So two years upfront and then a series of expansion options. Thanks, Kristian. Now, first of all, the Navy doesn't only have ships, they have airplanes. And so there’s Nav Sea, which is the deal we want and there’s there's Nav Air and it’s completely logical that the Navy would use the same system for the airplanes and that would, you know, potentially double it.

But then absolutely, we’re going to go pitch the same story to every other branch of the military who operates all these assets and really see if we can't get others to follow so. We think we have something special there. But you know, we’re not going to call anything right now other than put that in the category of the digital transformation tailwind for PLM, because this is not engineering in CAD, it’s digital product models under configuration management, for purposes of operations and support.

[Ken Wong, Guggenheim Securities]

Got it, well thanks for the detail. And actually maybe a follow-on, I guess beyond defense. I mean, it sounds like this is something that could potentially map out to kind of other end markets. Is that a fair statement? Or is this very defense-specific?

[Kristian Talvitie, Chief Financial Officer]

No, no, no it’s not defense-specific at all. In fact, they’re deploying commercial off-the-shelf software that we actually developed for initially for non-defense customers. So we’re certainly engaged in similar discussions with other customers. And in fact, if you go to the LiveWorx event two years ago, some of you might remember, I was doing a configuration managed augmented reality inspection procedure against the Volvo truck engine. That’s actually the same story, just a particular use case of it. So this definitely could go elsewhere. It’s just of course these military commands operate such large numbers of assets of such high value that they’re you know, really, really interesting if you can win them.

[Ken Wong, Guggenheim Securities]

Great. Thanks a lot, guys.

[Jim Heppelmann, Chief Executive Officer]

Thank you.

[Operator]

Thank you. And our final question comes from Rich Valera of Needham & Company. Your line is open.

[Rich Valera, Needham & Company]

Thank you. Thanks for fitting me in. Jim, a question for you on IoT. If you can put aside the logistical issues with deployment right now, I just wanted to get your sense of where that product is and its lifestyle – lifecycle in terms of adoption. And the things you’ve done specifically to facilitate adoption to reduce the friction and getting customers to adopt it. I know you just rolled out kind of insights as a service, which I think is one of the things in that sort of ilk. And you’ve also been working on sort of, I think, more templates to make it maybe more shrink wrapped and less customizable. But if you could just talk us through where that product is in its lifecycle and if you think there’s kind of an inflection somewhere down the road as you all these things sort of coalesce to make it more of a final product, as opposed to, you know, custom deployment.

[Jim Heppelmann, Chief Executive Officer]

Yeah, and I think that’s a great question, Rich, because I think the product has matured quite a bit as a great platform to develop and run IoT business applications, okay. But what we’d like to do is have more than pre-developed exactly as you said. We’d like it to be a solution in a way that has the platform in the background if you want it, but you’d really rather buy the solution.

You know, I kind of in the industry example that’s a bit dated would be like salesforce.com and force.com. You know what I mean? Like force.com is there, if you bought salesforce.com, but most people really would focus on the CRM system or what have you.

So just thinking about that for a minute, we’d like to have more value-oriented, outcome-based solutions that are ready to go. And that’s been a big focus at PTC, we hired a new executive to run that about a year ago now, Craig Melrose you know, a longtime McKinsey manufacturing expert. And so the reason I really like Craig is, he looks at it from a value standpoint. Hey, Mr. customer, what problems do you have? And what value could be created by solving those problems? And then we want to come and say, we have a solution that does exactly that.

Let’s not talk about developing anything, it’s ready to go. So that’s what we’re aiming for. Again, I think at the platform level, we now have a very mature system and really we’re focusing now on the solutions. This factory insight as a service is a down payment. But I think you know, in the next one and even two years, you’re going to see us roll out a whole series of very interesting solutions that will change the way we sell. We’ll go back to selling Enterprise Solutions built around the concept of IoT as opposed to an IoT platform you could use to build the Enterprise Solutions, which is kind of the world we’ve been coming from.

[Rich Valera, Needham & Company]

That makes sense. Thanks for that clarification, Jim.

[Jim Heppelmann, Chief Executive Officer]

Thanks, Rich.

[Operator]

Thank you. Ladies and gentlemen, that does conclude our Q&A portion. I’d like to turn this call back over to Tim for any closing remarks.

[Tim Fox, Senior Vice President, Investor Relations]

Thanks, Valerie. And again, thank you, everyone for joining us today. We will be participating in a number of virtual events coming up this quarter. You can find all the details on our investor website. We look forward to seeing you on the conference circuit in the coming months and again, thank you for your interest in PTC and we all hope you have a great evening. Take care.

[Jim Heppelmann, Chief Executive Officer]

Thank you.

[Operator]

Ladies and gentlemen, this does conclude today’s conference. Thank you for participating. You may all disconnect. Have a great day.