PTC returns to modest growth in FQ2 – but we’ll take it!
PTC announced its fiscal Q2 financials a couple of days ago, and I’ve been trying to figure out what to write about ever since. There was good news, in that revenue was up year/year for the first time in nine quarters. And the net loss narrowed. But I worry about the destabilizing impact of a surprise announcement: PTC is moving to all subs in the core Solutions and IoT products in North American and Europe starting January 1 2018. Cue the hair pulling and wailing? Maybe not.
Before we get to that, a few of the earnings details:
- Total revenue of $281 million was slightly short of expectations, in part because more buyers opted for subscriptions, but still up 3% over a year ago. PTC estimates that the higher-than-guidance mix of subscription in the quarter reduced revenue by $10 million
- The company reported a GAAP net loss of $1 million but, on a non-GAAP basis, positive net income of $35 million
- Subscription bookings were 71% of total, vs. an expected 60%. PTC buyers clearly like subs. So why are other company’s customers so torqued about them? Much more on this below.
- Software revenue was $235 million, up 5% as reported and in constant currency (cc). Within that total, subscription revenue more than doubled to $66 million while perpetual license revenue fell 31% to $27 million. Maintenance (aka support) revenue was $142 million, down 12% because of a “higher mix of subscription bookings, support conversions to subscription and fewer support win-backs in the channel as we launched a new win-back program in Q3’16 where customers continue to return to PTC on a subscription basis”. In other words, maintenance is down because the channel did a good job a year ago. And PTC is introducing another such program this quarter, for direct and channel customers.
- Services revenue fell 7% to $45 million, likely as PTC continues to move that work to partners
- Software revenue from the solution products (CAD, PLM and SLM) was $213 million, up 3% as reported and in cc, with “all deliver[ing]ed software revenue growth in the quarter”. CEO Jim Heppelmann gave a bit more detail than usual on the solutions group, telling investors that “CAD led the way with double-digit bookings growth driven by strength in our reseller channel, where go-to-market initiatives launched in fiscal 2016 continue to bear fruit …There’s a lot of exciting activity going on in our CAD business, and we look for continued positive results from this business moving forward. The core PLM business performed well again this quarter, with bookings in line with market growth rates. Once again, PLM benefited from a strong quarter for Navigate sales … We saw some variability again in SLM as we’ve seen in the past, with SLM bookings down year-over-year primarily due to the lumpiness and timing of large deals.”
- IoT software revenue was $22 million, up 26% as reported and cc, and up 1% sequentially
- By geo, software revenue from the Americas was $107 million, up 8%. From Europe, revenue was $82 million, up 2% as reported and up 5% cc. From Asia, $47 million, up 3$ as reported, flat in cc.
PTC characterized these results as beating guidance — and, in most metrics, they do. The notable exception is that the company forecast perpetual license revenue of between $31 million and $36 million, and reported $27 million. That would be OK if it all translated, somehow, to subs — but that forecast was for $64 million and the company reported $66 million. There’s no easy way to estimate how much subs revenue should have been created by that $4 million to $9 million in lost perpetual revenue but it appears that PTC lost some deals it had expected to close.
Mr. Heppelmann gave an unusual amount of color on the CAD offerings, which makes me do a little happy-jdance. Creo is too often downplayed in PTC’s excitement over its IoT products. Here’s what he told investors: “[CAD revenue growth] has been in the double-digits for 5 consecutive quarters, which is nice. … To me, it’s down-market [buyers]. Our channel is doing exceptionally well [and we’ve made] product improvements. But more importantly, many go-to-market and operational improvements that have been implemented in the past couple of years that are starting to work really well.” CFO Andrew Miller added that PTC had brought in new channel leadership [Kerry Grimes, formerly of Siemens], who has been “maturing the channel every single year, as well as working with the channel to add more sales headcount. At the same time, we’ve refocused, increased the segmentation of our [direct] sales force going after our enterprise customers to make sure we had people who were CAD sellers that were [in an] appropriate number to go after the opportunity there.”
Now to subs. PTC said that it will “transition to a subscription-only model in the Americas and Western Europe beginning on January 1, 2018. This decision represents an important milestone as the effect of this change will be PTC driving toward 100% subscription mix in these geographies that represent about 70% of our business.” Mr. Miller later added that PTC will “assess market condition and our license offerings in other regions and for Kepware, which is virtually all perpetual at this time.”
Mr. Miller also gave a bit more color on current subscribers: IoT saw a subscription mix of 73% despite Kepware being virtually all perpetual; “essentially all” of the ThingWorx bookings were subscription in FQ2, while SLM and PLM led the way had a subs mix “in the high 70% to low 80% range”, and CAD “improved to the low 60% range due in part to continued progress in our channel.” Looking at this another way, according to Mr. Miller’s data, in the direct business, subscription mix was 79%, while the channel saw a subscription mix of 55%, “led by the Americas and Europe, where over 2/3 of the channel bookings were subscription. Regionally, the Americas, Europe and Japan far outpaced the PacRim where adoption trends continue to lag the other geos.”
When Autodesk said something similar, some customers were furious that their perpetuals would someday no longer be supported, that they would have to pay to keep their subscriptions active when they had previously just continued to use perpetual-bought software without paying maintenance. To be fair, for a lot of them, this is serious money in a small business. Why is PTC doing this? Did they not see the teeth-gnashing over Autodesk? Three things:
- Autodesk has educated the market about subs, so this isn’t quite the shock it was a few years ago
- PTC says that subs “adoption in the Americas and Western Europe [is] consistently in the mid- to high 70s” (meaning percentage of deals choosing subs), this move will discomfit something like 30% of deals. Mr. Miller also said that “subscription adoption trends were … strong in every segment, every geography and in both our direct and indirect channels.” PTC is following its customers rather than leading them, which is smart.
- Finally, Autodesk has a lot of very small accounts, which might have a fewer than a handful of users. PTC’s accounts tend to be a bit bigger so the flexibility and cashflow implications of changing to a sub might be more attractive, and the concept of software compliance and governance, on average, more established.
So, to some extent, PTC will be systematizing what’s already happening. There will be some gnashing of teeth, to be sure, because no one likes change but PTC seems, like Autodesk of late, to be paying attention to how it can generate customer demand for subs through flexibility, pricing, business terms, software features, e-learning and other benefits. Focusing on the carrot and not the stick, I believe Mr. Heppelmann said. We’ll see how this shakes out next year.
For Q3, PTC sees total revenue of $288 million to $293 million — that’s a bit below expectations of $296 million, which sent the share price lower. For the full year, it projects total revenue of $1.16 billion to $1.17 billion.