PTC’s FQ3 a story of big deal misses and IoT growth

As PTC announced a few weeks ago, fiscal third quarter (FQ3) revenue was $304 million, below the company forecast of $306 million to $311 million. What happened in the quarter to cause revenue to be below expectations? It comes down to two things: PTC’s reliance on large deals and a focus on new business areas, possibly at the expense of its core PLM and CAD businesses. As a reminder, PTC got 80% of its revenue in FQ3 from its CAD and PLM+ALM (rebadged as ePLM) businesses and only 7% from the newest, shiniest opportunity: IoT. Yes, IoT is exciting and has huge potential but there are plenty of CAD and PLM customers to serve right now. Big deals are hard to close; that’s a given, regardless of the economic climate. Yet PTC annually relies on over a hundred large deals (defined as bringing over $1 million to a quarter) for around 22% of total revenue. That’s more than 2 of these deals per week. The average dollar value of these deals is relatively constant at $2 million to $2.5 million. Think about how long it takes your company to get a buy of this size approved: how many people need to sign off? How many committees need to review every word of the justification and contract? Big deals are, in some ways, easier to go after than smaller ones: fewer accounts to call on, fewer people to take to lunch, fewer benchmarks. But if one or two big deals fail to close, Sales misses its target for the quarter and management is in the position of having to explain it to Wall Street. CEO Jim Heppelmann said that this quarter’s miss was due to challenging macroeconomic conditions in the Americas and in China that made it hard to close large deals in the core CAD and PLM business. CFO Andrew Miller added that deal sizes “compressed”, which could mean that buyers bought less than expected or that they negotiated prices downwards. Mr. Miller and Mr. Heppelmann said that the situation hasn’t improved and have reduced PTC’s targets for FQ4 and fiscal 2015. Of course, the move to more repeatable and less lumpy revenue does continue, even if slower than PTC and Wall Street would like. In FQ3, subscriptions made up 16% of license and subscription solutions bookings — less than expected because several IoT buyers opted for perpetual and several large subscription deals across the business slipped out of the quarter. As a reminder, subscription bookings were 21% of license and subscription solutions bookings a year ago, when two big deals influenced the balance. If there was one overwhelming positive in FQ3, it was this: Mr. Miller said that roughly 60% of FQ3 revenue came from recurring business, up from 53% a year ago. That’s good, and shows growth in subscriptions, cloud services, and ratable support revenues. Mr. Miller says that company is working on a revamp of its subscriptions, trying to figure out by market segment and customer type how the offering should be structured.  So far, no surprise: it seems that buyers like subscriptions because of the ability to ramp up or down, and pay over time out of the operating budget. PTC wants to roll out new offerings later this year. The FQ3 details:

• Total revenue for FQ3 was $303 million, down 10% as reported and down 1% in constant currencies (cc)
• Total software revenue was $250 million, down 7% as reported yet up 2% in cc. On an organic basis, excluding Axeda and Atego, software revenue was down “low single digits” cc. Within the software total,
• License and subscription (L&SS) revenue was $84 million, down 14% as reported and down 7% in cc
• Support revenue (aka maintenance) was $166 million, down 4% as reported but up 6% in cc
• Professional Services revenue continued its planned decline, down 20% as reported (down 10% in cc) to $54 million
• By line of business, CAD and extended PLM (PLM + ALM, aka ePLM) declined y/y as large deals slipped out of the quarter. CAD revenue was $120 million, down 20% as reported (down 10% in cc), while ePLM revenue was $123 million, down 16% (down 6% in cc)
• CAD software revenue was $115 million, down 20% while CAD L&SS revenue declined 42% on a decline in Creo modules, upgrades and legacy CAD products. Apparently, new Creo seat sales declined but more modestly. Fewer large deals and a weaker than expected macroeconomic environment affected spending among discrete manufacturing customers
• ePLM software revenue was $88 million, down 11% (down 2% cc) as ePLM L&SS revenue declined 29%. Double-digit growth in ALM and in cloud services could not offset the decline in PLM license revenue. Fewer large deals, economic conditions and a strong quarter a year ago were cited for the decline
• SLM total revenue was $39 million, down 5% as reported and up 2% in cc. SLM software revenue was $26 million, down 3% (up 3% cc). SLM L&SS revenue was down 10% due to a higher mix of subscription solutions bookings in the quarter
• PTC highlighted the IoT segment, which it says performed well ahead of expectations. IoT software revenue was $21 million, up an insane percentage that’s not worth noting. ThingWorx added 78 new IoT customers in FQ3, for a total of 182 for the year so far, making it likely that PTC will exceed its target of 200 for the year
• By geo, revenue from the Americas was $134 million, up 3% as reported and up 4% in cc. Mr. Heppelmann said PTC struggled to close large CAD and PLM deals in this region, but saw strong sales of IoT and SLM, leading to double-digit software revenue growth in the region
• Revenue from Europe was $110 million, down 16% as reported but up 2% in cc. In constant currency, that meant modest software revenue growth due to sales of PLM/ALM, IoT, and SLM but a decline in CAD
• Revenue from the Pacific Rim was $33 million, down 10% as reported and down 8% in cc. The company says it saw a modest constant currency decline in software revenue again due to weak results in CAD, extended PLM, and SLM, primarily due to the overall slowdown in China. Revenue from Japan was $26 million, down 33% (down 21% in cc) year/year due to a very strong quarter a year ago
• PTC reported 8 large deals (>$1 million of license and subscription solutions bookings) in FQ3, down from 21 a year ago — when there was also one mega deal (>$5 million).  Three of the 8 large deals the company closed in FQ3 were IoT deals, which is worrisome: extending the practice of hunting big deals into the new IoT business expands big deal risk into a new domain.

The influence of the large deals on these results can’t be denied — and it also makes it hard to see where things are working (or not) in the sub-categories. There was a decline in Creo modules, upgrades and legacy CAD products, while new Creo seat sales declined more modestly. Is this because big deal buyers are going for modules and upgrades, and fewer of these materialized in FQ3? Mr. Heppelmann was asked on the earnings call if the deal slippage and overall down results in CAD and ePLM were due to competitive pressure, specifically from Dassault Systèmes. Mr. Heppelmann, not surprising, was a bit touchy in his reply:

“I don’t think there’s any competitive dimension here. I think that we are in a series of businesses and Dassault is a series of businesses. Our CAD and PLM businesses most directly correlate to Dassault’s CATIA and ENOVIA businesses. And I think over the last three years, the growth rates of those have been remarkably similar. Now, Dassault is in some higher-growth businesses like SolidWorks, and we are in some higher growth businesses like IoT. But I think you can’t really compare — Dassault is structured differently than we are, and I think that that has helped them in this quarter because the SolidWorks business performed well and so did our IoT business.”

At a total revenue perspective, of course, he’s right. DS is trying hard not to be seen as a CAD company, selling its Experiences as overall solutions to business problems. But the Experiences are composed of CAD, PLM and other components. So we do have a basis for comparison: CATIA revenue was up 4% cc and SolidWorks was up 11% cc while PTC’s overall CAD revenue was down 10% cc, admittedly over a very good quarter a year ago. How much of this difference is due to the pressure PTC’s customers feel from their business climates? Are they holding back purchases more than DS’s? Hard to tell. I think what Mr. Heppelmann was trying to say is that they haven’t lost any CAD or PLM deals to DS and that the companies are increasingly calling on different customers — or different people within their traditional accounts. What’s ahead? PTC once again cited the IoT business as the momentum driver for FQ4 but sees a “challenging” manufacturing economy holding back broader growth, especially in the Americas and China. On the plus side: number of the large deals that didn’t make it into FQ3 have already closed. The question, of course, is whether deals meant for Q4 will slide into Q1 … The company sees total revenue between $304 million on $319 million for FQ4, which means total revenue for the fiscal year of $1,250 million to  $1,265 million, flat or down 1% in cc.