PTC’s Q2 revenue misses but positions for the future

It’s tough to be PTC right now. Most indicators are going in the right direction: subscriptions are ahead of expectations (though that means perpetual license revenue is below plan), IoT-related sales are growing as PTC sells both standalone IoT solutions and begins to embed ThingWorx and Vuforia technology into its core CAD, PLM and SLM solutions and is positioning to improve execution on those core areas. PTC management needs to balance cost-cutting with investing in future growth. It all comes down to a waiting game: when will revenue tick back up to lead to profit growth?

The details of PTC’s fiscal Q2 2016, first the results as reported on a GAAP basis and then PTC’s metrics that are designed to help investors understand the shift to subscriptions:

• Total revenue was $273 million, down 13% as reported. On a GAAP basis, the company reported a net loss of $5 million or $0.05 per share, as compared to a $5.4 million net income a year ago
• Subscription revenue was $23.7 million, up 50% over last year (up 53% non-GAAP constant currency (cc))
• Support (aka maintenance) revenue was $160.6 million, down 5% (down 2% non-GAAP cc) — some of the decline was due to maintenance customers switching to subs, but I don’t think PTC quantified this
• Adding those two together, total recurring software revenue was essentially flat at $184.3 million
• Perpetual license revenue was hit hard, down 43% to $39.7 million; on a non-GAAP, cc basis, revenue was down 42%
• Adding together recurring and perpetual license revenue, total software revenue was down 12% to $224 million (down 9% cc)
• Finally, professional services revenue was down 16% to $48.7 million as part of PTC continuing push to drive services to partners
• One of the difficulties PTC sees (and others are avoiding by removing choice from the equation) is that customers are unpredictable. PTC had assumed that 26% of booking would come from subs; it turned out to be 54% of total bookings, so double what was expected and vastly ahead of last year’s 14% of bookings. Doing a bit of math, PTC thinks this reduced the perpetual license amount by about $24 million — so, had customers opted for perpetuals as expected, perpetual revenue would have been down roughly 8% and total revenue would have declined about 5%.
• PTC no longer breaks out revenue (or anything else) by product type (so CAD or PLM) but does offer nuggets. Solutions Group revenue was $206.7 million, down 16% as reported (down 13% cc). Not surprising, the decline is due to the switch to subs; PTC says subscription activity was “stronger than expected … across all segments of our Solutions business”. PTC says Solutions Group bookings grew in the low single digits in cc, with particular strength in ePLM. Finally, “On a constant currency, license mix-adjusted basis, Solutions software revenue was approximately flat YoY”
• The Platform Technology Group reported GAAP revenue of $17.3 million, up 98% as reported on the Kepware acquisition. On an organic basis, Platform revenue was up 15% non-GAAP cc. The company reports adding 66 new IoT logos in Q2 to bring the cumulative total of new IoT logos signed this year to 131.
• By geo, PTC reports seeing a “high subscription mix in the Americas, Europe and Japan, and while the Pac Rim and the channel are trailing in terms of total mix, we are seeing significant growth across all regions and sales channels.” This bears out what other vendors are saying, too: subs are not the preferred mechanism in all geos.
• Revenue from the Americas was $98.6 million, down 6% because (you guessed it!) subs
• Revenue from Europe was $80.4 million, down 9%. Subs again
• Revenue from Japan was $21.6 million, down 35% on a tough comparable with large and one mega deal a year ago and subs
• Finally, revenue from the Pacific Rim was $23.5 million, down 17%
• PTC is all about the future potential of subscription sales. The company says the total annualized contract value (ACV) of subscriptions signed in Q1 was $23 million; above guidance of $10 million and that annualized recurring revenue (ARR) was approximately $742 million at the end of Q2. Recall that the goal of getting to a mostly subs business is to have the year’s revenue in hand before the year starts; PTC is well on its way to that goal
• It’s not all roses and kittens, though. PTC is still working its way through the “realignment of resources” announced in October 2015 that was to repurpose or eliminate 8% of worldwide positions and to consolidate office space. This was expected to lead to restructuring charges of up to $50 million; $37 million was recorded in Q1 and a further $5 million was recorded in Q2. There was an interesting question on the investor conference call about PTC’s hiring efforts:

Q: There was recently a reasonably significant increase in the number of open positions you’re looking to fill .. [in] services … cloud … and even marketing. So I’m wondering how you’re thinking about adding to your head count behind the key initiatives versus balancing costs?

A: [James Heppelmann] … We’re seeing what’s the best way to use these resources. And we’re moving them around. We’re taking people; we’re doing something that wasn’t generating that much value in its 10th, 20th, 30th year and we’re putting them on things that are jaw-dropping new concepts for R&D …

The way to really grow this company is to figure out how to do it without having to have commensurate growth in the sales force … if you look at, for example, the Kepware business, they only have three sales reps and the productivity per rep is off the charge; it’s many, many millions of dollars per rep. That’s because they basically have perfected marketing-led, low-touch sales model.And then, Vuforia [which has something like] 210,000 customers and zero sales reps.We have an attitude that we’re going to win as a high-tech company and we’re going to do it by growing, but we don’t have to get fat to grow, because there’s plenty of portfolio management opportunity in a company of this size, we just have to be smarter about how to deploy our resources sometimes into marketing versus sales, sometimes into new ideas versus old; but make sure the whole portfolio works.

I know that maybe behind your question, there’s questions like are we spending enough money on CAD, and sometimes I laugh because companies I think about a lot are companies like Onshape, and I say how many developers they have, 20, 30, maybe. I mean, I only have 400. So I’m worried about somebody who has substantially less resources, but I’m worried because they might be innovating more. So then I ask my question, I’m not going to win the battle by putting the largest army on the field, I’m going to win the battle by innovating more, now we’re back to portfolio management. Is it better to write a line of code in Vuforia or in Creo? They’re all 3D products. So let’s look for the way to innovate most, and we can – like I said, we can aim to innovate and grow without aiming to get fat in the process.

Mr. Heppelmann said so many important things in that passage that it’s worth dissecting just two of the (to me) key aspects. First, he makes the point that PTC has spent decades building and deconstruction and building and destroying a direct sales channel that was, to be blunt, expensive. IT was old-school IT sales: long process, expensive lunches, high-touch. Think Digital Equipment, IBM, HP in the 1980s. That simply doesn’t work today, especially not if you’re selling subscriptions. Looking at the young, agile, new-generation companies PTC is acquiring for practices that can help sell more, and more cheaply, shows a great willingness to be open to new ideas. How well this succeeds in a customer base that’s habituated to waiting until the very end of a quarter to pressure a sales guy into one more lunch and some discounts remains to be seen — but it’s a great acknowledgement that the PLMish world has move on from the traditional big IT sales mode.

Next, Mr. Heppelmann called out another “old IT” norm: that you need big R&D to create big products. He’s right that OnShape (and others, to be fair) can create and innovate with far fewer resources. But it’s not that simple: OnShape has no legacy customers or IT structures to migrate forward; if PTC were suddenly to reinvent its CAD solution with no thought to that legacy, a huge chunk of revenue would vanish. The idea of managing R&D as a portfolio makes sense for PTC, but it needs to balance the needs of all aspects of that portfolio. [If you’d like to listen to the call replay, go here.]

PTC issued some pretty complicated guidance for FQ3 and the year, reflecting the fact that it can only control so many of the levers in this economy and in its transition to more subscription-based deals. Adding it all up, PTC expects subs revenue of $32 million, support of $159 million and perpetual revenue of $50 million or so, for total of software revenue of around $240 million. Add in services revenue of $49 million, and we’ve got a total total revenue of $287 million to $292 million for FQ3. For fiscal 2016, PTC is looking at $1160 million to $1175 million.

What’s my key takeaway? PTC is reinventing what we think of as CAD and PLM by integrating its IoTish technology with what we’ve traditionally labelled as “design”. PTC is starting to combine technologies, as it did with PTC Navigate, a Windchill 11 + ThingWorx combo that shipped a few months ago. Navigate powers role-based apps that make it easier for non-traditional PLM audiences to gain access to PLM data and processes. PLM not your thing? How about using virtual reality or augmented reality to really understand how a product performs? (Go here to see some amazing videos from PTC’s ThingEvent last January.) PTC is building a portfolio, a toolkit, a set of platforms and apps –call it what you will– that lets it meet the needs of manufacturing clients from early-stage concept through operations, services/maintenance and disposal by combining these technologies in new ways. CAD is often the driver in these scenarios, since that’s where the first 3D content is created, and the other apps serve it out to all of the different user types through the life of the object. That’s a grand vision, if you’re able to move with PTC to this new, connected, augmented world.