PTC’s FQ3 shows surprising demand for subs

Jul 22, 2016 | Hot Topics

It’s big-boy PLMish earnings week and, so far, so good. PTC on Wednesday (and Dassault Systèmes on Thursday, blog post in the works) reported that demand remains solid. PTC customers’ appetite for subscriptions continues to surprise as it came in significantly ahead of PTC’s expectations — that meant that more revenue was deferred than the company had planned on, which led to a smaller FQ3 profit than Wall Street had been expecting. But the Street recovered, and PTC’s share ended up just under 2%,

We need to realize that this is no longer the old PTC. PTC now sells CAD/CAM/CAE and PLM — long its core products; Service Lifecycle Management (SLM) solutions that help manufacturers extend their customer relationships beyond the time of sale; Application Lifecycle Management (ALM) to manage the software content that’s creeping into more and more traditionally mechanical products; ThingWorx, the Internet of Things (IoT) platform and Vuforia, the company’s augmented reality (AR) platform. That’s a broad portfolio, addressing old-school brick-and-mortar manufacturing companies, quick and agile teams that make apps, service groups that want to build 30-year relationships with their customers, and a lot of all of the above who are trying to figure out if Iot and/or AR fit into their business plans. Subs transition aside, this is a complex mix of products, customers, pain points, selling channels and strategies, and the results can be tough to predict.

The FQ3 details:

  • PTC reported total revenues for FQ3 of $289 million, down 5% as reported and down 5% in constant currencies (cc)
  • License & subscriptions (L&S) revenue was $77 million, down 9% as reported and slightly below the guidance range of $79 million to $84 million since more than anticipated came in as subscriptions. PTC estimates that L&S revenue could have been $11 million higher, had those customers chosen perpetual rather than subscriptions. It’s funky math since it’s “what might have been”, but in that scenario, PTC would have beaten its L&S subscription targets
  • Perpetual license revenue was $45 million, down 33%, as more people opt for subs, leading to
  • Subscriptions revenue of $32 million, up 85%
  • Maintenance (aka support) revenues of $162 million was down 2% as reported (down 3% cc). PTC said this was due more subscriptions but also to “fewer support win-backs in the channel as we launched a new support win-back subscription conversion program during the quarter.” PTC’s not alone in this: lots of people buy perpetual and don’t buy maintenance. Win-backs are incentives to get these people to re-up; in PTC’s case, with the added incentive of switching, perhaps, to a subscription. (See further down.)
  • In total, software revenue was $238 million, down 5% (down 5% cc).
  • Services revenue was $50 million, down 6% as PTC continues to shift work to partner companies
  • License & subscriptions bookings were $105 million, up 32%, with 58% of bookings coming in as subscriptions. That’s more than 3.5x the proportion a year ago (when 16% of L&S bookings were subs) — in part due to channel participation. PTC says that “PLM and SLM continue to lead the transition with mix in the 55% to 70% range, but CAD is closing the gap, with 50% mix in Q3, due in part to continued progress in our channel.”
  • Unfortunately, PTC no longer reports revenue by brand, but rather by Platform and Solution. Solutions Group (CAD, PLM, SLM, ALM) revenue was $218 million, down 5% (down 5% cc). PTC says this is squarely due to the subs transition, and that it would have reported 9% cc growth had these deals all gone perpetual — would have been “strong growth [cc] in CAD, PLM and SLM.”
  • Technology Platform (IoT, AR) revenue was $21 million, up 1% on a tough comparable a year ago, when 3 big deals totaled $9 million. This bucket includes the recent Kepware acquisition which contributed $6 millionExcluding Kepware, Platform revenue was down 26% because of those large deals. Mr. Hepplemann said that “IoT saw significant growth in bookings and transaction count, both from our direct customers and from our partner ecosystem.”
  • By geo, revenue from the Americas was $121 million, down 10%. Software revenue was $105 million, down 6%. L&S bookings in the Americas were up 38% as reported and in cc. But check this out: PTC says that subscriptions as a proportion of L&S booking “increase[d] … greater than 250% leading to a software revenue decline of 6%. We estimate that, on a constant currency, license mix-adjusted basis, software revenue would have grown 10%”. As it is, “subscription revenue grew nearly 50%”
  • Revenue from Europe was $109 million, down 1% (down 3% cc). Software revenue was $83 million, down 5% as reported and in cc, as subscriptions as a portion of total L&S were up 15% — if this had been perpetual, software revenue would have been up 1%. As it was, subscription revenue doubled year/year. Bookings were down 4% as reported and in cc
  • Revenue from Japan was $26 million, down 3% (but down 35% cc) while software revenue was $21 million, down 4% (down 10% cc). In one year, subscriptions went from 0 to “over half” of bookings in FQ3, leading to the software revenue decline. PTC thinks that, had these deals been perpetual, software revenue would have been up 39% cc. Bookings were up 142% (up 118% cc), PTC said that subscriptions made up only 4% of bookings in FQ3, which reflects what others say about this market’s preference for perpetual licensing
  • Revenue from the Pacific Rim was $33 million, up 1% (cc). Software revenue was $29 million, up 2% (up 7% cc).The subs mix here, too, grew at an insane level, up 10x as a proportion of total L&S bookings, and up 450% in revenue terms. Bookings were up 35% (up 42% cc)
  • Finally, PTC reports that direct revenue was $216 million, down 9%, while indirect revenue was $73 million, up 8%, mostly because subs are still being rolled out to the channel.

PTC forecasts FQ4 revenue of $305 million to $310 million, with lots of “unpredictable” related to the subscription/perpetual mix. That would mean a total for fiscal 2016 of $1,160 million to $1,165 million, a slight decrease from earlier guidance because …. more subs. For the year, PTC anticipates bookings in the range of $370 million to $380 million, which an increase of $8 million from last quarter’s guidance and would show growth of 6% cc over last year.

The big question on your mind is probably: “Why are so many people choosing subscriptions when all I see online is how many people hate the whole idea? (Looking at you, Autodesk!)” It’s not a simple answer, and it’s different for each buyer. The first is that Autodesk’s decision to offer only subscriptions immediately upset people who reacted viscerally to the removal of a choice. If we start thinking rationally about it, a subscription makes sense for buyers who don’t want to pay a lot upfront, who like the incentives sellers bundle into the offering to get buyers to switch, who like the “turn on//turn off” dynamic — and perhaps who are swayed by sales people incentivized to move subs. Autodesk’s decision to rip off the bandaid makes sense when we see how hard it is for PTC to predict what buyers will choose; it reported lower-than-expected profit because it can’t gear its business to suit the revenue that does come in in any given quarter, leading to lower profit.

This is why it matters to PTC: “For Q3’16, approximately 81% of software revenue came from recurring revenue streams, up from 73% in Q3’15.” And “Annualized recurring revenue was approximately $780 million, [up]6% com pared to Q3 2015 and [up] 5% sequentially.” PTC wants that predictability, that visibility into revenue that’s already booked before the year even begins.

PTC said this week that it is a full year ahead of its plan in this transition, and now expects that 46% of L&S bookings in fiscal 2016 will be subscriptions, ahead of their earlier expectation of 44%. In part, this is due to the product mix: CAD/CAM/PLM buyers seem to prefer subscriptions as over 50% of bookings are now subs, while those in Asia aren’t sold on the idea. This means that PTC will continue to struggle to forecast total revenue in any given quarter, given that a large Creo or Windchill deal could be subs — or not.

Another element of the subscription dynamic is maintenance. In the old world, one bought a perpetual license for, say, $10,000 and paid maintenance of, say, $2,000/year. So in year one, the tab was $12,000. In year 2, $2,000. In year 3, 4, 5, 6, etc., $2,000. In most cases, this was governed by a maintenance contract that was negotiated in advance — discounts for a large number of licenses, added premiums for quicker support, etc. PTC has been reporting that maintenance customers are also opting for subscriptions — so turning their perpetual licenses into subscriptions. This means the subscription revenue total goes up for the quarter, while the maintenance number goes down. PTC said there were 19 such deals (but without giving us a revenue impact) in FQ3. It’s interesting: CFO Andy Miller said that some customers didn’t switch to subs because they had negotiated below-market maintenance rates; PTC renewed their traditional maintenance contract at somewhere between market rate maintenance and what a sub would cost.

Forgetting the complexities of subscription accounting. let’s look at product families. PTC no longer gives us a breakdown, but said that Solutions Group (CAD, PLM, SLM, ALM) revenue was $218 million, down 5% because of the subs transition; absent that, the group would have reported 9% cc growth with “strong growth [cc] in CAD, PLM and SLM.” Long-term, PTC sees this group driving growth at about 6%, which it sees as comparable to the overall market for these solutions. If FQ3 is any indication (and if PTC’s math is solid), then that 6% certainly looks achievable. BUT only if PTC can shift its market-facing materials from all-IoT-all-the-time back to something the CAD and PLM audiences for whom IoT isn’t a thing. Creo 4.0 looked good at ThingWorx last month; I hope PTC spends more cycles promoting it than have been visible (to me, at least) so far.

What about the all-IoT-all-the-time part of the business? Without the contribution from Kepware, Platform revenue was flat even as bookings grew over 50% sequentially. We need to remember that this is a tiny part of PTC’s business right now, but with significant potential as pilot implementations turn into real projects, and then into real end-customer products. That timeline is hard to predict, but PTC clearly hope to ride the crest of that wave well into the future. When it happens.

At LiveWorx, PTC started doing a better job at messaging how this all fits together. One example was its new Connected Service Parts Management solution, which ties together IoT (get data from assets to plan services), SLM (what parts do we need?) and perhaps CAD (where do those parts go, again?) and VR (how do I install this?). Forecasting and planning service calls will let SLM companies improve service levels and increase customer uptime, while improving profitability by carrying fewer spare parts in inventory. That’s a very compelling story that will resonate with more and more of the installed base — and has absolutely nothing at all to do with the subs vs perpetuals narrative that’s swirling around the company right now. How you sell something matters, but it’s far more important that you have something interesting to sell. And I think PTC does.

One last thing: investors are smart. They understand that you can’t drive a billion dollar ship on a hundred million dollars of revenue. This week’s earnings call included a couple of sections that are worth reading. Here’s my transcription of the question and Mr. Heppelmann’s reply:

Q: Is there innovation coming, to stabilization the CAD base? And there’s talk about a cloud version of Creo — what’s the timing and how feature-rich is [the cloud offering] versus an on-prem[ise] offering?

A: The cloud-based CAD will come in phases. Some early phases involve repositioning the product largely in its current form but served through a cloud SaaS model. Then, subsequent to that, we’re likely to go into some deeper phases where we remodel the architecture to fully optimize it for the cloud.

You’re going to see us take some steps that allow somebody to purchase Creo, sort of as it now, in a cloud SaaS model. And then I think you’ll see the product evolve from there in more significant ways that represents something a little bit more to re-think. But that will be an option. We’re not going to take it off the market in its current form. We got a lot of customers who quite frankly use it on-premise and like it that way. So this for us will be an optional way to deliver the power of Creo.

Q: So you see it as more incremental to the base rather than potentially a cannibalistic product?

A: Yeah, we’re definitely not trying to flip the base to cloud. If some of them want to go there, absolutely. I think what we see is an incremental opportunity to do a better job participating in the low end with different pricing schemes, different delivery schemes, digital marketing schemes — things like that, that have kind of not really been in our playbook here today. So I think this means we run the CAD business as we know it and pursue an incremental opportunity enabled by a different technological delivery and go-to-market model.

I so wish the question had been broader. What’s in Creo 4.0 besides cloud? Lots, as it turns out, and some of it is quite innovative. Later, a question about Windchill releases was answered this way by Mr. Hepplemann:

A: More and more, we think about now how would you use elements of our existing product suites and their new technology to systematically transform the way you do engineering. And it’s kind of like an orthogonal view to selling more Windchill and more Creo. It’s sort of like, “how would you use Windchill, or Creo or Vuforia, ThingWorx, analytics to do engineering in a different way?” … So it’s a different way of looking at it. It kind of ticks me off staring at product release schedules and thinking more about the transformation roadmap which is something that I think we owe the world more detail on. We introduced it at LiveWorx but we need to go deeper so people understand that better.

Yes — you do! And it would be very helpful to learn the path forward for your diehard Creo and Windchill users, especially those who don’t right now see themselves in an IoT world.