Have PTC’s Parallel Product Lines Created a Conundrum?

New customers’ choice of SaaS over desktop products may be lowering company revenue.

PTC profit shot up in Q4 – then fell back to Earth. The spike was a result of a change in tax accounting and $69 million profit from an investment in Matterport. (Picture courtesy of TenLinks)

With both revenue and profit taking a dip in Q1 of FY2022 for PTC, should investors be worried? Not if they take a longer look back. The numbers over the last year will be reassuring. The precipitous decline in profit in Q1 (almost quarter billion dip from the previous quarter) was because the previous quarter was a freak. More on that later. The $46 million profit of the last quarter is more in line with the moving average of profit over the last two years.

Over the last year, the revenue alternates up and down – and may be a real reason to worry for the long term. PTC has created parallel product lines, one with desktop-based applications and one with cloud-based applications. Is growth of the latter coming at the expense of the former?

The Call

We read the transcript of the earnings call. Earning call are meant for financial analysts. For engineers they are an exercise in decoding financial speak and generally require reading between the lines of “another strong quarter” and “big wins” despite numbers that might be to the contrary.

In PTC’s most recent earnings call, CEO Jim Heppelmann refers back to the momentum built in previous quarter and an ARR of $1.5 billion for last year. Heppelmann is proud of recently adopted Arena Solutions, commenting on strong sales. Arena has given PTC a mid-market solution in PLM, which it did not have previously, as we pointed out last quarter.  

PTC’s latest quarter is lower in revenue and profit (see above chart) both sequentially and year over year. But instead of revenue and profit, the talk is of ARR, or annual recurring revenue (more on that later, too).

Heppelmann welcomed one large manufacturer back into the fold after their misguided adventure with a competitor. The giant German automotive supplier, Schaeffler (12.6 billion euros and 84,000 employees), had defected to Aras in 2017. Aras touted the 20,000 seats taken from PTC as another victory. The company had previously signed Airbus and were high from joining the ranks of the PLM elite, the few able to service truly large enterprises.

Last quarter’s USAF contract for PTC’s SLM (service lifecycle management), worth as much as $95 million contract if all options are exercised, is worth re-mentioning — especially in lieu of big wins this quarter. We are reminded of PTC buying Servigistics in 2012 for $220 million. There was PTC again venturing outside its core of CAD and PLM to “land and expand” in another. Supply chains, which include SLM, may have meant everything to the US military but meant little to anyone else at the time. Flash forward and here we are with supply chains broken down and shortages the world over. 

We pause to give PTC points for prescience.

PTC underwent a reorganization late in 2021, with plans to lay off an undisclosed number of employees and restructuring its product groups. The company had 6,500 employees worldwide and the cuts would contribute to a savings of over $60 million dollars a year according to estimates by the Boston Globe.  The timing of the cuts may seem odd, coming on the heels of the freakishly good quarter with profit shooting up to $293 million (from $51 million in the previous quarter). The windfall was a result of a low-key[i] investment and a one-time change in tax accounting. PTC had made a $78 million investment in Matterport in 2019 that yielded $69 million profit when Matterport went public.

The Business of CAD and PLM

PTC Velocity Group ARR growth year over year (Picture courtesy of PTC)

According to the PTC presentation during the earnings call, Onshape’s ARR grew by 53% year over year and Arena’s ARR grew by 20%. Together, the products constitute the Velocity Group, which had a 28% growth to $78 million year over year. The Velocity Group serves the mid-market, as opposed to enterprise customers, and is led by West Point graduate, Mike Ditullio. ARR is emphasized over ordinary revenue by software vendors who have pivoted from perpetual to subscription licensing. After Autodesk switched to subscription licensing years, we were to hear of ARR for more than two years.

From the ARR for the Velocity Group and the growth in each product, we calculate Onshape’s ARR in Q1 FY2022 to be $22 million, up from $15 million, and Arena’s ARR as $56 million, growing from $46 million. However, this does not agree with the $10 million ARR listed for the Velocity Group in Q1 FY2021, when the Velocity Group consisted of only Onshape. PTC was asked about the discrepancy but has not responded.

PTC placed a huge bet on Onshape (acquired for $470 million net in October 2019) as the future of CAD and SaaS while hedging its bet with its Core Products Group (which includes Creo). It was a bet based on the potential of Onshape despite its revenue. Onshape has been tightlipped about their revenue since its inception. One industry pundit estimated the company’s annual revenue had grown to $10 million. by the time it was acquired by PTC. However, the revenue for the Velocity Group in Q1 FY2020, and therefore Onshape, is revealed by PTC as only $1 million.

By Q1 FY2021, Onshape’s—and therefore the Velocity Group’s—revenue rose to $2 million. Revenue for the group jumped to $10 million in Q2 FY2021, the first quarter that included revenue from Arena Solutions. Arena, an even bigger bet by PTC on SaaS than Onshape, was acquired in December 2020 for $715 million.

PTC group revenue quarter by quarter (from data supplied by PTC)

“The time for SaaS has arrived in our industry and PTC is very well positioned. We’re already the SaaS leader in our space with continued strong SaaS growth in Windchill and FSG and high levels of growth in our cloud-native velocity business unit,” said Heppelmann addressing the financial analysts during the earnings call. “Sharing the Atlas SaaS platform, we have a dual strategy to win with Onshape and Arena powering a new agile product development approach, while we transition our digital thread portfolio and existing customer base to SaaS to elevate the platform strategies that so many larger companies have.

While revenue growth of the Onshape/Arena group has yielded impressive percentage growth every year that includes Arena revenue, total revenue for the Velocity Group with its SaaS products is still small in comparison to PTC’s total revenue. PTC’s bread-and-butter products—its Core Products Group of desktop products—contributed $282 million to the software total in Q1 FY2022, 16 times the revenue of its Velocity Group’s SaaS products.

Growth of the Core Group experienced heady growth since Q3 FY2020 but started flattening and acting erratic in Q2 FY2021, the same quarter that Arena pitched in revenue. Coincidence? Since Q2 FY2021, fluctuations in the core group have been more than the entire revenue of the Velocity group. Were sales of the company’s traditional desktop products being shook up by sales of the newer SaaS products?

If so, having functionally equivalent product lines, one with desktop products and one with less expensive SaaS products, may prove to be a significant challenge to PTC business in the next few years. If PTC customers migrate towards the company’s lower priced SaaS offerings, the company’s top line will suffer. Companies that have successfully transitioned from desktop applications to SaaS and increased revenue in the process have structured subscription pricing to match or surpass revenue generated from the sale of perpetual licenses and upgrades. Adobe is perhaps the best example of this transition. PTC may not be able to structure SaaS pricing high enough to match or surpass Creo and Windchill revenue because of their two-tier structure. PTC has one tier with lower cost for small and medium sized business, for whom initial and ongoing cost is most critical.

PTC may think the Core Products Group, although buffeted by market conditions, lack of big deals (this last quarter) and the pandemic, nevertheless able to hang in there while it nurtures emerging technologies (AR, IoT) and Atlas, it’s SaaS platform of the future, and grow its SaaS applications. Its SaaS applications are its babies and are growing fast. Give them time to grow and mature, and by the time the old products are ready to retire, the new products and technologies will be mature and ready to serve all customers.

“I’m pleased with PTC’s position and the opportunity that lies ahead,” concluded Heppelmann as he turned the microphone to his CFO.