Q3 2019 Earnings Call
[laughter].
Good afternoon, ladies and gentlemen, thank you for standing by and welcome to the PTC 2019 third quarter Conference call.
During todays presentation, all parties will be in a listen only mode.
Following the presentation the conference will be open for questions.
This call is being recorded if anyone has any objections you may disconnect at this time.
I would now like to turn the call over to Tim Fox Ptcs Senior Vice President of Investor Relations. Please go ahead.
Thank you Sue good afternoon, everyone and thank you for joining Ptcs conference call discussing our fiscal Q3 19 results on the call today are Jim Heppelmann, Chief Executive Officer, and Christian talented Chief Financial Officer.
Before we get started please note that today's comments include forward looking statements.
Greetings statements regarding future financial guidance and these forward looking statements are subject to risks and uncertainties and involve factors that could cause actual results to differ materially from those expressed or implied in such statements.
Additional information concerning these factors is contained in Ptcs filings with the FCC, including our annual report on Form 10-K , and quarterly reports on Form 10-Q .
Forward looking statements included on this call represent the company's view on July 24th 2019.
PTC disclaims any obligation to update update these statements to reflect future events or circumstances.
As a reminder, we will be referring to operating and non-GAAP financial metrics during today's call.
Discussion of our operating metrics and these items excluded from our non-GAAP financial measures and a full reconciliation of GAAP to comparable non-GAAP financial measures under both assay six five and six or six are included in this afternoons earnings release materials and related Form 10-K .
I'd also like to remind everyone that starting with fiscal Q1 19, we adopted assay six or six on a modified retrospective basis.
In our press release and prepared remarks, we've provided results under both six or six and six so five as well as under reconciliations between the two.
We have also provided guidance under both standards.
Finally, please note that the FCC requires the presentation of six so far results for comparability with prior year results.
Thus for such comparability our discussion on this call will focus on six so five results unless otherwise stated.
Also please note that certain operating metrics such as bookings in HCV.
non-GAAP financial measures such as free cash flow.
The same under both six so six and six so five and with that let me turn the call over to Jim.
Thanks, Tim.
Good afternoon, everyone and thank you for joining us.
Before we discuss our third quarter results I'd like to address the bigger picture regarding our performance to date and outlook for the balance of the fiscal year.
And discuss why despite having to navigate some near term challenges. We remain confident about PTC is long term growth opportunity and our ability to drive significant value for our customers and shareholders.
Through the first three quarters of fiscal 19, we've seen relatively strong performance on revenue and they are our metrics, but on the bookings front, we're disappointed with our performance relative to the outlook, we provided at the outset of the year.
With Christian coming on board and the benefit of his fresh perspective looking at our first three quarters of performance and full year outlook. We studied how the year has evolved so far versus our plan.
Through this analysis, it's become clear that the subscription transition has different impacts on different areas of the business.
To be clear there have been many many areas of strong performance, especially in our growth business of biotech and they are.
What we had not anticipated where some after effects of our subscription transition that are causing stress in the system.
And creating meaningful headwinds to bookings growth this year.
You can see these effects in our Q3 booking results and again in our Q4 guidance.
Christian will elaborate on the details, but the subscription cutover has created two specific short term challenges that I'd like to discuss.
First software bookings in geographies, such as China and Russia.
Which are sold primarily through our channel have declined materially following the end of perpetual license sales there.
Fortunately, we don't have a significant exposure in these countries, but this decline nonetheless cost us a few points of bookings growth versus our plan.
The second issue related subscription is a year or year over year decline in large VPA conversions VPA being volume purchase agreements.
As we cycle through the cohort of our largest support contracts over the past three years.
We converted many of these large VPA customers to subscription.
For customers that did not convert in most cases, we increased the support run rate.
This support price increase boosted our growth.
But note that per our convention, we did not count the incremental support HCV as new bookings.
As the customers, who did not convert come up for support renewal again, we get another chance to try to convert them to subscription.
However, we are seeing a much lower hit rate on this second pass as these customers are less incented to convert given that they've already accepted the higher support pricing.
We will need to adjust the offerings, but in the meantime, this year over year slowdown in large VPA conversions cost us a few more points of bookings growth.
The final factor, which is not specifically related to the subscription transition.
Was our execution on the resource shift from our productivity zone into a growth business that we discussed at length last quarter.
The shift has benefited our growth business significantly it continues to have a great year and bookings were strong again in Q3.
We've closed the sales hiring gap to the point that this is a non issue and the growth business now but of course, we need to keep the recruitment engine going to meet our ongoing growth means.
But as we've discussed previously a side effect of the resource shift has been a bookings deceleration in the productivity zone that was steeper than contemplated in our fiscal 19 plan.
And this tool cost a few more points of bookings growth.
When taken together these challenges have combined to create a double digit bookings growth headwind.
They represent a one time step down to what I see as a new normal bookings baseline.
The good news is that this new baseline will be a lot easier to grow from going forward.
It's important to note that inside a year, where we encountered the strong bookings headwinds there are many other things in our core and growth businesses that worked well.
In fact, our core CAD and PLM businesses.
Together with our identity and a our growth businesses.
Our expected to grow a combined 20% this fiscal year in those areas not impacted by the headwinds I just reviewed.
So the core CAD and PLM and the Aiotv and they are growth businesses would be on track to deliver the low double digit bookings growth. We had planned for if not for the unplanned headwinds that have reduced the forecast to low single digit bookings growth this year.
I do want to stress here how important it is to remember that we are talking about a bookings growth slowdown.
Whereas a are are a better indicator of future growth in the subscription business has increased double digits in the same period as have margin and cash flow.
So after whats turning out to be a transitional fiscal 19, that's resulting in a push out of our $850 million free cash flow target to 2024.
It's fair to ask what gives us confidence in achieving this plan.
Frankly, it's because we are fundamentally in a stronger position now than we were a year ago on almost every metric and many of these onetime challenges are now behind us.
Compared to June of 2018, when we first established this five year target. We now have significantly more or are more margin and more cash flow.
And we have higher bookings and lower churn until.
Heading into fiscal 20 will be growing off a run rate that as compared to 2018 has significantly less exposure to the onetime headwinds have been discussing.
I Trust you all believe that the $850 million of free cash flow remains a very attractive target even if it happens in 2024 and now the bar to get there is a lot lower than it was a year ago.
The bottom line is that the subscription transition effects have a short term impact yet we're more confident than ever about our ability to achieve that $850 million free cash flow target.
We also remain confident the PTC will emerge as one of the Premier public software companies in the next few years.
And that will create a lot of value for customers and shareholders in the process.
So with all that as context, let me turn now to our Q3 results.
Our financial performance across revenue earnings and our AR was solid once again this quarter revenue was in line with guidance.
Operating margin was at the high end of guidance and EPS came in at the high end of guidance.
Q3, A.R.R. of $1.1 billion grew 13% year over year and improvement of 200 basis points in growth rates over Q3 of 18, reflecting the strength of our maturing subscription business.
Excluding the currency impact.
Related to our guidance Q3 bookings of $110 million was at the lower end of the guidance range, primarily due to channel performance, mostly attributable to the phase out of perpetual that I mentioned earlier.
On a constant currency basis, Q3 bookings were flat year over year against very strong Q3 of 18 performance when we posted year over year bookings growth of 26%.
Let's turn now to our high growth Aiotv business, which in terms of reporting includes our AI business.
I mentioned that Aiotv bookings were again solid in Q3.
Consistent with recent quarters Aiotv bookings came from mix of new customer acquisitions and from expansions with the letter accounting for over 60% of Q3 Thingworx bookings.
Q3 was also another strong quarter for large deals with five seven figure deals, including for expansions and one new logo deal.
The large expansion deals came from a variety of vertical markets for both smart connected processes or factory use cases, and smart connected product use cases.
Notable wins came from Eaton.
A diversified power management supplier.
From NCR Corporation, a leading global provider of digital solutions for retail hospitality and banking.
And from UTI see aerospace, whose further deploying thingworx in their factories.
Turning now to our augmented reality business, we delivered another strong quarter there as well.
The number of six figure deals, which began to accelerate in Q2 continued to increase in Q3 driven in part by the early success of Vuforia expert capture which was just launched in April .
Clearly the recent trends, we're seeing in a are very promising and providing more evidence that industrial adoption is broadening and that this business is blossoming into a big hit for PTC.
Elsewhere and I don't see any are we are pleased to see our strategic alliances continue to gain traction.
On the Rockwell automation front, the pace of business accelerated again in Q3 with 34 deals closing in the quarter, including two firsts for the alliance.
This quarter marked the first before your expert capture deals sold by Rockwell automation, which was a sizable order in the pharmaceutical space.
We were also pleased to see the first smart connected product deal close by Rockwell.
The Sep use cases, an exciting adjacent market opportunity for Rockwell automation, where they can sell the factory talk innovation suite into machine builder customers, who embed rockwell controls into the products that they in turn sell into the market.
With over a 1000 opportunities in the pipeline and the positive outlook for Q4, our confidence around the success of this strategic alliance grow stronger every quarter.
Turning now to the Microsoft Alliance Q3 performance was once again strong with 36 deals closed in the quarter along with a notable increase in average deal size.
Fueled by three seven figure transactions.
Bookings doubled sequentially over Q2.
And again this past quarter, the composition of Microsoft deals extended beyond the smart connected product use case with a meaningful uptick in hybrid cloud factory deployments in pure cloud deployments hosting ptcs augmented reality solutions.
You may have heard this at Liveworx, but PTC was named Microsoft's partner of the year.
In manufacturing.
And again separately in mixed reality.
And we were also runner up to our joint partner Accenture and Aiotv.
Clearly Microsoft has tremendous momentum with Azure right now and we're pleased to be so closely aligned with them in aiotv and they are and manufacturing.
To summarize on Io TNF IR Q3 provided another strong data points, suggesting that adoption of these technologies continues to accelerate across the range of vertical markets geographies and use cases.
Let me turn now to our core CAD and PLM business.
Q3, combined CAD and PLM bookings declined modestly year over year against a tough comparison in Q3 18 with the biggest drivers being a bookings decline in our CAD channel related to the subscription transition headwinds I mentioned earlier.
On a positive note we continue to see good signs of early traction for Creo simulation life, our groundbreaking CAD solution using real time simulation technology from our strategic alliance with Ansys.
We closed 76 transactions in the quarter with average deal sizes, well above Q2 levels and we landed the largest follow on order to date with the leading defense contractor that intends to deploy Creole simulation live to hundreds and potentially even thousands of engineers across multiple business units.
While it's still early we're encouraged to see a growing pipeline and commercial adoption, that's beginning to accelerate.
We were pleased to see the continued solid performance of our core PLM business.
Which delivered above market bookings growth in the quarter.
Driven by strong expansion activity.
Customers increasingly understand the role of PLM as a backbone for digital transformation and they're investing accordingly.
To wrap up my comments from a growth perspective, our core PLM businesses performing well.
And our high growth in air businesses continued to gain significant market traction.
We remain confident that our cat businesses fundamentally well positioned.
And that the subscription related headwinds are transitory.
With that I'd like to welcome Christian to our earnings call and turn it over to him.
Great. Thanks, Jim and good afternoon, everyone.
Before I review our results I'd like to note that I'll be discussing non-GAAP results and guide.
And all growth rate references will be in constant currency.
And as Tim mentioned earlier.
We adopted the new Rev. Rec standard FCC, so six under the modified retrospective method on October Onest 2018.
For year over year comparability purposes.
I will be discussing our outlook and results under six so five unless otherwise stated.
Also please note that certain operating and non-GAAP financial metrics, such as bookings HCV and free cash flow are the same under six so five and six so six.
We've provided SC six so six guidance in our press release and our prepared remarks.
So starting with the long range plan, we are resetting our long range targets to be clear, we remain committed to achieving $850 million in free cash flow, but given our year to date performance in the current.
Outlook for this year.
We believe that it's appropriate to plant Betsy stake solidly in fiscal 2004 ground.
As Jim stated in his opening remarks, we're not satisfied with our overall performance this year.
Transforming a complex global company comes with challenges, but fundamentally there is a very positive growth story here. The changes made throughout the course of this year.
Have put in place the foundation for PTC to become a premier high growth.
Hi profit recurring revenue software company, and we remain firmly committed to that objective.
We will provide more detail around both our fiscal 20 and long range targets under AOCI six so six in November on our normal timeline.
Now turning to guidance frankly, we're taking a prudent approach there are some ongoing effects of the subscription transition within our channel primarily related to the end of life perpetual software.
End of life of perpetual software in certain geographies and we don't expect this to improve in Q4.
Additionally, on the direct side, our support conversion program is expected to remain a bookings headwind in Q4.
Particularly as it relates to large deal volume.
And we're not forecasting any mega deals in the quarter.
Clearly the macro environment is also not helpful. At this point and while we don't feel that it was a major factor in our Q3 performance. We are watching the situation carefully and are mindful of it in our Q4 outlook.
For the full year, we now expect bookings in the range of $458 million to $468 million.
This represents growth of 1% to 3% on a year over year basis.
We expect a full year subscription mix of 84% and to exit the year in Q4 with about 93% mix.
We are trimming fiscal 19 total revenue by $8 million at the midpoint to a range of 1.31.
<unk> billion to $1.32 billion, which represents growth of 7%.
Year over year, driven by software growth of 9%. Despite a 1600 basis point increase in subscription mix.
Recurring software revenue is now expected to be.
Approximately $1.2 billion or growth of 13% and is expected to be 94% of total software revenue for the year.
Our fiscal 19 operating margin guidance is 22% to 23% representing a year over year increase of approximately 400 to 500 basis points, reflecting ptcs well demonstrated approach to controlling spending.
We now expect operating expenses to increase only 3% year over year in constant currency.
Our effective tax rate is expected to be 18%, resulting in non-GAAP EPS of $1.73 to $1.78, which has approximately 21% growth at the midpoint.
Based primarily on our expected bookings performance for fiscal 19, we're reducing our free cash flow guidance by $30 million to a range of $235 million to $245 million and adjusted free cash flow of 260 to 270 million, which excludes cash payments for restructuring of approximately $25 million.
As with operating margin, we expect free cash flow to accelerate significantly in fiscal 20 as the subscription model matures.
Moving now to our third quarter results Q3 bookings that guidance FX, we're at the low end of our guidance range.
Primarily due to channel performance in certain regions and subscription conversion activity.
Outside that we saw bookings strength in the Americas across all product offerings, and we saw continued strength in our high growth business and solid growth for our PLM offerings.
Our solid Q3 financial performance reflects the strength of our subscription model with revenue margins and EPS, all within or at the high end of our expectations.
Moving on to the income statement.
Under the new Rev. Rec standard FC six so six total revenue in Q3 was $296 million operating margin was 13% and EPS was 23 cents.
Under assay six so five total revenue in Q3 was $323 million up 6% year over year and software revenue was $282 million also an increase of 6%. Despite a 1300 basis point increase in subscription mix.
Subscription revenue grew 39%.
Please refer to our prepared remarks document on our website, where we reconcile our six so six results to our six so five results.
Importantly, our AR grew 13% year over year to $1.088 billion.
This is a metric that I'd like to draw more attention to especially given that we're now primarily a subscription business as I mentioned that live works in fiscal 2000, you will be doing away with the current reporting framework, which frankly is anchored in a perpetual company view of the world.
So when we provide more detail on fiscal 20 in the revised L.R.P. targets in November we will be using the go forward six so six based reporting framework and using financial and operating metrics that are important to a subscription company.
Suffice it to say that our AR and cash flow will be critical elements of that framework.
Continuing through the six so five P.M. now Q3 operating margin of 19% at the high end of guidance reflects a 100 basis point improvement year over year.
EPS of 36 cents also at the high end of our guidance range.
Reflecting continued discipline on total spending.
And moving to the balance sheet, we remain committed to a balanced capital strategy.
We successfully completed the $1 billion Asrs that we entered into in Q4 of 2018.
In fiscal 19, we intend to repurchase shares equal to at least 40% of our F Y 19 free cash flow.
And as a reminder, last month at our Investor meeting, we increase that commitment for fiscal 20.
And starting next year, we have committed to return at least 50% of our free cash flow to repurchase shares.
In Q3, we used 25 million to repurchase 287000 shares at an average price of $87.
And we repaid $40 million on our revolving credit facility.
And wrapping up just to be explicit about our Q4 guidance under ASV six so five.
We expect bookings in the range of 135 to 145 million total revenue is expected to be in the range of $330 million to $338 million.
Q4, operating expenses are expected to be $189 million to $191 million, resulting in.
Operating margin in the range of 21% to 22% and EPS of 42 to 47 cents.
So with that I will turn the call over to the operator, and we can begin the Q and a.
Thank you we will now begin the question and answer session in order to provide everyone. The opportunity to ask questions. We ask that you limit your questions to one question only if you have further questions simply re insert yourself back into the queue and your additional questions will be answered as time permits.
To ask a question. Please press star followed by one please ensure your phone is on muted and record your name clearly when prompted again that is star followed by one to ask a question. If you need to withdraw your request press star two one moment. Please for the first question.
The first question comes from Ken Talanian with Evercore ISI you May go ahead.
Thank you.
Thank you for the question.
Could you give us a sense for that person.
Bookings relative to guidance that you've already closed in the quarter compared to what you typically close in July .
I don't actually think we have that data in front of us I think it so far feels like a pretty normal quarter.
For Q4.
So I mean, if you're really going to do we see some macro thing unfolding I think the answer is no.
Okay, and I guess you noted in the prepared remarks, you done because it may closing any.
For acute just to clarify were there any deals in your guidance.
There are no longer there and if they are in the pipeline what are the main issues to getting them closed.
Yes.
First just to remind everybody if a deal is more than a million dollar in PCB booking recall that large deal and the Mega deal, we refer to as more than $5 million in PE bookings.
So.
Keep in mind that a lot of times these big deals might be associated with a conversion.
And.
Because we don't see the conversions happening at the rate that we had been enjoying let's say a year ago.
We're a little reticent to assume that.
Deal that might be a large deal could be grossed up to a mega deal. So there's no deals we're losing.
There certainly are deals that could come in smaller and meaningfully smaller than.
Than we might have expected a quarter or two ago. When we were more confident about the impact that conversions would have so I think we're just being conservative you know we'd love we love. The surprise you didn't show up with the Mega deal, but I think.
At this point given the trend that we see in the data we don't feel like it would be prudent to.
To guide that way.
Great. Thank you.
Thank you. The next question comes from Ken Wong with Guggenheim Securities You May go ahead.
Great. Thanks for taking my question guys.
You guys mentioned.
VVA is or you guys had a tough time converting those.
No of the VA as you guys have remaining at any rough sense I guess, one what percent of.
Our still left to convert and as we think about when you convert like what's the potential uplift that we could we could potentially expect you're going to have to take that down from the 20% to 25% you guys are seeing in the past.
You want to take that one.
Yes sure.
So.
I think that we can break the conversions out into two or three different.
Different cohorts theres, the large BPA days of which.
We have converted approximately.
Half of them.
Over the past two to three years.
So lets say half in the first pass in the in the first path.
That there's still.
More of them.
About a couple of hundred left.
That have a significant support run rate I think if we look over the past.
Three years, when we were doing the conversion from the first pass for the for the large ones.
We were seeing uplifts.
In the 40% to 50% range off that run rate.
So we think there's still a significant opportunity.
For customers to get value out of this.
Program as we modify it.
And then there is a couple of other tiers theres still a tail of.
Mid tier where there is a significant significant number of customers there as well.
And then there's obviously the channel customers and frankly, we've actually seen conversions in the channel space increasing this year.
Significantly over the run rate from last year.
Maybe just to clarify some.
Data here associated with what Christian said the number of conversions is up however, it's up most in the channel space, where the conversions our smallest.
It's flat to up a little bit in the direct but not volume purchase agreement.
Cohort and then the volume purchase agreement the biggest accounts, it's down materially and so while the number is up the dollar value is down materially in aggregate.
Got it great. Thanks for the clarification guys.
And maybe maybe to clarify one other comment I said.
Christian mentioned, we got about half of these customers to convert in the first pass.
Ultimately, we plan to convert all of them.
It's just we need to go back and look at the offering.
Andy Miller always used to talk about the proverbial carrot and stick and so we need to go back to that conversation and think about how to make the carrot sway there and how to create another stake if need be.
So we're going to do it and overtime, it's inconceivable that they won't all convert because everything we sell them from this point forward will be on a subscription contract and so.
Overtime, even if they prefer perpetual and support it is going to get watered down with more and more subscription so we'll get them all.
It's just we're not getting them as fast here in fiscal 19, as we sort of have assumed we would and so we need to go do some more work to rethink the offering and go back and try to get them in a in a second pass.
Got it very helpful guys.
Thank you then the next question comes from Saket Kalia with Barclays. You May go ahead.
Hi, guys. Thanks for.
Hey, Jim Hey, Christian Thanks for taking my question here.
I'll I'll stick to the one question rule.
Maybe maybe the.
A few drivers that we've talked about here for the lower outlook for Q4, Jim if we sort of.
Puts some of the pricing things aside can you just talk about just fundamentally the health of underlying demand in CAD and PLM.
You've seen as you've talked to customers you talked about you're not really seeing anything kind of unfolding in the macro funding here in July but I would love if you could expand on that and also just given one of your competitors said. This morning, just about the competitive dynamics I was wondering if you could talk about market share dynamics.
In those core CAD and PLM businesses as well.
Yes, Saket I think if you set aside the situations that have external influences like VPA renewals or conversions and.
In this discussion about certain geographies that don't really like perpetual.
If you say aside from that how does demand look how is the business doing the business is doing very well.
The combined Aiotv Aer, CAD and PLM business were not affected by those external.
Year over year bookings up 20%. So I think we feel like the fundamental demand where companies are buying for the first time, where theyre expanding I think is very good and our competitive dynamic is very strong and we're seeing good success with the ansys stuff and so forth.
Again, this does other effects, though our material and so they've taken a lot of the wind out of the sale and.
So what should be a double that double digit bookings growth year overall gets watered down so what's going to be a single digit bookings growth year, and thats unfortunate, but we feel like.
Because the underlying fundamentals are so strong and because these headwinds have now become diminished size the base that the headwinds apply to is actually becoming quite small we feel pretty confident going forward.
So we feel like this year, we didn't make the progress we hope to this year.
But when we look going forward, we feel just as confident as we ever debts.
And anything on market share that you can talk about in CAD and PLM, Jim first I'm, referring to a little bit about what the show talked about in the call earlier any sort of share shift that you're seeing in CAD and PLM.
I mean, I think of anything PDC is holding its own now you can say in the quarter, our CAD business didn't grow but I think the solidworks business grew 4%. So I don't think.
I don't think really disclosed crushing that either right now.
But I think I think theres not a significant share shift going on I think again, if we don't talk about geographies, where we have this perpetual to subscription thing happening, which actually has nothing to do with fundamental demand, it's more business model change.
And.
If we if we look then generally at the SMB and sort of medium sized accounts its very strong so.
I don't know, we don't certainly don't think we're losing any share and.
I think from quarter to quarter, there can be little ups and downs brought on by external influences like we're seeing right now, but I think fundamentally we feel like the cat business. The PLM business in the Io DNA our businesses are fundamentally very competitive very strong and.
We expect that we're going to be in a position to have a strong growth year next year.
Very helpful. Thanks.
Thank you. The next question comes from Matt Hedberg with RBC capital markets. You May go ahead.
Okay.
Certainly Matt Swanson on for Matt.
Jim I know at the beginning of the year, when we talked about restructuring towards growth areas. The focus was not to do this in a bunch of small steps, but to align the company up with kind of a long term strategic outlook.
After the large shift do you feel that at this point, maybe that youve over rotate and maybe we need to invest resources back towards CAD and PLM or is the disruption just kind of a natural risk that comes with a change.
So Matt let me be clear, we did not shift resources out of CAD and PLM into Aiotv are we shifted resources out of places like LM SLM and what we call our classic product groups.
Small brands that rarely even get mentioned on an earnings call.
So we shifted resources out of low growth high margin businesses to make them potentially lower growth and higher yet margins and move those particular go to market resources into our high growth business, where we felt like to fuel the growth we needed a lot more resources.
So.
Yes. The consequence of that was successful on the high growth business, we're getting good growth.
But we had actually thought we'd give up some bookings growth ground.
And we gave up more than we expected now it's not worth putting resources back there those businesses are small to begin with and they are even smaller now.
They are very highly profitable to us they are kind of our small cash cows that don't get talked about that much but help us help generate profit for us.
The bookings.
The size of those businesses is small enough that what happens next year is not really going to be that impactful I mean, they were pretty small already from a booking standpoint, and having given up some ground. This year. They are actually pretty small going forward. So we would not put resources back there.
We hope to see them stabilize and be flat next year and that would be just fine, but they cannot go down as much next year in terms of bookings as they did this year because there isn't room to do that.
Just to put in perspective.
And then separate from this discussion about bookings I want you to understand the revenue and profit is going up in these businesses because in fact, the churn rates are very very low and the bookings still exceed the churn. So the size of these small profitable businesses is growing and the profit of course is growing even faster because we've taken quite a bit of resources out. So I don't want anybody to think these businesses are in decline.
The growth rate of bookings is in decline the businesses themselves continue to grow in both revenue and profit.
Thats helpful color. Thanks.
Thank you. The next question comes from Tyler Radke with Citi. You May go ahead.
Okay. Thank you, we'll take hi.
Good to talk to you guys. So.
You talked about a macro backdrop, that's not super helpful. Right. Now I was wondering if you could expand on that and then how do you think about the uptake of I O T. In a weaker macro backdrop, especially if some of these projects are more greenfield in a little bit.
You know more in the in the in the pilot phase like how does that help you factored that into your.
Assumptions relative to Aiotv with the macro backdrop. Thanks.
Yes, Tyler so I think the IOTV business, you know frankly as new enough that we haven't really been through a cycle, but.
Certainly we have no reason to believe it would be a cyclical business and frankly, we have evidence to the contrary that suggests it's a secular business.
The level of interest in digital transformation.
Is very very high and the level of demand and the level of bookings growth and revenue growth in our Iot DNA. Our businesses is very high even in this situation where the Pmires for example of kind of broken through 50 on the way down.
So we think in the data to date would suggest that aiotv in A.R.R. SEC legal secular businesses now CAD and PLM historical have shown some correlation to PMI. They are a little bit more cyclical CAD. For example is largely tied to head count if you hire more engineers you need more CAD seats.
If you're not hiring engineers, you don't but you know I don't see anybody cutting heads I, just really don't I couldn't name a single customer, thus, reducing engineering headcount right now even though the pmires are low so I think we're in a funny situation, where the job market is so strong that that.
You know and I think also the.
The fears people have about the economy, our soda short term like let's see what happens with China next week and maybe this isn't the problem after all so.
I don't think like this is a fundamental economic decline. It's just a period of uncertainty related in large part to trade in politics and nonsense like that that's got people nervous, but they're not acting on that nervousness. It appears in ways that hurt us. So we don't think at this point that the macro situation is any kind of a significant factor it might be a small factor in tiny pockets like I'll give you. One example, a lot of our Kepware software is sold with capital equipment, if somebody buys a machine and then they buy a copy of Kepware to go with it.
Maybe the sales of capital assets are down and our Kepware business, which is part of our our tea business. That's small pocket was a little bit weak, but it's not a big business is not a big part of Aiotv and frankly, it wasn't that week. So.
I think it could be a secondary factor in pockets, it's not thus far.
So far as we can tell a primary factor in what our issues are here in 2019.
Great.
And if I could ask a follow up on the conversion to subscription you mentioned some customers that.
Kind of proceeded with the maintenance price increase which caused a weaker subscription conversions, what's the what's the plan of attack there in terms of.
Converting those over going forward are you having to change your strategy. There could you just help us walk through what.
What's the strategy is thank you.
Sure I think again you need to go back and think in terms of these three cohorts. The large direct customers, who had volume purchase agreements all of the rest of the direct customers being the second cohort and the third cohort being all the channel customers. These really are three different situations and.
Situation, one has been challenged but situation too is okay and situation three cohort three is doing well so I think enough in the first cohort.
We need to go back and sweeten up the value proposition.
This proverbial carrot and stick I was talking about we need to give them more incentives to convert because in fact, they've already paid part of the tax in the first pass by paying more.
More support costs, so we need to sweeten it up and we'll do that we'll take a look at it and I think like I said in the end they will convert it's just a question of at what pace and thus far in 2019, the pace has been slower than we would have.
Expected so we need to go back and think about what can we do to sweeten it up and get them to convert faster in the end when you check back in a couple of years they'll all be subscription customers I'm pretty sure of that.
Yeah, I might just even say it is not necessarily just sweetening, it's making sure that we understand what the real value driver for them is that there was a curtain current value proposition right that was that resonated very well with a segment of customers.
But the first half and so now we just need to go back and make sure we understand.
What the what the real value driver is going to be for the second half and adjust accordingly, yes, and I might add you know there are well known.
Techniques here for example, Autodesk raised the support pricing materially.
And that created another incentive and we havent done that yet not not at all to the extreme level. They did but you know at some point, we might do that or do some variation of that to incent people really to move on to the subscription business model.
Thank you. The next question comes from Jay Fleece, However, with Griffin Securities You May go ahead.
Thank you Jay.
Hi.
Welcome back.
Christian.
Jim You mentioned, a number of short term and external influences.
To explain the bookings outlook.
Performance.
On the other hand, you also spoke about some positives.
In the business.
And then M&A audio tea.
The momentum behind CAD, and PLM and so forth.
So the remains of course that disconnect to the bookings that we can ultimately the cash flow outlook.
I'd like to ask you about what may be a missing in grief from here and your commentary thus far.
And that is.
Your product Roadmaps.
The detailed questions about that like last month.
At Liveworx, but to the extent that customers think in multiyear terms about the roadmaps of their vendors.
When we think about what you're doing in the CAD and PLM, particularly appealed.
Is there perhaps an issue here that there are positives I can see that in the roadmaps, but might there be some issues. Nevertheless that are cumulatively, adding up to some headwind.
To your your future business outlook.
Might there be some solutions that you need to offer in terms of not just price.
Sweetening that you mentioned, but perhaps a new configuration was new packaging something else or something.
More fundamental architectural that.
His deep down perhaps what's going on here in terms of the long term bookings CAGR.
So Jay.
I'm going to tell you no I don't believe that's the case and I want to say that pretty firmly because if we go through our products one by one let's pick the easy ones, there's nothing like our.
Our product out there it's phenomenal people love. It there is nothing like our I O T product out there. We have won every magic quadrant like analysis has been published in the last four or five years.
If we dropped down to PLM.
In fact.
You don't PLM had a pretty decent quarter and.
Sometimes people like to sale Eris is disrupting PTC and I'm.
Tony that's hogwash, our business is doing well.
By the way there was just a third magic quadrant like report published just in the past we care and PTC is the winter once again, so im just saying every piece of external data suggests PTC is best in class and PLM and our bookings are pretty strong.
So I feel like.
The story actually about PLM as a backbone for digital transformation, which for example, I told in my keynote at Liveworx. Our customers are super excited about that so I don't think theres a product issue in PLM now lets come over to CAD.
You know if you look at what we're doing with generative design and what we're doing with real time simulation theres nothing like that in the market customers are so excited about this stuff.
Because of the value that you can create in terms of high quality products coming to market much faster it's unbelievable. So.
I don't want to say, we couldn't do creative packaging and so forth. Yes. There is always room for that but if we go to the fundamental competitiveness of our products I feel like they are incredibly strong in each and every one of these four major businesses of CAD PLM loyalty and they are.
I don't think that's the problem I mean, just telling you a very frankly and very firmly I don't think thats the problem.
I think the problem is for example in China, we used up sell perpetual software to people, who would then drop maintenance, we don't want to do that.
We either want to sell them subscription software that they pay for year after year or we don't want to do business in China. There's no point in chasing empty bookings of perpetual software were maintenance doesn't attach at a high rate.
China, Russia places like that so thats, one factor, meaning we could take perpetual orders. If we want to we don't want to it's not really interesting to the bottom line to the cash flow strategy and so forth.
And then this issue about these VP A's, that's really just a year over year factor.
It helped us more last year than is helping us this year that means that this year's bookings on a year over year comparison are down, but nonetheless, the CAD business I think were not influenced by that stuff like I said is doing very very well so.
I don't know I mean, you and I can discuss this sometime when we're together again, but I'm going to say very definitively I don't think there is a product issue I feel very very very confident about our products a new normal product guy.
Who knows these products inside out I talked to customers all the time I'm very confident that our products are very very strong.
Thanks very much.
Thank you.
And then next question comes from Adam Borg with Stifel. You May go ahead.
Great. Thanks for taking the question.
I will say you guys talked about the various stages of the LTE journey with pilot production and expansion I know you called out a few larger expansion this quarter, but I guess when you look at the broader cohort of Aiotv more broadly maybe you could just dissect a little bit more how pilot production expansion did thanks.
Yes, I mean, we said that 60% of the bookings again came from expansion. So I think thats a pretty healthy number we have a lot of sales guys out there selling new deals the new deals tend to be small and then we come back and we want to we want to expand them and grow them all into significant aer our run rates.
We have seen this pattern of roughly 60% of our bookings coming from expansion for his many quarters as I can remember.
Okay.
Maybe I don't know, 60% is the perfect number or not but it feels like a good number where a lot of business.
Comes from people buying more even though far more energy is spent winning new accounts. So I think that's probably a decent ratio and.
It shows that we're having success up selling and turning small accounts in the big ones.
Great. Thanks again.
Yes.
Thank you. The next question comes from Steve Koenig with Wedbush Securities You May go ahead.
So Steve Thank you, Hey, Jim Hey, Chris.
Hey.
Just.
Maybe stepping back and thinking about and by the way I appreciate the granular detail.
On the headwinds that impacted you this quarter.
Kind of the discrete nature of a bunch of those things.
If we step back and just think about.
Fiscal night scene.
Versus fiscal 18, it's it's kind of a very different year and and so you've had you've had a bunch of headwinds.
And if you think about.
If you think about the execution levers you have to pull to make fiscal 20, a better year than fiscal 90.
How would you kind of rank those things what what are your priorities in terms of what you want to do to execute more consistently.
Well I mean, I think we want to.
Certainly stabilize this productivity zone, LM, SLM and what we call classic product scope.
Again, I want to be clear, though we could not have as big a fall off because there isn't room for it.
So even in the very worst case, where bookings went to zero it would be less of a headwind, but thats not going to happen and I'd like to see them be flat to up because I feel like.
Our execution left some business hanging out there that we could go get that's the main thing.
With respect to for example, the the problem of geographies that don't want to buy.
Subscription prefer to buy.
Perpetual.
I think we need to keep pushing on that.
It may just be a transitory thing, but nonetheless, it's also not a big thing.
We're really talking about.
A small percentage of our bookings, but that small percentage declined quite a bit in the last couple of quarters.
But.
Again from this run rate it can't declined a lot more because it's pretty small at this point, so I think to me.
The big headwinds there is no room for the headwinds to be that big that this this coming year of fiscal 20. Meanwhile.
The execution on everything else has been very very good and I think if we can just contain the headwinds than the beauty of how well we're doing in general is going to shine through in fiscal 20, and Thats really the way. We're looking at it you know we'll give you the data in roughly 90 days, but I think you're going to see us come out with a growth plan that we are pretty confident in next year.
And it's because we're going to be growing off a baseline that's very very solid with a lot of wind in our sales in terms of product momentum new sales capacity on that type of stuff that should be should put us in a position to do well.
Got it thanks, Tim.
Thank you the next.
Question comes from Matthew Broome with Mizuho Securities You May go ahead.
Hi, Thanks very much.
Hi.
Net retention for subscription revenue during the quarter.
Yes, it's Christian so.
Retention.
Has been really a stable I think on a sequential basis for the subscription space.
I think we've seen a slight improvement from last year and we have programs in place.
To try and.
Continue to improve these over the coming years.
But no meaningful change.
Okay. Thanks very much.
Thank you and I might add that.
And just I'm, sorry, if I could add you know if you look at some of the metrics Christian talked about where the recurring software revenues up 13% in the margins for the year should be up 400 to 500 basis points and so forth. We don't have a problem with the business. We have in house, it's really more of a headwind of bringing in the new bookings and then comparing it to last year. When we didn't have some of those headwinds.
Thank you and the next question comes from Sterling Auty with JP Morgan you May go ahead.
Great. Thanks.
Hey, Sterling is Jackson ader on for Sterling.
Just a couple of quick questions on the.
I have to see growth.
So subscription is growing you know approaching 40%.
But the overall business growing mid twentys on a on a constant currency basis.
Well, that's suggesting maybe that.
We've reached a point in the industry were.
Machines are coming with some pre configured.
Software to integrate to the Iraqi and maybe don't need.
Where layer like maybe we did a couple of years ago.
No I don't think so I mean.
Keep in mind when you go into a factory there is no new factory that has only new equipment in it.
So if a factory has 100 pieces of automation equipment in it and somebody buys a new one that doesn't need kepware. We are great. The other 99 still though and.
Ive actually said before publicly several times that maybe at some point in time.
The world wont need kepware, because all the machines will be brand, new and upgraded to the latest protocols, but I can't actually imagine that scenario happening you know.
In the timeframe that I'm still employed in the business because.
There is.
2030, 40, 50, 60 year old machines in these factories and they're not going anywhere because they're fully amortized and they worked well and so far so.
Thank God.
I don't want you to think Kepware had a bad quarter.
It didn't do quite as well as we expected, but it did grow year over year, just we had more ambitious growth plans, but nonetheless, it grew from a bookings and revenue standpoint.
And.
It's been a good strong performer for us it never was the fastest growing part of our I O C suite, but it's very very important part because it brings together.
The ability for our brand new machine to co exist with the machines that are five years 10 years 15, 2040, 50 years old altogether in one automated information system.
One other thing just just to clarify so that we don't have the wrong impression here.
I talked about how the combination of CAD and PLM and I OTN Aer were not influenced by these external factors was growing 20%, but that's a combination of aer and aiotv growing much faster and 20 and of course, CAD and PLM or not growing at the 20% level. So that was sort of an average of some moderate growers and so fast in some super fast growers coming together.
Okay.
And then actually one quick follow up on rather than Kepware, Let me.
Really helpful explanation all of that would be.
Was there any mention maybe one mistake of the fiscal 21 targets are they still in place or.
Are you hearing any shifting to those targets today.
Yeah, I think it's safe to say that.
When we come out in November and provide fiscal 2000 targets in the revised.
2024 targets.
That there will be a.
A change in in 21 as well.
Let me say, though from a from a guidance standpoint.
I know how Christian feels about this you don't we first of all we feel that PTC on the scale of things is quite disclosive.
What we'd like to do is guide for the current year.
Guidance for the next quarter, and then give you a five year guide.
But every time the five year guide becomes a four year guide or three year guide because a year has passed I don't think we want to keep updating all these numbers because at some point, we'd be giving you a number for every one of the next five years and that's just a little too precise I think for you know what we're capable of doing so.
We're not trying to take anything off the table, but we're also not trying to keep updating everything we ever said, even though it no longer fits into this game hopefully you understand that you know.
Again, we'd like to give you a one year guide one quarter guide and a five year guide and leave it at that and let that all well for us.
Sure. Okay. Thanks, guys.
Thank you. The next question comes from Alex Tout with Deutsche Bank You May go ahead.
Hi, guys. Thanks, Thanks, Thanks for taking the questions.
Just just kind of a follow ups. So the last question I know you don't want to give.
Slide number 21, right now, but if I look at.
50 million Fytwenty tool.
And your new guidance for free cash flow this year, it's implying 29% free cash flow saga.
So thats why 19 to 24, you did 15.
I'm trying to do about 15% constant currency. This year. So would you expect.
Sort of linear acceleration up so that 29% level.
Post 2019 or or or.
If you can give us any kind of idea of what to expect that.
So.
Given everything you've said about the headwinds going away.
Off the endpoint.
From a bookings perspective is the low teens bookings growth is still something that you can associate suit post why 19. Thanks.
Yes, so its Christian hey, thanks for the question listen to understand and appreciate the desire for more information.
I think.
We're just going to stick to we're going to provide.
A detailed plan.
And and outlook in November when we get there.
You know I think that the.
That's just the easiest way to do it so we're just going to stick to that.
Could I just ask.
Hello up.
The support revenues were a little bit light in the quarter.
We talked about the churn rates and subscription but have you seen an increase in the churn rates in the on the support side of things. So what would you attribute that.
No, we actually Havent seen a deterioration in in.
Support retention.
And as we said earlier actually the.
Conversion program.
In effective in the channel actually is working quite well and we've seen that pick up.
Quite a bit from last year. The Christian there was another factor here that might explain a little bit of this and that is that the quarter actually ended on June 29 for us this quarter and I'm wondering if that maybe would also play a little bit into this you know.
During the course of the year, we close our quarters on the Saturday rather than the last day of the month.
And so.
Keep in mind that any revenue that would have been recognized on the last day of the quarter meeting June Thirtyth actually for US ends up in the next quarter. So sometimes just the quarter ends effect this stuff by a little bit and I'm guessing that's probably what you're seeing.
Operator, we have time for one more question. Please thanks.
Okay. Thank you.
The next question comes from Jason Selena with Keybanc capital markets. You May go ahead.
Hey, guys. Thanks for taking my question. So when I think about kind of your channel commentary and I appreciate what you're saying around China, and Russia, but the areas of Ken I'd like your channel has been performing better.
Above market growth in CAD and PLM outside of the areas in China, and Russia, how did how did those two in the corner.
In general the the the channel had a respectable quarter.
But with a significant drop off.
With significant drop off in certain Geos, where.
We just did not succeed in selling subscription software that people are used to buying perpetual software from us.
But outside of those areas.
Sure Ken PLM growth was still above industry CAD PLM growth.
I don't know if it's above but it was a it was respectable.
Okay, not significantly above not significantly below I mean.
It.
Was not a great quarter for the channel I think we were we were clear on that and that means that most deals did well or decent respectable and then a few really took a hit and it's really that yet.
From a few deals that.
Affects the overall.
Growth rate.
Okay I appreciate the commentary thank you.
Okay. All right. So I think a lot of time, but let me just thank everyone for joining us.
I want to reflect actually on a few things that Christian said as he was talking here you know, we're talking about a disappointing year, but nonetheless, you know recurring software revenue is going to be up 13%.
Operating margin is going to be up 400 to 500 basis points EPS is going to be up 21% at the midpoint and free cash flow will be around 260 to 270 million so actually.
Though we are disappointed in bookings for the reasons that we elaborated on.
The business move forward quite a bit and.
Because of the booking situation, we pushed this very attractive targets back a year, but I think it's as attractive as it ever was and I think it's very very credible that from this point forward, we can accomplish that target and.
You know you heard Christian his confidence behind it he has got models behind that.
We feel like it's doable.
I mean, we got to do it for sure, but it's certainly an achievable target so.
We feel that this is essentially become a transition year and the fundamentals of the business are very strong and we're going to continue to.
Grow the R.R. and cash flow to very attractive levels.
We look forward to talking to you in about 90 days, if we don't cross pass sooner and at that point, we will be prepared to.
I'll share a lot more specific financial details with you about what we think.
Fiscal 2020 will look like so thank you very much and goodbye.
Thank you that does conclude today's conference all participants may disconnect. Thank you for your participation.