Execution Stumble and CFO Retirement

PTC, the leading industrial design software platform, reported mixed fiscal Q1 results. Sales were mixed (strong secular growth, offset by team execution issues) while profits were strong (disciplined cost control).

But the silver linings from Q1 were overshadowed by a mixed 2019 outlook from management. An announcement that the CFO will retire added to the uncertainty. The stock fell -6% after-hours on the news.

Q1 Takeaways

• Software sales were decent on a subscription basis (i.e. pay $X per year to use PTC's connected device software), but "bookings" which represent future sales, fell -13% vs. last year (excluding currency impact).
• Software sales were weak on a perpetual basis (i.e. one-time licenses to use the software for Y years). The culprit: "larger US government deals slipped into Q2 due to the shutdown."
• Instead of blaming the Q1 softness on the "macro", PTC's management owned up and believes the likely cause was their go-to-market realignment during the quarter, which impacted their sales team's ability to get a fast-enough start to the new year. "We ran out of time."
• On the upside, profit margins and earnings per share were strong, driven by disciplined expense management.

Putting it together, it was a mixed quarter for PTC -- results were okay, but execution was messy compared to Wall Street's high expectations in our view.

Irrespective of Q1 results, we know stocks are worth the sum of their discounted future cash flows, so let's pivot to what the future could look like. This is where things become messy.

Management Commentary on 2019

• "We are more cautious about the macroeconomic environment."
• "Bookings slipped from Q1 into our Q2 forecast...due to the [government] shutdown...however, we do not believe it would be prudent to assume we 'catch up' fully for the deals that slipped out of Q1."

Given the large software deals "slipping" into Q2 and the conservative macro stance, PTC's management is forecasting slightly slower growth in 2019 for both sales and earnings.

Additionally, the company's CFO will be retiring this year. He spent the past four years with PTC and played an integral role in its transition to a subscription software company. With that transition mostly complete, however, we understand he feels it's time to move on. A successor search is now underway.

The Path Forward

We think PTC's sales team needs to re-align faster and address its execution issues immediately. While the government shutdown and macro backdrop are out of its control, we'll be watching closely for signposts that management is addressing its "controllables" head on.

The stock deserved to be down on these results, in our view. The results simply missed the high near-term bar implicit in the stock's lofty valuation (49x P/E on Wall Street's 2019 estimated earnings per Sentieo).

What It Means for Our Thesis

It was a messy quarter, but we don't believe PTC's business is falling off a cliff. The secular shift toward automation and connectivity in industrial devices cannot be stopped, in our view. The shift will be lumpy, but we wouldn't bet against this technology transformation taking hold of every industrial enterprise. PTC remains a market leader within that wave.