PTC originally indicated that new logo count would be one of the primary metrics for the ThingWorx platform. PTC added 290 logos in FY 2015 and an additional 275 logos in FY 2016, indicating that logo growth decelerated in FY 2016 despite the introduction of a freemium model for ThingWorx in April 2016. PTC no longer discloses this metric either, stating that it is no longer relevant to the IoT effort. My field research further indicates that management has experienced difficulties integrating these acquisitions and has struggled to understand the underlying technology (Axeda and ColdLight in particular), focusing instead on customer lists.
PTC has recorded a total of $225mm of restructuring charges in the past five fiscal years, 98% focused on severance and reducing headcount by 2,266 (equating to turnover of ~1/3 of the entire PTC workforce).
While PTC has implemented widespread layoffs, these restructuring charges are highly suspect. The 2016 restructuring plan was originally estimated at $40-50mm, increased several times, and eventually totaled $76mm. This amount was ~98% focused on severance packages and was projected to save ~$17mm annually. This means that PTC is spending over 4x the annual cost savings to terminate these employees and paying $93k per employee in severance costs. In conversations with the company, PTC was unable to articulate if offices had been closed, leases exited, or even verifying those amounts, instead commenting that it was focused on reinvestment and reallocating resources into high growth areas.
Despite five consecutive years of restructuring charges, PTC has failed to reduce total headcount or operating expenses in any meaningful way. Excluding restructuring charges, PTC has guided to flat operating expenses due to "overall investment" and "certain cost increases" that will offset cost reductions from restructuring. This will represent yet another year with no expense reductions despite an outstanding restructuring accrual of $36.6mm. At what point are restructuring charges part of the normal course of business?
Bribery and Fraud Lawsuits:
On February 16th, 2016 PTC settled with the DOJ as a result of repeated FCPA violations in which PTC China subsidiaries were bribing foreign customers in order to secure business. The DOJ found that PTC had internally investigated the issue and intentionally withheld information from the DOJ in its investigation until the fraud was uncovered, suggesting direct involvement of management. The DOJ also found evidence of deficient internal controls that failed to detect bribery and misallocation of expenses (totaling ~$1mm plus an additional $250k of gifts). These bribes resulted in +$13mm of revenue to PTC and $28mm of penalties in the form of disgorgement, interest, and fines.
Similarly, GE Capital accused PTC in 2007 of participating in a scheme with Toshiba and resellers to finance fraudulent software sales. GE accused PTC of orchestrating fraudulent, unauthorized software shipments and falsifying supporting documentation that defrauded GE Capital. PTC settled the case in Oct 2010 for ~$48mm in cash.
Employee reviews are fairly mixed; consistent feedback includes excessive restructurings and layoffs, visible favoritism and nepotism within the organization, and underpaid employees. Also worth noting that changes were made retroactively to 2013-2014 performance based equity awards (due to obfuscation from ongoing business model transition) such that the CEO was awarded ~$5mm of stock (plus ~$3.6mm to other executives) that would not have otherwise been earned and subsequently paid.
PTC guided to GAAP EPS of $0.51-0.58 for FY 2017 only to revise this guidance down the next week to $0.21-0.32 after “inadvertently omitting” interest expense from their internal calculations. Beyond the embarrassment of having to file an 8-K for this miss, the omission in PTC's guidance does not exactly inspire confidence that PTC maintains effective internal controls or that management truly has a firm handle on the underlying GAAP reporting. PTC subsequently took this guidance down to $0.06-0.09 after reporting Q1 numbers.
PTC is also subject to currency risks as ~2/3 of their revenue is overseas vs. ~1/2 of their expenses. PTC uses forward contracts to hedge currency risk; according to details in the most recent 10-K, a €0.10/USD movement will result in a $8mm impact to operating income while a ¥10/USD movement will result in a $7mm impact to operating income. While difficult to properly evaluate the ongoing hedging program and currency risks to PTC, foreign exchange movements are likely to be a headwind for PTC in a strong dollar environment. Additionally, PTC maintains very little cash in the US with only about ~10% of the total held domestically.
PTC must comply with leverage ratios (4x total leverage, 3x senior leverage) and an FCCR (3.5x coverage) on its senior revolver. PTC has noted in 2016 conference calls that share repurchases have been suspended in order to maintain compliance with financial covenants. Depending on what assumptions are modeled, PTC could potentially trip these covenants in 2017. Even without violations, these covenants will likely impede PTC's ability to resume share repurchases in the near term.
Sell side coverage of PTC is overwhelmingly positive, predicated largely upon 1) the business model transition which drives higher revenue and operating margins over time and 2) the IoT investment which is expected to grow at a ~40% CAGR through FY 2021. Many sell side analysts are projecting an acceleration to double digit growth by FY 2019, disregarding restructuring charges and focusing entirely on non-GAAP metrics in their analysis. Additionally, the assumptions and downside risks do not seem to be well understood; as noted previously, introducing any churn or overall reduction in seats could meaningfully extend the break-even period for new subscription seats. Analysts also seem to be overlooking the reclassification of maintenance revenue into the subscription bucket.
While PTC has generally beat bookings targets, they have not fared well against GAAP metrics and management has been using the ongoing business model transition as a means to obscure financial performance. Management originally guided to an operating trough in FY 2018, however this timeline was accelerated on the Q4 2016 earnings call with the indication that PTC has already experienced the trough. Guidance implies that restructuring charges will abate in FY 2017 and that investors could expect non-GAAP operating margins to improve going forward. Despite this, management has guided to flat top line growth and a very slight increase in non-GAAP operating margins.
The peer group (same that appears in sell side reports) trades at 13x EV/EBITDA. Note, however, that this peer group has higher revenue growth and vastly superior EBIT margins than PTC. As such, it is fair that PTC should trade at a discount to the average, particularly with high quality names like Adobe included in the table.
PTC should trade at 10-12x EBITDA as a low to no growth legacy software company and should not be given any credit for the business model transition or success in the IoT segment until they can demonstrate real progress with either initiative. Guidance for 2017 essentially assumes a return to normalized operating metrics prior to the subscription transition (EBITDA margins ranged 19-20% in FY 2011-2013). Applying a 10-12x multiple to EBITDA (including stock based compensation) on an enterprise value basis yields a share price of $14.79-18.61 implying 65-73% downside from current price levels. The inability to return to historical operating margins, illegitimate restructuring charges, or inconsistencies with reported bookings figures could present further downside.