The market sold off shares of industrial software company PTC (PTC 1.30%) after it delivered a slightly disappointing fiscal second-quarter report last week. While the results and guidance could have been better, some perspective needs to be applied. The company remains in high-growth mode, and it's still one of the best ways to play the ongoing digital revolution in the industrial sector. Here are three reasons why PTC stock is attractive.
Guidance wasn't that bad
Let's start off by addressing the elephant in the room: The stock sold off by a double-digit percentage after the earnings release. The main reason for that was a slightly disappointing result on one key metric that management advises investors to follow -- the company's annual run rate (ARR). According to CEO Jim Heppelmann on the earnings call, by ARR, PTC is "referring to the annualized run rate of the book of recurring revenue contracts that are currently active."
PTC's organic ARR grew 11% year over year in constant currency in the fiscal second quarter, which ended March 31. That was bang in the middle of management's full-year guidance range for 10% to 12% growth. Moreover, management's full-year ARR at constant currency guidance remained unchanged. However, a less favorable exchange-rate environment means that its reported ARR growth is forecast to be in the 14% to 16% range compared to the previously estimated range of 16% to 18%.
Investors should be able to easily forgive the reduction in headline guidance. Still, in an environment featuring a fast-recovering industrial economy, investors probably expected ARR to exceed guidance, and hoped for underlying guidance to be revised upward.
That said, Heppelmann noted that PTC's deferred ARR is running ahead of previous expectations. For reference, PTC defines deferred ARR as "the incremental annualized exit value of customer contracts that are committed as of the end of the reporting period to start or increase in value in a future period." It's not included in the ARR guidance, and you can think of it as a backlog of future revenue. Heppelmann said he now expects a deferred ARR of $90 million as PTC exits its fiscal 2021 compared to a previous estimate of $80 million. In fact, total ARR growth (including deferred ARR) "was over 12% on an organic basis."
All told, both PTC's performance in the fiscal second quarter and its guidance were slightly disappointing, but the company is still firmly on track with its full-year guidance and doing slightly better in terms of deferred ARR.
In a nutshell, PTC is a play on the fourth industrial revolution and the increasing digitization of the industrial sector. The company's traditional products -- computer-aided design (CAD) and product lifecycle management (PLM) software -- are banded together as its "core" products. Meanwhile, its Internet of Things (IoT) and augmented reality (AR) offerings are lumped together as its "growth" products.
PTC's IoT software helps asset owners digitally model and simulate their physical assets' performance to make them more productive and improve their servicing. AR allows service technicians to work on equipment without even being physically present in the location where the equipment is, and enables technicians to be digitally assisted while working with complex machinery. The case for the stock is based on the idea that ARR from PTC's growth products will grow at a 30%-plus rate over the medium term, and that its core products will produce high-single-digit to low-double-digit percentage growth.
As you can see below, PTC is well on track relative to these targets.
The transition to software as a service (SaaS) will add growth and secure PTC's future
Management plans to make its entire portfolio of software solutions available as SaaS offerings. As Heppelmann noted on the earnings call, "While we'll continue to offer on-premise versions of core products indefinitely, a growing number of our customers want to enjoy the great benefits of SaaS at the same time."
The shift is likely to benefit PTC in two ways. First, as Heppelmann noted, "When an on-premise workload shifts to SaaS, the ARR of that workload roughly doubles." In other words, the shift toward SaaS isn't just a like-for-like replacement. It's also a major growth driver in itself.
Second, offering SaaS-based solutions will de-risk the company's future from potential competition as the market moves toward using SaaS. Simply put, PTC needs to offer SaaS solutions to protect and grow its market position.
All told, PTC remains on track to meet its medium-term aspirations, even if the market was looking for better numbers and more upbeat guidance from the company than it delivered. Its growth products' sales growth has picked up sharply as the economy has recovered. There's every likelihood that one result of the pandemic will be to pull IoT and AR spending forward as companies see the benefit of digitization and virtualization. Meanwhile, PTC's CAD and PLM solutions could see a lift in growth in the future as more of them are made available as SaaS options. PTC continues to have a very bright future.