Industrial software company PTC's (PTC -0.44%) latest results are likely to have divided opinion. Once again, they were in line with guidance but slightly disappointing in what many investors were expecting from the company. As such, the stock is increasingly testing the patience of many investors. Here's the lowdown.

A design engineer using computer-aided design software.

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The investment case for PTC

The case for buying PTC stock has long rested on a belief that the company would hit medium-term 2024 targets for free cash flow (FCF) of $700 million to $900 million. Unfortunately, the COVID-19 pandemic has pushed PTC toward the lower end of the target. Management expects to hit $700 million to $750 million in FCF in 2024; the midpoint would put PTC on a price-to-FCF valuation of less than 20 times FCF in 2024. That would be an excellent valuation for a company growing FCF at a 25% to 30% rate.

Moreover, the fiscal 2021 results (PTC's financial year ends on Sept. 30) were solid enough. In common with many software companies shifting to a software-as-a-service (SaaS) model, PTC guides toward a metric defined as the annual run rate (ARR). ARR is simply the "annualized value of our portfolio of active subscription software, cloud, SaaS, and support contracts as of the end of the reporting period," according to PTC.

Full-year ARR came in at $1.475 billion, a figure at the high end of the guidance given in the third quarter for $1.453 billion to $1.478 billion, and significantly above the $1.385 billion to $1.420 billion forecasted at the start of the fiscal year. Moreover, FCF of $344 million in 2021 was slightly above the forecast of $340 million at the beginning of year.

Three points of concern

While the 2021 results were solid enough, there are a few points to consider. The first two relate to the underlying earnings, and the third relates to the risk inherent in PTC's plan to accelerate its transition to SaaS solutions.

Person using augmented reality in practice.

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First, ARR growth was 16% for the full year, but organic ARR growth was only 12%. That's a figure at the top of the original guidance of 9% to12%. On the face of it, it's a good performance. However, in general, growth in the industrial sector has been more substantial than expected in 2021. As such, it's reasonable to expect a little bit more from PTC.

Second, PTC separates its solutions into two main groups. The core products are computer-aided design (CAD) software and product lifecycle management (PLM), with growth products comprising the fast-growing internet of things (IoT) and augmented reality (AR). The growth products are the key to PTC hitting its 2024 targets.

However, on the fourth-quarter earnings call, CEO Jim Heppelmann said, "Looking at our growth products, IoT grew mid-teens coming in below our target. However, bookings were strong in Q4, and we expect stronger ARR growth in fiscal '22." It completes a year where PTC's growth products portfolio (primarily IoT at the moment) has been a bit disappointing. Investors will want to see Heppelmann's prediction of a more robust 2022 come true.

Progressively higher stacks of bills.

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Third, management announced it would accelerate its SaaS transition in its core products, with an initial focus on PLM. Management believes it can add value to customer solutions, and in doing so, raise ARR for PTC while grabbing market share. Furthermore, it will de-risk the company from the possibility that competitors will jump ahead by offering SaaS.

While the SaaS transition is good news, it also comes with execution risk. Moreover, it will come at the expense of near-term FCF generation. For example, CFO Kristian Talvitie said the restructuring would result in a cash outflow of $50 million to $55 million in 2022, which is why FCF guidance for 2022 is only $400 million, rather than the $450 million which would put PTC on track for FCF of $700 million to $750 million in 2024.

Still a good value, but the pressure is building

On balance, PTC still looks like an excellent growth stock for investors. Still, it's difficult not to think that a combination of a 2021 trend toward slightly disappointing IoT performance and the risk around the push to accelerate the SaaS transition isn't putting pressure on the stock.