Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving PTC Inc. (Nasdaq: PTC or “the Company”), a legacy application software company (formerly Parametric Technology, Nasdaq: PMTC) struggling to transform through a subscription conversion story while hyping its Internet-of-Things (“IoT”) roll-up. We have conducted an extensive fundamental and forensic accounting review, and believe the nearly 100% appreciation in PTC’s share price since early 2016 is unwarranted. As a result, we have a “Strong Sell” opinion and a price target of approximately $27 – $32 per share, or approximately 50% to 60% downside. Our short thesis, which details PTC’s struggles to transform its technology legacy business, has striking similarities to our earlier and successful short campaigns against Sabre Corp (2016) and NCR Corp (2015).
Executive Summary
Quick Research Highlights Driving Our Strong Sell Opinion And 50% – 60% Downside Target:
PTC’s Conversion Story From Perpetual Licenses To Subscription Model Is Late To The Game, And An Excuse For Management To Explain Away Poor Results And Deteriorating Economics. Its Conversion Uses Gimmicks And A Questionable Value Proposition To Compel Users To Subscribe
Investors Are Ignoring PTC’s Weak Financial Results In Favor of Dubious Metrics Such As “Bookings”, “ACV” and “Unbilled Deferred Revenue” – Read The Fine Print, They Have No Correlation To Future Revenues. We Even Spoke With PTC’s Former EVP of Sales To Ask His Opinion What These Metrics Mean, And He Couldn’t Explain Them. We Can’t Even Find Evidence That PTC’s $20M Mega Deal With The Air Force (It Booked And Said Closed In Q4’16) Even Exists With PTC As The Prime
PTC Is Acting As If It’s Distressed. The Company Is Dangerously Levered, Just Did A Stealth Credit Amendment In Q1 After It Burned Cash For The First Quarter In Recent History, Has Largely Tapped Out Its Revolver, Has Too Much Cash Trapped Internationally, And Is Now Having To Fund Its Negative Working Capital Position
PTC’s 5 Yr. Recurring Restructuring Odyssey Appears To Be An Elaborate Accounting Scheme To Sell Investors On Meaningless Non-GAAP Figures. We’ve Done A Deep Dive Analysis And Are Shocked By PTC’s Overstatement Of Office Locations, And Irreconcilable Employee Headcounts. Are They Just Firing And Re-Hiring People To Expunge Expenses? We Believe Its Restructuring Directly Violates SEC Guidelines Given Its Inability To Make Reliable Estimate. PTC’s CFO Was Chief Accounting Officer At Autodesk During A Period It Had an SEC Investigation And Said Its Financials Could No Longer Be Relied Upon
PTC Has Squandered $585 Million On Its Internet-of-Things (IoT) Acquisition Spree. PTC’s IoT Is Nothing More Than A Highly Promoted, Low Growth, Money Losing Business Used To Distract Investors From Its Core Legacy Business Issues. Management Is Promoting Misleading Organic Growth And Can’t Get Its Market Share Figures Straight. We Estimate Organic Growth Below 9%. Analysts Expect 30-40% Growth. Its Market Share Appears To Be 10%, Not 18%-28% Touted By Third Party Reports
While All Analysts Say “Buy” Six Insiders Have Stock Sale Programs, And They Only Own 1% Of The Company. Analysts’ See Upside To $60 (+12%), But We See 50% – 60% Downside As Our Long-Run View. This Represents A Terrible Risk/Reward For Owning PTC’s Shares. PTC Is Trading At Peak Valuation With Little Covenant Cushion; Careful Investing To All….
Spruce Point Believes PTC Is A “Strong Sell” For The Following Reasons:
PTC (“PTC” or “the Company”) Is A Legacy Computer-Aided Design Software and Solutions Provider to Engineers, Manufacturers, and Others. In Our Opinion, PTC Is Struggling To Transform Itself And Masking Financial Distress By Heavily Promoting a SaaS Conversion “Story” And Hyping Its Low Growth, Money-Losing Internet of Things (IoT) Business
- PTC is showing many signs of an old-line technology company struggling to transform (Note: its name + ticker change from Parametric Technology (PMTC)). Spruce Point has a successful history exposing similar stories such as NCR and Sabre. With PTC, the similarities are striking. On the surface, the Company’s transformation appears wildly successful. Since PTC started its SaaS conversion story in FY14, and accelerated the move in FY16, its “Bookings” – an obscurely defined measure management steers investors towards – are up 6x, and significantly outperformed PTC’s guidance in FY16. As a result, PTC’s shares surged almost 100% from its early 2016 lows
- Investors are blinded by meaningless bookings, and ignoring the large GAAP vs. Non-GAAP discrepancies. PTC’s actual GAAP financial performance rapidly deteriorated in FY16. Part of the deterioration is explained by the short-term effect of the model transition. Subscription sales carry lower upfront costs than a fully paid perpetual licenses, so as a result there is a natural short-term depression of sales and EPS from this transition. PTC and its analysts’ believe that its results have bottomed, and it is set to have a rapid acceleration of earnings and cash flow; there are indications that this simply isn’t the case
- We believe that there’s more than just conversion dynamics suppressing results, and underlying disruption is occurring in PTC’s business from new competitors at much lower price points (free!). PTC’s long-term GAAP/Non-GAAP EBIT and EPS divergence total a stunning $933m and $7.15 per share since 2012. PTC’s working capital recently turned negative, it burned cash flow in Q1’17 for the first time, had to borrow on its credit facility to fund itself, make a credit amendment, and has limited remaining borrowing capacity. These results speak volumes about PTC’s fragile financial condition. The Company is highly levered at 3.5x Debt/EBITDA
- PTC effectively pulled forward FY16 results with gimmicks such as a Win-Back program (the name in and off its self tells you that PTC is losing out) which pushed maintenance users to take a subscription and inflated bookings. We believe many users were forgoing the expense of maintenance; PTC is now compelling them to take a subscription which includes maintenance. Although nothing has really changed, it allows PTC to inflate its bookings metric. The true organic progress of PTC’s conversions are impossible to discern. PTC defines its own, non-standard metrics, such Annual Contract Value (ACV), and Unbilled Deferred Revenue to spin its story. Read the fine print: these metrics have almost no relevance to expected revenues. For PTC to extract any value, its customers have to stick with a subscription for 4+ years, yet the average customer contract is just 2 years. If customers churn, PTC is toast. Most transition models don’t succeed, and we have plenty of examples
- PTC even introduced a “rule of thumb” to monitor the impact of its bookings impact on Sales and Non-GAAP EPS, yet this rule is a moving target, and a caveat was added that the analysis cannot be reconciled to GAAP results. Major red flag! The last company we exposed that said it couldn’t model its results to GAAP was Sabre Corp, which recently cut cash flow guidance twice. PTC’s conversion story looks nothing like others we’ve analyzed. The most unusual aspect of PTC’s model change is that its Deferred Revenues aren’t growing – another major red flag.
PTC Is Intentionally Obfuscating Or Not Disclosing Many Traditional Metrics Used To Evaluate Its Business
- PTC used to provide reasonably good information to investors in its excel spreadsheet posted on its investor relations website. A tab in the file called “Supplemental Data” would regularly disclose information such as Active Support Seats, Quota-Carrying Sales Reps, and deal size figures. These figures and are no longer provided. We think we know why: by analyzing the data leading up to its omission, revenue per Active Support Seats and per Quota Rep was in secular decline
- PTC sales are conducted either directly through its sales force, or through indirect channel partners (aka VARs). PTC used to provide the split of direct vs. indirect sales in its SEC filings, but stopped this practice. However, the Company still provides the % split in its Supplemental Data tab. To our dismay, these percentages do not reconcile to historical SEC filings and suggest potential $30-$50m of revenue misstatement. This fact caused us to take a deeper look into PTC’s channel partners. By using the Wayback machine to see total resellers listed on PTC’s website, we find significant shrinkage from FY11–FY16 of 440 to 253 or 43%
- PTC’s vanishing resellers and sales quota reps omission supports our view of PTC as a melting ice cube. The reason that PTC’s resellers are shrinking may be explained by a recent program guide we found on the PTC User Community website. PTC wants resellers to pay it upfront for selling subscriptions, which amounts to asking resellers to provide it financing. PTC reserves almost nothing for allowance for doubtful accounts, which again points to offloading cash collection to its partners. PTC pretends its DSOs are improving, but when adjusted for receivables buried in “other current assets” the DSO is stubbornly high
Perpetual Restructuring Charges, Segment Shuffling, Reclassifications + Other Signs of Unreliable Financial Reporting
- PTC has been taking restructuring charges now for 5 years totaling >$230m. Its assets are nothing more than people, computers and offices, yet it cannot seem to optimize itself correctly. Part of the issue, is that PTC has embarked on a reckless and expensive acquisition spree. Since 2011, PTC has made 11 acquisitions totaling $1.1bn (many to build its Internet-of-Things (IoT) hype machine (more on this coming up)). We’ve successfully argued that the best way to evaluate any roll-up strategy is to evaluate free cash flow after acquisition costs (See reports on our website: LKQ, Ametek, Echo Global Logistics). We find no evidence yet that PTC has extracted any value from these deals, especially in light of having its weakest cash flow quarter in Q1’17
- More to the point of restructuring charges, we find worrisome issues by looking carefully at the nature, composition, and impact of these programs on results. To illustrate, PTC appears to be getting lower return on investment (measured by opex savings) per cash cost of executing its restructuring programs. It is now even guiding to growth in operating expenses due to planned investments…huh? We also have difficulty reconciling employee headcount figures, while accounting for employees acquired from acquisitions, and those explicitly identified for termination or “repurposing” – PTC’s total employee count is down just 1.5% in the same period it has taken massive charges. Is the Company just firing and re-hiring employees to expunge expenses?
- If PTC were really executing on its restructuring program and optimizing its assets, we wouldn’t find so many discrepancies with its operational footprint. For example, PTC discloses in its Annual Reports its total square footage under the discussion of its properties. We find a net increase in total office square footage from FY11-FY16 despite reporting fewer offices. Furthermore, PTC cannot seem to reconcile its global office locations. To illustrate, using the Wayback machine, we find a systematic overstatement of office locations disclosed in its Annual Report vs. office locations listed on its website; the discrepancy is currently a 35% overstatement, which cannot merely be dismissed as a small oversight
- In light of the fact that PTC dramatically ramped up its guidance for restructuring charges in FY16, and cannot get its numbers straight, heightens our fear that its restructuring charges are nothing more than a means to flush expenses through the income statement. The SEC says that companies have to reliably estimate a restructuring program, yet PTC appears unable to do so. As part of PTC’s Non-GAAP figures, it asks investors to ignore these charges as an add-back to results. Its last restructuring program had charges totaling 10% of Adjusted Operating Expenses and 7% of sales. Now that PTC states its restructuring program is “materially complete” it puzzles us that its restructuring accrual still amounts to $25m. Shouldn’t it be $0?
- In addition to recurring restructuring, PTC has a dizzying amount of reclassifications and segment reporting changes. Due to recent changes, PTC stopped disclosing how it allocates these restructuring charges (along with other pertinent financial information such as segment depreciation, capital expenditures, etc.) across its business units. It appears to place it in violation of ASC 280 Segment Reporting. In our view, this augments or concerns that PTC’s restructuring program could be bogus. In addition, it appears obvious to us that PTC’s last segment reorganization stuffed more expenses into the “unallocated” line item, which serves to flatters the reporting of “segment profit” for each of its businesses
- There’s plenty of additional evidence to suggest weak financial controls. For example, in October 2016 PTC had to file an 8-K to correct its GAAP guidance because it “inadvertently omitted interest expense” – oops small oversight! Earlier in the year, PTC settled with the Dept. of Justice and SEC for $28m related to a Foreign Corrupt Practices Act investigation of payments by former employees to Chinese official between 2006 and 2011.
- PTC has often disclosed that “We are currently under audit by tax authorities in several jurisdictions.” Finally, investors are starting to see the magnitude of the issue. In Q4’16, PTC revealed a $12m payment to Korea tax authorities. PTC has tried to save taxes by reorganizing its European operations through Ireland (dissolving the Atego acquisition), but has left a sloppy trail and continues to act as if Atego is in operation. In the process, PTC’s GAAP and Non-GAAP tax rate seem meaningless. Its income statement shows tax benefits (allowing inflation of its EPS), but in reality PTC continues to spend $25m-$30m in cash taxes
Article by Spruce Point Capital
See the full PDF below.
