Kristian Talvitie
Executive Vice President and Chief Financial Officer at PTC
Thanks, Neil, and hello, everyone. Starting off with slide 14. In Q4 '23, our constant currency ARR was $1.941 billion, up 23% year-over-year and in line with our guidance range. On an organic constant currency basis, excluding ServiceMax, our ARR was $1.77 billion, up 13% year-over-year. In Q4, our as reported ARR was $38 million higher than our constant currency ARR. Also in Q4, our ARR was impacted by $8 million due to start date timing. The key point is we contracted the overall amount of business that we guided to at the beginning of the quarter. At end year starts landed as expected, we would have been around the high end of our guidance range. Now with approximately $20 million more deferred ARR in fiscal '24 -- starting in fiscal '24 compared to what started in fiscal '23, we're increasing our fiscal '24 guidance range to 11% to 14%. Moving on to cash flow. Our results were solid and ahead of our guidance with Q4 operating cash flow of $50 million and free cash flow of $44 million. For the full year, our free cash flow was $587 million, up 41%. When assessing and forecasting our cash flow, it's always good to remember a few things. The majority of our collections occur in the first half of our fiscal year and Q4 is our lowest cash flow generation quarter. And on an annual basis, free cash flow is primarily a function of ARR rather than revenue. Q4 revenue of $547 million increased $39 million or 8% year-over-year and was up 6% on a constant currency basis. For the full year, revenue was $2.097 billion, up 8% or 12% on a constant currency basis. As we've discussed previously, revenue is impacted by ASC 606, so we do not believe that revenue or EPS are the best indicators of our underlying business performance, but would rather guide you to ARR and free cash flow as the best metrics to understand our business and cash generation potential.
Moving to slide 15. We ended the fourth quarter with cash and cash equivalents of $288 million. Our gross debt was $2.322 billion with an aggregate interest rate of 5.7%. During Q4, we paid down $43 million of debt and at the end of Q4, we had $1 billion in high-yield notes, a $500 million term loan and approximately $202 million drawn on our revolver. In October of '23, we made the final payment for the ServiceMax transaction totaling $650 million, including $30 million of imputed interest, which will be included in our Q1 '24 free cash flow. We funded this payment with cash on hand and our revolving credit facility. The deferred payment was also -- was included in debt on our Q4 balance sheet, and also factored into our debt-to-EBITDA ratio, which was 3x at the end of Q4. Also in October, we drew an additional EUR85 million on the revolver related to the pure-systems acquisition. We expect to be below 3x levered at the end of Q1 '24 and remain below 3x throughout the remainder of fiscal '24. We're prioritizing paying down our debt in fiscal '24. We expect to use substantially all of our free cash flow to pay down our debt this year and end the year with gross debt of approximately $1.7 billion. We've paused our share repurchase program, and we expect our diluted share count to increase by approximately one million shares in fiscal '24. Heading into fiscal '25, we'll revisit the prioritization of debt pay-down and share repurchases. Our long-term goal, assuming our debt-to-EBITDA ratio is below 3x, remains to return approximately 50% of our free cash flow to shareholders via share repurchases while also taking into consideration the interest rate environment and strategic opportunities.
Next, turning to slide 16. Let's take a quick look at how we did against our initial guidance for the year. Summarizing our fiscal '23 financial results. In a challenging market environment, we executed well in all four quarters and consistently delivered solid top and bottom line growth. With that, let me move on to fiscal '24 guidance. Turning to slide 18. We provide ARR on both a constant currency basis and on an as reported basis. You can see on the slide how FX dynamics have resulted in differences between our constant currency ARR and as reported ARR over the past eight quarters. Clearly, as reported ARR embeds a lot of FX volatility. We believe constant currency is the best way to evaluate the top line performance of our business because it removes FX fluctuations from the analysis, positive or negative. That's why we provide ARR guidance on a constant currency basis. For fiscal '23, we provided constant currency ARR guidance for the year and constant currency ARR results for all four quarters, using FX rates as of September 30, 2022. For comparative purposes, we also provided constant currency ARR history at these FX rates. Next, on slide 19, we're taking the same approach for fiscal '24. Our as reported Q4 '23 ARR was $1.79 billion based on actual FX rates as of September 30, 2023. That rate is our baseline for our fiscal '24 constant currency ARR guidance. For comparative purposes, we've recast our constant currency ARR history at these rates which you can see on the upper half of this slide and is also in the data tables posted on our website.
With that, I'll take you through our guidance on slide 20. For fiscal '24, we expect constant currency ARR to grow from $1.979 billion to $2.19 billion to $2.25 billion, which corresponds to growth of 11% to 14%. Our Q1 constant currency guidance range of $1.995 billion to $2.01 billion corresponds to year-over-year growth of 22% to 23%. Note that we closed the ServiceMax acquisition right at the start of Q2 '23, so Q1 will be the last quarter we exclude ServiceMax from our organic growth rate. On cash flows, we're guiding for free cash flow of approximately $725 million in fiscal '24. Note that our cash flow guidance is not on a constant currency basis, so FX fluctuations can have an impact in either direction. For fiscal '24, our guidance for operating cash flow is $745 million. We're assuming capex of approximately $20 million. It's worth noting how consistent and solid our free cash flow results have been since completing our transition to a subscription business model. In addition, we maintain consistent billing practices, and we've optimized our AR, AP and budgeting processes over the past few years. The predictability of our cash generation is tremendously helpful as we manage our business and invest for growth. For example, we're able to maintain core long-term investments even in a turbulent macroeconomic environment, which is great for customers and employees alike. Beyond our core investments, we adjust our shorter-term or more discretionary investments accordingly given our business performance and outlook. The net result is solid and consistent free cash flow growth. In fiscal '24, we expect approximately 55% or more of our free cash flow to be generated in the first half of the year, which is less than we've seen over the past three years. This is primarily because in Q1 of '24, our free cash flow of $180 million includes a $30 million imputed interest payment related to the deferred payment on our acquisition of ServiceMax.
Finally, on this slide, we're continuing to provide revenue and EPS guidance to help you with your models. But as a reminder, ASC 606 makes revenue difficult to predict in the short term for on-premise subscription companies. More importantly, revenue does not influence ARR or cash generation as we typically bill customers annually upfront regardless of contract term lengths. Also, since revenue is impacted by ASC 606, it's important to remember that margins and earnings per share also impacted, so we do not view these as meaningful indicators of the performance of our business. Turning to slide 21. Here, you can see how we're investing for growth while delivering solid free cash flow. On the slide in blue, you can see our absolute level of R&D spending, which has increased steadily over the years. But more importantly, you can see the slope of the blue line has inflected in recent years, along with our transition to a subscription model. As our free cash flows expanded, this has enabled us to reinvest greater amounts year after year into R&D to drive future growth despite the turbulent macro environment we've been in. Moving on to slide 22. Here's an illustrative constant currency ARR model for fiscal '24. You can see our results over the past three years and the column on the right illustrates what's needed to get to the midpoint of our constant currency ARR guidance for fiscal '24. The illustrative model indicates that to hit the $2.22 billion midpoint of our guidance range, we need to add $241 million of net ARR this year. While this is higher than the amounts we added in fiscal '23 and '22, there are some important drivers to consider. First of all, as we discussed earlier, we have more deferred ARR contractually committed to start in fiscal '24. In fact, that amount is approximately $20 million higher at the start of fiscal '24 compared to the start of fiscal '23. Secondly, we expect Codebeamer to be a tailwind for ARR growth in fiscal '24. While we currently expect pure-systems to have de minimis impact on our ARR results in fiscal '24, given its overall size, we do expect that pure-systems will help drive our Codebeamer momentum.
Also, fiscal '24 will be our first full year of having ServiceMax under our roof. The broader PTC Salesforce has been equipped to sell ServiceMax, and they also have quotas now. All things considered, we believe we've set our fiscal '24 constant currency ARR guidance range prudently. Next, on slide 23, here's a similar illustrative model for Q1. You can see our results over the past eight quarters, and the column on the right illustrates what's needed to get to the midpoint of our constant currency ARR guidance. Because our ARR trends tend to see some seasonality, the most relevant comparison is the sequential growth in Q1 '23 and Q1 '22. The illustrative model indicates that to hit the midpoint of our Q1 guidance range, we need to add $24 million of net ARR on a sequential basis. We believe we've set our Q1 constant currency guidance range prudently. It's also worth mentioning that the incremental $20 million of deferred ARR we have starting in fiscal '24, is skewed to the second half of the year. Moving on to slide 24. I know that most of you model free cash flow using the indirect method, which uses the P&L and balance sheet as a starting point. Given the complexities related to ASC 606, there are inherent challenges in using the indirect method to forecast free cash flow for PTC. The model on this slide is based on what we use internally. I know that looking at it this way, may be unfamiliar to some of you, so please feel free to reach out if we can help. Starting at the top, for fiscal '24 ARR, we're using the midpoint of our constant currency ARR guidance range. Next, our perpetual revenue is primarily related to our Kepware business, which is moving to subscription over time. And the primary reason our professional services is modeled to decline in fiscal '24 is because a portion of our professional services revenue is transitioning to DXP over time.
These three line items get us to our expected cash generation for the year. Moving down the model, you can see that even though we continue to reinvest in the business, we also see room to expand our operating efficiency due to our sticky products and subscription business model, combined with operational discipline. Continuing to move down the model, we provide guidance assumptions for stock comp, capex, interest payments. You can find these on slide 29 of the earnings deck and also pages three and four of the press release. Specifically, interest payments are expected to be approximately $135 million in fiscal '24, driven by an increase in debt, higher interest rates and the timing of our interest payments. Next, cash taxes are modeled higher in fiscal '24, reflecting higher taxable income as well as the impact of Section 174. And finally, let's take a look at the other category. In fiscal '23, the $72 million is related to FX movements, pre-acquisition ServiceMax collections and working capital. For fiscal '24, the main driver of the $19 million being modeled is working capital to support continued growth. All this sums up to expected free cash flow of approximately $725 million. If the demand environment is such that we're trending to the lower end of the ARR guidance range, we'll be more judicious in incremental investment decisions. If the demand environment is such that we're trending to the higher end of the ARR guidance range, we would feel more comfortable increasing investments. We have a robust budgeting process internally and that helps us not only prioritize run rate spend but also prioritizes additional investments we might want to make. For example, even in a muted demand environment, we may want to increase R&D investments but it wouldn't necessarily make sense to increase sales and marketing spending. So turning to slide 25. For fiscal '25, we're reiterating our previous targets, and for fiscal '26, we're providing targets that extend the trajectory that we're on. We provide these targets to help you understand the potential of our business. But I also want to remind you that the macroeconomic environment, FX rates and interest rates have been volatile in recent years and could positively or negatively impact our midterm targets.
It's also important to point out that global tax law changes are expected to have a significant impact on our midterm free cash flow, which we've factored into our midterm targets. Next, on slide 26, I'd like to explain the progression of our free cash flow, looking back three years and looking forward three years. Over the course of fiscal '21 to fiscal '23, we delivered a 40% 3-year free cash flow CAGR. Over that time period, we had solid ARR growth. And as expected, our non-GAAP opex growth was roughly 50% of our ARR growth, it was actually 46%. Looking forward, we're targeting FY '26 free cash flow of approximately $1 billion, which reflects a 3-year free cash flow CAGR of approximately 20%. This factors in a continuous operational discipline, it also factors in a hefty step-up in cash taxes, particularly in fiscal '25 and '26 due to global tax law changes and the depletion of our deferred tax assets. We're focused on paying down our debt and while interest payments will increase in fiscal '24, we expect them to decrease in both fiscal '25 and '26. In summary, turning to slide 27. First, we have a strong portfolio and strategy. We have a solid position in CAD with a long-term opportunity to disrupt this market with Onshape and Creo+. This year, we've expanded our category leadership in PLM, which has become a technology backbone for digital transformation and industrial companies. The acquisitions of Codebeamer and pure-systems significantly strengthen our ALM position, which is becoming increasingly important to our customers as their products add more software and complexity to their products. And the addition of ServiceMax further extends what was already a unique portfolio of interconnected Digital Thread capabilities across the full product life cycle.
Second, our strong execution. With organic growth at double-digit levels already, we're in the early days of a major on-premise to SaaS transformation driven by the evolving needs of our customers, but it's an oversimplification to focus only on SaaS as the one and only major driver of growth for PTC. The delivery model is important, but it all starts with our robust software portfolio that meets the needs of industrial product companies. We continue to benefit from cumulative layers of PTC-specific growth drivers, including driving customer expansion through cross-selling our differentiated portfolio and PLM expanding beyond the engineering department and becoming an enterprise-wide system of record. Fiscal '24 is forecasted to be our eighth consecutive year of double-digit constant currency ARR growth. Third, we have a well-earned reputation for driving margin expansion that goes back more than a decade. We've been demonstrating that we're judicious with our investments, being mindful of both long-term opportunities and near-term macro uncertainty. From a cost and operational perspective, we're lean and a continuous improvement mindset is part of PTC's culture. Fourth, with organic ARR growth in the low teens, juxtaposed PMIs that are generally in the mid-40s, I trust you would agree we're actively demonstrating that our business model is very resilient. We're targeting solid top line ARR growth and bottom line free cash flow growth. And finally, we're led by a team that has deep expertise and a proven ability to drive growth and margin expansion. And while I personally will miss Jim, I'm also excited to have Neil join the team and help continue to drive and evolve PTC. For sure, the environment around us will continue to change, and we will continue to adapt accordingly while still pushing the envelope of what we can do for our customers.
With so many positive trends going our way, we continue to believe PTC has a tremendous opportunity to continue to create value for our customers and shareholders. With that, I'll pass it back to Neil for a couple of closing comments.
