Kristian Talvitie
Chief Financial Officer at PTC
Thanks, Jim. And good afternoon, everyone. Before I get into it, I'd like to note that the non-GAAP results and guidance and our ARR references I'll be discussing will be in both constant currency and as reported.
Turning to Slide 16. In Q2 of '23, our constant-currency ARR was $1.81 billion, up 26% year-over-year, and above the high end of our guidance range. On an organic constant-currency basis, excluding ServiceMax and Codebeamer, our ARR, was $1.63 billion, up 13% year-over-year.
As Jim explained, our solid topline in Q2 was broad-based across all geographies and product groups. Our pipeline development also continued over the past three months in a solid and consistent way and our outlook was steady all quarter long. In Q2, our organic top line continued to show good resilience. I'm sure many of you have been following the manufacturing PMIs due to the historical correlation with our top line when we operated a perpetual business model. The PMIs have been soft over the past year, particularly in Europe, where factory orders have been down 11 months in a row, and where the European-- Eurozone PMI was a little over 47 in March. In contrast to those trends, our topline, including in Europe has continued to grow. Our subscription business model makes our ARR resilient and demand for digital transformation continues across our customer base.
In fact, Q2 was one of our best booking quarters in Europe ever. On an as-reported basis, we delivered 23% ARR growth, 11% organic. In Q2, our as-reported ARR was $68 million higher than our constant-currency ARR. Remember, that for our constant-currency reporting, we use rates as of September 30, 2022 for all periods forwards and backward. On a year-over-year basis, currency fluctuations were still a meaningful headwind in Q2 and for the entire first half.
Moving on to cash flow, our results were strong, with Q2 cash from operations of $211 million and free cash flow of $207 million coming in ahead of our guidance. This performance was driven by continued strong execution based on a foundation of solid collections and cost discipline. 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, 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.
Q2 revenue of $542 million increased 7% year-over-year and was up 13% on a constant-currency basis. In Q2, recurring revenue grew by approximately $40 million, partially offset by small declines in perpetual license and professional services revenue. The decline in professional services revenue is consistent with our strategy to transition some of our professional services to DXP services, our partner for Windchill plus, lift and shift projects. And the decline in perpetual license revenue is consistent with our plan to continue transitioning Kepware to a subscription model over time. Kepware is the primary driver of the small amount of perpetual license revenue we have left.
As we've discussed previously, revenue is impacted by ASC 606, so we do not believe that revenue is the best indicator of our underlying business performance, but we'd rather guide you to ARR as the best metric to understand our top-line performance and cash generation.
Moving to slide 17, we ended the second quarter with cash-and-cash equivalents of $320 million. Our gross debt was $2.545 billion with an aggregate interest rate of 5.4%. In Q2, in conjunction with the ServiceMax acquisition, we took out a $500 million term loan and increased the size of our revolving credit facility from $1 billion to $1.25 billion. After the new borrowings and $205 million of debt pay-down in Q2, we had $1 billion in high-yield notes, a $500 million term loan and approximately $425 million drawn on our revolver at the end of the quarter.
As a reminder, we have a second payment for the ServiceMax transaction due in October of 2023 of $650 million, which consists of $620 million of debt and $30 million of imputed interest. We intend to fund this with cash on hand and our revolving credit facility. This deferred payment is included in debt on our balance sheet and is factored into our debt-to-EBITDA ratio which was 3.4 times at the end of Q2. We continue to expect to be around three times levered by the end of Q4 and below three times throughout fiscal '24.
Given the interest-rate environment, we expect to prioritize paying down our debt in fiscal '23 and fiscal '24. We've paused our share repurchase program and in fiscal '23, we expect our diluted share count to increase by approximately one million shares. We expect to have substantially reduced our debt by the end of fiscal '24 and we'll then revisit the prioritization of debt paydown and share repurchases.
Despite this interruption, our long-term goal, assuming our debt-to-EBITDA ratio is below three times, remains to return 50% or so of our free cash flow to shareholders via share repurchases, while also taking into consideration the interest-rate environment and strategic opportunities.
Next, slide 18 shows our ARR by product group. In the constant-currency section on the top half of the slide, we use rates as of September 30, 2022 to calculate ARR for all periods. 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 six quarters. Based on exchange rates at the end of Q2 '23, as-reported ARR in Q3 '23 would be higher by approximately $70 million compared to the midpoint of our constant-currency guidance, and fiscal '23 as-reported ARR would be higher by approximately $73 million compared to our constant-currency guidance midpoint.
We report both actual and current constant-currency results and FX fluctuations can have a material impact on actuals. But remember, we provide ARR guidance on a constant-currency basis. If exchange rates fluctuate significantly between the end of Q2 '23 and the end of Q3 '23, the impact to our as-reported ARR would also change. We believe the 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.
Given the continued volatility in FX that we've seen over the past few months, I thought it would be useful to update our ARR sensitivity, rule of thumb on Slide 19. Using FX rates at the end of Q2, the impact of a $0.10 change in the euro to USD rate would be about $40 million, positive or negative. And the impact of a JPY10 change in the US dollar to yen rate would be about $9 million, again, positive or negative. In addition to the dollar we transact in euro, the yen, and more than 10 other additional currencies. And of course, the estimated dollar impact to ARR is dependent on the size of the ARR base.
With that, I'll take you through our guidance on Slide 20. For all our ARR guidance amounts, we're using our constant-currency FX rates, which are as of September 30, 2022. For fiscal '23, we expect constant-currency ARR growth of 22% to 24%, which corresponds to a fiscal '23 constant-currency ARR guidance range of $1.925 billion to $1.95 billion. We raised the low end by $15 million and lowered the high end of our ARR range by $10 million. So the midpoint of our ARR guidance is up a few million dollars. I'm going to circle back on this on the next slide to provide a little more context.
For Q3, we're guiding constant-currency ARR to be in the range of $1.845 billion to $1.855 billion at the midpoint. This equates to 24% constant-currency growth. On cash flows, we are again raising our fiscal '23 cash flow guidance. We're now targeting cash from operations of $600 million and free cash flow of $580 million.
I think it's worth pointing out that we're raising our cash flow guidance for the year, while also increasing investments in select growth opportunities for our business in the second half of fiscal '23. The important point here is the resilience of our business enables us to maintain core long-term investments even in a turbulent macro-environment. In addition to that, as a baseline, we can adjust our shorter-term investments accordingly given our business performance and outlook. The net result is solid and consistent cash flow growth. We maintain consistent billing practices, and we've improved our processes around collections and payments over the past two to three years. Because of this, the quarterly seasonality of our free cash flow results has been very consistent over the past two years and we're on track to deliver similar quarterly linearity in fiscal '23 as well. As in the past two fiscal years, we ended the halfway point of fiscal '23 at approximately 65% of our full-year cash-flow target. For Q3, we're guiding to free-cash-flow of approximately $155 million. We expect approximately $5 million of capex and therefore, our cash from operations guidance is approximately $160 million.
Moving to revenue guidance for fiscal '23, we expect revenue of $2.08 billion to $2.14 billion which corresponds to a growth rate of 8% to 11%. ASC 606 makes it fairly difficult to predict in the short-term for on-premise subscription companies, hence the wide range. More importantly, revenue does not influence ARR or cash generation as we typically bill customers annually upfront regardless of contract term lengths.
Next on slide 21. We've taken you through a lot of details, so I think it's important to step back and give you a high-level perspective. We'll use the slide that we showed on our Q4 '22 call as a basis to do this. The initial guidance range and scenarios we provided on our Q4 '22 call is at the bottom half of this slide. We started the year providing a range of ARR outcomes that included organic bookings anywhere from up 5% to down 15% on a year-over-year basis and churn anywhere from flat to worst by 100 basis points.
On the top half of the slide, you can see a summary of the current guidance range. As you can see, we've narrowed the guidance from our initial range of $60 million at the start of the year to our current range of $25 million at the midpoint. In short, since Q4 of fiscal '22, we've taken the bottom-end of the ARR range up by $25 million and taken the top-end of the range down by $10 million, along with the adjustment for ServiceMax we made at the time of close.
So basically, based on our first-half performance and the outlook for the second half, we've taken the initial low-end scenario for ARR off the table, which called for an organic bookings decline of 15% and for churn to increase. Our organic bookings growth was solid in the first half and we expect flattish organic bookings for the full year. We've also continued our strong organic churn performance and we've actually seen an improvement of about 50 basis points in the first half. And while we continue to guide to flat churn for the year, we think this may be conservative.
There are lot of factors that could impact where we end the year in terms of ARR. And just to be clear on the major factors, they include, first, whether organic bookings are flat or a little better or a little worse than that. Second, how inorganic bookings perform also matters. The scenarios we're showing on the bottom half of the page, only contemplated organic bookings. In addition to the flattish organic bookings, we expect total bookings growth on a year-over-year basis, supported by bookings from ServiceMax and Codebeamer.
Third, whether churn comes in flat or continues on the trend of slight improvement we've seen in the first half. Fourth, we saw in Q2 in particular, increased customer interest and ramp deals. These are multi-year contractual commitments from customers where the ARR increases during the contractual term. In practice, what this means is that the amount of ARR we get in year-one is smaller than the exit run-rate, which is what creates deferred ARR for us.
These are great deals in the sense that they demonstrate significant customer commitments to PTC. And with the low churn rates we have, these deals bode well for future ARR growth. And lastly, it probably goes without saying that the difference in timing of booking a deal and when the contract term actually begins matters as well. We count the booking when we signed the contract, but ARR and revenue start only when the contract term begins. We have consistently called this out as a factor in ARR, especially in Q4 when we may sign a contract in Q4, but for a variety of reasons, it doesn't actually start until Q1.
This also can create deferred ARR for us, but it's just short-term deferred and the timing difference is generally measured in days or weeks. A lot of moving parts, for sure, but the net result of all of this is that we raised the midpoint of our ARR guidance by approximately $8 million from when we started the year. On the free cash flow side of the equation, at the beginning of the year, we said we thought $560 million was a good target regardless of the ARR outcome as we would moderate or increase spending based on the environment as we saw it.
As you know, we were cautious on spending and hiring in the first half and that has served us well. We're comfortable increasing the target to $580 million for the year given the results in the first half and the outlook for the back-half. While there is a tailwind from FX to be expected for the year, I'll remind you that FX rates in the first half are still below the FX rates for the first half of last year. So we've not really seen much of a year-over-year benefit from FX thus far this year.
And I'll also remind you, we generate about 65% of our free cash flow in the first half. But if FX rates hold for the second half, we should see some pickup. That said, this will be offset by higher-than-anticipated, interest rates and the increased investments we're making in select growth opportunities, namely Codebeamer, Windchill plus and Atlas in the back-half and this is all factored into our current guidance.
Hopefully. This slide helps clarify at a big-picture level, how we performed through the first half and our expected range of outcomes for the back half. Summing all this up, in the first-half of fiscal '23, we have-- we've been demonstrating the resilience of the model and the stickiness of our solutions or said another way, the value that customers are getting from our solutions in an uncertain macro-environment.
On the top line, we think the combination of flattish organic bookings compared to record bookings last year, with additional growth coming from our more recent acquisitions, and churn that is flat to improving is a compelling outcome in a difficult macro. On the bottom line, we're continuing to be judicious with our investments, being mindful of both long-term opportunities, and near-term macro uncertainty.
Turning to Slide 22, although we're not providing separate guidance on ServiceMax I thought it would be helpful to summarize the financial disclosures we made on ServiceMax in one place for you. These are the same number as we provided previously, with one exception. Since we focus on software ARR, we updated the geographic region chart to show the expected ARR mix instead of the expected revenue mix. As part of PTC, ServiceMax continues to trend toward the numbers we gave you.
Turning to Slide 23, here is an illustrative constant-currency ARR model for the back half of the year. You can see our results over the past six quarters and the two columns on the right illustrate what is needed to get to the midpoint of our constant-currency ARR guidance for Q3 and Q4 of fiscal '23. Because our ARR tends to see some seasonality, the most relevant comparisons are the sequential growth in Q3 and Q4 of fiscal '22. The illustrative model indicates that to hit the midpoint of our Q3 '23 guidance range of $1.85 billion, we need to add $36 million of organic ARR on a sequential basis. This is $7 million less than the $43 million we added in Q3 of fiscal '22. And in percentage terms, we need 2% organic sequential ARR growth to hit our guidance midpoint for Q3, which is at the lower end of what we've delivered over the past six quarters.
Next, to hit the midpoint of our full-year guidance range of $1.938 billion, we need to add $88 million of organic ARR on a sequential basis in Q4. While this is $12 million more than we added in Q4 of fiscal '22, we expect previously deferred ARR and sequential ARR growth from ServiceMax that we didn't have in Q4 of '22, we expect these two things will more than compensate for the additional $12 million sequential increase when compared to Q4 of '22. All things considered, we believe we've set our Q3 '23 and full-year constant-currency ARR guidance ranges prudently.
Turning to Slide 24, I'll conclude my prepared remarks today by highlighting that we prepared for a storm and we're demonstrating resilience in the midst of one. For sure, the environment will continue to change around us and we will continue to adapt accordingly, while still pushing the envelope of what we can do for our customers. From a top-line perspective, we serve industrial product companies, and R&D at those companies tends to be quite resilient. So we have a supportive top-line backdrop. We also have a subscription business model and our products are very sticky with our customers.
Given our results in the first half and the pipeline and outlook for the second half, we expect to deliver flattish organic bookings in fiscal '23 in comparison to record bookings in 2022. We also expect our ARR growth in fiscal '23 to benefit from incremental ServiceMax and Codebeamer contributions. And on the top line, we conservatively expect flattish churn from the already strong level of churn at the end of fiscal '22.
Just as importantly, from a cost and operational perspective, we are lean, having already battened down the hatches a while ago. In addition to the cost optimization work we did last year, we slow-planned hires and backfills in the first half of fiscal '23. We're well-positioned to deliver on our updated cash flow targets for the year. And now, at a time when many other technology companies are cutting costs, we're capitalizing on the strength of our business model and outlook by increasing investments selectively in long-term growth opportunities.
So with that, I'll turn the call over to the operator and we can begin Q&A.
