James E. Heppelmann
President Chief Executive Officer Member of National First Executive Advisory Board and Director at PTC
Thanks Matt. Good afternoon everyone and thank you for joining us. To simplify things please note that throughout my commentary I will be discussing all growth rates in constant currency. Turning to slide four. I'm pleased to share that PTC delivered another strong financial performance in fiscal Q2. All of our metrics came in above our guidance and the strength was broad based across all segments and geographies. Of particular note we saw organic ARR growth accelerate to 13% despite the self-inflicted churn caused by our decision to exit the Russian market. We ended Q2 with $1.56 billion of ARR. Bookings grew faster than ARR and renewals were very strong. We also continued our track record of translating top line growth into even better bottom line growth. In Q2 our adjusted free cash flow performance was strong at $158 million up 22% year-over-year and ahead of our guidance.
The non-GAAP operating margin of 42% in the quarter was the highest we've seen. The margin expansion strategies we outlined at our December Investor Day are generating the results we expected. Moving to slide five. While we're monitoring the global macro and geopolitical situation carefully we continue to see strong global demand environment for our offerings. Driving digital transformation across the product life cycle remains an important priority for our customers. Bookings were up mid-teens in the year-over-year and rent was broad-based. Growth was strong in both digital thread and velocity and across all three geographies. Q2 was the sixth consecutive quarter that bookings have grown faster than ARR which together with improving renewal rates creates an acceleration bias for ARR growth.
To help you understand the resilience of PTC as you think about any potential macro volatility that may lie ahead I'd like to expand on our business model dynamics to ensure you appreciate why our business model provides us with confidence in our ability to achieve our financial targets in the back half of the year. Let's take a look at slide six. On the left-hand side of the slide you can see that the 13% ARR growth we delivered in Q2 was based not just on Q2 performance but also on the momentum we built over the previous three quarters as well. ARR growth is a rolling 4-quarter metric. So when we say ARR grew 13% in the second quarter we mean the entire book of recurring business is now 13% larger than it was at this time last year. While this rolling dynamic dampens the impact of bookings in any single quarter such as the strong results in Q2 it also provides the foundation of stability and resiliency for the company. Remember that so long as bookings exceed churn ARR will grow. Bookings currently exceed churn by a wide margin. To help you run your own scenarios let me simplify the math by giving you some big round directional numbers to work with. Let's say PTC has around $1.5 billion in ARR. And on a run rate basis we're adding $300 million in annual bookings while seeing $100 million in annual churn. Over the next year the $1.5 billion of ARR would step up by $300 million and stepped down by $100 million to grow to $1.7 billion which is 13% growth.
That's consistent with our run rate performance. Note that because PTC provides sticky enterprise software our history in 2009 and again in 2020 shows renewals remain steady through a macro downturn. To better understand the sensitivity then of ARR to macro changes let's start with a hypothetical scenario where bookings stopped growing and remained flat indefinitely at $300 million. In that case with churn being steady ARR would experience double-digit growth for several years and high single digit for several more years after that. If you're concerned about a downturn in Europe which represents 40% of our business you could create an alternate model where 40% of our bookings declined by 25% for two quarters and then bounced back in which case we'd still deliver 12% ARR growth over the forthcoming year. If you want to run a more draconian global macro downturn scenario you could model a 25% reduction across all bookings for the next four quarters in which case you still get 8% ARR growth over the next year. Frankly no matter what scenarios you might model you'll consistently see that PTC has a very resilient business. Keep in mind that those were hypothetical examples because the actual results are considerably better.
When bookings grow faster than ARR as we've seen quarterly since the COVID rebound it creates an acceleration effect for ARR. Improvement in renewal rates which we've also been seeing are helpful as well. PTC is experiencing the benefit of these dual acceleration effects right now which is why we're raising our ARR guidance for the full year. In summary while the company is in position to accelerate ARR growth assuming conditions remain as they have been we're also in good position to power through any potential macro slowdown with strong results as we did in 2020 when bookings design declined sharply for several quarters due to the pandemic before rebounding again. PTC's FY '20 ARR growth of 11% compared very favorably to our more cyclical industry peers who don't have the same recurring business model. Some of whom even experienced top line declines in their comparable business lines.
The takeaway from this discussion is that our subscription model which took us years of hard work to put in place is a wonderful thing and it will keep PTC in a growth leadership position in our industry for years to come. Moving on let's take a quick look at our Q2 ARR performance by geography on slide seven before turning to our business units. In Q2 we saw strong ARR growth across all geographies. Our ARR growth in Americas was 12%. All product segments grew with the main growth drivers being continued strength in our core PLM and CAD segments and another strong contribution from our Velocity business. In Europe our ARR growth was 15% despite the Russia exit. We saw strong results across the board in Europe with growth primarily driven by our core PLM and CAD businesses and strong growth in the IoT and AR segment. In addition our velocity and FSG businesses delivered solid growth in Europe in Q2. Europe has the largest mix of channel versus direct and the resellers continue to perform well. I know that investors are concerned about exposure to Europe and the macro environment there so I'd like to reiterate that: first we're continuing to see strong bookings performance in Europe; and second as I've demonstrated quantitatively our model is highly resilient. Our ARR growth in APAC was 14% with our core CAD and PLM businesses again being the main drivers.
Next let's look at the ARR performance of our business units starting with digital thread on slide eight. In our largest product segment Digital Thread Core we delivered another double-digit growth performance in Q2 with 13% growth. Within this CAD grew low double digits while PLM grew mid-teens. Bookings grew faster in each case reflecting on Q2 across the now 18 consecutive quarters of double-digit ARR growth that we've seen in the core CAD and PLM business. This was the best performance yet which I attribute to a combination of strong demand for digital transformation best-in-class sticky solutions sold in the recurring revenue model with low churn rights and the growth tailwinds from our SaaS initiatives. In our core business our solutions are very strategic and we're executing well and taking market share.
You may have noted we also launched Windchill Plus during the quarter. which is our next-generation differentiated core SaaS PLM solution. Windchill Plus contains the technology and operational improvements that enable higher profitability and is now becoming our lead Windchill sales play. Windchill Plus is just the tip of the iceberg of a bigger plus strategy. And you'll see us follow with Creo Plus and similar premium SaaS offerings in FY '23 and beyond. In Digital Thread growth we saw ARR growth of 15%. While the sequential acceleration was modest we made good operational progress and remain on track to get growth to a two handle by the end of the year. Following the launch of our new ThingWorx Digital Performance Management Solution which we abbreviate as DPM in Q2 we landed our first nine deals across various different industries including aerospace and defense high-tech automotive and food and beverage.
Though these were started deals average initial deal size was six figures. Rockwell brought in several of these DPM deals and the DPM pipeline for both companies looks good going into the back half of the year. FSG had a great Q2 with 8% ARR growth. Servigistics retail PLM and Arbitext all performed well helping to drive solid results in terms of renewals and churn. Growth was particularly strong in the Americas and Europe. With FSG our strategy is to keep delivering value to customers by having dedicated focus on each of these products. And I'm pleased to see that strategy produced another strong quarter. Before I turn to our Velocity business unit let me run through a couple of quick customer stories that will give you a taste of how customers are leveraging our digital transformation capabilities.
I'll start with Bosch on slide nine. Bosch is a massive global supplier of technologies and services. With 400000 employees including 75000 engineers a key challenge for Bosch is how to drive end-to-end digital transformation at scale. Bosch is leveraging their Windchill PLM system as a backbone in combination with Creo and ThingWorx to enable new and improved workflows. This specific example is about Bosch using model-based design capabilities of Creo Winco. By moving beyond the world of 2D drawings and leveraging enhanced 3D Creo data across engineering manufacturing and inspection processes Bosch is driving improved productivity and bringing products to market faster. Next on slide 10. Cummins is the world's largest independent diesel and gas engine manufacturer and an interesting ESG story that we help enable. Cummins has long made it a company goal to reduce their environmental impact and digital transformation is a critical part of their journey.
By using generative design and ANSYS-powered simulation upfront in their Creo-based design process Cummins has been able to reduce material usage create better products and accelerate time to market. Turning to the Velocity business on slide 11. Year-over-year ARR growth for our Velocity segment was 27% in Q2 with both Onshape and Arena growing multiple times faster than the market which demonstrates there's a distinct and vibrant segment of the CAD and PLM market that prioritize SaaS and agile product development as their number one buying criteria. With Onshape and Arena PTC has a unique ability to serve this market segment and we're continuing to ramp both our Velocity product and go-to-market investments. Let's move to slide 12 where I'd like to take you through a Velocity example showing how Arena is empowering Filtronics global team to deliver innovative products faster. Filtronic is using Arena's SaaS PLM solution to control product design and supporting documentation and to enable collaboration across globally-distributed teams.
The benefits of providing complete visibility into critical product and quality processes are significant. For example engineering change cycle time was cut by 50% and the issue resolution time has been cut in half as well. Turning to slide 13. We announced two transactions last week and I'd like to recap both and provide some additional context. First we announced an agreement to acquire Intland Software a next-generation application life cycle management or ALM company for $280 million. For background PTC entered the ALM market a decade ago when we acquired MKS and their integrity suite. ALM has become an important and well-established offering within PTC's portfolio and is sold both standalone and as a key subsystem of our Windchill PLM offering. The codebeamer family of software products from Intland is a next-generation ALM suite that's fast becoming the new standard in safety critical and regulated industries especially in the large automotive industries where products are increasingly differentiated by the software bringing codebeamer into our ALM suite will bolster both ALM and PLM growth potential by significantly increasing our product strength and market momentum. Intland's a great company who matches their strong product with strong growth and surprisingly good profitability for their size. We expect to achieve both revenue and cost synergies with this acquisition.
When it closes the acquisition is expected to add roughly one percentage point of inorganic growth to our FY '22 ARR results. Intland will join our existing ALM unit. So codebeamer ARR will be reported as part of our FSG segment. We expect this acquisition will increase the growth rates of FSG going forward which we now expect to be consistently growing in the mid-single-digit range. Second we announced an agreement to sell a portion of our professional services business to long-time partner ITC Infotech to further power our SaaS strategy. This moves a continuation of a long-term strategy we've been executing to focus PTC's efforts on high-margin software while we look to a partner ecosystem to deliver the professional services that unlock the value of that software in the customer setting. As we ramp up the SaaS initiatives we described at our December Investor Day a key component of the program is the lift and shift efforts required to move on-premise customer deployments into our SaaS cloud. With a large installed base we're looking at the need for potentially thousands of services projects in the coming years.
These are projects where PTC needs to play a direct role because at the end of each project we will be taking ownership of the running system and carrying it forward. Rather than put our own professional services organization back on to a growth vector as we scale up to perform these projects we're instead planning to transition some of our key PLM talent into a new ITCI unit called DxPServices thereby allowing the lift and ship capacity to scale on ITC's P&L rather than ours. This new DxPServices unit will be our partner to run joint lift and ship projects with DXP doing the upgrade and de customization work that happens at the customer site and PTC assuming the resulting system into our centralized SaaS operations. This is a professional services transaction so it has no bearing on ARR. Kristian will comment further on the expected financial impact of these two transactions. We expect both will close in Q3.
To wrap up then on slide 14 I'm very pleased with PTC's position and the opportunity that lies ahead. Our portfolio of products is unique and compelling and it aligns well to customer demand. Throughout the first half of FY '22 bookings and renewals have been strong and growth is accelerating as we enter the second half of what will be our fifth consecutive year of double-digit ARR growth. We're poised to further accelerate growth as SaaS tailwinds blow harder in the coming quarters and as we gain momentum with DPM and other IoT and ARR initiatives. Our profitability continues to expand following the changes we implemented at the start of the year and as our start-up businesses continue to mature up the J curves. Our model has proven to be highly resilient even in the face of a slowdown like during the pandemic in 2020. We're raising our guidance for the second quarter in a row and I think the company has never been in a better position to create shareholder value.
With that I'll turn it over to Kristian for more details on the financial results. Kristian?