Jim Heppelmann
President and Chief Executive Officer at PTC
Thanks, Matt. Good afternoon, everyone, and thank you for joining us. Turning to Slide 4. I'm pleased to report that despite seeing some incremental macro softness, PTC delivered a solid first quarter to kick off fiscal '23. On the top-line metric of ARR, we came in at $1.603 billion, which was above the high end of our range, and up more than 15% year-over-year. The strength was broad-based across all product groups and geographies. [Technical Issues] Sorry about that; a little interference. Organic ARR growth was 14%, with Codebeamer then contributing that extra point of inorganic growth. The strong Q1 ARR results put the company in a position to narrow our original 10% to 14% full-year ARR guidance to 11% to 14% as we feel that the 10% outcome has become increasingly implausible with a solid Q1 behind us.
Switching to our bottom line metric of free cash flow, we delivered $172 million ahead of our guidance and up 28% year-over-year. We raised our free cash flow guidance for the full year by $15 million. Currency had little impact to free cash flow in Q1, but it is expected to be incrementally helpful as the year progresses. On the subject of currency, I'll remind you that Kristian will cover the ongoing effects of foreign exchange fluctuations later in the call. So, to simplify things, I'll focus my discussion on constant currency results when discussing top-line metrics.
Turning to Slide 5. Shortly after our first quarter close, we completed the acquisition of ServiceMax. ServiceMax is not included in the Q1 results we reported, though we did incur some acquisition-related costs that were a headwind to our nevertheless strong free cash flow results in Q1. With the deal now closed, ServiceMax will be included in our guidance going forward. To recap the highlights of this business as now part of PTC, ServiceMax is used to manage the service processes for high-value, long-life cycle products. Think of products like an MRI machine in a hospital, a machine tool in a factory, or pumping equipment at a refinery. This has always been a sweet spot for PTC, and we have many customers matching this profile. Referring to the infinity diagram on Slide 5, many of you know that PTC's logo represents the interplay of physical and digital, and that logo provides a good way to explain the fit with ServiceMax. The digital part of our logo refers to when products are under development. At this point, they exist in a purely digital form, which is authored in Creo and managed in Windchill. Being purely digital at this stage, products are easy to change and highly configurable. Each time our customers get an order, their factories take a configuration of the digital product data that matches the order and use it as the recipe to produce the physical product, which is then delivered to the end customer. That's where the physical part of our logo fits in.
Physical products are very different. If you want to change them, for example, you need to dispatch a truck to the customer site, carrying a technician and spare parts. Spare parts are managed in our Servigistics software. The technician will need access to similar types of digital product information as what the factory used when creating the product. This service information is created using Arbortext and Vuforia. High-value products are operated by the customer for years or even decades. These products require regular service to keep them up and running and this service is typically provided by the manufacturer who views the recurring service contracts and spare part sales as a highly desirable source of revenue and profit. ServiceMax helps the manufacturer manage their entire installed base of physical product instances and orchestrates all the necessary service activities. By monitoring the installed base of products, ThingWorx adds a lot of value to ServiceMax because it allows service to be more proactive and preventative in nature. And sometimes the service can even be done remotely, thereby canceling the need for a truck roll.
As you can see, ServiceMax has great synergy with Creo and Windchill, because on one hand, the service process consumes the digital product data created in engineering in the form of parts catalogs and service instructions, and on the other hand, the service process is the primary source of feedback that drives ongoing product improvements through engineering change orders, or ECLs. Windchill serves as the system of record for the digital definition of all possible product configurations, and ServiceMax serves as the system of record for the actual physical instances of products that exist, each of which may have a slightly different configuration. As the infinity diagram implies, there is a digital thread of product information flowing between these key systems in both directions throughout the product life cycle. Aligning ServiceMax with PTC's various offerings will lubricate this flow of data, creating tremendous business value. No competitor has a solution comparable to this.
Equally important, as the service system of record, ServiceMax knits together our existing SLM products, allowing PTC to now offer the industry's first truly comprehensive offering for service management optimization. You can think of our new SLM offering as a hub-and-spoke model with ServiceMax as the hub and PTC's various other service solutions as spokes. For example, ThingWorx IoT connects to and monitors the vital signs of installed products to enable preventative remote service. Arbortext dynamically publishes technical service information to match each product configuration in the installed base. Vuforia AR enables this technical service information to be augmented onto each installed product to make service technicians more productive. And Servigistics allows customer service level agreements to be met while carrying the smallest possible inventory of spare parts. With the acquisition now closed, work is underway to enable deeper integration between ServiceMax and these various PTC offerings.
I'm pleased to announce that Neil Barua, the CEO of ServiceMax, is joining PTC and will preside over this expanded SLM business that now exceeds $300 million of combined ARR. Neil and team will unveil a broad, new SLM vision at our LiveWorx conference in May. And based on the number of inquiries we're getting, I expect it to be one of the highlights of the conference. The strategic fit with ServiceMax is excellent, and we're excited about the synergies we can generate by cross-selling from engineering to service and vice versa, and also cross-selling between our various SLM offerings within the service domain. The financial fit is excellent too as the transaction is expected to be accretive to PTC's growth rate as well as to PTC's cash flow, and this drove part of today's guidance raises.
ServiceMax also increases PTC's total addressable market. The ServiceMax business has been growing in the mid-teens, which is a few points faster than the market, but we see potential for the business to accelerate the high-teens growth over time as synergistic cross-sell opportunities are realized.
Turning to Slide 6. Given the elevated focus on profitability that investors all share in today's market, I want to reiterate the margin expansion program the PTC management has been driving. The organizational realignment we did at the end of fiscal '21 and the resource rebalancing work we did during fiscal '22 have created an organizational model for PTC that's both highly efficient and fully sustainable. When we made these changes, we were not addressing a problem per se but simply pursuing margin expansion opportunities that we had identified. The actions we took proved prescient as we're now well-positioned for a macro downturn. While many notable tech companies are announcing layoffs to come to terms of bloated cost structures, thanks to our proactive actions, we're entering this period of uncertainty with a very lean cost structure, and we do not anticipate any need for layoffs or restructuring.
In Q1, non-GAAP operating margin expanded to 36% compared to 35% a year ago. That sounds like progress, but due to ASC 606 noise, it doesn't fully capture the full magnitude of improvements we've made. We prefer to assess our margin progress by focusing on a more meaningful metric we now call operating efficiency. Operating efficiency is the same metric that we previously called cash contribution margin, but we're changing the name of the metric to be more precise that it is an operating metric, not a non-GAAP financial measure. This is a change in name only. The metric is still calculated the same way and still measures how much of our billings we're able to convert to cash flow each year. At the midpoint of our ARR guidance range, based on actions already taken, we continue to expect this operating efficiency to expand by another approximately 450 basis points in fiscal '23, following the 300 basis-point improvement we delivered last year. The significant operating efficiency improvement, when layered on top of double-digit ARR growth, is what drove the strong Q1 free cash flow result and is what will drive the 38% free cash flow growth we're guiding to for fiscal '23. Kristian will elaborate further.
Turning to Slide 7. As you're aware, our FY '23 ARR guidance range has, from the start, contemplated the possibility of a potential macro downturn. In Q1, we saw further signs of a downturn in the form of incrementally softer bookings. At the same time, we were comforted by strong renewals, which actually improved slightly year-over-year, reinforcing just how sticky our software is. The net impact of these softer bookings and stronger renewals was a slowdown of about 0.5 percentage point from last quarter's 16% ARR growth rate, taking the Q1 ARR growth rate down to about 15.5%. This was obviously less than we had allowed at the high end of our Q1 ARR guidance range, so ARR results landed $3 million above the range. The softness was relatively consistent across various dimensions of the business, suggesting it was macro-related rather than any type of competitive issue. The summary is that after posting 15.5% growth in Q1, we remain well-positioned to perform against our financial targets and indeed, have raised our guidance accordingly.
Turning to Slide 8. With Q1 behind us, as compared to our original guidance, we're now on track to deliver ARR growth results within a narrower 11% to 14% range in fiscal '23, with the low end having been raised because the 10% outcome is less plausible now given that solid Q1. Keep in mind, the addition of ServiceMax to our portfolio happens here in Q2, and the inclusion of ServiceMax will recalibrate the ARR growth range upward. In a few minutes, Kristian will outline a new guidance range that's essentially 11% to 14%, plus 1,100 basis points more from ServiceMax added on top. Across this range of ARR outcomes, we've also raised the original cash flow guidance we provided a quarter ago by $15 million to $575 million, which now represents 38% growth for the full year. The raise is powered in roughly equal parts: by a strong free cash flow result in Q1, the expected $5 million benefit from the ServiceMax acquisition, and improving foreign exchange rates. Should exchange rates hold or further improve, FX could prove incrementally helpful as the year progresses. Kristian will elaborate on the various factors involved here too.
Turning to Slide 9. Let's look at ARR growth across all geographies. ARR growth in the Americas was 16%. In Europe, ARR growth was 15% despite the Russia exit in Q2 of last year, which still affects the growth rate given the trailing nature of our ARR metric. ARR growth in APAC was 12%. Across all geographies, the largest ARR growth in terms of magnitude was driven by continued strong demand for Creo CAD and Windchill PLM products. In the Americas, we saw the strongest ARR percentage growth in IoT, Arena, Windchill and Onshape. In Europe and APAC, the growth rate was highest for Arena, which has been expanding outside the U.S. Arbortext and Servigistics both delivered strong growth rates in Europe and APAC. And finally, in Europe, Onshape and Augmented Reality also delivered strong percentage growth.
Next, let's look at the ARR performance of our product groups on Slide 10. In CAD, which is those products that enable authoring of product data, we delivered 10% ARR growth in Q1 in a market that has been growing approximately 8%. Within this, the growth was primarily driven by Creo, supplemented by strong percentage growth in Onshape and Arbortext. In PLM, which includes those products that enable data management and process orchestration for product development, our ARR growth rate in Q1 was 20%, or 18% organic, with strong growth across all geographic regions. In PLM, we continued to significantly outperform the market, which has been growing approximately 12%. Half of our Q1 growth was driven by Windchill, but ALM, including Codebeamer, and Arena, IoT, and Retail PLM, also contributed to great Q1 PLM results by delivering strong percentage growth.
I'd like to discuss Windchill+ in the context of a new logo customer on Slide 11. Given the importance of our SaaS transformation program as a growth driver, I'm pleased to see good progress ramping up the new multi-tenant Windchill+ solution. While it's still early, across a combination of new logo deals, as well as lift-and-shift SaaS conversions, we now have about a dozen Windchill+ customers in production that are headed there shortly, with dozens more opportunities in the pipeline. As we said at our investor day, we expect an S-curve type of ramp over multiple years for our Plus offerings. And thus far, we're tracking well to that expectation. To share a customer story, we landed a new logo deal with a well-known motorsports company. That's a great example of an organization that's reaping the benefits of the streamlined PLM implementation experience that Windchill+ offers. This customer has committed to enter a new racing circuit but faces a tight timeline to get prepared. Their team needed a PLM system to be in place quickly because they're designing a more efficient power unit that needs to be completed and tested in short order. And then, as usual, there'll be a steady diet of changes and improvements thereafter.
With the Windchill+ implementation, the motorsports company achieved a production ramp-up time of several months, including integration with their hybrid SaaS ERP system. They got there so quickly by leveraging the out-of-the-box capability of Windchill+ delivered by PTC to the customer as a secure preconfigured service. This customer has no dedicated IT team, so leveraging SaaS applications is important to enable them to keep their internal efforts focused on racing while improving collaboration across team members in the field and around the globe. As a reminder, Windchill+ is the tip of the iceberg of a bigger Plus strategy, and you'll see us follow with Creo+ and similar premium SaaS offerings in FY '23 and beyond. We are aiming to launch Creo+ and the bigger Plus strategy at LiveWorx in May.
I'd like to share another customer anecdote to help you better understand the immense power of our technology. Turning to Slide 12. I want to tell you about an important project from our customers at the U.S. Department of Energy. I trust you saw the mid-December news that for the first time, scientists at Lawrence Livermore National Laboratory have produced a nuclear fusion reaction that generated more energy than it consumed. This major scientific breakthrough happened at Lawrence Livermore's National Ignition Facility and may pave the way to a future filled with clean energy. The National Ignition Facility, or NIF, is essentially a massive machine of enormous size and complexity. The NIF is a precision-engineered system of systems that generates and then directs 192 powerful laser beams onto a pencil eraser-sized area that heats to millions of degrees to ignite the nuclear fusion reaction. The sports stadium-sized NIF machine is all modeled in Creo and Windchill, everything they say, except the walls and the bathrooms. With 3.5 million components, we believe the NIF is the largest Creo and Windchill assembly ever made, and very likely, the largest assembly ever modeled in 3D CAD, which is a real testament to the power of our technology.
During our regular collaborations with DOE teams over many years now, PTC product teams have been challenged to further develop our products to enable such highly advanced projects in what has proven to be a mutually beneficial relationship. While substantially more work lies ahead in the effort to harness the potential of fusion energy, as demonstrated by the NIF, we're very proud of the role that our technology has played in enabling this early breakthrough. And the announcement was exciting for many PTC employees who have been involved, including me. PTC may very well prove to play a key enabling role in the ultimate ESG breakthrough.
Summarizing then on Slide 13, while in Q1, we saw incremental signs of a macro slowdown, there's a lot going our way right now. First, PTC has established itself as the clear category leader in PLM, which has become a must-have technology backbone for digital transformation at industrial companies. We just posted another quarter of 18% organic PLM growth, well ahead of market peers. We are conquering the PLM market. The addition of ServiceMax further extends what was already a unique portfolio of interconnected digital thread capabilities across the full product life cycle, and ServiceMax is expected to be a tailwind to ARR and free cash flow right from the start. Both Codebeamer and ServiceMax will provide a big boost to our PLM conquest efforts.
Second, while the company growth is at a double-digit level already, we're in the early days but executing well against a major on-premise-to-SaaS transformation that should provide a multi-year growth tailwind.
Third, we have a reputation for driving margin expansion that goes back more than a decade. And the proactive changes we've already made are driving high levels of free cash flow growth again this year.
Fourth, we're demonstrating that our business model is very resilient. Top-line growth and bottom-line profitability are at levels that are amongst the best in our industry peer group. Not many peer companies are projecting the double-digit organic top-line and 38% bottom-line growth that PTC is guiding to this year.
And finally, we're led by a team that has deep expertise and proven ability to drive growth and margin expansion. We're happy to welcome Neil Barua to the PTC executive ranks because Neil and the entire ServiceMax team share the same depth and passion for the business that's so important here in the PTC culture. With so many positive trends going our way, I continue to believe PTC has a tremendous opportunity to create shareholder value even in the face of a macro downturn we've all been expecting.
With that, I'll turn it over to Kristian for his more detailed commentary on financial results and guidance.
