Jim Heppelmann
President and Chief Executive Officer at PTC
Thanks, Kristian. PTC is at an exciting point in our history. Despite bumpy macro conditions, we have established a four-year track record of double-digit top-line organic growth based on a recurring revenue model and driven by widely recognized technology leadership positions in an industry increasingly motivated by digital transformation. In parallel, our decade-long track record of strong operational discipline has driven our margins up, enabling us to benefit significantly from leverage as we scale. You see that in the 61% free cash flow growth I highlighted at the start of the call. Given the strength of our financial performance in fiscal '21, the restructuring we announced today might come as a surprise to some of you, but sit tight because I think you will like what we're doing. For some time now, I've been telling investors about our plans to leverage the Atlas platform that we acquired with Onshape to pivot the whole company toward a SaaS future. As I had previously discussed it, much of the upside benefits of the SaaS pivot would come in fiscal '24 and beyond. Many of you have asked, why wouldn't we invest more to get to that SaaS upside more quickly? Frankly, that was a good question and one that we thought long and hard about. We even hired McKinsey to help us think through it and develop a strategy. Today, I will explain how, thanks to the changes we're making, we will invest substantially more in our SaaS initiatives while actually decreasing our overall run rate spending projection significantly. Let me hit the financial summary first on slide 16, and then explain the strategy and operational changes behind it. In terms of the financial view of the restructuring, we are reducing our spending run rate by approximately $60 million compared to fiscal '21 as we improve the efficiency of our organizational structure. We've also eliminated about $30 million of previously contemplated new spending run rate from our fiscal '22 plans.
So compared to the plan for fiscal '22 that existed prior to the restructuring, we now have -- we now expect to reduce our planned fiscal '22 run rate spending by approximately $9 million. And then reinvest about half of that into initiatives that accelerate our transition to SaaS, with the other half falling to the bottom line. Key SaaS investments will be used to increase capacity on Atlas, to accelerate work to adopt Atlas into our core products and to operate those products at SaaS, and into Onshape and Arena product development and sales capacity. Despite what will be a very significant investment, we expect to expand cash margins by approximately 400 basis points in FY '22. So we are accelerating both growth and margin expansion at the same time. Restructuring-related cash outflows are expected to be approximately $50 million to $55 million, with about two-thirds occurring in the first half of '22, and the majority of the remaining payments to be made in Q3. In other words, the restructuring will obscure the great cash flow progress for the next two or three quarters, but the benefits will start shining through after that. Already by Q4 of fiscal '22, we should be seeing a net free cash flow tailwind as a consequence of the restructuring. Then as Kristian will outline, fiscal '23 and beyond will look great. Let's go to slide 17, and I'll start by explaining why SaaS pivot is so interesting to PTC. There are three reasons why we think now is the time for PTC to align with and invest more in the SaaS transition. First, the industrial software market wants to go to SaaS. COVID has greatly amplified the interest in SaaS. PTC is already the recognized SaaS leader in our industry. Onshape and Arena have proven what's possible, and they've dramatically elevated PTC's credibility.
We are far ahead of competitors in terms of understanding what SaaS is and what it is not. Customers are looking for PTC to lead the whole industry through a transition to SaaS. Second, based on growing customer demand, we see the need to accelerate SaaS initiatives while better aligning with SaaS best practices in order to meet the needs of the market. The investments we're making now will allow us to play offense to capture the market demand. Third, we believe our new SaaS strategy will accelerate a major growth driver for PTC, giving us more pathways to mid-teens growth in the midterm and helping to de-risk our growth ambitions. Meanwhile, cost savings from the restructuring itself are expected to derisk our free cash flow growth targets, even if the growth should prove slower to materialize than I expect. Turning to slide 18. Owning the industry's only cloud-native CAD and PLM combo has been a big advantage. By comparing how our Onshape and Arena businesses work, as compared to the balance of BTC, we can see that certain ways in which PTC has been organized are quite inefficient. At the same time, we see an opportunity to serve customers better, too, and that's why we're choosing to evolve our organization to be more SaaS-like. I'd like to review several of the larger changes. Previously, in addition to working with sales, our customers would have more than a half dozen touchpoints across our broad customer success organization, including renewal sales, presales, post-sales consulting, customer success management, technical support, our cloud organization, a group called customer experience and others.
In comparison, most SaaS companies have a two-in-the-box model, where each customer has just one sales and one customer success contact. Not only is PTC's current model inefficient, perhaps, more importantly, customers hate being repeatedly passed from one contact to another as they proceed through their journey with PTC. So we are reconfiguring to deploy the same two-in-a-box model that SaaS companies utilize. This reconfiguration has no impact on the sales side of the equation. In fact, we're adding direct quota-carrying capacity into the current model. Aside from where we expand coverage, the vast majority of customers will retain the same sales contacts they know and love today. The bigger change for the customer will be that they now have one customer success contact rather than many. There's nothing but goodness here for everybody. Customers prefer this model, and it will save PTC a lot of money as it is much more scalable. The other major change is on the product development, delivery, and support side. With Onshape and Arena or any true SaaS company, this is all done by a single organization using modern DevOps practices. But within the core PTC product lines, the development cloud delivery and technical support organizations have been entirely separate with the latter to belonging to the field organization. You simply can't get to SaaS that way. As part of our reorganization, we have merged our cloud delivery and technical support groups into the product organization to mirror the Maven SaaS practices deployed by Onshape and Arena and everybody else in the SaaS world. This, too, will create significant operating efficiencies and a much-improved customer experience at the same time. Nothing but goodness here, too.
To better understand the demand drivers, let's take a look at an illustrative value proposition on slide 19, typical of what customers see in the transition from on-premise to SaaS. For every dollar a customer pays PTC or any other vendor for on-prem PLM, they have an estimated additional $2 to $3 in cost of ownership associated with on-premise servers and storage system administrators plus SIs who help with on-site installations and upgrades and all that. Their total cost of ownership can be $3 to $4. When the deployment, maintenance, and delivery responsibility for the software is shifted back to PTC, we can leverage significant efficiencies to serve that same functionality back to the customer for roughly an incremental dollar at margins that are attractive to us. Therefore, each dollar of on-premise software ARR today represents potentially $2 of future SaaS ARR for PTC plus a savings of $1 or $2 for the customer. The customer also gets to enjoy the many other benefits of SaaS. It is device-agnostic, it's ideal for a hybrid work environment, data shared with employees and suppliers in real-time, plus no more upgrades to do as everyone is always on the latest version. This value proposition for SaaS is not really new news to any of you, it's what Marc Benioff at Salesforce.com has been espousing for two decades now. More than half of the overall commercial software industry has already made this pivot. But that's not yet the case in our world of industrial software, where SaaS has low single-digit penetration. As Salesforce did in CRM, some company will have to lead the way to SaaS in the CAD and PLM industry. We think the time is right for industrial companies to move to SaaS, and PTC is best positioned to lead that transition.
Turning to slide 20. We've been delivering more and more new PLM projects as SaaS in recent years, as customer preference has shifted there. But going forward, we'll make SaaS our primary delivery model and deliver on-premise only when required by the customer. But we also have a large existing customer base with on-premise systems. In order for existing customers to get to SaaS, each customer has to go through a lift and shift process. This process entails lifting the on-premise deployment, upgrading and decustomizing it as necessary to eliminate technical debt, and then shifting it into the PTC cloud from where we can serve it back to the customer as a service. We plan to focus the lift and ship program first in Windchill where the biggest opportunity lies and bring Creo and other products into the fold in subsequent phases over time. So you may be wondering, well, how will this help to accelerate growth? The answer is that our organizational changes and the associated wave of investment enable us to scale up to make SaaS the default for new sales and to start the lift and shift process now here in fiscal '22. Though the value proposition for transitioning to SaaS is sound, we still have to go through a sales cycle with each customer. Returning the sales teams lows now with this proposition, and we expect the first projects to begin showing up in the back half of fiscal '22. The Windchill SaaS capability will be deployed into Azure and into the manufacturing cloud at that. So Microsoft is eager to help us sell this proposition. I'd like to think of this project as the last upgrade for each customer because when the lift and shift project is done, then PTC will take it forward father. Therefore, a good time to sell this program is whenever customers start planning their next upgrade.
Customers tend to upgrade Windchill systems once every two or three years, so we get a shot at a good portion of the base each year and expect success to accelerate in fiscal '23 and beyond. There are thousands of Windchill deployments out there, so I anticipate this process will take numerous years, perhaps a decade, and we won't get them all. Naturally, we'll focus first on the most ready customers and work on the long tail further out. In the end, I expect we'll ultimately get about 75% of the customers to transition, and we'll continue to offer on-premise variance of the product, born of the same code stream on an indefinite basis for those who do not want SaaS. PTC is all in on SaaS. The program we're launching is a major cross-sale effort on par with the highly successful program. We executed the move from perpetual to where we are today with 98% of our software revenue now being subscription. Like that subscription program, the SaaS transition program involves numerous changes to our offerings, to our pricing and packaging, to compensation, and more. We have the same program leader driving it. An important difference though is that the SaaS transition program is all about growth acceleration within the recurring software business model we currently have in place, which means we will not have the same so-called valley of death effect that our cash flow went back -- went through back then. Now we'll have all of the gain, but none of that pain. Taking you deeper into the elements of this program will be a key agenda topic at our December Investor Day.
One last related change we're making is to organize into two main business units, as shown on slide 21. With plans to leverage SaaS now in place and underway across the entire company, it no longer makes sense to have a SaaS business unit per se. Therefore, we plan to reunite Vuforia AR with the CAD PLM and IoT product lines into a business unit designed to promote higher levels of cross-selling across this integrated product portfolio. This new business unit, which focuses on the digital transformation driver, will be all about growing the base and leading them to SaaS. It will be called the Digital Thread business unit to reflect the highly integrated nature of its portfolio of products. Troy Richardson, who's been our Chief Operating Officer for the past year, is being promoted to become President of this business unit. Troy has already been managing the go-to-market side of these businesses, but now the product development arm will report to him as well to drive title liman. Naturally, I'll stay involved in the technology road map, because as you probably know, that's where my passing lies. You'll get more time with Troy Richardson at the upcoming Investor Day. Onshape and Arena will remain together under their current President, Mike DiTullio. This will be called the Velocity business unit to reflect that the cloud-native pure SaaS value proposition of Onshape and Arena, it's most attractive to companies who want to deploy agile product development processes and move fast. This business unit is all about disrupting the competition and landing new logos, which, in many cases, are SME customers. But we're seeing larger companies being drawn to Onshape and Arena solutions too because their existing vendor simply doesn't have anything that compares.
Companies like Garrett Motion, for example, the $4 billion automotive turbocharger company we profiled at our fiscal '20 Investor Day last year, who switched to Onshape from a high-end CAD competitor to gain increased business velocity. You'll have more time with Mike DiTullio, too, at the Investor Day. Both business units Presidents report to me. I'll help drive their respective strategies, while Troy and Mike preside over the operating cadence of each business unit. A related change is that the Atlas platform will move under our very capable CTO, Steve Dertien, who will develop the shared platform to meet the needs of both units. Steve will continue to report to me. I know that was a lot of information to take in. Turning to slide 22. Let me summarize, and then I'll hand it back to Kristian for more specific go-forward guidance. First, from a top-line perspective, our SaaS acceleration pivot unlocks another powerful multi-year growth catalyst for PTC and our shareholders. Exiting fiscal '21, Creo and Windchill together represent more than $1 billion of ARR, growing double digits organically. This growth pattern has been in place for four years now, right through the pandemic with the strong performance driven by the role both products play in the digital transformation strategies of industrial companies. With the SaaS program that we're launching, we're layering an additional growth driver into this core business that we expect could last a decade. Therefore, in our core business, we see double-digit ARR growth being sustainable well into the future. Together with the growth drivers in IoT and AR, plus Onshape and Arena, we're creating more pathways to drive ARR growth to the mid-teens.
In my view, PTC's growth story is alive and well. Second, from a bottom-line perspective, the strategic improvements we're making will drive up our cash contribution margins considerably and help de-risk our cash flow targets under a broader range of ARR growth scenarios. Kristian will expand on this. Given our confidence in growth, coupled with the higher margins, we remain committed to the midterm free cash flow targets that we set at our Investor Day last year. Recall that our guidance was for midterm free cash flow growth of approximately 25% to 30%. After we get beyond the restructuring payments, we expect to perform in that range, perhaps earlier than you might have expected. Our guidance for fiscal '22 assumes we'll get a small positive impact from the SaaS transition in the back half of the fiscal year, which is counterbalanced by slower assumed growth rates in FSG and somewhat conservative assumptions we have around Rockwell's contribution as they work their way through the Flex integration. Let me be clear that our commitment to the partnership with Rockwell remains as strong as ever, and that we're energized to work together because of the great potential we see ahead. In particular, we see tremendous potential for the DPM offering [Indecipherable].
Kristian, back over to you.