Jim Heppelmann
President and Chief Executive Officer at PTC
Great. Thanks, Matt. Good afternoon, everyone, and thank you for joining us. I'm pleased to report that PTC delivered an outstanding third quarter with top line ARR results and bottom line free cash flow results above our guidance, and we're raising our guidance for the third time this year. Before I dive in, I'd like to point out that Kristian will cover the effects of the strengthening dollar later during his section of the call. So to simplify things, I will focus my discussion of top line growth metrics on constant currency results. Turning to Slide 4. ARR and free cash flow results were very strong, and the strength was broad-based across all segments and geographies. Of particular note, we saw organic ARR growth further accelerate to 15%, driven by the acceleration we saw across the board in Digital Thread Core, Digital Thread Growth, FSG and Velocity units. ARR growth was helped by the lowest churn the company has seen in many quarters. I'm pleased to see PTC's organic growth rate move into that mid-teens range we've been targeting. We closed the Intland acquisition during Q3. I will refer to this business as Codebeamer going forward because that is the product name we will retain.
Codebeamer had an outstanding first quarter at PTC and added one point of inorganic ARR growth, taking PTC's ARR to $1.63 billion, up 16% year-over-year. In Q3, we complemented our top line growth with even stronger bottom line growth. Despite strong FX headwinds and nearly $20 million of restructuring and M&A transaction payments, our free cash flow performance was strong at $112 million, which was ahead of our guidance and up 33% year-over-year. Remember that the restructuring we implemented at the end of last fiscal year was designed to drive a more aggressive and efficient SaaS strategy. At the time it was announced, we viewed the charges as short-term pain for long-term gain. Now we're at the inflection point where most of the pain is behind us, leaving us with a cost structure that's in great shape, while the operational changes continue to generate the positive results we expected. I'm going to circle back on the margin topic in a few minutes when I reflect on macro scenarios. Moving to Slide 5.
Despite the scary headlines we read every day, we've continued to see solid global demand for our offerings. We did see some minor indications of macro-related softness in smaller European reseller accounts and in China due to COVID-related lockdowns, but this proved immaterial as organic bookings were up 29% year-over-year, roughly double the organic ARR growth rate. Europe bookings grew 20%. As I mentioned, renewals were also strong, and we're raising our FY '22 organic churn guidance as we're trending slightly better than expected. Growth was strong in both Digital Thread and Velocity units and across all three geographies. Q3 was the seventh consecutive quarter that bookings have grown faster than ARR, which, together with improving renewal rates, is driving the accelerating ARR growth we've been delivering all year. To help you appreciate the resilience of PTC as you think about any potential macro volatility that may lie ahead, on Slide 6,
I'd like to briefly again review our business model dynamics to help investors understand why, despite the uncertainty, we have confidence in our financial targets for the remainder of the year. On the left hand of the slide, you can see that the 16% ARR growth we delivered in Q3 was based not just on our Q3 performance, but performance over the prior three quarters as well. Given our definition of ARR as the annualized value of the book of active recurring software contracts, ARR growth is effectively a trailing 4-quarter metric. When we say ARR grew 16% in the third quarter, we mean that on average, ARR has now grown 16% over each of the past four quarters because the entire book of active recurring business is now 16% larger than it was at this time last year. While this trailing dynamic serves to dampen the impact of bookings in any single quarter, such as the strong results in Q3 where bookings grew roughly twice the speed of ARR, it also provides a tremendous foundation of stability for the company.
We are raising our ARR guidance for the full year because three of the four quarterly results that will comprise FY '22 ARR growth are already known, and we feel sufficiently confident about Q4. Kristian will elaborate during his guidance review. As you think about macro scenarios and their effect on PTC, remember the basic rule of thumb that so long as bookings exceed churn over the trailing four quarters, ARR will grow and so too should free cash flow. Bookings currently exceed churn by a wide margin, roughly 3:1. To demonstrate the resilience of our model, I'll quickly review the same big, round, directionally accurate numbers I supplied last quarter for you to run scenarios against. Think of PTC having 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. That's the 3:1 ratio I spoke of.
Over the next year, the $1.5 billion of ARR would step up by $300 million in bookings and step down by $100 million in churn to grow to $1.7 billion, which is 13% growth. That's roughly consistent with our current run rate performance, though our actual 15% ARR growth level reflects that we're running slightly favorable on both bookings and churn. I'll skip the details this time around. But on the right side of the slide, let me remind you of the hypothetical scenarios I shared last quarter. The first scenario has bookings slow 30% for four quarters like we experienced in 2009, and the second scenario has bookings slow 30% for two quarters like we experienced in 2020. In both cases, churn has held flat, consistent with experience in both periods. Across those scenarios, ARR grows upper single digits to low teens. Now to understand profitability in a downturn, let's take a fresh look at Slide 7, which I borrowed and updated from our December Investor Day presentation. Whether top line growth remains strong as it has been or it slows a bit due to macro developments, we expect to see significant margin expansion going forward. Margin expansion starts with the scale advantages we get by growing the top line faster than spending.
Fiscal year-to-date ARR is up 16%, while non-GAAP OpEx is basically flat. But we have several margin expansion programs that go further. The first margin expansion program is reflected in the actions we successfully implemented at the end of FY '21, which is shown on the left half of the page. Those changes are worth several hundred basis points of margin expansion once the restructuring is complete, and it now largely is. By the time we enter FY '23, we have the bulk of the operating costs and the restructuring costs removed from our results. In addition to that, we've also initiated a second margin expansion program, which is shifting resources within our portfolio in a way that addresses key staffing needs while driving up the profitability of our J-curve businesses as shown on the right half of the slide.
By reassigning some sales and R&D resources, and I'm talking about the actual people, from IoT and AR, where growth has been lower than expected, into other parts of the portfolio like CAD and PLM, where growth has been exceeding expectations, we're able to accommodate much of the company's resourcing needs while canceling more than half of the 800 open positions we had a quarter ago. This program will not involve layoffs or restructuring charges, just new assignments for existing employees. The avoidance of new hires and their previously budgeted cost is expected to yield a couple of hundred basis points of margin expansion over time. Note that a nice side effect of these resourcing shifts is that the Digital Thread Growth unit comprised of IoT and AR is now crossing into profitability.
We expect to see further margin expansion that comes naturally as these businesses continue scaling beyond the current $214 million in ARR. In addition to the margin expansion programs that are well underway, there's a third margin expansion opportunity. If we were to encounter signs of a significant macro slowdown, like the scenarios I mentioned, we would quickly implement new hiring restrictions against the balance of the open positions we have as well as other spending restrictions. This, too, would further help margins. The summary is that our cost structure is in great shape as we contemplate scenarios of what lie ahead. Given the cost lever we've already pulled with the restructuring at the end of last year, the lever we're pulling now by rebalancing resources within the portfolio and the additional lever that remains incrementally available to us if we see signs of a downturn, we're looking at substantial margin expansion drivers that make us confident we can deliver free cash flow growth in the mid-20s or better at Q3 FX levels and across most plausible ARR growth scenarios.
A mid-20s free cash flow growth rate supports the longer-term free cash flow guidance we currently have out there. So we continue to feel good about that even in this shaky environment. Because we have products that are compelling and sticky sold into good markets using a recurring revenue model, coupled with a long-standing reputation for spending discipline, PTC is in a good position to drive differentiated free cash flow growth no matter what macro scenario plays out. Getting back to Q3. Let's take a quick look at our ARR performance by geography on Slide eight before turning to our business units. In Q3, we again saw a strong ARR growth across all geographies. ARR growth in the Americas was 14%. In Europe, our ARR growth was 17% despite the Russia exit in Q2 which still affects the growth rate given the trailing nature of our ARR metric. Our ARR growth in APAC was 16%.
Knowing that investors are concerned about the macro environment, I'd like to reiterate that we are continuing to see strong bookings and renewal performance globally and in Europe. And given our recurring business model, ARR is likely to grow in all but the most extreme downturn scenarios one can imagine. Next, let's take a look at the ARR performance of our business units, starting with Digital Thread, on Slide 9. In our largest product segment, Digital Thread Core, we delivered another strong double-digit growth performance in Q3 with 14% ARR growth. Within this, once again, CAD grew low double digits, while PLM grew 17%. Bookings grew faster in both cases. Q3 was the best performance yet across the now 19 consecutive quarters of double-digit ARR growth we've seen in the core CAD and PLM business. On the SaaS transformation front, Windchill+ is in its early days, but we had a solid SaaS quarter for Windchill based primarily on a good mix of SaaS in new projects.
We continue to expect to see a growing SaaS impact from lift and shift conversions as that phenomenon ramps in FY '23 and beyond. A reminder, too, that Windchill+ is 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, which is IoT and AR, we were pleased to see ARR growth accelerate to 19% in the neighborhood of that two handle growth rate we're targeting. ThingWorx DPM had a solid quarter, including a multimillion dollar ramp deal with a leading global contract manufacturer for a 30-factory DPM rollout following a successful proof of concept. With ThingWorx DPM, we believe we have a turnkey IoT solution with strong product market fit, and this deal represents an excellent proof point. FSG posted great results again in Q3, accelerating to 9% ARR growth organically and growing 17%, inclusive of Codebeamer. Within FSG, Retail PLM, Arbortext and Servigistics all performed notably well, driven by solid results in terms of both bookings and renewals. Let's turn to Slide 10 and double-click on Codebeamer.
As the driver of the inorganic growth of FSG, Codebeamer had an outstanding quarter, beating its plan even before landing a mid-7 figures ramp deal with a European automotive supplier that's standardizing on Codebeamer across its thousands of software engineers. This transaction was actually the largest order PTC booked in the third quarter, which is quite an accomplishment for a business that currently represents 1% of our ARR. The Codebeamer product has best-in-class ALM capabilities and is seeing high demand because these capabilities are critical to manufacturers whose products contain embedded software. That's especially true in industries like automotive and medical devices that are regulated because an errant software chain -- change somewhere in the supply chain could lead to an unexpected product behavior that might kill people. Codebeamer is off to an amazing start, and early returns are very encouraging. We have combined Codebeamer with our previous ALM offering called Integrity and elevated this consolidated ALM business to be a key product line alongside CAD, PLM, IoT and AR in the Digital Thread portfolio.
Codebeamer will continue to be sold stand-alone, and we'll sell it with PLM as well. In addition to the strong stand-alone ALM sales that Codebeamer has been experiencing, adding it to PTC's portfolio is expected to drive incremental revenue and cost synergies. To keep our reporting simple in the near term, we will continue to report the ALM business in the FSG line item. Placing the high-growth Codebeamer business in the FSG reporting line item should take FSG from being a low single-digit grower to a sustainable mid-single-digit grower going forward, which, of course, helps to elevate PTC's overall growth rate as well. Before I turn to our Velocity business unit, let me run through a customer story on Slide 11 that illustrates how customers are leveraging our digital transformation capabilities. With more than 29,000 employees, Vestas is a key global provider of sustainable energy solutions to the energy industry. Vestas is a great PTC customer, and they use our software across their Digital Thread as they design, manufacture, install and service onshore and offshore wind turbines around the globe.
To meet the unique needs of each customer and each deployment, Vestas has embraced digital transformation. Vestas has literally taken an electrical mechanical wind turbine and turned it into a highly tailorable, software-controlled, connected powerhouse of clean and affordable energy. For Vestas, the first step was to establish a strong PLM foundation in engineering. Now Vestas is leveraging the end-to-end configuration management capabilities of Creo, Windchill and ThingWorx to drive process improvements across engineering and manufacturing. By eliminating manual handoffs and redundant work, Vestas is unlocking a step-function improvement in product and process quality while shortening lead times. Vestas is driving closed-loop innovation using data from a large number of connected wind turbines in the field to generate engineering insights. PTC's unique portfolio is well aligned to support Vestas along their digital transformation journey and their future plans include increasing use of ThingWorx and Vuforia as they continue to develop their best-in-class wind power solutions.
Turning to the Velocity business unit on Slide 12. Year-over-year ARR growth for our Velocity unit accelerated slightly to 29% in Q3 with Onshape and Arena, again, growing multiple times faster than their market. These cloud-native businesses, each a pioneering leader in its respective category, continue to give us proof points that suggest the future of the product life cycle software market will be SaaS. With Velocity, PTC has the best pure-play SaaS strategy in our market. It really is the industry benchmark for how SaaS should be done. And with the Atlas platform, borne of Onshape and now powering Windchill+ in the broader plus strategy, we are implementing SaaS across the entire portfolio. We expect the SaaS strategy to create strong growth tailwinds in the core business for years to come. Let's move to Slide 13, where I'd like to take you through a Velocity customer story. Wavemaker Labs is a product development accelerator known for product development excellence in automation applications.
They have a portfolio of companies, and they help these companies build disruptive technologies. Photo you see on the slide is the Flippy two automated frying robot from Miso Robotics, which is one of Wavemaker's portfolio companies. Miso Robotics is leveraging automation to revolutionize commercial food service, and their customers include Jack in the Box, Chipotle and White Castle, all favorites of Kristian Talvitie, I'm sure. To help Miso Robotics and their portfolio companies drive high-velocity product development, Wavemaker Labs has chosen Onshape and Arena. Speed, agility and flexible scalability are top priorities for Wavemaker Labs, making Onshape and Arena a natural fit. The unique analytics and management reporting capabilities of Onshape helps Wavemaker Labs to better understand the efficiency and the engagement of their engineers.
Also with their high-velocity mindset, Wavemaker Labs is focused on driving frictionless collaboration from start to finish. They're looking forward to being one of the first customers to deploy the new Onshape-Arena connection feature, which is in customer test now and will be released shortly. This connector will launch the industry's first integrated, pure SaaS CAD and PLM suite, which enables improved collaboration and a seamless flow of product data across engineering, supply chain and manufacturing or contract manufacturing activities. For a final topic, turning to Slide 14, there are two upcoming investor events I want to raise to your attention. First, we plan to hold a virtual FY '23 Investor Day event on November 17 where we'll give you a deeper view into PTC's financial plans for FY '23 and beyond.
Second, we plan to host a large LiveWorx ecosystem event on May 15 and 16 of 2023. That, assuming COVID cooperates, we expect will bring together thousands of customers, partners, investors and employees in a live event at the Boston Convention and Expo Center near our Seaport headquarters. We're hoping that many of you will attend the LiveWorx event where we'll have a dedicated investor track that allows you to participate in keynotes and investor sessions, plus gives you ample opportunity to interact directly with management, customers and partners across the PTC ecosystem. To make it easier for you, we plan to make the November event both shorter and virtual with the intention to give you what you need for your models to tie you over to the bigger LiveWorx event in May, where you can get a full dose of strategy and customer exposure. Please watch for a hold-the-date invitation from our Investor Relations team regarding both events.
To wrap up on Slide 15, demand remained strong in Q3, and we've seen only minor signs of a macro slowdown. But we're watching diligently, and we're well prepared for whatever lies ahead. Because of our resilient business model and spending discipline, we expect to deliver solid top and bottom line growth across any of the more plausible macro scenarios. Overall, I'm very pleased with PTC's position. Our strategy is working well. We've driven both our growth and profitability to levels that are near the top of our peer group. And I'm excited about the opportunities to do even better as we push ahead in parallel with our growth and margin expansion initiatives. Throughout the first three quarters of FY '22, bookings and renewals have been very strong. Growth has been accelerating all year, which is why we're raising our guidance for the third time. And we're entering the fourth quarter of what will be our fifth consecutive year of double-digit organic ARR growth. I think the company has never been in a better position to create shareholder value.
And with that, I'll turn it over to Kristian for more details on the financial results.
