PTC Inc (PTC) 2022 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the PTC 2022 Second Quarter Conference Call. (Operator Instructions)

I would now like to turn the call over to Matt Shimao, PTC's Head of Investor Relations. Please go ahead.

Good afternoon. Thank you, Savannah, and welcome to PTC's 2022 Second Quarter Conference Call. On the call today are Jim Heppelmann, Chief Executive Officer; and Kristian Talvitie, Chief Financial Officer. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today at www.ptc.com.

During this call, PTC will make forward-looking statements, including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's annual report on Form 10-K, Form 10-Q and other filings with the U.S. Securities and Exchange Commission as well as in today's press release. The forward-looking statements, including guidance provided during this call are valid only as of today's date, April 27, 2022, and PTC assumes no obligation to update these forward-looking statements.

During the call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website.

With that, I'd like to turn the call over to PTC's Chief Executive Officer, Jim Heppelmann.

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 4. 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 5. 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 year-over-year, and the strength was broad-based. Growth was strong in both Digital Thread and Velocity and across all 3 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 6. 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 3 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 2 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 4 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 7 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 8. 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 rates 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+ during the quarter, which is our next-generation differentiated core SaaS PLM solution. Windchill+ contains the technology and operational improvements that enable higher profitability and is now becoming our lead Windchill sales play. Windchill+ is just 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.

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 2 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 9 deals across various different industries, including aerospace and defense, high-tech, automotive and food and beverage. Though these were starter deals, average initial deal size was 6 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 Arbortext 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 9. Bosch is a massive global supplier of technologies and services. With 400,000 employees, including 75,000 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 and Windchill. 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 prioritizes SaaS and agile product development as their #1 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 Filtronic's 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 2 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 1 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 move is 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 DxP Services, thereby allowing the lift and shift capacity to scale on ITC's P&L rather than ours. This new DxP Services unit will be our partner to run joint lift and shift projects with DXP doing the upgrade and the 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 2 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 their 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?

Thanks, Jim, and good afternoon, everyone. Before I review our results, I'd like to note that I'll be discussing non-GAAP results and guidance, and ARR references will be in both constant currency and as reported.

Turning to Slide 16. At the end of Q2, our constant currency ARR was $1.564 billion, up 13% year-over-year. Our SaaS businesses in both the Digital Thread and Velocity business groups saw continued solid ARR growth in Q2 and represented a larger mix of our overall business, both year-over-year and sequentially. We delivered above the ARR guidance range we provided for Q2, which was for constant currency ARR of $1.54 billion to $1.55 billion. On an as-reported basis, year-over-year ARR growth was 11%. Foreign exchange was a $32 million headwind, and our as reported ARR in Q2 was $1.532 billion.

In March, following the Russian invasion of Ukraine, we announced that we would discontinue business operations and sales in Russia. Exiting Russia had a $4 million adverse impact on our Q2 ARR. We've accounted for the $4 million impact as churn in Q2.

Cash from operations of $142 million in Q2 was in line with our guidance. Considering the $32 million foreign exchange headwind to ARR, this was a strong outcome, reflecting expected seasonality and another quarter of solid collections performance.

In Q2, free cash flow of $140 million grew 21% year-over-year and included $18 million in restructuring and other related payments. Adjusted free cash flow was $158 million, up 22% year-on-year. Free cash flow and adjusted free cash flow were both ahead of our guidance due to strong cash from operations and also because CapEx in Q2 came in slightly lower than we had anticipated. The main takeaway on cash flow is that despite the headwinds related to foreign exchange, we've been executing well and delivering on our targets.

Q2 revenue of $505 million increased 9% year-over-year. As we've discussed previously, revenue is impacted by ASC 606. So we don't believe that revenue growth rates are the best indicator of our underlying business performance but would rather guide you to ARR as the best metric to understand our top line performance and cash generation. FX impacted revenue by about $6 million in Q2, and our revenue on a constant currency basis was $511 million.

Before I move on to the balance sheet, I'd like to provide some color on our non-GAAP operating margin, which expanded to 42% in Q2, as Jim noted earlier. This compares to 37% a year ago. Revenue is impacted by ASC 606. So other derivative metrics such as gross margin, operating margin and EPS are all impacted as well. Still, it's worth mentioning that our costs in Q2 benefited from the restructuring we announced in Q4.

Six months ago, we set an expectation that we would be eliminating some duplicative functions in our field organization and that our operating expense mix would shift towards R&D in alignment with our SaaS acceleration strategy. You can see the progress we've made in our Q2 results. We now have a more optimized operating structure. And we believe the improvements we've driven are sustainable and will enable us to deliver non-GAAP operating margin for fiscal '22 roughly in line with our year-to-date performance.

Moving to Slide 17. We ended Q2 with cash and cash equivalents of $307 million. Our gross debt was $1.28 billion with an aggregate interest rate of about 3.4%. During the second quarter, we generated cash proceeds of $43 million through the sale of our equity investment in Matterport. This, in conjunction with cash from operations, we used to pay down $175 million on our revolving credit facility in the second quarter.

Regarding our share repurchase program, as we communicated last quarter, we've completed our planned repurchases for fiscal '22 with $5 million settling in Q2. And for the remainder of the year, we'll focus on delevering. Looking forward to fiscal '23 and on a go-forward basis, assuming our debt-to-EBITDA ratio remains below 3x, our goal is to return approximately 50% of our free cash flow to shareholders via share repurchases.

Next, Slide 18 shows our ARR by product group. We post a set of financial data tables to our IR website that has our financial statements as well as ARR details. In that file, we share both constant currency and as reported ARR. As a reminder, when we calculate constant currency figures, we use our current year plan FX rates for all periods. Our fiscal '22 plan FX rates are based on foreign exchange rates as of September 30, 2021. We're using these rates to calculate constant currency figures for all quarters in fiscal '22 and for all prior periods as well.

To illustrate, you can see on the slide that we expect to report -- we expect as reported ARR to be lower than constant currency ARR for Q3 and fiscal '22. This is because of the FX headwinds and rate movements, which have moved significantly since September 30, 2021. Based on the exchange rates at the end of Q2, we expect as reported ARR for Q3 to be impacted by $32 million. And for fiscal '22, we expect the FX headwind to be approximately $34 million.

This is important to remember in context of our guidance because we provide ARR on a constant currency basis. And if the exchange rates fluctuate significantly between now and the end of Q3, the expected impact to our reported ARR would also change. We do believe constant currency is the best way to evaluate the top line performance of our business because it removes foreign exchange fluctuations from the analysis, positive or negative.

With that, I'll move on to guidance on Slide 19. We're raising our fiscal '22 constant currency ARR guidance based on our strong performance in the first half and despite our exit from Russia. The new range is now $1.64 billion to $1.665 billion, which translates to constant currency ARR growth of 12% to 13% for fiscal '22. For Q3, we're guiding constant currency ARR to be $1.58 billion to $1.595 billion. At the midpoint, this equates to 13% constant currency growth.

We continue to expect IoT and ARR to reach ARR growth of 20% or more by the end of the year. And our FSG and Velocity businesses continue to do very well in the market. That all said, the main driver of our fiscal '22 ARR guidance raise is the strong customer demand we're seeing in our core CAD and PLM offerings, which represented 70% of our ARR in Q2.

We're maintaining guidance for fiscal '22 cash from operations at approximately $430 million as our strong execution and operational discipline are helping us to offset FX headwinds and the Russia exit. Our guidance for Q3 cash from operations is approximately $110 million. We've updated our CapEx guidance for fiscal '22 to approximately $25 million, which is down from about $30 million that we set at the beginning of the year. And we're expecting approximately $5 million of CapEx spend for Q3.

Therefore, we're raising our full year free to cash flow target to approximately $405 million and guiding for Q3 free cash flow of approximately $105 million. We continue to expect our normal seasonal pattern in our fiscal '22 cash flow generation, primarily driven by invoicing seasonality. The majority of our collections occur in the first half of our fiscal year, and we continue to expect expenses to increase in the second half of fiscal '22 as we ramp hiring and our SaaS investments. because of these dynamics, Q4 is expected to be our lowest cash flow generation quarter.

Our free cash flow guidance for fiscal '22 includes $40 million to $45 million of restructuring payments compared to our expectation a quarter ago of $45 million to $50 million as some employees have otherwise departed PTC and some employees that were expected to depart have moved into new roles where we've been looking at hiring. Both of these are good things. We have less restructuring payments and have been able to fill new open roles with good people in a challenging hiring environment.

In addition, our fiscal '22 guidance assumes approximately $5 million of transaction-related payments that were incurred in the first half of fiscal '22. Therefore, consistent with raising our free cash flow guidance, we're also raising our adjusted free cash flow target to approximately $455 million.

For Q3, we expect approximately $10 million of restructuring payments and approximately $5 million of transaction-related payments, which were incurred in the first half, bringing our adjusted free cash flow to approximately $120 million.

Moving on to revenue. Despite foreign exchange headwinds and our Russia exit, we're taking the low end of our full year revenue guidance up by $25 million based on our Q2 beat and forecast for the remainder of fiscal '22. So our new revenue guidance range is $1.905 billion to $1.975 billion. The year-over-year growth we're guiding to now is 5% to 9%. ASC 606 makes revenue difficult to predict for an on-premise subscription company, hence the wide range. Note, revenue does not influence ARR or cash generation as we typically bill customers annually upfront regardless of contract term lengths.

Turning to Slide 20. Jim provided some highlights earlier in terms of the financial impact we expect from the Intland Software and ITC Infotech transactions we announced last week. While both transactions are expected to close during Q3, we have not incorporated the expected financial impacts to our guidance because these deals haven't closed yet. We will officially update all financial metrics and guidance when we report our Q3 earnings.

In the meantime, directionally, for constant currency ARR, we expect these transactions to have a positive impact of approximately $15 million in fiscal '22. We will report Intland in our FSG product group along with our other ALM assets. And regarding free cash flow, we expect the transactions to have an immaterial impact to free cash flow in fiscal '22 as incremental operational cash flows are expected to offset the incremental transaction-related fees and increased interest expense in the second half. And we expect these transactions to be accretive in fiscal '23.

Going forward, as Jim explained, we expect these 2 deals to help us drive the adoption of our SaaS offerings. And over time, ITC -- the ITC Infotech transaction is expected to result in lower professional services revenue but not expected to have a material impact on our profitability. Again, we'll provide a lot more detail at Q3 when we report our results and update all guidance metrics at that point.

I'll close out my prepared remarks today by taking you through an illustrative constant currency ARR model on Slide 21. Here, we're showing our ARR progression over the past 6 quarters and an illustration of what is needed to get to the midpoint of our constant currency ARR guidance for Q3 and fiscal '22. First of all, recall that in Q2 of fiscal '21, our ARR growth benefited due to the acquisition of Arena. So taking that into consideration, in the first half of fiscal '22, we added approximately $25 million more ARR on an organic basis compared to the first half of fiscal '21.

Next, calling your attention to the green box. This model shows targeted ending ARR at $1.588 billion for Q3 and $1.653 billion for Q4, both at the midpoint of our guidance ranges. The illustration shows a sequential ARR that's needed in Q3 and Q4 to hit the guidance midpoints. As you can see, in the second half of fiscal '22, we need to add about the same amount of new ACV as we did in the second half of fiscal '21 in order to hit the midpoint of our constant currency guidance. We believe we're well positioned to do that even given some of the macro concerns and noting that we also have more deferred ARR starting in the second half of fiscal '22 than we did in fiscal '21.

So hopefully, that's helpful. And with that, we'll turn it over to the operator and begin Q&A.

(Operator Instructions) And our first question will come from Joe Vruwink with Baird.

I guess I'll start with a question on macro. And obviously, I appreciate the backdrop is dynamic and your model at this point is built to withstand a lot of what I'm about to ask. But can you maybe just contrast how customers are maybe talking to you about strategic investments and some of your more complex implementation areas like PLM or IoT. Maybe contrast how this is different today than it would have been in mid-2020 or other periods that maybe have parallels to the past. And does it seem like customers are kind of separating strategic from the macro, appreciating that the things they're committing to today do have longer-term benefits, and so that just kind of scope of conversation is different than it has been in the past?

Yes. I mean absolutely, Joe, Jim here. Keep in mind that PTC is really helping customers plan and engineer and plan the production processes for products. We're not helping them to actually -- by and large, we're not helping them much to produce the product. So the supply chain problems really are production problems. And if you're having production problems, most companies don't see that as a reason to stop planning the next generation of products because suddenly, a production problem will be solved at some point. And then you'll be competing for who has the best next-generation product, and I hope you didn't take the year off. So we don't really see any connection. And frankly, we didn't see much connection in 2020 either in that particular way.

So I think the pandemic in 2020 put a lot of momentum into digital transformation. People realized you can't execute a hybrid work for us, for example, without a system of record for product data. It just doesn't work. So that momentum is carrying through, and people are forging ahead with their strategies to implement, for example, PLM and CAD to advance their digital transformation initiative even if their factories are idle because they're waiting on semiconductors or in some cases, wire harnesses that used to come from Ukraine and all that type of stuff.

So actually, I was in Germany in the last week of the quarter. And the customers I talked to were full speed ahead as it related to the PTC projects. And we mentioned that we had a very strong bookings quarter in Europe. And again, that's net of a fairly -- if you put all that churn from Russia in Europe, it's material. It's like probably a point of growth, I'm guessing, for Europe. So I think we're doing well and sort of feel like actually conditions look pretty good. And at the same time, we can withstand a lot and still really deliver some impressive growth and free cash flow numbers.

Okay. That's great. One follow-up just on how your approach to the Windchill transition to SaaS might be evolving just as you publicly announced that now have had a chance to have conversations. It seems like a lot of your peers are talking about success in their own cloud migration efforts. One specifically said things have accelerated recently. I'm just wondering if you're kind of getting the inkling that, that could play out for PTC as you're dedicated to Windchill at this point onward?

Yes. If you go back to our Investor Day, I'll remind you that we really feel like we're starting the third phase of our SaaS project. And the Windchill part of it started back in the first phase. So for us, we've had a lot of success with cloud. And it's one of the growth drivers for Windchill. It has been over the last 18 quarters. I think the difference is we didn't like the profitability of the cloud part of the Windchill cloud business as we used to do it.

So this Windchill+ is really our shift to the multi-tenant model, which to the customer doesn't look much different. But to PTC, it looks quite a bit different and produces quite a different outcome in terms of profitability. So I think customers like the Windchill in the cloud before. They still like Windchill in the cloud. It's just PTC likes Windchill in the cloud better now. And that's causing us to open the floodgates a little more because it's a more attractive business for us now.

Our next question will come from Adam Borg with Stifel.

Maybe just on IoT and AR. You talked about it last quarter and even in the slide deck today. You talked about a continued focus on upselling and cross-selling in the installed base. I'd love an update here on kind of what you're thinking about the strategy going forward for upsells and cross-sells as well as what -- just remind us of the synergies to customers in terms of combining PTC's core CAD and PLM with your IoT and AR.

Yes. I mean the key thing -- let's focus mostly on IoT because it's much larger. The key thing is there's 2 key use cases for IoT -- 3 key use cases, actually. One is smart connected products, which are the products you manufacture. The second one is smart connected factories, or we call it smart connected operations. That's the products you buy and operate in your factories. And then the third one is really this Navigate strategy of bringing in information from a lot of different systems, kind of an environment that just makes lightweight users more productive and so forth. But anyway, all of our discrete manufacturers produce products, and they all operate factories.

So what we really said is for efficiency reasons and success reasons, all that stuff, we ought to focus on selling to our customer base with more veracity than just selling to anybody. And so Troy Richardson put in place a stronger focus on cross-sell. And we're starting to see some, let's say, green shoots, particularly in DPM, Rockwell sold through the Rockwell base. But all the deals we sold really came from the customer base in PTC. That's good. And we think there's something there.

So keep in mind, when we think about IoT and AR in Q3 and Q4, there's a couple of things I want to point out. First of all, ARR is a rolling 4-quarter metric. So 3 of the 4 data points that say what's going to happen in Q3 are already in. And 2 of the 4 data points that say what's going to happen in Q4 are already in. So we have some visibility. But now what we -- what the rest of it hinges on is bookings, churn and backlog or deferred ARR.

And so we're looking at all this stuff. We look at the pipeline. We look at the forecast. We try to estimate bookings. And we don't have a crystal ball. And sometimes we're not perfectly right. But anyway, we have a read on what we think churn will be, and that's what we're looking at. And we're confident that that's going to get us to that 2 handle by the end of the year.

That's great. And maybe just as a very quick follow-up. It's great to hear the early success on DPM and just got the Rockwell partnership as well and seeing some success there. Maybe just 2 seconds on the state of the union on where we are with Rockwell overall.

Yes. Well, coincidentally, Scott Genereux, the Chief Revenue Officer from Rockwell, happened to be at PTC today. So I had lunch with him, and we talked it over. And the truth is DPM is a better fit for Rockwell than is ThingWorx as a platform, an IoT platform. And so Rockwell is leaning in. And their consulting arm, Kalypso, is really leaning in. And PTC is leaning in. So I think there's some promising, again, green shoots there. We were pleased to see Rockwell participate in DPM success right from the start. And I think it gives us a better foundation, if you will, to build success. It's a better fit for what both PTC and Rockwell are capable of. We're both solution providers. This is a solution versus a platform.

Our next question will come from Jay Vleeschhouwer with Griffin Securities.

Jim, starting with you on the Intland acquisition. Could you contrast the rationales for that acquisition and the addressable market from that acquisition? As compared with the rationales you spoke of 11 years ago, almost at a day when you bought MKS, which ultimately became a relatively small part of the business. So what's different now in terms of, let's say, an ALM arms race that makes Intland genuinely compelling and perhaps put it in the context of the overall closed-loop life cycle management strategy.

And then secondly for you, Kristian. By the end of the fiscal year, when you net out the effects of the restructuring, particularly in the field, minus the service headcount with the ITC transaction, the add back from Intland, where do you think your headcount ultimately lands at the end of the fiscal year?

Okay. I'll take the first one on Intland versus Integrity. I mean, Jay, it is fundamentally the same story. And I think we've had reasonable success with the Integrity product. But we had some challenges with the Integrity product that I think are fixed in this next-generation Codebeamer offering. Keep in mind that ALM is both a business by itself, and it's a key subsystem of our PLM system, which therefore means it fuels our PLM success as well.

But when I look at Integrity versus Codebeamer, there's a couple of things that stand out. Number one is SaaS. We didn't have a SaaS solution. We didn't have a path to a SaaS solution with Integrity. It's much older technology. That's one thing.

The second thing is Integrity had its own built-in source code management tools. And the entire development community has really shifted to tools like GitHub and so forth. It's very, very hard to sell against things like GitHub, which amongst other things tend to be free. So it turns out that the Codebeamer is designed to work with all these other modern tools out there.

And then the third thing is Codebeamer is really viewed as a sexy, best-in-class user experience, all that kind of stuff. So we're really, with Codebeamer, leapfrogging far ahead of where we were with Integrity, leapfrogging the competition. And we now have an offering that allows us to go back on the offense, back into automotive companies, back into medical device companies, aerospace and defense companies, anywhere people put safety critical or regulated software into products.

The thing in an automobile setting, and this is what I would have said 10 years ago, is you got to manage the software very carefully in the context of the automobile. You have a set of requirements for a new automobile. Many of those requirements get implemented into mechanical systems. But a bunch of them, and more every day, get implemented into software. And a bug in the software is as bad or even worse than a failure in a mechanical part.

And so there's deep concern by these automotive companies and then there's regulations around it that says if anybody in the supply chain changes a line of code, you need to know which line of code they change. You need to know why they changed it, and you need to have a test to prove they didn't break anything. And so it's a very, very difficult software management environment that frankly doesn't apply to a software company like PTC. We don't have any mechanical parts. So it's us -- it's just software, but they're a software in the context of a physical product managed in CAD and PLM, and that all needs to be integrated back together. So basically, Intland is a next-generation leapfrog move within our ALM and PLM strategies.

Jay, given all the moving parts, and it's obviously difficult to pinpoint precisely, but I'd say we're probably somewhere in the 6,700 range.

Okay. So headcount would probably end up being flat net by the end of the fiscal year, but on a larger base of revenue.

It should be -- do you mean flat year-over-year?

Right, right. Because you ended fiscal '21 at 6,700, so that's where you think you'll end up, but you'll be a bigger company in terms of revenue.

Yes, that's right. And I mean I'm also trying to factor in the somewhat challenging hiring environment. If possible, we'd like to do that. We could say 6,700 to 6,800. I'm just trying to be pragmatic.

Yes. I mean, Jay, you look at this data, you know we have a lot of positions open on one hand. We have attrition on another hand, and then we're spinning some employees out through this transaction. So it is a little hard to net those out because it's difficult to pin down attrition and pin down hiring success. But headcount won't go up dramatically here in the context of all that. It will probably be flattish, I mean, as a reasonable approximation.

Our next question will come from Yun Suk Kim with Loop Capital.

Jim, you expect the amount of professional services work to increase as part of the Windchill+ adoption over the next several years. Obviously, you are taking advantage of that opportunity and offloading some of the professional services business to partners and whatnot, and your transaction with ITC illustrates that. But given the tight IT labor market out there, do you feel comfortable that you have enough professional services capacity to meet the potential demand for the -- around the Windchill+ lift and shift adoption that you expect over the next several years? And overall, if you can just revisit the state of your partner ecosystem around implementation and deployment capacity and if you have any kind of investments that you're making beyond this transaction you announced today.

Yes. So I think we have tremendous scalability in the ecosystem. But just for the benefit of everybody, let's turn the clock back a little bit. If you go back 10 years, about 1/3 of our revenue was services. And now it's 9% going to, I don't know, 6% or so as a result of this transaction. And what happened over those years, in our quest for margins, which was very successful, we said, let's stop chasing services. Let's give it to the ecosystem. The ecosystem took that differential from us and added 10x that on their own. So literally, the ecosystem is doing billions of dollars of services around our stuff. It's not a one partner. It's in many, many, many partners. Some of them having names like Accenture and Deloitte and Cognos and -- not Cognos, Cognizant and Kalypso and on and on and on, many having smaller firms you never heard of.

So there's a lot of capacity out there. The thing is these projects, we can't just give to a partner because in the end, we're taking the systems into our running system. It has to be done very carefully. We have, for many, many years, subcontracted work to ITCI. We could have subcontracted these projects to ITCI, but I said I don't really want that in our P&L because subcontracted projects tend to have even less margin than projects we do with our own employees, of course. There's 2 margins there.

So rather than build up a subcontracting business because we didn't really want to go hire all those people, we just entered into this arrangement. It's a great win-win-win. ITCI is happy to grow the services business. That's the business they're in. By the way, they're fundamentally an Indian company. So they have a deep reservoir of access to lower-cost labor in India. And that will -- a lot of these projects will end up being done in India with their Indian capacity. And it will give us the talent because we're seeding DxP with the best in the industry, which are PTC's own services employees.

So DxP could have been a joint venture or something like that, could have been a subcontracting approach. We just said, you know what, we're a software company. We want to be high-margin, high-growth software, let PTC focus on that, and this is a good way to solve that lift and shift services [so that won't be a problem].

Okay. Great. And then just a quick question. I don't think anybody asked yet, but Jim, what is your expectation regarding the Windchill+ adoption at least the -- over the next several quarters in terms of the pace of the adoption?

Well, we've been doing a lot of adoption of Windchill in the cloud, that Phase 1 offering. So we're just going to pivot that to Windchill+ now. Windchill+, by the way, is not just Windshield in the cloud. It's Windchill plus a bunch of things, plus cloud, plus all the Atlas benefits, plus single sign-in across the suite, plus our workflow engine, our BPM workflow engine, plus our visualization in the cloud capabilities. So we're really trying to create a differentiated offering in part to help justify the higher price point but also to make it more attractive to go to the cloud.

Just for fun, I tell people, think of like a first class seat in an airplane versus a coach seat. It isn't just that the seat is bigger. And you wouldn't want somebody to say, well, I want to sit in coach but have a bigger seat at a lower price point. That's sort of like saying, could I have a system integrator, put my Windchill system into cloud for me?

So what we're doing is offering a bundle of things. It's a bigger seat. It's a bigger TV. It's better food. You get to board first. You got plenty of room for your luggage, quicker access to the restroom. I mean all those stuff that would be associated with a first-class seat and can't be unbundled and bought off a Chinese menu. So that's really what we're doing with Windchill+, and then we're going to follow the same strategy with the rest of the products as we're ready.

Our next question will come from Jason Celino with KeyBanc.

Great. When I think about PTC's main segments, on the SaaS acquisitions that we've seen over the last few years, we saw Onshape for CAD, Arena for PLM and now Intland for ALM. What other areas may PTC need to upgrade via make or buy for SaaS?

Well, keep in mind, there's a difference between things we have to do and being opportunistic when you find a really great company that's profitable and all that kind of stuff. I think that the main basis of CAD and PLM are covered. And then our IoT and AR stuff is already quite [savvy]. About half of AR is sold as SaaS, and more than half of -- I'm sorry, about half of IoT is sold as SaaS and more than half of AR. You might remember, we announced the AR capabilities available on the Atlas platform some time ago.

So I think -- I don't think we need to acquire anything. There's no gaping holes. Probably Integrity was the last important hole that we wanted to fill. And I don't think we would have bought Intland if it weren't such a strong company. It's disruptive in the market. It's growing fast, and it's highly profitable. And that allows us to bring it in, in a short-term free cash flow neutral, mid- and long-term free cash flow accretive kind of way, which works for us. So that's how we think about it, more strategic and opportunistic as opposed to its time to acquire something, what should we go get next.

And Savanna we'll take our final question for today.

And our final question will come from Matt Broome with Mizuho Securities.

I guess where are you in terms of expanding Onshape and Arena's sort of go-to-market activity across your reseller channel globally? And does that become easier now that SaaS is sort of going more mainstream, so to speak, now that Windchill+ is here?

Yes. Well, first, let me say that most of Arena is sold direct, to be frank, with an inside sales model. So there's not a big outside for us. So what we've really been expanding to drive Arena sales with some success is to globalize that largely inside model. An inside model is a great thing if you can get it to work. And PLM's particular big PLM systems are kind of complex and will probably require a higher-touch model. But with Arena, so far, so good. We've been able to scale this inside model. And so that's really what we're doing.

Now our resellers are interested in selling it. And I think as Arena goes upmarket and the deals get more complex, there'll be a need for a higher-touch selling process. And yes, probably our existing resellers at some point will play a bigger role with Arena and Onshape. But right now, that low-touch inside sales model is working, and it's a great thing to -- it's a great model to have if you can make it work. And so far, it sounds like we might be able to.

Okay. I think that was our last question, Matt, right? So thank you all for spending some time with us here today. And Matt tells me we're going to be very active on the circuit here in the next 90 days. We're going to be at like half a dozen different conferences. I'm going to a few myself, and Matt and Kristian will be at others. So we might see you on the road, and I hope so. I haven't seen a lot of you in a long time. It would be nice to see you face to face. And if not, we'll look forward to talking to you again in 90 days.

As you can see, we really feel good about the business. We've put in place a lot of strategic moves. They're mostly working. We've put in place profitability moves that are working pretty well, and that's a good combination to have strong growth and strong profitability, and it bodes well for us, particularly given the resilience of our model in good times and in bad.

So I'll leave you with that thought, and look forward to seeing you sometime in the next 90 days. Bye-bye.

Thank you for your participation, and you may now disconnect.