PTC Inc

NASDAQ:PTC

Earnings Call Transcript 2022-Q1

[Operator]

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the PTC's 2022 First Quarter Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions.

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

[Matt Shimao, Head of IR]

Hello. Thank you, Julian and welcome to PTC's results call for Q1 of fiscal '22. On the call today are James Heppelmann, Chief Executive Officer, and Kristian Talvitie, Chief Financial Officer.

During this call, PTC will make forward-looking statements, including guidance on 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, quarterly reports on 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 the call are valid only as of today's date, January 26, 2022, and PTC assumes no obligation to publicly update these forward-looking statements.

During the call, PTC will also discuss non-GAAP financial measures. These non-GAAP financial 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.

[James Heppelmann, President & CEO]

Thanks, Matt, good afternoon, everyone and thank you for joining us. Turning to slide three, I'm pleased to share that PTC delivered another strong financial performance in fiscal Q1. We executed very well building on the momentum we saw in Q4. To simplify things, please note that throughout my prepared commentary, I will only discuss growth rates in constant currency.

ARR came in at $1.507 billion, which was better than the $1.5 billion we had guided to at the recent Investor Day. that represents 16% growth, 11% of which was organic. Adjusted free cash flow was also strong at $145 million, which was up 20% year-over-year and better than the $140 million expectation we set at the Investor Day. We're off to a very strong start in fiscal 2022.

Turning to Slide four, of particular note was our booking strength. Bookings were up double digits organically and high teens overall against the very strong COVID bounce back quarter we saw in Q1 of fiscal '21, when bookings grew more than 30% over the prior year. To put it in perspective, given the tough comparison against Q1 of last year, we had planned bookings to actually be down slightly inclusive of Arena. So this performance was more than 20% above plan.

I know that some analysts and investors had voiced concern that the restructuring work we did in late Q4 and throughout Q1 would distract us, but obviously we didn't see that. The strength was broad based across direct sales and resellers and was achieved with no mega deals. Rockwell came in ahead of their part of our plan too, which was great to see and suggest my concerns of them being distracted may prove overstated. Arena contributed the inorganic element of bookings growth with another strong bookings quarter coming in above plan as well.

With the Arena acquisition getting round tripped here in Q2, Arena becomes part of the organic results going forward and their low twenties growth rate will then add another tailwind to the organic results. Arena's been a great acquisition. Bookings growth was particularly strong in PLM and in both Europe and Americas. From a macro perspective, global PMIs remain in expansion territory while digital transformation in SaaS continue to grow an importance as secular drivers.

The interest in digital transformation in SaaS has been driving strong bookings for what is very sticky software, which when layered into a recurring revenue model that is atypical of industry peers has allowed PTC to deliver performance in excess of market growth rates. This happened right through the pandemic, especially in the large core business that represents about 70% of our ARR and we fully expected to continue going forward. These factors gave us to raise the lower end of our ARR guidance range, which at the new midpoint basically means we rolled our Q1 beat forward.

Now let's take a look at the ARR performance by geography on Slide five, before turning to business units. In Q1, we saw strong ARR performance across all geographies. Our ARR growth in the Americas was 19%. All product segments grew with key growth drivers being the acquired arena contribution and the velocity business unit overall layered on top of another strong quarter in the core CAD and PLM business.

In Europe, our ARR growth was 13%. We saw strong results across the board in Europe, with the strongest drivers of the growth being our Digital Thread growth and core businesses. Europe has the largest mix of channel versus direct and the resellers continue to perform well. Our ARR growth in APAC was 14% with growth, primarily driven by our Digital Thread core business.

Next, let's take a look at the ARR performance of our various business units, starting with the Digital Thread group on Slide six. In our largest product segment, Digital Thread core, we delivered yet another double digit performance in Q1 with 11% growth. Within this, CAD and PLM both grew double digits with strong growth across all three geographies. This is the 17th consecutive quarter of double digit ARR growth in the core business and as we roll out our more aggressive SaaS strategy, I expect we'll see many more.

In the Digital Thread growth, which is IoT and AR, we saw ARR growth of about 14% consistent across both elements. This was in line with our plan and the mid-teens near term growth expectation we set at the recent Investor Day. While this level of growth remains accretive to company growth, we continue to expect an acceleration of growth into the twenties as we get into the back half of the year.

The biggest driver of growth in Q1 was from expansions, especially in Europe and APAC. We believe market conditions in IoT improving, and we like the way the pipeline for a new DPM offering is developing through both PTC and Rockwell channels. For AR, we continue to see a tremendous level of interest, but the market remains nascent. Perhaps most importantly, the formation of the Digital Thread business unit at the start of F Y '22 has driven important initiatives to increase our focus on cross-selling of IoT and AR into the core CAD and PLM customer base.

FSG had a great Q1 with 6% ARR growth. The expansion deal we recently announced with the US Air Force, both increases and extends this key relationship for up to five more years. Contracts like this demonstrate the value that our customers are realizing from served logistics and other FSG products, such as retail PLM and ALM.

You may remember I noted at our Investor Day that having FSG grow in the mid single digits rather than flat would be a helpful upside growth driver. So I'm pleased to see FSG post another strong quarter.

Let me run through a couple of quick customer anecdote to give you a sense for our Digital Thread customers and how they rely on us. On Slide seven MAN Energy Solutions is the world's top provider of large bore engines and turbo machinery for the maritime and energy industries. The company manufactures complex parts and nearly every engine they make must meet unique customer requirements.

Before implementing Creo, they relied on manual outdated processes that slowed design and production. With Creo, they've been able to transition from 2D to a full 3D model-based approach. Creo's broad range of toolpath automation capabilities enable them to save time in the programming of the tool pass used to machine the large complex engine parts greatly increasing efficiency in transitioning from design to production.

Turning to Slide eight, you may have noticed we announced a deal with the -- we announced that the German company Sheffler has expanded its relationship with PTC and I'd like to share a bit of the backstory. Sheffler has been a long time Creo customer and has successfully deployed wind Welsh within engineering. But back in 2017, one of our PLM competitors announced large PLM deal with Sheffler that appeared to cap PTCs expansion opportunity.

But that system didn't ultimately stick as Sheffler has now decided to consolidate on PTC systems with Welsh [ph] being the backbone and is broadly deploying our solutions in their standard out of the box fashion so that Sheffler can participate in the full power of our Digital Thread portfolio. I'm very excited about this collaboration and the further expansion that Sheffler is exploring with our IoT and ARR offerings.

On Slide nine, you'll see how EMA [ph] Group a global business that delivers packaging machines, services, and solutions to a wide variety of industries was looking for a way to expand their control room offering to help their customers improve overall equipment effectiveness and reduce downtime. As long-time users of PTCs Creo and windshield, EMA decided that ThingWorx was the ideal IoT solution for their initiative, and that Kepware could provide connectivity only to their machines, but to the other vendor's machines deployed alongside them.

EMA has successfully launched new revenue streams by enabling 24 7 monitoring of customer production lines and improved OEE by up to 16%. Euphoria integrated with ThingWorxs is the platform of choice for the US Air Force training initiatives. Slide 10 highlights the work that PTC partner Vektrona has done with the US Air Force.

With finite training resources and limited capacity, the US Air Force set out to incorporate augmented reality into their maintenance and munitions training. Vektrona using [indiscernible] studio worked with US Air Force to create immersive 3D AR experiences for phones, tablets and the HoloLens 2, that are designed to accelerate learning, improve work performance and facilitate remote training. The improved training shows better engagement and information retention with continuous and repeatable task training available regardless of the system or aircraft type.

Turning to Slide 11, the velocity we use ARR growth in Q1 was more than 650% due to the inclusion of Arena and 53% organically, which would be on shape. If you were to add Arena's pre-acquisition results into the prior year to get a better pro forma comparison, then you'd have the velocity business unit growing at 28% in Q1. That 28% is a mix of Onshape growing at 53% in the large Arena business growing in the low twenties.

Growth of both Onshape and Arena is multiple times higher than market rates clearly demonstrating that industrial companies see the benefits of SaaS. We continue to ramp investments to expand technology leadership and to broaden the geographic presence of our Velocity businesses.

On Slide 12, Beta Technologies, a leading developer of next generation electric aircraft for the cargo and logistics market, sought a cloud native product development platform where everyone would be working with one single source of truth without the workflow restrictions of traditional file based design systems. Beta turned to Onshape because of how it enables real time collaboration, allowing the engineering team to work from any location while streamlining their communications during the design process.

To profile an Arena customer, Potrero Medical on Slide 13 is a predictive health company developing the next generation of medical devices, leveraging smart sensors and artificial intelligence. Potrero needed a scalable quality management system to support its growing product development and compliance needs, including satisfying FDA audit requirements. Arena was the right solution offering a cloud native QMS with a quick implementation, leading to ECO cycle time reduction of 30% and non-conformance improvement of 20%.

As a final topic, I'd like to give you a quick update on our SaaS acceleration initiative on Slide 14, we've made tremendous progress in the past 90 days since we announced the more aggressive strategy. We've launched our SaaS program management office, which was modeled after the very successful approach we used to drive our subscription transition several years back. Our field organizations transitioned to the new two in a box customer success organization model without missing a beat.

We converged our cloud and tech support organizations with product development to deploy the DevOps type of approach you see in virtually all SaaS companies. We've made good progress advancing our offerings, especially the windshield multi-tenant version, which will go into production shortly this quarter and we made good progress preparing the SaaS conversion offerings that will power the hundreds of lift and shifts that will happen in the coming quarters and years.

We have more work to do, but we're certainly off and running. The time for SaaS has arrived in our industry and PTC is very well positioned. We're already the SaaS leader in our space with continued strong SaaS growth in windshield and FSG and high levels of growth in our cloud native Velocity Business unit.

Sharing the Atlas SaaS platform, we have a dual strategy to win with Onshape and arena powering a new agile product development approach while we transition our Digital Thread portfolio and existing customer base to SaaS, to elevate the platform strategies that so many larger companies have.

To wrap up on Slide 15, I'm pleased with PTC's position and the opportunity that lies ahead. Q1 gave us a strong start to what we expect to be our fifth consecutive year of double digit ARR growth. Our portfolio of products is unique and compelling and obviously aligns well to customer demand. Our results have been consistently strong for many quarters, but we're poised to accelerate growth as the SaaS tailwind blows harder in coming quarters and as we gain more momentum with our IoT and ARR initiatives in the back half of the year.

We're poised to drive higher levels of profitability too following the organizational changes we've already implemented and as our start-up businesses continue to mature up their J-curves [ph]. 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 Talvitie, CFO]

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 growth rate references will be in both constant currency and at as reported rates. So turning to Slide 17, we delivered constant currency, ARR of $1.507 billion, which is 16% growth year over year, and slightly exceeded our Q1 guidance of $1.5 billion. On an organic constant currency basis, this is 11% growth.

FX was an approximate $11 million headwind in Q1. So our as reported ARR was $1.496 billion. Our SaaS products in both the Digital Thread and Velocity business units saw continued strong growth in Q1 with growth rates, similar to what we discussed at our recent Investor Day. This is in combination with continued strong growth of our software-only sales. As of Q1, our SaaS portfolio is now 15% of our total ARR on a constant currency basis.

Q1 free cash flow of $134 million grew 21% year-over-year and includes $11 million in restructuring and other related payments. Adjusted free cash flow was $145 million and was slightly ahead of the $140 million we discussed at our Investor Day. Q1 revenue of $458 million increased 7% year-over-year. As we've discussed, previously, revenue is impacted by ASC 606. So we do not believe that revenue growth rates are indicative of our underlying business performance, but would rather guide you to ARR as the best metric to understand our topline performance and cash collections. FX only impacted revenue by about $1 million in Q1. So our revenue on a constant currency basis was $459 million.#

Q1 non-GAAP operating margin of 35% compared to 36% in Q1 of 2021. While, this is a strong result, it's still worth pointing out that because revenue is impacted by ASC 606, other derivative metrics such as gross margin, operating margin and EPS are all also impacted. Suffice it to say that our cogs and OpEx came in, in line with our expectations in Q1, and we continue to maintain good discipline on our operating expense structure.

I would like to point out that our GAAP results reflect a gain of $9.8 million related to our investment in Matterport and we're also slightly reducing the range for expected PNL charges from approximately $45 million to $50 million down to $40 million to $45 million for the full year and coincidentally, we're also reducing the range of expected cash payments for the restructuring and other from what was previously $50 million to $55 million down to $45 million to $50 million for the full year.

For guidance purposes, we will continue to show $50 million as the cash payments in the adjusted free cash flow reconciliation. But if payments come in lower, then we would just expect actual free cash flow to come in higher. There's no change to the $450 million adjusted free cash flow target.

Moving to Slide 18, I'll begin with our balance sheet. We ended Q1 with cash and cash equivalent of $296 million. In addition, at the end of Q1, we had medium term investments of $87 million primarily related to our investment in Matterport.

Our gross debt was $1.45 billion with an aggregate interest rate of about 3.2%. In Q1, we used $120 million of cash to repurchase shares. We also had an additional $5 million of repurchases, which settled early in Q2. For the remainder of fiscal '22, we will focus on de-levering and looking forward to FY '23 in an ongoing go-forward basis assuming our debt to EBITDA ratio was below three times, we will continue to target to return approximately 50% of our free cash flow to shareholders via share repurchases.

Turning to Slide 19. We post a data table to our IR website that has our financial statements, as well as ARR detail by segment. In that file, we share both constant currency and as reported ARR, as a reminder, when we calculate constant currency, we use our current year plan FX rates and restate history to the same rates.

So here, for example, on this slide, you can see our Q1 constant currency, ARR of $1.507 billion, and the actual as reported ARR of $1.496 billion. This is important to remember in the context of our guidance because we provide guidance at the plan rate. We believe this is the best way to evaluate the top line performance of our business because it removes FX fluctuations from the analysis positive or negative.

With that, I'll move on to guidance on Slide 20. As Jim mentioned, we're raising the low end of our full year constant currency ARR guidance by $10 million. The new range is now $1.625 billion to $1.660 billion. This essentially reflects rolling our Q1 over performance through the remainder of the year. We're now expecting constant currency ARR growth of 11% to 13% in fiscal '22.

It's worth pointing out that based on FX rates, at the end of Q1, we would expect a $13 million headwind against that full year ARR guidance. For Q2, we're setting constant currency ARR guidance of $1.540 billion to $1.550 billion. This is 12% organic constant currency growth at the midpoint. On an as reported basis, the FX impact we're calculating based on the FX rates at the end of Q1 is a $12 million headwind in Q2 compared to the constant currency guidance.

Moving to free cash flow, we're maintaining our full year free cash flow target of $400 million. This includes approximately $50 million of restructure and acquisition related payments. The majority of these payments are related to the reorganization we announced in Q1 with some residual payments, primarily related to our C port move for which we took the accounting charge in prior periods. So our adjusted free cash flow target for fiscal '22 remains $450 million.

Fiscal Q2 adjusted free cash flow is expected to be approximately $155 million. We expect to make approximately $20 million in restructuring and other related payments in Q2 bringing our free cash flow to approximately $135 million. Moving to revenue, we're also taking the low end of the full year revenue guidance up by $20 million. This reflects both the strength in software and strength in the professional services business that we saw in Q1 and the related forecasts for the full year.

So for fiscal '22, our new revenue guidance range is $1.870 billion to $1.975 billion. The year-over-year growth rate range is now 3% to 9%. ASE 606 makes revenue very difficult to predict for on premise subscription companies hence the wide range. Note that revenue variability has -- from 606 has no impact on ARR or its related cash generation as we continue to primarily bill customers annually upfront, regardless of term length. We continue to expect more than 60% of our annual free cash flow generation to occur in the first half of the year, collections are stronger in the first half and we expect expenses to increase as we ramp hiring in our SaaS investments throughout the year.

Wrapping up on Slide 21 with the free cash flow model that we use and went into some depth on at our recent Investor Day that you can see here, I know many of you use model three cash flow using the indirect method. However, given the complexities related to revenue recognition due to 606, this is difficult to do. The model we show here has proven quite effective. The table shows fiscal '21 actuals compared to the model we shared at Investor Day compared to our current guidance.

Let me take you through the model, focusing on the non-GAAP column on the right and starting at the top. First, we're showing the midpoint of our as reported ARR guidance of $1.630 billion which is different from the constant currency guidance that we gave due to the $13 million FX headwind and is also $5 million lower than what we showed at the Investor Day. We use as reported here because it's a better reflection of the cash we expect to generate.

You can also see that we have increased the perpetual license revenue forecast slightly, and also the professional services revenue increase that we mentioned earlier. Cogs is slightly higher reflecting the increased cost to deliver the incremental professional services revenue, and the rest of the assumptions remain the same and we still end up with our target adjusted free cash flow of $450 million.

Obviously this is a model based on assumptions, such as the midpoint of the ARR range, the impact of FX, the pace of hiring, etcetera. So if some of those variables change, which they invariably will, the model will have to be adjusted accordingly and as I mentioned earlier, if cash payments related to the restructuring, come in at the low end of the range, we would see a flip from the restructuring line to the free cash flow line, but the adjusted free cash flow target would remain unchanged. But as we sit here today, we think this is a reasonable view of how we expect the year to shape up.

So with that I'll turn the call over to the operator and we can begin Q&A.

[Operator]

[Operator instructions] Your first question will come from Andrew Obin from Bank of America. Please go ahead. Your line is open.

[Andrew Obin, Bank of America]

Just a bigger picture question, I apologize, I missed the first couple of minutes. We hear a lot about supply chain constraints and frankly, we're hearing that this might extend the run in terms of PMI expansion. So what are you hearing in terms of sort of, as you have convers about PLM and in terms of adoption, what kind of conversations are you having with your customers and do customers have awareness of supply chains being gummed up for longer and are you seeing this having any discernible impact on what kind of conversations you are having with people?

[James Heppelmann, President & CEO]

Andrew it's Jim? No, actually it's not really, it's not really a frequent topic in our conversations because well, first of all, since you said you missed the first minutes, one of the things I pointed out is that our bookings came in very, very strong and I explained about 20% higher than plan. So we had a very, very strong booking quarter and notable in that was PLM although frankly, the strength was broad based.

I think the key thing to remember is that PLM is really associated with preparing product data in engineering that will then subsequently be used in manufacturing and perhaps in aftermarket service and it's collecting data from supply chain partners and so forth, but production problems in a supply chain don't necessarily impede the collaboration during the engineering and the preparation for production process.

So I think people are saying like, maybe I can't get chips to complete the product, but that doesn't mean I should stop designing the next one because if it does then I'll fall behind. So I think that, our view would be that the product development process has largely been unaffected by the supply chain process.

Now, some other, we talked about how perhaps COVID had an impact on IoT. Perhaps the supply chain a little bit, although I think muted compared to COVID. So to me, the supply chain thing is fairly small factor in our results. We just see very little correlation between what's happening out there with supply chain problems and what's happening with our pipeline and frankly, with our bookings,

[Operator]

Your next question comes from Yun Kim from Loop Capital. Please go ahead. Your line is open.

[Yun Kim, Loop Capital]

Hi, Jim. Can you just talk about IoT business in terms of the large deal activity, what kind of trends are you seeing there? Obviously, you are expecting that business to accelerate in the back half, second half of the year. If you can talk about whether that confidence is coming from the, improvement in the large activity, or is it just the overall volume of the activity around IoT and then also if you can just come in around deal size activity around the ARR business as well. Thanks.

[James Heppelmann, President & CEO]

Yeah I think deal sizes are sort of unchanged from previous trends. If, you think, what are we looking at when we project forward, how IoT and ARR will perform well, we're looking at the bookings. Let me say at the pipeline that will drive bookings and for IoT and ARR was quite strong. We're looking at the backlog. Last year bookings actually had improved over the prior year and bookings that went into backlog are what, I'm sorry, what we call deferred ARR were quite high.

We were well ahead of our deferred plan number as we exited last year. So you could imagine we've got more, if you want to call it backlog waiting for us. And then what other initiatives are we doing? So for example, our DPM launch I think will be materially positive for our IoT results. It will drive bigger deals. It will drive better value propositions. It's really software that's ready to turn on and get value from as opposed to a platform.

And then the other thing is Troy Richardson talked at our Investor Day about organizing better for cross sell. And I think if we look backwards, maybe we had pivoted too much towards new logos, which are great. New logos are a wonderful thing, but we probably have low hanging fruit yet to pick within our install base of CAD and PLM accounts.

So I think it's really this combination of a strong looking pipeline, good looking trends, awaiting us in the deferred backlog and then these other initiatives kicking into place DPM and cross-sell but I think will all be very helpful as we proceed through the year. And again, I want to remind everybody, we set the expectation that the two handle would materialize in the back half of the year and that you wouldn't see it in Q1 and Q2. So we sort of feel like this was, as we had predicted just mid December a couple weeks ago,

[Operator]

Your next question comes from Jason Celino from KeyBanc Capital Markets. Please go ahead. Your line is open.

[Jason Celino, KeyBanc Capital Markets]

So one question on maybe the fast Windchill, launch with seems like it's coming along nicely and we could see something maybe go GA this quarter. Have you had a chance to maybe, discuss this with customers, how's the pipeline shaving or is it maybe better to think that the pipeline might start to form once we do go live?

[James Heppelmann, President & CEO]

No, we for sure started talking about it with customers, ramping up that process, we got to educate a lot of people and they in turn have to educate customers, but we've certainly made some progress and I can tell you the customer interest is actually quite high. You should know that actually customers were pushing us a little bit to get going with such initiative.

So, I feel like the demand is there, and in fact, again, just reflecting on what we told you, that business has been growing about 30% and Christian mentioned, we posted another quarter just like that without us really invoking the new strategy yet. So there's lots of demand. We're just looking for a model where we can promote the demand because we like the margin profile better and that's, what's coming into place here in Q2.

[Operator]

Your next question comes from Adam Borg from Stifel. Please go ahead. Your line is open.

[Adam Borg, Stifel]

Great. Thanks so much. And maybe just two quick ones. Just on the Sheffler win that you announced yesterday and highlight on the call earlier, one of the things I thought was really interesting in the press release was this opportunity around some more vertical specific or market specific solutions targeting either automotive or industrial companies. So maybe Jim, you could just talk about that.

And maybe just as a quick follow up just maybe for Christian, anyway, you could talk about this transit, it's great to hear the early feedback on the SaaS application efforts, but anyway to comment on how much this has contributed to bookings or the pipeline at least qualitatively. Thanks so much.

[James Heppelmann, President & CEO]

Yeah. I'll get the first part of the question, Chris, and you can take the second part. Yeah. So Sheffler is a great account and as I mentioned back in 2017, it appeared they were going a different direction and now they've decided to come back into the fold. And honestly, they did that for two main reasons. One is that they really want off the shelf technology, the other competitor had told them this low code, no code story and they tried that out and decided that's not really what they want. They don't want develop their own solutions. They want to deploy standard out of the box software that all works together. And then they wanna engage in partnerships with the vendor in this case, PTC to talk about how those solutions should evolve to be, more and more powerful to meet their needs.

So, yeah, I'm very excited. I'm in the middle of that relationship myself and yeah, what's going to come out of that is technology that fits better and better, for example, for the automotive supply chain which is a place where we have a lot of customers. So it's a great win or win back, maybe I should say and a great partnership going forward, that's going to produce a lot more bit for us in years to come.

And sorry, the second part of the question was around the transition to SaaS and how that's manifesting itself in terms of pipeline and activity. Is that right? Just making sure I got that right,

[Adam Borg, Stifel]

Exactly. Yeah. Any way to qualitatively comment from both, either bookings or a pipeline perspective.

[James Heppelmann, President & CEO]

Yeah, well remember, the bookings that we just reported were for Q1 and Q1 is really when we actually just announced the acceleration of it. So I would say there's actually limited impact in the actual bookings result here in Q1.

That said, as I mentioned, we continue to see strong demand for the SaaS properties that we have. That's both in velocity and the digital thread and so those products continue to grow at a rate higher than our software only products. And, now a as the program is pushing ahead, we expect to see demand and pipeline generate, especially with the windshield -- with the new windshield launch coming out here and the program continuing to pick up speed internally.

[Kristian Talvitie, CFO]

Maybe Adam, I could just add, we launched this phase three strategy 90 days ago on the earnest call. And there's nothing we've seen since that makes us any less bullish than we were back then. It looks like a really nice opportunity for PTC and we're pushing forward ahead as aggressively as we can, because we'd like to bring that very upside growth driver, closer in. So it has a bigger impact on '23 and '24 and so forth than it would otherwise have had.

[Operator]

Your next question comes from Jay Vleeschhouwer from Griffin Securities. Please go ahead. Your line is open.

[Jay Vleeschhouwer, Griffin Securities]

Okay. Thank you. Hello. Hi, Jim. Hi, Christian. Couple things with regard to the strength you noted for PLM at your partner conference six months ago, back in the summer management presented to the channel, your concept that PLM was no longer just an engineering vault that it was becoming a more, what you call multi-system multi-discipline concept. And the question is to what extent is that broader, more diverse view of PLM a current part of new business or in the pipeline for new business as compared to the more conventional historical way of of thinking about PLM? By our calculation, you were already the second largest brand by revenue in PLM and maybe talk about what some of the drivers are to that?

And then just a quick clarification you referred earlier to cross sell at the Analyst Meeting last month in the slide deck you referred to cross sell 10 times and relatedly account based selling PTC has often over the years, talked about cross sell, but maybe talk about what's different this time in terms of resources and programs across your various segments in your new customer segmentation model.

[James Heppelmann, President & CEO]

Yeah. Well on your first question, Jay, you are always very pressy on, you've been watching this industry for a long time. When we say multi-system, multi-discipline, what we're really talking about is an enterprise system. And so what's happened in the last couple years is PLM has graduated from being an engineering data management system to being an enterprise system that contains the, it's the system of record for the product definition.

And so if you're in manufacturing, well, you need to know the product definition. If you're in procurement, you need to know the product definition. If you're out on an installation or a support call, you probably need to know the product definition.

So definitely what's happened is that the enterprise deployments of windshield are multiple times larger than the engineering deployments of windshield. So something that's been driving growth for some years now is that the new deals we're taking are more and more frequently enterprise deals in they're larger.

You may remember last quarter, I told you we took the largest deal we had taken to date from a med device company. And the second thing that's happening is we're circling back to those companies who had deployed the engineering solution like Sheffler and we're up-selling them to the enterprise solution and turning that into a much bigger opportunity for us.

So definitely that's a real thing and it's been driving the momentum we've seen in windshield for a year. And frankly, there's a lot of it out ahead of us. Even before we start talking about SaaS, the upsell from a departmental solution to an enterprise solution is a driver taking that whole enterprise solution to SaaS is a whole another growth driver, that's on top of that and sort of orthogonal to it.

And then on the account based selling, there's two ways to look at that cross selling into your accounts is a great thing. You have established relationships it's much easier to sell another product to a existing customer than to sell a new product to a new customer or a first product to a new customer. At the same time, we like new logos. So it's really always about the balance of how much do you invest in new logos pursuits versus how much do you invest in selling more to the companies who know and trust you.

And I think perhaps with IoT and ARR, we realized we had over pivoted toward new logo, which is just generally speaking, less productive selling, you might imagine. And so the reason we formed this Digital Thread growth, which brought CAD and PLM and IoT and ARR, together under Troy Richardson, was to really lubricate how these products work together and how we position them together, and to be able to start anywhere and sell up and down that chain.

So it's a good strategy, it's one that we, it's a muscle we've developed. Well, over the years, we, we really built the windshield business largely by cross-selling to the Creo base. And I think this is going to be something that'll help us a lot, to kind of get the right balance of new logo pursuits in cross-sell.

[Operator]

Your next question comes from Ken Wong from Guggenheim Security Partners. Please go ahead. Your line is open.

[Ken Wong, Guggenheim Security Partners]

Thank you so much for taking my question. Jim or, or Christian. I wanted to perhaps dive into the double digit organic bookings growth couldn't help and notice you guys also had a very large service expansion deal with the air force because how much of that was already in expectations or did you get some, some boost there from timing shifts or anything of that nature?

[James Heppelmann, President & CEO]

Yeah, the let me, let me tell you, none of that actually contributed to the double digit growth because that was a Q4 deal. We released it when we had approval to release it and I commented on it because it was an important customer and so forth. And let me say that deal again, that was closed in Q4 both represented five years of extension, but also about a 50% growth in a ramp that happens over I think it's three years.

So it roughly goes from a $10 million run rate to a $15 million run rate over three years and stays there for a couple more that's what the contract contemplates. So some of that will come into ARR in Q4 this year, but the bookings actually were in Q4 last year. So that strength the strength we saw in Q1 was exclusive of that air deal, which just means was really great strength.

So, anyway it was hard to pin down where'd the strength come from because it came from CAD, it came from PLM, the the IoT number was actually pretty decent. It didn't all go into ARR. And then of course the velocity numbers and the FSG numbers. So it was broad based in all geographies and really in all product lines.

[Operator]

Your next question comes from Matthew Broome from Mizuho Securities. Please go ahead. Your line is open

[Matthew Broome, Mizuho Securities]

So Jim I mean, just, I guess, just on that so just deal that I can just mention get given the importance of supply chain management right now, are you seeing like ramping demand to the solution elsewhere and following on from that, is there a chance that FSG AR growth could actually accelerate on the back of that demand beyond the sort of the mid single digit level and actually come sort of more strategic in a way?

[James Heppelmann, President & CEO]

Yeah, that's one of the points Matt that I brought up at the recent investor day is that we've generally modeled FSG to be roughly flat, flat well, plus 1%, 2%, but it's actually been performing, I think last year, Christian was at up 7% FSG and it was up 6% here again in Q1. So yeah, we're overperform and serve logistics is one of the key drivers. And then the second one probably is retail PLM, which has also been doing fairly well.

So definitely, there's some, I think we'll be conservative and, and leave the FSG guidance where it is in the near term, but, I do like overperforming it because it's a growth driver. The FSG business is about the same size as the IoT and ARR business. So every point of growth we get there is pretty meaningful.

[Operator]

Your next question comes from Matt Hedberg from RBC Capital Markets. Please go ahead. Your line is open.

[Matt Swanson, RBC Capital Markets]

Yeah. Thanks. This is Matt Swanson on for Matt. I'll kind of follow up on a piece of, both Adam and Jay's questions. So looking at the Sheffler announcement, I think the thing I was really interested in was the idea around standardization and the idea around end to end. So could you talk a little bit about your customer's desire around standardization and, clearly this product roadmap has really expanded your TAM, but I think one of the upside areas, something we, maybe the holy grail of the transition would be more competitive displacement. And I'm just curious if you're starting to hear, any early or more talk around that because you're building something so differentiated?

[James Heppelmann, President & CEO]

Yeah. for sure. So the standard thing, I think maybe over the last couple years industrial companies have realized that they should be using software and not developing it. And so we saw this in our IoT business, and it's been why we've been heading up the stack with solutions like DPM is customers would like to buy the software and use it, not buy some kind of a platform and create it, because they just don't really know how to create it if I'm frank.

So Sheffler had gone down the path of kind of like I said, low code environments and came back to standard products and then they end to end thing, for sure the CAD data that's created in Creo and managed in windshield, gets used, for example, in augmented reality manufacturing and service instructions, much later and in a different part of the company, if it's all well managed and that connectivity from IoT, well, let's say from CAD to PLM to IoT to AR is what we call the digital thread.

And so we actually see so much interest in this that we kind of organized around that principle. Let's stop presenting these products as kind of independent things and let's shine a light on how well they work together in an end to end solution. And by the way, how they're all ready to go that this is something you just turn on and use. And that's really what one Sheffler over, but I can tell you Sheffler is not unique at all and it's really we're organizing to respond to that. SaaS is helpful by the way, because if you want a lot of technology working end to end, it'd be better not to ship it all to the customer site because it gets complicated. The customer would like to just use it, not, set it all up and care and feed for it on, on premise.

[Operator]

Your next question comes from Saket Kalia from Barclays Capital. Please go ahead. Your line is open.

Q - Saket Kalia

Okay, great. Hey guys. Thanks for taking my question here. Hey Jim, Hey Jim, maybe, Hey Christian, Jim, maybe for you. it was great to hear the PLM strength this quarter in bookings. with other companies that have done shifts like this, there's always a risk, I guess, of customers behaving differently, right? Whether that's slowing purchases to see what's coming or maybe pulling forward purchases before something new comes out now.

Now just to be clear, it doesn't sound like that happened here, but can you just stress test that for us a little bit and what you sort of look at to sort of manage what is, more choices for our customer to make. Does, that make sense?

[James Heppelmann, President & CEO]

Yeah. Are you referring just let me clarify, are you referring to like SaaS choices being new choices or..

Q - Saket Kalia

Yeah, that's right. Windshield, no windshield specifically.

[James Heppelmann, President & CEO]

Yeah So, keep in mind Saket, we have been selling wind shell as SaaS for some time. Remember the phase one phase two phase three thing. So since phase one, we've been selling wind shell and we showed you it's got a three year growth CAGR of 30% in SaaS. So the customer demand is strong. It's just on the PTC side. We need to pivot to multi-tenant because in the single tenant model, we just don't have the profitability we like.

So the demand is strong, the customers are buying it. Christian mentioned we had another strong quarter. So it really is we'd like to meet that demand with a solution that's more efficient for us to operate on behalf of the customer. And that's what phase three multi-tenant really is all about.

Now, when it becomes more efficient for us, we can then lean in on the promotion and marketing of it because we haven't really done that. So we've been servicing demand, not driving it and with phase three, we think there's an opportunity to drive demand and the preliminary data we've seen this quarter suggest customers are very responsive, both to buying new systems that way, but also to lifting and shifting the previous systems they bought and giving them to us to operate and serve back to them in a SaaS model.

[Operator]

Your next question comes from Joe Vruwink from Baird. Please go ahead. Your line is open.

[Joe Vruwink, Baird]

Great. Hi, everyone. Just to go back to bookings, does the strength of score absent mega deals suggest anything about either the demand environments or maybe just the health of your mid-market and SMB customers and looking ahead, are there going to be certain things you think about or track when contemplating the probability of more mega deals or maybe the larger ARR contributors for PTC, maybe, being a bit more represented in future bookings?

[James Heppelmann, President & CEO]

Christian, let me again, take a stab at that and maybe you'll find things to add. So I think if you look at the bookings again, they were phenomenal and it's hard to pin down. It wasn't one geography, it wasn't one product, it was all geographies, all products. So I think it tells us that the end market is very healthy. And I would say for two different reasons.

On one hand, the PMIs are in good shape. That's helpful. On the other hand the interest they have in the digital thread, digital transformation story in the interest they have in SaaS is secular. That interest is not related to the PMIs. It's kind of independent of them and so I think that we're just in a very healthy situation where industrial companies are leaning in on trying to get more digital. They see PTC as having a fairly unique and compelling portfolio and their interest in engaging and trying to make their companies more efficient.

I can tell that Sheffler, for example, it's one of the top initiatives in the company is to get more digital and as it relates to the whole product life cycle, the partners PTC, and we see that kind of phenomenon happening in a lot of places in the industrial world. So I think it's just good, strong secular and as well, macro environment out there right now. But I'll remind you that we've had good performance, even when the macro environment wasn't so strong. So all things being equal, I like the strong macro, but we're 17 quarters in with double digit growth in the core business. And there were a lot of bad macro quarters over the course of those 17. So I think it really is the secular driver Kristian, do you want to take?

[Kristian Talvitie, CFO]

Yeah. I agree with all that. Actually just on the big deal dynamic, what we used to call mega deals. We haven't -- I think we've had four in the past four years.

[James Heppelmann, President & CEO]

Yeah. Well, keep in mind, perpetual drove bigger upfront purchases. That's right and subscription or SaaS tends not to.

[Kristian Talvitie, CFO]

Yeah. Which is my point that we've been seeing good strong bookings performance and bookings growth, even with the absence of what used to be a fairly regular occurrence back in the perpetual days. Like we really don't see a lot of those.

[James Heppelmann, President & CEO]

Yeah. It's good. Healthy business. Okay. Next question.

[Operator]

Your next question comes from Blair Abernethy from Rosenblatt Securities. Please go ahead. Your line is open.

[Blair Abernethy, Rosenblatt Securities]

Thanks very much. Guys, just maybe a quick question on around partnerships in particular, if you just give us a little a little deeper dive into how things are going with Rockwell and as well on the simulation side with Ansys.

[James Heppelmann, President & CEO]

Yeah. So the state of the partner economy is good and Microsoft, I could put on that list is also strong. With Rockwell you'll remember in the past quarters I had said we should take a bit of a conservative posture as it relates to what Rockwell would contribute to PDCs numbers here in fiscal '22 and we did that because Rockwell had made a big acquisition.

Rockwell never completely agreed with me on that. Their own public commentary kind of indicated they didn't worry too much about that. And in Q1 we're right. So we're pleased to see that Rockwell's contribution was solid in Q1 and starting to feel pretty good about the year. I'll tell you one thing is this DPM solution appears to be a very good fit with Rockwell.

And in fact, their Calypso alarm is probably lined up to be our strongest partner in promoting DPM. So we're, very happy with that. Calypso has a long term relationship with PTC that even predates their acquisition by Rockwell. So great alignment around DPM. Again, DPM is a high value up to stack solution that drives bigger deal sizes and we think will be a very sticky solution. So lots of optimism around that.

With Ansys, we continue to differentiate now with best in class simulation. So, whereas simulation, some years back, would've been viewed as a soft spot for PTC. Now it's a strength, if we're competing against Autodesk or Siemens or [indiscernible]. Nobody's going to have a better simulation story than PTC because nobody has a better simulation story than Ansys and Ansys products are built into PTC products. So that's been going well. And then of course, with Microsoft, that partnership is performing well and poised to get a lot bigger because as we bring more stuff aggressively to SaaS, a whole lot of that is going to land on Azure. So I think all three partnerships are alive and well, and as important as ever and, helping us achieve the kind of results that we're achieving.

[Operator]

Your last question comes from Sterling Auty from JPMorgan. Please call ahead. Your line is open.

[Sterling Auty, JPMorgan]

Yeah. Thanks. Hi guys. Just wondering if you could characterize with the headcount changes that you pointed out are necessary to facilitate the acceleration to SaaS, where are you in that process what's left to go and kind of what's the timeframe that you expect to complete that over?

[James Heppelmann, President & CEO]

Yeah. Christian, I'm thinking the numbers were largely done, but not completely 80%, 90% done.

[Kristian Talvitie, CFO]

Exiting.

[James Heppelmann, President & CEO]

Yeah. we'll be hiring people throughout the year, so, but in terms of the people who are exiting they're largely exited by now that largely happened within the first quarter.

[Operator]

We have no further questions. I'd like to turn the call back over to Jim Heppelmann for closing remarks.

[James Heppelmann, President & CEO]

Okay. Well thank you all. There's a lot of good -- lot of good questions and I think good answers because the business is performing very well right now. ARR is doing well. Bookings are doing well. Free cash is doing well. I think we executed through good times and bad. We executed through the changes we made over the last quarter and we're set up to do pretty well for the balance of the year. So we very confident and look forward to talking to you all in 90 days. If we don't happen to cross paths with you sooner in an investor event or what have you. So thanks a lot for joining us and have a good evening.

[Operator]

This concludes today's conference call. You may now disconnect.