PTC Inc.
PARAMETRIC TECHNOLOGY CORP (Form: 10-Q, Received: 08/10/2011 17:15:45)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 2, 2011

Commission File Number: 0-18059

 

 

Parametric Technology Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Massachusetts   04-2866152

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

140 Kendrick Street, Needham, MA 02494

(Address of principal executive offices, including zip code)

(781) 370-5000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   þ     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer   þ    Accelerated filer   ¨    Non-accelerated filer   ¨    Smaller reporting company   ¨
         

(Do not check if a smaller

reporting company)

    

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   þ

There were 117,565,519 shares of our common stock outstanding on August 4, 2011.

 

 

 


Table of Contents

PARAMETRIC TECHNOLOGY CORPORATION

INDEX TO FORM 10-Q

For the Quarter Ended July 2, 2011

 

          Page
Number
 

Part I—FINANCIAL INFORMATION

  

Item 1.

   Unaudited Condensed Financial Statements:   
   Consolidated Balance Sheets as of July 2, 2011 and September 30, 2010      3   
  

Consolidated Statements of Operations for the three and nine months ended July 2, 2011 and July 3, 2010

     4   
  

Consolidated Statements of Cash Flows for the nine months ended July 2, 2011 and July 3, 2010

     5   
  

Consolidated Statements of Comprehensive Income for the three and nine months ended July 2, 2011 and July 3, 2010

     6   
   Notes to Condensed Consolidated Financial Statements      7   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk      40   

Item 4.

   Controls and Procedures      40   

Part II—OTHER INFORMATION

  

Item 1.

   Legal Proceedings      41   

Item 1A.

   Risk Factors      41   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      41   

Item 6.

   Exhibits      42   

Signature

     43   

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1. UNAUDITED CONDENSED FINANCIAL STATEMENTS

PARAMETRIC TECHNOLOGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(unaudited)

 

     July 2,
2011
    September 30,
2010
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 260,751      $ 240,253   

Accounts receivable, net of allowance for doubtful accounts of $4,113 and $4,559 at July 2, 2011 and September 30, 2010, respectively

     186,874        169,281   

Prepaid expenses

     42,430        32,116   

Other current assets

     93,405        91,126   

Deferred tax assets

     34,798        35,481   
  

 

 

   

 

 

 

Total current assets

     618,258        568,257   

Property and equipment, net

     60,704        58,064   

Goodwill

     623,638        418,509   

Acquired intangible assets, net

     228,244        127,931   

Deferred tax assets

     116,615        90,458   

Other assets

     34,054        43,845   
  

 

 

   

 

 

 

Total assets

   $ 1,681,513      $ 1,307,064   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 13,354      $ 11,734   

Accrued expenses and other current liabilities

     66,162        52,803   

Accrued compensation and benefits

     86,733        98,476   

Accrued income taxes

     10,933        516   

Accrued litigation

     —          50,644   

Deferred revenue

     308,048        238,821   
  

 

 

   

 

 

 

Total current liabilities

     485,230        452,994   

Revolving credit facility

     250,000        —     

Deferred tax liabilities

     53,993        22,452   

Deferred revenue

     9,592        7,019   

Other liabilities

     80,554        77,295   
  

 

 

   

 

 

 

Total liabilities

     879,369        559,760   
  

 

 

   

 

 

 

Commitments and contingencies (Note 11)

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value; 5,000 shares authorized; none issued

     —          —     

Common stock, $0.01 par value; 500,000 shares authorized; 117,517 and 115,826 shares issued and outstanding at July 2, 2011 and September 30, 2010, respectively

     1,175        1,158   

Additional paid-in capital

     1,799,125        1,802,786   

Accumulated deficit

     (956,358     (1,004,160

Accumulated other comprehensive loss

     (41,798     (52,480
  

 

 

   

 

 

 

Total stockholders’ equity

     802,144        747,304   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,681,513      $ 1,307,064   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PARAMETRIC TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 3,
2011
    July 3,
2010
 

Revenue:

        

License

   $ 81,431      $ 67,498      $ 231,119      $ 206,958   

Service

     210,352        175,500        596,405        535,025   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     291,783        242,998        827,524        741,983   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

        

Cost of license revenue

     7,617        7,621        20,129        24,000   

Cost of service revenue

     82,792        67,090        238,112        206,548   

Sales and marketing

     89,106        79,121        254,790        232,856   

Research and development

     51,103        50,597        155,676        151,247   

General and administrative

     31,882        22,755        80,078        69,633   

Amortization of acquired intangible assets

     4,753        3,836        12,873        11,869   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     267,253        231,020        761,658        696,153   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     24,530        11,978        65,866        45,830   

Interest and other (expense) income, net

     (6,271     (320     (8,979     (1,449
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     18,259        11,658        56,887        44,381   

Provision for income taxes

     2,733        940        9,084        6,798   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 15,526      $ 10,718      $ 47,803      $ 37,583   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share—Basic

   $ 0.13      $ 0.09      $ 0.41      $ 0.32   

Earnings per share—Diluted

   $ 0.13      $ 0.09      $ 0.39      $ 0.31   

Weighted average shares outstanding—Basic

     118,214        115,188        117,622        115,802   

Weighted average shares outstanding—Diluted

     121,164        119,003        121,149        119,996   

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PARAMETRIC TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Nine months ended  
     July 2,
2011
    July 3,
2010
 

Cash flows from operating activities:

    

Net income

   $ 47,803      $ 37,583   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     44,547        47,538   

Stock-based compensation

     32,458        37,657   

Excess tax benefits from stock-based awards

     (2,307     (226

Other non-cash (credits) costs, net

     (135     910   

Changes in operating assets and liabilities, excluding effects of acquisitions:

    

Accounts receivable

     18,059        11,228   

Accounts payable and accrued expenses

     3,881        1,602   

Accrued compensation and benefits

     (15,635     (6,850

Deferred revenue

     36,825        32,564   

Accrued litigation

     (52,129     —     

Accrued income taxes

     (17,855     (23,049

Other current assets and prepaid expenses

     (1,196     (1,768

Other noncurrent assets and liabilities

     (15,645     3,887   
  

 

 

   

 

 

 

Net cash provided by operating activities

     78,671        141,076   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions to property and equipment

     (18,295     (21,684

Acquisitions of businesses, net of cash acquired

     (265,153     (2,087
  

 

 

   

 

 

 

Net cash used by investing activities

     (283,448     (23,771
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings under revolving credit facility

     250,000        —     

Repayments of borrowings under revolving credit facility

     —          (50,832

Repurchases of common stock

     (39,947     (60,046

Proceeds from issuance of common stock

     22,261        8,524   

Excess tax benefits from stock-based awards

     2,307        226   

Payments of withholding taxes in connection with settlement of restricted stock units

     (22,052     (20,250
  

 

 

   

 

 

 

Net cash provided (used) by financing activities

     212,569        (122,378
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     12,706        (11,030
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     20,498        (16,103

Cash and cash equivalents, beginning of period

     240,253        235,122   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 260,751      $ 219,019   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PARAMETRIC TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 

Net income

   $ 15,526      $ 10,718      $ 47,803      $ 37,583   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax:

        

Foreign currency translation adjustment

     2,812        (15,757     11,085        (29,252

Minimum pension liability adjustment

     (137     (60     (403     (108
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     2,675        (15,817     10,682        (29,360
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 18,201      $ (5,099   $ 58,485      $ 8,223   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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PARAMETRIC TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Parametric Technology Corporation (PTC) and its wholly owned subsidiaries and have been prepared by management in accordance with accounting principles generally accepted in the United States of America and in accordance with the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. While we believe that the disclosures presented are adequate in order to make the information not misleading, these unaudited quarterly financial statements should be read in conjunction with our annual consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair statement of our financial position, results of operations and cash flows at the dates and for the periods indicated. Unless otherwise indicated, all references to a year mean our fiscal year, which ends on September 30. The September 30, 2010 consolidated balance sheet included herein is derived from our audited consolidated financial statements.

The results of operations for the three and nine months ended July 2, 2011 are not necessarily indicative of the results expected for the remainder of the fiscal year.

2. Deferred Revenue and Financing Receivables

Deferred Revenue

Deferred revenue primarily relates to software maintenance agreements billed to customers for which the services have not yet been provided. The liability associated with performing these services is included in deferred revenue and, if not yet paid, the related customer receivable is included in other current assets. Billed but uncollected maintenance-related amounts included in other current assets at July 2, 2011 and September 30, 2010 were $83.4 million and $76.8 million, respectively.

Financing Receivables

We periodically provide financing for software purchases to credit-worthy customers with payment terms up to 36 months. The determination on whether to offer such payment terms is based on the size, nature and credit-worthiness of the customer, and the history of collecting amounts due, without concession, from the customer. As of July 2, 2011 and September 30, 2010, amounts due from customers for contracts with extended payment terms (financing receivables) totaled $56.2 million and $44.3 million, respectively. Accounts receivable in the accompanying consolidated balance sheets include current receivables from such contracts totaling $46.2 million and $27.2 million at July 2, 2011 and September 30, 2010, respectively, and other assets in the accompanying consolidated balance sheets include long-term receivables from such contracts totaling $10.0 million and $17.1 million at July 2, 2011 and September 30, 2010, respectively. We periodically transfer future payments under certain of these contracts to third-party financial institutions on a non-recourse basis. We record such transfers as sales of the related accounts receivable when we surrender control of such receivables. We sold $4.0 million of financing receivables to third-party financial institutions in the three and nine months ended July 2, 2011. We sold $19.6 million of financing receivables to third-party financial institutions in the nine months ended July 3, 2010.

We evaluate estimated credit losses on financing receivables based on whether the customers are making payments as they become due, customer credit-worthiness and existing economic conditions. We write off

 

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uncollectible trade and financing receivables when we have exhausted all collection avenues. As of July 2, 2011 and September 30, 2010, we concluded that all financing receivables were collectible and no reserve for credit losses was recorded. We did not provide a reserve for credit losses or write off any uncollectible financing receivables in the three and nine months ended July 2, 2011 and fiscal year 2010.

3. Stock-based Compensation

We measure the cost of employee services received in exchange for restricted stock and restricted stock unit (RSU) awards based on the fair value of our common stock on the date of grant. That cost is recognized over the period during which an employee is required to provide service in exchange for the award.

Our equity incentive plan provides for grants of nonqualified and incentive stock options, common stock, restricted stock, RSUs and stock appreciation rights to employees, directors, officers and consultants. We award restricted stock and RSUs as the principal equity incentive awards, including certain performance-based awards that are earned based on achievement of performance criteria established by the Compensation Committee of our Board of Directors. Each RSU represents the contingent right to receive one share of our common stock.

Our equity incentive plans are described more fully in Note K to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010.

 

Restricted Stock Activity for the nine months ended July 2, 2011    Shares     Weighted
Average
Grant Date
Fair Value
(Per Share)
 
     (in thousands)        

Balance of outstanding restricted stock September 30, 2010

     329      $ 18.09   

Granted

     56      $ 23.05   

Vested

     (305   $ 18.35   

Forfeited or not earned

     —        $ —     
  

 

 

   

Balance of outstanding restricted stock July 2, 2011

     80      $ 20.58   
  

 

 

   
Restricted Stock Unit Activity for the nine months ended July 2, 2011    Shares     Weighted
Average
Grant Date
Fair Value
(Per Share)
 
     (in thousands)        

Balance of outstanding restricted stock units September 30, 2010

     6,053      $ 14.25   

Granted

     2,616      $ 21.91   

Vested

     (2,783   $ 14.34   

Forfeited or not earned

     (275   $ 11.34   
  

 

 

   

Balance of outstanding restricted stock units July 2, 2011

     5,611      $ 17.77   
  

 

 

   

We made the following restricted stock unit grants in the first nine months of 2011:

 

    Restricted Stock (1)     Restricted Stock Units  

Grant Period

  Performance-based     Time-based     Performance-based (2)     Time-based (3)  
    (in thousands)  
    (Number of Shares)     (Number of Units)  

First nine months of 2011

    —          56        604        2,012   

 

(1) The time-based shares of restricted stock were issued to our non-employee directors as part of their annual compensation. The restrictions on these shares lapse over one or two years from the date of grant.

 

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(2) Of these performance-based RSUs, 244,010 will vest to the extent earned in three substantially equal installments on the later of November 15, 2011 and the date the Compensation Committee determines the extent to which the performance criteria have been achieved, November 15, 2012 and November 15, 2013. The remaining 360,082 performance-based RSUs are eligible to vest in three substantially equal installments on each of the later of November 15, 2013, November 15, 2014 and November 15, 2015 and the date the Compensation Committee determines the extent to which the applicable performance criteria have been achieved; RSUs for this grant not earned in a period may be earned in a later period to the extent the cumulative performance criteria are achieved.
(3) The time-based RSUs were issued to employees, including some of our executive officers. Of these time-based RSUs, 1,063,707 will vest in three equal annual installments in November 2011, 2012 and 2013; 41,404 will vest in three equal annual installments in June 2012, 2013 and 2014; 17,536 will vest in three equal annual installments in May 2012, 2013, and 2014; 735,059 will vest in three equal annual installments in March 2012, 2013 and 2014; and 154,320 will vest in two substantially equal installments on September 30, 2011 and September 30, 2012.

As described below in Note 5, in the third quarter of 2011, in connection with our acquisition of MKS Inc., we granted 146,998 stock options to employees of MKS which vest over the next three years. These stock options were replacement stock options for unvested MKS stock options outstanding as of the acquisition date. The weighted average exercise price is $6.83 and the fair value of these grants is $2.5 million, of which $0.1 million was recorded as purchase price for the pre-acquisition service period. The remaining $2.4 million will be recognized as compensation expense over the vesting period.

The following table shows the classification of compensation expense recorded for our stock-based awards as reflected in our consolidated statements of operations:

 

     Three months ended      Nine months ended  
     July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in thousands)  

Cost of license revenue

   $ 4       $ 2       $ 10       $ 21   

Cost of service revenue

     1,857         2,186         5,577         7,007   

Sales and marketing

     3,062         3,471         7,841         10,065   

Research and development

     2,010         2,252         6,152         7,294   

General and administrative

     4,627         3,599         12,878         13,270   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 11,560       $ 11,510       $ 32,458       $ 37,657   
  

 

 

    

 

 

    

 

 

    

 

 

 

4. Earnings per Share (EPS) and Common Stock

EPS

Basic EPS is calculated by dividing net income by the weighted average number of shares outstanding during the period. Unvested restricted stock, although legally issued and outstanding, is not considered outstanding for purposes of calculating basic EPS. Diluted EPS is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding stock options, restricted shares and RSUs using the treasury stock method. The calculation of the dilutive effect of outstanding equity awards under the treasury stock method includes consideration of proceeds from the assumed exercise of stock options, unrecognized compensation expense and any tax benefits as additional proceeds.

 

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The following table presents the calculation for both basic and diluted EPS:

 

     Three months ended      Nine months ended  
Calculation of Basic and Diluted EPS    July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in thousands, except per share data)  

Net income

   $ 15,526       $ 10,718       $ 47,803       $ 37,583   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding—Basic

     118,214         115,188         117,622         115,802   

Dilutive effect of employee stock options, restricted shares and restricted stock units

     2,950         3,815         3,527         4,194   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding—Diluted

     121,164         119,003         121,149         119,996   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share—Basic

   $ 0.13       $ 0.09       $ 0.41       $ 0.32   

Earnings per share—Diluted

   $ 0.13       $ 0.09       $ 0.39       $ 0.31   

Stock options to purchase 0.1 million shares for both the third quarter and first nine months of 2011, and 1.5 million shares and 1.9 million shares for the third quarter and first nine months of 2010, respectively, were outstanding but were not included in the calculation of diluted EPS because the exercise prices per share were greater than the average market price of our common stock for those periods. These shares were excluded from the computation of diluted EPS as the effect would have been anti-dilutive.

Common Stock Repurchases

Our Articles of Organization authorize us to issue up to 500 million shares of our common stock. Our Board of Directors has authorized us to use up to $200 million of cash from operations to repurchase shares of our common stock in open market purchases. This authorization will expire on September 30, 2011 unless earlier revoked. In the third quarter and first nine months of 2011, we repurchased 1.8 million shares at a cost of $39.9 million and we have $78.1 million remaining under our current authorization. In the third quarter and first nine months of 2010, we repurchased 0.8 million shares at a cost of $15.0 million and 3.6 million shares at a cost of $60.0 million, respectively. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.

5. Acquisition

On May 31, 2011, we acquired all of the outstanding common stock of MKS Inc. (MKS), a publicly held company based in Ontario, Canada, for CDN $26.20 per share. We acquired MKS to expand our product offerings by adding MKS’s application lifecycle management (ALM) software used in developing software intensive products to our existing software solutions. We believe that the unification of MKS’s ALM solutions with PTC’s product lifecycle management solutions will enable manufacturers to better align the development and management of a product’s hardware and software components.

The total purchase price for MKS was comprised of:

 

     (in thousands)  

Acquisition of MKS stock

   $ 280,397   

Acquisition of MKS vested and unvested stock options

     18,040   
  

 

 

 

Total purchase price

     298,437   

Less: MKS cash acquired

     (33,193
  

 

 

 

Total purchase price, net of cash acquired

     265,244   

Less: Purchase price related to PTC options issued for MKS unvested options

     (91
  

 

 

 

Net cash used to acquire MKS

   $ 265,153   
  

 

 

 

 

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The purchase price included cash to settle outstanding vested stock options of MKS based on the purchase price of CDN $26.20 per share, and the conversion of unvested stock options of MKS into stock options to buy 146,998 shares of PTC common stock. We financed the transaction by drawing on our existing revolving credit facility in the amount of $250 million with the remainder funded by cash on hand.

MKS’s results of operations have been included in PTC’s consolidated financial statements beginning May 31, 2011. MKS had revenues of $79 million and $63 million for the twelve months ended April 30, 2011 and 2010, respectively. MKS’s revenue for 2011 included a particularly large transaction. The acquisition added $6.0 million to our third quarter 2011 revenue and unfavorably impacted our operating income by approximately $7 million for the third quarter of 2011 when including acquisition-related costs of $6.0 million and amortization of acquired intangible assets of $0.9 million recorded during the quarter.

The acquisition of MKS has been accounted for as a business combination. Assets acquired and liabilities assumed have been recorded at their estimated fair values as of the acquisition date, May 31, 2011. The fair values of intangible assets were based on valuations using an income approach, with estimates and assumptions provided by management of MKS and PTC. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The allocation of the purchase price is based upon a valuation of assets and liabilities acquired. Our estimates and assumptions in determining the estimated fair values of certain assets and liabilities are subject to change within the measurement period (up to one year from the acquisition date). The primary areas of the purchase price allocation that are not yet finalized relate to income taxes and the amount of resulting goodwill.

Based upon a valuation, the total purchase price allocation was as follows:

 

     (in thousands)  

Goodwill

   $ 191,649   

Identifiable intangible assets

     117,900   

Cash

     33,193   

Accounts receivable

     7,413   

Property and equipment

     4,880   

Deferred revenue

     (16,803

Deferred tax assets and liabilities, net

     (34,242

Net assumed liabilities

     (5,553
  

 

 

 

Total purchase price allocation

     298,437   

Less: MKS cash acquired

     (33,193
  

 

 

 

Total purchase price allocation, net of cash acquired

   $ 265,244   
  

 

 

 

The purchase price allocation resulted in $191.6 million of goodwill, the majority of which will not be deductible for income tax purposes. Intangible assets of $117.9 million includes purchased software of $36.9 million, customer relationships of $78.6 million and trademarks of $2.4 million, which are being amortized over weighted average useful lives of 7 years, 11 years and 7 years, respectively, based upon the pattern in which economic benefits related to such assets are expected to be realized. As a result, we recorded in the purchase accounting deferred tax liabilities of $42.6 million, equal to the tax effect of the amount of the acquired intangible assets other than goodwill and the fair value adjustment for deferred revenue. The resulting amount of goodwill reflects our expectations of the following synergistic benefits: (1) the potential to sell MKS products into our customer base and to sell PTC products into MKS’s customer base; (2) our intention to leverage our larger sales force and our intellectual property to attract new contracts and revenue; and (3) our intention to leverage our established presence in global markets.

In the three and nine months ended July 2, 2011, we incurred $6.0 million and $6.6 million, respectively, of acquisition-related costs, primarily associated with our acquisition of MKS. Acquisition-related costs include

 

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direct costs of completing an acquisition (i.e., investment banker fees, professional fees, including legal and valuation services) and expenses related to acquisition integration activities (i.e., professional fees, severance, and retention bonuses) . These costs have been classified in general and administrative expenses in the accompanying consolidated statements of operations.

Pro Forma Financial Information (unaudited)

The unaudited financial information in the table below summarizes the combined results of operations of PTC and MKS, on a pro forma basis, as though the companies had been combined as of the beginning of PTC’s fiscal year 2010. The pro forma information for all periods presented also includes the effects of business combination accounting resulting from the acquisition, including amortization charges from acquired intangibles assets, stock-based compensation charges for unvested stock options, interest expense on borrowings in connection with the acquisition, and the related tax effects as though the acquisition had been consummated as of the beginning of 2010. These pro forma results exclude the impact of the purchase accounting adjustment to deferred revenue and the transaction costs included in the historical results and the related tax effects. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisition had taken place at the beginning of 2010. For the three months and nine months ended July 2, 2011, the pro forma financial information is based on PTC’s results of operations for the three months and nine months ended July 2, 2011, which includes MKS’s results beginning May 31, 2011, combined with MKS’s results of operations for the two and eight months ended May 30, 2011. For the three months and nine months ended July 3, 2010, the pro forma financial information is based on PTC’s results of operations for the three months and nine months ended July 3, 2010, combined with MKS’s results of operations for the three and nine months ended July 31, 2010 (due to differences in reporting periods).

 

     Three months ended      Nine months ended  
     July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in millions, except per share amounts)  

Revenue

   $ 304.4       $ 258.3       $ 886.4       $ 789.8   

Net income

   $ 15.3       $ 8.8       $ 52.9       $ 39.6   

Earnings per share—Basic

   $ 0.13       $ 0.08       $ 0.45       $ 0.34   

Earnings per share—Diluted

   $ 0.13       $ 0.07       $ 0.44       $ 0.33   

6. Goodwill and Intangible Assets

We have two reportable segments: (1) software products and (2) services. As of July 2, 2011 and September 30, 2010, goodwill and acquired intangible assets in the aggregate attributable to our software products reportable segment was $821.4 million and $524.3 million, respectively, and attributable to our services reportable segment was $30.5 million and $22.1 million, respectively. Goodwill is tested for impairment at least annually, or on an interim basis if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting segment below its carrying value. We completed our annual impairment review as of July 2, 2011 and concluded that no impairment charge was required as of that date. Acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.

 

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Goodwill and acquired intangible assets consisted of the following:

 

    July 2, 2011     September 30, 2010  
    Gross
Carrying
Amount
    Accumulated
Amortization
    Net Book
Value
    Gross
Carrying
Amount
    Accumulated
Amortization
    Net Book
Value
 
    (in thousands)  

Goodwill (not amortized)

      $ 623,638          $ 418,509   
     

 

 

       

 

 

 

Intangible assets with finite lives (amortized):

           

Purchased software

  $ 175,633      $ 111,475        64,158      $ 134,375      $ 98,193        36,182   

Capitalized software

    22,877        22,877        —          22,877        22,877        —     

Customer lists and relationships

    233,148        72,941        160,207        148,753        60,490        88,263   

Trademarks and trade names

    10,882        7,235        3,647        8,274        5,196        3,078   

Other

    3,655        3,423        232        3,538        3,130        408   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 446,195      $ 217,951        228,244      $ 317,817      $ 189,886        127,931   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total goodwill and acquired intangible assets

      $ 851,882          $ 546,440   
     

 

 

       

 

 

 

Goodwill

The changes in the carrying amounts of goodwill for the nine months ended July 2, 2011 are due to the impact of acquisitions (described in Note 5) and to foreign currency translation adjustments related to those asset balances that are recorded in non-U.S. currencies.

Changes in goodwill for the nine months ended July 2, 2011, presented by reportable segment, are as follows:

 

     Software
Products
Segment
     Services
Segment
     Total  
     (in thousands)  

Balance, September 30, 2010

   $ 400,965       $ 17,544       $ 418,509   

Acquisition of MKS (1)

     183,649         8,000         191,649   

Foreign currency translation adjustments

     13,247         233         13,480   
  

 

 

    

 

 

    

 

 

 
   $ 597,861       $ 25,777       $ 623,638   
  

 

 

    

 

 

    

 

 

 

 

(1) As described in Note 5, the allocation of goodwill for the MKS acquisition by reportable segment is preliminary and will be finalized in the fourth quarter.

Amortization of intangible assets

The aggregate amortization expense for intangible assets with finite lives recorded for the third quarters and first nine months of 2011 and 2010 was classified in our consolidated statements of operations as follows:

 

     Three months ended      Nine months ended  
     July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in thousands)  

Amortization of acquired intangible assets

   $ 4,753       $ 3,836       $ 12,873       $ 11,869   

Cost of license revenue

     3,895         4,659         10,597         14,485   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization expense

   $ 8,648       $ 8,495       $ 23,470       $ 26,354   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The estimated aggregate future amortization expense for intangible assets with finite lives remaining as of July 2, 2011 is $10.2 million for 2011, $36.3 million for 2012, $36.0 million for 2013, $33.7 million for 2014, $30.1 million for 2015, $22.0 million for 2016 and $59.9 million thereafter.

7. Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. Generally accepted accounting principles prescribe a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs that may be used to measure fair value:

 

   

Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;

 

   

Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or

 

   

Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Our significant financial assets and liabilities measured at fair value on a recurring basis as of July 2, 2011 and September 30, 2010 were as follows:

 

     July 2,
2011
    September 30,
2010
 
     (in thousands)  

Financial assets

    

Cash equivalents—Level 1 (1)

   $ 89,182      $ 86,826   
  

 

 

   

 

 

 

Financial liabilities

    

Forward contracts—Level 2 (2)

   $ (9,020   $ (1,974
  

 

 

   

 

 

 

 

(1) Money market funds and time deposits.
(2) Includes a liability associated with forward contracts entered into in connection with our acquisition of MKS described in Note 8.

8. Derivative Financial Instruments

Our foreign currency risk management strategy is principally designed to mitigate the future potential financial impact of changes in the value of transactions and balances denominated in foreign currency resulting from changes in foreign currency exchange rates. We enter into derivative transactions, specifically foreign currency forward contracts with maturities of less than three months, to manage our exposure to fluctuations in foreign exchange rates that arise primarily from our foreign currency-denominated receivables and payables.

Generally, we do not designate foreign currency forward contracts as hedges for accounting purposes, and changes in the fair value of these instruments are recognized immediately in earnings. Because we enter into forward contracts only as an economic hedge, any gain or loss on the underlying foreign-denominated balance would be offset by the loss or gain on the forward contract. Gains and losses on forward contracts and foreign denominated receivables and payables are included in other income (expense), net.

 

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As of July 2, 2011 and September 30, 2010, we had outstanding forward contracts with notional amounts equivalent to the following:

 

Currency Hedged

   July 2,
2011
     September 30,
2010
 
     (in thousands)  

Canadian /U.S. Dollar

   $ 268,805       $ 1,280   

Euro/U.S. Dollar

     87,133         113,546   

Indian Rupee/U.S. Dollar

     23,134         20,262   

Chinese Renminbi/U.S. Dollar

     5,747         5,443   

Japanese Yen/U.S. Dollar

     15,546         —     

All other

     8,624         8,282   
  

 

 

    

 

 

 

Total

   $ 408,989       $ 148,813   
  

 

 

    

 

 

 

In the third quarter of 2011, in connection with our planned acquisition of MKS, we entered into forward contracts to purchase CDN$292 million (equivalent to approximately $305 million when we entered into the contracts). We entered into these forward contracts to reduce our foreign currency exposure related to changes in the Canadian to U.S. Dollar exchange rate from the time we entered into the agreement to acquire MKS (the purchase price was in Canadian Dollars) and the expected closing date. In the third quarter of 2011, we settled these contracts and recorded a net foreign currency loss of $4.4 million related to the acquisition of MKS. During the third quarter, after the acquisition, we entered into new forward contracts to hedge foreign currency exposure on a $260 million intercompany loan denominated in Canadian Dollars related to the acquisition. Subsequent to quarter end, this intercompany loan was significantly reduced.

The accompanying consolidated balance sheets as of July 2, 2011 and September 30, 2010 include a net liability of $9.0 million and $2.0 million, respectively, in accrued expenses and other current liabilities related to the fair value of our forward contracts.

Net gains and losses on foreign currency exposures are recorded in other income (expense), net and include realized and unrealized gains and losses on forward contracts. Net gains and losses on foreign currency exposures for the three and nine months ended July 2, 2011 and July 3, 2010 were as follows:

 

     Three months ended     Nine months ended  
     July 2,
2011
     July 3,
2010
    July 2,
2011
     July 3,
2010
 
     (in thousands)  

Net losses on foreign currency exposures

   $ 6,116       $ 508      $ 9,448       $ 2,196   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net realized and unrealized (gain) loss on forward contracts (excluding the underlying foreign currency exposure being hedged)

   $ 7,684       $ (1,807   $ 12,897       $ (3,294
  

 

 

    

 

 

   

 

 

    

 

 

 

9. Segment Information

We operate within a single industry segment—computer software and related services. Operating segments as defined under GAAP are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our President and Chief Executive Officer. We have two operating and reportable segments: (1) Software Products, which includes license and related maintenance revenue (including updates and technical support) for all our products except training-related products; and (2) Services, which includes consulting, implementation, training, computer-based training products, including maintenance thereon, and other support revenue. In our consolidated statements of operations, maintenance revenue is included in service revenue. We do not allocate sales and marketing or administrative expenses to our operating segments as these activities are managed on a consolidated basis.

 

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The revenue and operating income attributable to our operating segments are summarized as follows:

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 
     (in thousands)  

Revenue:

        

Total Software Products segment revenue

   $ 212,137      $ 185,336      $ 617,203      $ 563,746   

Total Services segment revenue

     79,646        57,662        210,321        178,237   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 291,783      $ 242,998      $ 827,524      $ 741,983   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income:

        

Software Products segment

   $ 134,157      $ 109,708      $ 385,881      $ 334,282   

Services segment (1)

     11,361        4,146        14,853        14,037   

Sales and marketing expenses

     (89,106     (79,121     (254,790     (232,856

General and administrative expenses

     (31,882     (22,755     (80,078     (69,633
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating income

   $ 24,530      $ 11,978      $ 65,866      $ 45,830   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The improvement in operating income in the third quarter of 2011 compared to the third quarter of 2010 is due to higher revenue from our computer-based training products. In the first quarter of 2011, we made a strategic decision to enter into a contract with a customer in the automotive industry, for which we expect our costs to exceed our revenue by approximately $5 million. Services segment operating income in the first nine months of 2011 includes immediate recognition of the approximately $5 million estimated loss on this contract.

We report revenue by product group, Desktop and Enterprise. Desktop revenue includes our CAx Solutions, primarily: Creo Elements/Pro, Creo Elements/Direct, Mathcad and Arbortext authoring products. Enterprise revenue includes our PLM solutions, primarily: Windchill, Arbortext enterprise products, Creo Elements/View and MKS Integrity. Data for the three and nine months ended July 3, 2010 includes immaterial reclassifications between product groups made to conform to the current classification.

 

     Three months ended      Nine months ended  
     July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in thousands)  

Revenue:

           

Desktop

   $ 154,511       $ 127,860       $ 455,312       $ 397,833   

Enterprise

     137,272         115,138         372,212         344,150   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 291,783       $ 242,998       $ 827,524       $ 741,983   
  

 

 

    

 

 

    

 

 

    

 

 

 

Data for the geographic regions in which we operate is presented below.

 

     Three months ended      Nine months ended  
     July 2,
2011
     July 3,
2010
     July 2,
2011
     July 3,
2010
 
     (in thousands)  

Revenue:

           

Americas (1)

   $ 104,618       $ 82,450       $ 299,111       $ 273,547   

Europe (2)

     120,302         101,838         334,132         294,536   

Pacific Rim

     36,873         33,156         106,694         95,473   

Japan

     29,990         25,554         87,587         78,427   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 291,783       $ 242,998       $ 827,524       $ 741,983   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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(1) Includes revenue in the United States totaling $98.7 million and $78.6 million for the three months ended July 2, 2011 and July 3, 2010, respectively, and $284.0 million and $263.6 million for the nine months ended July 2, 2011 and July 3, 2010, respectively.
(2) Includes revenue in Germany totaling $48.9 million and $44.5 million for the three months ended July 2, 2011 and July 3, 2010, respectively, and $120.6 million and $109.8 million for the nine months ended July 2, 2011 and July 3, 2010, respectively.

10. Income Taxes

In the third quarter of 2011, our effective tax rate was a provision of 15% on pre-tax income of $18.3 million, compared to a provision of 8% on pre-tax income of $11.7 million in the third quarter of 2010. In the first nine months of 2011, our effective tax rate was a provision of 16% on pre-tax income of $56.9 million, compared to a provision of 15% on pre-tax income of $44.4 million in the first nine months of 2010. In the third quarter and first nine months of 2011, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate and, in the first nine months of 2011, a $1.8 million tax benefit related to research and development (R&D) triggered by a retroactive extension of the R&D tax credit enacted in the first quarter of 2011. In the third quarter and first nine months of 2010, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate tax structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate.

As of July 2, 2011 and September 30, 2010, we had unrecognized tax benefits of $18.3 million ($18.0 million net of state tax benefits) and $15.9 million ($15.6 million net of state tax benefits), respectively. If all of our unrecognized tax benefits as of July 2, 2011 were to become recognizable in the future, we would record a $17.4 million benefit to the income tax provision.

Our policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of our income tax provision. In the first nine months of 2011 and 2010, we included $0.2 million and $0.8 million of interest expense, respectively, and no tax penalty expense in our income tax provision. As of July 2, 2011, we had accrued $1.9 million of estimated interest expense and we had no accrued tax penalties, compared to $1.0 million accrued as of September 30, 2010, which was net of interest receivable of $0.7 million refunded in the first quarter of 2011. Changes in our unrecognized tax benefits in the nine months ended July 2, 2011 were as follows:

 

     (in millions)  

Balance as of October 1, 2010

   $ 15.9   

Tax positions related to current year

     0.9   

Tax positions related to prior years

     1.5   
  

 

 

 

Balance as of July 2, 2011

   $ 18.3   
  

 

 

 

Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in favorable or unfavorable changes in our estimates. We anticipate the settlement of certain tax audits may be finalized within the next twelve months and could result in a decrease to our unrecognized tax benefits of up to $5 million.

 

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In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service in the United States. As of July 2, 2011, we remained subject to examination in the following major tax jurisdictions for the tax years indicated:

 

Major Tax Jurisdiction

  

Open Years

United States

   2003, 2008 through 2010

Germany

   2007 through 2010

France

   2007 through 2010

Japan

   2005 through 2010

Ireland

   2006 through 2010

11. Commitments and Contingencies

Revolving Credit Agreement

We have a multi-currency bank revolving credit facility (the credit facility) with a syndicate of ten banks for which JPMorgan Chase Bank, N.A. acts as Administrative Agent. The credit facility matures in August 2014, when all amounts will be due and payable in full. The credit facility does not require amortization of principal and may be paid before maturity in whole or in part at PTC’s option without penalty or premium. We expect to use the credit facility for general corporate purposes, including acquisitions of other businesses, and may also use it for working capital.

The credit facility consists of a $300 million revolving credit facility, which may be increased by up to an additional $150 million if the existing or additional lenders are willing to make such increased commitments (such increase may also be used, in whole or in part, for term loans). PTC is the sole borrower under the credit facility. The obligations under the credit facility are guaranteed by PTC’s material domestic subsidiaries and are secured by a pledge of 65% of the voting equity interests of PTC’s material first-tier foreign subsidiaries.

In May 2011, in connection with our acquisition of MKS, we borrowed $250 million under the credit facility at an annual interest rate of 2.1%. Accrued interest is due after three months at which time the interest rate will reset. As of July 2, 2011, we had $250 million outstanding under the credit facility. We did not have any borrowings outstanding under the credit facility at September 30, 2010.

Interest rates on borrowings outstanding under the credit facility range from 1.75% to 2.25% above an adjusted LIBO rate for Eurodollar-based borrowings or would range from 0.75% to 1.25% above the defined base rate (the greater of the Prime Rate, the Federal Funds Effective Rate plus .005%, or an adjusted LIBO rate plus 1%) for base rate borrowings, in each case based upon PTC’s leverage ratio. Additionally, PTC may borrow certain foreign currencies at rates set in the same range above the respective London interbank offered interest rates for those currencies, based on PTC’s leverage ratio. A quarterly commitment fee on the undrawn portion of the credit facility is required, ranging from 0.30% to 0.40% per annum, based upon PTC’s leverage ratio.

The credit facility limits PTC’s and its subsidiaries’ ability to, among other things: incur additional indebtedness; incur liens or guarantee obligations; pay dividends (other than to PTC) and make other distributions; make investments and enter into joint ventures; dispose of assets; and engage in transactions with affiliates, except on an arms-length basis. Under the credit facility, PTC and its material domestic subsidiaries may not invest cash or property in, or loan to, PTC’s foreign subsidiaries in aggregate amounts exceeding $50 million for any purpose and an additional $75 million for acquisitions of businesses. In addition, under the credit facility, PTC and its subsidiaries must maintain the following financial ratios:

 

   

a leverage ratio, defined as consolidated funded indebtedness to consolidated trailing four quarters EBITDA, of no greater than 2.50 to 1.00 at any time; and

 

   

a fixed charge coverage ratio, defined as the ratio of consolidated trailing four quarters EBITDA to consolidated fixed charges, of no less than 1.25 to 1.00 at any time.

 

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As of July 2, 2011, our leverage ratio was 1.14 to 1.00 and our fixed charge coverage ratio was 1.86 to 1.00. We were in compliance with all financial and operating covenants of the credit facility as of July 2, 2011.

Any failure to comply with the financial or operating covenants of the credit facility would prevent PTC from being able to borrow additional funds, and would constitute a default, permitting the lenders to, among other things, accelerate the amounts outstanding, including all accrued interest and unpaid fees, under the credit facility and to terminate the credit facility. A change in control of PTC, as defined in the agreement, also constitutes an event of default, permitting the lenders to accelerate the indebtedness and terminate the credit facility.

Legal Proceedings

We are subject to various legal proceedings and claims that arise in the ordinary course of business. With respect to such proceedings and claims, we record an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We currently believe that resolving these matters will not have a material adverse impact on our financial condition, results of operations or cash flows. However, the results of legal proceedings cannot be predicted with certainty. Should any of these legal matters be resolved against us, the operating results for a particular reporting period could be adversely affected.

Guarantees and Indemnification Obligations

We enter into standard indemnification agreements in the ordinary course of our business. Pursuant to such agreements with our business partners or customers, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally in connection with patent, copyright or other intellectual property infringement claims by any third party with respect to our current products, as well as claims relating to property damage or personal injury resulting from the performance of services by us or our subcontractors. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. Historically, our costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and we accordingly believe the estimated fair value of these agreements is immaterial.

We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products for a specified period of time. Additionally, we generally warrant that our consulting services will be performed consistent with generally accepted industry standards. In most cases, liability for these warranties is capped. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history; however, we have not incurred significant cost under our product or services warranties. As a result, we believe the estimated fair value of these agreements is immaterial.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q about our future financial and growth expectations, the development of our products and markets, adoption of our solutions and future purchases by customers, and the expected impact of our strategic investments and product releases on our business are forward-looking statements that are subject to the inherent uncertainties in predicting future results and conditions. Risks and uncertainties that could cause actual results to differ materially from projected results include the following: our customers may not purchase our solutions when or at the rates we expect; we may not achieve the license, service or maintenance growth rates we expect, which could result in a different mix of revenue between license, service and maintenance and could adversely affect our profitability; our strategic investments, including adding sales personnel, may not generate the revenue or have the effects we expect; we may be unable to attain or maintain a technology leadership position and any such leadership position may not generate the revenue we expect; new product releases may be delayed or may not generate the revenue we expect; the acquisition of MKS may not generate the revenue we expect; our ability to successfully differentiate our products and services from those of our competitors and otherwise compete could be adversely affected by the relatively larger size and greater resources of several of the companies with which we compete; the possibility that our investigation in China will lead to remedial actions that may have a material impact on our operations in China, as well as other risks and uncertainties described below throughout or referenced in Part II, Item 1A. Risk Factors of this report.

Our Business

Parametric Technology Corporation (PTC) develops, markets and supports product development software solutions and related services that help companies design products, manage product information and improve their product development processes. Our software solutions help customers increase innovation, improve product quality, decrease time to market, and reduce product development costs.

We offer solutions in the product development market, which encompasses the product lifecycle management, or PLM, market (product data management, collaboration and related solutions) and the CAx market (computer-aided design, manufacturing and engineering (CAD, CAM and CAE) solutions). Our software solutions provide our customers with an integral product development system that enables them to create digital product content, collaborate with others in the product development process, control product content, automate product development processes, configure products and product content, and communicate product information to people and systems across the extended enterprise and design chain.

We recently acquired MKS Inc., a global application lifecycle management (ALM) technology leader. MKS Integrity ® coordinates and manages all activities and artifacts associated with developing software intensive products, including requirements, models, code and test and ensuring comprehensive lifecycle traceability. By unifying MKS’s ALM solutions with PTC’s industry-leading PLM solutions, PTC will enable manufacturers to better align the management of a product’s hardware components and related software.

We generate revenue through the sale of:

 

   

software licenses,

 

   

maintenance services, which include technical support and software updates, and

 

   

consulting and training services, which include implementation services for our software.

The PLM and the CAx markets we serve present different growth opportunities for us. We believe the market among large businesses for PLM solutions (which we refer to as our “Enterprise Solutions”) presents the

 

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greatest opportunity for revenue growth for us and believe revenue from this market will constitute an increasingly greater proportion of our revenue over time. We believe that the markets for both our PLM Enterprise solutions and CAx Desktop solutions among small- and medium-size businesses also provide an opportunity for future growth. While the market for our CAx solutions among large businesses is a highly penetrated market, we believe our Creo product suite, which we released in June 2011, has created a growth opportunity for us in this market.

Our solutions are complemented by our experienced services and technical support organizations, as well as resellers and other strategic partners. Our services and technical support organizations provide consulting, implementation and training support services to customers worldwide. Our resellers supplement our direct sales force to provide greater geographic and small- and medium-size account coverage. Our strategic partners provide product and/or service offerings that complement our solutions.

Executive Overview

Revenue in the third quarter of 2011 grew 20% (13% on a constant currency basis) compared to the third quarter of 2010. We had growth in all lines of business with license revenue up 21%, maintenance revenue up 17% and consulting and training service revenue up 27%, reflecting increased demand for our products and services. We attribute this increased demand to improvement in the economy and the strength of our products. We have seen continued strength in maintenance and consulting services following a strong license revenue year in 2010. Additionally, the launch of Creo has positively impacted Desktop license revenue and maintenance revenue as customers have expanded their adoption and renewed seats under maintenance, and new customers, particularly in the small- and medium-size business space, have been added.

Additionally, we acquired MKS Inc. on May 31, 2011. MKS contributed $6.0 million to third quarter revenue ($6.7 million on a non-GAAP basis). Excluding the impact of MKS, our total revenue was $285.8 million and our license revenue was $79.4 million, which were both up 18% over the third quarter of 2010.

During the third quarter of 2011, consistent with the first two quarters of 2011, we saw a year-over-year increase in the number of customers from which license and/or consulting and training revenue exceeded $1 million, suggesting improved breadth and depth of our business. License and/or consulting and training service revenue of $1 million or more recognized from individual customers during the third quarter of 2011 totaled $61 million from 27 customers ($2.2 million average), our fourth consecutive quarter of over 20 customers, compared with $39 million from 14 customers ($2.8 million average) in the third quarter of 2010.

Further, our Desktop license revenue and total revenue grew 41% and 21%, respectively, in the third quarter of 2011 compared to the third quarter of 2010, attributable to an increase in the amount of large deals with direct customers. Enterprise license revenue and total non-GAAP revenue increased 3% and 20% (19% on GAAP total Enterprise revenue), respectively. While total organic (i.e. excluding MKS) Enterprise license revenue was down 3% year over year (against a relatively high prior year comparison), total organic Enterprise revenue was up 14% compared to the third quarter of 2010, and total organic Enterprise license and total revenue were up 40% and 15%, respectively on a sequential basis. We also saw continued overall strength in the small- and medium-size business market, with indirect license revenue and total indirect revenue up 24% and 13%, respectively, in the third quarter of 2011, compared to the third quarter of 2010. This was our sixth consecutive quarter of year-over-year indirect license revenue and total indirect revenue growth.

Our strong revenue performance led to improved profitability during the quarter. Our GAAP and non-GAAP operating income were $24.5 million (8% of total revenue) and $51.4 million (18% of total revenue), respectively, for the third quarter of 2011, compared with $12.0 million (5% of total revenue) and $32.0 million (13% of total revenue), respectively, for the third quarter of 2010.

 

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We acquired MKS for an aggregate cash purchase price of approximately $298 million ($265 million net of cash acquired). We financed the transaction by drawing on our existing credit facility in the amount of $250 million and using cash on hand for the remainder. Our balance sheet remained strong as of July 2, 2011, with $261 million of cash, flat with the second quarter of 2011, and $50 million available under our revolving credit facility. We generated $48 million of cash from operating activities in the third quarter of 2011 compared to $50 million in the third quarter of 2010. We resumed share repurchases in the third quarter of 2011, with $40 million of repurchases in the quarter.

Revenue, Operating Margin, Earnings per Share and Cash Flow from Operations

The following table shows the financial measures that we consider the most significant indicators of the performance of our business. In addition to providing operating income, operating margin, and diluted earnings per share as calculated under generally accepted accounting principles (GAAP), we provide non-GAAP operating income, operating margin, and diluted earnings per share for the reported periods. These measures exclude stock-based compensation, amortization of acquired intangible assets expense, acquisition-related charges, atypical gains or charges included in non-operating other income (expense), net and the related tax effects of the preceding items, and any atypical tax items. Excluding those expenses and atypical items provides investors another view of our operating results which is aligned with management budgets and with performance criteria in our incentive compensation plans. Management uses, and investors should evaluate, non-GAAP measures in conjunction with our GAAP results. We discuss the non-GAAP measures in detail under Income and Margins; Earnings per Share below.

 

    Three Months Ended     Percent Change     Nine Months Ended     Percent Change  
      July 2,  
2011
      July 3,  
2010
    Actual     Constant
Currency
        July 2,  
2011
      July 3,  
2010
    Actual     Constant
Currency
 
    (Dollar amounts in millions, except per share data)  

License revenue

  $ 81.4      $ 67.5        21     13   $ 231.1      $ 207.0        12     9

Consulting and training service revenue

    68.6        54.2        27     19     191.3        163.2        17     15

Maintenance revenue

    141.8        121.3        17     10     405.1        371.8        9     7
 

 

 

   

 

 

       

 

 

   

 

 

     

Total revenue

    291.8        243.0        20     13     827.5        742.0        12     9

Total costs and expenses

    267.3        231.0        16     11     761.7        696.2        9     8
 

 

 

   

 

 

       

 

 

   

 

 

     

Operating income (1)

  $ 24.5      $ 12.0        105     45   $ 65.9      $ 45.8        44     25

Non-GAAP operating income (1)

  $ 51.4      $ 32.0        61     37   $ 129.1      $ 109.8        18     10

Operating margin (1)

    8     5         8     6    

Non-GAAP operating margin

    18     13         16     15    

Diluted earnings per share (2)

  $ 0.13      $ 0.09          $ 0.39      $ 0.31       

Non-GAAP diluted earnings per share (2)

  $ 0.32      $ 0.21          $ 0.79      $ 0.68       

Cash flow from operations (3)

  $ 48.4      $ 50.4          $ 78.7      $ 141.1       

 

(1) In the first quarter of 2011 we entered into a strategic contract with an automotive customer for which we expect costs to exceed revenue by approximately $5 million. This loss was recorded in the first quarter of 2011 and resulted in a decrease in GAAP and non-GAAP operating income of approximately $5 million for the nine months ended July 2, 2011 compared to the nine months ended July 3, 2010.
(2) Diluted earnings per share in the third quarter and first nine months of 2011 includes foreign currency losses of $4.4 million recorded as other expense related to our acquisition of MKS. These losses have been excluded from non-GAAP diluted earnings per share.
(3) In the first quarter of 2011, we used $48 million, net, of cash in connection with the resolution of a litigation matter.

 

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Fiscal Year 2011 Expectations, Strategies and Risks

Our Business

We are encouraged by our financial results in 2010 and the first nine months of 2011. Based on these results, improvements in the global economy, and the competitive strength of our products, we expect 2011 revenue to be 14% to 15% higher than in 2010, with license revenue growth of approximately 15% and maintenance and services revenue growth of approximately 12% and 20%, respectively. Although economic conditions have improved, we believe it is still uncertain whether a sustainable recovery is taking place on a worldwide basis. If the economy does not continue to improve, customers may delay, reduce or forego technology purchases.

Our results have been impacted, and we expect will continue to be impacted, by revenue from large customers. The amount of revenue, particularly license revenue, attributable to large transactions, and the number of such transactions, may vary significantly from quarter to quarter based on customer purchasing decisions and macroeconomic conditions. While our Desktop license revenue growth has been strong during the first nine months of 2011, our growth rates have become increasingly dependent on adoption of our PLM solutions among large direct customers. Such transactions tend to be larger in size and may have long lead times as they often follow a lengthy product selection and evaluation process. This may cause increased volatility in our results. Our revenue and operating results may also continue to be impacted by currency fluctuations.

We are currently monitoring the situation in Japan caused by the recent earthquake and tsunami and are evaluating the resulting potential risks of disruption to sales of our products and services. Net revenue from Japan was $104.1 million, or approximately 10% of our net revenue, for the fiscal year ended September 30, 2010. The majority of our revenue in Japan is from maintenance contracts and our results of operations for the second and third quarters of 2011 were not materially affected by these recent events. However, if the situation in Japan worsens, it could affect our ability to conduct normal business operations, including selling new licenses and renewing or entering into new services contracts, and could adversely affect our future operating results.

From a product portfolio perspective, we have had a number of product launches in fiscal 2011. We launched Creo 1.0 in June 2011, Mathcad ® Prime 1.0 during the second quarter and Windchill ® 10.0 in April. In addition, we have a new release of Arbortext ® scheduled for the fall of 2011. Our acquisition of MKS, developer of MKS Integrity ® , an industry-leading platform for software application lifecycle management (ALM), adds important breadth and depth to our product portfolio.

Balancing an improving but still uncertain economic climate with the longer-term opportunity for our business, we are modestly increasing investments in our business, particularly adding sales capacity to better address market demand, that we believe are critical to delivering value to our customers and will help us gain market share, drive faster top line growth and improve operating profitability over the longer term. We may reduce or delay strategic investments and/or take actions to reduce our operating costs if revenue is lower than we expect. In addition, these investments may not deliver the results we expect.

Impact of an Investigation in China

We have identified certain payments by certain business partners in China that raise questions of compliance with laws, including the Foreign Corrupt Practices Act, and/or compliance with the Company’s business policies. We are conducting an internal investigation and have voluntarily disclosed this matter to the United States Department of Justice and the Securities and Exchange Commission. Based on the findings to date, we do not believe that this matter will have a material adverse effect on our results of operations or financial condition. If we determine that the replacement of certain employees and/or business partners is necessary, it could have an impact on our level of sales in China until such replacements are in place and productive. Revenue from China has historically represented 6% to 7% of our total revenue.

 

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Results of Operations

MKS Acquisition

MKS’s results of operations have been included in PTC’s consolidated financial statements beginning May 31, 2011. MKS had revenues of $79 million and $63 million for the twelve months ended April 30, 2011 and 2010, respectively. The acquisition added $6.0 million to our third quarter 2011 revenue ($6.7 million on a non-GAAP basis) and is expected to add approximately $18 million of revenue (approximately $20 million on a non-GAAP basis) in the fourth quarter of 2011. MKS’s revenue is classified as Enterprise revenue. The acquisition was neutral to our non-GAAP operating income during the third quarter of 2011 and is expected to be neutral for fiscal 2011. The MKS acquisition unfavorably impacted our GAAP operating income by approximately $7 million for the third quarter of 2011 when including acquisition-related costs of $6.0 million and amortization of acquired intangible assets of $0.9 million recorded during the quarter.

Impact of Foreign Currency Exchange on Results of Operations

Approximately two-thirds of our revenue and half of our expenses are transacted in currencies other than the U.S. Dollar. Because we report our results of operations in U.S. Dollars, currency translation, particularly changes in the Euro and Yen, relative to U.S. Dollar, affects our reported results. If actual reported results for the third quarter and first nine months of 2011 had been converted into U.S. Dollars based on the foreign currency exchange rates in effect for the comparable 2010 periods, revenue would have been lower by $17.0 million and $16.5 million in the third quarter and first nine months of 2011, respectively. For the third quarter of 2011, GAAP and non-GAAP expenses would have been lower by $9.9 million and $9.5 million, respectively, and for the first nine months of 2011, GAAP and non-GAAP expenses would have been lower by $7.7 million and $8.2 million, respectively. As a result, at foreign currency exchange rates consistent with the first nine months of 2010, GAAP and non-GAAP operating income in the third quarter of 2011 would have been $7.1 million and $7.6 million lower, respectively, and GAAP and non-GAAP operating income in the first nine months of 2011 would have been $8.8 million and $8.4 million lower, respectively. Revenue by line of business and revenue by geographic region in the tables that follow present both actual percentage changes year over year and percentage changes year over year on a constant currency basis, calculated by multiplying the actual results for 2011 by the exchange rates in effect for 2010.

Revenue

Desktop revenue includes our CAx Solutions, primarily: Creo Elements/Pro (formerly Pro/ENGINEER), Creo Elements/Direct (formerly CoCreate), Mathcad and Arbortext authoring products. Enterprise revenue includes our PLM solutions, primarily: Windchill, Arbortext enterprise products, Creo Elements/View (formerly ProductView) and MKS Integrity.

Direct revenue includes sales made primarily by our direct sales force to large businesses. Indirect revenue includes sales by our reseller channel, primarily to small- and medium-size businesses, as well as revenue from other accounts that we have classified as indirect. If the classification of a customer changes between direct and indirect, we reclassify the historical revenue associated with that customer to align with the current period classification. Revenue for the first nine months of 2011 and the third quarter and first nine months of 2010 reflected below also includes certain reclassifications between Desktop and Enterprise revenue. Such reclassifications were not material.

 

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Revenue by Product Group and Distribution Channel

 

    Desktop
Three Months Ended
    Enterprise
Three Months Ended
    Total Revenue
Three Months Ended
 
    July 2,
2011
    July 3,
2010
    Percent
Change
    July 2,
2011
    July 3,
2010
    Percent
Change
    July 2,
2011
    July 3,
2010
    Percent
Change
 
    (Dollar amounts in millions)  

Direct

                 

License revenue

  $ 27.0      $ 17.1        57   $ 32.8      $ 32.9        0   $ 59.8      $ 50.0        19

Service revenue:

                 

Consulting and training service revenue

    9.3        6.4        46     56.6        44.2        28     65.9        50.6        30

Maintenance revenue

    53.0        47.0        13     34.1        25.6        33     87.1        72.5        20
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    62.3        53.3        17     90.7        69.8        30     153.0        123.1        24
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 89.3      $ 70.5        27   $ 123.5      $ 102.7        20   $ 212.8      $ 173.2        23
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Indirect

                 

License revenue

  $ 16.9      $ 13.9        22   $ 4.8      $ 3.6        33   $ 21.7      $ 17.5        24

Service revenue:

                 

Consulting and training service revenue

    1.5        1.4        11     1.2        2.2        -46     2.7        3.5        -24

Maintenance revenue

    46.8        42.2        11     7.8        6.7        17     54.6        48.8        12
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    48.4        43.5        11     9.0        8.9        1     57.3        52.4        9
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 65.3      $ 57.4        14   $ 13.7      $ 12.4        10   $ 79.0      $ 69.8        13
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total Revenue

                 

License revenue

  $ 43.9      $ 31.0        41   $ 37.6      $ 36.5        3   $ 81.4      $ 67.5        21

Service revenue:

                 

Consulting and training service revenue

    10.8        7.7        40     57.8        46.4        25     68.6        54.2        27

Maintenance revenue

    99.8        89.1        12     41.9        32.3        30     141.8        121.3        17
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    110.6        96.9        14     99.7        78.6        27     210.4        175.5        20
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 154.5      $ 127.9        21   $ 137.3      $ 115.1        19   $ 291.8      $ 243.0        20
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

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    Desktop
Nine Months Ended
    Enterprise
Nine Months Ended
    Total Revenue
Nine Months Ended
 
    July 2,
2011
    July 3,
2010
    Percent
Change
    July 2,
2011
    July 3,
2010
    Percent
Change
    July 2,
2011
    July 3,
2010
    Percent
Change
 
    (Dollar amounts in millions)  

Direct

                 

License revenue

  $ 82.2      $ 52.5        57   $ 82.4      $ 99.8        -17   $ 164.6      $ 152.3        8

Service revenue:

                 

Consulting and training service revenue

    28        23.2        21     155        131.4        18     182.9        154.5        18

Maintenance revenue

    153.5        144.9        6     93.5        76.9        22     246.9        221.7        11
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    181.4        168        8     248.4        208.2        19     429.9        376.3        14
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 263.6      $ 220.5        20   $ 330.9      $ 308.0        7   $ 594.5      $ 528.5        12
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Indirect

                 

License revenue

  $ 51.4      $ 43.4        18   $ 15.1      $ 11.3        34   $ 66.5      $ 54.7        22

Service revenue:

                 

Consulting and training service revenue

    4.5        4.1        9     3.9        4.5        -13     8.4        8.6        -3

Maintenance revenue

    135.8        129.8        5     22.3        20.3        10     158.2        150.2        5
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    140.3        133.9        5     26.3        24.9        6     166.5        158.8        5
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 191.7      $ 177.3        8   $ 41.4      $ 36.1        14   $ 233.1      $ 213.4        9
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total Revenue

                 

License revenue

  $ 133.6      $ 95.9        39   $ 97.5      $ 111.1        -12   $ 231.1      $ 207.0        12

Service revenue:

                 

Consulting and training service revenue

    32.4        27.3        19     158.9        135.9        17     191.3        163.2        17

Maintenance revenue

    289.3        274.7        5     115.8        97.2        19     405.1        371.8        9
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total service revenue

    321.7        301.9        7     274.7        233.1        18     596.4        535.0        11
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

  $ 455.3      $ 397.8        14   $ 372.2      $ 344.2        8   $ 827.5      $ 742.0        12
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Revenue by Line of Business

 

     Three Months Ended     Nine Months Ended  
Revenue as a Percentage of Total Revenue    July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 

License

     28     28     28     28

Maintenance

     49     50     49     50

Consulting and training service

     23     22     23     22
  

 

 

   

 

 

   

 

 

   

 

 

 
     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Year over Year Percentage Changes in Revenue    Three months ended
July 2, 2011
compared to three months
ended July 3, 2010
    Nine months ended
July 2, 2011
compared to nine months
ended July 3, 2010
 
     As
Reported
    Constant
Currency
    As
Reported
    Constant
Currency
 

License

     21     13     12     9

Maintenance

     17     10     9     7

Consulting and training service

     27     19     17     15

Total

     20     13     12     9

 

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License Revenue

The increase in overall license revenue in the third quarter and first nine months of 2011 was due primarily to growth in direct Desktop revenue from sales to our large commercial customers. Additionally, we are continuing to see strength in license revenue from small- and medium-size customers, with increases in both indirect Desktop and Enterprise license revenue. We attribute the increases in Desktop license sales to the recent launch of Creo which has resulted in expansion orders from our existing customer base, and an increase in sales to new customers in our reseller channel. Additionally, we attribute the increases in Desktop license revenue to the economic recovery resulting in renewed customer demand.

MKS contributed $2.0 million to Enterprise license revenue in the third quarter. Excluding MKS, Enterprise license revenue was down 3% year over year. Enterprise license revenue results reflect decreases in revenue from sales of Windchill, which were 10% ($2.8 million) and 22% ($18.8 million) lower in the third quarter and first nine months of 2011, respectively, than in the third quarter and first nine months of 2010. The first nine months of 2010 included large Windchill transactions in North America, Europe and the Pacific Rim, resulting in a particularly strong year-ago comparative nine month period. We believe that one of the primary factors adversely impacting the Enterprise license revenue performance in 2011 is the dilutive impact of increased Desktop revenue on our Enterprise sales capacity. As a result, we plan to expand our sales capacity over the next five quarters.

Foreign currency exchange rate movements favorably impacted license revenue by $4.8 million and $5.6 million in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010.

Maintenance Revenue

Maintenance revenue is comprised of contracts to maintain new and/or previously purchased software. We have seen steady growth in maintenance revenue in 2011, particularly in the third quarter as maintenance revenue grew 17% (15% excluding MKS). Our recent launch of Creo has reinvigorated our base of Desktop customers and resulted in increases in our Desktop maintenance revenue. Enterprise maintenance revenue in the first nine months of 2011 benefitted from strong Enterprise license sales in fiscal 2010 (Enterprise license revenue in fiscal 2010 was 73% ($65.3 million) higher than fiscal 2009). In addition, MKS contributed $2.5 million to Enterprise maintenance revenue in the third quarter. Creo Elements/Pro and Windchill seats under maintenance increased 4% and 15%, respectively, as of the end of the third quarter of 2011, compared to the end of the third quarter of 2010.

Foreign currency exchange rate movements favorably impacted maintenance revenue by $7.8 million and $6.9 million in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010.

Consulting and Training Service Revenue

Consulting and training services engagements typically result from sales of new licenses, particularly of our Enterprise solutions. Accordingly, strong Enterprise license sales in 2010 had a favorable impact on services revenue in the first nine months of 2011. In the third quarter and first nine months of 2011, compared to the third quarter and first nine months of 2010, consulting revenue, which is primarily related to Windchill implementations among our direct Enterprise customers, was up 25% ($11.7 million) and 17% ($23.7 million), respectively, and training revenue, which typically represents about 15% of our total consulting and training services revenue, was up 41% ($2.8 million) and 21% ($4.5 million), respectively. In addition, MKS contributed $1.5 million to Enterprise consulting and training service revenue in the third quarter.

Foreign currency exchange rate movements favorably impacted consulting and training services revenue by $4.4 million and $4.0 million in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010.

 

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Revenue by Distribution Channel

We derive most of our revenue from products and services sold directly by our sales force to end-user customers. We also sell products and services through third-party resellers and other strategic partners. Our sales force focuses on large accounts, while our reseller channel provides a cost-effective means of covering the small- and medium-size business market. This enables our direct sales force to focus on larger sales opportunities and ensures greater coverage of all customer segments.

Revenue results by Distribution Channel can be found in the table Revenue by Product Group and Distribution Channel above.

Direct

Our direct revenue typically comprises approximately 70% of our total revenue. Direct revenue is generated by our direct sales force which is primarily focused on large enterprise customers. We expect to expand the number of sales teams over the fourth quarter and in 2012 to address market demand and what we believe to be current capacity constraints.

Indirect

We have over 420 geographically dispersed resellers that focus on sales to small- and medium-size businesses.

Our indirect revenue (primarily sold through the reseller channel) typically comprises approximately 30% of our total revenue. This was our sixth consecutive quarter of year-over-year indirect license revenue and total indirect revenue growth. We believe that this performance reflects improving macroeconomic conditions. In addition, we have seen an increase in the number of new customers served by our channel partners which we attribute in part to our recent release of Creo 1.0.

Revenue from Individual Customers

We enter into customer contracts that may result in revenue being recognized over multiple reporting periods. Accordingly, revenue recognized in a current period may be attributable to contracts entered into during the current period or in prior periods. License and/or consulting and training service revenue of $1 million or more recognized from individual customers from contracts entered into during the current period and/or prior periods is shown in the table below. For the third quarter of 2011 and 2010, there were 27 (15 in the Americas, 8 in Europe and 4 in Asia) and 14 (6 in the Americas, 5 in Europe and 3 in Asia) of these customers, respectively, with an average size of $2.2 million and $2.8 million in the third quarter of 2011 and the third quarter of 2010, respectively.

 

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The increase in license and consulting and training service revenue greater than $1 million from individual customers in the first nine months of 2011 compared to the first nine months of 2010 reflects increased revenue from Desktop licenses (mainly Creo) and Enterprise services, partially offset by lower sales of Enterprise licenses. The first nine months of 2010 included particularly large Windchill transactions in North America, Europe and the Pacific Rim.

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 
     (Dollar amounts in millions)  

License and/or consulting and training service revenue greater than $1 million from individual customers in a quarter

   $ 60.7      $ 38.8      $ 164.4      $ 128.1   

% of total license and consulting and training service revenue

     40     32     39     35

License and consulting and training service revenue greater than $1 million from individual customers in a quarter by product group:

        

Desktop

   $ 14.0      $ 2.0      $ 43.3      $ 9.6   

Enterprise

   $ 46.7      $ 36.8      $ 121.1      $ 118.5   

The amount of revenue, particularly license revenue, attributable to large transactions, and the number of such transactions, may vary significantly from quarter to quarter based on customer purchasing decisions and macroeconomic conditions.

Revenue by Geographic Region

 

    Three months ended     Percent Change     Nine months ended     Percent Change  
    July 2,
    2011    
    July 3,
    2010    
    Actual     Constant
Currency
    July 2,
    2011    
    July 3,
    2010    
    Actual     Constant
Currency
 
    (Dollar amounts in millions)  

Revenue by region:

               

Americas

  $ 104.6      $ 82.4        27     27   $ 299.1      $ 273.5        9     9

Europe

  $ 120.3      $ 101.8        18     6   $ 334.1      $ 294.5        13     11

Pacific Rim

  $ 36.9      $ 33.2        11     8   $ 106.7      $ 95.5        12     9

Japan

  $ 30.0      $ 25.6        17     4   $ 87.6      $ 78.4        12     1

Revenue by region as a % of total revenue:

               

Americas

    36     34         36     37    

Europe

    41     42         40     40    

Pacific Rim

    13     14         13     13    

Japan

    10     10         11     10    

Americas

The increase in revenue in the Americas in the third quarter of 2011, compared to the third quarter of 2010, consisted of an increase of 77% ($12.1 million) in license revenue, an increase of 25% ($4.8 million) in consulting and training service revenue and an increase of 11% ($5.2 million) in maintenance revenue. The increase in revenue in the Americas in the first nine months of 2011, compared to the first nine months of 2010, consisted of a 6% ($4.7 million) increase in license revenue, a 16% ($9.1 million) increase in consulting and training service revenue and an 8% ($11.7 million) increase in maintenance revenue. The relatively low license revenue growth in the first nine months of 2011 was, in part, because the first half of 2010 included particularly large Windchill transactions that closed in the first quarter of 2010.

 

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Europe

The increase in revenue in the third quarter of 2011, compared to the third quarter of 2010, consisted of an increase in license revenue of 1% ($0.3 million), an increase in consulting and training service revenue of 35% ($7.6 million) and an increase in maintenance revenue of 22% ($10.6 million). The increase in revenue in the first nine months of 2011, compared to the first nine months of 2010, consisted of an increase in license revenue of 22% ($16.0 million), an increase in consulting and training service revenue of 17% ($11.3 million) and an increase in maintenance revenue of 8% ($12.3 million). The increases in license revenue reflect growth in license sales of Desktop products to large customers for both the third quarter and first nine months of 2011. Total Desktop license revenue increased 82% ($7.4 million) and 58% ($18.5 million) in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010. The increases in Desktop license revenue were offset by decreases in Enterprise license revenue of 32% ($7.1 million) and 6% ($2.5 million) in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010, reflecting a significant transaction we had in the third quarter of 2010 which drove license outperformance in the year-ago periods.

Changes in foreign currency exchange rates, particularly the Euro, impacted revenue in Europe favorably by $12.5 million and $5.9 million in the third quarter and first nine months of 2011, respectively, as compared to the third quarter and first nine months of 2010.

Pacific Rim

The increase in revenue in the Pacific Rim in the third quarter of 2011, compared to the third quarter of 2010, was due primarily to an increase of 22% ($2.0 million) in maintenance revenue and an increase of 12% ($1.1 million) in consulting and training service revenue. The increase in revenue in the Pacific Rim in the first nine months of 2011 compared to the first nine months of 2010 was due primarily to an increase of 20% ($5.2 million) in consulting and training service revenue and an increase of 20% ($5.1 million) in maintenance revenue. Revenue from China, which has historically represented 6% to 7% of our total revenue, increased 15% and 11% in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010.

Changes in foreign currency exchange rates favorably impacted revenue in the Pacific Rim by $1.2 million and $2.5 million in the third quarter and first nine months of 2011, respectively, as compared to the third quarter and first nine months of 2010.

Japan

The increase in revenue in Japan in the third quarter of 2011, compared to the third quarter of 2010, included increases of 17% ($0.9 million) in license revenue, 26% ($1.0 million) in consulting and training service revenue and 16% ($2.5 million) in maintenance revenue. The increase in revenue in Japan in the first nine months of 2011, compared to the first nine months of 2010, included increases of 16% ($2.5 million) in license revenue, 21% ($2.5 million) in consulting and training service revenue and 8% ($4.2 million) in maintenance revenue. Japan revenue benefitted from a large transaction in the second quarter of 2011.

Changes in the Yen to U.S. Dollar exchange rate favorably impacted revenue in Japan by $3.3 million and $8.1 million in the third quarter and first nine months of 2011, respectively, as compared to the third quarter and first nine months of 2010.

 

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Costs and Expenses

 

    Three Months Ended           Nine Months Ended        
    July 2,
    2011    
    July 3,
    2010    
    Percent
Change
    July 2,
    2011    
    July 3,
    2010    
    Percent
Change
 
    (Dollar amounts in millions)  

Costs and expenses:

           

Cost of license revenue

  $ 7.6      $ 7.6        0   $ 20.1      $ 24.0        -16

Cost of service revenue

    82.8        67.1        23     238.1        206.6        15

Sales and marketing

    89.1        79.1        13     254.8        232.9        9

Research and development

    51.1        50.6        1     155.7        151.2        3

General and administrative

    31.9        22.8        40     80.1        69.6        15

Amortization of acquired intangible assets

    4.8        3.8        24     12.9        11.9        8
 

 

 

   

 

 

     

 

 

   

 

 

   

Total costs and expenses

  $ 267.3        231.0        16 %(1)    $ 761.7      $ 696.2        9 %(1) 
 

 

 

   

 

 

     

 

 

   

 

 

   

Total headcount at end of period

    5,799        5,289           

 

(1) On a constant foreign currency basis, compared to the year-ago periods, total costs and expenses for the third quarter and first nine months of 2011 increased 11% and 8%, respectively.

Costs and expenses in the third quarter and first nine months of 2011, compared to the third quarter and first nine months of 2010, were impacted by the following:

 

   

an increase of 383 employees in connection with our acquisition of MKS on May 31, 2011;

 

   

acquisition-related costs (included in general and administrative) associated with our acquisition of MKS of $6.0 million and $6.6 million in the third quarter and first nine months of 2011, respectively;

 

   

higher cost of service in support of services revenue growth;

 

   

a company-wide salary merit pay increase effective February 1, 2011 (approximately $11 million on an annualized basis) which resulted in an increase in salary expense across all functional organizations;

 

   

investments in our direct sales force;

 

   

a contract loss of approximately $5 million recorded in the first quarter of 2011 related to estimated costs to be incurred in completing a services contract in excess of the corresponding revenue;

 

   

severance and related expenses of approximately $3.0 million associated with 60 employees terminated in the second quarter of 2011, primarily in research and development; and

 

   

higher sales and marketing expenses associated with events, including our Creo product launch.

Cost of License Revenue

 

     Three Months Ended           Nine Months Ended        
     July 2,
2011
    July 3,
2010
    Percent
Change
    July 2,
2011
    July 3,
2010
    Percent
Change
 
           (Dollar amounts in millions)              

Cost of license revenue

   $ 7.6      $ 7.6        0   $ 20.1      $ 24.0        -16

% of total revenue

     3     3       2     3  

% of total license revenue

     9     11       9     12  

Our cost of license revenue consists of fixed and variable costs associated with reproducing and distributing software and documentation, as well as royalties paid to third parties for technology embedded in or licensed with our software products and amortization of intangible assets associated with acquired products. Cost of license revenue as a percentage of total license revenue declined in the third quarter and first nine months of

 

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2011 due primarily to amortization of purchased software, which was $0.8 million and $3.9 million lower in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010. Cost of license revenue as a percent of license revenue can vary depending on product mix sold and the effect of fixed and variable royalties and the level of amortization of acquired software intangible assets.

Cost of Service Revenue

 

     Three Months Ended           Nine Months Ended        
     July 2,
    2011    
    July 3,
    2010    
    Percent
Change
    July 2,
    2011    
    July 3,
    2010    
    Percent
Change
 
            
           (Dollar amounts in millions)              

Cost of service revenue

   $ 82.8      $ 67.1        23   $ 238.1      $ 206.6        15

% of total revenue

     28     28       29     28  

% of total service revenue

     39     38       40     39  

Service headcount at end of period

     1,823        1,488        23      

Our cost of service revenue includes costs such as salaries, benefits, and computer equipment and facilities for our training, customer support and consulting personnel; third-party subcontractor fees; and costs associated with the release of maintenance updates (including related royalty costs). Service margins can vary based on the product mix sold in the period. In the first quarter of 2011, we made a strategic decision to enter into a contract with an important customer in the automotive industry, for which we expect our costs to exceed our revenue by approximately $5 million. Cost of service revenue in the first quarter of 2011 included immediate recognition of this loss of approximately $5 million. In the third quarter and first nine months of 2011, compared to the third quarter and first nine months of 2010, total compensation, benefit costs and travel expenses were 27% ($11.9 million) and 14% ($18.4 million) higher, respectively, primarily due to increased headcount. Additionally, the cost of third-party consulting services was $4.2 million and $6.8 million higher in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010, primarily due to the increase in consulting and training service revenue in the first nine months of 2011. The cost of service headcount at the end of third quarter of 2011 includes 153 employees from the acquisition of MKS.

Sales and marketing

 

     Three Months Ended           Nine Months Ended        
     July 2,
    2011    
    July 3,
    2010    
    Percent
Change
    July 2,
    2011    
    July 3,
    2010    
    Percent
Change
 
           (Dollar amounts in millions)              

Sales and marketing

   $ 89.1      $ 79.1        13   $ 254.8      $ 232.9        9

% of total revenue

     31     33       31     31  

Sales and marketing headcount at end of period

     1,471        1,321        11      

Our sales and marketing expenses primarily include salaries and benefits, sales commissions, advertising and marketing programs, travel and facility costs. Our compensation, benefit costs and travel expenses were higher by an aggregate of $8.7 million and $17.3 million in the third quarter and first nine months of 2011, respectively, compared to the third quarter and first nine months of 2010. Additionally, costs associated with sales meetings and marketing events were higher by approximately $3.6 million in the first nine months of 2011, compared to the first nine months of 2010, primarily due to the Creo product launch, and higher costs related to our fiscal 2011 sales kick-off meeting and worldwide PTC user conferences. The sales and marketing headcount at the end of third quarter of 2011 includes 79 employees from the acquisition of MKS.

 

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Research and Development

 

     Three Months Ended           Nine Months Ended        
         July 2,    
2011
        July 3,    
2010
    Percent
Change
        July 2,    
2011
        July 3,    
2010
    Percent
Change
 
     (Dollar amounts in millions)  

Research and development

   $ 51.1      $ 50.6        1   $ 155.7      $ 151.2        3

% of total revenue

     18     21       19     20  

Research and development headcount at end of period

     1,920        1,936        -1      

Our research and development expenses consist principally of salaries and benefits, costs of computer equipment and facility expenses. Major research and development activities include developing new releases and updates of our software that enhance functionality and developing new products or features. Total compensation, benefit costs and travel expenses were higher in the third quarter and first nine months of 2011, compared to the third quarter and first nine months of 2010, by an aggregate of $1.1 million and $5.1 million, respectively. The first nine months of 2011 include approximately $2.2 million of severance and related costs incurred in the second quarter associated with a shifting of resources to support our long-term market opportunity in the Automotive vertical. The research and development headcount at the end of third quarter of 2011 includes 119 employees from the acquisition of MKS.

General and Administrative

 

     Three Months Ended           Nine Months Ended        
         July 2,    
2011
        July 3,    
2010
    Percent
Change
        July 2,    
2011
        July 3,    
2010
    Percent
Change
 
     (Dollar amounts in millions)  

General and administrative

   $ 31.9      $ 22.8        40   $ 80.1      $ 69.6        15

% of total revenue

     11     9       10     9  

General and administrative headcount at end of period

     573        531        8      

Our general and administrative expenses include the costs of our corporate, finance, information technology, human resources, legal and administrative functions, as well as acquisition-related charges, bad debt expense and outside professional services, including accounting and legal fees. Acquisition-related costs include direct costs of acquisitions and expenses related to acquisition integration activities, including transaction fees, due diligence costs, retention bonuses and severance, and professional fees including legal and accounting costs related to the acquisition. Compared to the third quarter and first nine months of 2010, the increase in general and administrative expenses is primarily attributable to acquisition-related costs associated with our acquisition of MKS. Acquisition-related costs were $6.0 million and $6.6 million in the third quarter and first nine months of 2011. Total compensation, benefit costs and travel costs were higher in the third quarter and first nine months of 2011 by $2.5 million and $2.1 million, respectively. The general and administrative headcount at the end of third quarter of 2011 includes 32 employees from the acquisition of MKS.

Amortization of Acquired Intangible Assets

Amortization of acquired intangible assets reflects the amortization of acquired non-product related intangible assets, primarily customer and trademark-related intangible assets, recorded in connection with completed acquisitions. The increase in amortization of acquired intangible assets in the third quarter and first nine months of 2011 was due to our acquisition of MKS. This acquisition added $117.9 million of finite-lived intangible assets including $78.6 million of customer relationships, $36.9 million of purchased software (the amortization for which is recorded in Cost of License) and $2.4 million of trademarks which are being amortized over average useful lives of 11 years, 7 years and 7 years, respectively.

 

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Interest and Other Income (Expense), net

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 
     (in millions)  

Interest income

   $ 1.0      $ 0.7      $ 2.7      $ 2.2   

Interest expense

     (0.8     (0.3     (1.3     (1.2

Other income (expense), net

     (6.5     (0.7     (10.4     (2.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and other income (expense), net

   $ (6.3   $ (0.3   $ (9.0   $ (1.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest and other income (expense), net includes interest income, interest expense, costs of hedging contracts, certain realized and unrealized foreign currency transaction gains or losses and exchange gains or losses resulting from the required period-end currency remeasurement of the financial statements of our subsidiaries that use the U.S. Dollar as their functional currency. A large portion of our revenue and expenses is transacted in foreign currencies. To reduce our exposure to fluctuations in foreign exchange rates, we engage in hedging transactions involving the use of foreign currency forward contracts, primarily in the Euro and Canadian Dollar. The increase in other income (expense), net in the third quarter and first nine months of 2011 compared to the third quarter and first nine months of 2010 was due primarily to net foreign currency losses, which were higher by $5.6 million and $7.3 million, respectively. The third quarter and first nine months of 2011 included foreign currency losses of $4.4 million related to our acquisition of MKS and the settlement of forward contracts to purchase CDN$292 million.

Income Taxes

 

     Three months ended     Nine months ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 
     (Dollar amounts in millions)  

Pre-tax income

   $ 18.3      $ 11.7      $ 56.9      $ 44.4   

Tax provision

     2.7        0.9        9.1        6.8   

Effective income tax rate

     15     8     16     15

In the third quarter and first nine months of 2011, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate, and for the first nine months of 2011, a $1.8 million tax benefit related to research and development (R&D) triggered by a retroactive extension of the R&D tax credit enacted in the first quarter of 2011. In the third quarter and first nine months of 2010, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate tax structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate (including a net benefit of $0.4 million and $1.7 million in the third quarter and first nine months, respectively, related to R&D cost sharing pre-payments by a foreign subsidiary to the U.S.).

We have net deferred tax assets ($103.5 million as of September 30, 2010) primarily relating to our U.S. operations. We have concluded, based on the weight of available evidence, that our net deferred tax assets are more likely than not to be realized in the future. In arriving at this conclusion, we evaluated all available evidence, including our cumulative profitability on a pre-tax basis for the last three years (adjusted for permanent differences) and improving profitability forecasts for the U.S. operations. We will continue to reassess our valuation allowance requirements each financial reporting period.

In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service (IRS) in the United States. We regularly assess the likelihood of

 

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additional assessments by tax authorities and provide for these matters as appropriate. We are currently under audit by tax authorities in several foreign jurisdictions. Audits by tax authorities typically involve examination of the deductibility of certain permanent items, limitations on net operating losses and tax credits. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in material changes in our estimates.

Our future effective income tax rate may be materially impacted by the amount of income taxes associated with our foreign earnings, which are taxed at rates different from the U.S. federal statutory income tax rate, as well as the timing and extent of the realization of deferred tax assets and changes in the tax law. There is pending legislation in Japan which, if enacted, could result in a change in rates and a discrete non-cash tax charge of approximately $3 million due to a change in the expected realizability of our Japan entity’s deferred tax assets. The timing and likelihood of the legislation being approved are uncertain. Further, our tax rate may fluctuate within a fiscal year, including from quarter to quarter, due to items arising from discrete events, including settlements of tax audits and assessments, the resolution or identification of tax position uncertainties, and acquisitions of other companies.

Income and Margins; Earnings per Share

As shown in the table below, our operating income and operating margins in the third quarter and first nine months of 2011 increased compared to the third quarter and first nine months of 2010, primarily due to margin contribution associated with higher revenue described in Revenue above, partially offset by higher costs and expenses described in Costs and Expenses above.

The non-GAAP measures presented in the discussion of our results of operations and the respective most directly comparable GAAP measures are:

 

   

non-GAAP revenue—GAAP revenue

 

   

non-GAAP operating income—GAAP operating income

 

   

non-GAAP net income—GAAP net income

 

   

non-GAAP operating margin—GAAP operating margin

 

   

non-GAAP diluted earnings per share—GAAP diluted earnings per share

The non-GAAP measures exclude a fair value adjustment related to MKS deferred maintenance revenue, stock-based compensation expense, amortization of acquired intangible assets expense, acquisition-related charges, atypical gains or charges included in non-operating other income (expense), net and the related tax effects of the preceding items, and any atypical tax items. These expenses and charges are normally included in the comparable measures calculated and presented in accordance with GAAP. Our management excludes these revenue and cost items when evaluating our ongoing performance and/or predicting our earnings trends, and therefore exclude them when presenting non-GAAP financial measures. Management uses, and investors should consider, non-GAAP measures in conjunction with our GAAP results.

Stock-based compensation expense is a non-cash expense relating to stock-based awards issued to executive officers, employees and outside directors, consisting of restricted stock and restricted stock units.

Amortization of acquired intangible assets expense is a non-cash expense that is impacted by the timing and magnitude of our acquisitions.

We use these non-GAAP measures, and we believe that they assist our investors, to make period-to-period comparisons of our operational performance because they provide a view of our operating results without items that are not, in our view, indicative of our core operating results. We believe that these non-GAAP measures help illustrate underlying trends in our business, and we use the measures to establish budgets and operational goals

 

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(communicated internally and externally) for managing our business and evaluating our performance. We believe that providing non-GAAP measures affords investors a view of our operating results that may be more easily compared to the results of peer companies. In addition, compensation of our executives is based in part on the performance of our business based on these non-GAAP measures.

The items excluded from the non-GAAP measures often have a material impact on our financial results and such items often recur. Accordingly, the non-GAAP measures included in this Quarterly Report should be considered in addition to, and not as a substitute for or superior to, the comparable measures prepared in accordance with GAAP.

The following tables reconcile each of these non-GAAP measures to its most closely comparable GAAP measure on our financial statements.

 

     Three Months Ended     Nine Months Ended  
       July 2,  
2011
      July 3,  
2010
      July 2,  
2011
      July 3,  
2010
 
     (Dollar amounts in millions)  

GAAP revenue

   $ 291.8      $ 243.0      $ 827.5      $ 742.0   

Fair value of acquired MKS deferred maintenance

     0.7        —          0.7        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP revenue

   $ 292.5      $ 243.0      $ 828.2      $ 742.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

GAAP operating income

   $ 24.5      $ 12.0      $ 65.9      $ 45.8   

Fair value of acquired MKS deferred maintenance revenue

     0.7        —          0.7        —     

Stock-based compensation (1)

     11.6        11.5        32.4        37.7   

Amortization of acquired intangible assets

     8.6        8.5        23.5        26.3   

Acquisition-related charges included in general and administrative expenses

     6.0        —          6.6        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP operating income (2)

   $ 51.4      $ 32.0      $ 129.1      $ 109.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

GAAP net income

   $ 15.5      $ 10.7      $ 47.8      $ 37.6   

Fair value of acquired MKS deferred maintenance

     0.7        —          0.7        —     

Stock-based compensation (1)

     11.6        11.5        32.4        37.7   

Amortization of acquired intangible assets

     8.6        8.5        23.5        26.3   

Acquisition-related charges included in general and administrative expenses

     6.0        —          6.6        —     

Non-operating foreign currency transaction loss (2)

     4.4        —          5.1        —     

Income tax adjustments (3)

     (8.5     (6.1     (20.1     (20.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP net income

   $ 38.3      $ 24.6      $ 96.0      $ 81.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

GAAP diluted earnings per share

   $ 0.13      $ 0.09      $ 0.39      $ 0.31   

Stock-based compensation

     0.10        0.10        0.27        0.31   

Amortization of acquired intangible assets

     0.07        0.07        0.19        0.22   

Acquisition-related charges

     0.05        —          0.05        —     

Income tax adjustments

     (0.07     (0.05     (0.17     (0.17

All other items identified above

     0.04        —          0.06        0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP diluted earnings per share

   $ 0.32      $ 0.21      $ 0.79      $ 0.68   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Operating margin impact of non-GAAP adjustments:

 

     Three Months Ended     Nine Months Ended  
     July 2,
2011
    July 3,
2010
    July 2,
2011
    July 3,
2010
 

GAAP operating margin

     8.4     4.9     8.0     6.2

Fair value of deferred maintenance revenue

     0.2     0.0     0.1     0.0

Stock-based compensation

     4.0     4.8     3.9     5.0

Amortization of acquired intangibles

     3.0     3.5     2.8     3.6

Acquisition-related charges

     2.0     0.0     0.8     0.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP operating margin

     17.6     13.2     15.6     14.8
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The decrease in stock-based compensation in the first nine months of 2011 compared to the first nine months of 2010 was due primarily to grants of fiscal 2010 stock-based awards being made in November 2009, our usual timing, while a portion of the fiscal 2011 stock-based awards were delayed until the second and third quarters of 2011 due to the limited number of shares that were available under the 2000 Equity Incentive Plan.
(2) In the third quarter of 2011, in connection with our planned acquisition of MKS, we entered into forward contracts to purchase CDN$292 million (equivalent to approximately $305 million when the contracts were entered into). We entered into these forward contracts to reduce our foreign currency exposure related to changes in the Canadian to US Dollar exchange rate from the time we entered into the agreement in early April to acquire MKS (the purchase price is in Canadian Dollars) and the closing date which occurred on May 31, 2011. We realized foreign currency losses of $4.4 million in the third quarter of 2011 recorded as other expense related to the acquisition of MKS. In the first quarter of 2011 we recorded $0.7 million of foreign currency losses related to a previously announced litigation settlement in Japan.
(3) Income tax adjustments reflect the tax effects of non-GAAP adjustments which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments listed above, as well as any atypical tax items.

Liquidity and Capital Resources

 

     July 2,
2011
    July 3,
2010
 
     (in thousands)  

Cash and cash equivalents

   $ 260,751      $ 219,019   
  

 

 

   

 

 

 

Amounts below are for the nine months ended:

    

Cash provided by operating activities

   $ 78,671      $ 141,076   

Cash used by investing activities

     (283,448     (23,771

Cash provided (used) by financing activities

     212,569        (122,378

Cash and cash equivalents

We invest our cash with highly rated financial institutions and in diversified domestic and international money market mutual funds. Cash and cash equivalents include highly liquid investments with original maturities of three months or less. At July 2, 2011, cash and cash equivalents totaled $260.8 million, up from $240.3 million at September 30, 2010 due primarily to $78.7 million of cash provided by operating activities in the first nine months of 2011.

Cash provided by operating activities

Cash provided by operating activities was $78.7 million in the first nine months of 2011, compared to $141.1 million of cash provided by operating activities in the first nine months of 2010. This decrease was

 

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primarily due to the resolution, as previously disclosed, of a litigation matter, which reduced our cash balance by approximately $48 million in the first quarter of 2011, including $52.1 million paid to settle the matter. In addition, in the first nine months of 2011, net cash outflows related to compensation accruals were approximately $8.8 million higher than the comparable year-ago period due primarily to performance-based and incentive cash plan targets, which were fully achieved in 2010 (paid in 2011) while such targets were not achieved in full in 2009 (paid in 2010). Additionally, year-end commission accruals were higher at the end of 2010 compared to the end of 2009 due to higher revenue in the fourth quarter of 2010 compared to the fourth quarter of 2009. Cash collections on accounts receivable remained strong with days sales outstanding of 56 days as of the end of the third quarter of 2011 compared to 57 days as of September 30, 2010 and 56 days at the end of the third quarter of 2010.

Cash used by investing activities

 

     Nine months ended  
     July 2,
2011
    July 3,
2010
 
     (in thousands)  

Cash used by investing activities included the following:

    

Acquisitions of businesses, net of cash acquired

   $ (265,153   $ (2,087

Additions to property and equipment

     (18,295     (21,684
  

 

 

   

 

 

 
   $ (283,448   $ (23,771
  

 

 

   

 

 

 

In May 2011, we acquired MKS for an aggregate cash purchase price of approximately $298 million ($265.2 million net of cash acquired). Our expenditures for property and equipment consist primarily of computer equipment, software, office equipment and facility improvements.

Cash used by financing activities

 

     Nine months ended  
     July 2,
2011
    July 3,
2010
 
     (in thousands)  

Cash used by financing activities included the following:

    

Borrowings (repayments) under revolving credit facility

   $ 250,000      $ (50,832

Repurchases of common stock

     (39,947     (60,046

Payments of withholding taxes in connection with vesting of stock-based awards

     (22,052     (20,250

Proceeds from issuance of common stock

     22,261        8,524   

Excess tax benefits from stock-based awards

     2,307        226   
  

 

 

   

 

 

 
   $ 212,569      $ (122,378
  

 

 

   

 

 

 

The increase in proceeds from issuance of common stock was due to higher stock option exercises in the first nine months of 2011 (1.6 million options) compared to the first nine months of 2010 (0.8 million options). As of July 2, 2011, we had approximately 3.3 million stock options outstanding (including 0.1 million shares granted in connection with our acquisition of MKS), all of which expire by the end of 2014.

Credit Facility

We have a revolving credit facility with a bank syndicate under which we may borrow funds up to $300 million (with an accordion feature that allows us to borrow up to an additional $150 million if the existing or additional lenders agree), repay the same in whole or in part, and re-borrow at any time through August 22, 2014, when all amounts outstanding will be due and payable in full.

 

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In May 2011, in connection with our acquisition of MKS, we borrowed $250 million under the credit facility at an annual interest rate of 2.1%. Accrued interest is due after three months at which time the interest rate will reset. As of July 2, 2011, we had $250 million outstanding under the credit facility. We did not have any borrowings outstanding under the credit facility at September 30, 2010.

The credit facility limits PTC’s and its subsidiaries’ ability to, among other things: incur additional indebtedness; incur liens or guarantee obligations; pay dividends (other than to PTC) and make other distributions; make investments and enter into joint ventures; dispose of assets; and engage in transactions with affiliates, except on an arms-length basis. Under the credit facility, PTC and its material domestic subsidiaries may not invest cash or property in, or loan to, PTC’s foreign subsidiaries in aggregate amounts exceeding $50 million for any purpose and an additional $75 million for acquisitions of businesses. In addition, under the credit facility, PTC and its subsidiaries must maintain the following financial ratios:

 

   

a leverage ratio, defined as consolidated funded indebtedness to consolidated trailing four quarters EBITDA, of no greater than 2.50 to 1.00 at any time; and

 

   

a fixed charge coverage ratio, defined as the ratio of consolidated trailing four quarters EBITDA to consolidated fixed charges, of no less than 1.25 to 1.00 at any time.

As of July 2, 2011, our leverage ratio was 1.14 to 1.00 and our fixed charge coverage ratio was 1.86 to 1.00. We were in compliance with all financial and operating covenants of the credit facility as of July 2, 2011.

For a description of additional terms and conditions of the credit facility, including limitations on our ability to undertake certain actions, see Note 11. Commitments and Contingencies in the Notes to Consolidated Financial Statements of this Form 10-Q.

Share Repurchases

Our Articles of Organization authorize us to issue up to 500 million shares of our common stock. Our Board of Directors has authorized us to use up to $200 million of cash from operations to repurchase shares of our common stock in open market purchases. This authorization will expire on September 30, 2011 unless earlier revoked. In the first nine months of 2011, we repurchased 1.8 million shares at a cost of $39.9 million. We have $78.1 million remaining under our current authorization and we expect to repurchase $15 million worth of our common stock in the fourth quarter of 2011. In the first nine months of 2010, we repurchased 3.6 million shares at a cost of $60.0 million. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.

Future Expectations

We believe that existing cash and cash equivalents, together with cash generated from operations, will be sufficient to meet our working capital and capital expenditure requirements through at least the next twelve months.

In the fourth quarter of 2011, we expect to use cash flow from operations to repay a portion of the balance outstanding under our revolving credit facility and to use $15 million to repurchase shares of our common stock. Capital expenditures for the remainder of 2011 are currently anticipated to be approximately $8 million.

We have evaluated, and expect to continue to evaluate, possible strategic transactions on an ongoing basis and at any given time may be engaged in discussions or negotiations with respect to possible strategic transactions. Our expected uses of cash could change, our cash position could be reduced and we may incur additional debt obligations to the extent we complete any significant acquisitions.

 

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Critical Accounting Policies and Estimates

The financial information included in Item 1 reflects no material changes in our critical accounting policies and estimates as set forth under the heading Critical Accounting Policies and Estimates in Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2010 Annual Report on Form 10-K. We did not make any changes to these policies or to these estimates during the quarter ended July 2, 2011.

Valuation of Goodwill

Our goodwill totaled $623.6 million and $418.5 million as of July 2, 2011 and September 30, 2010, respectively. We assess the impairment of goodwill on at least an annual basis and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. We conduct our annual impairment test of goodwill as of the end of the third quarter of each fiscal year. We estimate the fair values of our reporting units using discounted cash flow valuation models. We completed our annual impairment review as of July 2, 2011 and concluded that no impairment charge was required as of that date. The estimated fair value of each reporting unit was approximately double or better than its carrying value. Revenue growth and operating margin projections are significant assumptions in our analysis. A 10% decrease in those assumptions would not have had an impact on the results of our impairment analysis.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Except as described below, there have been no significant changes in our market risk exposure as described in Item 7A: Quantitative and Qualitative Disclosures about Market Risk of our 2010 Annual Report on Form 10-K.

In the third quarter of 2011, in connection with our planned acquisition of MKS, we entered into forward contracts to purchase CDN$292 million (equivalent to approximately $305 million when the contracts were entered into). We entered into these forward contracts to reduce our foreign currency exposure related to changes in the Canadian to US Dollar exchange rate from the time we entered into the agreement to acquire MKS (the purchase price was in Canadian Dollars) and the expected closing date. In the third quarter of 2011, we settled these contracts and recorded a net foreign currency loss of $4.4 million in other income (expense), net related to the acquisition of MKS.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Effectiveness of Disclosure Controls and Procedures

Our management maintains disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), as appropriate, to allow for timely decisions regarding required disclosure.

We evaluated, under the supervision and with the participation of management, including our principal executive and principal financial officers, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of July 2, 2011.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended July 2, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The European Commission is conducting an investigation of allegedly anti-competitive practices within the European Economic Area with respect to CAD and related software. In connection with its investigation, the Commission has requested information from PTC and, we understand, from other vendors as well. PTC is cooperating to provide the requested information. No charges or proceedings have been initiated by the Commission against PTC; however, the Commission has authority to impose significant fines if it identifies violations of European competition laws as a result of its investigation.

 

ITEM 1A. RISK FACTORS

In addition to other information set forth in this report, you should carefully consider the factors described in Part I. Item 1A. Risk Factors in our 2010 Annual Report on Form 10-K, which could materially affect our business, financial condition or future results. The risks described in our 2010 Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

We are investigating whether certain payments by certain business partners in China may violate applicable laws, including the Foreign Corrupt Practices Act, which could have an adverse impact on our results of operations or financial condition, and remedial actions we may take as a result of our investigation could adversely affect our sales in China.

In the third quarter of 2011, we identified certain payments by certain business partners in China that raised questions of compliance with laws, including the Foreign Corrupt Practices Act, and/or compliance with our business policies. We are conducting an internal investigation and have voluntarily disclosed this matter to the United States Department of Justice and the Securities and Exchange Commission. We are unable to estimate the potential penalties and/or sanctions, if any, that might be assessed in connection with this matter. If we determine that the replacement of certain employees and/or business partners is necessary, it could have an impact on our level of sales in China until such replacements are in place and productive. Revenue from China has historically represented 6% to 7% of our total revenue.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The table below shows the shares of our common stock we repurchased in the third quarter of 2011.

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period (1)

   Total Number of Shares
(or Units) Purchased
     Average Price Paid
per Share (or Unit)
     Total Number of
Shares (or Units)
Purchased as Part  of
Publicly Announced
Plans or Programs
     Approximate
Dollar Value  of
Shares (or Units)
that May Yet Be
Purchased Under
the Plans or
Programs
 

April 3 – April 30, 2011

     —           —           —         $ 118,012,208 (2) 

May 1 – May 28, 2011

     1,200,552       $ 22.61         1,200,552       $ 90,871,517 (2) 

May 29 – July 2, 2011

     570,494       $ 22.45         570,494       $ 78,065,345 (2) 
  

 

 

       

 

 

    

 

 

 

Total

     1,771,046       $ 22.56         1,771,046       $ 78,065,345 (2) 
  

 

 

       

 

 

    

 

 

 

 

(1) Periods are our fiscal months within the fiscal quarter.
(2) On May 20, 2008, we announced our share repurchase program in the amount of $50 million, and on November 26, 2008, we announced that the repurchase program had been increased to $100 million. On March 3, 2010, our Board of Directors extended the share repurchase authorization through May 31, 2011, and on September 15, 2010, our Board of Directors increased the amount authorized to be repurchased to $200 million and extended the authorization to September 30, 2011. Such authorization will remain in effect unless earlier revoked or extended.

 

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ITEM 6. EXHIBITS

 

    2   Arrangement Agreement dated as of April 6, 2011 by and among Parametric Technology Corporation (“PTC”), PTC NS ULC (“Acquireco”), and MKS Inc. (“MKS”) (filed as Exhibit 10.1 to our Current Report on Form 8-K filed on April 7, 2011 (File No. 0-18059) and incorporated herein by reference).
    3.1(a)   Restated Articles of Organization of Parametric Technology Corporation adopted February 4, 1993 (filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended March 30, 1996 (File No. 0-18059) and incorporated herein by reference).
    3.1(b)   Articles of Amendment to Restated Articles of Organization adopted February 9, 1996 (filed as Exhibit 4.1(b) to our Registration Statement on Form S-8 (Registration No. 333-01297) and incorporated herein by reference).
    3.1(c)   Articles of Amendment to Restated Articles of Organization adopted February 13, 1997 (filed as Exhibit 4.1(b) to our Registration Statement on Form S-8 (Registration No. 333-22169) and incorporated herein by reference).
    3.1(d)   Articles of Amendment to Restated Articles of Organization adopted February 10, 2000 (filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended April 1, 2000 (File No. 0-18059) and incorporated herein by reference).
    3.1(e)   Certificate of Vote of Directors establishing Series A Junior Participating Preferred Stock (filed as Exhibit 3.1(e) to our Annual Report on Form 10-K for the fiscal year ended September 30, 2000 (File No. 0-18059) and incorporated herein by reference).
    3.1(f)   Articles of Amendment to Restated Articles of Organization adopted February 28, 2006 (filed as Exhibit 3.1(f) to our Quarterly Report on Form 10-Q for the fiscal quarter ended April 1, 2006 (File No. 0-18059) and incorporated herein by reference).
    3.2   By-Laws, as amended and restated, of Parametric Technology Corporation (filed as Exhibit 3.2 to our Quarterly Report on Form 10-Q for the fiscal quarter ended July 4, 2009 (File No. 0-18059) and incorporated herein by reference).
  10.1   Amendment No. 2 dated as of May 9, 2011 to Credit Agreement dated as of August 23, 2010 by and among Parametric Technology Corporation, JPMorgan Chase Bank, N.A., KeyBank National Association, Sovereign Bank, RBS Citizens, N.A., Wells Fargo Bank, N.A., Silicon Valley Bank, The Huntington National Bank, HSBC Bank USA, N.A., TD Bank, N.A., and Bank of America, N.A.
  10.2*   Separation Agreement dated April 26, 2011 by and between Parametric Technology Corporation and Paul Cunningham.
  10.3*   Form of Executive Agreement by and between Parametric Technology Corporation and each of Robert Ranaldi and William Berutti, respectively, entered into May 6, 2011 and June 8, 2011, respectively.
  10.4   Voting Agreement dated as of April 6, 2011 between Parametric Technology Corporation (“PTC”), PTC NS ULC (“Acquireco”), and MKS Inc. (“MKS”) (filed as Exhibit 10.2 to our Current Report on Form 8-K filed on April 7, 2011 (File No. 0-18059) and incorporated herein by reference).
  31.1   Certification of the Chief Executive Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a).
  31.2   Certification of the Chief Financial Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a).
  32**   Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350.