PTC Inc.
PTC INC. (Form: 10-Q, Received: 08/11/2016 17:22:13)


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, 2016
Commission File Number: 0-18059
____________________________________________________
PTC Inc.
(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 114,956,077 shares of our common stock outstanding on August 8, 2016 .




PTC Inc.
INDEX TO FORM 10-Q
For the Quarter Ended July 2, 2016

 
 
Page
Number
Part I—FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Part II—OTHER INFORMATION
 
Item 1.
Item 1A.
Item 6.




PART I—FINANCIAL INFORMATION

ITEM 1.
UNAUDITED CONDENSED FINANCIAL STATEMENTS

PTC Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
 
 
July 2,
2016
 
September 30,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
294,626

 
$
273,417

Short term marketable securities
11,380

 

Accounts receivable, net of allowance for doubtful accounts of $999 and $998 at July 2, 2016 and September 30, 2015, respectively
151,718

 
197,275

Prepaid expenses
56,986

 
56,365

Other current assets
120,576

 
140,819

Deferred tax assets

 
36,803

Total current assets
635,286

 
704,679

Property and equipment, net
62,909

 
65,162

Goodwill
1,169,660

 
1,069,041

Acquired intangible assets, net
323,382

 
291,301

Long term marketable securities
33,226

 

Deferred tax assets
71,467

 
38,936

Other assets
43,216

 
40,794

Total assets
$
2,339,146

 
$
2,209,913

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
16,250

 
$
13,361

Accrued expenses and other current liabilities
77,003

 
97,613

Accrued compensation and benefits
91,861

 
82,414

Accrued income taxes
7,784

 
4,010

Deferred tax liabilities

 
1,622

Current portion of long term debt

 
50,000

Deferred revenue
410,996

 
368,240

Total current liabilities
603,894

 
617,260

Long term debt, net of current portion
778,125

 
618,125

Deferred tax liabilities
20,342

 
42,361

Deferred revenue
14,436

 
18,610

Other liabilities
59,688

 
53,386

Total liabilities
1,476,485

 
1,349,742

Commitments and contingencies (Note 13)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 5,000 shares authorized; none issued

 

Common stock, $0.01 par value; 500,000 shares authorized; 114,952 and 113,745 shares issued and outstanding at July 2, 2016 and September 30, 2015, respectively
1,150

 
1,137

Additional paid-in capital
1,584,675

 
1,553,390

Accumulated deficit
(628,606
)
 
(602,614
)
Accumulated other comprehensive loss
(94,558
)
 
(91,742
)
Total stockholders’ equity
862,661

 
860,171

Total liabilities and stockholders’ equity
$
2,339,146

 
$
2,209,913




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

1


PTC Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

 
Three months ended
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
Revenue:
 
 
 
 
 
 
 
Subscription
$
31,822

 
$
17,155

 
$
77,657

 
$
47,143

Support
161,881

 
165,687

 
494,262

 
516,042

Total recurring software revenue
193,703

 
182,842

 
571,919

 
563,185

Perpetual license
44,648

 
66,771

 
132,100

 
201,707

Total software revenue
238,351

 
249,613

 
704,019

 
764,892

Professional services
50,301

 
53,500

 
148,277

 
177,782

Total revenue
288,652

 
303,113

 
852,296

 
942,674

Cost of revenue:
 
 
 
 
 
 
 
Cost of software revenue
38,864

 
33,282

 
114,291

 
102,525

Cost of professional services revenue
43,606

 
46,094

 
128,518

 
155,847

Total cost of revenue
82,470

 
79,376

 
242,809

 
258,372

Gross margin
206,182

 
223,737

 
609,487

 
684,302

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
94,874

 
88,353

 
264,480

 
261,702

Research and development
57,118

 
54,078

 
171,397

 
175,333

General and administrative
35,485

 
46,201

 
107,968

 
113,725

Amortization of acquired intangible assets
8,294

 
9,105

 
25,040

 
27,691

Restructuring charges
2,815

 
4,393

 
44,541

 
42,625

Total operating expenses
198,586

 
202,130

 
613,426

 
621,076

Operating income (loss)
7,596

 
21,607

 
(3,939
)
 
63,226

Interest and other expense, net
(8,300
)
 
(3,668
)
 
(19,880
)
 
(10,492
)
Income (loss) before income taxes
(704
)
 
17,939

 
(23,819
)
 
52,734

Provision (benefit) for income taxes
(3,777
)
 
504

 
2,173

 
(377
)
Net income (loss)
$
3,073

 
$
17,435

 
$
(25,992
)
 
$
53,111

Earnings (loss) per share—Basic
$
0.03

 
$
0.15

 
$
(0.23
)
 
$
0.46

Earnings (loss) per share—Diluted
$
0.03

 
$
0.15

 
$
(0.23
)
 
$
0.46

Weighted average shares outstanding—Basic
114,795

 
114,764

 
114,499

 
115,021

Weighted average shares outstanding—Diluted
115,698

 
116,025

 
114,499

 
116,330

`











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

2


PTC Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
 
 
Three months ended
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
Net income (loss)
$
3,073

 
$
17,435

 
$
(25,992
)
 
$
53,111

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized hedge gain (loss) arising during the period
361

 

 
(3,633
)
 

Net hedge loss reclassified into earnings
(1,560
)
 

 
(727
)
 

Unrealized gain (loss) on hedging instruments
1,921

 

 
(2,906
)
 

Foreign currency translation adjustment, net of tax of $0 for each period
(5,961
)
 
1,201

 
(1,219
)
 
(41,695
)
Unrealized gain on marketable securities
7

 

 
7

 

Amortization of net actuarial pension loss included in net income, net of tax of $0.2 million and $0.1 million in the third quarter of 2016 and 2015, respectively, and $0.5 million and $0.4 million in the first nine months of 2016 and 2015, respectively
417

 
1,003

 
1,220

 
3,081

Change in unamortized pension loss during the period related to changes in foreign currency
413

 
(190
)
 
82

 
2,915

Total other comprehensive income (loss)
(3,203
)
 
2,014

 
(2,816
)
 
(35,699
)
Comprehensive income (loss)
$
(130
)
 
$
19,449

 
$
(28,808
)
 
$
17,412































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

3


PTC Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(25,992
)
 
$
53,111

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
64,721

 
63,455

Stock-based compensation
51,821

 
38,135

Excess tax benefits from stock-based awards
(94
)
 
71

Other non-cash items, net
246

 
(53
)
Changes in operating assets and liabilities, excluding the effects of acquisitions:
 
 
 
Accounts receivable
58,499

 
44,906

Accounts payable, accrued expenses and other current liabilities
(17,303
)
 
17,433

Accrued compensation and benefits
7,442

 
(27,462
)
Deferred revenue
44,592

 
51,393

Accrued and deferred income taxes
(17,470
)
 
(25,608
)
Other current assets and prepaid expenses
4,249

 
(5,109
)
Other noncurrent assets and liabilities
(1,115
)
 
(17,809
)
Net cash provided by operating activities
169,596

 
192,463

Cash flows from investing activities:
 
 
 
Additions to property and equipment
(16,632
)
 
(20,637
)
Purchases of investments
(44,605
)
 
(11,000
)
Acquisitions of businesses, net of cash acquired
(164,191
)
 
(98,411
)
Net cash used by investing activities
(225,428
)
 
(130,048
)
Cash flows from financing activities:
 
 
 
Borrowings
670,000

 
135,000

Repayments of borrowings under credit facility
(560,000
)
 
(122,500
)
Repurchases of common stock

 
(49,962
)
Proceeds from issuance of common stock
19

 
38

Excess tax benefits from stock-based awards
94

 
(71
)
Credit facility origination costs
(6,759
)
 

Contingent consideration
(10,621
)
 

Payments of withholding taxes in connection with vesting of stock-based awards
(20,636
)
 
(29,117
)
Net cash provided (used) by financing activities
72,097

 
(66,612
)
Effect of exchange rate changes on cash and cash equivalents
4,944

 
(14,397
)
Net increase (decrease) in cash and cash equivalents
21,209

 
(18,594
)
Cash and cash equivalents, beginning of period
273,417

 
293,654

Cash and cash equivalents, end of period
$
294,626

 
$
275,060

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

4


PTC Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
General
The accompanying unaudited condensed consolidated financial statements include the accounts of PTC Inc. 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, 2015 . In the opinion of management, the accompanying unaudited condensed 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, 2015 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, 2016 are not necessarily indicative of the results expected for the remainder of the fiscal year.
Income Statement Presentation
In 2015, we classified revenue in three categories: 1) license and subscription solutions; 2) support; and 3) professional services. Effective with the beginning of the first quarter of 2016, we are reporting perpetual license revenue separately from subscription revenue and are presenting revenue in four categories: 1) subscription; 2) support; 3) perpetual license; and 4) professional services.
Effective with the beginning of the first quarter of 2016, we reclassified certain expenses related to management of our product lines from general and administrative to marketing.
Revenue and costs and expenses in the accompanying Consolidated Statements of Operations have been reclassified to conform to the current period presentation.
Segments
Through the second quarter of 2016, we had two operating and reportable segments: (1) Software Products, which included license and related support revenue (including updates and technical support) for all our products except training-related products; and (2) Services, which included consulting, implementation, training, cloud services, computer-based training products, including support on these products, and other services revenue.
With a change in our organizational structure in an effort to create more effective and efficient operations and to improve customer and product focus, during the three months ended July 2, 2016, we revised the information that our chief executive officer, who is also our chief operating decision maker (“CODM”), regularly reviews for purposes of allocating resources and assessing performance. As a result, effective with the beginning of the third quarter of 2016, we changed our operating and reportable segments from two to three: (1) the Solutions Group, which includes license, subscription, support and cloud services revenue for our core CAD, SLM and ePLM products; (2) the Technology Platform Group, which includes license, subscription, support and cloud services revenue for our IoT, analytics and augmented reality solutions; and (3) Professional Services, which includes consulting, implementation and training revenue.
Revenue and operating income in Note 11. Segment Information have been reclassified to conform to the current period presentation.
Recent Accounting Pronouncements
Financial Instruments - Credit Losses
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This update introduces a current expected credit loss model for measuring expected credit losses for certain types of financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. ASU 2016-13 replaces the current incurred loss model for measuring expected credit losses, requires expected losses on available-for-sale debt securities to be recognized through an allowance for credit losses rather than as reductions in the

5


amortized cost of the securities, and provides for additional disclosure requirements. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019, our fiscal 2021, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2018. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Stock Compensation
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU includes multiple provisions intended to simplify various aspects of the accounting for share-based payments, including accounting for income taxes, earnings per share, and forfeitures, as well as certain practical expedients for nonpublic entities. The ASU is effective for public companies in annual periods beginning after December 15, 2016, our fiscal 2018, and interim periods within those years. Early adoption is permitted in any interim period, with all adjustments applied as of the beginning of the fiscal year of adoption. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Leases
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), which will replace the existing guidance in ASC 840, Leases. The updated standard aims to increase transparency and comparability among organizations by requiring lessees to recognize lease assets and lease liabilities on the balance sheet and to disclose important information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, our fiscal 2020, and interim periods within those annual periods. Early adoption is permitted and modified retrospective application is required. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Financial Instruments
In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which requires equity investments to be measured at fair value with changes in fair value recognized in net income and simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. Entities may choose a practical expedient, to estimate the fair value of certain equity securities that do not have readily determinable fair values. If the practical expedient is elected, these investments would be recorded at cost, less impairment and subsequently adjusted for observable price changes. The guidance also updates certain presentation and disclosure requirements. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, our fiscal 2019, and interim periods within those fiscal years. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Deferred Taxes
In November 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-17, Balance Sheet Classification of Deferred Taxes (Topic 740), to simplify the presentation of deferred income taxes. The amendments in this Update require that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. The guidance does not change the existing requirement that permits offsetting only within a jurisdiction and companies are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. ASU 2015-17 is effective for public companies for fiscal years beginning after December 15, 2016, with early adoption permitted for all entities as of the beginning of an interim or annual reporting period. This guidance may be applied either prospectively or retrospectively (by reclassifying the comparative balance sheet). We adopted this new guidance in our first quarter ended January 2, 2016 and applied this guidance prospectively. As a result, the deferred tax assets and deferred tax liabilities on the Consolidated Balance Sheet as of September 30, 2015 have not been reclassified to conform to the July 2, 2016 presentation.
Revenue Recognition
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In July 2015, the FASB approved

6


a one-year delay in the effective date. ASU 2014-09 is effective for us in our first quarter of fiscal 2019 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (ii) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09. Subsequently, the FASB has issued the following standards to provide additional clarification and implementation guidance on ASU 2014-09: ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations; ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. We are currently evaluating the impact of these new standards on our consolidated financial statements.
Debt Issuance Costs
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30), to simplify the required presentation of debt issuance costs. The amended guidance requires that debt issuance costs be presented in the balance sheet as a direct reduction from the carrying amount of the related debt liability rather than as an asset. It is effective for financial statements issued for fiscal years beginning after December 15, 2015, our fiscal 2017, with early adoption permitted. The new guidance will be applied retrospectively to each prior period presented. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
2. Deferred Revenue and Financing Receivables
Deferred Revenue
Deferred revenue primarily relates to software 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 prepaid expenses and other current assets. Billed but uncollected support and subscription-related amounts included in other current assets at July 2, 2016 and September 30, 2015 were $111.1 million and $129.3 million , respectively.
Financing Receivables
We periodically provide extended payment terms to credit-worthy customers for software purchases with payment terms up to 24  months. The determination of 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 and customers generally. This determination is based on an internal credit assessment. In making this assessment, we use the Standard & Poor's (S&P) credit rating as our primary credit quality indicator, if available. If a customer, whether commercial or the U.S. Federal government, has an S&P bond rating of BBB- or above, we designate the customer as Tier 1. If a customer does not have an S&P bond rating, or has an S&P bond rating below BBB-, we base our assessment on an internal credit assessment which considers selected balance sheet, operating and liquidity measures, historical payment experience, and current business conditions within the industry or region. We designate these customers as Tier 2 or Tier 3, with Tier 3 being lower credit quality than Tier 2.
As of July 2, 2016 and September 30, 2015 , amounts due from customers for contracts with original payment terms greater than twelve months (financing receivables) totaled $12.1 million and $27.4 million , respectively. Accounts receivable and prepaid expenses and other current assets in the accompanying Consolidated Balance Sheets included current receivables from such contracts totaling $9.1 million and $21.8 million at July 2, 2016 and September 30, 2015 , respectively, and other assets in the accompanying Consolidated Balance Sheets included long-term receivables from such contracts totaling $3.0 million and $5.6 million at July 2, 2016 and September 30, 2015 , respectively. As of July 2, 2016 and September 30, 2015 , $2.1 million and $0.5 million , respectively, of these receivables were past due. Our credit risk assessment for financing receivables was as follows:
 
July 2,
2016
 
September 30,
2015
 
(in thousands)
S&P bond rating BBB-1 and above-Tier 1
$
9,447

 
$
16,841

Internal Credit Assessment-Tier 2
2,623

 
10,593

Internal Credit Assessment-Tier 3

 

Total financing receivables
$
12,070

 
$
27,434

 
We evaluate the need for an allowance for doubtful accounts for estimated losses resulting from the inability of these customers to make required payments. As of July 2, 2016 and September 30, 2015 , 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

7


uncollectible financing receivables in the nine months ended July 2, 2016 or July 4, 2015 . We write off uncollectible trade and financing receivables when we have exhausted all collection avenues.
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 did not sell any financing receivables to third-party financing institutions in the nine months ended July 2, 2016 . We sold $3 million of financing receivables to third-party financial institutions in the nine months ended July 4, 2015 .
3. Restructuring Charges
On October 23, 2015, we initiated a plan to restructure our workforce and consolidate select facilities in order to reduce our cost structure and to realign our investments with what we believe to be our higher growth opportunities. The restructuring is expected to result in a charge of $50 million to $70 million , the upper range of which has increased from our original estimate of $50 million . In the first three quarters of 2016, we recorded charges of $37.0 million , $4.4 million and $2.6 million respectively, attributable to termination benefits associated with 518 employees. The majority of the remaining charges are expected to be recorded in the fourth quarter of 2016. Additionally, in the first nine months of 2016, we recorded charges of $0.5 million related to the closure of excess facilities. In the first, second and third quarters of 2016, we made cash disbursements of $16.7 million , $25.1 million and $8.1 million , respectively, associated with restructuring charges.
On April 4, 2015, we committed to a plan to restructure our workforce and consolidate select facilities to realign our global workforce to increase investment in our Internet of Things business and to reduce our cost structure through organizational efficiencies in the face of significant foreign currency depreciation relative to the U.S. Dollar and a more cautious outlook on global macroeconomic conditions. In the second and third quarter of 2015, we recorded charges of $38.5 million and $3.3 million , respectively, attributable to termination benefits associated with 411 employees and in the first nine months of 2015, we recorded charges of $1.1 million related to the closure of excess facilities. In the first, second and third quarters of 2015, we made cash disbursements of $17.3 million , $5.5 million and $25.0 million , respectively, associated with restructuring charges.
Additionally, in the first nine months of 2015, we recorded a credit of $0.3 million related to prior year restructuring actions.
The following table summarizes restructuring accrual activity for the nine months ended July 2, 2016 :
 
Employee severance and related benefits
 
Facility closures and related costs
 
Total
 
(in thousands)
October 1, 2015
$
14,086

 
$
1,168

 
$
15,254

Charge to operations
44,010

 
531

 
44,541

Cash disbursements
(49,059
)
 
(834
)
 
(49,893
)
Foreign exchange impact
103

 
(11
)
 
92

Accrual, July 2, 2016
$
9,140

 
$
854

 
$
9,994

The accrual for facility closures and related costs is included in accrued expenses and other liabilities in the Consolidated Balance Sheets, and the accrual for employee severance and related benefits is included in accrued compensation and benefits in the Consolidated Balance Sheets.
4. Stock-based Compensation
We measure the cost of employee services received in exchange for restricted stock unit (RSU) awards based on the fair value of RSU awards 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 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.

8


Restricted stock unit activity for the nine months ended July 2, 2016
Shares
 
Weighted
Average
Grant Date
Fair Value
(Per Share)
 
(in thousands)
 
 
Balance of outstanding restricted stock units October 1, 2015
3,654

 
$
33.64

Granted
2,465

 
$
37.20

Vested
(1,794
)
 
$
30.06

Forfeited or not earned
(500
)
 
$
36.53

Balance of outstanding restricted stock units July 2, 2016
3,825

 
$
37.23

 
 
Restricted Stock Units
Grant Period
TSR Units (1)
 
Performance-based RSUs (2)
 
Service-based RSUs (2)
 
(Number of Units in thousands)
First nine months of 2016
326
 
343
 
1,795
_________________
(1)
The TSR units were granted to our executive officers pursuant to the terms described below.
(2)
The service-based RSUs were issued to employees, our executive officers and our directors. Executive officers may earn up to  one  or, for our CEO,  two  times the number of time-based RSUs (up to a maximum of  343,000  shares) if certain performance conditions are met. Of the service-based RSUs, approximately 64,000 shares will vest in one installment on or about the anniversary of the date of grant. Approximately 121,000 shares will vest in two substantially equal annual installments on or about the anniversary of the date of grant. All other service-based RSUs will vest in three substantially equal annual installments on or about the anniversary of the date of grant. The performance-based RSUs will vest in  three  substantially equal installments on the later of November 15, 2016, November 15, 2017 and November 15, 2018, or the date the Compensation Committee determines the extent to which the applicable performance criteria have been achieved.
In the first quarter of 2016, we granted the target performance-based TSR units ("target RSUs") shown in the table above to our executive officers. These RSUs are eligible to vest based upon our total shareholder return relative to a peer group (the “TSR units”), measured annually over a three year period. The number of TSR units to vest over the three year period will be determined based on the performance of PTC stock relative to the stock performance of an index of PTC peer companies established as of the grant date, as determined at the end of three measurement periods ending on September 30, 2016, 2017 and 2018, respectively. The shares earned for each period will vest on November 15 following each measurement period, up to a maximum of two times the number of target RSUs (up to a maximum of 652,000 shares). No vesting will occur in a period unless an annual threshold requirement is achieved. The employee must remain employed by PTC through the applicable vest date for any RSUs to vest. If the return to PTC shareholders is negative but still meets or exceeds the peer group indexed return, a maximum of 100% of the target RSUs will vest for the measurement period. TSR units not earned in either of the first two measurement periods are eligible to be earned in the third measurement period.
The weighted average fair value of the TSR units was $46.96 per target RSU on the grant date. The fair value of the TSR units was determined using a Monte Carlo simulation model, a generally accepted statistical technique used to simulate a range of possible future stock prices for PTC and the peer group. The method uses a risk-neutral framework to model future stock price movements based upon the risk-free rate of return, the volatility of each entity, and the pairwise correlations of each entity being modeled. The fair value for each simulation is the product of the payout percentage determined by PTC’s TSR rank against the peer group, the projected price of PTC stock, and a discount factor based on the risk-free rate.
The significant assumptions used in the Monte Carlo simulation model were as follows:
Average volatility of peer group
28.1
%
Risk free interest rate
1.05
%
Dividend yield
%
Compensation expense recorded for our stock-based awards was classified in our Consolidated Statements of Operations as follows:

9


 
Three months ended
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
(in thousands)
Cost of software revenue
$
1,158

 
$
1,133

 
$
4,163

 
$
3,158

Cost of professional services revenue
1,342

 
1,317

 
4,072

 
4,510

Sales and marketing
3,195

 
4,075

 
11,254

 
10,821

Research and development
2,531

 
2,928

 
7,578

 
9,015

General and administrative
5,570

 
4,618

 
24,754

 
10,631

Total stock-based compensation expense
$
13,796

 
$
14,071

 
$
51,821

 
$
38,135


The stock-based compensation expense in the first quarter of 2016 included $10 million of expense related to modifications of certain performance-based RSUs previously granted under our long-term incentive programs. The Compensation Committee of our Board of Directors amended these equity awards due to the impact of changes in our business model and strategy and foreign currency on our financial results.
5. 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.

 
Three months ended
 
Nine months ended
Calculation of Basic and Diluted EPS
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
(in thousands, except per share data)
Net income (loss)
$
3,073

 
$
17,435

 
$
(25,992
)
 
$
53,111

Weighted average shares outstanding—Basic
114,795

 
114,764

 
114,499

 
115,021

Dilutive effect of employee stock options, restricted shares and restricted stock units
903

 
1,261

 

 
1,309

Weighted average shares outstanding—Diluted
115,698

 
116,025

 
114,499

 
116,330

Earnings (loss) per share—Basic
$
0.03

 
$
0.15

 
$
(0.23
)
 
$
0.46

Earnings (loss) per share—Diluted
$
0.03

 
$
0.15

 
$
(0.23
)
 
$
0.46


For the nine months ended July 2, 2016 , diluted net loss per share is the same as basic net loss per share as the effects of our potential common stock equivalents are antidilutive. Total antidilutive shares were 1.7 million for the nine months ended July 2, 2016 .
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 periodically authorized the repurchase of shares of our common stock. On August 4, 2014, our Board of Directors authorized us to repurchase up to $600 million  of our common stock through September 30, 2017. In the third quarter and first nine months of 2016, we did not repurchase any shares. In the first quarter of 2015, we received 1.1 million shares as the final settlement of the accelerated share repurchase ("ASR") agreement described below. In the third quarter of 2015, we repurchased 1.2 million shares at a cost of $50.0 million . All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.
On August 14, 2014, we entered into an accelerated share repurchase (“ASR”) agreement with a major financial institution (“Bank”). The ASR allowed us to buy a large number of shares immediately at a purchase price determined by an average market price over a period of time. Under the ASR, we agreed to purchase $125 million of our common stock, in total, with an initial delivery to us in August 2014 of 2.3 million shares.

10


6. Acquisitions
Acquisition-related costs were $0.9 million and $3.2 million for the third quarter and first nine months of 2016, respectively and $2.8 million and $8.7 million for the third quarter and first nine months of 2015, respectively. Acquisition-related costs include direct costs of potential and completed acquisitions (e.g., investment banker fees, professional fees, including legal and valuation services) and expenses related to acquisition integration activities (e.g., professional fees and severance). In addition, subsequent adjustments to our initial estimated amount of contingent consideration associated with specific acquisitions are included within acquisition-related charges. These costs have been classified in general and administrative expenses in the accompanying Consolidated Statements of Operations.
Kepware
On January 12, 2016, we acquired all of the ownership interest in Kepware, Inc., for $99.4 million in cash (net of cash acquired of $0.6 million ) and, $16.9 million representing the fair value of contingent consideration payable upon achievement of targets described below. We borrowed $100.0 million under our existing credit facility in January of 2016 to fund the acquisition.
The results of operations of Kepware have been included in our consolidated financial statements beginning on the acquisition date. Our results of operations prior to this acquisition, if presented on a pro forma basis, would not differ materially from our reported results.
The acquisition of Kepware has been accounted for as a business combination. Assets acquired and liabilities assumed have been recorded at their estimated fair values as of January 12, 2016, the acquisition date. The fair values of intangible assets were based on valuations using an income approach, with estimates and assumptions provided by management of Kepware and PTC. The process for estimating the fair values of identifiable intangible assets and the contingent consideration liability requires the use of significant estimates and assumptions, including estimating future cash flows and developing appropriate discount rates. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The former shareholders of Kepware are eligible to receive additional consideration of up to $18.0 million , which is contingent on the achievement of certain Financial Performance, Product Integration and Business Integration targets (as defined in the Stock Purchase Agreement) within 24 months from April 3, 2016 to April 2, 2018. If such targets are achieved within the defined 12 month, 18 month and 24 month earn-out periods, the consideration corresponding to each target will be earned and payable in cash. Up to $9.6 million of the total contingent consideration will become payable in 2017, and the remainder, if subsequently earned, will become payable in 2018.
In connection with accounting for the business combination, we recorded a liability of $16.9 million representing the fair value of the contingent consideration. The liability was valued using a discounted cash flow method and a probability weighted estimate of achievement of the targets. The estimated undiscounted range of outcomes for the contingent consideration is $16.9 million to $18.0 million . We assess the probability that the targets will be met and at what level each reporting period. Subsequent changes in the estimated fair value of the liability are reflected in earnings until the liability is fully settled.
The purchase price allocation resulted in $77.1 million of goodwill, which will be deductible for income tax purposes. All of the acquired goodwill was allocated to our software products segment. Intangible assets of $34.5 million includes purchased software of $28.7 million , customer relationships of $5.2 million and trademarks of $0.6 million , which are being amortized over weighted average useful lives of 10 years, 10 years and 6 years, respectively, based upon the pattern in which economic benefits related to such assets are expected to be realized.
The resulting amount of goodwill reflects our expectations of the following benefits: 1) Kepware’s protocol translators and connectivity platform strengthen the ThingWorx technology platform and accelerate our entry into the factory setting and Industrial IoT (IIoT); 2) cross-selling opportunities for our integrated technology platforms in the critical infrastructure markets to drive revenue growth; and 3) Kepware’s 20 years of manufacturing experience strengthens our manufacturing talent and domain expertise and provides support for our manufacturing strategy initiatives.
Vuforia
On November 3, 2015 , pursuant to an Asset Purchase Agreement, PTC acquired the Vuforia business from Qualcomm Connected Experiences, Inc., a subsidiary of Qualcomm Incorporated, for  $64.8 million  in cash (net of cash acquired of  $4.5 million ). We borrowed  $50 million  under our credit facility to finance this acquisition. At the time of the acquisition, Vuforia had approximately  80  employees and historical annualized revenues were not material.
The acquisition of Vuforia 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. The fair values of intangible assets were based on valuations using a cost approach which requires the use of significant estimates and assumptions, including estimating costs to reproduce an asset. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. 

11


The purchase price allocation resulted in $23.3 million of goodwill, $41.2 million of technology and $4.7 million of net tangible assets. The acquired technology is being amortized over a useful life of 6 years. All of the acquired goodwill was allocated to our software products segment and will be deductible for income tax purposes. The resulting amount of goodwill reflects the value of the synergies created by integrating Vuforia’s augmented technology platform into PTC’s Technology Platform solutions.
ColdLight
In the third quarter of 2015, we acquired ColdLight Solutions, LLC, for approximately $98.6 million in cash (net of cash acquired of $1.3 million ). The former shareholders of ColdLight are eligible to receive additional consideration (the earn-out) of up to $5 million which is contingent upon achievement of certain technology milestones within two years of the acquisition. If an earn-out milestone is achieved, a portion of the contingent consideration becomes earned and payable in cash after each six-month period. In connection with accounting for the business combination, we recorded a liability $3.8 million , representing the fair value of the contingent consideration. The liability was valued using a discounted cash flow method and a probability weighted estimate of achievement of the technology milestones. The estimated undiscounted range of outcomes for the contingent consideration was  $3.8 million to $5.0 million  at the acquisition date. Changes in the estimated liability are reflected in earnings until the liability is fully settled. As of July 2, 2016, our estimate of the liability was $2.5 million , after a total of $2.5 million payments made in December 2015 and May 2016. $1.9 million of the total payments represents the fair value of the liability recorded at acquisition date and is included in financing activities in the Consolidated Statements of Cash Flows. The remaining $0.6 million of the total payments represents changes in the estimated liability recorded at acquisition date and is included in operating activities in the Consolidated Statements of Cash Flow.
ThingWorx
The ThingWorx contingent earn-out second year payment criteria were attained in the first quarter of fiscal 2016. We paid the remaining $9.0 million of the total contingent consideration in April 2016. Of this payment, $8.7 million represents the fair value of the liability recorded at the acquisition date and is included in financing activities in the Consolidated Statements of Cash Flows. The remaining $0.3 million of this payment represents changes in the estimated liability recorded since the acquisition date and is included in operating activities in the Consolidated Statements of Cash Flows.
7. Goodwill and Intangible Assets
Through the second quarter of 2016, we had two operating and reportable segments: (1) Software Products and (2) Services. Effective with the beginning of the third quarter of 2016, we changed our operating and reportable segments from two to three: (1) Solutions Group, (2) Technology Platform Group and (3) Professional Services. We assess goodwill for impairment at the reporting unit level. Our reporting units are determined based on the components of our operating segments that constitute a business for which discrete financial information is available and for which operating results are regularly reviewed by segment management. Our reporting units are the same as our operating segments.
As of July 2, 2016 , goodwill and acquired intangible assets in the aggregate attributable to our solutions group, technology platform group and professional services segment were $1,206.4 million , $255.8 million and $30.9 million , respectively. As of September 30, 2015 , goodwill and acquired intangible assets in the aggregate attributable to our software products segment and services segment were $1,297.9 million , and $62.4 million , respectively. 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. We evaluate goodwill for impairment in the third quarter of our fiscal year, or on an interim basis if an event occurs or circumstances change that would, more likely than not, reduce the fair value of a reporting segment below its carrying value. Factors we consider important, on an overall company basis and segment basis, when applicable, that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant changes in our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period and a reduction of our market capitalization relative to net book value. We completed our annual goodwill impairment review as of July 2, 2016 and concluded that no impairment charge was required as of that date.
To conduct these tests of goodwill, the fair value of the reporting unit is compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, we record an impairment loss equal to the difference between the carrying value of goodwill and its implied fair value. We estimate the fair values of our reporting units using discounted cash flow valuation models. Those models require estimates of future revenues, profits, capital expenditures, working capital, terminal values based on revenue multiples, and discount rates for each reporting unit. We estimate these amounts by evaluating historical trends, current budgets, operating plans and industry data. The estimated fair value of each reporting unit was at least approximately twice its carrying value as of July 2, 2016.
Goodwill and acquired intangible assets consisted of the following:
 

12


 
July 2, 2016
 
September 30, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
(in thousands)
Goodwill (not amortized)
 
 
 
 
$
1,169,660

 
 
 
 
 
$
1,069,041

Intangible assets with finite lives (amortized) (1):
 
 
 
 
 
 
 
 
 
 
 
Purchased software
$
352,782

 
$
192,509

 
$
160,273

 
$
284,257

 
$
174,887

 
$
109,370

Capitalized software
22,877

 
22,877

 

 
22,877

 
22,877

 

Customer lists and relationships
355,504

 
198,335

 
157,169

 
349,938

 
174,017

 
175,921

Trademarks and trade names
19,012

 
13,151

 
5,861

 
18,534

 
12,759

 
5,775

Other
3,941

 
3,862

 
79

 
3,946

 
3,711

 
235

 
$
754,116

 
$
430,734

 
$
323,382

 
$
679,552

 
$
388,251

 
$
291,301

Total goodwill and acquired intangible assets
 
 
 
 
$
1,493,042

 
 
 
 
 
$
1,360,342

(1) The weighted average useful lives of purchased software, customer lists and relationships, trademarks and trade names and other intangible assets with a remaining net book value are 7 years, 10 years, 9 years, and 3 years, respectively.
Goodwill
Changes in goodwill presented by reportable segments were as follows:  
 
Software
Products
Segment
 
Services
Segment
 
 
 
Total
 
(in thousands)
Balance, October 1, 2015
$
1,016,413

 
$
52,628

 
 
 
$
1,069,041

Acquisition of Vuforia
23,316

 

 
 
 
23,316

Acquisition of Kepware
77,081

 

 
 
 
77,081

Foreign currency translation adjustments
228

 
(6
)
 
 
 
222

Balance, July 2, 2016 prior to reallocation
$
1,117,038

 
$
52,622

 
 
 
$
1,169,660

 
Solutions Group
 
Technology Platform Group
 
Professional Services
 
Total
 
(in thousands)
Balance, July 2, 2016 after reallocation
$
1,050,013

 
$
90,053

 
$
29,594

 
$
1,169,660

Amortization of Intangible Assets
The aggregate amortization expense for intangible assets with finite lives was classified in our Consolidated Statements of Operations as follows:
 
Three months ended
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
(in thousands)
Amortization of acquired intangible assets
$
8,294

 
$
9,105

 
$
25,040

 
$
27,691

Cost of software revenue
6,383

 
4,957

 
18,235

 
14,438

Total amortization expense
$
14,677

 
$
14,062

 
$
43,275

 
$
42,129

8. 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

13


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.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Money market funds, time deposits and corporate notes/bonds are classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets.
Certificates of deposit, commercial paper and certain U.S. government agency securities are classified within Level 2 of the fair value hierarchy. These instruments are valued based on quoted prices in markets that are not active or based on other observable inputs consisting of market yields, reported trades and broker/dealer quotes.
The principal market in which we execute our foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large financial institutions. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.
The fair value of our contingent consideration arrangements are determined based on our evaluation as to the probability and amount of any earn-out that will be achieved based on expected future performances by the acquired entities. These arrangements are classified within Level 3 of the fair value hierarchy.
Our significant financial assets and liabilities measured at fair value on a recurring basis as of July 2, 2016 and September 30, 2015 were as follows:
 
July 2, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
72,829

 
$

 
$

 
$
72,829

Marketable securities
 
 
 
 
 
 
 
Certificates of deposit

 
680

 

 
680

Commercial paper

 
9,930

 

 
9,930

Corporate notes/bonds
31,590

 

 

 
31,590

U.S. government agency securities

 
2,406

 

 
2,406

Forward contracts

 
1,739

 

 
1,739

 
$
104,419

 
$
14,755

 
$

 
$
119,174

Financial liabilities:
 
 
 
 
 
 
 
Contingent consideration related to acquisitions
$

 
$

 
$
19,497

 
$
19,497

Forward contracts

 
6,150

 

 
6,150

 
$

 
$
6,150

 
$
19,497

 
$
25,647


14


 
September 30, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
91,216

 
$

 
$

 
$
91,216

Forward contracts

 
507

 

 
507

 
$
91,216

 
$
507

 
$

 
$
91,723

Financial liabilities:
 
 
 
 
 
 
 
Contingent consideration related to acquisitions
$

 
$

 
$
13,000

 
$
13,000

Forward contracts

 
46

 

 
46

 
$

 
$
46

 
$
13,000

 
$
13,046


Changes in the fair value of Level 3 contingent consideration liability associated with our acquisitions of ThingWorx, ColdLight and Kepware were as follows:
 
Contingent Consideration
 
(in thousands)
 
ThingWorx
 
ColdLight
 
Kepware
 
Total
Balance, October 1, 2015
$
9,000

 
$
4,000

 
$

 
$
13,000

Addition to contingent consideration

 

 
16,900

 
16,900

Change in present value of contingent consideration

 
1,000

 
97

 
1,097

Payment of contingent consideration
(9,000
)
 
(2,500
)
 
 
 
(11,500
)
Balance, July 2, 2016
$

 
$
2,500

 
$
16,997

 
$
19,497

 Of the total, $11.8 million of the contingent consideration liabilities is included in accrued expenses and other current liabilities, with the remaining $7.7 million in other liabilities in the Consolidated Balance Sheet as of July 2, 2016 .
9. Marketable Securities
The amortized cost and fair value of marketable securities as of July 2, 2016 were as follows:
 
July 2, 2016
 
Amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair value
 
(in thousands)
Certificates of deposit
$
680

 
$

 
$

 
$
680

Commercial paper
9,934

 

 
(4
)
 
9,930

Corporate notes/bonds
31,579

 
11

 

 
31,590

US government agency securities
2,406

 

 

 
2,406

 
$
44,599

 
$
11

 
$
(4
)
 
$
44,606

Our investment portfolio consists of certificates of deposit, commercial paper, corporate notes/bonds and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. All unrealized losses are due to changes in market interest rates, bond yields and/or credit ratings.
The following table presents our available-for-sale marketable securities by contractual maturity date, as of July 2, 2016.
 
July 2, 2016
 
Amortized cost
 
Fair value
 
(in thousands)
Due in one year or less
$
11,387

 
$
11,380

Due after one year through three years
33,212

 
33,226

 
$
44,599

 
$
44,606


15


10. Derivative Financial Instruments
Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Our most significant foreign currency exposures relate to Western European countries, Japan, China and Canada. Our foreign currency risk management strategy is principally designed to mitigate the future potential financial impact of changes in the U.S. dollar value of anticipated 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, to manage the exposures to foreign currency exchange risk to reduce earnings volatility. We do not enter into derivatives transactions for trading or speculative purposes.
Non-Designated Hedges
We hedge our net foreign currency monetary assets and liabilities primarily resulting from foreign currency denominated receivables and payables with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These contracts have maturities of up to approximately 3 months. Generally, we do not designate these 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.
As of July 2, 2016 and September 30, 2015 , we had outstanding forward contracts with notional amounts equivalent to the following:
Currency Hedged
July 2,
2016
 
September 30,
2015
 
(in thousands)
Canadian / U.S. Dollar
$
16,148

 
$
17,448

Euro / U.S. Dollar
145,317

 
82,917

British Pound / Euro

 
9,409

Israeli New Sheqel / U.S. Dollar
6,147

 
4,607

Japanese Yen / Euro
30,900

 
25,133

Japanese Yen / U.S. Dollar
6,716

 

Swiss Franc / U.S. Dollar
229

 
5,149

Swedish Krona / U.S. Dollar
5,111

 
3,128

All other
7,933

 
9,464

Total
$
218,501

 
$
157,255

The following table shows the effect of our non-designated hedges in the Consolidated Statements of Operations for the three and nine months ended July 2, 2016 and July 4, 2015 :
Derivatives Not Designated as Hedging Instruments
 
Location of Gain or (Loss) Recognized in Income
 
Net realized and unrealized gain or (loss) (excluding the underlying foreign currency exposure being hedged)
 
 
 
 
Three months ended
 
 
 
 
July 2,
2016
 
July 4,
2015
 
 
 
 
(in thousands)
Forward Contracts
 
Other Income (Expense)
 
$
(1,059
)
 
$
(741
)
 
 
 
 
 
 
 
 
 
 
 
Nine months ended
 
 
 
 
July 2,
2016
 
July 4,
2015
 
 
 
 
(in thousands)
Forward Contracts
 
Other Income (Expense)
 
$
(1,645
)
 
$
(1,122
)
Cash Flow Hedges
Our foreign exchange risk management program objective is to identify foreign exchange exposures and implement appropriate hedging strategies to minimize earnings fluctuations resulting from foreign exchange rate movements. We

16


designate certain foreign exchange forward contracts as cash flow hedges of Euro, Yen and SEK denominated intercompany forecasted revenue transactions (supported by third party sales). All foreign exchange forward contracts are carried at fair value on the Consolidated Balance Sheets and the maximum duration of foreign exchange forward contracts does not exceed 13 months.
Cash flow hedge relationships are designated at inception, and effectiveness is assessed prospectively and retrospectively using regression analysis on a monthly basis. As the forward contracts are highly effective in offsetting changes to future cash flows on the hedged transactions, we record the effective portion of changes in these cash flow hedges in accumulated other comprehensive income and subsequently reclassify into earnings in the same period during which the hedged transactions are recognized in earnings. Changes in the fair value of foreign exchange forward contracts due to changes in time value are included in the assessment of effectiveness. Our derivatives are not subject to any credit contingent features. We manage credit risk with counterparties by trading among several counterparties and we review our counterparties’ credit at least quarterly.
As of July 2, 2016 and September 30, 2015 , we had outstanding forward contracts designed as cash flow hedges with notional amounts equivalent to the following:
Currency Hedged
July 2,
2016
 
September 30,
2015
 
(in thousands)
Euro / U.S. Dollar
$
60,742

 
$

Japanese Yen / U.S. Dollar
20,488

 

SEK / U.S. Dollar
9,267

 

Total
$
90,497

 
$

The following table shows the effect of the our derivative instruments designated as cash flow hedges in the Consolidated Statements of Operations for the three and nine months ended July 2, 2016 and July 4, 2015 (in thousands):

Derivatives Designated as Hedging Instruments
 
Gain or (Loss)Recognized in OCI-Effective Portion
 
Location of Gain or (Loss) Reclassified from OCI into Income-Effective Portion
 
Gain or (Loss) Reclassified from OCI into Income-Effective Portion
 
Location of Gain or (Loss) Recognized-Ineffective Portion
 
Gain or (Loss) Recognized-Ineffective Portion
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
 
 
July 2,
2016
 
July 4,
2015
 
 
 
July 2,
2016
 
July 4,
2015
Forward Contracts
 
$
361

 
$

 
Software Revenue
 
$
(1,560
)
 
$

 
Other Income (Expense)
 
$
9

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended
 
 
 
Nine months ended
 
 
 
Nine months ended
 
 
July 2,
2016
 
July 4,
2015
 
 
 
July 2,
2016
 
July 4,
2015
 
 
 
July 2,
2016
 
July 4,
2015
Forward Contracts
 
$
(3,633
)
 
$

 
Software Revenue
 
$
(727
)
 
$

 
Other Income (Expense)
 
$
(28
)
 
$


As of July 2, 2016 , we estimated that approximately all values reported in accumulated other comprehensive income will be reclassified to income within the next twelve months.
In the event the underlying forecast transaction does not occur, or it becomes probable that it will not occur, the related hedge gains and losses on the cash flow hedge would be immediately reclassified to “Other Income (Expense)” on the Consolidated Statements of Operations. For the three and nine months ended July 2, 2016 , there were no such gains or losses.
The following table shows our derivative instruments measured at gross fair value as reflected in the Consolidated Balance Sheets:

17


 
Fair Value of Derivatives Designated As Hedging Instruments
 
Fair Value of Derivatives Not Designated As Hedging Instruments
 
July 2,
2016
 
September 30,
2015
 
July 2,
2016
 
September 30,
2015
 
(in thousands)
 
(in thousands)
Derivative assets (a):
 
 
 
 
 
 
 
       Forward Contracts
$
95

 
$

 
$
1,644

 
$
507

Derivative liabilities (b):
 
 
 
 
 
 
 
       Forward Contracts
$
3,022

 
$

 
$
3,128

 
$
46

(a) All derivative assets are recorded in “other current assets” in the Consolidated Balance Sheets.
(b) All derivative liabilities are recorded in "accrued expenses and other current liabilities" in the Consolidated Balance Sheets.

Offsetting Derivative Assets and Liabilities
We have entered into master netting arrangements which allow net settlements under certain conditions. Although netting is permitted, it is currently our policy and practice to record all derivative assets and liabilities on a gross basis in the Consolidated Balance Sheets.
The following table sets forth the offsetting of derivative assets as of  July 2, 2016 :
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of July 2, 2016
Gross Amount of Recognized Assets
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Assets Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Received
 
Net Amount
 
(in thousands)
Forward Contracts
$
1,739

 
$

 
$
1,739

 
$
(1,739
)
 
$

 
$


The following table sets forth the offsetting of derivative liabilities as of  July 2, 2016 :
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of July 2, 2016
Gross Amount of Recognized Liabilities
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Liabilities Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
(in thousands)
Forward Contracts
$
6,150

 
$

 
$
6,150

 
$
(1,739
)
 
$

 
$
4,411

11. 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 three operating and reportable segments: (1) the Solutions Group, which includes license, subscription, support and cloud services revenue for our core CAD, SLM and ePLM products; (2) the Technology Platform Group, which includes license, subscription, support and cloud services revenue for our IoT, analytics and augmented reality solutions, and (3) Professional Services, which includes consulting, implementation and training revenue. Our reported segment profit includes revenue from third party sales of our products and services, less direct controllable segment costs. Direct costs of the segments include certain costs of revenue, research and development and certain marketing costs. Costs excluded from segment margin include cost of revenue, selling expenses, corporate marketing and general and administrative costs that are incurred in support of all of our segments and are not specifically allocated to our segments for management reporting. Additionally, the segment profit does not include stock-based compensation, amortization of intangible assets, restructuring charges and certain other identified costs that we do not allocate to the segments for purposes of evaluating their operational performance.
The revenue and profit attributable to our operating segments are summarized below. We do not produce asset information by reportable segment; therefore, it is not reported.

18


 
Three months ended
 
Nine months ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
(in thousands)
Solutions Group
 
 
 
 
 
 
 
Revenue
$
217,673

 
$
229,157

 
$
652,985

 
$
726,679

Direct costs
44,882

 
54,583

 
140,465

 
174,109

Profit
172,791

 
174,574

 
512,520

 
552,570

 
 
 
 
 
 
 
 
Technology Platform Group
 
 
 
 
 
 
 
Revenue
20,678

 
20,456

 
51,034

 
38,213

Direct costs
22,255

 
7,479

 
61,478

 
20,340

Profit (loss)
(1,577
)
 
12,977

 
(10,444
)
 
17,873

 
 
 
 
 
 
 
 
Professional Services
 
 
 
 
 
 
 
Revenue
50,301

 
53,500

 
148,277

 
177,782

Direct costs
42,393

 
44,703

 
124,832

 
151,521

Profit
7,908

 
8,797

 
23,445

 
26,261

 
 
 
 
 
 
 
 
Total segment revenue
288,652

 
303,113

 
852,296

 
942,674

Total segment costs
109,530

 
106,765

 
326,775

 
345,970

Total segment profit
179,122

 
196,348

 
525,521

 
596,704

 
 
 
 
 
 
 
 
Other unallocated operating expenses
168,711

 
170,348

 
484,919

 
490,853

Restructuring charges
2,815

 
4,393

 
44,541

 
42,625

Total operating income (loss)
7,596

 
21,607

 
(3,939
)
 
63,226

 
 
 
 
 
 
 
 
Interest and other expense, net
8,300

 
3,668

 
19,880

 
10,492

Income (loss) before income taxes
$
(704
)
 
$
17,939

 
$
(23,819
)
 
$
52,734


(1)
We recorded restructuring charges of $2.8 million and $44.5 million , respectively, in the third quarter and first nine months of 2016. Solutions Group included $1.4 million and $16.3 million , respectively; Technology Platform Group included $0.6 million and $1.3 million , respectively; Professional Services included $0.3 million and $4.8 million , respectively; and unallocated departments included $0.5 million and $22.1 million , respectively, of these restructuring charges. We recorded restructuring charges of $4.4 million and $42.6 million , respectively, in the third quarter and first nine months of 2015. Solutions Group included $1.0 million and $8.5 million , respectively; Technology Platform Group included $0.1 million and $0.3 million , respectively; Professional Services included $0.3 million and $10.9 million , and unallocated departments included $3.0 million and $22.9 million , respectively, of these restructuring charges.
12. Income Taxes
In the third quarter and first nine months of 2016, our effective tax rate was 537% on a pre-tax loss of $0.7 million and (9)% on a pre-tax loss of $23.8 million , respectively, compared to 3% on pre-tax income of $17.9 million and (1)% on pretax income of $52.7 million in the third quarter and first nine months of 2015, respectively. In the third quarter and first nine months of 2016 and 2015, our effective tax rate was lower than the 35% statutory federal income tax rate due to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland. In 2016 and 2015, the foreign rate differential predominantly relates to these Irish earnings. Our foreign rate differential in 2016 and 2015 includes a rate benefit from a business realignment completed on September 30, 2014 in which intellectual property was transferred between two wholly-owned foreign subsidiaries. The realignment allows us to more efficiently manage the distribution of our products to European customers. For the third quarter and first nine months of 2016 and 2015, this realignment resulted in a tax benefit of approximately  $9 million  and  $16 million , and $6 million  and  $14 million , respectively. Additionally, in the first nine months of 2016 and 2015,

19


our provision reflects a tax benefit of $2.6 million and $2.1 million , respectively, related to a retroactive extension of the U.S. research and development tax credit enacted in the first quarter of each of 2016 and 2015. In the first nine months of 2016 and 2015, this benefit was offset by a corresponding provision to increase our U.S. valuation allowance. In addition, in the first nine months of 2015, we recorded a tax benefit of  $3.1 million  related to the reassessment of our reserve requirements, and a benefit of  $1.4 million  in conjunction with the reorganization of our Atego U.S. subsidiaries.
As of July 2, 2016 and September 30, 2015, we had unrecognized tax benefits of $15.5 million and $14.1 million , respectively. If all of our unrecognized tax benefits as of July 2, 2016 were to become recognizable in the future, we would record a benefit to the income tax provision of $13.9 million , which would be partially offset by an increase in the U.S. valuation allowance of $4.8 million
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 believe it is reasonably possible that within the next 12 months the amount of unrecognized tax benefits related to the resolution of multi-jurisdictional tax positions could be reduced by up to $5.0 million as audits close and statutes of limitations expire.  
In the fourth quarter of 2016, we received an assessment from the tax authorities in Korea related to an ongoing tax audit of approximately $12 million .  The assessment relates to various tax issues but primarily to foreign withholding taxes. We intend to appeal and will vigorously defend our positions. We believe that it is more likely than not that our positions will be sustained upon appeal. Accordingly, we have not recorded a tax reserve for this matter. We have not yet determined whether it will be necessary to pay the assessment while our appeal is pending. If we do not pay the assessment while our appeal is pending and we lose our appeal, we could be subject to substantial additional penalties.
13. Debt
At July 2, 2016 and September 30, 2015, we had the following long-term borrowing obligations:
 
July 2,
2016
 
September 30,
2015
 
(in thousands)
6.000% Senior notes due 2024
$
500,000

 
$

Credit facility-revolver
278,125

 
193,125

Credit facility-term loan

 
475,000

Total debt
778,125

 
668,125

Unamortized debt issuance costs
(11,254
)
 
(7,587
)
Total debt, net of issuance costs
$
766,871

 
$
660,538

 
 
 
 
Reported as
 
 
 
Current portion of long-term debt
$

 
$
50,000

Long-term debt
778,125

 
618,125

Total debt
$
778,125

 
$
668,125

Senior Notes
In May 2016, we issued  $500 million  in aggregate principal amount of  6.0%  senior, unsecured long-term debt at par value, due in 2024. We used the net proceeds from the sale of the notes to repay a portion of our outstanding revolving loan under our current credit facility. Interest is payable semi-annually on November 15 and May 15. The debt indenture includes covenants that limit our ability to, among other things, incur additional debt, grant liens on our properties or capital stock, enter into sale and leaseback transactions or asset sales, and make capital distributions. We were in compliance with all of the covenants as of July 2, 2016.
On and after May 15, 2019, we may redeem the senior notes at any time in whole or from time to time in part at specified redemption prices. In certain circumstances constituting a change of control, we will be required to make an offer to repurchase the senior notes at a purchase price equal to  101%  of the aggregate principal amount of the notes, plus accrued and unpaid interest. Our ability to repurchase the senior notes in such event may be limited by law, by the indenture associated with the senior notes, by our then-available financial resources or by the terms of other agreements to which we may be party at such time. If we fail to repurchase the senior notes as required by the indenture, it would constitute an event of default under the indenture governing the senior notes which, in turn, may also constitute an event of default under other obligations.

20


As of July 2, 2016, the total estimated fair value of the Notes was approximately $517.5 million , which is based on quoted prices for the notes on that date.
Credit Agreement
In November 2015, we entered into a multi-currency credit facility with a syndicate of sixteen banks for which JPMorgan Chase Bank, N.A. acts as Administrative Agent. This credit facility amended and restated in its entirety our credit facility described in Note H of our Annual Report on Form 10-K for the fiscal year ended September 30, 2015. We expect to use the credit facility for general corporate purposes, including acquisitions of businesses, share repurchases and working capital requirements. As of July 2, 2016 , the fair value of our credit facility approximates its book value.
The credit facility initially consisted of a $1 billion revolving loan commitment, which was reduced to $900 million in June 2016 pursuant to an amendment to the Credit Agreement. The loan commitment may be increased by an additional $500 million (in the form of revolving loans or term loans, or a combination thereof) if the existing or additional lenders are willing to make such increased commitments. The revolving loan commitment does not require amortization of principal and may be repaid in whole or in part prior to the scheduled maturity date at our option without penalty or premium. The credit facility matures on September 15, 2019, when all remaining amounts outstanding will be due and payable in full.
PTC and certain eligible foreign subsidiaries are eligible borrowers under the credit facility. Any borrowings by PTC Inc. under the credit facility would be guaranteed by PTC Inc.’s material domestic subsidiaries that become parties to the subsidiary guaranty, if any. As of the filing of this Form 10-Q, there are no subsidiary guarantors of the obligations under the credit facility. Any borrowings by eligible foreign subsidiary borrowers would be guaranteed by PTC Inc. and any subsidiary guarantors.  As of the filing of this Form 10-Q, no amounts under the credit facility have been borrowed by an eligible foreign subsidiary borrower. In addition, PTC and certain of its material domestic subsidiaries' owned property (including equity interests) is subject to first priority perfected liens in favor of the lenders of this credit facility. 100% of the voting equity interests of certain of PTC’s domestic subsidiaries and 65% of its material first-tier foreign subsidiaries are pledged as collateral for the obligations under the credit facility.
As of July 2, 2016 , we had $278.1 million in loans outstanding under the credit facility. Loans under the credit facility bear interest at variable rates which reset every 30 to 180 days depending on the rate and period selected by PTC as described below. As of July 2, 2016 , the annual interest rate for borrowing outstanding was 2.44% . Interest rates on borrowings outstanding under the credit facility range from 1.25% to 1.75% above an adjusted LIBO rate for Euro currency borrowings or would range from 0.25% to 0.75% above the defined base rate (the greater of the Prime Rate, the FRBNY rate plus 0.5% , or an adjusted LIBO rate plus 1% ) for base rate borrowings, in each case based upon PTC’s total 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 total leverage ratio. A quarterly commitment fee on the undrawn portion of the credit facility is required, ranging from 0.175% to 0.30%  per annum, based upon PTC’s total leverage ratio.
The credit facility limits PTC’s and its subsidiaries’ ability to, among other things: 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  $75.0 million for any purpose and an additional $200.0 million for acquisitions of businesses. In addition, under the credit facility, PTC and its subsidiaries must maintain the following financial ratios:
a total leverage ratio, defined as consolidated total indebtedness to the consolidated trailing four quarters EBITDA, not to exceed 4.00 to 1.00 as of the last day of any fiscal quarter;
a senior secured leverage ratio, defined as senior consolidated total indebtedness (which excludes unsecured indebtedness) to the consolidated trailing four quarters EBITDA, not to exceed 3.00 to 1.00 as of the last day of any fiscal quarter; and
a fixed charge coverage ratio, defined as the ratio of consolidated trailing four quarters EBITDA less consolidated capital expenditures to consolidated fixed charges, of not less than 3.50 to 1.00 as of the last day of any fiscal quarter.
As of July 2, 2016 , our total leverage ratio was 3.15 to 1.00 , our senior secured leverage ratio was 1.09 to 1 and our fixed charge coverage ratio was 8.45 to 1.00 and we were in compliance with all financial and operating covenants of the credit facility.
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.

21


14. Commitments and Contingencies
Legal and Regulatory Matters
Korean Tax Audit
In July 2016, we received an assessment from the tax authorities in Korea related to an ongoing tax audit of approximately $12 million . See Note 12. Income Taxes for additional information.
China Investigation
The China Administration for Industry and Commerce (the “Agency”) recently initiated an investigation at our China subsidiary related to the investigation concerning expenditures by our business partners in China and our China business that we recently settled with the U.S. Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice (“DOJ”), but not necessarily limited to the scope of that investigation.  The Agency is authorized to issue fines and assess other civil penalties.  We are unable to predict the outcome of this matter, which could include fines or other sanctions that could be material.
Legal Proceedings
On March 7, 2016, a lawsuit was filed against us and certain of our current and former officers and directors in the U.S. District Court for the District of Massachusetts by a shareholder on behalf of himself and purportedly on behalf of other shareholders who purchased our stock during the period November 24, 2011 through July 29, 2015. An amended complaint was filed on July 11, 2016. The lawsuit, which seeks unspecified damages, alleges that, during that period, PTC’s public disclosures concerning the SEC and DOJ investigation described above were false and/or misleading and/or failed to disclose certain alleged facts. We intend to contest the action vigorously. We cannot predict the outcome of this action nor when it will be resolved. If the plaintiff(s) were to prevail in the litigation, we could be liable for damages, which could be material and could adversely affect our financial condition or results of operations.
We are subject to various other legal proceedings and claims that arise in the ordinary course of business. We do not believe that resolving the legal proceedings and claims that we are currently subject to will 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 proceedings and claims be resolved against us, the operating results for a particular reporting period could be adversely affected.
Accruals
With respect to legal proceedings and claims, we record an accrual for a contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. For legal proceedings and claims for which the likelihood that a liability has been incurred is more than remote but less than probable, we estimate the range of possible outcomes. As of July 2, 2016 , we had a legal proceedings and claims accrual of $0.4 million .
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 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 liabilities under 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 liabilities is immaterial.
15. Pension Plans
Our pension plans are described in more detail in Note M to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2015. In the first nine months of 2015, we contributed $20 million to a non-U.S. pension plan.
16. Subsequent Events

22


Employee Stock Purchase Plan
The first offering period under our employee stock purchase plan (ESPP) began on August 1, 2016 and will end on January 31, 2017. The ESPP allows eligible employees to contribute up to  10%  of their base salary, up to a maximum of $25,000 per year and subject to any other plan limitations, toward the purchase of our common stock at a discounted price. The purchase price of the shares on each purchase date is equal to 85% of the lower of the fair market value of our common stock on the first and last trading days of each offering period. The ESPP is qualified under Section 423 of the Internal Revenue Code. We will estimate the fair value of each purchase right under the ESPP on the date of grant using the Black-Scholes option valuation model and use the straight-line attribution approach to record the expense over the six-month offering period. 



23


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 that are not historic facts, including statements about our future financial and growth expectations, the development of our products and markets, adoption of subscription licensing by our customers, and adoption of our solutions and future purchases by customers, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. These risks include: macroeconomic and/or global manufacturing climates may not improve or may deteriorate; customers may not purchase our solutions when or at the rates we expect; our businesses, including our Technology Platform and SLM businesses, may not expand and/or generate the revenue we expect; our market size and growth estimates may be incorrect and that we may be unable to grow our business at or in excess of market growth rates; new products released and planned products, including Technology Platform-enabled core products, may not generate the revenue we expect or be released as we expect; foreign currency exchange rates may vary from our expectations and thereby affect our reported revenue and expense; the mix of revenue between license, subscription, support and professional services could be different than we expect, which could impact our earnings per share results and cash flows; our customers may purchase more of our solutions as subscriptions than we expect, which would adversely affect near-term revenue, operating margins and earnings per share; customers may not purchase subscriptions at the rate we expect, which could affect our longer-term business projections; sales of our solutions as subscriptions may not have the longer-term positive effect on revenue that we expect; our workforce realignment may adversely affect our operations and may not achieve the expense savings we expect; we may be unable to generate sufficient operating cash flow to return 40% of free cash flow to shareholders and other uses of cash and debt covenants could preclude share repurchases; our substantial indebtedness could adversely affect our business, financial condition and results of operations, as well as our ability to meet our payment obligations under our debt; we may incur material damages in connection with a recently-filed securities law lawsuit concerning disclosures about the SEC and DOJ investigation in China that we recently settled; as well as other risks and uncertainties described below throughout or referenced in Part II, Item 1A. Risk Factors of this report
Operating and Non-GAAP Measures

Our discussion of results includes discussion of our operating measures (including “subscription bookings” and “license and subscription bookings”) and non-GAAP measures. You can find an explanation of these measures in Results of Operations - Subscription Measures and Results of Operations - Non-GAAP Measures below.
Business Overview
PTC Inc. develops and delivers technology solutions, comprised of software and services, that transform the way our customers create, operate and service their products for a smart, connected world.
Our solutions and software products address the challenges our customers face in the following areas:
Technology Platform Group
Internet of Things (IoT)
Enabling connectivity, development, analysis, and augmented reality software applications for smart, connected products and environments.
Solutions Group
Computer-Aided Design (CAD)
Effective and collaborative product design across the globe.
Product Lifecycle Management (PLM)
Efficient and consistent management of product development from concept to retirement across functional processes and distributed teams.
Application Lifecycle Management (ALM)
Management of global software development from concept to delivery.
Service Lifecycle Management (SLM)

24


Planning and delivery of service, and analysis of product intelligence at the point of service.

Executive Overview
In the third quarter of 2016, we saw an acceleration in the adoption of subscription licensing by our customers, including the conversion by some customers of their support contracts into subscriptions. Subscription bookings as a percentage of license and subscription bookings grew to 58% for the third quarter of 2016, up from 54% in the second quarter of 2016 and up from 16% in the third quarter of 2015. License and subscription bookings grew 21% in the third quarter over the second quarter of 2016, with license and subscription bookings of $105 million in the third quarter of 2016, and grew 32% over the third quarter of 2015. Our success with our subscription initiative contributed to the decline in both revenue, including perpetual license revenue, and earnings in the third quarter of 2016.
Approximately 67% of our revenue in both the third quarter and first nine months of 2016 came from recurring revenue streams, compared to 60% in both the third quarter and first nine months of 2015. Approximately 81% of our software revenue in both the third quarter and first nine months of 2016 came from recurring revenue streams, compared to 73% and 74% in the comparable year-ago periods.
Results for the Third Quarter
Revenue was down year over year, despite growth in license and subscription bookings, due to:
a higher mix of subscription revenue in 2016 compared to 2015 as we transition from selling perpetual licenses to a subscription-based licensing model;
a decline in professional services revenue of 6%, consistent with our strategy to migrate more service engagements to our partners;
a challenging macroeconomic environment; and
the impact of foreign currency exchange rates on our reported revenue due to an increase in the strength of the U.S. Dollar relative to international currencies, most notably the Euro and the Yen.
 
 
Three Months Ended
 
 
 
Constant Currency Change
 
Nine Months Ended
 
 
 
Constant Currency Change
 
 
July 2, 2016
 
July 4, 2015
 
 
 
 
July 2, 2016
 
July 4, 2015
 
 
 
Revenue
 
 
 
Change
 
 
 
 
Change
 
 
 
(in millions)
Subscription
 
$
31.8

 
$
17.2

 
85
 %
 
84
 %
 
$
77.7

 
$
47.1

 
65
 %
 
68
 %
Support
 
161.9

 
165.7

 
(2
)%
 
(3
)%
 
494.3

 
516.0

 
(4
)%
 
(1
)%
Total recurring software revenue
 
193.7

 
182.8

 
6
 %
 
5
 %
 
571.9

 
563.2

 
2
 %
 
5
 %
Perpetual license
 
44.6

 
66.8

 
(33
)%
 
(32
)%
 
132.1

 
201.7

 
(35
)%
 
(32
)%
Total software revenue
 
238.4

 
249.6

 
(5
)%
 
(5
)%
 
704.0

 
764.9

 
(8
)%
 
(5
)%
Professional services
 
50.3

 
53.5

 
(6
)%
 
(6
)%
 
148.3

 
177.8

 
(17
)%
 
(13
)%
Total revenue
 
$
288.7

 
$
303.1

 
(5
)%
 
(5
)%
 
$
852.3

 
$
942.7

 
(10
)%
 
(7
)%

 
 
Three Months Ended
 
 
 
Constant Currency Change
 
Nine Months Ended
 
 
 
Constant Currency Change
 
 
July 2, 2016
 
July 4, 2015
 
 
 
 
July 2, 2016
 
July 4, 2015
 
 
 
Earnings Measures
 
 
 
Change
 
 
 
 
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Margin
 
2.6
%
 
7.1
%