PTC Inc.
PTC INC. (Form: 10-Q, Received: 02/09/2017 16:26:24)


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 December 31, 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 115,721,488 shares of our common stock outstanding on February 7, 2017 .




PTC Inc.
INDEX TO FORM 10-Q
For the Quarter Ended December 31, 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)
 
 
December 31,
2016
 
September 30,
2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
173,367

 
$
277,935

Short term marketable securities
22,738

 
18,695

Accounts receivable, net of allowance for doubtful accounts of $1,348 and $1,012 at December 31, 2016 and September 30, 2016, respectively
132,853

 
161,357

Prepaid expenses
62,981

 
52,819

Other current assets
121,249

 
131,783

Total current assets
513,188

 
642,589

Property and equipment, net
65,885

 
67,113

Goodwill
1,159,492

 
1,169,813

Acquired intangible assets, net
293,727

 
310,305

Long term marketable securities
27,096

 
30,921

Deferred tax assets
93,394

 
89,692

Other assets
44,159

 
35,296

Total assets
$
2,196,941

 
$
2,345,729

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
19,063

 
$
18,022

Accrued expenses and other current liabilities
77,291

 
84,141

Accrued compensation and benefits
88,574

 
145,633

Accrued income taxes
6,873

 
6,303

Deferred revenue
364,929

 
400,420

Total current liabilities
556,730

 
654,519

Long term debt
731,762

 
751,601

Deferred tax liabilities
14,889

 
13,754

Deferred revenue
10,100

 
13,237

Other liabilities
64,495

 
69,952

Total liabilities
1,377,976

 
1,503,063

Commitments and contingencies (Note 14)

 

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

 

Common stock, $0.01 par value; 500,000 shares authorized; 115,606 and 114,968 shares issued and outstanding at December 31, 2016 and September 30, 2016, respectively
1,156

 
1,150

Additional paid-in capital
1,597,886

 
1,598,548

Accumulated deficit
(666,220
)
 
(657,079
)
Accumulated other comprehensive loss
(113,857
)
 
(99,953
)
Total stockholders’ equity
818,965

 
842,666

Total liabilities and stockholders’ equity
$
2,196,941

 
$
2,345,729




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
 
December 31,
2016
 
January 2,
2016
Revenue:
 
 
 
Subscription
$
54,362

 
$
22,176

Support
151,478

 
171,756

Total recurring software revenue
205,840

 
193,932

Perpetual license
34,379

 
47,763

Total software revenue
240,219

 
241,695

Professional services
46,108

 
49,322

Total revenue
286,327

 
291,017

Cost of revenue:
 
 
 
Cost of software revenue
42,947

 
36,814

Cost of professional services revenue
39,168

 
43,333

Total cost of revenue
82,115

 
80,147

Gross margin
204,212

 
210,870

Operating expenses:
 
 
 
Sales and marketing
90,690

 
82,429

Research and development
57,914

 
57,669

General and administrative
36,695

 
38,567

Amortization of acquired intangible assets
8,067

 
8,350

Restructuring charges
6,285

 
37,147

Total operating expenses
199,651

 
224,162

Operating income (loss)
4,561

 
(13,292
)
Interest and other expense, net
(11,064
)
 
(6,253
)
Loss before income taxes
(6,503
)
 
(19,545
)
Provision for income taxes
2,638

 
4,347

Net loss
$
(9,141
)
 
$
(23,892
)
Loss per share—Basic
$
(0.08
)
 
$
(0.21
)
Loss per share—Diluted
$
(0.08
)
 
$
(0.21
)
Weighted average shares outstanding—Basic
115,290

 
114,151

Weighted average shares outstanding—Diluted
115,290

 
114,151

`











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

2


PTC Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
(unaudited)
 
 
Three months ended
 
December 31,
2016
 
January 2,
2016
Net loss
$
(9,141
)
 
$
(23,892
)
Other comprehensive income (loss), net of tax:
 
 
 
Unrealized hedge gain arising during the period, net of tax of $0.4 million and $0 in the first quarter of 2017 and 2016, respectively
3,037

 
1,643

Net hedge loss reclassified into earnings, net of tax of $0.1 million and $0 in the first quarter of 2017 and 2016, respectively
(356
)
 
(846
)
Unrealized gain on hedging instruments
2,681

 
797

Foreign currency translation adjustment, net of tax of $0 for each period
(18,652
)
 
(10,504
)
Unrealized loss on marketable securities
(139
)
 

Amortization of net actuarial pension loss included in net income, net of tax of $0.2 million and $0.2 million in the first quarter of 2017 and 2016, respectively
516

 
402

Change in unamortized pension loss during the period related to changes in foreign currency
1,690

 
550

Total other comprehensive loss
(13,904
)
 
(8,755
)
Comprehensive loss
$
(23,045
)
 
$
(32,647
)




























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

3


PTC Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Three months ended
 
December 31,
2016
 
January 2,
2016
Cash flows from operating activities:
 
 
 
Net loss
$
(9,141
)
 
$
(23,892
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
21,454

 
20,613

Stock-based compensation
17,988

 
23,189

Excess tax benefits from stock-based awards
(102
)
 
(56
)
Non-cash portion of restructuring charges
260

 

Other non-cash items, net
330

 
45

Changes in operating assets and liabilities, excluding the effects of acquisitions:
 
 
 
Accounts receivable
21,184

 
35,219

Accounts payable, accrued expenses and other current liabilities
232

 
(1,679
)
Accrued compensation and benefits
(53,840
)
 
12,054

Deferred revenue
(11,726
)
 
1,262

Accrued and deferred income taxes
(6,096
)
 
(3,355
)
Other current assets and prepaid expenses
(15,229
)
 
1,441

Other noncurrent assets and liabilities
(13,292
)
 
(3,587
)
Net cash provided by (used in) operating activities
(47,978
)
 
61,254

Cash flows from investing activities:
 
 
 
Additions to property and equipment
(7,100
)
 
(4,185
)
Acquisitions of businesses, net of cash acquired

 
(64,780
)
Proceeds from sales of investments
1,502

 

Net cash used by investing activities
(5,598
)
 
(68,965
)
Cash flows from financing activities:
 
 
 
Borrowings
60,000

 
50,000

Repayments of borrowings under credit facility
(80,000
)
 

Proceeds from issuance of common stock

 
1

Excess tax benefits from stock-based awards
102

 
56

Credit facility origination costs

 
(1,050
)
Contingent consideration
(2,711
)
 
(1,250
)
Payments of withholding taxes in connection with vesting of stock-based awards
(18,623
)
 
(14,833
)
Net cash provided (used) by financing activities
(41,232
)
 
32,924

Effect of exchange rate changes on cash and cash equivalents
(9,760
)
 
(1,833
)
Net increase (decrease) in cash and cash equivalents
(104,568
)
 
23,380

Cash and cash equivalents, beginning of period
277,935

 
273,417

Cash and cash equivalents, end of period
$
173,367

 
$
296,797

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, 2016 . 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, 2016 Consolidated Balance Sheet included herein is derived from our audited consolidated financial statements.
Our fiscal year ends on September 30th. Our fiscal quarters end on a Saturday following a thirteen week calendar, and may result in different quarter end dates year to year. The first quarter of 2017 ended on December 31, 2016 and the first quarter of 2016 ended on January 2, 2016. The results of operations for the three months ended December 31, 2016 are not necessarily indicative of the results expected for the remainder of the fiscal year.
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.
In an effort to create more effective and efficient operations and to improve customer and product focus, we implemented changes to our organizational structure, and consequently, 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 PLM products; (2) the Internet of Things (IoT) 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 earnings in Note 11. Segment Information have been reclassified to conform to the current period presentation.
Recent Accounting Pronouncements
Goodwill
In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-04 to simplify the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance will be applied prospectively and is effective for annual reporting periods ending December 31, 2020 and thereafter with early adoption permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Income Taxes
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). The purpose of ASU 2016-16 is to simplify the income tax accounting of an intra-entity transfer of an asset other than inventory and to record its effect when the transfer occurs. The guidance is effective for annual reporting periods beginning after December 15, 2017, our fiscal 2019, including interim reporting periods within those annual reporting periods and early adoption is permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements.


5


Cash Flows
In August 2016, the FASB issued ASU 2016-15 to clarify whether the following items should be categorized as operating, investing or financing in the statement of cash flows: (i) debt prepayments and extinguishment costs, (ii) settlement of zero-coupon debt, (iii) settlement of contingent consideration, (iv) insurance proceeds, (v) settlement of corporate-owned life insurance (COLI) and bank-owned life insurance (BOLI) policies, (vi) distributions from equity method investees, (vii) beneficial interests in securitization transactions, and (viii) receipts and payments with aspects of more than one class of cash flows. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, our fiscal 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Financial Instruments - Credit Losses
In June 2016, the FASB issued 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 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 FASB issued 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 FASB issued 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 FASB issued 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.
Revenue Recognition
In May 2014, the FASB issued 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 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

6


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 adopted this new guidance in our first quarter ended December 31, 2016 and applied this guidance retrospectively. As a result, the debt issuance costs of $6.5 million previously included in other long-term assets on the Consolidated Balance Sheet as of September 30, 2016 have been reclassified to conform to the December 31, 2016 presentation.
Going Concern
In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements - Going Concern: Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern," which requires management to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, provide certain footnote disclosures. This ASU is effective for annual periods ending after December 15, 2016, including interim reporting periods thereafter. We do not anticipate that adopting this standard will have an impact on the financial statements and are currently evaluating the potential impact to our footnote disclosures.
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 December 31, 2016 and September 30, 2016 were $112.4 million and $126.3 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.
As of December 31, 2016 and September 30, 2016 , amounts due from customers for contracts with original payment terms greater than twelve months (financing receivables) totaled $6.0 million and $7.1 million , respectively, all of which was included in accounts receivable in the Consolidated Balance Sheets.
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 December 31, 2016 and September 30, 2016 , we concluded that all financing receivables were collectible and no reserve for credit losses was recorded. We did not provide a reserve for credit losses or write off any uncollectible financing receivables in the three months ended December 31, 2016 or January 2, 2016 . 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 three months ended December 31, 2016 and January 2, 2016 .

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 actions resulted in total restructuring charges of $83.3 million , primarily associated with termination benefits associated with 795

7


employees. In the four quarters of 2016, we recorded charges of $36.8 million , $5.0 million , $3.4 million and $31.8 million respectively. In the first quarter of 2017, we recorded additional charges of $6.3 million , of which $3.9 million related to the closure of excess facilities. As of December 31, 2016, this restructuring plan was substantially complete.
Additionally, in 2016 and the first three months of 2017, we recorded a credit of $0.6 million and $0.1 million , respectively, related to prior restructuring actions included in charge to operations.
In the four quarters of 2016, we made cash disbursements of $16.7 million , $25.1 million , $8.1 million and $5.1 million respectively, associated with restructuring charges.
The following table summarizes restructuring accrual activity for the three months ended December 31, 2016 :
 
Employee severance and related benefits
 
Facility closures and related costs
 
Total
 
(in thousands)
October 1, 2016
$
35,177

 
$
1,431

 
$
36,608

Charge to operations, net
2,399

 
3,886

 
6,285

Cash disbursements
(15,537
)
 
(278
)
 
(15,815
)
Other non-cash charges

 
(260
)
 
(260
)
Foreign exchange impact
(1,143
)
 
(26
)
 
(1,169
)
Accrual, December 31, 2016
$
20,896

 
$
4,753

 
$
25,649

Of the accrual for facility closures and related costs, $2.4 million is included in accrued expenses and other current liabilities and $2.4 million is included in other liabilities in the Consolidated Balance Sheets. The accrual for facility closures assumes sublease income of $2.2 million over the remaining lease periods. 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.
Our employee stock purchase plan (ESPP), initiated in the fourth quarter of 2016, 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 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. 

8


Restricted stock unit activity for the three months ended December 31, 2016
Shares
 
Weighted
Average
Grant Date
Fair Value
(Per Share)
 
(in thousands)
 
 
Balance of outstanding restricted stock units October 1, 2016
3,776

 
$
37.30

Granted
1,391

 
$
50.58

Vested
(1,029
)
 
$
36.14

Forfeited or not earned
(522
)
 
$
37.10

Balance of outstanding restricted stock units December 31, 2016
3,616

 
$
42.77

 

 
Restricted Stock Units
Grant Period
TSR Units (1)
 
Performance-based RSUs (2)
 
Service-based RSUs (3)
 
(Number of Units in thousands)
First three months of 2017
356
 
316
 
719
_________________
(1)
The TSR units were granted to our executive officers pursuant to the terms described below.
(2)
The performance-based RSUs were granted to our executive officers and are eligible to vest based on the achievement of performance criteria for fiscal 2017 established by the Compensation Committee at the time of grant. Shares not earned will be forfeited. The shares will vest in  three  substantially equal installments on November 15, 2017, November 15, 2018 and November 15, 2019.
(3)
The service-based RSUs were granted to employees and our executive officers. All service-based RSUs will vest in three substantially equal annual installments on or about the anniversary of the date of grant.
In the first three months of 2017, 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, 2017, 2018 and 2019, 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 495 thousand shares). No vesting will occur in a period unless an annual threshold requirement is achieved. The employee, subject to certain retirement provisions, must remain employed by PTC through the applicable vest date for any RSUs to vest, but in no event will any RSUs vest if the performance criteria are not achieved. 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 $68.02 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
29.3
%
Risk free interest rate
0.99
%
Dividend yield
%
Compensation expense recorded for our stock-based awards was classified in our Consolidated Statements of Operations as follows:

9


 
Three months ended
 
December 31,
2016
 
January 2,
2016
 
(in thousands)
Cost of software revenue
$
1,437

 
$
1,905

Cost of professional services revenue
1,457

 
1,451

Sales and marketing
3,621

 
4,282

Research and development
2,997

 
2,513

General and administrative
8,476

 
13,038

Total stock-based compensation expense
$
17,988

 
$
23,189


The stock-based compensation expense in the first quarter of 2017 includes $0.6 million related to the ESPP. 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. Diluted EPS is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding RSUs using the treasury stock method. The calculation of the dilutive effect of outstanding equity awards under the treasury stock method includes consideration of unrecognized compensation expense and any tax benefits as additional proceeds.

 
Three months ended
Calculation of Basic and Diluted EPS
December 31,
2016
 
January 2,
2016
 
(in thousands, except per share data)
Net loss
$
(9,141
)
 
$
(23,892
)
Weighted average shares outstanding—Basic
115,290

 
114,151

Dilutive effect of restricted stock units

 

Weighted average shares outstanding—Diluted
115,290

 
114,151

Loss per share—Basic
$
(0.08
)
 
$
(0.21
)
Loss per share—Diluted
$
(0.08
)
 
$
(0.21
)

For the three months ended December 31, 2016 and January 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 1.8 million and 2.0 million for the three months ended December 31, 2016 and January 2, 2016 , respectively.
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. We did not repurchase any shares in the first quarters of 2017 and 2016. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.
6. Acquisitions
Acquisition-related costs were $0.2 million and $1.2 million for the first quarters of 2017 and 2016, 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 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 the acquisition date. The fair values of intangible assets were based on

10


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. As of December 31, 2016, our estimate of the liability was $15.3 million , after a $1.8 million payment made in December 2016, of which $1.8 million 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 purchase price allocation resulted in $77.1 million of goodwill, which will be deductible for income tax purposes. 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. 
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 IoT solutions.

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) IoT 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 December 31, 2016 , goodwill and acquired intangible assets in the aggregate attributable to our Solutions Group, IoT Group and Professional Services segment were $1,176.2 million , $246.7 million and $30.4 million , respectively. As of September 30, 2016 , goodwill and acquired intangible assets in the aggregate attributable to our Solutions Group, IoT Group and Professional Services segment were $1,196.6 million , $252.8 million and $30.7 million , respectively. Acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset

11


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.
Goodwill and acquired intangible assets consisted of the following:
 
 
December 31, 2016
 
September 30, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
(in thousands)
Goodwill (not amortized)
 
 
 
 
$
1,159,492

 
 
 
 
 
$
1,169,813

Intangible assets with finite lives (amortized) (1):
 
 
 
 
 
 
 
 
 
 
 
Purchased software
$
351,032

 
$
202,266

 
$
148,766

 
$
354,595

 
$
199,192

 
$
155,403

Capitalized software
22,877

 
22,877

 

 
22,877

 
22,877

 

Customer lists and relationships
349,593

 
210,132

 
139,461

 
355,698

 
206,515

 
149,183

Trademarks and trade names
18,789

 
13,289

 
5,500

 
19,007

 
13,323

 
5,684

Other
3,860

 
3,860

 

 
3,955

 
3,920

 
35

 
$
746,151

 
$
452,424

 
$
293,727

 
$
756,132

 
$
445,827

 
$
310,305

Total goodwill and acquired intangible assets
 
 
 
 
$
1,453,219

 
 
 
 
 
$
1,480,118

(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 9 years, 10 years, 10 years, and 3 years, respectively.
Goodwill
Changes in goodwill presented by reportable segments were as follows:  
 
Solutions Group
 
IoT Group
 
Professional Services
 
Total
 
(in thousands)
Balance, October 1, 2016
$
1,050,150

 
$
90,065

 
$
29,598

 
$
1,169,813

Foreign currency translation adjustment
(9,265
)
 
(795
)
 
(261
)
 
(10,321
)
Balance, December 31, 2016
$
1,040,885

 
$
89,270

 
$
29,337

 
$
1,159,492

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
 
December 31,
2016
 
January 2,
2016
 
(in thousands)
Amortization of acquired intangible assets
$
8,067

 
$
8,350

Cost of software revenue
6,388

 
5,127

Total amortization expense
$
14,455

 
$
13,477


12


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 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 is 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 December 31, 2016 and September 30, 2016 were as follows:
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
60,418

 
$

 
$

 
$
60,418

Marketable securities

 


 

 

Certificates of deposit

 
880

 

 
880

Commercial paper

 
11,964

 

 
11,964

Corporate notes/bonds
34,599

 

 

 
34,599

U.S. government agency securities

 
2,391

 

 
2,391

Forward contracts

 
4,505

 

 
4,505

 
$
95,017

 
$
19,740

 
$

 
$
114,757

Financial liabilities:


 


 

 

Contingent consideration related to acquisitions
$

 
$

 
$
16,594

 
$
16,594

Forward contracts

 
629

 

 
629

 
$

 
$
629

 
$
16,594

 
$
17,223


13


 
September 30, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
60,139

 
$

 
$

 
$
60,139

Marketable securities

 


 

 

Certificates of deposit

 
681

 

 
681

Commercial paper

 
11,925

 

 
11,925

Corporate notes/bonds
34,601

 

 

 
34,601

U.S. government agency securities

 
2,409

 

 
2,409

Forward contracts

 
260

 

 
260

 
$
94,740

 
$
15,275

 
$

 
$
110,015

Financial liabilities:


 


 

 

Contingent consideration related to acquisitions
$

 
$

 
$
19,570

 
$
19,570

Forward contracts

 
3,170

 

 
3,170

 
$

 
$
3,170

 
$
19,570

 
$
22,740


Changes in the fair value of Level 3 contingent consideration liability associated with our acquisitions of ColdLight and Kepware were as follows:
 
Contingent Consideration
 
(in thousands)
 
ColdLight
 
Kepware
 
Total
Balance, October 1, 2016
$
2,500

 
$
17,070

 
19,570

Change in present value of contingent consideration

 
74

 
74

Payment of contingent consideration
(1,250
)
 
(1,800
)
 
(3,050
)
Balance, December 31, 2016
$
1,250

 
$
15,344

 
$
16,594

 Of the total, $11.9 million of the contingent consideration liabilities is included in accrued expenses and other current liabilities, with the remaining $4.7 million in other liabilities in the Consolidated Balance Sheet as of December 31, 2016 .
Of the $3.1 million payments in the first quarter of 2017, $2.7 million represents the fair value of the liabilities recorded at the acquisition date and is included in financing activities in the Consolidated Statements of Cash Flows. In the first quarter of 2016, we paid $1.3 million of contingent consideration, all of which represented the fair value of the liabilities recorded at the acquisition date.
9. Marketable Securities
The amortized cost and fair value of marketable securities as of December 31, 2016 and September 30, 2016 were as follows:

December 31, 2016

Amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair value
 
(in thousands)
Certificates of deposit
$
881

 
$

 
$
(1
)
 
$
880

Commercial paper
11,972

 

 
(8
)
 
11,964

Corporate notes/bonds
34,839

 

 
(240
)
 
34,599

US government agency securities
2,402

 

 
(11
)
 
2,391


$
50,094

 
$

 
$
(260
)
 
$
49,834


14



September 30, 2016

Amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair value
 
(in thousands)
Certificates of deposit
$
681

 
$

 
$

 
$
681

Commercial paper
11,945

 

 
(20
)
 
11,925

Corporate notes/bonds
34,701

 

 
(100
)
 
34,601

US government agency securities
2,411

 

 
(2
)
 
2,409


$
49,738

 
$

 
$
(122
)
 
$
49,616


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  December 31, 2016 and September 30, 2016 .

December 31, 2016
 
September 30, 2016

Amortized cost
 
Fair value
 
Amortized cost
 
Fair value
 
(in thousands)
 
(in thousands)
Due in one year or less
$
22,650

 
$
22,618

 
$
18,585

 
$
18,549

Due after one year through three years
27,444

 
27,216

 
31,153

 
31,067


$
50,094

 
$
49,834

 
$
49,738

 
$
49,616

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 three 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 interest and other expense, net.
As of December 31, 2016 and September 30, 2016 , we had outstanding forward contracts with notional amounts equivalent to the following:

15


Currency Hedged
December 31,
2016
 
September 30,
2016
 
(in thousands)
Canadian / U.S. Dollar
$
8,460

 
$
14,685

Swiss Franc / Euro
4,897

 

Chinese Yuan offshore / Euro
9,487

 

Euro / U.S. Dollar
206,717

 
174,120

Japanese Yen / Euro
36,907

 
32,782

Israeli Shekel / U.S. Dollar
5,704

 
7,271

Japanese Yen / U.S. Dollar
4,649

 
6,716

Swedish Krona / Euro
8,618

 

Swedish Krona / U.S. Dollar
4,644

 
3,852

Singapore Dollar / U.S. Dollar
75,429

 
1,448

All other
8,571

 
8,660

Total
$
374,083

 
$
249,534

The following table shows the effect of our non-designated hedges in the Consolidated Statements of Operations for the three months ended December 31, 2016 and January 2, 2016 :
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
 
 
 
 
December 31,
2016
 
January 2,
2016
 
 
 
 
(in thousands)
Forward Contracts
 
Interest and other expense, net
 
$
(8,329
)
 
$
(1,014
)
In the three months ended December 31, 2016 and January 2, 2016, the foreign currency losses, net were $1.5 million and $0.0 million , respectively.
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 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.

16


As of December 31, 2016 and September 30, 2016 , we had outstanding forward contracts designated as cash flow hedges with notional amounts equivalent to the following:
Currency Hedged
December 31,
2016
 
September 30,
2016
 
(in thousands)
Euro / U.S. Dollar
$
32,893

 
$
26,181

Japanese Yen / U.S. Dollar
13,733

 
8,800

SEK / U.S. Dollar
2,165

 
4,078

Total
$
48,791

 
$
39,059

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 months ended December 31, 2016 and January 2, 2016 (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
 
 
December 31,
2016
 
January 2,
2016
 
 
 
December 31,
2016
 
January 2,
2016
 
 
 
December 31,
2016
 
January 2,
2016
Forward Contracts
 
$
3,471

 
$
1,643

 
Software revenue
 
$
407

 
$
846

 
Interest and other expense, net
 
$
10

 
$


As of December 31, 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 that an 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 interest and other expense, net on the Consolidated Statements of Operations. For the three and three months ended December 31, 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:
 
Fair Value of Derivatives Designated As Hedging Instruments
 
Fair Value of Derivatives Not Designated As Hedging Instruments
 
December 31,
2016
 
September 30,
2016
 
December 31,
2016
 
September 30,
2016
 
(in thousands)
 
(in thousands)
Derivative assets (1):
 
 
 
 
 
 
 
       Forward Contracts
$
1,655

 
$
44

 
$
2,850

 
$
216

Derivative liabilities (2):
 
 
 
 
 
 
 
       Forward Contracts
$
14

 
$
1,477

 
$
615

 
$
1,693

(1) As of December 31, 2016, $4,420 thousand current derivative assets are recorded in other current assets, and $85 thousand long term derivative assets are recorded in other assets in the Consolidated Balance Sheets. As of September 30, 2016, all derivative assets were recorded in other current assets in the Consolidated Balance Sheet.
(2) As of December 31, 2016, $628 thousand current derivative liabilities are recorded in accrued expenses and other current liabilities, and $1 thousand long term derivative liabilities are recorded in other liabilities in the Consolidated Balance Sheets. As of September 30, 2016, all derivative liabilities were 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.

17


The following table sets forth the offsetting of derivative assets as of  December 31, 2016 :
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of December 31, 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
$
4,505

 
$

 
$
4,505

 
$
(629
)
 
$

 
$
3,876


The following table sets forth the offsetting of derivative liabilities as of  December 31, 2016 :
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of December 31, 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
$
629

 
$

 
$
629

 
$
(629
)
 
$

 
$

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 PLM products; (2) the IoT 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
 
 
December 31,
2016
 
January 2,
2016
 
 
(in thousands)
Solutions Group
 
 
 
 
Revenue
$
218,736

 
$
228,594

 
Direct costs
45,932

 
49,744

 
Profit
172,804

 
178,850

 
 
 
 
 
 
IoT Group
 
 
 
 
Revenue
21,483

 
13,101

 
Direct costs
23,450

 
16,437

 
Loss
(1,967
)
 
(3,336
)
 
 
 
 
 
 
Professional Services
 
 
 
 
Revenue
46,108

 
49,322

 
Direct costs
37,824

 
42,014

 
Profit
8,284

 
7,308

 
 
 
 
 
 
Total segment revenue
286,327

 
291,017

 
Total segment costs
107,206

 
108,195

 
Total segment profit
179,121

 
182,822

 
 
 
 
 
 
Other unallocated operating expenses
168,275

 
158,967

 
Restructuring charges
6,285

 
37,147

 
Total operating income (loss)
4,561

 
(13,292
)
 
 
 
 
 
 
Interest and other expense, net
11,064

 
6,253

 
Loss before income taxes
$
(6,503
)
 
$
(19,545
)
 

12. Income Taxes
In the first quarter of 2017, our effective tax rate was (41)% on a pre-tax loss of $(6.5) million , compared to (22)% on pre-tax loss of $(19.5) million in the first quarter of 2016, respectively. In the first quarters of 2017 and 2016, 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 2017 and 2016, the foreign rate differential predominantly relates to these Irish earnings. Our foreign rate differential in 2017 and 2016 includes the continuing 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 first quarter of 2017 and 2016, this realignment resulted in a tax benefit of approximately  $7 million , and $3 million , respectively. Additionally, in the first three months of 2016, our provision reflects a tax benefit of $2.6 million related to a retroactive extension of the U.S. research and development tax credit enacted in the first quarter of 2016. This benefit was offset by a corresponding provision to increase our U.S. valuation allowance.
We have concluded, based on the weight of available evidence, that a full valuation allowance continues to be required against our U.S. net deferred tax assets as they are not more likely than not to be realized in the future. We will continue to reassess our valuation allowance requirements each financial reporting period.
In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service in the U.S. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. We are currently under audit by tax authorities in several jurisdictions. Audits by tax authorities typically involve examination of the deductibility of certain permanent items, limitations on net operating losses and

19


tax credits. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in material changes in our estimates.
As of December 31, 2016 and September 30, 2016, we had unrecognized tax benefits of $15.0 million and $15.5 million , respectively. If all of our unrecognized tax benefits as of December 31, 2016 were to become recognizable in the future, we would record a benefit to the income tax provision of $13.3 million , which would be partially offset by an increase in the U.S. valuation allowance of $5 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 $7.0 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 a tax audit of approximately $12 million .  The assessment relates to various tax issues but primarily to foreign withholding taxes. We have appealed 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 paid this assessment in the first quarter of 2017 pending resolution of the appeal.
13. Debt
At December 31, 2016 and September 30, 2016, we had the following long-term borrowing obligations:
 
December 31,
2016
 
September 30,
2016
 
(in thousands)
6.000% Senior notes due 2024
$
500,000

 
$
500,000

Credit facility-revolver
238,125

 
258,125

Total debt
738,125

 
758,125

Unamortized debt issuance costs for the Senior notes (1)
(6,363
)
 
(6,524
)
Total debt, net of issuance costs
$
731,762

 
$
751,601

 
 
 
 
Reported as
 
 
 
Current portion of long-term debt
$

 
$

Long-term debt
738,125

 
758,125

Total debt
$
738,125

 
$
758,125

(1) Unamortized debt issuance costs related to the credit facility were $3.8 million and $4.2 million as of December 31, 2016 and September 30, 2016, respectively, all of which was included in included in other assets.
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 December 31, 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.
As of December 31, 2016, the total estimated fair value of the Notes was approximately $532.5 million , which is based on quoted prices for the notes on that date.
Credit Agreement

20


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. We expect to use the credit facility for general corporate purposes, including acquisitions of businesses, share repurchases and working capital requirements. As of December 31, 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 December 31, 2016 , we had $238.1 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 December 31, 2016 , the annual interest rate for borrowing outstanding was 2.69% . 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 December 31, 2016 , our total leverage ratio was 3.45 to 1.00 , our senior secured leverage ratio was 1.09 to 1.00 and our fixed charge coverage ratio was 6.02 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.
In the first three months of 2017 and 2016 , interest expense of $10.3 million and $6.6 million was included in interest and other expense, net.
14. Commitments and Contingencies

21


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.
Legal Proceedings
On March 7, 2016, a putative class action lawsuit captioned  Matthew Crandall v. PTC Inc. et al ., No. 1:16-cv-10471, 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, ostensibly on behalf of purchasers of our stock during the period November 24, 2011 through July 29, 2015. The lawsuit, which seeks unspecified damages, interest, attorneys’ fees and costs, alleges (among other things) that, during that period, PTC’s public disclosures concerning investigations by the U.S. Securities and Exchange Commission and the U.S. Department of Justice into U.S. Foreign Corrupt Practices Act matters in China (the "China Investigation") were false and/or misleading.  The parties have agreed to settle this lawsuit for an amount that is not material to our results of operations and the associated liability was accrued in our fiscal 2016 results.  The settlement is subject to execution and final court approval of definitive settlement documentations. We cannot predict the outcome of this action nor when it will be resolved.
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 December 31, 2016 , we had a legal proceedings and claims accrual of $2.5 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. Subsequent Events
Borrowings
In January 2017, we borrowed $40 million under our credit facility to fund working capital requirements.
Sale of investment
In January 2017, we sold our cost method investment in a private company for $13.7 million for a gain of approximately $3.7 million .

22


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, 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: the 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 Internet of Things (IoT) business, may not expand and/or generate the revenue we expect; new products released and planned products, including IoT-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 EPS results and cash flows; 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 adversely impact 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 not achieve the expense savings we expect and may adversely affect our operations; we may be unable to generate sufficient operating cash flow to return 40% of free cash flow to shareholders and other uses of cash or our credit facility limits 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; and our non-U.S. earnings or any repatriation of or cash held outside the U.S., which constitutes a significant portion of our earnings and cash, could be subject to significant taxes; 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 financial measures. You can find an explanation of these measures in Results of Operations - Subscription Measures and Results of Operations - Non-GAAP Financial Measures below.
Business Overview
PTC is a global computer software and services company. We are organized in two primary businesses: the Internet of Things (IoT) and Solutions.
Internet of Things
IoT and Augmented Reality
Our IoT portfolio is comprised of our IoT, analytics and augmented reality software. This software enables connectivity, rapid application development, machine learning and predictive analysis, and augmented reality software applications for smart, connected products, factory operations, and other environments.
As the IoT gains momentum, software, sensors, and IP-enabled connectivity are increasingly embedded into the design and build of products and are becoming integral to the manufacturing and post-sales service processes. This transformation is taking shape across all manufacturing and industrial sectors. Our IoT software enables our customers to design, build and service smart, connected products.
Solutions
Our Solutions portfolio is comprised of our innovative Computer-Aided Design (CAD), Product Lifecycle Management (PLM) and Service Lifecycle Management (SLM) solutions for manufacturers to create, operate, and service smart, connected products.
Computer-Aided Design (CAD)
Effective and collaborative product design across the globe.


23


Product Lifecycle Management (PLM)
Efficient and consistent management of product development, including embedded software development, from concept to retirement across functional processes and distributed teams.
Service Lifecycle Management (SLM)
Planning and delivery of service, including service parts management, product intelligence, connected service, predictive service, and remote diagnostics.

Executive Overview
Our subscription transition continued to gain momentum in the first quarter of 2017. In the first quarter of 2017, subscription revenue grew 145% over the first quarter of 2016. Subscription bookings as a percentage of total license and subscription bookings grew 136% year over year. Approximately 86% of our software revenue in the first quarter of 2017 was recurring, up from 80% a year ago. In IoT, we had a record bookings quarter, driven by expansions and an increase in deal size with one large deal (greater than $1 million) and one mega-deal (greater than $5 million). Excluding the mega-deal and Kepware software bookings, which were not in the first quarter of last year, IoT license and subscription bookings were up over 90%. In our Solutions Group, bookings were driven by growth in CAD and in our core PLM Windchill and Navigate products. SLM bookings were down, due to a difficult comparison to results for the first quarter of 2016, which included a number of large perpetual deals.
Our success with our subscription initiative contributed to the decline in total software revenue and earnings as customers purchased fewer perpetual licenses and associated support and a portion of existing or lapsed support contracts were converted to subscription contracts. The decrease in support revenue was also due in part to two fewer days in the quarter. Professional services revenue was down 7% from the first quarter of 2016, due in part to the success of our strategy to migrate more service engagements to our partners -- service partner bookings grew approximately 30% year over year, with strong bookings growth among our large system integrator partners. The success of our subscription initiative also adversely affected earnings per share.
We ended the quarter with a cash balance of $173 million and marketable securities of $50 million. We used $48 million of cash from operations in the first quarter of 2017, which includes bonus and commission payments of $64 million, $16 million of restructuring payments, and our first bond interest payment of $15 million. At December 31, 2016 , the balance outstanding under our credit facility was $238 million and total debt outstanding was $738 million . In the first quarter of 2017 we repaid $20 million net under the credit facility.
Results for the First Quarter
Revenue was down year over year, due primarily to the growth in subscription bookings versus perpetual bookings, which adversely affected software revenue recognized in the current quarter, and, to a lesser extent, due to a decline in professional services revenue, consistent with our strategy to migrate more service engagements to our partners. The decline in revenue was offset by software revenue from our Kepware business, which we acquired in the second quarter of 2016.
 
 
Three Months Ended
 
 
 
Constant Currency Change
 
 
December 31, 2016
 
January 2, 2016
 
 
 
Revenue
 
 
 
Change
 
 
 
(in millions)
Subscription
 
$
54.4

 
$
22.2

 
145
 %
 
144
 %
Support
 
151.5

 
171.8

 
(12
)%
 
(12
)%
Total recurring software revenue
 
205.8

 
193.9

 
6
 %
 
6
 %
Perpetual license
 
34.4

 
47.8

 
(28
)%
 
(27
)%
Total software revenue
 
240.2

 
241.7

 
(1
)%
 
(1
)%
Professional services
 
46.1

 
49.3

 
(7
)%
 
(7
)%
Total revenue
 
$
286.3

 
$
291.0

 
(2
)%
 
(2
)%


24


 
 
Three Months Ended
 
 
 
 
 
December 31, 2016
 
January 2, 2016
 
 
 
Earnings Measures
 
 
 
Change
 
 
 
 
 
 
 
Operating Margin
 
1.6
%
 
(4.6
)%
 
 
 
Loss Per Share
 
$
(0.08
)
 
$
(0.21
)
 
(62
)%
 
 
 
 
 
 
 
 
 
Non-GAAP Operating Margin (1)
 
15.4
%
 
21.3
 %
 
 
 
Non-GAAP Earnings Per Share (1)
 
$
0.26

 
$
0.51

 
(49
)%
 
(1) Non-GAAP measures are reconciled to GAAP results under Results of Operations - Non-GAAP Measures  below.
 
Operating margins reflect lower revenue, primarily due to our subscription transition, and higher incentive-based compensation, partially offset by reductions in operating expenses driven by cost savings from restructuring actions. Our GAAP earnings also reflect restructuring charges of $6 million for the three months ended December 31, 2016 , compared to $37 million for the three months ended January 2, 2016.
Future Expectations, Strategies and Risks
Despite recent improvements in certain global macroeconomic factors, we continue to remain cautious of the global macroeconomic environment. Our transition to a subscription model was a headwind for revenue and earnings in the first quarter of 2017. We expect changes in foreign currency rates, relative to the prior year, to negatively impact results in the remainder of fiscal 2017.
Our 2017 initiatives are to: 1) focus on driving sustainable growth, 2) continue to expand our subscription-based licensing, and 3) continue to control costs and improve margins.
Sustainable Growth
Our goals for overall growth are predicated on continuing to grow in the IoT market and continuing to drive improvements in operational performance in our core Solutions business.
Subscription
Through 2015, the majority of our software licenses were sold as perpetual licenses, under which customers own the software license and revenue is recognized at the time of sale. We began offering subscription licensing for our core Solutions products in 2015 and expanded our subscription program in 2016. Under a subscription, customers pay a periodic fee to license our software and access technical support over a specified period of time. As part of our expanded subscription program, we also launched a program for our existing customers to convert their support contracts to subscription contracts. A number of customers converted their support contracts to subscriptions in 2016, and we expect there will be continued opportunities to convert existing support contracts to subscription contracts in 2017 and beyond due to the renewal cycles of some of those contracts. In the first quarter of 2017, subscription bookings were 65% of license and subscription bookings, compared to 28% in the first quarter of 2016; in 2016, 56% of our license and subscription bookings were subscriptions, compared to 17% in 2015.
We expect that a significant majority of our license and subscription bookings in 2017 could be subscription. The transition to a subscription licensing model has had, and will continue to have, an adverse impact on revenue, operating margin and EPS relative to periods in which we primarily sold perpetual licenses until the expected transition of our customer base to subscription is completed.
Cost Controls and Margin Expansion
We continue to proactively manage our cost structure and invest in what we believe are high return opportunities in our business. Our goal is to drive continued margin expansion over the long term. To that end, we restructured our workforce in 2016, and we completed facility-related restructuring actions in the first quarter of 2017. As of December 31, 2016, we were materially complete with those actions and had incurred total restructuring charges of approximately $83 million. Of that amount, $6 million was recorded in the first quarter of 2017.
We expect that the cost savings associated with the headcount and facility reductions will be offset by certain planned cost increases and investments in our business. As a result, we do not expect net operating expense reductions in 2017, as compared to 2016 levels.



25


Results of Operations
The following table shows the financial measures that we consider the most significant indicators of the performance of our business. In addition to operating income, operating margin, and diluted earnings per share as calculated under GAAP, the table also includes non-GAAP operating income, operating margin, and diluted earnings per share for the reported periods. We discuss the non-GAAP measures in detail, including items excluded from the measures, and provide a reconciliation to the comparable GAAP measures under Non-GAAP Financial Measures below.

Three months ended
 
Percent Change 2016 to 2017

December 31, 2016
 
January 2, 2016

Actual
 
Constant Currency

(Dollar amounts in millions, except per share data)
Subscription
$
54.4

 
$
22.2

 
145
 %
 
144
 %
Support
151.5

 
171.8

 
(12
)%
 
(12
)%
Total recurring software revenue
205.8

 
193.9

 
6
 %
 
6
 %
Perpetual license
34.4

 
47.8

 
(28
)%
 
(27
)%
Total software revenue
240.2

 
241.7

 
(1
)%
 
(1
)%
Professional services
46.1

 
49.3

 
(7
)%
 
(7
)%
Total revenue
286.3

 
291.0

 
(2
)%
 
(2
)%
Total cost of revenue
82.1

 
80.1

 
2
 %
 
 
Gross margin
204.2

 
210.9

 
(3
)%
 
 
Operating expenses
199.7

 
224.2

 
(11
)%
 
 
Total costs and expenses
281.8

 
304.3

 
(7
)%
 
(7
)%
Operating income (loss)
4.6

 
(13.3
)
 
(134
)%
 
(121
)%
Non-GAAP operating income  (1)
$
44.3

 
$
62.1

 
(29
)%
 
(40
)%
Operating margin
1.6
%
 
(4.6
)%
 
 
 
 
Non-GAAP operating margin  (1)
15.4
%
 
21.3
 %
 
 
 
 
Diluted loss per share
$
(0.08
)
 
$
(0.21
)
 
 
 
 
Non-GAAP diluted earnings per share (2)
$
0.26

 
$
0.51

 
 
 
 
Cash flow from (used in) operations
$
(48.0
)
 
$
61.3

 
 
 
 
 
 
 
 
 
 
 
 
(1) See Non-GAAP Measures  below for a reconciliation of our GAAP results to our non-GAAP measures.
(2) We have recorded a full valuation allowance against our U.S. net deferred tax assets and a valuation allowance against net deferred tax assets in certain foreign jurisdictions. As we are profitable on a non-GAAP basis, the 2017 and 2016 non-GAAP tax provisions are being calculated assuming there is no valuation allowance. Income tax adjustments for the three months ended January 2, 2016 reflect the tax effects of non-GAAP adjustments which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments listed above. Additionally, our non-GAAP tax provision for the three months ended January 2, 2016 excludes a $1.6 million tax provision related to a legal settlement accrual. Beginning in the second quarter of 2016, we changed our methodology to adopt a method that is more reflective of our full year expected non-GAAP tax rate. For the three months ended December 31, 2016, our non-GAAP tax provision is based on our annual expected non-GAAP tax rate applied to our year-to-date non-GAAP earnings.
Subscription Measures
Given the difference in revenue recognition between the sale of a perpetual software license (revenue is recognized at the time of sale) and a subscription (revenue is deferred and recognized ratably over the subscription term), we use bookings for internal planning, forecasting and reporting of new license and subscription sales and cloud services transactions.
Bookings
In order to normalize between perpetual and subscription licenses, we define subscription bookings as the subscription annualized contract value (subscription ACV) of new subscription bookings multiplied by a conversion factor of 2. We arrived

26


at the conversion factor of 2 by considering a number of variables, including pricing, support, length of term, and renewal rates. In 2016, the average subscription contract term was approximately two years.
We define subscription ACV as the total value of a new subscription booking divided by the term of the contract (in days), multiplied by 365. If the term of the subscription contract is less than a year, the ACV is equal to the total contract value.
We define license and subscription bookings as subscription bookings (as described above) plus perpetual license bookings plus any monthly software rental bookings during the period.
License and subscription bookings for the first quarter of 2017 were $90 million, up 31% over the first quarter of 2016.
We define total ACV as subscription ACV (as described above) plus the annualized value of incremental monthly software rental bookings during the period.
Because subscription bookings is a metric we use to approximate the value of subscription sales if sold as perpetual licenses, it does not represent the actual revenue that will be recognized with respect to subscription sales or that would be recognized if the sales had been perpetual licenses, nor does the annualized value of monthly software rental bookings represent the value of any such booking.
Annualized Recurring Revenue (ARR)
Annualized Recurring Revenue (ARR) for a given quarter is calculated by dividing the non-GAAP subscription and support software revenue for the quarter by the number of days in the quarter and multiplying by 365. ARR should be viewed independently of revenue and deferred revenue as it is an operating measure and is not intended to be combined with or to replace either of those items. ARR is not a forecast and does not include perpetual license or professional services revenues.
ARR was approximately $819 million for the first quarter of 2017, which increased 9% compared to the first quarter of fiscal 2016.
Impact of Foreign Currency Exchange on Results of Operations
Approximately two-thirds of our revenue and half of our expenses are transacted in currencies other than the U.S. Dollar. Because we report our results of operations in U.S. Dollars, currency translation, particularly changes in the Euro and Yen relative to the U.S. Dollar, affects our reported results. If actual results for the first quarter of 2017 had been converted into U.S. Dollars based on the foreign currency exchange rates in effect for the first quarter of 2016, revenue would have been lower by $1.1 million, costs and expenses would have been higher by $1.1 million, and operating income would have been lower by $2.2 million. Our constant currency disclosures are calculated by multiplying the actual results for the first three months of 2017 by the exchange rates in effect for the comparable period of 2016.
Revenue from Acquired Businesses
The results of operations of acquired businesses have been included in our consolidated financial statements beginning on their respective acquisition dates. Kepware, acquired in the second quarter of 2016, contributed approximately $6.6 million to our software revenue in the first quarter of 2017.
Allocations and Reclassifications
In 2016, we launched Navigate, a ThingWorx-based PLM solution. In 2017, revenue and bookings for Navigate are being allocated 50% to Solutions and 50% to IoT; 2016 reported amounts have been reclassified to conform to the current presentation. The impact of the reclassification on 2016 revenue was immaterial.
Deferred Revenue and Backlog (Unbilled Deferred Revenue)
We define unbilled deferred revenue as contractually committed orders for license, subscription and support with a customer for which the associated revenue has not been recognized and the customer has not been invoiced. We do not record unbilled deferred revenue on our Consolidated Balance Sheet until we invoice the customer. Deferred revenue primarily relates to software agreements invoiced to customers for which the revenue has not yet been recognized.
 
December 31, 2016
 
September 30, 2016
 
January 2, 2016
 
(Dollar amounts in millions)
Unbilled deferred revenue
$
450

 
$
369

 
$
188

Deferred revenue
375

 
414

 
389

Total
$
825

 
$
783

 
$
577

Total billed and unbilled deferred revenue increased 43% year over year and 5% sequentially primarily due to the increase in our subscription bookings, which are generally billed annually at the start of each annual subscription period. Billed deferred

27


revenue declined sequentially and year over year due to the timing of fiscal quarter ends and billing schedules. (Q1’17 ended on December 31, 2016 while Q1’16 ended on January 2, 2016.)
We expect that the amount of unbilled deferred revenue and deferred revenue will change from quarter to quarter for several reasons, including the specific timing, duration and size of large customer subscription and support agreements, varying billing cycles of such agreements, the specific timing of customer renewals, foreign currency fluctuations and the timing of when revenue is recognized.
Revenue
We report our revenue by line of business (as described above), by business group (Solutions and IoT Groups), and by geographic region (Americas, Europe, and Asia Pacific). Results include combined revenue from direct sales and our channel.
  Revenue by Line of Business
% of Total Revenue
 
Three months ended
 
December 31, 2016
 
January 2, 2016
Subscription
19
%
 
8
%
Support
53
%
 
59
%
Perpetual license
12
%
 
16
%
Professional services
16
%
 
17
%


Revenue by Business Group
Three months ended
 
 
 
 
 
Percent Change
 
December 31, 2016
 
January 2, 2016
 
Actual
 
Constant
Currency
 
(Dollar amounts in millions)
Solutions Group
 
 
 
 
 
 
 
Subscription
$
42.0

 
$
11.4

 
268
 %
 
266
 %
Support
148.7

 
169.8

 
(12
)%
 
(13
)%
Total recurring software revenue
190.7

 
181.2

 
5
 %
 
5
 %
Perpetual license
28.1

 
47.4

 
(41
)%
 
(40
)%
Total software revenue
218.7


228.6

 
(4
)%
 
(5
)%
Professional services
43.7

 
47.2

 
(7
)%
 
(8
)%
Total revenue
$
262.4

 
$
275.8

 
(5
)%
 
(5
)%
IoT Group
 
 
 
 
 
 
 
Subscription
$
12.3

 
$
10.8

 
15
 %
 
14
 %
Support
2.8

 
2.0

 
44
 %
 
44
 %
Total recurring software revenue
15.2

 
12.7

 
19
 %
 
19
 %
Perpetual license
6.3

 
0.4

 
1,564
 %
 
1,565
 %
Total software revenue
21.5

 
13.1

 
64
 %
 
64
 %
Professional services
2.4

 
2.1

 
15
 %
 
14
 %
Total revenue
$
23.9

 
$
15.2

 
57
 %
 
57
 %
Software Revenue Performance
Software revenue consists of subscription, support, and perpetual license revenue. Subscription revenue includes time-based licenses whereby customers use our software and receive related support for a specified term, and for which revenue is recognized ratably over the term of the contract. Support revenue is composed of contracts to maintain new and/or previously purchased perpetual licenses, for which revenue is recognized ratably over the term of the contract. Perpetual licenses include a perpetual right to use the software, for which revenue is generally recognized up front upon shipment to the customer.


28


Solutions Group
The decline in Solutions Group software revenue was driven by the higher than expected subscription mix in the quarter, as customers purchased fewer perpetual licenses and associated support contracts, a portion of existing support contracts converted to subscriptions, and there were fewer support win-backs in the channel as we launched a new win-back reactivation program in the third quarter of 2016, where customers return on a subscription basis. In addition, there were two fewer days in the fiscal quarter ended December 31, 2016, compared to the year-ago period, resulting in lower recurring software revenue. Recurring software revenue in the first quarter of 2017, compared to the first quarter of 2016, grew in CAD, PLM and SLM. CAD bookings in the first quarter of 2017 grew in the low teens, and we experienced solid growth in PLM, offset by a decline in SLM bookings, due to a difficult comparison to results for the first quarter of 2016, which included a number of large perpetual deals.
IoT Group
The IoT Group delivered revenue growth in the first quarter of 2017 driven by continued adoption and expansion of the ThingWorx platform, the Vuforia augmented reality solution, and Kepware solutions, which we acquired in the second quarter of 2016. In the first quarter of 2017, the IoT Group had one large deal (bookings greater than $1 million) and one mega-deal (bookings greater than $5 million).
Professional Services Revenue Performance
Consulting and training services engagements typically result from sales of new perpetual licenses and subscriptions, particularly of our PLM and SLM solutions. The decline in professional services revenue in the first quarter of 2017 was due in part to strong growth in bookings by our service partners, which is in line with our strategy for professional services revenue to trend flat-to-down over time as we e xpand our service partner program under which service engagements are referred to third-party service providers and to changes in how we deliver services to customers. Over time, we anticipate that we will continue to offer solutions that require less services and, as a result, we do not expect that professional services revenue will increase proportionately with software revenue.
Revenue by Geographic Region
 
Three months ended
 
Percent Change
 
December 31, 2016
 
January 2, 2016
 
Actual
 
Constant
Currency
 
(Dollar amounts in millions)
Software revenue by region:
 
 
 
 
 
 
 
Americas
$
106.9

 
$
108.1

 
(1
)%
 
(1
)%
Europe