Document


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 June 30, 2018
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth 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)
  
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
¨
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
There were 117,829,713 shares of our common stock outstanding on July 27, 2018.



PTC Inc.
INDEX TO FORM 10-Q
For the Quarter Ended June 30, 2018

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




PART I—FINANCIAL INFORMATION

ITEM 1.
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PTC Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
 
June 30,
2018
 
September 30,
2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
266,552

 
$
280,003

Short-term marketable securities
22,356

 
18,408

Accounts receivable, net of allowance for doubtful accounts of $591 and $1,062 at June 30, 2018 and September 30, 2017, respectively
130,079

 
152,299

Prepaid expenses
46,600

 
49,913

Other current assets
122,625

 
165,933

Total current assets
588,212

 
666,556

Property and equipment, net
64,456

 
63,600

Goodwill
1,182,462

 
1,182,772

Acquired intangible assets, net
214,657

 
257,908

Long-term marketable securities
31,816

 
31,907

Deferred tax assets
138,958

 
123,166

Other assets
35,070

 
34,475

Total assets
$
2,255,631

 
$
2,360,384

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
37,773

 
$
35,160

Accrued expenses and other current liabilities
58,296

 
80,761

Accrued compensation and benefits
87,401

 
110,957

Accrued income taxes
6,683

 
5,735

Deferred revenue
474,957

 
446,296

Total current liabilities
665,110

 
678,909

Long-term debt
693,053

 
712,406

Deferred tax liabilities
5,862

 
17,880

Deferred revenue
8,994

 
12,611

Other liabilities
48,227

 
53,142

Total liabilities
1,421,246

 
1,474,948

Commitments and contingencies (Note 13)

 

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

 

Common stock, $0.01 par value; 500,000 shares authorized; 115,491 and 115,333 shares issued and outstanding at June 30, 2018 and September 30, 2017, respectively
1,155

 
1,153

Additional paid-in capital
1,524,399

 
1,609,030

Accumulated deficit
(612,600
)
 
(650,840
)
Accumulated other comprehensive loss
(78,569
)
 
(73,907
)
Total stockholders’ equity
834,385

 
885,436

Total liabilities and stockholders’ equity
$
2,255,631

 
$
2,360,384








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

1


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

 
Three months ended
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Revenue:
 
 
 
 
 
 
 
Subscription
$
126,712

 
$
74,859

 
$
339,651

 
$
195,001

Support
121,127

 
140,428

 
379,007

 
433,624

Total recurring revenue
247,839

 
215,287

 
718,658

 
628,625

Perpetual license
25,780

 
32,348

 
82,604

 
94,099

Total subscription, support and license revenue
273,619

 
247,635

 
801,262

 
722,724

Professional services
41,158

 
43,658

 
128,041

 
134,936

Total revenue
314,777

 
291,293

 
929,303

 
857,660

Cost of revenue:
 
 
 
 
 
 
 
Cost of license and subscription revenue
24,010

 
21,648

 
71,505

 
62,333

Cost of support revenue
22,223

 
23,635

 
67,453

 
69,028

Total cost of software revenue
46,233

 
45,283

 
138,958

 
131,361

Cost of professional services revenue
35,323

 
36,985

 
109,187

 
114,852

Total cost of revenue
81,556

 
82,268

 
248,145

 
246,213

Gross margin
233,221

 
209,025

 
681,158

 
611,447

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
107,741

 
93,101

 
305,386

 
271,568

Research and development
61,218

 
59,850

 
187,381

 
175,474

General and administrative
33,082

 
35,294

 
101,439

 
108,789

Amortization of acquired intangible assets
7,850

 
7,973

 
23,566

 
23,986

Restructuring and other charges, net
1,627

 
1,551

 
1,846

 
8,300

Total operating expenses
211,518

 
197,769

 
619,618

 
588,117

Operating income
21,703

 
11,256

 
61,540

 
23,330

Interest expense
(10,646
)
 
(10,200
)
 
(31,072
)
 
(32,239
)
Interest income and other expense, net
(1,086
)
 
(357
)
 
(2,481
)
 
2,049

Income (loss) before income taxes
9,971

 
699

 
27,987

 
(6,860
)
Provision (benefit) for income taxes
(7,026
)
 
1,650

 
(10,809
)
 
4,336

Net income (loss)
$
16,997

 
$
(951
)
 
$
38,796

 
$
(11,196
)
Earnings (loss) per share—Basic
$
0.15

 
$
(0.01
)
 
$
0.33

 
$
(0.10
)
Earnings (loss) per share—Diluted
$
0.14

 
$
(0.01
)
 
$
0.33

 
$
(0.10
)
Weighted average shares outstanding—Basic
115,774

 
115,615

 
115,915

 
115,511

Weighted average shares outstanding—Diluted
117,500

 
115,615

 
117,687

 
115,511








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

2


PTC Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
 
 
Three months ended
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Net income (loss)
$
16,997

 
$
(951
)
 
$
38,796

 
$
(11,196
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized hedge gain (loss) arising during the period, net of tax of $0.6 million and $0.3 million in the third quarter of 2018 and 2017, respectively, and $0.1 million and $0 million in the first nine months of 2018 and 2017, respectively
3,910

 
(2,298
)
 
950

 
224

Net hedge (gain) loss reclassified into earnings, net of tax of $0 million in both the third quarter of 2018 and 2017, respectively, and $0.3 million and $0.1 million in the first nine months of 2018 and 2017, respectively
242

 
75

 
2,327

 
(777
)
Unrealized gain (loss) on hedging instruments
4,152

 
(2,223
)
 
3,277

 
(553
)
Foreign currency translation adjustment, net of tax of $0 for each period
(21,628
)
 
17,553

 
(8,859
)
 
3,893

Unrealized gain (loss) on marketable securities, net of tax of $0 for each period
67

 
21

 
(379
)
 
(50
)
Amortization of net actuarial pension loss included in net income, net of tax of $0.1 million and $0.2 million in the third quarter of 2018 and 2017, respectively, and $0.5 million and $0.7 million in the first nine months of 2018 and 2017, respectively
386

 
597

 
1,143

 
1,687

Change in unamortized pension loss during the period related to changes in foreign currency
884

 
(1,721
)
 
156

 
(343
)
Other comprehensive income (loss)
(16,139
)
 
14,227

 
(4,662
)
 
4,634

Comprehensive income (loss)
$
858

 
$
13,276

 
$
34,134

 
$
(6,562
)



























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

3


PTC Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
Cash flows from operating activities:
 
 
 
Net income (loss)
$
38,796

 
$
(11,196
)
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
 
 
 
Depreciation and amortization
65,303

 
64,187

Stock-based compensation
52,015

 
56,139

Other non-cash items, net
304

 
1,536

Changes in operating assets and liabilities, excluding the effects of acquisitions:
 
 
 
Accounts receivable
21,195

 
34,913

Accounts payable and accrued expenses
(16,539
)
 
2,594

Accrued compensation and benefits
(22,348
)
 
(50,518
)
Deferred revenue
82,794

 
45,985

Accrued income taxes
(30,005
)
 
(17,832
)
Other current assets and prepaid expenses
(5,434
)
 
(7,317
)
Other noncurrent assets and liabilities
(759
)
 
(16,028
)
Net cash provided by operating activities
185,322

 
102,463

Cash flows from investing activities:
 
 
 
Additions to property and equipment
(18,666
)
 
(19,333
)
Purchase of intangible asset
(3,000
)
 

Purchases of short- and long-term marketable securities
(18,063
)
 
(14,173
)
Proceeds from maturities of short- and long-term marketable securities
13,640

 
13,440

Acquisitions of businesses, net of cash acquired
(3,000
)
 
(4,960
)
Purchases of investments
(1,000
)
 

Proceeds from sales of investments

 
15,218

Net cash used by investing activities
(30,089
)
 
(9,808
)
Cash flows from financing activities:
 
 
 
Borrowings under credit facility
200,000

 
150,000

Repayments of borrowings under credit facility
(220,000
)
 
(190,000
)
Repurchases of common stock
(100,000
)
 
(34,994
)
Proceeds from issuance of common stock
7,472

 
3,978

Credit facility origination costs

 
(184
)
Contingent consideration
(7,750
)
 
(11,054
)
Payments of withholding taxes in connection with vesting of stock-based awards
(44,797
)
 
(26,244
)
Net cash used in financing activities
(165,075
)
 
(108,498
)
Effect of exchange rate changes on cash and cash equivalents
(3,609
)
 
(1,397
)
Net increase (decrease) in cash and cash equivalents
(13,451
)
 
(17,240
)
Cash and cash equivalents, beginning of period
280,003

 
277,935

Cash and cash equivalents, end of period
$
266,552

 
$
260,695


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 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, 2017. 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. The September 30, 2017 Consolidated Balance Sheet included herein is derived from our audited consolidated financial statements.
Unless otherwise indicated, all references to a year mean our fiscal year, which ends on September 30. Our fiscal quarters end on a Saturday following a thirteen-week calendar, and may result in different quarter end dates year to year. The third quarter of 2018 ended on June 30, 2018 and the third quarter of 2017 ended on July 1, 2017. The results of operations for the nine months ended June 30, 2018 are not necessarily indicative of the results expected for the remainder of the fiscal year.
Reclassifications
Effective at the beginning of fiscal 2018, in accordance with the adoption of ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, excess tax benefits are now classified as an operating activity on the statement of cash flows rather than as a financing activity. The prior period excess tax benefits have been reclassified for comparability.
Segments
In fiscal 2017, we had three operating and reportable segments: (1) the Solutions Group, which included license, subscription, support and cloud services revenue for our core CAD, SLM and PLM products; (2) the IoT Group, which included license, subscription, support and cloud services revenue for our IoT, analytics and augmented reality solutions; and (3) Professional Services, which included consulting, implementation and training revenue.
With a change in our organizational structure to streamline our operations, we merged our Solution Group segment with our IoT Group segment and 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 first quarter of fiscal 2018, we changed our operating and reportable segments from three to two: (1) Software Products, which includes license, subscription and related support revenue (including updates and technical support) for all our products; and (2) Professional Services, which includes consulting, implementation and training services.
Revenue and operating income in Note 10. Segment Information have been reclassified to conform to the current period presentation.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. We adopted ASU No. 2016-09 in the first quarter of 2018.

5


Effective with the adoption, stock-based compensation excess tax benefits or deficiencies are reflected in the Consolidated Statements of Operations as a component of the provision for income taxes when the awards vest or are settled. Previously they were recognized in equity. Upon adoption, under the modified retrospective transition method, we recognized the previously unrecognized excess tax benefits of $37.0 million as increases in deferred tax assets for tax loss carryovers and tax credits, $36.9 million of which were offset by an increase in our U.S. valuation allowance.
Additionally, on our Consolidated Statements of Cash Flows excess tax benefits from stock-based awards will no longer be separately classified as a financing activity apart from other income tax, and will be presented as an operating activity. As a result of the adoption of ASU 2016-09, the Consolidated Statement of Cash Flows for the nine months ended July 1, 2017 was adjusted as follows: a $0.4 million increase to net cash provided by operating activities and a $0.4 million decrease to net cash used in financing activities.
Finally, we have elected to account for forfeitures as they occur, rather than estimate expected forfeitures, which resulted in a cumulative effect adjustment of $0.7 million to reduce retained earnings as of October 1, 2017.
Pending Accounting Pronouncements
Derivative Financial Instruments
In August 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-12, "Derivatives and Hedging (Topic 815) Targeted Improvements to Accounting for Hedging Activities", which amends and simplifies existing guidance to allow companies to more accurately present the economic effects of risk management activities in the financial statements. The guidance is effective for annual reporting periods beginning after December 15, 2018 (our fiscal 2020) 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.
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. We expect to record a net deferred tax asset of approximately $77 million upon adoption, primarily relating to deductible amortization of intangible assets in Ireland.  Post adoption, our effective tax rate will no longer include the benefit of this amortization, which is reflected in our effective tax rate reconciliation under the current guidance. 
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.
Revenue Recognition
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09). ASU 2014-09 supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The FASB has also issued additional standards to provide clarification and implementation guidance on ASU 2014-09.
The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to a customer in an amount that reflects the consideration that is expected to be received for those goods or services. Under the new guidance, an entity is required to evaluate revenue recognition through a five-step process: (1) identifying a contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations in the contract; and (5) recognizing revenue when (or as) the entity satisfies

6


a performance obligation. The standard also requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In applying the principles of ASU 2014-09, it is possible more judgment and estimates may be required within the revenue recognition process than is required under existing U.S. GAAP, including identifying performance obligations, estimating the amount of variable consideration to include in the transaction price, and estimating the value of each performance obligation to allocate the total transaction price to each separate performance obligation.
ASU 2014-09 is effective for us in our first quarter of fiscal 2019. Companies may adopt ASU 2014-09 using either the retrospective method, under which each prior reporting period is presented under ASU 2014-09, with the option to elect certain permitted practical expedients, or the modified retrospective method, under which a company adopts ASU 2014-09 from the beginning of the year of initial application with no restatement of comparative periods, with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application, with certain additional required disclosures. We currently expect to adopt ASU 2014-09 using the modified retrospective method.
While we are continuing to assess the impact of the new standard, we currently believe the most significant impact relates to accounting for our subscription arrangements that include term-based on-premise software licenses bundled with support. Under current GAAP, revenue attributable to these subscription licenses is recognized ratably over the term of the arrangement because VSOE does not exist for the undelivered support element as it is not sold separately. Under the new standard, the requirement to have VSOE for undelivered elements to enable the separation of revenue for the delivered software licenses is eliminated. Accordingly, under the new standard we will be required to recognize as revenue a portion of the subscription fee upon delivery of the software license. We currently expect revenue related to our perpetual licenses and related support contracts, professional services and cloud offerings to remain substantially unchanged. Due to the complexity of certain of our contracts, the actual revenue recognition treatment required under the new standard may be dependent on contract-specific terms and, therefore, may vary in some instances.
Upon implementation of the new standard in fiscal 2019, we expect to make prospective revisions to contract terms with our customers that will result in shortening the initial, non-cancellable term of our multi-year subscriptions to one year for contract periods that begin on or after October 1, 2018. This change will result in annual contractual periods for most of our software subscriptions, the license portion of which will be recognized at the beginning of each annual contract period upon delivery of the licenses and the support portion of which will be recognized ratably over the one-year contractual period. As a result, we anticipate one year of subscription revenue will be recognized for each contract each year; however, more of the revenue will be recognized in the quarter that the contract period begins and less will be recognized in the subsequent three quarters of the contract than under the current accounting rules.
Under the modified retrospective method, we will evaluate each contract that is ongoing on the adoption date as if that contract had been accounted for under ASU 2014-09 from contract inception. Some license revenue related to subscription arrangements that would have been recognized in future periods under current GAAP will be recast under ASU 2014-09 as if the revenue had been recognized in prior periods. Under this transition method, we will not adjust historical reported revenue amounts. Instead, the revenue that would have been recognized under this method prior to the adoption date will be an adjustment to retained earnings and will not be recognized as revenue in future periods as previously expected. Because we expect that license revenue associated with subscription contracts will be recognized up front instead of over time under ASU 2014-09, we expect a material portion of our deferred revenue will be adjusted to retained earnings upon adoption. During the first year of adoption, we will record and disclose the amount of this retained earnings adjustment and intend to provide supplemental disclosure of how this revenue would have been recognized under the current rules.
Another significant provision under ASU 2014-09 includes the capitalization and amortization of costs associated with obtaining a contract, such as sales commissions. Currently, we expense sales commissions in the period incurred. Under ASU 2014-09, direct and incremental costs to acquire a contract are capitalized and amortized using a systematic basis over the pattern of transfer of the goods and services to which the asset relates. While we are continuing to assess the impact of this provision of ASU 2014-09, we likely will be required to capitalize incremental costs such as commissions and amortize those costs over the period the capitalized assets are expected to contribute to future cash flows.

7


Furthermore, we have made and will continue to make investments in systems and processes to enable timely and accurate reporting under the new standard. We currently expect that necessary operational and internal control structural changes will be implemented prior to the adoption date.
2. Deferred Revenue and Related Customer Receivables
Deferred Revenue
Deferred revenue primarily relates to software agreements billed to customers for which the subscription and support services have not yet been provided. The liability associated with performing these subscription and support 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 June 30, 2018 and September 30, 2017 were $108.7 million and $160.9 million, respectively.
3. Restructuring and Other Charges
Restructuring Charges (Credits)
In fiscal 2016, we initiated a plan to restructure our workforce and consolidate select facilities to reduce our cost structure and to realign our investments with what we believe to be our higher growth opportunities. The actions have resulted in total restructuring charges of $84.5 million, primarily associated with termination benefits associated with approximately 800 employees. This restructuring plan was substantially completed in 2017.
The following table summarizes restructuring accrual activity for the nine months ended June 30, 2018:
 
Employee severance and related benefits
 
Facility closures and related costs
 
Total
 
(in thousands)
October 1, 2017
$
1,736

 
$
4,508

 
$
6,244

Credit to operations, net
(509
)
 
(505
)
 
(1,014
)
Cash disbursements
(1,247
)
 
(1,207
)
 
(2,454
)
Foreign exchange impact
20

 
(80
)
 
(60
)
Accrual, June 30, 2018
$

 
$
2,716

 
$
2,716


The following table summarizes restructuring accrual activity for the nine months ended July 1, 2017:
 
Employee severance and related benefits
 
Facility closures and related costs
 
Total
 
(in thousands)
October 1, 2016
$
35,177

 
$
1,431

 
$
36,608

Charges to operations, net
2,582

 
5,718

 
8,300

Cash disbursements
(33,979
)
 
(1,351
)
 
(35,330
)
Other non-cash charges

 
(704
)
 
(704
)
Foreign exchange impact
(800
)
 
98

 
(702
)
Accrual, July 1, 2017
$
2,980

 
$
5,192

 
$
8,172

Of the accrual for facility closures and related costs, as of June 30, 2018, $1.6 million is included in accrued expenses and other current liabilities and $1.1 million is included in other liabilities in the Consolidated Balance Sheets. The accrual for facility closures is net of assumed sublease income of $3.1 million. The accrual for employee severance and related benefits is included in accrued compensation and benefits in the Consolidated Balance Sheets.

8


Other - Headquarters relocation charges
Headquarters relocation charges represent accelerated depreciation expense recorded in anticipation of exiting our current headquarters facility. In 2019, we will be moving into a new worldwide headquarters in the Boston Seaport District, and we will be vacating our current headquarters space. Because our current headquarters lease will not expire until November 2022, we are seeking to sublease that space. Further, if we are unable to sublease our current headquarters space for an amount at least equal to our rent obligations under the current headquarters lease, we will bear overlapping rent obligations for those premises and will be required to record additional headquarters relocation charges related to any rent shortfall. A charge for such shortfall will be recorded in the earlier of the period that we cease using the space (which will likely occur in the second quarter of our fiscal 2019) or the period we exit the lease contract. Additionally, we will incur other costs associated with the move which will be recorded as incurred. In the third quarter and first nine months of 2018, we recorded $1.9 million and $2.9 million, respectively, of accelerated depreciation expense related to shortening the estimated useful lives of leasehold improvements in our current facility.
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 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.
Beginning in the first quarter of 2018, we account for forfeitures as they occur, rather than estimate expected forfeitures.
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 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. 
Restricted stock unit activity for the nine months ended June 30, 2018
Shares
 
Weighted
Average
Grant Date
Fair Value
(Per Share)
 
(in thousands)
 
 
Balance of outstanding restricted stock units October 1, 2017
3,487

 
$
45.57

Granted (1)
2,167

 
$
75.99

Vested
(1,804
)
 
$
43.94

Forfeited or not earned
(531
)
 
$
50.95

Balance of outstanding restricted stock units June 30, 2018
3,319

 
$
65.48

 _________________
(1) Restricted stock granted includes 184,000 shares from prior period TSR awards that were earned upon achievement of the performance criteria and vested in November 2018.
 
Restricted Stock Units
Grant Period
Performance-based RSUs (1)
 
Service-based RSUs (2)
 
(Number of Units in thousands)
First nine months of 2018
961
 
1,022
_________________

9


(1)
Substantially all the performance-based RSUs were granted to our executive officers. Approximately 189,000 shares are eligible to vest based upon annual performance measures, measured over a three-year period. RSUs not earned for a period may be earned in the third period. An additional 250,000 shares are eligible to vest based upon a 2018 performance measure. To the extent earned, those performance-based RSUs will vest in three substantially equal installments on November 15, 2018, November 15, 2019 and November 15, 2020, or the date the Compensation Committee determines the extent to which the applicable performance criteria have been achieved for each performance period. An additional 500,000 shares are eligible to vest based upon annual performance measures, measured over a three-year period in fiscal years 2021, 2022 and 2023. RSUs not earned for a period may be earned in the third period.
(2)
The service-based RSUs were granted to employees, our executive officers and our directors. Substantially all service-based RSUs will vest in three substantially equal annual installments on or about the anniversary of the date of grant.
Compensation expense recorded for our stock-based awards was classified in our Consolidated Statements of Operations as follows:
 
Three months ended
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
(in thousands)
Cost of license and subscription revenue
$
421

 
$
347

 
$
1,242

 
$
954

Cost of support revenue
527

 
1,139

 
2,025

 
3,638

Cost of professional services revenue
1,471

 
1,505

 
4,846

 
4,500

Sales and marketing
4,910

 
3,296

 
14,827

 
11,047

Research and development
3,283

 
2,805

 
9,626

 
9,753

General and administrative
6,046

 
7,482

 
19,449

 
26,247

Total stock-based compensation expense
$
16,658

 
$
16,574

 
$
52,015

 
$
56,139

Stock-based compensation expense includes $1.1 million and $3.2 million in the third quarter and first nine months of 2018, respectively, and $0.9 million and $2.2 million in the third quarter and first nine months of 2017, respectively, related to the ESPP.
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 as additional proceeds.
 
Three months ended
 
Nine months ended
Calculation of Basic and Diluted EPS
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
(in thousands, except per share data)
Net income (loss)
$
16,997

 
$
(951
)
 
$
38,796

 
$
(11,196
)
Weighted average shares outstanding—Basic
115,774

 
115,615

 
115,915

 
115,511

Dilutive effect of restricted stock units
1,726

 

 
1,772

 

Weighted average shares outstanding—Diluted
117,500

 
115,615

 
117,687

 
115,511

Earnings (loss) per share—Basic
$
0.15

 
$
(0.01
)
 
$
0.33

 
$
(0.10
)
Earnings (loss) per share—Diluted
$
0.14

 
$
(0.01
)
 
$
0.33

 
$
(0.10
)


10


There were 0.1 million antidilutive shares for the nine months ended June 30, 2018. Total antidilutive shares were 2.0 million for the nine months ended July 1, 2017. For the nine months ended July 1, 2017 the diluted net loss per share is the same as the basic net loss per share as the effects of all our potential common stock equivalents are antidilutive, because we reported a loss for the period.
Common Stock Repurchases
Our Articles of Organization authorize us to issue up to 500 million shares of our common stock. Our Board of Directors periodically authorizes the repurchase of shares of our common stock. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.
On September 14, 2017, our Board of Directors authorized us to repurchase up to $500 million of our common stock in the period October 1, 2017 through September 30, 2020. In the first nine months of 2018 and 2017, we repurchased $100 million and $35 million, respectively, of our common stock. The 2018 repurchase was accomplished through an accelerated share repurchase ("ASR") agreement with a major financial institution that we entered into in April 2018. Under this ASR, we repurchased our common stock at a purchase price determined by the average market price over a period of time, with final settlement in June 2018.
In July 2018, our Board of Directors has authorized us to repurchase up to an additional $1,000 million of our common stock through September 30, 2020. We entered into a new $1,000 million ASR as described in Note 14. Subsequent Events. Final settlement of this ASR is expected to occur in 7.5 to 10 months.
6. Goodwill and Intangible Assets
In 2017, we had three operating and reportable segments: (1) Solutions Group, (2) IoT Group and (3) Professional Services. Effective with the beginning of the first quarter of 2018, we changed our operating and reportable segments from three to two: (1) Software Products and (2) 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 June 30, 2018, goodwill and acquired intangible assets in the aggregate attributable to our Software Products segment was $1,366.8 million and our Professional Services segment was $30.3 million. As of September 30, 2017, goodwill and acquired intangible assets in the aggregate attributable to our Software Products segment was $1,410.0 million and our Professional Services segment was $30.6 million. Acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.
We completed our annual goodwill impairment review as of June 30, 2018 based on a qualitative assessment. Our qualitative assessment included company specific (financial performance and long-range plans), industry, and macroeconomic factors, and consideration of the fair value of each reporting unit relative to its carrying value at the last valuation date. Based on our qualitative assessment, we believe it is more likely than not that the fair values of our reporting units exceed their carrying values and no further impairment testing is required.

11


Goodwill and acquired intangible assets consisted of the following:
 
June 30, 2018
 
September 30, 2017
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
(in thousands)
Goodwill (not amortized)
 
 
 
 
$
1,182,462

 
 
 
 
 
$
1,182,772

Intangible assets with finite lives (amortized) (1):
 
 
 
 
 
 
 
 
 
 
 
Purchased software
$
362,992

 
$
247,694

 
$
115,298

 
$
362,955

 
$
228,377

 
$
134,578

Capitalized software
22,877

 
22,877

 

 
22,877

 
22,877

 

Customer lists and relationships
357,904

 
262,982

 
94,922

 
359,932

 
241,554

 
118,378

Trademarks and trade names
19,080

 
14,643

 
4,437

 
19,138

 
14,186

 
4,952

Other
4,013

 
4,013

 

 
4,030

 
4,030

 

 
$
766,866

 
$
552,209

 
$
214,657

 
$
768,932

 
$
511,024

 
$
257,908

Total goodwill and acquired intangible assets
 
 
 
 
$
1,397,119

 
 
 
 
 
$
1,440,680

(1) The weighted-average useful lives of purchased software, customer lists and relationships, and trademarks and trade names with a remaining net book value are 9 years, 10 years, and 10 years, respectively.
Goodwill
Changes in goodwill presented by reportable segments were as follows: 
 
Software Products
 
Professional Services
 
Total
 
(in thousands)
Balance, October 1, 2017
$
1,152,917

 
$
29,855

 
$
1,182,772

Acquisition
4,350

 

 
4,350

Foreign currency translation adjustment
(4,542
)
 
(118
)
 
(4,660
)
Balance, June 30, 2018
$
1,152,725

 
$
29,737

 
$
1,182,462

Amortization of Intangible Assets
The aggregate amortization expense for intangible assets with finite lives was classified in our Consolidated Statements of Operations as follows:
 
Three months ended
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
(in thousands)
Amortization of acquired intangible assets
$
7,850

 
$
7,973

 
$
23,566

 
$
23,986

Cost of license and subscription revenue
6,798

 
6,517

 
20,029

 
19,294

Total amortization expense
$
14,648

 
$
14,490

 
$
43,595

 
$
43,280


12


7. Fair Value Measurements
Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. Generally accepted accounting principles prescribe a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs that may be used to measure fair value:
Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or
Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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 of 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.

13


Our significant financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and September 30, 2017 were as follows:
 
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
85,382

 
$

 
$

 
$
85,382

Marketable securities

 


 

 

Certificates of deposit

 
219

 

 
219

Corporate notes/bonds
52,962

 

 

 
52,962

U.S. government agency securities

 
991

 

 
991

Forward contracts

 
4,956

 

 
4,956

 
$
138,344

 
$
6,166

 
$

 
$
144,510

Financial liabilities:


 


 

 

Contingent consideration related to acquisitions
$

 
$

 
$
2,100

 
$
2,100

Forward contracts

 
1,190

 

 
1,190

 
$

 
$
1,190

 
$
2,100

 
$
3,290

 
September 30, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Financial assets:
 
 
 
 
 
 
 
Cash equivalents
$
49,845

 
$

 
$

 
$
49,845

Marketable securities

 


 

 

Certificates of deposit

 
240

 

 
240

Corporate notes/bonds
47,673

 

 

 
47,673

U.S. government agency securities

 
2,402

 

 
2,402

Forward contracts

 
1,163

 

 
1,163

 
$
97,518

 
$
3,805

 
$

 
$
101,323

Financial liabilities:


 


 

 

Contingent consideration related to acquisitions
$

 
$

 
$
8,400

 
$
8,400

Forward contracts

 
4,347

 

 
4,347

 
$

 
$
4,347

 
$
8,400

 
$
12,747


Changes in the fair value of Level 3 contingent consideration liability associated with our acquisitions were as follows:
 
Contingent Consideration
 
(in thousands)
 
Kepware
 
Other
 
Total
Balance, October 1, 2017
$
8,400

 
$

 
$
8,400

Addition to contingent consideration

 
2,100

 
2,100

Payment of contingent consideration
(8,400
)
 

 
(8,400
)
Balance, June 30, 2018
$

 
$
2,100

 
$
2,100


14


 
Contingent Consideration
 
(in thousands)
 
ColdLight
 
Kepware
 
Total
Balance, October 1, 2016
$
2,500

 
$
17,070

 
$
19,570

Change in present value of contingent consideration

 
392

 
392

Payment of contingent consideration
(2,500
)
 
(9,600
)
 
(12,100
)
Balance, July 1, 2017
$

 
$
7,862

 
$
7,862

 In the Consolidated Balance Sheet as of June 30, 2018, $1.1 million of the contingent consideration liability is included in accrued expenses and other current liabilities with the remaining $1.0 million in other liabilities.
Of the $8.4 million payments in the first nine months of 2018, $7.8 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. Of the $12.1 million payments in the first nine months of 2017, $11.1 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 connection with our acquisition of Kepware, the former shareholders were eligible to receive additional consideration of up to $18.0 million, which was 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 1, 2016. The estimated undiscounted range of outcomes for the contingent consideration was $16.9 million to $18.0 million at the acquisition date. As of June 30, 2018, we had made $18.0 million in payments and had no liability remaining.
8. Marketable Securities
The amortized cost and fair value of marketable securities as of June 30, 2018 and September 30, 2017 were as follows:

June 30, 2018

Amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair value
 
(in thousands)
Certificates of deposit
$
221

 
$

 
$
(2
)
 
$
219

Corporate notes/bonds
53,474

 

 
(512
)
 
52,962

U.S. government agency securities
1,000

 

 
(9
)
 
991


$
54,695

 
$

 
$
(523
)
 
$
54,172


September 30, 2017

Amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair value
 
(in thousands)
Certificates of deposit
$
240

 
$

 
$

 
$
240

Corporate notes/bonds
47,811

 
2

 
(140
)
 
47,673

U.S. government agency securities
2,407

 

 
(5
)
 
2,402


$
50,458

 
$
2

 
$
(145
)
 
$
50,315

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.
We review our investments to identify and evaluate investments that have an indication of possible impairment. We concluded that, at June 30, 2018, the unrealized losses were temporary. The following tables summarize the fair value and gross unrealized losses aggregated by category and the length of

15


time that individual securities have been in a continuous unrealized loss position as of June 30, 2018 and September 30, 2017.
 
June 30, 2018
 
Less than twelve months
 
Greater than twelve months
 
Total
 
Fair Value
 
Gross unrealized loss
 
Fair Value
 
Gross unrealized loss
 
Fair Value
 
Gross unrealized loss
 
(in thousands)
Certificates of deposit
$
219

 
$
(2
)
 
$

 
$

 
$
219

 
$
(2
)
Corporate notes/bonds
31,516

 
(358
)
 
21,446

 
(154
)
 
52,962

 
(512
)
U.S. government agency securities

 

 
991

 
(9
)
 
991

 
(9
)
 
$
31,735

 
$
(360
)
 
$
22,437

 
$
(163
)
 
$
54,172

 
$
(523
)

 
September 30, 2017
 
Less than twelve months
 
Greater than twelve months
 
Total
 
Fair Value
 
Gross unrealized loss
 
Fair Value
 
Gross unrealized loss
 
Fair Value
 
Gross unrealized loss
 
(in thousands)
Certificates of deposit
$
240

 
$

 
$

 
$

 
$
240

 
$

Corporate notes/bonds
15,254

 
(43
)
 
28,885

 
(97
)
 
44,139

 
(140
)
U.S. government agency securities

 

 
2,402

 
(5
)
 
2,402

 
(5
)
 
$
15,494

 
$
(43
)
 
$
31,287

 
$
(102
)
 
$
46,781

 
$
(145
)

The following table presents our available-for-sale marketable securities by contractual maturity date as of June 30, 2018 and September 30, 2017.

June 30, 2018
 
September 30, 2017

Amortized cost
 
Fair value
 
Amortized cost
 
Fair value
 
(in thousands)
 
(in thousands)
Due in one year or less
$
22,300

 
$
22,170

 
$
18,274

 
$
18,244

Due after one year through three years
32,395

 
32,002

 
32,184

 
32,071


$
54,695

 
$
54,172

 
$
50,458

 
$
50,315

9. 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

16


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 income and other expense, net.
As of June 30, 2018 and September 30, 2017, we had outstanding forward contracts with notional amounts equivalent to the following:
Currency Hedged
June 30,
2018
 
September 30,
2017
 
(in thousands)
Australian / U.S. Dollar
$
3,226

 
$
1,585

Canadian / U.S. Dollar
7,421

 
12,809

Swiss Franc / Euro

 
7,157

Chinese Yuan offshore / Euro

 
10,423

Euro / U.S. Dollar
309,733

 
244,000

Japanese Yen / Euro

 
17,694

Israeli Shekel / U.S. Dollar
7,677

 
8,820

Japanese Yen / U.S. Dollar
18,152

 
3,198

Swedish Krona / U.S. Dollar
8,568

 
4,627

Danish Krona / U.S. Dollar
2,645

 
1,743

Hong Kong / U.S. Dollar
2,628

 
915

All other
8,151

 
5,548

Total
$
368,201

 
$
318,519

The following table shows the effect of our non-designated hedges in the Consolidated Statements of Operations for the three and nine months ended June 30, 2018 and July 1, 2017:
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
 
Nine months ended
 
 
 
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
 
 
 
(in thousands)
Forward Contracts
 
Interest income and other expense, net
 
$
(9,392
)
 
$
6,669

 
$
(6,370
)
 
$
(1,422
)
In the three and nine months ended June 30, 2018, foreign currency losses, net were $2.2 million and $5.4 million, respectively. In the three and nine months ended July 1, 2017, foreign currency losses, net were $0.7 million and $3.2 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 is 15 months.
Cash flow hedge relationships are designated at inception, and effectiveness is assessed prospectively and retrospectively using regression analysis monthly. 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 it into earnings in the 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

17


contingent features. We manage credit risk with counterparties by trading among several counterparties and we review our counterparties’ credit at least quarterly.
As of June 30, 2018 and September 30, 2017, we had outstanding forward contracts designated as cash flow hedges with notional amounts equivalent to the following:
Currency Hedged
June 30,
2018
 
September 30,
2017
 
(in thousands)
Euro / U.S. Dollar
$
44,699

 
$
64,831

Japanese Yen / U.S. Dollar
11,830

 
22,675

SEK / U.S. Dollar
10,521

 
14,091

Total
$
67,050

 
$
101,597

The following table shows the effect of our derivative instruments designated as cash flow hedges in the Consolidated Statements of Operations for the three and nine months ended June 30, 2018 and July 1, 2017 (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
 
 
June 30,
2018
 
July 1,
2017
 
 
 
June 30,
2018
 
July 1,
2017
 
 
 
June 30,
2018
 
July 1,
2017
Forward Contracts
 
$
4,468

 
$
(2,627
)
 
Subscription, support and license revenue
 
$
(277
)
 
$
(86
)
 
Interest income and other expense, net
 
$
52

 
$
(29
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended
 
 
 
Nine months ended
 
 
 
Nine months ended
 
 
June 30,
2018
 
July 1,
2017
 
 
 
June 30,
2018
 
July 1,
2017
 
 
 
June 30,
2018
 
July 1,
2017
Forward Contracts
 
$
1,086

 
$
256

 
Subscription, support and license revenue
 
$
(2,659
)
 
$
888

 
Interest income and other expense, net
 
$
17

 
$
(23
)

As of June 30, 2018, we estimated that all amounts reported in accumulated other comprehensive income will be reclassified to income within the next twelve months.
If 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 income and other expense, net on the Consolidated Statements of Operations. For the three and nine months ended June 30, 2018 and July 1, 2017, there were no such gains or losses.

18


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
 
June 30,
2018
 
September 30,
2017
 
June 30,
2018
 
September 30,
2017
 
(in thousands)
 
(in thousands)
Derivative assets (1):
 
 
 
 
 
 
 
       Forward Contracts
$
1,994

 
$
540

 
$
2,962

 
$
623

Derivative liabilities (2):
 
 
 
 
 
 
 
       Forward Contracts
$
16

 
$
2,352

 
$
1,174

 
$
1,995

(1) As of June 30, 2018, $4,956 thousand current derivative assets are recorded in other current assets, in the Consolidated Balance Sheets. As of September 30, 2017, $1,128 thousand current derivative assets are recorded in other current assets, and $35 thousand long-term derivative assets are recorded in other assets in the Consolidated Balance Sheets.
(2) As of June 30, 2018, $1,190 thousand current derivative liabilities are recorded in accrued expenses and other current liabilities in the Consolidated Balance Sheets. As of September 30, 2017, $4,329 thousand current derivative liabilities are recorded in accrued expenses and other current liabilities, and $18 thousand long term derivative liabilities are recorded in other liabilities in the Consolidated Balance Sheets.

Offsetting Derivative Assets and Liabilities
We have entered into master netting arrangements that allow net settlements under certain conditions. Although netting is permitted, it is currently our policy and practice to record all derivative assets and liabilities on a gross basis in the Consolidated Balance Sheets.
The following table sets forth the offsetting of derivative assets as of June 30, 2018:
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of June 30, 2018
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
$
4,956

 
$

 
$
4,956

 
$
(1,190
)
 
$

 
$
3,766


The following table sets forth the offsetting of derivative liabilities as of June 30, 2018:
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
As of June 30, 2018
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
$
1,190

 
$

 
$
1,190

 
$
(1,190
)
 
$

 
$



19


10. Segment Information
Effective with the beginning of fiscal 2018, we changed our segments, see Note 1. Basis of Presentation for additional information. We operate within a single industry segment -- computer software and related services. Operating segments as defined under GAAP are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our President and Chief Executive Officer. We have two operating and reportable segments: (1) Software Products, which includes license, subscription and related support revenue (including updates and technical support) for all our products; and (2) Professional Services, which includes consulting, implementation and training services. We do not allocate sales & marketing or general and administrative expense to our operating segments as these activities are managed on a consolidated basis. Additionally, 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.


20


 
Three months ended
 
Nine months ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
(in thousands)
Software Products
 
 
 
 
 
 
 
Revenue
$
273,619

 
$
247,635

 
$
801,262

 
$
722,724

Operating Costs (1)
96,422

 
94,325

 
293,417

 
273,196

Profit
177,197

 
153,310

 
507,845

 
449,528

 
 
 
 
 
 
 
 
Professional Services
 
 
 
 
 
 
 
Revenue
41,158

 
43,658

 
128,041

 
134,936

Operating Costs (2)
33,945

 
35,588

 
104,634

 
110,681

Profit
7,213

 
8,070

 
23,407

 
24,255

 
 
 
 
 
 
 
 
Total segment revenue
314,777

 
291,293

 
929,303

 
857,660

Total segment costs
130,367

 
129,913

 
398,051

 
383,877

Total segment profit
184,410

 
161,380

 
531,252

 
473,783

 
 
 
 
 
 
 
 
Unallocated operating expenses:
 
 
 
 
 
 
 
Sales and marketing expenses
102,831

 
89,805

 
290,559

 
260,521

General and administrative expenses
25,458

 
27,263

 
80,272

 
81,270

Restructuring and headquarters relocation charges, net
1,627

 
1,551

 
1,846

 
8,300

Intangibles amortization
14,648

 
14,490

 
43,595

 
43,280

Stock-based compensation
16,658

 
16,574

 
52,015

 
56,139

Other unallocated operating expenses (3)
1,485

 
441

 
1,425

 
943

Total operating income
21,703

 
11,256

 
61,540

 
23,330

 
 
 
 
 
 
 
 
Interest expense
(10,646
)
 
(10,200
)
 
(31,072
)
 
(32,239
)
Interest income and other expense, net
(1,086
)
 
(357
)
 
(2,481
)
 
2,049

Income (loss) before income taxes
$
9,971

 
$
699

 
$
27,987

 
$
(6,860
)
(1) Operating costs for the Software Products segment includes all cost of software revenue and research and development costs, excluding stock-based compensation and intangible amortization.
(2) Operating costs for the Professional Services segment includes all cost of professional services revenue, excluding stock-based compensation, intangible amortization, and fair value adjustments for deferred services costs.
(3) Other unallocated operating expenses include acquisition-related and other transactional costs, pension plan termination-related costs and fair value adjustments for deferred services costs.

11. Income Taxes
In the third quarter and first nine months of 2018, our effective tax rate was (70)% on pre-tax income of $10.0 million, and (39)% on pre-tax income of $28.0 million, respectively, compared to 236% on pre-tax income of $0.7 million, and (63)% on a pre-tax loss of $6.9 million in the third quarter and first nine months of 2017, respectively. In the first nine months of 2018 and 2017, our effective tax rate was lower than the statutory federal income tax rates (21% and 35%, respectively) due to U.S. tax reform, as described below, and 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 2018 and 2017, the foreign rate differential predominantly relates to these Irish earnings. Our foreign rate differential in 2018 and 2017 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. For the first nine months of 2018 and 2017, this realignment resulted in tax benefits of approximately $9 million and $21 million, respectively.

21


On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act, (the "Tax Act"), which significantly changed existing U.S. tax laws by a reduction of the corporate tax rate, the implementation of a new system of taxation for non-U.S. earnings, the imposition of a one-time tax on the deemed repatriation of undistributed earnings of non-U.S. subsidiaries, and by the expansion of the limitations on the deductibility of executive compensation and interest expense. As we have a September 30 fiscal year-end, there is a blended U.S. statutory federal rate of approximately 24.5% for our fiscal year ending September 30, 2018 and 21% for subsequent fiscal years. The Tax Act also provides that net operating losses generated in years ending after December 31, 2017 will be carried forward indefinitely and can no longer be carried back, and that net operating losses generated in years beginning after December 31, 2017 can only reduce taxable income by up to 80% when utilized in a future period.
We estimate no federal income taxes payable as a result of the deemed repatriation of undistributed earnings as we estimate that the tax will be offset by a combination of current year losses and existing attributes which had a full valuation allowance recorded against the related deferred tax assets. In the third quarter we reduced our estimate for state income taxes payable by $5.4 million to reflect additional guidance on the state implications of the Tax Act. In the first nine months of 2018, we recorded a reasonable estimate of state income taxes payable on the deemed repatriation of $1.7 million.  We also recorded a deferred tax benefit of $14.1 million as a reasonable estimate of the impact of the Tax Act on our net U.S. deferred income tax balances. This was primarily attributable to the reduction of the federal tax rate on the net deferred tax liability in the U.S., and the ability to realize net operating losses from the reversal of existing deferred tax assets which can now be carried forward indefinitely and can therefore be netted against deferred tax liabilities for indefinite lived intangible assets.
We are continuing to assess the effects of the Tax Act on our indefinite reinvestment assertion and the realizability of our U.S. deferred tax assets. We are not able to make reasonable estimates at this time of the effects of certain provisions of the Tax Act that will apply to us beginning in our fiscal year ending September 30, 2019, including the Global Intangible Low Tax Income tax (the "GILTI" tax).
The changes included in the Tax Act are broad and complex. The final transition impacts of the Tax Act may differ from the above estimates, possibly materially, due to, among other things, changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, actions taken by U.S. state governments and taxing authorities in response to the Tax Act, any changes in accounting standards for income taxes or related interpretations in response to the Tax Act, or any updates or changes to estimates we have utilized to calculate the transition impacts, including impacts from changes to current year earnings estimates and foreign currency exchange rates of foreign subsidiaries. The Securities Exchange Commission has issued rules that allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. We currently anticipate finalizing and recording any resulting adjustments by the end of our current fiscal year ending September 30, 2018.
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 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 June 30, 2018 and September 30, 2017, we had unrecognized tax benefits of $9.7 million and $14.8 million, respectively. If all our unrecognized tax benefits as of June 30, 2018 were to become recognizable in the future, we would record a benefit to the income tax provision of $9.7 million, which would be partially offset by an increase in the U.S. valuation allowance of $3.8 million
Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in favorable or unfavorable changes in our estimates. We believe it is reasonably possible that within the next 12 months the amount of unrecognized tax benefits related to

22


the resolution of multi-jurisdictional tax positions could be reduced by up to $2 million as audits close and statutes of limitations expire.
In the fourth quarter of 2016, we received an assessment of approximately $12 million from the tax authorities in Korea.  The assessment relates to various tax issues, primarily foreign withholding taxes. We have appealed and intend to vigorously defend our positions. We believe that upon completion of a multi-level appeal process it is more likely than not that our positions will be sustained.  Accordingly, we have not recorded a tax reserve for this matter. We paid this assessment in the first quarter of 2017 and have recorded the amount in other assets, pending resolution of the appeal process.
In the first quarter of 2018, as a result of the adoption of ASU 2016-09, we recognized previously unrecognized tax benefits of $37.0 million as increases in deferred tax assets for tax loss carryovers and tax credits, primarily in the U.S. A corresponding increase to the valuation allowance of $36.9 million was recorded to the extent that it was not more likely than not that these benefits would be realized.
12. Debt
At June 30, 2018 and September 30, 2017, we had the following long-term debt obligations:
 
June 30,
2018
 
September 30,
2017
 
(in thousands)
6.000% Senior notes due 2024
$
500,000

 
$
500,000

Credit facility revolver
198,125

 
218,125

Total debt
698,125

 
718,125

Unamortized debt issuance costs for the Senior notes (1)
(5,072
)
 
(5,719
)
Total debt, net of issuance costs (2)
$
693,053

 
$
712,406

(1) Unamortized debt issuance costs related to the credit facility were $1.3 million and $2.0 million as of June 30, 2018 and September 30, 2017, respectively, and were included in other assets.
(2) As of June 30, 2018 and September 30, 2017, all debt was included in long-term debt.
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 the covenants as of June 30, 2018.
On or 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 would 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 June 30, 2018, the total estimated fair value of the Notes was approximately $520 million, based on quoted prices for the notes on that date.
Credit Agreement
In November 2015, we entered into a multi-currency credit facility with a syndicate of sixteen banks for which JPMorgan Chase Bank, N.A. acts as Administrative Agent. We use the credit facility for general corporate purposes, including acquisitions of businesses, share repurchases and working capital requirements. As of June 30, 2018, the fair value of our credit facility approximates its book value.
The credit facility consists of a $600 million revolving loan commitment. The loan commitment may be increased by an additional $500 million (in the form of revolving loans or term loans, or a combination

23


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 may borrow 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.  In addition, PTC's 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 June 30, 2018, we had $198.1 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 June 30, 2018, the annual interest rate for borrowings outstanding was 3.88%. 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 4.50 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 June 30, 2018, our total leverage ratio was 2.45 to 1.00, our senior secured leverage ratio was 0.73 to 1.00 and our fixed charge coverage ratio was 6.82 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.
13. Commitments and Contingencies
Legal and Regulatory Matters
Korean Tax Audit
In July 2016, we received an assessment of approximately $12 million from the tax authorities in Korea related to an ongoing tax audit. See Note 11. Income Taxes for additional information.

24


Legal Proceedings
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 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 June 30, 2018, we estimate approximately $1.1 million to $3.1 million in legal proceedings and claims, of which we had accrued $1.0 million.
Accounts Receivable
Accounts receivable as of June 30, 2018 includes an amount invoiced under a multi-year contract for which the period of performance, and related revenue recognized, has spanned a number of years (with no revenue recognized since the first quarter of 2017). The invoiced amount is being disputed by the customer. If we are unable to reach a mutual business resolution, we intend to vigorously pursue collection of the full invoiced amount. If we are unsuccessful in collecting the full invoiced amount, there could be a write-down of accounts receivable and professional services revenue, which could range from $0 to $17.3 million.
Guarantees and Indemnification Obligations
We enter into standard indemnification agreements in the ordinary course of our business. Under 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, accordingly, we 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.

14. Subsequent Events
Investment in PTC
As part of a strategic partnership, on July 19, 2018, Rockwell Automation made a $1,000 million equity investment in PTC, by acquiring 10,582,010 shares at a price of $94.50 per share, which represented a premium over our closing share price on June 11, 2018, the date upon which we entered into a securities purchase agreement. The Chairman and CEO of Rockwell Automation has joined PTC's board of directors.
Share Repurchases
We entered into a $1,000 million accelerated share repurchase ("ASR") agreement with a major financial institution ("Bank") on July 20, 2018. We used cash proceeds from the Rockwell Automation investment to fund the repurchase.

25


On July 20, 2018, 8,244,873 shares repurchased at the market price of $97.03 per share were delivered to us (totaling $800 million). The remaining $200 million represents the amount held back by the Bank pending final settlement of the ASR. Upon settlement of the ASR, the total shares repurchased by us will equal up to $1,000 million divided by a share price equal to the average daily volume weighted-average price of our common stock during the term of the ASR program less a fixed per share discount. Final settlement of the ASR will occur between 7.5-months and 10-months after execution, at the Bank's discretion. All shares repurchased are automatically restored to the status of authorized and unissued.

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 fourth quarter and full fiscal 2018 targets, and other future financial and growth expectations and targets and anticipated tax rates, 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 deteriorate; customers may not purchase our solutions or convert existing support contracts to subscription 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; foreign currency exchange rates may vary from our expectations and thereby affect our reported revenue and expense; the mix of revenue between license & subscription solutions, support and professional services could be different than we expect, which could impact our EPS results; our transition to subscription-only licensing could adversely affect sales and revenue; sales of our solutions as subscriptions may not have the longer-term effect on revenue and earnings that we expect; bookings associated with minimum ACV commitments under our strategic alliance agreement with Rockwell Automation may not result in subscription contracts sold through to end-user customers; we may be unable to expand our partner ecosystem as we expect and our partners may not generate the revenue we expect; we may be unable to improve performance in Japan when or as we expect; we may be unable to generate sufficient operating cash flow to return 40% of free cash flow to shareholders and other uses of cash or our credit facility limits or other matters could preclude share repurchases. In addition, our assumptions concerning our future GAAP and non-GAAP effective income tax rates are based on estimates and other factors that could change, including the geographic mix of our revenue, expenses and profits, as well as other risks and uncertainties described below throughout or referenced in Part II, Item 1 A. Risk Factors of this report.
Business Overview
PTC is a global computer software and services company. We offer industrial Internet of Things (IoT) solutions that enable companies to connect smart things and environments, manage and analyze data generated by those things and environments, and create industrial IoT applications and Augmented Reality (AR) experiences that transform the way users create, operate, and service products. We also offer a solutions portfolio of innovative Computer-Aided Design (CAD), Product Lifecycle Management (PLM) and Service Lifecycle Management (SLM) solutions that enable manufacturers to create, innovate, operate, and service products.

26


2018 Strategic Goals
          http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12380941&doc=83
Sustainable Growth
Our goals are predicated on continuing to drive bookings growth both in the high-growth IoT market and in our core CAD and PLM markets.

          http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12380941&doc=13

Expand Subscription Licensing
Our goal is to increase the percentage of licenses sold as subscriptions to increase our recurring revenue. Effective January 1, 2018, new software licenses for our core solutions and ThingWorx solutions are available only by subscription in the Americas and Western Europe. Perpetual and subscription licenses will be available to customers outside the Americas and Western Europe through December 31, 2018. Effective January 1, 2019, only subscription software licenses for our core solutions and ThingWorx industrial innovation platform will be available. Kepware will continue to be available under perpetual licensing.
          http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12380941&doc=12

Cost Controls and Margin Expansion
Our goal is to drive continued margin expansion over the long term. We continue to proactively manage our cost structure and invest in what we believe are high return opportunities in our business. We expect to deliver continued operating margin expansion in 2018, and we expect further margin expansion in 2019 and beyond, as we realize the compounding benefit of our maturing subscription business.
Operating and Non-GAAP Financial Measures
Our discussion of results includes discussion of our operating measures (including “license and subscription bookings” and other subscription-related measures) and non-GAAP financial measures. Our operating measures and non-GAAP financial measures, including the reasons we use those measures, are described below in Results of Operations - Operating Measures and Results of Operations - Non-GAAP Financial Measures, respectively. You should read those sections to understand those operating and non-GAAP financial measures.
Executive Overview
Our revenue results in the quarter reflect the adoption of subscription licensing by our customers and the compounding effect of the subscription business model as subscription revenue recurs and new subscription revenue is added in the year. Subscription revenue, software revenue and total revenue were all up over the third quarter of 2017, despite a 1,400 basis point increase in subscription mix year over year. Recurring revenue represented approximately 91% of our software revenue in the third quarter of 2018, up from 87% a year ago. Our revenue results also drove our operating margin results for the quarter despite increases in sales and marketing and research and development expenses, with both GAAP and non-GAAP operating margins, and EPS up over the prior year period.
In fiscal 2018, we have focused on several new strategic partnerships. We continued to see momentum with the Microsoft partnership that we signed early in the second quarter, closing ten new joint deals in the quarter. In the third quarter, we entered into a significant strategic alliance agreement with Rockwell Automation to align our respective factory automation software solutions and sell a combined software suite into our respective markets. We also entered into a strategic agreement with Ansys to embed breakthrough simulation capabilities inside our Creo product to create the first fully-integrated CAD and real-time simulation solution.

27


http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12380941&doc=80
 
 
Three months ended
 
 
 
Constant Currency Change
 
Nine months ended
 
 
 
Constant Currency Change
 
 
June 30, 2018
 
July 1, 2017
 
 
 
 
June 30, 2018
 
July 1, 2017
 
 
 
Revenue
 
 
 
Change