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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.
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.
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.
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:
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:
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.
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:
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:
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:
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.
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.
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.
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)
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:
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
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
(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
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.
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.
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.
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
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.
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.
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.
(1) Non-GAAP
measures are reconciled to GAAP results under Results of Operations - Non-GAAP Financial Measures below.
We ended the quarter with cash, cash equivalents and marketable securities of $321 million. We generated $185 million of cash from operations in the first nine months of 2018, compared to $102 million in the first nine months of 2017. As part of our previously announced share repurchase program, we completed a $100 million accelerated stock repurchase agreement and retired 1.15 million shares during the quarter. We borrowed $150 million, in part to finance the share repurchase, $100 million of which was repaid prior to quarter end. At June 30, 2018, the balance outstanding under our credit facility was $198 million
and total debt outstanding was $693 million, net of deferred financing fees.
28
Operating Measures
We provide these measures to help investors understand the progress of our subscription transition. These measures are not necessarily indicative of revenue for the period or any future period.
License and Subscription Bookings
License and subscription bookings for the third quarter of 2018 were $113 million, up 26% (23% on a constant currency basis) compared to the third quarter of 2017. On a year-to-date basis, license and subscription bookings were $316 million, up 15% (11% on a constant
currency basis) over the first nine months of 2017. For the first nine months of 2018 we saw continued strength in license and subscription bookings across our product portfolio, particularly from PLM, CAD, and IoT (when adjusted for an eight-figure booking in the first quarter of 2017), which all grew at or above our estimated market growth rates. For the second quarter in a row, SLM posted solid license and subscription bookings. IoT license and subscription bookings also benefited from customer expansions, which accounted for over 50% of our ThingWorx bookings. Additionally, our global channel continues to exceed expectations, growing license and subscription bookings in double-digits for the tenth consecutive quarter.
Subscription bookings as a percentage of license and subscription bookings in the third quarter and first nine months of 2018 increased by 1400 basis points and 700 basis points, respectively, compared
to the third quarter and first nine months of 2017. Subscription bookings as a percentage of license and subscription bookings continued to grow in the third quarter of 2018 despite foreign exchange headwinds and a geographic mix of sales slightly more weighted to Asia Pacific, where we still sell perpetual licenses. Subscription license bookings increased in part due to customers finding our subscription license offerings more attractive than our perpetual license and support offerings, our incentive plans that are designed to drive subscription sales and the fact that we began offering our software (other than Kepware) only by subscription in the Americas and Western Europe at the beginning of our second quarter of 2018. Subscription license bookings also increased due to support contract conversion and channel program incentives. We have further significant opportunities
to convert support contracts to subscriptions.
Americas license and subscription bookings grew 9% and 8% in the third quarter and the first nine months of 2018 compared to the year-ago periods. European license and subscription bookings increased 16% (11% constant currency) and 11% (3% constant currency) in the third quarter and first nine months of 2018 compared to the year-ago periods; the year-over-year comparison is negatively impacted by a $7 million deal we closed in the fourth quarter of 2017 instead of the first quarter of 2018. Asia Pacific license and subscription bookings increased by more than 20% in the third quarter and the first nine months of 2018 compared to the year-ago periods, driven by solid performance in China, Taiwan and Korea and by an easier comparison due to weak performance in Japan in the third quarter
of 2017. Japan performed above our expectations in the third quarter, and we believe the challenges there are behind us.
Subscription ACV
Subscription ACV increased 54% over the third quarter of 2017 to $44 million. The increase in subscription ACV is primarily due to strong subscription bookings in the quarter. The subscription mix increased year over year to 78% of total bookings. Both of these measures are tied to the increase in bookings discussed above.
Annualized Recurring Revenue (ARR)
ARR was approximately $994 million for the third quarter of 2018, which increased 15% ($129 million) year over year and grew 3% ($33 million) sequentially.
Deferred Revenue and Backlog (Unbilled Deferred Revenue)
Deferred
revenue primarily relates to software agreements invoiced to customers for which the revenue has not yet been recognized. Unbilled deferred revenue is the aggregate of contractually committed orders for license, subscription and support for which the associated revenue has not been recognized and the customer has not been invoiced. We generally do not invoice prior to the contractual subscription start date and for multi-year contracts we generally invoice annually. We do not record unbilled deferred revenue on our Consolidated Balance Sheet. When we invoice the customer, we record it as deferred revenue (billed).
Total
billed and unbilled deferred revenue increased 33% year-over-year and declined 4% compared to the second quarter of 2018 (sequentially). Billed deferred revenue grew 4% year-over-year and declined 3% sequentially, due to the timing of billings in the year. Recurring revenue billings on July 1, which were included in the third quarter of 2017 but not in the third quarter of 2018, were approximately $39 million in 2018. Unbilled deferred revenue grew 64% year-over-year and declined 5% sequentially; the sequential decline was due to the timing of billings in the year and exchange rate headwinds. The average contract duration has remained approximately 2 years for new subscription contracts.
We expect that the amount of unbilled deferred revenue
and billed deferred revenue will change from quarter to quarter due to 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, the timing of our fiscal quarter ends, foreign currency fluctuations and the timing of when revenue is recognized.
Results of Operations
The following table shows the financial measures that we consider the most significant indicators of the performance of our business. Results include combined software revenue from direct sales and our reseller channel. In addition to operating income, operating margin, and diluted earnings per share as calculated under GAAP, the table also includes non-GAAP operating income, non-GAAP operating margin, and non-GAAP 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.
(Dollar amounts in millions, except per share data)
Subscription
$
126.7
$
74.9
69
%
65
%
$
339.7
$
195.0
74
%
69
%
Support
121.1
140.4
(14
)%
(17
)%
379.0
433.6
(13
)%
(16
)%
Total
recurring revenue
247.8
215.3
15
%
12
%
718.7
628.6
14
%
11
%
Perpetual
license
25.8
32.3
(20
)%
(23
)%
82.6
94.1
(12
)%
(15
)%
Total
subscription, support and license revenue
273.6
247.6
10
%
7
%
801.3
722.7
11
%
7
%
Professional
services
41.2
43.7
(6
)%
(8
)%
128.0
134.9
(5
)%
(10
)%
Total
revenue
314.8
291.3
8
%
5
%
929.3
857.7
8
%
5
%
Total
cost of revenue
81.6
82.3
(1
)%
248.1
246.2
1
%
Gross
margin
233.2
209.0
12
%
681.2
611.4
11
%
Operating
expenses
211.5
197.8
7
%
619.6
588.1
5
%
Total
costs and expenses
293.1
280.0
5
%
2
%
867.8
834.3
4
%
1
%
Operating
income
21.7
11.3
93
%
45
%
$
61.5
$
23.3
164
%
6
%
Non-GAAP
operating income (1)
$
56.4
$
44.9
26
%
13
%
$
161.4
$
134.2
20
%
3
%
Operating
margin
6.9
%
3.9
%
6.6
%
2.7
%
Non-GAAP
operating margin (1)
17.9
%
15.4
%
17.3
%
15.6
%
Diluted
earnings (loss) per share
$
0.14
$
(0.01
)
$
0.33
$
(0.10
)
Non-GAAP
diluted earnings per share (2)
$
0.36
$
0.28
$
1.00
$
0.84
Cash
flow from operations (3)
$
49.0
$
73.7
$
185.3
$
102.5
(1)
See Non-GAAP Financial Measures below for a reconciliation of our GAAP results to our non-GAAP measures.
(2) We have 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 2018 and 2017 non-GAAP tax provisions are calculated assuming there is no valuation allowance. Income tax adjustments reflect the tax effects of non-GAAP adjustments which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments listed above. We have recorded the impact of the Tax Cuts and Jobs Act in our first quarter 2018 GAAP earnings, resulting in a non-cash benefit of approximately $7 million. In the third quarter of 2018, we increased the non-cash benefit by approximately $5 million
to reflect additional guidance on the state tax implications of the act. We have excluded this benefit from our non-GAAP results.
(3) Cash flow from operations for the nine months ended June 30, 2018 includes $2.5 million of restructuring payments. Cash flow from operations for the nine months ended July 1, 2017 includes $35.3 million of restructuring payments, a $12 million payment related to a Korea tax audit, and $3.3 million of legal settlement payments.
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, Yen, Shekel, and Rupee relative to the U.S. Dollar, affects our reported results. If actual results for the third quarter and first nine months of 2018 had been converted into U.S. Dollars based on the foreign currency exchange rates in effect for the third quarter and first nine months of 2017, revenue would have been lower by $9.6 million and $35.8 million, respectively, costs and expenses would have been lower by $5.9 million and $22.4 million, respectively, and operating income would have been lower by $3.7 million and $13.4 million, respectively. Our constant currency disclosures are calculated by multiplying the actual results for the first nine months of 2018 by the exchange rates in effect for the comparable period of 2017 excluding the effect of any hedging.
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Revenue
We
discuss our revenue results by line of business, by product group and by geographic region below.
Revenue by Line of Business
Software
Software revenue consists of subscription, support, and perpetual license revenue. Subscription revenue is comprised of 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 comprised 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 are a perpetual right to use the software, for which revenue is generally recognized up front upon shipment to the customer. Our subscription revenue includes an immaterial amount of Software as a Service (SaaS) and cloud services for which revenue is generally recognized ratably over the term of the contract.
As our mix of subscription sales relative to perpetual license sales has increased, perpetual license revenue and support revenue have declined and are expected to continue to decline as customers purchase our solutions as subscriptions and convert existing perpetual licenses with support contracts
to subscriptions. As our subscription business matures, recurring software revenue growth is expected to accelerate due to the compounding benefit of a subscription business model.
Professional Services
Consulting and training services engagements typically result from sales of new licenses; revenue is recognized over the term of the engagement. Professional services revenue was down 6% (8% constant currency) in the third quarter and down 5% (10% constant currency) for the first nine months of 2018 compared to the year-ago periods. These results are in line with our expectation that professional services revenue will trend flat-to-down over time due to our strategy to expand margins by migrating more services engagements to our partners and delivering products that require less consulting and training services.
Software revenue for the third quarter and first nine months of 2018 increased over the third quarter and first nine months of 2017 as a result of strong CAD, PLM and global channel license and subscription bookings over the past two years, offset by a significant increase in the subscription mix in the current period. Subscription sales have increased in part due to our support conversion programs that we have been offering over the past few years whereby customers may convert existing perpetual licenses and support to a new subscription. Recurring software revenue grew 13% both in the third quarter and first nine months of 2018 over the third quarter and first nine months of 2017, and has grown double-digits for six consecutive quarters.
Professional services revenue for the third quarter and first nine months of 2018 declined compared to the third quarter and first nine
months of 2017 due to our strategy to limit the amount of professional services we provide.
IoT Group
Software revenue for the third quarter and first nine months of 2018 increased compared to the third quarter and first nine months of 2017 due to increases in license and subscription bookings over the past two years, offset by a significant increase in the subscription mix. Software revenue for the third quarter of 2018 increased 10% sequentially over the second quarter of 2018. Recurring software revenue grew 33% both in the third quarter and first nine months of 2018 over the third quarter and first nine months of 2017. Recurring software revenue increased 7% sequentially over the second quarter of 2018.
Professional services revenue increased in the third quarter and first nine months of 2018 due in part to implementation and
adoption services we provide to our IoT customers as part of our efforts to help their IoT initiatives be successful.
33
Revenue by Geographic Region
Total revenue grew in all regions for the third quarter and first nine months of 2018 compared to the year-ago periods.
Strong license and subscription bookings have been driving revenue growth in the Americas, with new license and subscriptions bookings up 9% and 8% for the third quarter and first nine months of 2018 compared to the year-ago periods, despite a significant increase in the subscription mix.
Europe
Europe revenue growth is the result of seven double-digit year-over-year license and subscription bookings growth quarters between the fourth quarter of 2016 and the third quarter of 2018, despite an increase in subscription mix in the third quarter of 2018 compared to the third quarter of 2017.
Asia Pacific
Asia Pacific revenue growth is due to improved license and subscription bookings performance
of more than 20% in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017, driven by solid performance in China, Taiwan and Korea and by an easier
34
comparison due to weak performance in Japan in the third quarter of 2017, despite a significant increase in the subscription mix.
(1)
Non-GAAP measures are reconciled to GAAP results under Non-GAAP Financial Measures below.
The increase in total gross margin in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 is in line with total revenue growth. Total revenue in both the third quarter and first nine months of 2018 grew 8% over the third quarter and first nine months of 2017. Margins for license and subscription are beginning to expand as the subscription model matures and revenue that has been deferred begins to contribute to each quarterly period. Support gross margins are down in the third quarter and first nine months of 2018 compared to the third
quarter and first nine months 2017 primarily due to decreases in support revenue of 14% and 13%, respectively. The support revenue decreases are associated with an increase in our subscription mix and the conversion of existing customers from perpetual licenses with support contracts to subscription.
The professional services gross margin decreased slightly in the third quarter of 2018 compared to the third quarter of 2017 and remained flat in the first nine months of 2018 compared to the first nine months of 2017 due to the decline in revenue, offset by cost management. Professional services revenue declined 6% and 5% in the third quarter and first nine months of 2018, respectively, compared to the year ago periods. The decline in professional services revenue in the first nine months of 2018 is in line with our strategy to migrate
more services engagements to our partners and to deliver products that require less consulting and training services.
Costs
and expenses in the third quarter of 2018 compared to the third quarter of 2017 increased primarily as a result of the following:
•
a $10.7 million ($6.0 million constant currency) increase in compensation expense primarily due to salary and headcount increases and an increase in commission expenses,
•
a $2.5 million increase in cloud services hosting costs; of which $1.3 million is included in cost of license and subscription revenue, and
•
a
$1.6 million increase in transactional charges related to structuring strategic agreements,
offset by:
•
a $1.8 million decrease in restructuring charges.
Costs and expenses for the third quarter of 2018 compared to the year ago period include a $5.9 million increase due to changes in foreign currency exchange rates.
Costs and expenses for the first nine months of 2018 compared to the first nine months of 2017 increased primarily as a result of the following:
•
a
$33.4 million ($16.9 million constant currency) increase in compensation expense primarily due to salary and headcount increases and an increase in commission expenses,
•
a $6.5 million increase in cloud services hosting costs, of which $3.1 million is included in cost of license and subscription revenue,
•
a $1.9 million increase in facility costs (including depreciation), and
•
a
$1.1 million increase in acquisition-related and transactional charges related to structuring strategic agreements,
offset by:
•
a $9.3 million decrease in restructuring charges, and
•
a $3.8 million decrease in professional fees.
Costs and expenses for the first nine months of 2018 compared to the year ago period include a $22.4 million increase due to changes in foreign currency exchange rates.
Our
cost of license and subscription includes cost of license, which consists of fixed and variable costs associated with reproducing and distributing software and documentation, as well as royalties paid to third parties for technology embedded in or licensed with our software products, amortization of intangible assets associated with acquired products, and cost of subscription, which includes our cost of cloud services and our cost of software as a service revenue. Costs associated with providing post-contract support such as providing software updates and technical support for both our subscription offerings and our perpetual licenses are included in cost of support revenue. Cost of license and subscription revenue as a percent of license and subscription revenue can vary depending on the subscription mix percentage, the product mix sold, the effect of fixed and variable royalties,
headcount and the level of amortization of acquired software intangible assets.
In the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017, total compensation increased 2% ($0.2 million) and 13% ($3.4 million), respectively, due to increases in salaries, benefit costs and higher travel expenses. Cloud services hosting costs increased by 42% ($1.3 million) and 38% ($3.1 million), respectively, in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017.
Cost of license and subscription revenue as a percentage of license and subscription revenue has decreased in the third quarter and first
nine months of 2018 compared to the year-ago periods due to higher revenue as we realize the benefit of our maturing subscription model.
Cost
of support revenue consists of costs such as salaries, benefits, and computer equipment and facilities associated with customer support and the release of support updates (including related royalty costs) associated with providing support for both our perpetual licenses and subscription licenses.
Cost of support revenue in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 decreased primarily due to lower headcount, decreases in royalty expense and decreases in professional fees.
Our
cost of professional services revenue includes costs such as salaries, benefits, and computer equipment and facilities for our training and consulting personnel, and third-party subcontractor fees. In
37
the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017, total compensation, benefit costs and travel expenses decreased by 11% ($3.1 million) and 6% ($5.2 million), respectively, due to lower headcount; partially offset by higher third-party subcontractor fees, which increased by 17% ($1.0 million) and 3% ($0.7 million), respectively.
Our
sales and marketing expenses primarily include salaries and benefits, sales commissions, advertising and marketing programs, travel and facility costs. In the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017, total compensation, benefit costs and travel expenses increased 20% ($13.9 million) and 14% ($29.5 million), respectively, due to higher commission costs, an increase in headcount, salary increases and stock-based compensation increases.
Our
research and development expenses consist principally of salaries and benefits, costs of computer equipment and facility expenses. Major research and development activities include developing new products and releases and updates of our software that enhance functionality and add features. In the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 total compensation, benefit costs and travel expenses increased 3% ($1.6 million) and 9% ($12.0 million), respectively, due to an increase in headcount, salary increases and stock-based compensation increases.
Our
general and administrative expenses include the costs of our corporate, finance, information technology, human resources, legal and administrative functions, as well as acquisition-related charges, bad debt expense and outside professional services, including accounting and legal fees.
In the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 total compensation, benefit costs and travel expenses decreased 4% ($1.0 million) and 5% ($3.8 million), respectively, primarily due to lower stock-based compensation, offset by increases in headcount and salary increases. Professional fees also declined by $1.1 million and $2.8 million, respectively in the third quarter and first nine months of 2018 compared to the third quarter and first
nine months of 2017.
Amortization
of acquired intangible assets reflects the amortization of acquired non-product related intangible assets, primarily customer and trademark-related intangible assets, recorded in connection
38
with completed acquisitions. The decrease in amortization of acquired intangible assets in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 is due to certain assets being fully amortized as well as the impact of foreign currency exchange rates.
In
fiscal 2016, we committed to a plan to restructure our global workforce and consolidate select facilities to reduce our cost structure and to realign our investments with our identified growth opportunities. The actions have resulted in a total restructuring charge of $84.5 million and was substantially completed in 2017. We expect that the expense reductions will be offset by planned cost increases, investments in other areas of our business and the anticipated effects of foreign currency fluctuations, which effects are contemplated in our most recent financial targets for fiscal 2018. In the third quarter and first nine months of 2018, we recorded restructuring credits of $0.3 million and $1.0 million, respectively, primarily related to changes in estimated costs related to the closure of excess facilities. In the third quarter and first nine months of 2018, we made cash payments related to restructuring charges of $0.5 million and $2.5 million, respectively, compared
to $6.4 million and $35.3 million in the third quarter and first nine months of 2017, respectively. At June 30, 2018, accrued restructuring totaled $2.7 million, of which we expect to pay $1.6 million within the next twelve months.
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 existing 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
March 2017 we modified our credit facility to decrease the loan commitment to $600 million from $900 million, which reduced interest expense in the third quarter and first nine months of 2018 compared to the third quarter and first nine months of 2017 by $0.1 million and $1.7 million, respectively, due to the write-off of deferred financing fees and reduction of the associated commitment fees. We had $698 million of total debt at June 30, 2018, compared to $718 million at July 1, 2017.
Interest
income and other expense, net includes interest income, foreign currency net losses and other non-operating gains and losses. Foreign currency net losses include costs of forward contracts, certain realized and unrealized foreign currency transaction gains or losses, and foreign exchange gains or losses resulting from the required period-end currency re-measurement of the assets and liabilities of our subsidiaries that use the U.S. Dollar as their functional currency. We use foreign currency forward contracts to reduce our exposure to fluctuations in foreign currency exchange rates.
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.
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, the impact of the Tax Act results in 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 have 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
40
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 U.S. 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.
In the fourth quarter of 2016, we received
an assessment of $12 million from the tax authorities in Korea. The assessment relates to various tax issues but primarily to 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, pending resolution of the appeal process.
Operating Measures
Subscription Bookings and Subscription ACV
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 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.
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 at the conversion factor of 2 by considering many variables, including pricing, support, length of term, and renewal rates. In 2017 and for the third quarter and first nine months of 2018, 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. Beginning in the third quarter of 2018, minimum ACV commitments under our Strategic Alliance Agreement with Rockwell Automation are included in subscription ACV if the period-to-date minimum ACV commitment exceeds actual ACV sold under the Agreement.
We define license and subscription bookings as subscription bookings plus perpetual license bookings plus any 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.
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.
41
Non-GAAP Financial Measures
The non-GAAP financial measures presented in the discussion of our results of operations and the respective most directly comparable GAAP measures are:
•
non-GAAP revenue—GAAP revenue
•
non-GAAP gross margin—GAAP gross margin
•
non-GAAP
operating income—GAAP operating income
•
non-GAAP operating margin—GAAP operating margin
•
non-GAAP net income—GAAP net income
•
non-GAAP diluted earnings or loss per share—GAAP diluted earnings or loss per share
The non-GAAP
measures exclude fair value adjustments related to acquired deferred revenue and deferred costs, stock-based compensation expense, amortization of acquired intangible assets expense, acquisition-related charges, restructuring and headquarters relocation charges, pension plan termination-related costs, non-operating credit facility refinancing costs, identified discrete charges included in non-operating other expense, net and the related tax effects of the preceding items, and any other identified tax items.
These items are normally included in the comparable measures calculated and presented in accordance with GAAP. Our management excludes these items when evaluating our ongoing performance and/or predicting our earnings trends, and therefore excludes them from our non-GAAP financial measures. Management uses, and investors should consider, non-GAAP measures in conjunction with our GAAP results.
Fair
value of acquired deferred revenue is a purchase accounting adjustment recorded to reduce acquired deferred revenue to the fair value of the remaining obligation, so our GAAP revenue for the periods after an acquisition do not reflect the full amount of revenue that would have been reported if the acquired deferred revenue was not written down to fair value. We believe excluding these adjustments to revenue from these contracts (and associated costs in fair value adjustment to deferred services cost) is useful to investors as an additional means to assess revenue trends of our business.
Stock-based compensation is a non-cash expense relating to stock-based awards issued to executive officers, employees and outside
directors and to our employee stock purchase program. We exclude this expense as it is a non-cash expense and we assess our internal operations excluding this expense and believe it facilitates comparisons to the performance of other companies in our industry.
Amortization of acquired intangible assets is a non-cash expense that is impacted by the timing and magnitude of our acquisitions. We believe the assessment of our operations excluding these costs is relevant to our assessment of internal operations and comparisons to the performance of other companies in our industry.
Acquisition-related and other transactional charges included in general and administrative costs are direct costs of potential and completed acquisitions and expenses related to acquisition integration activities,
including transaction fees, due diligence costs, severance and professional fees. Subsequent adjustments to our initial estimated amount of contingent consideration associated with specific acquisitions are also included within acquisition-related charges. Other transactional charges include third-party costs related to structuring unusual transactions. We do not include these costs when reviewing our operating results internally. The occurrence and amount of these costs will vary depending on the timing and size of acquisitions.
Restructuring charges include excess facility restructuring charges and severance costs resulting from reductions of personnel driven by modifications to our business strategy. We do not include these costs when reviewing our operating results internally. These costs may vary in size based on our restructuring plan.
Headquarters
relocation charges include non-cash accelerated depreciation expense recorded in anticipation of exiting our current headquarters facility due to changes in the estimated useful lives of fixed assets. We do not include these costs when reviewing our operating results internally.
Income tax adjustments include the tax impact of the items above and assumes that we are profitable on a non-GAAP basis in the U.S. and one foreign jurisdiction. It also eliminates the effect of the valuation
42
allowance recorded against our net deferred tax assets in those jurisdictions. Additionally, we exclude other material tax items that we do not include when reviewing our operating results internally.
We
use these non-GAAP measures, and we believe that they assist our investors, to make period-to-period comparisons of our operational performance because they provide a view of our operating results without items that are not, in our view, indicative of our core operating results. We believe that these non-GAAP measures help illustrate underlying trends in our business, and we use the measures to establish budgets and operational goals (communicated internally and externally) for managing our business and evaluating our performance. We believe that providing non-GAAP measures also affords investors a view of our operating results that may be more easily compared to the results of other companies in our industry that use similar financial measures to supplement their GAAP results.
The items excluded from the non-GAAP measures often have a material impact on our financial results and many of such items recur. Accordingly, the
non-GAAP measures included in this Quarterly Report should be considered in addition to, and not as a substitute for or superior to, the comparable measures prepared in accordance with GAAP. The following tables reconcile each of these non-GAAP measures to its most closely comparable GAAP measure on our financial statements.
Acquisition-related and other transactional charges included in general and administrative expenses
0.5
%
0.1
%
0.2
%
0.1
%
U.S.
pension plan termination-related costs
—
%
0.1
%
—
%
—
%
Headquarters relocation charges
0.6
%
—
%
0.3
%
—
%
Restructuring
charges, net
(0.1
)%
0.5
%
(0.1
)%
1.0
%
Non-GAAP operating margin
17.9
%
15.4
%
17.3
%
15.6
%
(1)
We
have 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 2018 and 2017 non-GAAP tax provisions are calculated assuming there is no valuation allowance. Income tax adjustments reflect the tax effects of non-GAAP adjustments which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments listed above. We recorded the impact of the Tax Cuts and Jobs Act in our first quarter 2018 GAAP earnings, resulting in a non-cash benefit of approximately $7 million. In the third quarter of 2018, we increased the non-cash benefit by approximately $5 million to reflect additional guidance on the state tax implications of the act. We have excluded these benefits from our non-GAAP results.
Critical
Accounting Policies and Estimates
The financial information included in Item 1 reflects no material changes in our critical accounting policies and estimates as set forth under the heading Critical Accounting Policies and Estimates in Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2017 Annual Report on Form 10-K.
Recent Accounting Pronouncements
In accordance with recently issued accounting pronouncements, we will be required to comply with certain changes in accounting rules and regulations some of which are expected to have a material impact on our consolidated financial statements. Refer to Note 1. Basis of Presentation to the Condensed Consolidated Financial Statements in this Form 10-Q for all recently issued accounting
pronouncements which is incorporated herein by reference.
We
invest our cash with highly rated financial institutions and in diversified domestic and international money market mutual funds. Cash and cash equivalents include highly liquid investments with original maturities of three months or less. In addition, we hold investments in marketable securities totaling approximately $54 million with an average maturity of 15 months. At June 30, 2018, cash and cash equivalents totaled $267 million, compared to $280 million at September 30, 2017, reflective of $185 million in operating cash flows and $7.5 million from the issuance of common stock under our Employee Stock Purchase Plan, offset by $100 million used to repurchase common stock, $45 million used to pay withholding taxes on stock-based
awards that vested in the period, $20 million of net repayments made under our credit facility, $19 million used to acquire capital assets, $8 million used to pay contingent consideration, $6 million used to purchase businesses and intangible assets and $5 million used to purchase investments and marketable securities.
A significant portion of our cash is generated and held outside the U.S. At June 30, 2018, we had cash and cash equivalents of $17 million in the U.S., $97 million in Europe, $123 million in Asia Pacific (including India), and $29 million in other non-U.S. countries. All the marketable securities are held in Europe. We have substantial cash requirements in the United States, but we believe that the combination of our existing U.S. cash and cash equivalents, marketable securities, our ability to repatriate cash
to the U.S. more cost effectively with the recent U.S. tax law changes, future U.S. operating cash flows and cash available under our credit facility, will be sufficient to meet our ongoing U.S. operating expenses and known capital requirements.
Cash provided by operating activities
Cash provided by operating activities was $185 million in the first nine months of 2018, compared to $102 million in the first nine months of 2017. The increase is primarily due to higher collections of accounts receivable, lower restructuring payments (down $33 million year over year), and the $12 million payment related to the Korean tax audit made in the first quarter of 2017.
Net
income for the first nine months of 2018 was $39 million compared to a net loss for the first nine months of 2017 of $11 million.
Cash provided (used) by investing activities included the following:
Additions to property and equipment
$
(18,666
)
$
(19,333
)
Acquisitions
of businesses, net of cash acquired
(3,000
)
(4,960
)
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
Purchases of investments
(1,000
)
—
Proceeds from sales of
investments
—
15,218
$
(30,089
)
$
(9,808
)
Our
expenditures for property and equipment consisted primarily of computer equipment, software, office equipment and facility improvements. In the first nine months of 2018 we also used net $4 million to purchase additional marketable securities, $3 million to acquire developed software, $3 million for a small business acquisition and $1 million for a small investment.
Cash used by financing activities included the following:
Net borrowings (repayments) of debt
$
(20,000
)
$
(40,000
)
Repurchases
of common stock
(100,000
)
(34,994
)
Payments of withholding taxes in connection with vesting of stock-based awards
(44,797
)
(26,244
)
Proceeds from
issuance of common stock
7,472
3,978
Contingent consideration
(7,750
)
(11,054
)
Credit facility origination costs
—
(184
)
$
(165,075
)
$
(108,498
)
The
net repayments in the first nine months of 2018 reflect borrowings of $200 million under our credit facility to fund working capital requirements and stock repurchases, offset by repayments of $220 million. In the first nine months of 2018 we repurchased $100 million in common stock. We also paid $45 million in withholding taxes in connection with vesting of stock based awards, made $8 million in contingent consideration payments, and received $7 million from the sale of common stock under our ESPP plan.
Credit Agreement
We maintain a multi-currency credit facility with a syndicate of banks with a $600 million revolving loan commitment. The revolving loan commitment may be increased by an additional $500 million if the existing or additional lenders are willing to make such increased commitments. Outstanding revolving loan amounts
may be repaid in whole or in part, without penalty or premium, prior to the September 15, 2019 maturity date, when all remaining amounts outstanding will be due and payable in full. As of June 30, 2018, the fair value of our credit facility approximates its book value.
We and certain of our foreign subsidiaries may borrow under the credit facility. Any amounts borrowed by us would be guaranteed by our material domestic subsidiaries that become parties to the subsidiary guaranty, if any. Any amounts borrowed by one of our foreign subsidiaries
would be guaranteed by us and any subsidiary guarantors. The credit facility is secured by our assets and those of some of our U.S. subsidiaries (which include equity interests in some of our other subsidiaries).
47
As of June 30, 2018, we had $198.1 million in revolving 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 us. As of June 30, 2018, the weighted average annual interest rate for amounts outstanding was 3.88%. We also pay a quarterly commitment fee on the undrawn portion of the credit facility ranging from 0.175% to 0.30% per year based on our total leverage ratio.
The credit facility limits our and our subsidiaries’ ability to, among other things: incur liens or guarantee obligations; pay dividends and make other distributions; make investments and enter into joint ventures; dispose of assets; engage in transactions with foreign subsidiaries
and engage in transactions with affiliates, except on an arms-length basis. In addition, the credit facility requires us to maintain the financial ratios set forth below.
Ratio of consolidated total indebtedness to the consolidated trailing four quarters EBITDA as of the last day of any fiscal quarter.
Not
> 4.50:1.00
2.45 to 1.00
Fixed Charge Coverage Ratio
Ratio of consolidated trailing four quarters EBITDA less consolidated capital expenditures to consolidated fixed charges as of the last day of any fiscal quarter.
> 3.50:1.00
6.82 to 1.00
Senior Secured Leverage Ratio
Ratio of senior consolidated total indebtedness (which excludes unsecured indebtedness) to consolidated trailing four quarters EBITDA as of the last day
of any fiscal quarter.
Not > 3.00:1.00
0.73 to 1.00
As of the end of the third quarter of 2018, we had approximately $384 million of borrowing capacity under the credit facility.
As of June 30, 2018, 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 us 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 Inc., as defined in the agreement, would also constitute an event of default, permitting the lenders to accelerate the indebtedness and terminate the credit facility.
The terms and conditions of the credit facility are described in Note 12 to the Financial Statements.
Outstanding Notes
On May 12, 2016, we issued $500 million of 6.00% senior unsecured notes due 2024. Interest on the notes is payable twice per year in May and November.
We may redeem the notes, in whole or in part, subject to certain conditions, including in some cases a
payment of premium, prior to their maturity date. In addition, if we undergo a change of control, we will be required to make an offer to purchase all the notes at a price equal to 101% of the principal amount of the notes plus accrued and unpaid interest.
The notes were issued under an indenture that contains customary covenants. Subject to certain exceptions, our ability to incur certain additional debt is limited unless, after giving pro forma effect to such incurrence and the application of the proceeds thereof, the ratio of our EBITDA to our Consolidated Fixed Charges is not greater than 2.00 to 1.00. The indenture also restricts our ability to incur liens, pay dividends or make certain other distributions, sell assets or engage in sale/leaseback
transactions. Any failure to comply with these and other covenants included in the indenture could constitute an event of default that could result in the acceleration of the payment of the aggregate principal amount of the notes then outstanding and accrued interest. As of June 30, 2018, we were in compliance with all such covenants.
Share 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.
48
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 third quarter of 2018, we repurchased $100 million of our common stock through an ASR agreement with a major financial institution 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.
Future Expectations
Our 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 and the model has matured. This also affects consolidated EBITDA as calculated under our credit facility. Notwithstanding the effect of the subscription transition and those limitations, we believe that existing cash and cash equivalents, together with cash generated from operations and amounts available under the credit facility, will be sufficient to meet our working capital
and capital expenditure requirements (which we expect to be $40 million in 2018) through at least the next twelve months and to meet our known long-term capital requirements.
Our expected uses of cash could change, our cash position could be reduced and we could incur additional debt obligations if we decided to purchase our outstanding shares or to retire debt or to engage in strategic transactions, any of which could be commenced, suspended or completed at any time. Any such purchases or retirement of debt will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. We also evaluate possible strategic transactions on an ongoing basis and at any given time may be engaged in discussions or negotiations with respect to possible strategic transactions. The amounts involved in any share or debt repurchases or strategic transactions may be material.
ITEM
3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes in our market risk exposure as described in Item 7A: Quantitative and Qualitative Disclosures about Market Risk of our 2017 Annual Report on Form 10-K.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Effectiveness of Disclosure Controls and Procedures
Our management
maintains disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), as appropriate, to allow for timely decisions regarding required disclosure.
We evaluated, under the supervision and with the participation of management, including our principal executive and principal financial officers, the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of June 30, 2018.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
49
PART
II—OTHER INFORMATION
ITEM 1A. RISK FACTORS
In addition to other information set forth in this report, you should carefully consider the risk set forth below and the risk factors described in Part I. Item 1A. Risk Factors in our 2017 Annual Report on Form 10-K, which could materially affect our business, financial condition or future results. The risk described below and the risks described in our 2017 Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
On September
7, 2017, we entered into a lease for a new worldwide headquarters in the Boston Seaport District, beginning in January 2019. Because our current headquarters lease will not expire until November 2022, we are seeking to exit our current headquarters lease or sublease that space. If we are unable to do so, or unable to do so 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 a charge related to any rent shortfall, which could adversely affect our financial condition.
Under our current headquarters lease, we pay approximately $7.4 million in annual base rent plus operating expenses (together "rent obligations," an aggregate annual total of approximately $12.0 million). We will begin paying rent under our new headquarters lease on July 1,
2020. Our rent under the new lease when we begin paying rent will be an annual base rent amount of $11.3 million plus our pro rata portions of building operating expenses and real estate taxes (approximately 63% of such amounts, estimated to be approximately $7.1 million in 2020). The base rent will increase by $0.3 million each year over the term of the lease. Accordingly, we will be required to pay rent for both locations from July 1, 2020 until November 30, 2022 unless we can successfully negotiate an exit to our current lease or sublease our current premises. We may be unable to negotiate a financially desirable termination of our current lease or to sublease our current premises for an amount at least equal to our rent obligations under the current lease, which would require us to bear the overlapping rent obligations and to record a charge related to such
shortfall, and could adversely affect our cash flow and financial condition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The table below shows the shares of our common stock we repurchased in the third quarter of 2018.
Period (1)
Total Number of Shares (or Units) Purchased
Average Price Paid per Share (or Unit)
Total Number of
Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
(1) Periods are our fiscal months within the fiscal quarter.
(2) On September 14, 2017, our Board authorized us to repurchase up to $500 million worth of our shares in the period October 1, 2017 through September 30, 2020, which repurchase program we announced on September
19, 2017. Our Board expanded this authorization to $1,500 million on July 19, 2018, upon closing of the $1,000 million investment by Rockwell Automation.
(3) In April 2018, we made a $100 million payment to repurchase shares pursuant to an ASR with a major financial institution, of which 951,814 shares were repurchased in April and an additional 195,160 shares were repurchased in June 2018. See Note 5. Earnings per Share (EPS) and Common Stock of "Notes to Consolidate Financial Statements" included in this Quarterly Report.
The
following materials from PTC Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of June 30, 2018 and September 30, 2017; (ii) Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2018 and July 1, 2017; (iii) Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended June 30, 2018 and July 1, 2017; (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended June
30, 2018 and July 1, 2017; and (v) Notes to Condensed Consolidated Financial Statements.
_________________
*
Indicates that the exhibit is being furnished, not filed, with this report.
51
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
