424B2
Table of Contents

Filed Pursuant to Rule 424(b)(2)
Registration No. 333-211049

 

The information in this preliminary prospectus supplement is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell these securities and they are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to completion, dated May 2, 2016

Preliminary prospectus supplement

(To prospectus dated May 2, 2016)

 

 

LOGO

PTC Inc.

$500,000,000

        % Senior Notes due 2024

Interest payable                      and                     

Issue price:     %

We are offering $500,000,000 aggregate principal amount of our     % Senior Notes due 2024 (the “notes”). The notes will mature on                     , 2024. Interest will accrue from                     , 2016, and the first interest payment date will be                     , 2016.

We may redeem some or all of the notes at any time on or after                     , 2019, at the redemption prices set forth in this prospectus supplement, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. We may also redeem up to 40% of the notes using the proceeds of certain equity offerings before                     , 2019, at a redemption price equal to     % of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. In addition, at any time prior to                     , 2019, we may redeem some or all of the notes at a price equal to 100% of the principal amount thereof, plus a “make-whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. If we sell certain of our assets and do not reinvest the proceeds or repay senior debt, or if we experience specific kinds of changes of control, we must offer to purchase the notes.

On the issue date, the notes will not be guaranteed by any of our subsidiaries. After the issue date, the notes will be required to be guaranteed on a senior unsecured basis by any of our domestic subsidiaries that in the future becomes a guarantor of our senior credit facility or certain other material indebtedness of PTC Inc. or any other future guarantor. See “Description of notes—Future guarantors.”

The notes will be our senior unsecured obligations and will rank equally in right of payment to all of our existing and future senior debt and senior in right of payment to all of our future subordinated debt. The notes will be effectively subordinated to any of our existing and future secured debt to the extent of the value of the assets securing such debt. In addition, on the issue date, the notes will be structurally subordinated to the liabilities of all of our subsidiaries and in the future will be structurally subordinated to the liabilities of any of our subsidiaries that does not become a guarantor of the notes.

You should read this prospectus supplement, together with the accompanying prospectus, carefully before you invest in the notes. Investing in the notes involves risks. See “Risk factors” beginning on page S-22 for a discussion of certain risks that you should consider in connection with an investment in the notes.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these debt securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

     Price to public(1)   Underwriting discounts and
commissions(2)
   Proceeds, before
expenses, to PTC Inc.(1)

Per note

              %               %                %

Total

  $               $                $            

 

(1)   Plus accrued interest, if any, from                     , 2016.

 

(2)   We have agreed to reimburse the underwriters for certain expenses. See “Underwriting (conflicts of interest).”

The notes are a new issue of securities with no established trading market. We do not intend to apply to list the notes on any securities exchange.

We expect that delivery of the notes will be made to investors in book-entry form through The Depository Trust Company on or about                     , 2016.

Book-running manager

J.P. Morgan

Co-managers

 

Barclays      Fifth Third Securities      HSBC      Huntington Investment Company
Janney Montgomery Scott   KeyBanc Capital Markets    RBC Capital Markets    RBS
Santander      SunTrust Robinson Humphrey      TD Securities      US Bancorp

The date of this prospectus supplement is May     , 2016.


Table of Contents

You should rely only on the information contained in or incorporated by reference in this prospectus supplement, the accompanying prospectus and any related free writing prospectus prepared by us or on our behalf. We and the underwriters have not authorized anyone to provide you with different information. If you receive any other information, you should not rely on it. We and the underwriters are not making an offer of these securities, or soliciting an offer to buy these securities, in any jurisdiction where the offer or solicitation is not permitted. You should not assume that the information contained in or incorporated by reference in this prospectus supplement and the accompanying prospectus is accurate as of any date other than the date of this prospectus supplement or the accompanying prospectus, or the date of the document incorporated by reference. Our business, financial condition, results of operations and prospects may have changed since those respective dates.

Table of contents

 

     Page  
Prospectus supplement   

About this prospectus supplement

     ii   

Cautionary statement regarding forward-looking statements

     ii   

Market, ranking, industry data and forecasts

     iii   

Trademarks, service marks and copyrights

     iii   

Summary

     S-1   

Risk factors

     S-22   

Use of proceeds

     S-37   

Capitalization

     S-38   

Ratio of earnings to fixed charges

     S-39   

Management’s discussion and analysis of financial condition and results of operations

     S-40   

Description of other indebtedness

     S-89   

Description of notes

     S-91   

Book-entry settlement and clearance

     S-134   

Material United States federal income tax considerations

     S-137   

Certain ERISA considerations

     S-143   

Underwriting (conflicts of interest)

     S-145   

Legal matters

     S-149   

Experts

     S-149   

Where you can find more information

     S-149   

Incorporation by reference

     S-150   
Prospectus   

About this prospectus

     1   

PTC Inc.

     2   

Risk factors

     4   

Where you can find more information

     5   

Incorporation by reference

     6   

Cautionary statement regarding forward-looking statements

     7   

Use of proceeds

     8   

Ratio of earnings to fixed charges

     9   

Description of securities

     10   

Plan of distribution

     11   

Legal matters

     12   

Experts

     12   

 

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About this prospectus supplement

This prospectus supplement is a supplement to the accompanying prospectus that also is part of this document. This prospectus supplement and the accompanying prospectus are part of a registration statement that we filed with the Securities and Exchange Commission using a “shelf” registration process. Under the shelf registration process, we may, at any time from time to time, issue and sell to the public any combination of the securities described in the accompanying prospectus up to an indeterminate amount. The first part of this document is the prospectus supplement, which describes the specific terms of the notes we are offering and certain other matters relating to us and our financial condition. The second part, the accompanying prospectus, gives more general information about securities we may offer from time to time, some of which does not apply to the notes we are offering. You should read this prospectus supplement along with the accompanying prospectus, the documents incorporated by reference herein and therein, as well as any free writing prospectus that is filed, including the term sheet for the notes we are offering. Generally, when we refer to the prospectus, we are referring to both parts of this document combined. If the description of the offering varies between this prospectus supplement and the accompanying prospectus, you should rely on the information in this prospectus supplement.

Cautionary statement regarding forward-looking statements

This prospectus supplement and the documents we incorporate herein by reference contain disclosures that are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements include all statements that do not relate solely to historical or current facts, which can be identified by the use of words such as “may,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “believe,” “potential,” “should” and “continue,” including but not limited to statements about our anticipated financial results and growth, subscription adoption, the development of our products and markets, and anticipated tax rates. These forward-looking statements are based on our current plans and assumptions and involve risks and uncertainties that could cause actual results to differ materially from those projected. These risks include: macroeconomic and/or global manufacturing climates may not improve or may deteriorate; customers may not purchase our solutions when or at the rates we expect; our businesses, including our Technology Platform and SLM businesses, may not expand and/or generate the revenue we expect; our market size and growth estimates may be incorrect and we may be unable to grow our business at or in excess of market growth rates; new products released and planned products, including Technology Platform-enabled core products, may not generate the revenue we expect or be released as we expect; foreign currency exchange rates may vary from our expectations and thereby affect our reported revenue and expense; the mix of revenue between license, subscription, support and professional services could be different than we expect, which could impact our earnings per share results and cash flows; our customers may purchase more of our solutions as subscriptions than we expect, which would adversely affect near-term revenue, operating margins and earnings per share; customers may not purchase subscriptions at the rate we expect, which could affect our longer-term business projections; sales of our solutions as subscriptions may not have the longer-term positive effect on revenue that we expect; our workforce realignment may adversely affect our operations and may not achieve the expense savings we expect; we may be unable to generate sufficient operating cash flow to return 40% of free cash flow to shareholders and other uses of cash could preclude share repurchases; the settlements with the U.S. Securities and Exchange Commission and the U.S. Department of Justice to resolve our Foreign Corrupt Practices Act investigation in China (the “China FCPA Investigation”) may have collateral effects on our business in China, the U.S. or elsewhere; we may incur material damages in connection with a recently-filed securities law action concerning disclosures about the China FCPA Investigation; and material fines and penalties may be assessed against us in connection with the investigation by the China Administration for Industry and Commerce. In addition, our assumptions concerning our future GAAP and non-GAAP effective income tax rates

 

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are based on estimates and other factors that could change, including the geographic mix of our revenue, expenses and profits and loans and cash repatriations from foreign subsidiaries. Other important information about factors that may cause our actual results to differ materially from those contemplated by these statements is discussed under “Risk factors” in this prospectus supplement, as well as in our latest Annual Report on Form 10-K, which is incorporated by reference herein.

Market, ranking, industry data and forecasts

This prospectus supplement and the accompanying prospectus, including the documents incorporated by reference herein or therein, include market share, ranking, industry data and forecasts that we obtained from industry publications, surveys, public filings and internal company sources. Industry publications, surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of included information. We have not independently verified any of the data from third-party sources, nor have we ascertained the underlying economic assumptions relied upon therein. Statements as to our market position and ranking are based on market data currently available to us, management’s estimates and assumptions we have made regarding the size of our markets within our industry. While we are not aware of any misstatements regarding our industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Risk factors” in this prospectus supplement and the accompanying prospectus. Neither we nor the underwriters can guarantee the accuracy or completeness of such information contained or incorporated by reference in this prospectus supplement and the accompanying prospectus.

Trademarks, service marks and copyrights

We own or have rights to trademarks, service marks or trade names that we use in connection with the operation of our business. PTC, the PTC logo, ThingWorx, Creo, Windchill, Servigistics, Vuforia and Kepware, and all other PTC product names and logos are trademarks or registered trademarks of PTC Inc. or its subsidiaries in the United States and in other countries. We also own or have the rights to copyrights that protect the content of our products. Solely for convenience, the trademarks, service marks, tradenames and copyrights referred to in this prospectus supplement are listed without the ©, ® and symbols, but we will assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensors to these trademarks, service marks and tradenames.

 

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Summary

This summary highlights information appearing elsewhere or incorporated by reference in this prospectus supplement and the accompanying prospectus. This summary is not complete and does not include all of the information that you should consider before investing in the notes. You should carefully read the entire prospectus supplement and the accompanying prospectus, including the historical financial statements and related notes incorporated by reference in this prospectus supplement and the accompanying prospectus and the section entitled “Risk factors” and under “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2015, before making any investment decision. As used in this prospectus supplement, except as otherwise indicated or the context otherwise implies, when we refer to “PTC,” “the company,” “we,” “us,” or “our,” we are describing PTC Inc., together with its subsidiaries. With respect to any description of the terms of the offer or the notes, references to “PTC,” “us,” “we,” or “our,” refer only to PTC Inc. and not to its subsidiaries.

Unless otherwise indicated, all figures referred to “as adjusted” in this prospectus supplement give effect to (i) additional borrowings of $120.0 million on January 11, 2016 under our revolving line of credit, of which $100.0 million was used for our purchase of Kepware, Inc., and (ii) this offering and the use of proceeds therefrom.

Unless otherwise indicated, all references to a year are to our fiscal year, which ends on September 30.

Our company

We develop and deliver technology solutions, comprised of software and services, that enable customers to transform the way they create, operate and service their products for a smart, connected world.

We generate revenue through the sale of software licenses, software subscriptions, support (which includes technical support and software updates when and if available), and services (including cloud services, whereby our customers receive secure hosting and 24/7 application management).

Our solutions and software products address the challenges our customers face in the following areas:

Solutions Group

 

 

Computer-Aided Design (CAD):    Helps companies design and optimize their products through the creation of 3D virtual prototypes.

 

 

Product Lifecycle Management (PLM):    Integrates people, processes and systems from a product’s concept through service and retirement.

 

 

Application Lifecycle Management (ALM):    Manages global software development from concept to delivery.

 

 

Service Lifecycle Management (SLM):    Enables companies to maximize service efficiency, optimize parts revenue, and increase value for their customers.

Technology Platform Group

 

 

Internet of Things (IoT):    Enables connectivity, development, analysis and augmented reality for smart, connected products and environments.

 

 

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Our business

For 2015, we achieved revenue of $1,255.2 million, operating income of $41.6 million and Adjusted EBITDA (as defined in footnote 3 in “—Summary historical consolidated financial data”) of $333.2 million. We are currently working to transition our business from a perpetual licensing model to a subscription model in order to increase our lifetime customer value, increase the recurring nature of our revenue and better satisfy customer demand. While we expect that this transition will provide significant value to the company over time, until we have fully transitioned to a stable mix of subscription and perpetual license sales, we expect that our total software revenue will decrease due to the differences in the timing and amount of revenue recognized for a subscription (revenue is recognized ratably over the term of the subscription) and a perpetual license (revenue is generally recognized upon shipment of the software).

We have built a world-class portfolio of solutions through both internal development and acquisitions. Consistent with our vision to help our customers create, operate and service smart, connected products, we have completed a number of recent acquisitions related to our Technology Platform business, including Kepware in the second quarter of 2016, Vuforia in the first quarter of 2016, ColdLight in 2015, and Axeda and ThingWorx in 2014. We expect to continue to pursue opportunities to broaden our solutions and customer base through acquisitions.

We serve over 26,000 customers spanning a broad range of industries, including industrial products; electronics and high tech; federal, aerospace and defense; automotive; retail and consumer; and life sciences. No single customer accounted for more than 10% of our total revenue in 2015. We currently sell our software and services primarily through a direct sales organization while 20% to 25% of our products and services were sold in 2015 through third-party resellers and other strategic partners. Our direct sales force is located throughout the Americas, Europe, Asia Pacific and Japan. As we grow our Technology Platform business, we expect our go-to-market strategy will rely more on channel partners and marketing directly to end users and developers. We are expanding our service partner program, under which service engagements are referred to third-party service providers, as part of our overall margin expansion strategy.

The following charts break out our 2015 revenue by product area, geographic region and end market:

 

 

LOGO

 

 

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Products and services

Solutions Group

CAD

Our CAD products enable users to create conceptual and detailed designs, analyze designs, perform engineering calculations and leverage the information created downstream using 2D, 3D, parametric and direct modeling. Our principal CAD products are:

PTC Creo is an interoperable suite of product design software that provides a scalable set of packages for design engineers designed to meet a variety of specialized needs. PTC Creo provides capabilities for design flexibility, advanced assembly design, piping and cabling design, advanced surfacing, comprehensive virtual prototyping and other essential design functions.

PTC Mathcad is software for solving, analyzing and sharing vital engineering calculations. PTC Mathcad combines the ease and familiarity of an engineering notebook with the powerful features of a dedicated engineering calculations application.

In 2015, CAD revenue totaled $511.6 million. The CAD market is estimated to exceed $4 billion with an expected compound annual growth rate (“CAGR”) of approximately 4% between 2015 and 2018.

Extended PLM

Extended PLM (ePLM) includes our PLM and ALM products.

Our PLM products are designed to address common challenges that companies, particularly manufacturing companies, face over the life of the product, from concept to retirement. These software products help customers manage product configuration information through each stage of the product lifecycle, and communicate and collaborate across the entire enterprise, including product development, manufacturing and the supply chain, including sourcing and procurement. Our principal PLM products are:

PTC Windchill is a suite of PLM software that offers lifecycle intelligence—from design to service. PTC Windchill offers a single repository for all product information. As such, it is designed to create a “single source of truth” for all product-related content such as CAD models, documents, technical illustrations, embedded software, calculations and requirement specifications for all phases of the product lifecycle to help companies streamline enterprise-wide communication and make informed decisions.

The PTC Windchill product family includes supply chain management (SCM) solutions that allow manufacturers, distributors and retailers to collaborate across product development and the supply chain, including sourcing and procurement, to identify an optimal set of parts, materials and suppliers. This functionality provides automated cost modeling and visibility into supply chain risk information to balance cost and quality, and enables customers to design products that meet compliance requirements and performance targets.

PTC Creo View enables enterprise-wide visualization, verification, annotation and automated comparison of a wide variety of product development data formats, including CAD (2D and 3D), electronic CAD (ECAD), and documents. PTC Creo View provides access to designs and related data without requiring the original authoring tool.

 

 

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Our ALM products are designed for discrete manufacturers where coordination and collaboration between software and hardware teams is critical to understand product release readiness, support variant complexity, automate development processes, ensure complete lifecycle traceability and manage change. Our ALM products enable companies to accelerate innovation of software-intensive products.

PTC Integrity, our principal ALM product suite, enables users to manage system models, software configurations, test plans and defects. With PTC Integrity, engineering teams can improve productivity and quality, streamline compliance, and gain greater product visibility, ultimately enabling them to bring more innovative products to market.

Our Model-Based Systems Engineering (MBSE) solution connects requirements engineering, architecture modeling, physical product definition and system verification functions. Our solution allows multi-functional teams to work in concert while modeling the interdependencies of mechanical, electrical and software engineering components. In doing so, it enables users to drive efficiencies and process standardization, allowing distributed teams to collaboratively build digital models of complex systems, while managing system variability and enabling reuse.

In 2015, our ePLM solutions achieved $524.7 million in revenue. The PLM and ALM markets are estimated to exceed $5 billion and $3 billion, respectively, with expected CAGRs of approximately 6% and 8%, respectively, between 2015 and 2018.

SLM

Our SLM products help manufacturers and their service providers improve service efficiency and quality. These include capabilities to support product service and maintenance requirements, service information delivery, service parts planning and optimization, service knowledge management, and service analytics. Our principal SLM products are:

PTC Servigistics is a suite of SLM software products that integrate service planning, delivery and analysis to optimize service outcomes. PTC Servigistics products enable a systematic approach to service lifecycle management by providing a single view of service throughout the service network, enabling customers to improve their products and services and increase customer satisfaction.

PTC Arbortext is an enterprise software suite used by manufacturers to create, illustrate, manage and publish technical and service parts information to improve the operation, maintenance, service and upgrade of equipment throughout its lifecycle. These products are available in stand-alone configurations as well as integrated with PTC Windchill Service Information Manager and PTC Creo Illustrate to deliver dynamic, product-centric service and parts information.

In 2015, our SLM solutions achieved $166.1 million in revenue. The SLM market is estimated to be $2.8 billion with an expected CAGR of approximately 10% between 2015 and 2018.

Technology Platform Group

Our Technology Platform products allow manufacturers and their service providers to enable connectivity and optimize data intelligence for smart, connected products for the Internet of Things (“IoT”). Our solutions support the development of applications to gather, analyze and visualize product data, which in turn helps our customers design, operate and service smart, connected products. Our principal Technology Platform products are:

ThingWorx, a technology platform that enables users to create and deploy applications and solutions for today’s smart, connected world, enabling customers to transform their products and services, innovate, and

 

 

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unlock new business models. ThingWorx allows customers to reduce the time, cost, and risk required to connect, manage, and develop innovative applications for smart, connected products such as predictive maintenance, system monitoring, and usage-based product design requirements. Our ThingWorx solutions include tools added through our acquisition of Axeda, including cloud-based tools that allow customers to easily and more securely connect products and devices to the cloud, and intelligently process, transform, organize and store product and sensor data.

ThingWorx Machine Learning, a predictive intelligence tool that uses artificial intelligence technology to simplify and automate the processes of creating and operationalizing predictions inside ThingWorx-powered solutions and other systems of record. ThingWorx Machine Learning complements our Technology Platform portfolio by introducing data analytics to information collected from smart, connected products.

Vuforia, an augmented reality technology platform that enables applications to see things in the real world and then interact with them. Using computer vision technologies, and building them for mobile platforms, the technology is accessible through an application programming interface and developer workflows.

KEPServerEX, a communications platform that provides a single source of industrial automation data. The platform allows users to connect, manage, monitor, and control diverse automation devices and software applications through one intuitive user interface. KEPServerEx facilitates our entry into the factory setting and industrial IoT.

In 2015, our Technology Platform business achieved $52.9 million in revenue. The IoT market is estimated to be $1.1 billion, with an expected CAGR of 38% between 2015 and 2018 according to a leading industry source and management estimates.

Services

We offer consulting, implementation and training services through our Global Services Organization, with approximately 1,000 professionals worldwide, as well as through third-party resellers and other strategic partners. Our services create value by helping customers improve product development performance through technology enabled process improvement and multiple deployment paths. We also offer cloud services, whereby our customers receive hosting and 24/7 application management.

Competitive strengths

Deeply embedded, mission critical solutions drive high retention rates

We have historically had very low customer attrition. For example, our first customer, John Deere, circa 1987, remains one of our largest customers. Our solutions are mission critical and, because they underlie our customers’ ability to deliver their core products, are essential in day to day operations. Tens of thousands of engineers and designers use our CAD products to perform their jobs; relying on the historical data, designs, and configurations stored in our proprietary format to create new products and refine existing ones. Our PLM solutions benefit from the same drivers but are even more embedded in our customers’ operations, integrating employee interactions with product data across every business unit within a customer from product design to distribution and support. Our solutions span technological, organizational, and geographic boundaries; thus, by their very nature, they become deeply integrated into our customers’ systems and operations resulting in high degrees of customer loyalty.

 

 

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Strong competitive position with high level of technical expertise

Our competitive position is established and sustained through our core capabilities and high-level technical expertise. Engineering and design software is highly technical and complex and our solutions have been built through decades of research and development. Many of our customers operate in highly regulated industries and use our software to design products where precision and safety are paramount. Our long history of partnering closely with customers in the industries we serve provides a wealth of insight that allows us to continually innovate and serve our customers’ evolving needs. We believe that our extensive experience across many different sectors, leading technologies, expert workforce, which includes more than 1,100 engineers and more than 300 quota-carrying sales representatives, and ability to provide value-added services, position us well to serve our customers operating in dynamic environments.

Significant recurring revenue

Approximately 59% of our revenue in 2015 came from recurring revenue streams, which include our subscription solutions and support. This represents a 700 basis point increase from one year ago. We expect that our shift to a subscription model will increase our mix of recurring revenue to approximately 70% by 2021. We anticipate that this expected increase in recurring revenue will lead to greater visibility and stability in our business and will enhance our ability to innovate and invest, increase our resilience throughout economic cycles, and support leverage to grow returns. Recent changes to our support terms are expected to increase support renewal rates. Additionally, customers may elect to convert existing perpetual licenses with support to subscription licenses, which will decrease support revenue but increase subscription revenue.

Diverse revenue base including relationships with Fortune 100 companies and influential developers

We are widely diversified across geographic regions, industries, customers and products. During 2015, we derived approximately 42% of our revenue from the Americas, 37% from Europe, 11% from the Pacific Rim and 9% from Japan. Our revenue is also well diversified across multiple industry sectors, including industrial products; electronics and high tech; federal, aerospace and defense; automotive; life sciences; and retail and consumer. Our largest industry vertical, industrial products, contributed 31% of total revenue during 2015 while our largest solution area, ePLM, contributed 42% of total revenue. No single customer accounted for more than 10% of our total revenue in each of our last three fiscal years. We also have more than 750 partners, including value-added resellers, enterprise software and performance team partners, hardware and system integration partners and service and training partners.

Expanding margins and strong cash flow generation

Over the last five years, our management team has, with great success, focused on improving margins and operating efficiency. Non-GAAP operating margins increased from 15.6% in 2010 to 24.2% in 2015, driven by increases in sales and marketing efficiency, service margin expansion and modest reductions in research and development expense as a percentage of revenue. (GAAP operating margins fluctuated during the same period; they were 7.4% in 2010 and 3.3% in 2015.) These operational changes along with disciplined capital expenditures have driven significant free cash flow generation. For 2015, we converted $333.2 million of Adjusted EBITDA into $228.3 million of Adjusted free cash flow. (“Adjusted EBITDA,” “non-GAAP operating margin” and “Adjusted free cash flow” are defined in “—Summary historical consolidated financial data”.) Since 2011, our Adjusted free cash flow grew at a 23% CAGR through 2015. While our transition to a subscription model negatively impacts traditional financial metrics like revenue, Adjusted EBITDA and Adjusted free cash

 

 

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flow in the short term (see “—Recent developments” for more detail), we believe the subscription business model, once fully adopted, will provide a competitive advantage and will ultimately result in a more attractive financial profile.

Well-positioned to capitalize on emerging growth opportunities

We believe we have an opportunity to grow our business by capitalizing on the significant opportunity in the high-growth Internet of Things market with our award-winning ThingWorx technology platform, as well as our acquisitions of Axeda, ColdLight, Vuforia and Kepware, which have enabled us to create leading Technology Platform solutions. Our Technology Platform business generated 5% of our total software license revenue in 2015. We are focused on the B2B segment of this market. While the market for our Technology Platform solutions is in its early days, we believe demand is poised to grow significantly among our customers and our Technology Platform solutions are a natural extension of our core solutions, which manage the cradle-to-grave lifecycle of our customers’ products. Our Technology Platform solutions deliver valuable data from products in the field (e.g., usage, durability, performance) back to manufacturers that they can use to make future design improvements.

Business strategy

Sustainable growth

Our goals for overall growth are predicated on continuing to expand our Technology Platform footprint and making structural changes to our business to improve operational performance and increase growth potential for both our Technology Platform solutions and our core solutions. For 2016, we reorganized the company into two main business units: the Solutions Group, comprised of our core CAD, ePLM and SLM business, and the Technology Platform Group, comprised of our IoT, analytics and augmented reality business. This new structure facilitates appropriate focus on both our core business and the Technology Platform business. We expect to continue to invest in our businesses to support their growth.

Transition to subscription revenue

A majority of our software license sales to date have been perpetual licenses, under which customers own the software license and we generally recognize revenue upon shipment of the software. Due to evolving customer preferences, our plan to increase our recurring revenue base and our acquisitions in the IoT and cloud services space, a growing percentage of our business consists of subscriptions for which revenue is recognized ratably over the subscription term. Under a subscription, the customer does not own the software license but pays a periodic fee to license our software for a specified period of time, including access to technical support. In October 2015, we launched the second phase of our subscription program with the goal of accelerating our transition to a predominantly subscription-based model. To drive that acceleration, we launched new pricing and packaging for subscriptions and new sales incentive compensation plans. We also launched a program for our existing customers to convert their support contracts to subscription contracts. We expect there will be greater opportunities for the remainder of 2016 and into 2017 than in subsequent years to convert existing support and term license contracts into subscription contracts due to the cyclicality of certain of those contracts.

We believe that by 2018, a significant majority of our license and subscription order bookings will be subscriptions. We estimate that, over time, this can generate an approximately 40% higher lifetime value per customer.

 

 

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Cost controls and margin expansion

We continue to proactively manage our cost structure and invest in what we believe are the highest return opportunities in our business. Our goal is to drive continued margin expansion over the long term. To that end, in October 2015, we committed to a plan to restructure approximately 8% of our workforce and consolidate select facilities in order to reduce our cost structure and to realign our investments with our identified growth opportunities. The restructuring is expected to result in a charge of up to $50 million, of which $41.7 million was recorded in the first half of 2016 and the remainder of which is expected to be recorded in the second half of 2016. We expect that the expense reductions will be offset by planned cost increases, investments in our business and the anticipated effects of foreign currency fluctuations, which effect is contemplated in our most recent financial targets for fiscal 2016. Our financial targets do not reflect the effect of increased interest expense that will be incurred as a result of the proposed offering.

Recent developments

The discussion below includes discussion of our bookings and our license and subscription bookings operating measures. Information about these measures is provided in “Management’s discussion and analysis of financial condition and results of operations” below in this prospectus supplement.

The results of operations of acquired businesses, including Kepware and Vuforia, have been included in our consolidated financial statements beginning on their respective acquisition dates. Kepware contributed approximately $5 million to our revenue in the second quarter of 2016.

Second quarter results

Revenue for the second quarter of 2016 was $272.6 million, compared with $314.1 million for the second quarter of 2015, a decline of $41.5 million (13%), or (10%) on a constant currency basis. We believe the decline of $30.7 million (12%) in total software revenue in the quarter was due to the acceleration of adoption of subscription licensing by our customers, which resulted in subscription bookings constituting a higher percentage of license and subscription bookings in the quarter than in the prior year. A decline in professional services revenue of 18% accounted for the remaining $10.8 million of the decline in revenue in the quarter as a result of our strategy to grow our service partner ecosystem and transition more services to our partners. Revenue was also adversely affected by a challenging macroeconomic environment and the impact of foreign currency exchange rates on our reported revenue due to an increase in the strength of the U.S. Dollar relative to international currencies, most notably the Euro and the Yen.

Approximately 80% of our total software revenue in the second quarter came from recurring revenue streams (subscription and support revenue).

We recorded a restructuring charge of $4.6 million in the second quarter in connection with our restructuring plan announced in October 2015, bringing the total restructuring charge for the first half of 2016 to $41.7 million. We expect the remaining $8 million of the anticipated $50 million total charge will be recorded in the second half of 2016.

Adjusted EBITDA for our second quarter of 2016 was $45.5 million, as compared with $80.9 million for the corresponding quarter in 2015. This decline was driven primarily by the higher subscription mix and its resulting impact on total software revenue.

Excluding fines and penalties totaling $28.2 million paid to the U.S. Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice (“DOJ”) in February 2016 to resolve an investigation under the U.S. Foreign

 

 

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Corrupt Practices Act related to our China business (the “China FCPA Investigation”) and $25.1 million paid in the quarter in connection with the restructuring described above, Adjusted free cash flow for the second quarter of 2016 was $97.4 million, as compared with $91.3 million for the corresponding quarter in 2015.

Adjusted EBITDA, free cash flow and Adjusted free cash flow are non-GAAP financial measures. See footnotes (3) and (5) in “Summary historical consolidated financial data” and “—Information about non-GAAP financial measures” below for a discussion of management’s definitions and use of these non-GAAP measures and limitations of their use. The following table provides a reconciliation of non-GAAP operating income to operating income and of Adjusted EBITDA to net income (loss), the most directly comparable financial measures calculated in accordance with generally accepted accounting principles (“GAAP”), as well as a reconciliation of free cash flow and Adjusted free cash flow to net cash provided by operating activities, the most directly comparable financial measure calculated in accordance with GAAP.

 

      Three months ended  
(In thousands)    April 4,
2015
    April 2,
2016
 
     (unaudited)     (unaudited)  

Adjusted EBITDA reconciliation:

    

Net income (loss)

   $ 5,392      $ (5,173

Provision for (benefit from) income taxes

     (5,005     1,604   

Interest and other expense, net

     3,601        5,327   
  

 

 

   

 

 

 

Operating income

     3,988        1,758   

Fair value adjustment of acquired deferred revenue(a)

     1,133        1,063   

Fair value adjustment of acquired deferred costs(b)

     (151     (125

Stock-based compensation

     12,822        14,836   

Amortization of acquired intangible assets included in cost of software revenue

     4,714        6,725   

Amortization of acquired intangible assets

     9,173        8,396   

Acquisition-related charges included in general and administrative expenses

     1,892        1,071   

U.S. pension plan termination-related costs(c)

     1,713          

Restructuring charges(d)

     38,487        4,579   
  

 

 

 

Non-GAAP operating income

     73,771        38,303   

Depreciation

     7,080        7,169   
  

 

 

 

Adjusted EBITDA

   $ 80,851      $ 45,472   
  

 

 

 

Adjusted free cash flow reconciliation:

    

Net cash provided by operating activities

   $ 91,992      $ 48,885   

Capital expenditures

     (6,160     (4,681
  

 

 

 

Free cash flow

     85,832        44,204   

Restructuring payments(d)

     5,483        25,066   

Legal settlement payments(e)

            28,162   
  

 

 

 

Adjusted free cash flow

   $ 91,315      $ 97,432   

 

 

 

(a)   Reflects the restoration of the reduction of revenue as a consequence of the write-down of deferred revenue due to purchase accounting adjustments.

 

(b)   Reflects the restoration of the reduction of expenses due to purchase accounting adjustments.

 

(c)   We maintained a U.S. defined benefit pension plan that covered certain persons who were employees of Computervision Corporation (acquired by us in 1998). Benefits under the plan were frozen in 1990. We terminated the plan in 2015. In connection with the termination, we incurred pension expense of $1.7 million in the three months ended April 4, 2015.

 

(d)   In the second quarter of 2015, we implemented actions to restructure our workforce and reduce costs through organizational efficiencies. In October 2015, we adopted a plan to further restructure our workforce and consolidate select facilities. See Notes C and O to our audited consolidated financial statements included in our most recent Annual Report on Form 10-K, which is incorporated into this prospectus supplement, and Note 3 to our unaudited consolidated financial statements included in our most recent Quarterly Report on Form 10-Q, which is incorporated by reference into this prospectus supplement.

 

 

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(e)   Reflects the payment of our legal settlement accrual recorded as charges during the third and fourth quarters of 2015 in connection with the China FCPA Investigation. See “—Resolution of previously disclosed FCPA investigation in China” below.

The selected financial data presented above for the three months ended April 2, 2016 is preliminary and subject to the completion of our closing procedures for the three months ended April 2, 2016. Those procedures have not been completed, and we may make further adjustments as a result of developments occurring between now and the time the financial results for this period are finalized. Accordingly, these results may change and those changes may be material. This preliminary consolidated financial data has been prepared by and is the responsibility of our management. PricewaterhouseCoopers LLP has not audited, reviewed, compiled or performed any procedures with respect to this preliminary consolidated financial data. Accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto.

See “Summary historical consolidated financial data.”

Acceleration of subscription business model transition

The second quarter of 2016 saw significant acceleration in the adoption of subscription licensing by our customers. Subscription bookings as a percentage of license and subscription bookings grew to 54% for this period, up from 28% in the first quarter and up from 14% in the corresponding quarter of 2015. License and subscription bookings grew 25% in the second quarter over the first quarter of 2016, with license and subscription bookings of $86 million in the second quarter of 2016, and grew 6% over the second quarter of 2015.

For the first half of 2016, subscription bookings increased over 2015 subscription bookings at a higher rate than we had anticipated, and we currently expect that subscription bookings for the full 2016 year will be approximately 45% of our total bookings, while in our original 2016 plan we had expected subscription bookings to account for about one-third of our total bookings. Although we believe that this higher mix of subscription bookings will be favorable to our revenue and earnings over time, it has been and will be unfavorable to our reported revenue and earnings per share in 2016. If a greater percentage of our customers continue to elect our subscription offering in the second half of 2016 than we anticipated, our revenue, operating margin, cash flow and earnings per share will be adversely impacted relative to those financial targets, although this change in the mix of our business is expected to be beneficial to our longer-term prospects. In addition, subscription orders tend to be smaller than perpetual license deals, which can also adversely affect revenue.

Technology Platform acquisitions

On January 12, 2016, we acquired Kepware, a software development company that provides communications connectivity to industrial automation environments, for $100.0 million in cash and $18.0 million of contingent earn-out. At the time of the acquisition, Kepware had approximately 115 employees and historical annualized revenue of approximately $20 million. In January 2016, we borrowed $120.0 million under our senior credit facility, $100.0 million of which was used to fund the acquisition of Kepware.

On November 3, 2015, we acquired the Vuforia augmented reality business from Qualcomm. The Vuforia platform is a mobile vision platform that enables applications to see and connect the physical world with digital experiences. We paid $64.8 million in cash, net of cash acquired, for the Vuforia business.

Amended and restated credit agreement

On November 4, 2015, we amended and restated our senior credit facility with our syndicate of 16 lenders, whereby we repaid our term loan facility in full by borrowing additional amounts under our revolving line of

 

 

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credit, amended the financial covenants, granted the lenders a security interest in our assets, and made various other changes to the terms and conditions of the credit facility. We further amended the credit facility on April 18, 2016 to make additional changes to the terms and conditions of the credit facility, including an amendment to the definition of Consolidated EBITDA. The current commitment under our revolving credit facility is $1.0 billion (which may be increased by up to an additional $500.0 million in the aggregate if the existing or additional lenders are willing to make such increased commitments). Outstanding borrowings under the revolving line of credit were $838.1 million as of April 2, 2016. The credit facility matures in September 2019.

Resolution of previously disclosed FCPA investigation in China

On February 16, 2016, we announced that we had entered into an agreement with the SEC and that our China subsidiaries had entered into an agreement with the DOJ to resolve our previously disclosed FCPA investigation pertaining to expenditures by certain former employees and business partners in China between 2006 and 2011 that benefited employees of customers regarded as state owned enterprises in China (the “China FCPA Investigation”). In the second quarter of 2016, we paid $28.2 million in the aggregate to those agencies in connection with those settlements. Settlement of this matter could have collateral effects on our business in China, the United States and elsewhere that could materially adversely affect our financial condition or results of operations.

Lawsuit concerning disclosures about the China FCPA Investigation

On March 7, 2016, a lawsuit was filed against us and certain of our current and former officers and directors in the U.S. District Court for the District of Massachusetts by a shareholder on behalf of himself and purportedly on behalf of other shareholders who purchased our stock during the period November 24, 2011 through July 29, 2015. The lawsuit alleges that, during that period, PTC’s public disclosures concerning the China FCPA Investigation described above were false and/or misleading and/or failed to disclose certain alleged facts. We intend to contest the action vigorously. We cannot predict the outcome of this action nor when it will be resolved. If the plaintiff(s) were to prevail in the litigation, we could be liable for damages, which could be material and could adversely affect our financial condition or results of operations.

Investigation by China Administration for Industry and Commerce

On March 2, 2016, the China Administration for Industry and Commerce (“China AIC”) initiated an investigation at our China subsidiary related to the China FCPA Investigation, but not necessarily limited to the China FCPA Investigation. The China AIC is authorized to issue fines and assess other civil penalties. We are unable to predict the outcome of this matter, which could include fines or other sanctions that could be material and could adversely affect our financial condition or results of operations.

Other information

We were incorporated in Massachusetts in 1985. Our principal executive offices are located at 140 Kendrick Street, Needham, Massachusetts 02494, and our telephone number at that address is (781) 370-5000. We maintain a website at www.ptc.com where general information about us is available. We are not incorporating the contents of the website into this prospectus supplement or the accompanying prospectus.

For additional information regarding our business, we refer you to our filings with the SEC incorporated into this prospectus supplement by reference. Please read “Where you can find more information” and “Incorporation by reference” in this prospectus supplement.

 

 

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The offering

The following summary contains selected information about the notes and is not intended to be complete. For a more complete understanding of the notes, please refer to the section in this prospectus supplement entitled “Description of notes” and the section in the accompanying prospectus entitled “Description of securities.”

 

Issuer

PTC Inc.

 

Securities offered

$500.0 million aggregate principal amount of     % Senior Notes due 2024.

 

Maturity date

                    , 2024.

 

Interest rate

    % per year.

 

Interest payment dates

             and             , commencing                     , 2016. Interest will accrue from                     , 2016.

 

Optional redemption

The notes will be redeemable at our option, in whole or in part, at any time on or after                     , 2019, at the redemption prices set forth in this prospectus supplement, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption.

 

  At any time prior to                     , 2019, we may redeem up to 40% of the original aggregate principal amount of the notes with the proceeds of certain equity offerings at a redemption price of     % of the principal amount of the notes, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption.

 

  At any time prior to                     , 2019, we may also redeem some or all of the notes at a price equal to 100% of the principal amount of the notes plus a “make-whole” premium, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption.

 

  See “Description of notes—Optional redemption.”

 

Change of control offer

Upon the occurrence of specific kinds of changes of control, you will have the right, as holders of the notes, to cause us to repurchase some or all of your notes at 101% of their face amount, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. See “Description of notes—Change of control.”

 

Asset sales offer

If we or any of our subsidiaries sell assets, under certain circumstances, we will be required to use the net cash proceeds to make an offer to purchase notes at an offer price in cash in an amount equal to 100% of the principal amount of the notes, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date. See “Description of notes—Certain covenants—Limitation on asset sales.”

 

Future subsidiary guarantees

On the issue date, the notes will not be guaranteed by any of our subsidiaries. After the issue date, the notes will be required to be guaranteed on a senior unsecured basis by any of our domestic subsidiaries that in the future becomes a

 

 

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guarantor of our senior credit facility or certain other material indebtedness of PTC Inc. or any other future guarantor. See “Description of notes—Future guarantors.”

 

  For the twelve months ended January 2, 2016, our subsidiaries:

 

   

represented approximately 58% of our revenue;

 

   

generated approximately $173 million of operating income, excluding net intercompany charges by PTC Inc. to those subsidiaries; and

 

   

represented approximately 86% of our Adjusted EBITDA.

 

  As of January 2, 2016, our subsidiaries:

 

   

represented approximately 42% of our total assets, excluding intercompany receivables; and

 

   

had approximately $354 million of total liabilities, including trade payables but excluding intercompany liabilities.

 

Ranking

The notes will be our senior unsecured obligations and will:

 

   

rank senior in right of payment to all of our future subordinated indebtedness;

 

   

rank equally in right of payment with all of our existing and future senior indebtedness;

 

   

be effectively subordinated to any of our existing and future secured debt, to the extent of the value of the assets securing such debt, including loans made under our senior credit facility which are permitted to be made in an amount not to exceed the current commitment of $1.0 billion (which may be increased by up to an additional $500.0 million in the aggregate if the existing or additional lenders are willing to make such increased commitments); and

 

   

on the issue date, be structurally subordinated to all of the liabilities (including trade payables) of all of our subsidiaries, and in the future be structurally subordinated to all of the liabilities (including trade payables) of any of our subsidiaries that does not become a guarantor of the notes.

 

  As of January 2, 2016 on an as adjusted basis:

 

   

we would have had approximately $844.2 million of total indebtedness (including the notes) (without giving effect to approximately $4.0 million of outstanding letters of credit supporting leases and certain other obligations, approximately $1.1 million of which outstanding letters of credit are secured by cash);

 

   

of our total indebtedness, we would have had approximately $344.2 million of secured indebtedness (without giving effect to approximately $1.1 million of outstanding letters of credit which are secured by cash), to which the notes would have been effectively subordinated;

 

 

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we and one of our foreign subsidiaries which is a borrower under our senior credit facility would have had unused commitments under the senior credit facility of approximately $655.8 million, of which approximately $236.0 million would have been available for borrowing as a result of financial covenants; and

 

   

our subsidiaries would have had approximately $354 million of total liabilities (including trade payables but excluding intercompany liabilities), all of which would have been structurally senior to the notes.

 

  In addition, one of our foreign subsidiaries is a borrower under our senior credit facility and certain other foreign subsidiaries may become borrowers under our senior credit facility in the future, subject to certain conditions, and any borrowings by such subsidiaries will be secured indebtedness.

 

Covenants

We will issue the notes under an indenture with The Bank of New York Mellon, as trustee. The indenture will, among other things, limit our ability and the ability of our subsidiaries to:

 

   

incur additional indebtedness or guarantee indebtedness;

 

   

pay dividends or make other distributions or repurchase or redeem our capital stock;

 

   

prepay, redeem or repurchase certain debt;

 

   

make loans and investments;

 

   

sell assets;

 

   

incur liens;

 

   

enter into certain sale and leaseback transactions; and

 

   

consolidate, merge or sell all or substantially all of our assets.

 

  These covenants will be subject to a number of important exceptions and qualifications.

 

  If the notes are assigned an investment grade rating from both Standard & Poor’s Rating Group and Moody’s Investors Service, Inc., subject to certain conditions, many of these covenants will be suspended.

 

  For more details, see “Description of notes.”

 

Absence of public market
for the notes

The notes are a new issue of securities and there is currently no established trading market for the notes. We do not intend to apply for a listing of the notes on any securities exchange or an automated dealer quotation system. Accordingly, a liquid market for the notes may not develop. The underwriters have advised us that they currently intend to make a market in the notes. However, they are not obligated to do so, and any market making with respect to the notes may be discontinued without notice.

 

Use of proceeds

We intend to use the net proceeds of this offering to repay a portion of the outstanding indebtedness under our senior credit facility. See “Use of proceeds.”

 

 

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Underwriting (conflicts of interest)

Affiliates of certain of the underwriters will receive at least 5% of the net proceeds of this offering in connection with the repayment of a portion of the outstanding indebtedness under our senior credit facility. See “Use of proceeds.” Accordingly, this offering is being made in compliance with the requirements of Rule 5121 of the Financial Industry Regulatory Authority, Inc. (“FINRA”). This rule requires, among other things, that a “qualified independent underwriter” has participated in the preparation of, and has exercised the usual standards of “due diligence” with respect to, the registration statement. The Huntington Investment Company has agreed to act as qualified independent underwriter for this offering and to undertake the legal responsibilities and liabilities of an underwriter under the Securities Act of 1933, as amended (the “Securities Act”). See “Underwriting (conflicts of interest).”

 

Risk factors

Investing in the notes involves substantial risk. In evaluating an investment in the notes, prospective investors should carefully consider, along with the other information in, or incorporated by reference into, this prospectus supplement and the accompanying prospectus, the specific factors set forth under “Risk factors” for risks involved with an investment in the notes.

 

 

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Summary historical consolidated financial data

The following tables set forth our summary historical consolidated financial data as of and for the periods presented. The summary consolidated statement of operations data for the years ended September 30, 2013, 2014 and 2015 and the summary consolidated balance sheet data as of September 30, 2014 and 2015 were derived from our audited consolidated financial statements included in our most recent Annual Report on Form 10-K, which is incorporated by reference into this prospectus supplement. The summary consolidated balance sheet data as of September 30, 2013 was derived from our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended September 30, 2013, which is not incorporated by reference into this prospectus supplement. The summary consolidated statement of operations data for the three months ended January 3, 2015 and January 2, 2016 and the consolidated balance sheet data as of January 2, 2016 were derived from our unaudited consolidated financial statements included in our most recent Quarterly Report on Form 10-Q, which is incorporated by reference into this prospectus supplement. The summary consolidated balance sheet data as of January 3, 2015 was derived from our unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the three months ended January 3, 2015, which is not incorporated by reference into this prospectus supplement. Our unaudited consolidated financial statements have been prepared on the same basis as the audited financial statements. In the opinion of management, the unaudited interim financial information reflects all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial information in those statements.

The unaudited consolidated financial data for the twelve months ended January 2, 2016 was derived by adding our financial data for the year ended September 30, 2015 to the financial data for the three months ended January 2, 2016 and subtracting the financial data for the three months ended January 3, 2015.

 

 

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The summary historical consolidated financial data set forth below are not necessarily indicative of the results of future operations. This information is only a summary and should be read in conjunction with our consolidated financial statements and accompanying notes included in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q, each of which is incorporated by reference into this prospectus supplement, as well as “Use of proceeds,” “Capitalization” and “Management’s discussion and analysis of financial condition and results of operations.”

 

     Year ended September 30,    

 

Three months ended

    Twelve
months
ended
January 2,
2016
 
     

January 3,

2015

   

January 2,

2016

   
(In thousands)   2013     2014     2015        
                          (unaudited)     (unaudited)     (unaudited)  

Consolidated statement of operations data:

           

Revenue:

           

Subscription

  $ 10,073      $ 27,137      $ 65,239      $ 14,223      $ 22,176      $ 73,192   

Support

    654,679        688,502        681,524        181,629        171,756        671,651   
 

 

 

 

Total recurring software revenue

    664,752        715,639        746,763        195,852        193,932        744,843   

Perpetual license

    344,209        362,602        282,760        64,748        47,763        265,775   
 

 

 

 

Total software revenue

    1,008,961        1,078,241        1,029,523        260,600        241,695        1,010,618   

Professional services

    284,580        278,726        225,719        64,842        49,322        210,199   
 

 

 

 

Total revenue

    1,293,541        1,356,967        1,255,242        325,442        291,017        1,220,817   
 

 

 

 

Cost of revenue:

           

Cost of software revenue

    120,118        129,708        135,992        34,725        36,814        138,081   

Cost of professional services revenue

    252,921        243,975        198,742        58,217        43,333        183,858   
 

 

 

 

Total cost of revenue

    373,039        373,683        334,734        92,942        80,147        321,939   
 

 

 

 

Gross margin

    920,502        983,284        920,508        232,500        210,870        898,878   
 

 

 

 

Operating expenses:

           

Sales and marketing

    373,375        367,454        346,794        89,484        82,429        339,739   

Research and development

    221,918        226,496        227,513        61,097        57,669        224,085   

General and administrative

    119,202        132,225        158,715        35,130        38,567        162,152   

U.S. pension settlement loss(1)

                  66,332                      66,332   

Amortization of acquired intangible assets

    26,486        32,127        36,129        9,413        8,350        35,066   

Restructuring charges (credits)(2)

    52,197        28,406        43,409        (255     37,147        80,811   
 

 

 

 

Total operating expenses

    793,178        786,708        878,892        194,869        224,162        908,185   
 

 

 

 

Operating income (loss)

    127,324        196,576        41,616        37,631        (13,292     (9,307

Interest and other expense, net

    (1,090     (10,464     (15,091     (3,224     (6,253     (18,120
 

 

 

 

Income (loss) before income taxes

    126,234        186,112        26,525        34,407        (19,545     (27,427

Provision for (benefit from) income taxes

    (17,535     25,918        (21,032     4,123        4,347        (20,808
 

 

 

 

Net income (loss)

  $ 143,769      $ 160,194      $ 47,557      $ 30,284      $ (23,892   $ (6,619

 

 

 

 

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As of September 30,

    As of  
     

January 3,

2015

   

January 2,

2016

 
(In thousands)   2013     2014     2015      
                          (unaudited)     (unaudited)  

Consolidated balance sheet data:

         

Cash and cash equivalents

  $ 241,913      $ 293,654      $ 273,417      $ 261,052      $ 296,797   

Goodwill

    769,095        1,012,527        1,069,041        1,000,992        1,086,230   

Total assets

    1,828,906        2,199,954        2,209,913        2,137,223        2,215,893   

Total debt, including current portion

    258,125        611,875        668,125        605,625        718,125   

Total liabilities

    902,426        1,346,065        1,349,742        1,281,770        1,379,956   

Total stockholders’ equity

    926,480        853,889        860,171        855,453        835,937   

 

 

 

     

 

Year ended September 30,

    

 

Three months ended

    

Twelve

months

ended

January 2,

2016

 
       

January 3,

2015

    

January 2,

2016

    
(Dollar amounts in thousands)    2013      2014      2015           
                              (unaudited)      (unaudited)      (unaudited)  

Other financial data:

                 

Adjusted EBITDA(3)

   $ 317,749       $ 367,356       $ 333,229       $ 76,870       $ 69,229       $ 325,588   

Adjusted EBITDA margin(3)(4)

     25%         27%         27%         24%         24%         27%   

Adjusted free cash flow(5)

   $ 232,554       $ 299,852       $ 228,338       $ 23,012       $ 73,771       $ 279,097   

Ratio of total debt to Adjusted EBITDA(3)(6)

     0.8x         1.7x         2.0x         7.9x         10.4x         2.2x   

Ratio of Adjusted EBITDA to interest expense(3)(7)

     45.5x         45.0x         22.6x         20.4x         10.5x         18.5x   

As adjusted financial data:(8)

                 

Ratio of total debt to Adjusted EBITDA(3)(6)

                    2.6x   

Ratio of Adjusted EBITDA to interest expense(3)(7)

                    7.5x   

 

 

 

(1)   We maintained a U.S. defined benefit pension plan that covered certain persons who were employees of Computervision Corporation (acquired by us in 1998). Benefits under the plan were frozen in 1990. We terminated the plan in 2015. In connection with the termination, we contributed $25.5 million to the plan and recorded a settlement loss of $66.3 million.

 

(2)   In each of 2013, 2014, 2015 and the first quarter of 2016, we implemented restructuring actions to restructure our workforce and reduce costs through organizational efficiencies. In October 2015, we adopted a plan to further restructure our workforce and consolidate select facilities. See Notes C and O to our audited consolidated financial statements included in our most recent Annual Report on Form 10-K, which is incorporated by reference into this prospectus supplement, and Note 3 to our unaudited consolidated financial statements included in our most recent Quarterly Report on Form 10-Q, which is incorporated by reference into this prospectus supplement.

 

 

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(3)   Non-GAAP operating income and Adjusted EBITDA are non-GAAP financial measures. We define non-GAAP operating income as operating income (loss), excluding the impact of purchase accounting on the fair value of acquired deferred revenue and acquired deferred costs, stock-based compensation expense, amortization of acquired intangible assets, acquisition-related expenses, costs associated with terminating a U.S. pension plan, a litigation accrual associated with the China FCPA Investigation and restructuring charges. We define Adjusted EBITDA as non-GAAP operating income before depreciation. The following reconciles non-GAAP operating income to operating income (loss) and Adjusted EBITDA to net income (loss), the most directly comparable financial measures calculated in accordance with GAAP.

 

    

 

Year ended September 30,

   

 

Three months ended

   

Twelve

months

ended

January 2,

2016

 
     

January 3,

2015

   

January 2,

2016

   
(In thousands)   2013     2014     2015        
                          (unaudited)     (unaudited)     (unaudited)  

Adjusted EBITDA reconciliation:

           

Net income (loss)

  $ 143,769      $ 160,194      $ 47,557      $ 30,284      $ (23,892   $ (6,619

Provision for (benefit from) income taxes

    (17,535     25,918        (21,032     4,123        4,347        (20,808

Interest and other expense, net

    1,090        10,464        15,091        3,224        6,253        18,120   
 

 

 

 

Operating income (loss)

    127,324        196,576        41,616        37,631        (13,292     (9,307

Fair value adjustment of acquired deferred revenue(a)

    3,035        1,249        3,869        1,404        497        2,962   

Fair value adjustment of acquired deferred costs(b)

           (167     (526     (106     (132     (552

Stock-based compensation

    48,787        50,889        50,182        11,242        23,189        62,129   

Amortization of acquired intangible assets included in cost of software revenue

    18,586        18,112        19,402        4,767        5,127        19,762   

Amortization of acquired intangible assets

    26,486        32,127        36,129        9,413        8,350        35,066   

Acquisition-related charges included in general and administrative expenses

    9,855        12,715        8,913        4,033        1,207        6,087   

U.S. pension plan termination-related costs(c)

           381        73,171        1,684               71,487   

Legal settlement accrual(d)

                  28,162                      28,162   

Restructuring charges (credits)(e)

    52,197        28,406        43,409        (255     37,147        80,811   
 

 

 

 

Non-GAAP operating income

    286,270        340,288        304,327        69,813        62,093        296,607   

Depreciation

    31,479        27,068        28,902        7,057        7,136        28,981   
 

 

 

 

Adjusted EBITDA

  $ 317,749      $ 367,356      $ 333,229      $ 76,870      $ 69,229      $ 325,588   

 

 

 

  (a)   Reflects the restoration of the reduction of revenue as a consequence of the write-down of deferred revenue due to purchase accounting adjustments.

 

  (b)   Reflects the restoration of the reduction of expenses due to purchase accounting adjustments.

 

  (c)   See footnote (1).

 

  (d)   Reflects the add-back of our recorded charges of $28.2 million relating to the China FCPA Investigation.

 

  (e)   See footnote (2).

 

(4)   Adjusted EBITDA as a percentage of total revenue.

 

(5)   Free cash flow and Adjusted free cash flow are also non-GAAP financial measures. We define free cash flow as net cash provided by operating activities less capital expenditures (other than acquisitions). Adjusted free cash flow is defined as free cash flow plus cash paid for discrete charges as identified (for the periods presented this included U.S. pension plan termination payments and restructuring payments). The following reconciles free cash flow and Adjusted free cash flow to net cash provided by operating activities, the most directly comparable financial measure calculated in accordance with GAAP.

 

     

 

Year ended September 30,

   

 

Three months ended

   

Twelve

months

ended

January 2,

2016

 
      

January 3,

2015

   

January 2,

2016

   
(In thousands)    2013     2014     2015        
                           (unaudited)     (unaudited)     (unaudited)  

Adjusted free cash flow reconciliation:

            

Net cash provided by operating activities

   $ 224,683      $ 304,552      $ 179,903      $ 13,632      $ 61,254      $ 227,525   

Capital expenditures

     (29,328     (25,275     (30,628     (7,947     (4,185     (26,866
  

 

 

 

Free cash flow

     195,355        279,277        149,275        5,685        57,069        200,659   

U.S. pension plan termination payments(a)

                   25,475                      25,475   

Restructuring payments(b)

     37,199        20,575        53,588        17,327        16,702        52,963   
  

 

 

 

Adjusted free cash flow

   $ 232,554      $ 299,852      $ 228,338      $ 23,012      $ 73,771      $ 279,097   

 

 

 

  (a)   See footnote (1).

 

  (b)   See footnote (2).

 

 

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(6)   Total debt (including current portion) divided by Adjusted EBITDA.

 

(7)   Adjusted EBITDA divided by interest expense.

 

(8)   Calculated giving effect to the transactions described in this prospectus supplement as if they had occurred on January 4, 2015.

We have also presented non-GAAP operating margin in this prospectus supplement. Non-GAAP operating margin is a non-GAAP financial measure that excludes the same items that are excluded when calculating non-GAAP operating income as explained in footnote (3) above. The following reconciles non-GAAP operating margin to operating margin, the most directly comparable financial measure calculated in accordance with GAAP.

 

     

 

Year ended September 30,

    

 

Three months ended

   

Twelve

months

ended

January 2,

2016

 
       

January 3,

2015

   

January 2,

2016

   
     2013      2014      2015         
                              (unaudited)     (unaudited)     (unaudited)  

Non-GAAP operating margin reconciliation:

               

Operating margin

     9.8%         14.5%         3.3%         11.6%        (4.6%     (0.8%

Fair value adjustment of acquired deferred revenue(a)

     0.2%         0.1%         0.3%         0.4%        0.2%        0.2%   

Fair value adjustment of acquired deferred costs(b)

     —%         —%         —%         —%        —%        —%   

Stock-based compensation

     3.8%         3.8%         4.0%         3.5%        8.0%        5.1%   

Amortization of acquired intangible assets

     3.5%         3.7%         4.4%         4.4%        4.6%        4.5%   

Acquisition-related charges included in general and administrative expenses

     0.8%         0.9%         0.7%         1.2%        0.4%        0.5%   

U.S. pension plan termination-related costs(c)

     —%         —%         5.8%         0.5%        —%        5.9%   

Legal settlement accrual(d)

     —%         —%         2.2%         —%        —%        2.3%   

Restructuring charges (credits)(e)

     4.0%         2.1%         3.5%         (0.1%     12.8%        6.6%   
  

 

 

 

Non-GAAP operating margin

     22.1%         25.1%         24.2%         21.4%        21.3%        24.3%   

 

 

 

  (a)   See footnote (a) under Adjusted EBITDA reconciliation.

 

  (b)   See footnote (b) under Adjusted EBITDA reconciliation.

 

  (c)   See footnote (1).

 

  (d)   See footnote (d) under Adjusted EBITDA reconciliation.

 

  (e)   See footnote (2).

Information about non-GAAP financial measures

Non-GAAP operating income, non-GAAP operating margin, Adjusted EBITDA, free cash flow and Adjusted free cash flow are not recognized terms under GAAP and do not purport to be alternatives to operating income or net income as a measure of operating performance or to cash flows provided by operations as a measure of liquidity. We present these non-GAAP measures because 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 provide information on free cash flow and Adjusted free cash flow to enable investors to assess our ability to generate cash without incurring additional external financings and to evaluate our performance against our announced long-term goal of returning approximately 40% of our free cash flow

 

 

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to shareholders through stock repurchases. We believe that providing non-GAAP measures affords investors a view of our operating results that may be more easily compared to the results of peer companies. In addition, compensation of our executives is based in part on the performance of our business based on these non-GAAP measures. However, non-GAAP information should not be construed as an alternative to GAAP information as the items excluded from the non-GAAP measures often have a material impact on our financial results. Management uses, and investors should consider, non-GAAP measures in conjunction with our GAAP results.

Non-GAAP operating income, non-GAAP operating margin, Adjusted EBITDA, free cash flow and Adjusted free cash flow have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are:

 

 

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

 

 

non-GAAP operating income and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

 

 

non-GAAP operating income and Adjusted EBITDA do not reflect our interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

 

 

non-GAAP operating income and Adjusted EBITDA do not reflect our income tax expense or the cash requirements to pay our taxes;

 

 

free cash flow and Adjusted free cash flow do not reflect the cash necessary to service principal payments on our debt or to repurchase shares of our common stock;

 

 

free cash flow and Adjusted free cash do not represent the residual cash flow for discretionary expenditures;

 

 

Adjusted free cash flow does not reflect the cash necessary to pay restructuring obligations or cash amounts paid in connection with the U.S. pension plan termination; and

 

 

other companies, including companies in our industry, may calculate non-GAAP operating income, non-GAAP operating margin, Adjusted EBITDA, free cash flow and Adjusted free cash flow differently, which reduces their usefulness as comparative measures.

Because of these limitations, non-GAAP operating income, non-GAAP operating margin, Adjusted EBITDA, free cash flow and Adjusted free cash flow should not be considered as measures of discretionary cash available to use for reinvestment in the growth of our business or as a measure of cash that will be available to meet our obligations. You should consider these non-GAAP measures alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results.

 

 

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Risk factors

Any investment in the notes involves a high degree of risk. In addition to the other information provided and incorporated by reference in this prospectus supplement and the accompanying prospectus, you should carefully consider the risks described below before deciding whether to purchase the notes. The risks and uncertainties described below and in such incorporated documents are not the only risks and uncertainties that we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of those risks actually occurs, our business, financial condition and results of operations would suffer.

The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements. See “Cautionary statement regarding forward-looking statements” in this prospectus supplement.

This discussion of risk factors should be read in conjunction with “Management’s discussion and analysis of financial condition and results of operations” and the consolidated financial statements and related notes included in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q, each of which is incorporated by reference into this prospectus supplement.

Risks related to our business

I. Operational considerations

Our operating results fluctuate from quarter to quarter, making future operating results difficult to predict; failure to meet market expectations could cause the price of our securities to decline.

Our quarterly operating results historically have fluctuated and are likely to continue to fluctuate depending on a number of factors, including:

 

 

a high percentage of our revenue historically has been generated in the third month of each fiscal quarter and any failure to receive, complete or process orders at the end of any quarter could cause us to fall short of our revenue targets;

 

 

a significant percentage of our revenue comes from transactions with large customers, which tend to have long lead times that are less predictable;

 

 

one or more industries that we serve may have weak or negative growth;

 

 

our operating expenses are largely fixed in the short term and are based on expected revenues and any failure to achieve our revenue targets could cause us to miss our earnings targets as well;

 

 

our mix of license, subscription and service revenues can vary from quarter to quarter, creating variability in our operating margins;

 

 

because a significant portion of our revenue comes from outside the U.S. and a significant portion of our expense structure is located internationally, shifts in foreign currency exchange rates could adversely affect our reported results; and

 

 

we may incur significant expenses in a quarter in connection with corporate development initiatives, restructuring efforts or the investigation, defense or settlement of legal actions that would increase our operating expenses and reduce our earnings for the quarter in which those expenses are incurred.

 

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Accordingly, our quarterly results are difficult to predict prior to the end of the quarter and we may be unable to confirm or adjust expectations with respect to our operating results for a particular quarter until that quarter has closed. Any failure to meet our quarterly revenue or earnings targets could adversely impact the market price of our securities.

We now offer our solutions as subscriptions, which will adversely affect our revenue and earnings in the transition period and make predicting our revenue and earnings more difficult.

We began offering most of our solutions under a subscription option in 2015, in addition to our perpetual license option. Under a subscription, customers pay a periodic fee for the right to use our software and receive support, or to use our cloud services and have us manage the application for a specified period. We believe that a significant number of our customers will elect to purchase our solutions as subscriptions rather than under a perpetual license (if available). Until we have fully transitioned to a stable mix of subscription and perpetual license purchases, we expect that our license revenue will decrease due to the difference in revenue recognition for a subscription license (revenue is recognized ratably over the term of the license) and a perpetual license (revenue is generally recognized upon purchase) and that our support revenue (which comprises a significant portion of our revenue) may also decrease due to support services being included in the subscription offering.

Our revenue and earnings targets are based on assumptions about the mix of revenue that will be attributable to subscription and perpetual license revenue. If a greater percentage of our customers elect to purchase our solutions as subscriptions in a period than we assumed, our revenue and earnings will likely fall below our expectations for that period, which could cause the price of our securities to decline.

Our long range financial targets are predicated on revenue growth and operating margin improvements that we may fail to achieve, which could reduce our expected earnings and cause us to fail to meet the expectations of analysts or investors and cause the price of our securities to decline.

We are projecting long-term revenue and earnings growth. However, as we transition to a subscription model, our plan through 2021 assumes that our license revenue and earnings will decrease in 2016, 2017 and 2018 due to lower up-front revenue recognized for a subscription license compared to a perpetual license, and assumes increases in revenue from a recurring subscription revenue stream beginning in 2019. Our projections are based on the expected growth potential in the IoT and SLM markets, with more modest growth expectations for CAD and ePLM. We may not achieve the expected bookings and revenue growth if the markets we serve do not grow at expected rates, if we are not able to deliver solutions desired by customers and potential customers, and/or if acquired businesses do not generate the revenue growth that we expect.

Our long-term operating margin improvement is predicated on operating leverage from revenue growth, improved operating efficiencies, particularly within our sales organization, and service margin improvements. Services margins are significantly lower than license and support margins. Future projected improvements in our operating margin as a percent of revenue are based in part on our ability to improve services margins by reducing the amount of direct services that we perform through expansion of our service partner program, and improving the profitability of services that we perform. If our services revenue increases as a percentage of total revenue and/or if we are unable to improve our services margins, our overall operating margin may not increase to the levels we expect or may decrease. Additionally, if we do not achieve lower sales and marketing expenses as a percentage of revenue through productivity initiatives, we may not achieve our operating margin targets. If operating margins do not improve, our earnings could be adversely affected and the price of our securities could decline.

 

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Our significant investment in our Technology Platform business may not generate the revenues we expect.

We have made a significant investment in recent years in our Technology Platform business, including five acquisitions, totaling approximately $550 million. Our Technology Platform business provides technology solutions that enable customers to transform their businesses and leverage the opportunities created by the Internet of Things.

The Technology Platform market is a new market for us that requires us to adopt a new sales approach. The go-to-market approach for the Technology Platform business relies on an extensive and differentiated partner ecosystem to enable us to access markets and customers beyond our traditional markets, customers and buyers. We also expect to focus on marketing directly to software application developers to become the Technology Platform of choice for the IoT. We may be unable to expand our partner ecosystem as we expect and developers may not adopt our Technology Platform solutions as we expect, which would adversely affect our ability to realize revenue from our investments in this business.

Further, the Internet of Things is a relatively new market and there are a significant number of competitors in the market. If the market does not expand as rapidly as we or others expect or if customers adopt competitive solutions rather than our solutions, our Technology Platform business may not generate the revenues we expect.

Businesses we acquire may not generate the revenue and earnings we anticipate and may otherwise adversely affect our business.

We have acquired, and intend to continue to acquire, new businesses and technologies. If we fail to successfully integrate and manage the businesses and technologies we acquire, or if an acquisition does not further our business strategy as we expect, our operating results will be adversely affected.

Moreover, business combinations also involve a number of risks and uncertainties that can adversely affect our operations and operating results, including:

 

 

difficulties managing an acquired company’s technologies or lines of business or entering new markets where we have limited or no prior experience or where competitors may have stronger market positions;

 

 

unanticipated operating difficulties in connection with the acquired entities, including potential declines in revenue of the acquired entity;

 

 

failure to achieve the expected return on our investments which could adversely affect our business or operating results and impair the assets that we recorded as a part of an acquisition including intangible assets and goodwill;

 

 

diversion of management and employee attention;

 

 

loss of key personnel;

 

 

assumption of unanticipated legal or financial liabilities or other unidentified issues with the acquired business;

 

 

potential incompatibility of business cultures;

 

 

significant increases in our interest expense, leverage and debt service requirements if we incur additional debt to pay for an acquisition; and

 

 

if we were to issue a significant amount of equity securities in connection with future acquisitions, existing stockholders may be diluted and earnings per share may decrease.

 

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Our restructuring actions and reorganization may be disruptive and could harm our operations.

Over the past few years, we have taken a number of restructuring actions and reorganizations designed to realign our global workforce to our business needs, reduce our expenses and enable us to increase investment in our Technology Platform business. These actions may not have the expected long-term effect on our expenses or may not be sufficient to fully offset additional investments we may make in our business. Disruptions in operations have occurred and will likely continue to occur as a result of these actions. Disruptions may include attrition beyond our planned reduction in workforce, a negative effect on employee morale or our ability to attract highly skilled employees. Further, we could experience delays, business disruptions, decreased productivity, unanticipated employee turnover and increased litigation related costs in connection with the restructuring and other efficiency initiatives.

In October 2015, we committed to a plan to reduce costs and realign investments with what we believe are our higher growth opportunities by reducing our workforce and consolidating facilities. This restructuring may result in higher charges than anticipated and/or our actual projected expense reductions may fall below our expectations.

We depend on sales within the discrete manufacturing sector and our business could be adversely affected if manufacturing activity does not grow or if it contracts.

A large amount of our revenue is related to sales to customers in the discrete manufacturing sector. If this economic sector does not grow, or if it contracts, our customers in this sector may, as they have in the past, reduce or defer purchases of our products and services, which adversely affects our business. In 2015 and the first half of 2016, the manufacturing sector was weak, particularly in the Americas and China, which we believe adversely impacted our sales and operating results in those regions in 2015. We expect global manufacturing economic conditions could continue to adversely impact our results in the remainder of 2016, particularly in the U.S.

We face significant competition, which may reduce our profits and limit or reduce our market share.

The market for product development solutions and IoT solutions is rapidly changing and characterized by vigorous competition, both by entry of competitors with innovative technologies and by consolidation of companies with complementary products and technologies. This competition could result in price reductions for our products and services, reduced margins, loss of customers and loss of market share. Our primary competition comes from:

 

 

larger companies that offer competitive solutions;

 

 

larger, more well-known enterprise software providers with greater financial, technical, sales and marketing, and other resources; and

 

 

other vendors of various competitive point solutions or IoT platforms.

In addition, barriers to entry into certain segments of the software industry have declined and the ability of customers to adopt software solutions has increased with the ability to offer software in the cloud and the increasing prevalence of subscription license models and customer acceptance of both those models. Because of these and other factors, competitive conditions in the industry are likely to intensify in the future.

Increased competition could result in price reductions, reduced net revenue and profit margins and loss of market share, any of which would likely harm our business.

 

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A breach of security in our products or computer systems, or those of our third-party service providers, could compromise the integrity of our products, harm our reputation, create additional liability and adversely impact our financial results.

We have implemented and continue to implement measures intended to maintain the security and integrity of our products, source code and computer systems. The potential consequences of a security breach or system disruption (particularly through cyber-attack or cyber-intrusion, including by computer hackers, foreign governments and cyber terrorists) have increased in scope as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Despite efforts to create security barriers to such threats, it is virtually impossible for us to entirely eliminate this risk. In addition, we offer cloud services to our customers and some of our products are hosted by third-party service providers, which expose us to additional risks as those repositories of our customers’ proprietary data may be targeted by such hackers. A significant breach of the security and/or integrity of our products or systems, or those of our third-party service providers, could prevent our products from functioning properly, could enable access to sensitive, proprietary or confidential information, including that of our customers, without authorization, or could disrupt our business operations or those of our customers. This could require us to incur significant costs of remediation, harm our reputation, cause customers to stop buying our products, and cause us to face lawsuits and potential liability, which could have a material adverse effect on our financial condition and results of operations.

Our sales and operations are globally dispersed, which exposes us to additional compliance risks.

We sell and deliver software and services, and maintain support operations, in a large number of countries whose laws and practices differ from one another and are subject to unexpected changes. Managing these geographically dispersed operations requires significant attention and resources to ensure compliance with laws of those countries and those of the U.S. governing our activities in non-U.S. countries.

Those laws include, but are not limited to, anti-corruption laws and regulations (including the U.S. Foreign Corrupt Practices Act (FCPA) and the U.K. Bribery Act 2010) and trade and economic sanctions laws and regulations (including laws administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control, the U.S. State Department, the U.S. Department of Commerce, the United Nations Security Council and other relevant sanctions authorities). The FCPA and UK Bribery Act prohibit us and business partners or agents acting on our behalf from offering or providing anything of value to persons considered to be foreign officials under those laws for the purposes of obtaining favorable treatment. The UK Bribery Act also prohibits commercial bribery and accepting bribes. Our compliance risks with these laws are heightened due to the global nature of our business, the fact that we operate in, and are expanding into, countries with a higher incidence of corruption and fraudulent business practices than others, and the fact that we deal with governments and state-owned business enterprises, the employees and representatives of which may be considered foreign officials for purposes of the FCPA and the UK Bribery Act.

Accordingly, while we strive to maintain a comprehensive compliance program, we cannot guarantee that an employee, agent or business partner will not act in violation of our policies or U.S. or other applicable laws. Investigations of alleged violations of those laws can be expensive and disruptive. Violations of such laws can lead to civil and/or criminal prosecutions, substantial fines and other sanctions, including the revocation of our rights to continue certain operations and also cause business and reputation loss. For example, as discussed in Risk Factors II. Other Considerations, we recently resolved an investigation by the SEC and the DOJ concerning certain payments and expenses by certain business partners and employees in China, and we are currently subject to an investigation at our China subsidiary by the China Administration for Industry and Commerce (the “China AIC”).

 

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Our international businesses present economic and operating risks.

We expect that our international operations will continue to expand and to account for a significant portion of our total revenue. Because we transact business in various foreign currencies, the volatility of foreign exchange rates has had and may in the future have a material adverse effect on our revenue, expenses and operating results.

Other risks inherent in our international operations include, but are not limited to, the following:

 

 

difficulties in staffing and managing foreign sales and development operations;

 

possible future limitations upon foreign-owned businesses;

 

increased financial accounting and reporting burdens and complexities;

 

inadequate local infrastructure; and

 

greater difficulty in protecting our intellectual property.

We may be unable to adequately protect our proprietary rights.

Our software products are proprietary. We protect our intellectual property rights in these items by relying on copyrights, trademarks, patents and common law safeguards, including trade secret protection, as well as restrictions on disclosures and transferability contained in our agreements with other parties. Despite these measures, the laws of all relevant jurisdictions may not afford adequate protection to our products and other intellectual property. In addition, we frequently encounter attempts by individuals and companies to pirate our software. If our measures to protect our intellectual property rights fail, others may be able to use those rights, which could reduce our competitiveness and revenues.

In addition, any legal action to protect our intellectual property rights that we may bring or be engaged in could be costly, may distract management from day-to-day operations and may lead to additional claims against us, and we may not succeed, all of which would materially adversely affect our operating results.

Intellectual property infringement claims could be asserted against us, which could be expensive to defend and could result in limitations on our use of the claimed intellectual property.

The software industry is characterized by frequent litigation regarding copyright, patent and other intellectual property rights, as well as improper disclosure of confidential or proprietary information. If a lawsuit of this type is filed, it could result in significant expense to us and divert the efforts of our technical and management personnel. We cannot be sure that we would prevail against any such asserted claims. If we did not prevail, we could be prevented from using the claimed intellectual property or be required to enter into royalty or licensing agreements, which might not be available on terms acceptable to us. In addition to possible claims with respect to our proprietary products, some of our products contain technology developed by and licensed from third parties and we may likewise be susceptible to infringement claims with respect to these third-party technologies.

Some of our products contain “open source” software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business and subject us to possible litigation.

Some of our products incorporate so-called “open source” software and we may incorporate open source software into other products in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses. We monitor our use of open source software in an effort to avoid subjecting our products to conditions we do not intend. Although we believe that we have complied with our

 

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obligations under the various applicable licenses for open source software that we use, our processes used to monitor how open source software is used could be improperly followed or subject to error.

If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations. If our defenses were not successful, we could be subject to significant damages. We could also be enjoined from the distribution of our products that contained the open source software or be required to modify our products in order to comply with the conditions of the open source license(s) in question, thereby disrupting the distribution and sale of some of our products. In addition, if we combine our proprietary software with open source software in a certain manner, under some open source licenses we could be required to release the source code of our proprietary software, which would adversely affect our ability to derive revenue from the affected products.

Our financial condition could be adversely affected if significant errors or defects are found in our software.

Sophisticated software can sometimes contain errors, defects or other performance problems. If errors or defects are discovered in our products, we may need to expend significant financial, technical and management resources, or divert some of our development resources, in order to resolve or work around those defects, and we may not be able to correct them in a timely manner or provide an adequate response to our customers.

Errors, defects or other performance problems in our products could also cause us to lose revenue, lose customers and lose market share, and could subject us to liability. Such defects or problems could also damage our business reputation and cause us to lose new business opportunities.

We may have exposure to additional tax liabilities and our effective tax rate may increase or fluctuate, which could increase our income tax expense and reduce our net income.

As a multinational organization, we are subject to income taxes as well as non-income based taxes in the U.S. and in various foreign jurisdictions. Significant judgment is required in determining our worldwide income tax provision and other tax liabilities. In the ordinary course of a global business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain. Our tax returns are subject to review by various taxing authorities. Although we believe that our tax estimates are reasonable, the final determination of tax audits or tax disputes could be different from what is reflected in our historical income tax provisions and accruals.

Our effective tax rate can be adversely affected by several factors, many of which are outside of our control, including:

 

 

changes in tax laws, regulations, and interpretations in multiple jurisdictions in which we operate;

 

 

assessments, and any related tax interest or penalties, by taxing authorities;

 

 

changes in the relative proportions of revenues and income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates;

 

 

changes to the financial accounting rules for income taxes;

 

 

unanticipated changes in tax rates; and

 

 

changes to a valuation allowance on net deferred tax assets, if any.

 

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Because we have substantial cash requirements in the United States and a significant portion of our cash is generated and held outside of the United States, if our cash available in the United States and the cash available under our credit facility is insufficient to meet our operating expenses and debt repayment obligations in the United States, we may be required to raise cash in ways that could negatively affect our financial condition, results of operations and the market price of our securities.

We have significant operations outside the United States. As of September 30, 2015, approximately 72% of our cash and cash equivalents balance was held by subsidiaries outside the United States, with the remainder of the balance held by PTC Inc. or its subsidiaries in the United States. We believe that the combination of our existing United States cash and cash equivalents, future United States operating cash flows and cash available under our credit facility, are sufficient to meet our ongoing United States operating expenses and known capital requirements. However, if these sources of cash are insufficient to meet our future financial obligations in the United States, we will be required to seek other available funding sources or means to repatriate cash to the United States, which could negatively impact our results of operations, financial position and the market price of our securities.

II. Other Considerations

Collateral proceedings and effects of the resolution of a governmental investigation into our business practices in China could have a material adverse effect on our business and our results.

We recently paid fines and penalties totaling $28.2 million to the SEC and the DOJ to resolve the China FCPA Investigation. This resolution has prompted certain additional proceedings and could have other collateral effects on our business in China, the United States and elsewhere that could materially adversely affect our financial condition and results of operations. For example:

 

 

A lawsuit has been filed against us alleging that certain of our public disclosures concerning the China FCPA Investigation were false and/or misleading and/or failed to disclose certain alleged facts and additional lawsuits may be filed. We cannot predict the outcome of this action nor when it will be resolved, but, if the plaintiff(s) were to prevail in the litigation, we could be liable for damages, which could be material and could adversely affect our financial condition or results of operations.

 

 

The China AIC recently initiated an investigation at our China subsidiary related to the China FCPA Investigation, but not necessarily limited to the China FCPA Investigation. The China AIC is authorized to issue fines and assess other civil penalties. We are unable to predict the outcome of this matter, which could include fines or other sanctions that could be material.

We are required to comply with certain financial and operating covenants under our credit facility and to make scheduled debt payments as they become due; any failure to comply with those covenants or to make scheduled payments could cause amounts borrowed under the facility to become immediately due and payable and/or prevent us from borrowing under the facility.

Our credit facility consists of a $1 billion revolving loan commitment that matures on September 15, 2019, at which time all remaining amounts outstanding will be due and payable in full. As of April 2, 2016, we had $838.1 million outstanding under the credit facility. We intend to use the net proceeds of this offering to repay a portion of the outstanding indebtedness under our senior credit facility. We may wish to borrow additional amounts under the facility in the future to support our operations, including for strategic acquisitions and share repurchases.

We are required to comply with specified financial and operating covenants and to make payments under the facility, which limit our ability to operate our business as we otherwise might operate it. Our failure to comply with any of these covenants or to meet any payment obligations under the facility could result in an event of

 

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default which, if not cured or waived, would result in any amounts outstanding, including any accrued interest and unpaid fees, becoming immediately due and payable. We might not have sufficient working capital or liquidity to satisfy any repayment obligations in the event of an acceleration of those obligations. In addition, if we are not in compliance with the financial and operating covenants at the time we wish to borrow funds, we will be unable to borrow funds.

Risks related to the notes

Our substantial indebtedness could adversely affect our business, financial condition and results of operations, as well as our ability to meet our payment obligations under the notes and our other debt.

We have, and after this offering we will continue to have, a significant amount of indebtedness. As of January 2, 2016 on an as adjusted basis, our total debt would have been approximately $844.2 million (without giving effect to approximately $4.0 million of outstanding letters of credit supporting leases and certain other obligations, approximately $1.1 million of which outstanding letters of credit are secured by cash), of which approximately $344.2 million would have been secured (without giving effect to approximately $1.1 million of outstanding letters of credit secured by cash), and we and one of our foreign subsidiaries which is a borrower under our senior credit facility would have had unused commitments under our senior credit facility of approximately $655.8 million, of which approximately $236.0 million would have been available for borrowing as a result of financial covenants. The committed amount under our senior credit facility is currently $1.0 billion and may be increased by up to an additional $500.0 million in the aggregate if the existing or additional lenders are willing to make such increased commitments. PTC Inc. and one of our foreign subsidiaries are borrowers under the senior credit facility and certain other foreign subsidiaries may become borrowers under our senior credit facility in the future, subject to certain conditions.

Subject to the limits contained in the credit agreement governing our senior credit facility and the indenture governing the notes offered hereby, we may be able to incur substantial additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other purposes. If we do so, the risks related to our high level of debt could intensify. Specifically, our high level of debt could have significant consequences to the holders of the notes, including:

 

 

making it more difficult for us to satisfy our debt obligations, including the notes, and other ongoing business obligations, which may result in defaults;

 

 

events of default if we fail to comply with the financial and other covenants contained in the agreements governing our debt instruments, which could result in all of our debt becoming immediately due and payable or require us to negotiate an amendment to financial or other covenants that could cause us to incur additional fees and expenses;

 

 

limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements;

 

 

reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes and limiting our ability to obtain additional financing for these purposes;

 

 

increasing our vulnerability to the impact of adverse economic and industry conditions;

 

 

exposing us to the risk of increased interest rates as certain of our borrowings, including borrowings under the senior credit facility, are at variable rates of interest;

 

 

limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industries in which we operate, and the overall economy;

 

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placing us at a competitive disadvantage compared to other, less leveraged competitors; and

 

 

increasing our cost of borrowing.

Any of the above-listed factors could have an adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under the notes and our other debt.

We may not be able to generate sufficient cash to service all of our indebtedness, including the notes, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or refinance our debt obligations, including the notes, depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness, including the notes.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures or to dispose of material assets or operations, seek additional debt or equity capital or restructure or refinance our indebtedness, including the notes. We may not be able to effect any such alternative measures, if necessary, on commercially reasonable terms or at all and, even if successful, those alternative actions may not allow us to meet our scheduled debt service obligations. The credit agreement governing the senior credit facility restricts, and the indenture governing the notes offered hereby will restrict, our ability to dispose of assets and use the proceeds from those dispositions and may also restrict our ability to raise debt or equity capital to be used to repay other indebtedness when it becomes due. We may not be able to consummate those dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations then due. See “Description of other indebtedness” and “Description of notes.”

In addition, we conduct a substantial portion of our operations through our subsidiaries, none of which will initially guarantee the notes. Accordingly, repayment of our indebtedness, including the notes, is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Unless they are guarantors of the notes or our other indebtedness, our subsidiaries do not have any obligation to pay amounts due on the notes or our other indebtedness or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness, including the notes. Each subsidiary is a distinct legal entity, and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the credit agreement governing the senior credit facility limits the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to qualifications and exceptions. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required payments of principal, premium, if any, and interest on our indebtedness, including the notes.

Our inability to generate sufficient cash flows to satisfy our debt obligations, or to refinance our indebtedness on commercially reasonable terms or at all, would materially and adversely affect our financial position and results of operations and our ability to satisfy our obligations under the notes.

If we cannot make scheduled payments on our debt, we will be in default and holders of the notes could declare all outstanding principal, premium, if any, and interest to be due and payable, the lenders under the senior credit facility could terminate their commitments to loan money, the lenders could foreclose against the assets securing their borrowings and we could be forced into bankruptcy or liquidation. All of these events could result in your losing your investment in the notes.

 

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Despite our current level of indebtedness, we and our subsidiaries may still be able to incur substantially more debt and other obligations. This could further exacerbate the risks to our financial condition described above.

We and our subsidiaries may be able to incur significant additional indebtedness and other obligations in the future, including secured debt. Although the indenture that will govern the notes will contain, and the credit agreement governing our senior credit facility contains, restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions. The additional indebtedness incurred in compliance with these restrictions could be substantial. If we incur any additional indebtedness that ranks equally with the notes, subject to collateral arrangements, the holders of that debt will be entitled to share ratably with you in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of our company. This may have the effect of reducing the amount of proceeds paid to you. All of the borrowings under our senior credit facility would be secured indebtedness. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness. If new debt is added to our current debt levels, or we incur other obligations, the related risks that we now face could intensify. See “Description of other indebtedness” and “Description of notes.”

The credit agreement governing the senior credit facility contains, and the indenture governing the notes will contain, various covenants that limit our management’s discretion in the operation of our business.

The credit agreement governing the senior credit facility contains, and the indenture governing the notes will contain, various provisions that limit our management’s discretion by restricting our and our subsidiaries’ ability to, among other things:

 

 

incur additional indebtedness or guarantee indebtedness;

 

pay dividends or make other distributions or repurchase or redeem our capital stock;

 

prepay, redeem or repurchase certain debt;

 

make loans and investments;

 

sell assets;

 

incur liens; and

 

consolidate, merge or sell all or substantially all of our assets.

In addition, our senior credit facility requires us to meet certain financial ratios. Any failure to comply with the restrictions of our senior credit facility, the indenture governing the notes or any other subsequent financing agreements may result in an event of default. An event of default may allow the creditors, if the agreements so provide, to accelerate the related debt as well as any other debt to which a cross-acceleration or cross-default provision applies. In addition, the lenders may be able to terminate any commitments they had made to supply us with further funds.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Borrowings under our senior credit facility are at variable rates of interest and expose us to interest rate risk. If interest rates were to increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. Assuming all loans are fully drawn, each 25 basis point change in interest rates would result in a $2.5 million change in annual interest expense on our indebtedness under our senior credit facility. In the future, we may enter into interest rate swaps that involve the exchange of floating for fixed rate interest payments in order to reduce interest rate volatility.

 

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However, we may not maintain interest rate swaps with respect to all of our variable rate indebtedness, and any swaps we enter into may not fully mitigate our interest rate risk.

The notes will be effectively subordinated to our indebtedness under the senior credit facility and any other secured indebtedness of our company to the extent of the value of the assets securing that indebtedness.

The notes will not be secured by any of our assets. As a result, the notes will be effectively subordinated to our indebtedness under the senior credit facility with respect to the assets that secure that indebtedness. As of January 2, 2016 on an as adjusted basis, we and one of our foreign subsidiaries that is a borrower under our senior credit facility would have had total unused commitments under the senior credit facility of approximately $655.8 million of which approximately $236.0 million would have been available for borrowing as a result of financial covenants. In addition, we may incur additional secured debt in the future. The effect of this subordination is that upon a default in payment on, or the acceleration of, any of our secured indebtedness, or in the event of bankruptcy, insolvency, liquidation, dissolution or reorganization of our company, the proceeds from the sale of assets securing our secured indebtedness will be available to pay obligations on the notes only after all indebtedness under the senior credit facility and that other secured debt has been paid in full. As a result, the holders of the notes may receive less, ratably, than the holders of secured debt in the event of our bankruptcy, insolvency, liquidation, dissolution or reorganization.

The notes will be structurally subordinated to all obligations of our existing and future subsidiaries that are not and do not become guarantors of the notes.

On the issue date, the notes will not be guaranteed by any of our subsidiaries. After the issue date, the notes will be required to be guaranteed on a senior unsecured basis by any of our domestic subsidiaries that in the future becomes a guarantor of our senior credit facility or certain other material indebtedness of PTC Inc. or any other future guarantor. Except for any such future guarantees, our subsidiaries will have no obligation, contingent or otherwise, to pay amounts due under the notes or to make any funds available to pay those amounts, whether by dividend, distribution, loan or other payment. The notes will be structurally subordinated to all indebtedness and other obligations of any non-guarantor subsidiary such that in the event of insolvency, liquidation, reorganization, dissolution or other winding up of any subsidiary that is not a guarantor, all of that subsidiary’s creditors (including trade creditors) would be entitled to payment in full out of that subsidiary’s assets before we would be entitled to any payment. PTC (IFSC) Limited is currently a borrower under the senior credit facility. As of April 2, 2016, no amounts under the senior credit facility have been borrowed by PTC (IFSC). Under certain conditions, certain other foreign subsidiaries may become borrowers under the senior credit facility in the future.

For the twelve months ended January 2, 2016, our subsidiaries represented approximately 58% of our revenue, generated approximately $173 million of operating income, excluding net intercompany charges by PTC Inc. to those subsidiaries, and represented approximately 86% of our Adjusted EBITDA. As of January 2, 2016, our subsidiaries represented approximately 42% of our total assets, excluding intercompany receivables, and had approximately $354 million of total liabilities, including trade payables but excluding intercompany liabilities.

In the event any subsidiary becomes a guarantor of the notes in the future, such subsidiary guarantor will be automatically released from its note guarantee without the consent of the holders of the notes upon the occurrence of certain events, including the following:

 

 

the release or discharge of any guarantee or indebtedness that resulted in the creation of the guarantee of the notes by such subsidiary guarantor; or

 

 

the sale or other disposition, including by way of a consolidation or merger and the sale or disposition of all or substantially all the assets, of that subsidiary guarantor.

 

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If a subsidiary becomes a guarantor of the notes and its guarantee is subsequently released, no holder of the notes will have a claim as a creditor against that subsidiary, and the indebtedness and other liabilities, including trade payables and preferred stock, if any, whether secured or unsecured, of that subsidiary will be effectively senior to the claim of any holders of the notes. See “Description of notes—Guarantees.”

We may be unable to repurchase the notes upon a change of control.

Upon the occurrence of specific kinds of change of control events, we will be required to offer to repurchase all outstanding notes at 101% of their principal amount, plus accrued and unpaid interest, if any, to, but excluding, the purchase date. Additionally, under the senior credit facility, a change of control (as defined therein) constitutes an event of default that permits the lenders to accelerate the maturity of borrowings under the credit agreement and the commitments to lend would terminate. The source of funds for any purchase of the notes and repayment of borrowings under our senior credit facility would be our available cash or cash generated from our subsidiaries’ operations or other sources, including borrowings, sales of assets or sales of equity. We may not be able to repurchase the notes upon a change of control because we may not have sufficient financial resources to purchase all of the debt securities that are tendered upon a change of control and repay our other indebtedness that will become due. If we fail to repurchase the notes in that circumstance, we will be in default under the indenture that will govern the notes. We may require additional financing from third parties to fund any such purchases, and we may be unable to obtain financing on satisfactory terms or at all. Further, our ability to repurchase the notes may be limited by law. In order to avoid the obligations to repurchase the notes and events of default and potential breaches of the credit agreement governing our senior credit facility, we may have to avoid certain change of control transactions that would otherwise be beneficial to us.

In addition, certain important corporate events, such as leveraged recapitalizations, may not, under the indenture that will govern the notes, constitute a “change of control” that would require us to repurchase the notes, even though those corporate events could increase the level of our indebtedness or otherwise adversely affect our capital structure, credit ratings or the value of the notes. See “Description of notes—Change of control.”

The exercise by the holders of notes of their right to require us to repurchase the notes pursuant to a change of control offer would not be permitted under the senior credit facility if such change of control constituted a default under the senior credit facility, and if the relevant transaction was not a “change of control” under the senior credit facility, we would be required to satisfy a total leverage ratio to repurchase the notes under such change of control offer. In addition, a change of control offer could also cause a default under the agreements governing our other indebtedness, including future agreements, even if the change of control itself does not, due to the financial effect of such repurchases on us. In the event a change of control offer is required to be made at a time when we are prohibited from purchasing notes, we could attempt to refinance the borrowings that contain such prohibitions. If we do not obtain a consent or repay those borrowings, we will remain prohibited from purchasing notes. In that case, our failure to purchase tendered notes would constitute an event of default under the indenture governing the notes, which could, in turn, constitute a default under our other indebtedness. Finally, our ability to pay cash to the holders of notes upon a repurchase may be limited by our then existing financial resources.

Holders of the notes may not be able to determine when a change of control giving rise to their right to have the notes repurchased has occurred following a sale of “substantially all” of our assets.

One of the circumstances under which a change of control may occur is upon the sale or disposition of “all or substantially all” of our assets. There is no precise established definition of the phrase “substantially all” under

 

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applicable law and the interpretation of that phrase will likely depend upon particular facts and circumstances. Accordingly, the ability of a holder of notes to require us to repurchase its notes as a result of a sale of less than all our assets to another person may be uncertain.

Federal and state fraudulent transfer laws may permit a court to void the notes and/or the note guarantees, if any, and if that occurs, you may not receive any payments on the notes.

Federal and state fraudulent transfer and conveyance statutes may apply to the issuance of the notes. If in the future one or more of our subsidiaries becomes a guarantor of the notes, federal and state fraudulent transfer and conveyance statutes may also apply to the incurrence of the note guarantees. Under federal bankruptcy law and comparable provisions of state fraudulent transfer or conveyance laws, which may vary from state to state, the notes could be voided as a fraudulent transfer or conveyance if we, (a) issued the notes with the intent of hindering, delaying or defrauding current or future creditors or (b) received less than the reasonably equivalent value or fair consideration in return for issuing the notes and, in the case of (b) only, one of the following is also true at the time thereof:

 

 

we were insolvent or rendered insolvent by reason of the issuance of the notes;

 

 

the issuance of the notes left us with an unreasonably small amount of capital or assets to carry on our business;

 

 

we intended to, or believed that we would, incur debts beyond our ability to pay as they mature; or

 

 

we were a defendant in an action for money damages, or had a judgment for money damages docketed against us if, in either case, the judgment is unsatisfied after final judgment.

As a general matter, value is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred or a valid antecedent debt is secured or satisfied.

We cannot be certain as to the standards a court would use to determine whether or not we were insolvent at the relevant time or, regardless of the standard that a court uses, whether the notes would be subordinated to our other debt. In general, however, a court would deem an entity insolvent if:

 

 

the sum of its debts, including contingent and unliquidated liabilities, was greater than the fair saleable value of all of its assets;

 

 

the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

 

 

it could not pay its debts as they became due.

If a court were to find that the issuance of the notes was a fraudulent transfer or conveyance, the court could void the payment obligations under the notes, could subordinate the notes to presently existing and future indebtedness of ours. In the event of a finding that a fraudulent transfer or conveyance occurred, you may not receive any repayment on the notes. Further, the avoidance of the notes could result in an event of default with respect to our and our subsidiaries’ other debt that could result in acceleration of that debt.

Finally, as a court of equity, the bankruptcy court may subordinate the claims in respect of the notes to other claims against us under the principle of equitable subordination if the court determines that (1) the holder of notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to our other creditors or conferred an unfair advantage upon the holders of notes and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code.

 

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Your ability to transfer the notes may be limited by the absence of an active trading market, and an active trading market may not develop for the notes.

The notes will be a new issue of securities for which there is no established trading market, and we do not intend to list the notes on any national securities exchange or include the notes in any automated quotation system. The underwriters of the notes have advised us that they intend to make a market in the notes, as permitted by applicable laws and regulations. However, the underwriters are not obligated to make a market in the notes and, if commenced, they may discontinue their market-making activities at any time without notice.

Therefore, an active market for the notes may not develop or be maintained, which would adversely affect the market price and liquidity of the notes. In that case, the holders of the notes may not be able to sell their notes at a particular time or at a favorable price.

Even if an active trading market for the notes does develop, there is no guarantee that it will continue. Historically, the market for non-investment grade debt has been subject to severe disruptions that have caused substantial volatility in the prices of securities similar to the notes. The market, if any, for the notes may experience similar disruptions and any such disruptions may adversely affect the liquidity in that market or the prices at which you may sell your notes. In addition, subsequent to their initial issuance, the notes may trade at a discount from their initial offering price, depending upon prevailing interest rates, the market for similar notes, our performance and other factors.

A lowering or withdrawal of the ratings assigned to the notes by rating agencies may increase our future borrowing costs and reduce our access to capital.

When issued, the notes will have a non-investment grade rating, and any rating assigned to the notes could be lowered or withdrawn entirely by a rating agency if, in that rating agency’s judgment, future circumstances relating to the basis of the rating, such as adverse changes, so warrant. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of the notes. Credit ratings are not recommendations to purchase, hold or sell the notes. Additionally, credit ratings may not reflect the potential effect of risks relating to the structure or marketing of the notes. Any future lowering of our ratings would likely make it more difficult or more expensive for us to obtain additional debt financing. If any credit rating initially assigned to the notes is subsequently lowered or withdrawn for any reason, you may not be able to resell your notes without a substantial discount.

 

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Use of proceeds

We estimate that the net proceeds from this offering will be approximately $493.3 million, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We plan to use the net proceeds from the issuance of the notes to repay a portion of the outstanding indebtedness under our senior credit facility, and such amounts may be reborrowed in the future.

As of April 2, 2016, there was an aggregate of $838.1 million outstanding under our senior credit facility. The weighted average interest rate on the aggregate amount outstanding at that date was 2.1%. Of the indebtedness to be repaid with the net proceeds of this offering, $120.0 million was incurred under the revolving line of credit portion of our senior credit facility on January 11, 2016, of which $100.0 million was used to fund the acquisition of Kepware and the remainder was used for general corporate purposes. The remainder of the indebtedness to be repaid with the net proceeds of this offering was incurred on November 4, 2015 under the revolving line of credit portion of our senior credit facility and was used to repay the term loan portion of the prior senior credit facility in connection with the amendment and restatement of that facility. The senior credit facility matures on September 15, 2019, when all amounts outstanding will be due and payable in full. For more information about the senior credit facility, see “Description of other indebtedness.”

 

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Capitalization

The following table summarizes our cash and cash equivalents and our capitalization as of January 2, 2016:

 

 

On an actual basis;

 

 

On an “interim adjusted” basis giving effect to additional borrowings of $120.0 million on January 11, 2016 under our revolving line of credit, of which $100.0 million was used for our purchase of Kepware; and

 

 

On an “as adjusted” basis giving further effect to the net proceeds from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, and our application of the net proceeds therefrom to repay a portion of the outstanding indebtedness under our senior credit facility as described in “Use of proceeds.”

 

      As of January 2, 2016  
(In thousands, except per share data)    Actual     Interim
adjusted
   

As

adjusted

 

Cash and cash equivalents

   $ 296,797      $ 316,797      $ 316,797   
  

 

 

 

Total debt, including current portion:

      

Revolving line of credit(1)(2)(3)

   $ 718,125      $ 838,125      $ 344,215   

Notes offered hereby

                   500,000   
  

 

 

 

Total debt, including current portion

     718,125        838,125        844,215   

Stockholders’ equity:

      

Preferred stock, par value $0.01 per share; 5,000 shares authorized; no shares issued or outstanding, actual, interim adjusted and as adjusted

                     

Common stock, par value $0.01 per share; 500,000 shares authorized; 114,532 shares issued and outstanding, actual, interim adjusted and as adjusted

     1,145        1,145        1,145   

Additional paid-in capital

     1,561,795        1,561,795        1,561,795   

Accumulated deficit

     (626,506     (626,506     (626,506

Accumulated other comprehensive loss

     (100,497     (100,497     (100,497
  

 

 

 

Total stockholders’ equity

     835,937        835,937        835,937   
  

 

 

 

Total capitalization

   $ 1,554,062      $ 1,674,062      $ 1,680,152   

 

 

 

(1)   Our senior credit facility provides for borrowings of $1.0 billion of revolving loans and letters of credit, which may be increased by up to an additional $500.0 million in the aggregate if the existing or additional lenders are willing to make such increased commitments. As of January 2, 2016 on an as adjusted basis, we and one of our foreign subsidiaries which is a borrower under our senior credit facility would have had approximately $655.8 million of unused commitments under the senior credit facility of which approximately $236.0 million would have been available for borrowing as a result of financial covenants.

 

(2)   The as adjusted amount of debt outstanding under our revolving line of credit reflects an incremental repayment of debt of $0.6 million, which represents the portion of the estimated offering expenses payable by us that we had already paid as of January 2, 2016.

 

(3)   We expect to borrow amounts under our senior credit facility to make additional acquisitions. We 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.

 

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Ratio of earnings to fixed charges

The following table sets forth our ratio of earnings to fixed charges for the periods indicated:

 

                                                      As adjusted(3)  
    Year ended September 30,    

 

Three months ended

   

Year ended

September 30,

2015

   

Three
months
ended

January 2,

2016

 
     

January 3,

2015

   

January 2,

2016

     
    2011     2012     2013     2014     2015          

Ratio of earnings to fixed charges(1)

    7.7x        7.8x        7.3x        9.8x        2.0x        5.9x        (2)      1.0x        (4) 

 

 

 

(1)   The ratio of earnings to fixed charges is calculated by dividing earnings by fixed charges. For this purpose, “earnings” are determined by adding fixed charges to our income (loss) before income taxes. “Fixed charges” consists of interest expense on our indebtedness as well as the estimated interest component of rental expense under our operating lease commitments.

 

(2)   Our earnings were insufficient to cover our fixed charges during the three months ended January 2, 2016 by $19.5 million. Our loss before income taxes for the three months ended January 2, 2016 included a $37.1 million restructuring charge.

 

(3)   The ratios of earnings to fixed charges on an as adjusted basis for the year ended September 30, 2015 and the three months ended January 2, 2016 give effect to (i) additional borrowings of $120.0 million on January 11, 2016 under our revolving line of credit, of which $100.0 million was used for our purchase of Kepware, (ii) the net proceeds from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, and (iii) our application of the net proceeds therefrom to repay a portion of the outstanding indebtedness under our senior credit facility as described in “Use of proceeds” as if those transactions had occurred on October 1, 2014. The as adjusted ratios include the effect of incremental fixed charges of $28.6 million for the year ended September 30, 2015 and $4.1 million for the three months ended January 2, 2016 for interest expense related to these transactions. The as adjusted ratios do not necessarily reflect what our actual ratios of earnings to fixed charges would have been had these transactions occurred as of that date or predict our ratio of earnings to fixed charges for any future period.

 

(4)   On an as adjusted basis described in footnote (3), our earnings were insufficient to cover our fixed charges during the three months ended January 2, 2016 by $23.6 million. Our loss before income taxes for the three months ended January 2, 2016 included a $37.1 million restructuring charge.

 

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Management’s discussion and analysis of financial condition and results of operations

Information presented for the 2014 and 2015 fiscal years is derived from our audited consolidated financial statements included in our Annual Report on Form 10-K for 2015. Information presented for the three-month periods ended January 3, 2015 and January 2, 2016 is derived from our unaudited consolidated financial statements included in our Quarterly Report on Form 10-Q for the first quarter of 2016. This “Management’s discussion and analysis of financial condition and results of operations” should be read in conjunction with the “Management’s discussion and analysis of financial condition and results of operations” in our Annual Report on Form 10-K for 2015 and Quarterly Report on Form 10-Q for the first quarter of 2016 and our audited and unaudited consolidated financial statements included therein, as applicable.

Executive overview

Revenue was down year over year in 2015 and the first quarter of 2016 due to changes in our business, including an increasing mix of subscription revenue as we transition from selling perpetual licenses to a subscription-based licensing model, as well as external factors, including a challenging macroeconomic environment and the impact of foreign currency exchange rates on our reported revenue due to an increase in the strength of the U.S. Dollar relative to international currencies, most notably the Euro and the Yen. In the first quarter of 2016, a decline in professional services revenue of 24%, consistent with our strategy to migrate more service engagements to our partners, also decreased our revenue.

Overview of results for the first quarter of 2016

 

      Three months ended              Constant
currency
change
 
Revenue    January 2,
2016
     January 3,
2015
     Change     
     (in millions)                

Subscription

   $ 22.2       $ 14.2         56%         63%   

Support

     171.8         181.6         (5)%         1%   
  

 

 

       

Total recurring software revenue

     193.9         195.9         (1)%         5%   

Perpetual license

     47.8         64.7         (26)%         (22)%   
  

 

 

       

Total software revenue

     241.7         260.6         (7)%         (1)%   

Professional services

     49.3         64.8         (24)%         (16)%   
  

 

 

       

Total revenue

   $ 291.0       $ 325.4         (11)%         (4)%   

 

 

 

 

Perpetual license revenue declined due in part to our transition to subscriptions, as well as unfavorable currency movements. We believe that challenging macroeconomic conditions in the industrial market, particularly in the Americas and, in part, in China, impacted our ability to close large deals.

 

 

The Solutions business had higher subscription bookings year over year as customers elected to purchase more of our solutions as subscriptions, particularly in PLM and SLM.

 

 

In the first quarter of 2016, we launched a program for our existing customers to transition their support contracts to subscription contracts, which contributed to our subscription growth.

 

 

We delivered strong growth in our Technology Platform business, both with new customers and expansion with existing customers. The Technology Platform business represented 49% of our subscription revenue in the first quarter of 2016, up from 42% in the first quarter of 2015.

 

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Approximately 67% of our revenue in the first quarter of 2016 came from recurring revenue streams, compared to approximately 60% in the year-ago period. Approximately 80% of our total software revenue in the first quarter of 2016 came from recurring revenue streams, compared to approximately 75% in the year-ago period.

From a geographic perspective, the decrease in total revenue was primarily driven by PLM in the Americas, with fewer large deals than in the first quarter of 2015. Decreases in the Americas from perpetual license and professional services revenue were partially offset by increases in subscription revenue. In Europe, we saw an increase of 38% in subscription revenue, while perpetual license revenue and professional services revenue both decreased. Pacific Rim software revenue declined 15% due to weak results in CAD and SLM, particularly in China due in part to the overall economic slowdown there. Japan software revenue was up 7% from the first quarter of 2015 due to growth in CAD and SLM, partially offset by decreases in PLM.

 

      Three months ended              Constant
currency
change
 
Other operating measures    January 2,
2016
     January 3,
2015
     Change     

Operating Margin

     (4.6)%         11.6%         

Earnings (Loss) Per Share

   $ (0.21)       $ 0.26         (181)%         (164)%   

Non-GAAP Operating Margin(1)

     21.3%         21.4%         

Non-GAAP EPS(1)

   $ 0.51       $ 0.50         2%         15%   

 

 

 

(1)   Non-GAAP measures are reconciled to GAAP results under Results of Operations—Non-GAAP Measures below.

GAAP and non-GAAP operating margins reflect lower revenue, partially offset by reductions in operating expenses driven by cost savings from restructuring. Our GAAP earnings also reflect restructuring charges of $37.1 million. Currency movements reduced GAAP EPS by approximately $0.05. Both GAAP and non-GAAP EPS benefited from a lower tax rate.

We ended the quarter with a cash balance of $297 million. We generated $61 million of cash from operations in the first quarter of 2016 and we drew $50 million on our credit facility to fund the acquisition of Vuforia for $65 million (net of cash acquired). At January 2, 2016, the balance outstanding under our credit facility was $718 million.

Restructuring

On October 23, 2015, we initiated a plan to restructure our workforce and consolidate select facilities in order to reduce our cost structure and to realign our investments with our identified growth opportunities. The restructuring resulted in a charge of $36.8 million in the first quarter of 2016, which is primarily attributable to termination benefits associated with 432 employees.

Acquisition

On November 3, 2015, pursuant to an Asset Purchase Agreement, we acquired the Vuforia business from Qualcomm Connected Experiences, Inc., a subsidiary of Qualcomm Incorporated, for approximately $65 million in cash. We acquired the Vuforia augmented reality technology to enrich our Technology Platform portfolio. At the time of the acquisition, Vuforia had approximately 80 employees and historical annualized revenues were not material.

Subsequent events

On January 12, 2016, we acquired Kepware Inc., a software development company that provides communications connectivity to industrial automation environments, for approximately $100 million in cash

 

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and $18 million of contingent earn-out. The acquisition enhances our Technology Platform portfolio. At the time of the acquisition, Kepware had approximately 115 employees and historical annualized revenues of approximately $20 million. We will finalize our review of the purchase accounting prior to the filing of our report on Form 10-Q for the second quarter of 2016. In January 2016, we borrowed $120 million under our existing credit facility, $100 million of which was used to fund the acquisition of Kepware.

Future expectations, strategies and risks

The slowdown in the global manufacturing industry, uncertainty about the economic environment, the strong U.S. Dollar, and our transition to a subscription model were headwinds for revenue and earnings growth in the first quarter of 2016, as they had been in 2015. We anticipate that the macroeconomic conditions impacting spending among discrete manufacturing customers that faced PTC in the second half of 2015 will persist into 2016, particularly in the Americas and, in part, in China.

For 2016, we have three overriding goals: 1) drive sustainable growth, 2) expand our subscription-based licensing, and 3) continue to control costs and improve margins.

Sustainable growth

Our goals for overall growth are predicated on driving continued growth in our Technology Platform business, making organizational and structural changes that will allow for appropriate focus in our Solutions business to drive growth and leveraging technology from our Technology Platform business in our core Solutions to create additional offerings that expand our market opportunity.

Subscription

A majority of our software sales through 2015 were perpetual licenses, under which customers license our software in perpetuity and revenue is recognized at the time of sale. Due to evolving customer preferences, our plan to increase our recurring revenue base, as well as acquisitions we have made in the Technology Platform and cloud services space, we began offering our products under a subscription license model in 2015. A growing percentage of our business now consists of subscription licenses for which revenue is recognized ratably over time. Under a subscription, customers pay a periodic fee to license our software over a specified period of time, including access to technical support. Beginning October 1, 2015 we launched the second phase of our subscription program with the goal of accelerating our transition to a predominantly subscription-based licensing model. To drive that acceleration, we launched new pricing and packaging for subscriptions and new sales incentive compensation plans. We are targeting that by 2018 a significant majority of our license and solutions (L&S) bookings could be subscription. In 2016, we expect subscription bookings as a percentage of L&S bookings will be approximately 44%, up from 17% in 2015. If a greater percentage of our customers elect our subscription offering in 2016 than our base case assumption, it will have an adverse impact on revenue, operating margin, cash flow and EPS growth relative to our expectations. In addition, subscription orders may be smaller in size than perpetual deals.

Cost controls and margin expansion

We continue to proactively manage our cost structure and invest in our identified growth opportunities. Our goal is to drive continued margin expansion over the long term. To that end, on October 23, 2015, we committed to a plan to restructure our workforce and consolidate select facilities in order to reduce our cost structure and to realign our investments with identified growth opportunities. The restructuring is expected to result in a charge of up to $50 million, of which $36.8 million was recorded in the first quarter of 2016, which is primarily

 

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attributable to termination benefits. The remaining charges are expected to have been recorded predominantly by the end of the third quarter of 2016. We expect that the effect of the expense reductions will be offset by certain planned cost increases and investments in our business and the anticipated effect of foreign exchange rate fluctuations.

Impact of China FCPA investigation

We recently resolved an investigation by the SEC and the DOJ concerning the China FCPA Investigation. We paid fines and penalties totaling $28.2 million to those agencies to settle the matter. This resolution has prompted certain additional proceedings and could have other collateral effects on our business in China, the United States and elsewhere that could materially adversely affect our financial condition and results of operations. For example:

 

 

A lawsuit has been filed against us alleging that certain of our public disclosures concerning the recently resolved investigation were false and/or misleading and/or failed to disclose certain alleged facts. We cannot predict the outcome of this action nor when it will be resolved, but, if the plaintiff(s) were to prevail in the litigation, we could be liable for damages, which could have a material adverse effect on our financial condition and results of operations.

 

 

The China AIC recently initiated an investigation at our China subsidiary related to the China FCPA Investigation, but not necessarily limited to the China FCPA Investigation. The China AIC is authorized to issue fines and assess other civil penalties. We are unable to predict the outcome of this matter, which could include fines or other sanctions that could be material.

Overview of results for 2015 compared to 2014

 

      Year ended             Constant
currency
change
 
Revenue    September 30,
2015
     September 30,
2014
     Change    
     (in millions)               

License and subscription

   $ 348.0       $ 389.7         (11)%        (4)%   

Support

     681.5         688.5         (1)%        7%   
  

 

 

      

Total software revenue

     1,029.5         1,078.2         (5 )%      3%   

Professional Services

     225.7         278.7         (19)%        (12)%   
  

 

 

      

Total revenue

   $ 1,255.2       $ 1,357.0         (8 )%      —%   

 

 

 

 

Software revenue declined due to unfavorable currency movements and fewer large license transactions in the year than in the prior year. Perpetual license revenue declined $80 million in 2015 compared to 2014 ($56 million on a constant currency basis). We believe that challenging macroeconomic conditions and execution issues impacted our ability to secure large license transactions in our core business. Additionally, 2015 was a difficult comparison in relation to 2014, in which CAD and ePLM had double digit software revenue growth due in part to customer contract cycles.

 

 

Year-over-year revenue declines were partially offset by revenue from businesses acquired in 2014. On an organic basis (excluding revenue from acquired businesses), total license and subscription (L&S) revenue was down 18% year over year.

 

 

Professional services revenue declined primarily due to a shift of services to our partners in accordance with our margin improvement strategy.

 

 

We delivered strong growth in our Internet of Things business, closing a number of significant deals with large, industrial companies that are adopting our platform for their IoT initiatives. IoT license revenue represented more than 10% of our total L&S revenue in 2015, compared to 1% in 2014.

 

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Approximately 59% of our revenue in 2015 came from recurring revenue streams (subscription solutions and support), compared to approximately 52% in 2014.

From a geographic perspective, we believe macroeconomic challenges in the Americas and Europe impacted our ability to close large CAD and ePLM deals, which, given the maturity of these markets, tend to be more cyclical. Total Software revenue was flat in the Americas as growth in our IoT and SLM businesses offset our weaker results in CAD and ePLM. In Europe, we saw 4% software revenue growth on a constant currency basis, driven by IoT, SLM, and ePLM with a decline in CAD. Pacific Rim software revenue declined modestly due to weak results in ePLM and SLM, which we believe was primarily due to the overall economic slowdown in China. Japan software revenue increased 9% in 2015 on a constant currency basis from 2014 due to L&S revenue growth in IoT, SLM and ePLM, offset by a decline in CAD.

 

      Year ended              Constant
currency
change
 
Other operating measures    September 30,
2015
     September 30,
2014
     Change     

Operating Margin

     3.3%         14.5%         (77)%         (64)%   

EPS

   $ 0.41       $ 1.34         (69)%         (57)%   

Non-GAAP Operating Margin(1)

     24.2%         25.1%         (4)%         5%   

Non-GAAP EPS(1)

   $ 2.23       $ 2.17         3%         21%   

 

 

 

(1)   Non-GAAP measures are reconciled to GAAP results under Results of Operations—Non-GAAP Measures below.

GAAP and non-GAAP operating income reflect lower revenue, offset by reductions in operating expenses driven by cost savings from restructuring actions and by lower incentive compensation accruals associated with performance based incentive compensation plans for which the associated performance metrics were not achieved. Additionally, our GAAP operating margin includes a $66 million pension settlement loss due to the termination of our U.S. pension plan, a $28 million accrual associated with the then-pending China FCPA Investigation and restructuring charges of $43 million due to our April 2015 restructuring plan. Currency movements reduced GAAP EPS by approximately $0.26. Both GAAP and non-GAAP EPS benefited from a lower tax rate.

Our GAAP results reflect a tax benefit of $19 million related to the reversal of a portion of the U.S. valuation allowance related to reducing deferred tax assets in connection with settling the U.S. pension plan and a tax benefit of $18 million in 2014 related to the reversal of a portion of the valuation allowance on net deferred tax assets in the U.S. and a foreign jurisdiction as a result of accounting for acquisitions.

We generated $180 million of cash from operations in 2015, down 41% from $305 million in 2014, and we borrowed $56 million under our credit facility to fund acquisitions and stock repurchases. The decrease in cash from operations in 2015 compared to 2014 was due in part to pension funding which was higher by $34 million and restructuring payments which were higher by $33 million. We used $99 million of cash to acquire ColdLight and $65 million to repurchase stock. At September 30, 2015, the balance outstanding under our credit facility was $668 million and we had $155 million available to borrow under the revolving loan portion of our credit facility. We ended 2015 with $273 million of cash, down from $294 million at the end 2014.

Acquisitions

In 2015, we acquired ColdLight Solutions, LLC for $99 million. ColdLight offers solutions for data machine learning and predictive analytics, which expanded our technology portfolio in the IoT market. ColdLight was not material to our results for 2015.

 

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2015 Restructuring of our workforce

In April 2015, we committed to a plan to restructure our global workforce and consolidate select facilities to increase investment in our IoT business and to reduce our cost structure through organizational efficiencies in the face of significant foreign currency depreciation relative to the U.S. Dollar and a more cautious outlook on global macroeconomic conditions. The restructuring actions resulted in charges of $43 million during 2015, including $1 million of facility related charges and $42 million of charges related to termination benefits associated with 411 employees. This reorganization resulted in net annualized expense reductions of approximately $30 million. We recently announced a 2016 restructuring plan as described below in “Results of operations-First quarter of 2016.”

Pension termination

We maintained a U.S. defined benefit pension plan that covered certain persons who were employees of Computervision Corporation (acquired by us in 1998). Benefits under the plan were frozen in 1990. In the second quarter of 2014, we began the process of terminating the plan, which included settling plan liabilities by offering lump sum distributions to certain plan participants and purchasing annuity contracts to cover vested benefits. We completed the termination in the fourth quarter of 2015. In connection with the termination, we contributed $25.5 million to the plan and recorded a settlement loss of $66 million.

 

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Results of operations

First quarter of 2016

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

 

      Three months ended      Percent change 2015 to 2016  
      January 2,
2016
     January 3,
2015
           Actual            Constant
      currency
 
     (Dollar amounts in millions, except per share data)  

Subscription

   $ 22.2       $ 14.2         56%         63%   

Support

     171.8         181.6         (5)%         1%   
  

 

 

       

Total recurring software revenue

     193.9         195.9         (1)%         5%   

Perpetual license

     47.8         64.7         (26)%         (22)%   
  

 

 

       

Total software revenue

     241.7         260.6         (7)%         (1)%   

Professional services

     49.3         64.8         (24)%         (16)%   
  

 

 

       

Total revenue

     291.0         325.4         (11)%         (4)%   

Total cost of revenue

     80.1         92.9         (14)%      
  

 

 

       

Gross margin

     210.9         232.5         (9)%      
  

 

 

       

Operating expenses

     224.2         194.9         15%      
  

 

 

       

Total costs and expenses

     304.3         287.8         6%         11%   
  

 

 

       

Operating income (loss)

   $ (13.3)       $ 37.6         (135)%         (125)%   

Non-GAAP operating income(1)

   $ 62.1       $ 69.8         (11)%         —%   

Operating margin

     (4.6)%         11.6%         

Non-GAAP operating margin(1)

     21.3%         21.4%         

Diluted earnings (loss) per share

   $ (0.21)       $ 0.26         

Non-GAAP diluted earnings per share(2)

   $ 0.51       $ 0.50         

Cash flow from operations

   $ 61.3       $ 13.6         

 

 

 

(1)   See Non-GAAP Measures below for a reconciliation of or GAAP results to our non-GAAP results.

 

(2)   Income tax adjustments for the three months ended January 2, 2016 and January 3, 2015 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 below in Non-GAAP Measures. We have recorded a full valuation allowance against our U.S. net deferred tax assets and a valuation allowance against net deferred tax assets in a foreign jurisdiction. As the U.S. and the foreign jurisdiction are profitable on a non-GAAP basis, the 2016 and 2015 non-GAAP tax provisions are calculated assuming there is no valuation allowance in these jurisdictions. Additionally, our non-GAAP tax provision for the three months ended January 2, 2016 excludes a $1.6 million tax provision related to a legal settlement accrual.

Subscription measures

Given the difference in revenue recognition between a subscription booking and a perpetual license sale, we are using the subscription bookings and license and solutions (L&S) bookings metrics described below to gauge the health of our business for internal planning and forecasting purposes.

Bookings

In order to normalize between perpetual and subscription transactions, we define bookings as either the annualized contract value (ACV) of a new subscription multiplied by a conversion factor of 2, the annualized

 

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value of incremental monthly software rental bookings, or the contract value of a new perpetual license. We arrived at the conversion factor of 2 by considering a number of variables including pricing, support, length of term, and renewal rates. We define ACV as the total value of a new subscription solutions booking divided by the term of the contract (in days) multiplied by 365, unless the term is less than one year, in which case the contract value equals the ACV. For monthly rentals, bookings equals revenue in the period, and ACV equals the annualized value of the incremental monthly software rental bookings during the period.

Because subscription solutions bookings is a metric we use to approximate the value of subscription solution sales if sold as perpetual licenses, it does not represent the actual revenue that will be recognized with respect to subscription solution sales or that would be recognized if the sales were completed as perpetual licenses.

When calculating L&S bookings for a period, we add the value of the converted subscription bookings to our perpetual license revenue bookings for the period.

Subscription bookings were 28% of license and subscription bookings in the first quarter of 2016, compared to 19% in the year ago period.

Annualized recurring revenue (ARR)

Annualized Recurring Revenue (ARR) for a given quarter is calculated by dividing the recurring 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 non-recurring revenues.

ARR was approximately $754 million for the first quarter of 2016, which increased 6% on a constant currency basis compared to the first quarter of fiscal 2015.

Impact of foreign currency exchange on results of operations

Approximately two-thirds of our revenue and half of our expenses are transacted in currencies other than the U.S. Dollar. Because we report our results of operations in U.S. Dollars, currency translation, particularly changes in the Euro and Yen relative to the U.S. Dollar, affects our reported results. If actual results for the first quarter of 2016 had been converted into U.S. Dollars based on the foreign currency exchange rates in effect for the first quarter of 2015, revenue would have been higher by $21.2 million, costs and expenses would have been higher by $16.4 million, and operating income would have been higher by $4.8 million. Our constant currency disclosures are calculated by multiplying the actual results for the first three months of 2016 by the exchange rates in effect for the first three months of 2015.

Revenue from acquired businesses

The results of operations of acquired businesses (Vuforia, November 2015; ColdLight, May 2015) have been included in our consolidated financial statements beginning on their respective acquisition dates and were not material to our consolidated results of operations in the first quarter of 2016.

Reclassifications

In 2015, we classified revenue in three categories: 1) license and subscription solutions; 2) support; and 3) professional services. Effective with the beginning of the first quarter of 2016, we are reporting perpetual license revenue separately from the subscription revenue and are presenting revenue in four categories: 1) subscription; 2) support; 3) perpetual license; and 4) professional services. Effective with the beginning of the

 

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first quarter of 2016, we reclassified certain expenses related to management of our product lines from general and administrative to marketing. The discussion that follows reflects our revised reporting structure.

Revenue

We report our revenue by line of business (as described above), by product area (Solutions and Technology Platform Groups) and by geographic region (Americas, Europe, Pacific Rim and Japan). Results include combined revenue from direct sales and our channel.

Revenue by line of business

 

      % of total revenue  
     Three months ended  
      January 2,
2016
     January 3,
2015
 

Subscription

     8%         4%   

Support

     59%         56%   

Perpetual license

     16%         20%   

Professional services

     17%         20%   

 

 

Revenue by group

 

      Three months ended  
                   Percent change  
      January 2,
2016
     January 3,
2015
     Actual     

Constant

currency

 
     (Dollar amounts in millions)  

Solutions Group

           

Subscription

   $ 11.4       $ 8.3         37%         48%   

Support

     169.8         180.7         (6)%         —%   
  

 

 

       

Total recurring software revenue

     181.2         189.0         (4)%         2%   

Perpetual license

     47.4         62.5         (24)%         (19)%   
  

 

 

       

Total software revenue

     228.6         251.6         (9)%         (3)%   

Professional services

     47.2         64.3         (27)%         (19)%   
  

 

 

       

Total revenue

   $ 275.8       $ 315.9         (13)%         (6)%   
  

 

 

       

Technology Platform Group

           

Subscription

   $ 10.8       $ 5.9         83%         86%   

Support

     2.0         0.9         108%         112%   
  

 

 

       

Total recurring software revenue

     12.7         6.8         86%         89%   

Perpetual license

     0.4         2.2         (83)%         (83)%   
  

 

 

       

Total software revenue

     13.1         9.0         45%         47%   

Professional services

     2.1         0.5         312%         326%   
  

 

 

       

Total revenue

   $ 15.2       $ 9.5         59%         62%   

 

 

 

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Software revenue performance

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

Solutions group

The decline in software revenue was driven primarily by PLM. SLM had a strong quarter and ALM was up modestly on a constant currency basis, offset by a small decline in CAD. The Solutions Group had fewer large deals in a macroeconomic environment that continues to be weak in the US and China, impacting spending among discrete manufacturing customers. We believe the increase of subscriptions could result in fewer large deals.

Technology Platform group

The Technology Platform group delivered solid revenue growth, particularly in subscription revenue.

Professional services revenue performance

Consulting and training services engagements typically result from sales of new perpetual licenses and subscriptions, particularly of our ePLM and SLM solutions. The decline in professional services revenue in the first quarter of 2016 was due in part to strong growth in bookings by our service partners, which is in line with our strategy for professional services revenue to trend flat-to-down over time as we expand our service partner program under which service engagements are referred to third party service providers. Additionally, over time, we anticipate offering solutions that require less services. As a result, we do not expect that professional services revenue will increase proportionately with software revenue. Foreign currency exchange rates negatively impacted professional services revenue by $4.9 million in the first quarter of 2016.

Revenue by geographic region

 

      Three months ended      Percent change  
      January 2,
2016
     January 3,
2015
     Actual     

Constant

currency

 
     (Dollar amounts in millions)  

Software revenue by region:

           

Americas

   $ 108.1       $ 108.3         —%         —%   

Europe

   $ 86.0       $ 101.6         (15)%         (4)%   

Pacific Rim

   $ 25.6       $ 30.2         (15)%         (11)%   

Japan

   $ 22.0       $ 20.5         7%         17%   

 

 

 

      Three months ended  
      January 2,
2016
     January 3,
2015
 

Revenue by region as a % of total revenue:

     

Americas

     43%         42%   

Europe

     37%         39%   

Pacific Rim

     10%         11%   

Japan

     9%         8%   

 

 

 

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A significant percentage of our annual revenue comes from large customers in the broader manufacturing space. As a result, software revenue growth in our core CAD and ePLM products historically has correlated to growth in broader measures of the global manufacturing economy, including GDP, industrial production and manufacturing PMI.

Americas

The decrease in revenue in the Americas in the first quarter of 2016 compared to the first quarter of 2015 consisted of a decrease of 22% in perpetual license revenue, partially offset by an increase in subscription revenue of 65%. Support revenue decreased 1%.

Continued macroeconomic headwinds in the U.S. led to flat revenue performance year over year. Solutions bookings declined due to a significant decline in PLM, despite strong performance in SLM and ALM.

Europe

Revenue in Europe in the first quarter of 2016 compared to the first quarter of 2015 consisted of a decrease in perpetual license revenue of 42% (34% on a constant currency basis) and a decrease in support revenue of 10% (increase of 2% on a constant currency basis), partially offset by an increase in subscription revenue of 38% (55% on a constant currency basis).

Total software revenue declined primarily due to SLM and CAD declines; however, Technology Platform software revenue performed well in the quarter.

Changes in foreign currency exchange rates, particularly the Euro, reduced software revenue in Europe by $12.2 million in the first quarter of 2016 compared to the first quarter of 2015.

Pacific Rim

Revenue in the Pacific Rim in the first quarter of 2016 compared to the first quarter of 2015 reflected a decrease of 26% in perpetual license and a decrease of 5% in support (flat on a constant currency basis), partially offset by an increase of 139% in subscription revenue. Changes in foreign currency exchange rates unfavorably impacted revenue in the Pacific Rim by $1.6 million in the first quarter of 2016.

Total Pacific Rim bookings were down year over year, but we had strong bookings growth in the Technology Platform business. The challenging macro environment continues in the region, most notably in China.

Revenue from China, which has historically represented 4% to 5% of our total revenue, was 4% of revenue in both the first quarter of 2016 and the first quarter of 2015, and decreased 28% in the first quarter of 2016, as compared to the first quarter of 2015.

Japan

Revenue in Japan in the first quarter of 2016 compared to the first quarter of 2015 reflected an increase of 61% in subscriptions (76% on a constant currency basis), and an increase of 47% in perpetual licenses (59% on a constant currency basis), partially offset by a decrease of 4% in support (increase of 6% on a constant currency basis).

Changes in the Yen to U.S. Dollar exchange rate reduced software revenue in Japan by $2.2 million in the first quarter of 2016 compared to the first quarter of 2015.

 

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Gross margin

 

      Three months ended  
      January 2,
2016
     January 3,
2015
     Percent
change
 
     (Dollar amounts in millions)  

Gross margin

   $ 210.9       $ 232.5         (9)%   

Non-GAAP gross margin

     219.7         241.2         (9)%   

Gross margin as a % of revenue:

        

Software

     85.0%         86.7%      

Professional services

     12.1%         10.2%      

Gross margin as a % of total revenue

     72.5%         71.4%      

Non-GAAP gross margin as a % of total revenue

     75.4%         73.8%      

 

 

Gross margin as a percentage of total revenue in the first quarter of 2016 compared to the first quarter of 2015 reflects lower subscription and perpetual license volume and a higher mix of support revenue. Support revenue comprised 59% of our total revenue in the first quarter of 2016 compared to 56% in the first quarter of 2015.

 

      Three months ended  
      January 2,
2016
     January 3,
2015
   

Percent

change

 
     (Dollar amounts in millions)  

Costs and expenses:

       

Cost of software revenue

   $ 36.8       $ 34.7        6%   

Cost of professional services revenue

     43.3         58.2        (26)%   

Sales and marketing expense

     82.4         89.5        (8)%   

Research and development expense

     57.7         61.1        (6)%   

General and administrative expense

     38.6         35.1        10%   

Amortization of acquired intangible assets

     8.4         9.4        (11)%   

Restructuring charges

     37.1         (0.3  
  

 

 

    

 

 

   

Total costs and expenses(1)

   $ 304.3       $ 287.8        6%   
  

 

 

    

 

 

   

Total headcount at end of period

     5,654         6,237        (9)%   

 

 

 

(1)   On a constant currency basis, compared to the year-ago period, total costs and expenses for the first quarter of 2016 increased 11%.

Costs and expenses in the first quarter of 2016 compared to the first quarter of 2015 increased primarily as a result of the following:

 

 

restructuring charges of $37.1 million recorded in the first quarter of 2016 compared to $(0.3) million in the first quarter of 2015;

 

 

an increase in stock-based compensation expense of $11.9 million;

 

 

costs from acquired businesses (ColdLight and Vuforia added approximately 140 employees at the date of the acquisitions);

 

 

investments we are making in our Technology Platform business;

 

 

company-wide merit pay increases which were effective July 1, 2015; and

 

 

cash-based incentive compensation expense which was higher by $5.0 million in the first quarter of 2016.

 

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The increases above were partially offset by decreases due to:

 

 

cost savings resulting from restructuring actions in 2015;

 

 

foreign currency rates which favorably impacted costs and expenses in the first quarter of 2016 by $16.4 million; and

 

 

acquisition and pension termination-related costs, which were $4.5 million lower in the first quarter of 2016 compared to the first quarter of 2015.

Cost of software revenue

 

      Three months ended  
      January 2,
2016
     January 3,
2015
    

Percent

change

 
     (Dollar amounts in millions)  

Cost of software revenue

   $ 36.8       $ 34.7         6%   

% of total revenue

     13%         11%      

% of total software revenue

     15%         13%      

Software headcount at end of period

     777         730         6%   

 

 

Our cost of software revenue consists of fixed and variable costs associated with reproducing and distributing software and documentation, as well as royalties paid to third parties for technology embedded in or licensed with our software products, amortization of intangible assets associated with acquired products and costs to perform and support our cloud services business. Our cost of software revenue also includes costs such as salaries, benefits, and computer equipment and facilities associated with customer support and the release of support updates (including related royalty costs). Cost of software revenue as a percent of software revenue can vary depending on product mix sold, the effect of fixed and variable royalties, and the level of amortization of acquired software intangible assets. Amortization of acquired purchased software totaled $5.1 million and $4.8 million in the first quarters of 2016 and 2015, respectively. In the first quarter of 2016, compared to the first quarter of 2015, total compensation, benefit costs and travel expenses increased 5% ($0.9 million).

Cost of professional services revenue

 

      Three months ended  
      January 2,
2016
     January 3,
2015
    

Percent

change

 
     (Dollar amounts in millions)  

Cost of professional services revenue

   $ 43.3       $ 58.2         (26)%   

% of total revenue

     15%         18%      

% of total professional services revenue

     88%         90%      

Professional services headcount at end of period

     989         1,272         (22)%   

 

 

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 the first quarter of 2016 compared to the first quarter of 2015, total compensation, benefit costs and travel expenses were down 32% ($13.0 million) and the cost of third-party consulting services was lower by 47% ($4.3 million). The decrease in both compensation-related costs and third-party consulting services is due to lower professional services revenue. Professional services headcount at the end of the first quarter of 2016 included approximately 23 employees added from businesses acquired after the first quarter of 2015.

 

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Sales and marketing

 

      Three months ended  
      January 2,
2016
     January 3,
2015
    

Percent

Change

 
     (Dollar amounts in millions)  

Sales and marketing

   $ 82.4       $ 89.5         (8)%   

% of total revenue

     28%         27%      

Sales and marketing headcount at end of period

     1,335         1,433         (7)%   

 

 

Our sales and marketing expenses primarily include salaries and benefits, sales commissions, advertising and marketing programs, travel and facility costs. In the first quarter of 2016, compared to the first quarter of 2015, total compensation, benefit costs and travel expenses were lower by 9% ($6.3 million) including lower commissions and cash-based incentive compensation. Sales and marketing headcount at the end of the first quarter of 2016 included approximately 19 employees added from businesses acquired after the first quarter of 2015.

Research and development

 

      Three months ended  
      January 2,
2016
     January 3,
2015
     Percent
change
 
     (Dollar amounts in millions)  

Research and development

   $ 57.7       $ 61.1         (6)%   

% of total revenue

     20%         19%      

Research and development headcount at end of period

     1,894         2,125         (11)%   

 

 

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 first quarter of 2016 compared to the first quarter of 2015, total compensation, benefit costs and travel expenses were lower by 4% ($2.2 million). Research and development headcount at the end of the first quarter of 2016 included approximately 81 employees added from businesses acquired after the first quarter of 2015.

General and administrative

 

      Three months ended  
      January 2,
2016
     January 3,
2015
     Percent
change
 
     (Dollar amounts in millions)  

General and administrative

   $ 38.6       $ 35.1         10%   

% of total revenue

     13%         11%      

General and administrative headcount at end of period

     659         677         (3)%   

 

 

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. The increase in general and administrative costs in the first quarter of 2016 compared to the first quarter of 2015 was primarily attributable to an $11.7 million increase in performance-based bonus and stock-based compensation. This increase was offset by a decrease in acquisition and pension plan termination-related costs of $4.5 million, a decrease of salary, benefit costs and travel expenses of $0.8 million and a decrease in costs for outside professional services of $2.6 million.

 

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Amortization of acquired intangible assets

 

      Three months ended  
      January 2,
2016
     January 3,
2015
    

Percent

change

 
     (Dollar amounts in millions)  

Amortization of acquired intangible assets

   $ 8.4       $ 9.4         (11)%   

% of total revenue

     3%         3%      

 

 

Amortization of acquired intangible assets reflects the amortization of acquired non-product related intangible assets, primarily customer and trademark-related intangible assets, recorded in connection with completed acquisitions. The decrease in amortization of acquired intangible assets in the first quarter of 2016 is due to certain intangibles becoming fully amortized.

Restructuring charges

 

      Three months ended  
      January 2,
2016
     January 3,
2015
 
     (in millions)  

Restructuring charges

   $ 37.1       $ (0.3

 

 

On October 23, 2015, we committed to a plan to restructure our global workforce and consolidate select facilities in order to reduce our cost structure and to realign our investments with our identified growth opportunities. We expect the restructuring actions to result in a charge of up to $50 million in 2016, $36.8 million of which was recorded in the first quarter of 2016, related to employee termination costs. The remaining charges are expected to be recorded predominantly in the second and third quarters of 2016. We expect that this reorganization will result in net annualized expense reductions of approximately $17 million. Additionally, in the first quarter of 2016, we recorded $0.3 million related to previous restructuring actions.

In the first three months of 2016, we made cash payments related to restructuring charges of $16.7 million, compared to $17.3 million in the first three months of 2015. At January 2, 2016, accrued restructuring was $35.6 million, which we expect to pay within the next twelve months.

The net restructuring credit recorded in the first three months of 2015 was primarily associated with the completion of actions initiated in the fourth quarter of 2014.

Interest and other expense, net

 

      Three months ended  
      January 2,
2016
    January 3,
2015
 
     (in millions)  

Interest income

   $ 0.9      $ 1.2   

Interest expense

     (6.6     (3.8

Other expense, net

     (0.6     (0.6

Total interest and other expense, net

   $ (6.3   $ (3.2

 

 

Interest and other expense, net includes interest income, interest expense, foreign currency net losses and other non-operating gains and losses. Foreign currency net losses include costs of forward contracts, certain

 

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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. Because a large portion of our revenue and expenses is transacted in foreign currencies, we use foreign currency forward contracts, primarily for the Euro and Canadian Dollar, to reduce our exposure to fluctuations in foreign exchange rates. The increase in interest expense in the first quarter of 2016 compared to the first quarter of 2015 was due to higher amounts outstanding under our credit facility. We had $718 million outstanding under the facility at January 2, 2016, compared to $606 million at January 3, 2015.

Income taxes

 

      Three months ended  
      January 2,
2016
    January 3,
2015
 
     (Dollar amounts in millions)  

Pre-tax income (loss)

   $ (19.5   $ 34.4   

Tax provision

     4.3        4.1   

Effective income tax rate

     (22)%        12%   

 

 

In the first quarter of 2016 and 2015, our effective tax rate was lower than the 35% statutory federal income tax rate due to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland. In 2016 and 2015, the foreign rate differential predominantly relates to these Irish earnings. Our foreign rate differential in 2016 and 2015 includes a rate benefit from a business realignment completed on September 30, 2014 in which intellectual property was transferred between two wholly-owned foreign subsidiaries. The realignment allows us to more efficiently manage the distribution of our products to European customers. We expect this realignment to result in an annual tax benefit of approximately $15 million to $20 million for the next several years, declining annually thereafter through 2021. This realignment resulted in a tax benefit of approximately $3 million and $4 million in the first quarters of 2016 and 2015, respectively. Additionally, in 2016 and 2015 our provision reflects a tax benefit of $2.6 million and $2.1 million , respectively, related to a retroactive extension of the U.S. research and development tax credit enacted in the first quarter of 2016 and 2015. In 2016 and 2015, this benefit was offset by a corresponding provision to increase our U.S. valuation allowance.

We have concluded, based on the weight of available evidence, that a full valuation allowance continues to be required against our U.S. net deferred tax assets as they are not more likely than not to be realized in the future. We will continue to reassess our valuation allowance requirements each financial reporting period.

In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service in the U.S. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. We are currently under audit by tax authorities in several jurisdictions. Audits by tax authorities typically involve examination of the deductibility of certain permanent items, limitations on net operating losses and 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.

 

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2015 compared to 2014

The following table shows the financial measures that we consider the most significant indicators of the performance of our business. In addition to providing operating income, operating margin, and diluted earnings per share as calculated under generally accepted accounting principles, it shows non-GAAP operating income, operating margin, and diluted earnings per share for the reported periods. These non-GAAP measures exclude fair value adjustments related to acquired deferred revenue, acquired deferred costs, stock-based compensation expense, amortization of acquired intangible assets expense, acquisition-related and pension plan termination costs, restructuring charges, certain identified gains or charges included in non-operating other income (expense) and the related tax effects of the preceding items, as well as the tax items identified. These non-GAAP measures provide investors another view of our operating results that is aligned with management budgets and with performance criteria in our incentive compensation plans. Management uses, and investors should use, non-GAAP measures in conjunction with our GAAP results. We discuss the non-GAAP measures in detail under Non-GAAP Measures below.

 

     2015     2014     Percent change
2014 to 2015
    2013     Percent change
2013 to 2014
 
        Actual    

Constant

currency

      Actual    

Constant

currency

 
     (Dollar amounts in millions, except per share data)  

L&S revenue

  $ 348.0      $ 389.7        (11)%        (4)%      $ 354.3        10%        10%   

Support revenue

    681.5        688.5        (1)%        7%        654.7        5%        5%   
 

 

 

       

 

 

     

Total software revenue

    1,029.5        1,078.2            1,009.0       

Professional services revenue

    225.7        278.7        (19)%        (12)%        284.6        (2)%        (2)%   
 

 

 

       

 

 

     

Total revenue

    1,255.2        1,357.0        (7)%        —%        1,293.5        5%        5%   
 

 

 

       

 

 

     

Cost of L&S revenue

    53.2        45.0            39.0       

Cost of support revenue

    82.8        84.7            81.1       

Cost of professional service revenue

    198.7        244.0            252.9       
 

 

 

       

 

 

     

Total cost of revenue

    334.7        373.7            373.0       
 

 

 

       

 

 

     

Gross margin

    920.5        983.3            920.5       
 

 

 

       

 

 

     

Operating expenses

    878.9        786.7            793.2       
 

 

 

       

 

 

     

Total costs and expenses(1)

    1,213.6        1,160.4        5%        9%        1,166.2        —%        —%   
 

 

 

       

 

 

     

Operating income(1)

  $ 41.6      $ 196.6        (79)%        (57)%      $ 127.3        54%        52%   

Non-GAAP operating income(1)

  $ 304.3      $ 340.3        (11)%        5%      $ 286.3        19%        18%   

Operating margin(1)

    3.3%        14.5%            9.8%       

Non-GAAP operating margin(1)

    24.2%        25.1%            22.1%       

Diluted earnings (loss) per share(2)

  $ 0.41      $ 1.34          $ 1.19       

Non-GAAP diluted earnings per share(2)

  $ 2.23      $ 2.17          $ 1.81       

Cash flow from operations

  $ 179.9      $ 304.6          $ 224.7       

 

 

 

(1)   Costs and expenses in 2015 included $73.2 million of pension plan termination-related costs, $43.4 million of restructuring charges, a $28.2 million legal accrual, and $8.9 million of acquisition-related costs. Costs and expenses in 2014 included $28.4 million of restructuring charges and $13.1 million of acquisition-related and pension plan termination costs. Costs and expenses in 2013 included $52.2 million of restructuring charges and $9.9 million of acquisition-related costs. These restructuring, acquisition-related, pension plan termination costs and legal accrual have been excluded from non-GAAP operating income, non-GAAP operating margin and non-GAAP diluted EPS.

 

(2)  

Income taxes for non-GAAP diluted earnings per share reflect the tax effects of non-GAAP adjustments which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments described in Non-GAAP Measures , and also exclude the following non-operating income and tax items: The GAAP earnings per share in 2015 reflect a tax benefit of $18.7 million related to the reversal of a portion of the U.S. valuation allowance related to reducing deferred tax assets in connection with settling the U.S. pension plan. GAAP diluted earnings per share in 2014 includes (i) tax benefits of $18.1 million related to the release of a portion of the valuation allowance as a result of deferred tax liabilities established for acquisitions recorded in 2014 and (ii) a tax charge of $3.5 million to establish valuation allowances against net deferred tax assets in two foreign jurisdictions. GAAP diluted earnings per share in 2013 includes (i) tax benefits of $36.7 million related to the release of a

 

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portion of the valuation allowance as a result of deferred tax liabilities established for acquisitions recorded in 2013, (ii) tax benefits of $3.2 million relating to the final resolution of a long standing tax litigation matter and completion of an international jurisdiction tax audit, (iii) a tax benefit of $7.9 million related to the release of a portion of the valuation allowance in the U.S. as a result of a pension gain (decrease in unrecognized actuarial loss) recorded in accumulated other comprehensive income, and (iv) a tax benefit of $2.6 million relating to a tax audit in a foreign jurisdiction of an acquired company. GAAP diluted earnings per share in 2013 also includes a gain on investment of $0.6 million and a legal settlement gain of $5.1 million.

Acquisitions

In 2015, we acquired ColdLight (on May 7). In 2014, we acquired ThingWorx (on December 30), Atego (on June 30) and Axeda (on August 11). These acquisitions collectively added $69.2 million of revenue in 2015 and $9.8 million of revenue in 2014.

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. Currency translation affects our reported results, which are in U.S. Dollars. Changes in currency exchange rates, particularly for the Yen and the Euro, compared to the prior year decreased revenue and decreased expenses in 2015, and increased revenue and decreased expenses in 2014. If actual reported results were converted into U.S. dollars based on the corresponding prior year’s foreign currency exchange rates, 2015 and 2014 revenue would have been higher by $99.7 million and lower by $2.1 million, respectively, and expenses would have been higher by $56.6 million and $0.9 million, respectively. The net impact on year-over-year results would have been an increase in operating income of $43.1 million in 2015 and a decrease in operating income of $3.0 million in 2014. The results of operations, revenue by line of business and revenue by geographic region in the tables that follow present both actual percentage changes year over year and percentage changes on a constant currency basis.

Reclassifications

Through 2014, we classified revenue in three categories: 1) license; 2) service; and 3) support. Because we introduced subscription-based licenses in 2015, we have revised our revenue reporting. Effective with the beginning of the first quarter of 2015, we report revenue as follows: 1) license and subscriptions (L&S); 2) support; and 3) professional services. L&S revenue includes perpetual license revenue, subscription revenue and cloud services revenue. Cloud service offerings were previously reflected in service revenue and cost of service revenue. Consulting and training service revenue and consulting and training cost of service revenue are now referred to as professional services revenue and cost of professional services revenue. The discussion that follows reflects our revised reporting structure.

Revenue

Revenue is reported below by line of business (license and subscription, support, and professional services), by solution area (CAD, Extended PLM (ePLM), SLM and IoT) and by geographic region (Americas, Europe, Pacific Rim and Japan).

Results include combined revenue from direct sales and our channel.

 

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Revenue by line of business

 

     Year ended September 30,  
    2015     Percent change
2014 to 2015
    2014     Percent change
2013 to 2014
    2013  
     $ Amount     % of
total
revenue
    Actual      Constant
currency
    $ Amount     % of
total
revenue
    Actual     Constant
currency
    $ Amount     % of
total
revenue
 
    (Dollar amounts in millions)  

L&S

  $ 348.0        28%        (11)%         (4)%      $ 389.7        29%        10%        10%      $ 354.3        27%   

Support

    681.5        54%        (1)%         7%        688.5        51%        5%        5%        654.7        51%   
 

 

 

          

 

 

         

 

 

   

Total software revenue

    1,029.5               1,078.2              1,009.0     

Professional services revenue

    225.7        18%        (19)%         (12)%        278.7        21%        (2)%        (2)%        284.6        22%   
 

 

 

          

 

 

         

 

 

   

Total revenue

  $ 1,255.2        100%        (7)%         —%      $ 1,357.0        100%        5%        5%      $ 1,293.5        100%   

 

 

Revenue by solution

 

      Year ended September 30,  
            Percent change             Percent change         
      2015      Actual      Constant
currency
     2014      Actual      Constant
currency
     2013  
     (Dollar amounts in millions)  

CAD

  

           

L&S

   $ 125.8         (26)%         (20)%       $ 170.5         13%         13%       $ 150.4   

Support

     366.8         (5)%         3%         386.8         2%         2%         378.1   
  

 

 

          

 

 

          

 

 

 

Total software revenue

     492.7               557.3               528.5   

Professional services

     18.9         (22)%         (14)%         24.2         1%         1%         24.0   
  

 

 

          

 

 

          

 

 

 

Total revenue

   $ 511.6         (12)%         (4)%       $ 581.5         5%         5%       $ 552.4   
  

 

 

          

 

 

          

 

 

 

Extended PLM (ePLM)

  

           

L&S

   $ 134.2         (22)%         (14)%       $ 171.4         12%         12%       $ 152.6   

Support

     239.2         4%         10%         231.0         7%         6%         216.6   
  

 

 

          

 

 

          

 

 

 

Total software revenue

     373.4               402.4               369.2   

Professional services revenue

     151.3         (23)%         (15)%         196.9         (2)%         (3)%         201.9   
  

 

 

          

 

 

          

 

 

 

Total revenue

   $ 524.7         (12)%         (5)%       $ 599.3         5%         5%       $ 571.1   
  

 

 

          

 

 

          

 

 

 

SLM

  

           

L&S

   $ 43.8         1%         7%       $ 43.4         (15)%         (16)%       $ 51.3   

Support

     70.4         —%         5%         70.3         17%         17%         60.0   
  

 

 

          

 

 

          

 

 

 

Total software revenue

     114.2               113.8               111.3   

Professional services

     51.8         (9)%         (4)%         57.2         (3)%         (2)%         58.8   
  

 

 

          

 

 

          

 

 

 

Total revenue

   $ 166.1         (3)%         2%       $ 171.0         1%         1%       $ 170.0   
  

 

 

          

 

 

          

 

 

 

IoT

  

           

L&S

   $ 44.1         893%         904%       $ 4.4             $   

Support

     5.1         1,272%         1,297%         0.4                 
  

 

 

          

 

 

          

 

 

 

Total software revenue

     49.2               4.8                 

Professional Services

     3.6         928%         962%         0.4                 
  

 

 

          

 

 

          

 

 

 

Total revenue

   $ 52.9             $ 5.2             $   

 

 

 

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L&S revenue

2015 compared to 2014

The decline in L&S revenue in 2015 reflected year-over-year declines of 12% in the Americas, 15% in Europe (down 1% on a constant currency basis), and 5% in the Pacific Rim. Year-over-year amounts in Japan were flat and increased on a constant currency basis by 16%. The decreases were partially related to a higher mix of subscription bookings in 2015. Results also reflected lower L&S revenue, primarily due to fewer large license transactions in 2015. This was particularly true for CAD and PLM in Europe and the Americas. IoT revenue increased significantly, primarily as a result of our acquisition of Axeda.

Changes in foreign currency exchange rates unfavorably impacted L&S revenue by $27.5 million in 2015 compared to 2014.

2014 compared to 2013

L&S revenue was strongest in Europe and the Americas, with 33% and 12% year-over-year growth, respectively, offsetting year-over-year declines in the Pacific Rim region, which was down 17%. CAD L&S revenue was driven by double digit year-over-year growth in Creo modules and upgrades, training software, and certain heritage products. SLM L&S revenue in 2014 decreased due to a slower-than-expected rebuilding of our pipeline after a strong 2013.

Changes in foreign currency exchange rates favorably impacted L&S revenue by $0.7 million in 2014 compared to 2013.

Support revenue

Support revenue is comprised of contracts to maintain new and/or previously purchased software. Support revenue has tended to be fairly stable and predictable year-to-year. However, with our transition to subscription sales, we expect support revenue will decline as customers purchase our solutions as subscriptions.

Support revenue decreased in 2015 compared to 2014 due to the effect of foreign currency exchange rates. Changes in currency unfavorably impacted support revenue by $51.8 million in 2015 compared to 2014.

Support revenue increased 5% ($33.8 million) in 2014 compared to 2013. Changes in foreign exchange rates did not have a significant effect on support revenue in 2014.

Professional services revenue

Consulting and training services engagements typically result from sales of new licenses, particularly of our ePLM and SLM solutions. Expanding our service partner program, under which service engagements are referred to third party service providers, is part of our overall margin expansion strategy. Additionally, over time, we anticipate implementing solutions that require fewer services. As a result, we do not expect that the amount of services we deliver will increase proportionately with any L&S revenue increases.

2015 compared to 2014

The decrease in professional services revenue for 2015 was primarily due to a 25% decrease in PLM-related services and changes in foreign currency exchange rates. We attribute the decline in total professional services revenue to lower PLM and, to a lesser extent, CAD L&S revenue and to success in expanding our service partner program.

Changes in foreign currency exchange rates unfavorably impacted professional services revenue by $20.4 million in 2015 compared to 2014.

 

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2014 compared to 2013

In 2014, professional services revenue declined slightly due to the expansion of our services partner program.

Revenue by geographic region

 

     2015     % of
Total
revenue
    Percent change     2014     % of
Total
revenue
    Percent change     2013     % of
Total
revenue
 
        Actual    

Constant

currency

        Actual    

Constant

currency

     

 

 
    (Dollar amounts in millions)  

Revenue by region:

                 

Americas

  $ 530.3        42%        (5)%        (4)%      $ 558.7        41%        7%        7%      $ 522.8        40%   

Europe

  $ 467.8        37%        (11)%        3%      $ 528.1        39%        10%        7%      $ 479.9        37%   

Pacific Rim

  $ 139.2        11%        (6)%        (4)%      $ 148.2        11%        (8)%        (9)%      $ 161.6        13%   

Japan

  $ 118.0        9%        (3)%        12%      $ 122.1        9%        (6)%        4%      $ 129.3        10%   

 

 

A significant percentage of our annual revenue comes from large customers in the broader manufacturing space. As a result, L&S revenue growth in our core CAD and ePLM products historically has correlated to growth in broader measures of the global manufacturing economy, including GDP, industrial production and manufacturing PMI. PMI data in the fourth quarter of 2015, compared to the fourth quarter of 2014, suggests manufacturing economies in the U.S., China and Japan are slowing, while manufacturing activity in Europe has increased. For 2016, we are assuming a slower rate of growth in the manufacturing economies in the U.S., Japan, and the Pacific Rim.

Americas

In 2015, compared to 2014, Americas L&S revenue decreased 12% due primarily to a decrease in CAD and PLM L&S revenue, offset in part by increases in IoT L&S revenue (primarily due to our acquisition of Axeda) and SLM L&S revenue. Professional services revenue decreased by 23% and support revenue increased by 6%.

Americas revenue increased in 2014 compared to 2013 due to increases in all lines of business, primarily a 7% increase in support and a 12% increase in L&S revenue.

Europe

In 2015, compared to 2014, changes in foreign currency exchange rates, particularly the Euro, unfavorably impacted revenue by $73.6 million. In 2015, Europe L&S revenue decreased 15% year over year (down 1% on a constant currency basis) with constant currency growth in IoT and ePLM and modest constant currency growth in SLM, offset by a decline in CAD. Europe support revenue decreased 7% year over year and increased 7% year-over-year on a constant currency basis.

In 2014 compared to 2013, Europe L&S revenue increased 33% and support revenue increased 7%. Europe professional services revenue decreased 3% year over year. Changes in foreign currency exchange rates, particularly the Euro, favorably impacted revenue in Europe by $15.7 million in 2014 as compared to 2013.

Pacific Rim

In 2015, compared to 2014, Pacific Rim L&S revenue declined 5% year over year with growth in IoT and modest growth in CAD, offset by declines in ePLM and SLM. Pacific Rim support revenue increased 5% year over year and professional services revenue decreased 29%. Changes in foreign currency exchange rates unfavorably impacted revenue in the Pacific Rim by $3.2 million in 2015 compared to 2014.

 

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In 2014, compared to 2013, Pacific Rim L&S revenue declined 17% year over year and professional services revenue decreased 11%. Pacific Rim support revenue increased 7% year over year. Changes in foreign currency exchange rates favorably impacted revenue in the Pacific Rim by $0.6 million in 2014 compared to 2013.

In 2015 and 2014, compared to the prior year, revenue in China decreased 14% and 12%, respectively, and represented 4% and 5%, respectively, of total revenue.

Japan

In 2015 and 2014 declines in Japan revenue were due to changes in foreign currency rates. In 2015 compared to 2014, Japan L&S revenue was flat, support revenue decreased 10% and professional services revenue increased 15%. On a constant currency basis, L&S revenue increased 16%, support revenue increased 5% and professional services revenue increased 34%. Changes in foreign currency exchange rates unfavorably impacted revenue in Japan by $19.2 million in 2015 as compared to 2014.

In 2014 compared to 2013, Japan L&S revenue decreased 2%, support revenue decreased 8% and professional services revenue decreased 1%. On a constant currency basis, L&S revenue increased 5%, professional services revenue increased 9% and support revenue increased 3%. Changes in foreign currency exchange rates unfavorably impacted revenue in Japan by $12.8 million in 2014 as compared to 2013.

Gross margin

 

     2015    

Percent

change

    2014    

Percent

change

    2013  
    (Dollar amounts in millions)  

Gross margin

  $ 920.5        (6)%      $ 983.3        7%      $ 920.5   

Non-GAAP gross margin

    953.4        (6)%        1,013.0        6%        951.6   

Gross margin as a % of revenue:

         

L&S

    85%          88%          89%   

Support

    88%          88%          88%   

Professional services

    12%          12%          11%   

Gross margin as a % of total revenue

    73%          72%          71%   

Non-GAAP gross margin as a % of total non-GAAP revenue

    76%          75%          73%   

 

 

Gross margin as a percentage of total revenue in 2015 compared to 2014 reflects lower L&S margins due to a higher mix of cloud services revenue (due to our acquisition of Axeda), which has lower margins than license revenue, and higher support volume. Support revenue comprised 54% of our total revenue in 2015 compared to 51% in both 2014 and 2013.

Gross margin as a percentage of total revenue in 2014 compared to 2013 reflects higher service margins, partially offset by lower L&S margins primarily attributable to lower L&S revenue and higher amortization of acquired purchased software. The increase in our GAAP service gross margin in 2014 was due in part to improved consulting margin. Service margins have improved due to cost reductions and a reduction in the amount of direct services that we perform through expansion of our service partner program.

 

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Costs and expenses

 

      2015     

Percent

change

     2014     

Percent

change

     2013  

Cost of L&S revenue

   $ 53.2         18%       $ 45.0         15%       $ 39.0   

Cost of support revenue

     82.8         (2)%         84.7         4%         81.1   

Cost of professional services revenue

     198.7         (19)%         244.0         (4)%         252.9   

Sales and marketing

     338.8         (5)%         357.4         (1)%         360.6   

Research and development

     227.5         —%         226.5         2%         221.9   

General and administrative

     166.7         17%         142.2         8%         131.9   

U.S. pension settlement loss

     66.3                         

Amortization of acquired intangible assets

     36.1         12%         32.1         21%         26.5   

Restructuring charges

     43.4         53%         28.4         (46)%         52.2   
  

 

 

       

 

 

       

 

 

 

Total costs and expenses

   $ 1,213.6         5% (1)     $ 1,160.4         —% (1)     $ 1,166.2   
  

 

 

       

 

 

       

 

 

 

Total headcount at end of period

     5,982         (7)%         6,444(2)         7%         6,000   

 

 

 

(1)   On a constant currency basis from the prior period, total costs and expenses increased 9% from 2014 to 2015 and were flat from 2013 to 2014.

 

(2)   Headcount at September 30, 2014 included approximately 250 employees with termination dates after September 30, 2014 that were included in our fourth quarter of 2014 restructuring actions.

2015 compared to 2014

Costs and expenses in 2015 compared to 2014 increased primarily as a result of the following:

 

 

restructuring charges of $43.4 million in 2015 compared to $28.4 million in 2014, primarily for severance and other related costs associated with the termination of 411 employees;

 

 

costs from acquired businesses (Axeda, Atego, Thingworx and ColdLight added approximately 360 employees at the date of the acquisitions);

 

 

costs associated with terminating our U.S. Pension Plan which totaled $73.2 million (including a $66.3 million settlement loss);

 

 

a litigation accrual of $28.2 million related to the China FCPA Investigation; and

 

 

amortization of acquired intangible assets (including amortization of purchased software which is included in cost of revenue), primarily related to our acquisitions in 2014 and 2015, which was higher by $5.3 million.

These cost increases were partially offset by:

 

 

cost savings associated with restructuring actions in 2014 and 2015;

 

 

the impact of foreign currency movements which favorably impacted costs and expenses by $56.6 million in 2015; and

 

 

a decrease in cash-based incentive compensation of $18.1 million.

2014 compared to 2013

Costs and expenses in 2014, compared to 2013, decreased primarily as a result of:

 

 

restructuring charges, which were $23.8 million lower in 2014; and

 

 

cost savings resulting from restructuring actions in 2013.

 

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These cost decreases were offset by:

 

 

costs from acquired businesses (approximately 300 employees);

 

 

investments we made in our Internet of Things business;

 

 

company-wide merit pay increases totaling approximately $12 million on an annualized basis, which were effective February 1, 2014;

 

 

increased amortization of acquired intangible assets, which was $5.2 million higher in 2014; and

 

 

increased acquisition-related and pension plan termination costs, which were $3.2 million higher.

Cost of L&S revenue

 

      2015     

Percent

change

     2014     

Percent

change

     2013  
     (Dollar amounts in millions)  

Cost of L&S revenue

   $ 53.2         18%       $ 45.0         15%       $ 39.0   

% of total revenue

     4%            3%            3%   

% of total L&S revenue

     15%            12%            11%   

L&S headcount at end of period

     115         55%         74         80%         41   

 

 

Our cost of L&S revenue primarily consists of amortization of acquired purchased software intangible assets, fixed and variable costs associated with reproducing and distributing software and documentation and royalties paid to third parties for technology embedded in or licensed with our software products. Cost of L&S revenue as a percent of L&S revenue can vary depending on product mix sold, the effect of fixed and variable royalties, and the level of amortization of acquired software intangible assets. Amortization of acquired purchased software totaled $19.4 million, $18.1 million and $18.6 million in 2015, 2014, and 2013, respectively. Costs to perform cloud services were $19.0 million, $12.9 million, and $6.0 million in 2015, 2014, and 2013, respectively. The increase in costs to perform cloud services in 2015 is attributable to our acquisition of Axeda.

Cost of support revenue

 

      2015     

Percent

change

     2014     

Percent

change

     2013  
     (Dollar amounts in millions)  

Cost of support revenue