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PTC > SEC Filings for PTC > Form 10-Q on 5-Aug-2014All Recent SEC Filings

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Form 10-Q for PTC INC.


5-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Forward-Looking Statements
Statements in this Quarterly Report on Form 10-Q about our future financial and growth expectations, our intent to repurchase shares and to return 40% of free cash flow to shareholders, our intent to enter into a new credit facility, our intent to complete the Axeda acquisition, the development of our products and markets and adoption of our solutions and future purchases by customers are forward-looking statements that are subject to the inherent uncertainties in predicting future results and conditions. Risks and uncertainties that could cause actual results to differ materially from projected results include the following: the macroeconomic climate may not improve or may deteriorate; our customers may not purchase our solutions when or in the amounts we expect and that our pipeline deals may not convert as we expect, which could adversely affect our revenue, cash flow and earnings; we may not achieve the license, service or support growth rates or revenue we expect, which could result in a different mix of revenue between license, service and support and could adversely affect our profitability; foreign currency exchange rates may vary from our expectations and thereby affect our reported revenue and expense; our business, including the SLM and the ThingWorx/Internet of Things/Smart, Connected Products businesses, may not expand and/or generate the revenue we expect; we may be unable to achieve planned services margin and operating margin improvements; we may be unable to improve sales productivity as we expect; we may be unable to complete the Axeda acquisition as or when we expect and the acquisition, if completed, may not generate the revenue we expect; the use of cash for share repurchases could reduce our ability to undertake organic and inorganic growth initiatives, uses of cash for purposes other than share repurchases could reduce the amount of shares we repurchase, existing and/or other banks may be unwilling to enter into an expanded credit facility with us, remedial actions related to our investigation in China could have a material impact on our operations in China, substantial fines or penalties may be imposed by government agencies in connection with resolving that matter, and any such resolution may have collateral effects on our business in China, the U.S. or elsewhere; as well as other risks and uncertainties described below throughout or referenced in Part II, Item 1A. Risk Factors of this report.
Business Overview
PTC Inc. develops and delivers technology solutions, comprised of software and services, that transform the way our customers create, operate and service products for a smart, connected world. Our solutions help our customers in discrete manufacturing organizations optimize the activities within individual business functions, including engineering, supply chain, manufacturing and service, and coordinate these processes across the enterprise to create product and service advantage.
Our solutions and software products address the challenges our customers face in the following areas:
Computer-Aided Design (CAD)
Effective and collaborative product design. Product Lifecycle Management (PLM)
Management of product development from concept to retirement. Application Lifecycle Management (ALM)
Management of global software development. Supply Chain Management (SCM)
Management and optimization of global supply chains. Service Lifecycle Management (SLM)
Delivery and capture of product intelligence at the point of service. Internet of Things (IoT)
Development of applications for smart, connected products.

Our Markets The markets we serve present different growth opportunities for us. We believe the PLM, ALM, SCM, SLM and IoT markets present the greatest opportunities for revenue growth and revenue from these markets will constitute an increasingly greater proportion of our revenue over time. We believe the market for CAD among small- and medium-size businesses also provides an opportunity for growth. Conversely, the market for CAD among large businesses is highly penetrated and presents a lower growth opportunity for us.


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Executive Overview

In our third quarter, we continued to deliver on our margin expansion strategy with revenue in line with our expectations and non-GAAP earnings per share just above the high end of our expected range, including a favorable mix of revenue and a lower tax provision than anticipated. Earnings per share was up 11% to $0.32 from $0.29 in the year-ago period, and non-GAAP earnings per share was up 19% to $0.53 from $0.45 in the year-ago period.

For the third quarter, our total revenue was $337 million, up 7% year over year. Total license revenue for the quarter was $93 million, up 16% year over year, which reflects an increase in license revenue from large transactions and growth in CAD license revenue. From a geographic perspective, on a constant currency basis, total revenue grew 7% in Europe, 20% in Japan, 1% in the Americas and was flat in the Pacific Rim, compared to the year-ago period. Total revenue in Europe, Japan and the Americas grew 13%, 16% and 1%, respectively, and was flat in the Pacific Rim, compared to the year-ago period.
Our operating margin in the third quarter increased to 16% from 14% in the year-ago period (to 24% from 22% on a non-GAAP basis). Our GAAP and non-GAAP operating margins were impacted by a favorable mix of revenue and cost reduction measures, including our restructuring actions in 2013, partially offset by costs of acquired businesses and investments we are making in our Internet of Things business, and annual merit salary increases for employees.
We ended the third quarter of 2014 with $304 million of cash, up from $270 million at the end of the second quarter of 2014, reflecting, in part, $106 million in operating cash flow and $60 million used to repurchase shares of our common stock. At the end of the third quarter of 2014, the balance outstanding under our credit facility was $315 million and we had $682 million available to borrow under the revolving loan portion of our credit facility.
Non-GAAP measures are reconciled to GAAP results under Results of Operations - Non-GAAP Measures below.
Acquisitions
On June 30, 2014, we acquired Atego, a European-based developer of model-based systems and software engineering applications for approximately $50 million in cash. This acquisition enhances our portfolio of PLM and ALM solutions and strengthens our commitment to supporting our customers' systems engineering initiatives with powerful modeling capabilities. We expect Atego to contribute approximately $5 million to our fourth quarter 2014 revenue.
On July 23, 2014, we signed a definitive agreement to acquire privately-held Axeda Corporation, a pioneer in the development of solutions to securely connect machines and sensors to the cloud, for approximately $170 million in cash. Axeda's technology innovation, extensive customer base, and powerful partnerships directly complement our ThingWorx business, and will accelerate our ability to deliver best-in-class solutions across the entire Internet of Things technology stack. Subject to satisfaction of customary closing conditions and certain regulatory approvals, the transaction is expected to be completed in our fourth quarter of fiscal 2014.
Expanded Share Repurchase Authorization and Intent to Expand Credit Facility

On August 4, 2014, we announced a capital allocation strategy that over time is expected to return approximately 40% of free cash flow to shareholders while still enabling us to invest in organic and new growth opportunities. As part of this strategy, our Board of Directors has authorized us to repurchase up to $600 million of our common shares through September 30, 2017. We may use cash from operations or may borrow funds under our credit facility to make such repurchases. Under this authorization, we expect to repurchase $125 million of our common stock by the end of fiscal 2014 under an accelerated share repurchase (ASR) agreement. We expect to borrow $125 million under our credit facility for the ASR.

We also plan to enter into a new $1.5 billion credit facility in the fourth quarter of 2014 with a syndicate of existing and new banks. Upon closing, the new facility would replace our existing $1.0 billion credit facility, which is scheduled to mature on January 30, 2019. As we have only recently begun to explore this initiative, we cannot be sure if or when we may be able to enter into a new credit facility.

Future Expectations, Strategies and Risks


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While we have seen some indications of improvements in global manufacturing economic conditions, there is still a significant level of uncertainty about the pace of recovery in the global manufacturing industry. We continue to expect modest revenue growth and continued operating margin expansion in 2014 driven by: (1) continued vigilance on cost controls and cost savings from restructuring actions; (2) increased sales productivity; and (3) improvement in services non-GAAP gross margin to at least 15%. For 2014, our goal is to achieve year-over-year revenue growth of 3% to 4%. This revenue goal includes license revenue growth of 2% to 7%, support revenue growth of approximately 4%, and a decline in service revenue of approximately 1%. Our 2014 earnings goals are to achieve non-GAAP operating margin expansion of 300 basis points, from 22% in 2013 to approximately 25% in 2014 (expansion of GAAP operating margins from 10% in 2013 to approximately 17% in 2014) and non-GAAP earnings per share of $2.10 to $2.14 (GAAP earnings per share of $1.40 to $1.44). Our 2014 GAAP and non-GAAP goals exclude the impact of our pending acquisition of Axeda and our GAAP operating margin and earnings per share goals exclude the impact of acquisition accounting for the Atego acquisition. In addition, our 2014 GAAP and non-GAAP earnings per share exclude the impact of our intended $125 million accelerated share repurchase described above. If economic conditions do not improve or deteriorate further, or if foreign currency exchange rates relative to the U.S. dollar differ significantly from our current assumptions, our results could differ materially from our targets. Our targets assume rates for the fourth quarter of 2014 of $1.35 USD to one Euro and 101 Yen to one USD. Also, our results have been impacted, and we expect will continue to be impacted, by our ability to close large transactions. The amount of revenue, particularly license revenue, attributable to large transactions, and the number of such transactions, may vary significantly from quarter to quarter based on customer purchasing decisions and macroeconomic conditions. Our growth rates have become increasingly dependent on adoption of our solutions by large direct customers. Such transactions tend to be larger in size and may have long lead times as they often follow a lengthy product selection and evaluation process. This may cause volatility in our results. Impact of an Investigation in China
We have been cooperating to provide information to the U.S. Securities and Exchange Commission and the Department of Justice concerning payments and expenses by certain of our business partners in China and/or by employees of our Chinese subsidiary that raise questions concerning compliance with laws, including the U.S. Foreign Corrupt Practices Act. Our internal review is ongoing and now includes periods earlier than those previously examined. We continue to respond to requests for information from these agencies, including a subpoena issued to the company by the SEC. We cannot predict when or how this matter may be resolved. Resolution of this matter could include fines and penalties; however we are unable to estimate an amount that could be associated with any resolution and, accordingly, we have not recorded a liability for this matter. If resolution of this matter includes substantial fines or penalties, this could materially impact our results for the period in which the associated liability is recorded or such amounts are paid. Further, any settlement or other resolution of this matter could have collateral effects on our business in China, the United States and elsewhere.
We terminated certain employees and business partners in China in connection with this matter, which may have an adverse impact on our level of sales in China. Revenue from China has historically represented 5% to 7% of our total revenue.
Revenue, Operating Margin, Earnings per Share and Cash Flow from Operations The following table shows the financial measures that we consider the most significant indicators of the performance of our business. In addition to operating income, operating margin, and diluted earnings per share as calculated under 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 Results of Operations - Non-GAAP Measures below.


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                                              Percent Change 2013 to                               Percent Change 2013
                     Three months ended                2014               Nine months ended              to 2014
                   June 28,      June 29,                  Constant     June 28,      June 29,                Constant
                     2014          2013        Actual      Currency       2014          2013       Actual     Currency
                                           (dollar amounts in millions, except per share data)
License revenue   $    92.7     $    79.9        16  %       15  %     $   257.1     $  238.8         8  %       8  %
Service revenue        70.2          72.5        (3 )%       (5 )%         222.9        222.4         -  %       -  %
Support revenue       173.7         162.6         7  %        5  %         510.2        487.5         5  %       5  %
Total revenue         336.6         315.0         7  %        5  %         990.3        948.7         4  %       4  %
Cost of license         7.8           8.4        (7 )%                      23.3         24.7        (6 )%
Cost of service        61.9          62.9        (2 )%                     191.7        196.1        (2 )%
Cost of support        21.3          19.8         8  %                      62.8         60.7         3  %
Total cost of
revenue                91.1          91.2         -  %                     277.8        281.5        (1 )%
Gross margin          245.6         223.8        10  %                     712.4        667.2         7  %
Operating
expenses              191.2         180.6         6  %                     552.0        588.9        (6 )%
Total costs and
expenses (1)          282.3         271.8         4  %        3  %         829.8        870.4        (5 )%      (4 )%
Operating income
(1)               $    54.4     $    43.2        26  %       19  %     $   160.5     $   78.3       105  %     102  %
Non-GAAP
operating income
(1)               $    81.4     $    70.1        16  %       11  %     $   243.8     $  191.6        27  %      26  %
Operating margin
(1)                    16.2 %        13.7 %                                 16.2 %        8.3 %
Non-GAAP
operating margin
(1)                    24.2 %        22.2 %                                 24.6 %       20.1 %
Diluted earnings
per share (2)     $    0.32     $    0.29                              $    1.01     $   0.72
Non-GAAP diluted
earnings per
share (2)         $    0.53     $    0.45                              $    1.51     $   1.22
Cash flow from
operations        $   106.4     $    84.6                              $   253.4     $  181.0

(1) Costs and expenses in the third quarter and first nine months of 2014 included restructuring charges of $0.5 million and $1.6 million, respectively, compared to $3.1 million and $34.3 million in the third quarter and first nine months of 2013, respectively. Additionally, the third quarter and first nine months of 2014 included acquisition-related and pension plan termination costs of $1.5 million and $6.8 million, respectively, compared to $0.9 million and $7.6 million in the third quarter and first nine months of 2013, respectively. These restructuring, acquisition-related and pension plan termination costs have been excluded from non-GAAP operating income.
(2) Income taxes for non-GAAP diluted earnings per share reflect the tax effects of non-GAAP adjustments for the third quarters and first nine months of 2014 and 2013, which are calculated by applying the applicable tax rate by jurisdiction to the non-GAAP adjustments described in Non-GAAP Measures, and also include the following tax items. In the fourth quarter of 2012, a valuation allowance was established against our U.S. net deferred tax assets. The non-GAAP tax provision for the first nine months of 2014 and 2013 has been calculated assuming there is no U.S. valuation allowance. The second quarter of 2014 includes a non-cash tax benefit of $8.9 million related to the release of a portion of the valuation allowance as a result of deferred tax liabilities established for the acquisition of ThingWorx. The first nine months of 2013 includes a non-cash tax benefit of $32.6 million related to the release of a portion of the valuation allowance as a result of deferred tax liabilities established in accounting for the acquisition of Servigistics, and a tax benefit totaling $3.2 million related to final resolution of a long standing tax litigation and completion of an international jurisdiction tax audit. These tax benefits have been excluded from non-GAAP diluted earnings per share.

Results of Operations 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. Changes in foreign currency rates did not have a material impact on operating income in the first nine months of 2014. If actual results for the third quarter and first nine months of 2014 had been


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converted into U.S. Dollars based on the foreign currency exchange rates in effect for the third quarter and first nine months of 2013, revenue would have been lower by $4.8 million and $0.4 million, respectively, and costs and expenses would have been lower by $1.7 million in the third quarter and higher by $2.1 million in the first nine months of 2014, and operating income would have been lower by $3.1 million and $2.5 million in the third quarter and first nine months of 2014, respectively. Our constant currency disclosures are calculated by multiplying the actual results for the first nine months of 2014 by the exchange rates in effect for the first nine months of 2013. Revenue from Acquired Businesses
Total revenue from the ThingWorx (acquired in the second quarter of 2014), Enigma and NetIDEAS (both acquired in the fourth quarter of 2013) businesses was $2.8 million and $8.8 million in the third quarter and first nine months of 2014, respectively.
Revenue
We report our revenue by line of business (license, service and support), by solution area (CAD, Extended PLM and SLM) and by geographic region (Americas, Europe, Pacific Rim and Japan). Results include combined revenue from direct sales and our channel. The amounts presented below reflect reclassifications of services revenue between solution areas for historical periods to conform to the current classification. Such reclassifications were less than 2% of each solution area's total revenue for each period. CAD revenue includes PTC Creo® and PTC Mathcad®.
Extended PLM revenue includes our PLM solutions (primarily PTC Windchill®), our ALM solutions (primarily PTC Integrity™) and our SCM Solutions (primarily PTC Windchill FlexPLM®).
SLM revenue includes PTC Arbortext®, PTC Servigistics® and ThingWorx® products.
Revenue by Line of Business

% of Total Revenue                            Three months ended                     Nine months ended
                                      June 28, 2014       June 29, 2013      June 28, 2014       June 29, 2013
License                                     28 %                   25 %            26 %                  25 %
Service                                     21 %                   23 %            23 %                  23 %
Support                                     52 %                   52 %            52 %                  52 %

License Revenue
In the third quarter and first nine months of 2014, compared to the year-ago periods, license revenue was up 16% and 8%, respectively, and organic license revenue (excluding revenue from ThingWorx, Enigma and NetIDEAS) grew 15% and 7%, respectively. The amount of license revenue attributable to large transactions, and the number of such transactions, may vary significantly from period to period and by geographic region. We had one transaction with license revenue in excess of $5 million in both the third quarter of 2014 (in the Americas) and the third quarter of 2013 (in Japan) and four in the first nine months of 2014 (three in the Americas and one in Europe) and three in the first nine months of 2013 (two in Japan and one in the Americas). Service Revenue
Consulting and training services engagements typically result from sales of new licenses, particularly of our Extended PLM 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 fundamentally require less services. As a result, we do not expect that the amount of services we deliver will increase proportionately with license revenue increases. Consulting revenue typically represents approximately 85% of total service revenue and training revenue represents approximately15% of total services revenue. Year over year, service revenue in the third quarter and first nine months of 2014 was down 3% and flat, respectively (down 5% and 2% on an organic basis, respectively). Our consulting service revenue in the third quarter and first nine months of 2014 was down 3% and flat year over year, respectively, (down 4% and 2% on an organic basis, respectively). Year over year, training revenue was down 8% and 1% in the third quarter and first nine months of 2014, respectively.
Support Revenue
Support revenue is comprised of contracts to maintain new and/or previously purchased software. We have seen steady growth in support revenue in 2012 and in 2013, continuing in 2014. CAD support seats were flat as of the end of the third


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quarter of 2014 compared to the end of the third quarter of 2013 and Extended PLM support seats increased 5% over the same period.
Foreign currency exchange rate movements impacted support revenue favorably by $2.8 million in the third quarter of 2014 and unfavorably by $0.6 million in the first nine months of 2014, compared to the third quarter and first nine months of 2013.

Revenue by Solution                       Three months ended                                                Nine months ended
                                                                Percent Change                                                   Percent Change
                                                                         Constant                                                          Constant
                      June 28, 2014       June 29, 2013      Actual      Currency      June 28, 2014       June 29, 2013      Actual       Currency
                                                                      (Dollar amounts in millions)
CAD
License             $          45.4     $          35.7        27  %         26  %   $         117.5     $         102.7        14  %        15  %
Service                         6.0                 6.4        (8 )%        (10 )%              18.3                18.2         1  %         1  %
Support                        97.7                93.1         5  %          3  %             287.5               282.6         2  %         2  %
Total revenue       $         149.0     $         135.2        10  %          9  %   $         423.4     $         403.5         5  %         5  %

Extended PLM
License             $          39.5     $          36.3         9  %          7  %   $         112.8     $         105.5         7  %         7  %
Service                        47.9                49.5        (3 )%         (5 )%             152.3               155.5        (2 )%        (3 )%
Support                        58.5                54.0         8  %          7  %             170.6               161.1         6  %         6  %
Total revenue       $         145.9     $         139.8         4  %          3  %   $         435.7     $         422.1         3  %         3  %

SLM
License             $           7.8     $           7.9        (1 )%          -  %   $          26.8     $          30.6       (12 )%       (13 )%
Service                        16.4                16.6        (1 )%         (2 )%              52.3                48.7         7  %         7  %
Support                        17.6                15.5        13  %         12  %              52.1                43.8        19  %        19  %
Total revenue       $          41.8     $          39.9         5  %          4  %   $         131.2     $         123.1         7  %         7  %

CAD Revenue
The increase in CAD license revenue in the third quarter and first nine months of 2014 compared with the year-ago periods included double digit percentage license revenue growth in Europe, the Americas and Japan. This growth was driven by large deals, new seats, and sales of modules and upgrades associated with our Creo platform. For the first nine months of 2014 our total CAD revenue has increased 5% year over year. This overall CAD market is expected to grow in the mid-single digits.
In the third quarter of 2014, compared with the year-ago period, license revenue in Europe grew 32% ($3.5 million), up 26% on a constant currency basis, the Americas grew 11% ($1.0 million), and Japan grew 89% ($5.1 million), up 94% on a constant currency basis. In the first nine months of 2014, license revenue grew 38% ($12.9 million) in Europe (up 35% on a constant currency basis), 13% ($3.2 million) in the Americas, and 11% ($1.6 million) in Japan (up 19% on a constant currency basis), partially offset by a decline in license revenue in the Pacific Rim of 9% ($2.8 million). CAD channel revenue which represents approximately 40% of total CAD revenue, was up 8% in the third quarter of 2014 compared to the year-ago period (up 6% on a constant currency basis) with license revenue up 16% year over year. CAD channel revenue for the first nine months of 2014 was up 1% year-over-year with license revenue up 3% year over year. Extended PLM Revenue
Extended PLM revenue in the third quarter of 2014, compared to the prior year period, reflects double digit percentage license revenue growth in Europe, partially offset by a double digit percentage decline in license revenue in the Americas and the Pacific Rim. Support revenue grew in all regions, with double digit percentage growth in Europe, Japan and the Pacific Rim and mid-single . . .

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